Archive for the ‘Investment’ Category

Banking the Sopranos

August 2, 2011













For some time I have been meaning to take a look at the structure of Italy’s public debt, and finally I did it. Let me assure you that the picture is every bit as ugly as one could imagine. I don’t mean the scale of the debt, which is known to almost every one. I mean the fact that Johnny Foreigner is totally, utterly on the hook. If this family goes down, we go down with them.

For the record, Italian public debt is currently around 124 percent of gross domestic product. Historically, this debt is the product of large, recurrent government deficits beginning in the 1970s. Over time, the debt load was compounded by the legendary ‘cunning’ (known in some cultures as ‘childishness’) of Italian politicians, manifested in manoeuvres like racking up the highest pension liabilities as a share of GDP in Europe — because it falls to another government, down the line, to pay the bill. So vote buying of one kind or another and a general willingness to mortgage the country’s future produced a large public sector liability.

Next, because of Italy’s history of relatively high inflation, governments were only able to sell their debt by offering short maturities. The buyers of Italian bonds commonly insisted on stuff of less than three years’ maturity. As of this year, Italy has about Euro500 billion of debt — around one-third of GDP — coming due in the next 36 months, compared with the equivalent of less than one-fifth of GDP coming due in that period in Spain. Even Greece has a lower share of GDP coming due in the next three years than Italy. (See the charts below. Note that these data are already a year out of date — they are the most recent I could quickly obtain. As each of the countries rolls more debt over into future liabilities, the bars to the right will rise quickly…)

Before one freaks out about these numbers, you have to remember that debt is really an issue of capacity to pay. Greece has no capacity to pay, which is why the market has already written it off. Until recently, the market said Spain had less capacity to pay than Italy. But now Mr Market is re-thinking.

There is good reason to do so. Spain has an Anglo-Saxon problem. Its banks are bust because of excessive real estate lending — a private-sector debt problem. The solution, sooner or later, will be bank nationalisation followed by a fattening of bank spreads in a less competitive banking system. The raising of the spread between deposit and loan rates quietly socialises the cost of the bail-out without a full-scale political confrontation about who is responsible for the cock-up and who must pay (the people my Etonian banker friend calls ‘the great unwashed’). This is what is already happening in the US and UK. Real estate prices deflate and banks use fat margins on current business to offset losses on their historic mortgage books. It is a long and painful process, but ultimately the mechanism to pay for the banks’ greed and misadventure is relatively easy to put in place.

Italy is a different story. Its debt problem does not stem from a real estate bubble and banking excess. The banking system already restrains competition and banks have traditionally made good margin from lending conservatively. The problem of the Italian banks is instead that — partly as a quid pro quo for a protected, high-margin banking sector — they have been the domestic buyer of first resort of government debt. Domestic financial institutions hold the overwhelming majority of Italian-owned Italian government debt. Put another way, government has been bribing the population to acquiesces in its incompetence and inefficiency, and the banks have provided the funds to allow this to happen. It is a public debt problem, but the banks are are the private sector symptom of it. This is why the shares of Italian banks are getting hammered as the debt crisis deepens.

If you want a non-technical Italian analogy, the situation is as if Paulie Gualtieri had started a bank. The main business of Paulie’s bank is lending money to Tony Soprano so that Tony can buy Porsche Cayennes for Carmela, which keeps their troubled marriage from falling apart. This is a pragmatic arrangement, and Paulie and Tony regard it as very cunning. Of course, Paulie’s bank eventually runs into trouble. When this happens, there is no automatic mechanism to socialise the losses. Instead, Paulie and Tony have to go out on the street and raise new funds by ‘cracking heads’.

Unfortunately, this is where the analogy breaks down. Silvio Berlusconi may be hewn from the same moral block as Paulie Gualtieri and Tony Soprano, but he does not have the same resources in terms of soldiers on the street. Washed and unwashed alike lack ‘respect’ for Sil and his degraded lifestyle (some of them hark back to the days of the legendary capo Bennie Muss, but that ship has sailed…).   Sil’s ‘family’ has been paring expenditure for several years since the global financial crisis broke. But his real problem is that the Italian economy has expanded an average of only 0.2 per cent a year since 2001. And the latest industry surveys suggest the economy is perilously close to contraction this year.

Put simply, there may not be enough money on the street for Sil to shake down, even if he had the wherewithall to do it. Mr Market knows this, and has pushed the price of Italian debt due for roll-over to more than 6 percent. When Greece, Ireland and Portugal exceeded a  7 percent cost of new debt, their bonds started to be sold off so heavily — because people no longer believed that they could be repaid — that bail-outs became inevitable. Italy may entering that arena and the symptom, as mentioned, is that Italian bank stocks are in precipitous decline. (Some of the more obvious investment advice today is: Short. European. Financial. Stocks.)

At this point, I know what you are thinking: the Sopranos had this coming. They’ve been taking the piss for years and, frankly, we’ve got bigger problems of our own to worry about.

Except that I am not sure that we do have bigger problems to worry about…

It is true that Italian banks hold most of the domestic share of Italian public debt. (Ordinary Italians have been far too sensible to load up on this toxic dross, despite any number of government schemes — mostly tax breaks — to encourage them to do so. The public holds only about 15 percent of Italian debt.)

However, apart from that held by Italian financial institutions, there is another vast chunk of Italian state bonds held by a different mob of wholly amoral financiers — foreign banks. Get this: approximately 900 billion euros of Soprano paper has been sold to foreign institutions, most of which represent a liability — if they go bust — to north European taxpayers.

Nine hundred billion euros is not some Greek, Irish or Portuguese morning after; it is a colossal, gob-smacking liability that means the Sopranos can probably make the rest of Europe jump through whatever hoops of fire they fancy. The line that Tony once used on Carmela is the one that Sil will likely use on the ECB: ‘Who knows more about extortion, me or you?’















Take a look at the aggregate numbers, displayed on top of the bars below, comparing debt due for roll over in Italy versus Spain….   (Greece, further down, is like discovering your kids failed to pay for half a dozen ice creams.)

2009 2011        
Japan 218.6 231.9 245.6
Italy 115.1 123.5 128.5
Greece 113.4 126.8
Belgium 97.9 104.9
United States 84.8 97.7 108.2
France 77.4 86.6 92.6
United Kingdom 72.9 89.3 98.3
Germany 72.5 87.8 89.3
Ireland 64.5 87.9
Spain 55.2 66.9
Sources: European Commission, IMF, OECD.

Don’t let Japan, in the table above showing public debt as a share of GDP, make you feel better about Italy. Japan is a qualitatively different story because almost all its ridiculously large debt is financed by domestic borrowing. Indeed the willingness of the Japanese to pay for the debt at close to zero interest is what allows it to be so big. Italy, by contrast, plans to have its debt and then have foreigners pay for it. (The last column in the table above represents forecasts for 2014… for some reason the date will not reproduce.)

The thought to keep me awake at night:

In order to get out of jail, one Carnegie Endowment economist reckons Italy needs to achieve a primary budget balance (before interest payments) of PLUS-4 percent of GDP and cut real wages by at least six percent (to restore some competitiveness). Is this likely? After Italy joined the Euro in 1999, its borrowing costs were cut from a peak of 10 percent of government revenue before the Euro to under 5 percent because Italy was temporarily afforded German interest rates. This provided an extraordinary one-off opportunity to reduce public borrowing. What happened? Over the next 10 years, Greece cut public borrowing by more than Italy.

Also worth a look:

This recent European Commission study shows that, from 1998 to 2008, exports of goods and services grew more slowly in Italy than in any other member country.

I post this, log on to the FT, and discover this is the lead story (subscription needed).

Yo, Lloyd!

January 14, 2011

Sebastian Mallaby, author of More Money Than God: Hedge Funds and the Making of a New Elite, has written an oped in the FT (subsciption likely needed) highlighting the exquisitely self-interested spinelessness of Goldman, Sachs, which has just published a hippy-shit manifesto of promises to love its clients more after paying out a bunch of money to the SEC rather than defend its conduct and business model in court. Particularly righteous is Mallaby’s defence of hedge funds, which have taken such media stick in the past couple of years when it was really the money pigs of the investment banking establishment who deserved the spanking. I don’t go a bundle on either group as a species, but the Wall St. investment bankers are so obviously more malign.

All you actually need to read of Mallaby’s piece is the last two pars, so here they are:

‘The truth is that investment banks are rife with potential conflicts – first between their trading and that of their clients, and second between various classes of customer, whom banks may serve as advisers, market-makers, underwriters or as a fiduciary. No amount of yogic incantation can harmonise these split personae; the solution is to break banks into functional units, so that merger experts, marketmakers and proprietary traders no longer cohabit. A refashioned Wall Street of specialist boutiques would be healthier for customers. And since the boutiques would be smaller than today’s megabanks, they might be small enough to fail.

Of course, this has long been evident to anyone who cared to look. An army of specialist advisory firms and hedge funds – ignorantly attacked as “shadowy” because they lack publicists and friends in Washington – has sprung up on the principle that focused private partnerships are preferable to conflicted behemoths. But for years policymakers have shrunk from challenging the big investment banks, comforting themselves with the thought that if the customers did not like them they would vote with their wallets. The customers, for their part, have been either awed or ignorant. Perhaps Goldman’s pieties will encourage them to wake up.’

I am not sure the very last bit is quite right: that customers have gone with the investment banks only because of awe and ignorance — though there is plenty of both about. Customers have also gone with big investment banks because the regulatory structure hasn’t given them options. You can’t go to a hedge fund for an IPO or working capital. The politicians are therefore doubly to blame. And who has put more of its people into senior US political jobs in the past 20 years than any other big bank? Goldman. One day I will blog about my bizarre encounter with Hank Paulson in a West Virginia toilet.

Pity for the rich

October 20, 2010

It has been a very long break while I write the first part of a new book. When you are spending all day working on writing, the idea of writing a blog as well becomes rather less attractive. Nonetheless, with all the fun things going on in the world, I am going to see if I can get back into it after the summer break.

Joe Stiglitz (you will need a subscription) has come out swinging with an attack on what has been dubbed ‘QE2’ or a second round of quantitative easing of the US money supply. What is best about his analysis is that it points out the fallacy that monetary interventions are costless (whereas fiscal interventions raise public debt, as we all know). Stiglitz points out that QE1, which involved the purchase of around US$1 trillion of US government bonds and mortgage securities will have a cost down the line as US bond prices fall (or, put another way, as interest rates rise to more normal historic levels). With QE2 set to be of the order of as much as US$2 trillion, the quantitative easing expected to be confirmed in November will involve long term public costs of an even greater magnitude.

Stiglitz points out that fiscal interventions (can) have clear benefits. Of course there is the money you throw down in welfare benefits to those who lose their jobs. But over and above this, you build schools, railways, new energy infrastructure, etc, etc, which has a long term benefit to society. Things may not be the same with the long-run public cost of unconventional monetary policy.

What Stiglitz doesn’t do is to say where the gain from quantitative easing investment is likely to end up. The answer, surely, is that much of it will end up in the hands of the rich. The expectation of QE2 is already driving a big rally in the US stock market. Where QE1 probably prevented rigor mortis in the banking system during the initial shock, QE2 is mainly telling the financial system that stock prices are likely to rise, if only for ‘liquidity’ reasons. From a bullish stock market, the rich benefit disproportionately. The poor see little or no benefit, consistent with a 40-year trend in the US to make the rich richer relative to the poor.

The real gainers from QE2, I think, are going to be the decidedly rich and the super-rich. This is because, unlike the loose monetary policy after 2001 which fed housing bubbles, this time the liquidity is going to drive asset bubbles and stock market bubbles in developing country markets in which ordinary people do not much play. A flood of cheap dollars, passing through the hands of hedge funds which serve the rich, is headed for the stock markets of Thailand and Indonesia, condo purchases in Hong Kong and Singapore, Latin American local currency government bonds, and so on. The financial managers of the already-rich know how to trade these markets, ordinary Europeans and Americans do not.

There was an Asian stock market bubble in 1991-4 during the last great Euro-US recession. But that was largely based on ‘discovery of Asia‘ overexcitement. The emerging markets bubble we should expect next year will be based much more on domestic US monetary policy (remember that interest rates were high in the early 90s). It may serve, indirectly, to force some warranted currency realignments by pushing up the value of currencies that have been artificially held down by government interventions in east Asia. But above all, within the US, the experience is likely to see a large transfer of wealth from the taxpayer to the already opulent.

It’s all wrong

April 13, 2010

I have written nothing on this blog for over a month while I try to think through the logic of financial sector reform in the wake of the global financial crisis. Frankly, I haven’t got very far. I am not sufficiently knowledgeable about the detailed systemic workings of contemporary banks and ‘shadow banks’ (the bits, like brokers and pension funds, that cause bank-like problems without being banks) to be able to offer a clear blueprint.

Today, however, I was reading some of the now declassified material surrounding a policy choice by the United States government that was clear, decisive and hugely beneficial to tens of millions of people. This was the decision at the end of the Second World War to confiscate all rented farmland in defeated Japan, and to redistribute it to actual cultivators. Reading the original memorandum that led to the policy, one is struck by the extraordinary simplicity and clarity of the thinking: here are the lesser interventions we could attempt – most obviously tenancy reform – and here is why, though such interventions seem superficially tempting and easier, they will either change nothing or make the situation worse. Here is the case for a radical intervention (expropriation). Here is how it can be achieved and the valuation mechanism that will make the process affordable to the Japanese government (offering some small compensation to landlords). And that, of course, is what the US and the new post-war Japanese government did. They changed the institutional terms under which Japanese agriculture, and half the country’s population, operated, setting the stage for the most remarkable developmental story the world has seen (more remarkable than anything we have yet observed in China).

I mention this because reading a memorandum about an effective policy intervention reminds me that I can state a case about financial reform without spelling out every detail. The logic is the same as with the Japanese example for no other reason than that the case for radical change in finance is now just as compelling, and the likelihood that lesser interventions will achieve nothing or worse is just as great. In essence, financial reform requires its own act of expropriation: we have to take away from bankers, shadow bankers, and other speculators all money which they can play with in the current financial system but do not stand to lose because of explicit and implicit government guarantees.

Martin Wolf in The Financial Times (here and here and here, though possibly not if you do not have a subscription) thinks this is impossible because the financial system is too complex. His colleague at The FT, John Kay, thinks that it is possible if you hive off the most core ‘core’ of finance – the so-called ‘payments system’ – and restrict that bit of banking to buying only government securities with the retail deposits it takes in. This of course leaves huge chunks of finance – including things like mortgages – outside of what Kay and others call ‘narrow banking’, the little bit that under Kay’s proposals government would explicitly guarantee.

Japanese land reform makes me think that one should be able to do something more practical and far-reaching than what Kay proposes, given the political will. The counter to Wolf’s arguments is simply that finance is whatever politicians make it; they can rewrite the rules as they like. This, though we have forgotten it, is why we have politicians. And this means that the objective of separating speculative from non-speculative money is feasible.

In the UK, where the government already owns most of the retail banking sector, I would force all core banks to become mutuals (building societies), owned by their members. This is the appropriate form of ownership for the core, boring, low-cost bank activities, which should serve the needs of customers rather than third-party investors. These mutuals would take in government-guaranteed deposits which they would use as the float we employ to make regular payments, to finance mortgages on first homes, to provide working capital to business, and to purchase government securities — all within bands set by the Bank of England. The central bank would hence have a somewhat expanded mandate, giving core banks modestly changing limits for the amount of treasuries they could hold, the minimum business lending they had to do, and their mortgage lending range. This would not be finance by bureaucratic dictat because the Bank of England would be acting within its own limits and because the core mutuals would not provide all mortgages, all business finance, or buy all government debt. But people would use the mutuals because their deposits were guaranteed and credit would tend to be cheaper because the assets and guarantees behind it would tend to be better than outside the mutuals.

In effect, individual citizens would have a certain amount of core mutual ‘entitlement’ and would be encouraged, through voting, to set the agenda and objectives of their mutual. One role of the mutual part of the financial system would be to address the welfare needs which private bankers claim have been supported by private sector bank deregulation – they mean by this access to more mortgage lending for poorer people. Government would probably mandate the Bank of England to force the mutuals to lend a certain amount of their money to poorer people who maintain long-term exclusive accounts and (in a financial sense) behave themselves, such that they could borrow in excess of normal loan multiples to buy first properties. Separately, the mutuals would probably also offer some forms of ‘plain vanilla’, low(er) yield pension products that might be given capital guarantees – contraversial – or some other advantage, say preference in the allocation of government debt or legally-mandated first dibs on private sector initial public offerings (IPOs).

None of this would reduce risk outside the core banking field, indeed it might well increase it. Not to worry: more frequent, more limited collapses among non-guaranteed financial institutions would almost certainly be a good thing. When a crisis occurred, it would – unlike today – be possible to bankrupt the institution in question and send a clear message to people about the risk associated with investing in ‘the real world’. This would be possible, of course, because there finally would be a real world, instead of the unified Never-Never Land that global finance has become since the demise of clear regulation, beginning in the early 1970s. We would all have our building society account, and our other uninsured investments, and no one could be in any doubt about which was which. The system, I suspect, would also be fantastic for competition because it would allow lighter-touch regulation of uninsured financial institutions. My feeling is that politicians are far too keen at present to put the boot into hedge fund managers, who are a real font of new ideas (compared with bankers), because it is so much easier than changing an economy’s overarching ‘financial architecture’.

None of the above will happen, because it would need another World War with 50 million dead to make it happen (which brings us back to Japanese land reform). But it would still, I think, be the right thing to do and hence is worth discussing. Of course there are lots of problems with what I have outlined, not least finding a new, workable balance between the mutual and uninsured financial sectors.  Any thoughts on how to address such issues would be gratefully received.

Related items of note:

Paul Krugman suggests that the financial reform package in the US is likely to be so lame that it is best to boycott it.

Roger Alcaly, in the NYRB, reminds us that a lot of hedge fund managers (like him) are much nicer and more intelligent than a lot of bankers, with the best review of the mechanics of the crisis I have seen.

The manifesto of the British Conservative party for the 6 May 2010 election is full of bluster about mutual-style organisations, as are other party proposals. But no one I am aware of is proposing that a core banking system be restricted to mutuals, which would be a significant policy.

We should not forget the fiscal travesty in our financial system – the fact that interest on debt is tax deductible for business where dividends on equity are not. In essence, this provides a fiscal/legal guarantee of acute over-indebtedness at some point in every economic cycle. Various people have mentioned the fiscal issue in the past year (Martin Wolf, Clive Crook, someone at The Economist, me on this blog, me in a Mr. Angry letter to The FT). Unfortunately the tendency among the journalists is to drop the point down to the eighth paragraph (hard to avoid when no politician will even speak about the question). Still, the fiscal thing ought to be written about in its own right.

No FT, no rubbish on your breakfast tray

January 22, 2010

The Financial Times greets Obama’s promise to restore something akin to Glass-Steagall with the worst, most congenitally spineless and brainless editorial (you may need a subscription to read this drivel…) that I can remember on its pink pages.

It starts with a tabloid headline – ‘Obama in declaration of war on Wall Street’ – and goes quickly downhill. The first four words of the first sentence are ‘Markets nosedived on Thursday…’ This refers to falls of 1.9% in the S&P 500 and 1.6% in the FTSE 100. They didn’t write ‘spiralled out of control’ when the same markets went up by not much less a couple of days before.

But it is the non-attempt to critique what Obama is saying that riles. The president should not try, the paper says, to prevent deposit-taking banks from trading on their own account because: ‘Boundaries between bank functions will be hard to draw.’ It is that old chestnut of the gormless right: this sounds new and unusual and a little bit difficult, so let’s do nothing.

Instead, The FT recommends an immediate return to the failed approach of the past 40 years: ‘The government’s key policy lever should be to make sure that institutions hold enough capital to reflect the risks that they run and the threats that they pose to the rest of the financial system.’ There have been endless efforts to regulate banks through their capital rather than their structures and they have failed for a very simple reason. It is that you cannot make rules about capital adequacy that are valid through the economic cycle.

In other words, the amount of capital that it is appropriate for a bank to hold when no one wants to invest (like now) is completely different to the amount of capital a bank should be made to hold when the world thinks that property prices will never fall again (a la pre-crisis). This is why economists refer to banks as pro-cyclical: they make economic cycles worse by mirroring the greed and fear of society at large.

Management by capital alone could only be effective if it was run by some kind of omnisicient, globally-empowered committee. This would tell the banking industry how much capital it should have at different points in the economic cycle. Banks would be instructed by the world’s cleverest men and women when to calm down and when to lend against their will.

Think about this for a moment. You will now have realised that the proposal is completely impracticable. There could never be a Pareto-efficient agreement about who should be on this committee any more than there is about who should be on the UN Security Council. And such a system almost certainly would not work anyway, because the chances of finding omniscient people are extremely small.

So you do what works. That means separating the utility and speculative functions of financial institutions in a way similar to what was done by the 1933 Glass-Steagall Act. People who want to play with the savings of the ordinary, conservative public must run one kind of bank, whose activities are narrowly circumscribed; people who want to leverage up 30 or 40 times must operate a different kind of financial business in which the capital at risk really will be lost when things go pear-shaped.

Why is this so difficult to agree on? The FT completely fails to point out that Paul Volcker, who has been brought in to consult on the reforms, is a highly orthodox former federal reserve governor who was reappointed to that position by Ronald Reagan. He is not some kind of hippy. What Volcker has, and what Obama’s current economics and fed team palpably lacks, is the intellectual reach and self-confidence to figure out and push through simple, effective changes which the US establishment will not like.


The FT editorial is also completely at odds with what its own chief business commentator writes and with what its investment editor has to say

Here, in The New York Times, is someone else who is not a hippy writing sensibly about bank regulation.

Here is reaction from emerging markets guru Chris Wood.

The Economist is hurt by its Thursday publication day, having produced a two-page briefing on bank regulation prior to Obama’s ‘Glass-Steagall’ remarks. A reaction to the latest news is posted to The Economist site.

Upload: final three FEER articles

January 20, 2010

There have been various requests for me to upload some journalism and book-related work, so here is a (small) start. The following links connect to the last three articles I wrote for the Far Eastern Economic Review. We know they are the last articles, because in December the Wall Street Journal (now controlled by Rupert Murdoch), the owner of the FEER, closed that venerable magazine down. I was fortunate to be asked to contribute to the final issue, and wrote a piece contextualising China’s development in terms of what we have seen, historically, elsewhere in east Asia.  From the autumn of 2009 there is a piece about how China developed its iron and steel industry, again with lots of developing country perspective, which also explains why iron ore producers in Australia, Brazil, India and elswhere are making so much money out of China. Finally, in true Chinese spirit, there is a self-criticism of my 2002 book The China Dream, written in late 2008.

Your money or your freedom

January 15, 2010


Another rumbling of perhaps not-so-distant thunder. Google’s threat to pull out of China is a significant development in increasingly confrontational relations between China and ‘the West’ (which in my definition is not really west because it includes Japan, as well as Europe and the US). Google’s move ratchets up another notch the political pressure that has been rising over market access for foreign firms, the question of the Renminbi exchange rate, negotiations over China’s vast iron ore imports and the arrest (initially on espionage charges) of Rio Tinto employees, and the handling of Chinese political dissidents, not least ones involved in the new-ish Charter ’08 movement.


Note that most of these are commercial and economic disputes. A simple metric has been at work in relations between China and the West since the Tiananmen massacre of 1989. It can be summed up as a Western bottom line of: ‘Your money or your freedom’. In the early 90s, in the first months of Bill Clinton’s first term, there was a momentary clamour for China to mollify the West by becoming freer. This did not last very long, mainly because China offered the West a different prize: money (or at least the strong smell of profit via Chinese market opening). Everyone has their price, and in the golden years between the 2002 start of the last Chinese credit cycle and the 2008 global financial crisis, the West was paid in money.


The situation — or at least perception of it — began to change in the past two to three years as China recycled vast amounts of foreign exchange earnings into (mostly) foreign government bonds. The main result was to maintain an artificially depressed exchange rate which helps China-based exports. Everybody else in Asia has done this over the years but, as China’s currency management continued against a backdrop of global economic recession, and as more and more multinational companies started to complain that China is finding new ways to block their market access, Western governments have gotten increasingly miffed. Throw in the arrests of Rio Tinto employees, initially on charges of espionage, and you have the beginnings of a Western consensus that China is no longer paying enough for us to overlook its unpleasant human rights record. At least, I think, this is a useful way of viewing the situation.


Google’s threat to quit, interestingly, is more a human rights/morality position than a commercial one. It has, it says, been the subject of orchestrated attacks (using Microsoft’s Internet Explorer as the point of access) seeking to obtain information about human rights activists and campaigners dealing with China. Lots of other human rights lobbyists, lawyers, journalists and so on have had their Gmail accounts hacked, not via assaults on Google itself but through direct attacks on email users themselves. Google has not pointed the finger directly, but it is hard to imagine who would attempt to do these things on a regular basis beyond agents – at whatever degree removed – of the state. There have been various attempts in media coverage to spin the story such that Google, which has about a 30% share of the China search market compared with more like 60% for Baidu, is really willing to walk away because it is not the market leader. This is crude and unfair. The reality, surely, is that Google is putting up (morally) with way too much in return for what it is getting out (financially) from China. Everyone has their price, and Google’s is too high for China. That does not mean Google is bad, it means it is far better than most. The firm was willing to run censorship (albeit a bit less than Baidu) on its Chinese search engine in order to get a .cn presence, but having its systems attacked in a quest for information on political dissidents is too much. Compare that with Yahoo! which in 2004 voluntarily provided information to Chinese authorities which led to the jailing of a journalist for 10 years.


It will be interesting to see how the commercial fortunes of Baidu and Google are affected, long-term, if Google does quit China. Baidu’s share price has shot up around 15% since Google publicly stated its position, presumably on the assumption that it can now get a virtual monopoly position in search. Google’s share price is unaffected. I am making a note to check where they are at in five and ten years.


Meanwhile, for your delectation, here are some of my favourite word search terms that Baidu uses to censor and block web pages in China. These are my own (doubtless flawed) translations from documents leaked by a Baidu employee in 2009.


communist party



don’t love the party 

network blocked

the current government

China human rights

princeling [refers to children of political leaders]

the party now

one-party rule 

freedom of speech

common bandit

today’s police

defend legal rights


requisition land


the masses

government official drives the people to revolt

bandit officials

suppress students

Zhao Ziyang

political crisis

evedropping device

sell blood

wife swap

oral sex



mother and son incest

a night of passion

cheating in examinations
the sale of the answer
fake diploma

More links

Rebecca Mackinnon, who knows far more about this stuff than me, writes a spirited op-ed in the WSJ and seems to have a similar opinion.


Fit for a King

October 21, 2009

Mervyn King, governor of the Bank of England, finally comes out and tells it (more or less) like it is. Bless him. In a speech to businessmen in Edinburgh, Mr King observes that the Anglo-Saxon financial system has so far been bailed out, to the tune of trillions of dollars, with no fundamental change in the way the banking system operates. Huge bonuses will again be paid to bankers this year-end, despite the fact their earnings depend on a limitless supply of almost free taxpayer money. We give them free money, they make a profit: clever stuff.

Mr King suggests this is unfair, paraphrasing Churchill: ‘never in the field of financial endeavour has so much money been owed by so few to so many,’ he says. The solution turns out to be the same one that people like the governor figured out 80 years ago, in the wake of the Great Crash. The retail and investment functions of banking need to be separated, so that speculative activity by investment bankers faces a serious prospect of punishment by bankruptcy when things go wrong. When every kind of financial function is merged under one roof, this does not happen. In the latest crash: ‘Banks and their creditors knew that if they were sufficiently important to the economy or the rest of the financial system, and things went wrong, the government would always stand behind them,’ says Mr King. ‘And they were right.’

Of course Mr King does not mention America’s Glass-Steagall Act of 1933, which split banking functions in order to ring-fence speculative activities. That would be tantamount to admitting that banking regulators have not learned anything for the best part of a century. But his logic is exactly that of Glass-Steagall when he describes banking functions that are necessary to the community and those which are simply a matter of private speculation: ‘The banking system provides two crucial services to the rest of the economy: providing companies and households a ready means by which they can make payments for goods and services and intermediating flows of savings to finance investment,’ says Mr King (he could have put the second point more clearly by saying that banks, uniquely, provide working capital to industry). ‘Those are the utility aspects of banking where we all have a common interest in ensuring continuity of service,’ he goes on. ‘And for this reason they are quite different in nature from some of the riskier financial activities that banks undertake, such as proprietary trading.’

Mr King’s reflections on the financial crisis are about as candid and thoughtful as anyone connected with government in the UK or the US has managed in the past year. He is quickly supported by a forceful opinion piece from Martin Wolf in the Financial Times. Sadly, however, it is highly unlikely that there will be a new Glass-Steagall Act on either side of the Atlantic. The senior economic advisers to the Anglo-Saxon governments, whether Fat Larry Summers or Alastair ‘Hello’ Darling, are far too spineless and mired in the mathematical drivel of ‘modern’ economic theory. There will be an incremental regulatory ‘solution’ to the financial system’s instability, involving new rules relating to capital adequacy. This has been tried for decades, and does not work because banks’ prudential requirements for capital vary over the economic cycle and cannot be reduced to a workable regulatory formula. Still, there will be lots of new jobs for regulators until the next financial crisis.

A simple, radical solution, as Mr King recognises, is what is actually needed. It should not be embarrassing to admit that what people figured out in the 1930s is better than what their successors thought in the 1990s (when Glass-Steagall was finally repealed under Bill ‘Mind-On-Other-Things’ Clinton).

 Moreover, there is one new thing that governments could do to stop the cycle of ever more severe financial crises that has afflicted the world since the end of the Bretton Woods fixed exchange rate system in 1971. There is not a hope in hell that this change will be discussed, let alone happen, but it is worth mentioning. The change is simple: end the absurd tax treatment of corporate debt, whereby interest on debt is deductible as a business expense before taxes are paid. This is not the case with equity, where dividends have to be paid after tax. The contrasting, and logically indefensible treatment of debt and equity in contemporary tax systems first encourages companies (including banks) to load up on debt, and second discourages the creation of more employee-owned firms. It is one of those things that is so dumb, so fundamentally wrong, that it is not even discussed.

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