The Financial Services Club's Blog

£ $ € ¥ …元/圆: the Rise of Renminbi

We have a continual dialogue about Renminbi (RMB), or Chinese Yuan (CNY) if you prefer. 

What’s the difference? 

Well, Remnimbi is the proper term for the Chinese currency, as is referring to UK currency as the Pound Sterling and the American currency as the Dollar; whilst Yuan is the more colloquial term for Remnimbi, and is more like referring to pounds and dollars as quids or bucks,

FSClub friend Wim Raymaekers, Head of Banking Market at SWIFT, talks about this all the time, probably because so much currency movement is now moving through the SWIFT network.

He’s so wrapped up in this space, he sent me a guest blog post about it so, as it’s a worthwhile space to note, here’s what Wim has to say:

At the end of 2011, the RMB’s share of the global payments market was just 0.29% – dwarfed by that of the €/$ which combine to represent 90% of global volumes, at 43% and 47% of payments respectively – but the RMB did weigh in at #17 in the world’s payments currency league table, and its growth certainly outpaced that of other major currencies including the beleaguered euro.

The battle for supremacy among RMB offshore trading centres is also hotting up.

UK Chancellor George Osborne’s recent deal with Hong Kong, to position London alongside Hong Kong as such a centre, lays bare London’s ambitions in this regard – and the City could be starting from a stronger position than even Mr Osborne realises.

Hong Kong remains the world’s biggest RMB offshore centre, handling 78% of all RMB payments sent and received in December 2011, but the UK is well on its way to becoming the next big RMB offshore trading centre.

In Q4 2011, it already handled 30% of RMB payments (levelling with Singapore) and 46% of RMB FX transactions - not considering China and Hong Kong volumes in both cases.

This business intelligence is being generated by SWIFT to see which financial institutions have growing RMB volumes, where the corridors of activity are, which countries’ RMB businesses are growing, which are diminishing.

Taken as a whole, this data also demonstrates how rapidly the international RMB payments business is growing, and how actively many financial institutions are already participating in it.

Keep track of such information with the SWIFT RMB Tracker, published monthly.

Download the latest SWIFT RMB Tracker, January 2012

How to deal with an insolvent bank

Sitting in a conference talking about living wills isn’t how you want to spend your typical day, but it did spark a whole bunch of thoughts in my mind.

The FSA issued their consultative paper 11/16 last summer.

The idea is that every bank with assets over £15 billion must produce a Recovery and Resolution Plan (RRP) by the end of this June.

The RRP = a ‘living will’.

I’m not going to delve into the depths of such matters – you can read all about it on the FSAs website - except to say that the RRP comprises a Recovery Plan and a Resolution Plan.

The Recovery Plan must include a sufficient range of material and credible options to address a range of crisis scenarios, and show how the institution would address these issues to continue operating in a stable way, avoiding capital shortfalls and pressures on liquidity.

The Resolution Plan would show how a firm would wind-down if it failed for any reason, including how it would avoid any impact to taxpayers and the public funds.

All well and good.

Or is it.

Whilst I like the idea of a living will for a zombie bank, it strikes me that we still haven’t gotten to the heart of the matter.

The question is really: what do we do with an insolvent bank that could bring down the economy of our nation?

The answer is not to let a bank become so big that it could bring down the economy of the nation.

So the real answer should actually be more to do with limitations on bank size, structure and asset base leverage, rather than getting it to open up a living will.

To me, this is what the Vickers report separating investment and retail banking, and the Volcker Rule shutting down prop trading is all about.

So the two work in tandem – a bank must shrink its size to be big enough to fail and, if it does, have a clear plan for how to deal with failure.

Yet even then, it doesn’t solve the issues.

For example, the average life of a company in the S&P500 is just 15 years today; most banks have been around for over 100 years.

The reason why banks have been around so long is down to governments regulating and maintaining them, rather than any c0mpetitive forces.

If banks weren’t protected by regulations, they would fail far more often, just as commercial firms do.

And if a large commercial firm fails – Rover, BP or Tesco – they just get acquired or shutdown. 

They don’t bring down the entire economy.

When a bank fails, it brings down the whole economy because the economy runs on finance.

Finance is the oil in commerce – no oil, no commerce.

That’s why banks aren’t allowed to fail.

It’s also why we realise the mistake when they do.

A small bank – a Northern Rock – can fail, but it won’t shake the fabric of the economy of system.,

A large bank – a Citibank or Royal Bank of Scotland – is different.

At the height of the banking crisis, UK bank liabilities were 400% of GDP: £5 trillion against GDP of £1.2 trillion – and the Royal Bank of Scotland alone had more liabilities (£1.8 trillion) than the UK’s GDP.

So now we get into the heart of the matter.

How do you deal with an insolvent bank that could break the economy?

A living will is one piece.

The separation of investment and commercial banking (Vickers) is another.

But the real test would be to go back to the trigger of this crisis: would these regulations have dealt with Lehman Brothers collapse any better?

There are two or three things that come to light in this area.

First, when Lehmans collapsed they had $400 billion of debt on their books.  That debt was linked to global credit default swap derivatives (CDS) and amplified by a factor of 20, according to Barclays Capital.

So for every $1 of debt that Lehmans were exposed to, the markets were exposed to $20 due to their AAA-rating backing derivatives traded through the OTC markets.

Hence, the real exposure of risk the markets felt on September 14^th 2008 was a $8 trillion market collapse, not a small bank folding.

Do living wills, Vickers and Volcker deal with this spaghetti of complexity that each banks’ balance sheet is linked with?

Not yet.

Second, when Lehmans collapsed the company most wrapped up in their web of debt was AIG.  AIG Financial Products in London had been trading CDS to such an extent that most of the market exposure landed on their doorstep and dragged the firm down.

However, AIG Financial Products was also a complex web of structure.

AIG was the largest insurance firm in America, trading in risks through their London office which was registered for European operations in Paris.

So three regulators were meant to track the global risks being traded by one global firm through a web of global offices.

Fail.

Do living wills, Vickers and Volcker deal with this web of globality that each banks’ balance sheet is linked with?

Not yet.

The two points made here are making it clear that the regulators need a global level playing field if their attempts to regulate the markets successfully are going to truly succeed.

But a global level playing field is also impossible, as no country can agree with another on taxation, fiscal and monetary policies.

Just look at the EU right now, and the transaction tax, if you want to see why a global level playing field is not going to work.

Sorry to be a downer Messrs Osbourne, Barnier and Bernanke but, as one speaker said yesterday, “the worst mistake regulators can make is to believe in their own rules”.

Point taken.

 

Postnote: yes, I know that OTC Derivatives regulations with a single data repository is addressing some of the last points made here, but do bear in mind that they haven't yet agreed how to define 'speculative' versus 'commercial' derivatives locally, let alone globally, and you get a sense of why this isn't working yet.

 

Amartya Sen: thoughts on poverty and the global financial crisis

I attended an interesting lecture last night from an economic legend: Professor Amartya Sen of Harvard University.

If you haven’t heard of him, he’s known as the Mother Teresa of economics in his native India, and has spent a lifetime fighting poverty with analysis rather than activism. 

Awarded the Nobel Prize in Economic Sciences in 1998, for his contributions to welfare economics and interest in the problems of society's poorest members, Sen is best known for his work on the causes of famine.

He is currently Professor of Economics and Philosophy at Harvard University, as well as being a senior fellow at the Harvard Society of Fellows, distinguished fellow of All Souls College, Oxford and a Fellow of Trinity College, Cambridge, where he previously served as Master from 1998 to 2004.

An impressive guy.

Amartya delivered his speech as part of the London Stock Exchange Group series of lectures on the future of global finance, and the evening was hosted by LSE Chairman, Chris Gibson-Smith.

Here’s a brief summary of Amartya’s sentiments (I say ‘sentiments’ as this is not a record of his speech and incorporates my own spin on his words).

Some people say we live in interesting times, but I think we live in baffling times.

We live in baffling, rather than interesting, times because it is very hard to get any clarity about the future. 

The only thing that is certain is, in the words of George Bernard Shaw, “the greatest of evils and the worst of crimes is poverty”.

Shaw wrote this in the Preface to his brilliant play, Major Barbara, published in 1907. 

The tragedy of poverty is, of course, obvious to all - whether in Latin America, or in Asia or Africa, or in Europe and the United States. 

The calamity of deprivation and penury can hardly be missed by those who have bothered to think about the subject, no matter whether they are themselves poor or not. 

Lives are battered, happiness stifled, creativity destroyed, freedoms eradicated by the misfortunes of poverty. 

But Bernard Shaw was not talking, on this occasion, about the hardship of poverty, or the misfortune that goes with it. 

He was commenting, in a rather unusual way, about the causation and consequences of poverty - that it is bred through evil and ends up being a crime.

If poverty is indeed an evil, not to mention “the greatest of evils” as Shaw puts it, then there must be some wickedness, or at least some culpability, behind poverty - some wrong-doing that allows such human tragedies to occur and persist. 

This raises the immediate question: who, then, are the wrong-doers?

If you look to protesters today, such as the Occupy Wall Street movement, the wrongdoers are represented by the corporate greed of capitalists and the banks.

You can just as easily take the opposite view however, and look to the Tea Party movement who see the failure being that of government and government policies.

The Tea Party align with Adam Smith, the guru of capitalism, and believe that free markets should rule.

Who is right and who is wrong?

Or is this the right question? 

In thinking about strategic issues, we cannot but go into the question of culpability and the failure of duties and obligations. 

We have to ask: how can things be done differently so that the evil of poverty is ousted? 

We have to identify the nature and genesis of the wrong-doing that is responsible for the affliction. 

That is not, however, the same as trying to identify the wrong-doers?

The identification of wrong-doers is not our task and trying to identify the evil-doers is not the right strategy since the responsibility for creating an evil is very widely dispersed in the society. 

We have to see how the actions - and indeed inactions - of a great many persons together lead to this evil, and how changing our modes of actions - our policies, our institutions, our priorities - can help to eliminate poverty. 

Our focus definitely has to be on removing evil-doing, as part of our strategies and programs, rather than going on the wild-goose chase of catching the hugely dispersed collectivity of evil-doers, who may not even fully understand how their actions can be seen as part of an evil state of affairs.

In fact, we should eliminate the discussion of wrong doers completely, and focus our efforts more on how to stop poverty full stop.

This is why strategies such as closing sweatshop labour factories in poor countries, or arresting those who employ children in the making of carpets, would fail to eliminate the poverty of the victims if such action is separated from a general economic and social program. 

In the vast majority of cases the employees are there in those terrible jobs because they have very few options - none that are particularly good. 

This is because there has been a failure of the state and the society to create opportunities for decent employment, which makes it possible to recruit labour to do terrible jobs as the alternative may be unemployment and starvation.

That is why exploited labourers are led to soul-destroying work today in the poorer countries, and closing down sweated-labour factories without giving the victims alternative opportunities for employment or education - the latter is extremely important in the case of child labour - is not an adequate solution to the problems and predicaments of the precarious poor. 

There is, of course, moral merit in restraining the pursuit of profit of businessmen through exploiting vulnerable and freedom-less labour, but a fuller solution can emerge only through positive opportunities of alternative employment and occupation, and that demands societal action. 

So the first action to address poverty is to expand labour opportunities and assist in education, and not to just shutdown existing sources of income.

My argument so far has been based on seeing poverty as lowness of incomes. 

Is employment with income a full solution to all problems of poverty? 

To believe that would be to underestimate vastly the complexity of poverty, particularly the nature of persistent poverty. 

By way of example, lowliness of income is the primary cause of starvation rather than the lowliness of the availability of food.

Is employment for income in order to buy food the answer to everything therefore?

No, as this misses the point of why there is persistent poverty

Strategic examination about eliminating poverty, or even reducing its burden, has to go more deeply into the nature of poverty. 

Poverty is about the inability to lead a decent, minimally acceptable life, and while low income does make it difficult to lead a life of freedom and well-being, an exclusive concentration on seeing poverty as lowness of income misses out a great many important connections.

What are the other non-income factors that contribute to poverty: a lack of education, availability of work, investment in infrastructure and more, and capitalism addresses these issues by providing an insurance.

For example, all affluent societies have addressed extreme poverty issues through public policy programs, such as the public pension, the provision of school education, the availability of healthcare and more non-market non-commercial arranged facilities.

The economics of these areas are not obvious except that an insurance system run by the state or by some other social support system, not by profit-oriented private firms, may be a necessary part of the elimination of poverty. 

Affluent societies focus upon profit maximisation and the unrestricted search for profit, but if they only relied on profit maximisation they would not function.

As a result, they balance between market mechanisms and state activities.

There is no strategic formula as to the correct balance between market mechanisms and state activities – the contrast between China and Taiwan or America and Sweden are good examples of how approaches differ – but we need to understand these balances in order to create a better world that addresses poverty with finance.

Does this mean arguing against Adam Smith’s principles for free markets?

Not really.

That view is a result of a huge misunderstanding of Adam Smith’s principles, and my position is strongly influenced by his.

Adam Smith clarified how markets work and how they can work exceedingly well.  He believes that you need a well-functioning market economy and clarity of why you want such efficient markets to be.

The task of politicians in managing the economy is then to search for two distinct objectives: first, to provide plentiful revenue to cover the basic subsistence needs of the people before the subsistence needs of the state; and second, to provide the state with enough revenue to finance public services.

The financial focus of public services is a critical part of Smith’s work and Adam Smith had an overwhelmingly clear view about support of the poor and undersupported in his market view.

Within his free market principles, he clearly defended the role of the state to fund public services, such as education and poverty relief.

Adam Smith was deeply concerned about the inequality of society and never used the word capitalism.

The word capitalism does not appear in any of his books or any other writing, and it would be hard to carve out anything in his works on market economies that were based purely upon capital.

For example, he specifically argued about protections from unlimited usury practices.

So how should we think about the wrongdoers that need rectification, and how should we address poverty?

According to Adam Smith and my own thinking, the key is increasing employment.

Increasing employment must remain a worldwide priority and China, Brazil and India are doing much better at this than America and Europe.

As employment and economic welfare rises, the state must use such employment to improve public services for good living and public welfare and, in this respect, India is not doing this as well as China and Brazil.

Finally, for the West in general and Europe in particular, the crisis of 2008 was created by the malfunctioning of market economies – the result was the state had to create support for their economies and this is the reason for rising sovereign debt.

But the cause of this malfunctioning is clearly what was thought of as lack of accountability of governments, but governments are accountable and this is what we are seeing today.

What we are seeing is that, in order to pay back their debts, governments have far more accountability.  However, they are addressing this accountability in the wrong way.

It’s hard to see how massive austerity drives, which cuts demand and growth, can therefore be supported,

Just look at Japan and learn from what happened there over the last 20 years of austerity, which is still biting.

What these governments need is fast economic growth.

Economic growth creates resources to address unemployment and poverty.

This is the key to addressing issues in Europe and the West, and it is the indiscipline of governments that has failed the markets, not the markets themselves.

Europe needs a better form of economic accountability and management of their economies, rather than austerities which decimate human lives and economic growth.

In conclusion, I end by affirming that George Bernard Shaw was right, a hundred years ago today, to point to the connection between poverty and evil and crime.  The fact that this insight came not from an economist but from a dramatist and literary giant fits in well with my general thesis that the economics of poverty involves much more than just economics.  Human lives in society are interlinked through economic, social, political and cultural associations.  The nature, causes and consequences of poverty reflect the richness of those connections.  We have no reason to be surprised by that elementary understanding.

Amartya then took Q&A from the floor and was asked a few interesting questions.

Q: You appear to be saying that in this current crisis, it is the failure of states to regulate markets effectively that failed, rather than the markets themselves. Is this your view?

You cannot separate markets and state, and this crisis was a failure of both, but you also have to be aware of the relationship between free markets and state influence. 

For example, Adam Smith argued against usury, but was convinced to change his thoughts on interest after reading the works of Jeremy Bentham. 

The core of how markets and state should work is that free markets is the most efficient model of economic management, but free markets need states that set efficient regulations to avoid failure in order to be truly workable.

As this shows, free markets and the state are two separate entities that are interdependent.

A key question in the last crisis however is whether globalisation killed that interdependency to cause the spiral of crisis we see today.

Globalisation may have undermined national states, as government can no longer effectively regulate the free markets?

There may be some truth in this statement, and this is why the G20, G8 and other global activities – the World Bank and IMF included – are key to solving these issues this time around.

Q: Do you think the euro will survive?

No.

When the euro was created, I didn’t see why it was needed and didn’t believe it made sense.  I am a fan of Europe, don’t get me wrong there as my late wife was Italian, but to start a European integration without a fiscal foundation meant that it was never going to work.

You can see this today as many parts of the EU are not served well by a Europe that has no fiscal union.   Greece is a good example.

Now however the loss of a country would be very destabilising for this European Union.

This is why Germany is being forced to bailout Europe.

Could they retreat out of it? Yes.

Is that the right thing to do? I think so.

 

Postnote: some of Amartya’s speech is taken from a write up of an earlier presentation he made in 2007.  These words of wisdom are integrated in parts of this article to ensure more accuracy of content.

 

How will the world look post-crisis?

I’ve been debating some future presentations with various folks today, and a little ray of light went off in my head.

The light was triggered by a comment: “can you talk about what impact regulatory change may have on bank to corporate relationships using examples historically?”

The question was really asking about the unintended impact of regulatory change in the past and what it might mean for their future, but it made me think about something else.

Each time we have seen a major bubble burst, the cause has been a coagulation of several forces of change.

Forces for change come from four major directions: Political, Economic, Social and Technological (PEST).

These forces for change are used in many ways, and can be seen in my banking history discussions (and soon to be published book) which talks about many historical periods including the Italian Renaissance, the Great Depression and the Credit Crisis.

In each of these, we can see Political, Economic, Social and Technological forces working together at the same time to drive change.

In the fall of the Renaissance Italians, it was a mixture of change between the break from the Catholic Church with the Protestant and other movements (Political), mixed with the ruin of the Italian banks due to over-extension of credit to overseas Royal Houses (Economic), along with expansion of merchant shipping and colonisation (Technological).

In the Great Depression, we saw the end of the Industrial Revolution (Technological) combined with post-war wrangling over the gold standard (Political and Economic).

Right now, we see a major world of change too.

We have the rebalancing of power between America and Asia/China (Economic) combined with an internet revolution that is connecting everyone on the planet (Technological), leading to changes in society, where a Molly Katchpole can reverse a bank’s policy and an #Occupy movement can change global thinking (Social).

The Political outcome of all of this is what is driving bank regulations right now.

And the outcome of all of this will be a massive change.

A New World Order?

Probably not.

We already have a New World Order as China is expected to be the world’s largest economy by 2018 (ten years ago, it was estimated to be 2047).

But we will see a restructured playing field and one that is not level.

We can see this already as one major economy (America) bans prop trading whilst another (UK) just separates prop trading from retail bank operations.

Even more pronounced are the differences between the US and EU on OTC Derivatives regulations and how to define and regulate Systemically Important Financial Institutions (SiFi).

From CME Group in October 2011:

“In an ideal world, global financial regulators would function something like a team of horses, with policymakers in the United States, Europe, Asia and elsewhere all pulling at once in the same direction, and moving toward a common goal.

“Reality is turning out be far more chaotic, however. Regulators and lawmakers are having a tough time forming a consensus even within their own national borders, let alone across international boundaries. The result is turning out be a patchwork of overlapping and often inconsistent approaches to regulation in the aftermath of the financial crisis that gripped global markets in 2008 and 2009. Many financial experts fear that the inconsistent global regulatory framework will alter the flow of capital around the world, as trades are directed to the cheapest jurisdiction, a process known as regulatory arbitrage.”

So we end up with a world where the politicians are trying to react to the implosion of markets at the end of another revolution – Globalisation – and find that they are seriously lacking consistency, vision, leadership or agreement.

The Eurozone is one of the best illustrations of this, although America and China aren’t guaranteed to come out of this stainless as the American elections will change ground again, as will China’s challenges of a property market bubble and inflationary pressures.

All in all, the PEST approach to the world today says that we are going through a momentous change from all angles – Political, Economic, Social and Technological.

Where will it end up?

Probably in a place no-one expects and one which, on this blog, I’m going to avoid predicting decisively.

From Reuters:

“By 2020, the workforce in western Europe will shrink by 2.4 percent, including a 4.2 percent contraction in Germany, according to a Boston Consulting Group study.

Looking further ahead, HSBC projects that Germany's working population will shrivel by 29 percent by 2050, Russia's by 31 percent and Japan's by 37 percent.

Over the same period, the population of many African countries will double. Nigeria will log a rise of 3 percent a year in its workforce - in contrast to a 1 percent decline in Russia and Japan - and will have as many people as the United States by 2050.

On current projections, Pakistan will be the sixth most-populous nation by the middle of the century. And the Philippines could be the world's 16th-biggest economy, HSBC reckons.”

 

Jim O'Neill on the BRICs - the next decade

Just tweeted to our friends in the #OccupyLSE group – that’s Occupy the London Stock Exchange (LSE) for those who are not aware of the protest outside the LSE at St Paul’s – that I attended a meeting at the London Stock Exchange this morning.

Yes, I occupied the LSE!

Well, just for an hour in order to hear the thoughts of one Jim O’Neill, Chairman of Goldman Sachs Asset Management.

Jim is the man who coined the term BRICs for the growth countries of Brazil, Russia, India and China ten years ago (his paper was published in November 2001).

Since then everyone has taken the success story of China as read, although it has also been noted that the Brazil, Russia and India growth story also came true.

Now, ten years later, Jim was asked the question by the LSE: “Do BRIC countries still need the West for growth or is the reverse now true?”, and this was the theme of his presentation.

Here’s my spin on his talk (this is not a direct transcription therefore):

The question “Do BRIC countries still need the West for growth or is the reverse now true?”, couldn’t be more apt after the G20 meeting in Cannes last week.  In fact, I would claim that this is the most important question facing global economies and leaders today.

And my answer is yes, the reverse is true.

The West has been the most challenged since 2008 as their deleveraging crisis has been with them ever since, and the BRICs are an ever increasing part of the solution.

That being said, the BRICs are living in the same planet as the rest of us and cannot let the West completely implode.  For example, as we watch the troubling worlds of Greece and increasingly Italy, the BRICs are seeing more and more impact.

This is especially key for London, in its role in global finance, and is illustrated by the interesting events taking place a few yards away outside St Paul’s Cathedral (where the occupy LSE movement is demonstrating), which means it is very important that all of us involved in business and finance get a bit more objective about the issues being discussed in public forum these days.

Over the last decade the nominal increase in GDP amongst the BRICs has been greater than any other group of countries, apart from the G7.

This is difficult for people of my generation to see or accept, because it is new, although younger people get it far more easily.

Maybe this is because older people find it hard to adapt or change.

During the last decade, the GDP of G7 increased by $11 trillion.

Meanwhile, the Growth8 as I call them – the BRICs plus Indonesia, Vietnam, Mexico and Turkey – increased by a similar amount.

These countries are therefore so economically important that it’s rather sad and stupid that people still call these countries “emerging markets” when they have now emerged, and are contributing so much to growth and global markets.  We should call them something else, which is why I choose to call them the Growth8, as opposed to other countries which are emerging markets.

BRICs represent 80% of the Growth8’s $11 trillion growth in the last decade.

The ‘C’ in particular – China – has seen its GDP increase faster than the USA in the last decade.

Another example is Brazil, which has seen GDP increase faster than Germany, Japan and the UK.

From 2010 to 2019, the Growth8 will again rise faster, with China still leading the way.

BRICs will see GDP growth of over $12 trillion of the $16 trillion rise in the Growth8, with China contributing around $8 trillion, or half of that GDP growth.  This assumes an 8% average growth rate in their economy, so it assumes China’s growth will slow down.

However, if you look at the figures, the USA will only grow about $3 trillion in GDP by comparison, and Euroland by under $2 trillion.

In these figures, you would need a magnifying glass to see where Greece would sit in the global economy.  It’s not big enough to matter.

For example, China will grow by the equivalent of three Greece’s this year – it creates a new Greece GDP size every four months.

Unfortunately that is not the case with Italy.

Looking to the future, the global share of GDP in 2020 will be 41% for the G7; and 35% for the Growth8.  Of these, 27% of global GDP will be with the BRICs; 19% with the USA; 17% for China; and 16% for the whole of Euroland!

So during the next decade, the BRICs will be bigger than the USA.

This is important change, as the G20 and IMF are already changing their thinking about the BRICs.

For example, the IMF said at last week’s G20 meeting that it is going to review its Special Drawing Rights (SDR) basket of currencies before 2015, when it was next scheduled for review.

This implies that the Remnimbi (RMB) will be brought into the SDR basket before 2015 because China has moved far closer to full convertibility of their currency sooner than expected, which is incredibly important for everyone in finance, whether you invest in China or not.  

This means that debt or equity issued in Chinese RMB becomes normal, which is infinitely more important than what’s going on in terms of Greek and European politics.

For example, when we berate others about their fiscal affairs we have to be careful as, when you look at the budget deficits and government debt, it is clear that this not a sovereign debt crisis.

The gross government debt, as a percentage of GDP, in particularly high in the UK (85%), USA (100%) and Japan (233%) are far worse than in the Eurozone, but their governments still have highly rated sovereign debt. 

So the Eurozone issue is more a question of revealing the issue of the weakness of the European Economic & Monetary Union (EMU), rather than a question of sovereign debt.

And if you look at debt in the Growth8, the gross government debt as a percentage of GDP is under 25% for many.

This is why these economies are so key to the future and is illustrated by retail sales.

Retail sales since 2007 have dipped significantly in advanced economies but, in growth and emerging markets, are going up rapidly.

This is why German exports in the last four years have seen the biggest rise in sales to China, India and Russia.  By 2012, Germany will be exporting more to China than their neighbour France, which is a real shock.

This demonstrates why the BRICs are now independent of the West and the West needs them far more than they need us.

But the BRICs are not some homogenous area or singular market.

Two are democracies and two are not, and their wealth is very different. Brazil and Russia average around $15,000 a head; China $5,000; whilst India is under $2,000; so they are not similar in terms of wealth or politics.  Equally, they differ in content with two commodity producers and two importers, so they are not a region together.

The fact that they now meet as a group annually however is a symbolic move to Western leaders for change in economic governance, and to have these guys at the centre of it.

For example, the G20 is way too big and ugly, so we need a new G7 or G8, of which the BRICs and China will form a key part.  For the UK and Canada that’s tough as, in terms of their size of GDP, it makes you wonder what they’re doing there.

The real topic now is what’s happening to Chinese inflation.

It should get under 4% next year, which will be massively important as it will stop China’s tightening of monetary policy and will help the global economy as a result.

We should also note that 2020-2029 might be India’s decade.

China’s demographics will create a turndown and growing anywhere near 10% per annum will be tough a decade from now.

India has great demographics however, with India’s working population increasing by the size of the total USA population in a decade.

Finally, political instabilities are a factor in this outlook.

We have a Goldman Sachs Growth Environment Score (GES) that looks at 13 variables related to the sustainability of growth and productivity, and India scores the lowest of the BRICs on this score.

So when people ask me if I was mistaken about Russia being in this list, I respond by saying I’d take the ‘I’ out of BRICs before the ‘R’. 

India is challenged in terms of sustainable growth due to government finances and the lack of a credible framework for economic policy.  They also have many other issues of corruption and indecisiveness, which means that they can conceptually be a leader by 2020 or after only if they address these challenges first.

 

The Top 20 Banks of the World, 2011: China hits the Big Time

I’ve enjoyed the Banker’s Top 1000 listings for a long time now and, when last year’s listings came out, looked back over the last twenty years to see how things had changed.

This year’s list has now just been published (get a copy by subscribing) and makes for interesting reading, especially as Chinese banks have finally made the big time (doubleclick image to see large version).

All in all, this list when combined with my reflections in 2010 over the last twenty years, makes for a fascinating story of risk bubbles and bursts.

You had the banks from the rising sun rising up the charts in the early 1990s.

Then, as the Asian crisis nuked most of the region, the Japanese banks disappeared and the Anglo-Saxon banks took over.

The principle-led regulatory regime was rife and the Americans and Brits ruled until 2008 when their “debt whore” approach failed.

Now, everyone is bailing out everyone else, with PIGS, TARPS and QE’s by the shedload.

So last year’s list was interesting, in that we finally saw Chinese banks rising up the list and more diversity as the American and British banks stumbled a little.

I have been saying that China’s banks will dominate global banking since 2005, and certainly there is a growing swagger of China’s banks as they watched the failure of the West.

For example, it used to be that Chinese bankers were desperate to learn how the West did banking and would send troops of managers to European and American conferences to learn their ways, as well as hiring the best talent to import into Chinese territories.

Back then, we all scoffed at Asia for their poor risk management of credit leading up to the 1997 crisis, with debt defaults and NPLs everywhere. 

Now the Asians and Chinese may scoff at the West for the same reasons, although there is still risk in the Chinese system as most enterprise is propped up by financing given through the governmental influence over the banking system.

That aside, the fact that China's market capitalisation will rise to $41 trillion by 2030 from $5 trillion today, according to Goldman Sachs, makes it a market that cannot be ignored.  After all, this would make China's stock market the biggest in the world, as American market capitalisation rises to $34 trillion from $14 trillion over that time.   

This is one of the reasons why this year's Banker list is important as, for the first time, THREE of the TOP TEN banks of the world are Chinese.  Last year, there was just one.

This year, four of the top twenty banks of the world are Chinese, when there were none just a few years ago in 2004’s list.

So, no matter the risks, China’s banks have finally risen to the top ... but at what risk?

The original Asian crisis was created by a higher than expected percentage of Non-Performing Loans (NPLs) and Moody’s has recently downgraded China’s banks on the basis that “8 to 12 percent of all the loans made by Chinese banks could go unpaid.  Moody's had earlier estimated only 5 to 8 percent of the loans would be classified as ‘non-performing’.”

If China has a financial crisis, then we really will all be up the swanee ...

 

 

 

The Establishment is just PANTS!!!

I was quite intrigued to hear a speech by Ben Ramsden, Founder and CEO of Pants to Poverty.

Ben's talk was all about social business which, when combined with social finance, creates a completely different and new form of commerce that, if the next generation has any say, will compete with and potentially merge with traditional finance and business over time.

Ben began his talk by saying how he used to be motivated by money, like most of us.

His career launched into a trajectory in telco’s before the dotcom implosion, at which point he decided to try something different and travelled out to Guyana to see how other people lived.

It changed his life, and he ended up getting heavily involved with Amnesty International and, through that work, the “Make Poverty History” Youth Movement of 2005.

This was the event, wrapped up with Live8 and lots of other NGO (Non-Governmental Organisations) pressure groups changed the world, or was meant to, by getting the G8 to sign up for relief for African nations from debt.

Only five years ago, but a very different world.

At this time, Pants to Poverty was launched and sold 11,000 pairs of pants in just five months.

After a while, Ben realised this could be a business and created it as a social business.

What is a ‘social business’?

There are lots of definitions of social business, with many mistaking such businesses as charities. They’re not. They are businesses, but they are there to deliver against social and environmental needs, as well as financial ones.

The core of such businesses therefore is that they redefine the profit and shareholder view of the world.

Profits are based upon contributions to the environment and society, as well as the bottom-line, and shareholders are all of the stakeholders, not just the investors. So the farmers, shippers, staff, customers, investors and community all get a share of profit here, not just the business investor.

It may sound airey-fairey, but it works in practice as Pants to Poverty sources cotton from fair-trade farmers, turns it into pants at ethical factories in the developing world, and sells them in ways that raise awareness as well as making money.

And Pants to Poverty is very good at creating awareness. For example, the business holds the Guinness world record for the most people gathered in pants in public ...

 

... as well as the biggest pair of pants ever created!

The point that Ben made is that this had started as a social movement – to Make Poverty History – and had moved to being a social business – Pants to Poverty.

By being a social business, every stakeholder in the supply chain has a stake. The cotton producers get pesticides; the factories have inspectors to avoid any labour misuse such as child labour; and the distributors get rewards in both cash and kind.

For example, Pants to Poverty is going through a round of funding right now, to try and get £250,000 in order to build the brand and capabilities of the firm.

In order to raise the £250,000, the company has issued 100 convertible bonds valued at £2,500 each. The bonds last ten years and are designed to sell to friends and family, and anyone else who might buy them.

And interestingly enough, Pants to Poverty is finding a lot of High Net Worth Individuals are interested in taking the bonds.

Why?

Well, apart from the philanthropic virtues and the fact they are helping the world, there’s actually a really interesting triple bottom-line financial product on offer here.

What is the product?

For your £2,500 per bond investment, you get 8.65% annual interest.

The interest however, is paid in three ways via quarterly instalments consisting of:

• 12 pairs of Fairtrade and Organic underwear (inclusive of delivery)
• £21.63 paid in cash to offset tax at source
• £50 donation to the Pi Foundation, a charity set up by Pants to Poverty to help develop sustainable business models in the fashion industry

In other words, you actually only a small amount of real interest, the £21.63 cash, but add in the other components and it’s worth a lot more.

No wonder Pants to Poverty is gaining ground.

But what really intrigued me is the likes of Ben, Venessa Memis, Nicholas Negroponte and others, because they’re doing something for the world.

Changing it for the better.

Some in small ways and some in big ways, like Bob Geldof, and though the majority of us capitalist banking community might think they’re all a bunch of tree-hugging hippies, there’s something that struck me as Ben talked.

You see we have this old world, let’s call it the Establishment, and the new world, let’s call it the People.

The Establishment affirms the views of old, and believes that management of the People is through control mechanisms of which a key part is the traditional media.

The People represent the views of the next generations, and believe that anything can be achieved through crowdsourced change.

The Establishment has trashed the planet whilst the People want to change the planet.

And there’s the rub.

There is a real friction between Old World and New World.

This is what has occurred to me more and more as I think about Wikileaks, the rise of social networks and media, the ability for P2P to crowdsource globally and to think differently.

I thought it worth illustrating, and so created a few slides to illustrate the point ...

Future trends

 

If the key drivers of change accumulate to force old bubbles to burst, then the new outcomes will be different.

And the key drivers of change are accumulating today to force the old bubbles to burst:

• Political: the belief in our political leadership has been undermined by the Iraq War, expense and other scandals, with Wikileaks leading the charge to expose corruption and weakness;
• Economic: there is a loss of trust in the capitalist system, with leaders of the world striving to find new ways to rebuild whilst global socials build new financial models;
• Society: as the ageing population become a burden on the young, Gen Y will be the next generation of leaders who will have to manage the books to support the boomers and Gen X retirees whilst nurturing the Millennials; and
• Technology: is transforming the world by linking everyone P2P globally.

Not sure where all of the above leads, except that it is becoming more and more obvious, and some form of hybrid model will need to be created.

Otherwise, when two tribes go to war, a point is all you score.

 

VISA's pride before a fall over the Chinese wall

I was at a fascinating meeting yesterday looking at developments in credit, debit and prepaid cards. There was a standout moment when we had a discussion about China Unionpay (CUP), China’s card processing operator.

First a bit of background.

CUP was set up under the auspices of China’s central bank in March 2002, and is the only domestic credit card organisation recognised by the People's Republic of China as it is owned by 80 Chinese banks and other state entities.

The reason it is disliked by the likes of Visa, MasterCard and Amex is that there are barriers for these processors to get access into the Chinese markets, whilst CUP feeds off their networks to support processing overseas at discounted rates.

For example, the interchange fee structure that Visa, MasterCard and Amex operate is pretty much ignored by CUP.

Consumers who use cards which simply display a China UnionPay logo will not only be exempted from brokerage fees but also will enjoy various services provided by China UnionPay. However, if they choose to use Visa's settlement channel, they will be required to pay a currency transaction fee of 1 to 2 percent of the total amount they have paid or withdrawn ...

At the end of March, the three major global credit card companies, Visa, American Express and MasterCard, pushed the American government to urge China to open up its credit card market to foreign competition. The companies estimated that there was the potential for a 997.8 billion yuan ($150 billion) credit card market in the country. Meanwhile, China UnionPay has expanded its settlement network to 90 foreign countries and areas. They accept not only cards with the China UnionPay logo but also those that display both the Visa and UnionPay logos.

The figures above are actually low-balling it, as the firm describes themselves as follows:

To date, the total number of CUP card issued worldwide has exceeded 2.1 billion; in 2009, the number of CUP card inter-bank transactions reached 7 billion with an amount of USD 1.1 trillion; the overall merchants, POS terminals and ATMs reached 2.13 million, 2.88 million and 930 thousand respectively. China UnionPay has also established partnership with around 400 financial institutions all over the world. As of now, CUP card international acceptance network has been extended to 90 countries and regions. Over 10 of them, including Japan, Korea, Singapore, Russia, Mongolia etc, have issued CUP card.

So the figures are more like over two billion cards transacting over $1 trillion a year.

Wowser.

For a market that size, it does seem a bit strange for Visa to take the bold action of attempting to block CUP users from using their network outside China in June this year, as it resulted in CUP retaliating by blocking Visa from China for a year.

I say strange as Visa has shot themselves in the foot.

Rather than trying to pressure China into opening their borders to trade through international lobbying, whilst trying to partner with them, they have now become an enemy.

Meanwhile, firms like Amex and PayPal have partnered with them.

In a press release last week:

November 18, 2010 

China UnionPay and American Express today announced that they have signed a memorandum of understanding that calls for both companies to explore the expansion of their current cooperative activities. For the past several years, China UnionPay and American Express have cooperated within China where American Express Cards run on the China UnionPay network. This new MOU will establish working teams to develop potential new areas of cooperation between the two companies within China and in markets outside of China.

And in a press release in March:

17 March 2010 

PayPal and China UnionPay, China's bankcard association, today announced that China UnionPay (CUP) card members will be able to use PayPal to shop online, representing a new opportunity for international retailers to sell to a large base of Chinese customers who, combined, hold 2.1 billion CUP cards ... Chinese consumers have more disposable income than ever before and are starting to look for the best products the world has to offer. CUP card members will be able to use PayPal in the third quarter of 2010. This gives merchants the opportunity to spend the coming months preparing their Web stores for Chinese consumers, including adding Chinese translation and fast, cost effective shipping methods.

What this says to me is that firms who see China as the land of opportunity must be willing to adapt their business models and, potentially, their principles to gain access. You could admire Visa therefore for not dropping their values ... or view them as foolish for sacrificing access to this trillion-dollar opportunity by not changing their business approach.

Meanwhile, a nuance of this story is here in the UK, where RBS WorldPay has been opening access across UK POS and ATMs for Chinese tourists in partnership with CUP.

Chinese tourists only started arriving in London in 2005, and are now the biggest spenders in our country. Apparently, the average Chinese tourist spends about £800, compared to American tourists who spend an average £650 each.

Who would have thought the wealthiest tourists in the world would be Chinese a decade ago?

And who would have thought that RBS would be doing so much to bring wealth to our impoverished nation during these austerity times.

Bravo ... or is it shame on you?

Totally depends on your own point of view.

 

The Long Blog about the Long Now

Much of last week was focused on the Long Now and Long Finance for me.

Working with a group of thought leaders that included Venessa Miemis, Thierry Touchais, John Hagel, Stefan Nusser, Michael Mainelli, Paul Saffo, Bruce Davis, Brett King, Nova Spivack and more, we debated big topic items all week.

And yes, there were some conclusions too, so here’s the Long Blog Entry on the Long Now and Long Finance at SIBOS 2010.

First, it’s difficult to get the concept across and make it meaningful. Someone said to me: “What are you doing this week?” and I replied: “Building the concepts for a banking system that will last for 100 years.” They snorted dismissively and said: “Who cares about 100 years, I’m just interested in the next 100 days”.

As a result of this comment, the week taught me about why the Long Now is important, as it is totally concerned with what we leave our children.

When we think in business, we think short. Usually the next month or quarter.

If you are in charge of strategy, then maybe you think about the next year or two.

If you’re really lucky you get to think about the very long-term, especially if you are in charge of grand schemes like building, construction, oil or the environment.

Even then you are thinking long-term about how to make money rather than long-term about legacy.

What legacy are you going to leave your children?

Your wealth? Your savings? Your house? Your memories?

Does it matter?

Well, it’s only when you think about your children, their children and their grandchildren that you start to personally think Long.

The Long Now asks: what is your footprint going to be on this planet?

Many of us might not be that bothered about the footprint we leave on this planet as we just want to exist and enjoy the Now, not the Long Now.

Luckily, a few folks think differently, and I’ve blogged already about those thinkers who created Pyramids and Cathedrals.

Second, the Long Now is important for more than just a few bricks and buildings. Think about the current construct of our world? Our world is made up of forces that shape decades and centuries through decisions made today.

• If Alan Greenspan had left office in 2000, would there still have been a financial crisis?
• Where would Africa be today if there hadn’t been a Live Aid?
• Would the world be different if JFK had lived?
• What would have happened if Neville Chamberlain hadn’t signed a piece of paper with Adolf Hitler?

All of these decisions and moments in time shape the future. That’s why the Long Now is really important.

We are shaping the next decades today as we reconstruct our financial system from its meltdown.

• How do you want to shape this?
• How should it work?
• What happens if we rebuild it and it only lasts till 2020?
• Could the world survive another economic shock of this size and nature so soon?

These are the fundamentals with which the Long Now grapples, so sure, focus on 100 days and let’s just screw the children, the planet and our futures.

Third, Thierry Touchais gave a fantastic insight into Long Now thinking as he talked about the environment in the future.

Climate Change brings our world into sharp focus because we all now accept that this is important.

If you think you don’t believe climate change is important, do you recycle?

Do you think about carbon credits?

Do you fly as cheaply as possible, or do you accept there should be a carbon tax on your flights?

Finally, Paul Saffo finished our week with a view that again brought into focus the sharp reality of the Long Now.

He outlined the legal perspective, and said that rules and regulations were political fashion statements made to last a term in office.

Directives and legislation were structures made of cement, but that would only live for decades and not centuries.

What is really important is to focus upon the bedrocks of the system: the Magna Carta, the Constitution, the Napoleonic Code.

These are the Schema that rule our legal view of the world and, if these are shaken, our bedrocks of trust are shaken.

And here’s the rub: the longer the system lasts, the more we trust it works.

If the system changed every year, you would trust nothing and no-one.

This is why Facebook is not a trusted global currency: they are too young and fragile.

PayPal can create a global currency: but it’s not proven for the long-term. It is still not wholly trusted as a global conduit.

Banks can offer global commerce and trading finance: it is trusted because banks have been around doing this for over five centuries (the oldest bank in the world still surviving is Monte dei Paschi di Sienna, established in 1472 and still going today).

But has that bedrock trust been shaken?

If Facebook is the political fashion statement, and PayPal is the regulatory directive, have the banks that are the Constitution of the financial system cracked?

That is the question we were really grappling with last week: Do we need a new Magna Carta, Constitution, Napoleonic Code for the Financial Markets?

Is this what the authorities are creating right now anyway?

And no, we did not get an answer.

But what we did get was some illumination and, between the dialogue, some progress towards a view regarding what would ensure a robust financial market for the next century?

SWIFT, Long Finance, the Financial Services Club, IBM and others have determined to continue this work, and it will be interesting to see where it takes us.

In the meantime, we had several blogs produced, two videos and numerous white boards full of ideas, so here are a few of the other contributions.

Blogs from other attendees at the Long Now SIBOS sessions:

• Bruce Davis: A magna carta for money?: reflections on a week of talking about 'the long now'
• Brett King: What innovations will rock our world in the next 25 years?

The summary video (3 minutes 30 seconds), produced for Paul Saffo’s closing plenary.

This was a combination of the trailer of Sean Park's and Motherlode's "Financial Reformation" video and the "Future of Money" video produced by Venessa Miemis (Emergent by Design) and Gabriel Shalom.

The full videos are also worth watching individually.

The Financial Reformation by Sean Park (4 minutes)

Video on the Future of Money by Venessa Miemis and Gabriel Shalom (7 minutes 32 seconds)

The Future of Money from KS12 on Vimeo.

Full details: Web Premiere of Future of Money video; Now where do we go from here? 

Throughout the week, the guys from the ValueWeb provided scribing and visioning through their white board mindmap illustrations.  Here's a small selection of just a few.

The six big questions I raised and blogged about before the show:

"Trust" in banks and the creation of virtual currencies were a continual source of debate, especially Facebook credits.

Then PayPal announced a partnership with Facebook to do just that.

By the end of Day One, we had lots of themes and the challenge was how to put these into practice.  As a result, we asked team members to work on stories on Day Two about how to describe the Long Now.

And there were lots of good ideas.

Equally, we studied Long Now from many angles: political, economic, social, technological, environmental and legal.  I've mentioned the last two above in the text, but here's the picture of the social and technological views:

And finally, if you're really into the Long Now and Long Finance, here's my own 50-page summary from all the blog entries to date:  Download Long Now (PDF, 250Kb).

 

Which nation will be next global superpower?

As mentioned the other day, we are asking some big ticket long-term questions at SIBOS this year, such as:

• When will we know that financial systems work?
• How will we know when financial risk is not an issue anymore?
• What will America and Europe be doing when the economic power balance has shifted to Asia?
• Can we confidently create a way of investing for the long-term instead of our net present value short term view of today?
• Can we foretell a future where a human right includes "to not be poor", and what happens to work, life and war if there is no poverty?
• If money is just a way of exchanging value, and it's all now digitised, can we create digital money without the need for real money? How do virtual exchanges and virtual currencies change the commercial infrastructure?
• Could we create a world where financial transactions are sponsored, for example by Google ads, so that they are free? If so, what is the role of a bank and how will it make money, if all financial transactions are free?

This is all part of the focus upon the work of the Long Now Foundation and Long Finance group, of which I’m a part.

Long Now looks out at what will change over the next ten millennia, whilst the Long Finance looks out at a financial lifetime and how to build a financial system that could last 100 years.

In this series of discussions, I thought I would tackle one of the big questions we are considering: What will America and Europe be doing when the economic power balance has shifted to Asia?

Regarding the shift to the East, this is not a Long question, as the shift has already happened, if you listen to some folks.

But does it matter?

If America is no longer the great superpower but just a power, does it matter?

If Europe has zero competitiveness due to its fragemented structures, does it matter?

And what about Latin America and Brazil, don’t they matter?

And Russia?

And the Middle East?

The answer to all of the above is that of course it matters.

Any shift of economic or military power matters.

For example, we could pose a different view to the above if we really want to be Long, and ask: what happens when the balance of economic power is determined by Africa?

When we think of our land masses and populations, the real matters are determined by commodities, capabilities, processes and capital.

So let’s look at these areas, and then consider who has the balance of power and who will get it.

When we think of commodities, we think of oil, metals, cocoa, gold and similar.

Those who have an abundance of scarce commodities that have value are naturally going to be richer than those who have none but need them.

The Middle East has lived on their oil riches for long and will do so for the near future but, in the Long Now, some will fail.

This is because the oil riches are a finite resource, and will eventually be drilled to extinction.

The illustration of this issue is no better exemplified by Yemen, where poverty is rife having squandered away millions in oil revenues years ago, and being unable to create any substitute.

This is unlike the Emirates, who ballooned into a prosperous construction, tourism and trading centre, built upon sand.

So when we talk about commodities we are talking about a finite property, which is why there is scarcity and value. From a Long Now viewpoint, it must beg the question: what are you investing your finite billions in today for the infinite post-commodity years later?

The answer is that these nations should be investing in education, knowledge, brains and science, as these capabilities build a sustainable future.

The capability battle is one that Britain used well to build an empire a century ago, and that America used well to create prosperity through the twentieth century. It’s also what other nations, such as Singapore and India have realised in building their empires of today.

It’s all about looking at things that humans can create that are of value and, by building leadership in this area, it means that your nation can stay ahead of the world when it comes to technological, scientific or commercial scarcity.

Britain had that scarcity during Queen Victoria’s reign, with a technological leadership based upon naval and military strength. This allowed one small nation to colonise many other nations. By doing so, the strength of the nation increased by being able to access commodities of those nations, and gain commercial value, capital and further technological strengths which became a virtuous circle.

This leadership faded as the industrial revolution led to America, with its vast swathes of land and resources, to take over as the manufacturing engine of the world.

In America, that leadership came from building cars and computers, creating value through innovation, and through using knowledge to gain power over capital, commodities and resources.

Today, this is the piece that is shifting to the East.

China’s leadership is based upon people, processes, resources and investment in capabilities for building cheaper, faster and better.

China’s a nation that saw the weakness in the model of the world – the cost of manufacturing – and exploited it to gain growth. Now, having gained that edge, they are investing in all the other things to generate wealth from science and knowledge, and to maintain and sustain future growth.

This is why China has a space mission, as does India.

These are indicators of building capability leadership through scientific and technological research.

India saw a different weakness in the world’s model – the cost of service – and their strategy was therefore to invest in knowledge, and specifically to use their brainpower to gain economic growth. The use of English language and investment in technology skills, restructured the world’s knowledge chains in the same way as China re-engineered the world’s supply chains.

It is these investments in human capabilities that led to other nations, who had the commodity resources to support the wealth of manufacturing and services growth in China and India, to also enter a growth phase, particularly Brazil and Russia.

Now, Brazil has invested in human capabilities to sustain their growth, whilst Russia is still a fragile economy due to a lesser focus on building such a sustainable future.

So that outlines two cycles of economic power shifts: commodities and capabilities.

The thing that now makes the difference is that, if you start with an abundance of resources and use the investment capability of such resources to create capabilities, which nations get the Long Win, as in they become a superpower.

This is all down to processes.

The two go hand-in-hand, and are easily reflected by Germany and Japan.

Since the 1970s, we all say that Germany and Japan are the world’s leading nations in terms of their excellence in making cars and electronics.

This is because Germany and Japan had a huge squeeze on capital after the War, and therefore had to create efficiency and effectiveness in processes.

Luckily they could do that, thanks to a clean spread of land and knowledge that had a focus upon creating processes that maximised the efficiency and effectiveness of manufacturing.

Just look at the work of W. Edwards Deming in post-War Japan to see how Just-in-Time manufacturing re-engineered the world.

So where does this lead us to, in thinking of the Long Now future world?

Who will be the future superpower?

Not Europe, if the region continues in its current form.

This is because Europe has a problem with managing the four dimensions of commodities, capabilities, processes and capital, mainly because Europe is a grouping of 27 individual nations rather than a singular whole.

This is why Europe is bad at dealing with these, although some nations within Europe excel, as in Germany. This is why Europe is grappling with the question right now as to whether the Union can survive long-term if one or two nations are good at building a sustainable model of wealth, whilst having to give it all away to support the nations that aren’t.

China and America are different as they are a nation and not a region.

Admittedly, they are not a singular whole either – China and America are a formation of many individual states, like Europe – but they do have centralised governance for strategic planning and control, as well as a common language and currency. Again, I know some will be tutting at this point, saying that Mandarin and Cantonese are different languages and almost half of America speaks Spanish, but it is fundamentally different. This is because these nations do have a cohesive structure for planning, investment and management of commodities, capabilities, processes and capital, whereas Europe does not. Europe may in the future but, right now, it does not.

Equally, many claim that Europe fails due to disparate and historical legacy infrastructures, whilst America succeeds by starting as a new Nation, with a new currency and agenda. China’s a new nation, in terms of infrastructure, and again can exploit and leverage that capability.

So when we look at the capabilities criteria, China and America are the two large nations that both fit. Russia, Brazil, India and Africa would be the other contenders.

We can leave Africa off the list for the moment, as they suffer the same paranoia and fragmentation as Europe. Similarly with Russia, for they need some serious investment in people and capability if they are ever to maximise their resources and opportunities.

So, America, China, Brazil and India are the four Long Finance nations on the radar.

They are all single nations with central planning structures and a relatively new Nation mentality, which means that they are not bogged down by legacy infrastructures from an economic viewpoint.

They all have strong capabilities and access to resources, so we don’t need to think of these as an issue.

Therefore, for the next century, the superpower from these four will be based upon processes.

And here’s where it gets radical.

America has been very good on process, and India is very good on process.

Everything is in signed off in triplicate, checked, double-checked and authorised.

The thing is that this procedural approach to processes is not adept for the new millennia process, where the fast beat the slow.

Today’s globalised world works in seconds, not years, and the heavy-duty processes and rigid disciplines of the twentieth century will fail in the twenty first.

So, for these reasons, America and India may be hindered culturally in the Long Finance twenty-first century, which leaves Brazil and China.

You probably think it’s China, don’t you?

China will be the Big Superpower of the twenty-first century.

Well, maybe not.

Maybe Brazil holds the balance of power for the Long Finance world.

The reason for this conclusion is that China will be contracting in power in 2050-2060, due to their single child policy.

The lack of new blood and an aging population could drag China’s economic tiger into a toothless and clawless sloth in the Long View.

Meanwhile, Brazil has the commodities, capabilities, processes and capital to be the world’s largest economic force in the next century.

If that’s the case, North America will feed off South America, and will be the subservient economy to Brazil. It will be a reverse relationship to the structure of the twentieth century, where you had the poor South and rich North.

Similarly, Africa will have been raised from poverty, and India and China will still be forces of power, but not necessarily THE force of power.

Europe will still be fragmented, with member states fighting for capital and control just as they are today, and Russia will still be tipped as the next big economy and, if the government does invest more strategically in commercial capabilities and processes, it just might make it.

Meanwhile, I’m moving to Australia as, in the picture I’ve just painted, the world has turned upside down. All the wealth and control that was in the Northern Hemisphere has moved to the South, and so the natural juxtaposition of London will to live in Sydney.

Interesting.

Instead of coming from a land down-under, I’ll come from a land up-over ...

G’day mates.

The Rise of Islamic Finance

Ron Robins,  an Englishman now based in Canada who promotes the idea of ethical investing, shared another item with me this week which has some interest here.

The Rise of Islamic Finance
By Ron Robins, Founder & Analyst - Investing for the Soul

Islamic finance is spreading around the world. Governments realising its potential for profits and jobs are duelling with each other to create the best regulatory and supportive framework for it. Western money centres with growing participation in Islamic finance include London, New York City, Paris, Frankfurt, Tokyo, and Toronto. Islamic financial activities in these centres usually encompass the licensing of Islamic banks and offering of Shariah-compliant financial products that include bank accounts, home loans, and bonds.

Among countries, the growth and acceptance of Islamic finance varies considerably. For obvious reasons, it is in Muslim countries where its growth appears faster. However, the financial storms of recent years have earned it an increasing attention globally.

The ethics and morals behind Islamic finance and Shariah-compliant investing have similarities to ethical investing and finance, yet with significant differences too. Islamic financial structures avoid gambling style speculation and interest rates, and all trading, loans, and investing have to involve real assets.

The estimates vary as to the size of Islamic finance globally. Abdul Rahman Al Baker, executive director of financial institutions supervision at the Central Bank of Bahrain (CBB) believes it to be now more than $1.5 trillion. Bloomberg reports that Moody’s research indicates global Islamic finance totals about $950 billion. Malaysian based Islamic Financial Services and Saudi Arabian Islamic Development Bank are projecting the market to grow to $1.6 tn by 2012. Going even further is another report quoting Moody’s that Islamic finance could eventually reach $5 tn.

The countries with the largest Shariah-compliant banking assets are Iran, Saudi Arabia and Malaysia.

However for 2010, Bloomberg says that Malaysia leads the way in the international issuance of Islamic bonds. (These bonds, called sukuk, are asset-backed and the holder usually receives a percentage of profits rather than interest.)

By August 26 of this year, Bloomberg reported that Malaysia had 72 per cent of the total $9.8 bln issuance of international Islamic bonds. The Gulf States issued $2.5 bln representing about 26 per cent of the total. Media reports also said that Gulf sukuk issuance is down by 24 per cent from last year due to Dubai’s real estate problems and the sukuk defaults by Saad Group (Saudi Arabia) and Investment Dar (Kuwait).

The money centres with the biggest trading in sukuk are London, Dubai and Malaysia.

Bloomberg elaborates on the size and significance of Malaysia’s quest to lead in Shariah-compliant finance. According to Bloomberg’s reports, Malaysia’s Shariah-compliant assets are around $93 bln and account for 19.6 per cent of its banking industry. Moreover, the country is attracting foreign funds and asset managers with Shariah-compliant operations. These include Saturna Capital, Nomura Securities, Reliance Capital Asset Management, Franklin Templeton GSC Asset Management Sdn., HSBC Holdings Plc and Standard Chartered Plc. A total of 14 licences have been issued to foreign companies by the Malaysian government for Islamic fund-management activities.

Bloomberg also says that Malaysia last year established a commodities trading platform based on ‘murabahah,’ where the prices are governed by a negotiated profit margin that is Shariah-compliant, and that Bahrain is establishing a similar trading platform that will also include the trading of sukuk, real estate investment trusts, and options.

Other recent developments in Islamic finance include: Bloomberg reports of Turkey’s quest into Islamic finance which began in April with a $100 million sukuk issue by Kuveyt Turk Katilim Bankasi AS. According to Lawyers Weekly, the U.K. completed in August its first corporate sukuk deal of $10 mln for International Innovative Technologies Limited (IIT), while France wants to issue its first sukuk offering this year using French law and is building a Shariah-compliant regulatory framework that is compatible with foreign currencies for banking and investment applications all over Europe.

Shariah-compliant mutual funds now exist in several countries including the US, Canada, and India. Interestingly, some precious metals mutual funds are becoming Shariah approved as well. Furthermore, according to ETFdb.com, “Shariah compliant ETFs (exchange traded funds) are becoming popular investment options around the world – over the last year they have been introduced in Britain, India, Singapore, Malaysia, and South Africa.”

All Shariah compliant financial products have to be approved by Shariah scholars. Concerns surround the lack of standards and uniformity regarding the selection and qualifications of these scholars. “Banks try to search for competent [Shariah] advisers, sometimes they get the right person, sometimes they get the wrong person,” said Aznan Hasan, the president of the oversight committee of the International Shariah Research Academy for Islamic Finance in Kuala Lumpur, Malaysia, in another recent Bloomberg report. His organisation is endeavouring to create a worldwide professional organisation to certify and organise Shariah finance scholars.

Islamic finance is beginning to rise from its ancient past.

This posting was originally published on the Middle Eastern news portal Alrroya

The World's Top 20 Banks 1994-2010 ... Anglo-American Banking Rules!

I’ve just received this month’s Banker magazine which the editor, Brian Caplen, describes as their most important issue of the year as it covers the latest Bank 1000 listings.

This year’s listings show a surprisingly stable crew of American and British banks.

World   Bank                               Tier One              Pre-tax
Rank                                            Capital                profit
                                                      $m                    $m
1        Bank of America Corp        160,387.77           4,360.00
2        JP Morgan Chase & Co       132,971.00         16,143.00
3        Citigroup                          127,034.00          -8,445.00
4        Royal Bank of Scotland       123,859.00          -4,366.29
5        HSBC Holdings                   122,157.00           7,079.00

Considering the crisis was meant to have killed these banks, you may find it surprising to see that Citigroup and RBS have maintained their leading positions.

This is down to the fact that the Banker measures a bank’s strength by its Tier 1 Capital, and so their positioning is more of a reflection of the sheer size of these firms than by their brand or market capitalisation, which is used in some other studies of size.

The Banker’s data is fascinating though, as the database also contains profitability, revenue, cost-income ratio and more, so it’s a useful tool in all senses.  And the online data goes back to 1996, so you can do some useful comparisons.

Mind you, my data - old Banker magazines - goes back even further so I quickly took a snapshot of a few useful year’s – 1994, 1999, 2004, 2008 and 2010 – to see how things have changed.  Mapping out the Top 20 banks of the world for each year makes for an interesting picture (doubleclick the picture to see a larger version):

Back in 1994, Japan ruled the world.

Then their economy went South and Origami Bank folded, Sumo Bank went belly up, Bonsai Bank cut back their branches and something fishy went on at Sushi Bank where staff got a raw deal.

Post-Japan’s slump, the Anglo-American financial system ruled. So you would think that, as that system failed, it also would have gone South.

Not the case.

Maybe that’s a reflection of the sheer scale of investment American and European firms have put into these economies to avoid such a crash.

Well worth spending time looking at the data and looking forward to playing around with it further.

A SWIFT note on remittances

A final note on remittances and I've already been taken to task by one reader, who points out that a 'migrant worker' in one country is another country's customer overseas.

This is a key point for some banks, as they enable their customers to migrate and have full financial services whilst working overseas.  That's an opportunity for some ...

However, as I responded, the point of workers' remittances in this migrant worker context is that they are either unbanked or underbanked.  It's more about financial inclusion than banking, so it is a slightly different conversation.

And one solution for the underbanked discussed in some depth is SWIFT’s remittance services for banks. It is not surprising we discussed this in depth, as SWIFT are the premier conference sponsor.

The service focuses upon those banks that are trying to build bilateral services or using open correspondent banking services. The difficulties banks experience when dealing in such areas are all focused upon limitations in scalability, timing, price and service levels.

If you have a bilateral agreement, that’s great for the countries covered. But then, if you need to cover new country corridors, a new agreement with another bank is required. Equally, what happens if you’re only transacting four or five times a month?

A high cost for creating something that is basically unused.

On the other hand, if you use open correspondent banking relationships there is no guarantee of service levels, and therefore pricing and processing can vary.

Hence, SWIFT has focused upon creating a technical and commercial framework to solve these issues.

The framework covers everything from the terms and conditions of correspondent bank contracts to best practice rules and procedures to the messaging standards and services based around Fileact store and forward.

There’s a little bit more to it, and you can read all that stuff over here, but the bit that interested me is that the service already has 43 participants with 14 live users including certified payments services providers, such as Wall Street Exchange.

It was stressed that non-bank payments providers are welcome to join the system and so the question came up: “but why would we use SWIFT as you are very expensive?”

The SWIFT guys immediately responded by saying that the pricing is based upon a tiered system of usage volumes, with the most expensive items being priced at €0.08 per transaction down to €0.03 per transaction for the highest volume users.

“That’s reasonable”, came the reaction from the PSP, “is that all of the pricing?”

“Urm, there’s an annual fee of €1,000 to use the SWIFT directory of all participant’s reference data”, the SWIFT guys replied, “and, other than this, that’s about it.”

I think they won over a few more participants this week.

Why banks should avoid the remittance markets

Great conversations continue in the remittances space, or money transfer space if you prefer, with a chat with the global transaction services folks from a major bank.

This bank has a dilemma: are they in the remittances space or are they not?

They really want to be in this space but are worried about risk exposures, particularly reputational risk.

Their challenge is to find out whether there’s enough profit in remittances to be worth the risk.

They recognise that processing money transfers is a good business to be in. It can make money for them, and would fill in some missing pieces of their transaction services business.

Not just that, but it may be critical for them. For example, they see mobile money transfer as being key to their future, and see the use of mobile and transaction services as being so obvious that it’s a no brainer for them to be in this space.

They would like to do this in partnership with one of the major mobile carriers as, if they aren’t in partnership, others will be and that is dangerous as there are only so many partners out there.

If Deutsche Bank gets T-Mobile for example, and Citi gets AT&T, HSBC gets Hutchinson, Bank of Tokyo-Mitsubishi gets KDDI and Royal Bank of Scotland gets Vodafone, then there aren’t that many mobile firms left to partner with.

Soon, the markets are stitched up and banks that want to be mobile payments processors globally will be left in the cold.

Hmmmm.

Meanwhile, the real dilemma is why would a mobile carrier want to be the partner?

Sure, it’s not their business to process payments although, as they are also transaction processors, they can find this extension of their core business something they could implement quite easily.

Mobile carriers are also used to dealing with small accountholders. Think of your son or daughter’s mobile account.

How much is spent per month and how many transactions are made?

Maybe a few hundred text messages and a few telephone calls?

Maybe €5 to €10 of cost per month.

That’s diddly-squat, so mobile carriers are used to processing high volume, low margin transactions on masse.

And what’s the real game changer for mobile?

Reach.

Every person on the planet can probably get access to a mobile handset if they wanted – there are over four billion users out there – and so mobile carriers want to enable financial transactions for all o f their customers.

And there’s the rub: a bank only wants to deal with profitable customers, which is why only a billion people on the planet are banked, whilst carriers want to work with all customers, and three out of four are unbanked.

Now that wouldn’t be an issue, a bank could offer remittance and money transfers for the three out of four who are unbanked, but it is a problem because banks need to comply with AML and KYC rules.

Mobile carriers don’t provide that information and, in many instance, they don’t get or need that information.

Mobiles can be picked up and SIM cards used anonymously.

That’s no good for a bank ... although if the account is only €5 a month, maybe that is OK as banks do support limited use prepaid cards anonymously.

But then mobiles are topped up and that additional value needs to be monitored.

So, you now have mobile carriers starting to come in to the AML and KYC rules.

For example, on e African money transfer operator told me that customers are being instructed to re-register their telephones with some form of identification in some countries.

All well and good you may say, but then a banker replied that that is OK except that the mobile firms just get an ID with no proof of correct details.

For the banks, they need all the customer’s details plus proof to ensure the correct ID is being presented via utility bills and other means.

So there is an issue here.

But let’s say that it is solvable.

Then there’s still another issue: profit.

For a bank, the risk versus reward equation for remittances is skewed heavily against the money transfer market.

For example, several banks got into buying money transfer operations during the first half of the last decade as global migrant worker movements exploded.

They thought they could cross-sell to the users of these services and, as migrants became more affluent, maybe get them fully banked along with their family.

But this was not the case.

For example, Spanish banks tell me that the users they thought they could cross-sell to in Spain already had bank accounts. They just used the remittance service because it was cheaper, faster and more reliable than using the bank.

Hence, the cross-sell dream was a flawed vision.

And there are hardly any profits in remittances unless you’re a really big player with massive volume.

In fact, on that note, it’s getting worse as the credit crisis means that not only are there fewer migrant workers these days, as many have moved back home, but the ones that remain are sending less money home.

So margins are tight, there’s no growth in volumes or values, and profits are almost non-existent.

But let’s say you overcome the issue of AML and profitability, then what?

There’s another issue: coverage.

To be a player in this game, you need a lot of agents – Moneygram has 200,000 agents worldwide for example – to disburse payments and manage accounts. Those agents need appropriate licensing and vetting, and that’s a challenge for a bank.

Even if you have all the agents, you then need geographic coverage – Moneygram has reach to over 160 countries – and most banks do not have that coverage and, in the case of some, don’t want it.

For example, think about an American bank. An American bank would have no issue covering global service provision ... except when you start talking about coverage in Iran maybe. Or in Pakistan and other politically sensitive country operations.

Now these banks start to worry that they might have an exposure like the one that UBS encountered.

When the American forces broke open Saddam Hussein’s vaults in Baghdad, they found millions of dollars of crisp new dollar bills. However, the US had outlawed the supply of US dollars to Iraq for over a decade, so how did they get there?

The Fed investigated and found the currencies came through other outlawed nations including Libya and Syria, via branches of UBS.

Result: UBS were fined $100 million which, at the time, was one of the largest fines ever made for a bank infringement of US regulations.

So there’s the rub.

Even if you can organise money transfers, monitor things well, get the AML and KYC in place and operate profitability, a bank still has a huge reputational risk exposure if they get heavily into the remittances market.

Let’s say you can overcome all of this though, as a bank, then what?

Well, there’s a final issue: smell.

Banks think migrant workers are smelly and don’t want them in their branches and migrant workers think that banks are smelly, as they look down their noses at them.

You may think it over-states that case, but one French bank openly stated that they did not want to be in remittance services because they don’t want these “poor, foreign workers” in their branches.

And these “poor, foreign workers” often feel intimidated by bank lobbies and branches, and the sort of people who use them, so would rather deal with someone who speaks their language who they feel they can trust more.

There are loads of other points that could be made here but, all in all, even if you can organise money transfers, deal with the AML and KYC issues, find a way to make some money and manage the high reputational risk, a bank shouldn’t be getting into remittances because it does not smell right.

So who will make this space their own?

Hmmm ... now who are leading the remittances and financial inclusion space today?

Oh yes, Safaricom/Vodafone (M-PESA) and a few other mobile carriers and operators.

And so the real dilemma is: why would a mobile carrier want to be the partner?

Now it gets interesting...

Why is there no global mobile remittance service?

We had a really interesting free-ranging conversation about remittances and new services for remittances yesterday.

Oh yes, I should say that I’m at a remittances conference so that’s the reason why.

The discussion was about the NEXT BIG THING in money transfer ... or rather whether and if there is a NEXT BIG THING in money transfer. To be honest, there’s not.

There’s just mobile.

Building on yesterday’s discussions of mobile, there’s actually just two discussions about mobile worth having in the remittances space: SMS texts for receivers and Mobile Internet Services for senders.

The general view is that SMS is it for wiring money to and fro. However, for the smart iPhone and Android users of this world, a fuller and richer experience using mobile internet apps might be a good thing.

Then some really good conversation started about why mobile remittances are all focused upon national systems like M-PESA and GCash, rather than the promise we thought was there for global mobile remittance services.

Global mobile remittance services still have that promise but, today, it is all national.

This is because any mobile operator could launch a local remittance service.

They don’t necessarily need to partner with a bank – did Safaricom  for M-PESA or Globe Telecom for G-Cash – and they can just get on with it.

However, if you were launching a global service, you would need to include so many other players. Banks, Money Transfer Operators, Money Transfer Agents and Merchants, Mobile Carriers and more.

That gets way too complex and difficult.

We ended up saying that the breakthrough will come as we move towards national and regional hubs for payments and transactions.

In other words, SWIFT, the European Payments Council, the G8 payments development group, Mobey Forum, the GSMA and a few other key groups could create global standards and interoperability, along with multilateral clearing, to enable global money transfer.

Could be a long time coming, but worth watching out for ...

When's the next financial crisis and what will cause it?

WARNING: THIS BLOG ENTRY WILL NOT CHEER YOU UP [sorry]

I spent the morning with a group of futurists debating the long-term outlook for financial markets and am never sure about the usefulness of such debates, although there is definitely something of use in creating scenario plans for the future which is where we were focused.

The key question I kept asking myself during the conversation is: when will the next financial crisis take place, what will cause it and is it predictable?

To answer the first part of that question, we only need to look back in history.

If we take the first financial crisis as the fall of the Roman Empire then it was about 1,000 years until the second financial crisis occurred, with the collapse of the Medici banks of Renaissance Italy. Four centuries later, the South Sea Bubble and Great Tulip Collapse took place. 250 years after that, we hit the Great Depression; and 80 years after that we imploded in the Subprime Crisis and Global Credit Crunch.

Sure there were plenty of hiccoughs along the way - LTCM, Asia, Russia and Latin American implosions in the late 1990s for example - but global crashes have been notable.  Loosely speaking, global crisis are now occuring twice as fast as the previous ones:

• 1,000 years – the Roman Empire to the Medicis
• 400 years – the Medicis to the South Sea Bubble
• 250 years – the South Sea Bubble to the Great Depression
• 80 years – the Great Depression to the Subprime Crisis

On that basis, you could bet on the next crisis being anything between thirty and fifty years from now.

2040 to 2060.

So what would cause the next financial crisis? After all, we’re only just trying to get through this one. Surely we can regulate to avoid another one?

Maybe not.

Here’s a view you could take of the factors that contribute to the next financial collapse. I should say that it doesn’t make for fun reading, but the logic could have some grain of accuracy.

2011

Banks globally are heavily regulated, taxed and governed to avoid another subprime crisis. The focus is on derivatives, liquidity, capital and governance.

2012

The European Union struggles through a fragile and fallow period of financial and political instability with Portugal, Italy, Greece and Spain managing to just about maintain Eurozone requirements. Unfortunately, it is at the expense of citizens and governments in many of these nations.  In fact, the cuts and tight budgets in these Southern member states creates a major movement of economic migrants from Southern Europe into Northern Europe, with the associated tensions and fissures appearing between Northern Europe and Southern Europe as a result.

The outcome is that Europe never quite achieves the competitive economic zone it dreamed of becoming.

2016

China opens its markets to full financial servicing, with a rocking stock exchange in Shanghai that becomes the world’s second major investment banking city by volume and value by 2020, just behind New York  This is combined with a revaluation of the Remnimbi (RMB) that satisfies their critics but worries some, particularly the USA, as the Chinese currency is looked towards by the investment community as a possible alternative reserve currency.

2019

Rather than creating a reserve currency for the world, the investment community creates a basket of currencies to avoid too much exposure to risk in one economy – after all, they don’t want a repeat of the 2008 crisis. The basket includes Euro, RMB and Dollar, along with Gold and other commodities. Nevertheless, the decision to place a weighting towards RMB rather than the Dollar creates issues for the USA, which has spent most of the 2010s in stagnation.

2022

The Middle East enters a major crisis, as oil becomes less needed as a commodity due to the rise of alternative energy sources and conversion of many motorised vehicles to electricity. Iran and Israel go to War and there is a huge effort by the United Nations to bring stability to the region. Eventually, Sovereign Wealth from the GCC outflows towards new and rising economies, such as Africa, and tensions continue to rage across the region on an ongoing basis.

2025

Africa’s economy is raging onwards and upwards. Like the BRICs of the 2000s, Goldman Sachs creates a new investment portfolio known as CAGES – Congo, Angola, Guinea, Ethiopia and Sudan – where natural resources of platinum, cobolt, gold, diamonds, manganese, uranium, chromium and tantalite are abundant. Johannesburg is rising fast as one of the largest world financial centres.

China is now the largest trading partner and region with Africa, thank to their investments at the turn of the century. America finds this to be particularly challenging, as their view of Africa had been one of occupation and charity, rather than investment and growth, during this period.

But China doesn’t care too much, as China has now become the world’s largest economy.

2028

American and European investment firms decide to make RMB the reserve currency of the world, and drop the concept of the basket of currencies.

2032

The quiet rise of India as the world’s second largest economy had largely gone unnoticed but, in 2032, for the first time China’s economy had less than 3% growth. This was put down to the lack of skills in the country where skills were needed, and is a reflection of the aging population in China and lack of new blood. China’s one-child policy of the previous century, and a distinct lack of female population for the overly male populated society that resulted, means that 2 in every 5 citizens has reached or is near retirement age. This, combined with strict immigration controls, places a strain on continued growth and industry.

2039

India’s continually booming economy has created frictions between their Chinese border rivals, and a Cold War commences between the two nations. Like the Cold War of the previous century, no arms are traded or battles take place, but the economic controls freeze out much of China from India’s trading partners and vice versa. The result is an economic climate where India’s investment community trade with India and China’s with China.

There are ripples through the Shanghai and Mumbai stock exchanges as a result.

2044

India continues to see success as a stable and harmonised country. China appears to be becoming more unstable as the government struggles to maintain investment and trading, and avoid the inflationary pressures created by their exposure to investments in Africa for future commodities that can no longer be utilised.

The economy fails to achieve growth rates above 1% for three quarters, and the government determines that the Remnimbi needs devaluation. This angers the USA and Europe, who have major investments in Chinese land and other illiquid stocks, along with major reserves of Chinese currency.

The decisions taken by the Chinese government force them to look towards India and Africa.

2050

The outflow of investment by American and European investment houses from China results in aggressive currency arbitrage between the Chinese RMB and the Indian Rupee, with the latter winning as the RMB’s reserve currency status ends.

The resultant big time betting against the continued stability of China causes the Cold War between India and China to spill over into skirmishes.

The world sees a period of major instability ensue and the China Crisis is put down to currency speculation amongst the world’s capital markets created by complex foreign exchange instruments intertwined between the major economies.

Nothing to do with housing this time.

Jeez, that was a depressing vision and I told you this conversation wouldn't cheer you up.

Thank goodness it’s just fiction.

However, if you like this sort of future conjecture and dialogue, you are welcome to join us for two more optimistic discussions (hopefully) at the FSClub in June:

Monday, 07 June 2010
The Long Now of Finance
A panel discussion with Professor Michael Mainelli and guests

This evening is dedicated to a panel discussion focusing upon: "The Long Now of Finance - a Framework for the next 10,000 years".

Many financiers and academics are beginning to focus upon how to invest in long-term projects that secure the planet for our children and grand children and great grandchildren. Short-term thinking is killing the planet. So how do we think long term: the Long Now, and how do we fund it: Long Finance?

Long Finance is an initiative begun in 2007 by Z/Yen Group in conjunction with Gresham College, to establish a World Centre of thinking on Long-Term Finance. The initiative began with a conundrum – “when would we know our financial system is working?” and has worked on a variety of projects, including the signature program focused upon an Eternal Currency.

This debate will be chaired by Professor Michael Mainelli, a cofounder of Long Finance and Executive Chairman, Z/Yen Group.

Monday, 14 June 2010
The Future of Banking, a discussion with Professor Ray Barrell, Professor David De-Meza and Professor Donald MacKenzie of the Economic and Social Research Council, chaired by Brian Caplen, editor of the Banker Magazine.

The Economic and Social Research Council (ESRC) is the UK's leading agency for research funding and training in economic and social sciences. Established in 1965 as the Social Science Research Council, under a Royal Charter, the ESRC covers a wide range of disciplines, ranging from anthropology to statistics with a budget that has grown from £73 million in 2001-02 to £204 million in 2009-10. Financial services are a key sector for the Council's business engagement strategy. The ESRC is partnering with the Technology Strategy Board on the new Financial Services Knowledge Transfer Network. This evening the ESRC has kindly agreed to host a discussion focused upon the Future of Banking featuring three very distinguished scholars.

Professor David De-Meza is with the London School of Economics and has published many papers on banks policies in a wide range of journals. He is the on the Council of the Royal Economic Society and the Institute of Economic Affairs; Associate Editor of the Journal of Industrial Economics and Joint Managing Editor of the Economic Journal.

Professor Donald MacKenzie is a Professor of Sociology at the University of Edinburgh, with work that has constituted a crucial contribution to the field of Social Studies of Finance. He has also undertaken widely-cited work on the history of statistics, eugenics, nuclear weapons, computing and finance, and was awarded the Chancellor's Award from HRH Prince Philip, Duke of Edinburgh and Chancellor of the University of Edinburgh, in August 2006 for his contributions to the field of Science and Technology Studies.

Professor Ray Barrell is a visiting professor at Brunel University, Director of Macroeconomic research and Forecasting for the UK and World Economies, and Senior Research Fellow at the National Institute of Economic and Social Research. Previously, he has been a visiting Professor of Economics, Imperial College, London from 1996 to 2004, and was a part-time professor at the European University Institute, Florence, 1998-1999. He is on the editorial boards of Economic Modelling and was on the board of the Journal of Common Market Studies until 2007.

The future of banking regulation

The City of London released an interesting document yesterday on the future of regulation of banking. They talk about liquidity, leverage, capital and risk liberally, and state that the future regulatory regime must not clamp down on capital reserves in banking so hard that the banks are unable to lubricate the global economy.

What I found interesting is that there are quite a few contradictions in the 77 page report although, to be honest, I only read the Executive Summary.

From this summary, it’s interesting that they plead that the macroprudential structures don’t squeeze capital ratios, but hardly talk at all about the leverage issues Lehman Brothers created.

If my memory serves me, Lehmans was operating at leverage ratios of up to 1:40, e.g. for every $1 of capital, $40 was being used to ‘gamble’ on the global markets. I also remember that their debts at bankruptcy were around $400 billion and BarCap estimated that for every $1 of debt, around $20 of Credit Default Swaps were being leveraged against Lehmans AAA rating. In other words, $8 trillion of leverage was in the system off the back of Lehman Brothers.

That was the issue, particularly when this leverage – and therefore liquidity – disappeared overnight.

Following on from this, they refer to the fact that the crisis was not caused by a lack of capital, but by a lack of liquidity. True, but I did not gather a clear view on liquidity risk or leverage ratios from the document. It may be in there, but it’s hard to find.

For example, in Section Five that addresses Leverage Ratios, the report states that “judgement and discretion are vital, including judgement and discretion concerning circumstances under which firms will be permitted temporarily to have capital that is inadequate. The notion of employing a leverage ratio as a last-resort backstop to limit the damage caused by regulatory get-arounds arises precisely because of the limited ability and appetite of regulatory authorities for exercising discretion. That core problem is the one to address.”

A bit of fudge if you ask me there.

The same is true on liquidity risk, with the report proposing a global liquidity standard and yet they then say that they are “unconvinced that there is a case yet made for pursuing significant further deepening of international coordination of banking regulation. Indeed, we believe it quite likely that greater exercise of national discretion is the appropriate path forwards.”

Now I understand the conundrum that you cannot have one nation regulate for example to stop bank bonuses as it will just mean bankers jump across to other nations. So you need a global agreement of some form. Equally, no global agreement will work, as there is always gold-plating and protectionism of national instruments, so you need a global framework with local interpretation.

That is kinda what they’ve proposed, but it’s rather unclear. For example, their closing comment on liquidity is:

“In our view, improving liquidity standards are amongst the most important and material changes to be introduced — though they are likely to have high costs that must be recognised. However, the scope for international standards to deliver adequate liquidity is limited without increased roles for national lenders of last resort and in particular an increased role for central banks in prudential supervision.”

In fact, the regular mantra in the document appears to be the frictions and tensions between global and local. For example, they state that there is a “risk that regulation will not apply evenly or that regulation will apply in the UK before the rest of the world”, and that this “is seen as a significant threat to London’s competitiveness. It is therefore widely urged that the Basel measures enact a common international timetable. International firms that operate in multiple markets are particularly keen to see common, consistent frameworks and standards applied.”

Yet, as mentioned, they don’t think regulation will or can be applied consistently across multiple markets.

All in all, more questions raised than answers in this document, but worth a read for those who are technically minded and interested.

Download available from the City of London's website.

 

So not PC but ...

This is so politically incorrect that I almost didn't post it ... but then I did to show how cultures are different and sensitivities are not the same.

As I left Singapore, I saw this and felt quite offended:

Yet Singaporeans are desperate to avoid offending foreign visitors, as are most Asian countries, so how could I be offended?

Well, look more closely ...

I'm sure that my Western colleagues will get the point.

No wonder, following on from Damian Glendinning's points raised earlier, that we don't always agree:

• SAMBO (Singapore): a building company
• SAMBO (UK and USA): a racial slur

But then we arrive in Asia and handout business cards with one hand and immediately put a received business card in our pocket without reading it. 

In Asia, the protocol is that we should offer the business card to the receiver as a gift, with the upper top corners held in each hand so that the card is presented the right way round to be readable.  Similarly we should take their card with honour, and read the details of title properly before putting the card away.

These nuances of societies are brilliantly described in Richard Lewis's book, When Culture Collide, and have been used in HSBC's advertising to great effect for the past eight years.

It was 2002 when this ad first aired ...

... and it's true.

When global, think local, so I wasn't offended after all, as the meaning of the word is not intended.

Now, who was it called me ****** just now?

Are Asian corporates the same or different?

After writing earlier this week about the bullish views of HSBC on China and Asia as a whole, with the clear view that the world has decoupled, Asia is self-sustaining and China will be the largest economy in the world by 2035 or sooner, I was really interested to hear the views of Damian Glendinning and David Blair.

Damian Glendinning is Vice President & Treasurer with Lenovo, the Chinese PC firm, having previously worked for IBM in NYC, USA. David Blair is Treasurer with Huawei, the Chinese telecoms firm, having previously been treasurer with Nokia in Helsinki, Finland.

In other words, we have two guys in senior jobs at Western firms who have moved East. If anybody can explain the world of China, their outlook and view of the West, it’s these guys.

The main discussion came from Damian’s presentation titled: Asian Multinational Corporations (MNCs) – are they the same or different?, with the point being whether they act like European or American firms, or whether they have their own unique outlook.

Again, not verbatim, but here’s the summary of Damian’s presentation and yes, it’s very useful if you really want to know what’s going on in the world of Asia:

Asian Multinational Corporations (MNCs) – are they the same or different?

First, I think the question is wrong. It’s not Asia we should focus upon, but emerging markets including Russia, Brazil and Latin America.

We’ve seen massive growth in emerging markets for the past decade. For example, according to JPMorgan, GDP growth from 2002 to forecast in 2012, not compounded, is an average 11% growth in China, 8% in India, 7.5% in emerging markets overall. This compares with an average 2.5% across the world, and an average 2% growth in the USA, 1.5% in G7 countries and just 1% in Japan.

As you can see, the country with the lowest growth rate for the last twenty years is an Asian country – Japan – whilst two of the main emerging markets are also in Asia – China and India. So my first comment would be: don’t treat Asia as just some homogenous mass and remember that there are other emerging markets, particularly Brazil, that should be included in this discussion.

The companies which dominate these emerging markets are now not just international firms, but major MNCs:

• the top three banks by market capital are Chinese
• Tata, Mittal are huge Indian conglomerates
• InBev of Brazil is a very large drinks company

Part of the reason for the fast growth of these firms is that their technologies are better. For example, Lenovo are ripping out the IBM IT systems and implementing Lenovo ones. We expect a huge increase in productivity as a result.

Another factor about these companies, is that their home markets are under threat from Western firms who are looking towards emerging markets for growth. These foreign competitors are a major threat, as they can invest significantly to gain market share.

This means that the critical question emerging markets MNCs are asking is that, if you are the market leader in a domestic emerging market, what do you do?

You either expand or you face severe threat from foreign firms and, as the best method of defence is attack, you end up creating aggressive expansion and acquisition plans because you have to. That is a major factor in the reasoning as to why Lenovo acquired IBM’s PC division, why TATA bought Jaguar and Land Rover, why Geely buys Volvo and why Arcelor were bought by Mittal.

Sure, these sound like major expansion plans into overseas markets, but all of these acquisitions are to expand in markets where growth rates aren’t great. These Western brands do not offer growth as they are in mature markets where growth is less than 2%.

If you compare that to the strength of emerging markets, which is based upon growth, then you realise that any acquisition of a western brand is a pure defensive move, not an expansionist one.

I had this realisation when I realised that a decade ago, I lived in New York driving a British car, a Jaguar, and working for an American firm, IBM. I now drive an Indian car, still a Jaguar, and work for a Chinese firm, Lenovo. I suppose the only good news there is that Jaguar, a UK firm, is now being subsidised by Indians rather than by Americans.

So why are these firms buying into mature markets?

What they are buying is brand, access and knowledge of how these markets work.

They then have the challenge of how to make these acquisitions work.

Any firm expanding overseas has challenges, and the challenge here is whether they want to be a true MNC, or an international firm head officed in China or India.

The difference between an international firm and a MNC, is that a MNC has a broad base with diverse senor management whilst an international firm is controlled its from domestic HQ, with key positions occupied by home country nationals and standards imposed by the home country.

The latter are always seen as foreign, whilst the former is far more integrated.

Asian MNCs would historically include examples such as Toyota, Nissan, Hitachi, Sony, Honda and more from Japan; Hyundai, Samsung and LG from Korea; Lenevo, Huawei from China.

This means to be a MNC you have to make acquisitions.

Then you encounter all the other issues, with the biggest challenge being culture. A MNC is different because corporate culture in MNCs is stronger than national cultures. This is why international firms don’t work as well as MNCs.

Another big issue is merging IT platforms, as rarely can a MNC operate on multiple systems, so there has to be an evolution towards a single platform.

A further issue is pride. A Western firm acquired by an Eastern firm has employees who may feel slightly lessened by being owned by Mumbai or Shanghai rather than New York or Frankfurt.

The recent movement in banking is a good example, with high street banks taking over investment banks. Investment bankers have many qualities, but being modest is not one of them, so moving from working for a prestigious Wall Street brand to a common High Street one is not appealing to many of them. This is why so many of these people have moved firms.

Equally, buying an American firm if you come from a low income market, creates challenges develop about pay differentials and attitudes.

So the real issues for an emerging market corporation is where do you go for growth, particularly when developed markets are not growing.

Today, it means that you do look towards other emerging markets, but that creates other risks.

Now risk is interpreted differently based upon your view of the world.

Risk in financial context used to mean that emerging markets firms would look towards working with Western banks, because banks don’t fail, right?

Now, Chinese banks don’t fail, right!

Emerging markets MNCs will therefore say to you today to explain risk management. What are the qualities of risk management that you can give to us in the East, developed in the West? And you complain about our strict regulatory environment, but maybe our regulations aren’t such a bad thing. And with all of your systems and controls, tell us how they work again.

In fact, emerging markets can be less risky because government intervention can prevent overheating in the economy. Remember that the current crisis was purely one seen in developed markets, not in emerging economies.

We actually like our regulations because regulations can prevent excesses. There is no subprime lending in India or China, there’s a lack of derivatives and leverage has been pretty much smothered ever since the financial crisis which occured over here in 1997 to 1998,

Payment disciplines are different too.

For example, Days Sales Outstanding (DSO) for Lenevo in Asia is 15 days. This is because everyone knows payments are a problem, so we offer early payment incentives. In the USA, 30 days is our typical DSO whilst, in Europe, it’s 60 days. So, tell me where the risk lies?

Equally, where are the countries with excessive external debt?

China, Brazil and Russia are down at the bottom of the league table for sovereign debt, because we do not have leverage in emerging markets; whilst, at the other end of the table, the UK, USA, Japan and many European countries are leveraged to the hilt. So tell me, where the risk lies?

In conclusion, we are seeing MNCs coming out of emerging markets, but more because they have to as a defence than that they want to. As a result, they have to grow in developed markets, but the risks and reward are poor and, for many, they would feel more comfortable acquiring and growing in other emerging markets, where there are better opportunities for growth and less issues with regulatory barriers and other hurdles because, as an emerging market firm, they are used to them.

We will see some convergence with traditional MNCs, but we will also see some big differences. For example, emerging market MNCs are far more open than their counterparts, because they are buying in skills and intellectual property to integrate the workforce, not alienate them.

So I can’t tell you what the world will be like tomorrow but I can tell you it’s going to be different, and the future MNC will be much more open and embracing than those of the past.

China will be world's largest economy by 2035

So I’m hiding out this week in Singapore at the Eurofinance Cash, Treasury and Risk show for Asia.

I love this conference as you get here and see the sponsor’s names – HSBC, JPMorgan, RBS, Deutsche Bank, Standard Chartered and Bank of America Merrill Lynch.

There ya’ go, you just know it’s gonna be a rich week of food, entertainment, wine and song. None of that cheapskate IT show stuff, where everything has to be managed on a teensy-weeny small budget. No, this is way beyond the small budget syndrome so I know it’s gonna be fun.

It’s also gonna be fun because it’s in Singapore, a place I first came to in 1987 when, if my memory serves me right, the Merlion fountain sat in the grounds of the Raffles Hotel which sat in its own unique position on the Peninsula Marina.

Today, Raffles is surrounded by buildings, hotels and skyscrapers, and the Merlion statue has moved.

That’s progress, but then Singapore is a progressive place.

I won’t say too much about Singapore though as, if you’re interested, National Geographic had a superb supplement analysing all features of the country. I won’t say too much about the article, except that it’s opening gives away that it’s a great story:

“How did a sleepy little island transform into a high-tech powerhouse in one generation?” by Mark Jacobson

If you want to get a Singaporean to look up from a beloved dish of fish-head curry—or make a harried cabdriver slam on his brakes—say you are going to interview the country's "minister mentor," Lee Kuan Yew, and would like an opinion about what to ask him.

"The MM? Wah lau! You're going to see the MM? Real?"

You might as well have told a resident of the Emerald City that you're late for an appointment with the Wizard of Oz. After all, LKY, as he is known in acronym-mad Singapore, is more than the "father of the country." He is its inventor, as surely as if he had scientifically formulated the place with precise portions of Plato's Republic, Anglophile elitism, unwavering economic pragmatism, and old-fashioned strong-arm repression.

Unfortunately, it’s also a country I find difficult to enjoy straight away as I took the overnight flight from London which gave me about three hours sleep in 36 hours, so I spent yesterday fitfully sleeping on and off and watching crappy movies on HBO and Star ... but at least in Singapore you can watch crappy movies in the English language, unlike hotels in Europe where fitful night hours are dulled with non-stop CNN news.

Back to the conference though and Robert Prior-Wandesforde, Senior Asia Economist with HSBC, gave the opening speech: Asia - aren’t you glad to be here?

Here are my brief notes:

Asia - aren’t you glad to be here?

The economic recovery began around the second quarter of 2009 for most economies, and Asia’s industrial production index is now back on track, exceeding the peak pre-crisis levels of 2008. This unlike the Eurozone and USA, which took such a shock that their output is still at levels below 2000.

This means that Asia has reached a self-sustaining cycle, without dependency on USA and Europe, and the concerns over decoupling have not materialised because Asia is no longer coupled with the other geographies as they were a decade ago. In fact, Asia now has a virtuous circle of growth, based upon strong domestic demand, which boosts imports and exports, which helps lift personal income and profitability, which creates more domestic demand.

That is why HSBC forecasts year-on-year export growth of 20 %+ in the region, which is crucial to the level of sustainability of a recovery here in Asia.

But how can that level of export growth be the case when you have the mess that’s in the EU and America?

Answer: a lot of increase in demand has just been within Asia.

So we have this old world view of the American consumer being the consumer of last resort, but it has changed. For example, Korea’s electronic shipments to China and China’s shipments of electronics to the USA were closely coupled at the start of the 2000’s. Today, they are not.

Over the last 18 months, Korea’s exports to China have surged significantly but China’s exports to the USA have not. So it does suggest that the Korean products are going to China and staying in china. This is true not just for electronics, but for motor vehicles and more.

In other words, it’s the Chinese who are shopping!

Historically, China has been an export and investment led economy. That isn’t going to change necessarily, but the fact that private consumption as a share of GDP in China is about 36%, it singles the country out from others in the G20, such as the USA where private consumption is over 70% of GDP.

Equally, savings as a percentage of household disposable income has risen to almost 40% in China over the last decade, up from under 30% at the end of the 1990s. That compares to about 3% in the USA.

Why they are saving so much is, according to a survey of citizens by the Central Bank of China, for their child’s education and their own retirement. These are Chinese citizens’ major concerns and the Chinese government are therefore trying to change this mindset to encourage consumerism.

This does not mean a massive swing to USA-style consumerism, but does mean giving more assurance to citizens about education and pensions so that they save less and spend more.

If this does change the mindset of the people of China, then even a few percentage points swing to spending rather than saving will have a massive impact as it will change the habits of 1.4 billion consumers, not just a few million.

This does not mean that Asia does not need the USA and Europe though, and the risks of continued growth or not are related to America and Europe’s issues.

America has delivered better than expected results for the past few quarters, and so there is recovery there.

In Europe, there are different issues and the concerns about Greece are major. But Greece is a small country in Europe, and the contagion kicked off is not necessarily justified as Spain and Italy, which have been caught in this maelstrom, are different to Greece. Spain’s government debt to GDP ratio is half of that of Greece’s, whilst Italy does have a government debt issue but the budget deficit there is half of Greece’s.

The fundamentals are different but, overall, we do expect governments in Europe to increase taxes and reduce spending, with the UK being one of the critical countries to face that challenge.

In summary, Europe as a region may be in continued recession but you have to look to Germany, which stands out and is still motoring forward. Germany’s economy is about ten times the size of Greece’s and is stable. So there are positive indicators in the region along with those negative ones.

Other worries may be things like the end of policy support from governments, which is unlikely; the end of inventory-led growth, which is also unlikely; exchange rate appreciation, but that assumes demand disappears, and we cannot see that happening as Asia is now self-sustaining.,

There are also concerns about an asset-bubble boom and bust in China. For example, seventy Chinese cities saw property prices were up 12% year-on-year and, in Singapore, it is even more marked with private residential prices up 30% in just the last nine months.

In China, you then need to look at GDP growth, which was up 12% in the first quarter and nominal GDP growth for the last year was 15%, so a 12% rise in property prices makes sense.

What about inflation?

Inflationary pressures are showing some signs of issue, as it is growing rapidly with a bigger underlying inflation problem in the region anticipated for 2011. This means that asset price bubbles could develop in a more meaningful way going forward.

The issue here is that many of the Asian central banks are unwilling to tighten interest rate policies, but interest rates will need to be watched and managed carefully in Asia this year if we are to avoid an asset bubble next year.

Remnimbi is also a topical issue, with the Yuan:$ exchange rate pretty well fixed over past few years. The more pressure the USA puts on China to untie that fix, the more likely China will not do anything but we do think that China will appreciate the exchange rate later this year. It won’t be a massive revaluation of the remnimbi, however. It will just be tentative.

This is because China is worried about their exporters and want to avoid any double dip recession within China, so we expect it to be around a 5 percent appreciation of the Yuan against the US$ over the next nine months.

Longer term, our view is that we expect China to overtake the USA economy by 2035.

In other words, China will become the largest economy of the world in 2035, with the USA and Europe closely behind, and India nipping at their heels.

The only thing that can hold this back is that China’s government are showing too much concern right now about a double dip recession and asset price boom domestically, whilst India does have an asset price bubble and inflationary issues.

The Central Bank of China and Reserve Bank of India must get to grips with these issues to realise these dreams.