Chinese Economy: Early Signs of Rapid Deceleration

July 23rd, 2008

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

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.

The People’s Republic of Capitalism

July 11th, 2008

Yesterday I had the opportunity to watch Part 1 of Ted Koppel’s documentary series The People’s Republic of Capitalism on the Discovery Channel. Instead of going to Beijing and Shanghai, the normal stops for most first-time visitors to China, Koppel went to Chongqing, a city I have visited and written about.

The documentary is very intelligent and well-done, Koppel covers companies in the US who relocate their manufacturing to Chongqing, and the effect on the lives of the American workers who lose their jobs in the US, as well as the Chinese workers in the factory in Chongqing. He also compares how differently WalMart is viewed in China and the US. Koppel does a very good job of providing context about the effects of globalization, which mix good as well as bad for everyone.

Part of the reason the documentary format is appealing is because:

  • Many news departments cannot afford to send someone to a foreign country to live in and understand a different society for any length of time, even for a country as important as China
  • Most editorial head offices have their own agenda, and see things very differently from the local people, which leads to an unbalanced view
  • The views of many Chinese are often dismissed because westerners think that they are, rightly or wrongly, closely supervised by minders and are only speaking the government line

Koppel is fortunate because he had an excellent record on his nightly news program, Nightline, which he hosted for nearly 20 years. And now, he is able to make the kinds of programs he likes, without having to worry about time and budget considerations. It would be nice if there were more journalists who could make documentaries the way Ted Koppel is able to.

The series is a four-part series showing on four consecutive nights. If you are outside the US, you will most likely be able to buy the series from iTunes, because Discovery regularly sells their documentaries in the Apple iTunes Store.

Interfering In Another Country’s Internal Affairs

June 19th, 2008

“Interfering in another country’s internal affairs” is a routine mantra often used by Chinese government spokespersons, and is used most often when pointed at the US and US critics, especially with regard to human rights policies.

On the surface, this makes a lot of sense, especially with regards to generally ignorant US politicians, movie stars and others, who would have a hard time finding places like Tibet and Darfur on a map, but are moved by some of the images they see on television. For them, China and Chinese policies are a very convenient whipping boy, even though they have very little context and understanding of the real underlying issues.

This naturally puts the Chinese government on the defensive and more recently, some Chinese have become angry at the overseas criticism.

So who’s right and who’s wrong? Those who argue against interfering in another country’s internal affairs, or those who say it’s OK to do so?

The fact is that if a country is big and has a strong economy, whatever it does has an effect on other country’s economies, and on the global economy. Even though only American citizens’ can vote in their elections, the gross stupidity and ineptitude of American economic and trade policies in recent years do not end at America’s borders.

They go far beyond it.

And the Chinese government has started complaining about it. After all, they hold huge amounts of US dollar-denominated treasuries which are losing their value daily as the US dollar loses value, and their sovereign wealth funds are blocked from making investments in Europe and the US, mainly on political and not economic grounds.

So aren’t Chinese government officials interfering in US internal affairs? Yes, but the two countries’ economies are so tightly intertwined, the US policies are having an effect on the Chinese economy. When they are so tightly bound together by trade and economics, there is no borderline. It’s as silly as the right arm complaining about the left arm.

The fact is that the US and China are like two handicapped people: one is blind and the other is deaf. They need each other in order to survive.

The sooner politicians, officials and miserably deficient media on both sides recognize that, the better. If they don’t, ordinary people will continue to get caught in the middle and distracted by bad policies and ignorant offline and online media pundits getting them to chase red herrings while the real problems get worse.

Getting The Dragon Right

June 12th, 2008

On June 11, I attended an event in Beijing where Jack Perkowski, author of the book Managing the Dragon talked about his experiences doing business in China and on the Chinese economy. He also keeps a blog where he talks about China-related topics. In March, I had read the book and wrote an online review which you can read here.

During the dinner talk, Mr. Perkowski talked in greater depth about some of the issues he talked about in the book. Most of the audience of 20+ people were people who had considerable experience living and working in China.

He talked about how he saw China as having two different economies, which he calls the “local foreign economy” and the “local local economy”. He sees the local foreign economy as being made up of 400M people who have average annual income of US7500. The other 900M people have an annual average income of US2500. Right now, these are almost separate economies in the same country. The existence of the local local economy, which is very cost- and price-sensitive, means that there is a large part of the economy which needs modern things, but cannot afford western prices. Many Chinese companies are looking for new ways to reach this audience. This means that manufacturers are always looking for new ways to constantly cut their costs to reach them, which in turn leads to a very high rate of innovation.

An example he mentioned were piston rings. There are six global piston rings makers in the world, but there are 400 in China. The reason for the China discrepancy is because there is demand for cheaper solutions from the local local market, who are always looking for cheaper and more competitive components. While they have the same need for transport as the foreign local market, they cannot afford the expensive brand components.

In contrast, the foreign local economy accepts a higher level of costs, and is less sensitive to pricing pressure. These are mainly export manufacturers which have come to China from the US or Europe and come to manufacture auto parts first for their home markets and then later, other markets. Mr. Perkowski believes that in order to survive, it’s essential to reach down into the local local market. Unfortunately, many American car makers were unaware of this market, and wanted to sell only into the foreign local market. In the meantime, the toughest Chinese makers which have prospered and survived, claw their way into the local foreign market, where they are much leaner, meaner and smarter than the major US makers.

It made me think that in reality, China has a domestic market and an export market. The domestic market can be thought of as the local local market, and the export market is the local foreign market. Eventually, the two markets will merge, but it will take some time before that happens.

Mr Perkowski mentioned that the US “makes” 16M vehicles annually, of which 5M are imported from other countries. This means that in reality, the US makes some 11M vehicles annually. According to him, American makers are not able to make money on small cars, only on larger vehicles such as SUVs, which Americans are no longer buying because of high gasoline prices. The Chinese auto makers, in comparison, are able to manufacture small cars profitably. This year, Chinese makers will make some 10M+ vehicles, putting Chinese manufacturing capacity on a par with US makers. He believes that China will overtake the US economy in size, and Americans will have to get used to the idea of having the second largest economy in the world. (My note: Of course, it will take some time for India to take the world’s second largest economy position away from the US.)

He believes that the place where the US will continue to be dominant will be in efficient capital markets. This is a place where America will continue to be the world’s leader.

Mr. Perkowski does not speak Chinese, but his good common sense about doing business in China showed that he had a good deal more knowledge about China than many of those who speak the language. In his case, common sense and a good attitude have more than compensated.

Poverty Numbers As A Chinese Social Stability Indicator

June 9th, 2008

China Poverty Numbers

Seeking Alpha has an interesting article The Power of the Market: 600 Million People Lifted Out of Poverty Since 1981. The article comes with two graphs, one of which is above.

This shows that there has been a gradual fall in numbers of poor since 1981, but there was a bump in the years from about 1988 to 1994, when the numbers of poor stubbornly resisted to fall. This was a time of high inflation in China.

Do I need to tell you what happened in China in 1989?

This graph gives a rough indication that as long as the Chinese government is able to show a descending line that poverty numbers are going down in absolute terms, then the government’s position is safe. If inflation should pick up and the number of poor goes up, then they have something to worry about.

So far, developments on the economic front have been going well in China, with the noted exception of high inflation in China, much of which is due to higher commodity costs (food and energy costs) and capital inflows. Much of the capital inflow into China is due to investors who want to get out of the US dollar, and see China as the most attractive growth market for their money.

Rising inflation is usually an early indicator of other economic and social problems to come.

A few years ago, investment money coming into China was welcomed with open arms, but now times have changed, and the government doesn’t see them nearly as favorably as they did just one year ago. Capital inflows which are liquid can come into China, and also leave it very quickly, leaving the country’s economy and society in a lurch, just as it did during the Asian financial crisis of 1997 for the countries of Southeast Asia.

With the US economy heading for the dumpster, and Europe showing signs of weakness due to rising energy prices, that is not something the Chinese government wants. It is more than likely that the Chinese government will do anything to keep those poverty numbers going down in China, regardless of what it means for the rest of the global economy.

The need for social stability in China trumps everything else. Including commitments to globalization and the WTO.

Fasten your seat belts.

Where China Falls Short

May 1st, 2008

China’s economic growth over the past several years has excited many members of the international community, who see it as an alternative to the US’s and west’s leadership of the world order for the past two centuries. There has been a deep underlying distrust of the west, but it was brought to the fore by the Bush administration’s single-minded focus on the invasion of Iraq in 2003, and what to many, have seemed like trumped-up reasons for the invasion.

This, along with China’s dramatic economic growth, has opened up a great opportunity for China to offer an alternative vision of economic and social development. But China has fallen short with the recent fuss over the torch relay, and the actions of the fenqing (angry youth). In a very short period of time, a great deal of the goodwill China has earned has dissipated.

This situation has forced many supporters of the reform and opening-up of China into a lose-lose situation. If they support the Chinese position, they become seen as Chinese toadies, and if they criticize certain aspects of what has happened during the Olympic torch relay, they become dismissed by the Chinese, especially fenqing, as western toadies. Intelligent people should not be forced into making choices like this which are not real choices, and further polarize the two sides. People should be able to make constructive criticism without being forced to make bad choices and being pigeon-holed into one group or the other.

I, for one, believe that there is validity to the Chinese criticisms of the way China and the Chinese have been shown in the western media. There are biases; some are based on ignorance and some may be based on malice. But anger and heavy-handedness are not the right way to correct these perceptions; instead they validate the views and fears of China’s worst critics.

But this is not purely a public relations exercise. If China was a smaller and less influential country, maybe that would work. What China needs is to offer an alternative vision to the western model of development. This model must include dialogue, institutions and rules without a pre-conceived agenda which are pre-packaged for others, who must buy into it. Basically, a new framework needs to be created for Chinese engagement and dialogue on a global scale.

One of the criticisms of western hegemony is that it has offered a pre-packaged vision which in reality, offers pre-packaged western interests at its core. Joseph Stiglitz talked about this in his book Making Globalization Work.

So what is China’s vision? Is it just anger for western wrongdoing and the way it is depicted in the western-controlled media? How much goodwill will venting anger get China? There needs to be a better more thought-out way which offers more constructive results.

More people need to be included, and it should not just be government to government. It should be open where all can offer their views, and be listened to. Differing opinions should be debated and allowed to co-exist. Out of this, some kind of rationale for China’s rise has to come out, and this vision needs to be consistent with the rest of the world, as well as the Chinese people.

China is now a real power in every way. Real powers listen to and debate different views. If they don’t like certain views, they can offer a point by point rebuttal, or they can debate those views, but there is no need to get angry.

New times bring new challenges, and new challenges call for new thinking.

Let’s Get Past the China Monolith Narrative

April 18th, 2008

In the past month, there has been much discussion about how the Chinese government’s policy to Tibet has been intransigent and shows that China has not changed and reformed and become a more open society. Either deliberately or by implication, there is this myth that China is one big country with an authoritarian government which has a great plan to gobble up the world and take away the world’s natural resources, only to turn them into cheap products exported all over the world.

And China will not change, or make any effort to accommodate the rest of the world.

Many in the western media have not only failed to take into account changes in Chinese society, they persist in putting forth this outdated myth which many unknowing observers in the west continue to believe. One favorite is when speaking about China to always put it in the context of events of 1989. News images in the west routinely use an image of a man standing defiantly in front of a tank. The subtext of the message is simple: this is a government which does not care about rights and is not open. The result is that western audiences’ image of China is frozen in the past, and does not update to reflect current realities, and that is the reality of what China is today.

This would be as wrong, unbalanced and irrelevant as showing an image of a shackled African slave to show how racist American society is. Yes, there are injustices in society, but selecting extreme examples and implicitly citing them as fact do not contribute to the conversation. In fact, they make it much more difficult to reach some kind of understanding which can traverse cultural and linguistic boundaries.

In fact, Chinese society in 2008 is vastly different from 1989. For the most part, people have more freedoms than they did in 1989: they are free to choose their jobs, buy their own homes, where they live, who they marry and even to travel (with some restrictions) outside of China. Politics has taken a back seat, and most care more about their grocery bills (which have been rising precipitously) than what is going on in Tibet and adjacent regions.

Are there injustices? Yes, just as there are in any society which is undergoing rapid change. Just as there is no child who can learn to walk without taking some falls, there are sometimes setbacks. But let’s put things in context. The general trend is forward and to more openness, to a society which more closely resembles any modern society, warts and all.

Now there is another side to the recent Tibet events. If the Chinese government is indeed so powerful and all-knowing, why were they so taken off-guard by the events of March 14, and the other events which took place inside and outside China in the days and weeks after?

Does this sound like a government which knows everything about its citizens? I don’t think so.

My experience is that governments are incapable of performing very smart, or even halfway intelligent, acts. On an operational level, nineteen hijackers successfully pulled off the 9/11 terrorist attacks which killed 3,000 people, caused lasting damage to the American economy measuring more than 100 billion dollars, not to mention the American psyche. This was all done by nineteen highly-motivated individuals who were willing to die in the process of causing lasting damage to America. There was no government involvement of any kind.

Then contrast this with the current US administration’s decision to invade Iraq and remove Saddam Hussein from power. So far, this war has cost more than 4,000 American lives, thousands of Iraqi lives, and according to Joseph Stiglitz, has cost more than three trillion US dollars (most of it borrowed money; this is probably the first war in world history where the expense was put on the tab to be paid off by future generations) without any end in sight.

Who was smarter? Who is dumber?

This is the trouble with government conspiracy theories. They imply a level of secrecy, coordination, cooperation and intelligence which are almost impossible to find in any government.

The Chinese government is no exception to this rule.

Quality Fade: American or Chinese, Which is Worse?

April 5th, 2008

Paul Midler is an experienced sourcing expert who has worked in China for many years, and publishes The China Game blog. I believe that he is the first person to coin the term “quality fade”. Quality fade is, according to this article published in Forbes:

This is the deliberate and secret habit of widening profit margins through a reduction in the quality of materials. Importers usually never notice what’s happening; downward changes are subtle but progressive. The initial production sample is fine, but with each successive production run, a bit more of the necessary inputs are missing.

It seems a long time ago, but last year, a great deal of ink was devoted to covering the issue of defective products from China. In some cases, lives were lost in the US.

If I have one criticism of Paul Midler’s criticism of this very real problem, it is the impression it gives that somehow unscrupulous Chinese exporters are deliberately seeking to cheat and harm Americans, when in fact, many more Chinese have been injured and even killed by defective products coming out of Chinese factories. It’s just that the US media does not pick up these stories because the victims are, well, Chinese.

But if we are going to be fair about this problem, then shouldn’t we talk about the Chinese and other non-American victims of this problem as well? I think so.

Now, when it comes to the credit bubble problem, the issue of quality fade becomes even more interesting. This time, the culprit is not Chinese, but American. For a problem of such immense proportions, which is getting bigger and bigger by the day, amazingly, no one has identified the human culprits responsible for the bad decisions. But then, accountability never been a strong point for this US administration.

In China, when there was a problem with deaths caused by tainted drugs, the head of the Chinese Food and Drug Administration was sentenced to death and executed. No one yet knows the size of the credit bubble, but I have heard numbers from $15 billion to $45 billion bandied about. Mind you, the US economy is a US$12 trillion a year economy, so we are basically talking about anywhere from 1 year to four years of economic output disappearing.

Americans are losing their jobs, many are losing their homes, and the Fed has been scared into a series of panic interest rate cuts and into subsidizing the purchase of Bear Stearns by JP Morgan Chase and offering a Fed-backed unlimited credit lending facility to US investment banks.

In this article from The Washington Note, Steve Clemons talks about how the US exported poisoned financial products.

So, while Chinese factories have on occasion exported defective products, the US has exported defective financial products. And the US government participated because Treasury sold T-bills which were backed by these defective financial instruments.

Hmmm….

Now, back to quality fade. Let’s see if we can modify his definition of quality fade to capture the credit bubble situation:

This is the deliberate and secret habit of creating the illusion of increased purchasing power through the creation of fiat credit derivatives of dubious value. Exporters usually never notice what’s happening; downward changes are subtle but progressive. The initial credit derivatives are fine, but with each passing year, lose their value as more credit derivatives are created until there is a gradual collapse and new currencies and trading rules have to be established.

(The italics are where I have made changes to Paul Midler’s original text.)

When it comes to quality fade, the Americans have been wholesalers, while the Chinese are just occasional retailers.

George Soros Speaks Out On Current Financial Crisis

April 5th, 2008

George Soros spoke today in a talk and interview about the current financial crisis which started with the subprime mortgage crisis and has now become a global credit cresis. The event was hosted by the Steve Clemons of the New America Foundation, and which hosts a blog called The Washington Note. If you are interested in an intelligent perspective from Washington DC which goes beyond the political polemics, it’s definitely worth adding to your subscription list.

The New America Foundation has made an MP3 recording of the interview with George Soros available. If you are interested in the current financial crisis and where it may eventually go, it is definitely worth listening to.

George Soros has just written and published a new book called The New Paradigm for Financial Markets: The Credit Crisis of 2008 And What It Means. Because of the rapid unfolding of the crisis, he has chosen to make the book available in digital format so that readers can get it more quickly.

China Marketing: Think Deep, Not Big, and Add A Twist

March 30th, 2008

One of the things which I frequently hear from first-time visitors to China is that “It is so big!” Sometimes, I hear this even from Texans, an American state which takes pride in being bigger than almost any other state, with the exception of Alaska.

Westerners are not the only ones to fall victim to this thinking; Chinese also are enamored with these numbers. When I hear presentations, the most frequently heard numbers show 420 million mobile phone subscribers, 250 million IM subscribers, at which point the China virgins go gaga and start counting the yuan they are going to make (in their dreams) and planning their retirements (also in their dreams).

By now, I’m sure that you’ve figured out that I don’t buy into this view. Yes, China is big, but so what?

Instead, when you start looking at real revenue and earnings numbers, China is still way down there. And for many companies, both Chinese and western, it’s a difficult nut to crack.

But I don’t think that it needs to be. First of all, let’s get past the population and subscriber numbers. Yes, they are very big, and the only country which can even come close is India. All the thoughts, fantasies and conversation about projections should end there, and marketers should dig deeper to look at revenue and earnings projections, since they are the only real numbers which count.

Marketing 101 says that it isn’t the size of your market and number of units sold, it’s really all about your margins and accessories you can continue to cross-sell or up-sell to your customers after the initial sale. There is the often quoted example of “give away the razor, and sell the razor blades (where you really make the money).”

Since my field is the Internet, I frequently come across all kinds of interesting ideas where Chinese entrepreneurs are seeking funding. Let’s say that I’ve seen a lot of ideas in my lifetime, and I’m picky about what strikes my fancy. When I talk to people, I’m often looking for a “je ne sais quoi” which is different about them, or their products and services, and their ability to execute. China subscriber and user numbers don’t impress me, and make my eyes glaze over very quickly.

I’m much more impressed when people talk about revenue and earnings projections. I’m even more impressed when I find out that these numbers are not pulled out of thin air, and can relate to something the presenter/entrepreneur has worked on and delivered in the past. At this point, we cross the line from fantasy to a doable reality.

The trouble with many Chinese startups is that the founder is so focused on raising money that he forgets to even spin a good story about what he’s going to do with the money! And yet, China is such a hot place to be now that there are people with money who are willing to part with significant amounts of money without even asking for a good story about how they are going to execute!

Part of the reason so many poor ideas get funded is because the burn rate is so low in China that even if the startup fails in the initial stage, the burn can be kept so low that if/when the startup founder has to do a reboot (usually by coming up with a sensible idea), that there is still money left in the till for a repositioning and second chance. In reality though, I think that this is a bad strategy for investors. After all, if the founder/s did not come up with a good idea the first time, and it got funded, what is the incentive for him to come up with a good idea the second time around?

This is why countries like the US and Sweden and other countries continue to be competitive in the Internet startup field even though their initial startup costs and burn rate are much higher than in China. Being cheap and being good are too entirely different things, and often being cheap actually prevents you from being good because it allows, and even encourages, sloppy thinking and poor execution skills.

This is not healthy for the western investors and for the Chinese. This is a sign of a bubble, and is oddly reminiscent of that situation in the US just a few short years ago when many people thought that they could buy a house without a down payment and a job. Fortunately for China, the Internet sector is still a relatively small part of the economy, and while US and western funds may eventually come up $50 billion or so shorter in a few years, it won’t be significant enough to put a crimp in any venture capitalist’s or private equity fund manager’s retirement plans.

What is needed now, at least in the Internet startup area, are entrepreneurs who have actually had experience selling something, and actually understand the purchasing habits of Chinese consumers, and know how to provide a useful service to earn that money and are willing to put revenue projections into their pitches.

There are plenty of opportunities and China is still a big market. I can think of several things right off the bat.

But let’s stop talking population and subscribers, and start talking revenue and earnings, shall we?