The Great Debate

China’s massive supply of cheap labor may at last be drying up, a development that in time will bring higher wages, inflation, a stronger yuan and help to right dangerous global imbalances.

If these trends hasten financial liberalisation they could eventually set the stage for a broader Chinese bubble.
The formerly extremely unequal balance of power between workers and employers in China appears to be shifting.

Workers for a Chinese company which supplies Honda with auto parts have struck and successfully won large wage increases. Other strikes have followed, and firms have often been quick to compromise.

Hon Hai’s Foxconn, an electronics unit that supplies many leading western brands, moved to more than double many salaries as part of a series of reforms after a spate of suicides among workers at its highly regimented factories. Several regions have implemented or are debating increases to the minimum wage, a standard which didn’t even exist in China as recently as 2004.

Much of China’s economic development in the past 25 years has been built on the back, or backs if you like, of rural workers who were desperate to relocate to coastal manufacturing centers, wave upon wave of whom kept wages in check even as the economy boomed.

If ever you doubted that the euro zone bailout was in fact a bailout of banks, French and German banks in particular, look no further than the latest report from the Bank for International Settlements.

The trillion-dollar package of loans, backstops and emergency measures announced by the European Union, International Monetary Fund and European Central Bank in May was advertised on the basis that it would create breathing room for ailing southern European nations to impose fiscal discipline and establish a credible path to stability.

In the case of Greece, it is hard to see how it could dig its way out of its hole courtesy of a policy of austerity which was going to kick off a swingeing and long-lasting recession.

Europe won’t just be exporting deflation to the rest of the world, it will export serious trade tensions as well: first between the United States and China, and, possibly, eventually between Europe and the United States.

The austerity required to get Greece and other weak euro zone nations’ budgets in shape will exert a powerful deflationary force, as many countries which formerly imported more than they exported will be forced to cut back.

As well, the euro has dropped very sharply. Germany’s quixotic campaign against speculators — banning naked short selling against government debt and government credit default swaps — gave the euro its latest shove downward, but the trend has been strong for months. The euro is now about 15 percent below where it started the year against the dollar, making U.S. exports less competitive and adding to pressure on the United States to be the world’s foie gras goose: being force-fed everyone else’s exports while its own unemployment rate remains high.

Fear of lending to banks is rising again in Europe, as even a 750 billion euro zone rescue package proves not enough to stem fears that the banking system will prove the weak link when southern European nations can’t meet their obligations.

Strikingly many European and British banks are now being forced to pay more to borrow money in the interbank markets than before the joint European Union, International Monetary Fund and European Central Bank package was announced two weekends ago.

That deal, which should insulate highly indebted countries such as Greece, Spain and Portugal from funding pressure for the next two years or so, was effective in driving down the extra interest those countries had to pay to borrow as compared to Germany. Tellingly, it was less effective, even counter-productive, in restoring calm to the markets in which banks fund their short-term borrowing needs.

Europe desperately needs to get out in front of its solvency problem, Greek edition; not because it is right, not even because it will work in the long term, but to stem rapid and costly contagion through financial markets to other weak links in the euro zone, not least to banks.

Whether euro zone institutions will have the agility and resolve to quickly put in place out-sized measures for Greece is doubtful.

That Greece on Wednesday was paying more than 20 percent, or about double the rate of Hugo Chavez’s Venezuela, to borrow money for two years showed that investors were expecting either a default or very large burden sharing by existing creditors, and possibly a, by definition, disorderly exit from the euro by Greece. Spain joined the list of sovereign downgrades, as Standard & Poor’s cut its rating a notch to AA, a day after the debt rating agency slashed Greece to junk status and cut Portugal to AA.

If you want less of something, tax it.

That truism is often used as an argument against a tax on profits, or health benefits, or employment, but in the case of the rents extracted from the economy by the financial services industry here’s hoping it proves more of a promise than a threat.

The International Monetary Fund has put forward two new taxes on banks to pay the costs of future rescues, one of which is a fairly conventional “Financial Stability Contribution,” with an initial flat levy on all banks, to be refined later into something with more precise institutional and systemic risk adjustments.

More interestingly, the IMF is also proposing a “Financial Activities Tax,” (FAT) a tax on bank pay and profits which, if correctly designed, could serve as a tax on rents — the unwarranted spoils — of the financial sector.

So remind me, why will clients continue to do business with Goldman Sachs?

I know, it is a stupid question; investors and corporations will continue to do business with Goldman even after the bank has been charged with an alleged fraud for the same reasons they always have: because they hope, like every gambler, to beat stacked odds and because they flatter themselves that they are not the sucker at the table.
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Don’t count on the profitability of the financial services sector as a leading indicator of anything. Well, anything other than financial services compensation.

A stupendous recovery in profits is underway at U.S. banks, brokerages and insurance companies, but the big picture shows that for the rest of us that rebound may prove sterile.

Data from the U.S. Bureau of Economic Analysis shows the sector had an absolutely cracking 2009, with profits rising in the fourth quarter by 240 percent against the same period a year before.

Sometimes it's what doesn't happen that is most illuminating.

When Pay Czar Kenneth Feinberg first slashed executive compensation at U.S. firms that benefited most from a government bailout the cry was that this would hurt these weakened firms when they could least afford it, as the best and brightest would leave for better money elsewhere, where the free market still ruled.

Well, the door didn't hit them on their way out, but mostly because they stayed rooted to their desk chairs.
Feinberg evaluated the compensation of 104 top executives at affected companies in 2009, reducing pay for most to levels far below financial industry norms and their own former earnings.

Yet here we are in 2010 and about 85 percent are still working for the same firms, still toiling for the kinds of wages that may well make them wish they'd gone into the law rather than finance. Remember all those articles in glossy magazines about how impossible it is to make it in New York City on $500,000 a year?

Stock up on canned goods, the authorities appear to be opening a new front in the War Against Speculation; this time taking aim at the people who might profit from Greece and its European partners’ woes.

Just days after the U.S. Securities and Exchange Commission voted new limits on short selling, Germany is investigating the credit default swap trading of speculators to try to prevent them from profiting from any bailout of Greece.

“It would be bad if it were to emerge after a rescue that the money had gone into the pockets of speculators,” a source with knowledge of the efforts told Reuters.