Saturday, May 01, 2004

CHUNG KO - Middle Kingdom edition, Issue 1: Message in a bottle

The Financial Times has an incredible article out about what one would have to call a morality tale about what happens to some over-eager investors who try to strike it rich in China.

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In the early 1990s, accountant Tim Clissold was on the brink of becoming very rich. He and his partners had raised $400m and their company, Asimco, was riding high on China's foreign investment boom. Everything was done by the book: he learned Mandarin, they always bought controlling stakes and assiduously courted their hosts - even if it meant downing the odd deer's penis at official banquets.


What they hadn't counted on was China: when a factory manager absconded with $5m, an anti- corruption official said he would investigate only if he was given "a car and some working capital".

Meanwhile, the company's millions drained away, leaving a trail of furious investors. But all was not lost: in 1995 they bought a string of Beijing breweries. This is Clissold's story of what happened next

The first people to bring beer to China were the Germans, who built a brewery up in Tsingtao on the Shandong coast at the turn of the last century.

The locals' first tastes of the new drink confirmed their suspicion that these newly arrived foreigners were incomprehensibly barbarian: beer was bitter, sent clouds of gas up the back of their noses, and bloated the stomach before reaching the head.

But gradually beer became more popular, and by the 1990s the Chinese had overtaken the Germans as the second-largest consumers of beer, guzzling nearly 10 million tons every year. Multinational brewers were piling in, mesmerised by the prospect of one billion thirsty beer drinkers.

And the ultimate prize for a foreign investor in this booming market was Five Star, the country's biggest beer brand. It appeared hopelessly out of reach for us but, after months of convoluted negotiations, we beat 14 other suitors, including many famous names. Amid great celebrations in the spring of 1995, Asimco bought into three Five Star breweries plus a smaller rival brewery, Three Ring. My partner Pat and I were suddenly in the beer business.

Pat was a larger-than-life Wall Street banker, the son of a steelworker, who had reached the top. He even came packaged up with the pink silk ties, blue pinstripes, an ear-splitting laugh and an insatiable appetite for oysters, champagne and Cuban cigars.

He'd sit around after dinner, in clouds of smoke, with wine glasses strewn around the table, bantering and howling with laughter and all the time fiddling with the enormous red rubies on his gold cufflinks.

I met him after he came to China, convinced that, like the US in the late 1800s, it was poised for massive expansion. "But this time," he used to say, "it'll be bigger 'n' quicker."

From Wall Street, it looked as if America and China were the only two countries in the world big enough to support companies with just their domestic markets.

And China, just like late-1800s America, was about to see its industries consolidate. It was the last market on earth with such incredible potential, and what it needed was capital. Lots of it - and that's where we came in.

A few weeks after we made the brewery investment, just as the sounds of celebration started to die away, I received a note from the Five Star factory director, a Mr Xu. It was difficult for me to make out his badly written Chinese characters but he seemed to be asking for "understanding that he had made some urgent payments while Chairman Pat was out of the country".

I didn't take much notice at first, but when I asked someone to get me a cash balance from the joint venture, I was told that there were only a few million left in the accounts. It couldn't be true.

We had wired more than $60m into the account two weeks earlier, so I asked again. Sure enough, there was now only a few million left. About $58m had been transferred out over the previous three days. I was speechless.

How could that have happened? The signature cards lodged at the bank required signatures from our side before payments could be made. As I tried to understand what had happened, Pat called in from the US.

After I explained that $58m appeared to be missing, there was a long pause and then: "We gotta find that fucking money or it'll be time-out from the investors!"

It turned out that our Chinese partner at Five Star had huge loans from one of the state banks. The loans were overdue and the bank officials were worried that they could face a huge bad debt.

When they saw such a large balance of cash arrive in the joint venture bank account, the temptation had been too much. They called in Xu and persuaded him to take back the signature card for the account, replace it with one requiring Xu's signature alone, and pay off the loans. Xu, always the malleable one, had agreed.

He came to see us with guilt written all over his face, sweating more than usual and gulping loudly as he struggled through some weak explanations about penalty interest charges. But it was more or less a fait accompli.

The money was never recovered and, although we eventually recouped the value by setting it off against the Chinese partner's assets contribution, the business was left seriously starved of cash.

There was more trouble too: Xu confessed that he was having trouble transferring the Chinese assets into the joint venture. There was a dispute over a large piece of land at one of the breweries, and this had created a huge shortfall in the Chinese partner's assets. Wherever we looked more problems emerged.

It started to dawn on me that we were sliding helplessly into a huge quagmire. Calls to the Beijing government for help were met with a numbing silence. Our only course now was to deal with the intermediate level - Xu's direct boss.

As Five Star was a state- owned enterprise, that meant dealing with one of the industrial bureaux within the Beijing government.

Madame Wu Hongbo, chief engineer of the Fifth Light Industry Bureau of the People's Municipal Government of Beijing, stalked into the meeting room with a scowl and threw her handbag on the table. As the supervisory official with the bureau, she had been given the task of sorting out the mess, but she clearly had the greatest distaste for the job.

Hunkering down on the other side of the table, she announced that she would first review the performance of the brewery's management team and deal with me later.

"I have here," she said, eyeing the wretched Xu suspiciously through old-fashioned, thick-framed glasses, "three schedules with the results of each of the big Beijing breweries for the first quarter, and I want to know why you lot are so far behind!"

Pausing momentarily for Xu to grasp the awful truth that she had armed herself with facts, she raised her voice and, poking the air with her index finger, lashed him with statistics.

"Why did Five Star use 35 renminbi of electricity per ton of beer when the others used only 20?" Without waiting for an answer she surged on. "And what were we doing about this 14 per cent beer loss? Don't give me that old excuse about broken filters, you should have fixed that months ago."

I listened, somewhat aghast, to the scolding, and slowly realised that it would be my turn next, which it was. Plucking a small notebook from the depths of her handbag, Madame Wu asked me what I proposed to do to sort out the mess with the investment.

I told her that I really thought that it was the Chinese partner's problem. "We came up with the cash," I said, "and our investors just want to know when the Chinese side can come up with their assets."

She responded sharply that our investors were nothing to do with her and that if we really wanted to solve the problem with the assets we could add some old workers' dormitories instead of the land at Brewery Number Three. I said that there was no way we'd take them. "It might be all right for an old state-owned enterprise to have workers' dormitories but we've got to run a business here," I said.

"Well, how about a kindergarten, then?" she said. "There's one next to Brewery Number Two. And there's a water-treatment plant. It might be valuable if you drain away the pond!"

A huge row developed. "You agreed to buy some teacups," she said, "and it was up to you to check whether they were cracked or not." I said that was fine, but if the teacups weren't there in the first place she should come up with some cash.

She retorted, "Oh, no, I never use money meant for vinegar to buy soy sauce, so there's no cash for that sort of thing!" And so round and round we went. After two hours there was deadlock and we glowered at each other over the table.

Despite almost weekly meetings, it took an exhausting 18 months of shouting, rows and door-slamming to sort out the mess. Throughout, Madame Wu deliberately reinforced her image as a Chinese Boadicea, fearlessly defending the nation's honour against the wealthy foreigners, which went down famously with her superiors at the bureau. She was proud of her image and once told me shamelessly that she "used to be a soft young girl from Shanghai, but what you see now is a battleaxe from Beijing!"

She was short, stout, rather flat-footed and, from my point of view, entirely invulnerable to reason. She had trained as an engineer and worked her way up to the position of factory director.

After the government started to reform state-owned enterprises and demand they make a profit, Madame Wu had managed to haul a loss- making food-processing business into profit by pure force of personality.

This was her role before being promoted to the bureau. She was clearly competent at her job but she had a ranting style that instantly raised hackles and made me think that she was more intent on extracting catastrophic loss of face from her opponent than on reaching any reasoned compromise.

But, in addition to her innately turbulent nature, I knew that she felt justified in dealing with us roughly because of the way the joint venture had been set up.

We had approached the Beijing government, rather than her bureau, and we had used the former US trade representative, Carla Hills, to lobby senior ministers to get the contract approved. All the normal procedures had been ignored and the first Madame Wu's bureau knew of the deal was when it had been done.

They were livid for having been kept in the dark and probably relished a certain poetic justice in the way things had turned out. Carla had done a superb job in manoeuvring the ministers, but it had been an object lesson for us in how not to use guanxi (connections).

The mess was resolved only when I had legal papers drawn up to sue the Chinese partner and threw the bundle on to Madame Wu's desk. I knew we had a deal because she didn't immediately tell me to go to hell. It was a patched-up compromise but deep down I was pleased with it: we got stronger management rights, a bigger shareholding and extended the period of the joint venture from 30 to 50 years.

The only thing that Madame Wu and I had ever agreed on was that Xu had to go. She called him into the bureau and axed him. I never saw him again.

Meanwhile, the business had deteriorated rapidly. We had little time to pick a new general manager to replace the hapless Xu and the pressure was mounting....

knew that we were anything but an isolated case in the combat zone of Chinese investment. The whole business landscape was littered with the wrecks of failed joint ventures and, 10 years after we had first raised the money, hardly anyone embarked on joint ventures any more.

Most of the big multinationals set up their own wholly owned companies unless the government threw up restrictions. All but the most innocent of newcomers had concluded that joint ventures were just too hard to be worth it.

Even Pat had learned a little humility; he developed a habit of describing China as "the Vietnam war of American business".

Ironically, he had been right that Chinese industries would inevitably consolidate along lines that would seem familiar to a student of American history. It was just that the consolidators were from China, not from Wall Street.
[emphasis added]
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There's more, but it's all of a piece. Speaking of epistemology, it's always erroneous to take a single example and hold it up as a general indicator. However, it's also true that a single good example can drive home a point that a thousand generalities can't properly do justice.

Well critics may say, well after a failed decade American companies learned their lesson right? They bought outright and stopped using joint-ventures? So problem fixed right?

Well, not quite. Here's an example.

How can there be Free Trade when there is no Rule of Law in Commerce? Chinese agreements aren't worth the paper they're written on, but like idjits we keep on believing them. It's not the issue of whether or not "comparative advantage" is some esoteric theoretical economic benefit that does or does not work that bothers me about trade with China. It's about whether or not they're going to steal us blind!

I mean they're literally stealing nuclear weapons programmes from us!!!

This is the sort of thing we used to view dimly.

Then we went from Death Penalty for nuclear espionage to Engagement (USA_TODAY). WTF?!?!?!

When another country is stealing money and weapons from you, in order to build a huge ass army in return for a somewhat dubious economic benefit - see Newsweek's prescient late 2003 article predicting the problems of today - then one is entitled to ask what the hell is going on.

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For different reasons—overheating in China, rising deficits in the United States, runaway spending in Europe—there is a strong possibility that central banks will be compelled to raise interest rates and choke the recovery. While emerging markets are enjoying a stock-market boom, it is driven largely by a perceived shortage of opportunity in major markets, and could quickly dissolve in capital flight.
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In addition there are signs that the last Newsweek analysis of items threatening the world economy is an unwinding of currency pegs. This Asia Times article blames it on structural problems in a Asian Financial Crisis Redux, but it's just as accurate to say that it was the flawed "Free Trade" treaties that allowed the problems to develop to such an extent that structural flaws in the markets will collapse. This is akin to building a bed that will collapse under the weight of more than one person and selling it to a couple.

Free trade cannot be extricated and stood on its head as an absolute ideological good outside of the actual economic relationships that incarnate it. Just as one cannot talk about what a "good marriage" is meaningfully without referring to facts regarding how relationships work in actual real marriages. Yet empty pontification third hand is passed on as erudite economic wisdom.

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Hot money inflows. Weak banking sectors. Inflexible exchange systems. Regulatory shortcomings. When these and other structural deficiencies converged in 1997, laid bare by a calamity in offshore loan repayments and domestic capital accounts, Asia went into a financial meltdown that would ultimately erase a decade of growth from the young tiger economies of the East...

Yet the red flags are again being hoisted as regulators dither over a mass of policy challenges that should sound familiar: how to reduce the unhealthy reliance on export revenues; provide more cheap, local funding for business; and shield exchange regimes from external hiccups.
[emphasis added]
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This isn't trade - it's highway robbery!

"While overall Sino-US bilateral relations have never been better, it is arguable that, if current trends hold, the economic relationship between China and the United States could become the worst ever."

Hmmm ... let's see ... check ... check ... and check. Yep. Economy due for some unraveling. As one friend of mine, RSM, in the Financial industry said,

"The shirts were already lost."

Who knew he was talking about more than Chinese Laundromats?

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