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Showing posts with label Andrew Sheing. Show all posts
Showing posts with label Andrew Sheing. Show all posts

Wednesday 15 June 2016

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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Friday 17 July 2015

The great technology transformation

AFTER a week in the Silicon Valley, California last month, I came to the conclusion that I am a dinosaur. The speed of change from technology has been so fast and so profound that we are lost in transition, translation and transformation.

The digital revolution is already upon us, but the baby boomer generation, to which I belong, is having difficulty understanding this because we still upload (read) on paper, whereas the millenials (those born between 1980 and 2000) upload information mostly on mobile phones, video and communicate through social media.

Demographics say a lot. At the turn of the 21st century, the baby boomers (born 1946-1964) were half the work force, but today in the United States, millenials and Gen X (born 1965-1979) are roughly one-third each. The baby boomers may own most of the retirement funds and wealth, but the new wealth is being created rapidly by the younger generations.

A simple set of statistics says it all. The Forbes top five US companies by revenue are Walmart, Exxon, Chevron, Berkshire Hathaway and Apple. Walmart employs over 2.1 million people, with revenue just under US$485bil, but profits of US$16bil with market capitalisation of US$265bil. Apple, with only 80,000 employees, had double Walmart profits of US$39bil and a market capitalisation of US$725bil, larger than Walmart and Exxon put together. Twitter, with only 3,638 employees or less than 0.2% of Walmart workforce, is valued at 9.2% of Walmart. Facebook, with only 9,200 employees but 1.44 billion users, is valued at 86% of Walmart.

In fact, if it wasn’t for the fact that Silicon Valley is booming in terms of wealth creation, California would be suffering from the economic effects of the worst drought in years. But at US$2.3 trillion, California is growing at 2.8% per annum, faster than US real gross domestic product growth of 2.2% in 2014. The Western Pacific states of Oregon and Washington are growing faster at 3.6% and 3% respectively, thanks to growing trade and services from the boom in technology.

Two things that stand out in the Digital Disruption – speed and scale. The speed and scale of the digital transformation is so fast and so wide and deep that we are all having problems valuing what it means – which is why we have a tech bubble in the making.

It is quite normal for us to accept that the Silicon Valley is the world leader in digital change, but what was eye-opening as I dug into the data is that the next waves are already happening in China and India. This has mind-boggling implications on a geo-political basis, especially for smaller economies, such as Malaysia, Hong Kong or Thailand.

What struck me from delving into the pattern of growth in the Internet Revolution is the speed and scale of change in China and India. Who would have expected even five years ago that four out of the top 15 global public Internet companies, ranked by market capitalisation would be Chinese (Alibaba, Tencent, Baidu and JD.com) with a combined value of US$542bil or 22.4% of the total market valuation of US$2.4 trillion of these 15 companies as of May, 2105.


Scale and speed

The reason for this valuation is scale and speed of the Chinese transformation, already overtaking the world leader, the United States. The rate of Internet penetration is over 80% for the United States, only 40+% in China and 20+% in India. But China already has more Internet users (618 million), double the US population and its growth in smartphones is double (21%) that of the United States (9%).

Although incomes in China and India are far lower than the United States, Chinese and Indian millenials (for that matter, millenials in all emerging markets) are beginning to spend more time on their smartphones than the advanced countries.

There are two implications from this broad trend, which the Chinese Internet platforms like Alibaba and Tencent are beginning to exploit.

The first is the ease and convenience of buying, selling and paying using the smartphone – an all service tool. Partly because of regulation, the US leaders such as eBay, Amazon and Facebook are still in their core areas of strength, but Alibaba and WeChat (part of Tencent) have developed eco-systems that are simultaneously social networks, chatrooms, trading and investing platforms combined.

When I lost my Blackberry, MacBook and camera recently in Latin America, I was staggered that using WeChat on iPhone, I could go on video and instant chat with friends across half the world for free. My only constraint was the battery on my iPhone and that I had not set up to get funds transfer in case of need.

The second implication is that traditional service providers are way behind in this technology. My credit card companies are still on outdated phone-banking, which meant that in order to report lost cards, I was frantically trying to Press one, Press two and Press self-destruct! These companies are at least two generations behind in customer service technology.

Internet Revolution

My conclusion from this survey of the Internet Revolution is that the disruption from technology on conventional businesses is yet incomplete. In the 1990s, the Internet changed the music, photography, book sales and video rental business. Today, we book airline and hotel travel on the web.

But with the arrival of the iPad and iPhone, healthcare, finance, investing, education and social communications are being combined into one gadget (the mobile phone) to do what we have to.

This disruption is happening very fast in China and India, because these late-comers have no pre-conceived legacy ideas on what cannot be done with technology.

If China is currently going through its tech bubble, watch out for the next tech bubble in India.

Those who think only in terms of risks think that bubbles are to be feared. I have come to realise that the animal spirits in us change the game through excesses. But those who learn from their mistakes will create the new.

Silicon Valley is not a place but a mindset – nothing ventured, nothing gained. That mindset is truly the New Digital Transformation.

Watch this space in Asia.

Andrew Sheng comments on global trends from an Asian angle