Monday's Top 10: China's huge, risky transition; practical Piketty options; 297 words; the forever battery; Eduardo Porter; SOI; Clarke & Dawe; Dilbert, and more

Here's my edition of Top 10 links from around the Internet at 10:00 am today. We now have a Monday-Wednesday-Friday schedule for Top 10.

Bernard will be back with his version this Wednesday. We will have another guest posting on Friday.

As always, we welcome your additions in the comments below or via email to david.chaston@interest.co.nz.

See all previous Top 10s here.

1. What China risks with market-driven interest rates
Interest rate liberalisation is vital to sustaining China's long-term growth but comes at a big cost - rising defaults and a loosening of Beijing’s control. Can they do it?

If you have 30 minutes or more, here are links to two very smart articles by James Shinn, and ex CIA analyst and now a regular contributor to Institutional Investor.

He sets out why many professional observers think China will fail to contain its credit crisis, and then delves into why others think it will be a rough ride but one that China will come through.

It is a fascinating read. I thoroughly recommend it, although quite geeky.

Shinn is a very talented analyst and observer.

The snippets that follow aren't intended to summarise his view, they are just some interesting pieces.

But credit risk has not been fully priced into loans or, for that matter, into the deposit rates on different savings vehicles, because SOEs theoretically have no credit risk. According to Premier Li, this is about to change. Or is it?

One view, the prevailing opinion among the experts in China I spoke with earlier this month, says that it is indeed possible to gradually dismantle China’s long-standing system of financial repression and organically grow a new risk-priced market for credit in parallel with the existing state bank– and SOE-allocated credit structure. A Hong Kong–based private equity CEO described this as the “one system, two markets” view, a wry reference to Hong Kong’s status as a Special Administrative Region, whose largely independent coexistence as part of China is known as “one country, two systems.”

An opposing view, more prevalent in New York and London, says, in effect, “You can’t get there from here,” and anxiously awaits a credit train wreck in China. “China’s financial system is still insulated from external pressures; it’s a domestic problem. But it’s too complicated to run two huge domestic credit markets in parallel, no matter how clever the policymakers and how interventionist,” warns a Shanghai-based economist. “The leakage and indirect connections between the market systems and the allocated credit systems are getting more baroque every day. The demand for capital by firms is insatiable, at any price.”

Kyle Bass, the Hayman Capital founder and principal renowned for taking big macro bets on Asian markets, largely agrees. “I believe it to be naive at best for anyone to believe that it is possible to fully control a $25 trillion banking system with $9 trillion of GDP. This credit experiment in China has reached such a large gross critical mass that it is literally impossible to control, regardless of desire, incentive or perceived ability to do so,” he says. “How can anyone grow banking assets at 150 percent of GDP over a four-year period and hold NPLs [nonperforming loans] at 1 percent? Only if you are the person in charge of reporting the numbers, is my answer.

“NPLs will increase, and the changing value of collateral for the loans won’t be able to be stopped, in my opinion,” he predicts. “Even with the best intentions, the PBOC and powers that be won’t be able to slow down the credit bust.”

Although many bankers and naysaying critics in the West are transfixed by the prospect of a string of credit defaults in China, the more confident observers in Beijing and Shanghai claim this is the next phase of an evolutionary financial sector strategy that has been under way, step by step, since the reforms kicked off by former paramount leader Deng Xiaoping in 1978.

2. China likes Belgium best
China is parking its US Treasuries in Belgium banks it seems.Why would it do that?

Its currency reserves rose US$32 billion in December - and its holdings of Treasuries fell US$46.7 billion. Assuming its authorities need to keep a third of their overall reserves in U.S. debt, that leaves it looking for an alternative home for US$55 billion in December, according to Derrick’s calculations. That suggests that approximately the same amount of China’s Treasury holdings have been parked in Belgian banks.

3. Let's be practical
Thomas Piketty's Capital is a phenomenon. But almost everyone agrees that his solution, a global wealth tax, is almost certainly not going to happen. So others are stepping up with suggestions on how to counter inequality.

Here are ten by Tim Fernholz: (The details are in his article.)

1. Open the borders
2. Get rid of some intellectual property protections
3. Cut taxes
4. Crack down on off-shore tax havens
5. Open up the city (affordable housing)
6. Wait for China's labour costs to catch up
7. Unleash antitrust
8. Punish the financial sector
9. Create more sovereign wealth funds
10. Massive social upheaval and bloody conflict.

[This last one is ] not exactly ideal, but one of the most convincing empirical findings from Piketty’s research is that World War I, the Russian revolution and World War II were the great levelers of the 20th century, wiping out more than a century of capital accumulation and creating the conditions for more equitable growth in their wake. Continent-wide warfare may not be a pleasant prospect, but it’s probably a good deal easier to bring about than most of the solutions listed above. Why, there’s a handy little annexation going on in central Europe right about now.

4. 'A short list of valuable lessons'
Is this the 'greatest graduation speech ever'? or, 'teach you everything you need to know about economics'? or, show why economics 'has led us astray since 2008'?

You be the judge.

It's only 297 words, and was delivered to US Berkeley graduates in 2007 by economics professor Tom Sargent, an economist who won a Nobel Prize in 2011.

5. A disconnection
As regular readers will know, we keep track of reported job losses. There was a big one confirmed in Balclutha late last week. We have been doing this for more than a year now and one thing that struck me is not only the low number being reported, but how disconnected the quantum is from the [high] exchange rate. Makes it hard for those who usually complain about this issue.

Somehow it suggests that there are more benefits from a high exchange rate (low import prices) than costs (unemployment, low wages, etc.). We will get the next fix on employment and unemployment levels for Q1 2014 on May 7.

6. Don't use a Court to solve disputes
The Family Court in Australia has consented to giving their tax authorities records submitted to its judges so the taxman can pursue one or both the partners trying to settle their separation arrangements.

In a relationship breakdown, honesty is not a feature, which I suppose is why the courts are used to compel disclosure.

Now the documentation in Family Court will go straight to the ATO when they request it.

I wonder how this works in New Zealand. More by Michaela Whitbourn in smh.com.au

Warring couples may think twice about airing their dirty laundry in the Family Court after it ruled the Tax Office could use financial information filed in one dispute to audit the parties for potential tax evasion.

In a case decided this month, a three-judge bench of the Family Court gave the Tax Commissioner access to documents in a feud between a Mr and Mrs Darling, a Peter Pan-esque pseudonym given to the couple by the court.

It also released the Tax Office from an obligation not to use documents for a purpose unrelated to the original court case.

The Darlings settled their Family Court stoush in December 2010 but the commissioner was dogged in his determination to use the documents as part of a massive audit of Mr Darling's tax affairs stretching over two decades, from June 1991 to June 2010.

7. A good challenge
A reader quite rightly questioned my reasoning in an article of 'Going short' for term deposits, given we are in an almost certain rising interest rate period. Thank you Brett. His reasoning is very useful, and best explained in an option table.

After four years, its even. After five there is little in it. You might argue that this is a before-tax assessment and that tax will in fact be deducted. But that should not change the relative comparisons. I am impressed how close it works out. However, the estimate in two years for the 36 month rate might be optimistic given that rates for those terms are not OCR dependent. But then again, even if they are lower then, that will enhance the choice to lock in now. Food for thought.

8. The forever battery
We live on battery power these days in our electronic life, but not at home. Some electric cars essentially run on variants of computer batteries (Tesla). They do a good job of storing electricity for their purpose, but the main requirement is that they are tiny. But what if 'tiny' wasn't a criteria, like in your home? A new industry is growing to supply 5kW, 30 kW, even 500 kW battery storage in new vanadium-based batteries. They may be bigger, but they are of the scale that you could install at home.

That is what Imergy, a Silicon Valley start-up, among others, is about to launch.

Imergy has spent years perfecting an energy storage device that, if it lives up to its billing, will help accelerate the big green future by allowing companies and homeowners to pull the plug on their local utility by banking electricity from solar arrays and wind farms for use when the sun is not shining or the wind is not blowing. A 250-kilowatt battery system installed in a 40-foot container, for instance, could store solar energy from the rooftop arrays of a 40-home neighborhood for later use.

9. A search for consequences
I have mentioned this before, but Eduardo Porter is saying it better than me: just when economists are 'certain' of their claims that inequality is causing increasing problems, social scientists can't find the evidence "not by the kind of standards I would require."

It seems the certainties of those who have rushed into print can't be sustained by the data.

There are not many social scientists in the United States who have studied the United States’ widening income gap longer than Christopher S. Jencks.

But about a month ago, Mr. Jencks, a renowned professor of social policy at Harvard, abandoned his 10-year-old project of writing a book about the consequences of inequality on the nation’s health and opportunity, on its politics and crime. Why?

“I came to see a book with six or seven chapters that all said the same thing: It’s hard to tell,” he told me.

Mr. Jencks describes the state of the debate between friends and foes of inequality in these terms: “Can I prove that anything is terrible because of rising inequality? Not by the kind of standards I would require. But can they prove I shouldn’t worry? They can’t do that either.”

I read The Spirit Level but was wholly unconvinced (it was designed to extract money from people who already had their political view). I have just bought Thomas Piketty's latest and expect to be impressed (everyone else is). But if rigorous social scientists can't actually make the case, should we trust economists who claim they can?

It's wise to remain sceptical for a while yet. ["Believe those who are seeking the truth. Doubt those who find it."]

10. Today's quote
"How ironic is life. We spend so much money on expensive clothes, but the best moments in life are spent without clothes." - Anon