2012-04-30

As France and Germany threaten to bail on Schengen, Greece builds detention centers

France and Germany have called on the periphery states to buff up their border defenses and Greece is answering the call—albeit for domestic political reasons.

Greece opens detention camp for immigrants as election looms
About 130,000 immigrants cross the country's porous sea and land borders every year, the vast majority via Turkey, and the authorities are forced to release those who are arrested because of a lack of permanent housing.

With Greece in its fifth year of recession and worries over rising crime levels, illegal immigration has become a major issue in the run up of the May 6 election.

The once-obscure far-right Golden Dawn, which wants to deport all immigrants, is among the parties that has benefitted most from the mood among voters, and is expected to win its first seats in parliament.
This is just the beginning for Europe. Deportations are next, and then minorities will come under scrutiny, specifically Muslims. Unassimilated citizens may eventually be deported back to the lands of their ancestors, just as Jews were previously expelled at various times from various European nations.

Hugh Hendry's latest letter for Eclectica

April 2012 TEF Commentary

2012-04-29

Swiss politician says country has too many Germans

The immigration debate rhetoric is heating up in Europe. I don't place too much stock in this one comment (today), but it does show where the social mood is at since these types of comments are aimed at shoring up a politicians base.

Politician Sparks Uproar with Call to Limit German Workers
A Swiss politician has prompted a heated debate after suggesting that there are too many German immigrants in her country. "We really have too many Germans in the country," Natalie Rickli, a member of Switzerland's parliament with the right-wing populist Swiss People's Party (SVP), said during a television talk show on Sunday.

The actual topic of discussion on the talk show, broadcast on Zürich local television station TeleZüri, was supposed to be Switzerland's decision last week to curb immigration from eight central and eastern European countries. Last Wednesday, the Swiss cabinet, the Federal Council, announced it had decided to invoke the so-called "safeguard clause" in its agreement with the European Union on the free movement of persons. The move will significantly reduce the number of jobseekers from these countries allowed to enter Switzerland for a one-year period.
But that initiative apparently does not go far enough for Rickli. On the talk show, she argued that the safeguard clause should also apply to Germans. Many people shared her view that there were "too many Germans" in Switzerland, she said.

The other guests on the show reacted with shock, but Rickli kept going. "The parliament should have already activated the safeguard clause in 2009, when it would have also affected the Germans," she said, adding that Switzerland had a problem with the sheer scale of immigration. She said that she had already received a lot of mail from Swiss people saying that they had lost their jobs because cheaper Germans had been hired instead.

Rickli's comments reflect her SVP party's anti-EU and anti-immigration policies. Although it suffered a slight drop in support in the most recent election, the SVP has risen to become the strongest party in Switzerland since the 1990s. On the day after her talk show appearance, Rickli said that she had gotten many positive reactions to her proposal.
Many politicians and pundits incorrectly ascribe racial or ethnic motivations for anti-immigration sentiment, but since Switzerland is a nation of mixed ethnicity including Germans, it is another sign, along with the case in Hong Kong versus Mainland Chinese, that there's a much deeper sentiment of us versus them at play, one that even crosses all racial and ethnic lines. It doesn't matter what culture, race, ethnicity, language, whatever an outsider brings, it is the fact that they are viewed as an outsider.

Greece is "a nation in shock"

Here's a headline that gets the cause and effect backwards: Suicides have Greeks on edge before election. An accurate headline would be: Greeks on edge, leading to rise in suicides
On Monday, a 38-year-old geology lecturer hanged himself from a lamp post in Athens and on the same day a 35-year-old priest jumped to his death off his balcony in northern Greece. On Wednesday, a 23-year-old student shot himself in the head.

In a country that has had one of the lowest suicide rates in the world, a surge in the number of suicides in the wake of an economic crisis has shocked and gripped the Mediterranean nation - and its media - before a May 6 election.
There's a dual effect here: both a rise in suicides and the attention to them due to social mood. However, there's a major increase taking place, this isn't simply social mood expressed through media and public reactions to the story.
Before the financial crisis began wreaking havoc in 2009, Greece had one of the lowest suicide rates in the world - 2.8 per 100,000 inhabitants. There was a 40 percent rise in suicides in the first half of 2010, according to the Health Ministry.

There are no reliable statistics on 2011 but experts say Greece's suicide rate has probably doubled to about 5 per 100,000. That is still far below levels of 34 per 100,000 seen in Finland or 9 per 100,000 in Germany. Attempted suicides and demand for psychiatric help has risen as Greece struggles to cope with the worst economic crisis since World War Two.

..."We're a nation in shock," he said, even though he suspected that it was the media coverage of suicides that had increased dramatically rather than the actual numbers of suicides. He nevertheless says the crisis is behind a notable rise in mental health problems in Greece.

"I had one patient who came in with a severe depression - he owns a furniture making company that got into financial trouble and he had to lay off 20 of his 100 workers," he said. "He couldn't sleep and couldn't eat because of that. He said his good business was being ruined and he couldn't cope anymore."
Here's the chart of Greece's stock market represented by the Athens Index Composite.

2012-04-27

Bo supporter Zhou Yongkang fades from power

The fallout from the Bo Xilai story is that his supporter on the Politburo, Zhou Yongkang, is losing influence. Some speculated he might fall as well, but with a leadership transition on the way, he is simply fading away. The latest hot topic is the front page of the People's Daily from Thursday. Below is a picture of the People's Daily for April 26, 2012: there are stories on all of the Standing Committee members save one. I have highlighted 9 names and there are 9 members of the Standing Committee (pictured at wikipedia), but Wen Jiabao's appears twice. The missing member is Zhou Yongkang.

国家主席、中共中央总书记、军委主席:胡锦涛、
全国人大委员长:吴邦国、
国务院总理:温家宝、
全国政协主席:贾庆林、
国家副主席、军委副主席:习近平、
第一副总理:李克强、
中纪委书记:贺国强、
中央政法委书记:周永康
中央精神文明建设委员会主任:李长春

State President and General Secretary of the CPC Central Committee, Chairman of the Central Military Commission: Hu Jintao
NPC Chairman: Wu Bangguo
Premier: Wen Jiabao
CPPCC Chairman: Jia Qinglin
Vice President, CMC Vice Chairman: Xi Jinping
First Deputy Prime Minister: Li Keqiang
Secretary of the CPC Central Commission for Discipline Inspection: He Guoqiang
Secretary of the Central Political and Law Commission: Zhou Yongkang
Director of the Central Spiritual Civilization Construction Committee: Li Changchun

Here's an English article from The Australian: Bo Xilai's last backer loses influence
When Mr Zhou spoke up for Mr Bo, the son of one of the most senior leaders of China's communist revolution, he was confronted by the Chinese Premier, Wen Jiabao, who only that morning had used the final press conference of his ten-year term to hint at the anger he felt towards Mr Bo. One source said: "Wen Jiabao waved a sheaf of evidence at Zhou and told him that Bo was going to lose his position."

...Mr Zhou is extremely unlikely to lose his job until his scheduled retirement at a once-in-a-decade leadership transition in October because the unscheduled departure of a committee member would cause a political earthquake in China.

People's Daily editorial: rescue rumors are bunk

The People's Daily uses an idiom meaning unrequited love: the industry desperately wants a bailout, but they won't receive it. This is why I have often referenced the general tenor of the articles and debate over real estate in China: there is still a lot of optimism, expectations that prices will bottom out or the government will step in. The major papers have talked up reform lately and there are those who believe this means there's some agreement among party leaders over the next stage of reform. However, this editorial slams the door on bailouts and shows that there's nothing in the works. Here's one choice sub-heading in the article: Do not underestimate the government's determination. The editorial notes that the government doesn't want to the real estate slowdown to be a drag on the economy, but clearly any type of stimulus or rescue efforts will be directed at the broader economy, not the real estate sector.

人民日报:救市传言只是房企“单相思”

Social mood affects everyone, even the leadership

Bo 'had President wiretapped'
The hidden wiretapping, previously alluded to only in internal Communist Party accounts of the scandal, appears to have provided another compelling reason for party leaders to turn against Bo.

The story of how the president was monitored also shows the level of mistrust among them. Roderick MacFarquhar, a historian of China's elite-level machinations over the past half century, said: "This society has bred mistrust and violence.

"Leaders know you have to watch your back because you never know who will put a knife in it."

Beyond making a routine inspection, it is not clear why the disciplinary official who telephoned Hu - Ma Wen, the minister of supervision - was in Chongqing.

Her high-security land link to Hu from the state guesthouse in Chongqing was monitored on Bo's orders.
Here's a Chinese article based off a NYTimes report: 窃听中共高层电话 导致薄熙来下台
党内人士称,薄熙来窃听行为被视为对中央权力的直接挑战,使得他离攫取更高权力的距离越来越远,也加剧了中央对他的不信任。

  报道称,中共一些资深党员,包括媒体人、学者和与军方有关系的人士透露,薄熙来的窃听行动始于数年之前,表面上是为了打击犯罪和维护当地政局稳定,而该监视系统的“工程师”就是王立军。

  在薄王二人共同推动的“打黑”行动中受迫害的人士称,警方在极大范围内窃听了他们内部的通讯。已逃离中国的重庆富商李俊说:“在电话中,我们不敢谈薄熙来和王立军”,为了逃避监听,他们用手写交流,卸下手机电池,并囤积大量未经注册的SIM卡;但即使如此,也未能突破警方的窃听网。

  一名政治分析员也透露,薄熙来甚至尝试窃听所有近年来到访过重庆的中央领导,包括高层中的“挺薄派”周永康,因为“他想清楚地知道中央领导对他到底是什么态度”。

  在薄熙来的授意下,中共监察部部长马馼在重庆国宾馆与胡锦涛的通话也被王立军窃听。尽管通话内容可能并不涉及机密,但薄熙来对胡锦涛的窃听却让中央震怒,中纪委也在接下来几个月里收紧对王立军的调查。

  一名中共高官说:“薄熙来希望把责任推给王立军,而王立军不敢说是薄指使他的”

2012-04-25

Coca-Cola splits: what does Coke's chart signal?

One of the most interesting charts to me, in part because I own the stock, is Coca-Cola. Unlike the broader stock market, shares bottomed during the bear market of the early 2000s, and formed a major cup and handle chart since the peak in 1998. The chart is interesting in itself, in what it might mean and also because I'm bearish overall and this chart makes me question my assumptions.

First, the cup-and-handle typically leads to a major rally when the previous peak (the first edge of the cup) is broken. This cup forming phase is a long basing pattern and fits into Elliot Wave theory as a larger order corrective wave 2 or wave 4. Second, the chart shows a different pattern from the broader market.

In trying to think of why Coca-Cola could diverge from the market, or how it could stage a breakout (it must exceed 1998's high of 88.94, a gain of 19% from the current price) when it already has a relatively high P/E of about 20, calls for some explaining. First, I fully accept that KO may not breakout and we could see shares tumble along with the broader market. In the examples below, KO actually lags some strong performance by McDonald's and Nike. Even in this case, however, the fact that these companies did not make new lows in 2008 is interesting and implies strength that is lacking in the broader market.

I have two ideas I'm mulling on Coke and other multinationals: since China's entry into the WTO, emerging markets have made up an increasingly large share of the global economy and U.S. firms that sell globally could decouple from the U.S. market, if the U.S. were to continue its slow growth (taking a long-term view of a decade and more). The performance of some brand name firms suggests this is already happening.

Thinking in negative terms (what would cause KO to breakout when there's no positive reason), another possibility is that we are on the verge of hyperinflation. Gold (precious metals) performs best in hyperinflation, followed by hard assets, real estate and stocks. A company such as Coca-Cola is more than a drink seller, it owns an intangible asset in its brand and if hyperinflation leads to stock buying, the public will probably overload on blue chips.

I believe the economy on the other side of this crisis will increasingly be built upon intangible assets as manufacturing costs decline and software increasingly controls and customizes our experience with products. Imagine a world where the cost of manufacturing drops to zero: what is left is the image, the brand. Apple is perhaps the best example of this today and the performance of major brand names may be evidence that the market recognizes this ongoing shift to an information economy.

Here are some other companies that rely on their global brand name. In comparing them to KO, I'm looking for firms that did not hit a new low in 2008 or 2009; firms making the cut include global brand names such as IBM, McDonald's, Disney, Pepsi and Nike. Two brands that fail to make the cut are Microsoft and General Electric.

Maybe a major deflationary wave will take all of these stocks below their early 2000s lows. One reason many firms may have not hit a new low in 2008 is due to rapid growth during the decade. However, this brings me back to Coca-Cola, which didn't put up massive growth during the 2000s.







I have owned Coca-Cola since 1994 and have no plans to sell.

2012-04-24

Britain's UKIP now the third largest party

The UK Independence Party is now the third largest in Britain, based on the latest poll numbers, displacing the Liberal Democrats. Their top issue is a referendum on British membership in the EU. Thus far, UKIP hasn't won any seats in parliament, but they are said to be responsible for some Tory losses and their rising popularity means they could win or deal a much bigger blow to the Tories in the next election. They seem to be much closer to the Tea Party in the U.S. and Your Party in Japan, than to the National Front in France. That is, they are a fringe movement with many mainstream ideas and the most likely outcome is those ideas are incorporated into one of the existing party's platform or in a more extreme scenario, they eventually take over or replace one of the existing parties.

2012-04-23

Real estate transactions and prices bounce in mid April; analysts turn pessimistic on 2nd half;

Optimists are again taking hold of some short-term positive data in Beijing. New home sales in the week ended April 20 were up 24.9% from corresponding week in March and 51.8% above year ago levels. Average price rose to ¥18794 per square meter from ¥18263 per sqm. Existing home sales fell 4.2% from March, but rose 7.3% from last year.北京郊区降价盘领跑4月楼市 成交量上升51%

A survey of 20 Chinese and foreign real estate analysts reports that they expect home price declines to reach 10% in the third quarter and that declines in the speculative cities will reach 20-30%. 分析机构认为未来三季度房价将下跌逾10%

Pan Shiyi of SOHO China (0410.HK) said that most developers aren't starving to death, but instead have gorged themselves to death. 破产开发商多数是撑死的

Regulations fall with social mood

We see a mix of authoritarianism and regulatory cuts during a fall in social mood as different segments of society have different reactions during negative mood. While NYC mayor Bloomberg wants to put a scarlet letter on the apartment buildings that contain smokers, other states are moving the other way.

Bareheaded Bikers Cheer Rules End as Fireworks Go Legal
Michigan this year replaced a 1931 law that limited retailers such as Captain Boom to selling sparklers and non- exploding fireworks, allowing purchases of all fireworks cleared by the U.S. for public sale. Also, for the first time in more than three decades, state residents 21 or older can legally ride a motorcycle without wearing a helmet.

...As states have run out of money and cut back on taxpayer services and support, citizens have gotten more resentful of regulations, said Nick Gillespie, editor-in-chief of online and video productions at the Reason Foundation, a Los Angeles-based nonprofit organization that promotes free markets.

"What you're seeing is this push back on all these petty and arbitrary restrictions on everyday life," Gillespie said by telephone. "You don't get to run every detail of my life if you can't balance the budget. Suddenly things like regulating the size of barbers' waste baskets in Michigan don't make sense."

Sarkozy loses round one, will lose round two

Hollande wins first round, sets up run-off with Sarkozy
Socialist presidential challenger François Hollande topped the first round of France’s presidential election on Sunday with 28.4 percent of votes, while incumbent Nicolas Sarkozy finished second with 25.5 percent, according to exit polls. Those figures set up a widely expected run-off between Sarkozy and the candidate of France’s main opposition party who led most voter intentions surveys before the first round.
In 2007, Sarkozy won 31% in round one to Royale's 26%. This year, Marine Le Pen performed well, with 18%, while the communist candidate received 11%. Sarkozy is unlikely to pull as much from Le Pen though, while I expect Hollande will receive communist and centrist support.

2012 followed the socionomic pattern compared to 2007, but if you compare this year with 2002, it doesn't look as good. 2002 saw the National Front (Le Pen's party) win second place; not a single candidate won 20% in the first round, and there was an even higher abstention rate. However, if we consider the positions of the candidates, specifically the face that Hollande may well blow-up the eurozone, the mainstream shift towards more radical policies is in keeping with social mood. 2002 was an outlier because at that time, the mainstream parties were running on peak social mood policies and the mood was just beginning its big shift. As social mood continues to decline though, we will see how far mainstream parties can bend before they break and a radical party takes power in Europe.

You can see all the results and compare with previous elections at Présidentielle 2012 : tous les résultats du premier tour, ville par ville.

2012-04-22

Nationalist sentiment takes policy form in Europe

Falling social mood expresses itself as nationalism in Europe and it is taking policy form. For the past two years we've mainly seen increased fighting between the core European states, with countries such as Hungary implementing divergent policies. Now France and Germany are taking concrete steps (they claim temporarily) to rollback the European Union. The battle is over immigration and there's no open borders solution on the table. The two choices facing Europe are: shut the EU border to foreigners, or individual nations will shut their borders. Now we will see how much the left-wing eurocrats love their EU: will they accede to popular will on policy, or sink themselves?

A Vote of No Confidence in Europe
Germany and France are serious this time. During next week's meeting of European Union interior ministers, the two countries plan to start a discussion about reintroducing national border controls within the Schengen zone. According to the German daily Süddeutsche Zeitung, German Interior Minister Hans-Peter Friedrich and his French counterpart, Claude Guéant, have formulated a letter to their colleagues in which they call for governments to once again be allowed to control their borders as "an ultima ratio" -- that is, measure of last resort -- "and for a limited period of time." They reportedly go on to recommend 30-days for the period.

Of course, using catchphrases like "ultima ratio" and "limited period of time" is supposed to make such policies sound reasonable and proportionate. After all, the reasoning goes, it's just a few occasional border controls for up to 30 days. What's the big deal, right?
But the proposal is far from harmless and would throw Europe back decades. Since 1995, the citizens of Schengen-zone countries have gotten used to freely traveling within Continental Europe. Next to the euro common currency, free movement is probably the strongest symbol of European unity. Indeed, for many people, it's what makes this abstract idea tangible in the first place.
This is the intersection between feelings of nationalism and a pan-European identity, as well as domestic versus pan-European politics. From a socionomic perspective, all choices concur with social mood: Europeans are less welcoming of foreigners. Using the falling stock markets in Europe as a proxy for social mood, in addition to EU border states such as Greece, Spain and Italy being in financial distress, odds favor this becoming policy.

Taking it one step further, the border policies become a conduit to express further nationalist sentiment because it becomes a focal point of social mood. This policy sets all against all, and the next set of policies that will come under review? Economic.

In France, Old Protectionist Idea Reawakened
The Socialist Party has embraced a form of European trade protectionism in its manifesto, a shift from its previous endorsement of globalization as a win-win proposition for French workers.

The shift matters both because the Socialists and their Green allies have a good chance of unseating the center-right president, Nicolas Sarkozy, in the election next year, and because France has a way of setting the political agenda in Europe.
Here we have a similar template. The issue isn't whether there is trade protectionism, it is whether France or the EU will implement it.
Free trade has little political constituency in France. While the seafaring British and Dutch have long been free traders, the French have a protectionist tradition reaching back at least to the 17th-century mercantilist Jean-Baptiste Colbert, Louis XIV’s finance minister.

More recently, Maurice Allais, the Nobel economics laureate, published diatribes against free trade with emerging economies until his death last year, warning that it would cause mass unemployment and depression in Europe.

Another contrarian intellectual, the demographer Emmanuel Todd, is campaigning for European protectionism and an exit from the euro, saying the loss of jobs would otherwise tear French society apart.
This isn't a question of if, but when. Social mood favors a rollback of current free trade policies because like many other policies, they reached peak excess during the 1990s run-up to peak social mood.

Dutch prime minister says government austerity talks collapse
The ruling Dutch minority government was on the brink of collapse Saturday after anti-EU lawmaker Geert Wilders torpedoed seven weeks of austerity talks, saying he would not cave in to budget demands from “dictators in Brussels.”

New national elections that will be a referendum on the Netherlands’ relationship with Europe and its ailing single currency are now all-but-certain.

...Once considered one of Europe’s strongest economies, the Netherlands is suffering from high levels of personal debt, mostly mortgage related.
Netherlands has the will and a solid reason to take an anti-EU and anti-euro position. Since there are no snap elections, there's time for Wilders to benefit from falling social mood and win a victory that could shock Europe.


H/T: Mish Shedlock.

2012-04-21

China real estate round-up: more than 1000 developers disappear from 3 major cities; Beijing GDP growth slows to 7%; SOHO China buys low

More than 1000 developers disappeared from Beijing, Wuhan and Chengdu last year. The data uses different dates for each city: Beijing as of December 2011, Wuhan October 2011 and Chengdu July 2011. If over 1000 firms disappeared last year and the market has grown tighter, the numbers will be much much bigger this year. The data comes from the number of firms that did not renew their business license.
武汉四川等地已有上千家房企消失

Beijing's 2012 Q1 GDP growth fell to 7%.
北京新建住宅价格连降5月 仍将继续回落

SOHO buys low. iFeng has a whole page of articles on SOHO's (0410.HK) purchase of Greentown's Shanghai project. As I have written earlier, large and well financed developers may offer value even as the market declines. As one headline puts it, SOHO China nabbed a project worth ¥15 billion for ¥2.1 billion. The value would have to collapse for the firm to lose on that deal. SOHO still has ¥12.5 billion in cash and are looking for more buys.
SOHO中国二度“抄底”绿城土地 Here's an English article on the buy: Beijing Real Estate Billionaire Couple Continues Brisk Expansion In Shanghai

2012-04-20

Social mood in the headlines

Nicolas Sarkozy: Why is the French president so disliked?
German tempers boil over back-door euro rescues

Two more Chinese developers declare bankruptcy

Developers fail in Guangdong, Hangzhou
Two more property developers in Guangdong and Hangzhou have filed for bankruptcy, highlighting the growing pressure on cash-strapped small players that are struggling amid Beijing's efforts to cool the housing market.

Guangdeye Property Development in Shunde, southern Guangdong, declared bankruptcy on Wednesday due to its inability to repay debt, according to the People's Court in Shunde.

The private firm has not undertaken new projects since completing a commercial project, Shunde Commercial City, in 2008, when it reportedly started encountering financial difficulties.

Over in Hangzhou, Hangzhou Jinxiu Real Estate, which was developing a luxury serviced-apartment project on the West Lake, has reportedly filed for bankruptcy. It comes a week after the collapse of Hangzhou Glory Real Estate, says Hangzhou's news website, zjol.com The firm was unavailable for comment.

David Ng, a property analyst at Macquarie Equities Research, believes more small players would fold if the property downturn persists.
Yesterday in Hundreds of billions in private placements are just covert loan sharking; high interest loans masquerade as equity stakes, I noted that small and medium developers made use of extremely high-interest loans. Even though the large developers and the overall housing market may appear sanguine, there can be a financial disaster underneath as small firms go belly up and investment trusts eventually take losses.

Hong Kong moves ahead of New York in investor protection in IPOs

Hong Kong moves closer to bank liability for IPOs
Hong Kong's financial market watchdog will launch a public consultation in the next couple of weeks that seeks to toughen rules for banks sponsoring initial public offerings, including holding them liable for faulty deal documents.

The move is likely to draw strong opposition from foreign investment banks worried about increased risk in a market that has been the world's biggest for listings in two of the past three years, but has also seen a number of scandals.

According to sources with direct knowledge of the matter, the Securities and Futures Commission (SFC) is set to issue a two-part consultation paper, with one section proposing to toughen the code of conduct for IPO sponsors and the second making them liable for the contents of listing prospectuses.

"Everyone will be taking a step back and revisiting whether it makes economic sense to even pursue those deals," said Bonnie Chan, a partner at law firm Davis Polk & Wardwell and former head of Hong Kong Exchange's IPO transactions department. She had not seen the consultation paper.
Comments later in the article discuss how this could make Hong Kong too expensive to list in, but it also means listing in Hong Kong will be more valuable and likely confer higher price-to-earnings multiples. The new rules are a response to egregious fraud cases, where fraud was detected only a few months after a firm IPO'd.

Bankers could be jailed over dodgy listings
Bankers and brokers may be jailed if they fail to ensure the accuracy of listing prospectuses produced by companies they are sponsoring to join the stock market.

Allocating criminal liability for such misdeeds is part of the Securities and Futures Commission's plan to improve market quality in light of recent scandals that have tarnished the image of the local bourse.

Albert Edwards agrees: wider yuan band can allow faster devaluation of renminbi

"Utter, Utter Piffle" - Albert Edwards Lashes Out At The Media's China Groupthink
What a dunce I am. So silly of me to think China might be hard-landing! I now stand corrected. I was reading about China’s widening of the yuan trading band and found a story with the above quote from an expert. Apparently widening the yuan trading band is proof that China is not hard-landing. Why? Because otherwise the authorities would not have sanctioned such a move. What utter, utter piffle. There remains massive market over-confidence in the ability of the Chinese authorities to achieve a soft landing. And as the IMF now agrees with Chinese Premier Wen Jiabao that the yuan is no longer overvalued, it seems to me that on both technical and political grounds, the likelihood of a yuan devaluation has just increased.
The bulls on China seem to have a trend following attitude that since it worked before, it will work again, and the Chinese government won't "let" bad things happen to the economy. I'm mixed on the market because there are still plenty of ways to get rich in China, but investing in the stock market at this point may not be one of them. Edwards turns to this chart, which shows the yuan has been consistently falling in market trading. Why would a widening band make it more likely for the yuan to rise? This forecast is completely at odds with the market!

Speaking of yuan valuation, now investors will be able to place their bets with futures: HKEx set to launch yuan futures this summer
Hong Kong Exchanges and Clearing plans to launch yuan futures in the third quarter, a move that would help investors hedge their exposure to the currency and solidify Hong Kong's status as the main centre for the offshore yuan trade.
HKEx announced the plan yesterday, just one day after HSBC issued the first yuan-denominated bonds in London in a big move to advance the City of London's push to become a major centre for the offshore yuan trade itself.

The exchange's chief executive, Charles Li Xiaojia, said the plan "reflects our desire to support Hong Kong's development as an offshore RMB centre". He called the initiative part of the exchange's "strategy to expand beyond equities and equity-related derivatives".
One reason why so many people believe the yuan is a one-way bet is because there have been few outlets for bearish sentiment. As the yuan is internationalized, the bears will be able to place their bets. Even if the bears are wrong, as these products come to market, they yuan will seen downward pressure because the bulls can already place their bets.


2012-04-19

Hundreds of billions in private placements are just covert loan sharking; high interest loans masquerade as equity stakes

Are hundreds of billions in private placement loans from private equity funds (hedge funds) the next bomb to detonate in the real estate crisis? Are these funds just covert loan-sharking and will they follow in the footsteps of the Wenzhou crisis? According to one industry insider, only about 5% of loans follow regulations, the rest are high-interest loans where investors are promised 25% returns.

In 2009 a developer named Shen Ming (name changed) invested 800 million yuan to buy land: 400 million of his own capital and 400 million from a private placement. Due to real estate controls, they never broke ground and the private placement loan was due to be repaid in February 2012. Shen Ming transferred the land rights for 600 million yuan. The fund took 400 million plus 100 million interest, while the developer received 100 million and took a 300 million yuan loss. In the crazy days of 2009, Shen Ming agreed to 30% percent annual interest rates.

Shen Ming is not an isolated case. A developer in Changsha (Hunan) said most developers have taken out high interest loans through private placement loans. In second and third tier cities, small and medium developers have used the capital for bridge loans. Although they are called private placements, 95% come from investment advisory firms said an investment manager with WINS Investment (金地集团的稳盛投资管理有限公司). Some people want to borrow, some people want to lend, the loan sharks exist in the middle. Originally, most customers wanted to invest in shares, but they didn't need equity when the loans were offering 10% interest.

A lot of private placement and private equity is called equity investment, the firm receives stock rights, but all they've done is assumed credit risk. In the current monetary and policy environment, many funds believed the credit risk was comparatively less and the returns higher. Most of these loans, however, were bridge loans. The way it works is the firm would loan the money to the developer and receive an equity stake in land, shares or future sales. After the developer received the bank loan or started selling the properties, they would buy back the equity stake for a pre-determined price. In this way, high-interest loans masqueraded as equity investment. Most of these loans returned 15-25%, with some over 30%. A lawyer in Beijing said he saw one deliver a 40% return.

The more common agreements also have equity or land as collateral; if the developer cannot meet the 25% return, they transfer land or face other punitive measures. Most of the time, however, investors are deceived. If the developer cannot meet the payment, the private placement firms do not inform investors that anything has happened. If the developer cannot pay, the private placement firms take collateral and as long as investors don't lose money, they don't complain. There is no risk control in this market, only the shared risk in the project. Some developers are selling their properties for 50% off, but they cannot find buyers because these aren't existing homes, it's just land or a half-built building. The article cites this story to illustrate the point: Soho China Plans To Buy Shanghai Property Project For CNY2.1 Billion. The reporter says that since 2009, Greentown has used the aforementioned type of financing with interest rates exceeding 20%. (Greentown has been an aggressive seller of property over the past six months.)

Greentown stands out as a large developer using this type of financing. Most loans went to medium and small firms that have much less leeway and far greater risk. Since the second half of last year, there have been more than 5 cases of small developers hitting the road in Xiamen, Changsha, Zhuhai and other cities (similar to the stories from Wenzhou), all of whom used private placement high-interest loans.

A former Merrill Lynch executive said there will be a lot of disputes between investment managers and investors over the next 3 to 5 years. There's a legal framework, but no regulations or guidelines for the private equity industry. Some developers have also invested in funds, opening the door to all manner of problems. For example, a developer would want a cost of capital to be 6%, but a private equity firm wants 30% returns. The example is given where two developers have a vote and pressure the private equity firm to reduce their interest rate.

Nevertheless, some are upbeat. Capital remains scarce and there will be many mergers and acquisitions in Chinese real estate, driving the demand for fresh capital. Private capital is more concerned with the viability of projects than banks, for example they more closely examine cash flows and can pull funding in an instant. Regulation can help the industry increase transparency and educate investors.

Above summarized from this article: 千亿地产私募起底:“大部分是变相高利贷”

Socionomic look at France's election

How useful is socionomics? I posted this graph on March 26.

A Sarkozy loss seemed likely since the financial crisis and we've seen heavy turnover all across the globe. However, we can see the usefulness of socionomics based upon shifting headlines. Although Sarkozy's chances were always slim, his poll numbers were not terrible and he seemed to be making a comeback as the CAC 40 rose, exactly as socionomics predicts. I drew the lines on the chart based on a quick look at recent support and resistance: a retest of the lows and Sarkozy would be finished; a major rally to the recent highs would require a stunning rally and given that there are two rounds in the French election, would mean mood was tilting in Sarkozy's favor. What's interesting is that the 3200 line seems to be a relatively accurate prediction. The election has not yet happened, but the fall in the stock market to this level has ended Sarkozy comeback talk and the new story is that Sarkozy is finished.

The CAC 40 closed at 3240 on Wednesday and here is Thursday's headline: Hollande builds lead as Sarkozy allies admit writing is on the wall
Confronted with plunging polls and deserting allies, President Nicolas Sarkozy faces the prospect of a rout in the two-round French presidential election starting this weekend, with senior members of his government already said to be certain of defeat.

Understanding American Authoritarianism and the Atheist Puritan Theocracy

How do Americans and the American political system express authoritarianism? As social mood declines, how will authoritarian policies develop, what areas will see increased authoritarian control? Passport seizures and capital controls are easily predicted financial repression; how will authoritarianism express itself culturally? Where is the opposition to the system and how will it express itself? Most people think about politics within an existing framework of right-left that explains the differences within the system. One can also look outside the system as well and see it for its whole, an important perspective to take at major turning points in social mood because the entire system becomes unstable.

The following is one such view that steps fully outside of the left-right paradigm in American politics and sees it for its whole. Below is a short excerpt (yes, this is a short excerpt from a very long article that is only part 1 of a series) that lays out the basics of the author's opinion, namely that the U.S. is in fact a Puritan theocracy, sans God.

A gentle introduction to Unqualified Reservations (part 1)
The root problem with a state church in a democratic state is that, to believe in democracy, one must believe that the levers of power terminate with the voters. But if your democracy has an effective state church, the actual levers of power pass through the voters, and go back to the church. The church teaches the voters what to think; the voters tell the politicians what to do. Naturally, it is easy for the politicians to short-circuit this process and just listen to the bishops.

Thus the government has a closed power loop. With the church at its apex, of course. Which is exactly what we were hoping to avoid when we decided to make our state democratic, rather than authoritarian - an independent and unaccountable authority, which is in charge of everything else. In this case our authority is, of course, the church itself. Oops! We have engineered ourselves a big bucket of FAIL.

In other words, our so-called democracy is dependent not on the wisdom of the people, but on the internal power politics of the official church. If these politics produce a political platform which translates to responsible and effective actions, the government will be good. If they don't, it will suck. Either way, we have consigned the state to an unaccountable conclave of bishops. Why this is an improvement on monarchy, or any other form of autocracy, is unclear.

This political architecture, an abortion by any standard, is commonly known as a theocracy. Oddly enough, the classic historical case of a theocracy is... wait, hang on, I'm forgetting... oh, yes! Right here, in North America. Under those strange people we call the "Puritans."

For those who prefer their history fresh rather than aged, we can turn to Darren Staloff, whose Making of an American Thinking Class: Intellectuals and Intelligentsia in Puritan Massachusetts is badly-written but quite informative. Professor Staloff writes [italics mine]:
The Puritan ministers [...] created a completely new form of political authority - in the Weberian sense of legitimate power - which I have called cultural domination. Cultural domination, as here conceived, requires four formal supports.

First of all, like charismatic authority, it requires recognition in the form of ritual election or some similar mechanism of oath swearing or covenant signing. Fealty is sworn to the "correct" cultural formation, in this case Puritan biblicism, and the officeholder is empowered only as the specially trained bearer and interpreter of that cultural tradition. The "laity" generally conceive of this high cultural training - whether centered around biblicism or some other intellectually legitimating principle like reason or rationality - as being endowed with an automatic efficacy that need simply be applied to any problem to generate a univocal solution. The biblical truth is eternal and immutable, claimed Thomas Hooker, "but the alteration grows, according to God's most just judgment, and their own deservings."

Such belief gives rise to the second formal requirement, that officially authorized bearers of the cultural tradition must always agree in their public formulations or at least not disagree. If this condition is violated, the laity may come to see the cultural tradition as an amorphous collection of expressions or principles manipulated by "mandarins" for their own aggrandizement.

The third requirement is that all public expression of the culturally able must be bestowed on these public acts, including forced attendance, titulary homage, and silent obedience. Finally, to ensure the stability of the entire system, unauthorized cultural expressions must be carefully monitored and severely suppressed when they contradict or threaten to "desacralize" the authorized formulas.
The last explains political correctness clearly. Deviations from the mainstream discourse are treated with revulsion and disgust, essentially religious and emotional reactions to different opinion.

Emphasis in the passage below is mine:
And there is another card I've been holding back on. You see, the problem is not just that our present system of government - which might be described succinctly as an atheistic theocracy - is accidentally similar to Puritan Massachusetts. As anatomists put it, these structures are not just analogous. They are homologous. This architecture of government - theocracy secured through democratic means - is a single continuous thread in American history.

An excellent historical description of this continuity is George McKenna's Puritan Origins of American Patriotism - it gets a little confused in the 20th century, but this is to be expected. However, as a demonstration, I am particularly partial to one particular primary source - this article from 1942, which I found somehow in Time Magazine's wonderful free archive.

The nice thing about reading a primary source from 1942 is that you are assured of its "period" credentials, unless of course someone has hacked Time's archive. The author cannot possibly know anything about 1943. If you find a text from 1942 that describes the H-bomb, you know that the H-bomb was known in 1942. One such text is entirely sufficient.

What's great about the "American Malvern" article is that, while it describes a political program you will place instantly, it describes it in a very odd way. You are used to thinking of this perspective, which is obviously somewhere toward the left end of your NPR dial, as representative of a political movement. Instead, the anonymous Time reporter describes it as a religious ("super-protestant," to be exact) program. Isn't that just bizarre?

We have caught the worm in the act of turning. The political program and perspective that we think of as progressive is, or is at least descended from, the program of a religious sect. Unsurprisingly, this sect, best known as ecumenical mainline Protestantism, is historically the most powerful form of American Christianity - and happens to be the direct, linear descendant of Professor Staloff's Puritans. (You can also see it in abolitionism, the Social Gospel, the Prohibitionists, and straight on down to global warming. The mindset never changes.)

For a brief snapshot of where it is today, try this article. Note that Congregationalist and Puritan are basically synonyms, and American Unitarianism is a spinoff of Congregationalism. Of course, these belief systems have evolved since the time when these labels meant anything. Since the 1960s they have merged into one warm, mushy, NPR-flavored whole, which we here at UR sometimes refer to as Universalism. Michael Lerner is perhaps the ultimate Universalist.

Thus we see the whole, awful picture merge together. It is Cthulhu. We don't just live in something vaguely like a Puritan theocracy. We live in an actual, genuine, functioning if hardly healthy, 21st-century Puritan theocracy.
The whole article is worth a read if you are interested in U.S. politics, but what brought it to mind was the latest episode in Puritan red lettering.

NY law would identify buildings with smokers
New York apartment buildings that permit smoking would be identified under a new law proposed Wednesday by Mayor Michael Bloomberg.

Landlords of buildings with three or more units would have to inform prospective tenants and purchasers whether smoking was allowed in apartments and on balconies, as well as in common outdoor areas like rooftops.

Bloomberg said this would give potential renters the chance to choose a smoke-free environment, free from wafts of cigarette smoke from other apartments.

"Smoking kills and people have the right to know if they are going to be exposed to secondhand smoke," Bloomberg said.

"We pursued this proposal in response to complaints from New Yorkers. It won't ban smoking in residential buildings, only ensure that New Yorkers can choose a smoke-free place to live."
Just like no smoking sections in restaurants didn't lead to a ban on smoking, right?

How bad could global cooling be?

Pretty bad, according to one estimate as reported in Global Cooling: be very afraid
If his analysis of declining sunspot activity is correct, then global mean temperatures are going to decline by about 2 degrees C by 2040 – completely undoing all that lovely beneficial (but rather meagre 0.8 degrees C) global warming we have experienced in the last 150 years.

It will mean longer, colder winters and cooler summers. But far worse than the discomfort will be the effect it has on grain production. The shift in latitudes at which corn and wheat can be grown will be the equivalent of losing a belt 300 kilometres wide all around the world, leading to the loss perhaps 400 million tonnes per annum of grain.
Global cooling benefits the energy sector and parts of the agricultural sector. Northern farmland will do poorly. What's worth buying? Think Virginia ski resorts.

2012-04-17

India's alternative policies to reduce gold consumption

Previously, I said that with the import tax seeming off the table, India would find other ways to cut gold consumption. Today, one such measure was announced, with the central bank limiting bank loans to financial companies that lend to gold buyers.

RBI proposes banks reduce exposure to gold loan cos
The Reserve Bank of India (RBI) has asked banks to reduce their exposure to non-banking financial companies (NBFCs), which have given loans mostly against gold, sending shares of such companies sharply lower.
Expect more because India wants to reduce its trade balance.

Argentina stabs a wounded and angry Spain

Argentina picked a fight with the United Kingdom over the Falklands, and now it has kicked Spain while she's down. Reeling from a weak economy and a brewing sovereign debt crisis, Spain was dealt another blow as Argentina nationalized a Spanish-owned energy firm. Many shareholders are Spanish banks, an asset loss than none of them needs right now.

Spain vows 'forceful' response to Argentine oil move
Spain denounced the "hostile" decision by Argentina to nationalise Spanish-owned oil company YPF, a subsidiary of Repsol, and warned Monday that it would take "clear and forceful measures" in response.

Argentina's decision had "broken the climate of friendship" between the two countries, Foreign Minister Jose Manuel Garcia Margallo told journalists, speaking after a crisis cabinet meeting called by Prime Minister Mariano Rajoy.

The government strongly "condemns... the decision to expropriate" a controlling stake in the Repsol subsidiary, he added.

"It's a hostile decision against Repsol, thus against a Spanish business, and thus against Spain," said Industry Minister Jose Manuel Soria, speaking at the same news conference.
Argentina picked a bad target. Whereas British social mood is relatively positive, Spain is ready to fight. Perhaps only Greece is more in the mood for a battle, should one present itself. Not only is Spain determined to fight, but the rest of the EU faces losses if Spain's financial system breaks down.. Thus, the entire EU will likely join in a response to Argentina.

2012-04-16

Spanish financial system about to supernova?

Back when Greece was just starting to heat up in early 2010, I wrote Greece is yesterday's news, Spain is tomorrow's. The major problem in Spain back then was real estate on the bank's balance sheets carried at full valuation. Bad debts were effectively hidden and Spain looked as though it would have a real estate/banking led financial crisis that would require a bailout. I did not expect Spain would have a sovereign debt crisis; I though it would have a financial crisis that maybe led to a sovereign debt crisis.

Instead, this has metastasized into a monster because Spain's government is leading the crisis. Instead of a bank bailout potentially causing a government debt crisis down the line, the government is going first and will take the financial system down with it. This is why we are now seeing real estate prices tumble in Spain, not as the precursor, but as a result of sovereign default risk. However, that's not to say this is the end—what it signifies is that Spain, and by extension Europe, may be about to lose control of the situation as both the Spanish government and the banking system require simultaneous bailouts.

Spain’s real estate crash gathering speed
House prices are down between 22 and 29 per cent from the 2007 peak, according to various indexes, against roughly 50 per cent in Ireland. But there was an 11.5-per-cent year-on-year fall in March, according to Tinsa, the surveyors. And the trough probably still hasn’t been reached.

...Banks might give house prices another downward nudge this year. Lenders own nearly 20 per cent of the country’s estimated one million empty homes, according to Cheuvreux estimates. They have been understandably weary of selling houses and crystallizing losses. But they effectively have little choice. The government is demanding haircuts on foreclosed properties of 35 per cent on average.

Once banks start to write down the value of the properties, the theory is that they will be more willing to sell at large discounts. And anecdotally, banks are already flooding the market with cheap property.
There is one entity that can absorb the blow of a double default in Spain, it is the same entity that absorbed the default in Greece: the European Central Bank. By extension, this entity directs the force of the blow into the euro. The collateral damage from a falling euro will be a relatively stronger U.S. dollar and higher gold prices.

Capital and residents flee Ordos

China's ghost city is approaching its nadir as residents return to their home cities and take what's left of their capital along with them. Although some residents have built up sustainable businesses (albeit with income far below peak years), many are pulling up stakes as capital drains from the city.

鄂尔多斯曲终人散 放贷者血本无归外地人大撤离 (The end of Ordos; lenders lost their life savings, residents flee)

Out of a population of 400,000 in the prosperous Dongsheng region of Ordos, about 300,000 were from other parts of China. These people came to Ordos to earn money, but there's no money to be earned now, so they're leaving. At the peak, the lowest wage rate was about 3000 yuan per month, exceeding that of Beijing. Now, people work part-time or low wage jobs are lucky to earn 1600 yuan per month. Small restaurants have seen business tumble more than 70% since October. Taxi drivers are heading home, hotel rates and occupancy are down more than 50%. Only three short years ago, the hotels were fully occupied most of the time.

There's still some optimists hanging in. One man lent his friend 700,000 yuan and stopped receiving interest payments early on, but he's waiting it out and believes the local coal resources will eventually support the region.

2012-04-15

Euro shorts change direction and increase short exposure


Yuan band expands: Devil's advocate analysis

This grammatically confusing sentence headlines a Reuters article: Analysis: China currency move nails hard landing risk coffin
China's weekend reform of its currency regime nails shut the coffin on the last remains of doubt about whether the world's second biggest economy has successfully steered a course past a hard economic landing.

Investors were questioning whether the worst sequential slowdown in China's economy since the 2008-09 global financial crisis could enter a sixth quarter after data on Friday revealed the weakest three months of annual growth in three years and a run rate below the official 7.5 percent 2012 target.

Shifting the yuan trading rules is about the strongest signal Beijing could give that growth downside has diminished and potential pitfalls are manageable. Few reforms are as replete with risk as tinkering with the currency because faith in its soundness directly correlates to economic stability.

"For everybody who thought China was heading for a hard landing, it's over. This move says they are comfortable with the direction the economy is moving in," Paul Markowski, president of New York-based MES Advisers and a long-time investment adviser to China's monetary authorities, told Reuters.
This is what an expanded yuan band allows: a faster decline in the renminbi. That doesn't help the Chinese economy transition to a consumer economy, but a weaker yuan can support the manufacturing export sector. So does a wider band signal the economy will not have a hard landing? No, the expansion of the yuan band means China now has a more flexible tool in the exchange rate and try using it to avoid a hard landing.

2012-04-14

Socionomics in one picture

First the headline from Yahoo; Sarkozy's comeback hopes crumble, polls show
French President Nicolas Sarkozy defended his economic record on Friday as a slew of opinion polls suggested his prospects of re-election were crumbling just over a week from round one of a vote where Socialist Francois Hollande is the clear frontrunner.
And to understand why this story appears now and was expected by anyone following the French market:

2012-04-13

Beijing real estate thaw is over; transaction volume tumbles in April

After several weeks of slowly rising transaction volume in Beijing, the trend is over. Transaction volume tumbled 53% in the first week of April. Average price was ¥19451 per square meter, down 6.1% from the previous week.

北京新房成交环比大降五成

Chinese housing inventory numbers

The chart below shows actual housing inventory figures for tier 1 and tier 2 Chinese cities. The are from top to bottom: Beijing, Shanghai, Shenzhen, Guangzhou, (subtotal); Nanjing, Suzhou, Xiamen, Dongguan, Fuzhou, (subtotal); Total.

The numbers are homes measured in 万,or units of 10,000. For example, Beijing saw housing inventory increase by 31,800 units between March 2011 and March 2012. The total for all listed cities shows an increase of 41% between the two periods.

The middle figure is the 2012 year-end inventory. Beijing has started reducing inventory, but the average for all the listed cities shows an increase, albeit a very small one.

The accompanying article (linked below) goes on to detail the government's plans to help ease the inventory onto the market, which is to restrict advance sale permits. That will help keep inventory off the market, but it will also strain the financial position of developers who need to move property fast to recoup capital.



传政府欲动刀库存房 销售超7成才可推新房源

2012-04-12

Caixin editorial on weaknesses in Wenzhou reforms

Wenzhou reforms will face challenges and Caixin lays out several of the potential stumbling blocks in Laudable 'Wenzhou Project' Still Faces Many Obstacles
Also, under the Wenzhou project, some small loan companies can turn themselves into village and town banks, but they could be defeated by the Interim Provisions on the Administration of Village and Town Banks, which state that "at least one of the founders or investors of one such bank should be a banking financial institution."

Third, there is a lack of clear policies to support small loan companies.

The State Council has expressed clear support for private capital to enter the financial market. And, in 2008, the China Banking Regulatory Commission and the People's Bank of China jointly issued a set of guidelines on pilot small loan companies. The guidelines say that natural persons, legal persons and other social organizations can invest in and establish small loan companies, but their development is limited by another rule that their funding sources be restricted to registered capital.

The fourth failure is a number of unaddressed faults in the local capital markets.

Indirect financing has long played a key role in China's financial industry, while direct financing is a minor actor. Among the different types of direct financing, listing is the most popular, and bonds, equities and venture capital are among salient weak links.
Read the whole article.

Since the Wenzhou reform is just starting, there's room for changes that could hamper it or ensure it's success. The stakes are high:
The present central government's term ends in less than a year, so both central and local authorities should carry out various initiatives as quickly as possible. Any breakthrough in the explorative spirit of Wenzhou will affect the whole country.

2012-04-11

Economic reform is the key to China's development and political reform is hopeless without it

China is often criticized for it's lack of political reform. More importantly, however, is that much of the energy spent on viewing China is through a political lens. If you are in China, reading Chinese sources, then it's quite clear what the rising regime is aiming for: social stability via an economic transition that builds a domestic consumer economy. Against that are entrenched party interests that are happy with the current setup. Even without internal opposition, that is a hell of a challenge and one that may be assisted by some political reforms that touch on economics, but not something that needs the added chaos of serious political reform. That doesn't mean there won't be deep reforms: the reaction of the head of a defense industry SOE, warning that SOE privatization is a foreign assault on the Party and the PLA, shows how serious SOE and banking reform can be. Politics and economics are intimately linked in China and simply separating the two is a massive undertaking requiring years of determined effort.

In the NYTimes yesterday, Jonathan Fenby crystallized part what I would view as the typical Western view of China, although he goes on to accurately describe the reform movement afoot:

The Bo Xilai Sideshow
But the Bo affair is, essentially, a sideshow, a distraction from the essential challenges facing China under its changing leadership. Nobody can deny the country’s huge material achievements, and individuals live far better and freer lives than they did under the Great Helmsman. But the economic model is out of date.

China is gripped by a major environmental crisis and an acute water shortage is building up in the north of the country. Beijing lacks a coherent foreign policy. Corruption is rife. Regulation and safety standards are weak. There is a broad lack of trust in institutions. The falling birth rate and increasing longevity mean that the demographics will shift during this decade so that the People’s Republic may become old before it gets rich.
I disagree that Bo's take down is a distraction because the crackdown on leftist websites shows a larger force at work, it shows that the reformers have the power to remove their political enemies and that means they have the power to push through reforms. It is no accident that less than one month after Bo is taken down, the Wenzhou reforms halted in 2011 are restarted and expanded. That Wen Jiabao is speaking more boldly and the PBOC is in the spotlight on financial reform.

The second paragraph is a laundry list of Western concerns about China, not necessarily keys to growth or reform. Almost nothing in it is important to the point of being crucial. Demographics are key, but China does not have a pension system like the West. Demographic transition will be hugely important, but it will help with the transition to a consumer economy because it's a natural force pushing wages up. The environment is bad, but improving; in any event, Westerners place a high non-economic value on the environment and usually list it far too high on the priority list, exhibit A being the global warming hysteria. Corruption, regulation and safety standards, lack of trust and foreign policy all will improve with development and at least on this score, the current reforms are aimed in this area.

Party control over the economy leads to corruption and attendant costs such as lack of trust; high ranking party officials control the major SOEs; many SOEs are economically inefficient and rely on easy credit from state owned banks; state owned banks take their orders from the party. The current Wenzhou reform and rhetoric from Wen Jiabao and PBOC governor Zhou Xiaochuan are focused on creating a private financial sector. Even if there is no direct assault on the state owned banks, the rise of a private financial sector will reduce the importance of the banks relative to the economy. A key reform is underway, but many in the West want to rush China into a disaster of rapid reform. China won't be swayed by international pressure that grows weaker over time and my intent is not to beat up on China critics. Rather, it doesn't really matter and people who want to understand where China is headed should stick to looking at what's taking place on the ground and what leaders are saying, especially the rising leaders, men such as Li Keqiang who have spoken extensively of their reform plans for years.

As one example, take the property tax. It is a major assault on corruption and instability because it ends government reliance on a single sector of the economy. Right now the local governments rely heavily on land sales, which gives them an incentive to keep capital flowing to developers, to encourage real estate development and home buying. Since the government decides which land is sold, this also gives developers a reason to want to influence the decision. In contrast, while a property tax doesn't eliminate corruption, it reduces the government's need to keep the real estate sector and developers happy. Also consider the economic impact of high land prices. The government incentive was to drive up prices to increase revenue, pricing ordinary Chinese out of the market and increasing rent costs for factories, to say nothing of the financial bubble that accompanied it. China won't be bubble free in future, but the transition to a property tax system is a major component in economic reform and political reform, because down the road, an expanded tax base is what will eventually lead the push for expanded political rights.

Fenby's article does go on to address the reform efforts:
I even found myself pulled into the debate in a minor way when editors at China Daily, the state English-language newspaper, read an advance copy of my new book on China and asked me to write an article arguing the need for change. It ran exactly as written.

The reformers face formidable opposition. Wen and Li may talk of change, but the Communist Party is more powerful than the government, and the once-revolutionary movement has become an agent of the status quo. Interest groups are strong. State enterprises exercise monopolies or oligopolies entwined with the political system. Rule by consensus impedes adoption of tough measures.

How this process evolves will determine whether China finds a new future for itself or gets caught in the fallout of its own success. Given its place in the world, the outcome has major implications for the rest of the globe. If Bo’s fall has helped to open the door to change, it will have done some good.
He ends by hitting the nail on the head. Rule by consensus during rising social mood is what killed financial reforms in the middle of the last decade. With social mood more negative than before, conflict is favored over consensus and the reformers are moving fast, but they will focus on economic reform—and that is exactly what China needs, economically and politically.

Wenzhou to have complete financial system by 2014; to be pillar of economy by 2015

The reform in Wenzhou is the financial equivalent of the special economic zone in Shenzhen and will shake the economy to its financial foundation. A draft plan for the reforms will be released soon, with details leaked to the press.

温州金改拟三步走 2014年初步形成完善金融体制
By 2015, the financial sector will become the pillar of Wenzhou's economy. There will be three stages: this year is the trial phase; 2013-2014 will serve as the implementation stage, with the goal of having a complete local financial sector; 2015 will be the stage of perfecting and deepening reforms.
There are also some preliminary figures for the reform plan (this next bit is Google Translated):
The quantitative indicators is as follows: "Towards 2013 the city's new rural financial institutions and branches (rural banks, rural fund cooperatives, finance companies) the total number of over 30 full coverage of counties (cities, districts), deepening the pilot of the small loan companies batches public bidding to set up microcredit companies, the center of town and the functional areas cover the whole 2012, 30 new small loan companies, net capital reached 20 billion yuan, in 2013 a total of 100, net capital reach 40 billion yuan. "

PBOC's Zhou: Wenzhou reform's main purpose is deregulation

周小川:温州金融综合改革要点是减少管制
Research in Wenzhou, the central bank governor Zhou Xiaochuan recently said that points of Wenzhou financial reform and focus on deregulation, support innovation, encourage private services to the grassroots level to support the real economy, supporting coordination, security and stability ". In practice, on the one hand, to strengthen organization and leadership, on the other hand should give full play the enthusiasm of the grass-roots micro-main, so rely on the market to adapt to the market ". The task of reforming of the basic conditions, the mature one, start one.

Zhou Xiaochuan pointed out, promote financial reform in Wenzhou, to encourage and guide private capital to enter the field of financial services, smooth channels for private investment to improve the small micro-enterprises and the "three rural financial services, to broaden the financing channels for enterprises to maintain financial order and prevent financial risk.

Zhou stressed, Wenzhou financial reform based on the actual of Wenzhou, Wenzhou current economic and financial operation exist more than two dilemmas "(private capital investment is difficult; SME financing difficulties) outstanding problems, standardization and the sun to explore private financing of way, while avoiding disadvantages; will help standardize the financial order and prevent financial risks, to optimize the financial ecological environment; perfect market economy, financial system and operational mechanism.
That's a Google Translation, as I'm not interested in translating dry political speak. The main point, however, is what the headline says: the essential point of the reform is deregulation.

Developers hunt for cash; Beijing cracks down on fraud

Here's a long Chinese article on Beijing's crackdown on housing eligibility fraud. Chinese are issued residence permits by city and cities such as Beijing restrict housing purchases to those with Beijing residence permits or a long history of living in the city. This is just one form of restriction used to reduce new home demand, in addition to restrictions on the number of homes one can buy, etc. This shows that the government continues to pursue tight policies and is tightening by closing the weak points in regulation. 北京彻查购房资格舞弊 4000万灰色利益链起

Elsewhere, the WSJ reports that developers are looking for overseas investors in Property Investors Lie in Wait for China Slowdown
"In recent months we have seen more brokers wanting to introduce deals to us, but the sellers aren't desperate enough," said Chen Lijian, head of real estate for greater China, at UBS Global Asset Management. "We have capital to deploy, but the deals aren't attractive enough so far."

The outside investors have the luxury of the longer view. Many are looking in smaller cities, where land costs are lower compared with major cities like Shanghai and Beijing. China has in recent years pushed for growth in the interior and western parts of the country in an effort to spread development from its current focus in the south and near the coasts.

Bo Xilai officially out; wife under investigation; PLA attacks reform efforts

The Bo Xilai saga is fading into the background and reform is the topic of debate.
Bo ousted, wife in murder probe
The Communist Party has expelled Bo Xilai , the former high-flying Chongqing party boss, from its top ranks and launched a police investigation centred on his wife, Gu Kailai , in connection with the murder of Neil Heywood, a British citizen who worked closely with Gu and her son.

In a spectacular fall from grace that has rocked the nation's leadership succession, Bo has been stripped of his position as a member of the Central Committee and the Politburo.
This murder investigation is the key event that drove Wang Lijun to seek asylum.

Push to privatise SOEs 'a foreign plot'
The head of China's state-owned military and civilian aviation company said the privatisation of state-owned enterprises was part of a foreign conspiracy to shake the foundations of the Communist Party.

He warned the PLA would be the next target once SOEs were privatised.
The military isn't going to call Communist Party members traitors, but make no mistake, there is no foreign plot against Chinese SOEs outside of the protectionism we are seeing in all countries, against all other. The target of their rhetoric is interal:
"When the state-owned economy has collapsed, the enemies will then seek the army's collapse. Privatising the economy and taking away the party's control of the army by nationalising the military are conspiracies by international enemies to shake the base of the ruling party."
This is a very accurate statement. The Party controls the SOEs, which gives them economic control of the nation, while control of the military assures political control. Nationalizing the military doesn't necessarily follow from privatizing SOEs (and even if it does, that transition would probably take several decades or more), but once economic control is relinquished, military control is probably next.

2012-04-10

Snapshot of social mood in Europe and America, April 2012

This came to my email inbox via John Mauldin's Outside the Box.
I’m Worried

David Kotok
April 8, 2012

A note to readers. This 2000-word commentary is a longer-term view; think in terms of years, not months or days. The essay is not in conflict with the fully invested position currently held at Cumberland. The words reflect my personal thinking only. Some of my colleagues disagree. In my personal view, the future is uncertain (of course) and may be unattractive for the longer-term outlook. In my view, our American political system is failing us. In my view, we are joining the list of declining world powers. The framework to support that argument follows.

"The external menace 'You'll end up like Greece, if you do not do this and that' and the internal opprobrium heaped on some categories of taxpayers are very powerful and dangerous instruments to deprive people of their own personal freedoms." –Vincenzo Sciarretta

My friend Vincenzo is a journalist from Italy. He is a serious writer and researcher. He has covered the financial markets and economy of Italy for years. He and I co-authored a book on Europe during the optimistic period. If he and I were to write such a book now, it would probably be quite pessimistic.

Vince responded to my recent email series about the downward spiral underway in the euro zone. Readers may find those essays at www.cumber.com. Vince noted my reports from the meetings in Paris and my reference to the upcoming French elections, where the promise of the Socialist candidate is to raise the tax rate on the highest income level to 75%. I will end this commentary with a longer email from Vince, in which he quotes historian Will Durant and discusses the fall of the Roman Empire.

Now to write some thoughts that gnaw at me in the late of the night, when sleep is elusive.

Simply put: I'm worried.

When I get worried, I read and re-read in my library. I can honestly say that I have had my nose in a thousand of those books. The library holds many texts by giants. They wrote about history, economics, and finance. They took the strategic view. George Akerlof, Jared Diamond, Niall Ferguson, Carmen Reinhart & Ken Rogoff, Robert Shiller, and Nassim Taleb are among the modern writers. Milton Friedman, Martin Gilbert, Friedrich Hayek and his polar opposite John Maynard Keynes, Ludwig von Mises, R.R. Palmer, and Adam Smith are among the classics.

A favorite of mine is Paul Kennedy. Twenty-five years ago, this Yale historian concluded his monumental work The Rise and Fall of Great Powers with a profound observation:

"In the largest sense of all, therefore, the only answer to the question increasingly debated by the public of whether the United States can preserve its existing position is 'no – for it simply has not been given to any one society to remain permanently ahead of all the others, because that would imply a freezing of the differential pattern of growth rates, technological advance, and military developments which has existed since time immemorial."

Kennedy then argued that the United States has the ability to moderate or accelerate the pace of decline. Such is also the case for other great powers, many of which are in a state of decline from their centuries-old power peak. Among others in his treatise, Kennedy's history lessons examine Spain, France, Rome, and the Austro-Hungarian Empire.

I think I just covered a lot of the euro-zone geography.

In 1987, Kennedy warned us, "The task facing American statesmen over the decades, therefore, is to recognize that broad trends are under way, and that there is a need to 'manage' affairs so that the relative erosion of the United States' position takes place slowly and smoothly." He added the additional warning that it not be "accelerated by policies which bring merely short-term advantage but longer-term disadvantage."

Unfortunately, America's leadership has not heeded such warnings.

For decades futurists have complained about the rising use of government debt financing by the United States. They predicted calamitous outcomes, which did not arrive as expected. Paul Volcker and Alan Greenspan applied monetary policy in ways that allowed inflation and, hence, interest rates to spend a quarter century in decline. The Volcker-Greenspan era opened with the highest interest rates since the Civil War. Building on this downward momentum, Ben Bernanke has taken the target short-term interest rate to near zero and held it there.

During the same three decades, the US altered its fiscal policy, first under Ronald Reagan and almost continuously since. (The Clinton administration was the exception.) Rising deficit financing has been facilitated by falling nominal interest rates. That combination leads to level, or even falling, aggregate debt service. You can owe more and more and have smaller and smaller monthly payments. That is the magic of falling interest rates. Until they hit the zero boundary.

What happens when the music stops and the chairs are full? Are we reaching that point in the United States? It appears we have done so in Europe, certainly in Greece, the eldest of the declining great powers. We are also getting there in Japan and the UK. All four confront similar financial straits: zero-bound interest rates coupled with expanding national government debt.

About 85% of the capital markets of the world trade by means of the dollar, yen, pound, and euro. The G-4 central banks have collectively expanded their holdings of government securities and loans from $3.5 trillion to $9 trillion in just four years. At the prevailing very low interest rates, the functioning of monetary policy and the role of fiscal policy merge. Is there any difference between a million-dollar suitcase of one hundred dollar bills and a million-dollar, zero-interest treasury bill? You need an armed guard to protect the first one. With the second one, you need to clear an electronic trade in a safe financial institution, not an unsupervised (no more Fed surveillance) Federal Reserve primary dealer like MF Global. Your earnings on either the cash or the T-bill are the same: you earn zero. You can use the treasury bill to secure a repo transaction at a near-zero interest rate. You can use the cash to conduct many types of black-market or gray-market trades. Is it any wonder that the hundred-dollar bill is so popular? Isn't it understandable that roughly two-thirds of US currency circulates outside the United States?

Is this a healthy situation? How long can it persist? What happens next? When interest rates eventually rise, what will be the result of this blend of monetary/fiscal policy as its unwinding turns malignant?

Moreover, who then will be the politicians that inherit this mess? Who will occupy the central banker's chair?

I worry because there is no rationally explained strategic-exit plan in the G4. Not in the US. Not in Japan. Not in the euro zone. Not in the United Kingdom.

I also worry because the direction of taxation is up, if certain politicians continue to have their way. I worry because US business tax rates are now the highest in the entire world. In addition, I worry because of the increasing power that national governments wield in the mature economies of the world.

Applied power eventually leads to serfdom.

Increasing taxation is a characteristic of a declining great power.

Governments are failing to heed Paul Kennedy's warnings. They are worsening the longer-term outlook. The Western world's leaders ignored Kennedy when he wrote "… accelerated by policies which bring merely short-term advantage but longer-term disadvantage."

Zero-bound interest rates are a short-term advantage. We enjoy them. We profit from them. We expect them to continue for a while. They are like the oxygen administered to a very ill patient. If the patient dies, the oxygen has eased the pain in the terminal phase. If the patient lives, the lungs have been scarred and need many years of healing and repair. Today, the patient is receiving oxygen in the G4. Death is being delayed (Greece) or, perhaps, thwarted (elsewhere in the euro zone, Japan, US, and UK).

We do not know how this will play out. History only warns us that many of the likely outcomes may be unpleasant. The authors I cited have articulated their differing and diverse views. Their conclusions have tended to be in the form of warnings.

Paul Kennedy favors candor. In his second, exquisite work, Preparing for the Twenty-First Century, he wrote: "Many earlier attempts to peer into the future concluded either in a tone of unrestrained optimism, or in gloomy forebodings, or (as in Toynbee's case) in appeals for spiritual revival. Perhaps this work should also finish on such a note. Yet the fact remains that simply because we do not know the future, it is impossible to say with certainty whether global trends will lead to terrible disasters or be diverted by astonishing advances in human adaption."

Of course, we hope for the latter and worry about the former. History gives us little comfort.

For the time being we shall remain on the sanguine side with regard to this global experiment with increasing debt, zero-bound interest rates, and a monetary/fiscal policy compromise that obfuscates the difference between them.

As long as this persists, it means financial markets do well, stocks rise, risk assets regain favor, bonds with hedges yield results, and cash continues to earn zero return.

That is now. It may change tomorrow, next week, next month, next year or not for quite some time. There is no way to know.

For the downside from history we return to Vincenzo's email to me:

"Dear David,

"I invite you to read the last few sentences of the below article from The Lessons of History, by Will and Ariel Durant. It is about how the destruction of the Roman Empire through the taxation channel made people 'slaves,' in other words how serfdom emerged. This is my number one fear for Italy, but I guess France is making the same mistakes, just starting from a lower debt level. You can also find an online version of the book, thanks to Google.

"Rome had its socialist interlude under Diocletian. Faced with increasing poverty and restlessness among the masses, and with the imminent danger of barbarian invasion, he issued in A.D. 3 an edictum de pretiis, which denounced monopolists for keeping goods from the market to raise prices, and set maximum prices and wages for all important articles and services. Extensive public works were undertaken to put the unemployed to work, and food was distributed gratis, or at reduced prices, to the poor. The government – which already owned most mines, quarries, and salt deposits – brought nearly all major industries and guilds under detailed control. 'In every large town,' we are told, 'the state became a powerful employer, standing head and shoulders above the private industrialists, who were in any case crushed by taxation.' When businessmen predicted ruin, Diocletian explained that the barbarians were at the gate, and that individual liberty had to be shelved until collective liberty could be made secure. The socialism of Diocletian was a war economy, made possible by fear of foreign attack. Other factors equal, internal liberty varies inversely with external danger.

"The task of controlling men in economic detail proved too much for Diocletian's expanding, expensive, and corrupt bureaucracy. To support this officialdom – the army, the courts, public works, and the dole – taxation rose to such heights that people lost the incentive to work or earn, and an erosive contest began between lawyers finding devices to evade taxes and lawyers formulating laws to prevent evasion. Thousands of Romans, to escape the tax gatherer, fled over the frontiers to seek refuge among the barbarians. Seeking to check this elusive mobility and to facilitate regulation and taxation, the government issued decrees binding the peasant to his field and the worker to his shop until all their debts and taxes had been paid. In this and other ways medieval serfdom began."

Thank you, Vincenzo, for this serious response. Thank you Paul Kennedy for superbly articulating history and issuing clear warnings. Thank you, dear reader, if you are still with me. I hope I have provoked some thought.

Now we will seek another night's sleep and hope it is not elusive.

David R. Kotok, Chairman and Chief Investment Officer

India to scrap gold import duty?

Thus far only promises from the finance minister, no action. India Jewelers End Strike Over Gold

This is short-term positive for gold, but overall economic performance from China and India is still important. Nevertheless, I was expecting the tax to rise until gold imports slowed. I assume we'll see a new policy from India that aims to achieve the same goal (lower gold imports) without tipping off the domestic industry.