Dateline China: Mr. Zhou Takes on Western Finance

Changing Pro-cyclicality for Financial and Economic Stability” does not exactly sound like the title of a revolutionary treatise. Well, strap on your seat belts — and hold on for the ride.

The writings of China’s monetary supremo, Zhou Xiaochuan, the governor of China’s Central Bank, make one wish for a similar display of razzle-dazzle intelligence on the part of the once-lauded Alan Greenspan, who fell for the gibberish of his own confused pronouncements.

In sharp contrast, Mr. Zhou’s deliberations, while complex, are intriguing and quite original — mixing the worlds of systems theory, electronic engineering and monetary policy in a tantalizing fashion.

Most acutely, though, the governor has a sure-handed way of taking apart conflicts of interest, webs of half-truths and wishful thinking that, to him, characterize Western-style finance of late.

Now, Mr. Zhou may write with the benefit of hindsight, but the way in which he dissects Western practices lead directly to another, highly uncomfortable conclusion.

One wonders whether the labyrinth-like structures of the Chinese Communist Party — paired with the extreme focus on selection and internal advancement — do not present a better training ground for comprehending today’s complex financial edifices than the risk-reward patterns prevailing in the Western world.

It is particularly revealing, if not galling, to read Governor Zhou’s passages on extreme groupthink among financial risk managers, rating agency staff and regulators.

All of us who grew up in the West have long been conditioned to believe that any such displays of mindless conformity, are hallmarks of — yes, you guessed it — Communists, but definitely not of Western individualism and rationality.

What better reality shock than to realize that China’s Mr. Zhou turns out to be the all-knowing, savvy central banker looking right though all the shenanigans assiduously erected by private financial houses?

And what bigger wake-up call could there be than to acknowledge that, by contrast, Alan Greenspan was but a doctrinaire stooge blurting out uninformed gibberish in a desperate effort to look on top of the situation?

And who was accepting his pronouncements with the mindless obedience of party apparatchiks? Was it really our Western media — and our financial elites?

And just how long ago was it that these same Western prognosticators worried, in article after article, that the Chinese — with their four bad banks and high degree of “NPLs” (non-performing loans) — were really facing a major financial calamity, owing to the ultimate lack of transparency of the country’s financial system?

Now, what we collectively have to swallow are on-the-mark statements about Western banks, including:

• “Too many financial institutions outsourced the development of their internal control systems”
• To make matters worse, “most institutions use models built by a handful of quantitative analysts”
• “The system shows a strong pro-cyclicality” and need to add “negative feedback loops” to help “system stability and self-correction”
• as to rating agencies, in what cannot be deemed an accidental pun on the fate of Detroit, “specific ratings from the Big Three tend to be highly correlated”
• Too much “herding phenomenon” — and not enough “investor heterogeneity”
• “There is inertia and sloppiness among investment managers to ask tough questions”

Mr. Zhou makes it implicitly plain that the dialectic approaches pursued by Communist cadres may offer better job training for today’s complex world of finance than the happy-go-lucky, can’t-we-all-just-get-along approach pursued in the West.

Mr. Zhou’s final dagger is reserved for the speed of decision-making processes of competing political systems at a time of grave crises. Surprisingly at first, he argues that the integrated style of decision-making within China’s Confucian/Communist elites represents an advantage over the confused Western (especially American) style of trial-and-error, punt-and-delay.

In the words of Mr. Zhou, “untimely or delayed response” due to “a prolonged political process for mandates to finance ministries and central banks” often results in governments missing the best timing for action. This means that the central bank may be “behind the curve and would make the outcome less than desired even if the response is correct and strong.”

One cannot escape the notion that he is openly lamenting about the difficulties that U.S. Treasury Secretary Timothy Geithner faces in coming to terms with the toxic assets on the books of his nation’s top banks. China did go for the bad bank approach — and, says Governor Zhou, that effort “got a quick start and captured a good time window.”

The implication is more than obvious. Bank nationalization certainly did not get a quick start in the United States and, due to the severe recession, also won’t occur in a “good time window.” As things stand, the IMF’s Managing Director — who just recently warned again about further delays in dealing with toxic assets — could not agree more.

At the end of his remarkable treatise, Mr. Zhou cannot resist the temptation to rise to Greenspan-style pronouncements of superiority. “…The Chinese government has taken prompt, decisive and effective policy measures, demonstrating its superior system advantage when it comes to making vital policy decisions.”

There may be a hint of arrogance in that concluding statement, but it also demonstrates that we live in a brave new world. Nothing that we believed only the day before yesterday necessarily still holds today.

Western policymakers and politicians will have to work much harder to keep up their presumed system advantage. To be sure, Chinese policymakers — rising as they do from a nation of 1.3 billion people and in a very competitive, accountability- and performance-oriented system of career advancement and rigorous job rotation — are cut from top cloth.

Editor’s Note: This is a sample essay from The Globalist’s Executive Edition, where a version of this article was published on April 20, 2009.