The Gold Standard  

‘Economist’ thinks that there is no broken society in Britain. What say you?

Link from Paul Kedrosky on Niall Ferguson’s infidelity. Fascinating in its own way. Maintaining a certain consistency between what one says, one believes and does is, well, hard.

Again, thanks to Paul Kedrosky, this article in defence of Greenspan or a platform for Greenspan to defend himself. Not very persuasive.

The letter from a former student to Professor Emanuel Derman makes for interesting and thoughtful reading.

When I shared it with a colleague, he sent this thoughtful reply:

Quantitative Finance (QF) people will blame that it is the economics that doesn’t make sense (representative agent paradigm, CAPM, CCAPM, no-arbitrage = existence of martingale measure etc, SDF framework for asset pricing). The whole research community is too fixated with having a parsimonous model so they can do some comparative statics to get some predictions etc. But often when brought to the data, many of them don’t perform well (equity premium puzzle). Even extensions to heterogenous agents and bounded rationality don’t seem yield any ground breaking results.

Finance is one field where the reality is further away from the theory than other disciplines…

Professor Daniel Rodrik loses himself and us in the last four paragraphs. In Singapore style, I can only ask, ‘So, how?’

Debate on the above topic is heating up. Paul Krugman has a simple and yet scathing blog post on the topic of renmimbi undervaluation. See here. It is unlikely that he would be invited to China again. He links to this article in NYT which refers to President Obama’s comment on the Chinese currency:

to make sure our goods are not artificially inflated in price and their goods are not artificially deflated in price; that puts us at a huge competitive disadvantage

I had wondered why the United States made public calls for renminbi re-valuation when any public request has a higher chance of being rejected. I thought it might be a case of reverse psychology. That is, America did not want China to revalue. The logic I came up with was that it was because many American firms would lose competitive advantage since they had set up manufacturing centres in China. Revaluation of the Chinese currency would raise their input prices and lower their profits.

That might still be true but what may not be true is that American exporters based in China are behind this. After all, this is what M/S Xu and Lu had to say:

We find that an industry’s level of export sophistication is positively related to the share of wholly foreign owned enterprises from OECD countries and the share of processing exports of foreign-invested enterprises, and negatively related to the share of processing exports of indigenous Chinese enterprises. ['Foreign Direct Investment, Processing Trade and the Sophistication of China’s Exports' - you can do a search on this title and get to the full paper]

What it means that sophisticated exports are usually price-inelastic. They do not gain much from exchange rate undervaluation although it would help. Nonetheless, it is hard to beleive that they would be the vocal lobby calling for no change in the government policy on the renminbi. It has to be local exporters who process, manufacture and export cheaper and less sophisticated goods.

According to Professor Arvind Subramanian, they can only be taken on by a group of affected countries rather than by one single country. The countries whose exports are affected must be countries exporting low value-added goods. In Asia, this complimentarity exists with Thailand, Malaysia and Vietnam (I am guessing) and outside Asia, with some African countries. They are too small and too scared to protest and in other cases, China might be assisting them in other ways.

So, what can bring about a change? I have no idea.

However, one thing is clear. If the US Treasury does name China a ‘currency manipulator’ that would be a defining moment (mostly in a negative sense) for the global economy and for global trade. Watch out for it in April.

Some days ago, I had posted this comment on the AIG bailout. I had indicated that the real villains were the credit-rating agencies rather than one firm or the other. We have an update from Gretchen Morgenson of NYT. That does indeed shed new light on the subject. Few things stand out from this article:

(1) Goldman Sachs refused third-party valuation of the bonds it had insured with AIG while consistently reporting low values for them, to seek insurance reimbursement. I doubt if any insurance company would accept, at face value, the loss report of the insured party.

(2) I had argued that reimbursement to Goldman Sachs of the full face value of the insurance contract was reasonable since Société Générale too was reimbused to the full. It turns out that GS had an arrangement with SG and that some of the money that SG received flowed right back to GS.

The fact that Goldman did not own these bonds (on which it had bought insurance) and at the same time had bet on the mortgage market turning down, means that Goldman had everything to gain from the mortgage market crash.

Every day, in my mail box, I receive a mail from www.charityfocus.org. For the most part, I try to see what it says. Today, I decided to catch up with a few of them that I had not. The first one said that the best way for managers to become better leaders was to give up authority. You can read this brief comment here. That email also exhorted the reader to check out this TED talk by ‘designer’ Tim Brown. I listened to it for sixteen + minutes. I am glad I did. I do not want to overstate the message. You would be able to relate it to your own personal surroundings, actions and thoughts. Needless to add, it is an important message – reinforcement – for all of us driven solely by ideology. We forget that behind all of ideologies, theories and laboratories is people. That he cites a lot of examples from India must be a bonus for the Indian visitors to this site.

This mailer from Charityfocus on the 70 words of wisdom for 2010 opened a box of chocolates (ack: Forrest Gump). I have no problem in acknowledging that, until today, I had not heard of Seth Godin. I downloaded the file from here. I have just gone through some pages.

One of the words is ‘Meaning’. The person who chose ‘Meaning’ says this: ‘Never compare your inside to some one else’s outside’. Beautiful. It is the same as ‘Be yourself. Every body else is taken’.

This quote from Arianna Huffington is really good:

To trade multi-tasking for uni-tasking and — occasionally — no-tasking. It’s left me healthier, happier, and more able to try to make a difference in the world. My eyes have been opened to the value of regularly closing them.

I could not get the exact post in which she had written the sentence above. But,  I came across this post. Equally interesting and important. Just get enough sleep.

Now, back to Seth Godin. Apparently, his latest book, ‘Linchpin’ was released in January. There are plenty of reviews here. This post in Seth Godin’s blog sounds very interesting. I am yet to check it out. I hope one of you would do that and let me know too.

This second part begins with my comments on Gordon Chang’s piece on how China would go the way of Dubai. Dubai is a small place with no home-grown population. It has hardly done much to give the foreigner-residents a stake in the society or the country. It borrowed in foreign currency. It has no resources.  Yes, China can become a Dubai if growth stops. For that matter, any country can become a Dubai if growth stops. Simply put, if there is no top-line growth, even one dollar or one rupee of debt is too high.

Most of what he writes are well-known to all and well-known to the Chinese government. They must have done endless simulations on the scenarios that could develop. I doubt if they would be toppled by economic weaknesses. Again, one never says never on any matter in economics, finance or in social evolution and that too while commenting on non-transparent societies.  So, let me put it this way: I would not put my money on it.

Those who point to the risk of low growth and unemployment should recall how China managed the restructuring of its public sector in the 1990s.

Whether China makes ‘it’ and sustains it or falls apart would depend on how internally secure it is – ‘internally’ in the minds. If it thinks that overt projection of national power is what would please its people, then it would be courting trouble. Eventually, the rest of the world would unite. Deng XiaoPeng got it exactly right when he exhorted his countrymen and women to keep their heads down while still rising. Of late, they seem to have forgotten it.  They are not taking advantage of Europe’s disarray in handling Greece, Spain, etc.

By bailing out Greece, China might not still win brownie points in Europe but it would secure tremendous geo-political advantage over Europe and the US while creating room for potential conflicts between those two in dealing with China. China’s lack of reaction is puzzling. In fact, of late, it has not been in the market buying up the Euro while it was active in diversifying into the Euro at 1.50 and above!

Whether China rises or fails to do so, I think, is entirely in China’s hands. That much credit should be given to them.  The same cannot be said of India.

How can or how should the rest of the world deal with China?

Never yield to pressure or appear weak.  Both the powerful and bullies think very lowly of the weaklings. Stand up for one’s interests.

While no one single nation can match China’s combined economic and military strengths, collectively they can. But, China would be aware of that. Most powers – nations and people – know how to play the ‘divide and rule’ game between nations and inside nations. That is why it is puzzling that China is not warming up to the idea of bailing out Greece and other European nations.

Finally, we have to acknowledge that we know very little about how to deal with a rising power. For most of us,  it is the first time in our life times. Those who dealt with rising powers like the US are not alive to tell us what they did, then.

So, some prayers too would be in order and not out of place. It is time we all realize and act within our limits and limitations – whether it is finance, economics or geopolitics.

[Tailpiece: For a moderate insider's piece on how prepared itself for the economic crisis, see this piece by Fan Gang in MINT]

Good friend Ramnarayan in the US has sent several recent articles that appeared in various media sources, on China. Collectively, they do not make us any wiser or better informed about China. At most, we can say that they reflect the world’s anxiety about China’s rise and how it would behave. It does not exclude India.

Here are the various articles, links and some quick comments from my side. Finally, not to miss out on this, I share portions of my own thoughts from an email I penned to a colleague yesterday on China.

Looks like this is an editorial in ‘Washington Post’.  Its message is forthright. It wants Obama to prick the China bubble. I am not sure that Americans are that adept in pricking bubbles.  They allow bubbles to run their course. When they pop, they step in to mop up.

Peter Brown, writing for Asia Times is consoling himself by discussing the new military technology that the US might unveil later this decade.

This Leader in ‘Economist’ calls upon America to stand tough on issues like meeting Dalai Lama, on arms sale to Taiwan, etc. but to be less strident on trade and economics. It says that China ’should be encouraged to play its part on climate change, on Iran and by allowing its currency to appreciate’.

Now, how exactly would the world encourage/cajole/coerce China? No one has the answer. The West has tried all three, I think. They have not found one approach that elicits a consistent response. How does ‘Economist’ think that playing hardball on non-economics and softball on economic matters would ‘encourage’ China to do all that it says?

These muddled recommendations are echoed by Kanti Bajpai in his piece titled, ‘Stumbling tiger, leaping dragon’ for Times of India. I doubt if India’s foreign policy mandarins would have had their ‘eureka’ moment after reading that piece.

Mr. Bajpai knows geometric progression for sure. But, he has not read, I suspect, Niall Ferguson’s interview to be wary of the ‘BRIC future of Goldman Sachs’.  Niall said that there were multiple futures. Mr. Bajpai’s piece seems to suggest that there is only one in which China grows at 10-12% and India grows at 6-8% per annum. Needless and baseless growth differential projected far into the future.

Interesting to note is his reference to Prem Shankar Jha’s book on China. I have not read that. But, Mr. Jha has apparently observed that China has a better appreciation of its challenges. That is credible. I had alluded to that in my MINT piece.

There is a news article from ‘Financial Times’ on Beijing’s dismissal of US call for a revaluation of the Renminbi. Sometimes, I have wondered if the US actually wants China to continue to stick to its mercantilist approach, either because it would cause China to self-destruct [because such a policy creates periodic booms and busts in the economy, every time weakening its core foundations] or because American firms would lose out if the currency is revalued.

I think China would pretty much decide to move faster on this if it is able to reduce its reliance on export growth. For China to figure that out confidently would take another three years at a minimum. Until then, any progress on the exchange rate would be glacial. Further, by any chance, if it lent money to Greece, then the world could stop speculating on when the renminbi would be revalued.  Then, the answer would unequivocally be when China wanted it.

This article from ‘Economist’ would be useful to some of its readers as it highlights the personalities who run China’s financial systems and those that don’t.

For good measure,  good friend Sushant sent me this rather long ( like mine) blog post. It is at least a two-faced article. In the guise of a balanced prose, it basically asks Americans to accept greater stridency from the Politburo.  It tries to cleverly disguise its message. But it is not that difficult to see through it.

At work, this is the piece that a colleague sent me and sought my views.  Looks like Gordon Chang, the famous author of ‘The coming collapse of China’ is a prolific author. His prediction has not materialized yet. It may yet but again, it may not. There is no law of limitation to such forecasts. This is the article my colleague sent me.  It has also appeared here.

I will reserve the rest for Part 2.

It did not strike me but it should have served as a warning sign when I read this 2-pager on Jim O’ Neill in the FT in the flight from Zurich to Dubai on January 16th. The possibility of the magazine cover curse on either Jim O’ Neill or his ‘creation’ – the BRIC acronym – did not enter my head.

This BBC report should banish any thought of ‘magazine cover curse’.

Once, “the United States could export its recession around the world,” says Stephen King, the group chief economist of HSBC bank.

This crisis is different. Emerging economies, especially China and India, managed to avoid the worst of the contagion.

It’s “not perfect decoupling,” says Mr King, but over the long-term the crisis has sown the seeds for a move towards a “China-centric world rather than a US centric world”.

Stuart Gulliver, executive director at HSBC, sees a new economic bloc emerging that would sideline the US and Western Europe – stretching from China, Asia Pacific, the Middle East and Africa to Latin America.

As a bloc, these countries have “a lot of investable capital, huge commodity wealth, huge production capital and huge demand”.

It’s an area of emerging countries with so much domestic demand that a crisis in the West may cause it to stutter, but not to grind to a halt, argues Mr Gulliver.

Mr King points to the last three months of 2009, when China’s economy (and its exports) rebounded, even when US consumer demand did not.

The crisis has tipped the power balance.

But, reading this interview by Niall Ferguson with India’s Economic Times reminded me that that the thought of ‘magazine cover curse’ would have been legitimate.  My friend Sushant had sent me key extracts – the aspects that dealt with the rise of China, India and the possible futures that the world could have.

I now read the full interview. He does make me some compelling points on the legacy of the British empire. I like his point about thinking of the counterfactual.

I am impressed by this reply:

You’ve compared the potential of China and India . How do you see the future of the world panning out in terms of the China-India equation and where the two countries are headed?

First of all there is no such thing as the future of the world. There are futures. We all try and choose the one that we find the most attractive and we get the future that we somehow collectively will. One future is that of a familiar one where China’s GDP catches up with that of the US in 2027 and India’s with the US in 2050. The world rebalances and the East takes its rightful position as the dominant economic power. We thus go back to 1700. That’s a future that I would call a Goldman Sachs future.

There’s another future in which China’s attempts to have economic growth without political reform and breaks down. There’s another in which rivalry between India and China or between China and America produce conflicts. There’s another one in which the consequences of the financial crisis include a breakdown of the global economy due to tariff protection, currency wars and so forth. And those futures don’t strike me as significantly less plausible. In fact being a pessimist at heart I find them slightly more plausible than this happy story of Asian capture.

When you go back 100 years it would have been impossible, in let’s say 1910, to forecast that Japan’s GDP would overtake that of Britain at some point in the course of the 20th century. That’s what I take away from my historical studies . Projecting linear trends forward and saying that’s the future is a mug’s game. History is too full of twists and non-linear relationships [Emphasis mine] and we’ll be surprised just as people have been surprised by China’s growth. I remember going back to look at the Economist surveys through the 1990s to 2007. What really struck me was that they had missed the China story until it was right under them. Now it seems obvious to us. I read an Economist survey from as recently as mid-1990 s asking what is China going to export – tinned mushrooms? You know the future is very hard to predict.

Thinking of horizons much shorter than a century, the question is whether there is genuine de-coupling and whether one could safely predict that, after the re cent sell-off in the stock markets around the world, should one go back to buying Asia – China and Indian stocks – or should one practice caution?

This TIME magazine article leans in favour of India, again, from a long-term perspective. They make a valid point on this one:

Most important, India managed to achieve its substantial growth without putting its banking sector at risk. In fact, India’s banks have remained quite conservative through the downturn, especially compared with Chinese lenders. Growth of credit, for example, was actually lower in 2009 than in 2008. As a result, economists see continued strength in India’s banks.

But, who is to say that India’s fiscal profligacy is better or would be less problematic than China’s banking loans and potential non-performing loans? For example, continued nominal GDP growth well in excess of domestic interest rates could result in a much larger rise in banking assets than the rise in bad loans, in China.

My question is not rhetorical. I am really curious to know the answers that would help me make my investment choices.

This report filed from Davos by Chris Giles for FT has a rather astute observation from Raghuram Rajan:

Kenneth Rogoff told the Financial Times that, although aggressive policies should keep growth reasonably strong in 2010, “over the medium term, global consumption growth is likely to be slow for several years as the US consumer deleverages and the Asian consumer only gradually notches up her game”.

His view was shared by another former chief economist of the International Monetary Fund, Raghuram Rajan of Chicago University, who predicted imbalances would re-emerge, “because the structural forces that created them have not disappeared”. He also told delegates that there was a reason emerging markets could not start to consume more quickly: “Historically, emerging markets have never managed demand well.” [Emphasis mine]

So, it is not going to be that easy to bet on the so-called de-coupling, yet. It would still be a case of hope over reason, at least for now, notwithstanding the BBC report above and this story in ‘Economist’. Of course, Niall Ferguson said that predicting future was never easy. That should have been obvious long ago. Most of us do it not because we are good at it but because that earns our daily rice and roti.

Chairman Bernanke was confirmed for a second term as Chairman of the Federal Reserve with a vote of 70-30 in the Senate. It does not matter that, in standard democratic parlance, this was a comfortable victory. In the context of the post, 30 dissenting votes could be 30 too many. Chairman Bernanke’s speech at the American Economic Association was criticised for its failure to acknowledge the role of monetary policy in creating the housing bubble. I went through the speech transcript and his charts. He was not arrogantly indifferent to the role of the Fed in stoking the housing bubble. He was earnestly trying to defend himself and the Fed.

Interestingly enough, in chart 4, where he tries to show that Fed monetary policy was not too loose between 2002-2006 with his own reconstructed federal funds rate given by the Taylor’s rule – using real times forecasts for inflation, it was clear that the Fed policy was loose (if not ‘too loose’) during the period under discussion. In 2007, it was too tight. The Fed had actually engaged in compensating errors. Policy was too restrictive in 2007 as a compensation for being too loose in the previous five years. Was it a mistaken show of bravado or hawkishness?

Where he erred in that speech was his failure to acknowledge the role that Fed communication played in giving a sense of (needless or false) certainty to the market participants on the path of future rates. Second was the continued reassurance that Fed officials – himself and former Chairman Greenspan – provided to market participants on the housing bubble. They ignored warning signs and kept reassuring every one else that the US economy could not have a national housing bubble.

Another error of omission in the speech was his failure to set an example to the banking industry by admitting to errors. That would have made some in the banking industry reflect on their own failure to acknowledge errors of omission and commission.

For those interested, Mr. Bernanke’s speech at the AEA is here.

That brings me to another point. There are some people who find it convenient to blame only the Fed and the government and completely absolve (or keep quiet) on the role of the so-called private sector. They are among the perceptive observers of the world capital markets. Perhaps, it makes them feel comfortable to blame the public sector and not the private sector for that might be construed as an ‘attack’ on the so-called ‘free markets’. One example is here. Several others that I have read are ‘clients only’ documents.

A refreshing exception is, of course, Christopher Wood of CLSA, based in Hong Kong. He wrote in a special ‘flash’ edition of his well-known ‘Greed & Fear’ (clients only access) thus:

GREED & fear used to write editorials calling for repeal of the 1933 Glass-Steagall Act when working for The Economist in New York in the late 1980s. But at the time a naïve GREED & fear had assumed that repeal of Glass-Steagall would occur in the context of capital markets where at least a certain modicum of market discipline would be allowed to prevail. GREED & fear never expected that investment banks with no depositors would be bailed out in such obscene fashion as happened in the recent past (save for Lehman Brothers) with bond investors taking no hair cut whatsoever.

The simple point is that there was never any case for repeal of Glass-Steagall, or indeed for financial deregulation in general, if the political process was not prepared to contemplate punishing commercial failure in the context of the financial services sector.

But, were banks innocent babes in the wood  - lost for direction? Professor Raghuram Rajan is very clear  that they were and they are not:

It is hard to have much sympathy for the bankers, who have brought the public’s ire on themselves through incompetence and then through an outrageous haste to pay themselves. [More here]

They bought mortgage lenders and encouraged them to lend aggressively. They securitized those loans and encouraged them to lend even more to feed the securitization pipeline, they lobbied regulators to relax leverage constraints to offset the drag of a flat yield curve from 2005 onwards. They had no idea of risk management. They bought and sold Credit default swaps well in excess of the value of the underlying credit, they were supposedly trying to protect. Some finally said that they did not understand all that was going on. If so, why did they permit it?

These apostles of the private sector should read this short note on lobbying by financial firms.

Now, when the Obama administration tries to put an end to proprietary trading, the defendants of the so-called ‘virtuous private sector’ versus the ‘villainous public sector’ are up in arms against the government intervention. One is amazed at short memories. Without the government, where would these private sector banks be, today? Who incurred all these losses and brought the world to the brink? Governments?

Veteran Jeremy Grantham, in his latest missive, has this to say on the proposed ban on proprietary trading by deposit-taking institutions:

But since we bring it up, of course prop trading was indeed the rot at the heart of our financial problems (see last quarter’s Letter). Watching traders take home their $28 million bonus sent a powerful message to lowly salesmen and packagers of asset-backed securities, for example, to get out there and really take some risk. This rot spread to the very top, and pretty soon chairmen of boards were exhorting CEOs to leverage up and look more like some much more profitable rival that resembled a hedge fund rather than an investment bank. Thus encouraged – or intimidated – some CEOs just kept on dancing right off the cliff. Let’s learn from our near disaster.

Viral Acharya and Matthew Richardson write a sensible piece in the FT:

The main focus of financial reform should be to address such systemic risk. Separating commercial banking and other forms of financial intermediation from proprietary trading is a step in the right direction, since it limits systemic risk without affecting the financial sector’s ability to perform its core functions. [More here]

Prof. Raghuram Rajan takes a different route and simply calls for an end to deposit insurance for banks above a particular size. He is focusing on the issue of size and the conceptual problems associated with defining bank size. He did not dwell on the proposed ban on proprietary trading although the following sentence shows that he does not think highly of it:

Why not phase out deposit insurance as domestic deposits grow beyond a certain size? That would be far more effective in reducing risk than size or activity limits, and far easier to implement.

I would not even wait until the institution grows beyond a certain size. Simply do not provide deposit insurance to those institutions that want to do business beyond plain-vanilla banking, regardless of their size. Depositors would automatically demand a risk-premium for depositing their savings in such institutions or avoid such institutions. Either way, risk-taking by  such institutions would then be based less on deposit-insurance-subsidized source of funding and more on funds sourced from the market.

There is no better way to end this post than the article by David Stockman, the former Director of the  Office of Management & Budget under Reagan in New York Times recently. It is a masterpiece.  Some samples:

… by fixing short-term interest rates at near zero, the Fed planted its heavy boot squarely in the face of depositors, as it shrank the banks’ cost of production — their interest expense on depositor funds — to the vanishing point.

The resulting ultrasteep yield curve for banks is heralded, by a certain breed of Wall Street tout, as a financial miracle cure. Soon, it is claimed, a prodigious upwelling of profitability will repair bank balance sheets and bury toxic waste from the last bubble’s collapse. But will it?

In supplying the banks with free deposit money (effectively, zero-interest loans), the savers of America are taking a $250 billion annual haircut in lost interest income. And the banks, after reaping this ill-deserved windfall, are pleased to pronounce themselves solvent, ignoring the bad loans still on their books. This kind of Robin Hood redistribution in reverse is not sustainable. It requires permanently flooding world markets with cheap dollars — a recipe for the next bubble and financial crisis.

Moreover, rescuing the banks yet again, this time with a steeply sloped yield curve (that is, cheap short-term money and more expensive long-term rates), is not even a proper monetary policy action. It is a vast and capricious reallocation of national income, which would be hooted down in the halls of Congress, were it properly brought to a vote. ….

…… To argue, as some conservatives surely will, that a policy-directed shrinking of big banking is an inappropriate interference in the marketplace is to miss a crucial point: the big Wall Street banks are wards of the state, not private enterprises. During recent quarters, for instance, the preponderant share of Goldman Sachs’ revenues came from trading in bonds, currencies and commodities.

But these profits were not evidence of Mr. Market doing God’s work, greasing the wheels of commerce and trade by facilitating productive financial transactions. In fact, they represented the fruits of hyperactive gambling in the Fed’s monetary casino — a place where the inside players obtain their chips at no cost from the Fed-controlled money markets, and are warned well in advance, by obscure wording changes in the Fed’s policy statements, about any pending shift in the gambling odds. [More here]

Update:  These two news reports in BBC, in their different ways, offer hope for encouragement. One is because banks are ‘tone-deaf’, they are going to invite the kind of oversight that they deserve to get and, second, it is encouraging to see that policymakers are neither deaf nor blind. Let us wait to see their actions.

The main problem with this story is that this does not confront the question of what would have happened to the financial system globally had Goldman Sachs been allowed to take its loses on the CDS it had bought from AIG, if all that they are trying to prove is that the AIG bailout was a bailout of Goldman Sachs. The global financial system would have melted donw had Goldman gone down. Such was and is GS’ reputation and that is the truth. If Paulson openly came out and says that he bailed out Goldman because he wanted to avoid a systemic meltdown globally, he would be saying the truth.

Of course, why AIGFP posted a collateral when other monoline insurers did not and why AIGFP was not regulated are ex-post arguments. They were true even before the crisis broke out. Before the crisis, no one bothered.

The real story is what they say: the AAA rating that the senior tranches of the CDOs got duped/dulled/lulled AIGFP to issue countless CDS (more than the value of the underlying CDOs in the first place) to all banks and to agree to post cash collaterals.

Neither the CDS sellers (AIG) nor the banks believed – when they first entered into these transactions – that anything remotely resembling 2008 meltdown would happen.

That, in turn, was due to far too many loans, far too many bad loans, far too many securitized instruments on thse dodgy loans and far too easy top credit-ratings. The credit-rating agencies were the only ones that had a macro overview of what was going on, in the whole industry since all came to them for ratings.

They should have seen the total volume of CDOs (and CDO*2) that they were being called upon to rate, in relation to the pool of underlying mortgages and the rising proportion of sub-prime mortgages in relation to total mortgages and the rising proportion of sub-prime mortgages in the CDO mortgage pools.

The real scam, therefore, is why are these rating agencies still around and why this industry is not being thrown open to more and why do they still enjoy quasi-statutory status?

In the investment/analyst community, China has been in the news since Jim Chanos – famous for shorting Enron. It was quoted widely since he said that China was Dubai * 1000. You can see his comments here and here. I too think that was somewhat wild although one could understand the ‘sound byte’ angle to that comparison. As some one pointed out, China can print money and Dubai cannot. The blurring of lines between personal, public and private interests is the common element although one should think that it would be sharper and more widely prevalent in the monarchies of the Gulf region. Jim Rogers – a famous China bull – refuted him. See here.

Tom Friedman joined this debate. He said that China was not the next Enron, pointing to Mr. Chanos’ success with Enron. You can read his NYT Op-ed piece here. His main argument was this:

But it also has a political class focused on addressing its real problems, as well as a mountain of savings with which to do so (unlike us).

Soon after he wrote that, came the Google announcement. In case you missed their original announcement, it is here. Friedman was embarrassed. He wrote a clarification in which he split China into two parts: ‘command China’ and a ‘networked China’. He conceded that if Command China dominated ‘Networked China’, he would short the Communist Party of China! That was some finessing and the finer point (if any) was lost on many readers, including Yours Truly. See his column here.

Abe Greenwald takes issues with Mr. Friedman’s flip-flop. But, he fails to rebut him convincingly on the key issue that – rightly or wrongly – Mr. Friedman identifies as the key differentiator in favour of China – a political class focused on addressing its real problems. See his comments here.

I sided with Tom Friedman in a sense, on their economic competence in my MINT column last week. See the full column here. I had also alluded to their insecurity and obsession with control as the key risks that could trip or trick them into committing errors. An insecure (and fearful of losing control) mind plays games, you see. That too was on display in their reaction to Google’s threat as the Chinese finally lost their cool and saw the US government hand in Google’s decision. See how the Chinese media reacted. Usually, they are seen as HMV.

In the final analysis, I do not think we are anywhere closer to the truth with respect to divining China’s true economic health than we were, before these articles appeared. Therefore, I would stick to my view that their economic management remains on track to take their economy slowly (without major convulsions) towards a domestic orientation.

But, make no mistake. This move by the Greek government (through its advisers) to seek Chinese funding of its debt gives China a huge advantage over Europe and the rest of the World too. This is a classic understatement:

Chinese thinking is that Brussels could not let Greece fail, because the implications for the euro’s credibility are too dire. If that line of argument prevails in Beijing, then China may well be a buyer of Greek bonds. In the process, the Chinese may well be buying invaluable political capital in Brussels as well. [More here]

Just one argument would make it clearer: if China’s investment in Greek debt allowed the country to avoid a default and a potentially destabilizing crisis in the Eurozone, how would the Eurozone would be able to influence Chinese monetary or exchange rate policy when US dollar weakness results in excessive EUR appreciation? In addition, China has another reason to ensure that the EUR does not implode. One is that is a EUR implosion would rob China of an alternative currency to the US dollar to diversify its reserves. Collapse of the EUR against the US dollar would indirectly cause a significant appreciation of the Chinese currency against EUR, further stymieing China’s export prospects.

All told, I think this move is the soccer equivalent of China 10 – EU 0 (or) RoW 0.

Look at this news-item in FT: ‘China scientists lead world in research growth’. It was front-page news in FT Asia Edition on Monday and, on Wednesday, it was about Greece queuing up to China for money. India would do rather well to take note of the three factors cited as the key for China’s success in scientific research:

According to James Wilsdon, science policy director at the Royal Society in London, three main factors are driving Chinese research. First is the government’s enormous investment, with funding increases far above the rate of inflation, at all levels of the system from schools to postgraduate research. Second is the organised flow of knowledge from basic science to commercial applications. Third is the efficient and flexible way in which China is tapping the expertise of its extensive scientific diaspora in North America and Europe, tempting back mid-career scientists with deals that allow them to spend part of the year working in the west and part in China.

Together with this news and this news, one has to concede that after the Google saga, China still holds the aces. In fact, it has emerged stronger.