Greenspan, China, Asia and the Law

East Providence, RI   October 23 2008   Greenspan, China, Asia and the Law

The general consensus about emerging markets in Asia is that they will remain a safe haven during times of the Western crises. According to Mark Mobius, the "Predicted growth for emerging markets is an average of 5 percent in 2009 with 1 percent expected for developed markets" According to Mr. Mobius, the p/e ratios for emerging markets make for some very attractive buying opportunities. According to Haruhiko Kuroda, president of the Asian Development Bank "we can still expect around 7 per cent growth next year" across Asia excluding Japan." According to the Economist, "China has so far largely shrugged off the global credit crunch." But is this accurate?

Undoubtedly, these forecasters have relied on what Alan Greenspan calls the "best insights of mathematicians and finance experts supported by major advances in computer and communications technology". Which may be the problem. The combination of all this brain and computing power let the forecasters down. Mr. Greenspan is still having trouble coming to grips with the result. "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity (myself especially) are in a state of shocked disbelief."

But why should Greenspan be shocked? As I pointed out in my letter to the Financial Times in May, 2008, "The present subprime crises occurred because securitization changed the economic incentives for lenders. Since it was no longer necessary to keep a loan on their books, their economic incentive was to make as many as possible without regard to quality." In short, the lending institutions were protecting themselves by making the largest profit. The economic incentives were not constrained by any legal or economic disincentives, so the lenders were allowed to take all sorts of risks that ended in tragedy.

One would think that people like Mr. Mobius or Mr. Kuroda would have learned from this lesson. Rather than simply trust to a bunch of numbers, they might be a bit concerned as to where those numbers come from. This was evidenced by a particularly troublesome case that recently came to light out of China. Its seems that Citic Pacific, the Hong Kong-listed arm of China International Trust and Investment Corp, revealed that it had potential foreign exchange losses of about $2bn. The fact that these losses exist and were the result of unauthorized trading is troubling enough. Any firm though could suffer these problems. The real issue is that it took Citic Pacific six weeks to reveal that there was a huge hole in its balance sheet. Not to be out done now two other large Chinese corporations, China Railway and China Railway Construction, are suspected of having foreign currency losses.

Now as far as we know, after years of double digit growth, the Chinese economy like much of Asia, has slowed. Its growth rate declined from over 12% to 9%. Again the China bulls are telling us not to worry. In fact, this is something good! It will help cool an overheated economy and prevent the rise inflation. Besides the brilliant technocrats no doubt armed with the best insights of mathematicians and financial analysts are on the case and will increase economic stimulus to keep the economy growing.

It is not that simple. Before you can use the right economic levers, you have to have the right information. You have to have a system of rules that provide sufficient legal disincentives for managers not only to protect investors, but also to provide markets and regulators with timely, complete and accurate information. Across emerging markets, Asia and especially in China these disincentives in the form of a decent legal infrastructure do not exist.

Recently we have been treated to the scandal of tainted Chinese dairy products and even a continuation of issues with Chinese toys. These scandals occurred because the regulatory framework was insufficient to enforce the rules and keep Chinese manufacturers from poisoning kids. It's not that these manufacturers, like American lenders or Chinese corporate managers, are especially venal. Quite the contrary. I am sure in other circumstances that they are very moral individuals. It's just that the rules of the game were such that there was profit to be made without restrictions. Until people like Mr. Mobius and Mr. Kuroda make greater allowances for the quality of the numbers based on an assessment of the rules, their forecasts will be in the future, as they have been in the past, completely wrong.

I am William Gamble, JD, LLM, Ex MBA, KSC, a consultant specializing in emerging markets. I successfully predicted the collapse of the Chinese stock market and real estate market. I have been quoted or interviewed by ABC, CNN Asia, Bloomberg, Fox, CNBC, NPR and other television and radio stations around the world. I have published 24 letters in Financial Times and articles in Foreign Affairs, and Harvard International Review. I have been quoted USA TODAY, The Far Eastern Economic Review, The International Herald Tribune, The South China Morning Post, Sankei Shimbun. I have written two books Investing in China and Freedom: America's Competitive Advantage in the Global Market. In the past year I have spoken to CFA societies in 10 countries and 9 US cities as well as other conferences all over the world.

William Gamble, Your Globalized Lawyer
Author: Freedom: America's Competitive Advantage in the Global Market
EMERGING MARKET STRATEGIES   William Gamble
Emerging Market Strategies
East Providence, RI
Phone : 401-272-8906
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