Friday, October 28, 2011

Wenzhou wishes only its trains crashed

I try not to chase too much news of the moment – too many others stay on top of that information to make a contribution here useful.   And it's a good thing, because even when I try, the posts get lost in the suffle.  This is from about a week ago.   Since not much new has happened, I guess I can unburry this post and run with it.
Wenzhou, China made news recently with the crash of two high speed trains that highlighted safety concerns.  By census as having 3 million people, and describe (per article below) as having 9 million, Wenzhou in less spectacular terms is an old Treaty Port that is known for its industry on demand.  Small private firms will make products on demand for oversees based companies.  In an economy where much of industry is still controlled by government owned companies, these numerous small firms are disproportionately important to China’s economy. However, they are said to create 80% of the countries new jobs, and their export capabilities have been critical to China being able to follow the ‘Asian-Tiger” model to success.
The success of the area brought a lot of hot money in.   As most of these businesses were not able to get lending through the State owned banks, they used the informal banking system to generate the cash flow needed to keep operations moving.
Obviously, the slow economy of both Japan and the United States, and increased competition from other Asian countries wanting to follow the Asian-Tiger” model can lead to a cash flow crises.  When liquidity collapses – when the tide goes out – we get to see who is bathing without a suit on.
But there is another aspect to the problems of Wenzhou.
Elaine Kurtenbach, AP Business, 18 October 2011 via
Wenzhou's factory bosses are caught in a dire credit crunch. Pyramids of high-interest private lending are collapsing as companies whose profits are dwindling due to rising costs and weakening demand default on their debts. Dozens of tycoons have skipped town. The government has intervened, but many worry the stopgap measures will not prevent the problems from getting worse.
Mercedes, Cadillac and Toyota dealerships line the roads — attesting to the personal wealth that has left the city's nighttime sidewalks chockablock with parked cars and its streets choking with smog.
Vast chunks of the city are walled off for construction of luxury apartment complexes such as Noble Peninsula and Platinum Garden, while modern amenities such as a subway line are lacking.
Much of the estimated 500 billion yuan ($79 billion) in private borrowing in Wenzhou went not to manufacturing, but instead to potentially higher return investments in property or commodities — or to still more lending by the borrowers themselves.
Meanwhile, the government is slashing taxes and promising faster processing for export tax rebates…
The emergency measures, and a morale boosting visit by Premier Wen Jiabao and other top economic leaders, appear to have eased the recent panic…
But behind Wenzhou's woes lie a wider problem in China: many with capital to invest are no longer looking to manufacturing, when real estate, speculating in commodities such as Pu Er tea and high interest lending can offer much better returns.
The article notes that as many as 40% of the small manufacturers will either have to cut back production or go out of business.  On the plus side temporarily, the Chinese government is obviously willing to take measures to alleviate the cash flow portion of the problem.
Cash flow is a very real problem.  But insolvency is not cash flow.  If after you have sold your last widget, you have the ability to pay off all your debts, hopefully at a profit, than you are solvent.  Granted adding loans to the picture makes it a little trickier.  You have to project into the shutdown into the future.  The key is that you have the ability to shut down without being in debt.  That is why equity (rather than reserves) is considered so important.  If you put $100 million dollars of your own money into a company to float $200 million dollars of product onto the market, you can sell at a loss, and most likely the only person losing money is you.  However, if you but none of your own money in and  borrow 100% of the $100 million to float $200 million dollars of product, any lose at all is going result in your not being able to pay some of your bills. 
You can keep the game going for a long time so long as you have enough cash flow going to keep paying your current bills.  If you sell at a lose, but expand your sales at a greater rate then you are losing the money, you can keep going forever – or until sales drop.
When the Chinese business ran into trouble keeping up with their loan payments, the obvious choice was to jump into the speculative real estate market to make up the difference.  You jump to the bigger bubble – much like most of the United States jumped from a bubble to a residential real estate bubble of its own back in the naughts.
The Chinese, unlike the United States, decided to try and put the brakes on and pop the bubble before it became even more insanely larger than it is.  The hope is that you keep too much of the economy from becoming involved in a portion of the economy that is going to collapse.  These bubbles are very hard to stop, and in the case of China, they waited fairly late in the day to make the attempt.
Wenzhou - the pretty waterfront view

And just to show that if you wait a little longer, you will be given more ammunition:

Shanghai outlaws property discounting

Zarathustra, MacroBusiness, 27 October 2011 (ht: NC).

Chinese property developers have been in trouble for the best part of a year. Recently the penny dropped and many began cutting prices. Then guess what? People who already owned properties got cross and, in Shanghai, went to smash the showroom and sales office of a developer offering 30% discounts on flats.

But China is, after all, run by a Communist Party with a love of intervention and distorting the market with weird price controls from time to time. And yesterday Mingpao reported that the Shanghai government has banned China Overseas Land (688.HK) from cutting its prices by 30%. The regulator reportedly said that such a discount is “obviously violating the regulation”, and now any projects which are offering more than 20% discount should be re-filed to the regulators before sales.

So there you have it, property developers have been squeezed as volume dry up, and just as they finally face the reality to cut prices, the government helps to dry up the volume once more by banning price cutting so that they can’t sell as many as they would have wished. Socialism at its best.

Highlighted Text Note: This is to of course distinguish the Chinese Communists from the American Running Dog Capitalists who love of intervention and distorting the market with weird price controls from time to time. link

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