Monday's Top 10: China collapse; investment banking; creating money; habit-forming provision releases; liquidity trap; national team; Dilbert, and more

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

Bernard was on vacation last week and will be back this Wednesday with his new weekly edition.

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. State of decline
Jamil Anderlini is a Kiwi (born in Kuwait to a New Zealand mother and an American father. He is also a highly respected FT correspondent based in Beijing. He's their bureau chief, and at the centre of how we understand what is going on in China.

And he is reporting that as the Chinese economy slows and middle-class discontent grows, the question is being asked: how long can their Communist Party survive?

It is a question that’s now being asked not only outside but inside the country. Even at the Central Party School there is talk of the unthinkable: the collapse of Chinese communism.

“We just had a seminar with a big group of very influential party members and they were asking us how long we think the party will be in charge and what we have planned for when it collapses,” says one Party School professor who asked not to be named because he was not authorised to speak to foreign media. “To be honest, this is a question that everyone in China is asking but I’m afraid it is very difficult to answer.”

China has often been held up as evidence to debunk Fukuyama’s theory, [which holds that western liberal democracy represents the final form of human government and the endpoint of ideological evolution] with critics arguing that the party’s process of constant reinvention is far more responsive to the needs and demands of its subjects than traditional authoritarian systems.

Until a few years ago, David Shambaugh, director of the China Policy Program at George Washington University and a leading expert on China’s political system, was a strong proponent of this view. But he has changed his mind and now believes that the party is in a state of decline that echoes the dying days of Chinese dynasties throughout history.

The signs include a hollow state ideology that society does not believe in but ritualistically feigns compliance with, worsening corruption, failure to provide the public with adequate social welfare and a pervasive public sense of insecurity and frustration. Other signs include increasing social and ethnic unrest, elite factionalism, over-taxation with the proceeds mostly going into officials’ pockets, serious and worsening income inequality and no reliable rule of law.

2. 'Private banking'
A former director-level fixed-income banker exposes the cut-throat world of creating instruments for investment banks in a monologue that is part of a series in which people across the London financial sector speak to Joris Luyendijk about their working lives. It's from The Guardian:

Before you sign on investment banks treat you like a star. Then your job starts and you're one of many. I remember the first time I got onto the dealing room. Between 500 and 1,000 people on one floor … I realised, this is the heart of the machine. The 'client-facing' side of investment banks is impressive. Expensive suits, excellent catering, antiques on the walls. But the dealing rooms are factories. You've got a computer, phone and Bloomberg terminal with financial data and that's it. London investment banks do everything to make you as productive and focused on making money as possible. There's a dentist in the building, a doctor. Dry-cleaning, a travel agent, restaurants, fitness. There was even a guy going around the trading floor polishing your shoes for a few pounds.

I found out that my investment bank often hired two people for one role, to see who'd survive. That was bad [laughs]. Worse: the manager who had hired me left for another bank almost as soon as I started. I really was on my own. The bank had promised me a client segment all to myself. But that very first day I sat down at my desk to discover that, actually, several others also worked on that segment. Basically I was not allowed to call anyone in that segment. Banks divide up the world in a matrix; by product and by country.

There was always at least one person on whose toes I stepped. 'Where does an 800lb gorilla sit? Answer: wherever he wants to sit.' This summarises an investment bank pretty well. A newcomer is the opposite of an 800lb gorilla. You have to fight your way in. Nobody has time. Nobody cares who you are. But you have been brought in with 'a budget'. This is the money you have to make for the bank or out you go.

3. Wider responsibilities
I was taken by the news that the UK Government got investment banks to handle its postal service SOE selldown fee-free. In the end, does that make investment banking essentially a rent-seeking excercise? Eminent American economist Robert Shiller is coming to the view that it probably is, and such activity is harmful when it grows. More from Project Syndicate:

In the United States, 7.4% of total compensation of employees in 2012 went to people working in the finance and insurance industries. Whether or not that percentage is too high, the real issue is that the share is even higher among the most educated and accomplished people, whose activities may be economically and socially useless, if not harmful.

We surely need some people in trading and speculation. But how do we know whether we have too many?

To some people, the question is a moral one. Trading against others is regarded as an inherently selfish pursuit, even if it might have indirect societal benefits. But, as economists like to point out, traders and speculators provide a useful service. They sort through information about businesses and (at least some of the time) try to judge their real worth. They are thus helping to allocate society’s resources to the best uses – that is, to the most promising businesses.

But these people’s activities also impose costs on the rest of us. Indeed, a 2011 paper by Patrick Bolton, Tano Santos, and José Scheinkman argues that a significant amount of speculation and deal-making is pure rent-seeking. In other words, it is wasteful activity that achieves nothing more than enabling the collection of rents on items that might otherwise be free.

4. Today's raw market data ...
A quick new-week update:

5. Rude words? Maybe not
Ask David Andolfatto (who is an economist at the St Louis Fed) 'what is a bank?' and he will say "an agency that transforms illiquid assets into liquid payment instruments".

He's been thinking about the new four-letter word in banking, 'rehypothecation'. It's the new version of 'fractional reserve banking' which gets some people upset, especially those who don't actually understand banking. Creating money is what banks do; regulators basically work to keep it properly controlled.

Rehypothecation occurs when a creditor uses the borrower's pledged asset for his own use (e.g., selling it, or using it as collateral for his own borrowing). Rehypothecation plays a big role in the so-called shadow banking sector. The practice is often likened to fractional-reserve banking and is widely blamed for the failure of Lehman Brothers and MF Global; see here.

But just like fractional reserve banking, rehypothecation has its upside.

At each stage in this process, rights over the collateral are passed on to the last creditor in the chain. All previous debts are rendered unsecured; which is to say, the debts are supported by the debtors' desire to maintain their reputational capital. Creditors become more trusting. Is this a bad thing?

6. deja Vu
Pinch me. It's 2013, I'm pretty certain. But some bank regulators are worrying again about bank loan provisions and accounting standards.

Here is the US Comptroller of the Currency, Thomas Curry in a speech last week.

Of course, it is to be expected that banks will release reserves accumulated during difficult times as underwriting standards, loan performance, and the economic climate improve. Given the improvement that has taken place since the financial crisis, releases are certainly warranted. And, to the extent that higher profits enable banks to generate additional capital, they contribute to safety and soundness.

But for some banks, the ease with which the allowance could be repurposed as earnings has proved habit-forming.

Last year we noted a growing disconnect between the pace and magnitude of allowance releases and underlying credit trends.

Of particular concern to us was that significant reserve releases were continuing despite reports from our examiners that credit risk, as I mentioned earlier, was once again on the rise, with relaxed underwriting standards, pricing for risk, and more risk layering. It seemed to us a singularly bad time for banks to be scrimping on their allowances against their loan losses.

7. The New Keynesian liquidity trap
Paul Krugman's Keynesianism get up John Cochrane's nose. So he wrote a paper about why Krugman is wrong; its what academics do. Still, these tiffs can be interesting. This one has some relevance to New Zealand. Our growth is impressing many, but is it just because of the Christchurch quake rebuild? Cochrane has his doubt about its 'goodness'.

I just finished a draft of an academic article, "The New-Keynesian Liquidity Trap"  that might be of interest to blog readers, especially those of you who follow the stimulus wars.

New-Keynesian models produce some stunning predictions of what happens in a "liquidity trap" when interest rates are stuck at zero.  They predict a deep recession. They predict that promises work: "forward guidance," and commitments to keep interest rates low for long periods, with no current action, stimulate the current level of consumption.  Fully-expected future inflation is a good thing. Growth is bad. Deliberate destruction of output, capital, and productivity raise GDP. Throw away the bulldozers, let them use shovels. Or, better, spoons. Hurricanes are good. Government spending, even if financed by current taxation, and even if completely wasted, of the digging ditches and filling them up type, can have huge output multipliers.

Even more puzzling, new-Keynesian models predict that all of this gets worse as prices become more flexible.  Thus, although price stickiness is the central friction keeping the economy from achieving its optimal output, policies that reduce price stickiness would make matters worse.

In short, every law of economics seems to change sign at the zero bound. If gravity itself changed sign and we all started floating away, it would be no less surprising.

And of course, if you read the New York Times, people like me who have any doubts about all this are morons, evil, corrupt, and paid off by some vast right-wing conspiracy to transfer wealth from the poor to the secret conspiracy of hedge fund billionaires.

So I spent some time looking at all this.

8. Chinese milk powder strategy
China may be moving to 'support' a 'national team' approach to developing their own high-end milk powder capacity. They have been shaken by consumer demand for foreign infant formula. The subsequent prosecution of of foreign supplier operating in China may have been a reaction, but those firms do appear to have broken Chinese laws.

Now, recent reports have emerged in the Beijing Times that the Consumer Ministry is looking for a 'national team' or five companies to develop and launch a high-end milk powder brand. Ministry officials have denied that, but confirmed that the Chinese Dairy Industry Association will lead a similar project. Boosting consumer confidence in Chinese milk brands is a key objective.

To gain the techniques and commercial processes, it is likely New Zealand will become a new 'best friend'.

Please email us if you have local knowledge of how this is developing.

The following excerpt is loosely (and unreliably?) translated (via Google Translate) reports from Beijing Times, the China Broadcasting network, and Caijing.com:

Insiders said that local brands have to compete with foreign milk powder, prices, etc. The activities of the foreign milk monopoly on the domestic dairy industry has caused great impact on consumers' trust of local brands. It is not enough to continue as things are, so the state needs to establish and support local brands.

Dairy industry veteran Song Liang has identified four existing producers and one up-and-coming distribution campany to lead these efforts from the top ten local dairy companies.

However, he warns that it may be a 'cruel reality' that without a national effort, local companies may be consigned to occupy a second tier market position.

This morning there has been a brief Reuters report on the same issue.

9. News and entertainment
You obviously spend some time online. But how do you compare with other Kiwis? and how do we compare with Aussies in our media habits?

Is our excess radio just Aucklanders stuck in traffic? (or farmers glued to radioSport?) This data is from Roy Morgan Research as part of their Digital Universe Report.

10. Today's quote
"Car sickness is the feeling you get when the monthly payment is due." unknown