High Inflation

I was discussing college loan rates with a friend yesterday. He told me that not only has our loan provider thrown a 5.5-pt swing at us from last year to this year, but what's worse - they could potentially skyrocket with inflation if we keep them variable, which would suggest assuming a fixed rate instead of the current variable.

That got me thinking about the high inflation eras of the past and instead of wondering why this might happen, or what circumstances might cause such an environment, I would like to focus on the rumblings that I have been hearing from colleagues discussing the negative impact this could have on China.

First of all, China's monetary and foreign currency authorities are much savvier than we are giving them credit for, and I think that years ago they understood the feasibility of this type of predicament. And while I do believe the the problem is very big, it is still not a devastating blow to either the economy in China or the US-China relationship.

But here is where it could get very interesting. Although pension funds have always aggressively chosen to invest in primarily fixed-income assets, I tend to think that a sovereign wealth fund like the one China has can be slightly more aggressive than other such organizations and hence be in a position to purchase AA and above-rated bonds if they were to climb to 10+%.

Oh wait, this just in - our ratings agencies have no credibility either and China surely will not trust them any time soon.



"

Wen's Signals from Davos

The article in today's Wall Street Journal regarding China Premier Wen Jiabao's implicit comments of US negligence leading to the current world financial crisis is very interesting and worth reading, but there is one part of the message that I think the paper failed to report on that should have been reported, and here it is:

鼓励区域货币金融合作，稳步推进国际货币体系多元化。(1)
"Encourage regional currency financial cooperation, stably promote international currency system pluralization."

I think the tiff that is going on between the US and China regarding holdings of US treasuries is a major issue of concern, but I do not think that we are addressing the true meaning behind China's position and their words that reflect this. This pluralization (多元化) is not about switching to Euros, Yen, and Pounds. It is about a long-term strategy for the renminbi to become the world's international currency. Inevitably this will depend on China truly stimulating domestic consumption to become the world's dominant economy, but make no mistake: Wen's comments off as much about China's long-term strategy as they do about its short-term discord.




(1) http://news.sohu.com/20090129/n261968599.shtml

Summer's Gone and We're Back from China

It's been an eventful summer - May in Philadelphia, June and July in Shanghai and Beijing, and just wrapped up August in Philadelphia. Wharton-Lauder has been great so far. Let's kick off the fall by getting right into it. This past week, I saw two items of language in English and Chinese that highlighted amazing uses of colloquial language by Warren Buffett and a Chinese blogger, Cheng Shi.

Last week, Buffett, in classic form of criticizing the common Wall Street dogma showed what happens to speculators when it's time to pay the pied piper...

Speaking on Friday on CNBC television, Buffett said some housing-related businesses in his Berkshire Hathaway Inc conglomerate are struggling as the economy works off past excess in making credit available. 'You always find out who's been swimming naked when the tide goes out. We found out that Wall Street has been kind of a nudist beach,' said Buffett, who in March was called the world's richest person by Forbes magazine.(1) This English term is eerily similar to the Chinese idiom, 水落石出, one of my favorite classics, that means literaly, "Water recedes stone out." The English version, while a bit more colorful, is far less common than the Chinese version. But, what is most interesting is how they both perfectly identify the extent and shade of emotion that accompanies a financial crisis, namely, that speculators are left standing with not security at all, a plight that is ironically derived from the asset-backed securities which created the vanished wealth in the first place.

And herein lies the link to our next headline, taken from Chengshi's blog entry this week: 油价下跌：昙花一现还是趋势反转？ (2) "Oil prices fall: is it a transient flower or the reversal of a trend." 昙花一现 means fleeting, transient, or vanishing as soon as it appears. Although the author goes on to lay out his reasons for the temporary nature of oil's recent retreat, one could read into it so much more about the state of the current world credit market. Is the volatility going to settle with a decline in world oil prices, or is the damage much deeper than investors are willing to admit?

From the view in China, there is no major economic slowdown or recession in sight. As a result, that is going to continue to put massive pressure on world commodities and drive consumer price growth worldwide. The moment at hand is thus an incredible buying period for cheap blue-chip stocks, especially those that are currently experiencing unreasonable price hammering due to credit exposure. Identifying which of these are consumer monopolies and destined to survive with high return on equity ratios is our mantra for purchasing enormous long-term returns today.

(1) 22 August 2008 http://biz.yahoo.com/rb/080822/buffett.html

(2) 22 August 2008 http://cheng10.blog.sohu.com/

A Tale of Two Chinas

On back to back nights of April 28 to 29th, I attended separate talks on China that demonstrated a remarkable contrast of outlooks different interest groups have on industry in China. The first night was the latest installment of the Beijing Olympics Series put on by the Asia Society. They had some really quality speakers including Alexandra Harney, author of The China Price: The True Cost of Chinese Competitive Advantage, Paul Midler, President of China Advantage, Daniel Rosen, Principal of China Strategic Advisory, and Alan Schoem, Global Product Risk Practice at Marsh. First of all, I found their level of knowledge to be very deep, particularly Paul and Alan who waxed eloquently all night about the real challenges in China. Let me highlight a few of the issues they raised:


China makes everything, not just cheap stuff, from toys to airline parts. It's not that suppliers themselves are corrupt or skimming, but more often what happens is that they have a large network of suppliers themselves that they cannot readily police, so we have to be conscious of the whole supply chain when trying to identify problems there.

The US Consumer Products Safety Commission has about 390 employees. The equivalent body in China, the AQSAQ has 55,000!!! They are also strapped for cash and years behind the US and the EU. Moreover, the Federal Government of the US increased the budget for the Consumer Products Safety Commission to $80mm from $63 million last year, which in government budgets amounts to a huge increase.

Eventually there will be convergence in China for export and domestic quality products and that will help improve quality dramatically across the board. And, we can even see this happening today. There is a force pulling Chinese companies up the value chain and it is not just the CCP. They want their own brands now, and in order to receive marginal value for the products under those labels, Chinese companies will have to dovetail marketing with quality. Consider Haier. 10 years ago, no one in America knew this white goods maker. Now they have a substantial chunk of US market share in air conditioners and more.


Quality problems in China amount to one of two basic problems.
1: factory didn't know better - specifications mistake
2: willful corner cutting

AQSAQ can help to solve #1, but there is really little the organization can do about #2. Maybe penalties, maybe enforcement, but really very little in general.

The overriding theme of the night was that at the heart of the problem, and where the real responsibility lies is with corporations as huge as Proctor and Gamble all the way down to my business - it is with the exporters, the importers, and the factories. It is our job to make sure that quality is tested and bad product is not released.


The will is certainly there to change certain industries. For example, Mr. Schoem talked about the fireworks industry in Hunan Province, whence comes over 60% of US imported fireworks. It turns out that a number of years ago, the US Fireworks Standards American Fireworks Safety Lab was created to pemit imports of fireworks under the agreement of enforcement of stringent safety requirements. Hunan's government worked closely with the US authorities, and today, 90% AFSL-tested fireworks from China comply with mandatory standards. That compares with rates as low as 50% for compliance of similar product from other countries.

This is a nice segue into the talk on the 29th, when James Filippatos, Assistant Administrator for International Aviation at the Fedearl Aviation Administration (FAA) gave a talk at the National Council on China-US Relations. Mr. Filippatos' talk was truly a gem. He described his experiences in China with aplomb. Moreover, he introduced to me the fact that over the last four years, Chinese aircraft have had the safest record of any country in the world. He then reminded us that 15 years ago, Chinese planes were so dangerous that the US would not let them fly here. Now there arae 23 daily flights between the US and China and that number is sure to grow rapidly. The Chinese equivalent of the FAA, the CAAC, got together with the FAA to make this all possible. They emphasized that no matter what, the Chinese market needed better pilots, airplanes, and operational know-how. According to Mr. Filippatos, this is an unprecedented success story for the FAA and CAAC. The two bodies have trained hundreds of personnel and generally instilled a desire to constantly improve. We reap the benefits of that improvement every day.

Quick fact - one of the major factors deterring the expansion of its domestic commercial flight industry is that China's military controls 80% of the skies in China. The US equivlent is may 2 - 3$%. Wow - that negotiation is going to be a very long process. D



Moreover,

Blood in the Streets

I saw this in the Shanghai Daily yesterday and realized that it's official: there is now blood in the streets all over Western Europe and the US in terms of the property sector:

"Spanish builders are tempting reluctant home buyers with free cars, mortgage holidays and hard cash as they try to lift the crisis-hit housing sector. Some are also diving into the rental market. At this month's annual property fair in Madrid, the number of promoters was down by a third on the previous year, many of them victims of the deepening housing crisis. With fewer buyers milling between models of white-washed housing estates, there were scant queues to see sales representatives." [1]

The question is, why did this appear in the Shanghai Daily? The answer: propaganda. The regulators in China have continued to put enormous pressure on the property sector and as a result, they need to be able to justify their actions. One way to do that successfully is to point the finger at the alternative, which conveniently is much worse right now. In fact, this is great for the government as they take aim at developers and buyers alike in a common chorus, "Slow down."






[1] April 24, 2008 Harding, Ben and Clara Vilar, Copyright Shanghai Daily Information Network

Lobbying in China

Scott Kennedy's 2005 "The Business of Lobbying in China" is interesting. It's one of those books that is extremely exciting at the beginning as he breaks down how major corporations lobby in Beijing and get together in some instances but often times point the same finger at each other. However, at one point, he is so unsuccesful in keeping the reader involved because he gets so caught up in the names, functions, and history of China's major commercial associations, such as the SELA, PEA, CTVEA, ACFIC, MOFERT, and many others. Nevertheless, there are some interesting revelations, such as the fact that ACFIC, a non-profit organization, publishes the China Business Times. Also interesting was that the roots of the current associations system emerged out of the Mao era, which seems strange given the fact that these are very commercial bodies today. Back at the very beginning of Maoist China (early 1950s), being private was acceptable, however as time passed of course it became terribly taboo. Consequently, many of the associations that were built on private businesses shut down or suspended operations until the late 1980s.

Asia Society Meeting on Carbon Trading

Last night (4/7/08) at the Asia Society in New York City (70th St/Park Avenue), there was a terrific talk entitled "Carbon Trading Update: Business Opportunities for Asian Sustainable Infrastructure".

The main point of the talk was laid out early on by moderator Jon A. Anda, President, Environmental Markets Network and a trustee for the Asia Society (also a former Vice-Chair at Morgan Stanley).

Mr. Anda went through some basic background of the last several years that the carbon trading market has been around. He said that:

-Efficient CO2 mkt enables an efficient dynamic hedge of climate risk

-We don't have the tools yet to hedge the risk of BAD climate changes - the technological "tools" are simply not there yet

-We must limit quantities because you simply cannot tell people to "stop using carbon" and then just tax them more, for it will turn out like the cigarettes epidemic, where smokers just keep smoking and paying the higher taxes

If the US went to 80% reduction (70% by Senate) off its current usage ('08), the EU: 60% off it's 1990 usage (Merkel), and China 35% off its projected 2012 usage totals, then we would have an industry of hundreds of billions of dollars indeed possibly trillions.



And continued with the goals of the discussion, specifically to answer the following:


Carbon Trading: Is it a Good Idea?
Carbon Trading: Can it work?
Carbon Trading: Does it have a chance of being adopted in the US and then globally?

It was my general feeling that the panel of four that Mr. Anda moderated all answered yes to those three questions in one form or another.

First, a couple of definitions that I had no knowledge of going into the evening:


CCS - Carbon Capture and Storage - (from Wikipedia) Carbon capture and storage (CCS) is an approach to mitigate global warming by capturing carbon dioxide (CO₂) from large point sources such as fossil fuel power plants and storing it instead of releasing it into the atmosphere. Technology for large scale capture of CO₂ is already commercially available and fairly well developed. Although CO₂ has been injected into geological formations for various purposes, the long term storage of CO₂ is a relatively untried concept and as yet (2007) no large scale power plant operates with a full carbon capture and storage system.


CDM - The Clean Development Mechanism - an arrangement under the Kyoto Protocol allowing industrialised countries with a greenhouse gas reduction commitment (called Annex 1 countries) to invest in projects that reduce emissions in developing countries as an alternative to more expensive emission reductions in their own countries. A crucial feature of an approved CDM carbon credit is that it has established that the planned reductions would not occur without the additional incentive provided by emission reductions credits, a concept known as "additionality". (Wikipedia)

The panel was awesome. It featured:

Paul Ezekiel, Head of Global Carbon Trading, Credit Suisse
Peter Ho, Country Director, China, EcoSecurities
Timothy Profeta, Director, Nicholas Institute for Environmental Policy Solutions (@ Duke)
V Raghuraman, Head of Energy, Envt, & Natural Resources, Confed of Indian Industry



The contrast of opinions and projections was awesome. If I could highlight one major point I took from each panel discussion member, it would be:



Ezekiel:
The CDM has 2 phases:
2005- 2007, which failed miserably because of its market design in which over-allocation of free carbon allowances killed the market, and we saw 0 impact on emissions.

2008-2012 Expecting much improvement based on a new market design and many of the "kinks" worked out.


Raghuraman:
India: A mixed outlook on CDM because they started late and as such are forced to mitigate.
Most big industrial players in India are public, however most initiatives come from the private/NGO sector, therefore we see a disconnect right now between those that want to implement and those that should implement. In fact, many of India's upcoming projects are not looking at CDM.

Profeta:
The US political outlook on the subject in terms of chances of passing this bill are:
10% chance this congress
90% chance next congress

All US presidential candidates: Clinton, Obama, and McCain are in favor of a system, most strongly backed by McCain of all candidates who got on board back in '01. This will happen next presidency (we should note that the McCain - Lieberman Carbon Reduction Senate Bill was written by Dr. Profeta, and later it transformed into the current McCain-Warren Bill) There will be a debate on Senate floor before the Memorial Day recess. The US is studying a 70% reduction in emissions by 2050 from the 2005 level.

There are currently 2 main issues:
1) CDM is under political attack
2) The US can and probably will go to another trading system and only allow for 15% of its emissions buying on Europe's carbon trading markets


There are 45 billion pounds of greenhouse gases released into the atmosphere every year
67% of the total between now and 2050 is in the US and China.
Therefore, a bilateral deal could solve 2/3 of the problem



Ho
There are profit model issues here that need to be considered.
They looked at a wind farm investment in China that had an IRRof 4-5%, but if CDM credit trading could have been included, then the IRR would jump to 9-10%.

Moreover, this credit trading system is opposite to traditional building. In housing, you get the loan first, then you build. There are no such loans for CDM structures - you only enjoy the benefit three years after the reduced emissions are realized.

Remarks about Guanxi

My weekly book review this week brought me back to a fantastic publication from 1994 entitled, "Gifts, Favors, and Banquets: The Art of Social Relationships in China" by Mayfair Mei-hui Yang. This is an incredible piece that goes through the history of Guanxi and also some proven techniques that shed light on how to effectively work through getting things done in China. There is so much to be said on this topic, but I want to include a quotation from the very beginning of the book which provides a historical root for the practice in China. Before reading it, here is the lesson: giving and receiving is a fact of life, rite, etiquette, and ancient precedent (the source, The Book of Rites, is from the first centure BC) in China, and it needs to be studied cautiously as part of any due diligence or planning period in investment ventures in China.


太上贵德
其次务拖报
礼尚往来
往而不来
非礼也
来而不往
亦非礼也

Translation:
In the highest antiquity they prized (simply conferring) good;
in the time next to this, giving and repaying was the thing attended to.
And what the rules of propriety value is that reciprocity.
If I give a give and nothing comes in return,
that is contrary to propriety;
if the thing comes to me, and I give nothing in return,
that is also contrary to propriety

-Li Ji (Book of Rites) "Qu Li,"
1987:7; Legge 1885:65 [1]



[1] Yang, Mayfair Mei-hui, 1994, New York, Cornell University Press.

China, Laos, and the ASEAN sphere of influence

When I saw this headline, "Laos: Laos-China trade reaches 241 mln USD" I was immediately reminded of my trip to Laos last year. [1] No, it wasn't the beautiful temples in Vientienne, or the awesome scenery throughout the hills, nor the hiker paradise around Vang Vienne, nor that amazing coffee shop (and greater commercialization in general) in Luang Pra Bang. What struck me about this was just how readily apparent China's sphere of influence has become over the last five years in ASEAN, nowhere more apparent than in Laos. We crossed the border into China by bus in February of 2007, in a very similar fashion to how I had done so 5 years earlier. The glaring difference was that 5 years ago, the Laos side of the border was a no-man's land but the it was absolutely under the total control of the Laos authorities. Even though Chinese cars were crossing through at that point, they were still dealing entirely with Laos border patrol. Last year was totally different. Instead of dealing with Laos patrol, Chinese tourists were being carted through exclusively by Chinese tourist group leaders backed by pseudo-China authority. It was incredible! They barely even acknowledged they were in another country. Moreover, you could tell who was paying whom under the table, and to my even greater shock, the Laos authorities did not pay even nominal attention to what the Chinese tourists and group leaders were doing logistically to get across the border. Well, I guess that's how it is now.

[1] 4 April 2008 Thai News Service (c) 2008 Thai News Service

General Liu Yazhou on China, Japan, and the United States (Part II)

In the second part of General Liu's interview, he continues with his smoke and mirrors by challenging the common notion that China is the major enemy of the US in the current global environment. Instead, General Liu contends that Japan has continued to be the US' top concern over the last 60+ years and that remains in effect today,

"I have always believed that the primary adversary of the United states in Asia is not China but Japan. It is quite probably that not a few knowledgeable persons in the United States share this belief. The United States defeated Japan sixty years ago. That was a difficult and hard-fought battle for the United States, and Japan left it with a deep impression indeed. Japan's stalwart national spirit, well-equipped educational system, and highly developed science and technology - all these combined drew respect from the world. In Churchill's words: "Japan's war machine is frightfully efficient." In only three months' time Japan drove the British and U.S. forces out of the Pacific and Southeast Asia. What country had done so in the past? And what country will be able to do that in the future? Toward the end of the war, when Japan was at the end of its tether, it still drew up a plan called 'break a hundred million pieces of jade [committing suicide].' Awed by this display of determination, the United States finally resolved matters by dropping the atomic bomb. What sort of understanding did the United States gain by fighting this war? It concluded that Japan was a fear-inspiring enemy. The qualities a country displays in wartime can also be displayed in times of peace, although in different domains. This is manifestly evident from Japan's post-war flying economic advances...Japan was a pile of rubble in 1945. It was more or less the same level with China in the 1960s. Then China started its 'Great Cultural Revolution' and tormented itself whereas Japan's economy began to take off. in less than twenty years, Japan left China far behind and was way ahead, catching up with the United States. However, the United States consistently kept a choke hold on the Japanese economy. Japan was highly adept at manufacturing 'small' products but could not make a single 'large' product. Then, with the advent of the science and technology revolution, Japan once again tried to push ahead. Not daring to leave matters to chance, the United States hurriedly concocted an Asian financial crisis and succeeded in curbing the impetus of Japan's spurt forward. The United States knows that China is a country that places inordinate importance on ideology, goes to extremes, is very good at waring itself out, or what might be called "self-destructing," and cannot get is act together. The Japanese are a highly cohesive people. China is like an old man; Japan is like a youngster. China is lethargic, whereas Japan brims with vitality. That is why the United States is much more wary of Japan than China."

I'll interrupt General Liu here only to say that he is sending a signal here. Everything that Japan did from 1960 to 1989, China has now duplicated in every respect other than the average standard of living for its people. Infrastructure is world class, technology has moved forward, higher education is booming, and the people feel young again. Moreover, there is a determined advance underway in China's political circles - the leaders are made by the time they are forty. Many of our closest colleagues in government are making impacting economic decisions on their locales and these leaders are usually between 35 and 45 and have extensive experience abroad. The old man argument does not fool anyone. If anything, it expresses the fact that China finds itself wiser and more capable of taking on an opponent years ahead of it.

General Liu continues,

"That is why the United States has kept Japan so rigidly under its thumb. The United States is much more wary of Japan than of China. So now we can understand why the United States formulated a peace constitution for Japan, a constitution under which Japan forever anjures warfare. The United States is very selfish. It is not doing this for China or Asia but only for itself. It has done this so that when it eventually dominates the world it will have one less opponent and one more helper. In accordance with the U.S. design, today's Japan has become an economic colossus but remains a military dwarf and a political midget. As Shintaro Ishihara put it, "The United States has cut away Japan's testicles and Japan can only serve the United States as a court eunuch." Today, Japan is literally and faithfully serving the United States as a global court eunuch."

Well, I do not want to treat General Liu's metaphor with any type of indifference, because the truth of the matter is that I could not agree more. For a nation as militant as post-Meiji Restoration Japan was, the US has certainly caused an unnatural turnaround in their sovereign mission. Perhaps General Liu then is also signaling a glaring opportunity for China's sovereign desires.

General Liu also mentions that the US has put up more defenses against China in the forms of Taiwan and North Korea...

"The United States feels that having Japan as its only military dog is not enough, so it has bred the 'Taiwan Independence' military dog. These two dogs are keeping watch for it over China...The current focus of the Asian strategy of the United States is on firmly controlling Japan and at the same time guarding against China. 'Hold on to one, and keep an eye on the other.' And if possible possible, 'Swallow' yet another. Which one? North Korea."

General Liu seems to make a good case for the US' recent policy in Asia. I believe that once again we are going to see a war fought in North Korea, but this time it will be political and economic, not militaristic. Frankly, the recent negotiations between South and North Korea about liberalization would seem to favor the United States, as South Korea is every much in the US' pocket as it is in China's. However, if you talk to entrepreneurs in China, many of them have been buying and selling across the Jilin border town of Dadong into North Korea for years now, apparently giving the Chinese the upper hand in terms of economics. Of course we know that the US has an uphill battle to fight politically, given that almost all of North Korea's anti-West rhetoric over the last 50 years has been explicitly aimed at the US. Moreover, during that time big brother China was North Korea's only true ally. Nevertheless, if the US can meander into North Korea's political circles through South Korea, then it ultimately will have the best chance at setting up another front against China.

Finally, General Liu hits on a subject that really makes one think...

"However, that is not the end of it. The Asian strategy of the United States has still another and deeper level, a core level-preventing China and Japan from joining hands...Everyone thinks that is impossible, but Americans believe it is possible. Americans are always able to look ten or more steps ahead when they formulate strategy. We are doing quite well if we manage to look one day ahead. They are able to look two days ahead, three days ahead, and even farther. The biggest difference between China and the United States is the difference in the level of strategic considerations. The United States takes the whole world into consideration, enabling it to look farther ahead. Our perspective is regional, and that is why we are a notch inferior in our calculations. The United States knows that under the present circumstances, its position in Asia cannot be shaken by the individual power of either China or Japan, and the sole possibility of anything happening is if china and Japan join hands."

True. And we also have to read between these lines and realize that even General Liu himself finds that condition impossible under the present circumstances, because he knows that the leadership in Beijing and the will of the people of Japan is nowhere near ready for this. Why? First of all, because life for Japan has been great under the direction of the US. Moreover, the economic benefits that Japan enjoys from its trade relationship with China fall far short of the total benefits it receives in return for its current relationship with the US, including: greater access to world capital markets, a steady flow of immigration to the United States, preferred status among other nations for entering and leaving the United States, preservation and growth of its own culture, the highest standard of living in the world, etc. Can China offer this? Moreover, can China get over its own animosity for Japan? That of course remains to be seen.


[1] Chan, Alfred L Chinese Law and Government, vol. 40, no. 2, March - April 2007, pp45-49

General Liu Yazhou on China, Japan, and the United States

Last week I read one of the most astonishing and in-depth policy papers about the Chinese point of view of East Asian military strategy that I have ever seen. It was so impressive that I think it deserves a summary and comment here. I must mention the whole essay is actually excerpts from an interview between General Liu and a reporter from a 2005 article in the Beijing monthly, Dazhanlue guan. Our source is the translation found in the March - April 2007 edition of Chinese Law and Government. This article is so impressive and causes for cogitation on so many issues that I will have to devote more than just one entry to it. Finally, a brief introduction on General Liu copied verbatim from the beginning of the journal is as follows, "The son of a regular soldier in the Eighth Route Army, Liu was born in 1952, joined the People's Liberation Army (PLA) at age fifteen, rose through the ranks accruing extensive command experience, and became deputy political commissar of the PLA Air Force in 2003. Also an accomplished and prolific writer of report literature and novels since the 1980s, Liu has increasingly turned his pen to strategic thinking and military matters and is now one of China's most influential strategic thinkers." [1]


Interestingly enough, Liu starts with Europe before getting into the discussion of East Asia. He states, "In those years (post-WWII), the United States adopted a defensive stance in the face of the menacing concentrations of Soviet tank formations. But now the Soviet Union has collapsed, and the United States has gone on the offensive. However, one should not infer from this change in its offense-defense posture that the United States has shifted its strategic focus away from Europe. In fact, so long as the U.S. objective is to dominate the whole world, Europe reamins its center of gravity, its basic bearing point. It plants one foot on its own land - the United States - and the other foot on Europe. Doing so enables it to stretch out both its arms to cover the whole world. Asia does not furnish the conditions for shoring up the U.S. ambitions...When the Iraq war broke out, Europe saw through the United States' intention of controlling the center of the world as a prelude to taking control of the European continental plate, and they opposed that war with exceptional vigor - in fact, more vigorously than some of the Arab countries. But the United States fought the war anyway, and Europe was forced to swallow the bitter pills."

Fascinating. This is something that stares us smack in the face every day, but I believe we often forget about or overlook the significance of our military bases in Germany and southern Europe, or the reason the UK followed us right into Iraq with barely even batting an eye. The question is, what impact will this have on our Asian strategy?

Before he gets into talking about Japan, he spends a quick minute on a key point about the oversight that most Chinese have when studying the Taiwan issue,

"Those of us who have a world perspective can sense the heavy pressures to which others are being subjected, but those of us who merely have a Chinese perspective only sense that the United States is using the Taiwan issue to cause trouble. Actually, the pressures to which China are subjected are relatively minor compared to those offered by other countries and especially Russia. At first sight, it would seem that the exacerbation of the Taiwan issue places China in a dilemma. If China engages in an all-out arms race with the United States or, in other words, engages in an all-out arms race with Taiwan, it will ultimately be worn down by the United States, just like the Soviet Union. Yet if China maintains a policy of low military spending and devotes its financial resources to economic construction, the disparity will further increase and China will be helpless before the U.S. military blackmail."

From General Liu's perspective then it seems as though China has no way out. But much of this comment is smoke and mirrors and not a very good job of misdirection at that. What we should read between these lines is that there is no intention of China to engage in an arms race with T@iw@n (TW) when it fully believes that its colossal economic influence over TW can be converted into an equally effective political influence over time. Hence, one of General Liu's implicit suggestions of how to resist the expanding US world takeover is to be fought on the steps of the Yuan and TW's other political institutions. This goes a great way to explain why the Communist Party has been so active in inviting TW's leaders such as Lien Chan to tour the mainland and strengthen the political ties between the "two" countries.















[1] Chan, Alfred L Chinese Law and Government, vol. 40, no. 2, March - April 2007, p3

AMB Expanding China Holdings

I must say that I was extremely pleased to see that AMB is growing its China portfolio. As a believer in the enormous potential value that China's real estate industry holds for experienced American developers and real estate asset managers, I trust that our country's top firms will derive enormous profits from China in the future. On Saturday, the Shanghai Daily reported that,

"AMB Property Corporation, a world leading developer and owner of industrial real estate, announced yesterday that it had acquired approximately 133,100 square meters of land in the Xiuzhou Logistics Park in Jiaxing of Zhejiang Province. The company said it planned to build a 74,612-square-meter distribution center on the site, its latest effort to expand its distribution network throughout the country...AMB announced earlier it planned to operate US$1 billion to US$1.5 billion worth of assets in China by 2010. It currently runs a portfolio of approximately 185,882 square meters of distribution spaces in Shanghai, Kunshan and Ningbo. ProLogis, a United States developer, owner and manager of distribution facilities, has also recently expanded its footprint in the city through land acquisition in the same logistics park." [1]

If you look at AMB's past, China is a natural fit for them because they tend to raise their money privately. That matches well with the value-based investing that long-term investor industrial real estate investors are looking for in China. As Moghadam says, AMB, " 'has never raised money on Wall Street beyond our IPO.' Since its initial public offering, AMB has gone in the opposite direction of most REITs by retiring more than 6 million shares of stock through buybacks." [2]

AMB raises most of its cash through private capital - institutions and other funds that look for a leading industrial real estate firm to offer predictable returns on prime industrial complexes. What's amazing about AMB because it is an industrial REIT, its fortunes are barely connected at all to those of the general residential real estate market. In fact, its 2007 earnings of $2.96 per share were nearly triple 2006 earnings and almost double 2005 earnings. [3] Hence, while the residential market was still booming in the US, AMB was going through a bit of a slump. Likewise, while the residential market began to tank, AMB's profits grew nicely.

AMB is also a company to take note of because its approach. This move into Jiaxing, along the Yangtze River Delta, should signal to investors that the company now has its feet wet in China after investing in Shanghai, Kunshan, and Ningbo. Therefore, it will feel comfortable going after properties that need greater managerial expertise to derive value out of them in order to really position its investments in China to derive significant profit margins.







[1] by Cao Qian 29 March 2008 Copyright 2008 Shanghai Daily Information Company
[2] Bergmann, Paul, Maverick Real Estate Investing, Copyright 2004 by Literary Productions
[3] Standard and Poors, March 30th, 2008

China vs Rio/BHP

The standoff that is going on right now between Rio Tinto, BHP Billiton, and China is amazing.  This is one of China's very first tests of macro supply chain that will determine how much China can control price hikes in iron ore for decades to come. 

China has summarily refused to accept Rio Tinto and BHP's 71% price increases. 

Although they seem to indicate that the reason is the increase is too high, that is a bit hard to accept given that they handled Vale's 65% price increase just two months ago. No, there is much more at stake with Rio Tinto, BHP, and China.  

China wants a much bigger piece of the deal this time, and they have decided to strike while the iron is hot.  If they can continue to stave off the spot market shipments for a few more months, Rio Tinto and BHP will effectively lose several billion dollars in revenue.  That may cause the market to hammer their share prices and give China more leverage to buy a much larger stake of the planned merger than was originally anticipated.  My guess is that China wants at least 25% of the new company with two or three board members to boot.  

This battle is about the future of China's steel industry and several downstream industries that flow from there such as automotive and construction.  They are betting that they can sweat it out longer than BHP and Rio Tinto's shareholders.  My guess is that they are correct.

China Transportation - Subway or Rapid Transit?

Earlier this week, the following story about Wuhan's subway system expansion really struck me,

"City In Central China Plans To Spend $40B On Subway System...Wuhan, capital of Hubei province, plans to spend CNY300 billion (US$40 billion) to expand its subway system, Xinhua said. It will be extended from seven to 12 lines with 309 stations by 2015. Once the expansion is finished, 66% of the city's 8.7 million people will be able to find a subway station within 600 meters of their home, Xinhua said." [1]

Certainly for China's mega cities, of which Wuhan truly belongs in the mix, building a massive underground system is in order and will effectively reduce congestion in the years to come. But, what about China's smaller cities? Does the benefit outweigh the cost for cities such as Qingdao, Dalian, and Shenyang? Are there better and cheaper alternatives for Wuxi, Changzhou, Suzhou, and Hangzhou?

Yesterday, I was given a fantastic opportunity to put that in perspective when I visited with Professor Ralph Gakenheimer of the MIT's School of Architecture and Urban Planning. Dr. Gakenheimer specializes in urban planning and transportation planning and brought to my attention an interesting alternative to subway lines that has really caught on in Latin America, Europe, and increasingly the North America and Asia. That system is something called Rapid Bus Transit, or Rapid Transit. What happens in a system like this is that the municipality builds an extra lane exclusively for buses that will stop only at express points in a city or along a highway. To get on and off the bus, you need to have entered similar to a subway where your fare is already paid so that passengers get on and off the bus quickly. Dr. Gakenheimer says average stop times are reduced to 20 seconds and falling.

But, the real advantage to the system is the cost savings it offers a local government. Subway lines cost approximately $100 million per mile in the US (costs for China are unavailable). Rapid transit lanes, however, cost between $10 and $15 million, representing savings of between 85% and 90%. That is a tremendous savings and Professor Gakenheimer indicated that many of China's emerging 2nd and 3rd-tier cities that are dreaming of subway systems would be better suited to start preparing to build these alternative and more cost effective systems.

[1] 3 March 2008, Dow Jones International News (c) 2008 Dow Jones & Company, Inc.

March 4th Asia Society Talk Notes

I had the absolute pleasure earlier this week of listening to four China hands talk politics, law, economy, and much more at a meeting at New York's Asia Society on Park Avenue in New York. Moderating this four-person discussion was Howard Chao, Partner and Head of Asia Practice for O'Melveny & Myers LLP. He was joined by Nicholas Lardy, Senior Fellow, Peterson Institute for International Economics, Jonathan Woetzel, Director, McKinsey & Company, and Jimmy Hexter, Director, McKinsey & Company. Woetzel and Hexter's new book, "Operation China: From Strategy to Execution" was available after the talk for attendees. Here are some highlights from the talk:

Dr. Lardy began the talk with an overview of China's macro-economic barometers. One of th things I found most astonishing was that China's current account surplus is between 10 & 11% of GDP. By comparison, he noted, Japan's greatest account surplus in the 1980s was 4% of its GDP. That means that China seriously has a lot more cash stored up than even Japan did.

He went on to say that the jump in China's prices is not restricted to just food prices and the overall CPI, but rather the PPI, a barometer of price movements in machinery, is also up and accelerating more aggressively than the CPI.

Next, he talked about why there was so much craze for investments in stocks and real estate by showing us the following:

CPI: up 7%
Savings % offered by banks: 0.71%

So, your real savings rate is greater than negative 6%. Apparently, this is a textbook case of how you create a bubble in other asset classes. Of course, when you have 300 million people urbanizing, you are going to need huge amounts of capital investment in capital-intensive projects.


Next, Dr. Woetzel noted some interesting trends as well going forward...

Migration: From 1990 to 2007, apparently 250million urbanized, but mostly through establishing new cities and shifting boundaries. That's not going to happen because of land restrictions in the future. Effectively since that time, there have been only 100mm migrants to the major cities. Looking forward, there will probably be another 250mm migrants headed for the cities and a total urban population of 1 billion urban.

That is going to drive macro costs of health, education, and food way up. And the greatest burden will likely be on 3rd and 4th tier cities.


Jimmy Hexter then weighed in on China business strategy by explaining that the winners in China historically were those that executed bold strokes of strategy - whether through gaining advantageous licenses, exclusivity, or other sundry tools. However, as we look forward, the winners will most likely be those that deliver excellence of execution. Specifically, companies that can migrate world's best strategies and get their domestic operations to perform better at sourcing, procurement, manufacturing, sales, distribution, and development will win.

By his account, there is an enormous opportunity to improve performance in China, with increasing outputs by 30-50% via this shifting global best practices to result.


60%+ of exports are machinery and electronics


As far as the effect any rising world raw material prices will have on causing countries to shift to Vietnam and other Asian export economies, not likely to happen any time soon. Dr. Lardy cautioned us to remember that Veitnam's total exports amounted to $40billion in 2007, whereas
China's topped $1 trillion.


There was also a discussion of the transient talent pool in China. Here's why they move from one job to another:
1) Influence - want opp to drive performance
2) Promotion
3) More money

What they really want boils down to greater inclusion and recognition. Until they get it, we're likely to continue to see rates as high as 40% job turnover every year in China (in the US by comparison, it's 20%)

The final major topic that was discussed was capital flows in China. What we are seeing is huge amounts of capital being raised around the world, and a good portion of it is flowing to Asia and in particular, China and India. China has become a gigantic player in trade and finance, yet locally, allocation of capital has been poor because, as a result of the negative savings rate mentioned above, a large swathe of unsophisticated investors operating under duress are forced to enter a capital market that they do not really understand.

There was a great comment made about private equity investments in China. Apparently, right now, the players there that are doing well are small China private equity companies that are doing well investing in small companies with niche regional markets. For large caps, it is difficult right now because of high valuations, struggles for control, and disagreements over management.


This was a great talk put on by the Asia Society and we will continue to update you as more relevant talks occur.

China Technology Gap Narrows

Interesting article yesterday in Maeil Business about the technology gap shortening between Korea and China...

With Chinese enterprises pursuing at a frightful speed by means of an industrial spy or imitating industrially advanced nations, the technology gap between chief industrial corporations of Korea and China was found to be narrowing at a fast rate. According to the Korea Institute for Industrial Economics & Trade (KIET) on Sunday, a research conducted November last year, on 608 major companies in 10 core industries such as automobile, electronics, shipbuilding and semiconductors, evaluated the overall technology gap between Korean and Chinese manufacturing industries at 3.8 years. Technology gap between Korea and China had been evaluated at 4.7 years in 2002, 4 years in 2004 and has continued to narrow down.[1]

Now, I really have no idea how you would effectively measure this; it seems so onerous and dubious, yet at the same time it does seem to me that Cherry cars are about 4-5 years behind Hyundai cars and Haier is about the same length behind Samsung in electronics. But, I am not so sure how far you can go with this. For instance, there really are no major Korean lap top manufacturers out of Korea that we see competing on a global level on a daily bases. Moreover, when was the last time you saw a Korean telecom company try and bid for a US telecom company. Moreover, Chinese companies are on spending sprees to buy technology abroad - and they currently have much deeper pockets than their rivals in Korea. For that reason and the following additional reasons, we think this convergence will accelerate in the coming months:

1) Economies of Scale - Korea cannot possibly compete with China in numbers or foreign reserves to buy companies/technologies abroad
2) FDI - China is just crushing Europe here, let alone Korea
3) Technology transfer - astute China policy necessitates this in many investment deals
4) Reputation - now this needs some qualification. I am referring specifically to biotech and an incident in which one of Korea's most famed scientists, Hwang Woo-suk, falsely advertised successful fabrication of human embryonic stem cells by cloning. You will not see many Americans going to Korea for stem cell surgery - but they're flocking to China. The technology gap here in terms of revenues per unit of technology is most likely in China's favor and if not it will be within a year or two, not four.

[1] Korea-China Technology Gap Narrows to 3.8 Years 2 March (c) 2008 Maeil Business Newspaper

The Effects of Steel Prices Rsing

Rio Tinto, BHP Billiton, and Vale are major corporations and they're going to get theirs too, there's just no two ways about it. After Rio Tinto and BHP Billiton merge in two years, that neew mammoth $400 billion company will probably set its sites on Vale, assuming of course Vale has not ammassed its pile of smaller acquisitions to compete. We shall see.

On Tuesday, Xinhua gave a pretty nice summary of the recent iron ore price hikes, their inevitability, and their effects on steel prices in the coming year. Let's break this article down into those three sectoins:

1) Price hikes...

"After Brazilian mining conglomerate Vale hammered out 2008 benchmark prices for iron ore fines with Japanese and Republic of Korea (ROK) steel makers last week, Baosteel Group, China's largest steel maker, agreed on the price for fiscal 2008, accepting the Brazilian miner's price hikes that ranged from 65 percent to 71 percent compared with 2007."

71%!! I'm confused now because the rule of 72 is only supposed to be for compounded returns - so what happens if you get there in one year? Does 72% = 100% if it's one year? No, of course not, but if it did that probably would require me to immediately find a finance professor.

What's more, the article says that an almost identical hike occurred two years ago...

"Since China joined the international pricing negotiations in 2004, the price has risen every year. Price negotiations for 2004 ended with an 18.62 percent increase, followed by a 71.5 percent rise in 2005 and a 19 percent increase in 2006."

Now we can use compounding equations, and by such numbers, it would appear that steel prices have risen 2.5x over the last four years. What is this doing on a practical level? Let me give you a quick insight into our world. Two of my clients in the last week have said that their products are now more competitive if made in the North America - one in the US and one in Mexico. I am certainly not suggesting that this will be the case for years to come, and perhaps this is because their current China suppliers are in East China (as opposed to the cheaper western and central regions), but nevertheless, I do think this is a sign that things are moderately changing across various industries.

2) Inevitably. Basically, according to the article, this hike was going to hit China whether they liked it or not, whether they negotiated hard or not, and whether they neotiated early or not - it was all numbers...

"Baosteel, the partly state-owned representative of China's steel makers in the pricing negotiations, faced a challenge. The miners were holding out for higher prices, while other major Chinese steel producers wanted a favorable pact. Given the huge share of the market that China represents, Baosteel may have believed it had more bargaining power than it did. CISA estimated the 2008 price rise at only 20 percent.

So Baosteel waited -- but others negotiated.

'Even if Baosteel had concluded negotiations first, the price hike would not be lower,' said Hu (Kai, a senior analyst with the Chinese Umetal.com website.)"

There was no way around this. Especially given the fact that Chinese steel makers have enjoyed fat profits over the last two years as China's stock market has boomed.


3) Pricing effects

Well, we alluded to it above, but they make it quite clear in the article what the price increases are likely to be on steel tonnage...

"

The China Securities Journal reported on Monday that 57 domestic steel mills had raised their prices after the benchmark price was settled. And on Tuesday, the newspaper reported that Baosteel had raised steel prices for the second quarter of 2008. Its prices for major cold- and hot-rolled products will rise 800 yuan (111 U.S. dollars) per ton in the second quarter, compared with the first quarter, Tuesday's China Securities Journal quoted an announcement by Baosteel as saying.

Considering that Baosteel has a heavier reliance on imported iron ore than other domestic competitors, a 65-percent iron ore price rise could translate into cost mark-up of 258 yuan for Baosteel, as against 116 yuan for other domestic steel makers, according to statistics from Chemease, a business information provider on Chinese chemical commodity markets.

But a price hike of up to 800 yuan would offset its cost mark-up and also provide ample profit margins, said Chemease analysts."

So, why not just buy steel from Benxi I&S, or Ma'an I&S? It's just not that simple for two major reasons:

1) Logistics
2) Quality

Baosteel is one of the world's best steel plants and there are grades and qualities of steel that you need for certain applications that are available at perhaps two or three more factories in China. Secondly, the country is so large that regionalism plays a huge role in determining which steel ends up in which factory.

At the end of the day, the iron ore price hikes, in addition to oil, are the largest drivers of industrial price inflation. If we use this though as a basis for comparison, then what is the industrial subsidy equivalent for China's large subsidies on refined oil/gasoline? I would say that this question gets answered every day by those that find the real deals in China and those that just cannot seem to be profitable in China.

Source: 26 February 2008, Xinhua's China Economic Information Service, "Iron ore price rise could force China steel rationalization" (c) 2008 Xinhua News Agency. All Rights Reserved .

China's Credit Market Keeps Humming Aon

Great article in today's Asian Wall Street Journal by Professor Victor Shih of Northwestern. Professor Shih writes that although credit and broad money supply has tightened in the West, the opposite is true in China.

"Despite a cascade of State Council decrees restricting bank lending this year and a high-profile Politburo meeting in November that focused on the risk of inflation, bank lending last month grew by over 800 billion renminbi ($112 billion) -- equivalent to 22% of the total loan quota that Beijing's technocrats meted out to state-owned banks for 2008." (-Victor Shih, "China's Credit Boom", Asian Wall Street Journal, February 21, 2008)

That sounds like mixed signal calling to me. Shih goes on to describe in the article that indeed, although Hu Jintao backed Wen Jiabao's call for increased tightening of credit, the fact is that this did not happen which means that the Politburo is quite split on the matter. (Perhaps it's that Shanghai faction led by Xi Jinping and his people that had already begun to exert their influence even before he officially was selected into the Politburo).

Shih adeptly identifies this standoff as,

"an unusual game of chicken. China's major banks, all of which are majority state-owned and run by managers appointed by the Communist Party, are simply ignoring decrees issued by the highest authorities. In a state-dominated banking system, this is as unexpected as mid-level managers blatantly acting against the wishes of both the CEO and the board of directors. Formally the technocrats have the full backing of the ruling Communist Party and can dismiss any banker at any time. However, senior state bankers do not behave as if they take the threat of removal seriously. They've stared down such threats before, anyway -- in China, elite political discord has often compelled banks to disobey formal decrees."

I would add that this is a quintessential power struggle in China and one that will plague the Communist Party for as long as it continues to build wealth. I would also say that this is the modern version of a classic battle between the wealthy and the King in China. If this were the 1680s, we could clearly see similar factional divides between Emperor Kang Xi and the feudal princes Wu San-kuei, Shang Chih-hsin, and Keng Ching-chung (from "Emperor of China: Self Portrait of K'an-hsi" by Jonathan D. Spence, Vintage Books, 1988). The same nobility versus the king proxy struggles happened throughout European history and, let's face it, the history of the entire world ever since one person wanted something another had. But, the contemporary version of Chinese history, which is where we find ourselves today (and let's not kid ourselves, that's how the Chinese see it - they're just passing through China in the current dynasty), has an added element to it. This time the stakes are higher. 3000 - 1000 years ago, the rest of the world meant nothing to China. 800 years ago, it was the Chinese who got annihilated by the Mongols, (when David and Goliath were one in the same and no one could stop them). 150 years ago it was the Europeans who destroyed China. Now, with momentum, size, a growing military, and everybody's factories, the pie is a lot bigger and, most importantly to the Chinese, the face they stand to gain, both on an individual level and a national level, is far greater than ever before in history.

So, if you're watching the economy hum along at 9, 10, 11, and even 12% growth, and you have connections, the only mandate from heaven is to keep the wheels turning and the money flowing. That's why, as Shih astutely points out, today's biggest enemy is inflation...

"The Chinese government needs to continue monetary tightening by raising interest rates and the bank's reserve requirements. Furthermore, Messrs. Hu and Wen need to overcome internal opposition and make it clear to bankers that flouting central decrees begets serious consequences, including dismissal. Otherwise, they risk allowing inflation to spiral toward dangerous levels. In the opaque Chinese political system, strong signals, in addition to decrees and laws, continue to be necessary ingredients of credible policies."

The key policy is all of this is pricing. The biggest winners politically are going to be those that can continue to stem inflation. Given that, maybe the motivations and intentions of the bankers is in fact to prime inflation to fly through the roof and purposely sabotage the current administration in some sort of Pyrrhic Victory. (Or maybe I need to ease up on the conspiracy theories).

China, Oil, and Africa's Role

Two articles over the past two days have really caught my attention and wonder unlike many in a long time. The first one comes from Canada's Global Mail in which journalist Geoggrey York describes the situation of China securing Alberta's tar sands oil reserves as follows:"Iris Evans was in an upbeat mood when she walked into the Canadian embassy in Beijing last fall to pitch the Alberta oil sands to a high-powered group of Chinese investors. Ms. Evans, the Alberta Minister of Employment, Immigration and Industry, was expecting a smooth ride. But she was quickly ambushed by a hostile question from a Chinese journalist...'You say Chinese investment is welcome, but we feel a negative attitude from the Canadian government,' the reporter told her at a news conference. 'The Canadian media makes a big story about Chinese spies in Canada, and it seems the Canadian government does not trust Chinese people much.' Ms. Evans said she knew nothing about the spy issue. But the skeptical question was one example of China's doubts about Canada as an oil supplier. Beijing wants a relationship of trust with its oil suppliers - and that means it usually prefers to buy from authoritarian regimes in Africa, Latin America or the former Soviet Union, where there are no complications about democracy or minority rights."

The next article came from the Macau Daily Times, where the journalist, Christopher Cottrell, described a small block in Guangzhou known as "Little Africa." Here's an excerpt:
"Barbecued chicken smoke and Senegalese pop music fills one hallway. On another floor, mosquito coil incense and the odour of new leather bean-bags bound for Angola commingle. Welcome to the Tianxiu building, the home of China’s largest African enclave and a microcosm for the billion dollar trade boom taking place between African nations and China.Located along the bustling Xiao Bei Road in downtown Guangzhou, tens of thousands of Africans flock to Tianxiu to purchase everything from school erasers for Darfur to hair-weaves for Kinshasa’s beauty parlours. Whilst at least 2,000 make it their own, thousands more are just here for export shopping runs.“It is hard to get hair like this in the Congo,” comments Alice Clarisse as she peruses a Tianxiu shop specialising in hair extensions. “I come here about twice a year to Guangzhou for a week, the prices are very good.” Clarisse, whose home-town is Kinshasa, adds, “This city of markets is becoming famous all over Africa.” Indeed, since China opened in 1979, African students and merchants have been flocking to both Beijing and Guangzhou in droves. However, whilst Africans number into the thousands in Beijing, there are no areas that are considered to be wholly African in the capital. Not so in Guangzhou. The Tianxiu building began seeing hundreds of Africans move into the apartments above the lower shopping mall in the late 1990s. As more Africans moved in, more Chinese moved out to rent to them. By 2001, when China entered the WTO and the Beijing 2008 Olympics were announced, the building was considered Guangzhou’s answer to Chungking Mansions in Hong Kong."
What should the impression of a young voter in the United States of America be to the combination of these two articles?
Number 1 is that China is making moves in international energy strategy that clearly demonstrates its desire to get the job done, no matter how it needs to. Secondly, that there is a power circle growing around China that is in direct conflict with the United States on the status of almost every major conflict country in Africa and the Middle East.
I find it terribly ironic that China does not want to secure oil from CANADA because of political concerns that could lead to supply issues in the future. Yet the so-called 'rogue states', deemed so because of their political bent, are in China's eyes, in fact the more stable supplier economy. This is a huge gamble by Beijing, but it is paying off in more ways than even they had imagined. According to the evidence of so many African traders taking up at least periodic residence in Guangzhou, China is springing economic growth in Africa on a scale and in a paradigm that the Europeans never would have fathomed. Why? Because the 19th century European 'traders' in Africa were more 'raiders' than anything else. China is not only taking natural resources out of the continent, but also giving back in the form of cheap goods, political favor, and international markets beyond China.
The latter is what I find most interesting. I posted a trade lead recently on a well-known edible oil site for sunflower oil. Sure enough, half of the responses came from Africa. And a couple of those responses were Chinese names. Now, I had no interest in buying from Africa, but if I were so inclined, I would absolutely have negotiated with the Chinese broker above the other brokers, because I would feel comfortable negotiating with the Chinese anywhere in the world. This may be the exception today, but do not be surprised if in 10 years it is the rule that the Chinese communities of Africa take dominant positions in Africa's burgeoning international trade.

Volatile Stock Markets and China Still Rocking

Let's take a quick look at the daily headlines regarding China's stock market over the last four days:

Asian stocks rise on hopes worst is over (January 24, Agence France Presse)
Asian Markets Rebound After Fed Cut(January 23, AP)
Chinese shares follow world markets down, sink 4 pct at middday(January 22, Xinhua)
Asian Stocks Plunge In Global Selloff On US Recession Fears(January 21, Market News International)

In an article from two days ago, Kevin Rudd, a journalist for Australia's popular "The Advertiser" wrote the following, "It may be the Chinese and Indian economies and their demand for Australian minerals, meat and grain, which determine the direction of the world economy, not Wall Street."

China's Statistics Bureau today released figures for 2007 National GDP growth - not surpisingly it was a whopping 11.4%! The breakdown by level of industry was primary (agriculture) 3.7%, secondary (manufacturing) 13.5%, and tertiary (service) 11.2%. However, the real growth in manufacturing is closer to 18.5% (stats.gov.cn). The latter represents what is known as the "Total Value-added Industrial Growth" (全年规模以上工业增加值比上年增长18.5%)

So, despite all the rhetoric that China (and India) are the new centers of the global economy, the outright economic shift to Asia has still not taken full effect. However, the effects of the recession we are headed for are bound to influence the shift and in my mind it will only expedite it.
There are three major factors that contribute to this convergence:

1) Lowered interest rates in the US
2) Higher commodity prices
3) Appreciating RMB
4) Higher bank reserve ratio in China


1) Lowering the interest rates in the US is traditionally done for one reason: increase consumer spending. The problem with this logic in January of 2008 is that 2) Higher commodity prices have forced consumers into high levels of debt and spending based on increasingly higher cost goods. Since the last time the Fed cut rates in the early part of this decade, gas is up from an average of $1.40 (some points as low as $1.20) to $3.09 in December of 2007. 500 Kilowatt Hours (KWH) of Electricity cost you $48 in 2001. It's now up to $60 as of December 2007. Even the cost of 1 dozen eggs has jumped from $1 to $2 in that time period. (data.bls.gov) While many other commodities, such as fruits and bread have grown in step with inflation, the energy shocks are enough to wreak havoc on our economy.

3) The steadily appreciating RMB is causing China to make leaps and bounds in two related ways: A) Slowly the Chinese are able to buy more heavy equipment from Europe, the US, Taiwan, and Japan. Simultaneously, they are quickly building new roads, infrastructure, and factories in the hinterland to keep their economy relatively competitive with poorer development manufacturing countries in south Asia (India, Pakistan, Bangladesh), Mexico, Africa, and South America. This will offset many of the price pressures that they are facing. Here's an example. We know of a factory in the western part of Shandong where they are paying workers $0.40 an hour to do the same labor that was being done 10 years ago in Shanghai or Guangzhou for an even higher hourly wage. How can this be? It is because that region is so poor, that the workers can accept that low wage and still live comfortably. Meanwhile, the central and local governments have dramatically increased the port and road infrastructure at Rizhao Port and Lianyungang Port, a mere 3 hours drive from the factory.

4) China raised the central reserve ratio for its banks to 14% last week. That's high, but not high enough. According to experts, the prediction is that they will continue to raise it until it reaches 19% later this year. What this does is reduce the amount of money that banks can loan out to their customers. This in turn reduces the amount of money to start new businesses, buy homes, and get credit cards. It makes the economy much tighter and more secure. They are doing this to prevent a meltdown in their banking system. Given the amount of cash they have in the central bank, it is going to be possible that they will not need banks to lend to continue building roads and creating factories. The central government will effectively "fill in" as projects are short on cash.


All of this has led to not only predictions of a stronger China, but as you will see in the following quotation from George Soros' speech to the World Economic Forum in Davos, Switzerland, the dollar's day as king has passed us by...



“ 'The current crisis is not only the bust that follows the housing boom, it's basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency,' Mr. Soros said in a debate today at the World Economic Forum in Davos, Switzerland. 'Now the rest of the world is increasingly unwilling to accumulate dollars.' The dollar's share of global foreign-exchange reserves fell to a record low of 63.8 percent in the third quarter as demand for U.S. assets waned after the collapse of the U.S. housing market, according to International Monetary Fund data. The greenback accounted for 65 percent three months earlier. The euro's share rose to 26.4 percent from 25.5 percent. IMF quarterly figures go back to 1999, the year the euro was introduced..." (Bloomberg)