The Pin Factory Blog

According to Fitch Ratings, China faces a 60% chance of a systemic banking crisis by mid-2013, given credit growth estimated to exceed 15% annually over two years and real property prices estimated to rise more than 5%. In November 2010, Moody’s flagged concerns over the ‘intrinsic, stand-alone strength of China’s banking system’. Citigroup highlighted growing Chinese residential property investments, 6.1% of 2010 GDP, matching the US subprime bubble in 2005, and about 2% below Japan’s 1970s housing boom.

Despite intervention to dampen property inflation, prices in 10 cities out of 17 rose 10% or more, Haikou and Sanya reaching 21.6% and 19.1% respectively. Local governments are barred from borrowing directly, but US $300bn of loans involving local authority indirect guarantees are problematic. Official studies showed 26 % of the 7.66 trillion yuan lent to local authority finance vehicles by end June 2010 failed to meet regulations, faced "serious default risk", or were embezzled. Full payment was only being made on 24%, with the rest being serviced by local governments or with collateral.

Some key figures:

• Chinese reserves grew $469.6 billion in 2010 to $2.869 trillion (US$3.04 trillion in January 2011), just under triple Japanese reserves (second in the world behind Chinese), at $1.09 trillion in February 2011.

• China’s budget deficit is forecast at $137 billion (900 billion yuan) in 2011, 2.0% of GDP, falling from 2.5% in 2010 and 2.8% in 2009.

• In the prior China banking crisis in 1999/2000, bad loans reached $650 billion and an estimate has suggested this cycle could involve $400 billion.

Given China’s massive reserves, limited international indebtedness, low government debt and modest deficit, even sizeable banking problems are unlikely to swamp China’s economy overall, or come close to matching the problems faced in Europe and the US. If it needs to, China can defend itself by slowing capital outflows to elsewhere.

Brian Lawson is Special Consultant to Exclusive Analysis.

Private citizens in Mississippi doing what their government couldn't – protecting their homes from the overflowing Mississippi River with individually-made levees. More photos here.

Libertarians talk a good game about freedom and the state, but not about the deeper needs that people have. That’s a common criticism I hear, and not entirely unwarranted – it’s easy to mistake an argument that something should be allowed for an argument that that thing is morally good. This is incorrect: the law should be ethical – not necessarily moral – allowing people to act as they want inasmuch as it doesn’t impinge on other people’s ability to do so. (An example of the distinction here is adultery, which is usually immoral but should not be illegal since it doesn’t infringe on anybody else’s private property rights.)

Last night, the ASI hosted a lecture by Professor Tara Smith, who holds the BB&T professorship for the study of Objectivism at the University of Texas. Prof Smith argued that to lead a good life, selfishness (properly understood) was key. This doesn’t mean throwing everybody around you under a bus, but the realization that happiness isn’t transferable. You can’t make somebody else happy – according to Prof Smith, making yourself happy is the noblest goal that people can strive for.

The question of what happiness is is more difficult, to my mind. Smith talked a lot about the importance of “rationality” in finding true happiness. about the problems with hedonism being that it tends to sacrifice long-term happiness for short-term pleasure. I wonder how meaningful this dichotomy is: does a smoker sacrifice long-term happiness (given, say, an increased risk of disease) for the short-term pleasure of a cigarette? Probably not – the overall “short-term” pleasure may outweigh the “long-term” happiness. Hedonism can be a perfectly rational decision: a hangover doesn’t mean that the previous night’s drinking was irrational.

She argued that pride and productiveness are important in the pursuit of happiness. Aristotle said that pride “seems to be a sort of crown of the virtues; for it makes them greater, and it is not found without them”. Properly understood, she said, pride was the self-respect needed to think yourself worthy of happiness, and fundamental to its pursuit. Productiveness was another key point: seeing work not as a necessary evil, but as a good in and of itself. This attitude is in stark contrast to the old fashioned (and distinctly statist) idea that work is a gruelling evil to be suffered – a sort of penance for being alive – rather than a valuable part of one’s life. There's no need for a split between work and happiness, and the idea that both should be cherished as virtues is, to me, deeply appealing.

Philip Hammond, the Transport Secretary, says he wants to end the government subsidy for rail use:

"In the long term the taxpayer will not be prepared to just continually increase the level of subsidy that they give to the relatively small number of people who ever use trains – something like only 12% of the population. And of course those who use trains tend to be better off anyway," he said.

Wow – robust stuff, and great to hear from a senior government minister. But, sadly, other areas of transport policy don't reflect this. Consider this article by Hammond on the High Speed Rail 2 project:

The evidence from abroad is that high-speed rail is the only effective sustainable answer to our intercity transport challenges. Many of our competitors recognise the huge benefits of high-speed rail, and are pressing ahead with ambitious plans. Britain cannot afford to be left behind.

And this response to the businessmen who argued that HS2 was a white elephant:

Our railways are increasingly crowded, and more and more people are having to stand. We need to invest in new lines and new trains – sticking our heads in the sand, as these people seem to wish, is simply not an option.

No mention of cost anywhere – £17bn for the first leg, and up to £33bn for the whole project – or of why this portion of “the relatively small number of people who ever use trains” should enjoy a public subsidy. Hammond says he understands how silly it is to favour one mode of transport over others, but the HS2 project does exactly that. The government cannot pick winners, nor should it try to – the prestige of HS2 should not obscure the economic realities that make it a waste.

Our friend and supporter Malcolm McAlpine died this week at the age of 93 after a brief illness. Malcolm was President of Sir Robert McAlpine, the construction company which just last month completed the building of the Olympic stadium for the 2012 games. The company is very much a family-run partnership; he was the grandson of the company's founder, Sir Robert, and many other family members are involved.

We came to know Malcolm in the late 1970s as we strived to build up the Adam Smith Institute. A great believer in personal and economic freedom – and in the tendency of governments and regulators to mess things up – he was one of our earliest subscribers. Around 1983, when the Thatcher government looked as if it was running out of ideas, we went to him with a proposal to produce a report on every department of government, outlining precisely what it should do in order to achieve the free-market, liberal vision. It would involve twenty working parties of politicians, civil servants, academics, professionals and journalists. He told us that we were too small and too poorly organised, and he did not believe we could do the project, which we called the Omega Project. But we did it anyway, and Malcolm asked me over to his office to apologise for his lack of faith in us – and handed me a large personal cheque by way of apology.

He continued to give us support and advice through good times and bad, and was particularly supportive of our extensive programme of work with young people, particularly our Next Generation Group, our sixth-form seminar ISOS, and our Young Writer on Liberty prize.

Malcolm was a very straight talker who left you in no doubt when he thought you were doing something wrong, but would be the first to pick up the phone and praise you when you pulled off something significant. He was also surprisingly modest and amazingly energetic, coming to ASI seminars and dinners – and participating actively in them – right up to a few months ago. He was a good friend, and we will miss him.

Hector Sants of the FSA, the UK financial regulator, has warned banks that future dividend and bonus payments will be scrutinised for their potential impact on risk. Actually, it is the FSA that is the biggest risk factor in UK. Frankly, the body is not fit for purpose. It's rule-driven tick-box approach missed everything that was going wrong in the finance sector in 2007, and it is no more useful today. What's needed is real reform of the banking sector, and the introduction of a lot more competition, which is by far the best regulator and the best friend of customers – not more rules and inept rulemakers.

This might actually happen. The Independent Commission on Banking reckons in its interim report that the promotion of competition should be a core function of banking regulation. In other words, we should have a proper economic regulator, which looks at the structure of the industry and tries to make it as competitive as possible. Much of our trouble is that the huge expense of the tick-box regulation means that banks have had to grow big in order to afford it, and competition has largely disappeared.

It is interesting that scores of US banks fail every year. That is manageable, because they are all small. In the UK, by contrast, there is an implicit guarantee (and, up to the first £85,000 of your savings, an explicit guarantee), that the government will bail the banks out. That's not healthy for any business. You can run a pretty shoddy firm if you know that the taxpayers will pick up your debts.

Another idea of the Commission is to separate out retail banking, so if people really do want to make sure their money is safe, they can find somewhere to go. That makes sense too. If we had proper competition, it would already have happened. But like any insurance, government guarantees encourage risk-taking, with its associated high profits.

The question is how you achieve such restructuring. We certainly don't want Vince Cable in hobnail boots forcibly breaking up the banks as he sees fit. We can let the market do it. Making the stringency of banks' reserve requirements proportional to their size would favour the creation of smaller banks and would properly reflect the greater systemic risk which is generated by the bigger ones.

In Brazil, retail and investment banking licences are quite separate, and if you stray from one line of business to the other you get put in jail – which seems to work pretty well. But again, I think we can use the market rather than this top-down approach. Simply requiring banks to offer demonstrably safe deposit accounts – or even making them tell customers just how risky their accounts were – would achieve the retail-investment separation quite naturally. 

The more I think about it, the more amazed I am that I was ever able to drink milk. Even from a young age, I was drinking pints of the stuff every day: on one particularly hedonistic binge aged twelve, I consumed approximately 36 Weetabix, all of which was washed down with gallons of milk. Even when I return home today I have to tell mum to buy in extra milk. All things considered, I am a big milk fan. What I find most astonishing is that this happened spontaneously. I decided, in my uncontrolled youth, that I liked milk without a government advisory panel nor supra-national entity telling me to do so.

Soimagine my confusion when, looking out of the bus window this morning, I saw another bus adorned with the red-headed chap from Harry Potter, sporting a milk-moustache and the slogan 'Make Mine Milk'. At first I didn't think much of it: what's wrong with an industry promoting its own product? Nothing at all. If were a milk-magnate, all London buses would be plastered in adverts proclaiming the benefits of dairy. But, as I look a little closer, something strikes me. The EU flag. What's going on? Is Ron Weasley in cahoots with Strasbourg? It would seem so: the 'Make Mine Milk' campaign, according to this press release (PDF), received a €3,000,000 'promotional grant' from the European Commission.

At first I tried to reason with myself – surely it can't be a bad thing that the EU is promoting our health interests? What's the problem with encouraging people to drink milk and thus increase their calcium intake? Rather a lot, actually. First, it should not be the EU's business to effectively subsidise private industries. What differentiates giving €3,000,000 to the milk industry from giving €3,000,000 to the carrot, marzipan, or orange-squash industry? I'm sure they all have equally valid claims to health benefits: where would this process logically end? Let the consumer decide. Consumer "information" usually ends up as advertising for the loudest special interest.

Second is the nature of the EU's funding. €3,000,000 by itself isn't all that much, but it is a symptom of a wider disorder. The European Commission recently called for a 4.9% increase in the EU budget at a time of Europe-wide austerity (in theory, at least). Of the EU's budget, €700,000,000 (PDF) is spent on 'citizenship, including culture, media, public health and consumer protection'. Although this portion of the budget represents less than 0.5% of the EU's annual budget, it is a microcosmic view of a profligate behemoth. I dread to think about the money being squandered elsewhere.

The McNulty Report on the railways is to be broadly welcomed. In particular, a greater emphasis on ticket prices that are market-related is crucial: this should be the starting point for any reform. Hence, the proposal for far more shoulder-type fares – those applicable between peak and off-peak periods – is eminently sensible. The aim should be to manage demand, via the pricing mechanism, so that trains operate at high capacity throughout the day. Both Ryanair and EasyJet have load factors of around 85% compared with the 50% figure applicable on the London-Birmingham railway line.

And why cannot more long-distance trains operate during the night, like airlines, offering ultra cheap fares which would free up more capacity at the most popular travelling times? Surely, many students would travel during the night time if the fares were extremely low. Compared to many overseas railways, which are heavily subsidised, UK railway tickets are undoubtedly expensive. In part, this is due to the excessive costs incurred by Network Rail – a company in desperate need of restructuring – that are passed onto rail franchise holders.

Every effort, therefore, should be made to tackle Network Rail’s bloated cost base and its soaring capital expenditure. Importantly, the adoption of these market-orientated policies would further weaken the poor financial case for HS2, which was highly unconvincing even before the DfT’s recent sharp (8%+) cutback to its previous aggressive revenue growth assumptions.

Indeed, the DfT’s economic case for HS2 seems now to rest heavily on the nebulous "non-monetised benefits, which underpin the strategic case for high-speed rail". Overall, in reforming the railways, the priority should be to let the market set rail ticket prices, with some back-up regulatory protection to prevent price-gouging. Getting that right - and also addressing Network Rail’s excessive costs - would give the UK railway a sensible financial base on which to grow.

Inequality doesn’t matter. Or, rather, it shouldn’t matter to policymakers if they are interested in fighting poverty and improving people's living standards. A new paper by the Legatum Institute's Dalibor Rohac published by the ASI this week, Does Inequality Matter? (PDF), exposes the fallacies behind the contemporary focus on income inequality and argues that it is a fundamentally flawed measure in policymaking.

Equality measures tell us nothing about how well-off people are, and rising living standards across the board are often accompanied by increases in inequality. If the poor get richer, and the rich get richer even faster, inequality rises but everybody is better off. Is this really a scenario that we want policymakers to try to avoid? Few poor people care whether the rich in their society drive BMWs or Rolls Royces – what they care about is the opportunities and living standards for them and their children. As the paper shows, government policies that try to "narrow the gap" between rich and poor, rather than raise the bottom up as fast as possible, are facile and misguided.

The inequality measure is flawed for another reason as well: its focus on nation-states as single units. The Gini coefficient – the standard measure of income inequality – only compares income levels within individual nation-states. Is this a useful measure, when people are more mobile than ever? Perhaps not. Rohac uses the example of a middle-income worker moving from Guatemala to the United States. This person, who was earning an above-average wage in Guatemala, now earns a below-average wage in the United States that is nevertheless significantly larger than his Guatemalan wage. She is better off by any absolute measure – and perhaps has some extra money to send home – but inequality in both countries increases. It’s hard to judge exactly how much of an impact this has on inequality measures, but it should underline the conceptual difficulties involved.

Rohac also deals with the arguments made in The Spirit Level, which argues that happiness is significantly influenced by income inequality, and the argument made by Joseph Stiglitz that the financial crisis was caused by inequality. At a time when development aid and domestic poverty are at the top of the agenda, the paper is a valuable and thought-provoking addition to the debate.

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