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The Us recession will affect india economically leaving job loss and fdi cut down.

2008-07-27T05:45:00.000-07:00

Recession in US and its effect in India

What's a recession? How will US slowdown hit India
The fear of a recession looms over the United States. And as the cliche goes, whenever the US sneezes, the world catches a cold. This is evident from the way the Indian markets crashed taking a cue from a probable recession in the US and a global economic slowdown.

Weakening of the American economy is bad news, not just for India, but for the rest of the world too.

So what is a recession?
A recession is a decline in a country's gross domestic product (GDP) growth for two or more consecutive quarters of a year. A recession is also preceded by several quarters of slowing down.

What causes it?
An economy which grows over a period of time tends to slow down the growth as a part of the normal economic cycle. An economy typically expands for 6-10 years and tends to go into a recession for about six months to 2 years. A recession normally takes place when consumers lose confidence in the growth of the economy and spend less. This leads to a decreased demand for goods and services, which in turn leads to a decrease in production, lay-offs and a sharp rise in unemployment. Investors spend less as they fear stocks values will fall and thus stockmarkets fall on negative sentiment.

Stock markets & recession
The economy and the stock market are closely related. The stock markets reflect the buoyancy of the economy. In the US, a recession is yet to be declared by the Bureau of Economic Analysis, but investors are a worried lot. The Indian stock markets also crashed due to a slowdown in the US economy. The Sensex crashed by nearly 13 per cent in just two trading sessions in January. The markets bounced back after the US Fed cut interest rates. However, stock prices are now at a low ebb in India with little cheer coming to investors.

Current crisis in the US
The defaults on sub-prime mortgages (homeloan defaults) have led to a major crisis in the US. Sub-prime is a high risk debt offered to people with poor credit worthiness or unstable incomes. Major banks have landed in trouble after people could not pay back loans.

The housing market soared on the back of easy availability of loans. The realty sector boomed but could not sustain the momentum for long, and it collapsed under the gargantuan weight of crippling loan defaults. Foreclosures spread like wildfire putting the US economy on shaky ground. This, coupled with rising oil prices at $100 a barrel, slowed down the growth of the economy.

How to fight recession
Tax cuts are the first step that a government fighting recessionary trends or a full-fledged recession proposes to do. In the current case, the Bush government has proposed a $150-billion bailout package in tax cuts. The government also hikes its spending to create more jobs and boost the manufacturing and services sectors and to prop up the economy. The government also takes steps to help the private sector come out of thecrisis.

Past recessions
The US economy has suffered 10 recessions since the end of World War II.

The Great Depression in the United was an economic slowdown, from 1930 to 1939. It was a decade of high unemployment, low profits, low prices of goods, and high poverty.

The trade market was brought to a standstill, which consequently affected the world markets in the 1930s. Industries that suffered the most included agriculture, mining, and logging.

In 1937, the American economy unexpectedly fell, lasting through most of 1938.

Production declined sharply, as did profits and employment. Unemployment jumped from 14.3 per cent in 1937 to 19.0 per cent in 1938. The US saw a recession during 1982-83 due to a tight monetary policy to control inflation and sharp correction to overproduction of the previous decade.

This was followed by Black Monday in October 1987, when a stockmarket collapse saw the Dow Jones Industrial Average plunge by 22.6 per cent affecting the lives of millions of Americans.
The early 1990s saw a collapse of junk bonds and a financial crisis.

The US saw one of its biggest recessions in 2001, ending ten years of growth, the longest expansion on record.

From March to November 2001, employment dropped by almost 1.7 million. In the 1990-91 recession, the GDP fell 1.5 per cent from its peak in the second quarter of 1990.

The 2001 recession saw a 0.6 per cent decline from the peak in the fourth quarter of 2000.
The dot-com burst hit the US economy and many developing countries as well.

The economy also suffered after the 9/11 attacks. In 2001, investors' wealth dwindled as technology stock prices crashed.

Impact of a US recession on India
A slowdown in the US economy is bad news for India.

Indian companies have major outsourcing deals from the US. India's exports to the US have also grown substantially over the years. The India economy is likely to lose between 1 to 2 percentage points in GDP growth in the next fiscal year. Indian companies with big tickets deals in the US would see their profit margins shrinking.

The worries for exporters will grow as rupee strengthens further against the dollar. But experts note that the long-term prospects for India are stable. A weak dollar could bring more foreign money to Indian markets. Oil may get cheaper bringing down inflation. A recession could bring down oil prices to $70.

Between January 2001 and December 2002, the Dow Jones Industrial Average went down by 22.7 per cent, while the Sensex fell by 14.6 per cent. If the fall from the record highs reached is taken, the DJIA was down 30 per cent in December 2002 from the highs it hit in January 2000. In contrast, the Sensex was down 45 per cent. The whole of Asia would be hit by a recession as it depends on the US economy. Asia is yet to totally decouple itself (or be independent) from the rest of the world, say experts.

Is Britain's economy heading for the perfect storm?

2008-03-16T09:43:00.000-07:00

Is Britain's economy heading for the perfect storm?

* Record monthly fall for consumer confidence index
* Investment chiefs deny credit crunch recklessness
* FSA warns lenders to prepare for crisis
* David Prosser's Outlook: Why the R-words are unacceptable here
* Hamish McRae: I've changed my mind: the Bank must lower interest rates if we
are to avoid recession

The storm clouds are gathering over the jobs market; the climate on the high street is growing distinctly chilly; a typhoon of bad debt is buffeting the banks. Could a "perfect storm" be about to hit the British economy?

The signs couldn't be much bleaker. The switchback in sentiment since the credit crisis began in the summer has been violent. The Nationwide Consumer Confidence Index recorded its largest drop yesterday, and joins the GfK/NOP survey earlier this week in suggesting that a wave of pessimism not seen for years is washing over the economy.

House prices have begun to fall, albeit slightly; commercial property is seemingly on the brink of collapse on a par with that seen in the early 1990s. The buy-to-let market is vulnerable. The Bank of England has, unprecedentedly, voiced concerns about the grim prospects for real estate. And the Financial Services Authority has warned of the "very real prospect" of the global credit crunch getting much worse. It is that bad.

Shopkeepers are looking forward to a black Christmas. Sir Philip Green, the boss of Top Shop and BHS, said last night on Sky TV that "business is very, very tough". The British Retail Consortium says that sales grew only marginally in November, having slowed markedly in October. JD Sports, ScS furniture and Greene King are the latest household names warning of setbacks. About 4.4 million credit-card customers still haven't cleared debts they ran up last Christmas, according to MoneyExpert.com.

We're less ready to spend, particularly on "big ticket" items furniture, fridges, cars and so on. We're more pessimistic about our finances. We don't want to take on more debt and we want to rebuild our savings. The credit markets are seizing up again. That means banks are becoming much, much choosier about who they lend to, and are charging ever higher rates, despite the efforts of the authorities to keep money markets functioning normally. No lending; no spending.

That unwillingness to lend the credit crunch has started to affect businesses too, though firms remain generally more upbeat than consumers. Manufacturing firms, and in particular those in the car industry, are happy, a veritable ray of sunshine. However, manufacturing makes up only 15 per cent of the economy. In the financial sector, responsible for more than half of the recent growth in the UK's GDP, the mood is glum.

After months defying gravity, share prices have suffered some dramatic falls. City bonuses will be cut this year and next along with recruitment and investment. Barclays, HSBC and other banks have reported billions in losses, while the future of Northern Rock is uncertain.

Growth in the construction sector eased to a 14-month low in November, according to the Chartered Institute for Purchasing and Supply. The gentle rise in unemployment over the past 18 months may accelerate. The accountants KPMG say that "what we are seeing is that the credit crunch is tightening its grip over the economy... an underlying weakening, with both demand for permanent staff and vacancies down on the levels earlier this year."

Everyone from the Treasury to the IMF has trimmed their forecasts for UK growth; from close to 3 per cent for 2008, down to nearer 2 per cent. The IMF says that even this is now too optimistic. Is it time to start talking about the "R-word" recession, and the possibility that the economy might shrink?

The difficulty is that the credit crisis is a process that feeds on itself rather than an event that can be declared "over". It began with the collapse of the US sub-prime mortgage market and the housing crash there, problems which are intensifying. As more sub-prime customers default because of the credit crunch more banks record losses and stop lending, and more properties are dumped on to the depressed US housing market. That depresses confidence and spending, and the screw turns again.

On this side of the Atlantic we feel the chill because our banks are exposed to sub-prime and because the US economy is the world's biggest. If it slows, it drags us down with it. And the mood of economic gloom Northern Rock, headlines on house-price crashes, higher prices for fuel at forecourts and food at checkouts is reinforcing itself. Confidence is the magic ingredient in any economy; it is evaporating fast. There's no knowing how bad it could get.

The most pernicious aspect of this downturn is how it could turn not so much into a recession, but into "slowflation" slow growth plus inflation. A depressed economy can co-exist with high inflation, as the world found in the 1970s. Low demand and high input costs (such as oil at $100 [48] a barrel; wheat prices at record highs) squeeze profits and employment and cut the real value of wages. It also makes it tougher for the Bank of England to allow interest rates to drift lower.

But the really bad weather would arrive if the Chinese economy stumbled. Next year, more than half the world's growth will derive from China, India and other emerging economies. Were they to falter say because the Shanghai stock market bubble burst the world would almost certainly lurch into recession.

In all events, the worst of the slowdown will hit us towards the end of 2008, going into the spring and summer of 2009; the point when a general election is due. By then the public finances would be well out of control, though that may be the least of ministers' worries. Gordon Brown might not have sowed the seeds of the coming economic storm, but he may well reap the whirlwind.

Business as us

"There is an air of unease among stockbrokers at the moment. In recent weeks the market has been trying to factor in the credit crisis and what it means going forward. Obviously this has affected the bankers most, but it has trickled down to other areas. People in property have been severely hit, as have house building stocks. But further down, even the pub operators have faced trouble. There's certainly an air of caution that has descended on investors ever since Northern Rock there's no doubt about that and I'd say the mood is still cautious going into 2008. The stock market acts as a barometer of where things will be in the next six to twelve months, so investors must broadly expect conditions going forward to be difficult."

Ron Turnbull: Finance director of SCS Upholstery, Sunderland

"Clearly our sales have been worse this year than we forecast, and significantly down on the same period last year. We've been suffering for some time from the interest rate increases, and these are now filtering through to the customer.

"The effect of turmoil in the American sub-prime sector has had a big influence on the confidence of consumers over here. But it's not just that they're feeling more anxious because they see savers queuing up outside Northern Rock; they've actually got much less disposable income than they've had for a long time."

"Banks are less willing to lend to customers, even cutting down on lending to each other. Meanwhile essential spends like utility costs and council tax are rising way above the rate of inflation. All of this is coming together to make consumers much more cautious with their spending, and it is businesses like ours, which are vital to a healthy economy, that are suffering the consequences."

Barnaby Stutter: Store worker, Brixton Cycles Co-operative

"Like any other, our business is not 100 per cent recession- proof. But partly because we're a workers' co-operative, and partly because we've got a lot of fluidity, I think we'll survive any coming troubles. We can move from selling bikes to fixing them; pubs and restaurants, who really are suffering, don't have that sort of option.

"There's a snowball effect: the more people worry about it, the worse it becomes. Our culture seems to thrive on anxiety and people are ready to panic about what they're told to panic about. But retailers on the high street expecting a big Christmas bonanza are going to be disappointed.

"Realists always sleep well at night, and being realistic about the forthcoming festive season means lowering our expectations of it."

Carl Lester: Birmingham fashion boutique manager

"People do seem to be spending less at the minute. I've got two branches selling designer clothes in Birmingham, and overall the business is down.

"I think people who might once have shopped here once a month are coming more like once every two. Also, customers seem to be thinking more about what they already have before they spend.

"We've talked ourselves into a recession, and all of a sudden it seems like we're going to get one. I'm not too worried, as my business survived the same thing happening in the 90s."

Tony Brooks: Owner of the Cluny pub and restaurant, Newcastle

"I'm in no doubt that this is the start of the worst trading conditions in the 28 years I've worked in the industry. If you read the trade papers they're full of terrifying figures about the difficulty of the current climate. But in reality it's even worse than they make out.

"The pub trade in particular is coming under heavy attack from the Government on several fronts. Supermarkets selling ridiculously cheap alcohol make it impossible for us to compete, while the smoking ban has been a massive drain on our appeal. And new planning regulations are so tough it's proving harder than ever for us to make money. Some weeks, pubs are down 20 to 30 per cent on the same period last year.

"The broader economic conditions are making our life hell. Higher interest rates and unaffordable mortgages mean that disposable incomes are fast shrinking. Every consumer has priorities; our industry relies on there being some change in people's pockets after those priorities have been met. Today that spare change is disappearing.

"I'm not exaggerating in saying the next few weeks are going to be very painful, and 2008 will be the worst year ever for our industry, with more than 2,000 pubs almost certain to close."

Peter Clayton: Chief executive of the Association of Professional Recruitment Consultants

"As with any sector, there are noticeable trends in recruitment that are an indication of the health (or sickness) in our present condition. What we've seen over the past few months is a move to contract placements rather than permanent placements, which is a sure sign that employers are feeling shaky. Permanent placements have dropped by about 30 per cent in the last quarter a massive shift.

"These trends haven't been such a prominent factor in the recruitment sector for several years. Employers on the whole are feeling very anxious and less willing to increase their payrolls by expanding staff numbers. Businesses are starting to recruit themselves rather than through agencies which, again, is a sign of anxiety."

BHP Billiton's bid for Rio Tinto stirs fears of iron ore monopoly

2008-03-16T09:26:00.000-07:00

Some of the largest steel makers in Asia are voicing opposition to BHP Billiton's proposed takeover of Rio Tinto Group, asserting that such a takeover would create a "monopoly" in the iron ore trade.

The concerns come as BHP's chief executive, Marius Kloppers, travels the region seeking support for the proposal.

Posco, the South Korean steel maker, said Tuesday that a BHP-Rio combination would increase concentration in raw material supplies.

"We are concerned about it and we think it's not desirable," said Kwon Young Tae, executive vice president in charge of Posco's raw materials department.

The China Iron & Steel Association has also voiced objections to the proposed deal, publishing a statement on its Web site that said the merger would create a monopoly.
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The world's three biggest iron ore producers - BHP, Rio Tinto and the Brazilian mining company CVRD, or Companhia Vale do Rio Doce - account for more than 75 percent of all global iron ore trade, the statement said.

"We do not want to see this merger create an even bigger monopoly," it said, adding that as the world's biggest steel producer, China had the most to lose, and that it relied on imports from Australia for 38 percent of its iron ore. "This is not a good thing."

BHP is pursuing the bid after an offer of three of its own shares for each one of Rio's stock was rejected.

Combining BHP, the world's biggest mining company, with Rio would create a group with 38 percent of the world's seaborne iron ore trade, according to Australia & New Zealand Banking Group. CVRD has a similar share.

Kloppers has said that the proposed combination of BHP and Rio would allow the new company to produce more iron ore at a lower cost.

The proposed union is "a powerful proposition for customers," he said.

Still, Hajime Bada, president of the steel division at Japan's JFE Holdings, said Monday that the would-be merger "will be harmful to the fair trade of iron ore and high-grade coking coal."

The International Iron & Steel Institute, whose members include 19 of the world's 20 biggest steel makers, said on its Web site that the competition authorities should block the planned takeover.

Iron ore prices have tripled in the past five years on increased Chinese demand. Next year, contract prices for the commodity may rise by 50 percent, Macquarie Group estimated last month.

Kloppers met Tuesday with Posco's chief executive, Lee Ku Taek.

"We think this is a good proposal for shareholders and customers, but we have a lot of work to go through," Kloppers said before the meeting.

Kloppers said a merger could mean $3.7 billion in annual savings after seven years through synergies in iron ore, coal and other activities.

"We think the overlap of the operations, the fact that we have a solution on how to put the companies together, and the benefits is a very good proposition," he said Tuesday.

Tumbling dollar, inflation and short supply behind gold rally

2008-03-16T05:35:00.000-07:00

A tumbling U.S. dollar, inflation fears and supply shortfalls have driven up gold price, which briefly pushed past the psychologically important 1,000-dollar mark for an troy ounce on Thursday, analysts said.

Gold price rose sharply last year with a 32-percent rally and was up 20 percent this year. Analysts have believed hitting the 1,000-dollar level was just "a matter of time."

The devaluation of the dollar is the main driving force for gold's price hike, analysts said. The plunging U.S. currency made dollar-denominated assets like gold look cheaper and therefore helped drive buying by investors with stronger currencies.

"It's an investor-driven story, with the investor demand coming from U.S. dollar weakness," said Daniel Hynes, metals strategist at Merrill Lynch. Hynes predicted the trend would not abate "anytime soon."

Growing fears about a shaky U.S. economy and the Federal Reserve's interest rate-cutting campaign have plunged the greenback to record lows against other major currencies, especially the 15-nation euro.

The euro rose to a new high of 1.5625 dollars before falling back to 1.5587 dollars in late New York trading, still above the 1.5526 it bought late Wednesday. The dollar traded as low as 99.75yen before recovering to 102.04 yen Thursday.

For now, market players still expect a further interest rate cut by the U.S. Federal Reserve at its rate-setting session next week. A rate cut could add to the weakness of the dollar and drive up gold.

Secondly, worries about rising inflation have prompted investors to rush into gold to hedge against the risk.

U.S. consumer prices rose 4.1 percent last year, the fastest growth since 1990, and latest U.S. data showed inflationary pressure picked up recently.

The drivers for gold remain as investors buy precious metals to create a safe haven against inflation, a U.S. futures analyst said.

Besides, short supply has also contributed to the surge of gold. Supplies were not sufficient due to fast growth of investment demand and a limited increase in output.

Gold output stood at 2,477 tons in 2006, hitting a 10-year low. At the start of the year, power shortfalls forced some gold mines in South Africa, the world's second largest gold producer, to suspend production, leading to gains in gold price.

Back in the 1980s, gold reached 873 dollars an ounce, which is tantamount to 2,235 dollars now when inflation is taken into account. Given that, many analysts believe the current price is still well below historic highs and could rise further.

But other analysts warn risks may accumulate with every gain in gold price. The price could fall on profit-taking, they said.

Should Tata Motors Buy Jaguar and Land Rover?

2007-11-08T13:37:00.000-08:00

Should Tata Motors Buy Jaguar and Land Rover?

Tata Motors, India's largest car maker, has been in the news for the past month because of reports that it is interested in taking over Jaguar and Land Rover, two marquee brands that Ford Motor Company has put up for sale. The Tata Group made a huge acquisition last year when it acquired the Dutch company Corus for more than $12 billion, making Tata-Corus one of the world's largest steelmakers -- and some analysts believe that by pursuing Jaguar and Land Rover, the Tatas are trying to hit another home run. But does it make economic sense for Tata Motors to take over these two iconic brands from Ford? What could Tata Motors do for Jaguar and Land Rover that Ford could not do? India Knowledge@Wharton discussed these questions and more about India's fast-growing car industry with Wharton's John Paul MacDuffie, a management professor and co-director of the International Motor Vehicle Program.

: Does it make economic sense for Tata Motors to take over Jaguar and Land Rover from Ford? And, what would Tata Motors do for these iconic brands that Ford could not do?

I think that there are probably several interested buyers of Jaguar and Land Rover that may share certain attributes. I think for a company in a developing country that's looking to put itself on the map in this industry, particularly Tata, which would not be a new entrant, but certainly with passenger cars and certainly in this high end luxury segment, they would be very new. And, as a former British colony there might be a certain sense of pride in acquiring the "Jewel in the Crown" so to speak.

One of the advantages that you might imagine is that India is a low cost manufacturing base. This is not very much a factor here. I suspect that as a condition of the sale that Ford would insist that the buyer not move manufacturing outside of the UK -- at least not right away. There are a lot of political sensitivities in the UK about that with respect to the auto industry.

Tata has admirable cost reduction skills as they have shown in the development of the Indica, which is a small car. And there is great excitement and impatient interest in the so called $2,500 or Rs 1-Lakh car which Tata has been promising for some time. People have looked at this closely and think that Tata has a lot of the skills to really do that. So the company that is quite savvy about cost control can probably apply those skills even to a luxury car segment.

Ford has been investing in Jaguar and Land Rover. Land Rover actually sells at a pretty good margin; Jaguar is more financially troubled. Ford is selling not so much because these brands are in the worst trouble that they've ever been in, but simply because Ford's overall crisis and Mulally's desire for focus is pushing them towards just concentrating on the core business.

So Tata or any new buyer could pick up these firms presumably at a pretty good price and at a point where they are already on the upswing towards being in better shape. And that might make it easier to look triumphantly like you've managed them beautifully.

News reports suggest that while India's car market is smaller than China's, it's growing at 20% a year, which is faster than the Chinese market. What factors are driving this growth and what are the implications for global auto companies?

Forsome time the fact that the China market growth rate was so much higher than India was attracting some attention for similar reasons. People expected that the opportunities were pretty large in both. I think that perhaps the main factor is that we are talking about economic dynamics affecting the per capita income of people where there's quite a lot of price elasticity.

So if the price of vehicles comes down a rather small amount, there are a very large number of people who suddenly can imagine purchasing a car. These are particularly people with some rising income levels of their own. The competition that causes the prices to drop and the other economic trends that are raising incomes can suddenly bring a large number of people over to what is sometimes called the motorization threshold. This is the point where people suddenly feel that they are able to buy a vehicle. I think that is probably the main thing.

Of course the outside investor interest in India has grown in recent years. People rushed first into China and then a little more slowly into India. But India then looked less crowded competitively, so that brought sort of a second rush. Perhaps the main constraint in this that has affected some of the investment, is that the infrastructure in India is really not adequate to take on a lot of new vehicles.

China governmentally at different levels has recognized this for a long time and they have been pouring huge amounts of money into new highways and other infrastructure. India has not. So we could have years of terrible, even worse congestion in India before that gets solved. But, my guess is that it might break some political logjams on the infrastructure side, if market growth continues.

Looking at the big Japanese automakers -- Toyota, Honda and Suzuki -- all of them have been expanding capacity in India for the past few years. Could you comment on the strategies that these companies are adopting in India? And do you think that they ought to be focusing more on the domestic Indian market -- which I believe, right now, is about 1 million cars sold a year but is projected to grow by 2012 to about 3 million cars. Should they focus on the domestic market or should they use India as a base to export cars to other markets?

There's a slightly different story about each of the companies that you mentioned. And you left out one that I think should be included which is Hyundai, the Korean Company. Suzuki has by now a pretty long history in India, having come in as a partner in Maruti which was half owned by the Indian government. And, partly because of that government investment and some other favorable regulations, Maruti at one time had a staggering 80% of the market, at the very small car end, and they really represented the first sort of modern automotive technology to come into India in some time. This was back now some 20-plus years.

The government has just in May of this year completed the selling of all of its ownership of Maruti. Suzuki now has a controlling 54% share. Suzuki has poured a lot of new investment into the Maruti plants and into expanding the Maruti product line. The classic automotive models like the Ambassador are perhaps a historical legacy in India. They often had very long lives because it wasn't easy to replace them and you could get them repaired any place in the country. There was a huge amount of expertise, spare parts and the like.

Maruti is starting to benefit from the same thing; If you've got a Maruti, you can get it repaired anywhere and you can keep it on the road for a long time. Suzuki is going to try to take advantage of all of that head start lead that they have. Toyota came in much more recently and decided initially not to come in at the very low end of the market, but at a slightly higher end. My sense is that they slightly misgauged how much demand there would be at that level. The product didn't sell as well as expected, although they have gotten some valuable experience there.

They, just like everybody, are trying to find just the right low cost car to bring into India to catch some of this swelling demand. I think the other Japanese companies like Nissan are in not terribly different situations. Honda generally comes into every country with motorcycles first, so that's where more of their Indian investment has been, but they're also aiming to grow.

Hyundai is the real surprise. They came in relatively [recently] and built a plant that was almost an exact duplicate of a plant in Korea. This included lots of automation, which you wouldn't expect. They made the Sonata, which is a fairly mid-sized upscale car. But they also then brought in some small cars and managed to bring the price point down enough so that they have had really spectacular growth. And they have done some savvy things with their marketing to align their products with some iconic Indian images and people. In a way, they are the biggest success story of all of the newcomers in the Indian market and they are going to be tough competitors.

Last month, Toyota's chairman, Fujio Cho, was in New Delhi and he said that in the next couple of years Toyota is planning to launch a new small car. They considered a lot of different countries, but he did say that India might well be the first country where they launch it. Now, given everything that you just said about Suzuki and the popularity of the Maruti in India, do you think that Toyota will be able to take on Suzuki in the Indian market? And if so, what should their strategy be?

MacDuffie: Toyota is a very able competitor, as we all know. Overtaking Suzuki and let's say Hyundai, as the most successful newcomer, probably depends on, first of all, getting the product right. Toyota had rather slow sales in Europe for quite a number of years, in which they mostly took models that were world models sold also in Japan. When they finally focused design effort and actually set up a design studio in Europe and produced a small car just for the European market, they suddenly started to take hold. They were doing lots of other things at the same time.

I would assume that they have India in mind as the first place that their design efforts are very much focused on consumer acceptance. That will be necessary from a styling and feature point of view, but probably price point will be the most important. Everybody is trying to innovate in every possible way to get the price point low enough.

Some of that involves the re-use of components from other vehicles; some of it involves judicious decisions about where you can cut back on lighter weight steel, and what paint jobs [you can use] that aren't based on dealing with road salt in the northeast U.S. It's the creativity to get the right mix of those kinds of cost cutting moves. I expect that Toyota will be very good at that and a lot of other companies will be trying.

If you have the right product at the right price point -- then I think the Toyota advantages of a strong brand will kick in very strongly. Now again, Maruti has been perhaps a bit of a national favorite. Although, people know of course, that Suzuki is behind Maruti. Probably Tata, as Tata becomes stronger, will be even more the national pride purchase for an Indian consumer.

The Hyundai example again suggests that right product and right price, smart marketing and moving quickly are the key. Perhaps I will just say that Toyota is often a bit cautious and careful. And if speed does end up mattering, that may slow them down. But they have a tremendous track record for steady improvement and learning from their mistakes better than almost anybody. I think that if we look out five to ten years, we can expect Toyota to be strong

Among the U.S. auto industry's many challenges are the ongoing negotiations between General Motors and The United Automobile Workers Union aimed at coming up with a new contract to replace the one that expired on Saturday. A major sticking point seems to be GM's plan to turn over health care expenses to the UAW, by way of a trust that would cover GM's unfunded health care obligations to employees, retirees and their families. How would a trust work and why would the union agree to this?

MacDuffie: Those are very good questions and there are negotiators laboring away in windowless rooms right now, in the Detroit area, trying to solve them. This is probably the most striking feature of what I think are correctly labeled historic negotiations this year between the UAW and the Big 3. GM was picked as the first target [because it is] probably the healthiest financially at the moment. This is not to say that this makes them all that healthy.

The trust is something that has been done once before on a kind of experimental basis in the auto industry, both at GM and Ford. It puts funds into the trust which can be used for health care liabilities and the trust is then managed by the union. After the GM and Ford experience, this has been used twice with supplier companies. Both Goodyear and then, more recently, Dana negotiated these VEBAs [Volunteer Employees Beneficiary Association Plan].

So, there is beginning to be a little bit of experience with them. But the scale of what would be involved to do this for GM is of such a magnitude that it would be difficult to predict exactly what will happen.

Billions, like $50 billion, $55 billion?

Exactly. One of the big issues is how much money gets put into the fund up front and where does that money come from? The companies would like to put in as little as possible at the beginning and hope that the funds they put in will accrue at a rate that will cover the eventual liabilities. People will be retiring over time -- these costs are not incurred all at the beginning. The union would like that amount to be as high as possible.

If we look at the precedent, both the Goodyear and the Dana settlements were funded at about 70% to 71% of the calculated health care liabilities. In the run up to these negotiations, analysts were saying that GM would probably shoot for 50% -- wanting to fund at a level of 50%. The UAW would be thinking of something more like 90%. So already that reveals a big gap; those percentages apply to very big numbers.

The next issue is where does the money come from? Is it put in as cash, or is it put in as stock? If a lot of it is based on stock, then the future amount in the fund depends on the future stock performance. So that's a kind of bet by both sides on exactly what the future performance of the company will be.

Just from some of the press coverage that I've seen, I understand that there is talk of some contingencies that would deal with unexpected future events affecting the total amount in the fund. I guess one possibility that this contingency would cover is what if the fund generates huge surpluses? What if the U.S. implements a national health care plan and suddenly a lot of those costs are taken off the back of the fund? So there would be a provision to handle that, probably more importantly for getting the union support and also some provision if the funds run out.

Part of the experience with the small experiments at GM and Ford was that the funds ran out much sooner than expected. So the union has that in their very short-term memory as a risk.

There's a pretty big gap between the 50% figure that GM wants to fund it with and the 90% figure that the union wants GM to fund it with. Where do you think they'll end up?

It's hard to predict because I think it will be combined and interacted with many other features of the deal. But, I think that the union will be aware of the political risks for the union leadership [if they bring] forward a proposal that looks like it's giving away these hard won health benefits or putting them at risk.

After all, the leadership can only put together a contract -- but it has to be voted on by the membership. The health care concessions that the UAW made to both GM and Ford in the last couple of years were approved by a very narrow margin. In fact, at Ford it was narrow enough to make everybody very, very nervous. So if they put together a deal that doesn't get ratified, then it's much more politically complicated to put a new package together.

What's your prognosis of how the deal will work out this time overall?

: Well, my sense is that both sides are ready to try to do something very different here. I mean they could end up with something that is more of a continuation of past patterns -- but it wouldn't really deal with this health care problem. My guess is that there's a lot of energy going into trying to find a creative solution to this. That will probably push up the level higher than GM originally wanted. But it will probably be less than the union wanted because of some of these contingency plans which may reassure some of their concerns.

You know, with the Goodyear and Dana benchmarks of around 70-71%, and given that the automaker workers have thought of themselves as kind of the aristocracy of the blue collar, for them to take a deal that's not as good as the Goodyear and Dana workers would be tough. So I wouldn't expect it to be below that level.

If we can switch gears and talk about Chrysler for a moment. A few weeks ago there were reports about them hiring away James Press, the head of Toyota's North American operations. And, of course they have their new CEO, Robert Nardelli. What do you think the outlook is for Chrysler in the coming year?

Well this is another, in a sense, completely new terrain. There's never been another automaker owned by a private equity firm and perhaps no private equity firm owning such a large and iconic company. So there are a lot of things to watch. The new owners did state, very clearly, that they intended to invest and rebuild Chrysler. They were not interested in what many often assume is the basic private equity motivation, which is to turn and flip the assets quickly.

It was quite important to get the head of the UAW to say that he would support the deal. And in putting together what some consider a kind of dream team of automotive and executive talent to run Chrysler, it seems to back that up. Now, Nardelli's reputation from GE, but even more from Home Depot, is certainly as a cost cutter more than anything else. So that perhaps brings some anxieties on what his preferred and natural approach will be.

Many people, and I would agree, have thought that Chrysler's problems are more on the revenue side than on cost side. They've got to get their product mix right and begin to attract consumers on that basis. Jim Press, on the other hand, has an absolutely stellar record of building Toyota sales in North America and is a proven revenue booster. You know, Toyota has had people poached from them during the years that they have been so successful in the U.S. before -- but never an executive who was anything like the level of Jim Press.

And of course Jim had recently been appointed as a member of Toyota's Board of Directors -- the first non-Japanese in that position. So if I think of examples where other people have left Toyota with the intention of applying Toyota's methods in another company, it turns out that there's an awful lot in the broader organizational culture and organizational systems that make it possible for that person to execute so well. Jim will be stepping away from all of that at Toyota and into a different situation.

On the other hand, sales has always been more customized to the market, and the Toyota sales organization in the U.S. has very successfully, I think, argued with Japan about the best way to sell cars in the U.S. So, these are not really the things that he will bring in terms of insights into selling cars in the U.S.... It's a question of whether the people and the systems and the culture behind it will work.

My sense is that Jim Press was approaching probably the last few years of his career at Toyota, where they quite strictly do ask people to retire at a certain age. This Chrysler opportunity was a challenge probably greater than any he would have been offered at Toyota.

I have a couple of questions about Nardelli. First, I wonder if you have any first impressions of how he is doing. And second, at Home Depot he faced certain interesting challenges in dealing with shareholders which are particularly relevant because Home Depot is a public company. Now, in an environment that is controlled by a private equity entity, I wonder whether you feel his leadership style will be a positive or a negative in this new context.
Well, he won't have to deal with shareholders, so that's the first obvious plus. Although, people talk about this being a kind of redemptive opportunity for him; he might look for opportunities to redeem himself on that front as well. I think running an auto company is a big and complicated job even if you come from within the industry. He obviously comes from outside.

Alan Mulally at Ford has shown quickly that he's determined to have a clear and simple strategy; to remove various obstacles to that, to stay focused on a few central challenges and then to work closely with the people who really know the business. So, to see Nardelli and the other people at Cerberus putting together a strong team is a good sign. How Nardelli then manages that team, I think is the real key.

It's certainly true that there were many reassurances at the time that the sale was announced that the cost saving plan, which Dr. Zetsche from Daimler Chrysler had announced, was as far as they were going to go with cost cutting. But I did see recently that Mr. Nardelli said in light of the sub-prime crisis, in light of the credit crunch and in light of the impact on car sales, there might need to be a reexamination of that. So, that seems true to form and would again perhaps stir up some anxieties that he'll reach for the cost cutting lever first.

With all of the fall-out from the sub-prime mortgage crisis and hints of less consumer spending and lower consumer confidence, what's the outlook for the auto industry?

Well, it's sensitive to interest rates and it always has been. Cars have a longer life than they ever have. Often upgrading a vehicle or getting a new vehicle at the end of a lease is more of an option than an absolutely necessary activity. I think it is in that sense an immanently postponable thing for people. And the U.S. has a very thriving used car market which is where people often turn if they are feeling pinched.

The other variable is gas prices and product mix, particularly of the Big 3 automakers. Products that are relatively expensive and not very fuel efficient are going to be even more vulnerable. But anyone who truly needs a car and wants some of the new fuel efficient offerings that are relatively new in the market, probably has to go to the new market, or perhaps to a part of the used car market. I don't expect a deep, deep drop. But these are conditions that will make it harder for GM, Ford and Chrysler precisely at a time when they could have used a boost.

I'd just like to end with a question about China. There have been news reports about a car price war in China that's eating into the profits of companies like GM, VW, Hyundai, as well as China's own auto manufacturers. This is obviously good for consumers. What are the implications for the companies and could this type of price war occur in other countries, or is China unique?

MacDuffie: That is a fairly familiar pattern of a gold rush mentality in which a very rapidly growing and promising market, first of all, provides phenomenal returns to some of the first movers who get in and start to establish a dominant position. Often that advantage does lag for a while, even when other newcomers come in.

But everybody is benefiting and at a certain point, even with rapidly growing markets, it's suddenly a crowded market place. Then the price competition starts to erode things. Sometimes those that have made the least commitment will actually back out of markets. This was a story in Brazil, for example, in the mid 1990s, when there was also a lot of turbulence in government regulation and tax policy which heavily affected those trends.

The consumer credit picture in China has jumped around a bit and that's affected demand. But ... nobody is going to leave China. It's too big and important. Everybody is going to want to hold on to a piece of that market rather than concede it to the Chinese domestic companies that are coming on strong.

I think everybody believes that there are things to learn from the pursuit of these low cost cars that can apply to a lot of the rest of their business. So, both in China and in India there are incentives to stay in that game. It wouldn't surprise me if, in a few years, the same phenomenon is showing up in India for a similar reason.

The Face of britain after 2010

2007-10-07T04:42:00.000-07:00

Four major events will occur by 2010 that could have a devastating effect on your wealth.

First, let me show you exactly what these 4 landmines are, and where the biggest opportunities lie today...

Landmine #1: Even higher energy prices will crush the bull market in stocks
I'm sure you've felt the effects of rising energy prices in recent years. In 2006, for example, electricity bills in the U.K. rose 27% on average, and gas bills jumped 40%.
This was only the first sign of things to come. Energy costs are locked into a worldwide uptrend that will probably last the rest of your life. They are the product of a supply/demand squeeze, caused by the tremendous economic growth and industrialisation taking place in Asia. Unfortunately, it is a situation that will only get worse. In fact, our analysis suggests that within a few short years, the oil squeeze will cause energy prices to double, undermining both stock market returns and the world economy.

Consider, for example, that India's economy has been growing by more than 8% a year for the past four years, while China's annual growth rate has risen from 7% in 1999 to 10.5% today. That's nearly four times that of the U.K., and three times that of the U.S. This rapid Asian growth is pushing up demand for all types of commodities, including oil - which is why oil prices have climbed nearly seven-fold since 1998.

And yet, in Asia, per capita consumption of everything, including energy, is still very low compared to the West. While the average Brit consumes 10.4 barrels of oil per year and the average American burns through 26 barrels, the Chinese use only 1.5 barrels per person, and the Indians less than one barrel.
4.4 billion people all wanting fridges and cars means a HUGE demand for oil, whilst oil production is probably now in decline
As economic growth raises the average Asian's standard of living, his energy consumption will grow too. Soon every Chinese family will want a car. Every Indian family will demand a refrigerator and an air conditioner. Bearing in mind that China and India alone hold 4.4 billion people, the amount of additional oil needed to meet Asian demand will be staggering.
In fact, the International Energy Agency expects global oil consumption to rise by 50% in future years - largely as a result of Asian growth.
Rising oil demand would not be a huge problem - if oil production could increase by an equal amount. But no one has discovered a major oil field in nearly four decades. Instead, a growing body of evidence suggests that global oil production peaked in May 2005, and has already begun to decline.
American oil production, for instance, has been falling since 1970, despite the U.S. having the best technology in the world. Oil production on the North Sea started dropping in 1999, with the result that Britain is now forced to import oil from abroad. Today, we're also seeing oil output declining in countries such as Mexico, Kuwait, Russia, and Venezuela. Iran, currently the world's fourth largest oil exporter, has just introduced petrol rationing to avoid becoming a net importer in a few years!
In fact, the only countries where anyone believes oil output can still increase are Iraq (which we can't count on anytime soon) and Saudi Arabia. And Saudi Arabia is hardly a safe bet. According to analysis by Matthew Simmons, former energy advisor to U.S. President George W. Bush, Saudi Arabia has far less oil than it officially claims, and may be at its maximum production already.

I'm not saying the world will run out of oil, but from now on it will be harder and harder - if not impossible - to pump enough oil to satisfy demand. And that will lead to ever higher oil prices. Commodity expert Jim Rogers believes oil will reach $150 a barrel within a few years, more than twice what it costs today. If you think £1 is too much to pay for a litre of petrol, just wait. In a few years, it will seem like a bargain.
Of course, while the energy squeeze will certainly lead to economic hardship and lower profits for most corporations, it is also creating some spectacular investment opportunities.
Get ready to make triple-digit profits from oil shares!

As energy becomes more expensive, companies in the energy industry will see their profits expand exponentially. I would not be surprised to see some energy stocks double and triple in value in coming months. It's the one industry I feel you must have in your portfolio.
That's why, for the past five years, the team at MoneyWeek has been helping investors make money from leading oil shares. In August 2002, when many analysts were predicting oil prices to fall, in response to a "quick" victory in Iraq, we told our readers to BUY 4 oil companies poised to benefit from Asian growth and Venezuelan instability. By the end of 2005, oil prices had soared 115%. Those who heeded our advice made...
100% from Sibneft236% from Surgutneftgas275% from Lukoil300% from Premier Oil
One of our more recent picks, Heritage Oil is up 758% since we tipped it!
And as the oil squeeze continues, we'll help you find equally promising opportunities in the energy industry.
Opportunities such as 2 undervalued oil majors you can buy now for cheap, and watch skyrocket as the oil squeeze tightens.
Which downtrodden, overlooked industry could become the next big source of gains as oil prices rise.
The world's leading supplier of oil exploration equipment and services - whose fees (and revenues) are set to rise 75% this year.
Cutting edge developers of alternative energy, whose technology will become increasingly in demand as oil prices soar.
11 ways to cash in on the global rush to build nuclear reactors.
"Money Week encouraged me to go 100% oil, and I have gone £38K to £62K in a year." Garry Morrow, N Ireland
But while the oil squeeze may be the first of the Financial Landmines to hit the markets, it's by no means the scariest. You also need to be prepared for...
Landmine #2: The return of 1970s-style inflation will erode "safe" income streams, while making life more expensive
As oil prices rise, they add to the cost of everything - from getting to work each day, to transporting food to your table, to manufacturing virtually every product you buy. Another word for rising prices is, of course, inflation. And soaring inflation is the second landmine that will attack your savings over the next few years.
If you're old enough to remember the 1970s, then you know skyrocketing oil prices can drive inflation into double figures. During the 1970s, as OPEC embargoes forced oil prices from $5 to $40 a barrel, inflation in the U.K. averaged 13% a year - reaching a high of 27% in 1975. This time however, oil supplies are not tightening for political but for geological reasons - which means a solution will be much more difficult to find.
Every investor needs to pay attention to inflation, because rising inflation can cripple returns from nearly all investments, even those traditionally considered "safe." It increases expenses, reducing corporate profitability and share price gains. And it eats away at the returns from bonds and cash. For instance, if you keep your savings in bonds that pay annual interest of 6%, but the inflation rate climbs to 13%, then you will lose 7% of the purchasing power of your savings each year. That's what happened in the 1970s, and is likely to happen again.
Earlier this year the Consumer Price Index breached the Bank of England’s inflation target for the first time since it was introduced. It has since eased back a little, but don’t be fooled. Food prices are soaring, oil prices are higher than most experts believed possible this time last year, and crucially, the supply of cheap goods from China – which has helped keep official inflation down in the West – may be drying up, as manufacturing costs and soaring wages push up prices in the East. As energy and commodity prices continue to rise over the next decade, we expect to see inflation return to double figures once more. And when it does, the last place you want your money is in so-called "safe" investments, such as bonds. They won't be safe any more.
Of course, while rising inflation dampens the returns from most investments, it creates new opportunities in areas most investors will miss. Let me give you an example...
Be amongst the first to profit from the push for alternative fuels
Inflation is already becoming a problem in the food industry. Food prices are now increasing at a rate of 6% annually - the highest rate in a decade. Fish prices rose 12.6% in the past year. Vegetables are up 10.2%.
Several factors are causing food prices to climb - including rising wealth in Asia and climate change. But what may surprise you is that the oil squeeze is also a major factor. You see, as developed nations become more concerned about future oil supplies, they are promoting the use of new fuels made from agricultural products. Europe wants biofuels to meet 10% of energy demand by 2020. By 2012, half the cars made in the U.S. will be designed to run on 85% ethanol, a biofuel made from corn.
One consequence of producing more biofuel is that food becomes more expensive. For instance, the U.S. ethanol policy has already caused corn prices to hit a ten-year high in the spring of 2007. That's in spite of the fact that 2006 saw the third-largest crop on record. Protests took place in Mexico because the price of tortillas rose by 60% to 70%.
As the U.S. increases its ethanol production, corn prices will continue rising. And as they do, so will demand (and prices) for other grains, as people substitute wheat or rice for corn. Meat prices also climb, since most corn has traditionally been used to feed livestock. Higher meat prices will in turn raise demand for fish. And as more land becomes devoted to growing corn and other biofuel crops (such as rapeseed and tropical oils), less will be available for food production, adding to the supply/demand pressure, food prices, and inflation.
But while rising food prices are making life more expensive for everyone, they are also creating new opportunities for smart investors to profit. Taking advantage of these opportunities is an excellent way to preserve and grow your wealth as inflation rises. For example, we expect investors in food commodities and agriculture will make excellent returns as the push towards biofuels continues. That's why we'll keep you informed about such opportunities as...
How to use exchange-traded commodities (ETCs) to profit directly from rising food prices - and the 2 best diversified plays.
The 3 food giants best positioned to pass on higher food costs to consumers, and grow their earnings (thanks to their dominant market positions).
5 agricultural businesses whose shares will soar as nations struggle to increase crop yields to meet rising food demand.
4 companies that will profit from America's ethanol rush.
How to make substantial profits from the weather-driven ups and downs of 7 key soft commodities.
Of course, you may be asking, "Couldn't the Bank of England halt the rise of inflation by raising interest rates?" In theory, yes. The problem is that raising interest rates high enough to curb inflation runs the risk of detonating a third financial landmine...
Landmine #3: The collapse of the property bubble will devastate householders and turn "buy-to-let" into "buy-to-lose-money"
Since 1776, real estate prices and the economy have followed an 18-year cycle. The general pattern is 14 years of stable or rising prices, followed by four years of recession. In the light of this pattern, MoneyWeek advised readers in 2005 that the property market would experience two final years of rising prices, driven by reckless lending, before the next downturn began.
Now it's two years later, and the property boom is reaching its peak. Worldwide real estate markets have become dangerously overblown. In the U.K., property prices have risen 156% since 1996. In the U.S., they've doubled. And record high prices are occurring throughout Latin America, Africa, and Asia. Even concrete dwellings in Afghanistan, without running water, now sell for $300,000 - six times their cost two years ago.
The risk, as with all housing booms, is that property eventually becomes unaffordable for the average buyer, leading to a collapse in demand. According to the Land Registry Office, the average house in the UK now costs £211,000. If someone were to buy such a house with a typical 6%, 25-year, variable rate mortgage, he or she would pay roughly £1,264 a month. Unfortunately, the average worker only earns £1,550 a month - which means their housing costs would eat up 90% of their earnings! Not many households can manage such payments.
Nor are the deals any more appealing in the buy-to-let market. Last year, 58% of all mortgages sold were to speculative buyers, including buy-to-let. Yet, rental property yields owners just 3% income on average. That's less than what you can make in gilts. If you have to pay 6% mortgage interest on your rental property, you are probably losing money.
In fact, the only motivation for investing in buy-to-let right now is the hope that property prices will continue climbing - so that you can make a profit when you sell. And the only thing that's kept property prices rising is today's extraordinarily low interest rates.
Alert! History tells us that interest ratescould now practically double
This leads us back to the problem of inflation. You see, the Bank of England has kept interest rates low in recent years because it has been trying to stimulate the economy and ward off recession. (The housing boom was a side effect.) For comparison, in 1991, the last time inflation was as high as it is now, interest rates were close to 10%. Yet today they are a mere 5.75%.
The problem with low interest rates is that they allow inflation to keep rising. This puts the Bank between a rock and a hard place. If it raises rates to curb inflation, it risks recession. And if it lowers rates to stimulate growth, inflation rises.
So far, the Bank has tried to maintain a balancing act, raising rates as cautiously as possible - a mere 1% since last summer. But even slightly higher rates makes keeping up the mortgage payments on the family home much more difficult. Home repossessions are already at their highest rate in five years. According to Dr. Neil Blake of Business Strategies, if interest rates rise by just 0.75%, we could see 55,000 repossessions. That would certainly put a cap on housing prices.
As property prices stop rising, owners of rental property and other speculators will see their potential profits disappear. They will cease buying, and instead try to cut their losses by selling properties as quickly as they can, forcing prices down even faster. The result would be the end of the property bubble, and a decline in property values.
Ultimately, we believe the Bank of England will fail in its balancing act. It will neither increase rates fast enough to contain inflation, nor keep them low enough to prevent recession. According to the 18-year cycle, 2007 will be the last year when economic growth will occur. After that, a new recession will begin. But this time it will happen alongside rising inflation.
The result will be stagflation, that nightmare of the 1970s that gives investors the worst of both worlds. It will be a time when both unemployment and the cost of living rise at the same time. What's more, we believe this period of stagflation will be accompanied by a 20% to 30% decline in property values. If you own rental property, you may have only a few months to get out while prices are still rising.
Again, however, there are steps you can take today to avoid being hurt by this third landmine. In fact, there are ways you can make a considerable amount of money as the property bubble bursts. My team can show you...
2 stocks to sell short when property prices plunge - turning other people's loss into your windfall.
The newest buy-to-let scheme which you must avoid, because it will cost average investors big time.
The one country where real estate prices will continue to soar over the next few years - and your 5 best opportunities to profit from this trend.
One type of property you absolutely must avoid during the coming downturn.
... and many other ways to protect and grow your assets as the economy moves into stagflation.
However, there is still one more landmine I need to warn you about...
Landmine #4: The impending US dollar crash & the end of paper wealth
Over the past five years, the American dollar has fallen some 20% against other major currencies. This is an important trend to watch because many of the biggest companies in the FTSE 100 earn a sizeable percentage of their revenues in dollars. A falling dollar could eventually drag down share prices.
More importantly, the U.S. dollar has been the world's reserve currency for many years. A collapse, or even a serious run on the dollar would threaten the stability of the world's financial system.
Unfortunately, the fundamentals for the dollar are uniformly bad. In the first place, economic growth in the U.S. appears to be slowing. This year, the IMF expects the U.S. to underperform Europe. The Federal Reserve will therefore be under pressure not to raise interest rates (or even lower them) at the same time that rates are rising in Europe and Asia-Pacific. This makes the dollar less attractive to investors seeking income.
At the same time, inflation is rising in the U.S. at the highest rate in 10 years, just as it is here. Rising inflation is simply another way of saying dollars are becoming worth less - another reason not to own them.
Investors must also be concerned with the high level of government debt in the U.S., which currently exceeds $8.6 trillion - the largest debt anyone, anywhere, at any time in history has ever amassed. Would you want to lend money to such a spendthrift? Most likely holders of U.S. bonds will be trading them in over the next few years in exchange for something more secure. And this will put further downward pressure on the dollar.
And then there's the problem of the U.S. current account, which shows the balance of goods, services, and money flowing into or out of the country. Since 1990, the U.S. has been incurring ever higher deficits in its current account. Right now, the deficit stands at 6% of GDP. This is the level at which any smaller nation would experience a run on its currency. It's clearly unsustainable.
The rule of thumb among economists is that it takes a 10% drop in a currency to cause a 1% drop in the current account/GDP ratio. According to the Economic Policy Institute, this implies the dollar needs to fall at least 30% to 40% to reach a sustainable level.
Of course, when the dollar falls, other currencies go up. So you can protect yourself somewhat by investing in securities not denominated in U.S. dollars. Don't buy U.S. bonds. And don't buy shares in companies whose earnings are in dollars.
The real danger: a meltdown of the global financial system
The real danger, however, is that a collapse in the dollar would cause investors around the world to lose faith in the financial system, and in all forms of paper (or electronic) wealth. There are in fact no other currencies ready to take the dollar's place as the world's reserve currency. The Euro is the most likely candidate, but Europe has its own problems, including a declining population, social unrest due to immigration, and an out-of-control welfare state. The Bank of Japan is viewed as incompetent. China is hardly ready to step into the role of the world's financial bulwark. And the pound is laboured with similar problems to the dollar, including rising government debt and a record high current account deficit.
In a serious dollar collapse, most likely all currencies would lose value. The result would be skyrocketing worldwide prices for tangible assets. In other words, inflation.
If that occurs, the only people to preserve wealth (and make money) will be those who own commodities of all kinds, including metals, food, and fossil fuels such as oil.
And so we have come full circle.
Well, almost.
You see, there is one currency that would survive when all others are failing. It's the oldest currency in the world, and the only one whose value does not depend on any nation's financial management skills. That currency is... gold.
The one asset you can profit from in any financial storm
Gold traditionally gains value during periods of high inflation and declining currency values. During the inflationary 1970s, gold was one of the best investments. In the 1990s, when inflation was low, demand for gold waned and gold companies cut back on exploration. But since prices bottomed in 1999, gold has more than doubled in value. As a traditional store of wealth in most of Asia, gold is enjoying rising demand as that part of the world develops. Whilst in the West, increasing interest in "safe haven" investing is drawing more investors to the precious metal.
One reason we like gold is because gold can gain value in both inflationary and recessionary times. If central banks allow inflation to rise (by keeping interest rates low), currencies will lose value relative to gold. But if the banks raise interest rates too high (triggering a recession), gold will retain value better than paper assets, so its price will still rise. In other words, gold provides insurance against all types of economic woes.
Don't get me wrong. I'm not saying you should trade in all your investments for gold coins and bury them in the cellar. But keeping just 10% of your investments in gold or gold-backed securities can insure your savings against any weakness in the financial system. If the next few years turn out half as grim as I expect, you will be very glad to have some gold.
That's why MoneyWeek gives you the information you need regarding the best opportunities in gold, precious metals, and other commodities that can weather the coming financial storm.
For example, back in 2001, we recommended Merril Lynch's Gold & General Fund as an easy way for investors to get exposure to gold. Since then, this unit trust has produced a 165% gain. And our three top gold stocks are showing gains of 94%, 44%, and 174% respectively.
6 ways to profit from gold and precious metals
And in coming weeks, you can look forward to getting more great tips on gold and precious metals, such as...
Which gold mining stocks are currently underpriced.
How to profit from mergers & acquisitions in the gold industry.
Why some gold stocks have produced enormous gains in the last two years - and where to find similar opportunities right now.
The 10 mystery metals set to deliver major profits - and the shares that will benefit.
Why this precious metal (which is NOT gold) could be the single best investment you can own today.
Which precious metal ETF looks set to lag its fellows - and the one that's most likely to lead.

warrent buffet one eyes on small portion that multiplies very soon

2007-10-04T15:57:00.000-07:00

Buffett's Largest Stock Purchase in Years!
Find Out Why The Most Successful Investor in History Has Just Bought 39 Million Shares of This Stock ...
Dear Investor,
Imagine, for a moment, that you wanted to build the first highway ever built in your entire state. You knew that the initial price to build it would be very expensive, but that didn't deter you.
Owning the only highway in a state full of dirt roads is just too tempting a prize. Once it's built, companies would be able to ship five times the amount of products each year, generating billions of dollars in extra revenue.
But that's not the best part.
Once the highway was built, your capital spending would be minimal. That's because the majority of your costs are upfront costs. For example, it may cost you $10 billion to build the highway but only $1 billion each year in upkeep to maintain it.
In other words, once you're finished building it, you'll be able to sit back while the money rolls in. In short, you'd own a business where sales and cash flow were increasing while capital spending, a huge portion of your costs, was decreasing!
That was the realization that occurred to me after I researched Warren Buffett's recent purchase of 39 million shares of Burlington Northern Santa Fe Railroad (SYM: BNI) in the $80/share range.
Not only has it been his largest stock purchase in years, but it reminded me of what made Buffett a great investor: the ability to "see" things before the rest of the investing public.
In fact, I’m so bullish on this one stock, I’m convinced that it will be the best stock idea you’ve heard all year. This is a recommendation that can make you 50% — 100% richer in the next 2-3 years. If you’re patient, however, I’m confident that you can easily make 10 to 20 times your money over the long term on this stock.
Don’t worry. This isn’t one of those “teaser” reports that talk up a fantastic new investment idea, pique your curiosity, but never quite give it to you unless you order something. I can’t stand that kind of sneaky marketing. In fact, if you want to skip right to the equity research report and read all about this company that has me so excited.
I do hope you’ll read a bit more before getting to the stock pick, however, because you deserve to know something about who came up with it.
I want to make sure you understand how much your investing life will change for the better with your Tycoon Report subscription.
Once you see who I am, what The Tycoon Report is all about, and what we’ve been able to do for our subscribers, you’ll wonder why you’ve never heard of us before.
A Brand New Kind of Stock Advisory Service That Gives You an Almost “Unfair” Advantage, Once Reserved for Professional Money Managers
For way too long, the “little guy” investor has gotten the short end of the stick, while the big shots at the Wall Street firms made out like bandits.
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You’d never guess it from all those commercials the big investment firms run. But the sad fact is Wall Street doesn’t have much use for the individual investor ... the so-called “little guy.”
Sure they want the little guy’s money. They’ll take every cent he (or she) can put into a mutual fund or a brokerage account.
Yet when it comes to giving something in return – reliable research, for instance – forget about it.
The real research – the stuff somebody might actually be able to use to pick a stock – that goes to the big institutional investors and the fat cats at the top of the financial food chain.
The individual investor gets leftovers. Warmed-over and watered-down gruel that’s gone stale before it ever gets to him.
And the really bad thing is ... the little guy? Friend, that’s you.
That’s right. Every single one of us who tries to invest on his or her own (or with the dubious assistance of a broker) ... is what Wall Street contemptuously calls “the little guy.”
The reason I know so much about Wall Street’s rotten ways is because I used to be part of it all.
I was a senior equities analyst at one of the leading investment firms, and then owner of my own firm at 100 Wall Street. My stock picks helped make our big institutional clients richer and richer … while the individual investors who were supposed to be the mainstay of our firm got zilch.
And, compared to most other outfits, we were “good guys”. At least we never knowingly touted shaky stocks like a lot of other analysts.What I saw my fellow analysts doing made me sick to my stomach. I knew it was only a matter of time before the law came down hard. And I didn’t want to be around when some of my peers were led away in handcuffs.
Finally, after yet another sleepless night, I told my fiancee I was quitting ... saying sayonara to that big paycheck and the cushy corner office ... and going out on my own.
Several years later, we’re proud to say that The Tycoon Report has started to make a difference.
The Tycoon Report is the only publication that gives the individual investor ... “the little guy” ... the same information once available exclusively to the big institutional investors or the super-rich ... information critical to making serious money in the market.
Our Principles: What Makes The Tycoon ReportThe Most Valuable Investing Resource You’ll Ever Have
Our goal is simple: To level the playing field in favor of individual investors.
This isn’t just talk for us … we take what we do seriously.
Below are our founding principles. Some commentary has been added to each principle to further explain what it means to us.
1. We seek to create institutional quality research for individual investors.
Institutional investors (hedge funds, mutual funds etc) have access to better research than individual investors do. They are supported by teams of independent analysts, and the reports they read are the result of in-depth financial analysis.
By delivering in-depth and objective research to you, we seek to level the playing field.
2. We are a research firm only. Our goal is to provide you with research you can trust.
“Dylan, why are you giving The Tycoon Reoport away for free? Forget I said that. But seriously, I’m very thankful for everything you do. You’ve definitely taught this old dog some new tricks.” — Robert H., Ithaca, NY
Please forgive the populist tone here, but the sheer audacity of what some brokerages pawned off as research in the 90’s was stunning. As a result, the New York State Attorney General forced many of them to fund separate independent stock research firms.
We here at Tycoon Publishing have no interest in the “conflict of interest” business (we’ve seen what it does to people). We do what we do because we enjoy it and we’re good at it. Therefore know that we will never accept any payment, in any form, to recommend the shares of any company. Period.
3. We will try to explain our investment decisions in a way that enables you to become both a better investor and a better businessperson.
In addition to the research we offer, we try to present our facts in a way that will help you understand the rationale behind our thinking.It is our hope that during the course of our relationship you will gain a more sophisticated framework for making investment decisions both as an investor and as a businessperson. We believe that the more educated you become, the more likely it is that you will appreciate and recommend our work.
4. We will always admit our mistakes.
Only fools never admit and learn from their mistakes. Good investors are not born, they’re forged. It’s that simple.
5. Everybody we hire to give you investment advice will actually have real investment experience.
“I think there’s a real movement going on. Guys like me are sick and tired of the same old bad information. I don’t know if you realize how valuable what you’re giving us really is. I recommend The Tycoon Report to anyone who will listen. Thanks — a fan.” — Roy O., Palm Beach Gardens, FL
Need we say more? Well, we will. Why?
Because many of our “competitors” aren’t real investors — they’re marketers and journalists pretending to have the real world experience that separates the men from the boys.
All of our writers are battle tested traders first. The Tycoon Report is a powerful tool for a lot of individual investors out there … we’re not about to let somebody write to our audience until we’re absolutely convinced of their talent and professionalism.
6. We will always cherish your business, because if it wasn’t for you we wouldn’t be here.
It was Frank Sinatra who once said, “If you think customers are not important, try doing business without them for a while.”
Although he was referring to another singer who didn’t like to sign autographs, he could have been talking about any customer in any business.
In our offices we keep that quote posted on the wall just to remind us how fortunate we are to have you as part of our Tycoon Report family.
More Winning Trades than Most Paid Services
At the end of the day, if reading The Tycoon Report makes you a better investor, we feel like we've done our job. Leveling the playing field for the individual investor means arming you with the tools and the wisdom to beat Wall Street at its own game.
“The Tycoon Report is my new coffee. I get a headache if I don’t start my day with it.” — Donna H., San Diego, CA
This is NOT, in other words, a stock picking newsletter … it’s a newsletter that will help you pick great stocks for years to come.That being said, our writers can't always resist sharing trade recommendations with Tycoon Report readers.
Have a look at some of our past recommendations, and ask yourself if you've gotten the same kind of performance from some of the services you pay good money for:
Date
Investment
Closing Price on Recommendation Date
Subsequent High*
% Return
8/5/2005
Gold
$444/oz
$730/oz
+64
11/1/2005
Suncor (SU)
$53.72
$89.19
+66%
11/1/2005
Phelps Dodge (PD)
$56.24
$96.90
+72%
11/11/2005
Jun 160 OSX Calls
$32.00
$42.70
+33%
11/22/2005
2 Sep 200 OSX Calls
$20.00
$38.90
+143%%**
12/6/2005
Research In Motion (RIMM)
$61.95
$86.75
+40%
1/4/2006
China Mobile (CHL)
$24.50
$30.55
+25%
1/17/2006
PALM, Inc. (PALM)
$17.48
$24.00
+37%
3/14/2006
China I-Shares (FXI)
$71.80
$83.73
+17%
3/14/2006
Salesforce.com (CRM) - Short Position
$39.78
$24.90 (subsequent low)
+37%
4/28/2006
NBTY, Inc. (NTY)
$22.65
$26.49
+17%
* Data for “subsequent highs” calculated through date of this writing (6/26/06). ** Combined June 160 OSX and 2 September OSX call trades.
The Best Investing Education You Can Get …And Tuition Is Free!
“What can we do to empower individual investors? How can we truly level the playing field? What kind of value can we give people in The Tycoon Report?”
“As one of those who got involved in the daytrading craze … made a lot of money … and lost a lot of money, I appreciate good advice when I see it. Where were you when I started investing? It’s painful to think of what my account would look like if I’d found you back in ’99.” — Walter R., St. Joseph, MO
We ask ourselves these questions every single day.
And we keep coming back to the same answer: Knowledge is power. And for too long, it's what individual investors have lacked.
So, one of the foremost goals of The Tycoon Report is to provide a world class investing education to our readers, with each and every issue.
Readers who've been with us since the beginning have learned a lot, including …
A simple method for doing your own stock valuations;
How high levels of corporate debt can predict fraud (i.e. simple steps you can take to avoid disasters like Enron and WorldCom);
How to make more with your mutual funds;
The proper way to use stop-losses;
The basics on trading options … and more complex strategies such as “calendar spreads,” options straddles, and how to use options as “insurance” against your long stock holdings;
When to short a stock vs. when you should use put options;
How to remove emotion from your investing approach

2007-10-04T15:44:00.000-07:00

Globally, the value of property bought or sold for investment totalled a record $382 billion in the first half, up 16.6 percent from the year before, it said.
Global real estate investment expanded for the 16th consecutive quarter, with the Americas, Europe and the Asia Pacific seeing record volumes, it added.
Property investment in the Asia Pacific jumped 12 percent to $55 billion, mainly bolstered by cross-border investments, the consultancy said.
"Japan, China and Singapore represented the strongest real estate markets in the region," it said.
"Singapore became 2007's hottest global market, with prime capital values increasing by 50 percent (in the first half) fueled by astounding rental growth and yield compression."
Singapore's property market is heating up after years of weakness following a regional financial crisis in 1997. A strong domestic economy and efforts by the wealthy island-nation to raise its competitiveness, including a decision to build two massive casino resorts, have helped perk up the property market.
Stuart Crow, head of Asia capital markets at Jones Lang LaSalle, said Asia remains attractive to investors due to its strong economies, improved liquidity through real estate investment trusts and better transparency.
"Cross border investment is at an all-time high, yet is likely to increase further in the next 12 months, particularly in the most sought after markets of Japan, Singapore, India and China," Crow said. In the Americas, total investment was up 32 percent to $170.7 billion and investment in Europe climbed 4 percent to $156.6 billion, with the UK, Germany and France accounting for more than two thirds of the volume, it said.

Vedanta is either truly on the expansion path or it is selling copper and zinc for gold and silver

2007-10-04T15:14:00.000-07:00

As the old saying goes: It is not all gold and silver that shines. Vedanta Resources might look like a shining opportunity for investors, but to test whether it is for real, Vedanta needs to be judged by the execution of its stated expansion plans.

Many doubts have been raised by the investment community about the motives behind the Vedanta Resources IPO. The whole IPO process from timing, choice of banks, deal structure, management changes, targeted investors (hedge funds), information material and distribution has given this IPO an air of too much polish and too little substance. For the moment it is no more then a construct to attract investors with the following arguments: - rapid growth of Indian economy - substantial growth in the metals business due to strong demand from China - seasoned, big name, management in the person of the just appointed non-executive chairman Brian Gilbertson - Many expansion plans The hedge funds believe that the wider investment community will go for this construct and will start buying Vedanta after the IPO. They therefore, with the help of the banks, had a front row seat and have flocked to get a part of the IPO and made it a success. What to do now as an investor that was not included in the IPO? Given all of the above, it is imperative for investors as well as the Vedanta management to focus on the very substance of this IPO. While the growth areas and recently appointed big name management is all nice to have in the backdrop, the real test is whether Vedanta can successfully implement the expansion plans. Let's have a look these plans. (Source: The Hindu Business Line) “The investment programme envisages expansion of the Sterlite-controlled Balco aluminium smelter, Orissa alumina refinery and Hindustan Zinc Ltd. On the expansion programme of the company, Mr Agarwal said in the copper business, the expansion plans, which are expected to be wrapped up by December 2003, included expanding the capacity of the Tuticorin smelter from 1.8 lakh tones per annum (tpa) to 3 lakh tpa of copper anode and commissioning of a 1.27-lakh tpa copper refinery in Tuticorin. In the aluminium segment, the company plans to invest in two Greenfield projects — a 2.5-lakh tpa aluminium smelter at the Korba complex and a one-million tpa alumina refinery in Orissa. The refinery is expected to enable the group to supply alumina to the new smelter at Korba, as also to access the export markets. In the zinc segment, the company's principal expansion plans for Hindustan Zinc include expanding the capacity of its Rampura Agucha mine from 2 million tpa to 3.3 million tpa, Rajpura Dariba and Zawar mines to 1 million tpa and 1.25 million tpa, respectively, and construction of a new zinc smelter at Chanderiya to increase zinc production capacity by 1.7 lakh tonnes. In addition, Mr Agarwal said Vedanta group was looking at prospects for acquiring copper mines in Zambia. He pointed out that Zambia had the best copper mines and we have been selected as the preferred group. "As and when we get an opportunity we will look at further acquisitions," he said.” This all looks nice on paper, but only if Vedanta can prove to its investors that it is indeed rapidly investing close to 100% of the proceeds of the IPO into the mentioned expansion initiatives and manages to get a good ROI in the short to mid-term it is worth the trust of investors. Given the nature of this business, it will be difficult to show real audited results within a year from now. Until then, if I were an investor, I would let the hedge funds sit on their shares and be nervous.

Past and Future Equity Market Activity

2007-10-04T15:07:00.000-07:00

The potential of China’s equity markets is "huge," says Laura Cha Shih May-lung of the China Securities Regulatory Commission.1 There’s no question that the vice-chairwoman of the nation’s stock watchdog is right.
And so is Nicholas Lardy. In his testimony before the U.S.-China Commission on December 6 of last year the Brookings scholar said: "China really is fundamentally different from many other emerging markets in that its domestic savings are more than sufficient to finance all of its investment." Therefore, it should be a simple matter for the equity markets in Shanghai and Shenzhen to put those savings to good use. That is, after all, what stock markets are supposed to do.
As Cha suggests, tomorrow the country’s bourses may work. Today, however, they don’t: the stock markets of the People’s Republic are inefficient, corrupt, and
endanger social stability. They are, in a word, failing. The country’s current
reliance on foreign direct investment is a reflection of its failure to put domestic savings to good use. In short, the great FDI inflows are a testimonial to the weakness of China’s equity markets.
The truth is in the numbers, the numbers showing where the money is coming from. During the preceding three calendar years, Chinese companies raised an average of US$8.0 billion in the domestic equity markets in initial public offerings. The average masks significant year-to-year changes, however. In 1999 Chinese companies raised US$6.5 billion in these stock markets. In 2000 that number increased to US$10.5 billion. Last year, however, the amount fell by 34.3 percent to US$6.9 billion.
To put these numbers in perspective, Chinese companies raised US$1.1 billion on foreign exchanges in 1999 in initial public offerings, US$16.6 billion in 2000, and US$2.4 billion in 2001.
Analysts speculate that the increase in amounts raised in 2000 was attributable to equity offerings that, but for the Asian financial crisis, would have reached the markets in the immediately preceding years.2 This effect is especially noticeable in the foreign offerings.
All these figures are dwarfed by the approximately US$157 billion in new loans 2
extended by Chinese banks in 2001.3
Domestic and foreign initial offerings, illustrated in Figure 3.1, are derived from a table found in Appendix 4. Figure 3.1 Amounts Raised in Initial Public Offerings 1999-2001 (US$bn) 6.5 85.5% 6.9 74.2% 10.5 38.7% 1.1 14.5% 2.4 25.8% 16.6 61.3% 0.0 5.0 10.0 15.0 20.0 25.0 30.0 1999 2000 2001 Foreign Mainland China
source: China Securities and Futures Statistical Yearbook (various years) websites of various stock exchanges Bloomberg
The statistics show China’s increasing dependence on foreign markets. In 1999 14.5 percent of its funds from initial public offerings were raised in foreign markets. The corresponding percentage in 2000 was 61.1 percent. In 2001 the number was 26.7 percent.
Figure 3.2 shows the amounts raised in equity markets in the United States. 3 Figure 3.2 Amounts Raised in Initial Public Offerings in U.S. Markets 1999-2001 (US$bn) 2.0 83.3%0.7 58.3% 11.9 72.1% 0.4 16.7% 0.5 41.7% 4.6 27.9% 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 1999 2000 2001 Non U.S. U.S.
source: China Securities and Futures Statistical Yearbook (various years) websites of various stock exchanges Bloomberg
Foreign markets are becoming more important than the domestic ones. Because the People’s Republic has more than enough capital for its own needs, we have to ask: What is wrong?
The essential problem is that the Communist Party, having authorized the markets in the era of Deng Xiaoping in the early 1990s, has failed to back crucial reforms during Jiang Zemin’s tenure. Incomplete development has left the exchanges in disarray, and Beijing seems to be paralyzed, unable to do what every observer agrees must be done.
There are a few explanations for this generally deplorable state of affairs. First, state-owned enterprises are powerful in China’s politicized economy and there is virtually no accountability to shareholders. Left to their own devices, managers of these businesses do what they want to: grossly waste resources in a variety of ways. In the past, the state was the victim of this behavior. Now, China’s small retail investors are also losers.
And these investors do, in fact, lose due to blatant fraud.4 In one of worst cases, the 4
major shareholders of Sanjiu Medical Pharmaceutical Ltd. misappropriated US$303 million, almost all the assets of the company.5 In the eyes of too many managers of listed companies, outside shareholders are there to be fleeced.
Second, the stability of the financial system of the nation could be undermined if the markets worked too well. The country’s banks are in poor shape, as discussed in Appendix 2. Insolvent, these financial institutions are kept afloat by a stream of new deposits from the nation’s small savers. If the domestic markets were really attractive, ordinary Chinese citizens might cash out their deposits to buy stock and reduce the flow of new liquidity that keeps these institutions going. That would be great for the equity markets but could be disastrous for the nation as a whole. It is true that, from time-to-time, technocrats try to coax a little of the money out of the banks and into the stock markets. Yet at the first sign of trouble, the whole process is quickly reversed: Beijing’s first instinct is to protect these sickly financial institutions, the lynchpin of the economy.
Third, the CSRC seems to be a captive of the industry it is supposed to regulate--the government watchdog just watches all the problems and barks only when prompted. As a consequence, the exchanges of Shanghai and Shenzhen are infested, plagued by market manipulation, insider trading, accounting fraud,
outright theft, and a dozen other corrupt practices. The markets are even worse than casinos. "Even casinos have rules and you cannot look at other people’s cards," said Wu Jinglian, one of the leading Mainland economists, in early 2001.6 Wu caught some flak in Beijing for that colorful statement, but nobody seriously questioned the accuracy of his assessment.
Today, in a sign that things are getting better, everyone seems to be aware of the problems in the markets. It is common, perhaps fashionable, for people in
Beijing to complain. Deputies at the recently-concluded National People’s Congress
meeting criticized the CSRC for the mess in the markets as did members of the advisory Chinese Peoples’ Political and Consultative Conference. In the words of the official Xinhua News Agency, the CSRC "should be responsible for the listing of unqualified companies, the falsification of financial statements by listed companies, joint trading of listed companies with their controlling shareholders, excessive speculation and insider manipulation."7 But bad practices in the Chinese markets are like the weather: everyone complains but no one really does anything.
Central government regulators rail against the situation, of course. Yet considering all of the misdeeds that occur, extremely few miscreants are
punished. Historically, Beijing has tolerated a certain amount of corrupt practices in the
markets so as to obtain the political support of the wealthy.8 Belatedly, the CSRC has tried to reduce the tide of market misdeeds, but only because it has had to. Financial system risk increased dramatically in 2001 because bank funds were finding their way into the markets through securities companies, which were losing money due to mismanagement and corruption. The losses are reputed to have been huge, thereby dramatically increasing the risk of systemic failure.9 The CSRC finally forced illegal money out of the markets to the tune of US$18.1 billion according to an estimate from 5
Shenyin Wanguo Securities.
The markets did not react well to the crackdown, and the CSRC subsequently backed off enforcing rules according to observers.10 Moreover, the CSRC has also lost enthusiasm for implementing important reforms as well. Perhaps the most visible retreat occurred this March when the CSRC decided not to impose tough accounting regulations. Instead, it issued a "dramatically watered-down version" of provisional rules issued in December,11 the last month in the CSRC’s "year of market supervision." Zhu Rongji can call accounting fraud "a malignant tumour,"12 but he either cannot or will not do much to cut it out.
So companies try to get away with as much as they can. Guangxia (Yinchuan) Industry manufactured almost 95 percent of its earnings reported in 1999 and 2000. This Shenzhen-listed company had the dubious distinction of being outed not by government officials but by journalists at the now-famous Caijing magazine.13 This incident
highlights an unwholesome development: pressure for cleaning up the markets is coming from below and is often resisted by those in authority.
And the authorities are dragging their feet, progressing as slowly as they can. Some of the worst offenders are those in charge of the legal system. The Supreme People’s Court has come out with rules that say how liability should be apportioned for false financial data. That’s good, but the thrust of the new regulations appears to limit liability.14
The effort to limit recoveries is no surprise because that court is no friend of the individual investor. In January 2002 the court lifted a temporary ban that it had previously imposed on shareholder suits. Now, investors can go to court, but only if the CSRC first punishes the company in question. In other words, the central government refuses to let shareholders take the initiative and keeps them at the mercy of the fraudsters. Moreover, the Supreme People’s Court said that shareholders may only sue for false misrepresentation; they are still prohibited from filing suits for other wrongs, such as insider trading and market manipulation.15
It may be no mistake that market manipulators are beyond the reach of shareholders because the biggest manipulator of them all is the central government. If there is one single reason why the domestic markets don’t work well, this is it. Experts like Lardy may see the exchanges as mechanisms to efficiently allocate capital, but Beijing created them as a way to sell off chunks of state-owned enterprises. So the central government, in its dual role as regulator and largest market player, delays necessary reforms when they threaten its ability to sell stock of state enterprises to investors.
As a result, the markets are kept at abnormally high levels. Chinese stocks in domestic bourses normally trade at price/earnings ratios well above those of markets outside the Mainland. Chinese stocks trading in nearby Hong Kong, for instance, can be found for ratios under ten16 while a few miles across the border in Shenzhen the prevailing ratios are five or six time higher on average. Stock prices in China can be more than ten times net asset value, and some high fliers have no net asset value at all. It is a gravity-defying act. 6
And a dangerous one. Not only is the potential of the markets huge as Laura Cha tells us, so are the risks that they pose to social stability. Beijing’s leaders are constantly concerned about falling stock prices, in part because of the fear of angering tens of millions of shareholders.17 And there is every reason to be concerned. "Their markets are an accident waiting to happen," one broker said referring to the exchanges in Shanghai and Shenzhen. "They’re like Nasdaq in 2000 or Japan in the 1980s."18 A steep fall, and maybe even a small one, could spell trouble: the average investor commits to the markets a sum equal to 23 times his or her annual income.19
So far, the central government has restricted the supply of new shares entering the Mainland markets as a means of maintaining prices. In an ideal world, Beijing could keep the markets aloft indefinitely by adopting this tactic. In the real world, however, technocrats face a tight deadline.
China’s social welfare system is almost bankrupt. As mentioned in Appendix 3, Beijing will need to come up with about US$1 trillion, and maybe even more, in the years ahead to make up funding shortfalls. For this purpose Chinese technocrats have devised a general concept that should work: sell more stock of state enterprises. The state still owns a majority of the shares of listed companies, some 70 percent according to state media.20
This concept was translated into a State Council plan, announced in June of last year, which essentially required companies selling stock on public markets to sell additional shares equivalent to 10 percent of the original offer size. The proceeds from the additional shares were to be handed over to the national social security fund.21 The rules applied to both domestic and foreign offerings.
In reaction to the June plan, the markets tanked, losing more than 30 percent of their value, some US$181 billion in market capitalization. Eventually, the CSRC suspended the plan to sell off state shares (on October 22, 2001).22 Markets soared after the CSRC withdrew the plan: stocks immediately hit their maximum 10 percent daily ceilings.23
Reversing course solved the problem of sinking prices, but it did nothing to take care of the original problem. But Beijing is nothing if not persistent. Just when technocrats thought that it was safe to reintroduce their plan to sell state shares, local stock speculators proved them wrong. In late January of this year the CSRC announced over a weekend several proposals to unload state-held shares. The following Monday (January
28) saw domestic markets plunge across the board (the indexes fell between 6.3 percent to 8.7 percent on that day).24 By Tuesday the CSRC was in "damage control mode" and announced that the plan was only "preliminary" and that "a lot of improvement needs to be made through further discussions." Stocks, predictably, went back up on the new announcement.25
"The hasty introduction and suspension of the scheme, though both well-intentioned, are indications of the CSRC’s inconsistent governance of the market,"26 wrote People’s Daily. The Communist Party’s paper is correct, of course, but the essential problems are 7
deeper than indecision of Laura Cha and her colleagues.
For one thing, Beijing is finally paying the price for operating wacky markets. "The plan’s fatal problem is that it is based on the premise that the market is operating stably," said Wang Yuanhong of the State Information Centre. "But we don’t have such a stable market now."27
Even if the markets worked in general, the CSRC plan would not have fared will. The technocrats have little, if anything, to show for all the turmoil that they have caused in the markets because they were in denial about one of the fundamental building blocks of economics: the law of supply and demand. These men and women, no matter how much they may think of their own abilities, cannot announce a plan to sell hundreds of billions of shares without causing a severe adjustment in prices.28
The CSRC in January did say that it would compensate existing holders of shares for price declines, but it was sketchy on details as to how it would do so.29 Apparently, the regulators thought that their good word was good enough to keep the markets high. No matter how credible they may be, they ignored simple economics. "No matter how the reduction is carried out, it means [a] big market expansion," said Dong Chen, a China Securities Co. analyst.30 "The plan fails to find a way to introduce new capital."
As even CSRC officials have learned by now, sales of state shares at market value will take too much liquidity out of the markets. Therefore, they could soften the blow by letting go of new shares below prevailing prices. Selling below market, unfortunately, is not considered an option for two reasons. First, there is a matter of finances. "The state needs cash," says Anthony Neoh, senior advisor to the CSRC.31 Second, there are politics and ideology: selling at a low price would look like a giveaway of state assets,32 dynamite in today’s China, at least among the senior cadres who care about these things.
Because the good options are not options, the CSRC can only say that its sell-down plan will be implemented gradually.33 The CSRC’s new proposals allowed for sales over a long period, maybe as long as 15 years, and a lock-up period in which the shares could not be sold after they became tradable.34 That sounds fine on paper, but in practice such a plan means that China’s markets would be burdened for a long time.
Even economists working for investment banks do not think much of the plan. Andy Xie of Morgan Stanley says that the lock-up period will not help: traders know that the shares will be coming onto the market in the future. The impact might be delayed, but the outcome will be the same, he believes.35 "This isn’t going to work," says Mou Xudong an analyst at Southern Securities in Shanghai,36 speaking of the CSRC’s January plan.
Today there has only been one concept that might help. There is talk that whatever funds are drawn out of the equity markets can be reinjected by the nation’s social security fund, which is now restricted to investment in bank deposits and government bonds. That plan, even if implemented, cannot have much effect because the need to pay pensions is so great--it is unlikely that the state will ever accumulate enough to have a material effect on 8
stock prices.
Now the Chinese markets exist in the worst possible of worlds. On the one hand, China’s social welfare system remains "on the verge of bankruptcy."37 And on the other, China’s equity markets are, in the words of analysts, "on the verge of collapse."38 Investors know that the share sell-down plan is coming, and the uncertainty is making the situation even worse. "It would be very hard for the markets to stage a solid recovery until the final selldown plan is revealed and clarified," says a stock analyst,39 expressing simple common sense. "I’m depressed," said one investor. "I hope the final decision can be made soon so that we know where the bottom of the market is."40
Investors may want to know where that point is, but the central government is not brave enough to find out. Yet Beijing will have to do something. China needs to pay pensions and unemployment benefits to workers. It can turn its back on the problem for a year or maybe even a decade, but at some point it will not be able to defer the problem any longer.41 The longer the pain is deferred, the worse it will be for everyone concerned.
Until they can figure out a solution, Beijing’s technocrats tinker to prop up the domestic
markets. Perhaps the most important tinkering in recent years involved the moribund B shares. The Chinese government maintains fractured domestic markets. There are A shares, available only to domestic investors, and B shares, once available only to foreigners. The former are denominated in renminbi and the latter either in U.S. or Hong Kong dollars. Trading in both types of shares takes place in Shanghai and Shenzhen. Chinese enterprises also issue shares in the foreign equity markets of Hong Kong (H shares), New York, Singapore, London, and Berlin.
Last February regulators opened the illiquid and cheaply-valued B share markets to domestic investors with foreign currency. A year after doing so, the reform still has not achieved its primary purpose of attracting big foreign money: "overseas investors are still shying away from this highly volatile and speculative market."42 Foreign institutions are repelled by the lack of good stocks, small free floats, and dominance of local speculators "stir-frying" (speculating). When foreigners want exposure to Chinese stocks, they invest their funds in the markets outside the Mainland, especially those in Hong Kong.
Of course Beijing should fix small problems, and everyone knows that last year’s liberalization of the B share markets was a step in the right direction. Yet major restructuring is more appropriate at this point in time: every analyst agrees that China eventually needs to combine all the separate markets. Technocrats won’t do that for years, and maybe even decades, because a complete merger contemplates making the renminbi convertible. So we can understand why the job won’t be finished soon. Yet Beijing is now moving in the wrong direction by effectively creating even more
categories of shares. The next major move will be permitting domestic investors to buy shares listed in Hong Kong pursuant to the qualified domestic institutional investor scheme (QDII), which could be put in place as early as July of this year.43 Moreover, a few foreign companies will get permission to list on domestic markets by selling China Depository Receipts (CDRs), and this will permit 9
Mainland investors to use renminbi to buy the shares of these companies.44 These further divisions of the market can only lead to more inefficiency in the allocation of capital--and lead to a further erosion of prices on the A share market.
These steps also show that Beijing’s main goal these days is to support the stock price of Chinese enterprises. There is speculation that the stocks in the QDII scheme will be limited to Hong Kong-listed Mainland companies "with the likely result of
sending their prices in a straight line up."45 And in the first batch of CDRs will be the Hong Kong-listed companies that are arms of Mainland enterprises. So expect to see rising prices for China Mobile (Hong Kong), China Resources, Shanghai Industrial Holdings, and Beijing Enterprises.46
The CSRC also is working on smaller adjustments to the equity markets, such as the recent deregulation of brokerage commission rates.47 Such deregulation is a definite improvement, and many analysts see steps such as this as proof that regulators are pushing in the right direction. Although many CSRC officials personally would like to see reform, the motivation for regulatory activity has little to do with improvement of the markets. Brokerage commissions were deregulated to stimulate interest in stock trading.
Stimulating such interest is also behind another "reform": the central government will soon permit banks to make loans to retail investors with stock as collateral. The purpose is to permit the investors to borrow for further stock market investment.48 Beijing spent the better part of a half decade getting the banks out of the equity markets to prevent the further erosion of credit quality. Now it is pushing the banks back in. Stock prices will benefit, but banks will inevitably create new nonperforming loans.
Worse, regulators have maintained their policy of avoiding the delisting of bad companies. Only three companies have been thrown off a Mainland exchange so
far,49 and retailer Zhengzhou Baiwen, a shell of a company, has somehow avoided sharing their fate.50 It is inevitable that it will be delisted, yet it should have gone long ago. Many people think that Baiwen should have had the honor of being the first to be booted off a Chinese bourse. And there are many more Baiwens that regulators choose not to see. "We all know that the Chinese stock market has a lot of very troubled companies that are propped up by helium," says James McGregor, a consultant based in Beijing. "You think Enron is bad? You should see some of the companies here."51
The current situation is untenable, at least in the long run. On the one hand, there is no doubt that Beijing can keep stock prices high in the long term. After all, it sets the rules and administers the game. So it mostly gets the desired
results. In the future, it can continue to employ all of the old tactics to support the markets such as restricting investment alternatives, leaning on companies to scale back offerings,52 providing financial and other types of support for listed enterprises, and, when all else fails, talking up the markets. Especially when all else fails, regulators resort to issuing happy thoughts. "The authorities don’t want to see the market fall too much, so they released good news to keep investors from becoming even more pessimistic," said an analyst at Pingan Securities in Shenzhen.53 10
On the other hand, all these proven tactics defer the change that must occur if China is to achieve important, and some say critical, goals. There is, after all, no point in having stock markets if they do not allocate capital efficiently and thereby promote economic development. Beijing should listen to some folksy advice that economist Hu Ruyin dispensed in March of this year: "Yesterday I went to the dentist to pull a tooth. That means some short-term pain, but otherwise we would have long-term pain."54
And what is the future of the markets? There will not be much progress over the next few years: Beijing, even at this late date, is unwilling to endure pain. What forward movement we will see will come about only because the government will not have a choice. We have to remember that in this period of political transition in Beijing, even economic reforms are being put on hold.
Nick Lardy testified on December 6 that if the central government reforms the domestic markets, Chinese issuers will issue at home. If it cannot, they will have
to issue abroad. Because reforms will be slow in coming, we will see a stream of initial
public offerings abroad, most of them in Hong Kong55 but many in the U.S. as well. As Joe Zhang, head of China research at UBS Warburg, said recently: "The fund-raising channels on the mainland are temporarily blocked, so they are coming to Hong Kong."56
And there are other reasons why Chinese companies will list outside the Mainland. Jiang Zemin himself is giving an impetus to domestic enterprises to list abroad.57 His "go outside" theory is being interpreted by local cadres as approval to have their best enterprises sell stock overseas, which is easier than listing on the domestic
exchanges. Lardy, in his testimony, supplies the reason why the better companies will
have to continue to go offshore for at least the next few years. "Very large issues are not possible on the domestic market," he points out. "The continuing paradox is that a country with the highest rate of savings in the world . . . can’t float a share offering of significant size on its domestic market."58
As efforts to increase offerings at home fail, the state will seek to increase the flow of stock sales in foreign markets. For example, last Christmas Eve the State Development Planning Commission announced a plan to encourage overseas listings, even hinting that foreigners would be allowed to hold controlling positions in large state enterprises, except for those considered vital to national or economic security.59 Up to now, the state has permitted foreigners only minority positions in larger state enterprises in public flotations of stock. And the state will resort to a time-honored technique: talking up the markets.
The country’s stock markets could start a bull run lasting a decade after a period of adjustment this year, says the prestigious Chinese Academy of Social Sciences.60 The truth is, the markets are so wacky they could do anything, but going up seems improbable unless more capital is made available. Beijing can lean on its academics or even Laura Cha to say something nice, but this tactic by itself is not going to help investor confidence.
Until the state can get its policies right, we will have to listen to other voices. A 11
professor at Shanghai Fudan University, Xie Baisan, says that China’s markets are at a "critical point between life and death."61 Not everyone would use such stark words, but facts speak for themselves. Last year saw a drop in stock prices, overall market capitalization,62 and trading volume.63 And, despite the sky-high multiples that can be found in the home markets, there was an acceleration of the trend of issuing stock offshore. The money knows that something is wrong.
1 The potential of China’s equity markets is "huge": Lester J. Gesteland, "Potential for China’s Stock Market is ‘Huge,’ Says CSRC’s Laura Cha," chinaonline.com, March 29, 2002.
2 Analysts speculate: Stephen Harner in his written testimony submitted to the Commission (p. 4) suggests that the surge in offerings in 2000 was a direct result of the Asian crisis.
3 approximately US$157 billion in new loans extended: Peter Wonacott, 12
"China’s Efforts to Revive Market Might Take Away from Reforms," wsj.com, April 16, 2002.
4 due to blatant fraud: Bei Hu, "Chinese Cookery Books," scmp.com, March 26, 2002.
5 Sanjiu Medical Pharmaceutical Ltd. misappropriated US$303 million: Elaine Kurtenbach, "Enron Debacle Adds Urgency to Corp, Fincl Reform in China," wsj.com, March 12, 2002; "China Pushes Corporate, Financial Reforms Amid US Woes," Dow Jones Newswires, March 10, 2002.
6 "Even casinos have rules": Tiffany Wu, "Foreigners Welcome China Crackdown as Market Frets," Reuters News Service, February 11, 2001.
7 "should be responsible": "CSRC Under Fire at NPC, CPPCC Sessions," Xinhua News Agency, March 9, 2002.
8 Beijing has tolerated: Dan Slater, "Caijing Leads the Difficult Battle Against Market Manipulation in China," FinanceAsia.com, April 3, 2002.
9 increasing the risk of systemic failure: Stephen Harner, e-mail to author, October 26, 2001.
10 the CSRC subsequently backed off enforcing rules: See, e.g., Peter Wonacott, "China’s Efforts to Revive Market Might Take Away from Reforms," wsj.com, April 16, 2002.
11 "dramatically watered-down version": Bei Hu, "Tough Audit Rules Eased After Outcry from Interest Groups," scmp.com, March 2, 2002.
12 "a malignant tumour": "China’s Zhu Decries Accounting Fraud as Tumour," scmp.com, October 30, 2001.
13 the now-famous Caijing magazine: For general background about the growing influence of Caijing, see Dan Slater, "Caijing Leads the Difficult Battle Against Market Manipulation in China," FinanceAsia.com, April 3, 2002. For information about the fraud at Guangxia (Yinchuan) Industry, see Sophie Roell, "China Tightens Fincl Acctg Scrutiny for Listed Companies," Dow Jones Newswires, December 25, 2001.
14 Supreme People’s Court: Pamela Pun, "Courts Cast Wider Net on False Data," Hong Kong iMail, March 27, 2002.
15 they are still prohibited: See, e.g., Eric Ng, "Court Door Opens to Investors," scmp.com, January 16, 2002.
16 Chinese stocks trading in nearby Hong Kong: Edith Terry, "New York a Step Too 13
Far for Shanghai," scmp.com, April 5, 2002.
17 tens of millions of shareholders: It is often reported that there are 60 million domestic shareholders, but that is the number of brokerage accounts. Many of them hold multiple accounts. A recent survey concludes that there were about 34 million shareholders at the end of last year. See Bei Hu, "Exposure to Stocks Unhealthy," scmp.com, April 16, 2002.
18 "an accident waiting to happen": Edith Terry, "New York a Step Too Far for Shanghai," scmp.com, April 5, 2002.
19 a sum equal to 23 times his or her annual income: Bei Hu, "Exposure to Stocks Unhealthy," scmp.com, April 16, 2002.
20 70 percent: "CSRC Must Move Carefully to Ensure Investor Confidence," People’s Daily Online, January 23, 2002. Foreign media generally say 60 percent or sometimes 65 percent. See, e.g., Kenneth McCallum, "Securities Authorities in China Soften Message on Plan to Sell State Shares," Dow Jones Newswires, January 29, 2002.
21 proceeds from the additional shares: See, e.g., Peggy Sito, "Rules Revealed for State-Owned Stock Sell-Off," South China Morning Post, June 15, 2001, Business Post p. 4.
22 the CSRC suspended the plan: For background information, see Winston Yau, "Pressure Mounts for Boost to Market," scmp.com, March 5, 2002. The suspension of the state share plan applies only to domestic offerings: foreign ones must still contribute to the social security fund, as Aluminum Corp. of China, better known as Chalco, did when it listed last year in Hong Kong and New York. Chi-Chu Tschang, "Welfare Fund Still Gains from Share Sales," scmp.com, April 29, 2002.
23 Markets soared: Mark O’Neill, "China Ban Lifts Markets," South China Morning Post, October 24, 2001, Business Post p. 1.
24 markets plunge: Joe Leahy, "China Shares Fall on Sale Plan," ft.com, January 28, 2002.
25 went back up on the new announcement: Kenneth McCallum, "Securities Authorities in China Soften Message on Plan to Sell State Shares," Dow Jones Newswires, January 29, 2002.
26 "inconsistent governance of the market": "CSRC Must Move Carefully to Ensure Investor Confidence," People’s Daily Online, January 23, 2002.
27 "But we don’t have such a stable market now": "Disappointing State Shares Plan Incites Selling Spree," chinadaily.com.cn, January 29, 2002. 14
28 a severe adjustment in prices: The problem is even worse than the market thinks because many of the largest state enterprises, about a third, have yet to be listed. See Emmanuel Pitsilis, David A. von Emloh, and Yi Wang, "Filing China’s Pension Gap, " McKinsey Quarterly, 2002 Number 2 (available at www.mckinseyquarterly.com).
29 it was sketchy on details: "Disappointing State Shares Plan Incites Selling Spree," chinadaily.com.cn, January 29, 2002.
30 "No matter how the reduction is carried out": "Disappointing State Shares Plan Incites Selling Spree," chinadaily.com.cn, January 29, 2002.
31 "The state needs cash": William Kazer, "Neoh Says Market Too Jumpy on State Stake Sales Talk," South China Morning Post, April 30, 2001, Business Post p. 3.
32 selling at a low price would look life a giveaway of state assets: Jia Hepeng, "Market Concern Refocuses on State Share Sell-Off Plan," chinadaily.com.cn, January 22, 2002.
33 implemented gradually: "Disappointing State Shares Plan Incites Selling Spree," chinadaily.com.cn, January 29, 2002.
34 The CSRC’s new proposals: Peggy Sito, "Sale Fears Hit Mainland Stocks," scmp.com, January 29, 2002.
35 the outcome will be the same: Peggy Sito, "Sale Fears Hit Mainland Stocks," scmp.com, January 29, 2002.
36 "This isn’t going to work": Kenneth McCallum, "China Shares Plunge on Plan for Non-Tradable Shares," Dow Jones Newswires, January 28, 2002.
37 "on the verge of bankruptcy": Emmanuel Pitsilis, David A. von Emloh, and Yi Wang, "Filing China’s Pension Gap," McKinsey Quarterly, 2002 Number 2 (available at www.mckinseyquarterly.com).
38 "on the verge of collapse": "Upcoming Meeting Bids to Stabilize Bearish Market," chinadaily.com.cn, January 23, 2002. For similar sentiments, see "Disappointing State Shares Plan Incites Selling Spree," chinadaily.com.cn, January 29, 2002.
39 "It would be very hard for the markets to stage a solid recovery": "Shares Rise as CSRC Continues to Ponders [sic] Sell-Off Plan," chinadaily.com.cn, January 30, 2002.
40 "I’m depressed": "Disappointing State Shares Plan Incites Selling Spree," chinadaily.com.cn, January 29, 2002. 15
41 it will not be able to defer the problem: There’s something else that is being deferred: an important side benefit of a sell-down is that state enterprises would eventually be run by private shareholders. "Nothing really changes if a company becomes publicly listed but the government owns all the shares," says David Hutton of ING Pension Trust. Chi-Chu Tschang, "Scrip Sale Easy Way to Resolve Dilemma, " scmp.com, December 19,2001. Reform of state enterprises may actually occur when managements really have to answer to owners.
42 "overseas investors are still shying away": Ramoncito dela Cruz, "One Year After, China B Shr Mkt Still Punters Paradise," Dow Jones Newswires, February 24, 2002.
43 qualified domestic institutional investor scheme: For details about this new
program, see Clara Li, "Opening into SAR Stocks Welcomed," scmp.com, April 4, 2002; Bei Hu, "Foreigners Tipped to Run Investor Scheme," scmp.com, March 29, 2002; Mark O’Neill, "China Share Trade Closer," South China Morning Post, March 14, 2002, Business 2 p. 1; Bei Hu and Peggy Sito, "Careful Words on Investment Keep Players Guessing," South China Morning Post, March 13, 2002, Business Post p. 5.
44 China Depository Receipts: See Chi-Chu Tschang, "Think-Tank Predicts Decade-Long Bull Run," scmp.com, April 25, 2002.
45 "with the likely result of sending their prices in a straight line up": Edith Terry, "New York a Step Too Far for Shanghai," scmp.com, April 5, 2002.
46 So expect to see rising prices: "Capital Market Continues to Further Open Up," chinabiz.org, April 5, 2002.
47 deregulation of brokerage commission rates: See "China Lowers Commission for Stock Trading," People’s Daily Online, April 8, 2002.
48 to borrow for further stock market investment: Pamela Pun, "Easier Loans Policy Nears to Lift Tired Stocks," hk-imail.com, April 11, 2002.
49 Only three companies have been thrown off: Jianguo Jiang, "Baiwen Revises Profit to Loss, May Face Delisting (Update 1)," bloomberg.com, April 12, 2002.
50 Zhengzhou Baiwen: For more information about this company, see Bill Savadove, "Loser Baiwen at a Loss Again," scmp.com, April 11, 2002.
51 "propped up by helium": Elaine Kurtenbach, "Enron Debacle Adds Urgency to Corp, Fincl Reform in China," wsj.com, March 12, 2002.
52 all of the old tactics: "Reshuffle Aims to Combat Foul Play," scmp.com, October 17, 2001. 16
53 "The authorities don’t want to see the market fall too much": Bill Savadove and Samuel Yeung, "China Sets Pace on Fees," scmp.com, April 6, 2002 (comments of Gao Xing).
54 "Yesterday I went to the dentist to pull a tooth": "Sell State Shares Fast--Economist," chinabiz.org, March 23, 2002.
55 most of them in Hong Kong: Bank of China (Hong Kong) Ltd. has just scrapped the planned sale of shares in New York according to reports. It will go ahead with just a Hong Kong listing. Rob Stewart, "Bank of China Abandons U.S. Listing Plans in Favor of Hong Kong," bloomberg.com, April 15, 2002. Not everyone agrees the reports are correct. See Louis Beckerling and Eric Ng, "BOC Considers Early HK Launch," scmp.com, April 17, 2002.
56 "The fund-raising channels on the mainland are temporarily blocked": Chi-Chu Tschang, "SAR Back in Favour for Listings," South China Morning Post, April 6, 2002, Business Post p. 3.
57 Jiang Zemin himself: Chi-Chu Tschang, "Jiang Gives Impetus to List Abroad," scmp.com, March 25, 2002.
58 "The continuing paradox": Peter Wonacott, "China’s Efforts to Revive Market Might Take Away from Reforms," wsj.com, April 16, 2002.
59 the State Development Planning Commission announced: Fu Jing, "Overseas Investors to Buy into SOEs," chinadaily.com.cn, December 25, 2001. For additional information, see "China to Push Foreign Stakes in Big State Firms," Reuters News Service, December 24, 2001.
60 "a bull run lasting a decade": Chi-Chu Tschang, "Think-Tank Predicts Decade-Long Bull Run," scmp.com, April 25, 2002.
61 "critical point between life and death": Peggy Sito, "CDRs May Be Lunar New Year Investors’ Gift," scmp.com, January 17, 2002.
62 market capitalization: "Securities Market Shrank 9% in 2001," chinaonline.com, March 4, 2002. Market capitalization of China’s domestic equity markets at the end of last year was US$525.4 billion, down 9.5 percent from the previous year, according to Zhu Zhixin, director of the National Bureau of Statistics.
63 trading volume: Bill Savadove and Samuel Yeung, "China Sets Pace on Fees," scmp.com, April 6, 2002. "Since last year, there has been a dramatic drop in trading volume because of the reduction of state shares," says Gao Xing, an analyst in Shenzhen for Pingan Securities.

Billion dollar investing tips from Warren Buffett

2007-09-30T14:34:00.001-07:00

Widely considered the most successful investor of all time, Warren Buffett is a luminous example of the school of value investing. Starting with an initial fund of $105,000 in 1956, Buffet grew it to $45 billion over the next 50 years, making him the second richest man in the world. Though he is widely recognized as being an investor, the bulk of Buffet's wealth was built through intelligent use of leverage offered by his insurance companies. Since most individual investors do not have access to the type of capital that Buffet does, it is not easy to replicate his astounding wealth-building feat. However, by understanding and applying the basic guidelines of Buffett's investment approach to their own investing decisions, most long term investors can comfortably beat the returns of all but the best mutual fund managers.
So, how did Buffet accumulate the huge fortune that he eventually gave away to the charitable foundation run by his best friend, Bill Gates? One of the greatest attractions of Buffett for investors is that his investment methodology is easy to understand. However, it is far more difficult to apply because it calls for large amounts of patience and calm when your stocks move against you. It is also difficult to apply because it requires an orientation towards research and the ability to understand the complexities of accounting and finance. But for those willing to invest time and effort into mastering this approach, superlative investment performance over the long term is guaranteed.
Invest in Businesses, Not in Stocks
"Whenever we buy common stocks for Berkshire's insurance companies (leaving aside arbitrage purchases), we approach the transaction as if we were buying into a private business. We look at the economic prospects of the business, the people in charge of running it, and the price we must pay." -- Warren Buffett
This is the cornerstone of Buffett's investment style. Whenever he evaluates an investment opportunity he analyses it as a business and not as a stock. This makes him look closely at the company's fundamentals, earnings prospects, financial health and management. Conversely, this style of evaluating a business prevents him from buying a stock just because it is going up even though it has dubious prospects. A lot of investors tend to buy stocks based on tips from friends, acquaintances or brokers. By adopting Buffett's approach, you can save yourself a lot of grief later on.
Only Buy Businesses that You Understand
"Did we foresee thirty years ago what would transpire in the television manufacturing or computer industries? Of course not. Why, then, should Charlie and I now think we can predict the future of other rapidly evolving business? We'll stick instead with the easy cases. Why search for a needle buried in a haystack when one is sitting in plain sight?" -- Warren Buffett
Buffett has a track record of generating 21 per cent annually compounded returns over a 50-year time frame, a feat matched by very few investment managers. Though technology companies delivered some of the best returns during this period, Buffet has never owned one for the simple reason that he could not understand the long term prospects of these companies and evaluate them thoroughly. So the next time you get a tip to buy a "hot" company that you do not understand, you should ask yourself: "If the greatest investor in the world will not invest in something he doesn't understand, should I?"
Buy Companies with Defensible 'Franchise'
"As Peter Lynch says, stocks of companies selling commodity-like products should come with a warning label: 'Competition may prove hazardous to human wealth'." -- Warren Buffett
Most of Buffett's portfolio companies, such as Coca Cola, Gillette (now Procter and Gamble), American Express and Washington Post, are businesses which have a significant hold over their market. This is because they have inherent competitive advantages, whether it be a highly recognizable brand, or near-monopoly status in a geographic area. Such companies can typically raise their prices without fear that customers will walk away. This in turn produces fantastic earnings growth and, consequently, great investment performance. So, before you make an investment in future, try to understand whether the company you are investing in has a strong and defensible market position and whether it can raise prices if it needs to.
Hold for the Long Term
"We are willing to hold a stock indefinitely so long as we expect the business to increase in intrinsic value at a satisfactory rate . . . we do not sell our holdings just because they have appreciated or because we have held them for a long time." � Warren Buffett
Buffett's companies have generated enormous returns for him. For example, his investment of $10 million in 1973 in the Washington Post Company had grown to more than $1 billion by 2003. While a lot of us may be able to do this occasionally, Buffett has generated such returns with startling regularity. One of the reasons he is able to do so is because he holds for the long term and is not quick to enter or exit businesses. In fact, he stuck with WPC for two years even though its price fell below his purchase price because he understood the fundamentals of the business and believed that it was undervalued. Even once it became profitable, he was not quick to exit because he believed that it had greater potential. He held it through several bull and bear markets and no greater proof is needed than the return he achieved to show that he was right in holding it for so long.
Ignore Short-Term Fluctuations in Price
"Charlie and I let our marketable equities tell us by their operating results�not by their daily, or even yearly, price quotations�whether our investments are successful. The market may ignore business success for a while, but eventually will confirm it." � Warren Buffett
The stock market has a tendency to overreact on both the upside and downside. Often the market ignores the fundamentals of a business and reacts sharply to news flow. Sometimes entire sectors become either unduly depressed or overpriced. One of the key pillars of Buffett's approach is to ignore short-term fluctuations in price. He does not sell a stock because the market suddenly decides to drop. Neither does he buy one because it is going up. Once Buffett has calmly evaluated the fundamentals, he will buy the stock if its price is right. If the stock dips after he has purchased it, he does not worry so long as its fundamentals are good. Had he gotten jittery due to short-term price fluctuations, he would have been a lot less richer than he his currently.
Buy Good Businesses When Prices are Down
"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they feel elated when stock prices rise and depressed when they fall. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices." � Warren Buffett
On 19 October 1987, all global stock markets crashed. The Dow Jones Industrial Average actually suffered a decline of 22 per cent, the greatest single-day drop in its history. Every stock on the market fell. Most people sold their holdings in panic that day. Buffett, however, was buying! He made the single largest stock purchase of his life that day. While all others around him hit the panic button, Buffet bought 10 per cent of Coca Cola for $1 billion. Not only was it his largest single stock purchase, he also became the single largest shareholder in the company. In his analysis, Coca Cola had a great business, great long-term prospects and the ability to expand because of globalisation. If the market was willing to sell it at an unreasonably cheap price, he wanted to scoop it up with both hands. And scoop it up he did! Coca Cola became one of the most successful investments in Berkshire's portfolio. By 2006, Buffett had made over $11 billion on Coke since he bought it.
Don't Be an Active Trader
"Indeed, we believe that according the name 'investors' to institutions that trade actively is like calling someone who repeatedly engages in one-night stands a romantic." � Warren Buffett
Buffett is an atypical investor not only because he is highly successful, but also because he does not even look at stock tickers. He believes that trading too much is a tax-inefficient and costly approach to investing. Consequently, he has a very low turnover portfolio, very low brokerage charges and has not paid very much in the nature of capital gains taxes.
Do Not Over-Diversify
"If you are a know-something investor, able to understand business economics and to find five to ten sensibly priced companies that possess important long-term competitive advantage, conventional diversification makes no sense for you." -- Warren Buffett
A striking aspect of Buffett's portfolio at Berkshire is the small number of stocks in it. This number has rarely exceeded 10 stocks. Buffett believes that there are very few outstanding investment opportunities at any given point of time and that one should invest enough in each of those to make a substantial difference. In contrast, most people fill up their portfolios with more than fifty stocks. As a result, even if a stock appreciates 100 per cent, the impact on their net worth will only be 2 per cent. Investors who want to generate truly outstanding returns should identify a small number of great businesses at the right prices and invest a significant amount of their money in each of them.
Invest Only When There is a Margin of Safety
"Margin of safety" is a slightly difficult concept to understand. It can be loosely defined as the difference between value and price. If the value of what you buy is higher than the price you pay for it, you have a high margin of safety. If the price you pay is greater than value, you have a low margin of safety. When the margin of safety is high, the investor need not worry about short-term fluctuations in price and can buy more if he or she has the resources to do so. Also, if you are investing in a situation with a significant margin of safety, you are likely to make a higher return because you are buying at a relatively low price.
However, how does one quantify this margin of safety? It is admittedly a grey area. There are seemingly scientific approaches, such as the discounted cash flow, which are taught in most corporate finance textbooks. In practice, though, it is both very subjective and very difficult for an individual investor to apply. However, there are other short cuts which are more approachable. Since the discounted cash flow ultimately crystallizes into the price / earnings (P/E) ratio, one way of estimating the margin of safety is to look at the P/E ratio. A low P/E means there is a margin of safety. But even this approach has its pitfalls. Slow growing, lousy companies often tend to have low P/E ratios. And, sometimes, very promising companies have high P/E multiples. One way around this problem is to divide the P/E ratio by the growth rate of the company's profits to arrive at its price-earnings to growth ratio. Thus, if a company's P/E is 20 and the growth rate of its profits is 20 per cent, its PEG is 1. Oftentimes, a PEG of less than 1 implies that there is a significant margin of safety. A PEG of greater than one means that the margin of safety is not very high.
That said, PEG is not the holy grail of valuation and there are several ways to value a company -- and all these approaches have their flaws. You can consider your time well invested if you spend some time researching valuation by reading a corporate finance textbook.
Thus, Warren Buffet's investment approach is easy to understand, but calls for significant effort on your part to understand businesses, evaluate them and invest successfully but then, nobody said that becoming a billionaire was easy!

Will A Google Phone Change The Game?

2007-09-30T13:27:00.000-07:00

Mobile biggies are quaking at the idea of competition from a free, ad-based service Imagine your cellphone as a mini marketing machine. As you head into your car after dinner, a text alert pops onto the screen of your handset announcing the 9 p.m. lineup at a nearby cineplex. You choose the Jodi Foster flick The Brave One and a promo video for the next Warner Bros. (TWX ) release, a George Clooney movie, starts running. Afterward, more text appears, prompting you to launch the phone's Web browser so that you can click through to buy the movie's ringtones and wallpaper.

That kind of 24/7 advertising engagement--on a phone, no less--may sound like a nightmare. But what if you could determine the kinds of products you get pitched? Or, when your flight gets canceled in a faraway airport, text messages pop up for the best hotel deals in town? No random insurance ads or airline deals for trips to places you never visit. Best of all: Watch or read the custom ads, and your phone minutes are free.For big cell carriers, that's the real nightmare. And it may be coming in the form of a Google phone. Wireless industry consultants and marketing executives with knowledge of Google's plans say it has been showing prototypes of a new phone to handset manufacturers and network operators for a couple of months. Its plans have been kept top secret, but Google is expected to tap a company on the Pacific Rim that specializes in mobile design and manufacturing to build a handset to its specs. Google could then apply its expertise in operating software and user applications, says Paul Catalano, a partner at consultancy RelevantC Business Group (RCBG). Google officials won't talk about phones, and industry sources don't expect one before the second half of 2008.Still, Google has made it clear it has an interest in wireless. It is experimenting with wireless broadband networks in a couple of U.S. cities. In August, CEO Eric Schmidt announced his intention to participate in a federal auction early next year of the sort of radio spectrum that would help pull off a phone service.So far only a few outfits in Europe and the U.S. have dabbled with ways to serve up ad-based service. Most, like Virgin Mobile USA, have limited control over ad delivery because their service runs over a network leased from one of the big players. Moreover, there are good reasons that advertising accounts for less than 1% of phone company revenues: Consumers remain skittish about ads on their phone. Networks and handsets are only now getting sophisticated enough to deliver colorful, location-specific ads. And Verizon (VZ ), AT&T (T ), and T-Mobile have no interest in giving up their fat service fees.That equation goes out the window, though, once you combine Google's financial heft with its ultra-sophisticated ability to target ads to specific customers. "The day is coming when wireless users will experience nirvana scenarios--mobile ads tied to your individual behavior, what you are doing, and where you are," says Linda Barrabee, wireless analyst at researcher Yankee Group.BILLIONS OF EYESGoogle and advertisers drool over the growth potential in wireless. The more than 2 1/2 billion phones in use worldwide exceed the number of PCs and TVs combined. On Sept. 17, Google announced a Web program aimed at advertisers who have created sites for display on cell phones and other handheld devices. Like its online ad network, Google's AdSense for Mobile delivers ads relevant to the advertiser's mobile audience. "The sheer volume of users across the globe makes mobile the next channel for information," says Dilip Venkatachari, director of product management for Google's mobile team.Why stop there? The core of Google's online ad strategy has always been to help advertisers target their ads so they fit like spandex tights with user interests. Employing technologies that figure out where callers are and where they're headed boosts advertising prices by 50%, according to studies by RCBG.A number of existing strategies by smaller companies offer a glimpse into how Google might play its wireless hand, once all the cards have been dealt. Blyk, a wireless startup that made its debut in Britain on Sept. 24, offers free mobile phone calls and text messages for people aged 16 to 24 who agree to let companies such as L'Oréal, McDonald's (MCD ), and Coca-Cola (KO ) send text ads to their handsets. Blyk leases space on European carrier Orange's network in Britain, but it operates its own billing and marketing system. That lets it retain full control of valuable customer information and avoid sharing ad revenues with the carrier. Users fill out detailed information about their lifestyles, areas of interest, and brand preferences. Those who agree to receive tailored ads get 43 minutes per month of free mobile voice service and 217 free text messages.In the U.S., a service from Virgin Mobile called Sugar Mama offers subscribers a chance to earn free minutes if they agree to view tailored ads. As of August, more than 425,000 people had signed up. They can choose to have text ads in the form of quizzes and games sent to a phone a couple of times a week; play the games and you earn minutes.The big-time carriers already have banner ads from companies such as Avis or the Discovery Channel on the pages of their mobile Web portals. But don't expect the phone giants to change their business model if they don't have to. A Verizon spokesman says the incremental dollar value of advertising pales next to the cost of losing customers who don't like ads. Says AT&T Mobility's Mark Collins, vice-president for consumer data: "We don't believe in a world where you have to give everything away for free."That's precisely what Google represents. Even without a network, Venkatachari says Google plans to connect mobile advertisers with users based on information from its search engine, maps, and other software, just as it has done on the desktop. Via Google search, for example, an advertiser learns a user is at the corner bakery in downtown Chicago. And it learns the person has a taste for sweets. Wireless carriers have customer information as well, but "they are not a data warehouse, the way Google is," explains Richard Siber, principal of SiberConsulting.If Google decides to spend the $4.6 billion that may be needed to win the spectrum auction, analysts speculate that it has several options: continue its broadband expansion, or perhaps buy a wireless carrier, such as beleaguered Sprint Nextel (S ). Then it could launch the first ad- supported, and free, nationwide phone service. "Google is the first gambler sitting down with as big a bankroll as the carriers have," says John du Pre Gauntt, a wireless industry analyst for researcher eMarketer. "By playing in wireless, they have caused people to look at the industry in a different way

2007-09-22T13:13:00.000-07:00

All about commodity derivatives You would like to know before you start to put the bets on it.

Trading in derivatives first started to protect farmers from the risk of the value of their crop going below the cost price of their produce. Derivative contracts were offered on various agricultural products like cotton, rice, coffee, wheat, pepper, et cetera.
The first organised exchange, the Chicago Board of Trade (CBOT) -- with standardised contracts on various commodities -- was established in 1848. In 1874, the Chicago Produce Exchange -- which is now known as Chicago Mercantile Exchange -- was formed (CME).
CBOT and CME are two of the largest commodity derivatives exchanges in the world.
The Indian scenario
Commodity derivatives have had a long and a chequered presence in India. The commodity derivative market has been functioning in India since the nineteenth century with organised trading in cotton through the establishment of Cotton Trade Association in 1875. Over the years, there have been various bans, suspensions and regulatory dogmas on various contracts.
There are 25 commodity derivative exchanges in India as of now and derivative contracts on nearly 100 commodities are available for trade. The overall turnover is expected to touch Rs 5 lakh crore (Rs 5 trillion) by the end of 2004-2005.
National Commodity and Derivatives Exchange (NCDEX) is the largest commodity derivatives exchange with a turnover of around Rs 3,000 crore (Rs 30 billion) every fortnight.
It is only in the last decade that commodity derivatives exchanges have been actively encouraged. But, the markets have suffered from poor liquidity and have not grown to any significant level, till recently.
However, in the year 2003, four national commodity exchanges became operational; National Multi-Commodity Exchange of India (NMCE), National Board of Trade (NBOT), National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX).
The onset of these exchanges and the introduction of futures contracts on new commodities by the Forwards Market Commission have triggered significant levels of trade. Now the commodities futures trading in India is all set to match the volumes on the capital markets.
Investing in commodity derivatives
Commodity derivatives, which were traditionally developed for risk management purposes, are now growing in popularity as an investment tool. Most of the trading in the commodity derivatives market is being done by people who have no need for the commodity itself.
They just speculate on the direction of the price of these commodities, hoping to make money if the price moves in their favour.
The commodity derivatives market is a direct way to invest in commodities rather than investing in the companies that trade in those commodities.
For example, an investor can invest directly in a steel derivative rather than investing in the shares of Tata Steel. It is easier to forecast the price of commodities based on their demand and supply forecasts as compared to forecasting the price of the shares of a company -- which depend on many other factors than just the demand -- and supply of the products they manufacture and sell or trade in.
Also, derivatives are much cheaper to trade in as only a small sum of money is required to buy a derivative contract.
Let us assume that an investor buys a tonne of soybean for Rs 8,700 in anticipation that the prices will rise to Rs 9,000 by June 30, 2005. He will be able to make a profit of Rs 300 on his investment, which is 3.4%. Compare this to the scenario if the investor had decided to buy soybean futures instead.
Before we look into how investment in a derivative contract works, we must familiarise ourselves with the buyer and the seller of a derivative contract. A buyer of a derivative contract is a person who pays an initial margin to buy the right to buy or sell a commodity at a certain price and a certain date in the future.
On the other hand, the seller accepts the margin and agrees to fulfil the agreed terms of the contract by buying or selling the commodity at the agreed price on the maturity date of the contract.
Now let us say the investor buys soybean futures contract to buy one tonne of soybean for Rs 8,700 (exercise price) . The contract is available by paying an initial margin of 10%, i.e. Rs 870. Note that the investor needs to invest only Rs 870 here.
The price of soybean in the market is, say, Rs 9,000 (known as Spot Price -- Spot Price is the current market price of the commodity at any point in time).
The investor can take the delivery of one tonne of soybean at Rs 8,700 and immediately sell it in the market for Rs 9,000, making a profit of Rs 300. So the return on the investment of Rs 870 is 34.5%. On the contrary, if the price of soybean drops to Rs 8,400 the investor will end up making a loss of 34.5%.
If the investor wants, instead of taking the delivery of the commodity upon maturity of the contract, an option to settle the contract in cash also exists. Cash settlement comprises exchange of the difference in the spot price of the commodity and the exercise price as per the futures contract.
At present, the option of cash settlement lies only with the seller of the contract. If the seller decides to make or take delivery upon maturity, the buyer of the contract has to fulfil his obligation by either taking or making delivery of the commodity, depending on the specifications of the contract.
In the above example, if the seller decides to go for cash settlement, the contract can be settled by the seller paying Rs 300 to the buyer, which is the difference in the spot price of the commodity and the exercise price. Once again, the return on the investment of Rs 870 is 34.5%.
The above example shows that with very little investment, the commodity futures market offers scope to make big bucks. However, trading in derivatives is highly risky because just as there are high returns to be earned if prices move in favour of the investors, an unfavourable move results in huge losses.
The most critical function in a commodity derivatives exchange is the settlement and clearing of trades. Commodity derivatives can involve the exchange of funds and goods. The exchanges have a separate body to handle all the settlements, known as the clearing house.
For example, the seller of a futures contract to buy soybean might choose to take delivery of soyabean rather than closing his position before maturity. The function of the clearing house or clearing organisation, in such a case, is to take care of possible problems of default by the other party involved by standardising and simplifying transaction processing between participants and the organisation.
In spite of the surge in the turnover of the commodity exchanges in recent years, a lot of work in terms of policy liberalisation, setting up the right legal system, creating the necessary infrastructure, large-scale training programs, et cetera still needs to be done in order to catch up with the developed commodity derivative markets.
Also, trading in commodity options is prohibited in India. The regulators should look towards introducing new contracts in the Indian market in order to provide the investors with choice, plus provide the farmers and commodity traders with more tools to hedge their risks

What has happened to Iraq's missing $1bn?

2007-09-02T13:34:00.000-07:00

One billion dollars has been plundered from Iraq's defence ministry in one of the largest thefts in history, The Independent can reveal, leaving the country's army to fight a savage insurgency with museum-piece weapons.
The money, intended to train and equip an Iraqi army capable of bringing security to a country shattered by the US-led invasion and prolonged rebellion, was instead siphoned abroad in cash and has disappeared.
"It is possibly one of the largest thefts in history," Ali Allawi, Iraq's Finance Minister, told The Independent.
"Huge amounts of money have disappeared. In return we got nothing but scraps of metal."
The carefully planned theft has so weakened the army that it cannot hold Baghdad against insurgent attack without American military support, Iraqi officials say, making it difficult for the US to withdraw its 135,000- strong army from Iraq, as Washington says it wishes to do.
Most of the money was supposedly spent buying arms from Poland and Pakistan. The contracts were peculiar in four ways. According to Mr Allawi, they were awarded without bidding, and were signed with a Baghdad-based company, and not directly with the foreign supplier. The money was paid up front, and, surprisingly for Iraq, it was paid at great speed out of the ministry's account with the Central Bank. Military equipment purchased in Poland included 28-year-old Soviet-made helicopters. The manufacturers said they should have been scrapped after 25 years of service. Armoured cars purchased by Iraq turned out to be so poorly made that even a bullet from an elderly AK-47 machine-gun could penetrate their armour. A shipment of the latest MP5 American machine-guns, at a cost of $3,500 (£1,900) each, consisted in reality of Egyptian copies worth only $200 a gun. Other armoured cars leaked so much oil that they had to be abandoned. A deal was struck to buy 7.62mm machine-gun bullets for 16 cents each, although they should have cost between 4 and 6 cents.
Many Iraqi soldiers and police have died because they were not properly equipped. In Baghdad they often ride in civilian pick-up trucks vulnerable to gunfire, rocket- propelled grenades or roadside bombs. For months even men defusing bombs had no protection against blast because they worked without bullet-proof vests. These were often promised but never turned up.
The Iraqi Board of Supreme Audit says in a report to the Iraqi government that US-appointed Iraqi officials in the defence ministry allegedly presided over these dubious transactions.
Senior Iraqi officials now say they cannot understand how, if this is so, the disappearance of almost all the military procurement budget could have passed unnoticed by the US military in Baghdad and civilian advisers working in the defence ministry.
Government officials in Baghdad even suggest that the skill with which the robbery was organised suggests that the Iraqis involved were only front men, and "rogue elements" within the US military or intelligence services may have played a decisive role behind the scenes.
Given that building up an Iraqi army to replace American and British troops is a priority for Washington and London, the failure to notice that so much money was being siphoned off at the very least argues a high degree of negligence on the part of US officials and officers in Baghdad.
The report of the Board of Supreme Audit on the defence ministry contracts was presented to the office of Ibrahim al-Jaafari, the Prime Minister, in May. But the extent of the losses has become apparent only gradually. The sum missing was first reported as $300m and then $500m, but in fact it is at least twice as large. "If you compare the amount that was allegedly stolen of about $1bn compared with the budget of the ministry of defence, it is nearly 100 per cent of the ministry's [procurement] budget that has gone Awol," said Mr Allawi.
The money missing from all ministries under the interim Iraqi government appointed by the US in June 2004 may turn out to be close to $2bn. Of a military procurement budget of $1.3bn, some $200m may have been spent on usable equipment, though this is a charitable view, say officials. As a result the Iraqi army has had to rely on cast-offs from the US military, and even these have been slow in coming.
Mr Allawi says a further $500m to $600m has allegedly disappeared from the electricity, transport, interior and other ministries. This helps to explain why the supply of electricity in Baghdad has been so poor since the fall of Saddam Hussein 29 months ago despite claims by the US and subsequent Iraqi governments that they are doing everything to improve power generation.
The sum missing over an eight-month period in 2004 and 2005 is the equivalent of the $1.8bn that Saddam allegedly received in kick- backs under the UN's oil-for-food programme between 1997 and 2003. The UN was pilloried for not stopping this corruption. The US military is likely to be criticised over the latest scandal because it was far better placed than the UN to monitor corruption.
The fraud took place between 28 June 2004 and 28 February this year under the government of Iyad Allawi, who was interim prime minister. His ministers were appointed by the US envoy Robert Blackwell and his UN counterpart, Lakhdar Brahimi.
Among those whom the US promoted was a man who was previously a small businessman in London before the war, called Hazem Shaalan, who became Defence Minister.
Mr Shalaan says that Paul Bremer, then US viceroy in Iraq, signed off the appointment of Ziyad Cattan as the defence ministry's procurement chief. Mr Cattan, of joint Polish-Iraqi nationality, spent 27 years in Europe, returning to Iraq two days before the war in 2003. He was hired by the US-led Coalition Provisional Authority and became a district councillor before moving to the defence ministry.
For eight months the ministry spent money without restraint. Contracts worth more than $5m should have been reviewed by a cabinet committee, but Mr Shalaan asked for and received from the cabinet an exemption for the defence ministry. Missions abroad to acquire arms were generally led by Mr Cattan. Contracts for large sums were short scribbles on a single piece of paper. Auditors have had difficulty working out with whom Iraq has a contract in Pakistan.
Authorities in Baghdad have issued an arrest warrant for Mr Cattan. Neither he nor Mr Shalaan, both believed to be in Jordan, could be reached for further comment. Mr Bremer says he has never heard of Mr Cattan.
A week of violence in Iraq
* SUNDAY 11 SEPTEMBER
Gunmen killed a senior Iraqi judge, his brother and a Major General in the Iraq army. A British and a US soldier were killed in bomb attacks.
* MONDAY 12 SEPTEMBER
Gunmen killed nine civilians and two policemen in Baghdad and a roadside bomb killed six Iraqi soldiers in Fallujah.
* TUESDAY 13 SEPTEMBER
A car bomb killed five people and gunmen killed another four in the Mansour district of Baghdad Two civilians were killed by a suicide bomber on a bus in Hilla.
* WEDNESDAY 14 SEPTEMBER
At least 167 people were killed and 570 wounded in 14 bombings in Baghdad.
* THURSDAY 15 SEPTEMBER
Three suicide car bombers killed 28 policemen and eight civilians and gunmen killed four more people Baghdad.
* FRIDAY 16 SEPTEMBER
Two suicide car bombers killed 13 people, and gunmen shot dead eight more in Baghdad, including a local mayor in Iskanariya district and an imam in Sadr City.
* SATURDAY 17 SEPTEMBER
At least 52 people were killed or found dead throughout the country.
* SUNDAY 18 SEPTEMBER
At least three Iraqi soldiers were killed in a roadside bomb and an Iraqi MP and four others were shot dead by gunmen. Two dozen bodies of murder victims were found in the Tigris.

Study shows London has taken over as the new centre of world commerce

2007-09-02T13:20:00.000-07:00

An influential new report claims that London now tops a list of 50 cities as the world's centre of commerce - beating New York, Tokyo and Chicago.
The UK capital has overtaken New York in four of six areas including economic stability, the ease of doing business, volumes of financial flows and attributes as a business centre, according to the report by credit card company MasterCard.
The study is the latest to say New York lags behind London as a global commerce centre.
It follows in the footsteps of a report earlier this year by internationally renowned management consultants McKinsey, which stated that New York is losing its place to London as the world's leading financial centre.
And it follows a series of articles by newspapers and magazines that have celebrated London's global success.
In March, the respected American magazine New York admitted that London is 'shaping up to be the global capital of the 21st century'.
Two years before this, Newsweek said London's success means it is leaving other European cities behind.
In the latest report - MasterCard's first annual worldwide centres of commerce index - the authors state: 'Once considered the unchallenged financial capital of the world, New York cedes to London a key dimension measuring financial transactions primarily because bond market regulations in New York affect the volume of listed sales.' London has the biggest financial services network of all cities, with more banking, financial services and insurance companies based there than any other, said MasterCard.
London vs New York
London
Population - 7.5 million
By last year, a total of 419 international firms listed on London's Stock Exchange
318,000 people are employed in the financial district
New York
Population - 8.2 million
By last year, a total of 174 international firms listed on the New York Stock Exchange or Nasdaq
328,000 employed in the financial district

We Need a NewWorld Financial Architecture

2007-09-02T13:14:00.000-07:00

Dr. Sergei Glazyev, an economist and a member of Russia's State Duma (parliament), addressed the second panel of an EIR-sponsored seminar in Berlin on June 28. Glazyev has authored many books on economics, including Genocide: Russia and the New World Order, which was published by EIR in 2000.
First of all, I'd like to thank Mr. LaRouche for this initiative, which is very important, and to my mind has a crucial sense.
A few years ago, when he wrote a lot of articles about the collapse of the present financial system, very few people were thinking about that. Now this collapse is taking place. Each year, the crisis is going deeper and deeper, and now it's time to think about the new architecture of the world financial system. And this initiative, which was launched by Mr. LaRouche, is just in time. And nowadays, when unfortunately, heads of state, the heads of the central banks, and the heads of the largest financial corporations are trying to close their eyes to the growing problems, and imitate a good policy, we have a chance to sit here to discuss the future—which inevitably is coming in the nearest years—the future with a new, I am sure, financial architecture, which will emerge in any case, after the collapse of the present one.
I don't think that this collapse could be prevented. What we should think about, first of all, is how to—not to avoid the crisis, but how to minimize the costs of transition; and what could be the new, optimal, and sustainable system, financial system, which will give mankind an opportunity to continue economic development.
We really need a new architecture of the world financial system, because those which exist couldn't be improved. I don't think that the present dollar-based speculative financial system could be improved. It is going to collapse anyway, and the question is only, what will be the shortcomings of this collapse, and how we can minimize the costs.
I agree, that this financial crisis and collapse of the financial system is a disaster for the whole of mankind. And of course, all nations are trying to maintain the stability of the present financial system, and to avoid new risks. But the problem is that the risks are embodied in this system, and they are growing higher and higher.
What could we do, to save this system, which is based on injustice, on fraud, on unequal and imbalanced exchange in the world, and this imbalance is going higher and higher? In fact, the dollar-based financial system now, is what we call a "financial pyramid." It's just being maintained, due to the growth of financial speculations; and financial speculations determine the demand for the dollar; and the supply of dollars couldn't be really limited, because of the internal nature of the American financial system. They have to print more and more dollars to service the growing debts. And this is the endless process which finally leads to the collapse, as we see in the history of mankind: a lot of cases like that—of course, of much less scale—of the collapse of the financial pyramids.
Nowadays, this financial pyramid is supported by various financial speculations, including the speculations with raw materials, which we see in the growing oil prices, which are purely speculative. And the United States is trying to maintain the demand for dollars also with the help of wars, and trying to pressure various nations to keep their currency reserves in dollars. But this couldn't go on endlessly. Nowadays, the American Federal Reserve doesn't control dollar circulation: About 60% of the dollars which were created by the Federal Reserve System are circulated abroad, and they are out of the American jurisdiction entirely. At the same time, if you will look at the present structure of the dollar-based financial system, we shall see that the amount of dollars in circulation, together with Treasury bonds, is 25 times higher than the amount of the American gold and currency reserves. It means that there is nothing under the dollar, except the demand which is generated by growing speculative activity.
I don't think that somebody will push the American financial system into deep restructuring, which will balance this. How can we balance the reserves and the monetary base of the dollar, if the scale of difference is 25 times? It is completely impossible to decrease the amount of dollars by a factor of 25, except through massive devaluation.
We Need To Declare Bankruptcy
So, in order to improve the dollar-based system, trying to introduce some kind of New Bretton Woods principles, including fixed exchange rates, we need to, in fact, declare the bankruptcy of the Federal Reserve and bankruptcy of the dollar financial system. This is the only way to get rid of this surplus of 25 times, in comparison with the monetary base. But, if somebody does that, of course, it will create a huge panic in the world market, and everybody will run away from the dollar, which will inevitably lead to the devaluation of the dollar, not by 15 or 30%, but I think maybe by a factor of 10 or 30.
So, I don't think that anybody on Capitol Hill will have enough courage to take responsibility for restructuring on such a scale.
And it means, to my mind, that collapse will take place in spontaneous ways, and we should be ready for that. But, what could we do in this situation? At least I think we can try to elaborate some principles of the new world financial architecture. And, to my mind, at least we can discuss the following principles: First of all, no one country could privatize the creation of the world reserve currency. The weak point of the present financial system, is precisely that the United States privatized the function of the world reserve currency. In 1971, they pushed Western countries to take dollars instead of gold, and, in fact, privatized the right to creation of the world currency, and used this right for their own purposes, to finance the budget deficit and to finance the balance of payments deficits. So, America used its right to create the world currency, as a worldwide tax: Because those countries which used this currency as a reserve currency, in fact, paid a tax in the form of zero-interest-rate loans to the United States, in growing and growing quantities.
So, I think the first principle, from this lesson, should be that no one country could privatize the right to create the world currency.
The second principle is, that all countries which agree to participate in this new world financial architecture, should agree to keep a certain financial discipline in money creation and the structure of currency reserves. Maybe they should keep, also, some rules of determining interest rates and budget deficits. But at least, they should agree concerning the principles of money creation, the structure of currency reserves, and come to agreement concerning the basket of currencies which participate in this new financial architecture.
The third, I think quite elegant principle, is that in order to maintain stability in international exchange, you need some kind of international reserve: like, maybe, the IMF could play the role of this international reserve fund, which will work to stabilize currencies, which will come out of an agreement concerning the fixed rates, or some other proportions of world exchange. But we need to maintain stability, some kind of international reserve fund, which will work under multinational supervision.
To finance this international reserve fund, we can propose both financial contributions, in national currencies of countries which participate in this scheme, or—maybe, and—an additional source: the worldwide taxation of financial speculation, which was already mentioned today.
Who Will Create a New Financial System?
What countries could participate in this new financial architecture? I don't think that we can come to an agreement on the worldwide scale—under the United Nations, or some other international organizations. Perhaps only those countries which are ready to make steps in this direction, can take on the burden of the creation of the new financial architecture, not waiting for others. Because the time is limited, and the main players, namely the United States and Japan, in fact are not ready to limit their opportunities to create the world currency.
Both Japan and the United States create their currencies, not on the basis of their reserves, but on the basis of growing national debt. And these currencies, in fact, are pure national debts. And in order to go to the new financial architecture, the financial authorities of the United States and Japan should declare bankruptcy (I'm not sure about Europe), but this, to my mind, is quite evident, and, of course, these countries are not ready to do that.
What countries are ready, to my mind? Those countries who still keep control over their currency creation, money creation, and have enough reserves to protect their currencies from devaluation. Russia, for instance, has now currency reserves twice [the size] of the monetary base. So, each ruble has reserves—each ruble in circulation, which was created by the Central Bank, has reserves equal to two rubles. Of course, it is a crazy policy—I shouldn't comment on that now. But, at least it will give enough room for maneuver, for Russia to participate in any kind of new financial architecture based on fixed exchange, or other rules of currency exchange.
China and India are countries which are also ready to participate in the new financial architecture, because they are keeping control over their monetary system. And as you know, they were not affected by the financial crisis of 1997-98, exactly because they kept control over their monetary systems, and didn't liberalize them. For these reasons, having enough currency reserves and keeping control over money creation, these countries could easily participate in the new financial architecture.
The Arab countries could do the same, because of the large currency reserves which they have. I mean the Arab countries trading with oil.
So, at least we have a couple of countries, which are dominant, together, in the Eurasian continent. If the European Union joined this, it means that the whole Eurasian continent would be the platform to establish the new financial architecture.
I don't think the United States could participate in this new system, because their currency simply has no reserves. They have no reserves, and they have to limit their currency creation several-fold—and they're not ready to do that. And if you wait for the United States, I'm afraid that we shall go into collapse altogether.
So, my suggestion is, perhaps, we can elaborate some recommendations, at least for those countries which have opportunities, to start to think and negotiate about the new financial architecture.
Of course, it is not an easy question. And, for instance, I can tell you, that when I proposed to the Russian Central Bank and to the Russian President, to launch an initiative to switch to a new financial architecture, I didn't get any real answer. Because such steps, of course, will have immediate results. If at least two or three superpowers, in the Eurasian continent, will try to discuss together the new financial architecture, it could be a trigger for the financial crisis. So, it is a very delicate issue, but at least, I think we should think about that, and there is no other way than to push those who will be ready to make a first step—not wait for when the whole system will go into collapse.

Protect your savings from tax

2007-08-30T13:09:00.000-07:00

Nobody likes paying more tax than they have to. However, if you're saving or investing without making use of your individual savings account allowance, that's exactly what you're doing.

The thinking behind ISAs is simple. An ISA enables you to shelter £7,000 worth of investments from the tax man each year. You can save up to £3,000 in a cash ISA, or up to £7,000 in an equities ISA, which can hold a wide range of investments such as bonds, funds and even direct shareholdings. You can take out both types of ISA, but your total savings must not exceed £7,000.

There are significant tax advantages to taking out an ISA instead of just putting your cash into a standard savings account or investing outside an ISA. This is because both income and gains are allowed to build up tax-free within your ISA.

So if you've not taken advantage of this year's allowance it pays to do so by 5 April - the last day of the tax year.

Cash ISAs

The most popular option is the cash ISA. Simple and easy to understand, this is a tax-free savings account, which is useful for short-term savings.

However, if you already have enough cash for emergencies - experts recommend three to six months' salary - and your savings objectives are long-term, it's worth considering an equity ISA.

Remember that shares and investment funds can fall in value as well as rise, but if you're going to invest on the stockmarket you need to take a long-term view and not to get side-tracked by short-term fluctuations.

Equity ISAs

When choosing an equity ISA there's a multitude of options. What suits you will depend on your attitude to risk and your investment objectives.

Corporate bonds and gilts come at the lowest end of the risk spectrum. These are IOUs issued by companies (bonds) or by the government (gilts). The issuers promise to pay you a fixed-rate interest for the money you've lent them, and to return the money you've invested at the end of a fixed term. Bonds and gilts trade on the London Stock Exchange, so the price you pay is determined by the market forces of supply and demand and is not necessarily the same as the amount you would receive back if you held them to term.

Corporate bonds receive a risk-rating ranging from AAA to junk bonds, depending on the financial stability of the company issuing it - the safer the company the lower the rates they pay.

In the same way that you can invest in shares via a pooled investment fund, you can also invest in pooled funds of corporate bonds and gilts. These are typically lower-risk than funds which invest in shares, because the returns you receive from them are easier to determine in advance. But for this same reason, the returns you can expect will also be lower.

However, if you step up the risk a gear and invest in equities you can obtain much greater growth. You can invest in equities in several different forms. You can either buy shares via a stockbroker, using what is known as a self-select ISA (so long as the shares are listed on the LSE), or you can invest in a pooled investment fund run by a fund manager, such as a unit trust, an open-ended investment company (OEIC), or an investment trust.

From a risk point of view, a pooled fund is usually the best option for most investors - by investing in one fund you can get exposure to 50 or more companies and can benefit from the fund manager's expertise.

Unit trusts or OEICs are the most popular option. These are open-ended funds, with new 'units' becoming available for sale as and when investors need them. Investment trusts, on the other hand, have a limited number of shares (they are closed-ended). They are listed on the LSE, so the price fluctuates according to demand.

Investment trusts are overseen by a board of directors, which selects a fund manager to manage the investments, and have the ability to borrow money to invest further. So they're sometimes considered to be riskier than other forms of investment funds.

Unit trusts usually levy an initial fee, between 3.5% and 5.5%, and an annual management fee, 1% or 1.5%. Investment trusts usually do not levy an initial fee and have only minimal annual fees.

Many fund managers operate ISA savings schemes, which allow investors to pay money into their ISAs monthly. Some accept contributions of as little as £20 a month, although most start at £50 a month. Alternatively, all fund managers will accept lump sums.

When it comes to choosing a fund, the investment world is your oyster. Following a change in legislation at the end of 2005, you aren't just confined to bonds and equities, you can also hold commercial property funds in your ISA.

Funds that buy bricks and mortar directly can be a useful diversifier as they don't follow stockmarket movements. Alternatively, you can opt for real estate investment trusts (REITs), which allow you to buy shares in property companies. They have a slightly greater potential for growth, but because they are shares, their performance is correlated to the stockmarket - so they aren't such a good diversifier.

If you're new to investing it's best to go for a lower-risk option and steer clear of smaller company or emerging market funds.

You can buy equity ISAs direct from fund managers, but you may be limited to their range of funds. Discount brokers can be a good bet as they offer good discounts on charges. However, for active investors wanting to build up and manage their portfolio online, a fund supermarket - such as those offered by Interactive Investor - are often a better option.

While discount brokers and fund supermarkets can't offer advice, many do offer online tools to help you find the right options for you. If you don't understand the options it's always worth seeking the advice of an IFA - you can find a local one through IFA Promotion. Visit their website (unbiased.co.uk) or phone 0800 085 3250.

The new ISA rules

In December's pre-Budget report, Chancellor Gordon Brown confirmed changes to ISA rules and pledged to maintain the £7,000 ISA savings limit beyond 2010.

There will no longer be a distinction between mini and maxi ISAs. Now savers simply have to choose between a cash or an equity ISA.

It will now be possible to transfer any funds you have accumulated in cash ISAs into equity ISAs without losing any of the tax advantages or affecting your allowance for the year.

Holders of PEPs will also be able to transfer their fund into an ISA, as will holders of child trust funds, when they turn 18.

A new way of cutting tax from leading tax guru

2007-08-30T12:57:00.000-07:00

There are many ways in which you as an individual could trim your tax bill.

Usually, the steps you need to take are straightforward merely involve claiming what you are entitled to.

Income Tax

Everyone is entitled to a personal allowance - the amount you can earn before tax is due - from the day they are born. In the 2007/2008 tax year, this stands at £5,225.

Many people who have a partner, are married, or have children generally fail to optimise their use of personal allowances or lower tax rates.

If you have a partner or are married, it makes sense from a tax point of view to ensure that the individual who pays tax at the lower rate (22%), or does not work at all, holds the savings in their name.

Any money from grandparents will use the child's personal allowance

This ensures that as a couple you pay a lower rate of tax, or even no tax at all, on your savings.

You should also consider if a tax-free savings product such as an Individual Savings Account (ISA) is suitable.

Any money given to children by parents which earns interest will be treated as taxable on the parents.

But any money from grandparents will use the child's personal allowance.

Capital Gains Tax

Individuals are entitled to an annual exemption of £9,200 against any capital gains.

Assets which have built up a capital gain can be transferred between spouses so that both annual exemptions can be used.

As with income tax, you should try to ensure that the person paying tax at the lower rate will be the one who ends up with the taxable gains.

In all tax matters, it is important to think ahead.

For instance, if you have lost money on the stock market recently, then you can carry your losses forward and offset them against any gains you may realise in future years.

Inheritance Tax

There are also tax benefits to be gained if you are married. With Inheritance Tax (IHT), the transfer of assets between spouses is exempt.

Couples should ensure that they transfer assets between themselves in order to optimise their zero rate tax allowance band - called the Nil Rate Band.

Each spouse has a £300,000 Nil Rate Band (2007/2008 tax year).

Many people who run their businesses from rooms in their homes are unaware that they are eligible to claim a proportion of the household expenses

You should also consider making gifts to your children or grandchildren who will be entitled to the assets free of IHT as long as you survive for seven years after making the gift.

Working From Home

Employees who work from home need to consider their tax position if their employers agree to pay for home telephone bills.

Claims can only be made for the cost of business calls, and not on the line rental or other fixed charges. Reimbursed costs of private calls will be classed as a taxable benefit.

Self-employed people who work from home could be missing out on significant tax savings by not claiming their full expenses entitlement.

Many people who run their businesses from rooms in their homes are unaware that they are eligible to claim a proportion of the household expenses, such as heating, lighting and telephone calls, against their business income.

Any eligible expenses can be claimed through the Self Assessment tax return.

The amount which can be claimed for heat and light, for example, is the proportion of the bill calculated on the basis of the number of rooms used for the business against the total number of rooms in the house.

Nine Steps to Prevent Merger Failure

2007-06-15T13:34:00.001-07:00

There are nine "deadly sins" that can mess up any merger, according to Harvard Business School and MIT graduates now working for Booz Allen Hamilton. Most mergers fail at the execution stage—and execution can be fixed.

by Gerald Adolph, Karla Elrod, and J. Neely

It's a nightmare lived out all too frequently. Despite months of work, millions of dollars in fees, and a firm conviction that the transaction makes all the sense in the world, your merger is going down in flames. It is clear you're going to miss your Year 1 targets. The two cultures are not meshing. Key talent is heading for the door. And everyone knows it.

There are some transactions, such as the marriage of HP and Compaq, that are troubled from the start. There's little anyone can do. Fortunately, this is far from the norm. More than two-thirds of transactions that fail do so at the execution stage. DaimlerChrysler, for example, neglected early on to establish a proper set of guiding principles based on the merger's strategic intent, and then continued to misfire by failing to align leadership and integrate the cultures of the two organizations. Is there a lesson in this? Absolutely.

Execution-related failures can be avoided. To do so, you need to establish a program integration team early in the process that can respond to the execution risks inherent in all transactions. We call these risks the "nine deadly sins." Understanding them is a critical first step toward a successful merger.

Sin number one: no guiding principles
As rudimentary as this sounds, we often see merging companies fail to develop a set of guiding principles linked to the merger's strategic intent. These principles should get at the very logic of the transaction—is the merger an absorption of one company into another or a combination designed to take the best of both? Perfection may not be possible, but these principles will assure that all decisions drive the combined entity in the same direction. In a best-of-both-companies transaction, for example, one principle might be: "Combine IT organizations by selecting the most up-to-date systems and deploying them across the combined entity."

Sin number two: no ground rules
While this sounds similar to sin number one, ground rules for planning provide nuts-and-bolts guidance for how the planning teams should act as they begin to put the face of the merged entity on paper. These rules should include processes for how decisions are to be made and how conflicts should be resolved.

Sin number three: not sweating the details
It's hard to believe, but detailed post-close transition plans can be lacking even when two companies are working hard and have top-level leadership closely engaged. Why? To some extent, this reflects the daunting complexity of any integration. It can also, however, reflect the culture of the companies and a resistance to detail and top-down accountability. The acquirer may be suffering from acquisition fatigue, management distraction, a reluctance to share information, or a simple unwillingness to follow a methodical decision timeline.

More than two-thirds of transactions that fail do so at the execution stage.

Sin number four: poor stakeholder outreach
All relevant stakeholder groups—both internal and external—must receive communication about the transaction, early and often. While employees (see sin number eight), customers, and regulators get the bulk of the attention, there is a long list of additional stakeholders such as communities, suppliers, and the like who also need care and feeding. Management must strive to understand how these groups view the deal and how they might react to changes such as new pricing, the elimination of vendors, and adjustments in service and personnel.

Sin number five: overly conservative targets
Management must set aggressive targets from the start. This helps reinforce and clarify the transaction's guiding principles and strategic intent, specifically, how hard the integration teams need to push for cost savings and revenue growth. Most companies tend to focus on one or the other—but neglect to place adequate emphasis on both. Experience demonstrates that management never gets more in synergies than it requests. So, build your targets with some stretch and expect that your people will find a way to get there.

Sin number six: integration plan not explicitly in the financials
We have seen merging companies build detailed integration plans only to stop short of driving them into the combined entity's operating financials in a clearly identifiable manner. Institutional memory is short and the plans are often redone on the fly (see sin number nine). While the integration plan will evolve, you need to create financial benchmarks that can be tracked.

Sin number seven: cultural disconnect
Bringing disparate groups of people together as one company takes real work and represents an effort that is often largely overlooked. Culture change management is not indulgent; it is a critical aspect of any transaction. However, simply acknowledging the issue or handing it off to specialists is not enough. Management must set a vision, align leadership around it, and hold substantive events to give employees a chance to participate. Detailed actions and well articulated expectations of behavior connect the culture plan to the business goals.

Sin number eight: keeping information too close
There is a natural hesitancy to share information, and current regulations put pressure on what management can tell the organization without going to public disclosure. However, absent real facts, the rumor mill will fill the void. Tell employees what you can. Also, tell them what you can't tell them at the moment, why, and when you will be able to do so.

Sin number nine: allowing the wrong changes to the plan
After all the hard work and despite meticulously avoiding sins one through eight, some companies still miss the mark. The popular trend toward empowered line managers and decentralization carries the risk of handing off carefully designed plans to new decision makers who are not steeped in the balances and considerations that made the plan viable in the first place. Following handoff, every company needs clear decision rights about who can change the agreed-upon plans, under what circumstances, and with what approvals.

In working to avoid the nine deadly sins listed above, one key step is selecting the right person or people to lead the program integration team and track the plan's execution. The mergers that do best tend to have such leadership. Clearly, with proper planning and attention to detail throughout the merger process—from determining strategic direction, transaction design, and post merger integration—it is possible to avoid these sins and close a successful transaction.

Study dollar crash and impact

2007-06-13T15:58:00.000-07:00

For UK investors, the decline in the Dollar since the beginning of the year and recent acceleration has been broadly beneficial thus far. Strong sterling will tend to keep inflation down in part because imports are less expensive. Lower inflation should help keep interest rates down. The high Sterling will also make exports more expensive and lead to reduced sales from manufacturing - this will would reduce GDP, a further reason for not putting up interest rates. In addition, high interest rates will tend to drive Sterling higher - and because the Bank of England will tend not to want this to happen any further, it will also reduce the likelihood of a further interest rate rise. Holding a portfolio of property in the UK priced in Sterling is beneficial to those investors that bought before Sterling rose.

So why the shift away from the dollar - many reasons:

USA and the dollar are becoming globally less important as the Chinese, Asian and Indian economies expand.

The USA budget deficit and balance of payment deficit are so huge, many countries have decided to reduce their exposure to the dollar, in case it crashes or the economy goes into recession.

The housing boom has ended, GDP growth for 2007 is forecast to be significantly lower hen 2006.

Interest rates are thought to have peaked - and could dramatically reduce if the country looks like it is heading for a recession.

So what does this mean for property investors - does it represent an opportunity?

For UK investors investing in the UK - the chances of further interest rate rises have diminished. It's likely inflation will drop to say 2% over the next 6 months and GDP will reduce to about 2.3% - so interest rates will probably plateau at 5% before dropping mid 2007 to 4.75%. This should create stable condition for property investment - with prices continuing to rise in the south and staying fairly stable in the north (rising far less fast).

For UK investors considering buying in the USA - it's likely to be a bit early to do so. It's probably best to wait to see the dollar drop further and make sure the housing market is 'not' heading for a meltdown. There are tentative signs of stabilisation and improvement in the last month, but it's early days. If a full blown recession is avoided, interest rates drop and the dollar drops say another 10%, one could argue it would be the ideal buying opportunity - purchasing dollar assets from sterling at the bottom of the housing market just as interest rates start coming down, which would likely send US house prices higher. It's worth monitoring for a few months with a view to investing in early to mid 2007.

For all those doubters - the USA will always remain a huge growth engine for the global economy. In 1950 the population of the USA was only 150 million - it's now 300 million - by 2050 it will be 450 million. You do not have such population growth in a country with huge natural and intellectual resources without a big increase in GDP. Remember productivity and GDP growth in the USA has been higher in the last 5 years than almost all developed countries. The huge wealth of the babyboomers will be heading to the coasts of Florida, Carolina and California to retire - so the trick is to find coastal property with sea views that is not susceptible to flooding from sea-level rises, erosion and hurricanes.

Booming towns around the world worth giving an bird's eye

2007-06-13T15:52:00.000-07:00

For the adventurous and international property investor, we can provide some interesting insights into the current boom towns. Many of these cities are little heard of. Many are booming because of mining, oil and extractive industries. Quite some research has gone into preparing this list for our website visitors. The main sector themes cities where oil, mining or financial services have been very strong – there are no indications this will change in the next few years. Many analysts believe we are in the middle of a commodities “super-cycle”. The reason is because of China and India’s appetite for raw materials, global population growth and the European and USA’s continued reliance on these same raw materials. Other boom towns are tourist related – others a combination oil, financial services and tourism (e.g. London). But one thing is for sure - in all these cities and areas – populations are increasing, jobs are being created and not enough homes are being built. The ideal combination for property prices to rise.

Green River Wyoming – coal mining
Limpopo, Mpumalanga, Rustenburg – Rep South Africa – platinum and chrome mining
Houston – global oil & gas services
Macao – gambling, tourism
St Petersburg – oil & gas, tourism, finance
Moscow – oil & gas, tourism, finance
London – financial services, wealth management, M&A
Bratislava, Slovakia – low cost proximity to Vienna, E Europe boom
Warsaw, Poland – EU integration, low cost, increasing wealth
Muscat – oil & gas, tourism
Luanda, Angola – oil development
Doha, Qatar – gas developments
Mongolia – mining, proximity to China
Dubai, UAE – oil, financial services, tourism
Cape Town, Rep South Africa – tourism
Fort McMurray & Calgary, Canada – oil sands developments
Aberdeen, Scotland – international oil & gas services
Stavanger, Bergen & Kristiansen, Norway – oil and gas operations
Bangalore, India – IT/call centres/communications/services
Mumbai, India – financial services, manufacturing
Guangdong province, China – global manufacturing
Shanghai, China – financial services, manufacturing, export
Beijing, China – public sector, services
Ho Chi Minh City, Vietnam – manufacturing and services
Buenos Aires, Argentina – business and services
Cairo, Egypt – regional business centre

As advised in on our website, if one has a combination of:

Increasing population
Increasing employment
Increasing business (GDP growth)
Increasing wages
Low levels of home building
Low reliance on imported oil and gas
Low interest rates
Low inflation
Exposure to financial services sector
Land shortage and/or environmental constraints

Norway: This powerful combination will lead to booming property prices. If one uses these criteria for cities like Bergen in Norway, it’s difficult to see how prices would not continue rising. London is the same – it’s also a global centre of oil and commodities financing and re-investment of proceeds from the extractive industries that are booming. Moscow is similar albeit more regional in its sphere of influence.

South Africa: Localized gems occur such as Rustenburg to the west of Pretoria in South Africa. The population is booming as 25,000 new jobs are being created in the expanding platinum and chrome mines. Pretoria is also worth considering with its access to Johannesburg, government employment – it is the regional centre of the Bushveld Complex of minerals and mines, with most mines within a 100 km radius of the city.

Canada: Fort McMurray in NE Alberta, Canada is booming oil town. A huge wave of new jobs have been created in the oil sands business – accommodation is desperately short and rentals and in big demand. Many billions of dollars are being invested to grow oil sands production – in part because this makes the USA less reliant on overseas imports. This is something not likely to go away – hence Fort McMurray will likely see prices booming into the future. Calgary, the centre and HQ of the Canadian oil & gas business is another booming town – pleasant place to live as well. The creation of new oil and gas jobs and wealthy retiring oil workers will likely support prices into the next decade.

USA: The Green River area of Wyoming is another gem – who would believe that in 2007, a boom is taking place in a coal mining area in the USA. This part of the world has more barrels of oil equivalent hydrocarbons (locked up in coal) than Saudi Arabia and Russia combined. The USA will never be short of fuel for electric power station because some of these coal seams are 50 metres thick and mines are open-cast and of the highest quality anthracite coal. Huge wealth is being created as production is increased and this is supporting rentals and property prices in this remote area of the USA.

Mongolia: Mongolia is another gem – yes, this area is booming. The reason is its minerals mining. China is desperate for its products and there is a property boom to match the mining boom. Its not likely to go bust unless China’s economy goes bust – something most unlikely in view of the sustained 9.5% GDP average growth over the last ten years and China hugely increasing middle classes and 1.2 billion population next door. Mongolia has also benefited from being next door to booming Russia and the Siberian oil and gas fields. Some gas pipeline projects run close by and as long as there is peace in the area, Mongolia’s fundamentals and booming population look impressive.

Macao: Property prices have been booming for five years – massive investment in casinos and neighbouring China’s booming economy, middle classes and interest in gambling has made Macao the rival of Las Vegas. Difficult to see this changing – all the money being made in manufacturing in southern China will benefit Macao – talk of Richard Branson investing in the area is interesting. He’s well known for getting in early – the future looks bright for Macao.

Egypt: Cairo is an interesting city. Huge, traffic jams everywhere, pollution, rumour has it the true population of Cairo conurbation is 25 million. No wander the traffic never moves. This regional business centre has benefited from relative peace, expanding oil and gas businesses north and east, and booming population. Property in the city centre for business people to avoid the traffic jams is worth considering. Always at risk of instability but the city will likely further double in size the next 50 years, making central property values increase.

Need to see where to invest and what type of property

2007-06-13T15:47:00.001-07:00

ost business owners and millionaires live very close to where they invest their money. Despite the property business becoming ever more global, it is still most common to find successful property investors investing close to their “home”. This is because they can manage the properties more efficiently, make sure they do not get “ripped off”, can add value easily and step in quickly if anything negative happens to their properties. They can also spot a good investment and check it out quickly and easily – seizing a good opportunity once identified. They retain far more control and are able to protect their investment – they have the ability to add value to their investment. This lowers the investment risk.

Criteria to maximize returns: That’s not to say you cannot make a good profit from investing in property in another country, continent or the other side of the world, but you may have the following issues to counter:

Exchange rate fluctuations that may work against you
Expense of getting people around to solve small problems
Commissions and fees can be very high (13% of purchase price to buy then sell an off-plan apartment in Spain, rather than ca. 3% in UK for low price flat).
Less knowledge of interest rate movements, economic conditions and infra-structure investments and timing – not living in the area/country.
Legal issues over property title – and differences in legal aspects
Possible issues getting money out of the country
Complex taxes and fiscal treatment
Time and cost of traveling to check out your investment
Less knowledge of the local rental market and less control over tenants – bigger risks of void periods if property not managed will by local agent
Exposure to being “taken for a ride” by contractors
Exposure to hidden or unknown taxes
Complexity with inheritance, wills and capital gain tax liabilities

If you buy close to “home”, you will be far less exposed to all of the above – though as an example, tax in the UK or USA can change without much warning as well – like in overseas countries.

So in summary, if you buy property abroad, you have to convince yourself that the financial rewards out-way the increase in investment risk coming from the above aspects.

The romantic idea – does it make business sense? Many people may have a romantic view of property investment abroad – buying a nice villa in a beautiful location when prices are rising seems idyllic. However, making money in property investment is about as far from an idyllic setting as you can get – it does not matter what setting the property is in – it’s all about whether you can add value to the property when you purchase it, then add more value after the purchase – whilst achieving high rents and yields – to keep your cash-flow positive.

Let the numbers do the talking: Property should be viewed in a dispassionate and objective manner – the numbers should tell the story:

What is the return on equity after a year – after two?
What is the rental yield on the investment?
How quickly can you release equity after adding value, to continue building your portfolio?
What is the monthly (hopefully) positive cash-flow projected to be
What are the downside risks – voids, interest rate rises, cost escalations, chance of prices dropping?
What do you think prices will do in the next few years?
What major positive change is taking place that will project prices higher?

These criteria have little to do with a nice sunny location, historic buildings or an exotic location. That said, if you firmly believe that a property you identify in a historic, sunny, exotic location will benefit from massive price increases in the short-medium term and yields will be good – then it might be a good idea to buy such a property. But do not expect to be able to easily manage it – and consider the investment time it will take you to service or add value to such a property remotely – can you afford the time? Can you better use this time to purchase property closer to home, at lower risk?

What criteria should I use to choose an area? PropertyInvesting.net suggest using the following criteria to test whether a property is in a good investment area or not:

Population increase (0-15 year time horizon)
Land / property shortage
New infra-structure developments (rail, metro, road, retail, events, business)
New jobs (preferably services-banking)
Good communications
Regenerating area with major new investments
GDP growth and inflation under control
Interest rates about to drop
Attractive-popular area for rentals
Yields good
Fiscal - stable tax regime –secure legal title – currency stable

If you can find such an area close to home, then there’s less reason to go further a-field. For example, let’s compare properties in two locations:

1) a cottage in a village in rural central Italy (idyllic setting) £120,000

2) one bedroomed flat in Shoreditch – ½ NE of City of London (dull setting) £160,000.

For the Italian cottage:

The population is declining by 2% a year, there is no land shortage (many families are selling up to pay for retirement with the aging population in the rural areas), no housing shortage, no infra-structure developments anywhere close. Family run businesses are closing because of competition from Asia, tourism is stable but not increasing, no regeneration in the village, GDP is zero % in this area, interest rates for Eurozone are climbing and expected to for a few more years. It’s very remote so rental demand is low, roads are poor and the nearest airport is 80 miles away, yields are low because of high void periods, and the fiscal regime is uncertain because of political coalitions that change every few years in Italy. Overall – difficult to get to, manage and therefore risks are higher – one would describe it as a poor investment, unless you picked the cottage up at 25% below true market value and sold on quickly (though the market is slow, so this would be unlikely) .

For the London flat:

The population of London is forecast to increase by 10% in the next 10 years – an extra 800,000 people. More single people will need one bedroom flats. Not enough homes are being built – net shortage per year is about 15,000 homes in the London area. Located between the City, Docklands and the new Olympic site, Shoreditch is short of both land and housing. The local population is growing at about 1.5% a year – many wealth bankers are moving in because of travel problems getting to their city jobs – so one bedroom flats are popular for “weekly worker bolt holes”. Kings Cross International and Stratford International will be open end 2008 – with Paris 2½ hours away on the High Speed One train. The area is rapidly regenerating and the City fringes are expanding towards Shoreditch. New small businesses in services, media and finance are moving in. £5 billion will be spent in the nearby Lower Lees Valley on the Olympic development by 2012. 30,000 new jobs will be created in the next few years. London as a global financial centre has had a good run – and this looks like continuing – more financial services are moving from New York to London (shift in business projected to be 7% in the next 5 years). Rental yields are acceptable, and rental demand is strong – rents are likely to rise as the housing shortage worsens. The fiscal regime is not as stable as one would like, but one can read up about it in advance and see most of it coming – even react against it in some circumstances. Interest rates may be near their peak – and if they drop, asset prices could rise further. It’s one the last places you would expect a house price crash with so much money being made ½ mile away in the City and 1 mile away in the Docklands.

Why go Italian? So why would anyone living near London choose to buy an Italian cottage? Don’t have a good answer this one! (possibly a person close to retirement who is not interested in making money and does not mind get bored in a lonely part of the world – albeit in an idyllic setting). When you consider that in the time it takes to fly to Italy and back to visit your cottage you could have purchased another good London flat - you should consider this as lost “opportunity value” through not investing locally.

Experts stay focused: If you establish yourself in a certain area – it’s likely you will become somewhat of an expert in the local market – you’ll know the best contacts, establish a network, and have access to be the best deals. You will be able to eek out better value property because of your in depth knowledge of the market. You will not be diluting your knowledge. If you have an early local success – you have a very good opportunity to rapidly duplicate it and improve on it – it’s more difficult to do this rapidly when you purchase overseas. It may not be as exciting or indeed challenging. That said, if it’s simple, you can rapidly duplicate, leverage your skills in a focused manner – you will likely have the best possible chance of rapidly building a high equity property portfolio with lowest risk.

Does it matter to you whether you can tell your friend “I invest in Bulgaria and Cyprus – beautiful and exotic locations” or whether you can tell yourself “I made one million pounds net worth last year”. If the latter is more attractive for you – you’re probably more likely to achieve this by investing in a growing area close to home. Doesn’t sound quite as exciting – but property investing is primarily about making money, not excitement. You’ll find this out by asking experienced property investors and developers how and where they made their money – primarily locally and by duplicating something that worked well for them – and sizing it up. They also had fun – making money.

Objective and practical: We hope you have found this special report helpful – we try and bring you objective, impartial and practical advice and insights. We’re in the business like you are – to make money - as fellow investors - all this advice is aimed at helping improve your investment performance, and help you avoid the pitfalls.

The need to worry about you buying houses at peak time

2007-06-13T15:39:00.000-07:00

Very interesting times for house prices in the UK. There are signs the UK housing market is cooling – meanwhile the Bank of England surprised the market with a 0.25% interest rate hike to 5.25% in early January. This was followed by an inflation report which showed CPI inflation at 3.0% and RPI inflation at 4.4%. CPI is a full percentage point above the Bank of England’s target and very close to when the Governor is required to write a formal letter to the Chancellor describing what he is doing to control inflation.

The news about city bonuses and a “wall of money” – some £8 billion hitting the property market has helped fuel steep house price rises towards the end of 2006 in the expectation of continued rises in 2007 when this money is banked – mostly between end January and early April.

Many economists are now expecting rates could rise to 5.5% in early February because there are signs of high money supply levels, increasing wage settlements and retailers ramping up prices - and this would feed through causing inflation. The effects of higher oil and gas prices in early 2006 will feed out of the annual inflation figure which should help to moderate inflation, but there is a feeling and genuine concern that the buoyant economy is leading to increased spending patterns and retailers taking advantage of customers willingness to accept higher prices by raising their prices. The good news is, oil prices have dropped from $78/bbl to $50/bbl and wholesale gas prices from 80p/therm to 28p/therm – but it's almost as though this has fuelled growth, activity and hence inflationary pressures on this occasion.

There is also some evidence that India and China are jacking up prices, whilst eastern European labour is not as low cost as it was a few years ago – the skilled workers can now command higher wages now they are settled in the UK and the labour market remains tight.

So what does this mean for the property investing community?

Do not be surprised to see interest rates rise to 5.5% in February and possibly higher still by mid summer – make sure you budget for such increases in your cashflow projections.
Do not be surprised if house price growth drops to zero in the Midlands, North and West by Q2 2007 and moderates to say 2-5% in London and the South-East if inflation takes off in the next few months – we should see if this is the case by end February.
If prices fall, make sure you have enough cash in the bank to see you through any stormy period – and those with a lot of free cash and good positive cashflow would likely be able to pick up some real bargains if distressed sellers appear in the market.

It’s important though to note that, because the property market is such an important part of the overall UK economy, the last thing the Bank of England wants to see after their top priority which is inflation, is house prices crashing. Because the strength of the economy in the south (GDP growth 4.5% in London) is so much stronger than the north (GDP 1.5 - 2%), if interest rate rose so high it stifled the London economy and house prices dropped in London – this would imply the North, West and Midlands would be sent into recession with house prices crashing. So what this means is, the Bank of England would need to keep rates at an appropriate level to keep the north growing (not in recession) but cool London – and by implication – northern house prices may drop to 0-1%, whilst London would drop to say 3-5%. So its difficult therefore to see house prices crashing in London because this would imply a meltdown in the North. This is one of the reasons why PropertyInvesting.net favours property investment in London and southern England at present – it's lower risk. Also, London and southern England is rather less exposed to higher interest rates because earnings are higher, price to earnings ratios are moderate in areas close to London and property equity levels are generally higher. The population increase, services business growth and shortage of property and land all support prices, as well as jobs growth and international business.

So - keep monitoring the news, state of the market and which direct inflation goes, because it should be critical to your investment strategy - to "avoid" buying at the peak of the market and selling at the low of the market.

Why Has China Grown So Fast For So Long?

2007-06-02T15:53:00.000-07:00

Why Has China Grown So Fast For So Long?

This is the result of a personal effort to understand China. When I first came to China a little over three years ago, I really invested time in meeting with professors from Columbia and Harvard. I was based in New York, and I’d been following China for some time. When I got here I realized it was quite difficult to square what they were telling me with what I was seeing here. And that forced me to dig in and try to understand what was happening in China and give me a structured way of looking at things.

It also brought home a simple fact. I was told when I first got here that if you want to write a book about China, write it in the first three months. After that it becomes much more difficult. The longer you are here the less clear it becomes, and I had a very good friend who has been associated with China for 20 plus years. I said, “finally someone who really knows China,” and he said, “Well you know I only know very little about China.” So I think that China is a complex phenomena and a rich culture. All of that requires a very interesting review of the country and its performance.

I think it is quite remarkable what is happening, and maybe China has not been sufficiently reviewed in a way that is helpful to other countries. I was struck by the fact that the UN Human Development Report has never really taken on China to try to understand why it has grown for so long and so fast. China has really become a different country in just two generations – in a lifetime. Very amazing, it hasn’t happened elsewhere. Those who are economists find if very difficult using traditional techniques to explain all of this. What has China done so well?

China lifted something like three to four million people out of poverty – a remarkable example of a society shifting and transforming itself. I also want to highlight that development is fundamentally about transformation. And those who have studied economics, I hope that you also confirm that you are not taught that much about transformation. You are taught about microeconomics and microeconomics. And there’s a very good quote by Professor Stieglitz who said that successful development transformation must come from within the country itself, which must have institutions and leadership to catalyze, absorb, and manage the process of change and the change to society.

To me in a sense, this kind of sums up China. If you look at China through the transformation lens, you have a much more broad perspective and maybe the beginning of a explanation of China’s success; and I begin to look at the prospects for China’s future success. It’s also been very intriguing that whenever you look at the analyses of China, there have always been analysts who say that next year the Chinese bubble will collapse. Next year it will slow down. Now this has been going on for maybe the last 20 years, so maybe China has been doing something right after all, eh?

So the question is, what is that? So let me give you a little outline. China has the largest sustained GDP growth ever witnessed. It outperformed the previous tigers. Its share of world trade has tripled since 1990 and is still rising fast. It’s now reached a per capita income of $1700 which means China is no longer a low income country. It is actually alone responsible for the reduction in global poverty. If you took China out of the equation, global poverty actually rose. The human development index has gone up 43% since 1985.

The acceleration of growth is quite remarkable. And if you compare that with India, actually my own view is that the gap is not narrowing but increasing. Official poverty fell by fifteen percent: from 16% in 1984 to 2% in 2004. Admittedly this is quite a low definition, but even if you take the dollar a day poverty line, China has reduced poverty by 422 million people from 1981 to 2001. So regardless of measure, it is the largest reduction in human history.

As a result China is regaining its place. This is a quite interesting study done by an historian named Professor Madison. He has managed to get data from 1600 to 2003 – PPP data. By the 1820’s for a long period China had been 1/3 of global trade and went to low of 4% in 1920. But look at what is happening in 2003, we are beginning to see China gaining its rightful place in the global economy and global prowess.

Again, more towards the economists, if you look at all the studies done here, it is fascinating that some of my good friends try very hard to massage the economics to capture this. Now most of neoclassical economics, which is probably what you’re taught, sees growth and development as a simple form of adding more capital and labor. And then the emphasis is very much on standard policies and institutions regardless of the country specific context.

Now this is very important. China did not follow any of these prescriptions. It did not have prices which were reflecting scarcity value; it did not have institutions of the kind that have been recommended; it did not have capital markets; it did not have people trying to think in a global environment. But somehow it still did well. So privatization, marketization, liberalization are seen as key for achieving growth. This is the current dogma which is accepted globally. And China did not follow that.

So China did not follow any of the prescriptions in the so called ‘Washington Consensus’. A few years ago we had this big conference in Shanghai and Paul Wolfowitz, President of the World Bank said, “Let’s not talk about the Washington Consensus again. The Washington Consensus is finished. We won’t talk any more about it.” Because it was heavily criticized in the 1990’s for not having produced results. It was a very influential set of policies which every country was being recommended to follow.

And I’m being a bit provocative here. And yet the Chinese bumblebee, which someone told me is an appropriate metaphor here, continues to defy the laws of neoclassical gravity because neoclassical economics has defined some rules of gravity. And I said, “Is this the beginning of something called the Beijing consensus? A new consensus?”

Again to elaborate on how people have understood the standard development explanation: think of the shift of surplus labor out of agriculture to high productivity industrial sectors. That large pool of labor keeps wages low and returns to capital and investments high. And that all works out somehow to propel growth. And there have been a lot of studies on this basic understanding.

But many other countries have similar conditions, so why don’t they grow equally fast? So this question is not whether these two models work or they don’t work. And I know some mathematicians here may not like what I’m saying. The questions is how could China generate, sustain, and leverage the accumulation and reallocation of factors, I mean what is this thing called China? And again a little thin on traditional economic theories – there’s always a missing gap, capital labor can’t explain growth. And that’s not just true of China, that’s true of other countries as well. So that gap must be something special; and that gap they have called global factor productivity.

And different studies try to estimate what is that mysterious middle gap between contributing extra percentage points to growth. Some say it’s an extra three to five percentage points, but then some say a lot of the data in China is not very strong and they try to reduce some of the data. So I just want to put it out there for you to know that there are still other explanations to explain which China has done well or not.

Of course the question is what is total factor productivity and why has it grown. And of course this is a difficult question to answer because people try to give it as a residual and give it a name. But no one can fully explain it and I’ll explain it beneath some theory of development. My view has been that development is fundamentally about transformation. And I know some followed what happened in Russia and some of the former C.I. states.

My view is that there’s a very important relationship between ownership, capacity, and policy. And these three parts have to be kept together in a very serious way. And that’s the best way to understand Russia. When Jeffrey Sachs recommended the big bang approach – push forward with new growth oriented market oriented policies – why did it fail so miserably? It failed because you had social capital: how people relate to each other, you had organizational capital: which is institutions, and you had people’s own mindsets and attitudes: which were fit into how the Soviet Union was organized. There was an expectation of how factories are organized. There was an expectation of social benefits which are coming out of it.

And there was in some ways an alignment between these three: ownership, capacity, and policies even though the outcomeswas not a high level outcome. But when you shifted it and had new policies which were more market friendly, there were no institutions to manage them to implement them to make them happen. And people were resistant to it because they were not really for the free wheeling market. So there was a misalignment and that was a fundamental reason why that did not work for them.

In Russia, the big ban approach left a political vacuum. The state was captured by powerful interest groups; the state was seen as a grabbing hand, suffocating growth and development, not as a supporting hand. And I’ll come back to that in a minute. And in some areas the government classes just disappeared. Somehow there was a view that the state did not have a role to play and I’m going to argue that it has a lot of role to play. So managing development is all about managing transformation and managing this alignment, and how you sequence these things becomes very important.

There are at least 4 key elements which go very far in explaining why China has done well. First, long term commitment to reform and development. Quite remarkable. Twenty-five years ago when Deng Xiaoping launched his reforms in the late 70’s, early 80’s, he foresaw a 25-50 year period. That’s quite remarkable to have such a long commitment to reform and development. Most countries’ governments are for four to five years and they get into power the first few years and the last few years they want to stay on in power. So people have their political cycle and you actually see the cycles in the economic markets also. And China also. Rather than having a big detailed movement, there was much more almost like a philosophy, a strategy – you were aiming at a broad direction, but the means are flexible, you’re allowed to keep adjusting things as you go along.

Second it was about being pragmatic. If something was not working, you fix it, you change it. No policy since the late 70’s has been carried out in China in one go. There’s always been piloting and testing how it will pan out, again following Deng Xiaoping’s famous phrase of feeling the stones as you cross the stream. And that’s quite remarkable and I think that’s quite unique in many ways.

Third thing – institutions were strong and they kept changing to meet reform needs. Whenever there was a reform agenda, they were clear adjustments of institutions to deliver that.

Fourthly, public goods. You’ll be amazed that there was strong public growth in creating human capital which is education, cohesion bringing society together and a very deliberate investment in public infrastructure to open markets. And you can see that in the late 70’s and early 80’s public goods become very important and they keep on becoming very important.

Now I’ll talk about the role of ownership. When you compare what happened in the early 90’s in Africa, and there’s a lot of pressure on cooking up policy prescriptions from the outside and convincing African leaders to adopt them. The results were not very positive. I think what China has done well is to fundamentally say to everyone, and to believe themselves, that Chinese development is to be led by Chinese leaders and Chinese institutions; and to believe that they may not be perfect, but they’re ours. They’re our objectives, our policies. Very important,. I think this paints a picture. And maybe they did well because they didn’t listen to many outside. I’m talking about strategy issues as opposed to technical content.

Now people talk about the role of the Communist party and we were talking a little bit earlier on with the Vice President. There was a State elite which worked to define strategies, priorities; and this elite was deeply committed to improving people’s lives. It had a development vision. It was not what is referred to in the literature as a grabbing hand. And I talked about the piloting of scaling up. And finally on this point if you see how things have moved, there’s been a fascinating way of building constituencies for reform and compensating individuals. There’s never been a big dramatic shift from one point to another. In any change there are losers and winners, so how do you design a strategy to move them forward?

On the vision side, rather than big bang, a dual track was followed. There was not a shift dramatically from the state owned enterprises to the market sector in one go. But it was a gradual thing. The role of the state in non-agricultural employment is coming down. The private sector is going up. This is actually being done as a very conscious strategy. You have the market track along with a fixed planned track – two tracks. And it was permitted to outgrow the planned track by harnessing the market forces in its own dynamism. And of course there was a transition period to shift people away from the state owned enterprises to the market sector, and it was not meant to be immediate and dramatic, this is what the big bang tried to do in Russia.

The role of capacities. I think you know this very well. A lot of emphasis on education and capabilities. I think Amartya Sen was one of the leading contributors to the human development concept. There’s been a lot of literature on the relationship between human development investment and growth. I want to talk about the second part which I call organizational capacities. It was very interesting how the sequencing went – how economic reforms were connected to institutional transformations. Capacity building was a continuous priority. How research based management was introduced in China. If you’re a provincial official and have targets for your provinces and you really hustle and work very hard to achieve them – your future career depends on them. And those who don’t meet them, their future career also gets affected by them. Very strong results orientation.

This is investing in human development. Literacy rates have gone up dramatically in China. And this was not just in the past two decades, this started up in the 60’s as you can see. And the big jumps were late 70’s onwards. And this is very interesting. I think China had a very pragmatic approach to economic policy making and transformation. Deng Xiaoping, of course all the planners associated, saw that it was vitally important to reorganize the bureaucracy as a first step, as a precondition to reform. Remember what I said about Russia and misalignment. And this was a two year period. The reforms were introduced in the late 70’s, early 80’s and immediately they started changing a couple of things – age of the ministers, governors, mayors, department heads. In two years the average age was brought down. This meant thousands of people, because they felt that without that the reforms will not succeed. And secondly, it’s education levels. People with university degrees went up dramatically in two years – ministers, governors as you saw. And look at the emphasis at the provincial, grassroots level – mayors, county division chiefs. There was a view that unless people’s attitudes and their knowledge changes, reforms have no chance to succeed.

There’s a thing called social capital and again there’s a lot of debate in economics on what it means. It’s basically means how people hold together and if people hold together, well you have good social capital. Here, maybe I’ll make some provocative statements.

This investment in health and education in the 60’s and 70’s was critical in my view to keeping this cohesion together. And the link I mentioned between human development investment and economic growth is also well established. And in some ways you have this issue of historic equality and I‘d like to make a provocative statement – that without the foundations laid by Mao, Deng’s reforms would not have succeeded. Because what happened in the first stage was that the equality structure was totally transformed. And there was an equality which allowed policies to take full fruit. Mindsets were changed and also since many things had not succeeded, including the Great Leap Forward and others, people wanted something that worked. So there was certain pragmatism which was being built up. And some in society became more responsible to form a new incentive. And these issues which are difficult to quantify at times are far more important than fixing the market or market imperfections, which of course occupy economists a lot.

So what you had was an attempt to alighn – align institutions, align policies, no one can say the policies were first best policies, as economists like to say, or even second best; but they were appropriate. They were connected to a Chinese condition in a Chinese context. And therefore sequencing the relationship between policy and institution becomes very important and probably needs much more study. But detailed policy content may be initially of second importance, as a more fundamental transformation becomes much more important – the length, the condition for real sustainable growth.

And as the institutional framework becomes more refined, which is where we are coming to now, getting policies right becomes more important. Because the structural adjustments and conditions are being settled and you have to now bring policies to the next stage. And of course capacities then have to align to the new policies.

So in all of this clearly China has gotten something right. And here is the GDP per capita comparing China and Western Europe. And you see the real, almost vertical jump which is taking place. And you know the interesting thing that all of these structural changes and the constant adjustment as you go along; never aiming for the best, but trying to bring things together, keep moving forward.

Another thing which is very interesting – whenever there was a crisis, and there have been several points of crisis, the Chinese government has responded by additional reforms, not fewer reforms. Typically what happens is that whenever there’s a crisis, politicians and policy makers step back because some of the risks are too high, but in the case of China it was the other way around.

The thing which maybe we have not highlighted too much is that there is a lot of room given for local experimentation – China was highly decentralized as an environment. And if something wasn’t working it was scaled down; but provincial level officials had a lot of flexibility to do that. So this has clearly produced something useful and at the same time the fundamentals are doing better. The tax base has expanded to about 20% of GDP now. Quite remarkable for a developing country. Higher than most developing countries, which means you are moving into a different kind of economy and society. Much of the economy is now highly competitive, markets are becoming more important., trade has been liberalized, the economic expansion remained strong last year. Despite attempts by the government to slow it down, the economy grew by 10.7 percent. And yet, remarkably, inflation remained low.

If you are a traditional economist, economic planner, you will look and worry about macroeconomic and macroeconomic balancing. And you worry about inflation. But China put a lot of emphasis on creating the conditions and changing the supply response, producing growth and output, and in the end they seem to be doing that.

One think I haven’t talked about which is quite important is population growth. I think it will be incorrect to say that without this managed population growth rate China would have succeeded so much. The estimates are that instead of 1.3 billion China would have had between 1.5 and 1.6 billion. Clearly, the per capita growth would have been far less.

So in a sense, we come to the second part of our explanation. We’ve talked about the context, we’ve talked about how China has been doing and I want to talk a little about some of the challenges that are emerging. The substantial rise in income and non-income inequality; the rural population increasingly elderly, female, and vulnerable; rural-urban and other gaps are reducing social cohesion so the social capital is being affected. Migrant workers – there’s a challenge in terms of their rights. China is in the unusual situation where they’re still a developing nation, but there’s an aging population which is more characteristic of more advanced societies. And there are bitter signs that the poorest are no longer taking part in growth.

And there’s the recent table here by the World Bank that maybe the very poorest segment of the poor may be slipping backwards even though poor generally may be doing better. The fiscal burden remains heavy on local levels. If you are in Shanghai, you keep most of the money; it’s great because you can afford good health and education services. But if you are poor Gansu, it’s not so great because you are relying on the center for transfers of resources. And the feature of the previous success, which was heavy decentralization, needs some correction now because the state is needed much more in balancing these matters.

And again just to give some figures here, 80% of the rural population and 50% of the urban population are entirely uninsured for medical costs. Out of pocket spending on medical costs – 60% nationally, and 90% in rural areas. This is the challenge in front of China. 70% who refuse hospitalization cite cost as a major reason, and health costs are now responsible for 33% of new poverty. The maternal mortality rate in shanghai is 9.6, in Guizhou it’s 111.0, and Tibet even higher. Migrant women represent only 10% of urban pregnancies, but two-thirds of maternal mortality, and that is the current reality which is in front of us.

And in some ways these are challenges which the Chinese government is very aware of, but in my view, I think we are starting on a third phase of Chinese growth and development. People ask me the question – will this growth rate continue – and my answer is simple, yes. For the very simple reason that there are still inefficiencies in the system. As we get better policies, inefficiencies will be corrected and growth will continue on that score. If you look at the 11th five year plan, there’s a very conscious link between new shifts of balancing development, reducing urban-rural gaps, but also links that with new institutions. There’s a clear recognition that you must adjust current institutions to deliver on the future promise. The current institutions as they are constituted need to be adjusted to manage a more balanced development. This is not happening right now. And unification of the rural and urban economies will bring many benefits of scale and efficiency when the time comes. Right now they are segmented, and I know there is a lot of debate on how to unify the services part; but actually we need to unify the production systems part.

And structurally marketization is making traditional economic and institutions increasingly more important. Look at the stock market – better regulation, better transparency is needed. It was not an issue before. If you look at the coastal regions, 80% to 90% of new growth is market driven. Look at the figures for the Dongbei provinces which are in the Northeast – only 40% of the new growth is market driven. So as these other parts catch up, there’s going to be a lot of potential built into this thing. And given the strong economic fundamentals, if realignments succeed, this may well be only the beginning; so I’m at least an optimist on China on those scores. So what Deng Xiaoping foresaw on Xiaokang to achieve by 2020 is likely to happen.

As China developed the first stage of reform, this is where we are right now. Some features key to previous successes have to be revisited. And I highlighted some of them, institutional arrangements, emphasis on the unification of production structures. Policies are moving in the right direction. Xiaokang – all around development to be achieved by 2020. It’s very similar to the UN’s Millennium Development Goals. The “new socialist countryside.” The challenge now is no longer what to do but how to effectively make it happen.

And China’s too large and too complex to manage easily, so I really am absolutely awed and impressed by the competent leadership in China and the sheer emphasis on capacity building for those leaders. But perhaps we need to move to a phase where strengthening rule of law and scientific development become much more important. I have not talked about the environment and I have at least one colleague here who has been sent from the ministry of environment, from SEPA. I want to say something which is not there. I am absolutely clear and I know that Chinese leaders are clear that in order to sustain development, the environmental reality needs to be brought into the way we look at economic policies and development, and I’ll be happy to talk more about it in the question and answer session.

In my view the Chinese reform shows the importance of alternative approaches, country led approaches, homegrown approaches. There’s no shortage of this. Each country has to do the difficult job itself first – debate, discuss internally what works, what doesn’t. It can draw on international experience, but one can not replace the other. So alternative approaches to development are quite profound, and China is a great example. It goes far beyond the Washington Consensus and I would like to increasingly call it now the “Beijing Consensus.”

Now on delivering on Xiaokang. I can not resist saying something about this. I think when you talk about health, about education, on many other things, it’s clear the central government has to play a larger role on how the budgets are transferred, on the way responsibility for healthcare is settled. What is the role of the state in providing basic healthcare for all citizens? What is the role of states in providing basic social security? These are the two essential reasons why people save. This is why Chinese people save. I did not talk too much about that.

So new challenges require new policies which, in turn, require additional and new institutional features. We are at the point where I think this is the right time for a new, universal basic social security package. I know there’s been some debate on this and the debate in China seems to be moving very quickly on this. This whole question of rebalancing local, central and inter-provincial fiscal relationships, we have a program with the ministry of finance and People’s Bank of China on this. And how to make fiscal systems and monetary systems pro-poor, pro-people? Right now they are actually pro-rich and pro-urban. That is the reality right now when you do the analysis on it. Removing the dichotomy between urban and rural systems, I’ve already talked about. And perhaps start introducing human development targets. We have a program with NDRC assessing Xiaokang and having a broader range of indicators assessing how the country is doing in moving forward not just on economic growth, but also on health on social development and the environment. And fundamentally administrative structures need to be probably re-looked at, reorganized to raise efficiency and effectiveness, enhancing transparency and participation.

What could be the sum of the lessons for other countries? And this also interests me being a Pakistani and being an informal advisor to my own government on these matters. I’ve been trying to learn from China to see how other governments like that can learn. The first fundamental thing is ownership, and I’ve been saying a little bit about that. Unless leaders and people in each country are willing to do the hard work of sorting their differences out, the rest is not possible. Second – public policy is vital in creating the individual and social capacities to generally sustain reform and growth. Third, perfect policies and perfect things only exist in a perfect world. In an imperfect world, we have to come together and find the second and third best solution which moves things forward and continue to move forward.

Encouraging experimentation, scaling up initiatives. Even if they don’t fit into some planners or some economists preset ideas is fine as long as they’re working. Long term commitment to reform and development is absolutely critical. And how do you achieve in other societies – the government may change after four or five years. We need a long term vision of reform which may need to go beyond single parties or single governments. Building constituencies for reform. I think what is clear is that as human beings, if we feel that our future is not right, people respond and react to it. As human beings, that’s what people do. So those that are losers in a policy shift or change have to be somehow talked about, taken care of; so that social capital, social cohesion can be maintained and progress can be deepened. And a final comment, of course population. It’s not a sexy topic to talk about, but I think it’s quite important.

The right way to respond to China’s exploding surpluses

2007-06-01T11:57:00.001-07:00

What is the most important high-level dialogue in international economics? The answer is not the discussion among the finance ministers of the Group of Seven high-income countries. It is the “strategic dialogue” between China and the US. This is not because the latter will produce answers, but because it asks the right question. The biggest challenge in international economic policymaking is the incorporation of China. This, to his credit, Hank Paulson, the US Treasury secretary, has recognised. But his bilateral approach will fail. The G7 should, instead, be replaced by a multilateral body that can address such issues more effectively.

To understand the challenge, we must appreciate what makes China’s impact special. Experts often describe today’s globalisation as the “second globalisation”, to distinguish it from the “first globalisation” between 1870 and 1914. In the earlier era the rising economic power was the US and the UK was by far the world’s most important exporter of capital. But China is now emerging as both the world’s most dynamic economy and its largest source of capital. This helps explain a signal feature of our era: the combination of rapid growth with low real interest rates.

China’s current account surplus has exploded in recent years from a modest $46bn in 2003 to $250bn last year. This puts Japan’s $170bn surplus of 2006 in the shade. China’s current account surplus last year was 9.5 per cent of gross domestic product, more than double the highest ratio Japan has ever achieved, 4.3 per cent of GDP in 1986. If one adds the balance on flows of long-term capital (net foreign direct investment), the surplus in China’s “basic balance of payments” reached 12 per cent of GDP last year.

To put this in historical context, UK net foreign investment was 8 per cent of gross national product between 1905 and 1914. What makes China’s position even more extraordinary is that gross domestic investment itself appears to be more than 40 per cent of GDP. Thus China both is the world’s largest exporter of capital and has the world’s highest ratio of domestic investment to GDP. This is capital accumulation on a grand scale.

Yet the tale does not end there. In China’s case the government has been the direct source of the capital outflow. This has been a by-product of its interventions in the currency market aimed at keeping the renminbi down against the US dollar. Thus, between 2003 and 2006 the country had a cumulative current account surplus of $525bn, together with a $228bn net inflow of FDI. These were almost perfectly offset by its $777bn accumulation of official foreign exchange reserves. By March of this year, the reserves had reached $1,202bn, the biggest in the world and more than two-fifths of China’s GDP.

The reserve accumulations are not, it should be stressed, in response to inflows of speculative “hot money”. They reflect a policy of shipping out the foreign exchange received from huge trade surpluses and inflows of long-term investment, to keep the exchange rate down (see charts).

Is this behaviour desirable and, if not, what should be done about it?

A good argument can be made for the proposition that this pattern of behaviour is indeed desirable. It is desirable for the rest of the world because it lowers real interest rates, thereby allowing more spending. It is desirable for China, some economists also argue, because rapid export growth is the best way to generate sustainable economic expansion and higher employment.

The arguments against the pattern, however, are also strong, in my view stronger. So long as the counterpart trade deficits are concentrated in the US, there is a risk of protectionist action, particularly as the latter’s economy slows down. More important, it is hard to believe that vast accumulations of low-yielding foreign assets, so vulnerable to the almost inevitable appreciation of the renminbi against the dollar, make sense for the Chinese themselves. Indeed, the Chinese leadership itself has repeatedly declared its intention to rebalance growth, which has depended unduly in recent years on the growth of investment and the external surplus. Over the past two years, the expansion in net exports generated close to a quarter of the growth of GDP. This cannot continue much longer. At some point rather soon, demand has to grow at least as fast as GDP, if not rather faster.

In a thought-provoking recent paper*, Nicholas Lardy of the Peterson Institute for International Economics in Washington argues that the present development path has many evident disadvantages for China itself: household consumption is too low, at a mere 38 per cent of GDP in 2005; growth is too dominated by the coastal regions; employment growth ran at only 1 per cent a year between 1993 and 2004; energy consumption is too high; and the low domestic interest rates that result, in part, from foreign currency interventions distort the financial system and encourage wasteful investment.

So what is to be done? The answer seems simple: save less and let the nominal exchange rate appreciate faster, to eliminate possible inflationary consequences of such a policy shift. The Chinese government can easily afford to spend more on health and education. It can also usefully set up a modest pension system for those now alive. Moreover, the bulk of Chinese savings are not by households but by the government and corporations, many of which are owned by the government itself (see chart). Savings then are a policy choice, not a given. At 50 per cent of GDP, they also look far too high.

How then, if at all, can the outside world cajole China in a direction that seems to make such sense for the Chinese themselves? Mr Paulson is quite right to approach this question as a discussion of mutual interests. But it is almost inconceivable that the Chinese will grant what will appear to be one-sided concessions to demands from the “sole superpower”. That would be far too humiliating.

The Chinese will need, instead, to participate as equals in a wider global dialogue among the leading economic players. The obvious move is to replace the G7 with a group of four – the US, eurozone, Japan and China. In time, no doubt, India will join, but its time has not yet come. Such a grouping, moreover, should not focus on China alone. It must consider the range of policies adopted in these four dominant economies. Mr Paulson is indeed addressing many of the right questions, but in too narrow a forum. It is time to broaden the dialogue.