From President Obama’s State of the Union address.

We can’t afford another so-called economic “expansion” like the one from the last decade — what some call the “lost decade” — where jobs grew more slowly than during any prior expansion; where the income of the average American household declined while the cost of health care and tuition reached record highs; where prosperity was built on a housing bubble and financial speculation.

Interesting that this sounds a whole lot like the so-called economic “expansion” here in China…

I stayed up late to follow the iPad announcement via Twitter and the Gizmodo Live Blog. I talked with friends and read far too many online comments. The overall sentiment seems to be:

This can’t possibly replace a laptop or even a netbook. No Adobe Flash. No Multi-Tasking. No Camera.

For the people that really know how to Multi-Task, they should also be able to figure out how to Jail Break their iPad and use Kirikae or another multi-tasking app as many of us do on the iPhone right now.

Personally, I use Saft to disable Flash in Safari on my iMac, so I’m happy to avoid Flash on my iPhone and soon my iPad. Increasing the share of the internet who does not have Flash will hopefully force web designers to gradually abandon flash.

An expensive gadget in this economy that doesn’t replace better/faster/cheaper something I already think I need every day, and instead proposes to tell me there I things I didn’t think I needed that I now gotta have and

If it is bigger than pocketsized, it enters a class of “it doesn’t matter how much bigger than pocketsized, it might as well be WAY bigger since I have to carry it in a bag or under my arm.”

I’ve been using a MacBook Air as my primary computer for the last 2 years. Tasks like compiling software or running Photoshop are downright painful on the Air though. Fortunately, the iTab should be able to basically replace my Air on a daily basis: (Email, RSS, Books) and do so in a much more comfortable form factor than either my iPhone (screen is way too small) or my Air (how do you use it on the sofa? do you like looking like a geek at the airport?)

During these 2 years, I’ve basically had my Air with me every day, 24×7. Almost anytime I’m out, I’ve got my Air in my bag. At only 3 lbs, it’s been working great. However, getting almost the same resolution (30% less pixels) with 4x the battery life, half the weight, and for more adaptable to every day human life. Use it at the dinner table, sitting on the sofa, or standing and chatting with friends.

China whines about “Internet Freedom”

The first lines of the story really say it all.

CHINA hit back at US criticism of Internet control yesterday, warning that relations between the two countries were hurt by the unreasonable accusations in the name of so-called Internet freedom.

Yet another reminder that the CCP is their own worst enemy. It’s sad that the official mouthpiece of a nation with so many bright and talented people responds to intellectual challenge with “your wrong” and “that hurts”. Come on central comittee, you can do better than that.

It was as if the government had hired The Onion as its image consultant.

Seems that the CCP leaders believe they are the ones with the guns and they money and everybody wants to be their friend. However the turning point in Chinese foreign relations seems to have arrived. Their foreign business friends are getting ready to turn their backs just as the real estate bubble litters the landscape with empty luxury apartments and empty office towers.

Of course, the CCP response also included some hard hitting “facts” like:

China’s Internet is open

The Chinese constitution protects the citizens’ freedom of speech

There are a lot of Chinese folks that would sure like to see that new “free speech” version of the Chinese constution… Tank Boy vindicated? We all dream. Come on CCP, this isn’t gradeschool. There are thousands o expatriots and western educated Chinese out here that are here to help, just call before publishing this sort of thing.

Prof Chovanec on Chongqing

I think when you live in a place like Chongqing; you get a much better finger on the pulse than if you live in an expat community in Beijing. What’s happening in Chongqing is very typical of what’s happening throughout the rest of China.

This is an excellent point that is not made often enough. How much would you expect someone in Washington DC’s Chinatown to know about the intent of the president or the future policies to impact the nation? Yet too many of our int’l correspondents in China are not nearly local enough.

Obviously China’s opaque political system, relatively poorly educated average citizen, flexible (unpredictable?) government policy, restrictions on political speech and “state secrets” and lack of a long track record make accurate forward looking analysis difficult to produce.

Interesting excerpts. See the State Dept for full text. Clinton was very considerate of official Chinese reaction to the speech, and pointed out that the USA can’t really force China’s hand in this matter. In other locations, particularly the middle east, the US is prepared to take a more active role.

On their own, new technologies do not take sides in the struggle for freedom and progress, but the United States does. We stand for a single internet where all of humanity has equal access to knowledge and ideas. And we recognize that the world’s information infrastructure will become what we and others make of it. Now, this challenge may be new, but our responsibility to help ensure the free exchange of ideas goes back to the birth of our republic. The words of the First Amendment to our Constitution are carved in 50 tons of Tennessee marble on the front of this building. And every generation of Americans has worked to protect the values etched in that stone.

There are, of course, hundreds of millions of people living without the benefits of these technologies. In our world, as I’ve said many times, talent may be distributed universally, but opportunity is not. And we know from long experience that promoting social and economic development in countries where people lack access to knowledge, markets, capital, and opportunity can be frustrating and sometimes futile work. In this context, the internet can serve as a great equalizer. By providing people with access to knowledge and potential markets, networks can create opportunities where none exist.

States, terrorists, and those who would act as their proxies must know that the United States will protect our networks. Those who disrupt the free flow of information in our society or any other pose a threat to our economy, our government, and our civil society. Countries or individuals that engage in cyber attacks should face consequences and international condemnation. In an internet-connected world, an attack on one nation’s networks can be an attack on all. And by reinforcing that message, we can create norms of behavior among states and encourage respect for the global networked commons.

Taken in context, this reads to me like a veiled threat against China. Of course, the NSA’s job is cyber-espionage and cyber-terrorism, so it’s not really something new. Just part of The Great Game.

To use market terminology, a publicly listed company in Tunisia or Vietnam that operates in an environment of censorship will always trade at a discount relative to an identical firm in a free society. If corporate decision makers don’t have access to global sources of news and information, investors will have less confidence in their decisions over the long term. Countries that censor news and information must recognize that from an economic standpoint, there is no distinction between censoring political speech and commercial speech. If businesses in your nations are denied access to either type of information, it will inevitably impact on growth.

As it stands, Americans can consider information presented by foreign governments. We do not block your attempts to communicate with the people in the United States. But citizens in societies that practice censorship lack exposure to outside views. In North Korea, for example, the government has tried to completely isolate its citizens from outside opinions. This lopsided access to information increases both the likelihood of conflict and the probability that small disagreements could escalate. So I hope that responsible governments with an interest in global stability will work with us to address such imbalances.

And censorship should not be in any way accepted by any company from anywhere. And in America, American companies need to make a principled stand. This needs to be part of our national brand. I’m confident that consumers worldwide will reward companies that follow those principles.

In fact, I would like to see more governments, if you disagree with what a blogger or a website is saying, get in and argue with them. Explain what it is you’re doing. Put out contrary information. Point out what the pitfalls are of the position that a blogger might be taking.

Jeffrey Frankel, of Harvard University wrote “On the Renminbi”, concerning the RMB/USD peg as the view looked from 2005, just after the first minor devaluation (2.1%) of the RMB. When one currency is pegged to another, the value will typically be pegged too high, or too low. If pegged too high, there will be a run on the currency, just like an old fashioned bank run, but in this case it’s the nations central bank. If pegged too low, the currency will be undervalued. Hot money will arrive in anticipation of the eventual revaluation. Central Bankers must try to get the excess cash out of the system, primarily through Sterilization Bonds.

We have already mentioned that a balance of payments surplus implies that the reserve component of the monetary base is increasing. Some expansion in the monetary policy may be entirely appropriate, especially in an economy with strong long-term growth. But in an economy that is in danger of overheating, the central bank may wish to sterilize the inflow, so as to prevent expansion in the overall money supply.

If the money supply expands, you will create inflation and may also create asset bubbles which [mis]allocate resources from productive efficient. Recently these misallocations have expanded global housing markets and propped up global stock markets.

Sterilization can be a good response to an inflow, for a period of time. It can help the country maintain its exchange rate target without abandoning a target for the money supply or interest rate. But it can become increasingly difficult over time, especially if traditional barriers to capital flows have been gradually eroded. One problem is that it just prolongs the balance of payments disequilibrium, because it by-passes the automatic mechanism of adjustment that reserve flows provide under the monetary approach to the balance of payments. Another potential problem is the quasi-fiscal deficit: if the central bank has to pay high interest rates to get domestic residents voluntarily to absorb “sterilization bonds,” while receiving low interest rates on its reserves of US treasury securities, then it is running a deficit.

Under normal circumstances, Sterilization Bonds would require chinese state banks to purchase bonds from the government, reducing the size of the money supply (because money is handed back to the government). However, in China all foreign currencies collected at state banks are immediately surrendered to the central bank. I believe this policy removes the typical need for “Sterilization”.

Some governments are able to force their bonds down the throats of their banks without paying market interest rates, a form of financial repression; but this just weakens the balance sheets of banks and raises the odds of a banking crisis somewhere down the road.

With the banks all being owned by the Gov’t, this is the case here…

One disadvantage of a balance of payments surplus, on the other hand, is that the reserves, which are typically held in the form of US Treasury bills and bonds and other dollar securities, pay a low rate of return. Interest rates on US treasury bills are low because the market is so liquid and because default is assumed to be very unlikely — and also, during the period 2001-2004, because the Federal Reserve has held short-term interest rates well below normal historical levels. The Chinese authorities have evidently already diversified out of Treasury bills, into agency bonds and other longer term securities, which will probably help the yield somewhat. But it is more likely than not that the dollar will depreciate over the next ten years (not necessarily in the short run), in light of the large US trade deficit, which would reduce even further the return to holding dollar securities. (Diversification into the euro or other currencies has evidently not yet gone far.)

The low interest rates associated with this giant pool of money helped sow the seeds for the global financial crisis. Basically, there is too much money in RMB and not enough good USD investments, yet the Fed set interest rates too low. The result was Chinese bankers buying Fannie, Freddie and boatloads of mortgaged backed securities.

These points are drawn largely from the experience of emerging markets such as Colombia and Korea in the early 1990s. Those countries were able to sterilize capital inflows only for a year or two, before it became too difficult, due to high interest rates on the sterilization bonds and the prolongation of strong capital inflows (as in standard macro models). Chinese officials may be correct that their case is somewhat different, due to a financial system that is less open and less market-oriented.

See the “surrender” policy for dealing with foreign currency.

The capital inflow has consisted largely of Chinese citizens bringing capital flight money back home, speculating on a revaluation, and so far the authorities have not had to pay high interest rates locally to sterilize it. But they may find it increasingly difficult to sterilize further inflows.

The “inflows” are all the Chinese expatriate class returning home story was probably true when this story started, however the size of the bubble today and “Rise of China” being the most read story of the decade indicate the story has been stretched quite a ways now. Interesting that speculators always have a million reasons why it’s different this time and how other people are speculating, but not them and it’s not widespread.

Either way, if this gap is real, better to address it through appreciation than inflation.

But I doubt this is the policy that the CCP will peruse, despite how logical it may be and how much it may benefit the average citizen.

Voicemail is not very popular in Mainland China, but SMS has been very popular here for a long time. However, if you ever are out of the service area (ex, on a flight) you don’t know if you’ve missed a call. China Mobile has an excellent service called Incoming Call Reminder （来电提示）for only 3 RMB/month that will send you an SMS anytime you miss a call. The incoming SMS will appear to be from the person who tried to call you, making it very convenient to text or call them in response.

To enable the service on your China Mobile phone, send the message “3021″ to 10086.

• 302: Info about Incoming Call Reminders
• 3021: Activate
• 3022: Cancel
• 3023: Introduction
• 3024: Current Status

You’ll get a message back that says “请您回复1确认申请。申请来电提示当月生效，月功能费3元”. Just reply with a “1″ back to 10086 to activate the service.

China Unicom also has a similar service, it’s part of “China Unicom Secretary” （联通秘书）called “Lost Call Reminder” （漏电提醒）that doesn’t work nearly as well as China Mobile’s service. China Unicom’s service always comes from the China Unicom Secretary’s phone number (10655101981) so each time you must read the actual text message to see who called. The format is overly verbose, full of the same useless information and irritating iPhone ads tacked on the end of every message – even if you’ve already got an iPhone.

联通秘书在05:55为您接待了一位访客0018611112222（<选3G就选沃！联通携招商银行推出iphone手机0元拿!>)

The Unicom Lost Call service is also 3 RMB/month, but isn’t nearly as convenient to use as China Mobile’s service.

To subscribe to China Unicom’s “Lost Call Reminder” service, send “xxms” to 10011, or call 10010 for China Unicom Customer Service.

While we’re talking about China Unicom, let me point out that with the exception of WCDMA 3G support, there is no other reason I would use China Unicom over China Mobile. There are so many major annoyances using China Unicom:

• China Unicom signal coverage is very weak compared to the China Mobile signal everywhere you go. There are many locations where my China Unicom simply has NO SIGNAL – impossible to make or receive a call, yet China Mobile in the same place works great.
• China Unicom dialing has yet to be “globalized”. To dial a standard number in Shanghai, you would dial [+86] [021] [0000 00000] (where 0000 0000 is the local fixed line number). Dialing the prefix (+86) and the city code (021) ensures that the same number works regardless of where you’re currently located. This basic feature supported by nearly every company for both dialing and for caller ID simply DOES NOT WORK with China Unicom. If you’re in Shanghai, you can’t include the [021] city code, but if you’re in Beijing you must include it. If you’re in Hong Kong, you have to use both the Country Code and the City Code. Basically, China Unicom’s phone number routing is still stuck in the days of analog land lines.
• China Mobile has “IP Long Distance Service” activated by dialing the 12593 prefix. China Unicom has the same thing, but so far they refuse to activate it for 3G service, so I’m still stuck with “美加直通车/17900″ IP Phone Card for reasonably priced long distance – but the ADDITIONAL wasted 30 seconds in addition to the time waiting to pick up is quite annoying.
• As I pointed out above, the SMS reminders here on China Mobile work great, but the China Unicom ones don’t take advantage of you’re address book, and include annoying ads!

Caing reported that it’s going online. Now, the guys at google have decided to stop self-censoring, even if it means pulling their operations out of China! Full source (blocked by GFW)

These attacks and the surveillance they have uncovered–combined with the attempts over the past year to further limit free speech on the web–have led us to conclude that we should review the feasibility of our business operations in China. We have decided we are no longer willing to continue censoring our results on Google.cn, and so over the next few weeks we will be discussing with the Chinese government the basis on which we could operate an unfiltered search engine within the law, if at all. We recognize that this may well mean having to shut down Google.cn, and potentially our offices in China.

In Mainland Chinese culture, the person with slightly more authority in a situation routinely strong-arms the weaker party, and the weaker party generally goes along with the situation, saying “没办法 – No [other] method”. Google is another recent example 1st worlders of saying “No, are civilized and don’t agree with mafia negociation tactics”. Great job guys! Hope to see an explosion of cases like this in 2010!

The CCP has been using 8% annual GDP growth as the metric of success for years, but has lost sight of WHY 8% GDP growth has been the objective – and the bureaucrats have figured out how to manipulate GDP growth during the bubble years, the same way managers in American firms figured out how to manipulate stock prices in the 60s/70s. The resulting american conglomerate boom didn’t create long term shareholder value any more than the central planners focus on unproductive GDP will create long term financial benefit.

Deng Xiaoping made massive steps forward in Chinese reform by simply getting the gov’t out of the way, and with his support Zhao Ziyang and Zhu Rongji were able to go further. Chinese reform has been in exercise in gradualism, and this gradualism has avoid many undoable mistakes. However, we are left asking who are the reformers today? Wen Jiabao seems to generally came deeply about the welfare of the people, but without a free press and an independent judiciary, I think corruption will eat away at the efficiency of the Chinese economy and prevent mainlanders from reaching living standards of their brethren in Taiwan and Hong Kong.

The mainstream financial press has recently started picking up on the idea of weather or not “China” is a bubble. Longtime China bull Jim Rogers is quoted as saying: “I find it interesting that people who couldn’t spell China 10 years ago are now experts on China… China is not in a bubble.”

Rogers’ partner George Soros got famous shorting sterling. Meanwhile, Jim Chanos got famous shorting Enron. Chanos noticed that Enron had a very low return on Capital Investment (only 6-7%/year) and is seeing the same low return on invested capital here in China.

The first day I ever came to Shanghai, it was for a lunch invitation with Rogers. I fell in love with the place, and though it took a few months to get here, I plan to stay in Shanghai. Bubble or not. That first day in Shanghai, standing with Rogers on top of the Ritz Carlton, he explained to me the madness of the Shanghai real-estate bubble, and moreover, the world wide real-estate bubble. So there you go: “Rogers, China real-estate Bubble: Yes”.

Listen, Rogers is saying that “There is no commodities bubble”. Rogers has a huge amount invested in this, and if central banks keep printing money, they keep proving Rogers right. When China’s real-estate bubble pops, some commodities will take a short term hit, but the macro trend is that the USD is being devalued.

Chanos isn’t saying that he doesn’t think that China has a bright future, he is said the GDP numbers are “massively inflated by under-depreciating a very, very, very shaky capital asset base.” Chanos’ critics say that China’s different because there’s no leverage here, but that’s not true. The market is leverage by multiple layers of ownership each using existing property as collateral. Not unlike the structured leverage in Dubai, but completely different from the leveraging the the US property market.

Most interesting is that many in the US are vehemently opposed to government involvement in the economy, yet those same people are bullish on the China market because the Chinese Technocrats can “fine tune” the economy at their will. These are the same all powerful technocrats that drop dead regularly bingeing with the hostesses at KTV.

Here’s the relevant China situation, as it stands today, summed up quickly: 1. Everybody in China was dirt poor from 1949-1977 because the gov’t prevented private enterprise (basically the same as North Korea today) 2. In 1977, Deng Xiaoping created the first Special Economic Zone in Shenzhen, beginning the growth of China. 3. In the late 90s, Clinton arranged for China to enter the WTO, speeding up foreign direct investment 4. More investment more, higher efficiency factories and foreign exchange reserves soared 5. The gov’t invested (25%?) these foreign exchange reserves into infrastructure, creating hopes of a modern, industrialized, first world China at some point in the future. 6. The owners of the factories, the beneficiaries of the infrastructure projects earned private profits, and had to invest these profits – due to lack of investment options, most chose to invest in luxury real-estate, pushing up prices to current levels. 7. In ’07, the Global Economic Crisis came and China still had enough foreign reserves to weather the crisis, not only offsetting the drop in exports, but preserving the lucky “8%” GDP “growth”. 8. Throughout ’08/’09, Due to high real-estate prices and weakened global trade and investment options, even more money has been poured into Chinese Real-Estate

Things to remember. The Technocrat “Central Planners” have never had a good track record. We’re all aware of the disasters of Communist Central Planning of Russia, Cuba and the Closed China. In the 80s though, American’s talked about the magic of the METI (Ministry of Economy, Trade and Industry) explaining how America couldn’t compete with Japan’s centrally planned capitalism. That infatuation ended around when American’s bought Rockefeller Center back from Japanese investors for half the price.

Personally, I’m very long on the Chinese entrepreneurs and the Chinese people. In the next 50 years, I hope that most of them are able to join us Americans, and our allies in Japan and Europe in first world living standards – they’ve already done so in Hong Kong and Taiwan and it seems to be a great thing for all of us. Meanwhile, I’m very bearish on bureaucrats everywhere, and nowhere more so than where the bureaucrats are living in a giant bubble – and feeding the bubble for their own benefit.

Hu Shuli 胡舒立, founder of Caijing Magazine stepped down back in November. Hu Shuli is known to have backing from the CCP Standing Committee, enabling her to safely report on policy, corruption, law and human rights from a relatively independent perspective. Her situation is quite unique in China.

In September last year, Hu Shuli started stepping away from Caijing due to editorial constraints that were starting to impact the magazine. The scope of coverage started tightening in July, not due to editorial, but due to the magazine’s chief investor (Wang Boming 王波明) calling for caution. The All-China Federation of Industry and Commerce/中华全国工商业联合会, the party-led organization of businessmen that holds the magazine’s publishing license. Desk editors told reporters they wouldn’t be running any politically controversial stories — indefinitely. The move was related to the general restrictions of all forms surrounding the Oct 1st, 60 year anniversary of the CCP.

There are some things that even Caijing would have never been able to report on…

The untouchables are known among foreign media as “the three T’s and one F”: Tiananmen, Tibet, Taiwan, and the Falun Gong. Jeremy Goldkorn, who runs a Web site about Chinese media called Danwei.org, adds, “You don’t directly criticize central government and top leaders, and you don’t question their legitimacy. You can criticize lower-down officials, specific actions, and talk about local problems.”

Our worries seem to be over. This wasn’t a long term crackdown on transparency. It was only only an admission of frailty in preparation for the 60th anniversary military parade.

Hu Shuli 胡舒立 is back in action at Caing 新世纪周刊! Here’s the post at Caing: 胡舒立的团队和新闻职业共同体

Using Web Applications is getting easier every day, but there’s generally not quite as convenient as desktop applications. The only two exceptions I’ve found so far are Remember The Milk for task management and Google Reader for my RSS feeds.

This evening I found a way to bring RTM one step closer to “Native Application” like performance – now I can simply press “CTRL+ALT+R” or click the cute “Cow” icon in my Menubar and immediately add tasks to my RTM account.

Screencast of the Process

(Note that the video has narration – be sure you’re sound is enabled)

1. Download Fluid from fluidapp.com
2. Download the RTM Menubar Icon from Flickr
3. Copy this URL http://m.rememberthemilk.com/add

Once you’ve downloaded Fluid and the RTM icon from Flickr, open RTM and choose: * URL: http://m.rememberthemilk.com/add * Name: RTM Add Task * Location: Applications * Icon: The Icon you downloaded from Flickr

After choosing create, go to the Application menu and choose Preferences, then select the “General” and select the Global Shortcut.

Next, go back to the Application menu and choose “Convert to MenuExtra SSB”, choose OK on the prompt, and you’re done.

For years browsers have included options for “User Defined Styles”, allowing users to define a custom style sheet. But recently there has been massive innovation in allowing website users to customize the underlying sites.

The core of this innovation is XML and CSS, which has succeeded in finally separating the content from the presentation of websites. This is for practical purposes fully realized. Now for the next revolution.

The Revolution: User Scripting Websites

When we visit YouTube, Google, NY Times, or any other website, we’re never quite satisfied. The site always could have been better. It could have been easier to navigate. It could have been less cluttered. It could have included some key feature that would have made the site so much more useful. Like every engineering problem, the solution has always been possible – but the cost has outweighed the value, so modification of websites has not been wide spread.

Greasemonkey/Userscripts are leading the way into a new future. It can be commercialized. This will be bigger than Peer-to-Peer. Bigger than BitTorrent. Once this is integrated into every frequently used browser (IE, Firefox, Safari, Opera) UserScripts will become as important as XML RPC is to the modern internet.

User Scripts allow users to customize the look of any given website to match their preferences. Moreover, User Scripts allow the customization of the way that the given website actually works! For example, want Google Reader to look more like iTunes?

Default Google Reader in Safari

Google Reader Customized with “Mac OS X Snow Leopard” User Skin

Want to download .MPEG4 videos directly from YouTube?

Default YouTube in Safari

YouTube Customized with YouTube Perfect

Not only does this provide the ability to download FLV or MPG4 videos directly from Safari, it provides the ability to automatically select “HD”, to turn off the “Auto-Start” and even to change the color of the buttons!

Want to get rid of all the adds on the page you’re reading and focus only the content in a big, pleasant to read font? Usually the only rescue is to hit the “Print” button and try getting a reasonable page.

However, thanks to the “Readability” experiment, you can save yourself from any website and just focus on what you want to read – in a style that is most comfortable on your eyes.

Consider how many people enjoy “tuning” cars? Adjusting the suspension, the exhaust system, the interior, the lighting. Look at how much people customize their icons, their desktops. Once you can customize the software that you use, online, in an easy way, it’s going to unleash a revolution unlike any that have been seen in traditional software development to date.

1. Some customizations can be very efficient, saving users time or bandwidth
2. Customizations can change the feel to match the needs of certain groups of users (teens, employees of a specific company, seniors, students at a specific university)
3. The “cost” of customization will be much lower than what’s ever been seen in software because the changes are done automatically on the client side at runtime
4. The scale of such customizations will be vast. Imagine if Windows, Office, and Internet Explorer were released as Free Open Source software in 2000 – we would have hundreds of different versions of each. This will be even bigger!

A “bubble” is a sustained but temporary major misalignment between perceptions of value (momentarily reflected in market prices) and actual underlying value (eventually reflected in actual cash flows over time). In this sense, it is primarily a psychological phenomenon, caused by unrealistically high expectations of profit and/or underestimation of risk. I stress the words “sustained” and “major” because minor misalignments are taking place — and being corrected — constantly, which is what markets are all about. If all of us knew what returns would actually be over time, we wouldn’t even need markets — or entrepreneurs — in the first place. But there are times — we call them bubbles — when these misalignments persist and feed on themselves until, somewhere down the road, the market loses faith and valuations suddenly come crashing back to reality in one fell blow.

Some economic bubbles that we’ve experienced:

• Tulip Mania, Netherlands, 1637
• South Sea Company Bubble, UK, 1720
• Compagnie d’Occident / Mississippi Company, France, 1720. (Leveraged)
• Railway Mania, UK, 1840s
• Canal Mania, UK, 1790s
• Stock Market Bubble, US, 1920s (Leveraged)
• Japan Real-Estate and Stock Bubble, Japan, 1986-1990 (Leveraged)
• Internet – Dot Com Bubble, US, 1998-2000
• Housing Bubble, Worldwide, 2000-2006 (Leveraged)

Non-leveraged bubbles are still bubbles, but fortunately their ends are not as dramatic and there effects are not as long lasting as leveraged (credit boom) bubbles. Frederic Mishkin pointed out this distinction in the Financial Times (Not all bubbles present a risk to the economy [FT subscription required]).

Like the start of the Internet Industry, there were also bubbles at the start of the Automotive, Radio and Television revolutions. Each one changed our life. Each time, too much speculative capital chases too few good assets. Additionally, the excess supply of capital creates an excess supply of assets that can be purchased.

The common thread in these three bubbles is over-excited investors putting money into a relatively new product, financial scheme, or industry that seems, given its limited track record, to offer a sure-fire path to riches but whose real risks and rewards they do not yet fully comprehend. Funding those investments via debt is not a necessary ingredient.

I have not yet been able to find a lot of 3rd party sources covering real-estate leverage in China, for now I’ll quote Prof. Chovanec on the subject (Leverage and China’s Property Market).

According to current rules, Chinese developers must use their own capital to secure land. Once they do so, banks will lend them 65% of the money they need for construction and related development costs, with the land pledged as collateral. But saying developers must use “their own capital” to buy the land is a bit misleading.

Residential Sector: Developers build and offload projects rapidly to buyers, half of whom are paying cash.

• Many developers do raise such funds by listing on the domestic or Hong Kong stock exchanges
• Many bring in private equity investors.
• I’ve also seem them raise it in the form of debt
  • Parent company take out loans and then inject the funds as capital into a real estate subsidiary. (most common)
  • Issuing high-yield bonds (if they’re listed)
  • By taking on loans at multiple layers of holding companies, a developer can leverage up considerably to cover his “capital” commitment to the banks.
  • It’s very hard to quantify the extent of this exposure, due to the indirect way many of these loans were raised and channeled into real estate.
• Approximately 50% of all residential purchases in China today are financed with mortgages
• China’s mortgage market is relatively small — about 10% of GDP, compared to 48% for Hong Kong.

Commercial sector, developers are building properties mainly to hold and lease. That means they are raising debt — both from banks and subordinated creditors — and they are not deleveraging.

• Many commercial buildings sit nearly or completely empty
• Where does the cashflow to pay the loans on the property come from?
  • Does the bank care, or is it happy rolling over the loan because the (supposed) value of the collateral has risen?
• This is the Dubai story all over again — multiple layers of leverage, no tenants, no cash flow.

Credit vs Collateral

• In the West, banks usually make commercial loans to businesses based on an evaluation of their expected profits and cash flows — will they earn enough to repay?
• In China, as in many developing markets where banks’ technical skills are not so sophisticated, most business loans are made on the basis of collateral — are there assets the bank can seize if the loan goes bad?
  • Asset Chinese banks like most as collateral is real estate
  • Therefore SOEs enjoy both preferential access to land AND lion’s share of bank loans in China
• Nobody is really arguing that Chinese banks are over-leveraged.
• It’s their clients, the developers and SOEs, that are leveraged up on real estate.
• It’s loans to those clients, should property take a tumble, that would hit the banks as losses.

Cash Rich SOEs Pushing Real Estate Bubble Ever Higher

The National Audit Office data shows that 25 central ministries are involved in real estate violations, worth billions of yuan. Among them, unlisted assets of 51.6917 million yuan from the Ministry of Foreign Affairs have gone into purchasing real estate. The Ministry of Agriculture has developed commercial housing, acting beyond its authority, and has submitted false reports on housing subsidies. In 2008, a real estate rental service center under the Ministry of Finance took in rental income of 5.3193 million yuan. The Ministry of Public Security has approved construction projects worth 422 million yuan, utterly exceeding its authority. Other data show that among 136 central enterprises under the State-owned Assets Supervision Administration Commission, about 70% of the companies are involved in real estate, among which 16 firms are primarily based in the property industry, including Poly, Sino-Ocean, and China Resources, while more than 80 outside firms have business in real estate. Among the top ten highest priced land purchases in major cities in the first half of this year, 60% were gobbled up by SOEs.

Yes, that is 25 central ministries that have been caught speculating in the real-estate market.

• What is the Ministry of Agriculture doing building houses?
• And the Police Department (called “Public Security” here) is in the construction business too?

The government here is just as “asleep at the wheel” as the OFHEO was when regulating Fannie-May and Freedie-Mac.

The Office of Federal Housing Enterprise Oversight (OFHEO) was an agency within the Department of Housing and Urban Development. It was charged with ensuring the capital adequacy and financial safety and soundness of two government sponsored enterprises — the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).

Ignoring the Dubai Crisis and Bubble Concerns, Chinese SOEs Continue Playing “Land King”

Another 19 real estate companies also showed interest in the land bought by Sino Ocean, among them Gemdale Group, a private real estate company. It didn’t bother to bid, though, as prices were too high and a huge challenge for a private company. In the current environment, SOEs are able to take significantly greater risks than private enterprises.

My closest friend in Shanghai is also a land developer (房地产开发商) and I’ve heard the exact same story from him. Every time they try to bid on a project, some SOE backed business comes in at a higher price. No matter how much you are willing to offer, the SOE backed group raise the bid until they get the property.

Do SOE’s have a secret for generating better ROI than experienced, well managed, privately held developers? If they do, they should start a training academy teaching their “post-market economics efficiency”. Most likely this will be a lesson in buying high and selling low.

Zhang Shuguang, chairman of Unirule Institute of Economics, says, “Real estate policy next year is a choice among contradictions and big changes may not take place. Tightening policies will cause the real estate bubble to burst, resulting in economic problems, while excessive stimulus will bring a bigger bubble and greater risks.”

You’ve got a bubble on your hands. Choices I’m aware of are a) soft landing or b) hard landing. Sounds like the Chinese plan is to “manage the bubble”. Good luck with that.

The dilemma is more obvious for local governments. Zhang Shuguang says that half of local government income is real estate-related, and local real estate policies will not see big changes. Preferential policies may be fine-tuned instead of cancelled.

In case you want to know “why” the bureaucrats what to “manage the bubble” instead of fixing the economy? Because the bubble is putting money in their budgets. The bigger the budget, the bigger the kickback.

Can we bring Zhu Rongji back the way Deng Xiaoping was brought back? He’s ceased to exist as a public figure since 2003 – just about the time the economy started going way off track.

Zhu tackled the problems of an excessive money supply, rising prices, and a chaotic financial market stemming, in large measure, from runaway investments in fixed assets. After four years of successful macro-economic controls with curbing inflation as the primary task, an overheated Chinese economy cooled down to a “soft landing”.

Unfortunately, he’s not likely to be restored because:

Zhu has a reputation for being a strong, strict administrator, intolerant of flunkeyism, nepotism, and a dilatory style of work. For his hard work ethic and general truthful and transparent attitude, he is generally considered one of the most popular Communist officials in mainland China.