Confucianism and Trade Imbalances

The enlightened dictatorship of money

Posts Tagged ‘accounting

Ponzi economies

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I’ve been reading news reports a lot recently about Chinese banks lending money to companies in various sectors, just so they can stay alive long enough to pay back their previous loans.

I’ve had various reactions to that.  Throwing good money after bad; the cover-up’s worse than the crime; can we really trust Chinese capitalization data knowing that some of that money is being wasted; and how does anyone think that’s a good idea, given that the reasons these companies are going bankrupt because of powerful long-term trends (like severe oversupply), not some short term blip?

The response that Western readers will identify with the most, I expect, is this one: it’s a Ponzi scheme.  There are many variants (for convenience, I’m lumping in pyramid schemes as well) but the basic essence of a Ponzi scheme is to take capital as income.  These bankrupt companies are consuming bank capital to pay their basic expenses, not to make forward-looking investments.  For some reason, the banks are willingly entering into this arrangement.

This mixing of accounts is something I’ve encountered a lot, in various forms.  I a friend working in a tech startup, who told me, “people in my company don’t work too hard.  It’s not like a tech startup in Silicon Valley.  We just got a capital infusion, and we don’t really have to worry about anything until about two years from now.”  Even in a company that should be innovative sales-driven, it is the boss who is feared, not the customers.

This mixing of accounts can even be seen in legal terms.  I have been learning more about company setup in China, and one of the (many) strange facts I’ve discovered is that wholly foreign-owned enterprises (WFOEs) sometimes pay tax on capital infusions as if they were income.

These are unrelated examples – and I hardly know as much as I really should to be to write this post – but I feel sort of confident in saying that Chinese accounting doesn’t employ the firewall between the current and capital account (in national accounting terms; or expenses and capitalization) as in the US and Europe.  This firewall is the most important reason that accounting exists in the first place.  Ironically, this situation is the opposite when we’re talking about national accounting.  China keeps very close track of current and capital accounts, and some old regulations even required companies to use separate bank accounts for these two accounts.  So, I guess the conclusion to draw here is that Chinese collectivism doesn’t just mean looking out for those less fortunate, but is rather a very literal accounting principle.  Its lack of use for individual company accounting may help explain, if not excuse, its behavior towards various accountants recently.

Now, having gotten this far, I may as well talk about China’s partner in crime, the US. Richard Perry, in his failed presidential bid, controversially called Social Security a “Ponzi scheme.” It is true, but not in the way he meant it: it is true because Social Security savings, represented by government debt, are simply being “spent,” rather than “invested” in infrastructure and other long-term projects.  China also invests in those same government bonds, because it assumes that any country would balance their economy from a top-down perspective.  The US, meanwhile, buys Chinese products under the assumption that their suppliers are geared towards making a profit.  And we end up with a very big culture clash.

Written by Maofucious

October 17, 2012 at 10:23 PM

China’s failed apprentice system – part 3

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This the last part in a series on why wages are so low.  I will collect a few thoughts here, and see if it turns out into a coherent whole.

I realized that an important part of this situation, which I shouldn’t leave out, is really simple: Chinese discrimination against Chinese.  I had a Chinese client a couple of weeks ago who wanted to speak to me, and only me.  He only spoke Chinese, and I explained to him that I would have to refer him to my colleague for any meaningful communication to take place. He still wanted me to be his point man, even though I really didn’t have much to say to him. This seems to be an issue particularly in the Southeast, where I lived for two years.  (The client was from Ningbo.)  (See also this story from Nanjing, for instance.)

Anyway, earlier in this series I retold this story that a friend told me about aviation because it highlighted two things I had heard about healthcare:

  • People who go half of their careers without being able to do any real hands-on work, because of their bosses’ delicate egos.
  • Employers owning their employees’ work licenses and refusing to let them leave for other work.

The second factor is due in part to what might be the single most unappreciated fact about China: how local everything is.  During the Maoist era, localities were told to make their own arrangements for health, and these sorts of bureaucracies tend to end up as bottom-up patchworks just as often as top-down structures.

This system goes all the way back to China’s feudal past.  Land is extremely important in China.  For this reason, Google Maps isn’t allowed to match satellite images up exactly with its maps.  North and South are not universal attributes – highways in Beijing will direct you towards Guangdong, rather than the South Pole (which is a practically equivalent distance from there) since one is in China and the other is not.  Even public spaces become like little kingdoms, as there are walls put all around the place restricting walking routes.  (I will someday get a picture of the South Railway MRT station in Beijing, which has a series of metal railings fencing off areas of absolutely nothing.)  I could spend an entire post or more talking about Chinese spatial orientations.  This also has to do with feng shui, and, at its core, land might be linked with the concept of face.  That’s how fundamental territorial divisions are to the Chinese psyche.

So China is full of these little kingdoms, relics in the more recent (Communist) past of the danwei work-unit system.  This leads to a surplus of little kings, who don’t like to see their status challenged.  We can see these leaders acting like little kings now with the accounting standoff: they are not used to being questioned, even when it comes to increasing efficiency.  These relationships are born from tradition, not from any notion of maximizing shareholder value.  As a final example of the importance of physicality in Chinese law, any company document must be notarized by a company stamp, which functions as the official company signature.  A great deal of power is placed on the owner of the stamp – typically the management of a company, not the shareholders.

Wages are often set so low that they even fail to maximize profitability.  Healthcare is a very good example of the result: there are lines outside of clinics, sometimes for days, for top doctors.  Meanwhile, for everyone else, healthcare is getting more violent – yes, violent.  Attacks on hospital workers are becoming frequent enough (in the context of a generally low-crime society) that police are being stationed inside the hospitals.  For the workers, healthcare is unprofitable enough (despite this demand) that it’s not really a particularly sought-after profession.  The whole system is geared not towards maximizing value, but towards preserving these little fiefdoms.

Written by Maofucious

September 21, 2012 at 11:12 PM

An update on the short-selling situation

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There have been a number of worrying developments following the accounting standoff, which has already seen Deloitte employees threatened with life inprisonment for doing their job.  The WSJ reported in July on how short sellers are now feeling their safety is being threatened.  The Globe and Mail has an excellent article on how local police in Henan Province allowed themselves to be used as sock-puppets for a company that wanted to investigate a short seller.  The Canadian researcher may end up in prison for two years on charges of “disseminating false facts to impair another person’s commercial reputation.”

The state-run Xinhua service, demonstrating a surprising lack of understanding of Western capital markets for a media organization that has international aspirations, had an editorial last week calling for the SEC to “seriously investigate the short sellers” for unspecified charges.  Well, the SEC can’t just make short-selling illegal retroactively – the writer/editor seems to think that they can just make up charges to fit the political situation.

But I will give them the benefit of the doubt,and assume ignorance, rather than the level of planning implied by a Reuters piece calling this an “official editorial.”  The question is, where does that ignorance come from?  The author clearly had some reason to think the US would do that.  I have two ideas:

  • Defamation laws in Asia are much stronger than in most Western countries, because of the social role of face. In China, it can be a criminal offense.  If you report negatively on somebody, you better have it right. Part of the deal right now is that short sellers have been attacking companies that were apparently better prepared for it.
  • From more of an economics standpoint, Asians don’t have very well-developed attitudes towards risky investments.  The Hong Kong Stock Exchange weeds out risky stocks, which go on to the US. The American attitude is that with risk must come disclosure, but by avoiding risky investments, there is no need to strongly consider alternate viewpoints.

Now, my thought is that these two points are one and the same.  Face, as a social structure, implies a certain attitude towards risk, because if you have face, you don’t want to lose it at the end of the trading day.

Written by Maofucious

September 13, 2012 at 9:41 AM

Do either of the US presidential candidates care about the economy?

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If they do, they might want to take a careful look at a situation that’s developing in this part of the world.

Chovanec writes about a standoff that’s developing between US and Chinese stock regulatory authorities.  China is refusing to let Chinese accountants turn over information about Chinese companies listed on the US stock market, on the basis of “state secrets.”  As he writes, the current baseline scenario is for the SEC to simply delist all Chinese companies, within the next year or so.

This is very bad for the US economy – particularly if there are any long-term precedents being set here.  It will hinder efforts to increase American exports, a goal Obama has committed himself to.  Romney also agrees that exports are important to US economic growth, as he has promised a muscular response to currency manipulation.  Guess what?  This is currency manipulation!  Currency manipulation involves restrictions on the capital account.  If US companies can’t invest in China, while Chinese companies and the government can invest in the US, then the difference will be made up in the current account, or the trade balance, for reasons too complicated to explain here.  (It’s an accounting identity, holding a couple of other minor factors constant.)  A few billion dollars of investment money to China a year would translate to an equivalent amount of export sales to the US.  These numbers add up quickly.

So this is a very important issue from an American perspective – particularly thinking about what the American-listed Chinese stock market could become in the future.  But how about from the Chinese perspective?  It is also just as important.  The Chinese stock market has been stagnant for three years, largely because of accounting irregularities.  In response, companies tried to come to the US, using reverse mergers to avoid regulatory scrutiny.  After some scandals last year uncovered by short-sellers Muddy Waters, that tactic also failed, and Chinese companies have been largely unable to raise money on Wall Street either.  One of the main problems with increased transparency is that party officials don’t want their assets to be revealed (i.e. – an example from the last couple of days that apparently got Bloomberg banned from China.)  They are extremely sensitive to accusations of elitism – see the uproar over the fact that US Ambassador to China John Locke actually buys his own coffee at Starbucks.  So US negotiators should be able to push this point; the Chinese have zero bargaining power.

What can be done then (on the US side)?  Chovanec offers the following solution.

I was pondering the irresistible-force-meets-immovable-object dilemma here last night when I happened across a seemingly unrelated passage in Jim Fallows’ new book China Airborne, which offered a glimmer of hope.

In 1997, Jim relates, three Chinese airlines — Air China, China Eastern, and China Southern — had just been awarded or applied for very prestigious and strategically important routes to the United States, and had purchased brand-new state-of-the-art Boeing planes to fly those routes, with many further orders expected.  However, the safety record of Chinese airlines in the 1990s was atrocious.  In order to actually fly those routes, the airlines required approval from the U.S. Department of Transportation (DOT), the parent body of the FAA.  The DOT, at the FAA’s urging, demanded “confirmation that China’s regulatory standards, as applied by the CAAC, conformed to the worldwide guidelines laid out by international agreements.”  Until then, it was no fly.

The Chinese were furious, believing the Americans had double-crossed them by selling the planes and then reneging on the routes.  The whole thing could have concluded in respective chest-beating and a very ugly, damaging stand-off.  Instead, Boeing took the initiative (since its future sales were on the line) through a series of seminars, tours, and training sessions to reconcile the two points of view.  Key to its success was the way it handled Chinese sensitivities…

With due respect to his idea, I’m quoting it because it’s the exact wrong way to conduct the public diplomacy on this issue.  Airplanes convey the idea that something is complex, beyond the reasoning of the average citizen.  If that’s the attitude Americans or Chinese have towards this problem, it will be forgotten, and the status quo solution will prevail.  The message that needs to be conveyed is that Chinese companies are already capable of doing the actions required (no matter if they’re not world class), but that the government has been standing in their way, for no legitimate reason.  American politicians should take a stand here on principle, not let this become some kind of technical negotiation.  The more awareness there is for this issue, the better for the American position.  This issue gives politicians an opportunity to talk about the trade deficit, human rights, and foreign policy leadership all in one sentence – and all during an election year.  There’s no way they could screw this one up, is there?

There is much at stake here.  I’m going to go out on a limb to say that this is the most important economic crossroads for China since it joined the WTO in 2001.  In some ways, accountants are even more powerful than reporters, because nobody accuses them of bias.  It’s always possible that this is being used as a negotiating point for something else, some part of China’s grand scheme, and that things will smooth over naturally in due time.  But it really appears to be a larger culture clash: the Chinese side has been digging their heels in ever since the Muddy Waters incident – which they apparently blame on the investigators rather than the perpetrators. Whatever the case may be, until that part becomes more clear, this should be the American position.

Written by Maofucious

July 1, 2012 at 11:39 PM