William Gamble

China Stimulus Package: Part I, Bank Loans

Agreed. The difference is that in many countries there are independent agencies, newspapers, etc that have an incentive and sometimes legal duties to report the bad loans. In other countries these things do not exist, so it is difficult to determine the size of the problem

Emerging Market Toxic Assets: The IMF Questions Russia

The point is not about the IMF or Citibank. It is about information. The quality of information is a function from law and economics. Information in every country and every market has a high probability for being inaccurate because it has value. Why should it be given away? Why not provide misinformation?

Quantitative and fundamental analysis and all economic forecast by anyone is based on information, but there is little if any debate about its quality. The reality is that someone is lying to you. It is simply a matter of degree.

Emerging Market Toxic Assets: The IMF Questions Russia

I, of course, do not deny that there are some great returns in emerging markets. I also do not deny that information is imperfect everywhere. It is a matter of degree depending on the legal disincentives of the individual system.

What I am challenging is the concept that fundamental analysis has value in emerging markets. Since the information has a higher probability of inaccuracy, you need to change your strategy. I would suggest that investing in emerging markets is not about the 'story' of constant economic growth perpetrated by Goldman Sachs as in BRICs. Rather it the strategy should be similar to what George Soros calls "reflexivity". Of course you can buy RSX and hold it over ten years, but you will take an enormous amount of punishment with the reward.

If you have made money, good for you. You might take it off the table. See CItigroup's analysis on MarketWatch, just published.

China and Emerging Market Investing: Real Basis

expat in China

The function of contract law, unbiased representation and legal outcome success is limited.

Correct: This is because China and many other countries are what is called in game theory as a relationship based system. Most people feel it is part of culture. It is not. It exists everywhere and has for most of history. Two modern examples are eBay and the Mafia. (see Lawlessness and Economics, Dixit)

China and Emerging Market Investing: Real Basis

Sober Realist.

The best book on China's middle class would be Capitalism with Chinese Characteristics. Professor Huang does the best job of taking apart the Chinese economic model. Unlike many other authors, Rogers, Kynge etc. Professor Huang has actually dug deeply into the statistics and it is not about antidotes.

But the real questions is about stimulating consumer demand. An export policy (or any policy) is made up of numerous laws. Over time powerful groups develop vested interests in maintaining these laws. So it is very difficult to change them when circumstances change. Japan has a middle class, but low demand because they have been following the same policies (and party) for 60 years

China and Emerging Market Investing: Real Basis

In response to another reader

How would your article apply to the superpower nation of the United States of America?

The American banking industry was subsidized recently through Fannie and Freddie who were allowed to borrow at partially subsidized rate since there paper was backed by the US government. The results in the US were disastrous and resulted in an inefficient allocation of capital. But I believe that the experience proves the point of interference by governments in the banking system. Where ever it occurs whether in the US, France, India or China, it limits the ability of the banking system to be an efficient intermediary for allocating capital.

Were the allocations in the US banking industry and bailouts proper allocations of resources compared with China which enjoyed much greater growth rates?

Present and past growth rates in China are subject to a large debate. If you look at electricity consumption, which some economists feel is a proxy for growth, China may not be growing at all. (See Professor Thomas G. Rawski www.pitt.edu/~tgrawski/) Of course no one really knows.

I do not trust any government to give accurate information since their incentives and disincentives tend to encourage not telling the truth, unless there are legal disincentives. All information has value, it will not be given out unless there is consideration or a legal disincentive, like free speech or an independent judiciary. Neither exists in China. They do exist in other emerging markets.

The joblessness in the U.S. is predicted to grow alarmingly.

The jobless rate in the US is a problem. Of course, jobless rates in most of Europe were actually worse for most of the last decade. We really do not know what the jobless rate is in China because they really do not publish the numbers. The number most bandied about is that there are 20 million migrants who are unemployed but again without proper incentives and disincentives no one knows.
Iit would appear that the view you express makes one believe it emanates from a “holier than thou” attempt at “wrapping oneself in the American flag”. Do the Ponzi schemes of American banks and indeed the Federal Reserve constitute a higher level of resource allocation than that prevailing in China?

I think that wrapping ones arguments in any flag it’s a bad idea. I try to wrap my arguments in what I know of law and economics and game theory. In my view The ‘Ponzi’ schemes of American banks were the result of a failure of information. In a normal loan, the creditor has the incentive to get the best debtor and then monitor that debtor. The problem with securitization is that it changed the incentives. The bank’s incentive was to find any debtor and then once the loan was sold, not to monitor. Of course there are many fathers to this disaster. Take a look at the recent article, “Death of Kings” in the New Yorker for a suggested list.

As to allocations, state owned banks allocate to state owned companies for political reasons because both are run by the state which is run by politicians. A good example is GM, which should have been let go, but it is kept alive at taxpayer expense for to protect jobs and to provide smaller cars, which people do not want to buy from GM.

Since emerging markets, according to your article, have not grown faster than developed nations in the past, are you simply extrapolating from the past to substantiate your predictions for the future, ?

My view is that growth in emerging markets is always preceded by legal reform that lessens the power of government. Law can be used two ways. It can limit power or extend it. When the law limits power it is economically efficient and when it extends power it is economically inefficient. You might want to take a look at Professor Huang, Capitalism with Chinese Characteristics. His thesis was that China grew fastest when the coutryside were allowed to be more entrepreneurial as opposed to state capitalism in Shanghai. Also look at Good Capitalism Bad Capitalism

Politicians everywhere have an incentive to extend their power, that’s what they do. If the law does not limit them, which it often does not, then the economy will become less efficient and growth could slow. For example, in the 1950s, per capita incomes in Latin America were 25% of the US and Asia was 10%. Now Latin America’s incomes are 20% of the US while Asia is 25%. Countries with well govern systems like Brazil and Chile will grow. Countries where the government like Ecuador, Venezuela, and Bolivia lessens the efficiency of the economy by increasing its power over the economy will not grow.

China and Emerging Market Investing: Real Basis

Local officials burst unannounced into a middle school in Hubei province one afternoon and started sifting through the staff-room’s ashtray to enforce a ban on rival cigarette brands. The "cigarette marketing team" discovered three "non-compliant" cigarette butts and subjected the school to "public criticism" for "undisciplined practices," London’s Telegraph reports. Officials and teachers in Hubei province will be fined if they "fail to meet their targets" or are caught smoking brands from neighboring provinces. One village was ordered to purchase 400 cartons of cigarettes a year for local officials. "The regulation will boost the local economy via the cigarette tax," said Chen Nianzu, a member of the Gong'an cigarette market supervision team. In total, Gong'an officials and teachers have been ordered to puff 230,000 packs of Hubei-branded cigarettes.

[Editor’s Note: China has 350 million smokers, about a million of whom die each year from smoking-related illnesses. Despite anti-smoking campaigns, cigarette taxes form a major component of China's annual tax-take at local level.]
www.telegraph.co.uk/ne...

China and Emerging Market Investing: Real Basis

CautiousInvestor

"East meets West, with both hoping banks can earn their way out of this mess"

Like that, nice point. Well put.

Thank you. There are two differences. I first started writing about the Chinese legal system about 10 years ago. The problem with the bad loans in China is that there are no way to get rid of them.

Feel free to correct me, but I read several years ago in the CCB prospectus that it was illegal to foreclose residential property. In the US the foreclosures are seen as a problem. They are actually not since they are cleaning up the real estate market.

I do not believe that the new 2007 bankruptcy law applies to state owned businesses, yet that is where most of the bad loans will occur if for no other reason than that is where the money is going.

Bankruptcy is the plumbing of economics. If it gets clogged up the bad stuff pollutes the rest of the system. The bad loans from the AMCs (see my article Really Bad Banks on this site) are still around. So the bad loans being created now will hurt earnings. And yes, it was a bad idea to save AIG. Hopefully there will be orderly bankruptcies in the US for some other big banks like we are seeing with GM and Chrysler.

The second problem is that banks and bankruptcies have the same economic function, to allocate capital to the most efficient part of the economy, which in China like most countries are the SMEs. Unfortunately that is not what is happening. Instead the system is allocating capital to well connected large state owned business (see Prof Huang Capitalism with Chinese Characteristics). This will make sustain recover hard once the mountain of money goes to the wrong place and increases over investment in the wrong places.

I have traveled to over 40 countries. I love the cultural differences, but I believe that people order their economic lives based on the rules of the game, the legal infrastructure, not their culture.