Call on the Government to downsize the country’s bloated civil service


Sheriff: ‘Government bureaucracy has grown so big that it’s not only taking up too much resources but creating many failures in our finance economy

KUALA LUMPUR: One of Malaysia’s former top civil servants has called on the Government to consider downsizing the country’s bloated civil service, while it still can.

Malaysia has the highest civil servants to population ratio in the Asia-Pacific, employing 1.6 million people or 11% of the country’s labour force.

And that could be a problem Malaysia may not be able to sustain if it runs into a financial crisis, said Tan Sri Mohd Sheriff Mohd Kassim, the former Finance Ministry secretary-general and Economic Planning Unit director-general.

He said if the Government was really set on keeping the national deficit at 3%, it needed to look at retrenching employees, particularly in the lower levels of the civil service, to cut spending.

“Government bureaucracy has grown so big that it’s not only taking up too much resources but creating many failures in our finance economy. There are just too many rules and regulations that the public and private sector have to live with,” he told a delegation of economists, politicians and government officials at the Malaysian Economic Association’s forum on public sector governance.

He advised Malaysia to begin downsizing the civil service, “better sooner than later” if it wanted to avoid running the risk of falling into a Greece-like crisis, where the European country had to cut salaries and was unable to pay pensions for its civil service.

Drawing examples from the recent Malaysia Airlines restructuring, where 6,000 people were retrenched, Mohd Sheriff said it was better to let staff go now and compensate them with retrenchment packages while the Government can still afford it.

“It may cost the Government a heavy expenditure now but it is worthwhile to do it now while we can still afford it and not until we are forced into a financial crisis like Greece.

“We don’t want to be in that situation. I think we should do it gradually. It is kinder to do it now with incentives than to suddenly cut their salaries and pensions at a time when they can least afford it,” he said.

Malaysia is expected to spend RM76bil in salaries and allowances for the civil service this year, on top of another RM21bil for pensions. Efficiency and corruption dominated talks on the civil service at the forum, held at Bank Negara’s Sasana Kijang.

Mohd Sheriff, who is also former president of the Malaysian Economic Association, said these issues have been around since his time in the civil service decades ago though not much has changed due to a lack of political will.

In jest, he suggested Malaysia emulate United States President Donald Trump’s idea on downsizing the US civil service by closing down two departments of the Government if it wanted to open another one.

He also suggested that Parliament create a committee to monitor the performance of top civil servants and give them the ability to retrench these officers if they fail to meet their marks.

“In many countries, even Indonesia, they have committees to hold Government leaders to any shortcomings on policy implementations and projects.

“These are the kinds of checks and balance we need to make our civil servants aware that they are being monitored for their work and they can be pulled out at any time,” he said.

Finance Minister II Datuk Johari Abdul Ghani had said Malaysia’s ratio of civil servants is one to 19.37 civilians and that the high number of Government staff had caused expenditures to balloon yearly.

As a comparison, the ratio in Indonesia is 1:110, in China it is 1:108, in Singapore it’s 1:71.4 and in South Korea the ratio is 1:50.

Despite this, Johari said there were no plans to reduce the number of civil servants.

By Nicholas Ccheng The Star

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China cracks down on P2P lending to curb illegal activities


biznews005 CHINA’S P2P INDUSTRY OPERATION

BEIJING: China’s banking regulator issued tough new rules on Wednesday to tighten regulation of the country’s $60 billion peer-to-peer lending sector, which has been dogged by scandals and fraud.

The measures mark the latest attempt by China to reduce risks to the world’s second-largest economy by cleaning up the its rapidly growing but loosely regulated online financial sector.

Peer-to-peer lending (P2P) platforms will not be able to take deposits, nor provide any forms of guarantee for lenders, according to a joint document issued by the China Banking Regulatory Commission (CBRC), Ministry of Public Security, Cyberspace Administration of China, and the Ministry of Industry and Information Technology.

The regulator said some P2P firms were running Ponzi schemes and raising funds illegally, and said it would bar firms from 13 “forbidden” activities.

Under the new rules, P2P firms would not be permitted to sell wealth management products which are popular with many Chinese investors, nor issue asset-backed securities, and must use third party banks as custodians of investor funds, the regulator said.

It added that P2P firms cannot guarantee investment returns nor investment principal, and they would be subjected to higher disclosure requirements.

The regulations follow the April passage of a plan by the State Council, or cabinet, to clean up the non-bank financial sector after rare demonstrations by angry investors stoked fears of social unrest.

The banking regulator is responsible for tightening regulations over P2P, online trust businesses and online consumer finance firms

China’s online P2P lending platforms, which match small business and individual borrowers with retail investors with spare funds, has seen rapid growth in the past two years largely due to the lack of regulatory oversight.

The industry raised more than 400 billion yuan ($60 billion)by November last year, CBRC data showed.

But among the more than 3,600 P2P platforms, more than 1,000 were problematic, the CBRC had said.

The rise of P2P lending was originally seen by the government as a type of financial innovation that could make funds accessible to credit-hungry consumers and small businesses, which continue to struggle to get loans from traditional financial institutions.

Beijing’s hands-off approach to promote the rapid development of the sector, however, led to a large number of high-profile P2P failures, scandals and frauds.

The consequences have devastated many retail investors, who dumped their life-savings into P2P platforms in hopes of receiving double-digit returns, threatening China’s social and financial stability.

Ezubao, once China’s biggest P2P lending platform, turned out to be a Ponzi scheme that solicited 50 billion yuan ($7.5 billion) in less than two years from more than 900,000 retail investors through savvy marketing.

Investor funds were squandered by Ezubao executives on lavish lifestyles. Retail investors are still unable to get back their hard-earned money, and many have blamed Beijing for its lack of regulation and scrutiny. – Reuters

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Why do Chinese think differently from the West?


Sculptures of Confucius with his students are seen near the headquarters office building of Chambroad Holding in Boxing, Shandong Province, China, June 27.PHOTO: REUTERS

We live in an age of science and technology, so strictly speaking science should be able to forecast the future and help us make decisions better. But in this Age of Uncertainty, the best economic models did not predict the global financial crisis.

How did the ancients attempt to make better decisions? They relied on history, their own experience or oracles, astrology or mumbo-jumbo. In a situation of uncertainty, you make decisions on the basis of information that you have, and if don’t have that information, you simply have to consult someone or something you believe in.

Some people turn to old sacred text, such as the Bible, with a priest to interpret what God intends. The Greeks used the Delphic Oracle, dating back to 1,400 BC, whose predictions were in riddles that were interpreted by the female diviners. Divination was then serious business, with astronomers studying the stars for some cosmic order.

Most people think that Chinese philosophy began with Confucius [551-479 BC], but his school became famous because it compiled the existing ancient books into the Five Classics, of which the I Ching (or Book of Change) is one. The problem with any translation of ancient text is that we can never differentiate translations from interpretation. How an ancient text is read depends very much upon the translators’ biases or ignorance. This is why reading of sacred text is always personal.

My own view is that the I Ching deserves to be considered a book of early Chinese science, rather than as a book on divination, considered at best as pseudo-science.

The I Ching comprises two books, an earlier classic dated to roughly 1,000 BC, and an interpretive text written about 400-600 years later. The earlier classic comprises the Eight trigrams, attributed to Fuxi, one of the legendary founders of China, and the 64 hexagrams, reputedly invented by Duke Zhou, one of the founders of the Zhou dynasty. In simple terms, the Eight trigrams simply stand for eight possible situations, from good to bad; whereas the 64 hexagrams stand for 64 possible predictive outcomes. The later text is attributed to Confucius and his disciples, which helps the interpretation of what the hexagrams mean. To use the I Ching for divination or decision purposes, you randomly choose a hexagram and then consult the I Ching for what it means.

Herein lies a fundamental difference in decision making between Western science and the Chinese approach to life.

Science developed in the West partly because of the alphabetic language, derived from the Arabs, which means that you can define words and meaning much more precisely, since the English language comprises today over a million words. As the philosopher Wittgenstein argued, all concepts are defined by language.

The Chinese language, on the other hand, is basically ideogramatic and phonetic, meaning that each character comprises radicals that originally were pictures. For example, the character for man can easily be identified as a drawing of a standing man. Because there are limited sounds for each character, each character carries four or five tones, and complex words comprise combinations of different characters. Most people can read basic Chinese with about two to three thousand characters, with the maximum number of characters being roughly 50,000. Complex words are combinations of two or three characters.

Given limited sounds, tones and characters, the Chinese language is not as precise as English. A single character can have different meanings and different sounds, so that Chinese words and phrases can only be understood in context. So when I hear a Chinese speak, I often have to ask in what context is that particular sound/word being used? In other words, we have to add contextual information in order to interpret the meaning of what is being said.

Western science, following the Aristolean logic, is essentially reductionist and linear, seeking cause and effect. The language enables the conceptualisation to be precise and the logic flow to be consistent. The imprecision inherent in the Chinese language means that conceptual thinking is more organic and fluid, and subject to interpretation, including guessing.

In other words, whilst natural sciences could be more precise in communication between two machines, the communication between two human beings carry a huge amount of uncertainty. The social sciences are much more qualitative because one human being cannot by definition fully comprehend the other person’s life experience, values and preferences. Uncertainty is built into the social sciences.

Modern economics dealt with this problem by assuming perfect information, which actually assumed away uncertainty. Economic models based on such perfect information and rational players (mechanical decision-making) gave rise to precise or “optimal”, first-best outcomes. The first best ideal is then thought to be a natural outcome, and life will simply revert back to equilibrium or a stable situation.

Real life is obviously not so simple. The eight trigrams mean that in binary good and bad or black and white terms, there are eight possible outcomes in any decision: good, bad and six mixtures of good/bad. The 64 hexagrams makes life even more complicated, since black and white are only two possible manifestations of any system, the rest being 62 shades of grey (mixture of black and white).

By definition, any fundamentalist view of life is more likely to be wrong, because life is mostly shades of grey.

The best games that illustrates this difference between Western and Chinese thinking are the games of chess and Go (weiqi). Chess has defined linear moves with six types of pieces. It forces one to think logically and sequentially. Go comprises only black and white pieces, but the player has to think spatially, playing the piece in any position on the board, continually trying to outguess the other player.

Without understanding these fundamental differences in language, context and decision-making under uncertainty, it would be difficult to bridge the yawning gap between both sides of the Pacific. It also means that the Chinese approach to economics and geo-politics will be quite different than is more commonly interpreted outside China.

By Andrew Sheng, Asia News Network

The writer, a Distinguished Fellow with the Asia Global Institute, writes on global issues from an Asian perspective.

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The Age of Uncertainty


We are entering the age of dealing with unknown unknowns – as Brexit and Turkey’s failed coup show

The dark future of Europe

THE Age of Uncertainty is a book and BBC series by the late Harvard economist John Kenneth Galbraith, produced in 1977, about how we have moved from the age of certainty in 19th century economic thought to a present that is full of unknowns.

I still remember asking my economics professor what he thought of Galbraith, one of the most widely read economists and social commentator of his time. His answer was that Galbraith’s version of economics was too eclectic and wide-ranging. It was not where mainstream economics – pumped up by the promise of quantitative models and mathematics – was going.

Forty years later, it is likely that Galbraith’s vision of the future was more prescient than that of Milton Friedman, the leading light of free market economics – which promised more than it could deliver. The utopia of free markets, where rational man would deliver the most efficient public good from individual greed turned out to be exactly the opposite – the greatest social inequities with grave uncertainties of the future. Galbraith said, “wealth is the relentless enemy of understanding”. Perhaps he meant that poverty and necessity was the driver of change, if not of revolution.

The economics profession was always slightly confused over the difference between risk and uncertainty, as if the former included the latter. The economist Frank Knight (they don’t make economists like that anymore) clarified the difference as follows – risk is measurable and uncertainty is not. Quantitative economists then defined risk as measurable volatility – the amount that a variable like price fluctuated around its historical average.

The bell-shaped statistical curve that forms the conventional risk model used widely in economics assumes that there is 95% probability that fluctuations of price would be two standard deviations from the average or mean.

For non-technically minded, a standard deviation is a measure of the variance or dispersion around the mean, meaning that a “normal” fluctuation would be less than two; so if the standard deviation is say 5%, we would not expect more than 10% price fluctuation 95% of the time.

Events like Brexit shock us because the event gave rise to huge uncertainties over the future. Most experts did not expect Brexit – the variance was more than the normal. It was a reversal of a British decision to join the European Union, a five or more standard deviation event – in which the decision is a 180 degree turn. The conventional risk management models, which are essentially linear models that say that going forward or sequentially, the projected risk is up or down, simply did not factor in a reversal of decision.

In other words, we have moved from an age of risk to an age of uncertainty – where we are dealing with unknown unknowns.

There are of course different categories of unknowns – known unknowns (things that we know that we do not know), calculable unknowns (which we can estimate or know something about through Big Data) and the last, we simply do not know what we may never know.

Big Data is the fashionable phrase for churning lots of data to find out where there are correlations. The cost of big computing power is coming down but you would still have to have big databases to access that information or prediction. Most individuals like you and me would simply have to use our instincts or rely on experts to make that prediction or decision. Brexit told us that many experts are simply wrong. Experts are those who can convincingly explain why they are wrong, but they may not be better in predicting the future than monkeys throwing darts.


Five factors

There are five current factors that add up to considerable uncertainty – geopolitics, climate change, technology, unconventional monetary policy and creative destruction.

First, Brexit and the Turkish coup are geo-political events that change the course of history. In its latest forecasts on the world economy, the IMF has called Brexit “the spanner in the works” that may slow growth further. But Brexit was a decision made because the British are concerned more about immigration than nickels and dimes from Brussels. This is connected to the second factor, climate change.

Global warming is the second major unknown, because we are already feeling the impact of warmer weather, unpredictable storms and droughts. Historically, dynastic collapses have been associated with major climate change, such as the droughts that caused the disappearance of the Angkor Wat and Mayan cultures. Iraq, Afghanistan, Syria, Sudan and all are failing states because they are water-stressed. If North Africa and the Middle East continue to face major water-stress and social upheaval, expect more than 1 million refugees to flood northwards to Europe where it is cooller and welfare benefits are better.

The third disruptor is technology, which brings wondrous new inventions like bio-technology, Internet and robotics, but also concerns such as loss of jobs and genetic accidents.

Fourthly, unconventional monetary policy has already breached the theoretical boundaries of negative interest rates, where no one, least of all the central bankers that push on this piece of string, fully appreciate how negative interest rates is destroying the business model of finance, from banks to asset managers.

Last but not least, the Austrian economist Schumpeter lauded innovation and entrepreneurship as the engine of capitalism, through what he called creative destruction. We all support innovation, but change always bring about losses to the status quo. Technology disrupts traditional industries, and those disappearing industries will create loss in jobs, large non-performing loans and assets that will have no value.

Change is not always a zero-sum game, where one person’s gain is another’s loss. It is good when it is a win-win game; but with lack of leadership, it can easily deteriorate into a lose-lose game. That is the scary side of unknown unknowns.

I shall elaborate on how ancient Asians coped with change in the next article.

By Tan Sri Andrew Sheng

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The global mahjong winner’s curse


There is grave concern that the world economy is slipping into what Harvard professor and former US Treasury Secretary Larry Summers calls the global secular deflation. In simple terms, growth has slowed without inflation, despite exceptionally stimulative monetary policy. Larry’s view is that the advanced countries can use fiscal policy to stimulate growth, using massive investments in infrastructure. If needs be, this can be financed by central banks.

Central bank financing fiscal deficits is technically called “helicopter money”, named by the late monetarist economist Milton Friedman as the central bank pushing money out of the helicopter. Strict monetarism thinks that this would cause inflation.

The simple reason why the world is moving into secular deflation is that the largest economies are all slowing for a variety of reasons. Unconventional monetary policy applied since the 2007 crisis has brought central bank interest rates to zero or negative terms in economies accounting for 60% of world GDP.

Most economists blame current slow growth to “lack of aggregate demand” or “excess of aggregate production”. The rich countries are mostly aging and already heavily burdened with debt, so they cannot consume more. After the 2007 global financial crisis, the emerging market economies have slowed down, as demand for their exports have slowed. We are in a vicious circle where global trade growth is now slower than GDP growth, because the US economy is no longer the consumption engine of last resort. China, which has been a huge consumer of commodities, has slowed. Japanese growth has been flat due to an aging population. European growth has not recovered, partly because the leading economy, Germany, calls for austerity by its southern partners.

The Brexit shock threatens to weaken global confidence and send growth down another notch.

Former Bank of England Governor Lord Mervyn King famously called the global monetary order a game of sodoku, in which national current accounts in the balance of payments add up to a zero sum game. This is because in the global trade game, one country’s current account deficit is another country’s surplus. In the past, if the US runs larger and larger current account deficits, world growth is stimulated because everyone wants to hold dollars and has been willing to supply the US with all manners of consumer goods. This has been called an “exorbitant privilege” for the dollar.

The present global monetary order or non-order is a result of the 1971 US dollar de-link from gold, which gave rise to a phase of floating exchange rates and rising capital flows, which some people call Bretton Woods II. The old order, set at the Bretton Wood Conference of 1944, centered around a system of global fixed exchange rates, based on the US dollar link with gold price at US$35 to one ounce of gold.

But flexible exchange rates has resulted in a system where everyone seems to be devaluing their way out of trouble. Has the global secular deflation something to do with Bretton Woods II?

My answer must be yes. The reason lies in what I call, instead of sodoku, the mahjong winner’s curse. The Chinese game of mahjong has four players with a limited number of chips. If one player is the persistent winner, he or she ends up with all the chips and the game stops. Since the global game of trade cannot stop, the winner has both an exorbitant privilege (of being funded by the others) and an exorbitant curse (of bearing the loss if the others won’t or refuse to pay). To keep the game going, the winner has to give or lend the chips back to the other players, who play with the hope of winning the next round.

Indeed, if the winner is generous, the game can be made bigger, because the winner can issue more chips (defined as a reserve currency), which the others are more than willing to borrow and play.

The current world situation is that the Winners are the four reserve currency countries, the dollar, euro, yen and sterling, all of which have interest rates near zero or even negative. Until recently, the Winners blame China and the oil producing countries as having too high current account surpluses. But recently, after the huge European cutback in expenditure, Europe as a whole is the world’s largest current account surplus group of nearly 5% of GDP.

Herein lies the winner’s curse. The emerging markets should be able to stimulate global growth, but are unwilling to run larger current account deficits because they cannot get financing. The richer economies can stimulate global growth, but they are unwilling to do so, because they either feel that they already have too much debt or because they worry that stimulus would lead to inflation.

However, reserve currency countries have an advantage. As long as they are willing to run current account deficits, there will be little inflation because the world economy has huge excess capacity and surplus savings. If emerging markets run higher current account deficits, they will have to depreciate, which is exactly what Brazil, South Africa and others have done.

The winner’s curse is that if Europe is now unwilling to reflate and spend, the world will continue to slow. Indeed, in a world of greater geo-political risks, money is fleeing to the US dollar and the yen, causing both to appreciate.

What these capital flows into the reserve currencies when their interest rate is zero and they are unable to reflate imply is that the dollar and yen play the deflationary role of gold in the 1930s. As more and more mahjong players hold gold and don’t spend, the world global trade and growth game slows further. The mahjong winner’s curse requires the winners to stimulate and spend, bearing higher credit risks. That’s the privilege and responsibility of winners in the global game. If not, look out for more global secular deflation.

By Tan Sri Andrew Sheng who writes on global issues from an Asian perspective.

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Dealing with the new abnormal negative interest rate policies with exceptional high debt


Negative rates: ECB president Mario Draghi at the Brussels Economic Forum on Thursday. The ECB and Bank of Japan are already experimenting with negative interest rate policies. – Reuters
HOW can this be normal?

Twenty-nine countries with roughly 60% of the world’s GDP have monetary policy rates of less than 1% per annum. The world is awash with debt, with sovereign, corporate and household debt of over US$230 trillion or roughly three times world GDP.

To finance their large debt and deal with deflation, both the European Central Bank (ECB) and Bank of Japan are already experimenting with negative interest rate policies (NIRP). If these do not work, look out for helicopter money, which means central bank funding of even larger fiscal deficits.

Either way, at near zero interest rates, the business model of banks, insurers and fund managers are broken. Deutschebank’s CEO has recently warned that European bank profits will struggle more as negative interest rates play into deposit rates. No wonder bank shares are trading below book value.

The problem with the current economic analysis is that no one can ascertain whether exceptionally low interest is a symptom or a cause of deep chronic malaise. Exceptionally high debt burden can only be financed by exceptionally low interest rates. The Fed now feels confident enough to raise interest rates, which means that the US asset bubbles will begin to deflate, spelling trouble to those who borrow too much in US dollars, which would include a number of emerging markets.

As Nomura chief economist Richard Koo asserts, the world has followed Japan into a balance sheet recession, with the corporate sector refusing to invest and consumer/savers too worried about outcomes to spend. The solution to a balance sheet (imbalanced) story is to re-write the balance sheet, which most democratic government cannot do without a financial crisis. 

Like Japan, China’s dilemma is an internal debt issue of left hand owing the right hand, since both countries are net lenders to the world. This means that foreigners cannot trigger a crisis by withdrawing funds. The Chinese national balance sheet is also almost unique because the financial system is largely state-owned lending mostly (about two thirds) to state-owned enterprises or local governments. The Chinese household sector is also lowly geared, with most debt in residential mortgages and even these were bought (until recently) with relatively high equity cushions.

Unlike the US federal government which had a net liability of US$11 trillion or 67% of GDP at the end of 2013, the Chinese central government had net assets of US$4 trillion or 42% of GDP. Chinese local governments had net assets of a further US$11 trillion or 123% of GDP, compared to US local government net assets of 45% of GDP. Local governments hold more assets than central or federal government because most state land and buildings belong to provincial or local authorities.

Thus, unlike the US where households own 95% of net assets in the country, Chinese households own roughly half of national net assets, with the corporate sector (at least half of which is state-owned) owning roughly 30% and the state the balance. In total, the Chinese state owns roughly one-third of the net assets within the country, compared to net 4% for the US federal and state governments.

Sceptics would argue that Chinese statistics are overstated, but even if the Chinese state net assets are halved in value (because land valuation is complicated), there would be at least US$7.5 trillion of state net assets (net of liabilities) or 82% of GDP to deal with any contingencies.

Furthermore, unlike the Fed, ECB or Bank of Japan, the People’s Bank of China derives its monetary power mostly from very high levels of statutory reserves on the banking system, which is equivalent to forced savings to finance its foreign exchange reserves of US$3.2 trillion. Thus, the central bank has more room than other central banks to deal with domestic liquidity issues.

What can be done with this high level of state net assets, which is in essence public wealth? My crude estimate is that if the rate of return on such assets can be improved by 1% under professional management, GDP could be increased by at least 1.5 percentage points (1% on 165% of GDP of net state assets).

How can this re-writing of the balance sheet be achieved? There are two possibilities. One is to allow local governments to use their net assets to deleverage their own local government debt and their own state-owned enterprise debt. This could be achieved through professionally managed provincial level asset management/debt restructuring companies.

The second method is inject some of the state net assets into the national and provincial social security funds as a form of returning state assets to the public. People tend to forget that other than the painful restructuring of state-owned enterprises in the late 1990s, which led to the creation of China’s global supply chain, the single largest measure to create Chinese household wealth was the selling of residential property at below market prices to civil servants.

The size of the wealth transfer was never officially calculated, but it paved the way for boosting of domestic consumption by giving many households the beginnings of household security.

The injection of state assets into national and social security funds was not achieved in the 1990s, because the state of provincial social security fund accounting was not ready. But if China wants to boost domestic consumption and improve healthcare and social security, now is the time to use state assets to inject into such funds.

At the end of 2014, Chinese social security fund assets amounted to 4 trillion yuan, compared with central government net assets of 27 trillion yuan (Chinese Academy of Social Science data, 2015). Hence, the injection of state assets (including injection by provincial and local government) into social security funds as a form of stimulus to domestic consumption and more professional management of public wealth is clearly an affordable policy option.

In sum, at the individual borrower level, there is no doubt an ever increasing leverage ratio in China is not sustainable. But the big picture situation is manageable. If the policy objective is to improve overall productivity (and GDP growth) by improving the output of public assets, the timing is now.

By Tan Sri Andrew Sheng who is Distinguished Fellow, Asia Global Institute, University of Hong Kong.

 

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How do we get out of the debt trap without printing more money?


The policy options open to major economies, including China, to reduce debt, before another global crisis hits

ALL of us are worried about growing global debt as a precursor to another round of crises. After the last global financial crisis, 2007-2009, global debt rose to more than US$200 trillion or US$27,000 for each person in the world.

Since 2.8 billion or nearly 40% live on US$2 per day, there is no way that the debt can ever be repaid. The bulk of debt owed by governments, banks and companies will be repaid by creating more debt.

If we are happy to create money, we should be happy to create more debt. Right?

Wrong. The right question is not the size of the debt or liability, but where is the net asset? Individually, we can always repay the debt if we spend less than what we earn, or invested in an asset that generates sufficient income to pay the interest.

Collectively, the government can always borrow to repay, because it can always tax to repay, if not principal, at least on the interest. Countries only get into trouble when they owe foreigners and cannot raise enough foreign exchange to repay their debt.

Charles Goodhart, Emeritus Professor at London School of Economics and one of the foremost thinkers on money and banking has written a series of important articles for Morgan Stanley, analysing the current debt crisis.


Emerging markets

The reason we ended up with more debt than ever is due to three factors since 1970 – the willingness of the financial sector to lend, the increase in global savings relative to investment and the demand for safe assets. Professor Goodhart attributed the structural increase in savings to favourable demographics in the last forty years – particularly as emerging markets like China increased their savings from growth in their labour force that engaged in international trade.

The increase in savings relative to investments created a global savings glut, which meant lower real interest rates.

The willingness of emerging markets to park their excess savings in advanced countries in the form of official reserves and the banks willing to extend credit at lower interest rates created the boom in financialisation. Lower interest rates encouraged speculative activity (funded by debt) rather than investments in long-term productive projects.

When the bust occurred, the advanced central banks wanted to avoid a debt implosion and added to the bubble by lowering interest rates and flooded the markets with short-term liquidity.

The quantitative easing (QE) stopped the widening of the crisis, but its initial success enabled politicians to avoid taking tough action in structural reforms. The result was further slower growth from declining productivity, even as companies and governments continued to borrow, affordable only at near zero interest rates. In short, we are in a debt trap – more debt, little growth.

 

 

Negative interest rates as a policy tool was invented by small countries like Sweden and Switzerland to discourage large capital inflows that created excessive currency appreciation.

But for the eurozone and Japan to try that would actually destroy their banks’ profitability, which is why bank shares dropped after these were introduced. If banks think they will lose money, they will cut back lending to the real sector further, negating the objective of QE to stimulate growth. Banks receiving QE funds faced the double prospect of being punished for taking credit risks and also the need to increase both capital and liquidity due to the tighter bank regulations.

Helicopter money

Helicopter money is not about central bankers jumping out of helicopters to atone for their mistakes, but about central bank financing a massive increase in fiscal expenditure – truly monetary creation on a large scale. If this happens, watch out for a rise in gold prices.

Prof Goodhart has carefully analysed the three options for deleverging or getting out of the debt trap. The first is to deleverge by swapping debt for equity, being tried by China.

This is feasible when the country is a net lender and both borrowers and lenders are state-owned entities. The second option is to use inflation to reduce the real value of debt. As the recent experience showed, getting inflation even up to target was tough to achieve.

The third option is to address collateral by inducing lenders and borrowers to renegotiate their debt or make the debt permanent. This is both painful and difficult and is unlikely to be adopted unless other options are tried.

China’s banking regulator moves to contain off-balance-sheet risk

In my view, the true result of the Bank of Japan’s negative interest rates is a tax on the older generation, because they are the ones not spending.

Japan tried Keynesian fiscal spending, which failed to sustain growth but created a huge debt overhang.

The Japanese older generation and the corporate sector keeps on saving because they are worried about the future, not surprising given an aging population and sluggish demand for exports.

So if you can’t increase the inflation tax, or corporate taxation to reduce the fiscal debt, use negative interest rates to reduce the value of savings of retirees and the corporate sector. Only Japanese savers would not revolt under such inequity.

For countries that have net savings and large public assets, like China, there is a fourth option to get out of the debt trap, and that is to re-write the national balance sheet. Most foreign analysts who worry about China’s debt overhang forget that after three decades of growth, the Chinese state has also accummulated net assets (net of all liabilities) equivalent to 166% of GDP.

That can be injected as equity into the overleveraged enterprises and banks if and only if the governance and return on assets can be improved under better management.

In the short-run, a clean-up of the over-leveraged enterprise sector and local government debt, embedded in the official and shadow banking system, will help sustain long-run stable growth. How to do this technically will be explained in the next article.

By Tan Sri Andrew Sheng who writes on global affairs from an Asian perspective.

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