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Michael Brandl > Macro Updates > Archives > June 1, 2003 May 1, 2004 Growing concerns over China. The past few weeks have brought increasing signs that China is heading for trouble. The world’s fastest growing economy now appears to be suffering from an asset bubble and an overheating economy. Making things worse is that the “traditional” answer for an overheating economy, contractionary monetary policy, is not a viable option in China. The reason why a contractionary monetary policy will not work in China is that interest rates are relatively meaningless. The People's Bank of China (the Chinese Central Bank) has not changed interest rates in nine years. For changes in interest rates to have an impact, firms must base their borrowing and spending decisions on the cost of capital. For many firms in China, especially state owned enterprises, this is simply not the case. What economists call “connected lending” runs rampant in China. Connected lending occurs when non-economic concerns determine who gets access to capital. If you are in favor with the government, you get funding, regardless of your ability or willingness to repay. So the Central Bank of China, without an effective monetary policy is basically helpless in trying to stop this overheating, asset bubble driven economy. When was the last time we saw an overheating economy, driven by an asset bubble, thanks to fixed exchange rates, where the government runs large deficits and props up failing banks and inefficient firms? The list is rather long….but they all end basically the same way: financial crises.
Is the UK another asset bubble? There are growing concerns that England is suffering an asset bubble in its housing market. With housing prices skyrocketing and the British economy growing at a healthy rate many expect the Monetary Policy Committee of the Bank of England to go contractionary. That seems like a fair bet, but the issue of an asset bubble is a bit more tricky. The higher housing prices in England could be driven by a lack of supply. There are significant limits placed on new housing construction around England and it may simply be a case of a lack of available units. Looking at the overall inflation rate in England, less than 2%, does not seem to suggest there is an urgent need for contractionary monetary policy. Look for the MPC to nudge rates up a bit, but this probably won’t do much to slow the nicely expanding British economy.
Greenspan on U.S. banks. Looking over Fed Chairman Greenspan’s recent testimony before the Senate Banking Committee one notices some interesting comments on the future of the American banking industry. Typically when interest rates increase bank profits fall. This occurs because banks have long term assets (loans and bonds) and short term liabilities (checking and savings accounts). So when interest rates increase banks interest expense increases without an offsetting increase in interest income.Greenspan suggests that this might not happen any more. Since banks are becoming much more “fee generators” that are independent of interest rates, a hike in interest rates may not have that big of an impact on their income as they have in the past. In addition, Greenspan seems to be suggesting that if interest rates do increase look for banks to raise interest rates on loans but NOT raise interest rates on savings as quickly. Perhaps because banks have become more of a financial service provider the price elasticity of savings has dropped considerably. That is savings levels may not be all that price sensitive anymore. If this is the case an increase in interest rates might actually increase bank profitability or at least be revenue neutral. Interesting idea if he is right. It means another long standing axiom of financial markets, short bank equities when interest rates rise, may be on the way out. For some controversial discussions on economic issues, include the Presidential election, see my BLOG at http://brandl.easyjournal.com/All the best, MB |
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