The China Vortex

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.

Technorati Tags: China, credit, currencies, derivatives, economy, financial, globalization, instruments, lending, mortgage, products, qualityfade, subprime, trade, US

Two new startups in China have now entered the field of Internet-based personal lending and finance in China, and according to this article in China Web 2.0 Review, one of them, PPDai has already received first-round funding for an undisclosed amount from Essentia Equity.

The concept of personal lending is an outgrowth of microfinancing, which started with the Grameen Bank, founded by Muhammad Yunus in Bangladesh in 1971. The idea was to lend money to poor villagers, mostly women, in very small amounts. Banks did not lend money to these people because they did not have any collateral. Instead, these often illiterate women were asked to become co-signers for their fellow villagers’ loans, effectively guaranteeing the loan in case the borrower defaulted.

In the developing world, microfinancing has become an overwhelming success, and in recognition of his contribution, Muhammad Yunus was awarded the Nobel Peace Prize in 2006.

In China, the concept of microfinancing has been slow to gain traction in spite of official Chinese government support. The Chinese government still has four large state-owned banks, and it is much more profitable for them to pursue mortgage lending in China’s cities than to embark on lending to villagers in the Chinese countryside.

Now, add to this the Internet and Web 2.0. An important component of the promise of Web 2.0 is the idea of building new communities where people can feel a sense of community without feeling separated by time and distance. The most important online communities which have sprung up are MySpace, Facebook and LinkedIn. Among these three, LinkedIn, which is targeted at the business community, is now reputedly cash-positive, and will shortly announce IPO plans. Facebook had only US$150 million in revenue in 2007. While Facebook and MySpace have far greater membership numbers than LinkedIn, ad revenue has been disappointing, if only because it is hard to create effective creatives and clickthroughs for such a geographically diverse group with such wide interests.

In personal lending in China, the two web-based personal finance sites are PPDai and Qifang. Both companies propose to bring Web 2.0 tools to personal lending, making it easy for strangers to lend money to each other, and also including some kind of an informal feedback mechanism which would take the place of a finance credit system which has not yet been fully launched in China. Underneath it all lies the belief that the Chinese are now ready to experiment with and use a new web-based front-end system for personal lending. (On the backend, these systems tie into traditional bank payment gateways.)

Critics would say that the success of microlending depends on two factors:

• Trust in developing societies depends on face-to-face contact between the lender and borrower, and ideally, they should live in the same community
• China is now a low-trust society where people will run off with any money they can get their hands on

On the other hand, the Chinese government has put its very powerful media apparatus behind the idea of creating a “civil society”, which is a fancy way of saying that they would like Chinese to trust each other more, since the shysters are giving the society a bad name. Now, what could be more trusting than lending someone you have never met, or been referred to by a personal friend, money?

Qifang, in particular, has a strong social angle since it is targeted mainly at serving China’s students who are looking for funds to pay for their education. It has recently received coverage in TechCrunch in the US. In China, university education is an important indicator of future income, and poor families are willing to go into debt to send their single child (or children in the countryside) to good schools.

It will be very interesting to see how well these new and very innovative companies are received by Chinese users, and it would probably be fair to say that they will be very interesting barometric indicators of how much change and evolution Chinese attitudes to money and lending are now undergoing.

Technorati Tags: banks, China, Chinese, grameenbank, lending, microfinance, mortgagelending, muhammadyunus, personal, ppdai, qifang