China’s Curious Growth Data

What significant economic news from Asia cheered the global markets last week? The Chinese central bank decided to permit many financial institutions to lend more of their cash deposits to borrowers, a move that is expected to stimulate their economy.

As a result, analysts estimate that 1.5 trillion additional yuan (i.e. approximately $242 billion in American dollars) will be placed into the hands of Chinese businesses. China clearly needs this economic stimulus, given that the nation may miss its annual economic growth target for the first time since 1998.

Oddly enough, though, no one appears to have stopped for a moment to ponder the meaning of an annual target that has not been missed in sixteen years. Indeed, most pundits appear to share the universal assumption that the Chinese economy has been enjoying a perfect winning streak of real growth during that entire period.

Of course, that is certainly possible. And yet, sometimes, entities only appear to achieve an unparalleled string of economic or financial success through the adroit manipulation of statistics. General Electric, for instance, used advanced “earnings management” strategies to generate an astonishingly smooth and consistent string of annual profit announcements during the final years of the twentieth century.

To be sure, Nobel Prize winning economist Paul Krugman and others have cast occasional doubts on the validity of China’s statistical announcements. Nevertheless, generally speaking, most Western news organizations simply accept these announcements at face value and repeat them for public discourse.

So what should we make of this sixteen year Chinese winning streak that suddenly appears to be in peril? If most news organizations are correct, and if the winning streak is a real one, then the sudden threat to its continuation is indeed a serious concern about an unforeseen slump in economic growth.

And yet if the streak is simply a product of an actively “managed” series of economic statistics, then the sudden threat may represent far more than a simple slump. Indeed, it may represent the government’s unwillingness to continue to “manage” its economic statistics, a new position that may portend a long term shift towards a more transparent (and thus a healthier) Chinese economy.

Zombie Banks at Halloween

Why does Hewlett Packard spin off its personal computer and printer operations while the Bank of America remains a financial supermarket? For that matter, why is eBay compelled to shed its PayPal unit while Citigroup continues to operate retail bank branches and institutional service units under one roof?

In just the past two weeks, Hewlett Packard and eBay announced divestitures of significant ancillary operations in order to focus more intently on their core businesses. Meanwhile, Bank of America and Citigroup were preoccupied with their respective $8.5 billion and $16 million regulatory settlements while maintaining their existing lines of business.

Why is this possible? Why do technology firms cut themselves to pieces while global banks pay for past transgressions and continue practicing “business as usual”?

Well, in the turbulent technology sector, firms like Hewlett Packard and eBay must compete with numerous new rivals like Lenovo and Square. Heck, even the “venerable” Apple only emerged as a technology titan with the introduction of the iPod a decade ago.

But Bank of America and Citigroup? They and their four competitors of the American “Big Six” banks (i.e. Goldman Sachs, JP Morgan Chase, Morgan Stanley, and Wells Fargo) are all more than a century old. Only one was even founded in the twentieth century; the baby of the bunch, Bank of America, was launched in 1904 as the Bank of Italy in San Francisco.

Oddly enough, both the technology sector and the financial service industry maintain comparable traditions of innovation. After all, who can say whether the iPad and the Google Glass are more ingenious (for better or for worse) than the Interest Rate Swap and the Collateralized Debt Obligation?

So the secret of the longevity of the nation’s largest banks cannot be attributed to a superior pattern of innovation. But what other factor can explain why great technology firms perish? While ancient banking institutions continue to roam across the country like the zombie undead at midnight?

The answer may be found in federal government policy. Regulators have consistently permitted technology driven firms like General Motors, Kodak, Polaroid, Texaco, and Wang Laboratories to enter bankruptcy court. Despite reportedly becoming insolvent during the recent global economic crisis, however, none of the Big Six banks were ever permitted to do so.

Instead, with the support of TARP and other government aid programs, the banking institutions have been kept alive. Like zombies in a Halloween film, they maintain all of their limbs in perpetuity … and they simply refuse to die.

Libor and Bitcoin

One is a venerable industry benchmark that was first introduced by the world’s leading global banks several decades ago. The other is a virtual currency that only exists on the internet and that was first proposed by a software developer a mere six years ago.

What could these two financial mechanisms possibly share in common? Regrettably, they have both emerged as instruments of illegal manipulation on a mammoth scale. In addition, they have both raised existential questions about the limits of regulatory authority in a complex and evolving global economy.

Libor, of course, is the variable interest rate that is established by a daily opinion survey of a group of global banks in London. It has become the preferred benchmark for $350 trillion of variable rate loans, swaps, and other securities with valuations that depend on prevailing market rates.

Bitcoin, on the other hand, is the $7.7 billion virtual currency unit that has begun to be accepted as legal tender by a variety of global organizations. Many commentators have praised the Bitcoin as the internet era’s version of an ounce of gold, i.e. as a storage unit of monetary value that is not subject to revaluation by any individual government entity.

Both mechanisms, however, have been targets of manipulation and scandal during the past two years. Regulatory investigations and lawsuits are continuing to plague the global banks that contribute to the Libor rate, while similar controversies and investigations have just begun to stain the Bitcoin market.

Both sets of controversies have also raised existential questions about the limits of governmental oversight. Do banking regulatory officials possess the authority to regulate opinion surveys like the Libor mechanism? Or internet activities that produce virtual commodities, like the Bitcoin system?

Although the British banking authorities have concluded that the Libor survey process is subject to regulation, they are permitting the survey itself to remain in private hands. And the Japanese authorities, responding to the collapse of a major Bitcoin operator in Tokyo last week, are insisting that the Bitcoin is not legal tender and cannot be regulated as such.

In the meantime, though, private investors are pressing ahead with litigation to recover damages for losses suffered in the Libor and Bitcoin markets. Will we reach a point when such lawsuits will force government regulators to focus on these financial mechanisms?

If you were Jaime Caruana, the General Manager of the Bank of International Settlements, the international organization of federal central banks, would you recommend that the global system of financial regulation establish authoritative oversight mechanisms for Libor and Bitcoin?