Research Paper: "Economics in the Backyard"

This paper by Hughes Hallet and Richter looks at a series of interesting questions related to the Chinese integration of Hong Kong (and indirectly Taiwan).

These results reinforce some of my own previous results. The results are as expected. It is always useful to have ones intuition verified.

Economics in the Backyard: How Much Convergence is there between China and her Special Regions?

Andrew Hughes Hallett 1 and Christian Richter 2
1 George Mason University, University of St Andrews and CEPR; School of Public Policy, Fairfax, USA , and 2 School of Economics, Kingston University, UK

ABSTRACT

This paper tests the hypothesis that the links and dependency relationships between China and her special regions have changed over the past 20 years with the industrialisation of China, and the emergence of Taiwan as a source of investment and sophisticated manufactures, and Hong Kong as financial centre and supplier of services. Has this changed the size and direction of spillovers in the region, and has it curtailed or eliminated American economic leadership? We use time-varying spectral methods to decompose the links between six advanced Asian economies and the US. We find: (a) the links with the US have been weakening, while those within a bloc based on China have strengthened; (b) that this is not new – it has been happening since the 1980s, but has now been reversed by the surge in trade; (c) that Taiwan is more integrated with, and dependent on, the Chinese economy, while Hong Kong continues her separate development based on specialisation and comparative advantage; (d) that the links with the US are rather complex, with the US able to shape the cycles elsewhere through her control of monetary conditions, but the China zone able to control the size of their cycles; and (e) there appears to be no real evidence that pegged exchange rates encourage convergence; in fact the reverse may be true.

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Chinese company results - does anyone believe the numbers?

I am glad it not just me. This Chinese stock market rose and then fell and is beginning to climb again.

First, it should never have risen so high (we have previously covered why it did so).

Second, it should have fallen further (and may still do so).

Third, the recent rally will not last.

My personal worries again relate to what Chinese companies are reporting. I have had my doubts and this links in with my view that I simply do not believe the data that these companies are reporting.

It was reassuring therefore to see that the Economist has picked up on this and about time.

The issue of Chinese subsidies is very important. This is the mother of all stimulus packages and it is clearly helping companies survive but to what cost and to what end?

It is tempting to take a large short position on China at the moment.

Red flags [Economist]

CHINA’S stockmarket has been one of the best performing in the world this year, and the country’s firms have so far steered through the global financial crisis better than many of their global peers. Partly they may have been buoyed by robust business conditions in China. But two recent studies, which raise serious questions about the credibility of China’s corporate earnings, suggest that companies may also have had an artificial boost.

The less damning of the two is issued under the auspices of the Hong Kong Monetary Authority and written by Giovanni Ferri, of Italy’s University of Bari, and Li-Gang Liu of BBVA, a bank. It argues that the profits of China’s large state-owned companies are entirely a product of subsidised financing by state banks, which lets them borrow much more cheaply than private or foreign firms (see chart).

To reach that conclusion the authors sifted through government data from 1999-2005. Mr Liu believes that such subsidies may have even increased since last summer, because the big state-owned enterprises have been the main beneficiaries of China’s economic stimulus. In the short term the subsidies will have boosted profits, not least compared with the firms’ credit-starved private peers. But in the longer term Mr Liu believes that the political component of the loans will mean capital is being allocated inefficiently, raising the prospect of future losses.

At least the academics are convinced that the profits are genuine, even if they are subsidised. But an exhaustive working paper by TJ Wong and Danqing Young, of the Chinese University of Hong Kong, and Xianjie He, of Shanghai University of Finance and Economics, reaches a more alarming conclusion. It suggests investors have little faith in the numbers.

To measure this they looked at Chinese firms before and after the country broke with its accounting traditions in 2007, adopting something akin to international accounting standards, which base valuations on market prices. They then dissected earnings in three ways. First, they compared how shifts in earnings correlated with shifts in share prices under the old accounting system and the new. An improvement in accounting practices should have meant a closer correlation between earnings and the performance of the share price. Not only did this not happen—there were some signs that things got worse.

Nor were there correlations between the share price and the shift in reported value of investment instruments, goodwill and the impairment of assets—all typically critical to an investor’s analysis. Lastly, the academics examined a nuance in the new standards that allowed Chinese firms to book profits by restructuring debt that was owed to affiliated companies. Before the change in accounting standards, this kind of debt restructuring was rare. Afterwards, it was common: more than 200 companies, or over 15% of those in the study, did it in 2007. This resulted in clear gains to earnings but no impact on share prices. So is there anything in the company reports that investors do consider to be meaningful? That, says Mr Wong, is the subject of the next study.

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"Unfair West" threatens climate change progress

Apologies for a lack of recent posting. My senior academic management role is taking up more time that I initially expected. Fire fighting is almost under control now though so hopefully normal service can resume. I have missed some big stories but hope to recap some of them soon.

We begin with a return to the climate change problem. China has a lot to do but the government will is there. Of course this is largely a result of self interest - China is a country that is likely to suffer the brunt of climate change on its economy and environment.

Whilst the EU is doing a fair amount the US is still dragging its feet. Obama is trying but facing the brick wall of congress who are paid by the large lobby groups. Is this how democracy is supposed to work?

Yu is correct to state that it is a matter of political will in the West. The recession and current crisis (that will surely get worse) means this "will" will be in short supply.

INTERVIEW-China to act on climate, warns of "unfair" demands [Reuters]

BONN, Germany, June 2 (Reuters) - China promised on Tuesday to step up actions to fight climate change and cautioned that "unfair" new demands by rich nations could sabotage a new U.N. treaty due to be agreed in December.

"We will continue to focus on the improvement of energy efficiency, expansion of the use of renewable energy, more use of nuclear power and on reforestation," China's climate ambassador Yu Qingtai told Reuters of long-term plans beyond 2010.

And he said China was already doing a lot.

"We are pretty certain that our track record would not pale against anybody else in the world," he said on the sidelines of June 1-12 U.N. climate talks among 181 nations in Bonn.

He said China, for instance, was seeking to raise efficiency by cutting the amount of energy burnt per unit of economic output by 4 percent a year.

Washington says that China, which by most estimates has overtaken the United States as the top emitter of greenhouse gases, must do more to fight climate change under a U.N. pact due to be agreed in December in Copenhagen.

But Yu accused rich nations of introducing proposals that go beyond a roadmap for U.N. negotiations agreed in Bali in 2007.

"Copenhagen is only six months away -- instead of introducing new concepts, controversial concepts, unfair concepts, the world would be better served if we could focus on what is already agreed upon in the Bali roadmap," he said.

"If you start (questioning agreed principles), that can only meant that countries are not serious about future international cooperation. They are trying to create problems to sabotage the whole process," he said.

SINGAPORE Many developed nations, for instance, want a new yardstick that would redefine the existing group of 130 developing nations and demand more actions by the wealthier developing countries in slowing global warming.

Countries in the group of developing nations at the U.N. talks such as Singapore or the United Arab Emirates are wealthier per capita than many countries which have to cut emissions under the existing Kyoto Protocol.

"That would definitely not succeed," Yu said of an effort to redefine developing nations.

He said a 1992 U.N. Climate Convention made a basic split between nations that have caused climate change since the Industrial Revolution 200 years ago and victims -- including those that have recently become rich or major emitters.

Yu said that China's rejection of a new sliding scale did not mean however that all developing countries were able to do the same to slow climate change, such as more droughts, floods and rising seas. Under a separate principle, national circumstances vary. "We are aware that, as a country of 1.3 billion people, as a country that has enjoyed an impressive growth rate, we can do a lot more than a least developed country with a couple of million population," he said.

He said rich nations should focus on keeping pledges to curb greenhouse gases rather than place new demands on the poor. China wants the rich to cut emissions by at least 40 percent below 1990 levels by 2020 -- far deeper than cuts on offer.

A study by the Potsdam Institute for Climate Impact Research on Monday showed that promises by the rich so far amount to cuts of between 8 and 14 percent by 2020.

Asked if 40 percent was realistic when many nations say it would cripple their recession-racked economies, Yu said, "If there is political will...they can certainly do better than 8 or 14 percent. It is basically a question of political will."

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"Dollar Trap" snaps shut

One of the most intriguing political games being played out at the moment is the ongoing "death grip" between China and US over China's massive (and growing) holdings of US paper.

Both countries stand to suffer massive losses if either country deviates off the current, unsustainable path. How China and the US can get out of this is not clear to me but the only answer I can see if for there be a slow unwinding of positions over 5 to 10 years. Speculators will not make this easy.

I happen to believe the dollar will come under increasing pressure and opens up some interesting futures trading opportunities although there are other good FEX deals out there at the moment (on which more another day).

Stick the following title into google to read the whole story.

China Stuck in "dollar" trap [FT]

"China's official foreign exchange manager is still buying record amounts of US government bonds, in spite of Beijing's increasingly vocal fear of a dollar collapse".

The article goes on to say that China has little choice but to keep buying US paper. It is in a dollar trap. The massive volumes involved means that Chinese buying of any other currency would distort the market. Likewise, selling dollars would cause a collapse in the dollar.

I suspect Chinese outbound FDI will increase with less emphasis on US paper but this will be a long process. Look what happened to Japan when it went down this route in the early 90s.

China is overextending itself and its expertise.

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UK's ONS gets retail figures wrong

OK, hands up. I have criticised the reliability of Chinese data regularly on this blog to the extent that I do not believe a lot of the published Chinese macro data.

Interestingly, I did wonder about the robust UK retail numbers that were coming out of the ONS in the UK. Surely UK statistics can be trusted. Surely.

Only now do we get the truth. How hard can it be - honestly. OVERSTATED by 56% - that is simply dreadful.

It is becoming clear that this financial crisis is great for getting the world back on a more realistic track - the party is over - we now need to clear up the mess left behind.

Heads should roll at the ONS. China's statistical office can still learn a lot from this sort of misguided confidence that the head of the ONS showed in their own ability to collect a simple series of data.

There is political capital from posting wrong numbers whether it is to convince a domestic or overseas audience.

ONS gets sums wrong on retail sales [FT]

One of Britain’s most closely watched economic indicators has heavily overstated the quantity of high street sales over the past two years, the Office for National Statistics admitted on Friday.

Britain’s supplier of official statistics conceded that since the financial crisis began in August 2007, it has overstated the volume of retail sales growth by 56 per cent.

Many economists have been worried for some time that the published retail sales figures were too strong and have always received a furious response from the ONS.

Karen Dunnell, the national statistician, wrote to newspapers last October, insisting that “ONS retail statistics are the best available and are not inaccurate”.

She stuck to the same theme in another article, saying economists who had expressed surprise at the strength of ONS retail figures were upset because “City analysts also have a vested interest in not being proved wrong”.

Yet while the ONS head was defending the accuracy of the retail figures, industry experts knew the outdated nature of price measurement in the retail sales index was much more than a triviality.

The ONS previously said that between August 2007 and March 2009 retail sales volume grew 3.6 per cent. The changes announced on Friday mean it will now say the real rise in sales volumes was only 2.3 per cent.

Such a large difference in the one indicator that has persistently given a more positive account of Britain’s economy will cause red faces at the ONS, especially as it had insisted on the superiority of its retail data to unofficial estimates.

So confident has the ONS been that it warns users of the CBI or the British Retail Consortium sales data every month that these figures might not be “fit for purpose”.

The BRC on Friday welcomed the changes, saying they meant the official data would now be more in line with its figures.

The ONS’s old methodology failed to take sufficient account of goods that had risen strongly in price and so under-estimated the true rate of inflation in calculating the headline retail sales volume figures.

The ONS said on Friday it was changing the way it compiled its retail sales data to make sure it “more accurately captures recent trends in retail sales, including where consumers switch purchases to goods that have fallen in price’’.

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"Manchurian Paradox" - Can China see the wood for the trees?

Thanks to a comment on this blog directing me to an article by Stephen Roach who is the chairman of Morgan Stanley Asia.

It raises some interesting points. This is a long article. Highlights only below.

I agree entirely - I do not think that China sees the danger it is getting itself into. They are simply too optimistic. Having not experienced how ugly capitalism can get they are walking into a whole pile of trouble.

It is reassuring to read that I am not the only one who is calling that the emperor has no clothes.

Manchurian Paradox [The National Interest Online]

THE CHINESE word for crisis, weiji, includes elements of both danger and opportunity. This symbolic meaning has taken on especially great significance in recent years. The emergence of modern China as a global economic power can, in fact, be dated to the nation’s willingness to seize critical moments of adversity. That was very much the case during the Asian financial crisis of 1997–98, which marked a critical turning point in the ascendance of China as a major economic power. And it could also be the case today.

But there is an important catch: unlike earlier crises, it is not altogether clear that China senses the gravity of the current danger. That leaves it caught in something much closer to denial—making it difficult to seize the opportunity that peril can provide.

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There is nothing wrong with China’s gathering sense of self-confidence and its concomitant contribution to the global debate. In fact, it is to be encouraged. China has earned its place at the table. For a nation steeped in five thousand years of inward-looking experience, China is looking outward as never before. The world can only benefit from this sea change. But that underscores the biggest danger of all—the risk that China takes its newfound external dependence too far and ignores the lasting and serious pitfalls of a postcrisis world. If it fails to rebalance its unbalanced economy, China’s power play could be surprisingly fleeting.

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"Sickness of Savers in China"

Excellent piece on the FT on the role of health care provision in China and the link with savings.

This problem has been clear for the last ten years. Chinese consumers will not save the global economy when the social security and health care provision is so poor. The Chinese need to save such a large percentage for education, old age and health care.

Improving health care will help but it is only one part of the jigsaw. I disagree that the savings problem is primarily health related. Education I would argue is far more important. A well employed son or daughter can then pay the health bills of the parents in later life.

Sickness of the savers [FT]

China’s economy has turned the corner. Government banks have been lending at a rapid rate, factory output is rising again and the local stock market is blazing ahead. But just how quickly the world’s most populous country emerges from the global economic crisis will depend, in part, on places such as the cancer ward of Jingdong hospital in Sanhe, not far from Beijing, and how they treat patients like Cao Jun.

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If the US economy stored up problems for itself through consuming too much, China has distorted its economy by saving too much and spending too little. In recent years, the savings rate has risen as high as 50 per cent of gross domestic product, including the retained earnings of state-owned companies, and even families with incomes of less than $200 a year still save 18 per cent of their income, according to the World Bank.

One of the main underlying causes is the weakness of the social safety net. Many Chinese put a large chunk of their wages into bank accounts because they are worried about pensions, education expenses and – most of all – the prospect of a big hospital bill if a family member falls seriously ill.

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