The China Vortex

Warning: If you are easily frightened, upset and can get depressed, please do not read this article. The content is strong not in its language, but in its implications.

On Twitter I have acquired a reputation for my “Tweets of Doom”. For the most part, I do not consider myself to be a pessimist but a realist. My main area of interest in the unfolding financial crisis is how economics, history, demographics and politics come together and give us hints about future trends and show us where we are heading to.

Recently, I have read a fine article by Michael Lewis in the April Vanity Fair, Wall Street on the Tundra (also called “How Iceland Went Splat”), about how the crisis unfolded in Iceland, first transforming it from an economy based on fishing, to a country based on investment banking at the peak of the boom, then when the economy collapsed, back to fishing again.

Three paragraphs in particular stuck in my mind:

Back in 2001, as the Internet boom turned into a bust, M.I.T.’s Quarterly Journal of Economics published an intriguing paper called “Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment.” The authors, Brad Barber and Terrance Odean, gained access to the trading activity in over 35,000 households, and used it to compare the habits of men and women. What they found, in a nutshell, is that men not only trade more often than women but do so from a false faith in their own financial judgment. Single men traded less sensibly than married men, and married men traded less sensibly than single women: the less the female presence, the less rational the approach to trading in the markets.

One of the distinctive traits about Iceland’s disaster, and Wall Street’s, is how little women had to do with it. Women worked in the banks, but not in the risktaking jobs. As far as I can tell, during Iceland’s boom, there was just one woman in a senior position inside an Icelandic bank. Her name is Kristin Petursdottir, and by 2005 she had risen to become deputy C.E.O. for Kaupthing in London. “The financial culture is very male-dominated,” she says. “The culture is quite extreme. It is a pool of sharks. Women just despise the culture.” Petursdottir still enjoyed finance. She just didn’t like the way Icelandic men did it, and so, in 2006, she quit her job. “People said I was crazy,” she says, but she wanted to create a financial-services business run entirely by women. To bring, as she puts it, “more feminine values to the world of finance.”

Today her firm is, among other things, one of the very few profitable financial businesses left in Iceland. After the stock exchange collapsed, the money flooded in. A few days before we met, for instance, she heard banging on the front door early one morning and opened it to discover a little old man. “I’m so fed up with this whole system,” he said. “I just want some women to take care of my money.”

This made me ask myself a question: Maybe it was not enough to look at how economics, history, demographics and politics come together in this unfolding crisis? Maybe I should also take a look at human psychology and the role it played in the financial services industry? Were there certain personality traits which made it to the top of the financial services industry, making individuals with these personality traits captains of industry?

Armed with this question, I went to Wikipedia and looked up the term psychopathy and found this definition:

The psychopath is defined by a psychological gratification in criminal, sexual, or aggressive impulses and the inability to learn from past mistakes. Individuals with this disorder gain satisfaction through their antisocial behavior and lack remorse for their actions.

Now some of the characteristic symptons are:

Factor1: Aggressive narcissism
Glibness/superficial charm
Grandiose sense of self-worth
Pathological lying
Cunning/manipulative
Lack of remorse or guilt
Shallow
Callous/lack of empathy
Failure to accept responsibility for own actions
Factor2: Socially deviant lifestyle
Need for stimulation/proneness to boredom
Parasitic lifestyle
Poor behavioral control
Promiscuous Sexual Behavior
Lack of realistic, long-term goals
Impulsivity
Irresponsibility
Juvenile delinquency
Early behavior problems
Revocation of conditional release
Traits not correlated with either factor
Many short-term marital relationships
Criminal versatility

This was getting interesting, so I went to a Time magazine article which listed the 25 people to blame for the financial crisis. The behavior of some of these individuals is, to say the least, very interesting.

Then I went back to the article and read more about the traits of psychopathic behavior. Where appropriate, I have added emphasis. They are:

In practice, mental health professionals rarely treat psychopathic personality disorders as they are considered untreatable and no interventions have proved to be effective.[18] In England and Wales the diagnosis of dissocial personality disorder is grounds for detention in secure psychiatric hospitals under the Mental Health Act if they have committed serious crimes, but since such individuals are disruptive for other patients and not responsive to treatment this alternative to prison is not often used.[19]
Because an individual’s scores may have important consequences for his or her future, the potential for harm if the test is used or administered incorrectly is considerable. The test should only be considered valid if administered by a suitably qualified and experienced clinician under controlled conditions. [20][21]
Hare wants the Diagnostic and Statistical Manual of Mental Disorders to list psychopathy as a unique disorder, saying psychopathy has no precise equivalent[20] in either the DSM-IV-TR, where it is most strongly correlated with the diagnosis of antisocial personality disorder, or the ICD-10, which has a partly similar condition called dissocial personality disorder. Both organisations view the terms as synonymous. But only a minority of what Hare and his followers would diagnose as psychopaths who are in institutions are violent offenders.[22][23] The manipulative skills of some of the others are valued for providing audacious leadership.[24] It is argued psychopathy is adaptive in a highly competitive environment, because it gets results for both the individual and the corporations[25][26][27] or, often small political sects they represent.[28] However, these individuals will often cause long-term harm, both to their co-workers and the organization as a whole, due to their manipulative, deceitful, abusive, and often fraudulent behaviour.[29]
Hare describes people he calls psychopaths as “intraspecies predators[30][31] who use charm, manipulation, intimidation, sex and violence[32][33][34] to control others and to satisfy their own selfish needs. Lacking in conscience and empathy, they take what they want and do as they please, violating social norms and expectations without guilt or remorse”.[21] “What is missing, in other words, are the very qualities that allow a human being to live in social harmony.”[35]

This was getting very interesting. I would encourage you to search through Google or your search engine of choice and make your own observation whether these individual/s showed any psychopathic personality characteristics.

Basically, what the American financial services industry created an industry where individuals with psychopathic traits could rise to the top to positions of power, making decisions about billions of dollars in investments and assets.

Intelligent psychopaths exist in every society, and many become actors, politicians and lawyers. The genius of the American system was that it put them in charge of large sums of money.

But this is only the beginning. In the name of industry deregulation, they were given, by the US government the power to create financial instruments. In plain English, they were given the power, through leveraging, to make money out of thin air, out of nothing.

Over the past twenty years, using their talents and creativity, they have leveraged approximately every single US dollar 35-40 times, inventing CDOs, CDSs and other financial instruments in the process, all of which were interlocked. As if that were not enough, some of these personalities co-opted the whole financial media, earning their trust and selling their investment ideas directly to the American people over leading TV stations and print media. At no time did any of the financial media say “Wait a moment. These guys are shysters and are cheating and lying to the American people.” Instead, the media went along and played the game with them, becoming actors in the play when they should have questioned what was going on.

The lines between advertisers, corporations and media became completely blurred, and dissenting voices were simply not heard. It became a vortex which benefited all the players, who hyped the same worldview about finance.

What was missing in the whole equation? In one word, trust. The quants had created formulas such as the Gaussian copula formula to provide a rough measure of risk, but banks had become completely separated from their clients through a complex ecosystem which also included mortgage brokers, who originated loans, even for individuals who did not have work and had no chance of being able to make the monthly payments for the homes they bought.

The house of cards began to collapse in 2007 with the subprime credit crisis, and is continuing to unwind. At this stage, we do not know where it will all end.

What is even more interesting is that the personalities and personality traits which got us into the mess are still there, negotiating with US Secretary of Treasury Geithner in the belief that they should receive money from the government for their bad assets, which they believe will recover some value after the economy bottoms out. Others believe that these assets have no value, and the sooner the government recognizes this fact, the sooner recovery can begin.

American society had become one where competition and competitiveness were rewarded without regard to the implications for the society as a whole. The society was always looking for the next big thing, the instant hit without caring about the cost. Now it is paying the price for a screwed up values system. Now we know that there are no quick fixes, and none of the choices are good.

In the meantime, we are helpless in this world they have created for us.

If you haven’t poured yourself one already, maybe it’s time for a whiskey. A strong whiskey. Neat.

Open Web Asia is a new organization founded by Gang Lu, publisher of Mobinode. Today they are bringing together some of the leading western players in China, Asia, Europe and the US to talk about web trends in Asia, and especially the trend for US and European companies to come to Asia. The venue for this event is in Korea, and brings together experienced marketers from Europe who have successfully made the transition to marketing in China and Asia, such as Web2Asia, which is based in Shanghai.

As part of the event, Open Web Asia is putting together a web survey on what companies in the west are considering coming to Asia to start companies. The survey is about the challenges western companies face when coming to Asia, including cultural, economic, and other issues. The survey starts today (Oct. 14) and will be open for two weeks.

If you are interested in China, business, economics, the Internet and technology, then I highly recommend that you take this survey. All you need to do is click on the button below.

The results of the survey will be announced on November 14, when Robert Scoble, Shel Israel and others come to China as part of the China Web 2.0 tour which is put together by the China Business Network.

I’m sure that the results will be interesting, and I look forward to seeing them.

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.

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.

Just a quick note about what I see happening behind the scenes in China.

The administration of Hu Jintao has made a recent effort to push for transparency and accountability in China, especially related to disbursement of funds related to the Sichuan earthquake, and then acting quickly against corrupt local officials in Wengan in Guizhou province.

The center in Beijing is responding to a popular demand for greater accountability and transparency, and is using this as an opportunity clean house within the ruling party. The message from Beijing to the local party officials is simple: Shape up or be removed from your position.

When Deng Xiaoping introduced his reforms beginning in 1978, he gave local officials wide leeway as to how investment was brought in. The reason for this was simple: Beijing had no money; it was bankrupt. The side effect of this policy has been rampant local corruption. All kinds of games have been played in the name of making the numbers reported back to Beijing. Many of these corrupt officials have escaped China, and are living in the US in multi-million dollar mansions paid for in cash. Behind the scenes, the Hu administration has been quietly working with the US’s Justice Department to bring these officials back to China for prosecution.

As the amounts of the corruption have grown, so has popular resentment. Beijing knows that it must act to clean house. The failure of local governments and party organizations to act forcefully and clean up their own houses have handed Beijing an excellent excuse to act forcefully, and handed multiple PR victories to the center. Chinese bloggers who highlight local corruption have become the eyes and ears of Beijing on the local level. When the decision is made that local corruption needs to be escalated to the national level, then Xinhua mobilizes its formidable machine to shape public opinion on the national level. Then Beijing comes in and acts forcefully, removing the corrupt officials, and making them an example to local government and party organizations all over China.

If you believe that this is simply about accountability and transparency though, you would be naive. It is also about money and how investment decisions are made in China.

Beijing is seeking to recover many of the financial and investment decision making powers which Deng handed over to the provinces and local party officials. In the context of this drive against local corruption, the local administrations and organizations are in a weak position to resist Beijing’s efforts to recover investment-making decisions. China needs higher value-added, higher technology industries which rely more on research, development and IP. Provincial governments and party organizations have not acted quickly enough to upgrade from inefficient, dirty industries which rely on cheap labor. This means that now the investment decisions need to be made from the center in Beijing, with the support of public opinion, of course.

While the Chinese government does not understand PR in a western context, it knows exactly what it’s doing in a Chinese context.

This is pretty self-explanatory.

Investors who bought notes due February 2018 on March 17, just after the Fed helped arrange the bailout of Bear Stearns Cos., have lost 6.2 percent, according to Bloomberg data.

The 10-year note, at 4.25 percent, yields no more than the inflation rate, leaving investors with real returns near zero. Consumer prices have exceeded 10-year yields by an average of 36 basis points since December, Bloomberg data show. In 1980, inflation reached a 33-year high of 14.8 percent and yields averaged 11.4 percent.

`Out of the Bottle’

Yields on 10-year notes had dropped to an almost five-year low of 3.28 percent on March 17, after the Fed cut the discount rate at an emergency weekend meeting and backed JPMorgan Chase & Co.’s deal to buy Bear Stearns Cos. Rates on three-month bills plunged to 0.39 percent, the lowest since the 1950s, the same day as investors sought the safety of the shortest maturity government debt.

Consumer prices advanced 4.2 percent in May from a year earlier, the Labor Department said June 13. The rate was above the median forecast of 3.9 percent in a Bloomberg survey of economists, and the highest since January.
Economists at New York-based Morgan Stanley say inflation will reach 5 percent to 5.5 percent this summer, the highest since 1991.

“The global inflation genie is out of the bottle,’’ Morgan Stanley analysts led by Joachim Fels, co-head of global economics, said in a June 11 report. Even if the pace moderates in coming months, “we are likely to see higher average inflation rates,’’ they said. Inflation averaged 3.1 percent during the past two decades.
`Unsustainable Levels’

Inflation is also eliminating the rewards of owning U.S. stocks. Standard & Poor’s 500 Index shares yield 0.2 percentage point more in profits than the interest on 10-year notes, the smallest advantage since 2004, data compiled by Bloomberg show. The last time corporate earnings returned less than bonds, the index posted its biggest monthly decline in five years.

“What did you say? You wanted us to buy more US assets?”

Oh, and I forgot to mention, this is in straight dollar terms only. You need to also figure in how much the US dollar is going to depreciate against other currencies in the coming ten years.

“Ouch!”

I wonder how the Chinese government is going to explain this to Chinese citizens, since it is their official responsibility to protect Chinese investments and assets? And that the situation, particularly re inflation, is going to get much worse before it gets better?

And it really doesn’t matter who becomes US president either, at least with regard to this set of issues.

Not even a US president can do anything about this.

China Law Blog is a good source of legal information about Chinese business and investment regulations and one of his comments in my previous post got me thinking about why Chinese entrepreneurs don’t like to work not just with American lawyers, but lawyers of any nationality.

Here is his comment in full:

Right idea. Wrong country. What you predict will happen, I am certain of it. I am certain of it because our German and Russian clients have over the last few weeks been calling us (here in the US) like crazy to help with this or that deal they are doing or want to do. The deals range from high tech to old line manufacturing (that’s right) to real estate. When we tell them our legal fees I can almost hear them gasp (particularly the Germans) at how low they seem for those used to paying in Euros. That’s right, step right up, the US is on sale to foreigners ….. Like it or not. BTW, no calls from Chinese and I don’t expect many either, both because they tend not to use lawyers so much and they also tend not to be big buyers of existing US companies. At least not yet.

So why is it that Chinese entrepreneurs don’t like to use lawyers and legal services, even when using them the right way, and intelligently, will help them to greatly expand their businesses?

I have a theory.

For many Chinese, “the law” is whatever the Chinese government says it is. Just because some new kind of business is done in China, does not mean it is legal, it is just tolerated. It usually means that it is so new to the slow-moving bureaucracy that it hasn’t figured out whether it should be legal or illegal, so it’s “tolerated”.

Your business may be tolerated, then the government says it is “illegal”, or it may be tolerated, then the government says it is “legal”. Then it might switch from “legal” to “illegal” and told to shutdown almost overnight. This happens, and continues to happen all the time. This is part of the price of doing business in China.

Here’s another example.

The Chinese government says that new businesses in China have to list their “business categories” and the business they are in. Think about it; does this make sense? From a business point of view, it makes little if any sense. Let’s say a consulting business needs to do a marketing survey. They may run afoul of the law because this is not allowed; they registered as a consulting business but need to do a marketing survey for a client who wants to enter the Chinese market. So while it makes perfect business sense to do this, the bureaucrats and regulators prevent it from doing so, because from their POV (the government regulators), categorizing businesses makes more sense.

Among Chinese business people, there is a large degree of frustration at these sudden changes which come out in the morning, and may change before the sun goes down. For Chinese entrepreneurs, this is the face of the law.

So, in order to succeed, they spend a huge amount of their time avoiding the regulators and getting warned, or even shut down. If the regulation comes from Beijing and they are in Hangzhou, they will go talk with Hangzhou city government officials to avoid getting crushed because local Chinese officials have the power to “interpret” the law. Sometimes this means ignoring what Beijing says, without openly confronting Beijing.

And this is why many Chinese entrepreneurs avoid lawyers, because so much of the time, the government officials are the face of the law, and are not there to represent their rights, but are there to warn them, or even shut them down. So, from their perspective, the law is bad news.

When Chinese companies go overseas, they continue to act this way. They avoid relatively small up-front legal fees, thinking that they can outmaneuver them and the regulators, never thinking that the law can in fact work both ways, and can help them to gain benefits. They are guilty of thinking that they are still in China and behave as if they were still in China.

Moreover, they know that the advantage of Chinese businesses lie in their cost structure, and fear losing it if they go overseas. This means that they act very cheap when they go overseas, and acquire reputations for being cheap and micro-managing their foreign employees, trying to extract every little bit of time and value out of them.

In the long-term, this hurts the reputation of Chinese companies as a whole.

In fact, company cost structures evolve and adapt to the market and society they are a part of. No country can have the same cost structure as China, just as no country can have the same values as America does.

And there is no reason that they should.

One of my recurring themes is that Americans have become too good at consuming, down to the point of consuming their children’s futures through deficit spending, and have not done enough to invest in the future. This is an important legacy of the current Bush administration which has repeatedly mortgaged the future in order to achieve their short-term political goals.

China has done a somewhat better job of investing in education and infrastructure; the recent snowstorms and transportation breakdowns in central and southern China have shown that even though large amounts have been spent, there is still a long road to go before China has a modern transport infrastructure which can serve the needs of its 1.3B citizens.

At one time, Americans were respected worldwide for their ability to make things. Now, these capabilities have been largely outsourced. Instead, American politics is much more focused on fractious issues which have little or no substantive meaning, but are manufactured to capture air time on television or on the Internet. The result: an increasingly polarized society where people increasingly talk at each other, instead of to each other.

For this reason, I was very pleased that a group of concerned Americans have set up a website to debate the future of science in the US, and the platforms of the respective presidential candidates on the issue.

If you are concerned about the future of American science, then you should take a look at it.

Chinese can be very peculiar about some things.

One thing which is especially peculiar by western standards is that they get really annoyed and angry when a lot of money is lost, and they are not afraid to say so. Take the Chinese government’s loss, er investment, in Blackstone Group for example.

Within several weeks of the investment being made, Blackstone’s share price took a bath, and many Chinese got really angry. As a matter of fact, they got so annoyed that they actually demanded accountability. They reasoned that since this was their money, they had some say about it.

Obviously not a rational move. They just don’t understand the rules of the game.

Compare this with the subprime mortgage scandal in the US, which has morphed into a never-ending nightmare, seemingly growing bigger and bigger all the time…

Has anyone been blamed or gone to jail? No. Has anyone been held accountable? No. Have newspaper editorials placed the blame on anyone for the disappearance of billions, maybe trillions, in dollars? No. Is anyone angry because the futures of millions of Americans have been put in financial jeopardy? No. Have you heard any of the candidates talk about doing something about this? No.

We are above such petty finger-pointing, which won’t do any good anyway.

We’ve got more important things to worry about like race, and the right to life, and illegal immigrants taking American jobs, just to name a few…

In the meantime, the Chinese are having a hard time finding Chinese fund managers who want to invest and manage their trillion+ in reserves, especially since the Chinese manager of the Blackstone Group investment was unceremoniously removed from his post. Managing all this money sounds like an invitation to an execution.

Your own.

In the meantime, the French are partying with recent events of their own at Societe Generale…

In light of recent events, many Chinese can be excused if they think that globalization sounds more than a little like an invitation to the premier crossing of the Titanic from Southampton to New York.

UPDATE: Just in case you had any doubts the inmates might indeed be running the insane asylum, read this.
(hat tip to Chris Masse).

In the west, there is a whole industry called “risk consultancy”. Basically, this industry is built around informing large- and medium-sized corporations about risk. Originally, this was built around business risk and would answer questions like “How safe is it to invest $500M in an industrial diamond mine in the Congo (formerly Zaire)?” The consulting firm would then send practice consultants to the target country, where they would study sunk costs (including bribes which were never written about in the report, regulations, who was related to the president, political opposition, major competing firms, etc.) Most of these questions were positioned as questions which any board would ask the CEOs before they would greenlight an investment.

Underlying all this is the belief, at least in west and among western corporations that “risk” is something which can be quantified and measured objectively.

One of the big topics in the west now is China’s investments in Africa. What is fascinating about China’s investments in Africa is that while the amounts of money and people who go to Africa are huge, China really doesn’t have risk consultancies, and Chinese really have not yet started thinking in terms of quantifying risk in the ways western corporations have.

So how have the Chinese judged risk so far, and will the present method change over time to something more akin to the western way of thinking? When it comes to Chinese investments in Africa, many of the early-stage investments were a part of Chinese foreign policy aimed at securing raw materials for manufacturing, and more importantly, energy sources. The typical model has been to find a country, build a new palace for the president and a new sports stadium to win over the people. This would help state-owned construction firms to gain a footing in the country, which were then quickly followed by Chinese logistics firms and wholesale distribution firms which would sell products to the local African population.

Viewing the local African population as customers were one area where Chinese viewed Africa fundamentally differently from the west. While Beijing, Shanghai and the Chinese tier one and tier two cities are relatively modern, it is very easy to forget that when it comes to pervasive poverty, China is only 10-20 years removed from the levels of African poverty. Basically, Chinese companies know how to sell to poor people because they had lots of practice in China.

When you are working from a low cost basis, there really is not a whole lot of need to measure risk because the only way to go is up. Remember, in China labor is still very cheap compared to the west, and the Chinese government is always interested in keeping people employed in the interests of social stability. On the other hand, when you have large risks but your investments are backed by the Chinese government, there is not a need to measure them either. But things get complicated when you are in the middle, and are a mid-sized Chinese company (US50M-1B) which is private and are looking at Africa, as many are now.

Right now, the path many are taking is to send executives, management and staff wholesale to Africa, and basically telling them to figure things out on the ground. This is the Chinese version of “Let’s throw spaghetti at the wall and see what sticks” approach. But what happens when you don’t really have the protection of the Chinese government and local Chinese embassy, and the Africans start complaining that Chinese companies aren’t creating enough local jobs for local Africans? Obviously, these are the sorts of questions which are very complicated, since they include a social factor, in addition to the corporate and economic equation.

Will the Chinese companies turn to the western risk consultancies? Not likely. First of all, they are too expensive by Chinese standards; Chinese management is still very price-sensitive and is not likely to be willing to spend the large amounts which these companies charge. Also, they are not likely to entrust this kind of sensitive information to an outside firm which may recirculate some of the data for a competitor. Most Chinese companies are very tightly held, and risk is whatever the CEO thinks it is at that moment in time.

For western corporations which work from a high-cost basis, risk consulting is an item on “research” for executives, even though it may easily run into the millions of dollars.

For the Chinese, that’s way too much…