Daily Archives: February 11, 2014


It could be tempting for the rest of Europe to dismiss Swiss voters as irrational after Sunday’s referendum. The vote results in a constitutional amendment that will control immigration, including from EU countries, violating the terms of Switzerland’s treaty with Brussels. Yet to dismiss Swiss voters in this way would be a mistake.

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The outcome of the vote is a blow for the government. Hope of meaningful EU concessions will melt away like the late spring snow. A country situated in the heart of Europe now faces a stark choice. Will it continue to enjoy the prosperity that springs from an economy deeply embedded in Europe, and accept the partial loss of political sovereignty that comes with it? Or will it become once again the master of its own domain and accept lower living standards as it grows more distant from European markets? The government must enact legislation within three years to implement the constitutional amendment. There is little time left.

The referendum’s far-right sponsors won the vote because they know what they want. The centre and centre-left lost because they failed to provide an alternative narrative and were afraid to put up a fight. It is hard to prevail in the ring when you refuse to use both fists.

Switzerland now confronts a fork in the road. The Swiss parliament might want to begin by jolting the political status quo. One possibility would be to appoint another far-right minister to join the one already in government, and give them both key cabinet posts. That way, the far right can be accountable for upcoming discussions with Switzerland’s EU counterparts, and the challenging search for a compromise.


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What lessons can Europe, and in particular the UK, draw from this historic vote by the Swiss people and its messy aftermath? It is time to recognise that various dimensions of European integration no longer enjoy broad support. The European project needs to be reformed lest it lose its democratic legitimacy. Arguably, this should move in two directions. Eurozone stability depends on deeper integration among the 18 member states, which should culminate in the establishment of a common fiscal authority. But parts of Europe do not want to follow the path of ever-closer union. For them, reform probably means refocusing on the original trade and customs union remit.

Such a dual-track approach could make it possible for deeply independent countries such as the UK and Switzerland to find a form of membership of, or relationship with, the EU that stands a chance of winning lasting popular consent. It could also smooth the path to entry for Turkey and Ukraine. These countries are vital to European interests but will never be able to join the EU in its present deeply integrated form.

The centre and centre-left lost because they failed to provide an alternative narrative and were afraid to put up a fight

Such far-reaching changes would probably require significant treaty changes. So far, there is little evidence that the calls for help from David Cameron, UK prime minister, are being heard. Perhaps the Swiss vote can serve as a reminder for Angela Merkel, German chancellor, and President François Hollande of France that, without concessions and reforms, Europe may soon face a much bigger hangover from polls elsewhere than it did this week in Bern.

“Why has government been instituted at all?” asked Alexander Hamilton, one of America’s founding fathers. “Because the passions of men will not conform to the dictates of reason and justice without constraint” was the answer. He was right. But his logic can be taken only so far in a modern democracy. If governments consistently ignore the passions of men and women, they will ultimately be rendered impotent.

From an investor’s perspective, protracted uncertainty about the long-term institutional make up of Europe will undermine growth. This is something the European economy cannot afford as it finally climbs out of the second recession since the onset of the financial crisis. For the continent’s politicians, there is no task more urgent than allaying doubts about the democratic legitimacy of the European project.

The writer is vice-chairman of BlackRock and former chairman of the governing board of the Swiss National Bank

Some market watchers, shaken by the eye-popping increases in China’s debt indicators, have concluded that a financial crisis is imminent. After all, countries whose debt ratios have risen by similar magnitudes in just a few years have all crashed soon after. China, they say, seen as no different.

Yet when analysts drill into the balance sheets of borrowers and banks, they find little evidence of impending disaster. Government debt ratios are not high by global standards and are backed by valuable assets at the local level. Household debt is a fraction of what it is in the west, and it is supported by savings and rising incomes. The profits and cash positions of most firms for which data are available have not deteriorated significantly while sovereign guarantees cushion the more vulnerable state enterprises. The consensus, therefore, is that China’s debt situation has weakened but is manageable.

Why are the views from detailed sector analysis so different from the red flags signalled by the broader macro debt indicators? The answer lies in the role that land values play in shaping these trends.

Take the two most pressing concerns: rising debt levels as a share of gross domestic product and weakening links between credit expansion and GDP growth. The first relates to the surge in the ratio of total credit to GDP by about 50-60 percentage points over the past five years, which is viewed as a strong predictor of an impending crash. Fitch, a rating agency, is among those who see this as the fallout from irresponsible shadow-banking which is being channelled into property development, creating a bubble. The second concern is that the “credit impulse” to growth has diminished, meaning that more and more credit is needed to generate the same amount of GDP, which reduces prospects for future deleveraging.

Linking these two concerns is the price of land including related mark-ups levied by officials and developers. But its significance is not well understood because China’s property market emerged only in the late 1990s, when the decision was made to privatise housing. A functioning resale market only began to form around the middle of the last decade. That is why the large stimulus programme in response to the Asia financial crisis more than a decade ago did not manifest itself in a property price surge, whereas the 2008-9 stimulus did.

Over the past decade, no other factor has been as important as rising property values in influencing growth patterns and perceptions of financial risks. The weakening impact of credit on growth is largely explained by the divergence between fixed asset investment (FAI) and gross fixed capital formation (GFCF). Both are measures of investment. FAI measures investment in physical assets including land while GFCF measures investment in new equipment and structures, excluding the value of land and existing assets. This latter feeds directly into GDP, while only a portion of FAI shows up in GDP accounts.

Until recently, the difference between the two measures did not matter in interpreting economic trends: both were increasing at the same rate and reached about 35 per cent of GDP by 2002-03. Since then, however, they have diverged and GFCF now stands at 45 per cent of GDP while the share of FAI has jumped to 70 per cent.

Overall credit levels have increased in line with the rapid growth in FAI rather than the more modest growth in GFCF. Most of the difference between the ratios is explained by rising asset prices. Thus a large share of the surge in credit is financing property related transactions which explains why the growth impact of credit has declined.

Is the increase in property and underlying land prices sustainable, or is it a bubble? Part of the explanation is unique to China. Land in China is an asset whose market value went largely unrecognised when it was totally controlled by the State. Once a private property market was created, the process of discovering land’s intrinsic value began, but establishing such values takes time in a rapidly changing economy.

The Wharton/NUS/Tsinghua Land Price Index indicates that from 2004-2012, land prices have increased approximately fourfold nationally, with more dramatic increases in major cities such as Beijing balanced by modest rises in secondary cities. Although this may seem excessive, such growth rates are similar to what happened in Russia after it privatised its housing stock. Once the economy stabilised, housing prices in Moscow increased six fold in just six years.

Could investors have overshot the mark in China? Possibly, but the land values should be high given China’s large population, its shortage of plots that are suitable for construction and its rapid economic growth. Nationally, the ratio of incomes to housing prices has improved and is now comparable to the levels found in Australia, Taiwan and the UK. In Beijing and Shanghai prices are similar to or lower than Delhi, Singapore and Hong Kong.

Much of the recent surge in the credit to GDP ratio is actually evidence of financial deepening rather than financial instability as China moves toward more market-based asset values. If so, the higher credit ratios are fully consistent with the less alarming impressions that come from scrutiny of sector specific financial indicators.


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