The China Vortex

For a long time, I have been telling my friends that China is not going to use its foreign exchange reserves to bail out the US and the rest of the world. Aside from the fact that China does not feel like a superpower, it is becoming apparent with each passing day that China has very real problems of its own, and is going to have use its own reserves to help itself.

Another popular argument is that the newly rich Chinese consumers will go out and spend their yuan, helping the newly poor west out of its self-made predicament.

I have a few stories to tell you which make me doubt this.

Recently, at an apartment in Beijing, I went out to take the garbage, which is in the common area of the building near the elevators. Shortly after going into this area, I noticed that the only lights in the area, which has no windows, were two low-energy consumption bulbs on the other side of the area. Nothing else was on except for those two bulbs, including the stairwell, which was completely black and did not have any lights on. Obviously, the building management company, in an effort to save electricity, had turned off the lights to less than what I would consider safe.

So these are the same guys who are going to bail out western consumers from their problems? Hmmm….

Anyone who has stayed in China for any length of time will find small cards which have a photo of an attractive young woman smiling prettily, with a rate card and mobile phone number on the back. On these cards, the young woman will offer “massage services” with services called 西班牙骑士 and 综合保健 offered. Sometimes the cards mention that the young woman is a university student.

Now, what caught my attention recently was that their rates had gone down! The most expensive package 综合保健 or Total Healthcare Package had gone down from 398 yuan to 298 yuan. My guess is that the market was pulling back, and these young women were asking for less, at least according to my completely informal China Masseuse Index.

Then yesterday I flew from Beijing to Shenzhen. On arrival at Shenzhen airport, I took a small 20+ person bus to downtown Shenzhen. During the ride, as we were going downhill, I noticed that the bus mysteriously went silent. Then, it occurred to me that the bus driver had turned off the engine to save gasoline/petrol costs and was coasting downhill until we reached the toll booth. After we reached the toll booth, he restarted the engine, and we were on our way.

Taken in isolation, I would have said that each would at most, have been an interesting and amusing anomaly. Taken together, they paint a picture of a society which is indeed worried about the future, and is doing its best to cut expenses.

So that, from the street, is my reasoning for thinking why China will not help the west. It has too many problems of its own.

UPDATE: Caijing, the leading economics and business magazine in China, has a short report which supports my observations about falling energy demand from Chinese consumers. (h/t to Bill Bishop)

If there is one thing which most western companies coming into China miss out on is the idea of “trial spots”, or as they are called in Chinese 试点。

So what is it? Basically, it’s a city, place, province or region which is used to try out something experimental which has not been tried before. When China first opened up, Shenzhen was a trial spot for opening up the economy to foreign manufacturing investment. When the experiment succeeded, it was pushed out to the other parts of China. Shanghai and Beijing were opened as tier one cities to foreign companies and employers, mostly in the service sector. When these experiments worked, the opening up gradually started. In most cases, the trial spots were selected by the central, provincial or municipal governments.

Now, there is another little secret. Large SOEs (state-owned enterprises) also often have their own trial spots. Most of the time, these are used to put some of the rising senior-level managers in to try new management practices. They are usually given a city, and a long leash, and are encouraged to try new ways of management. Often these managers are people who have made it to a certain level in a state-owned enterprise, but will not or cannot rise higher because they are somewhat non-conformist, and shall we say, less interested in politics. (Remember that in SOEs, the party also has a say in the selection of candidates for senior positions.)

Frequently, the Chinese way of handling these non-conformists is to give them a “trial spot” where they can experiment in a city or provincial division on their own. If something goes wrong with their experiment, then the damage is limited to their immediate market. If, on the other hand, the experiment was successful and includes practices which can be used on a larger scale, then that person may be promoted to a higher position with greater responsibility. This is how the current leadership of China has been groomed, just to cite an example.

The interesting thing is that many western companies, even consultants, are completely unaware of these practices. They look at their choice of investment areas in western terms, which usually means that which is clear, and out there, in the open.

They don’t study the people.

Instead, they should ask where the different “trial spots” are, and the backgrounds of the people they are dealing with. The right questions to ask for SOEs are:

• “How did this person get to this position?”
• “What is he trying to do?”
• “How is he different?”
• “What do his employees think of him?”
• “What are his goals and his definition of success?”

If it sounds like questions an intelligence agency would ask when examining the new leadership of a country, then it does because it is just like that. I call this “due diligence with Chinese characteristics”.

And how do you get this information? I find the best way is walk in and ask (In Chinese, of course. Speak English and you only get the official line.)

For the most part, you will never find these people in Beijing or Shanghai unless they have been very successful. These are two highly conformist politically-charged cities, and the only way they make it to these cities is if they are in very senior positions, and their views have been vindicated.

Generally speaking, Chinese, even including the party, are more tolerant of non-conformists. Just don’t look for them in Beijing and Shanghai. Deng Xiaoping, the architect of China’s reforms, was for many years considered a non-conformist and was punished repeatedly for his views. Eventually, his policies became the mainstream.

So, how will the recent economic problems affect things? Basically, we are going through the collapse of an old world order, and nothing new to replace it has come up yet. The Chinese government, the party and Chinese SOEs will be looking for answers on what comes next to restore order, growth and stability. After all, this is what Chinese social stability depends on.

For Chinese government and party officials, it will be a good time to be something of a maverick. But these mavericks will only survive and prosper if they can come up with the right answers to some very tough questions.

With all the chaos on world’s markets, it is easy to overlook developments in China. The biggest piece of Chinese domestic news is the decision to give limited rights to land use to China’s farmers. This decision came out of the Third Plenary Session of the 17th Party Congress of the Chinese Communist Party (三中全会), which is now convening in Beijing.

The overall thrust of this meeting is to focus on the development of rural China, which has not fared so well as the east coast cities. If the cities continue to develop, and the countryside continues to stay poor, you have the recipe for social unrest on a large scale.

The salient points about China’s development are that China has about 1/3 the arable land of the developed economies for farming, and about 500M live in cities, while 800M continue to be rural Chinese. National development plans (many of which were formulated under Jiang Zemin, who came from Shanghai) called for the urbanization of China.

China’s first 30 years of reforms required the development of the eastern coast to attract foreign capital, and to make the companies and the westerners who came to China feel comfortable. Only when they had reached some level of comfort, and were attracted by the market potential would the capital follow. They became comfortable and the capital and trade followed.

And now the westerners living in Beijing, Shanghai and the west expect the Chinese with their nearly US2T in foreign reserves to bail out the western economies? Let me tell you why it won’t happen.

• Successive Chinese regimes have always lost power when they coddled the urban elite and ignored the needs of the countryside. This was how Mao rallied the Communists, surrounded the cities (the strategy was called “using the villages to surround the cities” or “乡村包围城市”), then threw out Chiang Kai-shek in 1949. Hu Jintao and Wen Jiabao know this, and know that they need to swivel around and develop the countryside so that the wealth gap can be narrowed.
• The Chinese government will focus on developing a new size of town, which in Chinese is called the 城镇 or village town. This will be mainly a distribution, education and trading center for farmers and their families in the immediate vicinity. Population will be 250-500K.
• For the next 15-30 years, the cities will stagnate in growth. People will not lose their homes the way they do in the US since China does not have foreclosure laws, but their salaries will not go up. Many of the wishes new university grads entering the workforce hoped they had will just become dreams. Somehow they will have to learn to live in this new drastically changed environment.
• The Chinese government is already talking about the development of rural infrastructure including rural insurance, microlending, etc.
• Many young Chinese who would have scoffed at the idea of working in the countryside will now go there, simply because job opportunities in the east coast cities will be limited. This, in turn, will help to clean out the party apparatus in the countryside, which has been seen as generally corrupt.
• Western companies will not benefit too much from this next stage of development because they do not, for the most part, understand how to sell to the bottom 2/3 of the Chinese pyramid. Most only know how to sell to the top 1/3 in the cities. Companies which will prosper are those who sell to the “local local economy”, or bottom 2/3, as Jack Perkowski calls it, as opposed to the “local foreign economy”. The local foreign economy is city-based on China’s east coast; the local local economy is mainly rural and inland.
• The companies which will survive and prosper are the swift pivoters who can quickly learn how to sell to the “local local economy”. This means that they made some money in export manufacturing, but now switch to sell domestically to Chinese consumers in the new inland towns and cities. Not many companies can do this, but those that do will do well. Most will be entirely new businesses, and local Chinese brands will have an advantage.
• This next stage of development will require a lot of money. Those foreign exchange reserves of US2T will be needed by China. Now, if you ruled China and you had the choice of 1) lending the money to the west, which has just acted about as irresponsibly as anyone can imagine or 2) investing the money in China to narrow the wealth gap between rich and poor, city and countryside and keeping your regime in power for more than a half century, what would you do? I think that it’s a pretty easy choice.

China may now have the world’s largest foreign exchange reserves, but that is not what makes a country a superpower. The recent tainted milk scandal has shown that it is still lacking controls in many key areas, and it is far short of being a developed nation. Instead, China is a developing nation with rich reserves it needs for its own development.

In order to become a developed nation with a developed economy, it needs to spend that money on building its own infrastructure and narrowing the wealth gap between the developed cities on China’s east coast and the inland countryside. Any Chinese regime which acts otherwise would be making a very risky decision, and would be putting the future of its own rule in jeopardy.

China can manage without export markets, but it cannot survive if its own countryside is in turmoil.

Following on the global credit crisis, many have come to me to ask how these changes will affect China. As I have said earlier, China and the US are two sides to the same coin, and it pays to look at them as one economy, as this Newsweek article does. It goes without saying that this crisis will have a profound effect on China, and I’m not optimistic about the capability of the Chinese central government in Beijing to deal with it as quickly as it should. Michael Pettis, who lives and teaches in Beijing, has been a persistent advocate of stimulating more domestic spending from Chinese consumers, and continues to advocate that position. I agree that this is necessary; I don’t think that this will happen quickly or on an even basis. There is a simple reason for this: stimulating consumer spending depends, to a large extent, on the rollout of a national healthcare system; this is something which Beijing has tried to do since the early 90s, all without success. When it comes to the lack of a national healthcare system, the US and China are in the same boat, and the national governments are equally ineffective.

So what are some investment rules you can use? Let me list seven below:

• Avoid Shanghai and Beijing. Both have excellent universities, and Beijing has central government ministries while Shanghai is the commercial capital of China. In IT, companies have preferred to hire from Tsinghua for smart technology people. But there are major problems with both cities. First of all, staff turnover is too high, and costs are too high. In the past few years, staff have routinely asked for 20-30% raises just to stay in the same company! And with all the western companies constantly going into those cities, there has been a bidding war for staff. We are in tough times now, so do you really want to get involved in bidding wars over your local staff and deal with staff turnover issues? I don’t think so. And when it comes to Internet/IT, I say that the Internet already has become a platform and there is plenty of talent around. Do you really need expensive people from the very best universities in China who may prove a pain to manage? If you don’t, second-tier people who are reliable and don’t ask for huge pay raises are good enough, and maybe even better. When hiring local talent, look for tortoises, not hares. We are heading for much tougher times, and you need a good stable team. Beijing and Shanghai have too many hares. Your most loyal people will be the ones you hired and trained on the job. They will also be the ones who understand local market and conditions and connections.Another major issue about Beijing and Shanghai is that they are geared for exports, especially to the US. Do I need to tell you what happened to that export market?
• Instead of going to Beijing and Shanghai, look at the 20 major city markets in China if you are thinking of selling to Chinese consumers. Now is a good time to get into services for Chinese consumers. Think of cities like Dalian, Hangzhou, Ningbo, Xiamen, Guangzhou, Wuhan, Nanchang, Chongqing, Chengdu, Fuzhou, Kunming, Nanning, Nanjing, etc. If you want to get into China under the radar (in my opinion, always a wise strategy), these are places to look at very seriously. If you need knowledge workers, as in programming or game production or pharmaceuticals, pay special attention to the local universities, and partnering with them to hire their graduating students. If you show the cash and commitment, and can guarantee jobs for their students, you will get multiple offers of good deals.
• Guangdong and Zhejiang are the two largest manufacturing provinces in China. Guangdong’s factories depend on a huge pool of unskilled immigrant laborers, mostly young women, from Sichuan and other provinces. These factories and workers are going to be hit hard because of their dependency on the US market. There is too much overcapacity, too little value-added, and too little profit for most of these factories to move up the value chain. Unemployment in Guangdong and Sichuan will become a major issue. Zhejiang’s factories are mostly family-owned, and it has less reliance on immigrant workers. Because of Zhejiang’s strong private sector and private wealth, they will be able to make the adjustment in market demand from exports to domestic Chinese consumption more quickly.
• If you are a private equity or hedge fund investor, you need to think about investment horizons. In order to make up for the dropoff in exports, Beijing and provincial governments would naturally think of investing more in infrastructure. So far, most of this money has gone into infrastructure, manufacturing and real estate. The problem is that these areas are already built up and have over-capacity. They are really at a loss about what to do. If you can help and offer investments which create jobs and upgrade the skill force, you are in a good position. Be sure to get your money and profit back within 15 years (by 2023). That is because if you are selling to Chinese consumers, you are selling to the current group who are in their 20s – 40s. By 2023, China’s demographics will fall off a cliff because of the one-child policy, and they will be in savings mode instead of spending mode.
• When it comes to modernization, China is crossing a 30-foot chasm with a 20-foot rope, with each foot representing one year. China’s hardware development and infrastructure are very impressive and are the most modern in the world, as the Beijing Olympics showed. The hardest part to modernize is peoples’ mentality as the tainted milk scandal has shown. China’s aging demographics do not give it enough time to cross the chasm, so Chinese will get old before they get modern. When that happens, China will look like a bigger version of Japan, and will have all the problems Japan has today. Just hope that China has a national healthcare system in place by then.
• The wealth gap will become wider over the next 10 years between the cities and the countryside, then stabilize for five years, then shrink as the city worker bees retire in 15 years. Rural infrastructure is less developed, and so far, the Chinese government has made all the wrong moves in rural development by not supporting the development of rural collectives for the farmers. There is an excellent article (in Chinese, h/t to Stan C) about the failure of China’s rural development, and how Chinese rural development will look like the Philippines with large food processing companies employing poor farmers. This organization is partly responsible for the Sanlu tainted milk scandal, and is copied from the US. But the US has a surplus of land and shortage of farmers, while China has a shortage of land and excess of farmers! If you are interested in macroeconomic issues, this is worth more study. Its view converges very well with the view of Yasheng Huang in his new book Capitalism with Chinese Characteristics, which I have also mentioned in my previous article.
• The dumb money has already been made in China. It’s time to rebalance your portfolio to make smart money. It can be done, but it won’t be easy. Think smart, work smart, and invest for 15 years. By that time, you should be able to retire.

If you need more information specific to your fund/company/situation, you can contact me from the About page.

In the past few days, Henry Paulson has come up with his US$700B proposal to save the major lending institutions which made bad decisions re CDOs, with all the bad loans being covered by the US taxpayer. This is happening at a time when the US middle class is under unprecedented pressure already.

Over the next year, all the bad decisions made by China’s economic planners over the past 30 years will show through. These include:

• The decision to become overly dependent on the US as an export market, and buying US treasuries to effectively buy this single captive market and continue to sell it goods far beyond its capacity to pay for China’s exports.
• Somewhere along the line, a decision was made to jumpstart China’s economy and put it on the fast-track of economic development. To a large extent, this has happened. But China’s economy is like a body builder whose upper body strength is massive, but has toothpick legs. More incidents like the melamine milk incidents will become common, simply because the government is not equipped to handle incidents of this kind.
• China, unfortunately, has a reputation for cheap, low-quality products, in spite of the successful Beijing Olympics. For the most part, Chinese companies do not have the talent to work up the value chain creating better products. (There are some, but they are too few to make a significant difference.) This takes time to build.
• Exports will slow, and the Chinese domestic market will not pick up the slack fast enough to prevent major unemployment problems, especially among university graduates.
• The wealth gap between the rich and poor will widen dangerously, and real estate prices, which are already falling, will fall even more.

China became addicted to US orders and the US dollar the same way Americans became addicted to Chinese junk products. (This is a generalization; many goods are not junk. But the general image is of, well, junk.) For both sides, it was a dream which was too good to be true.

Now it’s over, and the Beijing Olympics are turning into the final hurrah for that period.

If you would like a well-presented systematic presentation, my friend Corbett Wall has written an interesting piece.

The fat days are over, and we are in for a tough 20-30 years ahead.

One of my biggest complaints about western observers of China is the overly used term “China market”. In fact, there is no China market, just as there is no European market. While there is a European Union, which many Europeans complain about as some kind of bloated legislative bureaucratic monster, it would be silly for any marketer to think that there is anything like a European market on the ground. After all, what are you talking about? Are you talking about the UK, Germany, Belgium, Spain or Italy? Even within these national markets, there are vast social and cultural differences within the same country.

While China is ruled as a single nation from Beijing, the political, regional, social and cultural differences within China are just as big as in Europe. While many western observers see Beijing as authoritarian, the truth is that Beijing has to play a huge juggling act among its own provinces. Every time the center asks for something from the provinces, it has to offer the provinces something in return. In this respect, China is just like the US, Russia and other big countries. There is endless bargaining, trading and swapping of favors, most of which does not occur publicly and is not common knowledge.

These local differences even extend to Internet businesses. The two biggest and most successful companies which dominate in CPC advertising and micropayments are both based in Shenzhen, and are not in Beijing and Shanghai. They are Tencent and Xunlei. Tencent is the leader in charging for micropayment-based subscription services and is the leader with its popular instant messaging client, QQ. Tencent is publicly listed in Hong Kong, and analysts love the company’s business model. Xunlei is a leader in P2P distribution of video, and inserts ads into video content before sending them on their way through its network. Although it is still private, it is already profitable, and Google has invested in the company.

If you go to Beijing, the media landscape is dominated by Sina, Sohu and Netease, China’s leading portals. I think of these companies as being like Web 1.0 national newspapers; they are like the Wall Street Journal and New York Times in China for the Internet generation. Because media content is a politically sensitive area in China, they need to be close to the government, which is why they are in Beijing.

And Shanghai is where most of the gaming companies are. While Beijing is home to serious media and sports, Shanghai is much more entertainment oriented. In the twenties and thirties, Shanghai was the home for China’s film industry; and the talent for entertainment had strong roots in Shanghai. After 1949, many of the producers, directors and actors moved to Hong Kong, but with China’s opening up, many have returned to their old base in Shanghai.

Think about it. Why is it the case that two of the leading micropayments companies in China are based in Shenzhen? I believe that being in Shenzhen forced these two companies to be much more consumer-oriented since fewer VCs ventured there. The paucity of easy access to capital forced them to be creative. In their early days, they were able to get favorable rents, cheaper employees and lower their other costs because of favorable terms from the Shenzhen municipal government. Micropayments really started in desperation as a payment system for poor people who had no credit in a nation without a national credit-ranking system who did not have credit cards. Without money from VCs, these companies were forced to innovate, and had to come up with a solution which got money from consumers.

Getting paid by your users; what a neat idea!

In China, many smart entrepreneurs go to second- and even third-tier cities so that they can get a local municipal government to support them. This is called finding a 靠山 or literally “a mountain to lean on”. After all, every city official wants to be able to say someday: “I helped set up Tencent (or Xunlei, or whatever.)” That would look good on their resume.

I’m always mystified that western-funded companies like to set up in Beijing and Shanghai; why don’t they strike out into other Chinese cities? Most of the time, I think it’s because their management are able to enjoy a level of living which is closer to what they would enjoy in the west. The problem is that because they are more like western cities than most Chinese cities, they give a skewed and sanitized view of what China is really like.

As a result, they unwittingly hand over the advantage to smart local Chinese companies. With the huge number of Internet companies in those two cities of Shanghai and Beijing, it’s almost impossible to find any Chinese government officials who can serve the role of mountains to lean on. And when you can find them, the cost of the mountains are much higher.

In China, you know something has become big when the government starts worrying about how to regulate it. (Come to think of it, that’s the way it is with most governments, not just China’s.)

China’s central bank, the People’s Bank of China, has asked the Finance Department of People’s University in Beijing to come up with draft plans to regulate micropayments in China. (People’s University is traditionally the training ground for government officials.) Right now, micropayments occupy a gray area, which means that they are not technically legal or illegal. They just exist.

And they are unregulated. Right now, the Chinese government has no idea about how to regulate this market, which it obviously expects to grow substantially. Some have even grumbled that this new virtual economy will eventually grow in size to rival offline economies.

The most successful subscription micropayment based company in China is Tencent, which is based in Shenzhen and gets unofficial support from the Guangdong provincial government. (The Chinese have a saying: 天高皇帝远 which literally means “The skies are higher when the emperor is farther away.” Unfortunately for most western companies, they are not aware of and do not heed this very wise Chinese saying.) It has its own virtual currency, the QQ-Coin, which can be purchased one-way with Chinese yuan, but cannot be converted back into Chinese yuan. The company recently announced record earnings.

You get big, you get regulated.

The Chinese government’s watchdog for equities, the CSRC (China Securities Regulatory Commission) has issued an edict to local fund managers that they are not to issue any pessimistic reports about equities during the Olympics in Beijing.

My question is “Why bother?”

The Shanghai market has been down 50% in the first half of the year, and what started out as a subprime mortgage problem in the US has now morphed into a banking problem with more US banks at risk.

In the meantime, Pony Ma, CEO of Tencent has joined in the chorus with Alibaba’s Jack Ma to talk about hard times ahead. The Chinese government has signaled that the rise of the yuan against the dollar will slow down, with a very public discussion in the People’s Daily. The signs of economic deceleration are everywhere.

When there is so much public discussion about upcoming economic challenges in the Chinese and western media, what good could possibly come from telling local fund managers not to say anything bad which might upset the Chinese equities markets? While many western observers of China see this as a sign of an authoritarian regime, for many Chinese, it looks more like desperation. Instead of allaying fears, it makes those who are still in the market fear the worst, and think that the government is trying to suppress even worse news, which in turn will fuel the rumor mill and make the market even more volatile.

In short, this looks more like a desperation move than a well-thought policy move. Instead of helping the market, it’s likely to make things worse.

This is what happens when politics interfere in the markets.

Over the past year, the tone of coverage of many China-related topics in the US has improved. For the most part, writers covering China have tried to look past the generally-accepted stereotypes, and have tried to get a deeper understanding of what is going on in China.

But occasionally something finds its way through the cracks.

This article is really exemplary; it seems like the writer has taken all the stereotypes about Apple and China, and thrown them all together in one basket. Judging from the tone of the article, and what he professes to be truth, it seems like he has never set foot in China. Otherwise, how could be believe some of the things he writes?

Let’s take a look at some of the choice statements:

Apple has less than 8 percent market share in China for media players, and far less than 1 percent of either PC or cell phone market share.

Yes, so? I wonder if the writer has walked into any cafe in Shanghai, Beijing and Shenzhen, and looked around? Or has he taken any of the subways in any of those three cities and looked around for the signature white earbuds? The question should not be the percentage market share. It should be the trend, and whether it is tracking up or down.

Apple’s second biggest hit in China, the iPhone, isn’t authorized. One Chinese analyst estimates that some 1 million Apple iPhones are currently operating on just one Chinese carrier — China Mobile — with a smaller number on other carriers. Most Apple “Authorized Resellers” in China sell black-market iPhones, and many even offer illegal cracking services — a process that reportedly takes less time than activating an iPhone 3G in California.

Apple makes money off of every iPhone sold, whether it is through authorized or unauthorized channels. Sure, Apple would like to have a carrier agreement in China, but having a group of fans, even though it is relatively small percentage-wise, which is very enthusiastic about Apple products, is a good thing. Besides, there are a lot of people in China who pay even more for more expensive feature-packed mobile phones in China. In fact, the iPhone is not the most expensive phone in the market. Ask Nokia.

Apple succeeds because customers love the products and the brand. But in China, brands mean little to most potential customers, and hardware even less. Chinese consumers prize value above all.

This quote is a true gem and qualifies as one of the most ignorant sweeping statements about China for 2008, even though we are only halfway through the year. Obviously the writer has not been to China and walked in the downtown of any major city. Here is an article about the runup to the recent opening of the Sanlitun store in Beijing and another story about Chinese youth camping out in front of the Beijing Apple store, where they were behaving just like American Apple fans.
I guess that’s why there are no Mercedes Benzes, BMWs, and Chinese women don’t care about the labels they wear? Maybe he thinks that they still wear Mao suits?

The rest of the world’s love of the Apple brand has enabled Apple to get favorable terms with carriers around the world. But this hasn’t helped much in China. Apple initially demanded a big two-digit percentage of carriers’ wireless revenue as a condition for granting its coveted exclusivity deal, according to reports (one company says Apple demanded 30%). The Chinese carriers were apparently unimpressed by the value of Apple’s brand compared with the value to Apple of access to Chinese consumers. They appear to have forced Apple to drop its demand for any share of wireless revenues.

The reason Apple has not been able to get an agreement with China Mobile is because they are both big companies with very big egos who want to control everything. I would say that Apple and the carriers have trouble reaching an agreement because they are so much alike, and don’t believe in compromise.

One-party rule in China actually affects product quality. One example is that Apple will probably be required to disable the iPhone’s Wi-Fi feature in order to comply with the Communist Party’s strict Internet control and censorship rules.

The relationship between one-party rule and product quality is an arguable point. But if it is that simple, then why are ALL of Apple’s products made in China? As for the disabling of Wi-Fi on phones sold in China, that is a China Mobile requirement, not a State Council requirement. (If you think that the rulers of China don’t have better things to worry about than whether mobile phones in China have Wi-Fi functionality, you don’t know anything about the country and how it’s ruled.) Besides, with the recent re-arrangement of the Chinese telcos, it’s not as if China Mobile is able to control Wi-Fi as much as it would like.

China is number one in intellectual property theft

Apple’s whole business model is based on creating value through exquisite design, superior branding and the sale of creative intellectual property (IP) — then defending its rights against the IP thieves, pirates and counterfeiters.

How will this formula succeed if China doesn’t enforce intellectual property laws?

The music piracy rate in China is between 90 and 99 percent, depending on whom you ask. China is the global epicenter of intellectual property theft in general, and of Apple IP theft in particular — especially iPhones and iPods.

Fake iPhones, and phones that steal Apple branding; illegal iPhone unlocking services; trade in illegal movie and music files; all appear to be tolerated and even government-protected activities in China.

Oh yes, how can we talk about China without IP violations? Seriously though, this is an issue. The best way to fight IP though, is for a country to get more prosperous. As people become wealthier, they are more willing to spend money on software, music, etc. In China, it is also very important to explain the importance of IP to various government ministries, and even be flexible about how much you charge Chinese consumers. Many Chinese think that they should not have to pay as much for music as US consumers because they have a lower income and standard of living. Does that fit into any American companies’ equations? Up until four years ago, Microsoft had a very high level of illegally installed Windows licenses in China, and constantly lobbied with the US Congress to “punish” China. When Microsoft China changed tactics and chose to engage Chinese ministries, educate them, and lower the license fees (as China’s standard of living increased), first the ministries, then the schools, then the people started buying original software from Microsoft. Now Microsoft gets more revenue from China, and the relationship with the government is much less confrontational. Piracy of Microsoft software still exists, but again it’s about the trend, which is improving.

Steve Jobs is an exemplary business and marketing genius. But when it comes to learning about other markets, he is lazy. He would like nothing better than to set prices for all media products sold through iTunes himself, and he would like it to be the same all over the world. China is a major kink in his vision.

How many times has Bill Gates been to China? How many times has Steve Jobs been to China?

I rest my case.

Some signs point to a rapid deceleration of the Chinese economy:

• Politburo to convene urgent economic meeting
• Chinese Domestic Olympic Travel Falls Lower Than Expectations
• Unsold inventories climbing
• Shanghai Vanke first to lower real estate prices in Shanghai (in Chinese)

The whole idea of an urgent politburo meeting just three weeks before the Beijing Olympics is a strong indicator of how serious the ruling levels of the Chinese government see this situation and would, in my opinion, be an ominous sign.

All of the signs point to an economy which is rapidly deflating, following on the falling performance of the Shanghai stock exchange, which has fallen more than 50% in the first half of the year. A lot of money which people thought they had made, and did not think of converting into cash thinking that it would go higher, is no longer there.

In China, this is always a warning sign of potential social instability. It also explains a lot about why the Chinese government has introduced new licensing regulations for online video and other communications means where people can communicate quickly, spreading views contrary to the official line, and events can quickly spin out of control.

If the Chinese economy deteriorates, as signs suggest, then it would be safe to say the government controls would tighten further. This would especially be the case in areas where foreign investment capital has gone into sensitive media sectors, which is always viewed with some degree of suspicion by the Chinese government.