Saturday, September 29, 2012

Unanswered questions regarding the Bo Xilai affair

As I have indicated earlier, the whole of the Bo Xilai affair bodes ill for the future of China.

It shows that, in spite of all the material progress that has taken place, China has made zero progress culturally, because its way of running the country is essentially still the same as during the time of Lin Biao.  There is rumour, there is innuendo, there are machinations and plots, there is murder or imprisonment on some grounds or other, which may be manufactured, imagined or real.  And the massive Chinese political machine marches on, now under the control of one clique and now under the control of another clique.

Here are some unanswered questions regarding the Bo Xilai affair:

1.  In a country where the secret police is evidently numerous, active and efficient, is it possible that they and their masters were unaware of "grave violations of party discipline" on the part of someone as prominent as Bo Xilai?  After all, the man ran, in turn, the not unimportant city of Dalian (the location chosen by the Chinese authorities for the World Economic Forum's "Annual Meeting of the New Champions" ), the whole of Liaoning province in northeast China, and indeed the entire Chinese Ministry of Commerce. If he did in fact commit grave crimes and misdemeanours, who were the people who protected him for all these decades?  If Bo has now ceased being protected, have his protectors escaped?  If not, who are they and what has happened to them?

2.  If Bo did not commit the crimes and misdemeanours of which he is charged, who has manufactured the "evidence" which will be released?  Presumably those who have won the power struggle within the Politburo?  So: Xi Jinping and his allies?

3.  What are the crimes and misdemenours of which Bo is accused?  Though the system reserves to itself the right of changing the charges, it is principally that he asked Police Chief Wang Lijun to suppress evidence relating to the murder of British businessman Neil Heywood, apparently by Bo's wife who is usually referred to as Gu Kailai but whose official name is Bogu Kailai.  The official story is that, in the latter half of 2011, Bogu Kailai and her son had conflicts with Heywood over business matters, that Heywood threatened her son in e-mails, which made Bogu Kailai fear for her son's personal safety, and decide to murder Heywood. The question that arises is:  could the wife and son of one of the top Chinese officials not have handled threats from a British businessman by referring the matter to the Chinese police, rather than by murdering him?  Of course, the answer must be "No" if Bogu Kailai and her son had something they did not wish to be discovered by the Chinese authorities.  If so, what was it that they were really involved in?  How come no one is investigating that and "only" talking about the murder of Heywood?

4.  Bogu Kailai has been awarded "a suspended death sentence", which means that she will be executed if found guilty of having intentionally commited further crimes during the two years following the sentence (as this case demonstrates, the definition of a "crime" is rather fluid in China).  Supposing that the system finds it convenient not to charge her of any further crimes, her sentence will be automatically reduced to life imprisonment.  Indeed, if the system finds her to have behaved well during the two years, the life sentence can be reduced to imprisonment for a fixed term.  In other words, Bogu will be hauled before the courts again after two years and the system will then take a view of her behaviour during these two years, and decide the number of years, months, weeks, or days she will continue in prison.  It is not clear what sort of prison she is or will be in. We all know that prisons can be horrible, but some prisons can presumably be like 5-star hotel rooms.  Has justice been done?  Has it been seen to be done?

5. Wang Lijun, former vice mayor and police chief of southwest China's Chongqing municipality, has been sentenced to 15 years in prison for bending the law for selfish ends, defection, abuse of power and bribe-taking. The official story is that Bogu Kailai had confessed to him that she had poisoned Heywood, but he not only concealed the fact as well as the recording of her confession, but also gave Bogu Kailai a video recording that showed her at the crime scene on the night of Heywood's death. If so, how did these facts become evident?  The only possibility is that Bogu turned on him.  Why would she do so when doing that was tantamount to signing her own death sentence?  

The official story goes on to say that Wang then appointed Guo Weiguo, at that time deputy chief of the bureau and a close friend of both Wang and Bogu Kailai, to take charge of the case. Guo conveniently found that Heywood had died from drinking too much. However, after Wang had unspecified conflicts with Bogu Kailai, Wang told personnel at the Chongqing Public Security Bureau to re-investigate the case, and provided them with the recording of Bogu Kailai admitting the murder of Heywood. On February 7, 2012, Wang offered the case files to the authorities. If that is in fact what happened, Wang is clearly less intelligent than the head of security needs to be: did he not realise that by turning Bogu in, he would make an enemy of everyone connected with her?  

The official story continues that in early February 2012, Wang felt in danger when he was in effect demoted and his close aides were interrogated. This is curious: so the system punished him (slightly) rather than rewarding him (even slightly) for bringing a crime to light?

In any case, the official story continues that, because of his insecurity, Wang fled to the US Consulate General in Chengdu on February 6 and asked the US side for political asylum. This is curious.  Why would an intelligent man like Wang go to the US Consulate in Chengdu and not in Beijing or in Shanghai, from where it would have been easier for the US authorities to smuggle him out of the country.

Presumably, the US authorities decided for their own reasons not to grant him asylum.  Why?  How come such an important "catch" was turned down by the US, which might have given the US access to at least some of the inner workings of the Chinese system?  Was there a deal between the US and Chinese authorities? 

From the Chinese point of view, Wang had defected, or attempted to defect, and was therefore liable for the severest penalty.  However, the official story is that Wang was persuaded by the Chinese to leave the US Embassy on February 7.  Now if you were Wang, would you have allowed yourself to be persuaded to leave the US Embassy, if you did not have cast iron guarantees of safe conduct?  What were the arguments and inducements used by the Chinese side?  What happened to whatever assurances were given to Wang?  Is the sentence part of the "deal"?

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Saturday, September 15, 2012

What should we make of the NewQE or the Fed's New Stimulus Programme?

The announcement was both expected and unexpected.  
*Some* action had been expected in view of economic recovery that I had, much to everyone's surprise, announced in October last year - but is, as expected, much too slow and is not adding anything much in terms of jobs.  
While the Fed's announcement is far less in quantity than was expected (a total of $85 billion a month, instead of the current $100 billion), the disappointment was compensated for by two new and unexpected dimensions which have been added in comparison to earlier rounds of Quantitative Easing or QE.
The first dimension is the announcement articulates the determination of the Fed to continue providing as much QE as needed till there is "a sustained upturn in the jobs market".  That is a huge change, because it marks official recognition that, in view of the nature of the crisis that we are experiencing, ModernQE is not an "once in a blue moon" action but is going to require more or less continuous injection of QE probably for several years.
Second, ModernQE is tied to purchase of mortgage-backed securities, which means that those who bet on the mortgage market will laugh not just this weekend but for years.
The results of the Fed's new actions will be, on one hand, massive gains for speculators (specifically those who bet on the mortgage market) - so it is no wonder that stock prices jumped to a 5-year high; on the other hand, the result is going to be faster inflation for the average person - still low compared to historic highs, but unwelcome at a time when the real economy is stagnating or growing extremely slowly.  In response to those expectations of faster inflation, it is no wonder that gold prices also jumped up.
By contrast, the Fed expects its actions to result in lower rates for mortgages - but whether that will really happen and, if so, when, and by how much, remains to be seen.  
The Fed also expects investors in mortgage-backed securities (MBS) to move into other assets. Theoretically, that is correct.  But don't expect a very quick move as long as there is a killing to be made in the MBS market.

Further, the Fed expects that businesses will now feel more comfortable about going out and start hiring employees.  

Well, expect a marginal improvement, more in the nature of strengthening the floor than in the nature of adding a new storey.  But the Fed anticipates that the unemployment rate will move down, by the end of 2014 (!), to somewhere between  6.7 and 7.3 percent (versus their earlier forecast of somewhere between 7.0 and 7.7 percent, which was the forecast in June).  My view is that 6.7% may be hit sooner than anyone expects at present, but it won’t be for reasons to do with the Fed’s actions, it will depend rather on clarity about the wider rules of the game such as Frank-Dodd and the Romney versus Obama approach to economic growth versus economic inclusion.

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Tuesday, September 04, 2012

What Caused the current Great Recession - and how to get out of it?

A new book has appeared on this subject: Boom and Bust Banking: The Causes and Cures of the Great Recession, published by The Independent Institute, USA.

It is a collection of essays edited by David Beckworth, who is an assistant professor of economics at Western Kentucky University (earlier, he was an international economist at the U.S. Department of the Treasury, before which he was assistant professor of economics at Texas State University).

Lawrence H. White's overview of U.S. monetary policy from the early-to-mid 2000s accuses that of creating the housing boom, because the target federal-funds rate was extremely and unjustifiably low. That influenced even the types of mortgages that came into existence.

David Beckworth argues that the Fed kept monetary conditions so easy for so long because it was concerned that raising the federal-funds rate would jeopardize economic growth. In other words, the Fed was more committed to economic growth than it was to monetary sense.

Diego Espinosa argues that Fed's low interest-rate policy, coupled with the expectation that it would persist, created the new game of borrowing at low short-term interest rates and investing in higher-yielding long-term assets. That is what fuelled securitization, including that of subprime mortgages, and led to the emergence of so-called "structured finance". In other words, the growth of the shadow banking system was the direct and inevitable result of Fed policy.

Christopher Crowe joins Beckworth in arguing that the international housing boom was not caused by a global savings glut, but by the global influence of the Fed: other countries followed similar policies, leading to the flood of global liquidity, and the accumulation of foreign reserves.

In Scott Sumner's view, the recession that started in December 2007 became virulent by the end of 2008 because monetary policy tightened. If the Fed had not been so stupid, it would have understood that it was tightening, and it would have further understood that monetary policy need not be limited by the zero bound. In other words, it could have prevented the Great Recession by real monetary easing.

Jeffrey Rogers Hummel contrasts Ben Bernanke with Milton Friedman. Bernanke believes that financial crises result from aggregate supply problems, so they are best dealt with by having the Fed act as a lender of last resort, which is why, from August 2007 to August 2008, the Fed created liquidity to prop up the financial system, but allowed monetary policy to tighten. On the other hand, Friedman saw financial crises as the result of monetary policy failure. He would have urged the Fed to respond to the sharp decline in monetary velocity in 2007 and 2008.

W. William Woolsey agrees, on the basis that, since any shock to the supply or demand of money disrupts the entire economy, the Fed’s failure to attend to the huge demand for money in 2008, helped transform an economic downturn into the Great Recession. He suggests that the excess money-demand problem also helps explain the liquidity trap, the paradox of thrift, and the balance-sheet recession.

Nicholas Rowe applies Woolsey's explanation to a global level: In 2008, the excess money-demand problem went global because the U.S. dollar is the world’s most important currency. Only one central bank, the Fed, was capable of responding to the spike in the global demand for liquidity. The Fed did in fact supply enough dollars through currency swaps to other major banks, but it was too slow off the mark. Technically (even if not in reality), the Great Recession is over, but the global demand for dollars is still strong, so the Fed must continue to print dollars or face an excess demand that could drive the U.S. economy into recession.

Some of the above may seem like madness for US citizens concerned about a super-inflationary future. So what can be done to avoid the boom-bust cycle growing even bigger (and perhaps even too big) in the future?

Joshua R. Hendrickson calls for the Fed to be bound by a nominal-income targeting rule. Not only is this easier to follow than the Taylor Rule, with which the Fed complies in theory (or when it wants to), Hendrickson believes that nominal-income targeting would make the Fed respond systematically to aggregate demand shocks as well as to ignore aggregate supply shocks. The result would be a stabilization of total current-dollar spending, while changes in the price level driven by aggregate supply would be ignored.

But William R. White wonders whether nominal-income targeting could cause the Fed to ignore other risks, such as credit bubbles which, when they burst, would still need to be bailed out by the Fed. Was it not precisely the Fed’s attempt to clean up after the stock-market decline of the early 2000s that fuelled the housing boom? He therefore thinks the Fed needs to worry not only income and business cycles but also about credit cycles - and it is of course difficult to do everything simultaneously.

Laurence J. Kotlikoff doubts that the Federal Reserve can maintain macroeconomic stability at all. He considers our entire financial system vulnerable, because it is very easy for financial institutions to gamble with other people’s money. Kotlikoff believes in limited-purpose banking: in his ideal world, there will be only two kinds of financial mutuals: one providing investment opportunities, the other providing checking accounts 100-percent backed by highly liquid assets. This is not very far from the Glass-Steagall Act, with the additional consideration that the Fed would then gain complete control over the money supply and so be better able to stabilize aggregate demand.

George Selgin explores how monetary conditions might evolve in the absence of central banks: private banks would issue banknotes fractionally backed by some kind of reserve, and those banknotes would circulate as cheques do today. They would be cleared as banks return their competitors’ banknotes directly to them for redemption or through a central clearinghouse; any dues owed by one bank to another would be netted or settled by transferring reserves.

There is a lot to discuss in this book but (apart from my asides above) let me for the moment confine myself to the following observation: Assuming Selgin does not believe in conspiracy theories, why did Selgin's solution (unregulated banking with competitive issuing of notes) fail in actual history to provide that stability and lead instead to the formation of the Fed in the first place?
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