(Al)ready made: Incentives in US and Chinese Corporations

Excelent point made by twofish:

You need to ask what situation personally benefits the managers that make decisions.
With Chinese companies, the more money you have in your bank account, the higher the salary and benefits of the managers.
If you have large amounts of cash in the bank, you are more able to pay yourself large salaries and give yourself a better car. It doesn’t matter to the management where the cash comes from, but as banks have tightened lending, it becomes harder to use bank loans to create large cash accounts, so the tendency has been to hoard cash from operations. Also it’s not the ratio that matters but the absolute amount of cash. You can have company with huge amounts of cash, but even larger amounts of debt.

By contrast, American managers are rewarded if they have high stock prices and high stock prices come from having large amounts of return on equity. This encourages American companies to borrow heavily and have as little in cash reserves as possible. Also US corporate law makes if very dangerous for a large company to have large amounts of cash because any company with huge amounts of cash is susceptible to a leveraged buyout.
The theory behind American corporate governence is that by rewarding companies based on profitability you are encouraging efficient use of capital, unencouraging people not to keep capital and to move capital from low return uses to high return uses.

The problems with this idea are that:
1) you get high returns by boosting risk, and by boosting risk, you are putting the people you are borrowing from at risk
2) if you are highly leveraged, you are very vulnerable to economic shocks, and
3) this sort of structure encourages people to borrow short term liquid instruments to fund long term illiquid investments, once this funding runs out, you are in some serious trouble.
My belief is that Chinese companies and banks will find themselves in better shape than American companies and banks because the companies that were not shut down have large supplies of cash and hence are more shock resistant. Being shock resistant is important since it gives you time.
If you are highly leveraged, you could go from seemingly healthy to dead in a few days (see Bear-Stearns and Lehman Brothers) and if you have an economy which is highly leveraged you run the risk of a domino effect that can bring down the entire financial system. By contrast, if you have a lot of cash, and something bad happens, you have a few weeks, months, or in some cases years, to do something about it.

FED direct assets purchase

The sooner journalist and commentators stop talking of fiscal stimulus in the US, the better.
As long as the words conserves their meaning the word fiscal has always meant financed through taxes. At ZIRP fiscal and monetary policy blurs.
And yet, from Bloomberg:

"The new strategy is likely to involve unusually close cooperation with the Treasury of President-elect Barack Obama, which is still formulating its economic-rescue plans. The aim is to kick-start borrowing and spending to propel the economy toward a recovery by the middle of next year.
“It’s going to take a combination of fiscal and monetary stimulus to get the job done,” said former Fed Governor Lyle Gramley, now senior economic adviser at Stanford Group Co. in Washington. The central bank has signaled it will “make sure that the fiscal stimulus package, which is going to be a big one, is fully supported” and “in effect financed by the Fed.”

Back IbnBattuta.
Will them succeed? Hard to say. The only thing that even the economic layman can foresee is inflation, an hidden and regressive tax that hit harder on wage earners and small savers, and it's the equivalent of a light default for bond holders.

Because either the currency of bondholders country float free(they avoid inflation) and they take the hit with the decrease in the face value of their bonds or they keep the currency pegged and instead import inflation from the the US, without the chance to finance their deficit through the emission of treasuries with a US$ interest rate negative in real terms(as in the post-Volker super cycle).

Many are starting to worry, here nakedcapitalism:

"Consider further: the Fed assumes it has no constraints, because it can bloat its balance sheet to any size. But it has limits of staff, focus, expertise that restrict what it can do. For it to succeed in its aims, it is going to have to intervene on behalf of every type of troubled credit and make allocation decisions among them. Going on auto pilot (that is, dealing with the "presenting problems", the ones that surfaced first, means that they get priority when that might not be the best use of collective resources (it is not desirable from a competitive standpoint to bloat our housing sector back to status quo ante)".

Hard to feel relieved

Middle East Demography: 80 million new jobs needed within 2020

Isobel Coleman, Senior Fellow for U.S. Foreign Policy
An old(but crucial) article from Dallas Morning News:

While the Middle East lurches from crisis to crisis, its greatest challenge today is probably not what most people think. It’s jobs.
With 65 percent of the region’s population under the age of 25, the Middle East has the fastest-growing labor force of any part of the world. This youth bulge is surging onto the labor market like a massive demographic tsunami. Just to keep pace with population growth, the Middle East must create 80 million new jobs over the next 15 years. And if it hopes to put a dent in its already high unemployment rate of 15 percent, it must create 100 million new jobs by 2020—a near doubling of today’s total employment.
To put this into perspective, the Middle East must create jobs at twice the pace of the United States in the go-go Clinton years, in an increasingly competitive international environment that is already accommodating the rise of India and China. Without making deep structural reforms, Middle East governments will never be able to meet the employment needs of its increasingly disaffected youth—a stark fact that, left unaddressed, leaves an entire generation ripe for radicalization.

M:i:IV or, how to spend 2 trillion dollar before Hyperinflation or US$ devaluation(or both) wipe it out?

Today fabiusmaximus has a great post about shopping madness in the US.

Another shopping that we all should be more concerned about is that of China. The use that they will finally give to their 2 trillions(and counting) of Forex.
In this blog I will write quite a bit about the issue.
Take it as the ultimate financial and geopolitical Great Game.
The mission?
For China to get the most from its Forex before the US$ collapse.
Their long term strategies have been limited by the short-term self-interested choice of financing US household's consumption.
Keynes put it out pretty clearly: "If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has."
For the US the mission is to prevent the treasury bubble from bursting and the dollar from collapsing. Preserve its AAA creditworthiness and the possibility to run a twin deficit that finance its overstretched military expenditures.


On the one hand US officials would certainly prefer to have the trade-surplus countries retaining big stakes in the US economy. But since they cannot really prevent China to buy dollar denominated assets with its reserves, they can do their best to impede them to acquire strategically important assets, both in the US territory and abroad.
The big issues is that we still cannot really see whether the deflationary or inflationary outcome will prevail.
Here (and here)you can find a very good (and possibly final) post by London Banker, a former central banker and securities regulator, that takes issue with some of the conventional wisdom surrounding the efforts to remedy our economic crisis via liberal applications of monetary easing and fiscal stimulus.

From London Banker: "For a while now I have been on the fence on the inflation/deflation issue – whether the massive monetisation of bad debts by central banks and governments will lead to rapidly escalating inflation as currencies are debased or, alternatively, lead to deflation as bad debts and illiquidity undermine all commercial and financial activity in the economy. I’m now coming down on the side of deflation for a very simple reason: there is no longer any incentive to save or invest, and so debt and investment cannot increase much beyond current bloated levels.
(...)
While it may take the Asian and the Gulf State investors longer to embrace my analysis, I have no doubt that they too will eventually conclude that parting with their savings under the terms now on offer will only deepen their losses. They would be better off keeping the money at home, investing locally under local laws and vigilance, and letting the US and UK implode. The argument against this has always been that with trillions already invested in the US during the deficit years, the Chinese and Gulf States would suffer even more horrible losses from a collapse of the western economies. This is accurate, but not complete, as it ignores the relative value of cash investment at the top and bottom of a bursting bubble. Once the collapse has bottomed out, so long as a globalised economy survives, there will be even better opportunities for those with savings to invest selectively in businesses with clearer prospects and more certain profitability under regulatory frameworks which have been restored to a proper balance of investor protection and intermediary oversight.

Yves Smith also make some very good point.

From nakedcapitalism: "London Banker argues that punitively low yields will lead foreign investors eventually to retreat even from government debt. He argues that they will tire at throwing good money after bad, and will prefer to seek returns closer to home.
(...)
If investors come to doubt the fairness of the markets, or think that the rot in its economy is not being cleared out and will undermine growth, that will hold investment back. As Brad Setser has pointed out, foreign capital flows have consisted almost entirely of central bank purchases of Treasuries and Agencies for quite some time, hardly a vote of confidence. We also have the question of how long the high dollar/low Treasury interest game can go on. Bernanke wants rates low to try to stimulate economic activity and has even broached the idea of long bond purchases to keep yields on the long end of the curve down. But the poster child of deflation and low interest rates is Japan, which due to its high savings rate, was not dependent on external funding. The US should want the dollar cheaper to boost exports, but that risks the ire of our creditors, who would take big losses on their FX reserves (many economists argue this idea is specious, but try explaining the loss in paper wealth to a populace not schooled in such niceties. FX losses, when the dollar was weakening earlier in the year, produced a lot of ire in China, including among bureaucrats). Similarly, even if you subscribe to the deflation outlook, 3%ish 30 year bonds is a pretty risky bet independent of the currency risk. So it looks like our friendly funding sources are likely to get burned one way or another, perhaps both. There is a real risk of a disorderly fall of the dollar, and it is hard to tell what the collateral damage would be.
(...)
There is another huge extenuating circumstance with the war spending that observers choose to forget. The US's problem in 1929, like China's appeared to be (at least in part) overproduction, that there might be too much global capacity relative to consumer demand.

Back IbnBattuta.
I feel compelled to end this post with the ultimate philosophical demonstration that overcapacity doesn't exist. I only wonder what Parmenides would have thought.
More on the topic in the next posts.