Out with old, in with the … ???
January 19th, 2009 by Technomic Asia NewsI woke up this morning thinking about capitalism. I know…heady stuff for a Monday morning. First thoughts Monday morning should be limited to pondering which texture of socks to wear that day (the color, black, is a given). Wednesday or Thursday is when the brain has fully recovered from Weekend Mode and can handle the deeper, philosophical issues: politics, economics, why tomatoes are considered a fruit. When Kierkegaard first asked “is there a teleological suspension of the ethical,” you can be darn sure it was not on a Monday morning. Monday he was thinking about his socks, too.
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But the first moment of consciousness Monday morning upon emerging from the depths of R.E.M. brought this thought to my addled brain: “I wonder if, when I’m 80, capitalism will be the same?” Funny I did not question whether or not I would make it to 80, but there you have it.
Nine months ago I would not have been on this train of thought. I would have agreed with the recent presidential runner-up who said, at that time, that the “fundamentals” of the U.S. economy – the poster child and standard bearer for modern day capitalism – were sound. Daily, the sun rose in the east and my 401(K) followed the same upward path, bouncing a bit each 24-hour period but still following a generally buoyant trajectory. But suddenly, the Invisible Hand of capitalism grabbed a whistle, blew it and yelled, “Everybody out of the pool!!” And dang it all if we didn’t listen.
This, of course, got me to thinking about the situation here in China – because, when I am not thinking about my socks or capitalism, I guess I am thinking about China (someone, pity me quickly!). For years, the wizards and witches from the Hogwart’s School of Western Economics have been slapping Chinese leaders for not “opening up” their economy. The problem, quoth the wizards, was that the Chinese economy was too regulated where creativity and risk was not allowed free play, thus constricting growth and maturity. Cash, said the witches, was too important to the Chinese economy, not allowing it to bloom under the liberal application of credit, spread around like Dolly Levi’s manure, encouraging little things to grow.
The mad rush from the Pool of Western Capitalism was not just because of the lifeguard’s whistle … it seemed that someone had an accident in said pool and left a floater of assets that were so over-leveraged that they had nearly left their solid state and were approaching a gaseous one (OK, I know I mixed a metaphor there but, it being Monday morning, I am not sure how to make it right…work it out yourselves). The very principles upon which capitalism was based contributed to its downfall, the body economic had turned on itself in a cannibalistic fervor.
Which brings me to my initial question this morning – if the fundamentals of what we thought were capitalism are, in fact, contributing to its downfall, how then shall we live? Well, while the jury is still out, maybe the pithy and somewhat tongue-in-cheek “capitalism with Chinese characteristics” could have something to teach us.
First, the Chinese economy is very regulated – yes, too much so in certain cases, but I am not sure that a pendulum swing a bit right of center would be the worse thing for Western capitalism at this point (I have visions of sub-prime mortgage lenders standing at a chalkboard writing a thousand times “I will not destroy the very foundations of millions of people’s lives for my own selfish gain”). The Chinese government has regulations on who can invest; how much they can invest; what forms that investment can take; how much equity they can get for that investment – heck, even the currency exchange rate for foreign investment is controlled through a diaphanous peg to a “basket” of currencies. Regulatory control in China is ultimate; however, ENFORCEMENT is spotty and the reality is that things do fall through the regulatory cracks. But still, the Chinese regulators’ underlying philosophy – besides the maintenance of one-Party rule – is that we are NOT “rational actors” in any sense of the phrase. We are irrational, lemming-like creatures who will follow, nose-to-tush, the rodent in front of us as we all dive off the financial cliff du jour.
Sages in the West are nodding their heads in agreement that we need to “do something” and that greater regulation is part of that something. Talk is easy. As parents, its easy to feel bad once Junior is caught cheating at school and we might assuage our guilt by agreeing, as caring-yet-responsible parents, that Junior needs more discipline. Its easy to talk about this in the car on the way home, shooting Junior putative glances in the rearview mirror as he sulks in the backseat. But it is not easy to get home and dial back on Junior’s daily four-hour Guitar Hero fix and get his nose back in the books. His backseat sulk is a joy of Smurf-like proportions compared to the hooded glares of adolescent hate he will be shooting at you from his books. Same with demanding more regulation in Western capitalism – my fear is that its going to be difficult to keep them down on the Regulatory Farm when they’ve been to the Credit Circus and have ridden the cheap financing elephant.
Which brings us to point number two: Old Capitalism might need to dial back our obsession with credit. Economists will differentiate between a “leveraged deal” and a “Ponzi scheme,” as if it were a binary, black-and-white thing rather than a sliding scale full of more shades of grey than a Rauschenberg. In China, cash still rules – it is an incredibly frustrating thing running a business here where you still have to schlep around massive amounts of cash because, though wire transfers are certainly possible, the approval process can sometimes crush you (depending on which banks are involved). The penetration rate of credit cards is still only in the single digits in China (in the U.S. it is in the many hundreds of percent if you count the multiple cards that people often have). Though loosening slightly, real estate purchases in China – particularly residential – still require 30-40% cash up front. Over 90% of automobiles in China are purchased with cash, not credit.
So not only does Junior need to hit the books, he needs to limit his spending to what he earns mowing lawns on weekends. I often test my understanding of concepts by seeing if I can explain them to Chinese friends and colleagues. Not only does it challenge me to really understand the fundamentals, it also provides a moment of comedy relief for my friends – double bonus! In trying to explain credit derivatives and the sub-prime mortgage my Chinese friends would ask, “but how can you buy something when you can’t afford it.” I’d shake my head, like a majestic lion with a bothersome tse-tse fly buzz-diving its ears, and try again – “You don’t get it,” I’d say, “the credit allows you to buy what you could not originally afford…you look bigger than you really are.” One friend said, “I get it … just like the most popular elective surgery in China these days is the boob job.” Touché…
Third – and to me, this is the biggest one – we in the West would benefit from taking a longer view of our investments, how much they return to us and when. For our U.S. clients who are publicly traded, the pressure to show quarterly (or even monthly) progress borders on an obsessive-compulsive disorder. Monk might be a great detective but I’m not going to trust him with my stock portfolio. Every time we help a client do a big investment deal, I sit with the executives and, with full eye contact and a lot of love in my heart, tell them: “You know … some day, sooner or later, this China investment is going to look like doggie doo-doo. You are not going to hit your numbers; your manufacturing is going to suffer quality problems; your partner is going to go cowboy on you; your biggest distributor is going to hold you hostage for a larger margin; sudden regulation is going to make part of your original strategy obsolete. One, several or all of the above are going to happen. And when it does, what are you going to tell the market and the analysts? Draft the script now and keep it in a ‘Break Glass In Case of Emergency” box.’ You’re gonna need it.”
Wouldn’t it be nice to not have to worry so much about that? If the markets and analysts could show more grace; more patience; more understanding. To sit still long enough, take their eyes off their Blackberrys, stop Twittering every time they experience a gas pain and LISTEN to a company’s long term global strategy. To see the destination and not just the road thirty inches off the front bumper. To say, “yea, I get where you are going … it sucks that you had a bad month-slash-quarter, but life happens. I am not going to invest any more until I can see whether this is a blip or a trend – but I am not going to jump ship. I got your back, homey.”
All right, asking an analyst to use the word “homey” is probably demanding a bit much, but you get my drift. Our clients who are privately-held – although lacking in some of the experience and resources of their larger, publicly traded cousins – have a fundamental advantage in China simply because they often have more space to do something, stumble a bit, and then keep walking. Would that the NYSEs and NASDAQs of the world had the same grace.
Let me be clear here; I am not asking for the guilty to cry a tear-stained confession in front of the congregation, begging for our forgiveness. The guilt behind this global financial crisis is no one individual’s responsibility to confess nor is absolution ours to offer. That would be giving both parties too much power. But I am saying that there is a third way, grasshopper. Get back to the fundamentals, like in the bad old days: look for good assets that fit a validated growth strategy; acquire them at the right valuation and then run the heck out of them, knowing full well that the final movie will not follow the original script. Too simple? Yea, probably. But I don’t know of a company that got in trouble for doing just this.
We recently completed a commercial due diligence program for a large, publicly traded company. They were looking at an acquisition deal in China and we were tasked with assessing the feasibility of the deal – could our client believe the target’s marketing brochures and could our client execute the strategy they had in mind through this company. After many weeks of very intense work – and to grossly over-simplify – I had the meeting with the Big Dogs back in the U.S. At the end of my report, Chief Big Dog said to me, “So Kent, would you do this deal?” And I said – again, with full eye contact and empathy – “No, I would not…they are not who they say they are and you are not going to be able to do what you want to do with them if you were to acquire them. Besides, they are asking too much and you’d be giving up too much control. Plain and simple…no.” I gave him several other options that he should consider, each of them taking a bit more time and effort from his deal team to explore and execute but, in my mind, infinitely more do-able.
He was a bit shocked at my candor – I guess real consultants are given to more prevarication and use “it depends” every other sentence [Note to self: need to work on that]. But I could tell that he REALLY wanted to do this deal. I mean REALLY. His company was looking for some good news; something to show the Street that they were not going to let a pesky global financial meltdown ruin their plans for growth. He already had the press release drafted (in his mind if not on his laptop) and it sounded good. Really good. Lots of active verbs in a Dilbertesque homage to the gods of Leverage. The specter of old capitalism was on one shoulder, telling him in a raspy, been-there-done-that-deal-guy voice to do it. I am not sure if I embodied the spirit of new capitalism or if I was just being difficult, but I was on the other shoulder, and of a different mind.
Now is a difficult time to be making this decision, when the ghosts of old capitalism are still haunting us. Fast forward 30 years and the decision, I hope, will be easier because we will have learned our lesson. Somehow, though, I don’t think so – so I am going to keep this Podcast close. After all, I am going to be older then and won’t want to be working so hard. So when I wake up on a Monday morning pondering capitalism I will just call this up, change the dates a bit and re-record it. Then I can get on to more important things … like sorting my socks.
Remember our motto: In China, everything is possible, but nothing is easy. We’ll see you next time on the China Business Podcast.
