The China Vortex

“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.

Technorati Tags: China, Darfur, dollar, economy, media, policy, Tibet, trade, US

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

This morning I was watching a TV program on China’s CCTV-4 which talked about the history of gold, historically and in China. The program, all in Mandarin, had a fascinating format. It started off with history and the Bretton Woods agreement of 1945 and when the US controlled about 80% of the world’s gold reserves. At the time, the US Federal Reserve had a standing policy of letting non-US citizens redeem their gold at a price of US$35 per troy ounce, while not allowing Americans to own gold. Then, as the value of the dollar fell, Nixon basically opted out of Bretton Woods and the US government would no longer redeem gold. This started the period of different currencies floating against each other in floating exchange rates.

Before and during Bretton Woods, because of the tie to gold, the US dollar was often referred to as “meijin” 美金 instead of the now popular term “meiyuan” 美元 or US dollar. The implication is that in earlier times, the US dollar was as good as gold.

Not now.

In 1979 with 17% inflation in the US and the Soviet invasion of Afghanistan, gold shot up to US$850 an ounce. Then when things settled down, so did gold prices.

Now, because of all the trouble with the US dollar and the subprime mortgage crisis, gold is back between US$700-800 per troy ounce.

Then the program took a curious turn and started interviewing Chinese who were investing their savings in gold. The best way to describe it was as if it had suddenly become the Home Shopping Channel program for gold. China opened up the gold market to trading for Chinese retail investors in Oct. 2002. Then it proceeded to interview housewives and ordinary Chinese urban consumers about their investments in different gold markets, all in China, and how much money they had made. Then there were interviews with gold analysts for gold exchange websites, all of whom were gold bulls.

And this program went on and on for an hour. The interesting thing is that this program was broadcast on CCTV-4, which is the news channel. And of course, nothing gets on this channel without official approval. The underlying message of the program was that gold is a good investment for Chinese investors in turbulent times. Not euros, not yen, and certainly not the dollar.

Gold. So go forth and buy gold, and rest assured that you will not lose your investment money. I could not escape the impression that the Chinese government was trying to talk its citizens out of putting their savings in dollars, and wanted them to save their money in gold.

Fascinating!

Ever since the subprime mortgage crisis began, the US dollar has become the currency nobody wants. Private equity and venture capital firms from the US have been actively investing in Chinese companies, just because they want to get out of US dollars. This pace is picking up as even the top-tier VCs from the US are relocating to China. Sometimes I think that if you breathe and can count to 10 in English you can get seed funding for your China startup. (Follow-up rounds are not as easy; they depend on company fundamentals, at least for now.)

It seems like the Chinese are getting tired of buying economic activity in the form of exports to the US, and getting paid in depreciating dollars. Add to that some other recent tensions, and you get the picture that things are going to start getting more rocky on the economic, military and political fronts.

There was a time when the US financial markets were looked up to and trusted by the Chinese and the rest of the world as a model. That trust has been shattered. At the end of the day, that is what capital markets depend on to work: trust. Already we are seeing a trend away from going public in the US and to other capital markets.

All of this adds up to my view that globalization is one of those ideas which makes good sense when viewed from 30,000 feet, but simply will not work in the real world of economic, political and military power.

The US dollar’s fall, in a way, is a direct result of globalization. When the US had the world’s leading economy and was the home of the world’s most voracious consumers (consumers who continued to consume even after they had no savings), the rest of the world had almost no choice except to use the dollar as the main currency for international transactions. With the rise of Japan, then the European Union, and now China and the African nations, that has all changed. Economic strength and activity are now highly diversified; there is no single center of power.

China is investing heavily in the development of Africa. The world-famous China-Europe International Business School (CEIBS) based in Pudong, Shanghai will soon announce plans for an African campus. Other parts of the world, including India and oil-rich countries of the world continue to grow. And they have less need for dollars which continue to depreciate in value. Add on to this the general unpopularity of US foreign policy in the rest of the world. They are looking for more stable investments which more or less keep their value.

All this adds up to a picture of a world which has less demand for dollars. If the US did not rely on depreciating the dollar as a policy to lessen the debt burden, the falloff would not have been as precipitous as it has become. Sometime soon, American consumers will have to learn about living within their means, and saving money. I’m of the opinion that the sooner they learn, the better. In order for it be worthwhile for Americans to save, the dollar must be stable.

If there is one thing impressive about China, it’s all the investment in infrastructure. Sure, a lot of it is tacky and even poorly constructed, and sometimes there are bridge collapses, but it is getting better in quality. Most importantly, the government is building for the future.

It’s time the US started investing more in its own future, instead of just consuming for today.

But now, the world is looking for other choices besides the US and the US dollar. And globalization is giving the rest of the world more choices to pick from.

Technorati Tags: , , China, consumer, dollar, economy, globalization, gold, infrastructure, investment, trade, US

For the past fifty years, globalization was offered as the answer to all the world’s ills: it would raise standards of living in the developing world, it would create more wealth, nations would understand each other better and eventually trust each other, and so on and so forth.

I’m going to state what is increasingly obvious: globalization is fading in the struggle against nationalism for peoples’ hearts and minds. The world has not become global; instead capital, wealth, classes and class values, as I have mentioned in the previous post, have gone global while leaving most of the rest of the world behind. For the moneyed classes, nations are less important, perhaps even irrelevant. That is happening now as the Chinese economy grows and Chinese companies are expanding their presence to other nations by investing in their financial companies, for example.

But the moneyed classes represent only a comparatively small percentage of the world’s population. Most belong to the middle class, who still see the world in terms of the nation-state. What do they think?

They are becoming more, not less, nationalistic. A recent article shows that Chinese consumers are gravitating to Chinese brands, not western brands. In the online search struggle, search engines become victims of these games.

The simple fact is that although the US and Chinese economies are tightly bound together, and depend on each other as their largest trading partners, they do not trust each other. This trust is getting wider and deeper with the passage of time; it is not getting smaller. People for the most part, still think in terms of national interests, not global interests.

As the rich/poor divide widens, and as the US dollar weakens and the US standard of living starts to head downhill, it will become expedient to blame globalization for the country’s ills. We aren’t there yet, but we will be. Previous administrations and the WTO will be blamed for the shortcomings of globalization. Increasingly, China and the Chinese people will be seen as a threat to western values and the western way of life.

This will make it increasingly difficult for brands to become international. Are they national? Whose side are they on? Who sits on their boards? These are questions they will be asked more and more.

That is why globalization is failing, and will ultimately fail. It’s just that no one wants to take the blame and be the first to make the call.

But that will happen soon enough…

Technorati Tags: China, Chinese, economy, globalization, nationalism, trade, US, usa, values, western, wto

The consulting industry in China is flourishing. After all, it is the largest potential single market in the world, and everyone is flocking to it. New companies need information and advice about how to tackle the unique challenges of this market. For any MBA who is fluent in Chinese, or who has grown up in China, and is familiar with the tools of the trade, such as financial modeling, business negotiations and company valuations, China represents an “iron rice bowl” which will make their careers for years to come.

Or is it? My experience is that there are errors which are repeated over and over again. It gets like being condemned to watch a single Broadway show, over and over again, where the only things which change are the sets and the actors; the lines are the same.

I have covered one of the major fallacies in a previous posting, Getting Past the China Market Hype, which covered their initial reasons for entering China. This posting will cover some of the reasons for failing post-entry.

Since most of my experience has been with technology/media/startups from the US, I am naturally biased towards those companies in my evaluation. There have been many success stories from the financial sectors, engineering and consumer goods. These areas, unlike hi-tech, have had decades, and in some cases even more than a century of experience, building their China presence, and understanding the challenges involved. They have the money, and have built up a knowledge base of experience which they can draw from, and because of the large scale of their businesses, even if they cannot draw from in-house experience, they know how and where to get it when needed.

Some of the US technology companies which have come to China and have failed to succeed in the Chinese market are eBay, which basically had to hand over its operations in China after running into the strong local player, Taobao.com, in the auction field. Yahoo! had to basically pay a China partner, Alibaba.com, US1B to take over its China operations. More recently, Google, the US search advertising firm, has had to fight an uphill battle against the largest Chinese search firm, Baidu.com. Online gaming is a new area which does not exist in nearly as large a form as the US, with Shanda being the granddaddy in China, while newer players such as Perfect World (PWRD) have sprung up with new and different business models, and successfully going public on the Nasdaq. In instant messaging, Tencent’s QQ has been able to rack up 600M registered users, and unlike any US IM clients, become profitable.

Because most US startups come from technology backgrounds, they tend to believe that their business is scalable. The word “scalability” is in itself, an engineering term, which means that an architecture can go from 1 user to one billion (or infinite) users, or across national borders and into different languages and markets, without any major architectural hiccups. For this reason, they tend to play down distribution and cultural differences in their most initial stages. Most of the time, they have people on staff or in management who know something about the local market; more often than not, they are not in senior decision-making roles.

Then, when they get to China, they try to do what they did in the US, and quickly discover that the rules in China are very different. Whereas labor is very expensive in the US, with each hire drawing the attention of different company committees, in China it is one of the single cheapest expenses. (Except for senior and executive management, where highly qualified individuals cost just as much, if not more, than in the US.)

The most common failing comes in the area of product management, when the US insists on controlling the product development and launch schedule, with local product launches coming only after the US is ready. In smaller markets, that’s fine, but in fast-moving large markets, especially one as large as China’s, it’s a killer. (Even in fast-moving small markets it’s a dubious strategy; in South Korea, Google has been consistently beaten by Naver, a highly successful Korean company.)

This puts the China office in a continuous battle with the US headquarters for resources; the Chinese local competitor has no such restrictions on what it can do, and the Chinese company surges ahead in capturing market share, and eventually, revenue. The American company then organizes what can best be called a “strategic withdrawal”, as did eBay.

In more mature industries where there is some kind of brand equity, product lines are already fairly mature, and headquarters makes resources available to country managers as needed. Because of the fast-changing nature and relative immaturity of hi-tech, this has not yet happened.

When the American companies fail, the blame is usually assigned to some form of Chinese government protectionism, and favoritism to the local companies. Of course, this explanation is more palatable to Congress members seeking re-election and US TV talk-show hosts, but more often than not, it is a vast over-simplification of a complicated issue.

Technorati Tags: advertising, baidu, business, China, Chinese, google, HR, information, language, management, market, qq, resources, Shanda, trade, US, yahoo

This is the opinion of Paul Craig Roberts, who previous served as Assistant Secretary of Treasury during the Reagan administration, and is often quoted as the “father of Reaganomics”. (You can read the Wikipedia entry about him here.)

Recently there has been discussion about China’s threat to use the “nuclear option”, or and basically destroying the value of the US dollar as a global reserve currency by dumping more dollars on the markets than they can absorb in a short time, forcing the dollar into a free-fall.

The prevailing wisdom among US economists is that China would not make such a move, as the damage to China’s own economy would be too great. Roberts rebuts this claim saying that

American economists make a mistake in their reasoning when they assume that China needs large reserves of foreign exchange. China does not need foreign exchange reserves for the usual reasons of supporting its currency’s value and paying its trade bills. China does not allow its currency to be traded in currency markets. Indeed, there is not enough yuan available to trade. Speculators, betting on the eventual rise of the yuan’s value, are trying to capture future gains by trading ‘virtual yuan.’ The other reason is that China does not have foreign trade deficits, and does not need reserves in other currencies with which to pay its bills. Indeed, if China had creditors, the creditors would be pleased to be paid in yuan as the currency is thought to be undervalued.

In addition, he refutes the claim that China would lose US markets with such a move.

The notion that China cannot exercise its power without losing its US markets is wrong. American consumers are as dependent on imports of manufactured goods from China as they are on imported oil. In addition, the profits of US brand name companies are dependent on the sale to Americans of the products that they make in China. The US cannot, in retaliation, block the import of goods and services from China without delivering a knock-out punch to US companies and US consumers. China has many markets and can afford to lose the US market easier than the US can afford to lose the American brand names on Wal-Mart’s shelves that are made in China. Indeed, the US is even dependent on China for advanced technology products. If truth be known, so much US production has been moved to China that many items on which consumers depend are no longer produced in America.

Roberts then builds a case for China’s dumping dollars as a reaction against US pressure for revaluing the yuan, refuting claims that this is an impossible scenario.

Consider that if China were to increase the value of the yuan by 30 percent, the value of China’s dollar holdings would decline by 30 percent. It would have the same effect on China’s pocketbook as dumping dollars and Treasuries in the markets.

Consider also, that as revaluation causes the yuan to move up in relation to the dollar (the reserve currency), it also causes the yuan to move up against every other traded currency. Thus, the Chinese cannot revalue as Paulson has ordered without making Chinese goods more expensive not merely to Americans but everywhere.

Compare this result with China dumping dollars. With the yuan pegged to the dollar, China can dump dollars without altering the exchange rate between the yuan and the dollar. As the dollar falls, the yuan falls with it. Goods and services produced in China do not become more expensive to Americans, and they become cheaper elsewhere. By dumping dollars, China expands its entry into other markets and accumulates more foreign currencies from trade surpluses.

Basically, Roberts makes a strong case for the argument that the US no longer has leverage over China and global financial markets the way it used to. You can read his whole article here.

Have we reached a tipping point in American power and global influence?

Technorati Tags: Beijing, China, Chinese, deficit, dollar, economic, economy, Fed, global, information, interest, rates, research, trade, US, yuan