Mittwoch, April 01, 2009

Risks, Risks and Risks...

Today's FT has a commentary from Yu Qiao, who is a professor of economics at the School of Public Policy and Management, Tsinghau University, Beijing. Link here.

But before getting to Professor Qiao's article, let's talk about risks.

You have the risks you know about, quantifiable ones. These are risks like the risk of flying, of driving a car, of not wearing your seatbelt, of falling in the home, all those risks which are statistically identifiable and can be compensated for. Worried about the risk of accidents when driving? Get insurance, buy a safe car designed to protect you in an accident, wear your seatbelt, learn how to drive defensively, etc.

You have the risks that you don't know about, unquantifiable ones. Is your sexual partner lying about diseases and sexual partners, if there is paperwork, is it up-to-date? Are your bosses stripping the company in order to dump it? Are your children doing what they say they are doing when they're out with friends? Is your accountant really putting that money into those accounts? These are aspects that can't be insured against, but have to do with trust and the catastrophic results of a breach of that trust: ruined health, lost jobs, destroyed families, fraud and theft.

Then there are the more subtle risks, ones where intangibles are involved. Fudge too much on your expense account and you'll be considered untrustworthy; get caught cheating on your partner and she or he will never want to have anything to do with you again; get caught being ... economical with the truth and no one will want to do business with you; get your data and models wrong and no one will want your services. These risks are subtle, because there is no causal chain that says you can lie 6 times and get caught on number 7, or that you can sleep around as long as your partner doesn't know the people, or that you can screw up a forecast 4 times and on the fifth people notice.

The first series of risks can be insured against and prepared for. The second happens to you passively: you need to learn how to cope and develop your skills of discovering deceit, fraud and untruthfulness. The third...

Ah, the third group of risks. These are the ones that destroy you, force you to move to another town and hope you can live it down. What makes these risks especially dangerous is that you're the one ultimately responsible.

Back to the article: How Asia Can Protect Itself From A Dollar Default.

Not could, not may have to: can.

Remember the Asian virtues, the virtues of thrift, savings and deferred consumption until goals were reached. These are the virtues of the Gods of the Copybook Headings, the laws of physics, of logic, of economics, of business, of banking and investment.

What Professor Qiao is telling us - the readers of the FT and indirectly the Western world - is that China and the other Asian countries don't have to continue to play the game we've been playing:

President Barack Obama is set to urge leaders to boost government spending to save the world economy. European Union countries are expected to focus on fixing lax financial regulatory systems. For Asian countries, however, the key agenda issue is the safety of their assets denominated in dollars, as they look ahead to a devalued dollar from rising US sovereign debt.

This is now the risk facing the US and, indirectly, the rest of the West: that Asia will decide to do what it damn well prefers to do, rationally and emotionless, based on its own interests. More on what that implies later.

Most of Mr Obama's stimulus spending is devoted to social programmes rather than growth promotion, which may exacerbate America's over-consumption problem and delay sustainable recovery. On top of this, the unprecedented fiscal stimulus, with the Federal Reserve's move to inject money into credit markets, contains self-destructive seeds. The US risks ending the dollar's role as the reserve currency, especially considering there is already $10,000bn (€7,535bn, £7,009bn) in US Treasury debt, and much more in liabilities from the costs of social security, healthcare and financial institution bail-outs.

Here we have the nexus, the core of the problem: the plans of the Obama administration and the democratic Congress are not making things better, since what we need is growth, not more of the same.

The provision of stable, reliable and viable dollars may be subordinated to short-term US interests, posing a risk to global monetary stability. In the long term, America may seek to resolve its economic mess by devaluing the dollar at best and a default at worst. This is depicted in a Chinese proverb: "Drinking poisonous liquid to quench thirst". History points to examples such as the collapse of the Bretton Woods system in the early 1970s. It is the foreign holders of US obligations denominated in dollars that would end up paying.

And those foreign holders are increasingly unwilling, if you'll excuse the expression, to be butt-fucked at the whim of the US. Which has happened in the past, obviously, and what is at stake is nothing less than the credibility of the US government to actually do something without fucking it up. Seriously:this is the core threat that the Obama administration apparently fails to even be able to percieve, let alone act to prevent. US credibility is at stake. Not US credibility as a military power, but rather US credibility to do the right thing when it needs to be done.

Analysts have warned of the dangers of the US Treasury bond bubble that developed in late 2008. Although insurance against sovereign debt default may reduce credit risk, it is unable to safeguard the real value of dollar-denominated securities. If this bubble burst, east Asians would be victims. Their economies directly hold more than $1,600bn of US sovereign debt, or 25 per cent of the total held by the public. Including direct holdings, Asians may hold half of the outstanding public-owned Treasury bonds. China, by some estimates, directly and indirectly holds more than $1,200bn of US Treasury bonds. If the dollar collapsed, the consequences would devastate Asians' hard-earned wealth and terminate economic globalisation.

Let's make this clear: the Obama administration isn't just playing with taxpayer monies, they are playing with Asian savings, and most fundamentally they are playing with US credibility.

No other international monetary system offers a viable alternative. However, we can make the main reserve currency power more accountable by creating an instrument to help manage the global crisis.

This is the demand: be accountable. This is the voice of Asia, as it were, demanding that we behave responsibly. Ignore it at your peril, or, more exactly, the US can ill afford to ignore it. The arrogance of the Obama administration in playing games with US credibility is, bluntly, directly attributable to President Obama and the Congress: political expediency and, foremost, political survival of the guilty has vastly greater priority than getting the US household back in order.

The basic idea is to turn Asian savings, China's in particular, into real business investments rather than let them be used to support US over-consumption. While fixed-income securities are vulnerable to any fall in the value of the dollar, equity claims on sound corporations and infrastructure projects are at less risk from a currency default. But Asians do not want to bear the risk of this investment because of market turbulence and a lack of knowledge of cultural, legal and regulatory issues in US businesses. However if a guarantee scheme were created, Asian savers could be willing to invest directly in capital-hungry US industries.

You know what? These are not unreasonable demands. Seriously: how stupid does the Obama administration think the Chinese are? Obviously fairly stupid, given the increasing inability of this administration to take actions that are both credible and are actually aimed at dealing with the problem.

First, Asian countries could negotiate with the US government to create a crisis relief facility. The CRF would be used alongside US federal efforts to stabilise the banking system and to invest in capital-intensive infrastructure projects such as a high-speed railway from Boston to Washington DC.

I think that the operative word isn't "negotiate", but rather demand.

Second, Asians could pool a proportion of their holdings of Treasury bonds under the CRF umbrella to convert sovereign debt into equity investment. Any CRF funds, earmarked for industrial commitment, would still be owned and managed by their respective countries. In return, Asians would hold minor equity shares that would, like preferred stock, be convertible .

This is a fundamental shift. Normally if people want equity, they buy into companies, usually on the stock market. You only see bonds and other financial instruments turned into equity when ... companies can no longer pay their bills and have entered into such debt-for-equity swaps in order to avoid insolvency.

Thanks, Congress and the Obama administration: your greatest debt holders outside of the US are making contingency plans for US bankruptcy.

Third, the US government would act as the guarantor, providing a sovereign guarantee scheme to assure the investment principal of the CRF against possible default of targeted companies or projects. Fourth, the Fed would set up a special account with the US government to supply liquidity that the CRF requires to swap sovereign debt into industrial investment in the US.

The CRF would lessen Asians' concern about implicit default of sovereign debts caused by a collapsing dollar. It would cost little and help the US by channelling funds to business investment. Conventional Keynesian policies – fiscal and monetary expansion on a national basis – cannot solve the problem but will make it worse.

Two last points: Professor Qiao is right, conventional Keynesian policies are making things worse and not better; second, a debt-for-equity swap may end up with the Chinese owning more of American industry than anyone in Washington would be comfortable with.

These are the risks that the Obama administration is now taking with US credibility. With luck, he can pull them off.

But be very, very afraid of the destruction of the illusion that the US government is capable of doing anything besides screwing things up.

The Democrats and the left - sorry, I repeat myself - were fond of claiming that the Bush administration was effectively undermining US credibility.

We may be seeing them, instead, actually do it. The impact of the collapse of US credibility would change the world, and it is a world thereafter where the word of the US government is not worth the paper it is written on...


Ed hat gesagt…

Hello, I've a couple of comments. First, from the FT article:

insurance against sovereign debt default may reduce credit risk

Does insurance against default on US treasury bonds make sense? OK, I can imagine it working to cover small amounts, but which insurance company has trillions of $ to pay out in the event (however unlikely) of a default? Better yet, will still have trillions (or even just billions) of $ after the economic fallout of a default?

Seems like a false sense of security to me, which wouldn't matter so much except it works to reduce the demands that investors make for holding treasury bonds, and hence the discipline imposed on the government.

But Asians do not want to bear the risk of this investment because of market turbulence and a lack of knowledge of cultural, legal and regulatory issues in US businesses. However if a guarantee scheme were created, Asian savers could be willing to invest directly in capital-hungry US industries.

All investors would love such guarantees! Providing them is a terrible idea. If you want the potential returns, take the risk. Lack of knowledge is a poor excuse, especially for any investor who can potentially invest so much money. Failing that, just put the money into something like the Vanguard VITPX fund.

From the other side, if you want the investment, make yourself attractive to investors without being covered by a government guarantee.

John F. Opie hat gesagt…

Hi Ed -

Thanks for the comments.

There really seems to be a persistence of belief that you can insure for everything. This is definitely not the case.

Risk is a necessary part of doing business: this is where the lack of economists in the decision-making chain warning that people need to do right and proper due diligence research and make their decisions on the best information available: it's the lawyers who think that you can get around this simply by buying insurance against any bad thing happening.

It's a nightmare how poorly informed decision-makers are. Being a good businessman is really, really hard work: too many people think all you need to do is a cool deal...

Again, thanks for the comment...