Gao Xiqing, CIC and Scary "Derivatives"

There's a soft interview in The Atlantic Monthly that provides a (nearly) unfiltered soapbox for Gao Xiqing, the president of the $200b China Investment Corporation. It's disappointing, given Fallows' unique position that he doesn't seem to ask Xiqing about the backroom rivalry between CIC and China's SAFE Fund but instead focuses on what's become fairly standard and elitist foreign schadenfreude over the collapse of US financial markets.

Xiqing appears to put the blame squarely on American profligacy - particularly in his criticism of financial innovation to the point it harkens the days of communist rhetoric over 'western decadence'. Xiqing however is hardly alone. Even Warren Buffett in 2003 began calling complex financial derivatives "weapons of mass financial destruction" (BBC). After regulators stepped in and formed a central clearinghouse following the collapse of Lehman Brothers, it has become quickly apparent this view is wrong.

The reality is that despite the initial hysteria over credit default swaps, it turns out that the exposure ended up being limited. According to Bank of America, because of compound counting (double counting, multi-fold), the real exposure to the entire collapse of CDS is really only around 3.2 trillion dolllars (and in FT Alphaville's terms, this would require absolute and total financial armageddon far worse than the Great Depression and require practically every major company with any debt to go bankrupt). While 3.2 trillion is not a small number by any means, it's hardly the 576 trillion-1.14 Quadrilliion the Bank of International Settlements (BIS) had ridiculously and previously estimated (Jutia Group). Indeed, it makes them more "weapons of mass innocuousness" (Over the Counter).

Regulators appear to be positioning themselves to respond to the previously held and hysterical view - my guess is because they for some reason believe the markets are truly beyond reason and it was in theory a credible disaster and in response to public pressure (or more cynically, out of ideological convenience). We fear what we don't understand and in these remarkable times, if there's anything that journalists have proven, it is that they seem to understand very little. As Paul Kedrosky points out, even common publicly traded shares fit the definition of the "scary derivatives" that are supposed to keep us awake at night. It may be useful to remember, as regulators rush to protect the markets from themselves, that innovation is the golden goose from which the US draws its economic power.

Xiqing points out that there are many betting against the US, and if regulators move to crowd out private investment and make it costlier to raise and find capital, regulators will make those like Xiqing right.