Is Humility a Former Chinese Characteristic?

My father repeatedly emphasized the importance of humility. He was right. It is something good to have, especially in the stock market — if only to avoid becoming the object of Schadenfreude and gloating when the inevitable fall from grace comes to pass.

Recent comments from Chinese officials makes me wonder if they are feeling a tad too smug, reflecting a “pride goeth before a fall” magnitude of arrogance that used to be culturally unacceptable.

FT reports China rating agency condemns rivals:

The head of China’s largest credit rating agency has slammed his western counterparts for causing the global financial crisis and said that as the world’s largest creditor nation China should have a bigger say in how governments and their debt are rated.

“The western rating agencies are politicised and highly ideological and they do not adhere to objective standards,” Guan Jianzhong, chairman of Dagong Global Credit Rating, told the Financial Times in an interview. “China is the biggest creditor nation in the world and with the rise and national rejuvenation of China we should have our say in how the credit risks of states are judged.”

. . .

Mr Guan said his company’s methodology has been developed over the last five years and reflects a more objective assessment of a government’s fiscal position, ability to govern, economic power, foreign reserves, debt burden and ability to create future wealth.

“The US is insolvent and faces bankruptcy as a pure debtor nation but the rating agencies still give it high rankings ,” Mr Guan said. “Actually, the huge military expenditure of the US is not created by themselves but comes from borrowed money, which is not sustainable.”

A wildly enthusiastic editorial published by Xinhua, China’s official state newswire, lauded Dagong’s report as a significant step toward breaking the monopoly of western rating agencies of which it said China has long been a “victim”.

“Compared with the US’ conquest of the world by means of force, Moody’s has controlled the world through its dominance in credit ratings,” the editorial said.

First established in 1994, Dagong signed a three-year “technology co-operation” agreement in 1999 with Moody’s, which provided the Chinese company with its “core knowledge” and its first “systemic understanding”, according to Mr Guan.

A couple of days ago, the headline was Wen calls bluff of moaning multinationals:

Beware the wrath of a corporate titan scorned. A year ago, the bosses of the world’s largest companies oozed with praise for China’s handling of the global crisis. “Man, these guys are good,” Jeff Immelt, head of GE, told an audience at West Point.

Maybe it is the summer weather, but when the subject of Beijing comes up these days, multinationals seem to get hot under the collar. Mr Immelt confessed at a dinner in Rome earlier this month: “I am not sure that in the end they want any of us to win, or any of us to be successful.”

At the weekend, Jürgen Hambrecht, chief executive of German chemicals group BASF, and another corporate leader who has assiduously courted China, told Wen Jiabao, premier, that Beijing’s current approach to foreign companies “does not exactly correspond to our views of a partnership”.

According to reporters present, the exchange was so sharp that Mr Wen asked his German visitor to “calm down”.

Clearly, something has changed for many multinationals in China, even if there are few obvious new policies to explain the shift. In the technology sector, Beijing wants to use new “encryption” rules to get companies to hand over core software, while foreign companies are also hit by its public procurement policies and weak protection of intellectual property.

Some multinationals say they are getting a rougher ride from Chinese bureaucrats, despite all the hours spent courting them at banquets or making painfully polite speeches. Others complain that while their business is expanding, it is well short of expectations or the growth in their market.

. . .

Beijing hopes it can have it both ways, using policy to boost its own companies while receiving new foreign factories. At a now infamous meeting last year in Brussels, Wang Qishan, vice-premier, dismissed complaints from a group of European executives. “You are going to invest there anyway,” he said. And he was right. Even with the crisis, foreign direct investment to China jumped 19.6 per cent in the first half of this year. China is essential to many industries, either because of the depth of its supplier networks or the size of its market.

However, there are also plenty of companies that have realistic alternatives for new facilities. And if Beijing saw that foreign investment really was dropping off, the bureaucracy would be very worried. Multinationals have a choice, therefore. They can complain as loud as they like about Chinese industrial policies, but if they continue to behave as if there is no alternative, Beijing will keep calling their bluff.

Recall Mike Pettis’ observation in Never short a country with $2 trillion in reserves?

Friedman proposed the rule sarcastically – as both untestable and too obvious to need testing. It is so obvious that no country has ever had such high levels of reserves, so you can’t really test the hypothesis, but it’s also pretty obvious that a country with $2 trillion in reserves is in great shape. Anyone who wanted to short it must be pretty stupid, right?

But it turns out that reality is not as obvious as he imagines. Let us leave aside that the PBoC’s reported reserves are a lot more than $2 trillion, and that if correctly accounted they would be pretty close to $3 trillion. China’s foreign reserves are certainly huge. They add up to an amount equal to about 5-6 % of global gross domestic product.

But they are not unprecedented. Twice before in history a country has, under similar circumstances, run up foreign reserves of the same magnitude.

The first time occurred in the late 1920s when, after a decade of record-beating trade and capital account surpluses, the United States had accumulated what John Maynard Keynes worriedly described as “all the bullion in the world”. At the time, total reserves accumulated by the US were more than 5-6% of global GDP. My back-of-the-envelope calculations suggest that this was probably the greatest hoard of central bank reserves ever accumulated as a share of global GDP, but please check before you accept this claim.

The second time occurred in the late 1980s, when it was Japan’s turn to combine huge trade surpluses, along with more moderate surpluses on the capital account, to accumulate a stockpile of foreign reserves only a little less than the equivalent of 5-6% of global GDP. By the late 1980s, Japan’s accumulation of reserves drew the sort of same breathless description – much of it incorrect, of course – that China’s does today.

Needless to say, and in sharp rebuttal to Friedman, both previous cases turned out badly for long investors and brilliantly for anyone dumb enough to have gone short. During the early years of the Great Depression of the 1930s, US stock markets lost more than 80 per cent of their value, real estate prices collapsed, and the US economy contracted in real terms by an astonishing 30-40 per cent before recovering in the 1940s.

Japan’s subsequent experience was economically less violent in the short term, but even costlier over the long term. During the period following its astonishing accumulation of central bank reserves, its stock market also lost more than 80 per cent of its value, real estate prices collapsed, and economic growth was virtually non-existent for two decades.

The idea that massive levels of reserves are a guarantor of economic stability is, in other words, based on a profound misunderstanding both of history and of the nature of reserves. Reserves of course are not useless as an enhancer of financial stability, but their use is for very specific forms of instability. Having large amounts of reserves relative to external claims protects countries from external debt crises and from currency crises.

Great, but neither Chanos, nor even the most pessimistic Sino-analyst, has ever said that these are the kinds of risks China faces today, any more than they were the risks faced by the US in the late 1920s or Japan in the late 1980s. The risks that China faces today (and the US in the late 1920s and Japan in the late 1980s) is of excessive domestic liquidity having fueled asset and capacity bubbles, the latter requiring the uninterrupted ability of foreign countries to absorb via large and growing trade deficits. These risks include an explosion in domestic government debt directly and contingently through the banking system.

These are, very typically, the kinds of risks that threaten rapidly developing large economies, unlike the external debt and currency risks that typically threaten small economies. And reserves are almost totally useless in protecting these economies from the risks they face (and, no, no, no, reserves cannot be used to recapitalize the banks – only domestic government borrowing or direct or hidden taxes on the household sector can be used to recapitalize the banks).

We have been here before, and something tells me this time will be no different. Think of Katherine Heigl leaving Grey’s Anatomy. Or Micha Barton quitting The OC. Or Denise Crosby ditching Star Trek, the Next Generation. Or Farrah Fawcett punting Charlies Angels. Or Pam Anderson swimming prematurely into the Baywatch sunset.

Their futures looked brilliant — at the top. Not everyone can be a George Clooney: best to work for a full seven seasons and, as they say in Hollywood, “don’t believe your own bullshit.”

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