S&P Looks at Temasek Part II

The S&P criteria for evaluating investment holding companies (IHC’s) has the potential to move Temasek from a AAA rated credit firm to Greece as the headlines have noted.  While this headline does accurately capture the potential impact, too many have focused on the outcome and a misreading of the its implication and not enough effort focusing on how the proposed methodology arrives at the new rating.  In fact, the potential outcome of the S&P proposal rests on much more technical reasons than a sudden belief that Temasek is a low credit quality firm.

The biggest proposed change is the importance S&P gives to liquidity in their risk assessment of IHC’s noting that “we propose to give a greater weight to our assessment of asset liquidity than to our assessments of asset diversity and asset credit quality.”   S&P stresses the importance of liquidity “…because the ability to sell assets quickly is the ultimate source of debt repayment if an IHC cannot refinance maturing debt.  Our assessment reflects how quickly we expect the entity can liquidate assets at a reasonable price.”

There are solid financial reasons, especially for a firm like Temasek, to accept higher liquidity risk by holding lower liquidity assets.  Studies have found that asset liquidity is valued so that financial firms, such as hedge funds, willing to hold lower liquidity assets receive a premium for bearing that risk.  University endowments have targeted lower liquidity investments given longer investment time horizons and the ability to sell at their discretion.

The second major proposal is to use “spot prices” rather than some “average price over n trading days – to value listed assets.”  Related to but also distinctly different from liquidity, this focuses on what price could assets be sold to cover debt payments.  This debate has raged for how banks should value their loan portfolios in what is typically called “mark to market” by valuing a bond or loan at the market price the bank could expect to sell it at or at some other less potentially volatile rate such as a long term average or expected stream of cash flow basis.

There is reasonable and straightforward logic as to why spot prices should not be used.  Let’s use a simple scenario to illustrate why.  Assume the market price of an asset declines and a financial institution reaches a level where they have to sell the asset to cover their debt payment.  When they sell an asset this further depresses the market price potentially causing other firms to be forced to sell.  It is also possible to recreate this scenario in reverse when prices are going up.  Fundamentally, there is a solid argument that using market prices can increase volatility.  It should be strongly emphasized that reasonable people have reasonable disagreements on this very tricky issue.

While these two concepts need to be considered separately, they also need to be considered jointly.   S&P is proposing that we ask the following about credit risk as it pertains to IHC’s: if an IHC needs to sell assets to repay a debt, how easily can it sell its financial assets and at what price?

How do these concepts apply to Temasek specifically?  Temasek can reasonably be considered a somewhat less liquid IHC for two reasons.  First, Temasek asset holdings are relatively concentrated.  Temasek holdings are concentrated with significant stakes in key firms like Singapore Telecom, DBS, Standard and Chartered, and China Construction Bank.  As one article noted, approximately 50% of Temasek assets are concentrated in ten firms.  If Temasek needed to sell some of these stakes, given the large size of the holdings, this would reduce the liquidity by pushing down the price if Temasek needed to sell a significant amount or if the market found out Temasek was selling a sizable block.  Also, if Temasek ever needed to sell its entire stake in a major holding, this would significantly reduce companies with the ability to finance large acquisitions.

Compare this to Norges Bank Investment Management (NBIM) which manages the Norwegian sovereign wealth fund.  They have limited themselves to 2% of outstanding equity of any company they hold.  While this essentially turns them into an index fund as they hold 1-2% of most every listed company, this also means that they remain very liquid.  NBIM is able to easily sell stakes in entire companies in relatively short periods of time or in many companies when needed.  In short, there is elevated liquidity risk due to the concentration of Temasek’s portfolio.

Second, there is what I will term political liquidity risk.  Look at the major holdings in Temasek’s portfolio and you will see politically strategic firms like Singapore Telecom, DBS, and Singapore Airlines.  Those are for all practical purposes completely illiquid investments where Temasek depends on dividend cash flow for debt repayment.  Removing firms from the Temasek portfolio that are for all practical purposes illiquid, reduces Temasek liquidity to cover debt repayment even further.  The S&P concern over liquidity risk has a significant impact when focusing on Temasek.

Turning to the question of what price Temasek might be able to secure for its assets under different market conditions returns us to the issue of asset concentration and political risk.  Not only is the Temasek portfolio concentrated within its portfolio, it is concentrated by industry and geography with an increasing allocation to higher risk assets like financial and natural resource firms.  For example, three of the top four holdings are in financial firms and Temasek remains closely linked to Singapore and surrounding countries.  This implies a high degree of correlation among their holdings.  If the market is declining, then Temasek would need to price any significant asset sale at an even larger discount.  Conversely, in a rising market Temasek might be able to extract a sizable premium for one of its strategic stakes.  However, given the concern about debt coverage from asset sales, we should focus on down markets and again there is cause for concern.  There would be significant pricing pressures on any significant asset sales by Temasek.

There would also be pricing pressure due to potential political risk.  Let’s assume for one moment that Temasek decides to sell a significant stake Singapore Telecom, DBS, or Singapore Airlines.  Given the long historical record, key personnel through each firm, and political significance, any buyer would be enormously concerned about undue influence exercised after the sale.  The same could also be said about most Asian holdings for instance in China Construction Bank or Bank of China.  The Chinese government would most likely have a strong opinion about Temasek selling its holding to anyone else.  Political risk is likely to impact the final sales price and not positively.

The primary risks the S&P is proposing to increase in its credit model for IHC’s are the ability to sell and the price it will receive for selling.  I believe there is a fair and reasonable case to be made that when Temasek is narrowly analyzed against these two criteria, it does have an elevated risk level.  There is good reason to have some concern over liquidity and asset pricing risk should it need to sell assets to cover debt repayment.

As noted at the beginning of this article, while the S&P frameworks does raise the risk profile of Temasek, it is important to note the reasons why.  Their reasoning focus on specific and technical issues and not due to a new belief in the underlying quality of Temasek assets.

Note:  Part III will cover the Temasek response, whether they should be considered as risky as Greece, and other bigger picture issues.

S&P Looks at Temasek and Sovereign Wealth Funds Part I

Somehow I missed the November release of the credit ratings agency S&P asking for comments on its proposal for updating standards of investment holding companies (IHC) and government related entities (GRE).  This is both a somewhat technical exercise and discussion by credit ratings agencies that takes place to reassess their standards for evaluating credit risk but also has very tangible impact on Singaporeans and can be explained in ways that make sense.

Before beginning to analyze the proposed S&P standards and Temasek’s response, let me try and provide some background to better understand the overall situation.

  1. S&P is one of the three major global credit ratings agencies along with Moody’s and Fitch.  Their market dominance stems primarily from their oligopolist position conferred by the US government within the American market.  Less than 10 credit rating agencies in the United States are recognized as “nationally recognized statistical reporting agency” which allows a privileged position for instance in rating investment grade debt held by a large variety of institutions.  The big three are estimated to control approximately 95% of the credit rating market in the United States which they leverage into dominant positions throughout the world.
  2. S&P, in putting forth generalized standards, is trying to create a clear, transparent, framework that they can use to compare different companies rather than make every analysis unique.  To take a simple scenario, they might state that companies with a debt to equity ratio of greater than 3:1 will receive a B rating while a company under than will receive an A.  Framework standard sacrifice detail and uniqueness, which individual analysts will provide later when researching companies, for broad standards than can be applied throughout the world.
  3. The broad framework standards used by every credit ratings agency can be used to disguise the true risk.  Frameworks to assess credit risk are generally solid guidelines but like all rules can be used to manipulate the overall system.  During the global financial crisis, many mortgage linked products met the technical guidelines to receive a high rating even if it clearly masked the true level of risk for that financial instrument.  Guidelines laid forth by ratings agencies should be considered fallible frameworks that attempt to capture common risk factors but they absolutely should not be considered final and perfect assessments of individual risk.
  4. Credit rating agencies are riddled with group think and conflicts of interests, but at the same time historical data reveals a very clear relationship between defaults and ratings.  The riskier the rating the higher the probability of default (PDF).  Credit ratings are imperfect by any measure with a systematic downward risk bias, but they should be ignored at your peril.  There is a strong relationship between both initial rating and adjusted rating and default probability.
  5. Credit ratings rarely change so consequently, there is a lot more interest in the framework or the rules that allow firms to receive top credit ratings.  Unlike credit default swaps (CDS) which trade daily and can be used to predict default probability, bond ratings typically go years without a ratings change so the initial rules of the game matter a lot more.  According to S&P, the last time it changed its IHC framework was May 2004 when it was entitled “Rating Methodology For European Investment Holding And Operating Holding Companies.”  The “European” in the title should giveaway how outdated the S&P framework is.
  6. Every firm that does not receive the rating they feel they deserve will loudly protest that there are factors unique to their situation that the ratings body is not accurately weighing.  Most of the time, but definitely not always, firms arguments that the ratings agencies fail to accurately understand their industry or firm are poor attempts to gain a better ratings.  Credit ratings by the large agencies on average accurately assess the credit risk associated with firm issued debt.  If anything, credit ratings agencies on average understate rather than overstating the risk associated with debt products.
  7. S&P in its framework creation rarely deals with the type of issues I raise such as accounting or corporate governance problems but rather on much narrower concerns focused on whether debt can be repaid and potential stress concerns.  For instance, two issue which S&P raises which may seem technical are liquidity and mark to market vs. trailing average over some period.  Again, these are broader framework issues narrowly focused on repayment rather than the specific corporate concerns.

So as not to turn this into an excessively lengthy post, I am going to limit this post to the broader framework and background surrounding this issue.  This is a very important issue that has very real ramifications for Temasek, Singapore, and everyday Singaporeans.  I want to make sure the background and broader issues are understood so that when I turn to analyzing S&P’s proposal and the Temasek argument, everyone is aware of what is unfolding.

This may seem somewhat technical and boring but let me assure you it is vitally important and will be very important.

Revisiting Chinese Consumption

In my last post, I expressed significant skepticism over the supposed rapid rise of consumption in China to bolster GDP growth.  Given wide spread reporting of declines or slowing of Mainland revenue by both Chinese and foreign firms, it seemed incongruous that that official consumption data was significantly accelerating.  While some heralded the GDP data as proof of the rising Chinese consumer in the face of slowing investment, it appears the truth source of consumption growth is again the Chinese National Bureau of Statistics.

Gordon Orr at McKinsey China was also puzzled by the consumption data and not only stumbled upon the source of consumption growth but uncovered very large data gathering change by the CNBS.  Looking at the data he noticed that urban consumption growth slightly outpaced income growth but not enough to be responsible for the required consumption growth.  However, when examining  rural consumption growth he noted that official YoY consumption grew at 27%.  Let me repeat that: according to the China National Bureau of Statistics rural consumption grew 27% from between 2013 and 2014.

Even for an economy growing at 7.5% this seem large so he asked the CNBS for an explanation.  The CNBS responded that they “expanded the coverage of their rural survey in 2014, and that the (higher) 2014 data is not comparable to prior years.”  This is a stunning revelation if true and raises many issues.

First, China has been a serial data methodology reviser over the past decade and all revisions have made significant upward revisions to GDP.  Just this past January, China made additional revisions that added the GDP of Malaysia on top of 2004 and 2008 revisions to GDP that added approximately 20% to GDP.  Given the enormous problems with other economic data such as unemployment which remains virtually unchanged over the past decade and inflation which claims that urban housing prices grew only 8% in total from 2000-2011, the supposed concern over statistical with regards to GDP that is only revised in one direction seems inconsistent.  Maybe if inflation and unemployment were both revised upward, as is the CNBS pattern, some credibility might be established.

Second, the CNBS apparently stresses that there is a break in consumption data and 2014 is not comparable to previous years.  Assuming this is true, 2014 GDP then is not comparable to 2013 GDP.  Given the inconsistency in Chinese GDP data, it seems nearly impossible to compare any year to any year with their self admitted data issues.

Third, if this data methodology revision is not included into 2014 GDP, official GDP would be at least 1% lower doing some basic back of the envelope math.  Conversely, if this new method is applied historically, this would increase Chinese GDP by approximately 1% annually.  These are not insignificant data revisions.  One mistake commentators make when tracking Chinese GDP is comparing GDP across time when it is clearly not comparable across time by even the NBSC’s own admission.

Fourth, though the CNBS announces or lets other uncover the new methodology, there is never any detail provided about the revised methodologies.  Others who have studied similar type of data on Chinese consumption the NBSC uses to revise GDP upwards have found that GDP in recent history has been significantly overstated.  The scientific method relies on others being able to replicate the results from similar or identical data and methodology.  The NBSC refuses to release the data or methodology it uses to justify these upward revisions and others using similar data an widely accepted GDP accounting methodologies find strikingly different results.  This should concern people.

Fifth, there is the supposed sampling error raised by Gordon Orr himself.  If the NBSC expanded its survey of Chinese households to better account for rural consumption the most logical step is that they would improve sampling of poorer and more remote areas with lower consumption.  Take this simple scenario.  Assume that previously, the NBSC collects samples from all villages over 10,000 people and extrapolates this for villages under 5,000 people.  Under the new methodology however it samples both groups of villages.  It would seem unlikely that the large majority of wealthy high consuming rural inhabitants are in under sampled areas like villages under 5,000 people, as described in this scenario.  This basic phenomenon would result from relatively extreme abnormal population distributions.  In other words, the NBSC is asking you to believe that the only people it didn’t sample before or extrapolate their data to previously are a group of previously hidden Mercedes driving farmers living large who consume so much as to swing national GDP data by more than 1%.

Having been writing about Chinese economic data for years, I am not sure which surprises me more: the obvious and blatant manipulation of data or that people still give it any credence.

Analyzing Chinese Growth

The world was aflutter when the Chinese National Bureau of Statistics announced GDP growth of 7.3% beating expectations of 7.2%.  While focused on the difference between the .2 and the .3, others chose to herald the rising power of the consumer in driving Chinese rather than investment.

What most analysts seem to be overlooking is whether there is any actual accuracy to these numbers.  First, we know that the Chinese NBS has a long history of manipulating official statistics.  Can anyone claim that urban Chinese housing price inflation was 6% total from 2000-2011 with a straight face?

Second, all signs point to a decline in industrial activity.  Steel production was essentially flat and grew at a tepid 3.8% well beneath GDP.  Others have noted that electricity and other forms of energy have essentially decoupled from Chinese GDP growth recently.  This implies that either the entire structure of the Chinese economy has changed, in macroeconomic terms, overnight or Chinese economic activity is not as robust as officially reported.  While it is too early to draw firm conclusions, given the relative speed with which energy and GDP decoupled and the lack of change to the economy, it seems more likely that there is underlying weakness that is not being reflected in official data.

Third, while some have even used the recent data to herald the rise of the Chinese consumer, official data stands in stark contrast to all other reports about Chinese consumption. Whether it is luxury cognac makers or domestic beer makers, companies across industries have been reporting weakness in Chinese sales.  Foreign cognac and Chinese beer makers are two examples but there is simply no evidence from company reports that indicate the Chinese consumer market is suddenly bursting forth to make up for a decline in investment and heavy industry.  Large number of both Chinese and foreign businesses are talking about a consumer slow down and their sales reflect that.

This leaves a very simple scenario.  Industrial activity is clearly slower and most companies are reporting sales described as soft, but somehow the official statistician is declaring results that beat expectations.  Given what we know about the history of Chinese data, it might be worth it to carry a healthy skepticism about the official data.

There simply is no independent data from either the corporate/industrial sector or the consumer side to support the idea that Chinese GDP beat expectations.

Note: I was interviewed by the Dutch newspaper Het Financieele Dagblad where I said it is more plausible that GDP growth is 2-4% lower than official data reflect.


Things Seem to Be Getting Interesting

My apologies for being quiet for so long.  I have had a lot on my plate with unrelated projects and unable to focus on writing for the blog.

I have been prompted to write more given the interesting developments in the Chinese economy among other things.  There are two stories that I wanted to touch upon that are both unrelated at the same time.

First, despite a publicly positive economic outlook from Beijing and the PBOC, the economic fundamentals are much more stressed.  Money is flooding out of China as the anti-corruption (political enemy purge) continue to gain steam.  This puts pressure on weak businesses that have relied on bank lending to fund never ending expansion with little expectation of being repaid.  Despite repeated disavowals, Beijing is pushing a series of unofficial stimulus that are beginning to approach the 2009 orgy of debt and spending. It seems strange if the economy is so good as claimed, that new projects are being announced and existing projects being sped up.  Central banks don’t injects hundreds of billions of RMB into banks if they are healthy.

Second, this pressure is manifesting itself in businesses that have seen nothing but expansion and raising serious questions about the official finances.  Kaisa, a real estate developer in Shenzhen, missed a coupon payment on a 2020 bond.  What makes this case interesting is that they supposedly have 9 billion rmb in cash and missed a 120 million rmb payment.  While they have a waiver to pay the required amount within a 30 day period, after which they would be in technical default, this raises serious questions about the real state of finances beyond the official books.  Considering most of their projects have come to halt with even routine approvals being denied, many suspect there is something more serious.

Given that little is straight forward in financial and economic matters in China, these two seemingly unrelated events are raising concerns.

Hong Kong: The Game Behind the Game

Lost in all the hand wringing about Hong Kong is a larger more important issue: Chinese GDP is in all likelihood zero. China is not just on track to miss, though officially meet, its growth target but miss badly.

Steel and electricity consumption are falling.  Real estate prices have begun falling causing riots among consumers who feel defrauded or that apartments selling at almost $1,000 a square foot were a one-way bet.  Despite these falling indicators the People’s Bank of China continues to pump money into an already saturated market.  In the middle of September, the PBOC injected 500 billion rmb into major state owned Chinese banks.  All the while, Beijing continues to release additional stimulus measures while continuing to insist it will not release a major stimulus package as it did in 2008-2009.

Nothing here bears the hallmark of a healthy economy much less one growing at 7.5%. One source indicated that 7.5% was internally believed to be the number which would maintain enough cash flow to keep the Chinese economy from tipping into a crisis given the poor state of finances.

This matters for one very simple reason.  The implicit agreement between the Chinese populace and the government has always been an acceptance of political repression if the economy was growing rapidly.  If you want to see protests on the streets of every major city in China announce that housing prices have fallen by 50%.  Riots break out over smaller changes to prices and a significant slow down in Chinese growth would break the acceptance of political repression.

Beiing views taking a hard line with Hong Kong as a dress rehearsal for the serious economic problems festering just beneath the surface inside China.  Breaking their part of the agreement of rapid economic growth means needing to enforce the other side of the agreement, even if the Chinese population decides they want to opt out.

Standing up to the student protesters organizing recycling has always had nothing to do with Hong Kong and everything to do with the Mainland.  The self admitted fall in steel, electricity, and real estate prices, are prompting Beijing to see Hong Kong as nothing but the opening act.

Revisiting Hong Kong

I visited Hong Kong two days ago primarily because I had a previously scheduled business meeting but also to walk the streets to witness history first hand. Here are some more thoughts on both details and bigger picture items.

  1. If Beijing isn’t already scared, they should be. The protesters are motivated, organized, and have little to lose by continuing their protests. This is just the type of group that can take on and embarrass the Beijing goliath.

  2. Beijing and Hong Kong seem to be adopting the wait them out strategy and hope they melt back into society never to be heard from again. I am very doubtful this is going to happen. The protesters are motivated and organized. Walk around the streets and everywhere are people helping people. Trash brigades patrol the crowds to pick up trash and place it into the proper recycling bags. First aid is widely available at marked stands and food is distributed by volunteers walking around as well as at marked stations. This is done to keep protesters spirits high but also gain the support of the Hong Kong community. Non-luxury businesses I saw near the protest sights were doing a brisk business from all the foot traffic. The people I talked to away from the protests largely went about their daily business and ranged from tacit understanding to strong agreement with the protesters. The students and organizers seem to understand that this is not going to be a short term battle and that there would be no point in starting the mass protest unless they were in for the long term.

  3. Time is on the side of the protesters not Beijing. The longer this plays out the more pressure Beijing is going to face, both domestically and internationally, to resolve this situation. The more information that gets through, the more Chinese citizens learn about the protests, and the more foreign governments continue to speak out, the greater pressure facing Beijing. The biggest time pressure the protesters face is that their enthusiasm will wane and crowds will fail to materialize. I see mounting domestic and international pressure on Beijng as a bigger long term risk than a decline in crowds to Occupy Hong Kong.

  4. I would love to be inside Beijing and Hong Kong government offices right now to hear the strategy debates. I am beginning to have serious doubts about how unified Beijing and Hong Kong are about how to deal specifically with the Hong Kong protests and the bigger picture questions of potential democratic reforms. While the official Hong Kong government strategy appears to wait out the protesters, I think there is also reason to believe that internally there is some degree of support for the protesters. I believe even in internal discussion in Beijing, there is probably some support for the protesters. As one example, China routinely reduces internet speeds around major political events and national holidays to dial up speeds or attacks VPN services with such force that connections regularly drop. The Hong Kong protests however have seen virtually no change in speed or VPN reliability. I have actually been quite amazed at my ability to stream video of the protests and continue accessing Twitter and other sites. People in China, at all levels of society, know and believe that political change will happen someday in China. I think it is highly likely some of the ongoing strategy discussions are including people pushing for some degree of political liberalization.

  5. The Mainland response to the Hong Kong protests is mixed but most fail to understand what is causing this ambivalence. Read the comments in reported in the media and talk to Mainlanders in private about their aspirations and dreams and you will find they correlate quite closely with the Hong Kong protesters. The difference is this. The Mainland political thinking is pervaded with a sense of fatalism that nothing can ever change and I cannot make a difference so why even try. Working as a business school professor at one of the elite schools in China, I see all the time the extreme aversion to any type of risk students and business people have. No one ever wants to be first to do something and lower paying jobs in state owned enterprises or government with a promotion every two years are preferred for their stability over start ups or foreign enterprises. Talk in hushed tones to almost any Mainlander and they will all talk about China will change someday and become a democratic country that respects people and then qualify it by saying someday when the government tells us it is acceptable. In China people fear the government and do not believe they matter; in Hong Kong people do not fear the government and believe they matter.

  6. Strategically, Beijing is very limited in its options. Except for crossing their fingers and hoping this comes to an end, Beijing has few options. There would be significant back lash in Hong Kong, China, and internationally if significant force was used; however, if they back down in any significant way, they know very well they could be opening the door to greater problems. So far the Hong Kong and Beijing response seems to depend on repeating that the protests are illegal and everyone should go home. I doubt this will succeed in dispersing protests.

I believe this will be a much longer process and protest than is currently expected. As Beijing always wants to talk about democratic development according to the realistic situation, it will be interesting to see if they believe the words they publicly declare or if they are empty mantras.

Thoughts on Hong Kong

I don’t have time today to prepare a longer analysis but I wanted to put forth a number of thoughts on the Hong Kong protests.

1.  The protests will not be quelled soon.  Watching and reading a variety of international media outlets, I am surprised at the number of people that expect this to be a day or two of protests before returning to normal.  I would personally be quite surprised if this was a short lived protest movement.

2.  The protesters are dangerous because they feel as if they have nothing to lose.  Hong Kong has many grievances against China and they feel as though they have nothing to lose by taking this final step.

3.  This is Beijing’s worst nightmare.  The one thing Beijing has been trying to avoid for years in Hong Kong and the Mainland was a mass protest through all the color revolutions.  They were caught flat footed by the Umbrella Revolution.  They know this has already spiraled out of control for them and now they hope to defuse the situation.

4.  The official response has been astoundingly inept.  Whether arresting a sympathetic high school student, firing tear as on protesters with the hands in the air, or issuing press releases which say nothing will change now please go home, the official response would fail any crisis management section in public relations.

5.  Beijing and Hong Kong are between a rock and a bigger rock.  Official responses to issues like the White Paper and potential protests have been heavy handed and only served to bring out more protesters.  However, giving the protesters too much freedom risks having the protests spread to the Mainland or force Beijing to back down.  Right now the official strategy appears to be do nothing and hope that people go home.  I doubt that is going to happen.

6.  The issues at play are much deeper and more complicated than portrayed in the media.  The White Paper from Beijing is merely the last straw that provoked this and not the only issue.  I will write more about this in the coming days.

7. Beijing technically allowed Hong Kong universal sufferage but it gets to pick the candidates.  This harkens back to the Henry Ford saying about cars that “you can have it any color you want as long as its black.”  Hong Kongers may have a chance to vote, that doesn’t mean they have a choice.


Anti-Trust Policy in China Needs Some Economics

There has been a lot of interest recently in whether Chinese authorities are unfairly using anti-trust regulation against foreign companies favoring domestic firms.  This is an interesting question but the data is to sparse to really know whether the authorities are using it to favor domestic companies.  What has been almost entirely neglected is whether the Chinese authorities have good economic arguments that foreign firms are monopolists in the Chinese market and if they are, whether they are abusing their dominant market position to extract economic rents.   Let’s try to examine the economic argument closely.

The absolute pre-requisite for an anti-trust case is that a company have either a dominant position in a market or be a part of a group which dominates a market.  Anti-trust law was originally designed to target companies with a monopoly position in a specific industry but has also been expanded to examine industries with high concentrations of firms.  This means that anti-trust cases should be where individual companies or a small collection of firms have a dominant market position.

However, in no instance could any foreign firm that has been charged with anti-trust violations be found to have a dominant market position.  Let’s take two recent examples.  In the summer of 2013, China issued fines against six baby formula manufacturers for price fixing while three other firms were charged but not fined.  Now before even analyzing the meat of the charges, it is important to emphasize that there are at least nine major manufacturers of baby milk powder.  That would meet any definition of a competitive market place as no individual firm has a dominant position and there is no charge or evidence that the firms were colluding to set prices.

The Chinese government instead charged them with “disrupting market order” and fixing their own prices, at a price which the Chinese government unilaterally deemed too high.  It is important however to note why foreign firms charge “…more than double…” domestic brands.  Put bluntly, Chinese do not trust domestic brands of milk powder due to numerous scandals and are willing to pay significantly more for foreign milk powder.   Standing in a customs line returning from Hong Kong into China, the Chinese return with armfuls of two products: luxury goods and milk powder which in a way are the same thing.  Foreign producers saw the increased demand and raised their prices to maximize profit.  It is worth emphasizing that no foreign firm had a dominant position in the baby powder milk market or even among foreign manufacturers.  Returning to economics 101, foreign producers enjoyed a surge in demand and prices increased.  That is very different than an anti-trust violation.

More recently Mercedes was charged with antitrust violation due to what Chinese authorities said was high prices for car parts and services for existing vehicles.  In other words, Mercedes was charging too much to repair its own cars at its own dealerships.  This specific case is a bit more complicated than the milk case because this case does not involve Mercedes dominance in the overall car market but in Mercedes dominance in the pricing of its own car parts.  Let’s examine the this case closer.

Mercedes has a dominant market position in the sales of its own products.  Mercedes sets the prices for the products it sells.  The question should not however be whether the price of a Mercedes car part is too high but whether Mercedes is engaging in anticompetitive behavior in the secondary market of car parts to extract higher prices.  In every car market, China included, consumers have the choice of purchasing replacement parts and services from the manufacturer of the car or going to other mechanics and purchasing non-dealer replacement parts.  The primary argument cited by Chinese authorities is that if you were to build a Mercedes from spare parts it would cost 12 times the cost of the Mercedes rather than 3 times in other markets.  This indicates that Mercedes is charging significantly more than other markets but says nothing about anti-trust or anti-competitive abuses.

The question then becomes whether Mercedes was trying to keep other companies from selling replacement parts for Mercedes.  With the exception of a small number of parts, most car parts have off-brand manufacturers that will make replacement parts for Mercedes cars.  These are not branded as Mercedes but they are acceptable as replacement parts.  Similar to the milk case, Mercedes is not even charged with trying to prevent third party manufacturers from selling replacement parts to Mercedes owners.  In other words, consumers are perfectly free to buy cheaper replacement parts for their Mercedes in a competitive market, place given concerns over quality, they prefer to purchase branded Mercedes replacement parts.

The baby powder milk formula and the replacement Mercedes car parts have two interesting and common threads.  First, Chinese consumers are highly skeptical of the quality of Chinese products.  No amount of Beijing led witch hunts on foreign companies is going to change that.  Chinese consumers paid more for foreign baby formula because the chances it is laced with melamine is much lower than its domestically purchased equivalent.  Chinese consumers willing to pay more for a branded product they trust is not anticompetitive behavior by the foreign firm selling them the product but rather charging a premium price for a premium product.  That is simply good business sense.  Second, these “anti-trust” cases are not about market dominance or anti-competitive behavior  by firms but rather selling a product at a price that Beijing does not approve.  Just because a product prices are different either between competing companies or between countries is no surprise to any economist.  Firms have a variety of pricing strategies and sell their goods for different prices to different customers at different places.  There is no evidence that any of these firms either enjoy a dominant market position or engage in anticompetitive behavior.

There are two final notes worth mentioning.  First, Microsoft has recently come under anti-trust scrutiny in China for its supposed dominant position in operating systems and office software programs and how this impacts pricing.  What is so puzzling is given that approximately 90% of Microsoft labeled software in China is pirated, how can Microsoft be assumed to have a dominant position?  It seems more reasonable to charge the pirates with anti-trust violations.  Second, this focus on the price of the good now armed with anti-trust regulation continues Beijing’s obsession with   demanding foreign firms lower their prices.  Previously CCTV, just as much an arm of the government as the anti-trust regulators, had targeted firms like Starbucks for the price of a cup of coffee.  Even though evidence indicates that Chinese Starbucks are not outside the normal pricing range, Beijing tried to make the cost of a latte an anti-foreign firm political issue.

Whether or not Beijing is deliberately targeting foreign firms and not domestic firms, is difficult to say given that lack comparison data.  However, it is easy to tell that these so called anti-trust violations are not based upon economics.

Between Apathy and Risk

I admire Roy Ngerng.  I admire Roy Ngerng not for what he said, though I generally agree with what he said.  I admire Roy Ngerng because he spoke out willing to accept the risks of speaking the truth.  Much of the time when I write about Singapore, I feel like a fraud because I am not generally in harms way when writing about the enormous financial discrepancies.  Roy Ngerng who faces much greater risk than I do has accepted that risk and calling.

Though I generally do not read comments on my work, I happened to browse through the comments section at TRemeritus.com a few months back and a reader asked me to write about specific issue that has haunted me ever since.  To paraphrase with my interpretation, what will rouse Singaporeans from their apathy in determining their course as free men and women with God given rights?

The English philosopher John Stuart Mill stated that “Bad men need nothing more to compass their ends, than that good men should look on and do nothing.”  People make calculations on the risks of speaking out and too often decide to remain silent, allowing bad men to compass their ends.  This attitude of cynicism and self interest permeates views about those who accept risks.  One Chinese youth was quoted as saying people don’t do things for ideals.  The world is a sad and lonely place when people do not hold ideals and the people that do are considered lunatics.

I do not believe it is my place to advise Singaporeans who to vote for or what specific policies you should implement.  However, I strongly believe you should demand transparency, openness, and accountability from any government of your choosing.  I strongly believe you have the right to criticize your government or any other government without fear of retribution.  I strongly believe Singapore and Asia need more men and women like Roy Ngerng who are willing to accept the risks of speaking truth regardless of consequence.

Too often we think of doing the right thing as earning reward and benefits when frequently the reality is the complete opposite.  Doing right may earn scorn, derision, and retribution.  During my five years in Asia, I have met many wonderful people and found them insightful and  thoughtful.  I have however found too many people unwilling to stand up for what they believe is right.  Consumers and citizens are more informed now than ever before and instead leadership creates fear and infantilizes them insisting “you wouldn’t understand.”

Roy Ngerng has met his fundraising objective of paying for the fine, but go further by attending the Return our CPF meeting at Hong Lim park on June 7th.  Maybe I will come as just an innocent bystander to observe the proceedings. There is nothing about CPF, Temasek, GIC, or Singaporean finances that I can say that will make people stand up and make their voice heard.  The bigger question is whether the good men and women of Singapore will stand by and do nothing.

Brief Specific Points on the CPF (as I have already written much on the topic):

1.  There is no interest rate guarantee.  As I have long noted, there is no guarantee because you cannot guarantee yourself.  The government guarantees CPF funds and Singaporean tax payers are the funders of the government.  The Singaporean tax payer is “guaranteeing” itself.  This is the equivalent of buying life insurance from yourself and promising to put the payment in a separate account so that based upon your expected death, there will be the same amount for your children.  If there are ever problems with CPF and Singapore government finances, guess who will be footing the bill for this guarantee?  Singapore taxpayers will be paying for their own guarantee.  If something goes wrong and you have to bail yourself out, that is not a guarantee.

2.  If the government via any means is legally mandating citizens provide it revenue: that is a tax.  The CPF is a significant form of wealth taxation on Singaporeans. In the MOF response, they state that they keep all funds above the “guaranteed” rate meaning they are imposing an implicit form of taxation.  A government simply cannot pass a law requiring citizens that confiscates money and not call it a tax.

3.  Please raise your hand if you would rather have the guaranteed CPF rate of 2.5% (a total weighted 3.67% based upon all CPF funds) or the unguaranteed GIC rate of return of 6.5% in USD terms?  What about the 16% of Temasek primarily holding historical Singaporean state owned firms?  Anyone? Anyone?

4.  As I have noted before, as a matter of prudence, I support raising the guaranteed requirement.  However, to achieve those ends it would be better to let Singaporeans share the benefits of the GIC and Temasek through any number of various proposals, rather than make it that much harder to meet the minimum standard.  Temasek is comprised primarily of historically state owned firms and GIC, by the governments own admission, is comprised of public investment capital.  The people of Singapore should share this bounty rather than being forced into indenbtured servitude.