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Leland Miller
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Leland R. Miller is Managing Director and co-founder of Avascent International, a global risk advisory and consulting firm with representative offices in nine cities on four continents. He worked previously as an attorney for a major international law firm in New York where he represented... More
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  • Can China Stop its Banks from Lending?

    Will a shift away from bank lending quotas actually help rein in lending by Chinese banks?  Beijing thinks so.

    On January 11, the People’s Bank of China (PBOC) announced that Chinese banks had lent a total of 7.95 trillion yuan ($1.2 trillion) in 2010, considerably above the government’s declared target of 7.5 trillion.  This is in addition to another 2-4 trillion yuan of off-balance-sheet lending for the year, meaning overall Chinese lending in 2010 was in the vicinity of 10-12 trillion yuan.  A huge number, especially on the heels of a 9.6 trillion yuan lending spree in 2009.  

    But with inflation on the rise and the global recession finally ebbing, 2011 will be different, right?  Not so fast.

    Following last month’s annual Central Economic Work Conference, an annual pow-wow where Chinese financial authorities announce broad macro policy goals for the coming year, Beijing declared that tempering loan growth and reining in inflation would be key priorities for the coming year.

    Yet Chinese banks continued their lending frenzy through the first weeks of January, doling out 600 billion yuan ($91 billion) in new loans in the first week of 2011 alone.  In fact, lending in January may reach 1 trillion yuan, Caijing magazine reported last week, citing analysts.

    This has left bank regulators and policymakers alike scrambling for a better solution.

    Unlike monetary policy in the West, which relies principally on managed interest rates, China has traditionally relied on a more simplistic, two-pronged approach: wielding the spigot and the mop.  In theory, the PBOC sets loan quotas to dictate the amount of loans (liquidity) it wishes to dump into the system, then soaks up any excess liquidity by ordering banks to park a certain percentage of their reserves with the PBOC.  (That rate—known as the reserve requirement ratio (NYSE:RRR)—is currently 18.5% for China’s largest banks.)

    A combination of factors, however, has worked to undermine the efficacy of the loan quota system.  First, Chinese banks typically hit their loan targets far before year end, leaving regulators the impossible (and perhaps dangerous) job of enforcing an almost total clampdown of credit at the end of the year.  In 2010, for instance, Chinese banks hit their quota mark in November but still managed to loan a massive 480 billion yuan in December.

    Moreover, according to a December report by Fitch ratings, Chinese banks have learned to simply offload trillions in loans from their balance sheets by artificially reducing their holdings of discounted bills and repackaging loans into investment products for sale to investors.  As a result, the actual loan quota number has become essentially meaningless.

    None of this should be surprising.  In an economy as large and complex as China’s, the “spigot/mop” approach to monetary policy is woefully inadequate.  But rather than meaningfully hike interest rates—which would help moderate runaway lending but also eliminate the credit (subsidies) that keeps low margin Chinese businesses afloat—Beijing has opted to simply tinker with the banking system more aggressively.

    So here's the government's new play: While an official announcement is still pending, sources close to the PBOC claimed on January 6 that China will no longer rely on a formal lending target for banks in 2011. Instead, regulators will evaluate a series of factors including loan growth, minimum capital adequacy ratios and government targets for inflation and economic expansion, and then determine the reserve requirement for each bank separately.  As the Financial Times notes,

    By closely monitoring each bank individually and responding to lending surges with regular targeted reserve requirement adjustments and tighter capital requirements the regulators hope to smooth out the credit cycle and keep overall credit growth in check.

    Described as a "dynamic adjustment of differentiated reserve requirement ratio," any credit expansion by a lender that is not matched by its capital strength will trigger an increase in that lender’s RRR levels.  As People’s Daily explains, “banks that fail to meet such criteria will be ordered to adjust their credit immediately.”

    Will this system actually increase transparency and evenhandedness in the Chinese banking system, as regulators hope?  Perhaps.  But the reality is, it may not matter.

    So long as Chinese banks offer deposit rates that lag behind the rate of inflation, Chinese money will continue to be pumped back into the economy, driving inflation higher still.  Cracking down on profligate lending is a crucial first step, but without wholesale changes to its monetary toolbox, Beijing is only postponing an inevitable reckoning.


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Jan 13 12:16 AM | Link | Comment!
  • Rating Agency Foolishness (with Chinese Characteristics)
    News flash!  Not only is the United States no longer a AAA-rated creditor, it isn’t even worthy of a AA rating anymore.

    At least that’s the conclusion reached this week by China’s flagship domestic rating agency, Dagong Global Credit Rating Company, which downgraded the US credit rating another notch to A+, while reaffirming its “negative” outlook.

    While few, myself included, believe the United States is doing itself any favors with the Fed’s latest round of quantitative easing, Dagong’s inability to separate debt economics from the politics behind it shows that the firm is still not quite ready for the big time.

    According to China’s state-run Xinhua News Agency,

    The United States has lost its double-A credit rating with Dagong Global Credit Rating Co. Ltd., the first domestic rating agency in China, due to its new round of quantitative easing policy.

    The Chinese rating agency said the downgrade reflected the US’ deteriorating debt repayment capability and drastic decline of the US government’s intention of debt repayment.

    “The serious defects in the US economy will lead to long-term recession and fundamentally lower the national solvency,” Dagong said in [the] report…

    “The credit crisis is far from over in the United States and the US economy will be in a long-term recession,” Dagong [warned], adding a weakening greenback will cripple the US’ capability to attract dollar capital reflow.

    Dagong rationalizes the new downgrade by explaining that QE is bound to exacerbate the “potential overall crisis in the world caused by the US dollar’s depreciation [and thus] increase the uncertainty of the US recovery”.  Calling QE “entirely counter to the interest of creditors,” Dagong concludes “the US government’s move to devalue the dollar indicates its solvency is on the brink of collapse”.

    No one yet knows where this new round of money printing will take the US economy.  But even under the more cynical scenarios, Dagong’s mangled logic misunderstands the very nature of rating government debt.  In fact, the one thing that QE will do with near certainty is make it easier for the US to service its debt, making it more—not less—likely that US creditors (aka debt purchasers) will get paid back.

    While it’s true that investing in US T-bills may now be an increasingly foolish investment from a returns basis, an ability to repay debt isn’t something directly affected by QE, and in fact (as stated above) QE probably makes repayment more likely as cheaper dollars make the debt burden eminently more manageable.

    What Dagong, and its Chinese government sponsor, are protesting through issuance of this report are foreign investors’ diminishing investment returns, not diminishing serviceability of the debt.  Yet the place for investors to voice their concern over returns is in the debt market, by bidding up the rates at auction.

    This dynamic should be happening—but investors, including the Chinese, are still accepting astonishingly low interest rates.  As Director-General of China’s Banking Regulatory Commission Luo Ping famously quipped last year, “US Treasuries are the safe haven.  We hate you guys, but there is not much we can do.”

    What’s left is a war of words—one that China is waging aggressively in the run-up to the G-20 summit, even through one of its supposedly “independent” rating agencies.  The fact that the SEC in September turned down Dagong’s application to rate bonds in the US makes the report’s prognosis, if not its timing, even more suspect.

    Bottom line: The US economy may indeed prove to be as vulnerable as Dagong’s report suggests.  But if China truly wants to establish its own credible credit rating system, it should stick to rating debt, not berating debtors.

    With this latest report, Dagong has significantly set back its efforts to be taken seriously.
    Disclosure: No positions
    Nov 10 5:38 PM | Link | Comment!
  • The Rise of Xi Jinping: Why all the Excitement?
    Earlier this week, Chinese VP Xi Jinping was elected vice chairman of the Central Military Commission (NYSE:CMC) during the Fifth Plenary Session of the 17th Central Committee of the Chinese Communist Party, virtually guaranteeing that he will be China’s next paramount leader after the retirement of current President Hu Jintao.
    The news, however, was really much ado about nothing.  Unlike past transfers of power in the People’s Republic of China, nearly every serious China watcher knew that Xi’s appointment to the CMC was not a question of “if”, but when.  In fact, despite a recent highly-publicized stream of Western news coverage detailing growing battles between various Party factions over the need for political and economic reform, 2010-2012 will likely represent the most fluid and methodical political transition period in the young history of the People’s Republic of China.
    So why was Xi’s appointment to a simple vice chairmanship front page news?
    The reason many Western commentators have seen drama in the week’s events where none is present is that they fundamentally misunderstand both the power structures and processes in a Chinese leadership succession.
    China, like all traditional communist countries, has a three-tiered power structure:  the government, the Party, and the military.  While transfer of the first two offices (head of the govt and head of the Party) have followed a relatively orderly pattern since Deng Xiaoping (with party leadership transferred during designated party conferences held every ten years: 1992, 2002, and presumably again in 2012, with governmental leadership transferred a year later), the same thing is not true for the transfer of the third office, the head of the military.  But that doesn’t mean the process is chaotic either.  Deng held onto the CMC spot for several years even after transferring the other two offices to Jiang Zemin; Jiang held onto it for several years after Hu Jintao rose to power; and it is basically accepted that Hu will stay on for at least several years as head of the CMC after Xi’s ascension to Party General Secretary in 2012 and to president a year later.
    Why is this done?  Partly because rulers are reluctant to step down entirely, thus relinquishing all their power at once; partly to stay on long enough to ensure their protégés are able to avoid being purged or pushed aside; but also because it has become an accepted part of the succession process—to ensure the transition is balanced and that stability is assured.
    When Hu doesn’t relinquish the CMC spot to Xi in 2012—and it is very likely he will not—it will not be a sign of regime instability.  Rather, it will reflect a developing norm in Chinese politics, the staggering of the three-tiered power transfer.

    Disclosure: No positions
    Oct 21 7:08 PM | Link | Comment!
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