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Play Nice

G-8 meeting this week in Germany. The finance ministers will be discussing 3 main issues: 1) how to make hedge funds more transparent; 2) aid to Africa; 3) climate change issues. There is apparently no mention of excessive valuations in financial markets or excessive money supply growth ... hmmm! They obviously think that market intervention is not the correct strategy, and also the current global bull run in stocks is OK. and within limits of sensibility. Other than that, better and stricter regulation on hedge funds is long overdue. The adoption of more regulations over hedge funds will go a long way to cushion the time bomb.

Wolfowitz finally out of the World Bank. Surprisingly, Henry Paulson will not be attending the G-8 meeting. Something more important on his calender, the Chinese visiting Washington on May 23 onwards. I don't think Paulson is giving a lot of face to the Chinese, rather I think he wants to stay around to help pacify the "anger and rants" by certain lawmakers on China's role to help redress the US trade deficit.

The hedge fund issue is contentious with some G-8 members. Britain, the United States and Japan are still uncertain over any strict guidelines. The systemic risks are getting higher as these funds can also leverage. At the end of 2006, around 9,400 hedge funds operated worldwide, controlling assets of some US$1.4 trillion. That's more than twice as many hedge funds as operated five years ago, while funds under management have nearly tripled during the same period. While I am basically for free markets, the developments of the global economy over the last 5 years have made each and everyone connected. When there appears significant players within a group with substantial capital and leverage, it could cause a systemic implosion, that is what we want to guard against.

Already China's Vice Premier Wu Yi has already signaled some offerings prior to the visit by widening the trading band for the yuan. He also said that the China-U.S. business and trade relations are of win-win in nature., and that China's exports brings incontrovertible economic benefits to the U.S. Just to preempt the inevitable anger and protests, Wu noted that "attempts to politicize trade issues should be resisted." About half the cabinets of China and the US will meet in Washington tomorrow for their second in a series of meetings. And the focus will be on how to head off American pressure for a full-blown trade war with China. While there isn't much being written for the time being, I think certain members of the congress will make radical statements and even antagonistic claims against China over the trade issue. Mind you, they also need to stand out with the elections next year. I believe some American lawmakers will try to capitalise on the issue to win political points. Look for all presidential candidates to give their two cents on the issue - again, when placed against contenders, everyone will try to outshine the others, expect some fiery comments. It will not be an easy week for Wu Yi and Paulson. Morgan Stanley chief economist Stephen Roach told a hearing of three House of Representatives subcommittees last week that "by going after China, you in the Congress are playing with fire". Throwing the gauntlet down to China will result in the US imposing restrictions or duties on trades with China. China will still survive. The US needs to appreciate the delicate balance of a planned economy trying to adopt a capitalistic free market economy, with loads of inefficiencies still in the financial system. Got to work with, not against the big wigs. Roach rightly pointed out that Congress's case relied on flawed macro-economic analysis "focusing on a large bilateral trade deficit with China rather than on an unprecedented domestic savings shortfall that gives rise to a large multilateral trade deficit". Sanctions on China "could quickly impact the rest of Asia, which has become increasingly integrated into a China-centric pan-regional supply chain". Its high time address the US savings rate, and not just look at the external party to blame your woes on.

Naturally its not all "bad for the US", as a matter of fact China needs to address a few issues as well:
a) removal of state subsidies in the form of tax deduction and fuel costs
b) anti-dumping issues
c) much stricter imposition of patent, IT and trademarks

At the end of the day, the US congress has to realise that at least 60%-70% of the exports from China are funded or owned (or partially owned) by MNCs, many of them US companies. They are just relocating the production side to China and re-exporting back. You kill the outsourcing, you kill the cost savings for the MNCs (which I think is a significant factor driving profits for MNCs over the last 5 years). Its certainly not black and white, but many shades of grey.

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