Is China Facing a Growth and Debt Crisis?

"Will China Shake the World Again?” is a recent article written by Robert Preston. Preston is the Business Editor for the BBC. The piece discusses China’s ability to sustain its growth, manage its heavy debt positions and avoid a disaster equal to or greater than the 2007-2008 financial crisis

Preston believes China has an "unbalanced economy whose recent sources of growth are not sustainable.”

In 2007-2008 “…the Chinese government unleashed a stimulus programme of mammoth scale: £400bn…growth accelerated... But the sources of growth…have a limited life.” “…China's growth rate…really looking at 4%."

 “But what makes much of the spending and investment toxic is the way it was financed: there has been an explosion of lending. China's debts…have increased since 2008 from 125% of GDP to 200%.”

“…investing at that pace…it is a…certainty that much of it will never generate an economic return…debtors unable to meet their obligations…large losses for creditors; the question is not whether this will happen but when, and on what scale.”

Based on my experience working with operating companies in Shanghai and Guangdong, I have to agree. My expectation for China’s future is negative, as their potential for serious growth and continued competitiveness will prove to be very difficult.

Having inspected a number of Chinese owned manufacturing companies in mainland China, it becomes apparent manufacturing knowledge, processes, and systems are woefully behind the times. Contemporary manufacturing in China corresponds to the USA’s 1970 manufacturing capabilities.

Therefore, cost increases from higher wages and inefficient operations are to be expected. Also, unfavorable changes in currency valuation will be a factor. This will result in lower growth, employment and capital availability. This will make it far more difficult to service its debts and fund necessary initiatives.

Judging from my visits, the young and educated Chinese appear much more independent, aggressive and spontaneous. It may make its citizens more difficult to control. Social unrest could be a major issue affecting China's economic development as well.

Click on this link to read Mr. Preston’s article.

Here are some other posts on China:

Is China’s decline permanent?

China to surpass USA as World Leader in manufacturing?

Can Manufacturing Return to the USA?

Bankruptcy and the Financial Crisis

On June 30, 2009 New York University held an excellent seminar on “Bankruptcy and the Financial Crisis".

The link to view NYU's webcast of the seminar is included below.

The subjects discussed included:

1. Federal government policy on large financial institutions and managing too-big-to-fail firms.

2. Creditor’s rights particularly reconciling Chapter 11 filings with section 363 of the federal bankruptcy code. Has anything changed in the distressed trading markets based on the handling of the Chrysler and General Motors bankruptcies?

3. Will a large bank fail? Actions the federal government will take if there are failures. Is capitalism affected and sacrificed to expediency?

4. Bankruptcy trends and risks – increase in distressed businesses.

The “Creditor’s Rights” panel:

• Moderator: Thomas Cooley, Dean, NYU Stern School of Business
• Barry Adler, Professor, NYU School of Law
• Edward Altman, Professor, NYU Stern School of Business
• Gerald Rosenfeld, Deputy Chairman, Rothschild North America

The keynote speaker: Thomas M. Hoenig, President, Federal Reserve Bank of Kansas City:

1. Mr. Hoenig rejected the notion that some firms are too-big-to-fail. He laid out a three-step plan to address troubled, large institutions and the need to avoid ad-hoc approaches.

2. He suggested that large firms be held accountable including replacing management.

The “What if a Large Bank is Failing?” panel:

• Moderator: Matthew Richardson, Professor, NYU Stern School of Business
• William Ackman, Pershing Square Capital Management LP
• Edward Altman, Professor, NYU Stern School of Business
• Micheal Krimminger, Special Advisor, Federal Deposit Insurance Corporation
• Nouriel Roubini, Professor, NYU Stern School of Business
• Myron Scholes, Chairman, Platinum Grove Asset Management

Click here to access the webcast link to NYU’s seminar.

Why William Clay Ford, Jr. Failed

In October 2006, the Ford Motor Company replaced William Clay Ford, Jr. as its Chief Executive Officer.

Why did Mr. Ford fail?

His own words, reported by Micheline Maynard of the New York Times on July 16, 2006, titled "Is Ford Running On Empty" revealed the answer.

"I bowed to managers on what I knew were product development mistakes”. “I can’t delegate to anybody…dealing with unyielding managers that stymie and condescend to me.” “… would have performed better if not faced with people obstacles”. - William Clay Ford, Jr.

Mr. Ford cited as one of his victories his environmentally friendly new River Rouge assembly plant. He believed this to be a victory because “…I did it over the objections of company executives.”

He brought in a new Chief of Staff and Gatekeeper, who is his best friend and brother-in-law, whose prior experience was as manager of the Henry Ford Museum. “He helps me decide which meetings and projects deserve my attention.”

One of his priorities was examining “…everything from how we’re going to treat each other in meetings to the trappings of our job.”

All of the priorities he listed in the article were essentially 'trivial many' when he had vital priorities that need attention. His “River Rouge” victory was quite minor with the intractable problems Ford is facing. Crowing about it publicly was a polarizing mistake. His new Chief of Staff, his brother in-law, further undermined him.

He made the fundamental CEO error, not persuading his managers to change their position on vital priorities. If he couldn’t persuade them, he should have made the correct strategic decision. He was not leading the company. He was not in command.

One example of Ford’s bloated overhead is its executive dining room replete with waitresses, multi-course menu, and silver finger bowls. Mr. Ford would have been more successful if he had executed an operational restructuring that significantly reduced salaried headcount in 2006 – not phased in over 3 years.

Better yet, he would have been well served to adopt Toyota’s performance target of 10% improvements in salaried productivity every year. If he adopted these principals, Mr. Ford, Jr. might then have been in a position to encourage unions to voluntarily modify contracts, base wage rates, pensions, and retiree medical care.

Leadership is learned. Taking command is learned. Mr. Ford held the CEO position for five years. He did not learn.

His lack of leadership and lack of prioritized focus, as demonstrated by his poor relationship with his managers, turned into poor performance at Ford. Only increasing Ford's low quality ratings, unimpressive new models, lack of worldwide integration in sourcing - product development, and the negative financial performance.

Alan Mulally, Ford’s new CEO, would be well served if he followed the practice of Neville Isdell when he was first named CEO of Coca-Cola. He was asked what are his plans for the company. Mr. Isdell's memorable response: "I plan to spend the first 120 days visiting employees and managers around Coke finding out what the state of the business really is."

Certainly the correct approach.

It is just that simple to get a company focused. Establish a rough-cut strategy, lead and motivate the team.

Follow-up to Analysis of the Financial Crisis

Two weeks ago, I posted about Mr. Komal Sri-Kumar’s near calming treatise of the financial crisis provided on October 3rd. He is TCW Group’s Chief Global Strategist.

Mr. Sri-Kumar expects a 6 to 9 month Recession, with the stock market starting it's recovery in April 2009. He is rather bullish on equities, and does not believe we are heading into a Depression. Bearish on oil and bullish on the dollar: Oil $75, Euro $1.25, Gold $700.

However, last week I attended New York University’s financial crisis seminar. This Panel’s views and forecasts were decidedly bleaker than Mr. Sri-Kumar’s.

NYU Panelists:

• Dennis Berman, Deputy Bureau Chief, Wall Street Journal’s Money & Investing
• Mark Patterson, Chairman, MatlinPatterson Global Advisors LLC
• Nouriel Roubini, Professor of Economics, NYU Stern School of Business
• Lawrence White, Deputy Chairman & Professor of Economics, NYU Stern School of Business
• Moderator: Thomas Cooley, Dean, NYU Stern School of Business

The NYU Panel’s views:

1. Predicted that the worse is yet ahead.

2. The recession would last 18 to 24 months. The question is whether the recession will be V, U or L shaped. While the word “depression” was not used, the Panel described the economic recession as one of the worst since the Great Depression years.

3. Equities will decline further from current levels and will not have a meaningful recovery for perhaps two years.

4. Housing prices expected to decline further. Housing prices will not recover quickly and will reduce the net worth of consumers to such an extent that it will affect spending.

5. Expect consumer loan defaults and hedge fund failures to add to the financial crisis.

6. The bond default rate is currently at 3%. Its historical average is 4%. The Panel expects it to rise to 10% or higher with the possibility it could reach 25%. The covenant light and toggle loans will delay defaults and bankruptcies.

7. China’s funding the USA trade deficit will become problematic and may require higher interest rates and perhaps a political “quid pro quo” such as Taiwan.

Mr. Sri-Kumar and the NYU Panel are in agreement that:

1.The Financial Rescue Plan was not developed and implemented effectively. The solutions have come late to a problem that was obvious in 2007. The handling of the Crisis by officials world-wide undermined their credibility and the predictability of the Crisis which has exasperated it.

2. “Inter-bank lending” is a key variable.

Click here to access the NYU Panel’s webcast link. Seminar held October 15, 2008. Duration: 97 minutes.

Click on this link for a summary and to access Mr. Sri-Kumar’ October 3, 2008 teleconference call.