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THE GROWTH MYTH LEADS TO THE CRISIS by Paolo Savona HOW THE FINANCIAL POWER CENTRE IS CHANGING by Marcello De Cecco PROFILES AND PROSPECTS OF THE REAL ECONOMY by Fabrizio Onida NAPOLEONI: A NEW BRETTON WOODS? COME ON… by Donato Speroni PROFUMO: MORE GOVERNMENT, MORE REGULATION, MORE MARKET by Vittorio Borelli THE TURMOIL SPREADS TO THE EAST by Fabrizio Coricelli and Debora Revoltella FINANCIAL SHOCK by Antonio Barbangelo WAITING FOR CHINA BY Alessandro Arduino and Cristina M. Bombelli After the Tsunami Grazia Neri_AFP DOSSIER DOSSIERDRAMATIC TURN OF EVENTS ON THE FINANCIAL MARKET LED TO THE AFFIRMATIONS THAT THE MARKET HAD FAILED, WHILE THE USE AND ABUSE OF FREEDOM OF ACTION WAS NOT ONLY ALLOWED, BUT ACTUALLY ENCOURAGED BY POLITICIANS, AND THE FEW CONTROLS THAT SHOULD HAVE DOSSIER The growth myth led to the crisis by Paolo Savona The crisis emerged because the U.S. used its economic policy, especially the monetary aspect of it, to sustain income and employment growth without accepting the balance of payments constraint that practically every country in the world faces. And now the West should not envisage getting out of the crisis by discharging responsibilities that are primarily its own on China and Asia If we do not give in to the temptation of “thinking badly, convinced we are getting it right”, to paraphrase former Italian prime minister Giulio Andreotti, we can reasonably affirm that the control of finance slipped out of the hands of American official authorities and private-sector managers, with disastrous consequences for their country and subsequently for the rest of the world. The problem, which was initially financial, is now becoming real, and will end up affecting the geopolitical balance. It is to be hoped that the new American President will have the courage to immediately reject a logical extension of the concept repeated by more than one Treasury Secretary, i.e. that the dollar is their currency, but our problem. There is not the shadow of a doubt that the financial crisis is our problem, but it is theirs too, and the ways in which it will be tackled could change the world’s political framework and undermine the American leadership, thereby putting the European Union in serious difficulty. There has been one declaration of good intentions after another, including joint ones, but no “political” diagnosis of why this happened. And, with the exception of a few monetary steps, action has been confined to the national level. The crisis emerged because the U.S. used its economic policy, especially the monetary aspect of it, to sustain income and employment growth without accepting the balance of payments constraint that practically every country in the world faces. This was made possible by the fact that the dollar is used as an international reserve currency and that the U.S. enjoys confidence as the world leader. The policy of indiscriminate support for internal growth can be considered to be nothing short of subjugation to the “growth myth” that has penetrated American politics so deeply that it conditions the election of a president. If he is running for re-election, the candidate has to convince citizens that he has worked well for the economy, and if he is a first-term candidate he has to show that he is capable of doing it. The difference in the way the two American parties govern the economy has diminished considerably in the past few decades and, after Kennedy and Johnson’s ideal of a “Great Society” had demonstrated its limits, the growth myth dovetailed with the conviction that free initiative would satisfy the American dream better than public intervention. However, the free market turned into financial anarchy without political or business leaders realising that they were heading down a dead end street. Nonbanking finance in particular used derivatives to abuse the freedom it was given and the crisis became inevitable. The dramatic turn of events on the financial market led to affirmations that the market had failed, while the use and abuse of freedom of action was not only allowed, but actually encouraged by politicians, and the few controls that should have been exercised were applied in a very “loose-knit” manner. There are therefore several reasons to invoke government failure, or at least both government and market failure, and once again, those who will pay most dearly are the ants, the people who were saving money, not the grasshoppers who were getting into debt. The United States will probably manage to limit the collapse of manufacturing and get the stock market going again, making it possible to reabsorb part of the serious financial losses it has incurred, but pension funds and similar forms of savings accumulation, i.e. the backbone of society and the economy in America and the rest of the world, will still suffer damage. This backward step on the road to wellbeing will be hard to explain to the people who viewed their financial savings as a way to protect them in their old age. However, instead of turning to the market and asking the government to extract it from financial anarchy, they will keep thinking of and asking for public protection, thereby increasing the public debt and diminishing the extent to which their own wellbeing can increase. Frightened by the way the crisis was shaping up a few weeks before the elections, the American electorate appeared likely to turn to the Democratic Party led by Obama, who promised to widen the social protection network without questioning whether the U.S. Treasury’s commitment to save what could be saved of the financial system would leave sufficient room to fulfil the promise of more welfare. If, on the other hand, the elements that make up the American dream – free enterprise and the expansion of opportunities offered to citizens – had continued to be held valid even after wiser regulation of finance, then electors might have renewed Grazia Neri_AFP BEEN EXERCISED WERE APPLIED IN A VERY “LOOSE-KNIT” MANNER. THEREFORE IT WAS THE GOVERNMENT WHICH FAILED, TOO. BUT ONCE AGAIN, THOSE WHO WILL PAY MOST DEARLY ARE THE ANTS, THE PEOPLE WHO WERE SAVING MONEY, NOT THE GRASSHOPPERS WHO WERE GETTING INTO DEBT their confidence in a Republican administration. The electoral test was interesting not so much in terms of the traditional right-left divide as in terms of ascertaining to what extent the crisis had shaken up the American conviction of a domestic and global free market being a good thing, albeit within a new regulatory framework capable of forestalling abuse and crisis as much as possible. The problems the financial crisis has created on the other side of the Atlantic and the Pacific, on the other hand, appear to be less serious but more delicate to tackle. The “European dream” put equal faith in market possibilities and thereby allowed the birth of a single currency; however, it put less faith in the virtues of competition, counting to a larger extent on public assistance rather than job opportunities. The European citizen insistently asks the State for more guarantees. If the American financial crisis were to seriously spread to the global real economy, the resulting social tension could diminish an already insufficient will to forge a common destiny for the “Old” Continent and strengthen the centrifugal trends of the political union, which emerged with the French referendum on the proposed EU Constitution and the Irish referendum on the Lisbon Treaty. The first impact would be an overlapping of the European dream within the context of a “zollvereign”, a Customs Union. This could still have its advantages, if not for the fact that economic history teaches us that such unions do not last long unless they are reinforced by common political will. If this were the only political structure, the euro in its turn would come under strain. It is no coincidence that it is the euro that has devalued significantly at the worst time for the dollar. There is obviously a loss of belief in the staying power of a political European Union regardless of the fundamentals of its economy, which, although far from brilliant, are nevertheless less exposed to risk than those of the American economy at this juncture. The economic problems actually appear to be minor on the Asian side of the Pacific. Very little is known of the extent to which the financial crisis has impacted Chinese savings. One news item has symbolic value, however: the Chinese central bank has lost all its capital because of the devaluation of its dollar investments – a unique event in the history of these institutions. Of course it is nothing serious, because the loss concerns the country’s State-administered wealth and will have no direct impact on banks and financial markets, which are, on the other hand, exposed to the winds of the crisis. The global recession will slow down the process of export growth, but China has such ample accumulated reserves that it can substitute domestic demand for foreign demand by accelerating its social spend, which is still lower than the rest of the developed countries. If it does not do so, social tensions, which are already running high, could increase further and the problem would be transferred to China’s geopolitical relations, especially vis-à-vis the United States, where their crisis originated. This interpretation principally points an accusing finger at Grazia Neri the American authorities, but it is only correct to emphasise that the American policy of sustaining domestic demand to the point of running up a huge foreign debt by creating dollars and selling financial assets allowed the establishment of an insane laissez-faire on traditional and innovative financial markets. Authorities in the rest of the world did not challenge this policy, wrongly interpreting it to mean that despite accumulating imbalances, it was useful for world growth. The originating error was matched by passiveness at the receiving end. And this passive attitude does not seem to be the focus of critical revision and adequate decisions, considering that even the latest documents produced after the meetings of heads of State, finance ministers and governors of central banks contain affirmations that, besides outlining measures to be taken at the national level (supply liquidity, recapitalise banks, guarantee deposits and support the financial system in various ways), approve certain positions that are at odds with the stability that appears to be the objective of their declarations of intent and the decisions they have taken. We believe that politicians have good reasons to gloss over an examination of the origin of the crisis and its development, since they have to mitigate its negative impact on international relations. What we cannot understand is how the central banks (all of them, in our opinion, but the Fed and the ECB in particular), which have been guaranteed independence from democratic bodies to make them freer to take the right decisions, even unpopular ones, could sign a release saying “We reaffirm our shared interest in a strong and stable international financial system” and then add that “excessive volatility and sharp currency fluctuations have adverse implications for economic and financial stability” without mentioning that the world’s currency exchange regime must therefore change from “free” to “dirty”, i.e. managed, while making a general statement that the objective will be achieved by monitoring exchange markets and co-operation “as appropriate”. Their statement is at odds with the desire for a strong and stable international financial system because it says that, “given China’s important role in the global economy, we urge the authorities” (Chinese, of course) “to allow accelerated appreciation of the effective yuan-renminbi rate as a means towards a better balance in the domestic economy and the promotion of external stability”. Going by this release, greater stability and less volatility in markets depend on the balance between Chinese exports and domestic demand and a revaluation of the yuan. However, the release makes no mention of the fact that these steps will require a re-absorption of excessive U.S. domestic demand and the laxity of U.S. lending activity, the creation of a global monetary standard, the elimination of differences in exchange rate regimes as a result of the WTO’s liberalization rules and the re-organisation of the substantial build up of dollar reserves to regulate their conversion into euros on the market and their use by sovereign wealth funds. These problems must be solved if we wish to ensure that we do not go from one crisis to another. How the financial power centre is changing by Marcello de Cecco It is unclear who will take the place of Goldman Sachs and the other broker-dealers. They could actually stay at the centre if a patched-up “originate-to-distribute” model were to remain in place after various bailouts. There is undoubtedly a Chinese power centre alongside the traditional American one. Europe must work fast to forge a common strategy The “originate-to-distribute” model appears to have had its day, at least as regards the possibilities it shows for further expansion. The crisis actually casts doubt on its continuation, since the leverage capacity the model requires will have to be considerably resized if the absolute liquidity preference situation the system suffers from, which has made it semi-immobile for nearly a year, is to be partly or fully eliminated. Goldman Sachs and Morgan Stanley’s request to become commercial banks and therefore be subject to Federal Reserve supervision rather than the more indulgent supervision of the SEC, which they had fought to obtain at the beginning of the decade, is clear proof that these titans of the model, who formed the centre of the huge network of innovative financial transactions created in the past decade together with JP Morgan Chase and AIG, feel that the model has no prospects and that the near future will belong once more to institutions with a substantial deposit base. So the financial power centre of the world is changing and it is unclear who will take the place of Goldman Sachs and the other broker-dealers. They could actually stay at the centre if a patched-up “originate-to-distribute” model were to remain in place after various bailouts. It appeared that the moves by Treasury Secretary Paulson were to be interpreted along these lines, at least until the acceleration of events forced him to act from a standpoint of absolute emergency and actually abandon the attempt to set up a financial structure that would allow investment banks to survive as the nerve centre of the whole system. Besides the “originate-to-distribute” model, the global financial system has grown over the past two decades by creating the network banking model and granting loans on so-called probabilisticinsurance principles and no longer on the basis of stable relationships evaluated using traditional reliability criteria for individual customers. Moreover, many loan relationships have been turned into market transactions and shifted off-balance sheet to follow and circumvent the Basel I regulations, which increased capital coefficients and made them the central element of bank supervision. The question is whether this model too will end in crisis, considering that the main reason it was able to develop was that returns on loans granted in the new way are high if the loans are treated as commodities that can be packaged into big securitizations and rapidly sold so that the capital used re-circulates quickly. Also, in the case of non-performing loans, the sale of packages to entities different from the banks but owned by them generates a loss for the Grazia Neri_AFP banks, which can be written off for tax purposes with the hope of profits for off-balance sheet companies if they manage to resell securitized loans at prices higher than the purchase price or collect loans by the due date, possibly by selling them to special purpose debt collection companies: separate entities that, however, remain the property of the originating banks. Another essential element for the model are credit default swaps to cover potential losses, traded by the two earlier-mentioned investment banks, the now-defunct Bear Stearns and Merrill Lynch and the survivors AIG (now partly government-owned) and JP Morgan Chase. This market grew by sixty times in volume since 2005 because it, too, was essential to the working of the new business model that most of the world’s financial operators adopted in the climate of marked uncertainty that prevailed on the market post-2005, when U.S. monetary policy changed direction with a rapid hike in the Federal funds rate. We will see the extent to which the market will be transformed by the regulation on such transactions that New York State has already announced and that the head of the SEC has requested. The regulation brings another important problem to mind: that of the particular methods used to carry out the majority of so-called innovative financial transactions, i.e. agreement between the two parties for each individual transaction without any fixing of prices in regulated or free, but centralised, markets. This method, known as over-the-counter trading, is now being held responsible to a large extent for the uncertainty related to evaluating the new financial instruments, which has facilitated the creation of the state of absolute liquidity preference that markets have been reduced to for the past year. In fact, transactions carried out in this way give the market no possible way to exercise its best-known and most useful function: that of price discovery. The prices of individual transactions are not public; they cannot be compared by agents, apart from those directly involved, and therefore cannot form a basis for other transactions. Another activity essential to the functioning of the model is risk evaluation by rating agencies. Even though they cut a sorry figure in the first half of the decade with the Enron case, Parmalat etc., these companies were still entrusted with essential functions like risk analysis of bonds, which form the basis of securitization. The systemic conflict of interest in which these companies found themselves, and still do, because they are paid by the clients whose products they rate, has been criticised several times, but nothing has been done to eliminate the situation or replace the rating agencies with other entities. In fact, ratings serve as the basis for the risk evaluation used to calculate capital coefficients under Basel II. Moreover, a change in the legal status of U.S. rating agencies in 2004 made it possible for them to be held accountable for their advice only in case of fraudulent intent, not even in case of gross misconduct. This amounts to virtual legal immunity. Ecofin and the Brown Plan, as well as the IMF reform policy, now envisage supervision of these companies by watchdog authorities. It would be opportune for the latter to do so efficiently, starting by at least eliminating the unbelievable clause that rating agencies have felt the need to add to each rating they produce, which exempts them from all responsibility. DOSSIER The collection of international regulatory standards known as Basel I and II are also one of the basic reasons for the transformation of international finance in the past decade. These accords chose capital coefficients as the main instrument to measure banks’ credit potential and credit risk. Alongside the regulations that go under the collective name Basel I and II, there is a type of bank supervision that takes only, or practically only, compliance of quantitative coefficients into account (Basel II has modified this approach to some extent) and almost totally abandons the traditional activity of credit risk and asset improvement evaluation carried out by supervisors on a case-by-case basis. And with assets in bank portfolios circulating faster, massive recourse to bilateral transactions and the spread of risk obtained – at least in formal terms – because of securitization, it is quite difficult to evaluate the portfolio itself at any given time. Additionally, the notion of capital coefficients loses much of its effectiveness as an indicator of a bank’s solvency when the bank’s actual assets are spread out among vehicle entities that are independent of the bank on paper but really fully owned by it. Legally, these entities are not consolidated in the bank’s balance sheet, but as things turned out, they had to be consolidated when the banks ran into difficulties and realised they would be more likely to risk their reputation by refusing any responsibility for these entities than by consolidating them into their balance sheets, even though their capital coefficients plunged as a result. It was precisely for this reason that the American authorities took a cue from the Brown Plan and used a substantial $250 bn of the $700 bn allocated by the Paulson plan to recapitalise banks, with the government taking stakes in major banks (albeit in the least invasive way possible). Looking at the way the global financial system has evolved over the past two decades, particularly the evolution of the American financial system, which forms its centre, the unavoidable conclusion is that American economic policy authorities intentionally encouraged this growth pattern; that most developed countries imitated it with a combination of admiration and repulsion, and that international financial organisations tried to impose it at every opportunity on developing countries as well. The authorities’ actions and omissions were aimed at achieving this pattern. For example, regulatory and economic policy authorities in the U.S. and many other countries, as well as most academic economists, viewed the fact that the Basel regulations led banks to develop huge amounts of officially off-balance sheet financial activity to comply with the establishment of capital coefficients as legitimate financial innovation and a sign that the more efficient operators were in good health, rather than as clear evasion of existing norms in most cases. However, if it is true that the end goal of economic activity is to maximise the production of goods and services, maintaining that a reduced level of financial activity would not have major consequences on the activity of the real economy, as most of the media and the authorities did over the past twelve months (until the seriousness of the crisis revealed the inanity of their position), is equivalent to estimating that the bulk of the financial innovation that has taken place over the past 20 years is functionally irrelevant. If financial bubbles can come and go with no serious effects on the real economy, it means that finance is essentially an end in itself. In that case, why view its evolution as a sign of progress? If progress 110 Grazia Neri_AFP stops and actually goes backwards, and the financial system contracts as a result, it means that all the activities that compose the system can disappear, with no damage to anyone apart from those working in the financial sector. If the size of the financial sector were to be reduced, however, at least one consequence would be that a part of those employed by the sector would be laid off, and this would negatively impact the demand for goods and services. All other things remaining equal, a country’s growth rate would diminish compared to the earlier situation. In some countries, such as the U.S. and the U.K., there would undoubtedly be a significant effect on employment and income, at least for some kinds of demand for consumer goods and services. Generally speaking, maintaining that the financial system has little relevance for the real economy corresponds to the neoclassical position, which holds that currency is merely a veil covering the economy’s real transactions: it is able to influence the general level of prices but incapable of influencing relative prices. How will the American financial system, which showed the way for the rest of the world, change in the wake of the current crisis? It is essential to stabilise the system, even if this seems extremely difficult at the moment. It is easy to predict that it will head towards reregulation. It is easy, but does not mean much, given that the regulations introduced over the past few decades have tended to demolish the segmented financial system inherited from the New Deal, but were in fact regulations that abolished and modified other regulations in line with a philosophy opposed to the earlier one, without the regulators ever leaving the scene. Consider, for example, the panoply of regulations that go under the name of Basel I and II, or the collection of U.S. regulations known as Prompt Corrective Action. The philosophy behind them is undoubtedly opposed to the one on which the previous system was based. Regulators have tried not to prescribe specific behaviour to the regulated, but merely to create environments within which each regulated entity can move freely: the assumption being, however, that short-term maximisation of profit by financial institutions should be the basic behaviour model – or the default model, to use the current term, because it inevitably leads to a more efficient system. However, the new model of regulation introduced in recent decades appears to have forced the authorities into a level of interventionism that is greater, at the end of the day, than in the previous period. Its introduction has been accompanied by an increase in the frequency and seriousness of financial crises, which has obliged the authorities to act in ways that contravene the principles they have repeatedly affirmed on the self-regulation of the financial system within a “light touch” regulatory environment. The American and British reactions to the current crisis are only the latest and most glaring example of this. It was believed that the government’s role in safeguarding savings, which had shaped the 1930s reforms, could be reduced to encompass merely the weaker sections of society, while the strong could be left to take care of themselves. Instead, governments have very often been forced to invoke the protection of the weakest to get the strongest out of the messes they have repeatedly got themselves into. _Declarations by both Paulson and Bernanke (above) gave firstly the impression that, in order to overcome the crisis, it was enough to take measures that would serve above all to reverse expectations 111 DOSSIER _The recent crisis has revealed the need to take measures to move towards unified supervision at the European level. And also the ECB (in the picture President Trichet) should have a different philosophy to that of the United States 112 A new model of regulation must therefore take a direct and unfeigned approach to the issue of moral risk that has been created by the accumulation of a succession of crisis-resolution incidents using public money and direct intervention by regulators in the role of the saviours of the system and each of its components. Specifically, following the current crisis and its probable developments, it will be truly hard to maintain the credibility of the notion that no market operator is too big to fail. What are the lessons for Europe? If we take a pessimistic outlook, regardless of any possible detailed intercontinental agreements (which, however, seem improbable, even if they are now requested out loud by the highest bodies such as the U.N. General Assembly), measures to move towards unified supervision will have to be taken at the European level, establishing in due time whether such supervision should be entrusted to the ECB or to an institution separate from it. Those who defend the latter hypothesis could risk appearing in the same light as those who maintain that the lastminute lender should intervene to help illiquid but not insolvent banks. In fact, it is near impossible to keep the two institutions, the monetary and the supervisory one, separate in practice even if they are located in different European countries. The important thing is for both to be isolated from the influence of national governments or even a EU government that might be created on the basis of the Lisbon Treaty’s recommendations. Both the ECB and a European watchdog authority should of course have a different philosophy to that of their sister organisations in the United States. While these philosophies may concur, Europe’s must be the result of an independent thought process to reflect the specificity of European financial institutions, the European economic system as a whole and European values. Even if Europe manages to create a common watchdog, the fact remains that our real and financial institutions cannot isolate themselves from a global trend towards wealth concentration that has emerged particularly strongly in the past decade and substantially led to the financial behaviour mentioned earlier (excepting the spread of subprime loans, which is however also a reaction to the trend, an attempt to keep two mutually exclusive models going: wealth concentration and the “Saudi-Russian” model preceding its spread and the model that gained the United States the whole world’s affection over the past century. Subprime loans, Alt-A loans and even Jumbo loans are basically the financial equivalent of Wal-Mart and Ikea, as they are used to try and keep some income groups within the middle class by allowing them access to assets such as home ownership that have typified the middle class for decades). Like the growth of private banking, the hedge fund boom is also part of the divergence of the distribution range. While it is true that hedge funds have recently gone through a process of “democratization”, they are the financial system’s response to the new situation of fairly substantial wealth concentration, most of it still in the United States but also on the rise in countries such as Italy, France, Spain and even Germany in the 1990s and the new century. Their growth was also caused by a progressive slump in returns on mutual funds, based on global portfolios. Hedge funds are now cutting back because of the non-availability of leverage and Olycom their customers fleeing, but if there is no change in the polarization of income and wealth, the return to a banking model based on collecting deposits through a widespread network of branches through the country could coincide with either a decline in bank profits or, worse, an attempt on the part of banks to keep profits high by extorting their retail clientele, which has benefited from reduced service fees because of increased competition in recent years. Now Goldman Sachs and Morgan Stanley’s decision to become commercial banks and probably buy up a few deposit and branchrich banks, which was preceded by Deutsche Bank’s acquisition of Germany’s post office bank and Mediobanca’s initiative to create an online bank to collect deposits on the lines of the ING Orange Account, should demonstrate that the lead players in the system believe they are turning the page and returning from the market to the intermediaries. If this is really the case, Europe, with its financial system in which banks still predominate over the markets, its conservative approach to mortgage lending and its ability, demonstrated anew recently, to take shared action, after dangerous hesitations and individual efforts, in order to follow a best practice example such as the Brown Plan, should find itself in a better position than the United States and able to withstand the competition from financial systems such as China’s, which has huge reserves and is still very dirigist. However, the recent events have brought another problem to light: the size of the big banks and that of the economies of the countries in which they are headquartered. The “too big to fail” idea conflicts with the effective credibility of the notion that the monetary authorities and the government of a given country can save a bank when the totals on that bank’s financial statement are substantially larger than the GDP of the country. The idea has therefore changed into “too big to be saved”, which is borne out by the comparison between the balance sheet figures of some big banks and the GDP of the countries in which they have their headquarters. Taking this consideration too into account, the main question remains: given that we will have to navigate on permanently stormy seas, do we want the big banks, which can withstand shocks better, to be strengthened in Europe, and put aside the entire philosophy of the European Court of Justice, for example, or that of the European Commission or some countries like Italy, of encouraging transparency and competition? Should the recently introduced IAS regulations, for example, be permanently changed as regards the marking to market of bank assets? Big banking groups in France, Germany and even the U.K. have long been making undercover attempts to obtain a return to the old system. These efforts became overt after the crisis worsened, to the point that authorities at the national and supranational levels have declared the objective of rejecting the new rules. We can now ask whether the decision to allow some assets that have lost a lot of value because of recent market trends to be classified as held-to-maturity instruments instead of held for trading is only a temporary one dictated by the imperative of emergency, or whether it indicates a lasting change in the regulatory and accounting philosophy. We are therefore looking at a systemic situation for the banking systems of major countries, where bank consolidation prevails, 113 DOSSIER especially after the mergers and acquisitions caused or enhanced by the crisis and encouraged by the authorities. Banks have therefore become even bigger in recent times and the level of competition within individual countries has diminished further as a result of the crisis. But national authorities are still responsible for bailouts, except for cases like Dexia and Fortis, where the national authorities involved split up the task of intervening to save these cross-border banks. This is obviously an untenable situation and Europe will have to remedy it in a stable manner, and not through emergency operations in which national authorities act together while claiming that such joint efforts are exceptional. Alternatively, should we do for the financial sector what was done for the airline sector, with France and Germany allowing their national airlines to have extremely large shares of the national market and thereby be very dynamic on the intercontinental front and very competitive, or is it better to follow the example of Italy, which has liberalised the sector by encouraging the creation of a number of small companies incapable of surviving and allowing the national airline’s share of the Italian market to drop to 30%? This is a rhetorical question and it is being asked after the fact, but the basic question remains whether we wish to choose the path to follow by developing a European financial system integrated into a global one in which the “Chinese model” will probably prevail over the model that the American authorities, the Italian authorities and the European Court of Justice view as the right one. Do we want neomercantilism at a pan-European level or not? This will decisively depend on the direction taken by Europe’s main interlocutors, which are still the United States and Japan. While it is not hard to predict a more or less marked return to the mercantilist philosophy that prevailed until a few years ago in Japan, it is harder to predict what the United States will do, because the impression that actions by the government and supervisory authorities have so far given is that of a temporary slackening of rules and a philosophy of government intervention justified by the need to tackle the emergency by giving private sector operators public funds, but with no pretension of contributing to any extent to deciding the operating strategies of the private institutions in which the government has taken a stake. This is clear, for example, from the government’s view of the legal status of the two institutions the State bought after having created them in the past. The current government does not appear to still consider them public assets. It is too soon to formulate precise opinions on the position the new Democratic President will take vis-à-vis these issues. Perhaps the position of the President and his collaborators will be initially classifiable in one way and change radically after a few months. This has already happened in the past: during Clinton’s first term, when the U.S. went from a dirigist and mercantilist position such as France’s and especially Japan’s, with a preference for a weak dollar and the views of economists such as Laura d’Andrea and Joseph Stiglitz, and then made a 180° turn under the influence of Robert Rubin and Lawrence Summers and Greenspan’s very authoritative support to adopt a strong-dollar policy and reposition the New York stock exchange as the world’s top financial market, freeing institutions of virtually all controls. The current Democratic platform tilts far less towards a precise 114 world view as regards banking, finance and currency, reflecting the caution that has so far seemed to be the watchword of the Democratic President-elect. It is even harder to see which way the cat is going to jump now that the elections are over. A lot will probably depend on the turn the international financial crisis takes and the consequences it will have on the real economy: consequences that appear to be a lot more serious than those that many, including the IMF, hoped for until only a few months ago and did not hesitate to openly say. Finally, we should remember that one of the worst sources of the worsening of the crisis that has struck the international financial system was its coincidence with the long American electoral campaign. We cannot say how the American authorities would have tackled the crisis without elections in the offing, but we do know that many of the actions they did take were influenced by the upcoming election deadline, reducing the range of these actions and leading to a preference for a sequential approach of handling one problem at a time with temporary and limited measures. In general, observers got the impression, corroborated by declarations by men such as Paulson and even Bernanke, that the American leadership thought it was enough to take measures that would serve above all to reverse expectations without really going to the roots of the situation. Despite the warnings of experienced people such as Anna Jacobson Schwartz, who co-wrote the well-known Monetary History of the United States with Milton Friedman, this was said to be a liquidity crisis that did not concern the solvency of financial institutions. The American leadership thought that a market liquidity freeze based on uncertainty could be melted with a barrage of declarations and measures, which in their turn were declared rather than implemented, such as the announcement of the setting up of a $700 billion fund to buy up banks’ toxic assets. The subsequent recourse, as mentioned earlier, to the “Brown model”, with the State buying stakes in banks, demonstrated a delayed awareness of the fact that insolvency, and not only illiquidity, was the issue at stake, and that it was therefore necessary to go from “Chinese shadow boxing” to “Western” boxing with genuine, not merely simulated, blows. Therefore, it is not in the least exaggerated to conclude that the American leadership significantly worsened the crisis on finding itself in the eye of the global financial hurricane. It generalised and extended the crisis to the outreaches of the system by taking reluctant and delayed action because it was concerned about the electoral consequences of drastic and general measures, and therefore determined to avoid them until they became inevitable. Since the crisis had exploded in the United States, no one but the American authorities could tackle it. The rest of the world therefore watched the actions and omissions of American leaders with a growing sense of frustration. Leaders elsewhere were aware that they could not stand in for the Americans and would perhaps only be able to avoid the consequences for their own financial institutions with a return to marked national dirigisme: a far cry from the recent operating philosophies of most of the governors and the governed in most countries. They were also aware that the consequences of the American financial crisis on the global real economy would be absolutely unavoidable. 115 DOSSIER Profiles and prospects of the real economy by Fabrizio Onida Grazia Neri_AFP If Schumpeter’s “creative destruction” stimulates real economic growth through the rapid spread of technology and strong competition between companies, the financial crisis we are experiencing appears to be more of a “destructive creation”, i.e. an excess of unregulated or badly regulated financial innovations resulting in market paralysis and triggering recessive crises. To gauge the extent of the phenomenon, consider that the Bank for International Settlements has estimated that the face value of all the financial contracts in the world went in the space of one decade from US$ 75 trillion at the end of 1997 to US$ 600 trillion at the end of 2007, i.e. approximately 10 times world GDP _For Russia and other oil and gas producing countries, the fact that international prices have dropped by half compared to the early2008 peak has begun to seriously erode prospects of maintaining the growth rhythm of household consumption and investments 116 1. What does economic theory suggest as regards the impact of this financial crisis on the real economy? A healthy, albeit delayed, rediscovery of Keynesian macroeconomics provides the key elements of the response. The primary effect, slowing household consumption, is the result of the so-called “wealth effect”: the bursting of the speculative bubble in housing prices in the U.S. as well as the U.K., Spain and many other countries, and the related global bond market bubble, quickly resized the purchasing power of savings, thereby generating a rapid downward revision in planned spending, starting with consumer durables such as cars, household appliances, furniture, computers and televisions. The collapse of stocks and bonds on global markets triggered by the subprime crisis through the upside-down pyramid of opaque securitizations self-sustained this negative “wealth effect”. In a climate of a generalised crisis of confidence in market risks and credit and counterpart risks (without offending the stabilizing “rational expectations”, so different from potentially destabilizing Keynesian expectations), liquidity in the inter-bank market has dried up drastically and household and business loans have tended to grow rarer. Banks and non-banking financial intermediaries (from investment banks to hedge funds) have been forced to sell off assets to deal with withdrawals by customers and partners fearing for their savings, thereby contributing to sending the share prices of the best companies, which are more easily sold on the market, into a spin. And current yield losses of savings in stocks and bonds have gone into a dangerous tailspin. It is a short step from the wealth effect to the “disposable income” effect, because the drop in demand for durables translates into fewer hours worked, less demand for intermediary goods, less income and, in turn, less demand for consumer goods. The prospect of lower sales and profits lead companies (manufacturing, construction and services) to postpone investment plans, the other important component of demand that supports GDP. Corporate investments and working capital financing could risk strangulation because of signs (so far limited ones) of a credit squeeze by the worst hit banks. Export companies try to expand their foreign clientele, sacrificing export profit margins if need be, to compensate for the fall in 2. Emerging markets’ role as drivers of the world cycle to weaken I fear this is still too optimistic a scenario because of the progressive worsening of recessive signals in the “triad” countries and the negative repercussions on the rest of the world, as well as because many emerging markets (the OPEC countries, Russia, Brazil, South Africa and others) will be hit by the downward trend in the prices of vital commodities after these peaked all the way to early 2008. The effect of decoupling the locomotive of the emerging markets and the slow-running wagons of the wealthy countries could however diminish in the coming quarters, because the recessive cycle is tending to self-propagate through world goods and services markets and increasingly interdependent capital. Juan Somavia, director general of the International Labour Organization in Geneva, fears that the number of unemployed people outside the triad countries could go up to 20 million by the end of 2009. China has been the world’s second-largest economy after the U.S. for some time now based on GDP at purchasing power parity, and recently also became second largest in current dollar terms, not to mention the world’s second biggest exporter at market prices. The IMF estimates that China’s growth will slow by nearly three points in 2009 to less than 9%, while countries in East Asia, Australia and New Zealand will suffer smaller markdowns. There has been a drop of about 20% in outbound Chinese tourism, which has become a significant foreign currency earner for many neighbouring countries. The drop in property prices in coastal Chinese cities has gone hand in hand with a 70% loss of value for the Shanghai stock exchange compared to one year ago. However, one positive effect of the Chinese economy’s slowdown is the fall in prices of many raw materials and semi-finished goods, particularly iron ore and steel, for which prices had climbed steeply in recent years precisely because of the voracious demand sparked by China’s massive infrastructure investments. One worrying sign of an international recession is the steep dive (95% since May) of the dry bulk shipping index, the Baltic Dry Index, which covers a range of commodities including iron ore: the plunge reflects a strong downturn in freight movement from countries like Brazil and Australia to China, America and Europe. Despite the slowdown of the Chinese engine, several Asian Grazia Neri_AFP domestic demand for consumer goods and investments. Unfortunately, the ploy does not work a time like this, when a domestic demand crisis and the resulting drop in imports are affecting most markets. In recent years, when emerging countries showed robust GDP growth rates, there was a lot of talk of “decoupling” the growth prospects of different parts of the world, counting on the vigorous expansion of these new players in the global economy to offset low or slow growth in the advanced economies (the “old” Europe, the U.S. and Japan). On 6 November, the International Monetary Fund rushed to lower the 2009 world economic growth forecast that it had drawn up three weeks previously (which had in turn been lowered by nearly one percentage point compared to the April World Economic Outlook) for the advanced countries, where growth is now forecast at -0.8%, as well as the emerging markets, for which the IMF now predicts growth of 5.1%. _The International Monetary Fund has lowered the 2009 world economic growth forecast. The robust expansion of emerging countries is also slowing down. Growth in China, which has long been the world’s second biggest economy in GDP terms, will slow by nearly three points in 2009 117 DOSSIER NAPOLEONI: A NEW BRETTON WOODS? COME ON… edited by Donato Speroni Early this year, Loretta Napoleoni, an expert in terrorism and international economics, published a bestseller called Rogue Economics, which uses a number of disturbing examples to demonstrate the effects of an uncontrolled globalization accompanied by the “death of politics”. Has the recent economic crisis changed the overall picture? east put this question to the author. Not even you imagined that the system would be hit by the crisis so quickly… It seemed impossible that this crisis could explode before the election in America. But the US Treasury and the Federal Reserve miscalculated the reaction of the markets and thus created a situation that was unmanageable on the eve of the election. What will happen now? Are we witnessing the return of politics? The only solution to this crisis is a political one. Let’s see whether Obama can regain control. But I doubt it. Don’t you think that this is a global crisis which demands solutions involving international governance? A new Bretton Woods is being talked about. I think that’s an illusion. Today’s world is very different from the post-war world, where 62% of gross internal product (GIP) came from Western countries, which set down the new rules. Contrariwise, the current crisis will further increase the contribution of newly industrialized countries to global GIP because we in the West are slowing down. The Arabs and the Chinese will hold the new Bretton Woods… Don’t you think that the global economic slowdown will also affect emerging countries? In China, factories that export Christmas toys for Western children have shut down… The Chinese have a great deal of available capital and a great need for infrastructures. If the impact of demand from Western countries decreases, they’ll find other markets or will invent a New Deal of their own. You’ve documented numerous cases in which the Beijing government has looked the other way (and in both directions) in response to 118 countries have registered increased volatility in the foreign exchange market, stoked by nervousness related to foreign capital flows, perilously recalling the 1997-98 monetary crisis. South Korea’s balance of payments has slipped in the space of a few months from a comfortable surplus to a current account deficit and capital outflows and the banking system is undercapitalized with respect to the size and quality of the country’s debt exposure. The effective exchange rate of the Korean won slipped by 30% in a few months, partly as a result of the constant appreciation of the Japanese yen and (to a lesser extent) the Chinese yuan against the dollar. The ASEAN countries have begun to discuss the need for a common financial watchdog. For Russia and other oil and gas producing countries, the fact that international prices have dropped by half compared to the early-2008 peak has begun to seriously erode prospects of maintaining the growth rhythm of household consumption and investments. The massive capital outflows from Russia in recent weeks reflect a growing lack of confidence on the part of the leading financial groups in the government’s ability to balance the books, and could cause cuts in planned public investments: a worrying scenario considering the urgent need to modernize basic infrastructure. The drop in oil prices to below $60-70 despite the OPEC agreeing on some supply cuts limits the scope of Chavez’s expansive populist policy, with unfavourable consequences for the poorer countries neighbouring Venezuela. In the Gulf States, alongside a net drop in property prices there is the expectation of substantially reduced revenue from oil exports, cooling the enthusiasm with which foreign investors had increased the share of their oil-related stock portfolios. The drop in international prices of many agricultural and mining commodities, which benefits importing countries, therefore jeopardizes the foreign currency position of many emerging markets in South America and Africa. In Argentina, President Kirchner asked Parliament to approve a plan to nationalise pension funds, which administer US$30 billion for 9.5 million contributors, while the Buenos Aires stock market plunged amidst fears of a default risk. Argentina, and other countries where national earnings are strongly dependent on exports, is worried about an export credit squeeze caused by lower refinance loans from the international banking system. Finally, many Central and Eastern European countries, which have significantly driven the “old” Europe’s production cycle in recent years, are showing signs of fragility. The current account deficit is spiralling towards dangerously high thresholds: 15% in Romania and 25% in Bulgaria. 3. What are the prospects and risks in the response of governments to the worsening crisis? In the “Financial Times” dated 28 October, Jeffrey Sachs estimated that a 6% drop in world GDP, with the recessive effect of demand spreading over a few quarters, could be the direct and indirect effect of the fall in property wealth in major countries, starting with the U.S. Sachs believes we can avoid a hard-hitting generalised recession (the spectre of the Great Depression in 193032 until the turning point of Roosevelt’s New Deal) by shoring up domestic demand in China (the new locomotive of the world cycle?) Grazia Neri and through large-scale intervention by the IMF and central banks to provide markets with loans. Many analysts believe that the huge infrastructure investment programmes in the BRIC countries among others should be maintained, as this is a pre-requisite to removing the bottlenecks to full integration of emerging markets into the global economy. Also writing in the “FT”, Steve Roach urged central banks to consider the stability of financial markets as important an objective as inflation control through money supply, because the recent bubbles teach that the markets do not adjust on their own: rather, they could worsen the crisis. Martin Wolf says in no uncertain terms that “preventing a global slump should be the priority” because “the danger remains huge and time is short”. Larry Summers notes that 40% of American corporate profits in 2006 went to the financial sector and hopes that the skewed distribution of income in favour of finance will soon be remedied. The experience of the financial crises in Asia, Russia and South America at the end of the last decade have led to critical thought on the so-called Washington Consensus, particularly as regards the traditional recipes of rapid and indiscriminate liberalization of shortterm capital flows. However, there do not so far seem to be any solution to tackle a debt crisis and capital flight that does not involve a steep hike in interest rates, as we observed recently at the negotiations during which the IMF had bankrupt Iceland raise its interest rate to 18% in exchange for a bailout. Meanwhile, an increasing number of Central and Eastern European countries, from Hungary and Bulgaria to Ukraine, are banging on the IMF’s door to get loans to bolster liquidity reserves and prop up their currencies. The 27-member EU, which was considerably less shaken up than the US by the property bubble and especially the subprime crisis, will have considerable responsibility in supplying adequate responses to the worsening of the economic situation. In the absence (for a long time to come) of genuine European political and economic federalism, other, stronger collective actions such as the ones recently undertaken under the French Presidency, which expires end-2008, will be needed. The major issue of how to make up for the systemic incapacity of markets to supply public goods such as macroeconomic stability, safety, confidence and development infrastructure has emerged once again. There is an obvious risk that without reinforced cooperation between national governments, the structure of the acquis communautaire, i.e. the shared rules that guarantee full integration of markets and a progressive push towards modernization and competitive efficiency to the entire region, will be called into question once more, starting with a revision of State aid compatible with competition rules as outlined in Article 87(3) (b) and (c) of the Treaty. In short, these principles are: a) any interventions are to be minimal, timely and temporary; b) they should be watchful of taxpayers’ interests; c) institutions benefiting from State aid should bear due consequences including the payment of fees and a commitment to partial future repayment of previous aid, with shareholders bearing losses and management taking cuts in remuneration; d) the legitimate interests of competitors must be protected and negative spill over effects should be avoided. There is some concern in this sense about possible. There are callous behaviors such as the exploitation of labor and the failure to protect consumers. Do you think this crisis will lead to greater awareness? These behaviors will not change over the short term, but only with development. For those living below the poverty line, certain distinctions are meaningless. Such change is an inherently natural process. In concrete terms, then, what must be done? Do we wait for China to develop? I’m not offering solutions. I’m only describing situations… But in your book, you advance several surprising theories on the economics of the future. For example, you say that citizens will revert to tribalism. I’ve examined the way youth gangs operate. Although they do represent an escape from reality, they also express a demand for participation that’s typical of tribalism and which is common everywhere. You also say that the Islamic system of finance may be an answer. In what way? It expresses the principle the bank and the borrower share the risk. If the Sharia had been applied, the speculative bubble that led to the current crisis would never have occurred. Without resorting to such extreme solutions, perhaps a little common sense by financial managers would have been enough, as in the healthy capitalism of yesteryear… No, what you call “healthy capitalism” did not include the principle of copartnership that distinguishes the Islamic approach to finance. 119 DOSSIER signs of risk as regards political reactions to the ongoing crisis. On the domestic front, in Germany Chancellor Merkel and Finance Minister Steinbruck are studying selective measures in favour of the automobile industry (such as tax credits on the purchase of new non-polluting cars and car trading incentives) and an extension of the Hermes export credit guarantee on capital goods. In Italy, Economic Development Minister Scajola has mooted similar aid measures for consumer durables such as cars and household appliances. These are of course measures to sustain domestic demand, which will however be carefully evaluated to ensure that they do not contain any details to the detriment of competition. Poland could well increase aid to its shipbuilding sector, which is now as uncompetitive as West Germany’s was in the past. On the foreign front, governments will have to monitor the additional problems that the current phase of the financial crisis and the recent re-emergence of parties with a clearly populist inspiration in Germany, Austria, the Netherlands and Denmark create for a satisfactory conclusion to the WTO’s Doha Development Round. In this context the EU could accept the recent proposal by two American economists, i.e. encourage the governments of the main countries (the G20) to start a detailed and committed global dialogue on major issues such as food safety, energy and the environment, which have been pressing for some time, and go beyond pure trade liberalization, given that the WTO’s permanent action fortunately continues to provide strong supervision to ward off scenarios of a return to the ghosts of a distant protectionist past, such as the 1930 Smoot-Hawley Tariff. Finally, it should be emphasised that there are good reasons to exclude that the scenarios of the 1929-32 collapse of the world economy will happen again today. These include: a) The willingness of governments and central banks to exercise cooperative strategies to stabilize markets and counter the temptation of the “beggar thy neighbour” policies of isolationism and exaggerated nationalism that typified the big crisis under the regimes of the time; b) WTO supervision of a multilateral trade regime is opposed to the tariff war of the past, which produced the most autarchic dark age of the 20th century; c) The decision to give up attempts to fix unrealistic exchange rates such as the return of sterling to the gold standard in 1925, with the resulting overvaluation of sterling (similar to Mussolini pegging the exchange rate at 90 lira per British pound); d) The absence of degenerative phenomena such as German hyperinflation. We will refrain from any forecast, considering that some (Anders Aslund of the Peterson Institute on the “FT” Economists’ Forum) do not exclude even worse scenarios than the Great Depression for the near future. Such pessimism is based on elements such as the risk of contagion panic (toxic shares) that the huge power of the media and the Internet contribute to spreading, destabilizing exchange rate fluctuations, the bursting of the property bubble extending to regions such as Russia and the Gulf States and the bankruptcy of some countries (with Italy likened to Iceland and Ukraine!). 120 Profumo: More government, more regulation, more market edited by Vittorio Borelli We are emerging from a long period of constant growth. The crisis was caused by an excess of debt over capital. Emerging markets will keep growing, but we will only come out of the crisis when America gets going again. Europe needs a genuine, not just a theoretical single market, UniCredit chief executive Alessandro Profumo tells east As chief executive of UniCredit far the past ten years, Alessandro Profumo has turned it into one of the most profitable and highly capitalized banks in Europe, which has been named Best Bank of the Year on more than one occasion. At the height of the crisis, Alessandro Profumo found himself in the unaccustomed position of being on trial. The markets, which had symbolically elected him their champion in recent years, suddenly turned their backs on him. It is well known that all the banks in the world ran into difficulties, with their equity levels rapidly proving to be inadequate as a result of the crisis. It is equally well known that some of the major American and European banks had to accept the help of their governments in 121 one form or another. But the difficulties of UniCredit and Profumo, who had honestly admitted a few errors of judgement, were splashed across the front pages, thereby worsening what was actually a general crisis. How did the CEO of UniCredit cope with the situation? What are his views of this major crisis and its causes? What changes does he think are required to turn the page? east interviewed him at the end of November, when there still seemed to be no clear way out of the tunnel At difficult times, we tend to forget the positive aspects of the past. In Slaughterhouse-Five Kurt Vonnegut obsessively repeats the catchphrase “So the world goes”. Once the panic caused by the subprime crisis dies down, we will have to remember that it was preceded by fifteen years of uninterrupted growth which allowed many countries to hitch their wagons to the global economy train and lifted at least 500 million people out of poverty. I agree that we do not only have mistakes and excesses behind us. It would not be wise to throw the baby out with the bathwater. How did the crisis start? By definition, growth is financed by capital and debt. The problem is that in the past few years there was an excess of debt over capital. We are now heading in totally the opposite direction and if we do not find new balances, growth will obviously be much slower. What is the basis for recovery? It is both technical and financial. Some aspects are connected to the future development model, which will be based partly on the market and partly on the public economy. This raises the key issue of governance to hold together and make the two of them work well. Merit should theoretically be the selection factor in the market economy, while political participation should obviously carry more weight in the public economy. Who will act as the locomotive on the macroeconomic front: China? Asia? I think the United States will get us going again. Asia has kept on pulling, but it has a big problem with domestic consumption: a substantial part of its growth has so far been export-driven. This is why I think America will once again be the engine, psychologically as well. What about China? China has major resources that come from savings. In theory this could get the consumer market going, but there is a problem: the absence, in China, of an efficient welfare system. If the Chinese government were to decide to do something in this respect, the growth of domestic consumption could compensate for the drop in exports. But this is not a realistic short-term objective: it will take years. Who is most to blame for the crisis, in your opinion? That is an absolutely legitimate question, but the answer could get us all into a muddle. There will be time and ways to analyse the responsibilities: for the moment we must focus on the answers. The emergency can only be overcome if we look ahead. As I said earlier, there was excess debt and, as Professor Tabellini wrote in an excellent article in “Il Sole 24 Ore”, this essentially relates back to the authorities, which must regulate it. It is true that the financial system threw itself blindly into the situation, under-evaluating the risks of the excessive availability of liquidity. But as the saying goes: People who live in glass houses shouldn’t throw stones. How can we rebuild market and consumer confidence? There will have to be concrete and perceptible changes. Every player should do his bit at this level: there are tasks politicians are responsible for and others that are up to the authorities. As for banking, I think it will all revolve around new products and new customer relationship models. We will need time to recover. Speaking of changes, at one point, given the daily, irrational destruction of stock market value, someone proposed shutting down the stock market the way Putin did in Russia. The thing is that while you shut down the stock markets, you have to do something to make sure that trading won’t restart the same way as before when they reopen. Shared measures would have been necessary in any case. I think the main problem is to get the debt market working again, not least because the stock market is basically the only liquid market left. Various people in various places have said and written that we are at an epoch-making turning point, that the market economy is no longer enough and that we need more politics in the economy. In fact, the way that first the American and then the European governments took action on the banks seemed like a glaring disavowal of Adam Smith’s “invisible hand” philosophy. Even George Soros lashed out against “unchecked capitalism”. The point to debate is this: do we want the State as player or the State as regulator? I think the government should be a stronger regulator than it has been so far. I’ll say it with a slogan: more market and stronger regulators. I would be a little scared of the State as player, except in emergency situations and for a limited period of time. What are the most urgent financial market reforms to be undertaken? Europe should create a de facto common market, not just talk about it. Then we need a rule for all operators: many operators are not at all regulated today. One of the problems is that taxpayers in individual countries are made to contribute in different ways. This is a tension factor for people like us, who operate in many countries. As things stand, these countries continue to function rather well. And our banks in these countries are working very well. Olycom How has the crisis impacted the economies of the so-called New Europe? DOSSIER No worries about the near future? There are some concerns, for example about the political situation in Ukraine. But we should consider that the effects of a possible crisis on the accounts of the parent company would be very limited. From market champion to the target of attacks, including personal ones: what does it feel like? I’ve chalked it up to experience. I am resigned to it, and I am certainly not about to start railing about the markets. The markets do what they have to do. One observer wrote that the acquisition of Capitalia snapped his own sympathy for the market. Maybe so. But I still think that that was a strategically important operation for UniCredit. What about your relationship with the shareholders? Rumours about misunderstandings with this or that shareholder have been circulating ever since UniCredit was set up. I would add that it is normal that there should be some tension considering the situation that has been created. You were one of the first people in Italy to talk about corporate social responsibility, ethics etc. Like many other Italian managers, you are now coming in for a lot of criticism for earnings that are considered to be disproportionate – some even say immoral. I can confirm that around 75% of my earnings are strictly related to the company’s results. So there is no possibility, unlike in America, for me to earn staggering amounts of money when the company is doing badly. I should add that I am not the one who decides my salary: that decision is made by a committee, with the help of external experts who all supply international reference benchmarks. UniCredit is a multinational group that compares in this respect too with other groups of the same type. In fact we have chosen to position ourselves in the third quartile of the salary bracket, not the highest quartile. I would welcome any discussion on these issues as well, as long it is based on full knowledge of the facts and not on rumours or for purposes of scandal mongering. 124 The turmoil spreads to the East by Fabrizio Coricelli and Debora Revoltella One year after the beginning of the international financial turmoil, high uncertainty and volatility persist at the global level, with no signs of abating. The financial sector crisis is deepening, moving from the US to the UK and Western Europe. Stock markets have been falling for weeks; liquidity has become an issue for the banking sector, while risk aversion is strongly on the rise. The resulting global credit squeeze means that the worst has to come for the real economy, with growth forecasts for the next year ranging around 0% for both the US and the Eurozone. The hit is generalized. The crisis has its centre in the core markets, but is quickly spreading to emerging markets, CEE included. On top of lower international growth, re-pricing of risk and strong risk aversion in international markets have led to a substantial reduction in capital inflows towards emerging markets. Need for quick realisation of investments as well as some speculative attacks have also materialised, testing, behind fundamentals, the solidity of single countries. Not all countries are suffering and will suffer in the same way, however. The first, obvious, observation is that countries with larger external financing requirements are more vulnerable. Most of the CEE countries are running wide current account deficits; an indication that the economy has been unable to generate enough domestic savings. Economic growth has been financed by “importing” external savings – mostly (at least in Central Europe and in South Eastern Europe) in the form of FDIs or private debt. The banking sector has played a role, with strong lending growth – one of the main drivers of the retail and investment boom – being largely financed from abroad. The re-pricing of risk at the international level has led to an increase in the cost (and more generally availability) of such external financing, meaning a tightening of monetary and credit conditions. In some cases, such tightening has been moderate, leading to a cooling of economic activity, in others more abrupt, causing a strong correction in terms of growth. The experience of the Baltic countries is a clear example. A correction in the real estate market (also due to lower capital inflows) has been combined with lower lending growth, as the foreign owned banks (largely owned by Nordic banks) Grazia Neri_Panos One year after the beginning of the International financial turmoil, high uncertainty and instability persist globally without signs of mitigation. The crisis of the financial sector is heightening, from the US to the United Kingdom and Western Europe. Stock markets have been falling for weeks; liquidity is a problem for the banking community, while risk aversion is on the rise. The resulting global credit crunch implies that the worst for the real economy is still to come, as the growth expected for the next year ranges around 0% both in the US and in the Eurozone _In Kazakhstan the correction in the overheated real estate sector and the complete closure of the international market for domestic borrowers has lead to a domestic credit crunch, which has again exacerbated the problems of the real economy 125 DOSSIER COST OF RISK have been aggressively tightening credit policies, while reducing their funding to the local daughter companies. The result has been a cooling of the economy, with Estonia and Latvia entering into a recession and Lithuania – which can profit from a relatively more diversified industrial base, a lagged cycle and lower overheating of the economy prior to the global turmoil – cooling more slowly. Countries with greater dependence on foreign capital and facing a higher cost of risk-insurance (credit default swap) are more exposed to a correction. Figure 1 shows the sensitivity of CEE countries to a slowdown in capital inflows and their risk premia. The current account deficit is corrected by deducting FDI funding. However, under the assumption that some forms of FDI are more volatile than others, FDI in real estate and in the financial sector were not considered a corrective factor. The resulting external imbalance is than divided by the value added coming from the tradable part of the economy (basically 1. SENSITIVITY TO CAPITAL industry and agriculture, INFLOWS AND COST OF RISK construction and services excluded). The obtained measure is just a variation of 3000 the one used in the sudden stop Ukraine literature by Calvo and others. 2500 The idea is that under the current circumstances, the 2000 more the economy is servicebased, the quicker lower capital 1500 inflows will revert in negative Russia effects for the real economy. Kazakhstan Latvia 1000 The cost of risk is measured as Turkey Romania Bulgaria the spread on CDSs. Hungary Croatia 500 The Baltics and Kazakhstan Serbia Czech Republic Poland Estonia appear more exposed to the risk Lithuania Slovakia of a drop in international 0,00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 0.80 0.90 1.00 capital inflows, followed by SENSITIVITY TO CAPITAL INFLOWS: Current Account– FDI (excluding RE & Financial Sector) South-Eastern Europe. Here √VA in tradable sectors+Imp-Exp the main challenge is probably related to the possibility of a Note - Sensitivity to capital inflows is calculated as Current account deficit net of FDI (excluding FDI in real estate lower funding from and financial sector), 2007. All divided by Value Added in Tradable Sectors, plus import, minus exports international banks active in the region to their local daughter banks. However, credit tightening does not necessarily mean a credit crunch. Local Central Banks, which were actively intervening in the market to constrain lending growth in the past, have room of manoeuvre for enhancing liquidity, just by releasing the high reserve requirements they have imposed in the past. The second, less obvious observation is that aggregate, net, figures such as CAD or net flows are not the end of the story. When large segments of the economy have over-borrowed, with a sudden stop it is not ensured that these sectors will be helped and rescued by the surplus sectors, being other private sectors or the State. This might explain the case of 126 Grazia Neri_Panos Kazakhstan last year and Russia today. In Kazakhstan the correction in the overheated real estate sector and the complete closure of the international market for domestic borrowers (banks included) has lead to a domestic credit crunch, which has again exacerbated the problems of the real economy, as both services and construction contribution to GDP growth have been vanishing quite quickly, while the rest of the economy has failed to take over. The oil rich country is now using its reserves in order to support a massive rescue plan, which accounts for more than 15% of domestic GDP. The plan favours a recapitalisation of a development agency which should be used to fund strategic companies, like the major real estate companies. Also, the authorities have been offering to enter in the capital of the major banks, by acquiring up to 25% of non voting shares, to allow a recapitalisation of the banks. This is however an ex-post intervention rather than a direct substitution of drivers of growth, with revenues from oil being used to solve the problems of the over-indebted part of the economy which entered into trouble. In Russia as well, despite positive current account balances, the over-borrowing of some specific sectors of the economy has caused several troubles. Increased cost of risk and limited access to international and domestic capital markets have led to a tightening of credit conditions for the corporate sector. This has led to a liquidity crunch in the banking industry, with even the large banks sitting on their liquidity, but refraining from lending. On top of that, the strong correction in stock market prices. Massive government intervention to support the banking industry and the major corporations will grant stability of the major players in the market and might allow a solution of the liquidity crunch, but will not prevent a huge worsening in credit quality. Investments are likely to strongly contract next year, with only State financed infrastructural projects (again financed through the oil proceedings) providing some support to growth. More generally, future prospects may be adversely affected by the dominant role of the State in the economy. The third point to consider is that, under the current international scenario, countries might be hit more than what their macroeconomic fundamentals would predict, just because they are more exposed to international financial markets. We can think of investors which might be forced to realize investments (eg hedge funds or mutual funds having to face unexpected redemption flows) or even speculative attacks against specific currencies. This might have been the case in Hungary. The country was emerging from a period of low economic growth, which was due to a strong fiscal correction plan implemented in order to correct the internal and the external unbalance. The fiscal correction plan had been successful. True, there were some macroeconomic weaknesses, such as lower growth, the still high external debt, current account and fiscal imbalances, though not very large relative to other CEE countries. The _Oil rich Kazakhstan is now using its reserves in order to support a massive rescue plan, which accounts for more than 15% of domestic GDP 127 DOSSIER main weakness might have been that Hungary had a wide and relatively liquid (for the region) debt and equity markets. This made the country vulnerable in the current international context. In the last weeks the bond market has collapsed. The exchange rate has been constantly deteriorating and the Central Bank has been forced in an emergency move to hike rates by 300 bps to halt the depreciation of the Forint. The IMF, the EU and the World Bank came up with a 20 Euro billion package to rescue the country. Therefore, a more relevant place in the international portfolios and the liquidity of debt and equity markets may prove the key factor exposing to the risk of a crisis in the current context of global crisis. 2. SENSITIVITY TO INTERNATIONAL Figure 2 summarizes the CAPITAL MARKETS VOLATILITY position of the different countries in terms of their importance in international 7% Ukraine portfolios and links this Turkey position to the volatility of 6% exchange rates observed in the 5% last 10 months. Russia Poland Hungary The countries more at risk Slovakia 4% appear Poland, Russia and Turkey. Therefore, the risk of 3% contagion from the global Czech republic Romania financial turmoil is high for 2% these countries. Given their Croatia importance for the economies 1% Latvia of the whole European region, Kazakhstan Lithuania Bulgaria Estonia governments and international 0% 10% 20% 30% 40% 50% institutions’ actions should be (PORTFOLIO EQUITY+SECURITIES HELD BY FOREIGN SECTOR)/GDP, 2007 quickly implemented to avoid a repetition of a crisis like the one occurred in Hungary. The setting up of an exchange rate stabilization fund, financed by the ECB, would help preventing currency crises in the larger emerging European countries. Alternatively, the announcement that the ECB is ready to step in to support the exchange rate of new EU members and candidate countries, such as Turkey, would discourage currency attacks. EXCHANGE RATE VOLATILITY (LAST 10M) USD DE FACTO BASKET EURO USD INF. PEG QUASI CB CB 128 CB USD DE FACTO CB Financial Shock by Antonio Barbangelo Yale professor and economist Robert Shiller’s book Irrational Exuberance, published in early 2000, predicted the bursting of the Internet bubble. In 2005, two years before it actually happened, he warned that the US housing bubble would burst. Now that his predictions have come true, the academic reviews the real estate bubble in his new book The Subprime Solution: How Today’s Global Financial Crisis Happened and What to Do About It. The book develops one of the author’s favourite themes: financial democracy In the 1930s, says Robert Shiller, the U.S. reacted to the economic depression by strengthening its financial system. Europe did not take the same route and later regretted it. Today, lower income and culture groups should be given access to unbiased consultancy and financial information should be more amply provided to genuinely help people to pick the right investments. Shiller’s latest book was presented and discussed on 20 October at the Institute for International Political Studies (ISPI) in Milan. Marco Annunziata, chief economist with UniCredit, Franco Bruni, vice president ISPI and a professor at Bocconi University, Mario Deaglio, a professor at the University of Turin and Franco Venturini, a columnist with “Corriere della Sera”, took part in the discussion. The debate, moderated by Marco Liera of Italian financial daily “Il Sole 24 Ore”, focused on the cultural aspects of the crisis as well as why it happened. Take the issue of information. How did the media react to the financial crisis? “I would like to focus on three of the various interpretations that appeared in the media”, said Bruni, “one positive and two negative. The positive one is that the crisis appears to have made it clear to everyone that there is a need to tackle the management of the global economy through multilateral dialogue. Almost nobody denies that it is time to sit down at the table and redefine some of the rules of the game”. As for the negative aspects: “I totally disagree with the way finance has been demonized in the media”, Bruni added. “Even Shiller is very clear on this point: he says finance – even sophisticated aspects of finance, like derivates trading – can be good for financial democracy”. _The cover of Robert Shiller’s latest book. The US economist is also famous for having developed the Case-Shiller index (maintained by Standard & Poor’s), to evaluate the housing market Market economy under fire To sum up, Franco Bruni commented on an idea that seems to have forcefully emerged recently, i.e. that the crisis demonstrates the failure of the market economy. “I consider this another negative 129 interpretation”, the Bocconi professor said. “Of course the current situation should make us rethink the mechanisms of the market economy, but I think it is better not to make simplistic declarations. It is very hard to argue that the crisis is proof of a free market failure, first of all because financial markets have always been regulated in every country, even the U.S. They could not function without those rules”. Here, too, Bruni agrees with Shiller’s view. In real estate circles, the American economist is also known for another reason: he developed the Case-Shiller index used by Standard & Poor’s to evaluate the housing market. “The property market worldwide now recognises the Case-Shiller index”, said Mario Deaglio. “So when the Yale professor predicted the property bubble burst two years ago, he was speaking from the bottom of his heart, just like Paul Krugman, the winner of the Nobel Prize for Economics. However, Shiller overlooks other aspects such as the historical dimension. Let’s try and understand how the housing bubble started. The Federal Reserve, then headed by Alan Greenspan, cut interest rates by half a percentage point in January 2002 in reaction to the crisis sparked by the 2001 terrorist attacks. Everyone in the real estate sector got cheaper loans and the U.S. economy got some breathing room. However, too many people focused excessively on real estate; at one point, everyone wanted to invest in housing. The extremely strong growth in demand was met by a huge rise in supply. We can now ask whether American watchdog institutions could have tried to slow down the phenomenon”. U.S. regulators did not act The question revived the doubts of those who have pointed a finger at regulators. Bruni said: “The Fed could have taken action to stem the degeneration of the subprime market: it either did not do so, or did it badly. The public sector and American politicians encouraged the situation. The SEC, the stock market watchdog, also had the tools to restrict excessive lending by the big investment banks, but did not do so – it actually did the opposite. Once again, we cannot say it is the free market that has failed; rather, it is the SEC’s policies that have failed”. Deaglio added: “Besides this, there were several dishonest operators involved. It is no coincidence that the Governor of the Bank of Italy, Mario Draghi, spoke of a ‘parallel system’ in his speech on the international financial situation in May. Those are very clear words. They mean that some operators escaped all controls. This has to be said out loud”. So the big financial jolt would seem to have been very instructive. “This crisis is teaching us that many of us – economists, journalists, financial commentators - have to relearn some intellectual humility”, said Annunziata. “Some, like Shiller, were able to spot the hurricane a few years before it hit. Where were all the others? The housing bubble burst more than a year ago, in August 2007: after 12 months, almost nobody had hypothesized that it would get so much worse. The roots of the financial upset can undoubtedly be traced to financial policy errors, inadequate controls and behaviour bordering on fraud, like the subprime loans given to American families that would not be able to pay them off. All this has been proved true. But, as Shiller points out, there was huge uncertainty on the information front”. The UniCredit economist continued: “Before this flop, we had had record levels of world economic growth for four or five years. So we were in a situation in which elements of the property bubble could be seen (as in the end-1990s, when the technological bubble started spreading). This time around, too, there were elements that should have seemed suspect, and instead… maybe we shouldn’t be surprised that there was no interest in slowing it down”. World balance The participants also discussed another aspect of the financial tsunami: how is it changing international politics? “We don’t know yet”, said Venturini. “I don’t agree with some analysts who are already giving the crisis the power to radically change world balances. The financial crisis will not change world balances; it will speed up changes that were already underway. What will speed up? The passage to a multipolar world, but then this process was already ongoing for quite some time. We know that there are emerging countries such as China and India, others like Russia which are trying to make a comeback on the international scene but have feet of clay, others, like Europe, which are trying to assert themselves and yet others, like the U.S., who are trying to defending their leadership. The crisis could accelerate these trends”. Venturini also pointed to the issue of world governance. “We know that the end of the Cold War in 1989 created an institutional problem at the international level. The U.N. no longer appeared to be able to provide responses and the G8 was considered incapable of making decisions. Global governance was already a problem and now the crisis could lead to an acceleration – a tumultuous one in this case – towards a change in governance”. Will Europe change? “Almost without realizing it and without discussing it”, said Venturini. “Europe has built an avant-garde. Four countries (Italy, France, Germany and the U.K.) – first met in September to tackle the emergency; subsequently, 15 countries got together in London. This is a cultural revolution: the concept of avant-gardes has been discussed for years as an antidote to excessive enlargement and excessively speedy enlargement. The financial crisis has supplied at least one advantage for now, at least as far as Europe is concerned”. Grazia Neri_AFP New objectives for central banks Having analysed what happened, the question is: What happens next? “There has been a debate on the behaviour and objectives of central banks for quite some time”, said Annunziata. “What should central banks do? Until a few months ago we would have said that they have to keep an eye on inflation and observe growth and employment trends. I have talked to representatives of several central banks recently and there is already a change of direction. There will now have to be serious rethinking on the objectives of central banks. We have already witnessed coordinated action by these monetary regulators in October to resuscitate the financial market, especially the interbank market, which had seized up completely, with a risk of repercussions for the real economy. The measures to breathe new life into the interbank market are working. There are significant signs of a ‘defreeze’ as regards the financial crisis per se. The situation should return to normalcy little by little. It will take time. We are looking at a huge problem”. Waiting for China by Alessandro Arduino and Cristina M. Bombelli The prospect of China stepping into the world financial crisis raises doubts and fears. China’s central bank recently cut interest rates for the first time in seven years, reducing its benchmark one-year lending rate to 7.2%. The American financial crisis, which has spread as rapidly as an oil spill, spurred the Chinese government to take preventive action As recently as two years ago, international analysts were mooting the possibility of China’s domestic economic problems sparking a global financial crisis. Today, many view China’s excess liquidity as a key factor in remedying the current financial crisis. The fall of the Shanghai and Shenzen stock markets, the dizzying rise in property prices and Chinese banks’ bad loans fed a speculative bubble that everyone predicted would soon burst and that no one is mentioning any more. Meanwhile, the Chinese economy continues to accelerate, with GDP growing at double-digit rates. Chinese socioeconomic growth is proceeding apace, regardless of the slump in exports and the recent implosion of the Shanghai Stock Exchange. In this context, the People’s Bank has continued to restrict easy loans by introducing new regulations and continuously hiking interest rates. The central government has passed macroeconomic measures to discourage speculative short-term foreign investments. Despite this evidence, the West continues to have an essentially negative perception of China in matters related to the economy. The general view is that the PRC competes unfairly in foreign markets by hoarding global energy resources, dumping goods and forcibly devaluing the yuan. Accusations related to China’s rising trade deficit are backed by criticism of adulterated Chinese goods, unfair competition and the loss of jobs to outsourcing. China’s presence on the international financial and money markets raises fears without proposing suitable alternatives. The Chinese market socialism model, which is hard to understand, is seen as a pragmatic form of capitalism exercised by an élite made up of technocrats: an obstacle or, worse, an enemy in the making. In actual fact, the increasingly concrete possibility of a recession provides an opportunity to give the PRC full-fledged entry into global financial markets without obliging it to change radically, and accept a perspective that is not exclusively ethnocentric, with a view to mutual benefit. The stable and gradual entry of Chinese finance could create a virtuous circle and end the liquidity crunch in Western markets while establishing a proper system of controls and sustainable development within the PRC. The collapse of various US hedge funds presaged the recent storm that hit financial markets, starting with the disintegration of the Long Term Capital Management (LTCM) fund, the founders of which included two Nobel Prize-winning economists. With the unexpected bankruptcy of the American investment bank Grazia Neri_AFP Lehman Brothers and the sale in extremis of Merrill Lynch to the Bank of America Corp., China found itself having to resort to preventive measures to avoid exposure to the damage caused by an imported financial crisis. China’s lawmakers made the fight against inflation the priority in its 2006-2001 five-year economic plan in order to encourage harmonious and sustainable development, but the sudden relaxing of its credit squeeze helped to give the economy some breathing room. However, the economy must continue to maintain a sufficient annual growth rate to survive. Having restricted corporate and individual access to loans in recent years, China can now afford to relax the squeeze to make more credit available for domestic consumption. It is worth asking at this point whether China will act, through its national investment funds, to save or at least stem the problems of global finance, and whether the country can allow itself the luxury of being a passive spectator with a global recession in the offing. With the US and European economies on the brink of recession or, worse, stagflation, a Chinese market-oriented move could give a strong and effective signal of China’s ability to react quickly to a sudden economic crisis. Arab and Asian sovereign funds face a pressing need to take defensive measures or take advantage of weak overseas markets to speculate on sell-offs, as Chinese insurance giant Ping An’s recent unsuccessful attempt to buy a stake in the investment bank Fortis NV clearly shows. Fortis’s hostile rejection of the 3.03 bn euros Chinese bid only enhanced the insurance company’s share price on the Hong Kong stock market: its 14% share price surge was a demonstration of strength and stability at a time of crisis. Ping An’s desire to become a leading international financial services operator by upping its stake in Fortis from 4.99% to 50% came up against a partial nationalisation of Fortis by the governments of Belgium, the Netherlands and Luxembourg aimed at staving off the Chinese threat on their territory. The cautious, waitand-see approach of Ping An’s management in regard to the failed buyout reflects similar behaviour by big Chinese Stateowned companies, which have swapped the aggressiveness of previous years for a more conservative approach. The fall in the Shanghai composite index, which plummeted from 6,000 to 1,800 points in the space of only eight months, also hints at a change of attitude. The State-owned Chinese investment fund China Investment Corporation (CIC) has not so far approved any significant acquisitions in 2008. Last year, investments totalled $200 bn and included the Blackstone Group (US$ 3 bn), Morgan Stanley (US$ 5.6 bn) and the British bank Barclays, all of which underwent short-term losses. The simultaneous Chinese stock market slump led to widespread but unpublicised internal dissent about the capital not being used to fund the local market, especially to help the emerging middle class, which is losing a sizeable portion of its savings on the stock market. The political factor is of particular significance in the DOSSIER management of sovereign funds for the investing country as well as the country receiving the investment. Over the past two years, there has been open hostility towards overseas M&As by State-owned Chinese companies. CNOOC’s failure to acquire Unocal in the US is a reminder that such investments are met with wariness or even outright hostility. China’s moves on foreign markets are seen as predatory and contrary to free market criteria, as they tend to be based on geopolitical rather than purely economic considerations. At the same time, sovereign funds’ requests for adequate financial guarantees in the acquisition of majority stakes in banks such as Morgan Stanley could lead the US government to issue a guarantee to cover risks, thereby going against the opinions of an impressionable public at election time. Problems with approval by the relevant organisms within the Chinese government could work against quick acquisitions such as the one to buy a higher stake in Morgan Stanley. When negotiations with CIC came to a standstill, the bank agreed to sell up to 20% of its shares to the Japanese financial group Mitsubishi UFJ: the slowdown was probably due to the Chinese State Council taking too long to approve the deal. The current restructuring on Wall Street could, however, benefit Chinese financial institutions, which will find themselves with a qualified pool of human resources in search of new jobs, primarily U.S. degree-holders in China who have embarked on a career in business and finance. Local banks will be able to enhance their in-house talent by hiring returning Chinese or expatriate staff fleeing the City or Wall Street. The stock market debacle notwithstanding, most Chinese banks are well placed to withstand the impending crisis. The injection of funds by the central government and limited exposure to the U.S. subprime crisis have given Chinese banks an aura of stability that experts thought was nonexistent until only a year ago. Bank of China and China Commercial Bank have declared total losses of US$ 350 mn due to the bankruptcy of Lehman Brothers: a figure that might be considered quite a hefty one taken on its own, but that is equivalent to a loss of 0.01% when all the assets of these two banks are taken into account (0.19% considering available liquidity alone). The central government has declared that the objective of its current financial policy is to maintain order on the domestic front to continue with harmonious and sustainable growth. The message being officially broadcasted by Beijing’s mandarins is meant to soothe both domestic complaints about excessive investment outside the country and countries that fear a Chinese financial invasion. China’s leaders are focusing their attention not only on the international financial crisis but also on the need to guarantee land use rights to the rural population and the increased income it will generate. The objective is to reach per capita GDP of US$1,000 in 2015 from US$550 in 2007 and lift 15 million peasants out of poverty. While the declaration by the Communist Party’s constituent assembly that “China must look after its domestic issues” might suggest a marginal, wait-and-see policy as regards global financial trends, it is worth remembering the symbiotic 134 Grazia Neri_AFP relationship between the Chinese and American economies. The RPC holds US$1.8 trillion worth of U.S. Treasury bonds and is heavily dependent on exports to the U.S. If Chinese banks, unlike their American and European counterparts, are well placed, it is because they are presumed to have cash reserves and are operating in a growing domestic bond market. The ethnocentrism that causes the West to be wary of China could therefore rule out fruitful collaborations aimed not only at weathering the free market crisis but also at developing new models of cooperation to contribute to increased Chinese respect for market regulations, keeping in mind, however, that China’s vision of growth does not necessarily involve Westernization. If there is no change in the West’s prejudiced outlook, there will be inevitable questions about the damage and consequences that China’s disorderly entry into financial markets on the basis of its unmediated position of strength could cause. This is not a theoretical issue, and it does not only concern the kind of strategy the Asian giant will adopt: given the fact that the economic strength of the parties involved is different, the question is whether the bill will be presented for payment sooner or later. _If Chinese banks, unlike their American and European counterparts, are well placed, it is because they are presumed to have cash reserves and are operating in a growing domestic bond market. In the picture, the Chinese Central Bank 135