You are browsing the archive for 2014 April 03.

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Barron on the Ricardo Effect

April 3, 2014 in Economics

By Mises Updates

Mark Thornton writes:

Patrick Barron on Redmond Weissenberger’s podcast Better Red than Dead, on The Ricardo Effect.  Like Say’s Law, it’s another piece of classical economics that is under-appreciated by modern Austrians.  Barron also makes the point that I had not heard before that there is a perverse Ricardo effect put into play by government intervention.

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IMF Chases Wrong Targets in China

April 3, 2014 in Economics

By James A. Dorn

James A. Dorn

The International Monetary Fund (IMF) has recommended that China institute deposit insurance before embarking on interest rate liberalization and opening its capital markets. Higher rates on deposits may encourage more risk taking by banks and some of the lending/investments may go sour. The IMF sees deposit insurance as a way to prevent bank runs.

That logic may be true, but deposit insurance also encourages banks to take more risk, because ultimately taxpayers will have to make depositors whole if a bank fails. Most banks in China are already state owned and have an implicit guarantee that the government will not let them go bankrupt. Deposit insurance may help smaller private banks compete against the giant state banks. But the real problem is not the lack of deposit insurance; it is the lack of private ownership and responsibility that permeates China’s financial sector.

So long as capital freedom is hindered, China can never become a world-class financial center.”

Federal deposit insurance was not introduced into the United States until 1934. Previously, banks used liability rules to prevent excessive risk taking and protect depositors. Instead of today’s limited liability rules, bank owners and managers faced double, triple, and, in some cases, unlimited liability. Because shareholders could lose more than their investment in a bank, they tended to be responsible risk takers and imposed conservative lending practices on managers.

From 1865 to 1934, US national banks were subject to double liability, and depositor losses as a percentage of total liabilities in the national banking system were relatively low, as legal scholars Jonathan Macey and Geoffrey Miller have documented. When liability rules are sound, banks will also tend to be sound.

Deposit insurance treats symptoms, not causes, of unsound banking practices. China’s banks are by definition “too big to fail” because state ownership naturally means the politicization of investment/lending decisions. There is a strong incentive for state-owned banks to lend to state-owned enterprises rather than to private firms, which the government will not bail out.

The absence of widespread private ownership in the financial sector and the influence of the Chinese Communist Party mean the threat of bankruptcy for state-owned banks and state-owned enterprises is slim. The result has been a very inefficient use of capital and the rise of “shadow banking”.

China needs to restructure its ownership system in order to fully liberalize its price system, including deposit and lending rates. Piecemeal …read more

Source: OP-EDS