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from MacroScope:

Manifest currency? U.S. dollar’s global dominance not set in stone

Incumbency, it is often said, confers many advantages.

Sitting U.S. presidents certainly have reaped its benefits – in the past 80 years, only three have been unseated.

Most economists believe the same benefits apply to reserve currencies. Yes, the U.S. dollar may one day be supplanted as the leading international currency, the thinking goes, but that day is many decades away.

Then again, maybe not.

A new working paper from the National Bureau of Economic Research that looks more closely at the dollar's own rise to the top in the 20th century suggests, among other things, that "the advantages of incumbency are not all they are cracked up to be."

By looking at the currency denomination of foreign public debt issued by 33 countries from 1914 to 1946, the authors – University of California-Berkeley professor Barry Eichengreen and Livia Chitu and Arnaud Mehl of the European Central Bank – find that dollar-denominated bonds were nearly equal to those priced in sterling by the late 1920s. That's about two decades earlier than the date assumed by previous scholars.

When stripping out Commonwealth countries that had strong commercial and political links with Britain, the dollar overtook sterling in 1929.

from Breakingviews:

Miners can live with a not-so-super cycle

By Kevin Allison

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

The super cycle is turning and miners’ super returns are under threat. But they can probably avoid another period of value destruction like the one that preceded the decade-long materials boom.

The problem is slowing demand in China, which is expected to account for the bulk of demand growth for copper and iron ore this year. Chinese housing starts fell sharply year-on-year in April. Industrial production, domestic retail sales and exports also looked weak.

With production costs increasing at an annual double-digit pace, miners need prices to stay high if their egregious profitability is to be sustained. The likes of Rio Tinto, BHP and Anglo American enjoyed operating margins of 30-40 percent last year, on a par with Google. Margins in iron ore, which accounted for the bulk of the five biggest miner’s 2011 profits, were roughly double that, according to Rio.

Miners’ average return on capital was 19 percent in January, according to data from Aswath Damodaran at New York University. The industry’s average cost of capital in 10 percent. Fast back to 2000, before the China boom kicked off, and returns were at 6 percent.

Could single-digit returns become the new norm? Probably not. China’s appetite for raw materials is softening not ending, and momentum would pick up if Beijing eased off the monetary brakes. Fading demand for steel in construction should be partly offset as newly affluent Chinese urban-dwellers buy more appliances and cars. And after steel intensity peaks, later-cycle commodities like potash (used in fertiliser) and diamonds tend to pick up. Moreover, the western miners are generally the lowest-cost producers, so have a competitive advantage in a downturn, especially versus Chinese rivals.

from Breakingviews:

China doesn’t need a policy U-turn

By Wei Gu

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

The last thing China’s economy needs now is another giant stimulus package. Premier Wen Jiabao has raised investors hope for a policy U-turn by saying that growth deserves more attention. But Beijing shouldn’t panic this time. Unlike in 2008, there are no massive job losses threatening stability, and still too much money sloshing around from the last stimulus. Structural reforms are the right remedy.

China’s economy is at its coolest level in three years. First-quarter GDP growth at 8.1 percent was the slowest since mid 2009. The World Bank has cut its forecast for 2012 GDP to 8.2 percent. China’s three growth engines - fixed investment, exports and consumption - are all losing steam. Fixed asset investment grew 20 percent year on year in April, the slowest since 2002.

Still, employment has been surprisingly resilient. The official unemployment ratio has remained at 4 percent since late 2010. The country added 12 million jobs in 2011, exceeding the 9 million goal, even after 10 percent annual minimum wage increases in the past few years. As China’s population ages, there is less need to grow as fast as before to absorb new workers coming into the market. China’s working population will stop growing in 2013, according to China Social Science Academy.

Moreover, there is a growing consensus on the side effects of a monetary stimulus - which would probably mean getting banks to lend more. Inflation dropped to 3.4 percent in April, but faces upward pressure as Beijing liberalises energy prices. Asset prices could also rise. House prices are continuing to climb in around a fifth of Chinese cities. The system is still coping with the last round of stimulus. China’s central bank was responsible for half of the new creation of “M2” money globally in 2011, according to Standard Chartered.

True there is room to give domestic demand a small boost, but this can be done through reforms rather than spending. On the investment side, Beijing is likely to push forward key infrastructure projects, especially in the underdeveloped west, to resolve logistics bottlenecks. Speeding up the modernisation of state-controlled sectors like railways, and breaking up remaining monopolies like healthcare, would help unlock potential demand. There’s no need yet to throw money at the problem.

from Breakingviews:

China diversified dot-coms avoid Facebook pitfalls

By Wei Gu

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

High-growth Chinese internet companies may be surprisingly defensive investments. True, fears about the cyclical advertising business have driven down shares in Renren, China’s Facebook lookalike. But other Chinese dot-coms should suffer less. Strong roots in gaming, whose revenue is still surging, makes diversified players like Tencent and Sohu comparatively recession proof.

Facebook’s poor showing in its first few days as a public company has damped enthusiasm for social networks. GM, a large U.S. advertiser, recently dropped Facebook ads for fear it may be a less effective channel than other forms of internet advertising. Facebook’s ads garner just half the clicks per page view of the average ad-hosting website, according to internet ad consultant Wordstream.

China’s advertising spending can be particularly cyclical. Developers and auto companies, the biggest spenders on advertising, are suffering due to Beijing’s home purchase restrictions and slower domestic demand. Renren’s first-quarter advertising revenue tumbled 46 percent from the previous three months. Sohu’s Brand advertising dropped 22 percent quarter on quarter.

But China’s dot-coms have been focusing on a more resilient line of business: gaming. Sohu’s online game revenue rose 3 percent quarter on quarter to nearly a record high. Tencent’s gaming revenue grew 15 percent in the first three months of 2012. Internet games are cheaper than a night out, making them attractive during economic downturns.

The gaming business is not only steadier; it can also be more lucrative. Games tend to have a longer shelf life than movies and news, and it takes fewer people to develop. The gross margin of Nasdaq-listed Changyou is almost 90 percent, compared with under 60 percent at Sina, which mainly relies on advertising. The increasing popularity of mobile devices also favours gaming over social networks, as it is harder to display ads on small devices.

from Global Investing:

Quiet CDS creep highlights China risk

As credit default swaps (CDS) for many euro zone sovereigns have zoomed to ever new record highs this year, Chinese CDS too have been quietly creeping higher. Five-year CDS are around 135 bps today, meaning it costs $135,000 a year to insure exposure to $10 million of Chinese risk over a five-year period. According to this graphic from data provider Markit, they are up almost 45 basis points in the past six weeks.  In fact they are double the levels seen a year ago.

That looks modest given some of the numbers in Europe. But worries over China, while not in

the same league as for the euro zone, are clearly growing, as many fear that the real scale of indebtedness and bad loans in the economy could be higher than anyone knows.  Above all, investors have been fretting about a possible hard landing for the economy, with the government unable to control  a growth slowdown.

The CDS rises have coincided with worsening economic data -- state-owned companies' profits have fallen 8.6 percent in the January-April period from year-ago levels while industrial production weakened sharply in April. Fixed asset investment - a key driver of the economy - has hit its lowest level in nearly a decade.

CDS fell slightly today after Premier Wen Jiabao called for more efforts to support growth. His comments also provided a mild boost to China's stock markets.  Gavan Nolan, Markit's director for credit research, says Wen's comments suggest growth is taking precedence over inflation in policymakers' minds:

from Breakingviews:

Long-awaited Yahoo deal heaps pressure on Alibaba

By Wei Gu

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Alibaba has finally reached a truce with Yahoo. The Chinese e-commerce giant is offering at least $7 billion to buy back its own shares from the U.S. internet group, recapturing half the stake Yahoo acquired in 2005 for $1 billion. The timing is good, since Facebook’s IPO has left cashed-up investors who could help finance the deal. But a successful outcome will heap pressure on Alibaba.

Yahoo is making some compromises in giving Alibaba what it has long wanted. The new deal will expose it to a hefty tax bill - something it had hoped to avoid. Yahoo will also give up one of the two seats it currently holds on Alibaba Group’s four member board. Still, the U.S. group will keep some upside from Alibaba shares, by holding on to half of its 40 percent stake until Alibaba eventually lists its shares.

Alibaba too is taking the rough with the smooth. It has agreed to value itself at a minimum of $35 billion, compared with the $32 billion at which it sold shares in 2011. The final price, which will be decided by a sale of Alibaba shares, may be higher. Moreover, it must come up with at least $6.3 billion in cash in the next six months. That comes just months after it borrowed $3 billion from a group of six banks to privatise its B-to-B e-commerce portal, Alibaba.com.

Facebook’s recent initial public offering has probably helped, by creating substantial new wealth among Internet investors. Russia’s Digital Sky Technologies, which participated in Alibaba’s last round of fund raising in 2011, is one. It just sold $1.6 billion worth of shares in the U.S. social media giant. Others who invested in Alibaba in the past, such as Singaporean state investor Temasek, may also be interested.

Once the money is raised, Alibaba founder Jack Ma must deliver growth to justify its valuation. The $35 billion at which it must raise finance is equivalent to 130 times 2011 net profit, compared with 31 times for Tencent and 45 times for Baidu, China’s two biggest internet companies by market capitalisation. Moreover, new investors are likely to one day want an exit. In closing the door on the Yahoo saga, Ma may be saying “open sesame” to another.

from Stories I’d like to see:

Press-dinner proceeds, cat-and-mouse China reporting, testing the testers

1. The White House Correspondents’ Dinner: How much for charity?

Two Sundays ago, Tom Brokaw used an appearance on Meet the Press to attack the increasingly over-the-top annual gathering of press, politicians and Hollywood stars and hangers-on known as the White House Correspondents’ Dinner. Brokaw called it “an event that separates the press from the people that they're supposed to serve. It is time to re-think it.” Incoming correspondents’ association president Ed Henry of Fox News quickly tweeted back that the dinner, which featured among other celebs Kim Kardashian, “raises TON of $ for needy kids who might not get into journalism w/out help."

Really? The association’s website lists just $78,000 for 15 scholarships in 2012, plus one scholarship whose amount is not listed. Assuming it’s about $6,000 (a bit above the average for the other 15 scholarships), that would be $84,000 in scholarships. Plus, there’s a $30,000 grant listed for a high school mentoring program. Yet this year’s dinner, according to an association board member, sold “nearly” 2,700 seats at $250 each to various media companies. That would raise over $650,000 for the dinner, compared with what, again, looks like $84,000 for scholarships and $30,000 for mentoring. That’s a total of $114,000.

Moreover, on the page where the website lists the scholarships, the correspondents’ association names 18 donors who are thanked for their “generosity.” The donors include Bloomberg, Time Inc and Thomson Reuters, and they seem to have given to the scholarship fund apart from buying dinner tables, or at least the website makes it appear that way. If so, wouldn’t these deep pockets have already come up with some or all of that $114,000 “TON of $” before the dinner was even held? That’s only a donation of about $6,000 each. Which would mean that the revenue from the dinner had little or nothing to do with the scholarships.

There could be lots of explanations for this, such as the possibility that this year’s dinner will pay for an expanded array of scholarships next year. But the numbers suggest that someone ought to look at exactly how much the party actually helps Ed Henry’s “needy kids.”

2. Dateline China

from MacroScope:

Is U.S. economic patriotism hurting?

Any Americans believing that their country is being bought up by the Chinese might want to pay heed to a new report from the Vale Columbia Center on Sustainable International Investment. It says that China is a minimal player in terms of foreign direct investment in the United States and that Washington should in fact be doing a lot  more to get it to gear up its buying.

To start with, look at the magic number.  In 2010, the last year for which numbers are available, only 0.25 percent of FDI into the Untied States came from China.  Switzerland, Britain,  Japan, France, Germany, Luxembourg, the Netherlands,  Canada were all far bigger. In the U.S. Department of Commerce's report on the year, China, numbers were so small they were lumped into a category simply called  "others".

This is not enough, the Vale Columbia report says. Given China's burgeoning economic role across the globe, America can benefit from a lot:

First, FDI provides an influx of capital into the struggling economy, increasing employment at no cost to the taxpayer. Second, jobs in foreign affiliates are typically better remunerated than similar jobs in domestically owned companies. Third, keeping the US open to foreign investment demonstrates a global example for international openness. Finally, Chinese money refused by the U.S. could alternatively be directed to competitors or even the U.S.’s enemies.

(On the latter point, its worth reading our global economic correspondent Alan Wheatley's story on China's influence in Europe)

The Vale Columbia report acknowledges that Chinese FDI  is controversial - primarily because a lot of Chinese companies are state-controlled and therefore raise fears that FDI may be more strategic that profit-seeking. There is also the concern about subsidies, piracy and economic espionage.

But the gains from opening the door to Chinese outweigh the risks, the report -- entitled Economic Patriotism: Dealing with Chinese direct investment in the United States -- says, recommending a series of steps such as dumping reciprocity clauses in FDI bilateral dealings.

from Breakingviews:

China has strongest hand in Philippine stand-off

By Wayne Arnold

The author is a Reuters Breakingviews columnist. The opinions expressed are his own. 

China’s stand-off with the Philippines over disputed islands in the South China Sea puts Manila in a difficult spot. While the Philippines has the support of U.S. military muscle, China is its number-three importer, and it needs China to help fund new mines and fill new casinos. Whoever gets to tap the oil and gas beneath the South China Sea, China would be the biggest buyer. That argues for a peaceful, face-saving solution.

What’s at stake is an atoll called Scarborough Shoal, roughly 200 kilometres from the Philippines and four times as far away from China. China has 13th century records it says establish its claim to the shoal, the entire South China Sea, its fish, and the 2 quadrillion cubic meters of natural gas it estimates lie beneath it - 30 percent of proved global reserves. Its trawlers already have free roam, and the sea’s claimants have agreed to exploit its hydrocarbons jointly. So China already has what it wants in function if not in form.

Manila has taken advantage of Washington’s recent tilt toward East Asia to reaffirm military ties. That buys it insurance and can mollify local nationalists. But Beijing is unlikely to react well to any real sabre-rattling: with its Politburo in transition, leaders can’t afford to seem weak on sovereignty. China hasn’t yet overplayed its hand, but that doesn’t mean it won’t.

Economic threats can be equally potent. China is already discouraging tours to the Philippines and threatening trade and investment. China’s $790 million in direct investment into the Philippines in 2011 was tiny, but stands to grow as Manila tries to double mining exports by 2016. China’s $6.1 billion in imports make it the Philippines’ third-largest export destination. And developers are building four casinos in Manila to lure Chinese gamblers.

Even if the Philippines managed to shoo China from Scarborough’s undersea riches, it would ultimately have to negotiate with China to buy them. Manila thus needs a way to defend its claim without demanding China abandon its own. As the Middle Kingdom expands, its economic heft will inevitably chafe its neighbours. Its challenge will be to create as little offence as possible; for neighbours it will be to avoid taking any.

from Breakingviews:

Chongqing won’t be allowed to fail with Bo

By Wei Gu

The author is a Reuters Breakingviews columnist. The opinions expressed are her own. 

China’s most populous city won’t be allowed to fail the way its disgraced former leader did. With Bo Xilai ousted, a bailout is already being assembled, with new funds from the country’s main policy bank, and help from state-owned firms. Chongqing’s debt-financed growth model is discredited, but the need for stability and growth prevails.

Bo’s dramatic removal as party secretary in March is a turn-off to foreign investors. Korea’s Samsung Electronics in April chose another western city, Xi’an, over Chongqing for its new flash memory factory. And U.S. private equity firm TPG Capital, which has been raising funds for investment in Chongqing, is considering shifting more resources to Beijing and Shanghai, according to the South China Morning Post.

The city’s stretched finances look even more worrying. With Bo gone, the risk is that his pet projects may also be abandoned, leaving Chongqing with lots of unfinished buildings, and lenders waiting to be repaid. Much of the city’s 26 percent nominal GDP growth in 2011 was funded by debt. The local government’s fiscal deficit was 11 percent of GDP in 2011, far more than Beijing and Shanghai’s 3 percent.

The central government is stepping in. China Development Bank signed a memorandum with Chongqing in May to provide more capital for roads and social housing. This may look risky now, but makes long-term economic sense. The west presents better catch-up growth opportunities compared to the maturing east, and should helps promote healthy consumption, as poor people tend to consume more of their income than the rich.

State-owned companies have also offered symbolic support. The heads of China’s top 117 SOEs were set to meet on May 17 in Chongqing, according to local government officials. That raises the possibility that Chongqing may get preferential access to key inputs like power. The city’s bid to become a new technology manufacturing hub has been held back by energy shortages.