Home' Trinidad and Tobago Guardian : April 17th 2014 Contents APRIL 2014 • WEEK THREE www.guardian.co.tt BUSINESS GUARDIAN
THE ECONOMIST | BG21
The rise of China has changed every
region, but it also has reinforced existing
China s demand for commodities has
entrenched Latin America s position as
a supplier of raw materials, for example.
The country guzzles oil from Venezuela
and Ecuador, copper from Chile, soy-
beans from Argentina and iron ore from
Brazil, with which it also signed a corn-
import deal on April 8.
Chinese lending to the region also
has a strong flavour of natural resources.
Data are patchy, but, according to new
figures from the China-Latin America
Finance Database, a joint effort between
Boston University and the Inter-Amer-
ican Dialogue, a think tank, China com-
mitted almost US$100 billion to Latin
America between 2005 and 2013. The
biggest dollops by far have come from
the China Development Bank. Chinese
lenders also committed some US$15
billion last year, almost three times the
World Bank s US$5.2 billion in fiscal
year 2013. Foreign commercial banks
lent an estimated US$17 billion.
More than half of China s lending to
Latin America has been swallowed by
Venezuela, which pays back much of
the loan from the proceeds of long-
term oil sales to China. Ecuador has
struck similar deals, as has Petrobras,
Brazil s state-controlled oil firm, which
negotiated a US$10 billion credit line
from the China Development Bank in
Such loan-for-oil arrangements suit
the Chinese, and not simply because
they help secure long-term energy sup-
plies. They also reduce the risk of lend-
ing to less creditworthy countries like
Argentina and Venezuela. Money from
oil sales is deposited in the oil firm s
Chinese account, from which payments
can be directly siphoned.
It is no surprise that Chinese money
is welcome in places where financial
markets are wary. Ecuador, which
defaulted on its debts in 2008, has used
Chinese loans both to fill holes in its
budget and to re-establish a record of
repayment as a prelude to an attempt
to tap bond markets again.
Chinese credit also has its attractions
in other economies, however. It often
makes sense for countries to diversify
sources of lending. Loans can open the
door to direct investment.
Furthermore, as Kevin Gallagher of
Boston University points out, the Chi-
nese banks and the multilaterals gen-
erally operate in different sectors. Of
the money China has lent in the region
since 2005, 85 per cent has gone to
infrastructure, energy and mining.
Borrowers may have to spend a pro-
portion of their loan on Chinese goods
in return, and some observers worry
about the laxer environmental standards
of Chinese banks. The main thing, how-
ever, is that money is available. Expect
the loan figures to rise.
@2014 The Economist Newspaper
Ltd. Distributed by the New York
to Latin America
Ever since Lehman Brothers went bank-
rupt in 2008, a common assumption
has been that the crisis happened
because the state surrendered control
of finance to the market. The answer,
it follows, must be more rules.
The latest target is American housing, the source
of the suspect loans that brought down Lehman.
Plans are afoot to set up a permanent public backstop
to mortgage markets, with the government insuring
90 percent of losses in a crisis.
That might be comforting, except for two things.
First, it is hard to see how entrenching state support
will prevent excessive risk-taking. Second, whatever
was wrong with the American housing market, it
was not lack of government: Far from a free market,
it was one of the most regulated industries in the
world, funded by taxpayer subsidies and with lending
decisions made by the state.
Back in 1856 an editor of The Economist, Walter
Bagehot, blamed crashes on what he called "blind
capital," periods in which credulous cash, ignoring
risk, flooded into unwise investments. Given not only
the inevitability of such moments of panic but also
finance s systemic role in the economy, a government
had to devise some special rules to make finance
Bagehot invented one: the idea of central banks
rescuing banks during crises. Bagehot s rule had a
sting in the tail, however: The bailout charges should
be punitive, he argued. That toughness rested on the
view that governments should, as far as they could,
treat financiers like any other industry, forcing bankers
and investors to take as much of the risk as possible
upon themselves. The more the state protected the
system, he felt, the more likely it was that people in
it would take risks with impunity.
That danger was amply illustrated in 2007-2008.
Having pocketed the gains from state-underwritten
risk-taking during the boom years, bankers presented
the bill to taxpayers when the bubble went pop.
The lesson has not been learned, however. Since
2008 there has been a mass of new rules, from Amer-
ica s unwieldy Dodd-Frank law to transaction taxes
in Europe. Some steps to boost banks capital and
liquidity do make finance more self-reliant---America s
banks, for example, face a tough new leverage ratio.
Overall, though, the urge to regulate and protect
leaves an industry that depends too heavily on state
The numbers would amaze Bagehot. In America
a citizen can now deposit as much as US$250,000
in any bank blindly, because that sum is insured by
the government. What incentive is there, thus, to
check if the bank is any good? Most countries still
encourage firms and individuals to borrow by allowing
them to deduct interest payments against tax. The
mortgage-interest subsidy in America is worth more
than US$100 billion.
Even Bagehot s own financial backstop has been
perverted into a subsidy. Since investors know that
governments will usually bail out big financial firms,
they let them borrow at lower rates than other busi-
nesses. America s mortgage giants, Fannie Mae and
Freddie Mac, used a US$120 billion funding subsidy
to line shareholders pockets for decades. The overall
subsidy for banks is worth as much as US$110 billion
in Britain and Japan, according to the International
Monetary Fund, and US$300 billion in the euro area.
At a total of US$630 billion in the rich world, the
distortion is bigger than Sweden s GDP and more
than the net profits of the 1,000 biggest banks.
In many cases the rationale for the rules and the
rescues has been to protect ordinary investors from
the evils of finance. Nonetheless, the overall effect
is to add ever more layers of state padding and to
This fits with historical patterns. Regulation has
responded to each crisis by protecting ever more of
finance. Five disasters, from 1792 to 1929, explain
the origins of the modern financial system. This
includes hugely successful innovations, from joint-
stock banks to the Federal Reserve and the New York
Stock Exchange, but it also has meant a corrosive
trend: a gradual increase in state involvement.
Deposit insurance is a good example. Introduced
in America in 1934, it protected the first US$2,500
of deposits, a small multiple of average earnings then,
reducing the risk of bank runs. Today America is an
extreme case, but insurance of more than US$100,000
is common in the West. This protects wealth, and
income, and means that investors ignore creditwor-
thiness, worrying only about the interest-rate offer,
which sends deposits flocking to flimsy Icelandic
banks and others with pitiful equity buffers.
The overall effect is not only to enrich one industry,
but also to mute the beneficial effects of finance.
Healthy financial markets speed up an economy,
channeling credit to firms that need it. They also
can make an economy fairer and more competitive,
providing the funds for those without them to chal-
lenge incumbents. Modern finance is a more slanted
system in which savings are drawn toward subsidies
and tax distortions. Debt-fueled housing goes wild
while investment in machines and patents runs dry.
All this dulls growth.
How can the zombie-like shuffle of the state into
finance be stopped? Deposit insurance should gradually
be trimmed until it protects no more than a year s
pay, around US$50,000 in America. That is plenty
to keep the payments system intact. Bank bosses
might start advertising their capital ratios, as happened
before deposit insurance was introduced.
Giving firms tax relief on financing costs is sensible,
but loading it all onto debt rather than equity is not.
Still more can be done to punish investors, not tax-
payers, for failure. A start has been made with "living
wills," which describe how to wind down a megabank,
and loss-absorbing bonds, which act as buffers in a
crisis. Europe is far behind America here, however,
and the issue of how to deal with huge, cross-border
The chances of politicians withdrawing from finance
are sadly low. However, they could at least follow
Bagehot s advice and make the cost of their support
explicit. The safety net for finance now stretches well
beyond banks to undercapitalised clearing-houses
and money-market funds. Governments should report
these liabilities in national accounts, like other sub-
sidies, and exact a proper price for them.
Otherwise they have merely set up the next crisis.
@2014 The Economist Newspaper Ltd. Distrib-
uted by the New York Times Syndicate
of last resort
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