How to Succeed in Business without Really Trying: Chinese Style

If the world learns nothing about modern day China it must know that the current incarnation of the so-called Communist Party are pure capitalists with authoritarian government power.  There is nothing Communist about the Chinese communist party today.  Lest anyone forget, this is the same group of communists that took the People’s Daily Online “the website of the flagship newspaper of the Communist Party of China” public in Shanghai.  Marx is still spinning in his grave after being asked for a quote on the Propaganda Department of China being listed.

After the flurry of activity from the Third Party Plenum, enterprising institutions, including my own Peking University, saw a market to make some money by selling classes (Chinese link) on how to interpret the reforms, policies, and communiqué released by Beijing.  In fact, according to news reports, Peking University classes started the day after the policy release.

Nor are the classes cheap.  One university was charging 8,800 RMB ($1,500 USD) for one day of classes.  Peking University was at least more reasonably priced at 3,200 rmb ($525 USD).  Zhejiang University was charging 6,800 rmb ($1,100) with no word on whether this class included more endless droning insightful lectures on how best to interpret the holy words of honey handed down from the Third Party Plenum.

There are two final points of interest.  First, the Party is desperately concerned that people follow the directions rather than think for themselves.  The snake oil information being peddled about the courses promise to help  “accurately grasp the policy”and “what is the overall program of comprehensive deepening the reform..”.  Second, the courses are exclusively for Party members and government employees.  These courses are not for private citizens, foreigners, or corporations.

All this taken together has two real implications.   First, when you hold monopoly power, the Party knows that you should never miss an opportunity to use it and extract a little more money from the consumer.  Second, Beijing is very worried that they won’t be able to control the message.  This is the tightrope they are walking: how do you encourage the free market while still controlling it?  Beijing is working really hard to make sure they still control the free market which is easier said than done.

In China, there is a generally accepted pattern of easing of economic and political freedoms for a number of years followed by a 3-6 month tightening or crackdown.  The idea being that people need to be reminded who is in charge and that the government still controls every aspect of your life if they need to.  Beijing never wants people to get comfortable.  With such an early declaration of reforms, Beijing is probably worried that this will embolden people at the beginning leading to problems later on.

This is how you succeed in business without really trying Chinese Communist Party style.

Happy Thanksgiving to my homeland and US readers.

From the “This Can Only Mean Good Things” file

China is a flurry of activity right now.  The Economist reports on Chinese interest in spinning off its state owned enterprises into a holding company built around the Temasek model.  They write:

…the Development Research Centre (DRC), a government think-tank, advertised an ambitious set of reform proposals, including an overhaul of China’s inefficient state-owned enterprises (SOEs). Simply privatising these companies remains out of the question for China’s leaders. But there are alternatives, and Singapore provides one.  The DRC’s plan named Temasek, a holding company for SOEs in Singapore, as a potential model.

Just as the China Investment Corporation essentially owns the banking industry in China through its holdings of the four major state banks in China, they want to replicate Temasek management as holding DBS and promoting it as a national champion while shielding it from domestic competition.

What is interesting is what The Economist notes is driving this Chinese interest.

The enthusiasm for reform of SOEs in China reflects their deteriorating returns and accumulating debt. According to M.K. Tang of Goldman Sachs, their return on assets was 6.5 percentage points below that of other Chinese firms in 2012 and their shares trade at a growing discount.

As I noted in previous posts about what is driving Chinese reform: not a position of strength trying to become stronger, but an intimate knowledge of just how bad resource allocation is in China and just how weak state owned enterprises are and specifically the banks.

I think there is one key mistake in this article and that concerns the distance between Temasek and its major portfolio companies.  The Economist writes:

…the Temasek model also allows the state to distance itself from the management of its enterprises, without relinquishing ownership. Temasek avoids meddling in the day-to-day running of the GLCs in its portfolio, which are free to hire professional managers at market rates. With a few exceptions, it does not directly appoint board members either….Temasek has evolved into an active investor, but not an activist one, says Stephen Forshaw, its chief spokesman. Although it does not appoint directors, it does meet regularly with its wards’ boards to make its feelings known.

It is entirely true that Temasek is not an activist shareholder but considering the level of political influence they have over key executives in their Singaporean based portfolio, there is no need for formal control such as board seats.  Virtually all senior executives at Temasek linked Singaporean companies are politically preferred appointees.  Many are PAP appointees hired for the government connections.

Given the Communist Party control over Chinese financial industry and other key sectors appointed by informal relationship to the government, China is already be operating under a version of the Temasek model.  It should then come as no surprise that Chinese bank financial returns are just as fraudulent managed as Temasek’s fraudulent managed financial statements.

PS:  Lest anyone doubt my undying love for Singapore Airlines, it is now proclaimed in The Economist when they write that “Even Mr Balding, meanwhile, is happy to fly Singapore Airlines.”  I am.  Singapore Airlines: call me maybe.

Thoughts on the Plenum

Well the Chinese Party Plenum in Beijing is over and after an enormously underwhelming communiqué, the policy releases since then have been significant and positive.  The one child policy is officially being relaxed, supposedly a policy is being developed to increase the number of privately owned banks, state owned enterprises will be reformed, and hukou residency permits will be addressed.  In all the talk of the policy releases, I believe there are some important points that are being overlooked.

First, while I won’t go so far as to say these reforms are “unprecedented”, putting this level of reform and detail into an official Party policy documents is significant.  The Party has never gone this far in policy documents and it is encouraging the direction they have charted out before them.  The Party is committing themselves to what they intend to accomplish and I sincerely hope they accomplish most everything they have announced.

Second, we must keep in mind that announcing policy intentions are very different from actual accomplishments.  It is important that they have declared what they want to do, but before we get carried away, let’s remember they haven’t accomplished any of these things yet.  China has talked about rebalancing, moving away from an export driven economy, and increasing consumption for about a decade and for about a decade, those numbers have done nothing but become more extreme in the wrong direction.  Don’t mistake talk for results.  Remember: in the communiqué, they emphasized the importance of publicly owned industry.

China is going to have an extremely difficult time rebalancing away from excessive credit growth and fixed asset investment to drive GDP.  State owned enterprises, and especially the major banks, are not going to take kindly to competition.  There are going to be a lot of battles to realize this policy wish list and a thousand ways to derail many of these proposed reforms.  While the policy declarations are important, hold the euphoria for when you see it implemented.

Third, many of the policy prescriptions are not announced out of strength but due to a recognition of just how bad things are.  Winston Churchill is reported to have quipped about the United States that “when all other options have been exhausted, Americans can be counted on to do the right thing.”  This seems to fit this round of economic reform declarations.  To take one obvious example, any population boost from relaxing the one child policy won’t enter the labor force for 20 years.  By that time, the Chinese working age population will have been declining for nearly 25 years.  Assuming continued economic prosperity and China following the path economic development and declines to child bearing, the Chinese population will become very old with little real boost to the population.  Relaxing the one child policy today isn’t going to change the direction of the Chinese population Titanic headed for the old age iceberg.  Population is now counting against GDP growth due to its decline.  Unfortunately, Beijing decided to reverse this policy about 10 years too late.

Banks aren’t being invited to compete in China because the leadership realizes that competition is good but because Chinese banks are in such bad shape.  They are raising capital in Hong Kong as fast as they can file the paper work at enormous discounts.  This door is being opened because Beijing has a better idea of the enormous misallocation of resources and bad loans than the rest of us that we just don’t have the privilege of seeing yet.

I don’t want to downplay the importance of what has been announced but neither do I want to pop the champagne cork.  What has been announced is a good first step but let’s reserve judgment until we see some of this executed.  The best intentions of politicians don’t always see the intended results.

Early Returns from the Party Plenum

While the international press has been obsessed with the Communist Plenum wrapping up in Beijing, the Chinese government and by extension press a has been obsessed with American talk show host Jimmy Kimmel calling for him to apologize for a third time after a child on his show said the best way to solve America’s national debt problem was to “kill everyone in China.”  The plenum in China has hardly been publicized with major Chinese news portals omitting it all together.

What is so interesting about the international coverage is their focus on specific phrases.  One paper focused on the official communiqué giving greater role to the free market.  Chinese media however focused more on the wording giving primacy to public ownership of industry.  Only a few international outlets decided to focus on the repeated emphasis on “develop(ing) the public economy.”    The official communiqué was written to give everyone a little meat without actually saying anything at all.  If you changed the date at the top, the same communiqué could have been written for any plenum since 1979.

There are a couple of points worth noting specifically.  First, what is amazing isn’t that the communiqué was so bland, that was somewhat expected, but that Beijing had set the bar so high prior to the plenum and then released this.  It was only a couple of weeks ago that Beijing was promising “unprecedented” reforms.  This is not a good example of managing expectations.

Second, given the opaqueness of Beijing politics, the real detail can be expected in dribbles over the next few months.  In Chinese politics, it is frequently only after the fact what the policy actually was.  So far no official policy has been released, only vague generally platitudes that signify nothing.  Maybe the real reforms will come later, but as with the communiqué, don’t hold your breath.

Third, what I believe is most puzzling is the western idea, and even held by some in China, that the new leadership is interested in real economic reform.  It is a very common narrative to cast the new leadership and Xi Jinping as crusading reformers obstructed only by reluctant local governments, the military, or even Maoists.  While internal party politics undoubtedly factor in, there is no tangible evidence that the new leadership has anything in mind other the continuing current policies.  Bank continue to create credit a break neck pace even while setting less aside to cover bad loans.  Fixed asset investment is still growing at twice the rate of industrial production and more than 50% faster than consumer spending.  There is absolutely no tangible evidence that economic policies are pursuing anything other than the historic growth model.

If China bears can rightly be accused of always expecting an apocalypse, China bulls can rightly be accused of having faith in the complete lack of evidence.  There is no rebalancing.  The PBOC continues to keep banks afloat.  Economic reform for the first year has been non-existent.

The markets reaction has been predictable.  The Hang Seng dropped about 1% upon the communiqué has been flat pretty much the past two days.  Investors are not impressed.

Here’s hoping the next year produces more economic reform than the last one.  Though, I wouldn’t hold your breath.

The Real CPF Scam

I recently read Part I and Part II by Leong Sze Hian and Roy Ngerng on the Central Provident Fund of Singapore and commend them for their level of detail and analysis.  I would urge everyone to read and re-read their work to understand what is going on financially in Singapore.  Rather than revisiting or reanalyzing their work, I would like to emphasize a couple of points which I believe are of central importance to understand the financial management of Singapore.

First, the CPF acts as an implicit tax on Singaporeans forcing you into lower earning CPF investments.  Currently, CPF returns 2.5-4% beneath returns on other assets and beneath the rate of inflation incurring large losses on savers.  What makes this forced saving is that it is regressive in nature.  In other words, it penalizes the poor more than the wealthy.  This is simply immoral.  Ask yourself whether the wealthy in Singapore who make little if any forced CPF contributions would accept earning 2.5% on their investments?

Second, given that CPF contributions are invested with either GIC or Temasek, the government is essentially confiscating all returns above the CPF rate of return.  This is best noted in Chart 6 of Part II.  The implication here is that the Singaporean government is keeping an enormous amount of money using the retirement savings of its citizens.

Let me try and make this concrete and use a hypothetical scenario.  I am an investment manager and you have money for retirement savings you want to invest.  Like any informed consumer you ask me how much I will charge you to be the investment manager.  I reply, if you invest your money with me, I will keep most of the money you make and if I lose money, well you lose.  Would you invest your hard earned money with anyone who gave you that sales pitch?

If this one-sided deal sounds too absurd to believe then look no further than Temasek Holdings and GIC.  While there are valid unanswered questions about the returns of Temasek which have been written about in great detail, all Temasek money belongs to the citizens of Singapore not the government, executives, or other special parties.

Public surpluses and CPF capital saved by the citizens of Singapore is used to fund Temasek and GIC.  Yet, the government of Singapore only pays savers 2.5-4% despite claims of earning 7 and 17% respectively between GIC and Temasek.  That claimed 7%  earned by GIC in USD belongs to CPF savers and the people of Singapore.  The claimed 17% earned by Temasek in SGD belongs to the people of Singapore who provided the public surpluses and capital investment to build companies.

CPF contributions are borrowed to finance investment.  The CPF saver receives a guaranteed 2.5-4% while the borrowing party, GIC or Temasek receive all returns in excess of 2.5-4%.  The government via GIC and Temasek is confiscating returns that belong to CPF savers and taxpayers.

This is not an insignificant amount of money that the government of Singapore via CPF contributions is confiscating for its own use.  As I estimated here, an average Singaporean earning an average wage with CPF contributions and CPF interest would have approximately $537,000 at the end of their working career.  However, if we took those contributions and they earned GIC interest, they would now have $799,000.  If they earned the Temasek rate of return the average Singaporean would have $4 million SGD in the bank after a career of hard work.

That means that if the average Singaporean was not confined to earning below market returns in CPF savings, they would be $300,000-3,500,000 richer!  Put another way, the Singaporean government is keeping all money in excess of the 2.5-4% CPF return from your savings.  Put yet another way, this is an implicit wealth tax on the average Singaporean worker amounting to $7,500 annually or more than 10% of per capita GDP.

The most important point is this: CPF is your money and investment returns are the investment returns of hard working Singaporean savers.  The investment returns from CPF capital and public surpluses do not belong to the government, the PAP, Temasek, or GIC but to the Singaporean people.

CPF, GIC, and Temasek returns are not the governments money.  They belong to the savers and tax payers of Singapore who have made it a great country.  Remember: this is your money.

Note 1: Part of this post is from a previous post.

Note 2: Here is a spreadsheet that details the calculations made here.

Note 3: My apologies for not writing more pertaining to Singapore recently, I have been quite busy and pulled in numerous different directions

Note 4: I have a long awaited update to my original paper on Singapore and Temasek that I am working on and hope to release before the end of the year.