The market continued its losing streak with the SSE Composite dropping 64 points to close at 2093, down 3.0% for the day, with financial institutions and property developers once again leading the way. During the trading day my student Shang Ning sent me the following (slightly edited) email:
The PBoC issued 1-year bills, at 3.91%, 9bps lower than last week, and 15bps lower than the annual average 4.06%. This pushed up the market like crazy; with yields dropping some 10-20 bps for medium-term treasuries. Obviously the auction indicated that banks were eager to buy bonds.
What else it can indicate? Can it suggest a declining willingness to lend money out to corporations, since bond market and loan market are substitute goods? Or a great expectation of basis rate cut soon?
Shang Ning seems to have got it right. Seemingly as part of a concerted global effort to support markets, the PBoC announced later that it was cutting interest rates (for the second time in less than a month, after six years of raising rates), with the benchmark 1-year rate dropping from 27 bps to 6.93%. The PBoC also reduced minimum reserve requirements by 50 bps to 17%.
How effective will these measures be in spurring the economy? According to the most recent data loan growth has been slowing. I don’t have the numbers in front of me but an article last week in Caijing had this to say:
In the second half of 2008, the People’s Bank of China loosened its credit control by five percent. But July and August statistics did not show a rebound for loan growth. Even if the quota were further relaxed, loan growth this year would hardly match 2007’s.
It seems to me that at least part of the reason for slowing loan growth has been corporate reluctance to borrow. If that is the case, I doubt whether lower rates (let alone lower minimum reserves) will have much impact. After all it hasn’t been high interest rates that have constrained borrowing in the past. We will need to watch loan growth figures closely in the next few months.
On a completely separate topic, a journalist friend of mine called me earlier today to ask me what I thought about the popular discussions about whether the current crisis marked a “paradigm shift” that would see a sharp decline in the relative power of Wall Street and London and a rise in the power of one of the Asian financial centers. Aside from the fact that I am a little allergic to paradigm shifts, I thought this was an interesting question. I usually get asked where the New York or Shanghai stock markets will close Friday (for the record: I don’t know).
This is also one of those “big” questions about which I think most of the current debate is a little muddled. To begin with, I don’t think the current crisis is a paradigm shift at all. It is simply yet another in the sequence of crises that have marked the six (as I count them) globalization cycles of the past 200 years. Of course there will be big changes in the worlds of commerce, finance, and politics, but these changes won’t represent a brave new world so much as a reversion to a more standard world.
After all, during the great liquidity cycles that underlie the globalization cycles, we always see in the late stages a massive growth in financial transactions and the power of financial institutions. During these periods banks get larger and larger, often though acquisitions and expansion abroad, and financial activity expands dramatically until it seems to become the hub of all industrial, commercial and political activity.
But it is these late periods which are the anomaly, not the norm. Every end of a globalization period (which usually ends in crisis) we experience a sharp deleveraging and a massive reduction in speculative activity. Along with that inevitably banks and financial markets become less central and less active. The expected decline of Wall Street and London, in other words, is not a shocking new reality but simply a reversion to more normal times – when it is not the dream of 8 out of 10 graduates of elite colleges to become investment bankers. To tell the truth when I was graduating I didn’t even now what investment bankers did. In a few years an awful lot of young graduates will be just as ignorant as I was. That is probably not a bad thing.
I suspect that a lot of experienced bankers, academic, and students of financial history will agree with me so far, but here is where I am going to get controversial. The debate about the “paradigm shift” seems mainly to be between those who say that the current crisis marks the relative decline of Wall Street as the center of world finance and those who argue that it will maintain its relative position.
But I think the effect of the crisis will actually increase the relative position of New York and London as world financial centers. Why? I say this largely because previous global financial crises were just as brutal as the current one, or even more so (1825, 1837, 1873, and 1929 were all more brutal), and yet during the subsequent years the then-global-financial-centers became more, not less, central.
Why this happened is not hard to figure out, I think. During the liquidity booms, the great advantage of the primary financial centers – the fact that they are much more liquid than other markets – is usually sharply eroded by the huge increases in liquidity, trading volumes, and financial transactions across the world, and with them, the decline in the value of liquidity. In fact it was always during the long boom periods that secondary financial centers were able to grow in importance – just as Sao Paolo, Frankfurt, Delhi, Shanghai, Singapore, Dubai and even Hong Kong have all grown dramatically in the past 10 years.
After the booms, however, the sudden reduction in underlying liquidity and the greater value investors and issuers placed on liquid markets typically causes most of the secondary financial centers to die out as trading and issuance migrate to the deeper markets of the primary financial centers. This is simply a form of the old traders saw – “liquidity draws liquidity.” If liquidity truly dries up around the world and trading and issuance volumes collapse, the value for investors and users of capital of accessing New York or London will be greater, not smaller.
What about the argument that an Asian financial center will rise in relative importance? I think this may very well happen, but it will have little or nothing to do with the current crisis.
An Asian financial center will or will not rise depending on several factors. These include the liquidity and value of its currency for international transaction, the strength and impartiality of its legal framework, the scope for political and regulatory independence, a clear governance framework (which implies, among other things, that managers are minimally constrained by policy needs), the size of the home market, the openness to foreign markets, the importance of financial markets (as opposed to large banks) in financing, and several other obvious and not-so-obvious things. The financial center also needs to be perceived as politically (and geopolitically) safe and stable, and especially a safe haven in times of tension, which is not always an easy thing in an Asia which consists of several very large, often heavily armed countries with a long history of mutual distrust and rivalry.
I may be wrong about whether or not New York (and London) maintain their pre-eminence, but I think I am certainly right in suggesting that any argument about what-will-happen-next that ignores the last 200 years of surging and waning global liquidity and the past several globalization cycles is likely to get very little right. What we are experiencing is dramatic, but it isn’t new