Home Appliances for Villages

Chinese economy needs a structural change, and many seem to agree that to stimulate domestic demand is key.

In my view it is something rather fundamental, but short-cut ideas fly around. Look at this guy, who is a people’s representative of the National Congress, advocate a nutty idea of national holiday to release domestic demand. By that logic, unemployment would really help.

BTW, the guy owns a tourism company, so that more leisure time would surely boost his business, and he spoke bluntly about it. Great. While convening to speak for the people, why not as well use the marketing platform to speak for himself?

Recently an usual thing happened – the government decided to subsidize farmers to make home appliance purchases by reimbursing 13% of sales price. Items include TV, cell phone and fridges.

It’s a serious project. They even built an online information management system for it. According to one village survey, farmers are satisfied, though not without concerns.

It is somewhat another unprecedented, well-intentioned socialism move by the government.

Leave the gun, take the cannoli.

http://icecurtain.blogspot.com/

How the Money is Spent?

Do an intellectually lazy post on a short- to medium-term outlook of Chinese economy.

• There’s a credit expansion in Q1, with a targeted increase of RMB5 trillion from ‘08
• There’s a 20% YoY drop of export (an increasingly significant part) in Jan and Feb, reversed from 20% increase in ‘08
• Corporate profit is hurting, almost 40% YoY dip in the first two months for large-size industrial companies

Hmmmm, so we are taking more debt while selling less and earning less. Not a good sign, is it?

http://icecurtain.blogspot.com/

SASAC, the Big Boat that Tugs and be Tugged

There is a news piece about the Chinese SOEs (state-owned enterprises). If you are not familiar with how the Chinese system operates, it would be quite inspiring.

MoF as an Activist Investor: What A News Piece Reviews

The news is about the negotiation between the SOEs and SASAC (State-owned Assets Supervision and Administration Commission of the State Council, a long name that you should remember). SASAC is a government agency that manages the SOEs worth $1 trillion -$4 trillion, including major resource-based, government-monopolized Fortune 500 companies.

The story goes that because of diminishing profit in ‘08 ($100 billion or 30% below ‘07 level, after 30% increase in ‘07), SOEs are pleading for a deduction in budgeted profit turn-in, but SASAC is not relenting, stating that the money is of crucial use, for things like capital investment in strategically important SOEs and capital replenish for the weakened state-owned utilities and airlines. MoF weighed in to support SASAC’s view.

I have thought that Chinese companies hold too much cash, and paying out extra cash to relocate the capital may be a good idea, despite of the less efficient capital market. (As a reference point, share buyback have been a popular move for S&P 500 corporations in recent years.) Since the CEOs are increasingly richer and more powerful, most individual investors could only act as dividend takers.

It is a completely different case when the government steps in. It must be a tough act for the SOEs.

The Long Value Chain

What’s more interesting is the nexus of money of the colossal Chinese SOE system. I’ve raised the issue when looking at China Shenhua, a partially-listed, state-owned coal and utility company.

Let me belabor the point with yet another example – PetroChina.

• PetroChina, Limited is a public oil & gas company listed on Shanghai Stock Exchange, Hongkong Stock Exchange, and ADR-ed on NYSE, with ‘08 sales of RMB1 trillion and book assets of RMB1 trillion.
• The above is 87%-ly owned by PetroChina Corporation, who is not a mere holding company but one with a much larger size, with ‘08 sales of RMB9 trillion and book assets of RMB14 trillion. It is ranked #38 of Fortune 500.
• The above is a SOE managed by SASAC, thus 100% owned and managed by the Chinese government.

How the government runs the SOEs such as PetroChina? You may ask. The answer is quite complicated, but here’s a quite telling executive order. The order mandates that SOEs shall do a separate book-keeping with the government, with items including budgeted profit turn-in, capital gains from selling state-owned shares (which is another complicated matter that drives the vicissitude of the Chinese stock market), etc.

In return, I assume that the government would (have to) ensure the overall profitability, in one way or another. What’s socialism is about otherwise?

Should you Invest with China, Inc.? Individual Investors’ Perspective

If you are an individual investor asking for stock advices on PetroChina and its ilk, I don’t know what to tell you – I am not prepared for this. The success very much depends on how well you read the multi-trillion China, Inc. and how it works. In other words, besides reading the 10Ks of the listed companies that is only a tip of the iceberg, you should read the much bigger (somewhat opaque) book behind.

The good news is that instead of an invisible hand, the hand is visible. The bad news is that it is quite unpredictable: imagine to tell the fortune of a child with powerful parents, who would presumably take care of his interest. But it is a big family and parents are busy with a range of considerations. That child - though spoiled a bit - may not be the preferred from time to time.

Debt, Growth and Interest Rate

Warning: this is a model.

A note on the relationship of federal debt, GDP growth and interest rate.

The Formulas

1. In the long run, the steady debt to GDP ratio is

Debt/GDP=Rdef/g

where Rdef is the rate of deficit (including interest payment) to GDP; g is the growth rate of GDP

2. In the long run, the ratio of deficit less interest to GDP is

(Def-Int)/GDP=Rdef(1-Rint/g)

where Rdef is the rate of deficit (including interest payment) to GDP; g is the growth rate of GDP; Rint is the interest rate.

What It Says

• The beginning debt to GDP ratio doesn’t matter in the long run
• If there’s GDP growth, debt to GDP ratio always stabilizes in the long run
• The net deficit (i.e., deficit less interest payment) depends on whether interest rate exceeds GDP growth
• If they equal, the net deficit is zero
• if interest rate is higher than growth, the net deficit is negative, or federal spending would have to be less than tax revenue
• The GDP growth rate here is nominal, so that inflation helps

An Example

Suppose the beginning Debt/GDP ratio is 80%, GDP growth 4%, interest rate 3%, deficit/GDP 2%:

Long-term Debt to GDP approaches 50%.

Net deficit would be 0.5% of GDP.

 

http://icecurtain.blogspot.com/

$1 Trillion for Christmas Shopping

You are in suit business. Usually you sell a suit for RMB 1,000 on a cost of RMB 800, so business is good.

One day an importer from Iceland called you for an order of 100 suits, paying ISK 70,000 (Iceland Kroner) per suit, delivery at 6 months later.

You checked the exchange rate: the price equals RMB 1,200 (ISK 10 = RMB 1), enough to compensate delivery and other extra costs. Besides, you're excited to open a new business line in Europe. So you decide to go ahead.

...Upon delivery, ISK depreciated to ISK 20 per RMB 1.

International business brings an additional risk, the currency risk. Unscrupulousness will blow things up, sometimes costly.

That's why I can never understand why there's the Forex trading business for individual investors. I can't see any legitimate purpose beyond pure speculation. And it's leveraged.

China's $1 trillion

This explains why it bogs my mind when looking at China's USD 1 trillion reserve.

It's accumulated over the years when China was running a large and rising trade surplus with the US. The 2007 Current Account (I don't know what it is) stood at around $300 billion, or 7% of China GDP.

The nature and the sheer number makes it a bit larger and more complicated issue than the suit business. It seems both side consider the imbalance more a prob.

Prof. Wu spoke about it recently from the China side (吴敬琏：解决内外失衡的出路在于推进改革，实现增长模式的根本转变). You cannot find a more educating explanation. Warren Buffett also expressed his concern on it.

However, more questions remain. For example, when RMB appreciated 10%, does it mean that the reserve has lost $100 billion in value? Now China is pegging RMB to the dollar, how should China manage the Forex policy in the future?

Most importantly,

How should China spend the Money?

Right now, China is holding a huge amount of US treasury notes, using the US as a bank while trying to figure out how to spend the lump sum.

Chinese economic development has in a sense taken a route of Japan (and I have to say that it's not necessarily a good sign). It may help to take a look at Japan.

Japan was running trade deficits and accumulating foreign reserves. Besides holds a big sum of US treasury notes, it's been in a shopping spree around the world. Overall, it holds $3 trillion in financial assets around the globe, plus a FDI position of an additional $1 trillion. It bought the Rockefeller Center and Columbia Pictures.

Can China do that some day? Will China do that?

Stimulate the Domestic Demand

The amazing growth rate of the Chinese economy has partly driven by the export growth of the manufacturing sector. "China is the world factory," as they say. It's done by maintaining a certain level of price discrepancy by a currency peg to the USD, attracting FDI while supplying abundant labor force to the world.

Now the export (around 35% of GDP in '07) is deteriorating responding to the global recession, how to stimulate the domestic demand becomes more important.

It's actually an old topic that's been talked about for years. Chinese economy saves almost 50% of GDP, hence the high investment rate. In comparison, the U.S. saving is 20%. As for the household sector, the Chinese saving rate is 50%, while that of the U.S. is virtually zero.

I have some random thoughts on the disparity of the consumer saving/spending rate between China and the U.S.:

First, there's a cultural thing. US consumers have a passion on shopping for some reason. read Born to Spend, I shop therefore I am for an understanding.

To support it, US has a well developed consumer credit market: the total consumer credit outstanding stands up to $2.6 trillion. It's not only mortgages, but HELOC, car loans, credit card, etc. it allows you to pay installments even for furniture.

Besides, US has a consumer credit system to back it up. Every citizen has a credit score, a historical score keeper for your past credit borrowing and repayment as well as a gorge for creditors' lending decisions.

A sound social safety net (pension, healthcare, unemployment insurance) is also significant. Although the US doesn't carry too much pride in this area - the Viking countries are role models - it should be well developed.

Income inequality counts. I'm not against Grandpa Deng's "Let some get rich first" policy, but some part of Chinese population is really, really poor. If someone brags to you the market size of cell phones in China, saying "if everyone buys a phone, it's a 1.3 billion market." he's bullshitting.

Finally, there's the long-term economic and social stability.

What's not on the list is a booming stock market. If you're a frequent reader of this blog, you know that I have some beef with "十教授上书建议扩大内需把提振股市作为切入点." The last post is here.

Those lame ducks spoke again today:

"是不是能够使用资本市场的提振措施来刺激国内的需求，从1998年的时候刺激房地产，刺激股市，的确对后来的内需起到了很大拉动作用，这在十年前是有成功经验的。10年前已经有过成功经验的情况之下，推出这样一个以刺激股市为内容之一的内需提振政策，我想应该是有点效果的。"

"根据美国经济学家的测算，就是行情好的时候，财富 效应对消费需求具有一个固定的带动系数，比方说，股票涨了100元，肯定其中要有7元或8元钱，拿来去消费。这是一种非常巨大的消费需求支出比例。"

I've never heard of US federal government interfering stock markets. In fact, they hate doing it.

What are you suggesting, professors? A government-led Ponzi Scheme?

I want my digital TV.

4,000,000,000,000

A caveat emptor first: I don't know what I am gotta talk about in this post. But the number is everywhere, so I decided the sheer size of it deserve a post.

Get Some Sense

Since we don't encounter numbers like this one everyday, let's try to make some sense out of it first. Chinese GDP '07 was a bit short of RMB 25 trillion. So the 4 trillion is something like 15% of GDP. Or look at it in another way: if doled out evenly, every citizen will get a good RMB 3,000. Way to go?

It seems we're already in a sense into the New Deal mode, which was an effort to cure the Great Depression. The conclusion? By the judgement of our beloved Party leaders, the situation is kinda really bad out there.

How It's Done

Macro policies has two channels - either monetary (a list of hot actions here) or fiscal (a proposal here). The TARP is targeting to save the financial system. I personally consider the monetary policies more fun (I don't know why).

The point of distinction is, putting aside what they can do, it decides how the money is distributed and who owns what.

According to my read into the 4-trillion plan, it sounds like a fiscal plan: standard op items like infrastructure, education, healthcare, environment, plus tax cut and housing and farmer subsidies. At the same time, monetary policy is of course expansionary (also here).

How It's Funded

I have a limited knowledge of the fiscal in China. However, my guestimation is: the major banks will loan the money to the government, at some interest rate. It'd be amazing to the capitalists, but we nationalized the banks long before the capitalist Europe and U.S.. Take that, capitalism!

Still, it bodes a big time government deficit. The federal spending is around 20% GDP in '06 with a deficit of 1%, and the treasury notes outstanding is RMB 5.2 trillion today.

I guess what I'm saying is, if a major part of the 4 trillion goes fiscal, it's not easy to pull off the funding. It'll be a war-time like public debt issuance.

And I keep thinking about its side effects, though things like this make my head explode..

Let's Wait and See

If you're interested in the early-wave spending, it's here. We'll wait and see for the rest.

Now ponder this: you're head of a government agency, and you're told that your budget have just been doubled, what will your reaction be?

It's tax payers' money. Spend it wisely, comrades.