On Political Risk

PINR: As China and the United States Compete for Influence in Central Asia, the Xinjiang Region becomes an Area Strategic Interest

Here's a piece that I wrote for PINR (no longer online) back in 2004 on Xinjiang's strategic position.  Since the riots are casting a spotlight on the region again, I thought it might be worth re-posting, even if much of the context has changed (Russia-China no longer in lock-step on Central Asia, U.S. re-engaging in Afghanistan, etc.).

From the collapse of the Soviet Union until September 11, 2001, China was able to successfully use its security concerns within the Xinjiang Uigher Autonomous Region to build alliances with the newly formed states of Central Asia.  Russia’s domestic concerns and the U.S.’s focus on fostering democratic principles in the fresh nations allowed China to form multilateral organizations favorable to its concerns and establish economic ties with its western neighboring states.  These conditions were of great importance to Beijing’s strategies for containing separatist movements within Xinjiang, but following the attacks of September 11, 2001, the U.S. reengaged Central Asia and overpowered the multilateral agreements that China had established.

China’s attempts to adapt to the new environment initially met with mixed results.  Beijing attempted to link the Xinjiang separatists to the U.S.’s “war on terror,” but even after a Uigher militant group was placed on the official U.S. of terrorist organizations, Washington was generally cool to China’s claims.  Recently, China has been moving to reestablish the economic and cooperative security ties that it previously established with Russia, Tajikistan, Kazakhstan, Kyrgyzstan and Uzbekistan in order to contain the Uigher militants, reinforce Beijing’s claim over the Xinjiang region and to prevents a strategic “encircling” by the United States.  Russia’s situation in Chechnya has prevented Moscow from countering Beijing’s efforts, and in the current environment it likely that Moscow will welcome China’s attempt to regain regional power from the U.S.  Should China be successful in this strategy, it will have profound effects not only on the status of the Xinjinag region, but also on the geopolitical environment of Central Asia.

History of the Xinjiang Region
Between the 1700’s and mid-1800’s, China conquered most of the homeland of the Uighers – a Turkic-speaking people who converted to Islam in the 1300’s.  China maintained weak control over the region now known as Xinjiang until the Chinese civil war, during which the Republic of East Turkestan was briefly established.  In 1949, communist troops established control over the region, and Han Chinese were resettled throughout Xinjinag to dilute the Uigher population and secure the region’s cooperation with Beijing.  The Han population has increased from 7% to over 40% in Xinjiang since 1949.

Uigher groups who were opposed to China’s control were fracturous and lacked a charismatic leader to gain appeal for their cause in Western countries, while the Han Chinese largely settled in the northeastern area of Xinjiang, away from the heartland of the Uigher population.  The situation was largely unchanged, if not stable, until the 1990’s.  

In late 1990, a small uprising in Baren, a town near Kashgar was led by Abdul Kasim, a leader of the Free Turkistan Movement, in which 22 people are killed.  Beijing claimed that the weapons were supplied by Afghan Mujahadeen, and its reaction was swift and harsh.

After the Soviet Union collapsed in 1991, the Central Asian republics formed independent states; the Uigher separatists within Xinjiang drew inspiration from their neighbors’ independence.  Militant Uigher groups exploited the weak central governments of the newly formed states and Xinjiang’s porous border with Kazakhstan, Tajikistan, Kyrgyztan and Afghanistan to establish training camps outside of China’s reach.

China’s Move toward regional dominance
By 1996, Russia was prosecuting its second war with Chechnya, Tajikistan was still suffering from its civil war and the Uzbek government of Islam Karimov was dealing with Islamic fundamentalists looking to establish an Islamic government in Uzbekistan.  China feared that this instability would spread to Xinjiang, and Beijing launched series of new crackdowns and a controversial “Strike Hard” (Yan Da) campaign to reestablish order, in which 1,700 suspected “terrorists” were arrested. 

In April, 1996, China looked to engage its western neighbors by creating the “Shanhai-Five” (China, Russia, Tajikstan, Kazakhstan and Kyrgyzstan) to serve as a bulwark against Islamic fundamentalist subversion.  Soon the signatory states began cooperating to end the “three evil forces” – terrorism, separatism and extremism. 

China’s new aggression was answered with a backlash from the Uigher separatists -- in May 1996, a high ranking official to the Xinjiang Peoples Political Consultive Conference was assassinated and there were a number of bombing on China’s railroad lines linked to Uigher groups. When Afghanistan fell to the Taliban in September 1996, some Uigher groups fought on the side of the Taliban.  China charged the Taliban and al Qaeda with funding, arming and training Uighurs within Afghanistan.  This was followed by more attacks with Xinjiang against Chinese interests.  By late 1998, China feared that violence in Xinjiang is spiraling out of control, and Beijing moved to increase its regional influence in Central Asia.

China’s move towards greater regional authority was met with little resistance from the U.S. and with tactic cooperation from Russia.  In the summer of 2000, Madeline Albright visited Central Asia, and offered a mere $16 million in assistance to the Central Asian states for help in the establishment of democracy and pluralistic societies.  Tajikistan, Kazakhstan, Kyrgyzstan and Uzbekistan viewed this as a sign of disinterest because their priorities were funding for security concerns.  China’s anxiety over the Xinjiang region was more inline with the interests of the Central Asian states, and Beijing was able to use this convergence of concerns to increase its regional profile.

In June 2001, Uzbekistan was admitted to the “Shanghai Five,” which then evolved into a permanent group called the Shanghai Cooperation Organization (SCO).   The coalition worked to prevent Kazakh or Uigher separatists from using Asian states as a safety zone to plot separatist activities, and it established an anti-terrorist center in Bishkek, Kyrgyzstan where the member states could better coordinate their efforts.  During this time China’s relationship with Washington was becoming strained as the two nations drifted towards becoming “strategic competitors.”

Tensions were building over the new administration of George W. Bush’s plans for a national missile defense system, U.S. weapon sales to Taiwan, the EP-3 spy plane collision, Chinese missile exports to Pakistan and frequent complaints about China’s record on religious freedoms.  Washington, and the Western powers, viewed China’s claims that Uigher groups were tied to international terrorist organizations as propaganda and an excuse to persecute political dissidents.

The United States Unilaterally Engages Central Asia
After September 11, 2001, Washington’s priorities quickly changed in Central Asia, as fighting the Islamic terrorist networks tied to al Qaeda became a top priority.  The U.S. established bilateral agreements with the member states of the S.C.O., which greatly undermined the organizations relevance and China’s ties to the countries.  The newly created S.C.O. anti-terrorist center in Bishkek, Kyrgyzstan was not used by the U.S. and the bilateral agreements did not encourage cooperation among the S.C.O. members.  Beijing began to worry that its “strategic competitor” was pursuing a long-term strategy to contain or encircle China’s activities on its western border.

In this new environment, China tried to link its efforts to suppress the Uigher separatists to Washington’s “war on terror” as a means of engaging the Bush administration with the hopes of maintaining its prominent role in Central Asia.  On October 12, 2001, a Chinese foreign ministry spokesman said, “We hope that our fight against the East Turkistan [Xinjiang] forces will become part of the international effort against terrorism.”  Washington dismissed the ties between Uigher separatists and al Qaeda in an effort to isolate China’s interests from those of the other S.C.O. members.  In October, 2001, President Bush said that China should not attempt to use the war on terrorism as an “excuse to persecute minorities.”

However, since the U.S. reengagement of the region, Beijing and Washington have established closer ties, largely for economic reasons, and the Bush administration gradually allowed its interests to shift towards those of China in return for cooperation on intelligence and anti-terror initiatives.  Some analysts believe that Beijing is cooperating to gain concessions on Taiwan, Tibet and the Xinjinag region.  One example that the U.S. is willing to go along with Beijing’s concerns was the August 26, 2002, announcement that the East Turkestan Islamic Movement was added to the U.S. list of terrorist groups.

As the U.S. Pulls Back, will China Move in?
This new relationship with China has increased the importance for Washington to distinguish the violent militant groups from peaceful independence movements.  It is in Washington’s interest to root out those groups that have a history of cooperation with terrorist organizations outside of China’s borders, but it is also important that peaceful independence movements are given tactic backing from Washington.  This maintains pressure on China for concessions human rights issues important to Washington, as well as weakening China’s control of its periphery regions – a strategic importance should a conflict occur between the two states in the long term.  

China has received Washington’s cooperation in dismantling groups such as the United Revolutionary Front of Eastern Turkistan, who took up arms against China in 1997; the Wolves of Lop Nor, who have claimed responsibility for train bombings and assassinations in China and received training in Kazakhstan; and the Uigher Liberation Organization, who’s dispersion throughout Central Asia has allowed them to assassinate Uighers viewed to be cooperating with the government of China.  However, other groups such as East Turkestan National Congress and the Regional Uigher Organization have received tactic and financial support from Washington.  The Uyghur American Association (Uygher is an alternate spelling of Uigher) was the recipient of a grant from the U.S.-government-funded National Endowment for Democracy – a first for a Uigher exile group.

Since 2003, China has been actively working to reestablish the importance of the S.C.O. and has expanded economic ties with the Central Asian states, while the U.S. has shifted resources out of Central Asian and into Iraq.  In October, 2003, China and Pakistan held joint naval exercises off the coast of Shanghai, China’s first naval exercise with any foreign country.  Kazakhstan and China began negotiating trade agreements to supply natural gas to China via a pipeline through Xinjiang.  China has also increased its funding for the anti-terrorist center in Bishkek, Kyrgyzstan, as an effort to decrease the importance of bilateral agreements with the United States in shaping the member states’ foreign policies.  This August, China and Pakistan held joint military exercises code named Youyi (friendship)-2004.  The operations focused on counter terrorism and were held in the southern section of Xinjiang near Kashgar, the region with the highest population of Uighers in Xinjiang. 

While China moves to assert its power in Central Asia by growing closer to its neighboring states, the U.S. has largely focused its relationship with China on issues in the Taiwan straight and the Korean peninsula.  Russia’s concerns in Chechnya will drive it approach to the region, but, with limited recourses and domestic concerns taking a priority in Putin’s response, Moscow is likely to be content with the existing structure of the Shanghai Cooperation Organization, and allow China to consolidate its influence in the region.  This environment provides China with an opportunity that it will not let pass to rout the U.S.’s encirclement on its western border.  Washington will be reassessing the deployment of its diplomatic and military resources in Central Asia after the elections is Afghanistan; the size of the withdrawal of resources will signal how serious Washington is in controlling events in Central Asia and how concerned it is with the situation in Xinjiang.

Why is China obsessed with the SDR?

Zhou’s at it again.  China’s central bank governor released a report today calling for a global shift away from the US dollar as the world’s reserve currency.  He wants the world to adopt a basket currency created by the IMF.

Big talk from the guy sitting on the largest US dollar reserves in the world.

It’s also baloney. 

China’s only real concern right now with the dollar is liquidity for trade finance.  Talking down the dollar doesn’t help with that directly, but it might cause other countries to agree to allow their trade to be denominated in yuan.  This let China set up a few currency swaps earlier this year.

But what China really wants to do is help its exporters. 

China has increased the export tax rebate for its manufacturers seven times since the credit crisis hit.  This bodes ill for its needed shift toward domestic consumption.  A cheaper yuan would be another bonus for exporters, but China knows this would bring hell down upon it from the US and EU.

Since China can’t devalue its currency directly, it has to do this through the backdoor.  For the past year or so, China has maintained a de facto peg to the US dollar.  Talking down the dollar also brings down the value of the yuan against every other currency in the world.  While this might not help with US trade, it certainly helps everywhere else.

Still, this is a risky gamble for China.  After all it does sit on the world’s largest pile of greenbacks.  If the rest of the world really does buy the argument that the dollar is dead, then China will get burned worse than anyone (save the US, maybe).   

Can BRICs ever really be more than a Goldman Sachs marketing tool?

With the upcoming BRICs meeting this week, I'm going to be writing something about the viability of the grouping.  In the meantime, here are some clips from an article I wrote for World Politics Review after the first ministerial meeting last year.  

The one-day summit in the Ural Mountains city of Yekaterinburg brought together ministers from the most populous country (China), the largest democracy (India), the biggest energy exporter (Russia), and the second-largest food producer (Brazil). 

...

By joining forces the BRIC nations will be in a position to push for reforms at the IMF, World Bank, WTO, and UN that favor emerging markets and reflect the general drift of economic power away from the US and Europe.  However, if their demands are not met, the BRIC summit could evolve into a multilateral organization that could challenge the dominance of the existing world policy forums.

...

Still, vast differences may prevent the BRIC forum from becoming a coherent organization.  Brazil and India are thriving democracies, while Russia is slipping backwards and China maintains a single party system.  Commodities dominate the economies of Brazil and Russia, while the thirst for commodities is driving the foreign policies of India and China.  Also, regional disputes have limited the effectiveness of the past RIC summits, and expanding the group to include Brazil may not alleviate the problems. 

The myth of a post-Tiananmen deal with the CCP

Yesterday’s twentieth anniversary of the Tiananmen massacre sparked loads of op-eds about China’s failure to democratize since the tank man was dragged away all those years ago.  Some were quite good, some less so.  But there seems to be two things wrong with the standard picture in my mind: the Tiananmen protests were not really about democracy, and China’s government does not have some sort of implicit deal with its population were they trade democracy for economic growth. 

Perhaps if the West can get past these two things, cooperation with China would be a lot less tricky.

First off, despite the simplistic dreams of WSJ’s op-ed page, the Tiananmen protests were about a lot of things—democracy was certainly part of it, but the students weren’t really pushing for a Jeffersonian turn as much as a more responsive government.

The Financial Times’ James Kynge says this better than I can:

It was, above all, the unburdening of the hopes of a generation easing itself free of the strictures left from Chairman Mao's rule.  Almost everything fell within its scope: campaigns against corruption, nepotism, inflation, police brutality, bureaucracy, official privilege, media censorship, human rights abuses, cramped student dormitories and the smothering of democratic urges. But to say the demonstrations were to "demand democracy" is an oversimplification.

More importantly the notion that after Tiananmen, China’s population gave up its goal of democracy for economic growth is just silly.

After Tiananmen the Chinese government didn’t react by unleashing the power of free markets, which began years earlier, it reacted by becoming a better government (though it still has a very long way to go).

The Chinese government today is more inclusive, more responsive to public opinion, better managed, and more accountable than it has been since coming to power.   Why?  Because it had to in order to survive.

Everybody agrees that democracies are more stable than autocracies, once a certain development hurdle is cleared at least. But dividing governments into two clear categories misses a lot.   Selectorate theory captures this dynamic in a more fluid way.  (Other theories do too, but I’m at NYU, ground zero for selectorate theory.)

Briefly, governments’ primary goal is to survive.  They do this by supplying private and public goods to those that keep them in power, the winning coalition.  This winning coalition is a part of the selectorate, or all the people in the country who have any say in deciding the leadership.  Different coalitions compete within the selctorate for power, and depending on how the system is wet up the size of the winning coalition can be very small or quite large.  When leadership is challenged, the incumbent can respond by co-opting the challenger’s coalition, or by expanding the selectorate to reduce the potency of the challenge.

Dictatorships can be maintained with a small winning coalition, and therefore their loyalty can be bought with private goods (oil revenues, lucrative contracts, etc), and generally come from systems with small selectorates (few powerful business or military figures, maybe).  Where there’s a large selectorate and a large winning coalition, leaders cannot pay for loyalty with private goods (there simply aren’t enough bribes to be had), so they have to supply private goods (like the rule of law or financial regulation) in order to maintain power.   

The Chinese Communist Party studied their history after Tiananmen and then went to work expanding both the selectorate and winning coalition in order to ensure its grip on power.  Since the early 1990s, CCP membership has grown to 74 million from 50 million.  This is most of the winning coalition, but non-members in business are also inside.  The selectorate has grown, too.  The emerging middle class is certainly part of it.  But even in rural villages, where the central government cannot monitor the performance of officials as well, the population now has some say in choosing their representatives.

All of this adds up to a more responsive government.  There are plenty of protests in China today, but now the government is generally responsive.  The press is far from free, but stories of corruption often spark positive reactions from the government (though I’m not executing them is okay by any measure).

The larger winning coalition also explains the greater diversity in China’s fifth generation of leaders. Vice President Xi Jinping (expected to take over the presidency from Hu Jintao) and Vice Premier Li Keqiang (Premier Wen Jiabao’s replacement) are not like Hu and Wen.   They, and their comrades, are not all engineers.  Further, as Cheng Li argues, they represent two very different camps with the party.  Xi is a pro-business elitist, and Li is a feel-your-pain populist.  The sixth generation of leaders looks to be even more diverse.

So it seems to me that the main reason May 35 passed so quietly is not because the Chinese people bit their tongues in return for economic opportunities, but rather because they got a pretty significant part of what they asked for at Tiananmen.  Still, there is much more they deserve from their government.

Agriculture outsourcing: perils and prospects

I have a new article out at ISN Security Watch today on agriculture outsourcing.  Here's the lede.

From Mexico to Pakistan, citizens took to the streets last summer to protest what they saw as their government's inability to do anything about skyrocketing food prices. In Burkina Faso, rioters shut down main streets in three cities and burned government buildings; police used teargas to turn back about 10,000 protesters in Bangladesh; and a series of deadly riots forced out the Haitian prime minister.

Shaken, governments in the Middle East and Asia moved quickly to ensure empty stomachs could not threaten their control. The cure, however, looks nearly as bad as the disease.

Middle Eastern and Asian governments have been buying up underproductive farmland across Africa and Southeast Asia to grow crops that will be exported back to the home country. The International Food Policy Research Institute (IFPRI) estimates that as much as 20 million hectares, twice the cropland area of Germany, will be leased under such agreements in 2009. 

The deals are not for the faint of heart. One of the reasons the land is underproductive, and thus an appealing target for these governments, is that it is largely in politically unstable countries. Sudan and Pakistan top the list, but even where there is political stability, selling potentially productive farmland to foreigners can prove disruptive.  South Korea's Daewoo arrangement to lease 1.3 million acres in Madagascar helped to spark a coup in March; the new government quickly canceled the deal. 

Still, the world's growing population and taste for meat will require more productive farming. If land is being unused or under-utilized in poor regions across Africa and Southeast Asia, money from capital-rich and land-poor nations could help prevent another global food crisis.

International organizations around the world are now trying to find a way to do this that is both fair and productive. The right policy mix might be able to bring down food prices and pull some of the world's poorest out of poverty.

Political risk and corporate strategy

Via my old colleague, Federico Bordonaro, here's a good primer on how political risk can factor into a company's strategic planning from Treasury and Risk. 

Political risk analysts claim that while companies have a formal, rigorous approach to the management of other exposures, like currency risk or business continuity, they usually tackle political risk on an ad hoc basis. When the issue raises its head, they’ll react by calling up a consultant, buying some insurance or engaging a lobbying firm–but it’s rare to find a company that monitors the issue on an ongoing basis, says Corene Crossin, senior consultant with risk advisory firm Control Risks Group in London: “We know of few companies with a central, dedicated focus on political risk. It tends to fall between stools, and the companies who handle it best are those who have a joined-up approach to the issue. Often, the ones that fall victim to political risk are the ones that don’t  take it seriously, don’t recognize it as an issue and therefore don’t address it in their business at all or just file it away in one small area like community relations or government relations,” she says.

Why the obsession with Social Security reform?

Mark Thoma notes that Republicans are latching on to the new estimates that Social Security's fund will be exhausted in 2037, and pushing for reform again.  They might try to use this as a negotiating chip in the healthcare reform debate, he argues.  

This is a personal pet peeve of mine.  When the system can be easily fixed with small tweaks, why do Republican's favor large changes?  Why do Republicans lump Medicare spending (a REAL problem) with Social Security (a FAKE problem) in order to justify the need for reform?  

Oh, right:  Social Security plan may add billions to mutual funds, brokerage accounts

Don't get me wrong.  I fully understand that the current pay-as-you-go-system likely retards overall growth slightly by diverting funds that would be invested in companies into transfers to old folks.  However, converting to a mutual-fund type system would not be cost free.  

First, there's the transition cost that my generation would have to pay, which would be huge.  We'd have to cover the current PAYGO commitments, plus fund our personal accounts.  That sounds like a bad deal to me, but if it was for the betterment of humanity, fine - I'd do it.  But it's not.

Secondly, private accounts would not be friction-less.  So while US investment could be slightly higher if the Social Security system was altered into a plan that directed money into investment, then dispersed it to the same generation, a private account system would eat up most or all of this benefit.  Mutual funds blow.  They take a performance fee for delivering crap results. Throwing everything into an index fund would reward established players at the expense of upstart, small companies that would be the drivers of a new economy.  Basically, if the Social Security fund invested in only index funds to avoid subsidizing the asset management business, established listed companies would get an equity subsidy, mutual funds would still get a cut, and most of the extra investment would be wasted anyway.

Third, PAYGO smoothes risks, while private accounts cluster it.  The people retiring right now would be pretty much screwed under a private account system, and would likely demand some sort of bailout to compensate for their losses.  They'd probably get it because old people vote.  This would lead to extra costs, and more economic retardation.  A PAYGO system is basically risk-less for retirees, and prevents any need for a bail out (or a costly systematic program for smoothing payouts).

In summary: fix Medicare and Medicaid.  Shut the crap up about Social Security.  Tweak it to make it more sustainable.  Raise the retirement age a bit, raise the cap on deductions, lower payouts, but don't say the sky is falling just because a fund that was set up to smooth a bulge in retirees is likely to be spent after this bulge is long dead.  

Social Security is not going to be broke in 2037, just the fund that was set up to take care of baby boomers is.  It's still a PAYGO system. Of all the problems of PAYGO systems, going broke isn't one of them.

The genius of Ecuador's default

In my initial assessment of Ecuador's decision to default on some of its sovereign bonds, I was mostly shocked that President Rafael Correa would so blatantly sell out his country's long term creditworthiness for a short term political gain.  Now I'm coming around to the possibility that Correa not only made the politically smart decision, but may have made the right economic choice too.

At the end of last year Ecuador had a decent level of currency reserves, and could easily have made its payment on the bonds, but Correa decided not to make the payment.  Normally, the cost of this would be a spike in the risk premium on Ecuador's future bond issuances. 

But these are not normal times.

The fact is, whether or not Ecuador defaulted or not, Correa's populist reputation and today's election, Ecuador would not have been able to borrow at a decent rate anyway.

Sure, neighboring Peru was able to tap the bond market last month (and on a 10-year bond!), but Peru's president has sent consistent signals that he would undertake the necessary economic reforms to ensure the interest payments could be made.   Correa's political base means he cannot do this, and the elections meant his political base was more important to his political survival than access to foreign currency. 

So, given that Correa was never going to get new loans this year, why pay on the old ones?  Argentina established a pretty nice settlement mechanism (for the defaulting government, anyway) that avoids the IMF, saves loads of money, and can put your country back on the path to speculative loan status. 

And that's exactly what Ecuador did.  It offered investors a huge haircut (but slightly above market prices), and I'm willing to bet that it gets enough bond holders to accept the deal. 

In the end, Ecuador pays basically nothing in opportunity or reputation costs, gains from the reduction in payments.  Plus, Correa wins politically by playing to the anti-payment lobby (populists) at home, guarenteeing him another term in office. 

Tip of the hat, President Correa!

China's economy rebounding?

With numerous reports of "green shoots" sightings in the global economy, some analysts are arguing that China has already hit or is near the bottom of its contraction. 

How does the evidence stack up for China?

Positive signs:

Manufacturing
One of two Purchasing Manager Indexes showed signs of expansion in March.  The CFLP showed the PMI rose to 52.4 in March from 49 in February, the first month of the last seven to be in expansion territory.  The other PMI suggests that manufacturing continued its contraction of the last eight months.  However, both have been improving for the past three months (the second derivative is positive). 

Since manufacturing is about 40 percent of the economy, this is good news. 

Shipping Traffic
Shanghai shipping traffic shows first jump in 7 months. Traffic jumped 28 percent above the level in February.  How accurate this data is, I'm not sure.  However, it's hard to paint this as anything but good news.

Mixed signals:

Corporate bonds
Corporate bond markets are being deepened as more companies access the bond market to finance investment.  Most investment has traditionally been financed through retained earnings, but corporate profits were off sharply in Q1.   This is good for China's development of financial economy, and should reduce borrowing costs in the longer term.

Still, because of government role in the bond market, only large and well-connected companies have access to the bond market.  The drivers of China’s growth, SMEs, face a contraction in earnings, limited access to equity markets, and no bond market access to finance investment. 

Also, borrowing in bonds could prove risky in the coming years since developing liquidity in a market is hardly ever done in a straight line.  This could see some companies facing problems rolling over their debt down the road.

Housing sales rebounding
Housing prices continue to fall, but sale volume appears to be stabilizing or rising.  Let's just say this is pretty good, but large housing stocks remain and the market will not fully stabilize until the price floor is established.

Bad news travels slow:

Trade statistics
China’s trade volume contracted sharply in Jan/Feb.  One reason given for this was that the New Year holiday fell in January this year, but February last year.  March data should be clean of any anomalies, but won't be out for another week and change.  Taiwan reported a large drop today for March, which can't be a good sign.

Bank lending tightening
China’s banks lent RMB 1 trillion in March, but credit may be tightening in the coming months as bank inspectors look into the loans.  Worse, the corporate share dropped to 10% from 40% in the previous two months.  Plus, most of the activity came at the end of the month; suggesting banks were pushing loans out before the new restrictions are in place.  Most is short-term financing and probably of little economic benefit.

No sign of facing economic imbalance
Export taxes were cut to zero, and export tax rebates increased to 17 percent in an attempt to boost struggling exporters who face a drop in demand. However, this only prevents the restructuring of China’s economy toward domestic demand.

FDI continues to wither
FDI has dropped for 5 consecutive months to March, though the rate is starting to slow.  China has reduced the red tape for FDI, especially for smaller firms, but credit for FDI remains tight.

Global trade finance shortage
Trade finance remains significantly below demand.  Though China has extended swap agreements to six countries in recent weeks, China’s main export markets have not participated and the effect of the swap arrangements is likely to be more political than economic.

Final verdict:

Although there are some positive signs coming from China's economy, the overall trajectory appears one of contraction.  The good news is that China has done more than most governments to help boost their economy.  The bad news is that much of China's growth depends on other governments doing more to boost demand. 

Overall, China has not done enough to spark domestic demand.  Though in their defense, China's high savings rate is not likely to be something that can be reversed over night.  

My best guess is that China's growth remains positive in Q1 and Q2 this year, but at levels well below its potential. 

Why the Financial Stability Board is likely to fail

Gillian Tett highlights one of the least noticed, but potentially most important outcomes of the G-20 meeting—the creation of the Financial Stability Board (pdf)

The FSB was built on top of the institutions of the Financial Stability Forum, which served as a place for western central bankers and supervisors to meet and discuss macroeconomic issues.  It was founded in the late 1990's, and began looking at banking regulation only after the credit crisis emerged in the summer of 2007.  It published some reforms last summer and another set of recommendations today. 

In recent months, the FSF began to be the place where central banks could coordinate the crisis measures taken by each government. 

The new FSB is to be charged with monitoring global financial stability and promoting medium-term reform.  Its membership is to be expanded to include the full G20, and it will expand its tiny staff and secretariat. 

But can the FSB accomplish anything?

Political economic theory does not bode well for the FSB's prospects.  Here are a few reasons I am skeptical.

1. More members, with a wider variance in agenda
Loads of literature in political economy is filled with variations on a simple theme: the success of collective action is inversely related to the number of players.  Expanding the FSB/FSF membership to the full G20 makes any compromise less likely. 

Compounding the problem is the nature of the new members.  Whereas the FSF was a rich, mostly-Western club, the new membership will include China, Argentina, Russia, India, and Mexico.  If the US and Germany have been unable to coordinate their macroeconomic policies, chances are that the inclusion of these new members will only make it more difficult. 

2. No monitoring or enforcement capabilities
The game-theoretic strand of political economy has demonstrated that agreements that do not include any punishment mechanisms for cheating are destined to fail. 

The FSB may prove to be a lively debating forum for central bankers, but it is unlikely to move beyond that unless states can somehow be bound to following its prescriptions.  While the relative transparency of macroeconomic data makes the monitoring problem less acute, the fact that by statute none of the reforms the FSB recommends will be binding seem to doom the organization's fate. 

3.  The speed of its formation
James Fearon and others have demonstrated how the "shadow of the future" affects bargaining and enforcement in international cooperation.  States that believe an agreement will have lasting effects bargain harder for position, and the bargaining process tends to drag out.  In this case, a few quick conversations seem to have been all that was needed to set up the FSB.  This seems to indicate that none of the members think it will play a significant role in international political economy. 

If this isn't enough, there's the IMF.   The IMF, once the most hated organization in international politics, is riding high today with a $500 billion in new(ish) finding and $250 in new special drawing rights.   The FSB's mandate in many ways overlaps that of the IMF.  One organization is huge, well staffed, and well funded.  The other is has a skeletal staff, no real powers, and no money.  The outcome of any turf battle seems predetermined, especially since the US will remain the dominant power in both organizations for the foreseeable future. 

Still, there is one reason that the FSB could prove important in the coming years.  Given the trend toward an international system of financial regulation, the FSB is well placed to serve as a place where the US could force through its preferred system and dress it up in multilateral clothes.  Given that the rest of the world blames the US system for creating the credit crisis, I'm not sure how likely that is at the moment though.