Breakingviews

China’s absent princeling is a mystery not a crisis

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

China’s growth is slowing, and president-in-waiting Xi Jinping hasn’t been seen in public for two weeks. China-watchers are discussing little else. The former issue matters greatly to the world, while the latter is fascinating, but basically unimportant.

Xi hasn’t made an appearance since Sept. 1. He was not listed as having attended a meeting of the military commission, and cancelled sit-downs with U.S. secretary of state Hillary Clinton and the Danish prime minister. Reporters were chided for asking foreign ministry officials about his health. Rumours – all unsubstantiated – range from a mild heart attack to an assault by forces loyal to ousted Bo Xilai.

It’s not the first time China’s authoritarian public relations machine has left the public to fill in the gaps. Two decades ago, premier Li Peng disappeared from view for over six weeks. Rumours at the time included a heart attack, or a political ouster. He subsequently returned to serve for five more years.

China needs a president, of course. What’s less clear is how much it matters that it’s Xi. China’s one-party system relies ever less on individuals than in the era of Mao Zedong and Deng Xiaoping. Technocratic president Hu Jintao and his premier Wen Jiabao represented a big step away from strongman politics. The Party’s standing committee is a study in homogeneity, right down to the haircuts.

Xi’s views are as much a mystery as his whereabouts. What gives him legitimacy isn’t his unremarkable track record, but the belief that he has the support of the Party and, crucially, the military. If Xi can ensure stability and growth, he should have public support – but so might anyone else who can deliver those things. It’s a far cry from the issues-based politics of the U.S. presidential race. And of course, ordinary Chinese don’t get to choose.

U.S. political jamborees alienate Mr. Market

By Daniel Indiviglio and Jeffrey Goldfarb The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Mr. Market would have felt unwelcome in Charlotte and Tampa over the last couple of weeks. The political jamborees hosted in the two southeastern U.S. cities offered stark differences in tone that mirror the different options Americans face in November’s elections. Eat the fiscal spinach served up by Mitt Romney and the Republicans, or gorge on the pro-worker red meat dangled by Barack Obama and the Democrats. Voters may be tempted by one or the other, but investors will probably turn their noses up at both.

A broad cross-section of America showed up for the Democratic convention, which wrapped up proceedings on Thursday night with President Obama formally accepting the nomination to run again. The party’s diversity was obvious throughout Time Warner Cable Arena, even without organizers jack-hammering the point home on stage. And yet while union bosses, mayors, auto workers, abortion rights activists, firefighters, equal pay advocates and celebrities like Scarlett Johansson got their say, there was little room for Mr. Market.

He would have winced anyway at the repeated brags by Vice President Joe Biden and many others about the president’s deal to save General Motors and “more than 1 million American jobs,” which required upending the automaker’s capital structure and trampling on bondholder rights. He would have balked, too, at all the unqualified praise for Obama’s healthcare law, aggressive environmental enforcement and financial regulation.

The lack of attention to Uncle Sam’s biggest long-term challenge also would have alienated Mr. Market. How to reduce the nation’s debt load, which surpassed the $16 trillion mark during the Democratic convention, got scant mention during the three-day event and only brief lip service in the keynote speeches of former President Bill Clinton and Obama, whose $3 trillion of proposed deficit cuts over the decade starting in 2013 would all come from collecting more taxes.

Delegates from across the country liked the idea of raising taxes on the rich to balance America’s accounts, a populist and impractical notion that could stifle investment and growth if applied excessively. “Desperate Housewives” star Eva Longoria summed up the sentiment on the final day of the Democratic convention. “Eva Longoria who worked at Wendy’s flipping burgers – she needed a tax break,” Longoria said. “But the Eva Longoria who works on movie sets does not.” Wall Street was much less in evidence than Hollywood. The only banker who made a meaningful splash was Robert Rubin, the former Treasury secretary and Citigroup bigwig, who fell in a pool at the Ritz-Carlton.

The GOP convention started out all wet, too, with a hurricane washing out the first day. Once the Republicans started, though, they delivered a tsunami of “We built that!” rallying cries, derisively riffing on an Obama syntax gaffe which, taken out of context, suggested the government was responsible for business success. Mr. Market might have shared the disdain of everyone in the (publicly funded) convention hall for this twisted version of what the president said – but he wouldn’t have approved of the political rhetoric that obscured the reality of the issues that concern him.

U.S. leaders could learn from European austerity

By Daniel Indiviglio The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

U.S. leaders could learn from Europe’s austerity. Noting the lessons of the continent’s flubs and fixes would help either Barack Obama or Mitt Romney tackle the policy and politics of a debt load that just surpassed $16 trillion. Waiting too long might give investors time to make a new choice.

European nations have been coping with two types of busted budgets. Greece, Portugal and Ireland require aggressive fiscal reforms to try and stop the drift toward default. Their gross debt-to-GDP ratios are ominously high. According to the IMF, Greece’s could hit 165 percent next year.

Britain epitomizes the less dire austerity. Economic output there should remain below national borrowing. But to avoid the fate of its neighbors, UK Prime Minister David Cameron was proactive, seeking fiscal reform two years ago.

With the Democratic National Convention in full swing this week on the heels of last week’s Republican bash, visiting European politicians reckon deficits should be high on the agenda. Though forecasts vary, the IMF sees gross U.S. debt accounting for 110 percent of GDP next year.

Yet bond yields in some troubled European countries have soared as the dollar’s reserve currency status kept U.S. Treasury yields low. Portuguese 10-year bond yields, for example, have doubled since 2007, while their American counterparts fell three percentage points. That preference could fade if Uncle Sam continues to live beyond his means.

There’s a U.S. political impasse on how to tighten the belt. A quarter of UK deficit cutting comes from tax hikes. While Republicans would balk at such a revenue-based solution, even center-right European People’s Party officials doubt the GOP can avoid raising taxes altogether, as many Republicans have pledged, and say additional tax cuts would be irresponsible.

China mistakes foreign law firms for Party poopers

By Reynolds Holding The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

China seems to be mistaking foreign lawyers for Party poopers. They’re dealmakers, not threats to communist rule. Yet wary leaders refuse to license non-Chinese law firms. That’s no way to lure overseas investment. Any policy change must wait until a tense murder case and political transition are over. But economic preeminence won’t come without the help of global lawyers.

There are already plenty of foreign lawyers in China. More than 200 big firms, like Paul Hastings and Clifford Chance, have offices in the country. They just aren’t allowed to practice Chinese law. That leaves court appearances, advice on local rules and other essential services to attorneys approved by the People’s Republic.

Though many are highly skilled, foreign clients often hesitate to hire them. About a third of Chinese lawyers are Communist Party members, and all must swear allegiance to Party leaders. None is officially bound by the attorney-client privilege, meaning client secrets could theoretically leak to the Politburo. And since relatively few Chinese lawyers are international-transaction experts, demand for overseas legal help is high.

To some extent, that demand is being met. Foreign lawyers with decades of experience in China informally advise on the nation’s law, and government officials look the other way. That’s how big mergers, joint ventures and financings involving global banks and corporations get done.

The danger is the so-called cobra in the chandelier: the Ministry of Justice official who could strike without warning. In 2006, for instance, the Shanghai Lawyers Association publicly condemned foreign firms for illegally hiring Chinese lawyers. Though no official action followed, Chinese attorneys showed the government and the Party had their back.

PRC legal eagles may no longer need this sort of protection. Some have thousands of lawyers and outposts in New York, London and Paris. Beijing-based King & Wood merged in March with Australian heavyweight Mallesons Stephen Jaques to create a global force. International lawyers understandably worry about Chinese competition. At the very least, they want reciprocity, with China loosening its rules before its firms can expand in their home markets.

It’s the budget, not the economy, stupid

By Rob Cox 

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

It’s the budget, not the economy, stupid. That variation of the 1992 slogan that propelled Bill Clinton into the Oval Office may now apply to Mitt Romney’s candidacy. The Republican presidential wannabe’s choice of conservative House budget chief Paul Ryan as his running mate has the power to transform a heretofore mealy campaign into something substantive: a referendum on fixing the American balance sheet.

It’s pathetic that it has taken the nomination of a 42-year-old Wisconsinite from Congress to give Romney’s candidacy much appeal, even to his base, beyond the simple fact that he is not Barack Obama. But at a time when debt crises threaten the sovereignty of developed nations and the U.S. fiscal picture is about as bleak as it has been has outside of wartime, righting the country’s finances is the stuff of long-term legacy creation.

Despite his relative youth, Ryan has spent 13 years in the House, neutralizing arguments that he’s unprepared for the post. Though that includes the Bush era, when Congress was at its most profligate, Ryan has since distinguished himself as a proponent of fiscal probity. His recent counter-proposal to the White House’s budget was a serious attempt to propose constructive fixes to vexing long-term economic problems.

Elements of Ryan’s plan, particularly deep cuts to entitlement and Medicare spending, offer the Democrats a distinct target. But that’s a necessary debate for the country to engage in. For Romney, too, it’s a better issue to campaign on than a half-hearted defense of the GOP’s more recent obstructive record in Congress.

Moreover, whatever either candidate says on the stump, tangling with America’s finances will be the chief legislative task of the new president. Congress will not find a solution to the so-called “fiscal cliff” of some $450 billion of tax increases and $1.2 trillion of spending cuts that take effect from 2013. In all likelihood, a lame-duck legislature will extend the implementation of these into the first half.

UK interest in hybrid Libor is on the right track

By George Hay

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Martin Wheatley is on the right track. The chief executive-designate of the UK’s new anti-market abuse regulator, the Financial Conduct Authority, has published a discussion paper on how to reform Libor. As befits the start of a consultation, Wheatley does not try to give definitive answers. But he is asking the correct questions.

The central problem Wheatley has to resolve is whether Libor, which underpins $300 trillion of derivatives contracts, should be set using the actual rates that banks pay each other, or what they say they are paying. On the face of it, using real data makes it harder to fiddle the rate for selfish financial gain. But, as Wheatley recognises, this creates other risks.

Using actual numbers only works if there is enough interbank activity to create representative data. In 2011, volumes in eight of the fifteen quoted Libor maturities were classified as “low activity”, according to Oliver Wyman research. In a crisis, there may be no reliable data. That’s why Wheatley’s suggestion of a hybrid system sounds the right way forward. Transaction data could be used when volumes are strong; judgment calls deployed when they are not.

The hybrid way forward, coupled with better oversight, seems more promising than moving to other benchmarks, some of which also suffer from liquidity problems.

But while the general thrust looks right, the detail of implementation will be critical. Wheatley envisages a central repository to collate all the trade data, but acknowledges this would be complex and costly to set up. He also flags that the Libor-setting process could concentrate on fewer maturities than the 15 it currently uses, and raises the question of whether every bank’s Libor submissions needs to be published. One of the current system’s flaws is that banks are incentivised to submit lower rates during a crisis to make themselves look less troubled.

India begins the post-Mukherjee clear-up

By Jeff Glekin

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Pranab Mukherjee’s reign as Indian finance minister was stained by economic meddling and political favouritism. Now he is gone, and some of his excesses are being reversed. An enemy has been pardoned and a friend has not received a plum job. This could be the beginning of a better era.

Imagine if Tim Geithner had been accused of putting pressure on the securities regulator to protect some political friends. The U.S. Treasury Secretary would be in serious hot water. But when the former number two at the Securities and Exchange Board of India (SEBI) accused Mukherjee of something similar – putting pressure on the SEBI chairman to “manage” some high-profile corporate cases – there was little attention.

Rather, in a move that was all too typical of the Mukherjee regime, the finance ministry countered with allegations against the whistle-blower, K.M. Abraham. But the post-Mukherjee government is different. Prime Minister Manmohan Singh has cleared Abraham.

In another development, the board of UTI, Asia’s oldest asset management company, is set to appoint a new chief executive. The position has been vacant for the past year and a half as the finance minister put pressure on the company, 26 percent owned by U.S. fund manager T. Rowe Price, to appoint the brother of one of Mukherjee’s most powerful advisors. The former political favourite, Jitesh Khosla, hasn’t made the new shortlist.

India’s new finance minister, P. Chidambaram, is also shaking up his own team. On Sunday he announced that the top officials in the revenue and expenditure departments would swap jobs. That seems to be a signal of a shift in the tax department’s priorities. It might pave the way for a reversal of Mukherjee’s damaging retrospective tax grabs.

Uncle Sam still living well beyond his means

By Martin Hutchinson The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Uncle Sam just can’t seem to stop living beyond his means. While U.S. consumer credit failed to match its June 2008 peak, outstanding debt of domestic U.S. non-financial sectors still stands at nearly 250 percent of GDP, against 232 percent just before the financial crisis hit. While the consumer has deleveraged a bit, business debt is flat and government borrowing has soared. At some point, this just has to end. 

Economists Carmen Reinhart and Kenneth Rogoff demonstrated that recessions preceded by a financial crash can be exceptionally deep and long, because of the reduction of debt that needs to occur before normal growth returns. Since 2008, with unprecedented levels of fiscal and monetary stimulus, no net U.S. deleveraging has occurred; rather the liabilities of non-financial sectors have grown faster than GDP. While households have cut back (partly through defaulting on mortgages and credit cards) from 97 percent of GDP to 83 percent, business debt kept pace with GDP and the government’s balance sheet has soared from 57 percent of GDP to 89 percent. 

In the longer term, taking a 20-year comparison from 1992, all three sectors have increased their debt-to-GDP ratios by more than 20 percentage points, though the increase in government borrowing has been entirely concentrated in the last four years. As a result, economic activity since 2008 has been given an artificial boost. That suggests that the true deleveraging process, in which debt is reduced closer to 1992’s level of around 182 percent of GDP, will be very painful indeed, requiring major reductions in consumption at all levels. 

The first stop will be the federal deficit, which inevitably must come down. The corporate sector will likely need more equity, which would dent stock prices generally. Though anathema to policymakers, higher real interest rates would allow consumers to rebuild savings and discourage further indebtedness. Whatever the solution, it’s hard to see a trifecta of negative real interest rates, rising stock prices and trillion-dollar deficits lasting too much longer.

StanChart anti-U.S. rant will resonate

By John Foley

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The stand-out quote in the New York financial regulator’s attack on Standard Chartered is the description of an unnamed banker allegedly railing at “f—ing Americans” who “tell us, the rest of the world, that we’re not going to deal with Iranians”. This charmless F-bomb will rankle domestically, but may resonate further afield.

The U.S. approach to international finance is “our market, our rules”. That’s understandable. But effectively the United States sets the global standard, since few big banks can avoid selling to Americans, hiring them or trading in their currency.

Lately, the U.S. has been making greater use of its economic leverage. The Volcker Rule on financial services will crimp the activities of non-U.S. banks with a U.S. presence. New tax rules, known as FATCA, are designed to get non-US institutions to share information with U.S. regulators, without any respect for local bank secrecy laws. And American sanctions against Iran cast a wide net, including Standard Chartered’s dollar-denominated business with the Islamic Republic.

Americans often see their international reach as right and just. Others see it as arbitrary meddling. Up to now, though, the debate is academic. What the economic superpower wants, it still gets.

That could change, if there is enough opposition. The Americans should take note of the EU’s effort to impose an extraterritorial airline carbon levy. Even though Brussels represents a market with a larger GDP than the United States, it is likely to yield to opposition from an alliance of seventeen countries, including the United States and China.

Japan Inc’s earnings tell worrisome global story

By Wayne Arnold

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

At first glance Japan Inc’s earnings look dazzling. Operating profits at the country’s four biggest manufacturers quintupled in the latest quarter, relative to same period last year. Growth in the U.S. and a post-tsunami rebound in Japan overwhelmed the drag from weaker economies in Europe and China. But the message is actually more sobering: the buffer from such slow-growth economies is unlikely to last.

The total annual revenues of Toyota, Nissan, Honda and Hitachi are a little less than $600 billion, about half from outside Japan. Their combined story is pretty close to the story of the global industrial economy.

Not surprisingly, in this quarter Europe was the weak link: sales there for the big four shrank in the three months ended June 30, led by Nissan’s 13 percent decline in revenue. Sales into Asia were better, growing 23 percent overall, but were held back by diversified industrial giant Hitachi’s 15 percent drop. Thanks to slowing demand from China, Hitachi’s heavy construction equipment and power systems couldn’t compensate for weak sales of LCD TVs. China’s slowdown also hit global copper prices, pushing down Hitachi’s sales of electronic wires and cables.

Japan’s carmakers managed to restore production after the earthquake and tsunami in March, 2011, in time to catch a 24 percent rise in second-quarter car sales in the United States. But the U.S. economy now appears to be flagging, and with it car sales.

A similar fate may await Japan Inc. in its most important market, Japan. There sales grew 44 percent, as production revived and the government started to roll out $240 billion in reconstruction spending. Hitachi will undoubtedly reap part of that windfall, but the government is also cancelling a $1,200 subsidy for purchases of cleaner automobiles.