Archive for January 9th, 2010

Saturday, January 9, 2010

Hermit explains the Economic Crisis

Hello Children,

[This information from an amateur Confucian perspective may be outdated, and is just an amateur’s take, anyway. Don’t count on it.]

Hermit: Hello Children

Hermit the Taoist Dragonfly explains the economic crisis.

if your parents are in a bad mood, maybe it isn’t actually because of you and your stupid questions. Maybe it is because of the economic crisis. What is an economic crisis? An economic crisis means that your parents’ bosses have no money and don’t want to pay them the same amounts of wages anymore and maybe fire them altogether. Then your parents don’t know how to answer your questions about your birthday presents or why you can’t celebrate your birthday at a fast food restaurant with your friends and have to celebrate with a dry pie baked by your Mom instead.

An economic crisis can have a lot of causes, but this one (the one which is why our Dad voted for Obama despite his Golden Ku Klux Clan membership card) is easy to explain, although it is not a short explanation.

The government is the problem, not the solution, they say.

The government is the problem, not the solution, they say.

Lets start with the investment banks. Investment banks created the economic miracle that started when a B-movie star » became president of the United States. Investment banks are here to invent financial instruments that raise capital so that your Daddy’s boss can launch his latest business, or so that your Mom and Dad can build a house with very little money of their own.

Only a bank which doesn’t do what your Mom’s and Dad’s bank does is an investment bank. An investment bank doesn’t necessarily run accounts for people like your Mom and Dad where their bosses remit the monthly wages. Investment banks organise mergers and acquisitions, and raise capital. That’s considered to be  more profitable, as a rule.

And that’s where your Mom and Dad may come into play after all. It doesn’t matter that their money is so small. It can be combined into big flows of money by the investment banks. And such big flows of money can be put into smaller packages again which make it possible for your Mom and Dad to build a house without much (or any) money of their own.

The small packages may be called securities. If your Mom and Dad bought a house and don’t talk much any more, chances are that their house is part of an asset that backs up an asset-backed security. A now very famous kind of asset-backed security is named Collateralized Debt Obligation or simply CDO.

A CDO is based on a portfolio of loans (like loans to your Mom and Dad to buy their house). Tons of such loans or maybe less are packed into one portfolio. Now, a portfolio looks a bit like the dry pie baked by your mom. It’s a bit like this one. But it is more colorful or diverse. Think of it as just as round, but made up of many different pie slices of different colors and sizes and properties (some with strawberries, some with cheese, some with beef, for example). Every slice is a different loan to some couples like your parents who use the loan to buy and finance their house.

The portfolio and the securities from it are the stuff that investors may be interested in. Investors aren’t necessarily huge business people, but rather, they are people who have some money left for experiments, or people who think that “security” means secure. The securities are the little pieces of paper that tell the investor how much money he will get if he buys this piece of paper and if everything goes according to plan.

OK. Then there is your Mom’s and Dad’s house (the asset), then the portfolio the loan your Mom and Dad took for the house is part of, and the picture also shows you the blokes who bought the Collateral Damage… erm… Collateral Debt Obligation which, as I said earlier, is an asset-backed security. And the asset may be your Mom’s and Dad’s house, for example. In an indirect way you could say that the investors are your Mom’s and Dad’s creditors. Of course, the investment bank is between the creditors and your Mom and Dad. Your parents and the investors will probably never meet in person.

OK. One of the investors may be a retired American. He has no clue about the system, thinks that “securities” comes from “secure”, but at least he bought first class securities (also referred to as senior tranches). A rating agency (there are people working there who people expect to know what is good and bad) has rated them AAA which means “very good”. That plus “security” sounds very reassuring to our admiral.

People outside America can buy CDOs too, of course. Let’s just assume that Net Nanny is a bit corrupted by money and is an investor too. Haha, just an example! She wants to be on the safe side too but is less connected in and informed about America. So “security” sounds good enough to her. So she gets a mezzanine tranche, that is a security rated AA to BB which isn’t as safe as AAA. On the other hand, she gets a premium which is bigger than the AAA, because her risk is bigger, too, that too much of the loans making up the portfolio will not be repaid by your Mom and Dad. Of course, if it goes wrong, she gets nothing. In a situation where AAA investors still get their money because only a certain share of loans goes bust, the AAAs may get their money, and she gets nothing. Anyway, she’s in jail now.

Then come people like Forrest Gump or Lei Feng or me, because someone has to be the most likely loser. On the other hand, if an unexpectedly small amount of loans remains un-re-paid and the interests payments by your Mom and Dad also come in as planned (or more or less so), we might actually be big winners, because our premium for taking the risk is so high!

In such a case, Forrest Gump will become a very rich man and build his girl a big house without taking a loan himself at all, and they’ll go on a luxurious journey around the world, and here in China, Net Nanny would have cashed in on her security just to threaten Lei Feng and me with her high position and high connections and take care of our money too, and we would be the losers anyway – but the bottom line is that our motherland’s economy as a whole will be richer than before anyway.

Unfortunately, it all went wrong. The Americans should have watched out, rather than hurting our economy. The Americans hurt the feelings of many Germans, too. Now they fear that they can’t trust their banks if they offer them 30 per cent returns on their investment. Isn’t that terrible?

That much for today, children. Tune in again next time when I explain how even Net Nanny could have been fooled by the bloody Americans. Got to fly now. Stay patriotic.

Saturday, January 9, 2010

Welcome, Trade War

China’s monetary policy was to blame for most of the current global imbalances, Germany’s weekly Die Zeit writes. In exceptional situations, tariffs and trade barriers are warranted, the author adds.

Meantime, U.S. software developer Cybersitter is suing China’s Green Dam producers for alleged piracy. America and China are in a brawl about tariffs on tires and steel pipes.
And for less economical, but rather patriotic reasons, Chinese Vice Admiral Yang Yi (杨毅) recommends defensive countermeasures against U.S. companies which sold weapons to Taiwan, but also wanted to sell aircraft and other goods to China.

James S. Chanos questions the idea that China’s economy could drag the rest of the world out of the economic recession, in the wake of the global financial crisis. Chanos warns that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict.

The argumentative circle closes with a recommendation by the a/m Die Zeit article: the exporting industry was immensely powerful, it writes – another good reason to become less dependent on exports.

Nothing (OK, only some news) is as good or bad as first reported. China’s monetary policy is objectionable and must be addressed – but that will hardly lead to a remarkable rebalance of global im- and exports. Chanos’ remarks carry more weight – but only starry-eyed ruminants of the CCP’s propaganda would expect something better than a rather bumpy ride there. Far-sighted investors don’t go to China for a quick buck. They either go there with a realistic strategy, or they stay away. Or they aren’t far-sighted.

To me, vice admiral Yang Yi’s point for a trade war actually make more sense then all other arguments. We need to reduce our dependence on exports to China for political reasons. When top military officials like Luo Yuan (罗援) make European opportunism a cornerstone in their Taiwan “reunification” policies, this indicates a strong moral imbalance which we need to tackle.


Update / Related:
“Everyone wants to talk about Currencies”, M. Pettis, January 9, 2010

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