China Daily

China’s chance to cash out USD-denominated assets

please download here: ChinaDaily_2010.5.27.pdf


In books related to modern finance, US Treasuries (UST) have been considered as the safest investment and T-bill rates have been widely accepted as a benchmark for risk-free rates by the market. However, their risk-free status is being questioned because of the falling greenback, an increasing trade deficit and also because of the mounting Federal budget deficit after 2000. During the aftermath of the financial tsunami, China continued to purchase UST securities to help stabilize the global financial system. Starting last October, China began to moderately decrease her UST holdings from $938 billion to $877 billion in February. However, a very recent report indicates that in March, for the first time in six months, China resumed accumulation of sizable holdings – an additional $17.7 billion worth of UST.

The UST holdings scale-back that started in October was probably due to the low yield of the UST and the risk of greenback devaluation. The Obama visit in November has improved the Sino-American relationship but not the US financial and economical structure. The United States has been disturbed by the financial crises and the Federal government has to sell more UST to finance its $1.6 trillion 2010 budget deficit. As the Federal Government fiscal year ended in September, the UST auctions in the autumn are essential and an attractive greenback is the key.

Interestingly, the US dollar began to strengthen after November. The US Dollar Index, which measures the dollar against a basket of currencies with the euro weighted around 56-57 on November 25 to rocket to 87.068 on May 18. As the Greece sovereign debt crises worsened, the second most widely-used currency lost 18 percent of its value against the USD. As a result, the crises have successfully drawn liquidity assets to the safe haven of the dollar. The total amount of UST held by foreign countries increased from $3.67 trillion in November to $3.88 trillion in March. The pain and suffering of the Eurozone turned out to be to the gain of the Americans.

If one carefully dissects the constituents of the US GDP, it is clear that none of the components has the capability to generate steady and sustainable growth. The 9.9 percent unemployment rate in April is considered structural, strongly suggesting that it will take time for a booming economy to absorb the existing labor force. Alongside the choppy housing sector, US consumer spending will not be sufficient to drive GDP strongly enough to replicate the pre-2008 era.

According to Obama’s fiscal 2011 budget, the US government will be running a deficit of around 10.3 percent of its GDP in 2010. More importantly, the 10 year plan proposed by the Obama government will generate cumulative deficits of $10 trillion by 2020. At the projected rates of increase, the size of the debts will equal 90 percent of the projected GDP of 2020. The federal government is doing its utmost in hopes of confirming and applying the theory of John Maynard Keynes on government spending. Although a lot of corporations have improved their balance sheets, small and medium companies are still struggling to get affordable financing, while domestic private investment is not robust enough to enhance the GDP.

The White House will need stronger net export figures in the next 12 months to improve employment and boost the economy in order to deliver Americans the “change” promised. Currently, the US heavily relies on export commodities and technology related products. A weak dollar would help to boost export of traditional goods and save jobs in manufacturing sectors such as steel and the automobile industry. Therefore, the dollar is likely to remain stable or even depreciate or be devalued when the panic selling related to the recent financial turmoil subsides.

For years, there have been questions about China’s approach of accumulating depreciating USD denominated assets to finance the squandering US consumers. When the rest of the world is jostling for greenbacks, it may be the right time to cash out and decrease our Treasury holdings and to diversify the existing foreign reserve portfolio.


Credit rating agencies: crises catalysts?

please download here: ChinaDaily_2010.5.14.pdf


Amid the lack of fiscal discipline among the PIIGS countries, few recognized the strong influence on the role of the credit rating agencies (CRAs) behind the miserable Greece debt turbulence that possibly induced the massive global equity sell-off last week.

Standard & Poor downgraded Portugal and Greece’s bonds in the middle of the ongoing Greece rescue plan talks. Greek bonds were trashed below investment grade to BBB–, the highest junk bond rating by S&P, while Moody’s and Fitch maintained their AAAs rating. Standard & Poor dropped the last straw onto the back of the groaning camel by downgrading the bonds of Spain from AA– to AA the following day. The action came with impeccable timing that not only complicated the exploration of the Greece restructuring plan by the ECB and the IMF, but also heightened negative emotions permeating the already fearful market.

S&P claimed the downgrades were incidental and by credit committee collective decision. As per S&P, the decisions had to be released immediately to prevent leakage. However, the timing of such moves remains controversial. To a certain extent, the downgrades were reactions to the previous selloff of the troubled European sovereign debts and came at a time when there were chances of stabilization. S&P’s action catalyzed the panic-selling, but, because of the time lag, in fact the downgrades demonstrate very little indication of the credit worthiness.

The creditability and the effectiveness of credit agencies have been questioned since the Enron scandal, in which the problem company failed to preserve its investment grade rating only four days before its bankruptcy filing. In the midst of the financial crises in 2007-2008, both AIG and Lehman Brothers kept their investment grade rating until the very last moment before these gigantic financial conglomerates collapsed. In most of those incidents, although pre-crises alerts were not considered to be the CRAs’ intent or preference, they did in fact trigger a death spiral of the underlying asset prices. This happened because their continuous downgrade actions directly added fuel to the fi re-sale conflagration that reduced the troubled financial institutes to virtual financial ash.

In the aftermath of the 2008 financial tsunami, the CRAs were blamed for their role in rating the complicated residential mortgage-backed security (RMBS) and commercial mortgage-backed securities (CMBS) collateral debt obligations (CDO) and thus further pumped up the dangerously inflated US housing bubble.

Without the support of the CRAs, none of the investment banks in Wall Street could have packaged these complex structured products and attracted billions of dollars to fund the US housing bubble. The fact that CRAs were paid to rate these complicated investment products also raises questions about their independence and objectivity, especially when the quality of risk assessment for these complicated products was considered questionable. A good example is the Abacus ABS CDO, which was structured by Goldman Sachs for John Paulson, a hedge fund manager, to short the mortgage markets.

The collateral of Abacus was rated AAA by both S&P and Moody’s, but these were downgraded to junk status within a year. Nevertheless, while the investment bankers took their lumps, CRAs were questioned but never punished.

The rating agency system has evolved since the 1930s. when regulators encouraged banks and institutions to rely on CRA independent ratings in assessing credit worthiness of different debts. Among the 10 Nationally Recognized Statistical Rating Organizations (NRSRO) recognized by SEC, the big three, namely Standard & Poor, Moody’s and Fitch, according to a congressional report, dominated 98 percent of all the rating services and collected 90 percent of total rating revenue, by some accounts.

Traditionally, institutions such as insurance companies have relied extensively on the CRAs’ services, as there are investment restrictions on the percentage of their investments to be maintained within investment grade and on disposal of junk-graded assets in their books. Under the framework of Basel II, there are requirements on the components of assets within their balance sheet and these requirements are heavily reliant on the CRAs gradings.

The CRAs also have significant influence over many indexes components; in many cases the constituent companies or issuers may have to be removed as a direct result of downgrading. Therefore, the gold label of triple AAA or investment grades from the big three have not only affected a country or a corporation’s ability to raise capital, but have also impacted the demand curve of the assets being rated.More oft en than not, the effects of these ratings have also rippled through other sectors or, as in the recent case, the market as a whole, because of the whole financial systems’ tight bonds with the rating mechanism.

The recent development has once again triggered scrutiny of the CRAs. Bill Gross of PIMCO, the firm managing the largest fixed income portfolio in the  world, challenged markets to disregard the rating agencies, because of their “timidity and lack of common sense”. He argued that the rating mechanism adopted by SEC starting back in 1975, in recognizing these CRAs, was the direct cause of the big three’s current debt-rating dominance.

More importantly, the National Association of Insurance Commissioners is moving ahead on a proposal to have PIMCO rate CMBS assets, rather than rely on the big three.

In Europe, in light of the developments in Greece, Austria’s central bank governor has also promoted the idea of establishing a separate rating mechanism of European bonds, which would be serviced and rated by the ECB itself.

For China, this ongoing debate over rating agencies is substantial.

The central government has been working years to prepare its financial system to be mature enough before finally opening it up to volving both learning from the Anglo-American market forces as well as developing an independent, domestic rating system, which would allow participation from different domestic and foreign foreign financial and capital markets. Beijing has allowed the establishment of independent rating organizations such as China Cheng Xin International Credit Rating Co, Ltd, which is 49 percent owned by Moody’s.

The strategic JV structure helps domestic talents accumulate overseas experience and knowledge. However, in light of the recent developments in continental Europe and the demonstration of the destructive power of rating agencies, the central government should consider a parallel development inrating agencies.




China's challenge: to contain inflation, boost the yuan

Please download here: chinadaily_2010.3.12.jpg


When Premier Wen Jiabao presented his annual work report at the National People's Congress on March 5, he not only provided a comprehensive yearly update on the current situation of the country, but also its outlook. In maintaining the target growth rate of 8 percent, preserving its proactive fiscal policy and continuing its moderately easy monetary policy, it is clear that the pace of sustainable and stable growth in the past 12 months is still within the safety zone of the central government's gauge.

Managing an economy that consists of 1.3 billion people is no easy task, not to mention enduring the aftermath of the global financial tsunami and orchestrating it while leading the pace among the major global economies.  Behind Premier Wen's commitment to building a harmonious society, there are underlying uncertainties and risks in maintaining the target growth rate.

The problem lying ahead is clearly in the wake and potential consequences of the counter-cyclical stimulus. Take a glance at the recent Consumer Price Index (CPI) figures from November to January, running at a resilient pace of 0.6 percent respectively.  There are signs suggesting accelerating inflationary pressure.

The overheating property market also poses another strong sign that inflationary pressures exist, at least in certain segments within the economy.  In January, housing prices in the 70 major cities within China rose an average of 9.5 percent a significant increment compared with the 12 months' growth ending July 2009, which was only 1 percent Residential sales climbed a staggering 80 percent increase in 2009. Containing the heat without cooling of the sector will be the biggest challenges for the government. After all, the sector accounted for 8-10 percent of the nation's GDP.

Meanwhile, the manufacturing sector is ratcheting up into a higher gear. In certain cities in Guangdong, wages have risen as much as 20 percent in recent months.  These supply/demand imbalances and tide of rising wages certainly will inject further inflationary pressure into the system.

The "undervalued" renminbi is potentially another source of inflation.  The renminbi was pegged to the US dollar at 6.83 for the whole of 2009.  According to the People's Bank of China, it was a "special policy to weather the financial crises".  This special policy has been working well and sheltered exporters from the plunge of overseas demand on goods. However, the cost is the increasing supply of renminbi.  As there is no clear indication of a timetable for the renminbi to detach, and with the interest rate spread against the dollar increasing, renminibi assets will continue to attract investors and capital, and potentially create asset bubbles.

While inflation is an imminent threat, it is the systematic and structural risk that may impact the economy on a greater scale. After joining the WTO, the country has had as its objective the gradual opening of its markets, sector by sector and eventually the capital market as well. However, the momentum has been cautiously slowed down, as China has already developed into the world's second largest economy, while the renminibi has not yet become an international currency.  The longer the renminbi remains inconvertible, the imbalances and the disparities between China and the developed economies will accumulate, squandering the micro-management and adjustment efforts of the government, posting a potential threat by the time the government is willing to let the yuan become freely tradeable.

Even though the nation is now gearing up with more fortunes and widespread wealth than anyone could imagine 20 years ago, the road to opening up the markets has been paved with obstacles. The key is whether the government can contain inflation pressures for the lower- and middle-class population, and at the same time maintain order while establishing the renminbi as an international currency and further develop the structure of the existing fiscal and financial systems.

Professor Wang Guan Yi is a Visiting Professor at Asian International Open University, and a Commentator an international finance at NOW Business News Channel.  The views expressed are entirely his own.


HK's 'deep-rooted' economic challenges

Please download here: ChinaDaily_2010.3.31.pdf


Concluding the Third Session of the 11th National Congress, Premier Wen Jiabao mentioned problems and challenges he described as "deep-rooted" in Hong Kong. He amplified his thoughts and advised Hong Kong in a five point strategic overview that comprised 1) further development to preserve Hong Kong's status as international financial center, shipping and trade hub of the region, 2) boosting the service sector, 3) co-operation with the Pearl River Delta region, 4) improvement of people’s livelihoods while enhancing the education system and 5) maintaining the unity, prosperity, and stability of Hong Kong.

Premier Wen also urged Hong Kong people to "accommodate and collaborate". The phase echoes the harmonious society that the premier has vowed to establish in China. When he uttered his concerns on Hong Kong’s “deep-rooted” issues, he emphasized that it is the livelihood and well-being of the mainstream Hong Kong people, ranging from white-collar professionals in Central, to street hawkers in Mongkok, that he is concerned about.

For the past 13 years, the central government has granted continuous support via favorable policies and measures to aid Hong Kong after the city suffered a series of macro-disasters the 1997 financial crisis, IT bubbles, SARS and the 2008 financial tsunami. But the "privilege" of such support was deemed by the majority to be inaccessible to them. In at least one survey, Hong Kong scored the Highest on income inequality (Gini Coefficient) in 2007, among the world's most advanced economies.

According to a report by the Hong Kong Council of Social Service, the inequality of wealth distribution has worsened in the past decade.  If all households are being classified into rich and poor groups, and their median incomes are compared for the past two decade, you will find the differences widening.

The median family incomes for the poor and rich group in 1989 were HK$5,000 and HK$13,000. The differences then enlarged to HK$10,000 versus HK$30,000 in 1999 and widened even further in 2009 to the gap between HK$9,000 versus HK$32,600, respectively.

The shocking result demonstrated a deteriorating environment for low-income families as they suffer declining household incomes while the high income groups are benefiting from even higher incomes.

Hong Kong is undergoing an economic transformation, which is one of the leading causes behind the income inequality. Our economy has gradually shifted towards service-oriented industries, which contributed 92 percent of the total GDP in 2008 to the economy. The finance and insurance sector alone grew from 12 percent to 16 percent 2004 to 2008 (33 percent growth).  Jobs with low levels of educational attainment have diminishing GDP contributions; for example, manufacturing dropped from 3.6 percent to 2.5 percent (a 30 percent decline).

Premier Wen urged Hong Kong to further develop the trading, finance and transportation sector, but it is where victims suffered massive monetary losses from complex financial structured products, i.e., minibonds and other structured products. The series of resulting protests not only dampened the confidence of investors, but also has damaged the reputation of Hong Kong as an international financial center.

Moreover, not only is the financial sector troubled, but also we are seeing setbacks in other sectors as well.

Hong Kong once handle the largest number of containers in the world, but Singapore and Shanghai have already bypassed Hong Kong as the top and second biggest container transporting ports, while Shenzhen, operating at a much lower cost, has quickly caught up at fourth.  The number 10 container pier has been planned for years, but the government will be able to commence construction only in 2012 and ready to operate in 2015, while our neighbors in the Pearl River Delta are building up multiple container ports to share the increasing demand.

Another source of challenges lies in escalating property prices. Rising property prices are as destructive as double taxation, suppressing business ideas and choking off social mobility. In the last two decades, Tokyo has demonstrated the massive damage caused by a ballooning housing bubble and its impact on a developed metropolis that led to suffering of its citizens.

As a free economy, the HKSAR government should not interfere with the property market. However, upholding a stabilized and fair environment for its citizens and maintaining a fair and open market-oriented economy is the duty of modern governments.

It is not uncommon in the late phase of capitalist development that major industries are dominated by a small number of large players inadvertently hamper the minority market participants, especially when the bigger players dominate so many aspects of the market and marketing.

A law has recently been passed to aid developers in seeking compulsory sale for redevelopment, at a time when a record sale of HK$88,000 per square feet was proudly announced, in a series of what turned out to be questionable deals.

We have floor numberings as the 68th and 88th Floors, but for suites actually located less than 50 floors from the ground. All of these maneuverings are happening at a time when government officials continue to claim they are constantly monitoring the housing market and the livelihood of the majority is being safeguarded.

However, poverty is a disease that reallocation of social resources alone cannot cure.  The poverty rate of teenagers aged between 15 to 24 years old grew from 15.4 percent in 1999 to 20 percent in the first half of 2009.  While the cause may relate to factors such as globalization and economic transformation, the government cannot simply reapply the social welfare formula. Neither should it allow the problems to grow.  If the government does not deal with these issues property, the competitiveness and the cohesiveness of the community will wear out, further eroding the reputation of the city.

Hong Kong is at a crucial stage of economic transformation.  The government needs to listen and accommodate the need and requirements at different levels to establish a harmonious society, for the community to be able to collaborate for the city to prosper and succeed – "accommodate and collaborate", as suggested by the Permier Wen.

Professor Wang Guanyi is a Visiting Professor at Asian International Financial Commentator at NOW Business Nesw.


Behind the call for the appreciation of the renminbi

Please download here: ChinaDaily_2010.4.16.pdf


The White House has finally recognized openness to compromise would be better than coercive persuasion, amid implicit pressure from Capitol Hill.  The surprise visit by US Treasury Secretary Timothy Geithner to meet with Vice Premier Wang Qishan cleared the sky over the Sino-US dispute overnight.  The White House has waved an olive branch and postponed the currency report in which China might be accused of being a currency manipulator.  With President Hu Jintao attending the Nuclear Security Summit in Washington, market participants see it as a sign that China will soon free up the renminbi pegging against the dollar.

Hampered by over-leveraged consumers, the road of recovery in the US will be long and arduous.  Although the combined efforts of the Federal Reserve and Department of Treasury have together reinflated the once deflated asset bubble and contracted credit expansion, and may have inadvertently saved asset values for the wealthy, retained jobs for the Wall Street elites, the majority of Americans still suffer from the aftermath of the 2008 crises.  The latest US unemployment rate stood at a staggering 9.7 percent. Consumer spending is sluggish and housing markets remain choppy. Deficits on both state and federal governments’ ledgers continue to climb in tandem with the burden on social security.

The United States is running multilateral trade deficits with more than 90 countries and the effect of narrowing its overall trade deficit by relying on revaluing a single currency is questionable.  The nature of the Sino-US trade imbalance is largely structural.  Between 2005 to June 2008, the renminbi has appreciated approximately 21 percent against the US dollar.  Yet the US trade deficit with China has grown $104 billion from 2004 to 2008.  Although political propaganda has been telling US voters that renminbi revaluation is essential for job creation, the truth is that the flow of cheap imported goods is being driven by US consumers' demand regardless on the place of origin. A strong Yuan will only divert demand to Mexico, India, Vietnamor whichever can produce cheaper goods, but not to dearer substitutes produced in Michigan or Texas.

The latest $7.2 billion deficit in March shows clearly that the Chinese economy is not purely export driven. The Sino-US trade imbalance was worsened by the US government's reluctance to allow high technology exports to China.  For years, different levels of limitations and barriers were posted by the Congress, limiting China to shop with a restricted list.  The United States has successfully boosted its economy through high tech industries during the past decades, yet has been unwilling to capitalize on one of its largest trading partners.

China has its own renminbi agenda, which is largely economic stability.  As President Hu pointed out in the first day of the Summit, any action must take into account its own imprint on economic and social development.  The peg against the US dollar at 6.83 renminbi was just one of the numerous policies launched to cope with the 2008 crises.  The primary goal of China was to boost both the public and private sectors and not to “manipulate” a currency or export the problem to her trading partners.  Nevertheless, given its significant size, export remained crucial to the Chinese economy.  Any significant appreciation of the renminbi will erode the export competitiveness overnight and impact the livelihood of tens of millions workers employed.

Any change of Chinese currency policy have to be limited within the scope that it will help meet the government s target GDP growth at a pace of 8 percent per annum and its determination to contain the CPI.  The stimulus package has successfully boosted the Chinese economy.  However, with the global economy still riddled with uncertainties, the Chinese government can neither decelerate the economic engine, nor let the inflationary heat threaten the livelihood of its population. Demand for raw materials, accompanied by the credit expansion, has already fueled the CPI. The central government has to maneuver its monetary policy delicately to cope with the liquidity issue.  While gradually lifting interest rates and bank reserve requirements helps to cool off the economy moderately, a sizable liquidity is still spilling over into the equity and property markets.

Consumer prices rose 2.7 percent year-on-year in February, a significant climb from 1.5 percent in January.  A slightly stronger renminbi might ease part of the inflationary pressure and be beneficial to the overall economy, given that the government certainly has studied plans to lift the currency. However, that would largely depend on weighting the cost/benefit ratio of loss of manufacturers' exports against boosting domestic consumer spending and in hope of minimizing the impact on society.  Throughout this process, China is aiming to avoid the painful lesson of the yen's appreciation during the 80's.

In my assessment, if the central government resolves to change the currency policy, it will likely either expand the bandwidth by allowing a limited floatation of renminbi against dollars, or revalue the currency at a reasonable pace, not exceeding 5 percent against the dollar within the next 12 months, and of course, based on China's own estimation of the speed of absorbing the loss in exports through growing domestic consumption.