The Rating Agencies

There is a fascinating piece of news that I have just stumbled upon in Bloomberg, regarding the EU and the ratings agencies:

Credit rating companies face curbs on when they can assess government debt and restrictions on their ownership under draft plans agreed upon by the European Union to limit the industry’s influence and tackle conflicts of interest.

Investors will also get the right to sue ratings companies if they lose money because of malpractice or gross negligence in the plans agreed upon yesterday by lawmakers from the European Parliament and Cyprus, which holds the rotating presidency of the EU.

The interesting point here is that the Basel banking regulations entrenched the ratings agencies within the financial system. Essentially, the ratings agencies became the key to the level of capitalisation of the banking system. The small detail that the ratings agencies were paid by said same banks to undertake the ratings did not cause concern in the bizarre world of banking regulation. No doubt there will be many who will applaud the EU for taking action against the agencies; they really are, in some respects, the guys with the black hats. However, we must also remember that their power in the market was underpinned by a regulatory framework; the Frankenstein that created this monster was the regulators.

The problems with this latest move from the EU is that it does not seem to be founded in a genuine motivation for reform, but rather to de-fang the major ratings agencies, which are coincidentally downgrading sovereign debt. One suspects that the motives here are not entirely about the aim stated in the article, which is about 'financial stability'. The reason I am doubtful about the intentions is that the stated aim is to address conflicts of interest. This is the most simple problem to fix, and does not require this rather odd approach. It is so absurdly simple to fix the conflict of interest that the solution given absolutely must have different motivations; the absurdly simple answer to resolve conflicts of interest would be to ban any rating of any financial product that is paid for by the issuer of the product. It does not matter whether the product is a personal pension, or a complex derivative product.

Also, with regards to sovereign ratings, this is one of the few areas where (relatively) there is little conflict of interest. How curious is it that this is the focus of the attention of the EU? The following passage from Bloomberg tells the story:

On sovereign debt ratings, lawmakers and officials agreed that each credit rating firm must pick three days a year when they would be allowed to give so-called unsolicited assessments of governments’ creditworthiness, according to Jean-Paul Gauzes, a lawmaker involved in the talks. Ratings firms may get a chance to issue unsolicited ratings -- those that haven’t been requested and paid for by a client -- outside those dates if they can justify it to regulators.

“Credit rating agencies will have to be more transparent when rating sovereign states, respect timing rules on sovereign ratings and justify the timing of publication of unsolicited ratings,” Barnier said. “They will have to follow stricter rules which will make them more accountable for mistakes.”

Here we have the distinctly curious situation of the lawmakers seeking to restrict the access to the ratings when the ratings are paid for by entities that need an independent rating; it is the very opposite of the absurdly simple solution to conflict of interest. Just as the rating of a derivative should be paid for by the potential purchaser, the same with bonds. In this case, this is exactly what the ratings agencies are doing. They may be useless at their job, which is not the point of this post, but they are in this case presumably acting in the interest of the purchasers, not the issuer. This is how the system should work, but that is what is being attacked. In summary, this is simply an attempt for the EU to try to bury the crisis that is threatening the EU and the Euro project.

The news should be greeted with outrage, but the visceral ant-ratings agency feeling will probably see applause from many quarters. Whilst I would like to see the agencies de-throned, this is not the solution, and it tells us more about the terror being felt in the upper echelons of the EU than it does anything substantive to fix the agencies.

The Greek Crisis (again)...

Yet again, I have an unfinished post, and again it is due to events that I have changed direction. The Greek crisis has now entered a new phase, with the bailout from the IMF and EU finally enacted:

Greece bowed to market pressure yesterday and formally requested a bailout from the European Union and the International Monetary Fund.

It is the first time a eurozone member has asked for a financial rescue and it is likely to test European political cohesion as well as the stability of the euro itself.

Greece asked for the €45 billion package after being downgraded by the Moody’s credit rating agency on Thursday.

The first problem is that it is just not going to be enough. The problem of the scale of Greek debt is worse than was feared:

Greece' deficit for last year is worse than the cash-strapped country originally reported and could still be revised higher, the European Union said Thursday, news that weighed on the common currency. A sharp upward revision to the 2009 figure, which sent Greek bonds into a tailspin, was surprising because Greek officials just two weeks ago denied reports of a big spike.

And the bailout will only take Greece so far.....

However, there are concerns that despite the unprecedented scale of the loan, it will not be sufficient to do little more than buy the country time, allowing it to finance its state only for another few months. The full details of the loan will not be laid out in the next few weeks, as IMF and euro area officials hammer out an economic plan for the country, which is likely to involve further severe cuts in public spending.

Then there is the problem of the potential challenge in Germany as to whether the Greek bailout is unconstitutional:

The German constitutional lawyer seeking to derail Berlin's contribution to a Greek rescue plan said he likes his chance better this time than in 1998, when he tried unsuccessfully to block Germany's adoption of the euro.

Karl Albrecht Schachtschneider, a retired University of Nuremberg law professor and expert on the constitutional court, said he believes that the Greek aid package is in clear violation of European treaties and the German constitution and sees a chance of convincing the court this time.

What may seem a contrarian quest has attracted attention in financial markets, where investors fret over any sign that Germany would withhold or even delay providing its share to the EUR30 billion rescue plan if Greece requests it.

Schachtschneider is drafting the legal complaint with three other established euro skeptics, all of whom are into retirement age.

Working with him are economics professors Wilhelm Hankel, Wilhelm Noelling and Joachim Starbatty. Noelling is a one-time governor of the Bundesbank, Germany's central bank. The same foursome were behind the ill-fated legal challenge 12 years ago.

I would like to give some perspective on whether the challenge might be realistic, but must confess that I have no particular insight on the issue. Some time ago, when first reading about this (sorry, no references), I did see some fairly persuasive cases for the challenge, but still remain on the fence with regards to whether the challenge might gain traction.

As I have posted before, the real issue of interest is the wider consequences of the Greek crisis. When first starting this blog, I contemplated the possibility that the Euro might not survive the crisis, and others are now seriously contemplating this possibility. This is Edmund Conway of the Telegraph writing from the G20:

Though they don’t admit it, they also privately suspect that this crisis will be the biggest challenge yet for the euro project. And for many it is no longer anathema to suggest that the euro may not survive this crisis – at least not in its current form.

I would agree that, at the very least, that there will be strong pressure to reform the structure, with Germany leading the way. Of course, the only kind of reform that might work is closer regulation of Euro-wide fiscal policy, which implies a significant loss of sovereignty of Euro member countries. Somehow, I suspect that, even for those who support the European project, this might just be too much.

Then there are the next contenders for debt crisis. Spain and Portugal are looking increasingly vulnerable:

Iberian stocks fell sharply Thursday amid concern the escalating Greek debt crisis could spread to other southern European countries with troubled finances.

Madrid's IBEX-35 index ended 2.19% lower at 10,821.9 points, while Portugal's PSI-20 index closed 2.57% down at 7,751.95 points.

"There's confusion and a great insecurity in the market," said Karsten Sommer, a trader at BCP in Lisbon, adding that rising government sovereign yields are bad news for stocks.

As Moody's Investor Service Inc. downgraded Greek sovereign debt, the cost of taking out insurance of Greek government bonds through credit default swaps surged about 10% to 620 basis points earlier Thursday. Spanish CDS spreads were also pushed higher to 171.5 basis points from 158.5 earlier in the day, while Portuguese CDS spreads moved to 260 basis points from 232.

Banking stocks were hit hard, with Banco Santander SA (STD) down 3.1% to EUR9.91, and Banco Bilbao Vizcaya Argentaria SA (BBVA) plunging 3.1% to EUR10.55. Portugal's Banco Espirito Santo SA (BES.LB) shed 4.1% to EUR3.569 after a Nomura downgrade.

....then there are the banks that hold Greek bonds, with the largest holders in France and Germany. A Greek default will put new stresses on an already stressed banking system. Unlike commercial loans going sour, it will be hard for the banks suffering such losses to have the news buried or obscured:

Private investors are already seeking ways to decrease their exposure to Greek debt although European banks appear to own some 58% of Greece’s 270 bln euro debt. Greece’s indebtedness to European banks appears to have been one of the key facts that convinced Brussels to take the lead and seek a mainly European solution.

It is worth reminding readers that the Basel rules gave OECD debt a zero risk rating in the calculation of capital adequacy ratios..... These are the same regulators who will now, apparently, be able to foresee future risk and prevent it. The new regulation will, of course, learn the lessons of the past, implement a new and more secure structure, and so forth. Just as they do after each crisis and problem.....and remember, this is not new obscure financial instruments, this is sovereign debt. This has been around for centuries.

With regards to the next phase of the crisis, it is tempting to use emotive expressions such as 'now that the markets have tasted blood...' and all of the cliches that we see in so many articles. However, it is not a question of 'tasting blood', but rather the facing up to the reality of the terrible fiscal position of so many 'rich world' nations. The markets, the holders of 'safe' sovereign debt, are just waking up to the fact that it is not, after all, safe.

The big questions, aside from the crisis in Greece is who is next, and where the bailout money might come from? Will the EU also be prepared to bailout the next country in line, or the next....? How about the IMF? Can it fund a series of EU country bailouts? As has been discussed in the case of Greece, this bailout is likely to just be the first tranche....Greece will need further finance later. Then there will be the steep fall in Greek GDP as the austerity bites, and the picture will be one of a GDP to debt ratio moving in the wrong direction....it will not be pretty. This will cause even more alarm, as the markets see what happens to an economy that is mired in debt and where GDP has been sustained/obscured with debt.

And then...if the crisis gathers pace, will the markets start to look at economies such as the US, the UK and Japan. For example, Japan has now had a rating downgrade:

Fitch Ratings said Thursday that Japan's credit ratings face downward pressure in the medium term due to the ballooning debt, increasing the urgency that the government come up with a plan to get it public finances under control.

"In the absence of sustained economic recovery and fiscal consolidation, government debt will continue to rise, placing downward pressure on sovereign credit and ratings over the medium term," the credit-rating agency said in a report.

"The Japanese government is one of the most indebted in the world," Fitch said in the report titled, "Just How Indebted Is The Japanese Government?"

Fitch estimates Japan's headline gross government debt reached 201% of gross domestic product at the end of the last year, the highest ratio of any country the agency rates.

Any downgrade would elevate market concerns about Japan's creditworthiness and could prompt investors to unload their government bond holdings.

"It's important to show that the government is managing fiscal policy in an appropriate manner," Cabinet Office Senior Vice Minister Motohisa Furukawa said at a press conference following the release of the report.

Just for the sake of interest, I undertook a Google new search for 'sovereign debt' and found an article that is illustrative of the growing concerns in the media:

So here’s a brief look at some aspects of the UK’s debt vulnerability compared with that of France, using a useful table in an IMF report issued this week. (The link is below).

It shows the rating agencies agree with the continental finger-pointers. France’s top triple-A rating is stable; while the UK’s has a negative outlook. That’s even though the UK’s deficit at the end of this year will be below France’s, at 78% of GDP compared with 84%.

By some measures, France is more vulnerable. Foreigners tend to be more skittish than domestic bond holders and foreigners hold only 22% of British debt, compared with 58% of France’s. On top of that, a fifth of France’s debt is maturing in the next year, compared with 8.4% of UK government debt.

The article is not of particular interest of itself, but for the way that it is framed. The article is about relative vulnerability. The framing of the article speaks volumes. The IMF now sees sovereign debt crisis as a real possibility, and they are a long way from the (sometimes) radical musings of a blogger - they are the embodiment of the mainstream:

Greece's upheaval could mark the starting point of a "new phase" in the global crisis if countries don't get their fiscal houses in order, despite the low risk of contagion, the International Monetary Fund said Tuesday.

While the IMF slashed its projections for bank losses from the crisis to an amount deemed manageable, the rapid buildup of sovereign debt among advanced countries to levels not seen since the end of World War II has emerged as the biggest threat to global financial stability.

"In spite of recent improvements in the outlook and the health of the global financial system, stability is not yet assured," said Jose Vinals, director of the IMF's monetary and capital markets department, at a press conference to discuss the semi-annual Global Financial Stability Report.

"If the legacy of the present crisis and emerging sovereign risks are not addressed, we run the real risk of undermining the recovery and extending the financial crisis to a new phase," he said.

All of this leads to a question. When, and under what circumstances are the policymakers, the politicians and economists cheerleading for fiscal profligacy going to wake up to what is taking place. When I first started writing this blog, the situation was different. Reality was obscured, theory was not being tested in the real world, and there was some kind of excuse (albeit a poor excuse) for the lunatic policy that was being enacted. As we now see the consequences, there is simply no excuse for the continuation of the madness, but still it continues.

Notes:

The UK election has taken some unusual twists and turns of late, with the Liberal Democrats making a big splash. However, I am not convinced that they, any more than the Conservatives or Labour, are serious about the dire fiscal crisis. Interestingly, some commentators and analysts seem to think a hung parliament is not a problem. I am agnostic on this, as it is always possible that the right leader, and the right coalition might work, but do recognise that this represents big uncertainty. What will finally matter is not who does it, but what they do.

Yet again, some very interesting comments on the last post, and it good to see some further challenges to Lord Keynes. Interestingly, his view of economics is now starting to face the real test. I would like him to be right, as I do not want what is coming, but alas I think this unlikely.

My original post was on housing / real estate, and I will try to finish in the week.

The Greek Problem

A storm has slowly been brewing in the press over recent weeks in regards to the state of the PIIGS (Portugal, Ireland, Italy, Greece and Spain). According to some analysts, the Euro area itself might be at risk of break up.

Before going further, it is worth mentioning that the dangers that we are now seeing are hardly unforeseen. I trawled through my own blog and found several of my own references to the problem (but probably missed many others), such as the following in a post from 2008:

Also, an interesting comment from VKP who suggests that the UK and Greece have many similarities. I am not as familiar with the details of the economy of Greece as I would like, but am aware that they are running very large deficits. I have mentioned the possibility of the abandonment of the Euro, and the state of the finances of Greece is one factor in that consideration. I am not sure how much longer Germany will play ball....

And a little later, at the start of 2009:

As an aside, I long ago suggested that the cohesion of the Euro might be strained as the economic crisis progressed, and there have been an increasing number of articles recently mirroring this view. I still believe that the Euro may not come through this crisis, and think the likelihood of either a partial falling apart, or complete abandonment of the Euro is possible. We could yet see the return of the mighty Deutsche Mark. As such, if you hold any Euros, make sure that they are held in a German bank in Germany....

More recently, I described the problems of Greece as an 'outrider' for larger economies - as a foretaste of the coming problems. I have not been alone in these early concerns for the Euro in the economic crisis, but have no references for those that were sharing them (apologies). However, the view that I shared with such Euro pessimists was that it was not possible to have a stable currency with the huge variations in individual government policy and economic structures. It was the tragedy of the commons writ large, with the Southern European states acting as free riders. With no method of effectively enforcing discipline and rules, it was possible to free ride in the system. The economic crisis would just bring these problems to the surface (though I had not imagined in such a dramatic way).

Despite this, the Euro enthusiasts have a counter argument. In a recent outing to a bar, I was speaking with a German on the subject of the risk to the Euro, arguing that Germany would not tolerate bailing out Southern Europe when confronted with its own problems. His response was to highlight the position of Germans as 'good Europeans' (including mention of Germany's troubled history) and that Germany would therefore support the integrity of the Euro area. I expressed my doubts about this, suggesting that Germany would not support profligate spending.

The attitude in Germany is of particular interest due to the economic weight in Europe, such that their agreement is essential for any bailout to proceed. This is from Die Welt:

"The EU has given Greece a long leash for far too long. Now Brussels has no choice. All that is left is the weak instrument of budgetary surveillance and a vague hope that, somehow, everything will go well. Sanctions, such as the freezing of EU subsidies, penalties to the tune of billions of euros or exclusion from the monetary zone are not feasible. Any such step would plunge the Greeks even further into the abyss and weaken confidence in the euro even more."

"Brussels is backing strict austerity measures. That is correct, but also wrought with dangers. The planned massive spending cuts and tax increases could stifle the economy of Greece and lead to deflation -- causing a vicious circle. The Greek drama is far from finished. It may well be that a few euro countries like Germany will soon have to jump in as a savior, offering billions in bilateral aid. That would be bitter pill to swallow."

Variations on these themes can be seen from other news outlets in Germany. I strongly recommend the summary contained in Spiegel Online if you would like to understand the direction of German sentiment.

I emphasise the press reactions, as the basic question that arises from the Greek crisis is not a question of economics. The EU has always rested upon compromise, upon politicians measuring their national interest against the 'great European project'. Such compromises have always been hard to sell to domestic audiences, but the problems of the Southern European states are a scale of a different order. It is very tough indeed to justify, when you have your own problems, why you might wish to bail out those whose problems are largely of their own making. Having said this, the elites within Europe have often managed to their goals in the face of opposition. Might they manage this in the face of crisis? I am really not sure.

The point I am trying to make here is that the Euro is more a political confection than it is an economic unit. The same may be said about all currency, but the existence of the Euro relies upon a continuing process of compromise and tolerance. The indications are that Germany are increasingly unwilling to bail out Greece, despite the potential for a broad crisis for the Euro itself. A search against 'Euro' and 'Greece' paints the picture of the sense of crisis for the Euro. One headline says it all, with the Sydney Morning Herald suggesting that 'Greece Trips, Euro Could Fall'.

The crisis in Europe has profound implications. I have long argued that the continuance of the massive accumulation of government debt in the 'rich world' rests upon a flimsy premise. This premise is that delusion that the Western world (and now Japan) have always been rich, and will always be rich. Iceland could be dismissed as exceptional, Dubai was still not the 'West', but the fall of Greece risks a spreading crisis that will undermine the belief in the 'rich world'. This is a Euro economy, and whatever the particular peculiarities of the Greek situation, the cracks in the edifice of belief will enlarge. As I have also long argued, the deficits of the major debtor economies are structural, and will not disappear. The cracks in belief will refocus minds on this underlying reality, and the closer the reality is examined, the greater the cracks will grow.

Will the crisis in Greece be enough to herald the denouement to the lax and unsustainable fiscal and monetary policies that have supported countries like the UK and US? Much hangs on the response to the crisis, but a response of a bailout will only serve as a delaying mechanism. Furthermore, a bailout might further stretch the economies of those that come to the rescue of the PIIGS, with Ambrose Evans-Pritchard of the Telegraph comparing the potential damage to the absorption of HBOS by Lloyds.

Chickens are coming home to roost. And for those who say that countries who have control of their own currency are in a different situation, the answer is very simple. The only way those with control of their own currency can avoid the same crisis as Greece is if they inflate away debts. However, doing so whilst raising record amounts of debt on international markets looks to be implausible. The US might get a benefit of 'flight to safety', but only for a short while. At some point, investors will realise that they have fled the bear only to hide in the bear's cave. It is an analogy I have used before, as the US is no haven of safety.

The position now is; 'wait and see'. A cobbled compromise might serve to delay the final act of the economic crisis. However, it is possible that the economic crisis is entering the last act. If Greece topples, who will follow?

Note: I have included Ireland in the PIIGS acronym, and Ireland is certainly at risk. However, Ireland is facing the fiscal problems head on, and should really be in a different category. I am not saying that it should be considered and treated as safe, but that it should be viewed as less of a risk than the other PIIGS. I have great respect for the efforts of the Irish government to reign in the deficits, and therefore will be sorry to see that their efforts might have come too late (or the crisis too early???).

China: A brewing confrontation?

It seems that China is, at last, really being noticed by mainstream analysts. When I see really, I am referring to the key part that China is now playing in the world economy. Of particular note is that the growing share of the world export market held by China and that China is now the world's largest automotive market (mentioned in a recent post).

Perhaps it is these statistics that have served to focus minds.

The actual analyses that are being offered, and the opinions about what might be done about China, are varied. A good contrast can be found between Dylan Grice of Socgen and the Economist magazine. Grice notes that different standards are applied when analysts and investors view the Chinese economy, and provides an example in the comparison of value between Lloyds of the UK and ICBC of China. Both are part government owned, both have potential risks in their loan book, but Lloyds is potentially subject to malign government intervention, whereas ICBC is actually subject to malign government intervention. Despite this, the valuation of ICBC is much higher.

Grice sees this as an example of irrational exuberance on the part of investors towards China. He notes that there is a boom in credit in China, and questions the idea that an infrastructure investment boom will not lead to a bust, citing studies that show that such a bust is possible.

The Economist offers a very different perspective, giving their article the title 'China's Economy: Not Just Antother Fake'. They commence their article with the many aspects of the Chinese economy that might look bubble like, and make comparisons with the conditions in Japan before the Japanese economy popped. However, they go on to say the following:

Scary stuff. However, a close inspection of pessimists’ three main concerns—overvalued asset prices, overinvestment and excessive bank lending—suggests that China’s economy is more robust than they think. Start with asset markets. Chinese share prices are nowhere near as giddy as Japan’s were in the late 1980s. In 1989 Tokyo’s stockmarket had a price-earnings ratio of almost 70; today’s figure for Shanghai A shares is 28, well below its long-run average of 37. Granted, prices jumped by 80% last year, but markets in other large emerging economies went up even more: Brazil, India and Russia rose by an average of 120% in dollar terms. And Chinese profits have rebounded faster than those elsewhere. In the three months to November, industrial profits were 70% higher than a year before.

In a later article (1), the Economist discusses the rise and rise of China's exports, and asks whether the growth might continue. They again compare China with Japan, and note that Japan's exports peaked once Japan had moved up the value chain. However, in the case of China, it is possible to move up the value chain, and keep lower value exports, as China can substitute the low for high value in the coastal cities, and still keep the low value in the inland provinces.

An even more optimistic assessment of China's prospects comes from Foreign Policy magazine (sorry, no link and reliant on memory for the article details). The thesis of the article was one in which China would rapidly develop to become the most dominant economy, and signals the decline of Europe and the US in comparison. Whilst the Western economies might not decline in absolute terms, the article saw them losing economic power and influence.

So where do I stand on the question of the prospects for China? In a series of articles (see links in the notes at the end) I have offered a cautious view of China's prospects. In my first article, at the start of the economic crisis, I suggested that China, on balance, would be likely to come out of the crisis stronger:

So where does this leave the economic future of China? Where would I place my bet? Would it be on ongoing growth, recession and instability, or what outcome? The honest answer is that I would not place the bet at all but, with a gun to my head forcing me to to make the bet, I would choose continued economic growth, albeit at a slower pace than before. In the meantime the Western world needs to accept that it is no longer in a position to continue with its complacency. China poses a real and ongoing threat to the world economic order, and will continue to grow at the expense of the West, unless the West responds by restructuring of their economies through (real) improvements in education, lowering their cost base, and taking an aggressive approach to intellectual property and fair trade (for why, see here).

You will note that this is a very cautious prediction. I have highlighted some of the potential problems in the Chinese economy, such as the frothiness of the housing market, potential for dud lending by the Chinese banks, and (above all else) the potential for social unrest if Chinese growth ever goes into reverse, and many other concerns.

Within all of the discussions of China, there is often a fundamental problem. This is the idea that China sits as a stand alone entity, in which the policy of China might just be continued. I have frequently highlighted the mercantilism policy of China, and have long been arguing that, unless China acts to trade more fairly, it should be subject to trade sanctions. I have highlighted the manipulation of currency, the theft of intellectual property, and the conditionality of inward investment (with insistence on the transfer of technologies), as well as many other problems.

In August 2008, for example, I argued strongly that it was time to get tough with China, and highlighted a series of unrelated stories, all of which pointed to China using mercanilist methods to enhance their economic position. Whether they are making threats to destroy the $US, using the media to slander overseas businesses, arranging theft of intellectual property, China appears to be set on a course of establishing itself as THE economic power of the world. For example, I have previously mentioned the use of hacking by China to steal commercial secrets from overseas competition, and (again) this is actually starting to be noticed more widely.

The purpose in highlighting these points is that there has been a complacent attitude to the mercantilism of China, but the winds of change are blowing. China has a club to beat the world with, which is the holdings of massive foreign reserves. In an early post I highlighted that it was better to face down China now, rather than later. The ongoing growth of reserves held by China would just make confrontation ever more difficult. The complacency over the method of the ascent of China is now disappearing, but the potential dangers of confronting China have now grown. Nevertheless, there is an increasing recognition that something has to give. This from Roger Bootle in the Telegraph:

The looming threat to the world economy comes from the same source which contributed so much to the financial crisis, namely the draining of demand from the world economy through excessive Chinese saving. But now it will come at a time when most countries of the West are in no position to offset this effect through more stimulus policies and indeed, as in the case of the UK, may actually be about to tighten fiscal policy. We may be not far off the point where, if the Chinese don't take steps to make their trade with the West more balanced, then the West will take steps to do it for them.

Such sentiments can be found elsewhere, and I even find myself in agreement with Krugman, who is arguing against allowing the ongoing manipulation of the value of the RMB. However, what remains missing from these analyses is the complete picture. It is not just the matter of currency manipulation, but the many other policies of the Chinese government in conjunction with the currency manipulation. There is a pattern here, and I long ago discussed this in another post, saying the following:

It is very clear that China intends to rise economically by any means, fair or foul. The crazy part is that the foul is unnecessary, and one then becomes very suspicious of the underlying motives for such methods.

I have not detailed the many individual stories that support the argument of this post, as they can be found in other posts (see list at end). The important point is that, if considering the future of China, it is necessary to consider the actions of China's key trading partners. My best guess is that the situation will not be endured by China's' trading partners much longer - that China will be confronted over the mercantilism. This is, of course, in the hands of politicians, who are by their nature unpredictable. What approach, when, or how they might seek to address the problems, and how China then responds, will play a key part in the determination of whether China continues on the current upward trajectory.

My best guess is that China is heading for very troubled waters. I do not think, as the economic crisis proceeds, that the world will sit by and watch as China continues with the current policies. At the same time, China knows that it must continue to grow if it is to achieve social stability, and that means that it fears make any concessions. In fact, from the point of view of the Chinese government, China MUST continue to grow. That means that they will not back down easily, as the mercantilism is a key element in the level of their growth. In other words, the stage is being set for a confrontation, and the outcome of the confrontation might have profound effects on the ascent of China.

(1) 'Fear of the Dragon', Economist print edition, 9th January 2010

Note: Links to previous posts on China. These posts are the ones that are largely focused on China, but there is discussion of China in other posts. From Trade and Forfaiting Review:

Shanghai Suprise

From the Blog:

1. July 2008, China - What Future?
2. August 2008, China Propping up the $US
3. January 2009, Free Trade 'Yes' - Mercantilism 'No' - Why China Should be Shut Out
4. January 2009, The Myth of the Eternal Status of the $US as 'the' Reserve Currency (post indirectly associated with China)
   
5. February 2009, China's Pivotal Role in the Next Step for the World Economy
6. Fenruary 2009, China and the US - Fighting on the Edge of a Cliff
   
7. March 2009, Economics and Power, the Loss of US Power
8. March 2009, China, Gold and the $US
9. April 2009, China as the World Economic Power?
10. April 2009, The RMB as the Reserve Currency
11. May 2009, China, the RMB and the $US
    
12. July 2009, The RMB as the Reserve Currency - an Update
13. Sep, 2009, The Rise and Rise of China
14. Sep, 2009, China and Treasuries: A Puzzle
15. Oct, 2009, The Great 'Shift' China and the West
16. Jan, 2009, China on Track - The Car Industry
    

And the role of China in the development of the broader economic crisis can be found here (on Huliq).