World Bank to Name Lin
New Chief Economist

The World Bank is poised to name a scholar from China as its chief economist, a move by bank president Robert Zoellick to address criticism that the institution needs more senior management from developing nations and should be better attuned to emerging markets.

Justin Yifu Lin is expected to fill the vacancy left by François Bourguignon, who retired as chief economist in October, according to bank officials. The 55-year-old Mr. Lin is the founder and director of the China Center for Economic Research at Peking University, and has frequently served as an adviser to the Chinese government. He would be the first Chinese citizen to be the Bank's chief economist, a job that has traditionally gone to eminent academics from the U.S. or Europe.

The choice of Mr. Lin would continue a shift in the World Bank's relationship with China, which for years was a major recipient of the bank's aid. With strong government finances and $1.5 trillion in foreign-exchange reserves, China today has little need for outside financial assistance. Although the bank continues to run projects in China in areas like environmental protection, its loans to the country now carry more commercial terms. Last year, for the first time, China agreed to contribute to the World Bank's fund for aid to the poorest countries.

The chief economist can play a powerful role at the World Bank, by setting its research agenda and helping establish its intellectual direction. Under the tenures of Stanley Fischer and Lawrence Summers, in the late 1980s and early 1990s, the bank forcefully advocated that poor countries liberalize their economies by repealing trade restrictions and opening their markets to foreign investment.

Under Joseph Stiglitz in the late 1990s, the bank became a critic of the International Monetary Fund's handling of financial crises, arguing that the IMF prescriptions were too fiscally restrictive and could worsen downturns.

The world's largest poverty-fighting institution since World War II, the World Bank has long been plagued by disagreements among poor countries that receive its aid and the wealthy countries that provide most of its funding. Mr. Zoellick has made efforts to bridge those gaps since he became Bank president in July.

Mr. Lin's own career over the last three decades has been founded on analyzing China's approach to economic development. He was born in Taiwan and earned a master's in business administration from National Chengchi University in Taipei in 1978, the year that mainland China began its market-opening reforms.

The next year, Mr. Lin, then serving as an officer in the Taiwanese army, left for rival China. Numerous published accounts over the years have said that Mr. Lin defected by swimming to China from the Taiwanese-controlled island of Quemoy, also called Kinmen. Mr. Lin went on to study at Peking University, China's top university. He earned a doctorate in economics from the University of Chicago in 1986, becoming one of the first students from China to complete such a degree in the U.S. during the reform era.

Mr. Lin gave a hint of how he might apply lessons from China to other developing nations in lectures at Cambridge University last year. China and Vietnam, he noted, have achieved long periods of fast economic growth while flouting some conventional free-market policies. Many countries in Eastern Europe and Latin America, by contrast, have been quicker to liberalize but have worse records of sustaining growth and reducing poverty.

Yet Mr. Lin didn't argue that China's specific policies would necessarily work elsewhere. He argued more for experimentation and gradualism than adopting a formula. "Principles or experiences of other countries should not be applied in a dogmatic way," Mr. Lin said then, according to a copy of his lecture notes. "A gradual, piecemeal approach to reform and transition could enable the country to achieve stability and dynamic growth simultaneously and allow the country to complete its transition to a market economy."

Mr. Lin couldn't be reached for comment in Beijing over the weekend. The Bank's governing board hasn't yet approved his appointment, but final approval is expected by the end of the month.

 

Markets and the Dollar

By DAVID MALPASS

High-profile foreign investments in U.S. financial institutions have been making headlines recently. But those capital injections are a trickle when compared to the outward flood of dollars from U.S. companies seeking to increase assets and earnings in some currency other than the sinking dollar.

To fight financial market turbulence and a slowing economy, the Fed has injected extra liquidity, cut the discount rate, and cut the fed funds rate a full percent. As it prepares to hit the rate-cut panic button harder, the Fed should also try using its most powerful tool, a stronger dollar, to draw liquidity into credit markets, reduce oil prices and restart economic growth.

At 4.25%, the fed funds rate is now below both the 4.3% consumer price inflation rate and the 4.9% third-quarter real growth rate. That's a more proactive interest rate stance than any previous pre-recession environment. The Fed is trying to make the best of a bad monetary situation. Most of the damage was done once the fed-funds rate was forced down to 1% in 2003 and held artificially low as the value of the dollar evaporated and housing bubbled through 2005.

The Fed's late-December policy innovation — auctioning funds through the discount window — will gradually shift as much as 7% of the Fed's $900 billion in assets from Treasury bills to collateralized bank loans. This is constructive medicine. It should help deposit-taking banks finance mortgages, and also leave sought-after Treasury bills in the market.

While some worry that central banks are losing their power due to the size and complexity of global markets, the more likely problem is too much power. Central banks cause wide swings in interest rates and the value of their currencies. With a delay, the swings penetrate the price level as inflation and deflation. Central banks are the only institutions that have a literally unlimited balance sheet — in the case of the Fed, the ability to instantaneously create and inject into the economy as many billions of dollars as it determines useful (by buying Treasury bills or acquiring temporary control of mortgage-related securities).

The elephant in the living room — the topic Washington won't broach — is the dollar itself as a powerful but unused monetary policy tool. The Fed didn't mention the dollar in its Dec. 11 rate-decision communiqué, nor in its November economic forecasts. In his recent 500-page memoir, and his Dec. 13 opinion piece on this page, former Fed Chairman Alan Greenspan barely mentions the wide swings in the value of the dollar — probably the most important economic and investing variable in the last decade — and their causal connection to first deflation and now inflation.

President Bush showed no embarrassment over dollar weakness in a November interview with Fox Business News. He was asked: "Even if the economy is weak, shouldn't the dollar be strong?" Rather than a simple "yes," the president said: "All I can tell you is the policy of this government is a strong dollar. We believe the marketplace is the best place to set the exchange rates." Pressed if he was satisfied with where the exchange rates are now, he replied: "Well, I am satisfied with the fact that we have a strong-dollar policy and know that the market ought to be setting the exchange rate between the U.S. dollar and other currencies."

Current U.S. dollar policy leaves only "the market" responsible for the dollar's collapse. Not known for deep thinking, the currency markets tend to sell currencies issued by countries which make markets responsible for currency values. The euro found this out the hard way in 2000 when Wim Duisenberg, then head of the European Central Bank, invited markets to set the value of the euro based on Europe's economic fundamentals. Look out below. The free fall didn't stop until Jean-Claude Trichet took over and installed policies to preserve the euro's value regardless of the market's view of economic fundamentals.

There's no reason to think markets set currency values based on economic fundamentals anyway. In the early 1990s, Japan's yen was super-strong through 1995 even though it pushed Japan into a decade-long deflation spiral. Currency markets are famous for going to extremes, distorting economies and people's lives without any qualm of conscience or reference to value.

One of the Fed's main explanations for its hope that inflation could moderate despite dollar weakness — the same explanation it used in the late 1990s for claiming that dollar strength wouldn't cause deflation — is its research showing that the "trade-weighted" value of the dollar is not well-correlated to U.S. inflation. The obvious problem with this approach is that the trade-weighted dollar mixes together changes in the dollar's value with changes in the value of foreign currencies.

The dollar's trade-weighted value can be down due to foreign currency appreciation, and vice versa, with little impact on U.S. inflation. In contrast, the connection between gold-measured changes in the value of the dollar and the U.S. inflation rate is too clear to keep ignoring.

The relationship between currency values and inflation or deflation is equally strong in other countries. China is suffering high inflation now because the gold-measured value of the yuan is weak (even though the trade-weighted yuan is strong due to dollar and yen weakness). Yen strength in the late 1980s and early '90s drove Japan into a deflation spiral, the same process that struck the U.S. in the late '90s.

By saying they want a stronger dollar, the Fed, the president or the Treasury could make it happen. Government policy makers have almost absolute control over perceptions of the future scarcity of dollars. This controls the demand for dollars almost as much as it does the supply, setting its value as much or more than rates do.

* * *

But world markets expect a dovish Fed now and in the future. This is driving capital away from the dollar. Washington can easily change this perception by linking a stronger dollar to its much-needed fight against inflation. Coordinated currency interventions are a helpful and decisive signal of a monetary policy change, but aren't required.

As a next step in addressing financial-market turbulence, the Fed and the administration should say they want the dollar to strengthen in order to attract capital, spur U.S. growth and slow the inflation rate. There's still time. Jobless claims are not yet at recession levels, stock prices are high, and exports are booming. The weak dollar doesn't seem to be at a tipping point — it's more of a constant drag on the economy, like American litigiousness and the anti-growth tax code.

But the harder the economy works to repair the weak-dollar damage from the bottomless liquidity punch bowl of 2004, the deeper the urge for the "hair of the dog" medicine of more rate cuts. Those may weaken the dollar more, adding to inflation. The clear alternative is to strengthen the dollar first.

Mr. Malpass is chief economist at Bear Stearns.

WSJ, January 18, 2008

HONG KONG — Early signs of a softening real-estate market in southern China's two largest cities suggest that government measures to temper investors' zeal for property could be working.

Discounts touted by developers to drum up transactions and a decline in new-home prices reflect concerns that the market has risen too high too fast. They have also left investors wondering whether weakness in China's south might foreshadow the first nationwide downturn in housing prices since private homeownership became a reality in China in the late 1990s.

Prices for new homes in Shenzhen, a southern boomtown of nine million that borders Hong Kong, dropped 8% from September to the end of the year, according to global real-estate advisers DTZ. In nearby Guangzhou — China's third-largest city, behind Beijing and Shanghai, and the nexus of its manufacturing might — prices for new homes fell 9.9% in November from a high of 11,574 yuan ($1,600) a square meter in October, according to city-government statistics. The declines come after years of consistently strong market sentiment in both cities.

A sharper or broader property downturn in China could shake investor confidence, further pressure stocks and hurt the booming economy. But for now, the situation stands in contrast to the housing picture in the U.S. There, a broad decline in prices is linked to fears of recession, and the government is trying to spur activity, not damp it.

"Because inflation is higher, [Chinese] policy makers are increasing their resolve" to curb lending, says Mei Jianping, a professor of finance and a real-estate specialist at the Cheung Kong Graduate School of Business in Beijing. "Some cities will adjust more than others, but this is going to be a nationwide phenomenon."

Many brokers and analysts are reluctant to draw too many conclusions from the downturn in the south. They point to the swelling tides of Chinese that continue to pour into the big cities, looking to buy a first home.

"Fundamental demand in China across the board is very strong and will remain that way for the next 10 years," says Alan Chiang, the Shenzhen-based head of mainland China residential property at real-estate broker DTZ. "We still have a very, very long road to go on urbanization."

China's property prices have reached dizzying highs in recent years, as the nation's cities have taken in tens of millions of new residents and the number of middle-class homeowners rises. Investors have followed the property boom with speculative money.

Prices for new homes in Guangzhou fell 9.9% in November from October.

After posting double-digit growth for several years, real-estate markets in Shenzhen began to wobble this past summer as central authorities rolled out their latest measures to curb speculation there. First, transaction volumes plunged, with November levels falling 81% from a high of 8.6 million square feet in January 2007, according to DTZ. The decline in new-home prices followed.

On the ground, the declines have sparked a phenomenon so far unseen in these cities: promotional gimmicks by developers that, for instance, had residents of Guangzhou lining up overnight for a small discount or free furniture thrown in with a purchase. Chinese news media have seized on any sign of trouble, with readers keenly tuned to the topic. One report this month said Shenzhen-based real-estate broker Chuanghui was shutting hundreds of branches because of declining interest from home buyers.

Central-government policy makers have pressed on with their campaign to curb access to easy credit. This past week, the government again increased the ratio of capital that banks must hold in reserve, a measure it used 10 times last year to restrain bank lending.

Todd Schubert, an analyst at Deutsche Bank AG, says the slowdown is evidence that Beijing's antispeculative measures are taking root. Mr. Schubert expects further price declines across the country in 2008.

In Shenzhen, prices dropped 8% from September to the end of the year, according to global real estate advisers DTZ.

Such a decline could have wider implications for investors in the stock market, since stock prices and home prices are so closely linked in China's closed capital system. Ordinary Chinese investors, with few options, plow stock-market gains into real estate, and vice versa. In recent years, that cycle has spurred both markets to records; now, as stocks retreat, the cycle could work in reverse. The measures are also likely to put a crimp in China's high-flying property developers.

"What the government is trying to do is shift that wealth from the private developers to the general public," says Eric Lam, general manager for the Guangzhou office of Colliers International, a property broker and consultant.

In the big picture, though, the declines don't necessarily spell widespread trouble for a country that has seen a benchmark index of property prices in 70 major cities rise at a solid rate in December, compared with last year. The latest figures, released Thursday by Beijing, showed price growth holding steady in general across the country.

Deep troubled Wall Street financial firms are scourging in the world to find their next big capital injection. First Singapore, China and the Gulf, now the begging lists expanded to South Korea and Japan. Dollar recycling just took another form. It also shows you how serious the problem we are facing: it's no more a liquidity crisis, now is solvency crisis.

Merrill Gets $6.6 Billion Infusion

 

Citigroup Swings to $9.83b loss, another $12.5b investment from foreign investors

 

 

Alwaleed, China to Invest in Citi

Prince Alwaleed bin Talal is poised to once again come to the rescue of Citigroup Inc.

This time, the Saudi billionaire is expected to be joined by other investors, including the China Development Bank, people familiar with the matter said. While it isn't clear how much Prince Alwaleed will invest, the Chinese entity is expected to invest roughly $2 billion, one person said. Prince Alwaleed's total stake in Citigroup is likely to remain below 5% in order to avoid regulatory scrutiny. However, given that Citi has a stock market value of $140 billion, even a 1% stake would end up being a significant sum of money, and a potential vote of confidence in the struggling bank.

While Citigroup is still working out details of the planned investments, and there's a chance they could fall apart, the bank is hoping to collect a total of $8 billion to $10 billion from a number of investors, likely including at least one fund affiliated with a foreign government, the people said.

China Development Bank was set up in 1994 as one of the country's three policy banks. On Dec. 31, China's sovereign wealth fund China Investment Corp. made an infusion of $20 billion into the bank, in an move to turn the bank into a commercial lender.  

This would be at least the third major investment by a Chinese institution in a struggling Wall Street firm. China Investment Corp. is investing $5 billion in Morgan Stanley, while Citic Securities agreed to a $1 billion investment in Bear Stearns Cos., though Bear will also invest that amount in the Chinese firm, albeit over many years.

Citi is also talking to other existing shareholders, including U.S. investment funds, to potentially up their stake in  the bank.

A cash infusion would leave Prince Alwaleed in a familiar role. In 1991, he pumped $590 million into what was then known as Citicorp. The investment, which was in the form of a private placement of convertible preferred stock, gave him an ownership stake of nearly 15% at the time. For years, he was Citi's largest individual shareholder.

Prince Alwaleed ceded that title last month, when Abu Dhabi's investment arm paid $7.5 billion for a 4.9% stake in the cash-strapped company.

In recent weeks, though, the bank's troubles have continued to pile up. Citigroup decided to bring onto its balance sheet $49 billion in assets from seven struggling investment affiliates, a move that further depleted its already weak capital ratios. The New York conglomerate also is facing more than $15 billion in fourth-quarter losses stemming from its exposure to mortgage-related investment vehicles.

Citigroup is hoping to unveil the investments Tuesday when it reports fourth-quarter earnings. At the same time, the company also could announce that it is cutting its dividend payment.

Thanks to his large stake, Prince Alwaleed has wielded considerable influence at Citigroup. In 2006, he publicly warned Citigroup's then-chief executive, Charles Prince, that he needed to take "Draconian" steps to contain the company's spiraling expenses. Months later, Mr. Prince followed up with a cost-cutting plan that included the elimination of 17,000 jobs, or about 5% of Citigroup's workforce.

Despite Citigroup's struggles through the first three quarters of last year, Prince Alwaleed continued to publicly support Mr. Prince. But last fall, as Citigroup executives realized they were facing billions of dollars in write-downs, Prince Alwaleed withdrew that backing. In early November, Mr. Prince handed in his resignation.

An old Chinese myth

Contrary to popular wisdom, China's rapid growth is not hugely dependent on exports

MOST people suppose that China's economic success depends on exporting cheap goods to the rich world. If so, its growth would be seriously dented by a stuttering American economy. Headline figures show that China's exports surged from 20% of GDP in 2001 to almost 40% in 2007, which seems to suggest not only that exports are the main driver of growth, but also that China's economy would be hit much harder by an American downturn than it was during the previous recession in 2001. If exports are measured correctly, however, they account for a surprisingly modest share of China's economic growth.

The headline ratio of exports to GDP is very misleading. It compares apples and oranges: exports are measured as gross revenue while GDP is measured in value-added terms. Jonathan Anderson, an economist at UBS, a bank, has tried to estimate exports in value-added terms by stripping out imported components, and then converting the remaining domestic content into value-added terms by subtracting inputs purchased from other domestic sectors. At first glance, that second step seems odd: surely the materials which exporters buy from the rest of the economy should be included in any assessment of the importance of exports? But if purchases of domestic inputs were left in for exporters, the same thing would need to be done for all other sectors. That would make the denominator for the export ratio much bigger than GDP.

Once these adjustments are made, Mr Anderson reckons that the "true" export share is just under 10% of GDP. That makes China slightly more exposed to exports than Japan, but nowhere near as export-led as Taiwan or Singapore (which on January 2nd reported an unexpected contraction in GDP in the fourth quarter of 2007, thanks in part to weakness in export markets). Indeed, China's economic performance during the global IT slump in 2001 showed that a collapse in exports is not the end of the world. The annual rate of growth in its exports fell by a massive 35 percentage points from peak to trough during 2000-01, yet China's overall GDP growth slowed by less than one percentage point. Employment figures also confirm that exports' share of the economy is relatively small. Surveys suggest that one-third of manufacturing workers are in export-oriented sectors, which is equivalent to only 6% of the total workforce.

Even if the true export share of GDP is smaller than generally believed, surely the dramatic increase in China's exports implies that they are contributing a rising share of GDP growth? Mr Anderson's work again counsels caution. Although the headline exports-to-GDP ratio has almost doubled since 2000, the value-added share of exports in GDP has been surprisingly stable over the same period (see left-hand chart). This is explained by China's shift from exports with a high domestic content, such as toys, to new export sectors that use more imported components. Electronic products accounted for 42% of total manufactured exports in 2006, for example, up from 18% in 1995. But the domestic content of electronics is only a third to a half that of traditional light-manufacturing sectors. So in value-added terms exports have risen by far less than gross export revenues have.

Many of China's foreign critics remain sceptical. They argue that China's massive current-account surplus (estimated at 11% of GDP in 2007) proves that it produces far more than it consumes and relies on foreign demand to buy the excess. In the six years to 2004, net exports (ie, exports minus imports) accounted for only 5% of China's GDP growth; 95% came from domestic demand. But since 2005, net exports have contributed more than 20% of growth (see right-hand chart).

This is due not to faster export growth, however, but to a sharp slowdown in imports. And even if the contribution from net exports fell to zero, China's GDP growth would still be close to 9% thanks to strong domestic demand. The boost from net exports is in any case unlikely to vanish, even if America does sink into recession, because exports to other emerging economies, where demand is more robust, are bigger than those to America. According to Standard Chartered Bank, Asia and the Middle East accounted for more than 40% of China's export growth in the first ten months of 2007, North America for less than 10%.

Multiplier effects

China's economy is driven not by exports but by investment, which accounts for over 40% of GDP. This raises an additional concern: that weaker exports could lead to a sharp drop in investment because exporters would need to add less capacity. But Arthur Kroeber at Dragonomics, a Beijing-based research firm, argues that investment is not as closely tied to exports as is often assumed: over half of all investment is in infrastructure and property. Mr Kroeber estimates that only 7% of total investment is directly linked to export production. Adding in the capital spending of local firms that produce inputs sold to exporters, he reckons that a still-modest 14% of investment is dependent on exports. Total investment is unlikely to collapse while investment in infrastructure and residential construction remains firm.

An American downturn will cause China's economy to slow. But the likely impact is hugely exaggerated by the headline figures of exports as a share of GDP. Dragonomics forecasts that in 2008 the contribution of net exports to China's growth will shrink by half. If the impact on investment is also included, GDP growth will slow to about 10% from 11.5% in 2007. This is hardly catastrophic. Indeed, given Beijing's worries about the economy overheating, it would be welcome.

The American government frequently accuses China of relying excessively on exports. But David Carbon, an economist at DBS, a Singaporean bank, suggests that America is starting to look like the pot that called the kettle black. In the year to September, net exports accounted for more than 30% of America's total GDP growth in 2007. Another popular belief looks ripe for reappraisal: it seems that domestic demand is a bigger driver of China's growth than it is of America's.