02.28.09
Posted in Economic Analysis, Japan, Latin America at 6:52 pm by Administrator
We’re in a position in the world economy that few in America would have imagined one year ago. And yet there are lots of examples from countries around the world that went through similar crises — we just never thought it would happen to us.
I’m shifting the focus of the my postings over the next few months from Asia to Latin America. I’ll be teaching a course on “Doing Business in Latin America” at Golden Gate University and I’ll work in examples from that. There are many examples of dealing with debt crises and cleaning up bad bank loans from the crises in the 1980’s that swept through the continent.
But before we switch gears, I’d like to take one final lesson from Japan. I talked previously about how Japan had gotten itself out of the “Lost Decade” of the 1990’s by taking the tough medicine of forcing the banks to clean up their loans and by making internal reforms in government organization and regulation. There are lingering costs however in terms of consumer spending. The New York Times wrote a great article last week about how Japan’s consumers have cut back spending as a response to stagnant real incomes. The Japanese were famous for saving up to the 1980’s but even that rate has fallen as the country rapidly ages.
The US has finished not so much a business cycle as a credit cycle. Private sector debt has risen steadily as a percent of GDP since 1952, accelerating rapidly during the Reagan years and since 1997, reaching over 350% of GDP. The market is correcting and credit will be tighter. This means less consumer spending, fewer leveraged buyouts, less M&A activity, lower inventory levels, etc. Companies will have to rely on organic growth as opposed to infusions of equity (especially from hedge funds) or debt. We face a difficult era ahead for the middle-class worker.
What is the way out? The US has traditionally grown around 2 1/2 to 3 1/2 percent in real terms. About half of this has been due to population growth while the other half has been due to increases in productivity. The emphasis is going to have to be on productivity and the key there is education, education and education.
Send me your thoughts.
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01.30.09
Posted in China, Economic Analysis at 10:51 pm by Administrator
The New York Times ran on January 16 an analysis of the dramatic drop in international trade since last summer. Virtually every major economy has suffered a drop. (See this graphic which sums it up quite nicely). There has been undoubtedly a reduction in demand as economies turn into recession. The countries that pursued export-led economic strategies have paid the heaviest price — China’s exports to the US were down 3% as US retailers cut back orders sharply for the Christmas season. Again the New York Times ran a good analysis on January 21 and the misery is felt even in low wage countries like Indonesia.
Another reason was the sharp reduction in credit. With the collapse of many major creditors and the remainder becoming extremely skittish about lending, trade has been hit particularly hard. Banks have cash on hand and even guarantees such as from the US EXIM Bank but still there is a reluctance to lend. The new O’Bama administration, in concert with the leaders of other major industrialized nations, needs to add trade finance to the list of areas where banks need to be nudged.
One of the features of the Great Depression brought on by protectionism (Smoot Hawley Act in the US) was the dramatic decline in trade volume. The lack of credit can have the same effect. The world economies cannot recover without adequate trade finance facilities.
It’s going to be a difficult New Year. Send me your thoughts on how international business can cope in the recession.
Gung Hay Fat Choy!
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12.29.08
Posted in China, Economic Analysis, Exchange Rates, Obama Administration, Trade Policy at 6:49 am by Administrator
The New York Time has been running an oustanding series entitled “The Reckoning” which explores the causes of the global economic crisis. I recommend the one published this week entitled “Chinese Savings Helped Inflate American Bubble” by Mark Landler. Landler pointed out how Chinese money (from the huge export surplus due to the fixed exchange rate policy) helped the US run a risky economic policy (sharply expansive fiscal policy fueled by large deficits at the same time as an expansive monetary policy from a low interest rate policy). The first to write about the phenomenon was a leading economist (guess who?). Landler starts off the article:
In March 2005, a low-key Princeton economist who had become a Federal Reserve governor coined a novel theory to explain the growing tendency of Americans to borrow from foreigners, particularly the Chinese, to finance their heavy spending.
The problem, he said, was not that Americans spend too much, but that foreigners save too much. The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption.
This colossal credit cycle could not last forever, he said. But in a global economy, the transfer of Chinese money to America was a market phenomenon that would take years, even a decade, to work itself out. For now, he said, “we probably have little choice except to be patient.”
Today, the dependence of the United States on Chinese money looks less benign. And the economist who proposed the theory, Ben S. Bernanke, is dealing with the consequences, having been promoted to chairman of the Fed in 2006, as these cross-border money flows were reaching stratospheric levels.
As I blogged previously, the US consumption binge was fueled with Chinese money. The trade policy of a fixed exchange rate allowed China to price its goods aggressively in the US markets. China however had to sterilize the inflationary effects of the export surplus by buying up the excess dollars. It then invested those dollars in Treasury securities, even though the Fed was keeping US rates low. (Other Asia export-oriented countries did similarly with their surpluses, although at a much smaller scale.)
The US made its share of economic mistakes as well. The Bush Administration started two wars without raising taxes, relaxed financial regulation and supervision and took advantage of the Alan Greenspan’s low interest rate policy. In the ensuing party, the banks gave away mortgages to just about anyone, causing a huge housing bubble. Unfortunately, US policy makers focused largely on the domestic US market, and thus they missed the “blinking red light.” The US inflation indicators excluded the wealth effects of higher stock indices and higher housing prices. Without those two components, inflation looked under control, especially in the consumer goods portion of the CPI where Chinese imports kept down prices. The little that US policy makers looked at international issues was with regard to the euro/dollar or yen/dollar relationship.
One lesson that has to be learned is the US is inextricably entwined in the world economy and that it no longer sets the agenda. It can play a leadership role if it chooses to participate in the game. The incoming Obama administration has the intellectual horsepower to make that mental shift. My New Year’s wish is that the Obama administration will formulate its economic policies with a global vision.
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11.30.08
Posted in Economic Analysis, Government Resources, Strategies at 8:10 pm by Administrator
I ran a roundtable discussion on international markets at the Fifth North Bay Growth in Innovation Forum in Santa Rosa on November 13. (I organized these in conjunction with the City of Santa Rosa — Nancy Mancester — and some great Chamber member volunteers, this time led by Mike Adler) As usual there were lots of companies with great ideas — computer architecture to combat viruses and spyware, web 2.0 social networking, green building, etc. One of the entrepreneurs told me that he wasn’t participating in my roundtable discussion because he had to concentrate on domestic markets. I said that this was exactly the best time to renew your international efforts.
Why?
– Markets that were previously very competitive may have shrunk, but this is the time where customers will be rethinking costs and traditional relationships. If you concentrate domestically, you will be fighting on a limited market.
– Competitors may now be willing to look for partnerships with the weaker ecoomy. This opens the potential to create new product lines and markets. Again, you have the entire globe, instead of a shrinking domestic market.
– Suppliers around the world are hungry for new customers — you can cut deals now that were unattainable even two months ago.
One theme that emerged from the Fifth Growth & Innovation Forum was that there are incredible resources available. Nowhere is that more true than with international markets. Yes, there is greater risk but there is greater support. So get out there!
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09.29.08
Posted in China, Economic Analysis, Exchange Rates, Finance, Strategies at 2:47 am by Administrator
A number of months ago, I blogged about the interconnectedness of modern financial markets. The events of the last month have clearly demonstrated this.
We have to look back about a decade for the origins of the crisis which had its origins in the US policy to promote home ownership. In 1997, the US changed its rules on capital gains to allow individuals to avoid (on two properties no less) capital gains tax on less than $500,000. (Remember that the US allows a personal tax deduction on interest only for those associated with a home mortgage.) After that, banks and other lenders began liberalizing the documentation required to get home loans and lots of people qualified for loans that previously couldn’t. People do react to the economic incentives around them and the prices of houses in real terms began to soar — who couldn’t afford to be part of the great bonanza provided by Uncle Sam.
A second enabling factor was the huge fiscal deficit by the United States. George W. Bush decided to fight two global wars without a tax increase. The result was over a trillion dollars injected into the economy.
Next, the expansive fiscal policy was complemented by an accommodating monetary policy. From early 2001 when the tech downturn took place and accelerating after the 9/11 attacks, the Fed cut and maintained interest rates at very low levels. From their point of view, the Fed looked at domestic inflation and saw little impact, but did see a continuing weak economy. It continued its accommodating monetary policy into 2005-7.
Both the White House and Fed saw the positive impact of their policies in a steady US expansion. What they missed were the negative results. First, despite the grossly expansionary fiscal and monetary policies, there was little US inflation as measured by the CPI or WPI. Why — first of all housing prices were not included in the CPI — only rental prices as a proxy. Secondly, Washington didn’t look at the role of international markets. – specifically tradable versus non-tradable goods and services.
While US prices have not move dramatically over the past years, the subsets have. Internationally traded goods — like food, clothing and consumer goods — have shown little growth and in the case of electronics, prices have fallen. Why? Because as international trade barriers have fallen, cheaper international goods have flooded the US marketplace. The consumer has profited from lower prices. There have been negative effects for those workers in those industries who saw their jobs move overseas. Non-traded goods, like health care and education, soared since consumers had extra money in their pockets (often after having taken out second mortgages on their homes that suddenly were worth much more). And the non-traded good with the largest price increase — houses — were excluded from the index. In short, we exported part of the inflation (and at the same time lots of US jobs) and we were baffled at why education and health care continued to rise far faster than the CPI.
As Americans purchased more goods and services from overseas, the trade and current account deficits soared. Suddenly there were lots of US dollars flooding world currency markets. Here comes in the last element — normally, the rates of exchange would have corrected themselves by making dollars cheaper, pushing exports and decreasing imports. However during most of this time, China wanted to keep its exchange rate fixed to ensure continued export competitiveness. The Chinese were able to support the RMBI only by buying up the excess dollars, with which they bought US Treasury notes.
US home prices started turning down in late 2006 and accelerated this past year. As a result, many found their home prices less than the mortgage, causing defaults. That cascaded from the mortgage holders to the guarantors of the mortgages (Fannie Mae and Freddie Mac) to the investment banks (Bear Stearns, Lehman Brothers) to the insurers of the derivatives (AIG). At the same time, the Chinese government lost the capacity to control the influx of cash and resultant inflation. It has let the RMBI appreciate at a 15% per year rate and took severe measures to restrict the leverage of the Chinese banks. When the financial crisis hit in the US, the Chinese were also worried about buying US securities, accelerating the global credit crunch.
What’s the moral in this? Bad economic policy catches up with you. In this interconnected world, the results may be less easy to see, but the markets eventually punish excesses. So for all those who say Wall Street greed led to the collapse, you missed the essential elements. The bubble couldn’t have built up except for huge fiscal deficits, tax policy pumping up one sector, accommodating monetary policy and attempts internationally to fix exchange rates. Wall Street firms are supposed to be greedy — it’s the job of the politicians and ordinary citizens to make sure that this doesn’t happen.
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08.28.08
Posted in China, Economic Analysis, Government Resources at 9:23 pm by Administrator
This year’s Olympics were a triumph for China and awakened considerable interest in this rising power. Here are a couple of great resources for you to check out on doing business in China.
Song White, who has incredible experience in doing business in China, has developed Beijing Show and Go which provides a translation aid for in Mandarin and English especially for Beijing. While you’re there, check out her regular site, White Song Books, which also has telephone cards for China. It’s certainly much cheaper than paying for the international rate for phone call from your mobile phone when you’re just calling around the corner.
“The Little Red Book of Doing Business in China” is a great book which takes sayings from Chairman Mao to understand the how and why of doing business in contemporary China. The author, Sheila Melvin, spent seven years working in China, including for the Shanghai chapter of the US-China Chamber of Commerce. This is far and away the best guide for understanding the business culture of China that I’ve come across.
Another great book to help you understand the culture and thought processes of China is “China Road, A Journey into the Future of a Rising Power” by Rob Gifford. Rob, for many years the NPR correspondent in Beijing, writes about a trip he took from Shanghai to the Kazakhstan border on one of China’s national roads. Much like the US Route 66, parts of the road have been replaced by superhighway, but like Route 66, the trip to the cities and small towns reveals the soul of the country. One of the features of the books is that it takes face on the strengths and the problems of contemporary China, including pollution, ethnic minorities and human rights. This is a great read that I recommend highly.
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08.27.08
Posted in Economic Analysis, Exchange Rates, Finance, Government Resources at 3:43 am by Administrator
If you ever lived through a period of hyper-inflation, you know the effects on an economy. Savings are lost, basic necessities become scarce and credit disappears. Ending a period of high inflation always requires major contractionary policies, policies that inevitably hit the poor and weakest members of society the hardest.
I remember one time visiting in Brazil when the prices changed from the morning to afternoon. I was completely dumfounded by the currency — there were several varieties floating around and in one case the government just added six zeros to the old currency. One curious fact that I realized is that in high inflation economies, there are no coins. The metal in the coins rapidly becomes more valuable than the currency and bad money (cheap paper bills) drives out the good (copper or even aluminum).
The New York times reported this week about the crippling effects that inflation has had on Vietnam.
The country’s fledgling stock market, which had been booming a year ago, has fallen in volume by 95 percent and is at a virtual standstill.Squeezed on all sides, people are cutting back on food, limiting travel, looking for second jobs, delaying major purchases and waiting for the cost of a wedding to go down before marrying.
More importantly, the downturn has crushed hopes for a better life.
The mood in Vietnam, after years of upward mobility, is tense, said Kim N. B. Ninh, the Asia Foundation’s country representative. “I think people are pessimistic,” she said. “You sense a tougher environment, a more restricted environment, a more pessimistic environment. It’s a moment of turmoil, I think.”
So how does the international businessperson cope with the highly inflationary atmosphere? The answer to remember that “Cash is King.”
You certainly cannot extend credit in the local currency. You also have to check that your banks will continue to extend trade finance — if conditions worsen, even respected guarantee agencies like EXIMBANK will go off cover for a country.
All transactions have to be in a stable international reserve currency — usually the US dollar. Obviously a currency hedging strategy is useless with such volatility. But even be careful of contracts in dollars backed by dollar deposits from within the country. Argentines woke up in 2002 to find that their dollar deposits were frozen –even to pay for international contracts.
Lastly, rely on your customers to figure out how to handle the inflation and resulting foreign exchange problems. Frankly in the 1990s and early 2000’s the average taxi cab driver in Buenos Aires or Sao Paulo knew more about foreign exchange strategies that all but a handful of traders in London or New York. If you work with your established customers during the down times, they will remember you when the market stabilizes again. It always does return — the question is just how long until “again” arrives.
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07.31.08
Posted in China, Economic Analysis, Trade Policy at 4:12 am by Administrator
The media is reporting today that the latest round of WTO talks has (again) collapsed. Having been involved with trade talks since the mid 1970’s, my reaction is ‘it ain’t over until its over.’ Talks may string out over time but they eventually pick up where they left off.
That being said, today’s news comes at a difficult moment for the world economy. The US is finally accepting that it is in recession (housing prices nationwide down 16% yr/yr and where I live 35%) and there is a real credit crunch at this moment. Europe, also suffering from a bursting real estate bubble and run-up in oil prices, also faces a period of slow growth — perhaps even a downturn. It’s at times like these, that our political leaders have to take brave steps of keeping open and expanding markets despite domestic political pressures from declining industries.
It is particularly ironic, however, that China and India seem to bear the responsibility for the latest breakdown in the trade talks. Their economies have the most to gain and the most to lose in this period of economic uncertainty. Both have just emerged on the world stage as important exporting nations. With that newfound status playing as equals on the stage of the major industrialized countries, comes the responsibility to resist domestic political pressures to protect traditional markets. Having benefited from GSP and other programs, their products have had for years preferential access to developed country markets with little required in return. To go the next step, the countries will have to make meaningful concessions, particularly in agricultural markets. Ag markets worldwide have been the last to lose protection, but trade barrier reductions in this area that will benefit consumers worldwide, particularly as we see food commodity prices soar and shortages develop.
There is no question that overall the world is better off for having undertaken over a half-century of tariff and trade barrier reductions. We are a much more interdependent world and political relations between countries have strengthened as trade ties have increased. It’s always a hard sell to the public, but our political leaders know the benefits. And that is why we will have to complete these trade talks, eventually.
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06.11.08
Posted in China, Economic Analysis, Exchange Rates at 4:01 am by Administrator
The Bank of China again raised the amount of cash that banks must keep on hand. The reserve requirement limits the amount that a bank can on-lend. At its current level of 16.5%, a bank can lend out approximately six times the deposit base. Until mid-2003, the level was only 6%, allowing the banks to lend out 16 times the deposits. The authorities are trying to limit money supply (M1) growth and this rapid increase in the reserve requirements has done that. Interest rates (both lending and deposit) are up about 100 basis points although inflation remains a concern, particularly in the wake of skyrocketing prices for crude oil and other commodities.
Usually Central Banks regard changing reserve requirements as a sledgehammer approach to controlling inflation. Why did China pick this policy? The basic answer is that the continuing trade and current account surpluses are creating challenges in controlling the money supply. When a dollar comes in from an exporter, the Bank of China is required to convert it into yuan, thus increasing M1. With such a large and continuing surplus, the normal monetary policy controls (buying and selling of treasury notes) are overwhelmed. China has also been reluctant to use the other instrument of a major revaluation of the currency. (Note: the Peoples Bank of China has put the Yuan on a 15% percent annual appreciation course; nevertheless most observers believe that the currency continues to remain undervalued.)The change in reserve requirements is a much more blunt instrument and has effects of tightening credit, taking some wind out of the overheated economy. As noted in previous posts, watch out for major economic contractionary measures after the Olympics.
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05.19.08
Posted in Economic Analysis, Government Resources, Strategies, Taxes & Tariffs at 5:12 am by Administrator
I was speaking with the site manager for a large corporation that has a significant R&D component. The Company has steadily off-shored manufacturing of its sophisticated product and little traditional manufacturing is left in the US. What is new is that the company is being tempted to offshore its R&D jobs as well. In this case Ireland is offering incentives of € 20,000 per research worker. I remarked to him that that was “real money” — the incentive being in Euros instead of dollars. Another factor was that Ireland has a low corporate income tax rate and that in particular moved decisions at the US headquarters
There is an on-going discussion about whether offering incentives produces real long-term economic growth. There are certainly lots of examples where the jobs never materialized or the industry hit hard times later on and the new plant shut down. On the other hand there are examples like the German and Japanese automakers who opened sites in the US South, bringing jobs and prosperity to those regions.
There are several issues to be addressed — does the industry fit the development strategy of the region? Putting a heavy polluting plant in Northern California would be a non-starter. Trying to develop a Web 2.0 cluster in an area of the country where few such companies exist may not result in lots of jobs.
Another issue is the net effect on government revenues – i.e. taxes. Some countries and localities have given such large concessions that the result is that the government unit has greater costs with a permanently lower income level (look at some of the oil drilling concessions). On the other hand, a good project will produce not only more jobs in the long run but also greater prosperity for the community and a larger tax base. With the aid of economic models, those contributions can be quantified.
Do incentives work? There are lots of examples where they have made an impact but the government authorities must carefully craft a package appropriate to the economic development strategy.
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