Wednesday's Top 10 with NZ Mint: The free market didn't work for banks; China's insolvent banks; China's finance companies; Eurogeddon awaits; I'm off to Vegas; Dilbert

Here are my Top 10 links from around the Internet at 10 to 8 am (shocking outperformance!), brought to you in association with New Zealand Mint for your reading pleasure.

I welcome your additions and comments below, or please send suggestions for Thursday's Top 10 at 10 via email to bernard.hickey@interest.co.nz.

I'll pop any surplus suggestions I get into the comment stream.

1. 'We've learnt nothing' - Former US banking regulator William K Black argues at HuffPo that banks need to be regulated and the new Congress' moves to let markets regulate themselves is sowing the seeds of another disaster.

This is a must read for the Libertarians in our audience.

I'm thinking of you Tribeless.

Today's must read for the cynics and banking regulators out there too.

They need to be controlled.

If we have learnt anything in the last 10 years it is that.

William K Black wrote a book called "The Best Way to Rob a Bank is to Own one"

All power to the Reserve Bank here.

Representative Paul's claims epitomize the triumph of ideology over fact: "The market is a great regulator, and we've lost understanding and confidence that the market is probably a much stricter regulator." No, the "market" is not a "great regulator" and the ongoing crisis is only the latest example of that point.

Efficient, non-fraudulent markets would be a very good thing. Inefficient, markets with fraudulent participants can be a catastrophically bad thing.

The "market" also does not deal effectively with externalities (and they can be lethal) and with market power. The neoclassical claim that cartels cannot persist and that potential entry solves prevents all serious ills proved false in the real world.  

2. The problem with CEOs - Prominent US Democrat and former Labor Secretary under Clinton, Robert Reich, has some tough things to say here in his blog about the influence of big business in America and how a more pro-business Obama isn't actually creating any jobs in America.

He makes some powerful points that cut to the heart of the problem with globalism. It's great for the CEOs and Hedge funds, but bad for employees and economies.

Reich illustrates the point by explaining how much of Apple's iPhone accrues to American workers.

The White House caved in on the Bush tax cuts for the wealthy, and is telling CEOs it will be on their side from now on. As the President recently told a group of CEOs, the choice “is not between Democrats and Republicans. It’s between America and our competitors around the world. We can win the competition.”

There’s only one problem. America’s big businesses are less and less American. They’re going abroad for sales and employees. That’s one reason they’ve showed record-breaking profits in 2010 while creating almost no American jobs.

Consider one of most popular Christmas products of all time – Apple’s iPhone. Researchers from the Asian Development Bank Institute have dissected an iPhone whose wholesale price is around $179.00 to determine where the money actually goes.

Some shows up in Apple’s profits, which are soaring. About $61 of the $179 price goes to Japanese workers who make key iPhone components, $30 to German workers who supply other pieces, and $23 to South Korean workers who provide still others. Around $6 goes to the Chinese workers who assemble it. Most of the rest goes to workers elsewhere around the globe who make other bits.

Only about $11 of that iPhone goes to American workers, mostly researchers and designers.  

3. A ludicrous continent facing Eurogeddon - Jim Saft at Reuters nails the European predicament on the head in this excellent summary of the problems the various powers-that-be are trying to deny. Europe is insolvent. The market knows it. The politicians won't accept it. It will all end in tears.

Read this piece fully to truly understand how nuts the Europeans are.

You can lie to taxpayers or you can lie to creditors, European authorities are learning, but doing both at the same time is very hard.

The proposed policy that current senior creditors to troubled states will not face losses on their loans but future private lenders will be forced to share in losses with taxpayers is so irrational, so bound to fail that it falls out of the realm of economics and into the ambit of brain injury. The only way you could make this policy mix work was if you could find a very rich lender with no ability to conceptualize the future.

Hmm, let’s see a rich entity with limited ability to fully imagine a future state – it must be the European Union!

Few private lenders will stick around, they will sell their bonds and the only buyers will be the EU or ECB, which itself as it understands this predicament is hugely unwilling to play along.

Private money is quite happy to keep funding a bankrupt entity but only so long as the moral hazard play, the implied guarantee from on high, is still in force.

Why then haven’t spreads on weak euro zone bonds risen even higher? Well, besides the fact that the European Central Bank is actively buying, it is the fact that investors can’t quite believe that the European Union is serious. They know that getting out will be a disaster and a humiliation but that forcing private creditors to take haircuts could cause a banking crisis.

So, no haircuts and no reckoning. Investors are betting, at least for now, that the EU is lying to taxpayers, or to itself, rather than to them.

My guess is that we go on like this for a while; periodic crises that force the EU to pledge ever more money to member states without ever acknowledging that they are insolvent or forcing their private creditors to swallow losses.

That ends only if one of three things happens; the market decides that it won’t lend to Germany and France anymore, the weak nations revolt from austerity or the taxpayers of Germany and France decide that euro-geddon is better than picking up every check.  

4. Debt of 1,000% of GDP - No wonder financial markets don't believe the Europeans or the Irish. FTAlphaville reports here what the IMF said about Ireland. Startling stuff.

Ireland’s external debt is the highest of recent exceptional access cases, with private sector debt accounting for the largest share. Ireland’s total external debt is projected at over 1000 percent of GDP at end-2010…

While a substantial portion of gross debt is accounted for by the liabilities of International Financial Sector Center (IFSC) participants, which do not reflect Irish risk, excluding an estimate of the bank component of this IFSC debt would still leave total external debt at almost 800 percent of GDP, with banks’ external liabilities accounting for about half…

At end-2010, Ireland’s total stock of private short-term external debt is projected at approximately 370 percent of GDP, of which about a fifth consists of banks’ repos with the ECB.  

5. Very cool interactive graphic - Forbes has produced this great interactive graphic showing how much oil is produced, reserved and consumed by countries. It shows perfectly the huge imbalances in the world economy. Click on the chart or this link to get the graphic.

5. Debt pyramid scheme - Roger Lowenstein writes at Bloomberg how the debt pyramid scheme is now the norm in America. He makes the point that income tax cuts don't necessarily boost the economy. The key is whether the budget is balanced at the time of the cuts. A lesson for New Zealand perhaps?

Republicans claim that higher taxes translate to lower growth. Recent evidence is to the contrary. In the 1990s, the top tax rate was 39.6 percent. The U.S. enjoyed a booming economy, warmed by the balmy breezes of a balanced budget. In the 2000s, George W. Bush cut the top rate to 35 percent. Deficits ballooned, and the economy was mostly lousy.

Going back further, the connection is murky at best. In the 1960s, marginal tax rates were extremely high -- 70 percent and in some years even more. The economy roared. In the 1970s, taxes remained high and the economy slumped. In the 1980s, President Ronald Reagan slashed taxes: By 1988, the marginal rate was only 28 percent and the tax code was greatly simplified.

Clearly, those giant tax cuts, plus the elimination of many loopholes, stimulated a boom. Though that decade-by-decade synopsis inevitably simplifies, the evidence suggests tax rates should be as low as possible subject to the constraint that the budget IS roughly in balance in good times, and even in bad times avoids the risk of runaway deficits. But with the government borrowing equal to 9 percent of gross domestic product, and with large entitlement- spending increases looming, we are well into runaway territory already.

With the private sector recovering, albeit slowly, and public finances worsening, the time to restore our public finances to health is now. And if doing so delays the economy’s return to full and robust growth, then let the recovery come more slowly -- and let it be built on sound financing and not on a new pyramid of debt.  

6. The dark heart of the American collapse - I'm going to Las Vegas in early January for a work conference with my wife, who exports digital designs through a US website. I'll be babysitting, but hope to have a look around. Here's a sneak preview from the Las Vegas Sun of what I might see.

A land of ghost suburbs and half finished eyesores on the desert. Should be fun.

Might go to a few open homes.

7. China's Finance Companies - Many are watching what is happening inside China's banking system very closely. Many are worried that bad loans are mounting up after an explosion of lending to dodgy property developments in 2009.

The government has cracked down  on lending by banks, but may not be able to control the institutions outside the banking system that are still on the lending warpath. The Wall St Journal has the story.

China's government has traditionally used its control of the largely state-owned banking sector to regulate the country's pace of economic growth, directing it to pump out cheap credit in good times and restricting the volume of new loans to prevent overheating. But controlling credit has become more difficult as the financial system gets more sophisticated, analysts say, complicating Beijing's efforts to bring the economy in for a smooth landing in coming months.

China has a long history of gray-market financing flowing from small, informal and unregulated groups, to sectors not well covered by banks. A number of formally incorporated entities, including trust, leasing and guarantee companies, have also emerged, with the scope to provide alternative financing.

As banks labor under stricter limitations on how they can lend, they have been looking to trust companies in particular to trim their balance sheets and lessen their regulatory burden. In a report Fitch Ratings estimated that China's banks already have blown past the 7.5 trillion yuan ($1.126 trillion) limit that regulators set on new local currency lending for this year and extended more than three trillion yuan in credit that hasn't been recorded on their balance sheets.

"Lending has not moderated, it has merely found other channels," Fitch said in the report. That "helps explain why inflation and property prices are still stubbornly high, why [third-quarter] GDP growth was stronger than expected, and why Chinese authorities have voiced so much concern about further quantitative easing in the U.S."

This following bit is particularly alarming and looks a lot like our finance companies or the sub prime vehicles that exploded in America.

Trusts—which are investment vehicles unique to China with little in common with Western-style trust firms—enabled banks to stay below their loan quota by using an informal type of securitization to repackage bank loans as investment products.

With banks' deposit rates so low—at 2.5% for one year, the rate is below the level of inflation—banks had no trouble finding investors seeking a higher return.  

8. The real worry in China - Further to this meme about the problems in China's banking system, here's a piece from Alan Abelson at Barrons reporting on comments from fund manager Harald Malmgren about China's banks.

He notes that while investors everywhere have been uneasily eyeing the rise of the inflation dragon in that nation and have anticipated that Beijing would hike interest rates to contain the beast, it hasn't. And the reason why it hasn't, he posits, is that profit margins for many Sino businesses are razor thin, and an abrupt rate boost would mean appreciably higher debt-service costs, really putting the kibosh on profits.

Despite all the global focus on inflation, Harald contends, the big challenge confronting China can be found in the nonperforming loan portfolios of its banks and kindred financial institutions. That enormous pile of deadbeat loans is the legacy of late 2008-2009, when exports dried up and the spooked rulers of the command economy ordered the banks to seriously step up their lending -- no ifs, ands or buts. The banks dutifully complied with an awesome $1 trillion in fresh lending.

Much of that huge mountain of loans has fallen into the nonperforming category, which translates from the polite banking parlance into delinquency, big time. To avoid a financial meltdown, Harald expects, Beijing will raise capital-adequacy requirements substantially during the first few months of 2011, conceivably in incremental steps to cushion the pain. Since he anticipates Chinese banks will have trouble raising capital, he expects a large-scale shrinkage in lending.

Chinese banks, he emphasizes, aren't suffering from insufficient liquidity. Rather, he warns, the danger to the country's banking system is insolvency. In the current lineup of problem banks around the world, he would rank Chinese banks as the most troubled, with European banks next, followed by U.S. banks and Japanese banks probably holding down fourth place.  

9. The end of consumerism - John McCrone at The Press has written this nice summary of the thesis that peak oil and growing population will force the global economy to slow consumption growth. Here's the detail. It's well worth a read.

A change is about to be forced on society because energy consumption pretty much is the economy. And we are about to run short of the cheap energy which has been driving the past century of unchecked economic expansion. There is this myth going round, says Krumdieck, that with every decade we have grown wealthier because we have collectively become smarter and more productive. If everything is bigger, better, brighter, well, it has been earned.

Yet actually we have just been digging up and burning more fossil fuel. Graph the world's energy consumption against its gross domestic product (GDP) and the two lines track. So get down to the nitty gritty and this is what it has all been about. Converting oil or coal into shoes, hamburgers, cellphones and SUVs.

However, a reckoning is coming. The ecological limits on growth have come into view. Climate change and over- population. But peak oil most immediately.  

Totally last Jon Stewart video of the year - He is angry. Fair enough. America is descending deeper into a plutocratic state and few there seem to care or know.

And this is Jon Stewart doing some journalism that no one else in America seems to be doing.