Confucianism and Trade Imbalances

The enlightened dictatorship of money

Posts Tagged ‘capital accounts

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

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

Chinese company ‘Shanghaied’ in North Korea

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I ran into this little tidbit today (h/t Sinocism), which was so amazing that I had to blog about it.  I can’t find the (long) company press release in English, so I will go ahead and translate it.

I have to say, even though this is clearly expropriation, I don’t really have that much sympathy for Xiyang.  Even in China, some foreign investors in China’s energy sector have ended up in jail for violations of “state secrets” laws . Did they really think North Korea would have a friendlier environment for foreign investment than their home country? Note below that they said a tax on the order of 25% wiped out all of their profits.  Was a profit margin less than 25%, as healthy as that might be in other contexts, really worth the political risks here?

Read the rest of this entry »

Written by Maofucious

August 11, 2012 at 6:30 PM

The Chinese view of money

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A few months ago, I was at the National Palace Museum in Taipei with a Chinese travelling companion. We were looking at some cute little drawers for storing doodads. Of course, these were used by royalty, so the deal was that each one was specially made for the objects to fit in it, i.e. if you had a comb, there would be a place to put that comb, and only that comb. She remarked something about how that was a place you could put your money.  Clearly, that was not cash she was referring to. That got me thinking about the traditional Chinese and Asian view of money, and how it differs from the Western view.

My theory is that money in Asia is tied in closely with the social institution of face (a concept that originated in China). China of course independently invented paper money, and their concept of money apparently emphasizes its role as a medium of savings over its role as a unit of account, as we tend to think of in the west as an arbiter of value. Their experiment with money without fundamental value ended with hyperinflation, which might explain why such trinkets are seen as possessing value in themselves. It might also relate to the value Confucianism places on other real investments like infrastructure and education – not to mention the way luxury markets work in Asia.

I ran into something today that might shed more light on the differences. In China, the rich and powerful can hire body doubles to do their prison time for them. Surprisingly, this is not a recent phenomenon.

“Replacement convicts” are not new. For centuries, the use of criminal substitutes was among the first things Westerners would mention when discussing China’s legal system.  … Some imperial Chinese officials who admitted to the use of substitute criminals justified its effectiveness. After all, the real criminal was punished by paying out the market value of his crime, while the stand-in’s punishment intimidated other criminals, keeping the overall crime rate low. In other words, a “cap-and-trade” policy for crime.

So, markets in everything. This reminds me of something else (pdf) I ran across at some point. In Korea, there is apparently an active sex-selection market for children. Parents take a look at the sex ratio in their locality among 20-29 year-olds. Eventually, things come into balance, although the girls end up being born to worse-off families, and the boys to better ones. Less controversially, marriage and other family relations are also seen in the context of money.

It seems that Asian cultures don’t have many of the ethical hangups related to money that Western cultures do. Another association to make here is to the Sun Zi conception of war, ‘economics by other means’ (as opposed to Clausewitz, “politics by other means”), a conception that has been born  out by modern Asian history.  Understanding what money means in Asian cultures might help one better understand economic warfare in the context of current trade disputes.

I leave with one final association. In a system with financial repression, it can be more important to keep the government out of your savings than to understand what it is you’re really investing in. Hence, gambling in Macao is used as an outlet for savings, and it may in some sense be more legitimate than ‘ordinary’ savings through the banking system. This may have something to do with Chinese attitudes towards both gambling and financial markets.

Written by Maofucious

August 5, 2012 at 12:38 AM

Three ways China will disappoint in 10 – 20 years

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We’ve all heard predictions of China’s collapse, and it doesn’t appear to be happening.  They will make themselves a world economic power in some way or other (as the second-largest economy, they really already are) but they do so by covering up certain problems rather than solving them.  Here are some things that surprisingly are really not necessary for development, even if China doesn’t really win any awards for developing without them.

1) They will never really develop soft power.  Sure they have done some innovative things in their relationships with smaller countries – basically buying them off – but when the money runs dry, there won’t be too much else there.  Whenever they’re not looking, these countries will form their own opinions.  (Note that at the ASEAN conference, which disintegrated over the China territorial issue, there was really only one country, Cambodia, on China’s side.)  At the end of the day, soft power comes from listening, not expanding communications networks to deliver whatever the latest propaganda message is.  And I really doubt that they would address certain concerns like, for instance, the biggest famine in world history, instigated by the Communist government.  …Or other minor details.

2) They won’t become a reserve currency.  Even the preliminary step of internationalization is quite controversial, if you read through the lines.  With this accounting standoff, for instance, there seems to be a strong sentiment that Chinese capital should stay in China.  Well guess what?  Chinese capital is denominated in RMB.  There are really two ideals at stake here, national status and national protectionism, and they are mutually exclusive when it comes to capital movements.  In fact, it is not at all clear if Chinese policy makers even knew what they were signing up for in the first place with this internationalization thing.  They seem to have two sleek sounding propaganda slogans on this issue, with messages that are diametrically opposed.

3) They will have mafias – even state linked ones – running around inside their borders with immunity.  The Bo Xilai thing was just the tip of the iceberg.  All East Asian countries seem to have similar issues, due to underdeveloped legal institutions, but with China, due to the size of its government, I can see the potential for corruption to get much crazier in general.

Written by Maofucious

July 22, 2012 at 12:34 PM

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