Is China heading for a crash?

Rapid economic development over 20 years led some commentators to claim China could deliver sustained global growth. But it has started to falter, and risks becoming a destabilising factor in the world. And the dramatic growth has created vast inequalities within this vast country.

China, for two decades the world’s fastest growing economy, has become a major force in the global economy. But as the ostensibly ‘communist’ regime in Beijing struggles to put the brakes on an economy which is experiencing an extreme form of overheating, euphoria among the capitalist class internationally has given way to nervousness. As Steven Roach, chief economist at investment bank Morgan Stanley, warns, "the world may be unprepared for the impact of a Chinese slowdown".

Last year, according to official statistics, China’s gross domestic product (GDP) grew by 9.1%. For years, independent economists have viewed official Chinese statistics with scepticism, believing them to be exaggerated. Today, many believe the figures understate reality – the economy may have grown by 11 or 12% in 2003. One reason for the discrepancy is that city and provincial governments are playing down local growth data in order to avoid penalties from Beijing aimed at reining in overheated sectors such as property, steel and cars.

Investment in new steel capacity rose by 87% last year and total output is set to double – again – in two to three years. The director of a stainless steel mill on the Yangtze river, owned jointly by South Korea’s Posco and China’s largest private steel company, Shangang, told the UK Financial Times: "Do you realise, that in a few years this complex alone will be making as much steel as the whole of France?"

The steel sector is an example of the uncontrolled expansion of capacity taking place throughout the economy, much of which is ‘blind’ or ‘duplicative’ according to the government. This is creating huge imbalances: chronic shortages of electricity, water and raw materials. Blackouts, often forcing factories to halt production, are commonplace even in the most developed cities.

Despite huge investment in recent years, road, rail and port capacity is overloaded. These shortages are being exploited by capitalists and corrupt officials for huge speculative gains. Shipping costs for freight in northeast Asia rose by 400% last year on the basis of surging Chinese orders, with scrap metal, coal and iron ore for the steel industry accounting for half this sea-borne traffic.

While mining and energy transnationals made bumper profits from the Chinese boom, other branches of the world economy have been squeezed by higher prices for raw materials. Just months after President Bush lifted his controversial tariffs on steel imports, there are calls from US industry for ‘export tariffs’ to stop all the steel leaving the country!

Another 20 years?

In December 2003, Martin Wolf in the UK Financial Times asked: "Can China continue to grow at anything close to current rates for another two decades, or even more? The answer", he added, "is a resounding Yes". This echoes the prevailing view of the Chinese regime. Recently, however, media comment on China has struck a more cautious tone.

Signs of overheating are unmistakable: an explosion of credit; rampant overcapacity (nine tenths of manufacturing goods are in oversupply); and the return of inflation (2.8% in the first quarter of 2004). President Hu Jintao, and his prime minister, Wen Jiabao, have assured financial markets that ‘resolute’ measures are being taken to rein in excessive investment and engineer a ‘soft landing’ for the economy but, so far, with no discernible impact.

"China is in a situation of severe over-investment", noted Credit Suisse First Boston’s Hong Kong office. What’s more, this investment is chasing diminishing returns. According to The Economist, China currently needs $4 of investment to generate each additional dollar of annual output, compared with $2-3 in the 1980s and 1990s.

Ominously, China displays many features of Asia’s ‘tiger economies’ in the period leading up to their spectacular crash in the summer and autumn of 1997. Last year, fixed asset investment accounted for an unprecedented 47% of China’s GDP, with the construction sector accounting for half this figure. By comparison, in 1992-96 fixed asset investment in South Korea, Thailand and Indonesia averaged 40% of GDP, still extremely high by international standards. In the same period, Indonesia, Malaysia, Thailand and the Philippines experienced money and credit growth rates of 25-30% a year. China’s money supply grew by 20% last year, and bank credit (new loans) by 56%.

The main problem in the case of the ‘tigers’ was that their exports became uncompetitive on world markets just as this new industrial capacity came on-line. The sharp rise of the US dollar in 1995, to which most Asian currencies were linked, priced them out of world markets.

China, although it exports 25% of national output, is less dependent on the world market. The super-Keynesian measures of the government – implemented in response to the Asian crisis – to boost demand by slashing interest rates six times since 1997, and by financing huge infrastructure projects, have increased the specific weight of the home market. But this market is chronically oversupplied.

Workshop of the world

China is now the world leader in many branches of manufacturing, including cellular phones, colour TVs and computer monitors. Since the start of its global export offensive 20 years ago, manufacturing industry in China has shifted from low-tech sectors like textiles, toys and simple manufactures to computers and electronics which now account for 60% of exports. Reflecting the increased role of high-tech production, China accounted for 14% of global semiconductor consumption in 2003. Also, perhaps more surprisingly, 16 million manufacturing jobs have actually disappeared since 1995, as Chinese industry has upgraded its technology. Shanghai Baosteel Group, for example, the world’s sixth largest steel producer, cut its workforce to 100,000 from 176,000 five years ago.

As industry in the southern and eastern provinces has become more capital intensive, low-tech production has shifted to the poorer (and cheaper) inland provinces. This right now is where there is greatest resistance to government attempts to curb new investment.

China still lags behind the advanced capitalist countries in the application of new technology, but the gap is closing. A million engineering graduates leave Chinese universities every year and there is an ongoing transfer of technology from the huge network of foreign partnerships and joint ventures. A survey by the Japanese newspaper, Nihon Keizai Shimbun, based on interviews with 350 Japanese corporations, concluded that, "in the field of technical development China would catch up with Germany and Japan within ten years".

China’s integration into the capitalist world economy means that huge swathes of US and European industry are now dependent on components or finished products from Chinese factories. "In a crisis", warned Ted Dean, managing director of consultancy firm, BDA, "Chinese labour could become as destabilising a force for the world economy as oil prices".

Profits squeezed

These indisputable facts are often cited by capitalist commentators to present a picture of unstoppable economic progress: a 20-year Chinese boom. This ignores the laws of capitalist economy which, as its Stalinist centrally planned economy is dismantled, play an increasingly dominant role in determining the rhythm of the Chinese economy.

The telecom industry is an illustration of this. With 282 million mobile phone subscribers, China is the world’s biggest market. But growth rates are already slowing, with fewer new subscribers in the first months of 2004. Overproduction – too many phones chasing too few buyers – has caused prices to plummet, which in turn squeezes profit margins. The Economist survey on China (20 March 2004) pointed out: "China has 40 mobile phone makers selling over 800 models. Annual demand should rise from 80m units to 100m in the next two years, but supply will double to 200m".

This survey reported from one phone-maker, Bird, based in Zhejiang province: "Bird’s modern factory is full of industrious workers and high-tech machines, but Dai Maoyu, Bird’s executive vice-president, looks tired. The former economics professor says he is making phones he cannot sell, that a price war is destroying everyone’s margins and that Bird wants to diversify into cars".

As this report makes clear, ‘modern factories’ and ‘high-tech machines’ do not in themselves mean profits. And what happens when companies like Bird, faced with falling returns, "diversify into cars" or other product lines? This only aggravates conditions in these sectors which, in general, already suffer from overcapacity.

The re-emergence of inflation (rising prices) in China is mainly due to the rising cost of capital goods, some farm products and services such as education. A more serious problem, however, is the longer-term potential for deflation (falling prices) arising from such extreme levels of overcapacity. Deflation not only squeezes profits, it magnifies the problem of debt, making repayments costlier in relative terms. This is a potential time-bomb for the Chinese economy which has financed its investment boom with unprecedented levels of credit. Nor is this a purely Chinese problem: if the country’s pool of unsold goods is re-routed onto world markets the result will be a massive injection of deflation into the world economy.

For years, Chinese labour has been a source of super-profits for global corporations and local capitalists. Manufacturing wages averaged just 61 US cents (€0.52, £0.34) an hour last year, compared with $16 in the US and $2 in Mexico. One hundred thousand Chinese workers die every year from industrial accidents or work-related illnesses.

Low wage levels impose severe limits on the growth of a mass consumer market. Obviously, Chinese workers can only afford to buy back a fraction of what they produce. The car market, for example, despite sales of 1.8 million units in 2003, is still fundamentally a luxury market. One third of the cars sold last year cost over $25,000 – 24 times annual urban income levels – and 70% of these were paid for in cash!

While average per capita incomes have risen rapidly in the last 20 years, the gap between rich and poor is now the biggest in the world. This has been a largely urban boom, with average incomes in the cities six times those of rural ones. Shanghai, with 16 million inhabitants, has the same per capita GDP as Portugal. But the poorest region, Guizhou, has a per capita GDP lower than Bangladesh.

Although incomes for China’s 800 million rural population are now rising due to a rise in prices for farm goods, the Financial Times pointed out that, "a consumer society has largely failed to materialise among two thirds of China’s population". Less than half of rural households have televisions and less than 20% have fridges.

Even in the cities, predictions of hundreds of millions of wealthy consumers are wild exaggeration. The pressure of migration from the countryside – with up to 400 million set to move to the cities by 2020 – will tend to hold down wage levels.

Beijing consensus

The Chinese economy is a peculiar mix of the remnants of a Stalinist planned economy – the dictatorial rule of the Communist Party – alongside what James Kynge of the UK Financial Times called, "a ferociously competitive brand of raw capitalism". The nearest comparison is the state-led capitalism prevalent in other East Asian countries like South Korea and Taiwan. High levels of state investment, in China’s case around four fifths of total investment, have stimulated industrial development in a way which is unthinkable in the advanced capitalist economies under current neo-liberal policies. This year, China is adding the equivalent of Britain’s entire electricity generating capacity to its generating plant, and plans a similar expansion in 2005. A new $15 billion natural gas pipeline from Xinjiang province to Shanghai is bringing cleaner fuel to the coastal areas while being uneconomical from a strictly ‘market’ standpoint. Eighty-six new subway lines are under construction.

These policies, rather than aiming to improve living conditions for the masses, aim to create a more effective framework for the exploitation of Chinese labour. In the absence of democratic control of these projects by workers’ organisations (non-existent in China), waste, corruption and abuses such as environmental degradation and the forcible relocation of local communities are legion.

These policies have won admirers within the capitalist class internationally, most notably Joseph Stiglitz, the World Bank‘s former chief economist. The term ‘Beijing consensus’ has been coined to signify an economic model opposed to the IMF’s neo-liberal ‘Washington consensus’. But while this growth has been spectacular, the crisis of 1997 showed that Asian economies have not invented a new, teflon-coated capitalism, immune to recessions and crises.

According to prime minister Wen, the Chinese economy has reached a ‘critical juncture’. Despite a raft of government measures since the end of 2003, there are few signs yet of any cooling off. Beijing’s dilemma is that it does not want to be too successful and precipitate a sharp decline or slump, which is a real danger in the current situation.

The retreat from central planning and the growth of market forces have limited the scope for government intervention. Government efforts so far have concentrated on curbing credit growth – total loans are equivalent to 145% of GDP – and property speculation. Twenty-six thousand square kilometres of farmland – an area the size of Albania – have been turned over to building developers in the last five years, one of the factors behind falling grain harvests and rising prices.

In April, the central bank raised the minimum level of deposits that banks must keep in reserve from 7% to 7.5%. Smaller banks were ordered to halt all lending temporarily. This has been backed up by police measures: a crackdown on ‘illegal’ sales of farmland, and beefed-up environmental and other controls at new factories and construction sites.

But these measures are being thwarted by alliances of capitalists and corrupt local officials who want to shield their own areas from cutbacks. China’s banks, despite being state-owned, are described as ‘multi-storey’ in that regional and local offices enjoy a wide degree of autonomy. The Economist commented: "Branch managers often have closer ties to local officials and businessmen than to their own bosses, which breeds corruption".

This goes a long way to explain why investment in property continued to grow at the explosive rate of 41% in the first quarter of this year, according to the national bureau of statistics. Housing construction in China is overwhelmingly pitched towards the luxury market and, again, overcapacity in the form of vacant properties is rife. Still, property prices rose by 25% last year and are approaching US levels in cities like Shanghai and Beijing. This points to the danger of a crash in land prices which, in turn, could trigger a banking collapse. China has "the weakest banking system of any large economy", in the words of the UK Financial Times. Bailing out the banks could cost as much as $500 billion or 30% of GDP.

Currency peg

It looks as if the government will soon be forced to bite the bullet either by raising interest rates, for the first time since 1995, or abandoning the renminbi’s peg to the US dollar. That both options have been under discussion for some time indicates how reluctant the government is to move on either front. Higher interest rates would be the most effective way to regain some control over credit levels and investment, but the results may be too dramatic. By encouraging people to save, and making consumer loans more expensive, this could undermine consumption at a time when the opposite is sorely needed. A rise in interest rates will also aggravate the banks’ problems with ‘non-performing loans’ which, according to official estimates, are equivalent to 20% of GDP. Some economists believe the figure is closer to 40%.

Yet another problem is the huge sums of so called ‘hot money’ – around $12 billion a month – which is pouring into China as foreign banks and hedge funds bet on an imminent rise in the renminbi (yuan). Higher interest rates could trigger even bigger speculative inflows which, as the experience of the ‘tigers’ showed, are highly destabilising.

Revaluation of the renminbi is not a painless option, either. On the plus side, it would ease inflationary pressures, cheapen imports of raw materials, and perhaps postpone the need for a rise in interest rates by putting the brakes on some forms of investment. It would also help to cool trade tensions with the US, China’s biggest export market.

But the risks are considerable, not least because the central bank may not be able to control the currency’s rise once the present dollar peg is abolished. Exports would suffer, as would foreign direct investment, but the financial system, too, could be placed under new pressures from speculative assaults on the renminbi. The global effects would be considerable, especially if China was forced to begin selling its massive foreign exchange reserves, worth $440 billion in May 2004, which have helped finance the twin deficits (Federal budget and balance of payments) of the Bush administration in the US.

More than anything, the regime fears ‘political instability’, and a movement of the working class. Literally every day there are labour protests somewhere in China, though mostly, at this stage, among unemployed workers, laid-off from the state sector. These movements have so far been isolated, local outbursts, which have been defused by a combination of concessions and repression from the authorities. The most famous protest in recent years led, briefly, to the formation of an independent trade union among workers in Daqing and Lioaning, north-eastern China. Two of the leaders of this movement, Yao Fuxin and Xiao Yunliang, are now serving long prison sentences.

Given the now pivotal role it plays in the global economy, it is clear that any re-run of the Asian crisis in China, would have major international implications. Even a soft landing, resulting not in a slump but in a more ‘normal’ rate of growth (say, 4-5%), would be a body blow for Asian and world capitalism, not to mention China’s ‘stability’. The Economist survey concluded that a slowdown "carries with it the risk of massive job losses and social upheaval, recalling the days of the Tiananmen protests in 1989". This is the spectre which haunts the Chinese regime and its friends and supporters in global big business.

China & the world economy

Although it accounted for just 4% of world GDP last year, making it the sixth largest economy in dollar terms, China’s role as the number one market for capital goods (minerals, fuel, building materials and machinery) made it the main locomotive of global growth. World GDP grew by 3.2% in 2003, with China contributing a third of this growth, or 1.1%, while US capitalism accounted for just 0.7%.

China’s role within Asia, the only region of world capitalism experiencing strong growth, is now crucial. In 2003, it accounted for 70% of Japan’s total export growth, and 40% of South Korea’s (Asia’s first and fourth largest economies respectively). By surfing the Chinese wave, Japanese capitalism recorded its highest ever level of exports in the first quarter of 2004. This export boom is the main factor behind the current upturn in Japan’s crisis-torn economy, which has seen GDP growth exceed 5% (annualised) for the last two quarters.

Last year, China became the world’s third largest importer after the US and Germany. For the first time since 1993, it is heading for a trade deficit in 2004 (with imports exceeding exports on an annual basis). The surge in Chinese demand in 2003 drove world prices for industrial raw materials up by 73%. China consumed half the world’s concrete output, a quarter of its steel and one third of its iron ore. China is the world’s biggest steel producer, accounting for one fifth of global output in 2003 (220 million tonnes) – as much as the US and Japan combined.

In 2003, China also became the world’s third largest market for motor vehicles with sales growing 60%. But here too, capacity growth is outstripping demand. Driven by herd mentality (a fear of being left behind), transnationals like GM, Volkswagen, Toyota and Honda have stormed into the Chinese market, announcing more than $20 billion of new investment in 2003. By 2007, capacity is forecast to reach 15 million vehicles, against sales of 7 million. In this case, China’s pool of unsold cars would be greater than the entire Japanese market (6 million cars per year).

Already prices are falling. While steel prices rose 35% in the twelve months to February 2004, car prices fell 5.1%. Fierce competition between car-makers makes it impossible to pass on rising costs to consumers, so profit margins are falling.

Its share of world cotton consumption rose from 25% in 1999 to 32% last year, reflecting the predominant role of its textile industry. It consumed one third more refined copper (20% of the global total) than the US, reflecting the explosive growth of telecoms. A similar picture emerges in category after category.

My advice to be a millionaire

Understanding and Controlling Your Finances

Incentives

by Marshall Brain

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One of the very hardest things about "controlling your finances" is getting started down the path. During high school and college, and even after college for most people, finances are mysterious and maddening. There is never enough money.

One way to start down the path of control is to give yourself some sort of incentive to do so. If you feel that you are getting something from controlling your finances, then it is much more likely that you will do it. Different incentives work for different people. Let us try two approaches that might incent you to at least look into the prospect of starting to control things better.

Approach 1: Becoming a Millionaire

Many people find it hard to believe, but becoming a millionaire is fairly easy. Becoming a millionaire overnight is more difficult, but doing it over time is a reachable goal for every American citizen who is 25 years old.

Here is how you can become a millionaire. Start at age 25 and simply deposit $20 every week in an account that earns 12% interest. $20 is not a lot of money. If you smoke, it is the amount of money you are probably spending on cigarettes each week. If you go out to eat for lunch every day, it is less than what you are probably spending on your lunches. It is less than $3.00 a day. Every American - even homeless Americans begging at a New York subway stop - can put together $3.00 each day.

If you added that much money to an interest bearing account earning 12% every week, and you did that starting at age 25, then by age 65 you would have a million dollars. If you started at age 20 instead of 25 you would have a whole lot more.

Here is another way to think about it. Imagine your first child. Imagine that your first child is to be born tomorrow. If, on that day, you opened an account earning 12% and deposited just $20 per week in that account, then at age 20 you would be able to write your child a check for about $80,000. Hard to believe but true. Small amounts of money, accumulated consistently and earning interest over a long period of time, really add up.

You probably have three questions:

• What, are you kidding? That is all I have to do?
• Why didn't anyone tell me?
• Why didn't my parents do this for me when I was born? I sure could use $80,000!

One other question you need to ask is, "Where can I find an account that pays 12% interest?" We will discuss this question later in this series.

The point is, with just a little discipline over time you can accumulate huge amounts of money. That is what "control" is all about. You will learn a lot more about accumulating wealth in the other articles in this series.

Understanding and Controlling Your Finances

Monthly Cash Flow Calculator

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A cash flow analysis shows your income and expenses and determines whether you are "living within your means" or having to borrow money each month. The calculator below will help you to categorize your monthly income and expenses expenses and will show you whether or not you are spending more than you make.

After tracking your expenditures over the course of 30 days you can categorize the money you spend and create a cash flow analysis. Even if you don't feel like tracking every cent you spend for a month, you will find that the calculator below has a large number of categories that help you to guesstimate your monthly expenses fairly accurately. It will be useful to collect together your check book and a stack of monthly bills before starting in with this calculator, as they will contain the data you need to fill in all of the different fields.

You will want to use the Hidden Expense Calculator first because the monthly number it generates is needed in this calculator.

Income
Regular Income - Enter you normal monthly income here. If you are married add your income and your spouses.
Other Income - Enter any extra monthly income you might make from a night job, royalties, etc.
Expenses
Rent or Mortgage - Enter your monthly rent or mortgage bill here.
Car Payment - If you have a car loan(s), enter the total monthly payment(s) here.
College loans - If you are making payments on a college loan, enter the payment here.
Other loans - If you make monthly payments on other loans for furniture, boats, appliances, etc., enter the total monthly payments here.
Insurance - If you make monthly payments on any type of insurance, enter the amount here (do not enter insurance policies that you pay yearly or every six months, as they will be on the hidden expense calculator).
Groceries - Enter the amount you spend per month on food at the grocery
Eating Out - Enter the amount you spend per month on food at restaurants, vending machines, etc.
Gasoline - Enter the amount you spend per month on gasoline
Electricity - Enter your average monthly electric bill here.
Gas - Enter your average monthly natural gas bill here.
Water/Sewer - Enter your average monthly water bill here
Telephone - Enter the amount you spend on local and long distance phone service per month
Clothing - Enter the amount you spend on clothing per month
Habits - If you smoke, play the lottery, etc. on a regular basis, enter your average monthly expenses here.
Cable TV - If you have cable enter your monthly bill here.
Cellular phone or beeper - If you have a cell phone or beeper and pay a monthly bill on it, enter the bill here.
Entertainment - Enter you average monthly expenditure on entertainment: movies, videos, nightclubs, shows, music (CDs and tapes, concerts, etc.), Internet, video games, etc.
Medical - If you spend money monthly for medicine, treatment or medical insurance, enter the amount here.
Other - Enter here anything else you can think of that you typically pay on a monthly basis.
Hidden Expenses - Use the Hidden Expense Calculator to calculate your total hidden expenses, and enter the monthly number from that calculator here.
Click this button to calculate the total.
Total Income - This is your total income per month
Total Expenses - This is the total amount of money you spend per month on expenses.
Loss or gain - This number is total income minus total expenses, and indicates your loss or gain each month. A positive number indicates that you make more than you spend and therefore are able to save money each month. A negative number indicates that you spend more than you make and are therefore borrowing money each month.

If you find from this analysis that you spend more than you make, then it may be time to look at your lifestyle and make some corrections.

Approach 2: Getting Something You Really Want

Let's say that the thought of a million dollars in 40 years doesn't do anything for you. You want something now. Here is another way to think about your finances.

Television is a funny thing. The technology behind it is simple and seemingly harmless: television transmits moving pictures to your home. What could be the problem with that? The weird thing about television is that if the proper images are transmitted to your home, they can change the way you think. In particular, they can increase your desires. Take, for example, the Salad Shooter. Would it have ever sold without the mind-bending influence of TV? No. At the same time television tends to encourage you to satisfy all of your desires immediately. That is why, two weeks after you have purchased a brand new car, commercials can make you believe that you need another one.

Let's try to imagine an alternate and parallel universe without television. In this universe, a person who wants something stops and says, "in order for me to have that something, I need to save up enough money to buy it first. Then I will go purchase it." Would this work? No it would not in some cases. For example, is it worthwhile to wait 30 years until you save up enough money to buy a house, and then go buy one? No. See the section on buying a house for a discussion of this particular purchase. Is it worthwhile to save money for five years before you buy a car? Not necessarily, mainly because you have to have a car to survive in most American environments.

But let's say that on all other desires in your life you were to follow a "save first, buy later" rule. What would happen? Two things: first, you would notice that your desires might suddenly change dramatically. Second, you would have to find a way to accumulate money over time and hold it so you could realize your desires.

It is this simple but fundamental change of thinking - the "save first, buy later" rule - that can lead to the concepts of "controlling your finances" and "accumulating wealth". If you can make that change, it will cause you to modify your thinking so much that in a short period of time things like stocks, bonds, CDs and all the rest suddenly become interesting and relevant.

You may find yourself thinking one of three things right now:

• "There is no way I want to live my life that way. It is too constricting."
• "There is no way I can organize my life enough to live that way. Things are too chaotic."
• "There is no way my life will ever be organized that way. I'm too far in debt now to ever get out of it."

If you find yourself thinking one of those things, let me ask you simply to put the idea on hold for a few minutes. Suspend your disbelief long enough for a new concept to enter your mind.

In order to organize your life in this "save first, buy later" way, you have to determine your financial priorities. This can be hard, and to do it right it helps to have some experience with other financial concepts. Therefore, a later article will help you to see how to do it right. In this article let's ignore doing it right and simply try out the concept to gain some experience with the process.

To determine your financial priorities, the first thing you have to do is think of the things you would like to have in the future, and then organize them. Therefore, I would like you to try taking 15 minutes to come up with a list of "things you would like to have one day." Simply take out a sheet of paper and list as many of your desires as you can think of. It may take a few minutes to get started; if you find yourself staring at a blank sheet of paper here are some thoughts to help you get started:

• Do you want or need a new car?
• A new house?
• New furniture?
• An encyclopedia?
• A computer?
• A new spring wardrobe?
• A comfortable retirement?
• A new riding lawn mower?
• A deck or swimming pool?
• A college degree for your kids?
• A trip to Paris?
• An engagement ring for your girl friend?
• No more payments on your credit card?

Just start imagining all the things you would love to have one day, and write as many of them as you can think of down on the sheet of paper. For most folks, if you think about all of the things you want to have both short- and long-term, you end up with a pretty long list. If you have a spouse create the list together. Come back in about 15 minutes.

Now you have a list. Take another five minutes and write down prices next to everything. If you don't know the exact number, write down an approximate number. If you don't know an approximate number, just guess and then double that number.

Now take your list and find the one thing on that list that you REALLY want. The thing that would make you happiest or solve the most problems or bring the most joy to you or a friend. On that list there is one thing that brings the biggest smile to your face when you think about it. Put a big star next to it and focus your attention on it.

Now here is an important fact: You can have that thing. It will take some work but you can have it, and you will have it if you can gain control of your finances.

Let's go back to Bob from the previous article. He made his list. He put prices next to everything. Then he took about half an hour to think about everything on the list and discovered the one thing that he really wants, more than anything, is a pilot's license. Bob wants to learn how to fly. He can't exactly explain why. He just wants to get his license and he has wanted it since age 13. He called a local airport, and it costs about $4,000 for a person to get a private pilot's license. So what Bob needs is $4,000. And his question is this: "This is great. Now I know exactly what I want, and I can taste it I want it so bad. But where in the world am I going to get $4,000???"

You may find yourself thinking exactly the same sort of thing. In the next article we will discuss this problem and how to solve it.

Airport privatisation in india

India giving risk to economy by booming the keys privatisation of airports

china is lifting asian economy but apart for this he got mind of strategy to get in western hemisphere

A growing Chinese presence in Latin America is causing a stir across the hemisphere. Top Chinese officials visit the area frequently. In the last five years, overall trade between China and Latin America has increased 900 percent. In 2004, nearly half of China’s direct investment overseas, almost $20 billion, went to Latin America. Guided tours in places like Machu Picchu are now also offered in Chinese. Former U.S. ambassador in Bolivia Manuel Rocha recently remarked, “Your children may have to start learning Mandarin … if you wish to see them involved in business in the Americas.”

The response across the hemisphere has been mixed. Some countries view China’s presence as a threat, others see it as a panacea, and a third group of countries believe Beijing is their ideological ally. All three groups are wrong.

The United States, Mexico, and the Central American republics are among the countries that feel threatened by China’s presence in Latin America. Brazil’s early enthusiasm has also cooled down. Judging by the recent hearings in the Senate on China’s increasing involvement in the Western Hemisphere, the U. S. thinks China is challenging its geopolitical standing in the area. Mexico and Central America fear that China will displace them from apparel markets. Brazil thinks China is unfairly undercutting its exports of car engines.

Argentina, Peru, and to some extent Chile are among the countries that think China’s presence in the region will be their panacea. They see China as an insatiable buyer of commodities and therefore a guarantee of their economic development. Brazil—a seller of soybeans to China—likes that part too.

Then, there are the ideologues. Cuba sees China, a country that has invested $500 million in a nickel plant in the island, as the friend who will help the Communist Party perpetuate its monopoly on power after Castro. Hugo Chávez also believes China will invest astronomical amounts of money in Venezuela for political reasons.

Are U.S. fears that China wants to be a hegemonic power in Latin America justified? No, China is essentially seizing economic opportunities under a strategy that seeks to maintain current levels of growth. That strategy also explains why China spent $10 billion looking for oil in Africa last year. Although Beijing has a few political goals—such as luring the twelve Latin American countries that support Taiwan towards the “one China” policy, Chinese presence in the region is economically motivated.

Is China a danger to the Central American and Andean economies? Although Chinese textiles are competing with Latin American textiles, most Latin American economies are protected against these Chinese imports (Mexican trade barriers have probably cost China some $20 billion in the last fifteen years). All of this imposes costs on the citizens of the “protected” nations and props up privileges in those societies. Chinese competition can eventually help Latin Americans get rid of parasitical producers and their political allies.

Is China’s thirst for Latin American commodities a guarantee of prosperity, as countries like Argentina and Peru believe? No. Latin America has been selling raw materials and commodities to many countries, including Britain and the U.S., for the past two centuries. The result is always the same. In times of high prices, growth figures look good and everyone thinks prosperity will soon arrive without realizing that prosperity requires a system conducive to systematic wealth creation. In times of low prices, everyone blames the “unjust terms of trade” for the region’s backwardness.

When Hu Jintao toured Latin America at the end of 2004, he discussed investing $100 billion in the region’s infrastructure. Latin Americans celebrated the fact that China’s supposed displacement of the U.S. in the area would produce roads, ports and oil rigs across the region. In fact, China was trying to obtain official recognition as a “market economy” from countries like Brazil and Argentina in order to protect itself against anti-dumping measures at the World Trade Organization. While Beijing does have an interest in improving the region’s appalling infrastructure to insure a steady supply of raw materials, China will only invest in countries where it can actually make a profit. Because Latin America is still a place where investors expect smaller returns and greater insecurity than in other places, the $100 billion have not even started to materialize.

Finally, is China’s bureaucracy an ideological ally of Fidel Castro and Hugo Chávez, as both men think? For China, Castro is a temporary embarrassment, while Chávez is the President of a country that happens to be the world’s fifth largest oil producer. Since U.S. investors cannot, for the moment, invest in the island, the Chinese are filling the space. Hu Jintao would have done business with whoever replaced Chávez in Venezuela, if the coup attempt there in 2002 had been successful. Ironically, the country that China trusts the most is Chile—Latin America’s number one capitalist country, which is why Beijing and Santiago have been busy negotiating a free trade agreement.

The last thing the Western Hemisphere needs is to adopt the Chinese model of political dictatorship and relative economic freedom or to see Beijing as some form of ideological ally. But moving decisively toward the free flow of ideas, goods, services, capital and people across the Pacific is something that will benefit everyone—the U.S., Latin America and China itself—immensely.

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Alvaro Vargas Llosahe business landscape in nearly all Asian countries and regions looks pretty rosy, and global fund mangers say a booming China has played a central and largely benign role.

China is definitely the locomotive uplifting all its neighboring economies, which also have helped the former by injecting huge investments, analysts said.

Currently, stocks in Asia have been sprinting ahead. Markets in Singapore, South Korea and India have approached or surpassed previous highs, and others, like those of Hong Kong and Indonesia, are at their best levels since the economic crisis of the late 1990's.

The rallies have produced big gains for global mutual funds specializing in Asian stocks. The average fund that invests in Asia, excluding Japan, was up 30.4 percent in the 12 months through September.

Managers of Asia funds have no trouble explaining the strong performance, but some question its staying power and are downshifting to stocks in industries less susceptible to economic swings. Some global fund managers also express reservations about Asia, although others embrace the region and expect continued strength.

Yet everyone seems to agree on one idea: that China has had a central and largely benign role. From a distance, China might look able to muscle aside the industries of smaller Asian countries and to squeeze their markets, given its cheap labor and huge manufacturing capacity. But analysts say the formerly know Four Asian Tigers, South Korea, Singapore, Taiwan and Hong Kong, have instead grabbed their big neighbor by the tail. They have invested huge sums in Chinese mainland factories, and so have made growing profits.

"As China has grown, it has brought up the rest of the region with it," said Edmund Harriss, manager of the Guinness Atkinson Asia Focus fund, in an interview by The New York Times.

Mark Headley, president of Matthews International Capital Management, a firm specializing in Asia, said the rest of the region had also brought up China, by furnishing money and expertise.

"It's the Taiwanese that built most of the mainland's manufacturing, and now the Koreans are there in a big way," he said. "The companies that really grasped the opportunities 10 years ago are reaping the benefits."

So are Chinese workers, whose standard of living has soared. That has benefited companies throughout Asia, which have a big, new consumer market to pursue.
"Because Chinese GDP is growing at 8 to 10 percent, it provides a huge source of incremental demand for other Asian countries selling to domestic Chinese consumers," said Ben Walker, a manager of international equity funds at Gartmore Investment Management.

The low cost of Chinese-made products also helps the region, Mr. Walker said. "Increasing supply from China is keeping inflation lower in Asian economies," he said.

Outline some of the problems the economy might face in recovering from a period of recession

To recover from a recession there needs to be, either a rise in AD, or a readjustment in prices and wages.

Classical economists argue that a recession will only be temporary, because labour and product markets are flexible. However, Keynesians argue that wage and price rigidity can keep the economy below full capacity for a long time.

For example, to regain equilibrium it may be necessary to reduce prices and therefore reduce nominal wages by an equivalent amount. However, this may be difficult because trades unions will resist cuts in nominal wages, also firms would be unwilling to cut wages because it may lead to lower productivity amongst workers.

1. Low Consumer confidence.

In a recession there will be rising unemployment and, therefore, a fall in consumer confidence. This will cause a rise in the savings ratio. In other words people will spend less of their disposable income and save more, leading to a bigger fall in AD. If confidence remains very low, for a long time, then it will be difficult for the govt to increase AD. For example, if the govt cut income taxes this would increase disposable income, but if confidence was low people would not be willing to spend any extra and the economy would remain in a recession.

2. Ineffectiveness of Monetary Policy.

In a recession the Bank of England could cut interest rates to stimulate demand. Lower interest rates reduce the cost of borrowing, and therefore people should be more willing to spend and invest. However, Monetary policy could be ineffective. Firstly, firms may be reluctant to invest, even though it is cheap to borrow, because they cannot see any increase in demand. If a country is a member of the EURO then it may be particularly difficult to increase AD in a recession. This is because interest rates will be set by the ECB and the country will have no control over interest rates. If the UK is in a recession and other countries in the Euro zone are growing too fast -interest rates may be too high

3. Effectiveness of Fiscal Policy.

Keynesians argue that expansionary fiscal policy can be used to increase AD and get the economy out of a recession. However, there may be many problems of using fiscal policy to increase AD.

Firstly there will be time lags. It takes time for the govt to change its spending plans and once implemented it will take time for this spending plan to actually increase AD

Also increasing AD may cause crowding out. This means that if the govt increases its spending then it will lead to a corresponding fall in private sector spending. This is because the govt borrows from the private sector to finance its spending. However, Keynesians reject this argument, they argue that the govt will only be using previously unemployed resources therefore there will be no crowding out.

4. Deflation.

If there is deflation this makes it difficult to increase demand. This is because people will not spend if they feel that prices will be cheaper in the future. Also monetary policy will become ineffective because interest rates cannot fall below 0%, therefore, with deflation real interest rates may remain high. E.g. Japan has experienced deflation during the 1990s and this made it very difficult to increase AD and economic growth.

5. Hysteresis.

This states that what has happened in the past will affect the future. For example if unemployment is high then it is likely to continue being high. If people are unemployed for a long time they become de-motivated and less employable, because they are now less skilled (less on the job training). Also, if productive capacity is not used for a long time then firms will shut factories down completely, causing a fall in AS. Therefore, in a prolonged recession there will be not just a fall in AD, there will also be a fall in AS, causing a permanent fall in the potential output of an economy. This occurred during the Great depression of the 1930s.

6. Supply side shocks.

If there were a fall in AS, as well as AD, this would make the recession more severe. For example, if there was a rapid rise in the oil price like in the 1970s then AS would shift to the left causing lower growth and higher inflation.

What a outlook matters in one's eye on his own economy

Booming and Bubbling India-II

India vs. China: The eight Indian companies are part of S&P’s list of 300 mid-size companies across 37 countries in the latest S&P Global Challengers List. India ranks seventh in terms of the companies per country that figure in the list. In contrast, China has four companies on the list.

An innovative nation: In a new study, India has emerged as the second best place for business innovation after the US. In a survey of 485 senior executives worldwide carried out by Hong Kong-based Economist Intelligence Unit, Japan has emerged as the world’s most innovative nation in terms of business practices, followed by Switzerland, US and Sweden. India has been ranked at 58th position, ahead of China’s 59th position in a ranking of 82 economies, based on their level of innovation during 2002-06. But the report also concludes that India will give away its lead over China as an innovative country in the next five years.

IT excels: IT services major Wipro Technologies said it has bagged the ‘SAP Pinnacle Award’ in the area of Software Solutions Leadership.

Industrial Manufacturing CorridorAccording to India and Japan, the DMIC (Delhi Mumbai Industrial Corridor) project-to be launched in 2008 and completed by 2015-would entail an investment of $45-50 billion.

Corporate India helps rural poverty alleviation: HLL will aim to reach 600 million consumers in five-lakh villages through one-lakh entrepreneurs by 2010.

India matters for Airbus and Boeing: Rapidly expanding Indian carriers have ordered close to $40 billion worth of big jets over the past two years. So far, Airbus, has bagged 295 orders from Indian customers since January 2005, vs. 138 for Boeing. The value of Boeing’s order book is close to $20 billion at list prices, while it is roughly $22 billion for Airbus.

Chindia ahead of other BRIC members: According to a survey of 350 international, mainly expatriate investors, mostly belonging to the US, UK and continental Europe by Luxembourg-based broker Internaxx, Chindia make a more compelling proposition than the first half of the BRICs acronym. The survey found that 42 per cent of international investors felt positive about China and 32 per cent about India, while only five and six per cent respectively felt positive about Brazil and Russia.

White Revolution continues: Indian dairy industry will reach Rs5.20 lakh crore by 2011. “Out of the anticipated output of 120 million tonnes, the share of liquid milk will be 97.5 million tonnes, while the remaining 22.5 million tonnes will get converted into milk products.”

Manufacturing Sector Moving in top gear: India’s manufacturing sector registered the highest growth in over a decade at 14.1 per cent in March 2007, up from 10.1 per cent in the same month of the previous year, the commerce and industry ministry said Tuesday. The growth rate of the sector has doubled since 2002-03 from six per cent to 12.3 per cent in 2006-07.

Sky-High Ambitions of Indian Outsourcers: Tata Consultancy Services (TCS) has worked on projects for GE Aviation involving digitally testing the configuration of jet designs and is currently designing the business class portion of a plane for an undisclosed aviation customer. Tata Technologies hopes to leverage the expertise of its parent company to reduce the cost and weight of airline components for international customers. Infosys has designed part of the Airbus A380 super jumbo jet, which is now undergoing test flights. Last year it set up an engineering center to team with Spirit Aerosystems (SPR), a major supplier of structures including fuselage, nose sections, and floor beams.

India’s Global raid continues: Billionaire Vijay Mallya’s distillery group agreed to buy Scottish liquor maker Whyte & Mackay for 595 million pounds ($1.18 billion, Rs4, 700 crore), extending a record year for international takeovers by Indian companies. Mallya formed United Spirits by combining McDowell & Co, Shaw Wallace & Co, Herbertsons and other liquor makers of the group. The company, with 145 brands and 69 factories, became the world’s third largest spirits company after Diageo and Pernod Ricard. Today’s acquisition of Whyte & Mackay promises to enhance Mallaya’s position in the Forbes’ list of billionaires, which placed him 746th in 2006.

Mumbai’s famed diamond district of opera house becoming a global diamond-trading hub: Indians are becoming integrated global players, involved in the entire supply chain right from sourcing of the gems to retailing finished jewellery. The recent spate of acquisitions by the big players in the business of reputed US brands, and the removal of import duty on polished diamonds are giving big push in the direction of creating a global hub in India. India is already the largest manufacturer of cut and polished diamonds with 10 out of every 11 diamonds being processed here. Diamond and jewellery exports reached $16.6 billion last year, second only to IT-related exports. With London and Antwerp slowly declining in importance, India could soon become the manufacturing as well as trading hub.

India exports cars: The export of passenger cars from India is expected to touch one million by 2010, a shade lower than the last financial year’s total domestic sales of 1.3 million, and nearly a third of the projected production of three million. Last year, the country exported only 198,478 cars - less than 13 per cent of the 1,544,850 produced.

India Attractting global manufacturers: Singapore-based $2.1b IT component major eSys Technologies, with worldwide back office operations is investing Rs 1,000 cr in India. This includes a Rs 250 crore investment in setting up a PC manufacturing plant at Nalagarh, Himachal Pradesh with an annual capacity of 1.2 million units and another Rs 100 crore in global back-office operations in Chandigarh.

India as R&D hub

1.The world’s largest manufacturer of healthcare products, Johnson & Johnson, is making India a global hub of its research and development as it looks to ramp up its pharmaceutical business in the country. The company is investing $17.5 million in its analytical and pharmaceutical development centre in Mumbai, which conducts early-stage drug development. In a few months, the number of professionals working there will rise from 65 to 150.

2.Korean consumer electronics major Samsung would hire about 700 R&D software engineers for its centre at Noida. “Currently, we employ 300 people at Samsung India Software Centre (SISC) and would take the number up to 400 by this year end, eventually we hope to touch 1,000 in the next three years,” Samsung India Electronics Vice President Software Centre Vikram Vij told PTI.

3.Blackberry-maker Research In Motion (RIM) will soon set up its R&D and customer support base in India. The company could in fact look at turning India into a hub for its customer support services eventually.

4.Indian expatriates returning to work on R&D: According to the Society of Indian Automobile Manufacturers (SIAM), there are already over 250 Indian expatriates who have returned to work on R&D in domestic automobile companies Mahindra & Mahindra, Ashok Leyland, Tata Motors and Hindustan Motors. SIAM predicts that their numbers will double in two years. With investments of over Rs 100,000 crore lined up in the Indian automobile industry, and European and US car majors making an aggressive push into India, Indian car companies have begun to understand the significance of R&D.

Textile sector invests tons: India’s textile sector is expected to attract investment of Rs 150,600 crore in the next five years and will achieve the export target of Rs 225,665 crore (55 billion dollars) by 2012. The industry that is growing by 9-10 per cent would increase to 16 per cent in the coming years.

India getting benchmarked: Nissan Motor Co, Japan’s third-largest automaker, is designing a $2,500 car to compete in India with the low-cost model planned by Tata Motors, Chief Executive Officer Carlos Ghosn said. “We are working on how we can make a car for $2,500,” Ghosn told reporters today at a dinner in Versailles, France. A Nissan advance engineering group is doing the study,” he said.

Is not India bubbling

certainity is illusion and growth is neccessity

Some of the problems with our prevalent economic system as I understand it is this:

Money is created by banks. In part by central banks who can make up amounts and lend them out, mainly to central governments, but also to regular banks.

The worst problem is not that the central banks are mostly outside the control of any elected representatives of the population, even though that is certain cause for some suspicion and alarm. In some areas, such as the U.S., the central bank is a completely privately owned institution, owned by its member banks. The central bank of central banks, the Bank of International Settlements in Basel Switzerland, is also not controlled or owned by any government, but is a corporation with stocks. It is located on land that is not considered part of Switzerland or any other country, it is not answerable to any public body, and it does its business in secret.

However, the worst problem is that interest is being charged for the money that is lent out. It might well be a good idea to use fiat money, that is, money that doesn't have any inherent value, but is only valuable because we trust that it is. All currencies on the planet are, as far as I know, fiat money. However, the problem is the interest.

For example, the Federal Reserve Bank lends a billion dollars to the U.S. government. That money is created out of thin air. The Federal Reserve Bank doesn't particularly lend it out because it has accummulated produced value. It simply has been given the authority to invent the money. It gives the money to the government. The government spends it one what it thinks it needs to spend money on. The money is now due back from the tax payers. That is not in the first place a problem, since the money is out there in circulation.

But, the bank wants the money back with interest. And the ridiculous thing is that there is nowhere the money can come from except for by being lent out by banks.

The central bank is not the only one that can create money. Any bank can. Regular banks create money by being allowed to lend out a certain number of times more money than they have deposits for. For example, if there is 1 million in the bank, it can lend out 10 million, thereby creating 9 new millions.

Regular banks also charge interest. Meaning that, no matter how much they create, they always need MORE back.

Technically speaking, that is impossible. It only appears possible because there are enough banks around and the total economic transactions are complicated enough that it always seems like there is somewhere else the money can come from. But, if we add it all up, there isn't anywhere else it can come from.

People trust money to be valuable, so they use it as a medium of exchange. That drives the production of a lot of things, and it buys people a lot of things that they want. And, as long as the wheels keep spinning around, that seems OK.

However, the system can't lead to anything else but a higher and higher amount of money that is being owed to banks. That is, national debts increase, and personal debts increase, and a higher and higher percentage of the actual assets in the world are being owned by the banks as "security" for the debts.

All current money systems are based on debt. If all debts in the world were paid back there would be no money in existence. I repeat, NO money. However, that in itself is impossible in that there isn't enough money around to pay all the debts that are there, because of the accrued interest. It can only be a never-ending escalation, by the banks issuing more new loans so that people can pay the installments for the old loans.

That appears to work as long as there is never-ending expansion. As long as more and more stuff is being produced and people need more and more money, the system might keep working.

But, we are on a limited planet, with mostly limited resources. Certain activities can not be expanded indefinitely. There is for example a limited number of physical assets that the banks can get as security or as payment for the loans, and sooner or later they would all be owned by banks, and the escalation would stop.

And now, if we look around us, most people seem to have a perpetual scarcity of money. There somehow doesn't really seem to be enough to go around. However, our ongoing need to provide a livelyhood for ourselves and our families drive us to pursue more money anyway, and one way or another we get by. And we are too busy to notice that there is something fishy about this lack of money. There will always be somebody around who has a lot of it, so that we are reminded that this would be possible for us too. But we might not see that it wouldn't be possible for everybody in the current system.

The current system is built on scarcity. The system is driven by the idea that there isn't enough, and we have to compete for what is there.

It happens not to be true. If we add all the cummulative resources together and manage them well we could very well all live comfortably. It is just that the economic system tells us that we mostly don't own these resources, but they are just beyond our reach, and if we manage our credit well, we can keep being rewarded with nice stuff. Never mind that the bank owns our houses and our cars and the companies we work for, we can at least pretend that we own them for a while.

The weird thing is that most people don't know these things at all. Most people think that the national debt is a big problem, but they haven't really thought of who this money is owed to. Or how come almost all countries in the world can have such astronomic debts that we all have to work twice as hard just to pay off the interest to it. And all of this money is owed to somebody who didn't own any real value in the first place.

There are plenty of economic experts around who will provide very complicated explanations for what is wrong with the economy. There is too much unemployment or we buy too much stuff from Japan or something. Whereas the actual mechanics of the economic system are never mentioned.

I suppose that if a solution had to be found centrally it would be something along the lines of nationalizing all the central banks and canceling all the national debts, which never existed in the first place anyway. And then letting the governments issue money without interest. I'm sure there would be some major repercussions in that that I don't understand, but I'd say that sounds like an attractive solution just speaking from common sense.

If that doesn't happen I'd say the solution is in creating different schemes of economic interaction that aren't based on borrowed money that has to perpetually be paid back with more borrowed money.

A system is a set of relations that influence behavior. An economic system that were inherently viable could influence people to behave in generally more sane and enjoyable ways.

A system based on a fixed quantity of assets, such as gold, is problematic in that the amount of produced value is mostly increasing in the world. So, if there were only a fixed quantity of money, there still wouldn't be enough to buy everything.

I think what is needed is a system that allows money to be created in tune with value being produced. That is, at the same time as something that is perceived valuable is being created, an equivalent amount of money to pay for it needs to be brought into existence. And that money needs to be available for those who need and appreciate the created value. And there should be no future installments due based on that exchange.

Ultimately I don't think money will be needed at all. However, to get to a future where resouces are used and shared in a sensible way, we might need some intermediary systems that point in that direction.

How exactly to do that, I don't know. I do know that it is possible. I also know that isn't very likely to be done through the mechanics of the old system. You probably don't go to the bank and get a loan to finance a new money system. You just make your own system and start using it more and more.

what is quality financial reporting

Quality Financial Reporting

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BY PAUL B.W. MILLER

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customer walks hopefully into a car dealership. When the salesperson asks what she is looking for, the customer says she is tired of the standard model and wants a car with a CD player, leather seats, cruise control and a bright color. The salesperson breaks out laughing and responds, “You have to be kidding—we don’t have anything like that!” When the customer asks why, the salesperson replies with scorn: “Because we aren’t required to. If you order this tan model, we’ll deliver it some time in the next three to six months.” The customer can hardly believe her ears and quickly walks toward the door.

This short fable illustrates the futility of operating a business based only on supply without regard for demand. That way of doing business is rooted in the attitude: “If we build it they will buy it.” In today’s economy that sort of arrogance will get a company nowhere, even if it has a monopoly on a product or service. Once it’s clear a company doesn’t care about its customers, other innovators will come and take them away.

This type of situation caused the AICPA special committee on financial reporting (the Jenkins committee) to issue its report, Improving Business Reporting—A Customer Focus, in 1994. It urged the accounting profession to adopt a customer focus when providing information to the public. Nevertheless, it appears some accountants are like the car dealer above because we have not made any significant reforms in how we deal with capital markets. Instead, the entire accounting profession seems to have fallen victim to an overwhelming inertia that is blocking any significant changes. To remain relevant everyone—practitioners, academics and regulators—needs to tap into the same economic forces that have caused demand-driven enterprises to succeed while supply-based businesses have withered on the vine.

My proposal is that the change to being demand driven can be accomplished through what I call quality financial reporting (QFR). This concept offers a new paradigm that shows the tremendous rewards that await managers who change the way they report financial information to stockholders and to the public.

QFR SUMMARIZED

QFR is an attitude, not a set of specific practices. It involves companies getting in touch first with capital market participants to better understand their needs and serve them more quickly, thoroughly and conveniently than their competitors. To be this nimble and creative, accountants cannot consider minimum compliance with politically compromised GAAP to be sufficient, any more than car designers can consider minimum government safety and pollution standards sufficient when creating marketable vehicles. Instead, QFR calls for voluntarily expanding the scope and quality of reported information to ensure market participants are more fully informed.

What kinds of concerns might give companies the incentive to adopt this new attitude? These four axioms show what happens when financial reporting does not tell the whole story:

Incomplete information fosters uncertainty.

Uncertainty creates risk.

Risk motivates investors to demand a higher rate of return.

That demand results in a higher cost of capital and lower security prices.

Companies have somehow overlooked the axioms even though the key to customer focus lies in understanding that uncertainty increases capital costs and puts managers, employees, customers, creditors and stockholders at a disadvantage. More important, higher capital costs harm society by reducing the economy’s efficiency. Despite its simplicity, this logic can transform financial reporting.

To exceed the requirements of GAAP, managers, practitioners, auditors, regulators and educators must change the paradigm. In particular, managers should respond to the powerful drive for greater wealth by making changes in the content, format and frequency of reports.

To accept QFR, we must understand that regulation has not been and never will be able to bring about optimum reporting practices. However, competitive forces combined with regulations will get us closer to where we should be.

First steps. A risk-free route to applying QFR lies in making better choices when preparing GAAP financial statements. For example, FASB has issued three standards that recommend certain reporting practices while permitting companies to use other practices that are less informative: Statement no. 89, Financial Reporting and Changing Prices, Statement no. 95, Statement of Cash Flows and Statement no. 123, Accounting for Stock-Based Compensation. Despite FASB’s extensive research and input from statement users, managers have overwhelmingly chosen the less preferred alternatives. Specifically, they have rejected FASB’s recommendations for reporting supplemental market value information, for using the direct method of accounting for operating cash flows and for putting option expense on the income statement. By so doing, companies have increased uncertainty, risk and capital costs. QFR makes it clear that using the preferred methods produces the opposite results.

THE JENKINS COMMITTEE AND QFR

In its report, the Jenkins committee used these words to justify dependence on FASB but mistakenly framed the issue as a choice between a standards-based system and no standards at all:

Some constituents . . . ask: Why not let the marketplace for capital determine the nature and quality of business reporting? The marketplace, they argue, already offers powerful incentives for high-quality reporting. It rewards higher quality reporting and punishes lower quality reporting by easing or restricting access to capital or [by] raising or lowering the cost of capital. Additional reporting standards, they argue, would only distort a market mechanism that already works well and would add costs to reporting, with no benefit.

Unregulated reporting is unrealistic, if only because standards are so thoroughly imbedded in the reporting system they cannot be eliminated.

A realistic alternative is a quality-driven financial reporting system that relies on standards to establish minimums while freeing financial managers to compete by providing information that goes beyond minimum requirements. Under this view, businesses need standards to promote progress, facilitate understanding and take action against those who try to mislead. But standards alone can’t create quality.

INCOMPLETE INFORMATION

Suppose a company owns a block in downtown Dallas that it purchased in 1952 for $5 million. Under GAAP, management is not required to report that its value is now closer to $200 million. How will the market react to this incomplete information?

One remote possibility is that the market will accept the smaller figure and grossly undervalue the company’s securities, increasing its cost of capital. Another possibility is the market will throw up its hands and walk away because management hasn’t provided useful information. In 1994, Warren Buffett told a student audience, “If I pick up an annual report and I can’t understand a footnote, I probably won’t—no, I won’t—invest in that company because I know that they don’t want me to understand it.” The point here is that bowing to the temptation to manage a company’s financial image through accounting policy choices won’t work. Doing so destroys trust and shrinks demand for the company’s securities, driving value down, not up.

While investors might be attracted to the company despite the limited public information, the situation will force investors to discount the price of the company’s securities to protect themselves. Some will gather their own private information, which means

They will incur processing costs that they must recover.

The data will be incomplete, unaudited and unreliable.

The few who have the information can earn abnormally high returns.

QFR addresses these problems by attacking their root: uncertainty. Ironically, the problems are easy to avoid because financial managers already know most of the information investors will find useful. If they don’t, they should; further, they are in a better position than financial statement users to produce it reliably.

ARGUMENTS AGAINST QFR

Practitioners invoke two arguments against QFR: New information is costly, and it reveals a company’s plans to its competitors. While both arguments are reasonable, a closer look indicates the obstacles they present are surmountable. Some financial managers think they are helping stockholders by limiting the cost of producing, auditing and publishing information. However, they miss the point that stockholders face lower security prices when useful information is not reported. More informative reports make stockholders and everyone else better off. Although information overload is possible, the “Q” in QFR stands for quality, not quantity. The market needs better information, not more.

Those who think additional information would help a company’s competitors should consider two points:

Management is locked in a capital market contest that is just as important as the competition for its products or services; it’s shortsighted to neglect one while pursuing the other.

Because QFR is voluntary, it does not force anyone to exceed minimums. Managers decide what they will reveal. If they don’t want to report something, they don’t have to. The decision is in their hands, not in those of standard setters.

While there are additional responses to these objections, this forum doesn’t provide enough space to discuss them all. I believe these and other obstacles cannot defeat the unarguable truth that more complete reporting can produce large economic rewards. It’s up to practitioners to decide whether they will claim those rewards directly or try to get them through incomplete or even deceptive reporting. QFR shows that the latter options will fail.

MARKET-VALUE-BASED INFORMATION

Much has been written about the role of market value information in financial reporting. The arguments were sometimes strongly worded because the issue was defined as whether the financial statements should use values or costs. QFR helps break this impasse by framing the issue in terms of whether voluntary supplemental reporting of market value information will, in FASB’s words, help investors and creditors “assess the amounts, timing and uncertainty of prospective net cash inflows.” As long as GAAP remains focused on costs, companies must report these numbers. However, QFR should encourage everyone to consider whether supplemental reporting would be helpful.

While many remain skeptical about its relevance, market value usefully describes assets and liabilities because it continuously reflects their ability to affect cash flows. Assets that might bring larger future cash flows have a greater value than those assets with lower expectations. Assets that might bring in cash sooner have a greater value than those that might bring it in later do. Assets that are more likely to produce cash have a greater market value than those that are less so. Although accountants might find comfort in reporting historical cost, book value and the present value of predicted cash flows, they should realize that market values are more effective for describing an asset’s current ability to affect future cash flows.

It doesn’t matter whether market values’ usefulness can be proven; it is enough for financial managers to realize they offer great potential for improving reporting. Managers who report only historical numbers are like carmakers that design vehicles without stereos or comfortable seats. They might claim a small capital market share, but most investors will look elsewhere.

AUDITS AND INDEPENDENCE

QFR offers guidance for all areas of financial reporting, not just the contents of reports. For example, it sheds new light on the importance of auditor independence. Specifically, audits add credibility to management’s reports and reduce uncertainty, risk and the cost of capital. It follows that management can help stockholders by engaging unquestionably independent auditors. If new standards increase independence, stock prices will rise. However, there is little wisdom in waiting for regulators to act because QFR shows managers they can create value by voluntarily increasing auditor independence. Financial managers are better off engaging the toughest auditors they can find so they can advertise their reports as having survived their scrutiny.

From the accounting profession’s side, savvy auditors will attract QFR clients by protecting and promoting their independence. These auditors will understand that client service means doing good for the client, not just making the client look good. Of course, managers and auditors should not wait for tougher independence rules. Rather, they should figure out on their own how to differentiate their statements and services from those of their competitors.

QFR reveals that traditional audits have lost value because minimum compliance with GAAP produces low-quality information. If financial statements lack relevance, increasing their reliability with an audit does not make them more useful. Thus, CPAs who seek markets for new assurance services should not overlook the potential for auditing the relevant information managers would produce under QFR.

QFR AND PUBLIC POLICY

Financial reporting affects the public interest in numerous ways. For example, an efficient economy generates and distributes wealth. In turn, a well-run capital market is key to an efficient economy and useful information is essential to that market. Until now, securities regulation and litigation have been the only policy tools applied to promote useful information. The public encourages managers to report primarily by threats of recrimination for failing to comply with standards. This “stick” approach has been reasonably successful, especially in the United States. In contrast, the QFR paradigm offers a “carrot” that rewards managers for producing quality information by reducing capital costs and increasing security prices. Ultimately, widespread adoption of QFR will produce a more efficient capital market, a more productive economy and a more prosperous society.

How can policy makers encourage managers to use QFR? I have five recommendations:

Federal regulators must not flinch when prosecuting financial managers and others who try to mislead investors by reporting false and incomplete information.

Managers who try to provide useful information should have a safe harbor against sanctions for their legitimate efforts to improve reporting quality beyond GAAP.

FASB, the SEC and the AICPA should help auditors and managers see QFR’s advantages.

FASB should continue to issue standards that identify best practices and weaker alternatives; further, they should require managers who don’t adopt the best practices to explain why.

CPAs should lead Congress and others to understand that choking off useful information creates inefficiency and higher capital costs. Limited reporting simply forces the market to seek other, less credible, less complete and more expensive information. Congress must understand that laws can never force the market to act on information that is not useful or ever keep it from getting useful data from other sources.

MOVING AHEAD

Everyone will gain from QFR, except a very small group who may have successfully misled the market. It’s better to ignore these few and encourage others to reduce uncertainty by flooding the market with useful information. Some market participants will resist QFR, just as they were slow to embrace other business revolutions. For example, some still reject total quality management, human resources management and just-in-time inventory management. Like QFR, these innovations show that it is better to build open relationships with markets. Thus, TQM mandates continuously addressing customers’ needs, HRM encourages team building and JIT requires managers to work closely with suppliers. Similarly, QFR would cause managers to create positive capital market relationships.

Moving ahead with QFR offers little downside risk and the potential for substantial benefits. The result could be a fable with a quite different ending:

A customer walks hopefully into a car dealership. When the salesperson asks what she is looking for, the customer says she is tired of the standard model and wants a car with a CD player, leather seats, cruise control and a bright color. The salesperson breaks into a big smile and says, “You’ve come to the right place. Sit down and we’ll find out what we can build to meet your needs. We’ll offer you a competitive price and deliver the car in a week—less if our network has one that matches your specifications.” The customer can hardly believe her ears and walks quickly toward the salesperson’s office.