An oft-told story about drunks relates the instance of a passer-by asking a muddled and tipsy wanderer what he is looking for under a streetlight, only to be told that the inebriate lost some keys in the nearby bush but is looking under the light because, well, there is light around.
In much the same way, politicians and central bankers are stumbling around aimlessly blaming any convenient target for the problems faced by their constituents. They need some help in connecting the dots; here then is an attempt towards the objective. In this article, I will examine the common thread running between five different stories that surfaced this week:
- Mitt Romney’s pledge to save Michigan’s auto industry, that apparently won him the Republican nomination from the state.
- Mounting credit losses and attendant capital raising by US banks.
- The World Bank’s most recent acknowledgment of the corruption that plagues most of its projects, this time involving healthcare projects in India.
- China’s further tightening of lending conditions at its commercial banks even as it announces explicit price curbs on key food and other products.
- The launch in India of the world’s cheapest car.
On the face of it, there is not much linking these stories. The state of Michigan, for example, plays host to America’s once-mighty automotive industry. That’s not the only reason it is in the news these days – the state also has the dubious distinction of being in the top five most delinquent states for personal finance (you know, credit card debt repayment, mortgage repayment and all that sort of thing).
Things are so bad that some economist wags are calling the state Michi-Gone: yes, humor is among the various talents that economists do not possess. It is easy to make the link between the declines of the auto industry and the personal wealth of the state’s citizens, but that’s not the full story.
Add to this the question of why the auto companies squandered their hard-won prosperity from the nineties (Of black swans and greedy oilmen, Asia Times Online, January 5, 2008) and a more complex picture emerges. With a strong US dollar that was helped along by billions in so-called safe-haven flows following the Asian financial crisis, America simply had too much money, which is usually the first condition for capital misallocation. That is what led banks and smaller financial companies to lend willy-nilly for mortgages, credit cards and the like essentially to people chasing the American dream – ie a house of your own with a two-car garage and excessive cholesterol intake.
These inflows kept the US dollar strong thereby making Americans less worried about the steady rise in oil prices and a concomitant feed through into inflation. This house of cards could have fallen long back but for the deflationary impact of China adding manufacturing capacity in every conceivable industry, which helped to keep prices low in the US. Asians also had the good habit of saving more than they spent, and also shipping the piggy banks to New York for investment in anything that their honest Wall Street advisers told them to buy (The robbery of the century) Asia Times Online, July 14, 2007.)
Unfortunately, along the way some Chinese decided to properly urbanize their own cities, live in beautiful modern buildings rather than old shanties along the Yangtze. In doing so, the delicate price equilibrium underpinning low inflation in the US (and Europe) swung out of control and unleashed greater inflation, in turn pushing central banks to raise rates. Rising interest rates in turn made bankrupt the people borrowing money they couldn’t pay for houses they couldn’t afford on incomes they didn’t have.
It just so happened that a number of such people had been recently made redundant by the auto factories in Michigan, and thus had more than ample time to become property “investors”.
The banks that lent them a lot of money have now had to fess up to their losses. Worse, they have opened their doors to a bunch of new owners from the Middle and Far East, who may not be the sharpest knives in the cupboard (Storm warning for Asia Asia Times Online, January 4, 2008) but will at the very least prevent these banks from opening up their balance sheets to risky US homeowners in future – remember after all that these are the same chaps who cling on to the lessons of the Asian financial crisis of 1997 as if that were the only event in their sorry little lives.
I am not sure that Mitt Romney or indeed any other politician understands the dynamics laid out above: thus when they talk about defending America by making the US dollar cheaper for example, they would also sow the seeds for a permanent wealth cut of these homeowners. Meanwhile, the ones dreaming of restoring the US dollar to its glory would have to pass the shovel around to bury the remnants of the American auto industry. As much as it hurts Mitt and Co, the US dollar has lost credibility because of the economy, not the other way around. They should pay some attention to the experience of India’s Nano car, which is profiled below, as it shows the right response of a capital-starved company to a changing market dynamic.
Meanwhile, in Wonderland
A recent report by the World Bank uncovered significant corruption in its aid to India across multiple projects totaling some US$550 million [1]. The bank’s new chief, Robert Zoellick, and Indian officials promised to get to the bottom of the mess, quite ignoring that the very high likelihood that the key culprit was the aid program itself.
There is an old saying that give a man a fish and he will eat once; teach him how to fish and he will lie forever about the size of the one he caught with Todd the other day. That aside, the point that making a large pot of money available to people in poor countries without the relevant safeguards has been lost on the “ugly sisters” – the International Monetary F and the World Bank – for many decades now. Their own bankers remain distant, academic and uninvolved, thereby allowing easy assignment of blame to ex-colleagues. Asian countries remain notoriously corrupt (Wages of corruption, Asia Times Online, August 19, 2006) and yet the World Bank insists on throwing money at non-existent projects. Bankers caught with their hands in the cookie jar are reprimanded, but almost never dismissed thanks to the complete lack of accountability at the World Bank as well as the frequent US-European management skirmishes.
Meanwhile, the central bank of China finds itself in the sorry situation of being both the poacher and the gamekeeper as it attempts to fend off dodgy loans by commercial banks even as it floods the financial system with liquidity that has in turn led to surging prices for pork and other foods (Inflation: China’s Lost Battle Asia Times Online, December 15, 2007). Attempting to control lending to “inflationary” sectors like construction, the government has mandated banks to lend to “desirable” sectors such as development projects in the hinterland. This has led to some interesting loan decisions across the country to dubious industrialists and businessmen on non-existent collateral. Frequently, the heads of major Chinese banks disappear only to be placed on a corruption trial and then shot in the back of their heads [2]. Reading about the different outcomes for bankers at the World Bank and China’s commercial banks does make me wonder if the punishments aren’t interchangeable, but perhaps that’s just me.
The problem is that in both China and at the World Bank, lending decisions are mandated from the top rather than being made commercially. This leads money to be allocated to undeserving projects, even as more deserving (economic) candidates are ignored because they are out of policy. Other instances of such policy madness certainly exist – for example, a forum member (Chan Akya forum, Asia Times Online) asked a question about “priority” lending to India’s Muslims by commercial banks. This is a bad idea that is intended to stave off a serious problem, namely the relative economic backwardness of India’s urban poor including Muslims (India’s Muslim ‘problem’) Asia Times Online, September 1, 2007.) As Chinese banks are learning now, being forced to lend based on economic policy is about the worst kind of investment decision that can be made.
Both the World Bank and the People’s Bank of China (PBoC – central bank) though should take a look at the cheapest car in the world, called the Nano, launched in India this week. The car represents a shift in the thinking of domestic manufacturers in Asia, as it is targeted firmly at an audience within the country at a price that more lugubrious foreign competitors will find difficult to match. This is a confident step from one the region’s biggest conglomerates aimed at the very heart of today’s mega-corporations in the US and Europe.
The car also represents a paradigm shift for another reason. The export boom in China’s industries from the eighties relied heavily on a resource advantage, namely cheap labor. India’s information technology boom also relied on the relative cheapness of its engineers, although the gap narrowed far quicker than China’s labor wages gap has (to equivalent workers in the US). As a labor advantage disappears, China and India have gone on a brand expansion spree as they attempt to capture more value-added products and brands. That’s a fancy way of saying that since our workers are more expensive, our products will have to cost more.
What the Nano represents though is sheer unbridled innovation; original thinking and engineering savvy that would make richer countries sit up and take notice. It is no longer the brute force of cheap resources, but the more tangible strides of engineering prowess that would give global automakers sleepless nights.
As one news service (Bloomberg) called it this week – “Nano is talk of the Detroit motor show, and its not even there”. True, there has been more than the usual criticism about the car’s design, features and all that, but the underlying nervousness is palpable: “If these guys can deliver more than a passable car at US$2,500, what can they do for a budget double that? None of us can deliver a car for under US$15,000, so we have some way to go.”
Every one of those reasons should convince the World Bank and the PBoC, among other policymakers, that the most useful contribution they can make to their and the world economy is to simply get out of the way. For the World Bank, this would mean turning itself into an academic institution that trains future economists, while for the PBoC it would mean letting the yuan float and get out of the business of managing bank balance sheets.
This will push the yuan higher against the US dollar and over the short-term cause billions of dollars in lost profits (not losses) for manufacturers, before they too get the joke like Indian manufacturers have about improved resource optimization and value addition on a tight budget.
Chinese banks will lend to the most credible businessmen, and they will in turn unleash superb innovations that change the global industrial landscape; evolving from their position as mere assemblers of Western and Japanese technology.
US banks have shown that being in a free market doesn’t make them immune to market abuse as well as reaping the fruits of such actions. Their ability to attract capital will hopefully be accompanied by a new humility with respect to financial innovation, but also an acknowledgement of new economic realities that put developing Asia in front of all other constituents. Group of Eight economies are a drag on the world now (Dear Dinosaurs Asia Times Online, October 20, 2007); the only choice for these banks is to focus all their energies on Asia.
Thus, what unites all the stories is the fallacy of top-down decision-making that ignores ground realities and more importantly the integral impact of decisions on each other. The unwinding of one bubble will almost always set off another, targeting areas of uneconomic decision-making. If the authorities in China and India do not wake up to this reality, the current asset bubble in stocks and property will also blow up in much the same way as the American dream has.
Notes
1. Detailed Implementation Review of the Department of Institutional Integrity, World Bank, 2008.
2. From later this year they will no longer be shot, but have more humane lethal injections instead.