March 26 – April 1

America’s mobile phone merger – Not so Fast, Ma Bell

AT&T has proposed a $39 billion takeover of T-Mobile USA, creating a dominant cell-phone operator with a 39% market share in the US and near duopoly with Verizon, the current leader. The combined market share of the two companies would be 70%. To tempt the Obama administration, AT&T claims the merger aids the agenda of allowing greater access to broadband internet for more Americans. The firm argues that the combined entity will create a stronger rival to Verizon, allowing for improved industry competitiveness. In sharp contrast, Canada recently concluded that the lack of competition in the country has resulted in having some of the rich world’s highest calling rates. In the UK, the recent 4G auctions are to be managed in a way to guarantee that consumers have at least 4 national operators to choose from. The writer’s conclusion is that a duopoly would reduce choice for Americans, consolidate an already uncompetitive marketplace, and be difficult to reverse.

The Texas Budget – A Blow to the Model

The most recent official budget estimate puts Texas at a $27 billion shortfall for the 2012 – 2013 budget. The state has a projected outlay of $99 billion with$72.2 billion available in general revenue plus $9.4 billion in its “rainy day” fund. Additionally, the state’s unemployment rate has now crept up to 8.3%, despite staying well below the national average for most of the recession. During the recession, Texans were quick to point fingers at states like California and highlight the Texas model of fiscal prudence, low-taxes, and low services. Now it seems the tides are turning. However, some of the state’s problems can be blamed on the national economy. The success of the Texas economy during the recession attracted a large number of job seekers from other states, and the level of job creation has not been able to keep up. The comptroller’s office argues that high energy prices and other incentives will continue to grow job creation. Eventually, the shortfall will need to be closed by brutal budget cuts that are now being made.

Portugal’s government collapses – The next domino
This week Portugal’s Prime Minister Jose Socrates resigned from office after being voted down for the fourth time on proposed austerity measures. His measures included a special tax as high as 10% on pensions and were opposed by leaders of the centre-right Social Democrats (PSD). Portugal is already likely to seek help from the European Financial Stability Facility (SFSF), and recent events may create further complications. Portugal’s bond yields are currently trading at their highest point since joining the Eurozone. Since joining, the country has been among the slowest growing economies and also the EU’s poorest member. As attention in the EU turns towards the cost of bailing out Portugal, markets will likely move on to begin the attack on Spain.

China’s Carmakers – Dream Deferred
In 2008, a subsidiary of Warren Buffett’s Berkshire Hathaway bought a 10% stake in BYD, a Shenzen based company that makes mobile phone batteries, cars, and solar panels. Within a year, share prices had risen 9X, but today they are trading at a third of their peak. Recently, BYD announced a series of delays for a hybrid car intended for the US market. In the domestic China market, the once popular, low-priced F3 sedan is getting outsold by Geely. Sales are up, but they do not meet estimates and are expected to decline further. Adding to the pain, BYD was fined for obtaining land improperly for a factory in Xi’an and Chinese cities are increasingly restricting the number of cars to curb congestion and pollution. In two years, the company that once signaled the promise of China’s future is finding it much more difficult to make those visions a reality.


February 26 – March 4th

The Future of Food: Crisis Prevention

Prices of food in real terms are at their highest since 1984, marking the second major price spike in less than four years. As G20 countries put their focus on food security, the problem needs to be segmented into three types: structural, temporary, and irrelevant. Temporary price shocks are a result of drought in Russia and Argentina, floods in Canada and Pakistan, and other market manipulations by countries and currencies. Energy price spikes also affect the inputs to food such as fertilizer. As for the irrelevant, Nicholas Sarkozy has blamed evil speculators such as hedge funds as the root cause of the food problem, of which there is little evidence. In financial markets, trading is unable to drive up prices in the long run because for every buyer there must be a seller. Structural shifts include the rise of China and India demanding more food and different diets to feed their increasingly urbanized cities. Thus far, the two countries have largely been able to satisfy their own demand, but this year China may become a net importer of wheat. Estimates say that global food production will need to rise by 70% by 2050 in order to keep up with a total population of 9 billion. Climate change is another structural shift that will exacerbate the problem. For the first time since 1960, yields of wheat and rice (the world’s most important crops) are rising more slowly than population growth. To combat the food problem, countries need to invest in agricultural research to boost farm output, reduce waste, and lower tariffs and trade bans that manipulate world markets. Bio-fuel initiatives such as ethanol subsidies are another wasteful business that needlessly distort the market.

Venezuela’s Economy: Oil Leak

Credit default swaps on Venezuelan government debt imply a 50% chance of default by 2015. This is surprising considering Venezuela is currently the world’s 8th largest oil producer. The main reason for the fears has been Mr. Chavez, who has been pillaging the state oil firm PDVSA, and using the profits for social spending. Meanwhile, Chavez has nationalized hundreds of companies resulting in capital flight and causing the country’s economy to depend entirely on oil. He has also created a warped currency system pegging the bolivar at 5.3 to the dollar even though the real dollar price is around 8-10 per dollar. To appease public unrest, the government has borrowed abroad. Since 2008, China has lent $12 billion to the country in return for oil shipments. Net public debt rose from 14% of GDP in 2008 to 29% in 2010, with an estimated 35% this year. Even with the unsustainable growth in debt levels, the government is unlikely to default with oil prices at or over $100/barrel. Funds have also been stashed away by the central bank (22.5 billion in cash and gold) and a separate, unaudited fund called “Fonden” ($39 billion). It is speculated that these funds will are being saved for 2012 when Chavez will be up for re-election and require some spending money.

Taiwan’s commonsense consensus

Since Ma Ying-jeou’s election as president in 2008, there have been 15 cross-strait agreements between Taiwan and China, including last year’s Economic Cooperation Framework Agreement (ECFA), an embryonic free-trade agreement. China and Hong Kong now make up 40% of Taiwan’s exports, and Taiwanese businesses have invested at least $90 billion in mainland China where some 800,000 Taiwanese live. Direct flights have commenced since July 2008, and 1.6m Chinese tourists visited the island last year. Mr. Ma’s political party, Kuomintang (KMT) has hoped to show voters the benefits that come from better ties with China. Last year, Taiwan’s economy grew by over 10% and reaped a $70 billion trade surplus with China and Hong Kong. China has also hoped that economic prosperity will win the hearts and minds of the Taiwanese and keep the KMT in power. Unfortunately, the plan does not seem to be working, as the opposition Democratic Progressive Party (DPP) recently won more votes in local elections. Support of unification with China “as soon as possible” is at the lowest levels ever, and more have called for independence. This has put Mr. Ma in an awkward position, balancing economic friendliness with China with political aloofness.

Very big ships: The Danish Armada

Maersk Line recently ordered 10 of the biggest container ships ever built to be delivered in 2013 (with an option for 20 more). The vessels will cost $1.9 billion and be built by South Korea’s Daewoo Shipbuilding. Each ship will be able to carry 18,000 boxes (2,500 more than the largest ships today), and require 50% less fuel per container. On February 23rd, Maersk announced profits of $2.6 billion for 2010 indicating a recovery in the shipping industry. Maersk projects global trade to grow by 6-8% with Clarkson’s projecting closer to 10%. Bulk carriers on the other hand (transporting coal, iron ore, grain, etc) have been hit hard due to overcapacity.  The Baltic Dry Index shot up to 11,793 in 2008 causing many shippers to order more ships to accommodate China’s demand for raw materials.  Overcapacity in ships led to a collapse with the index falling by 90% to 1,300. The container ship industry fared much better due to the industry’s consolidation, whereas the bulk-carrier industry is much more fragmented.

Oil and the Arab world’s unrest: Oil pressure rising

In the last month, Brent crude oil has risen from $96 to $115/barrel.  Africa and the Middle East provide 35% of the world’s oil with Libya producing 1.7m of the world’s 88m barrels per day. Thus far, the price increase has not been a result of actual supply disruptions, but future expectations. The worry is that the region’s unrest will lead to another shock similar to the oil embargo of 1973, the Iranian revolution, or Iraq’s invasion of Kuwait. Recovering economies in the rich world as well as Asia’s growth spurt have led to a depletion of inventories with most global oil producers running at full capacity. The spare oil in the world rests with OPEC countries.  If Libya’s oil stopped flowing, importers would look to Saudi Arabia, which could most likely plug the gap, resulting in little to no global spare capacity left.

Analysts at Nomura project that another halt from Algeria would absorb all remaining slack, resulting in oil at $225/barrel. The worst case scenario would be a supply disruption in Saudi Arabia itself, with unrest spilling over from neighboring Bahrain. The king this week announced $36 billion in benefits for the people to appease growing unrest. A shock to global oil supply could be weathered by rich nations depending on the extent and duration of the disruption.  Current stockpiles in the hands of governments and industries are estimated at 4.3 billion barrels, which is equivalent to nearly 50 days of global consumption at current rates.

Japanese banks: home and away

After suffering its own non-performing-loan bubble in the 1990’s, Japanese banks largely avoided the global subprime lending crisis. The country’s three largest banks are now flush with deposits with Mitsubishi UFJ currently the second-biggest bank in the world by deposits. Although the banks are profitable, they trail their global rivals due to having a domestic focus in a country with a dim economic future. Most Japanese firms are also cash rich, and when they do require financing, most do not turn to banks when, preferring to go directly to the markets. Retail banking is also in a slump with most risk-averse savers preferring cash or CD’s to higher yielding investments. With no other options, most banks have turned to Japanese government bonds which were recently downgraded by both Moody’s and S&P.

With bleak prospects in the domestic market, the banks have looked abroad. Nomura purchased the European and Asian arms of Lehman Brothers, Mitsubishi UFJ bought failed banks in the US to roll into Union Bank, purchase 21% of Morgan Stanley, and recently took over the project finance loan book of RBS. SMFG listed itself on the NYSE, allowing for greater ease in potential acquisitions, and Mizuho bought a 1.6% stake in Blackrock. They have also been active in expansion throughout China and the rest of Asia, forming alliances and hiring throughout the region. However, previous internationally forays have not ended will for Japanese banks. They are notorious for arriving late, paying too much, mismanaging, and leaving with losses. Other issues such as Basel 3 may also put a temporary halt on expansion plans, requiring “global systemically important financial institutions” to set aside higher amounts of equity to guard against potential losses.

February 19-25

Cover: The Awakening

Two months ago, a Tunisian fruit seller set himself on fire, and with it sparked a revolution that has spread from Tunisia to Egypt and now the entire Middle East (Iran, Bahrain, Libya, Jordan, Algeria, and Yemen). For decades, many of these countries have been ruled by iron-fisted governments who justified their existence by suppressing radical Islamists. The power vacuum left after Mubarak’s defeat is taken by many to mean that either another powerful autocrat will fill the seat or worse, the Muslim Brothers, a violent political group with connections to al-Qaeda. Even so, the Muslim Brothers should be allowed to take part in the new political system if democracy is to truly exist. Attempting to suppress the Brotherhood will only cause them to grow stronger in the shadows as before. The new constitution is currently being re-drafted by the Army which is promising to return Egypt to civilian rule. Time will tell whether democracy is a better alternative than authoritarianism when it comes to radical Islam.

Governing Brazil: A Promising Start

Dilma Rousseff, the new president of Brazil, came on board with big shoes to fill. Endorsement by her widely popular predecessor Lula da Silva was the major reason she was elected in the first place. Lula’s term saw Brazil’s rise to prominence on the world stage under minimal reform of red tape and taxes. Rousseff inherited an overheating economy, rising currency, and the upcoming 2014 World Cup. In her first six weeks, she has proven to be quite different from Lula in a number of important ways. She signaled the need for budget austerity ($30 billion in budget cuts), focused on eliminating extreme poverty (10% of Brazil’s population), and pursue tax and political reform. Abroad, Lula was often seen as friendly to dictators, and Rousseff has criticized them with intent to grow closer with the United States. At the end of the day, she will most likely be judged by how she handles the economy, and whether she is able to sustain fast growth alongside economic stability.

Worried Israel: Encircled by Enemies Again?

Israel has grown increasingly nervous about recent events in the Middle East. Egypt’s revolution could undo a peace treaty that has been in place for 32 years. The possibility of an Egyptian government ruled by the Muslim Brotherhood opens up threats to the Gaza Strip, where Hamas would grow stronger.  In Lebanon to the north, the new prime minister is backed by Hizbullah (sponsored by Iran). This comes in addition to Syria (who supports Hamas) and Iran itself (growing ever closer to nuclear readiness). In Jordan, stirring unrest threatens the only other Arab country (aside from Egypt) that has a formal treaty with Israel. Meanwhile, peace talks with Palestinians have broken down and have little chance to continue for the remaining two years of Netanyahu’s term. American and European mediators see a primary reason being Israel’s refusal to freeze building Jewish settlements in the West Bank. This is another concern, as America’s loyalty to Israel (especially on the Democratic side) seems to be waning. In some ways, doubts about support from the West (US & Europe) may be even more important than the Islamist governments in the region.

Britian: Inflation and Interest Rates

For many years the Bank of England had a simple job. A weaker economy meant interest rate cuts, and a recovery meant a rate rise. This was true as long as economic weakness was coupled with falling inflation. Today is a very different story. Recent figures show that Britain’s inflation rate reached 4%, which is double the bank’s target rate. Expectations are that inflation will continue to rise to 4.5% in coming months. The Bank of England’s report states that a rate increase to 3% should bring inflation figures back down to a modest 2%. However, the bank must weigh the risk of stubbornly high inflation with the threat of deflation if the fragile economy stays weak. In addition, the inflation figures today factor in a number of temporary influences such as energy and food prices, increases in VAT, and a weaker GBP. These inflationary effects may fade away on their own, leaving an interest rate hike to cause more harm than good.

The problem becomes more complex as the Treasury is also engaged in a bout of fiscal prudence, aggressively cutting public spending. The Treasury was hoping that the central bank would counterbalance fiscal tightening with loose monetary policy, setting the two parties in a “credibility race” that may stifle the economic recovery. If a rate rise does occur, Britain will be following in the footsteps of Canada, Australia, and Sweden who have all raised interest rates since the crisis.  The difference is that these countries all have far stronger economies and public finances than Britain, which has very little room for error in its economic policy decisions.

China’s luxury boom: The Middle Blingdom

Sales of luxury goods in China are projected to grow by 25% this year, over twice as fast as overall consumption. Rather surprisingly, luxury spending is growing even faster than spending on education, projected at 16%. China already makes up the largest market in the world for Luis Vuitton at 15% of global sales, and within 3 years, the luxury market in China is expected to surpass Japan’s. What’s more, it is estimated that 55% of luxury goods bought by Chinese consumers are purchased outside of mainland China.  This is in order to avoid domestic luxury tariffs (as high as 30%) and to avoid the stigma of counterfeits.  Bragging about the handbag you bought from Paris shows that one is rich enough to travel and afford genuine products.

Several distinctions mark the Chinese luxury consumer.  The average Chinese millionaire is 39 which is 15 years younger than the rest of the world. Wealthy Chinese are also less shy about flaunting their wealth, and some feel that it is necessary to be taken seriously.  Lastly, men make up a larger percentage of luxury consumers in a market typically dominated by women. Men are not only buying for themselves but also for others as gifts which are typical in the business world.

Alternative Investments in Brazil: The Buys from Brazil

In 2010, local hedge funds in Brazil managed around $243 billion in assets, up 23% from 2009. Private equity firms oversaw an additional $36 billion. Several reasons aside from Brazil’s economic rise can account for the growth in the industry. The country’s capital markets have matured, including improved minority shareholder rights and the ample liquidity of the BM&FBOVESPA exchange (now fourth largest in the world). Since 2009, Brazil’s pension funds have been able to place funds more freely with alternative investment firms. Rising inflation and falling interest rates have spurred fund managers to chase higher yields. The government has also held a largely positive attitude towards private equity firms and venture capitalists, seeing them as investors in the country’s entrepreneurs, providing credit where banks are unable to.

The boom in the industry does have some side effects such as increased competition for executives (salaries have tripled in the last 3 years) and deal flow, although deals are said to be cheaper than China where there is more competition.  Foreign firms entering Brazil also prefer leveraged buy-out deals, which may damage the industry’s conservative reputation. Private equity in Brazil has historically been comprised of unleveraged, minority positions in medium-sized companies (partly because debt is too expensive).  The industry is also highly transparent, with many funds offering daily liquidity and required to report NAVs daily.  Positions are reported publicly on a monthly basis, which may cost some managers their edge. Overall, the guidelines of transparency and liquidity have benefited the country in terms of the industry’s legitimacy, and other countries may begin to follow suit as regulations on alternative managers picks up.

January 15-21, 2011

Federal Debt: Dancing on the ceiling

On Jan. 6th, Tim Geithner sent a letter to Congress asking to raise the ceiling on the national debt. The Republican House is refusing to approve the new debt until they see a $50 billion spending cut.  The treasury’s current ceiling is $14.3 trillion, and should be breached sometime between March 31st and May 16th. This is after borrowing an additional $327 billion and drawing down $200 billion in deposits at the Fed.  Additional funds could be freed up by redeeming debt issued to civil service pension plans and selling mortgage-backed securities and privately originated student loans acquired during the crisis.  These measures should extend the Treasury’s runway until autumn.  Afterwards, it may have to default on something. The Treasury is able to service the interest on its existing debt through tax revenues, but other obligations may be postponed such as civil service salaries, tax refunds, Medicare/Medicaid payments, or Social Security.

Latin America’s Economies: Waging the Currency War

Strong performance in the Latin America region has resulted in an influx of foreign capital. With it has come an appreciation of the regional currencies against the USD, creating difficulties for exporters. The rise reflects the region’s sound financial footing and link to the commodity boom, but it is quickly becoming too much of a good thing. In the past two years the Brazilian Real has appreciated by 38% against the USD. As a result, inflation and loss of manufacturing jobs have increased. Governments are now taking measures to curb the value of their respective currencies. Chile this month announced it would by $12 billion of foreign reserves in 2011, and Brazil has required all banks to cover 60% of their bets against the USD with deposits at the Central Bank. Other countries such as Peru, Mexico and Colombia are following suit. Tweaking policy is however a tricky feat: raising interest rates to combat inflation may boost the currency further, and lowering the value of the currency through buying reserves may stoke inflation. Another method employed has been encouraging investment abroad through the private sector, pension fund investments, or sovereign wealth funds.

Mr. China goes Shopping

In the past several months, Chinese leaders have visited a number of European countries in an effort to show support for the EU, the Euro, and willingness to buy bonds to help struggling peripheral states. It is a testament to how quickly China has risen and Europe as fallen behind, clinging to a country with an economy one-third the size of its own for help. China has many reasons to help: the EU is its biggest export market and an important source of technological knowledge. Shoring up the Euro helps keep Chinese exports cheap while protecting the country’s Euro denominated assets.  Lastly, strengthening the Euro helps China to diversify its reserves away from the USD. Despite these measures, China has not bought itself much goodwill from the EU in terms of policy and trade. Issues such as the value of the Yuan, exports of rare earths, and intellectual property rights have taken on a sharp tone, and the EU has started to make protectionist remarks about China. On a higher level, the rise of China is quickly exacerbating the decline of Europe, threatening everything from the low-end manufacturing of shoes and textiles to higher-end cars, trains and planes. Although the Chinese still love their BMW’s and Gucci bags, it remains to be seen whether Europe can survive on its luxury brands alone (“Switzerland on a continental scale”).

Portugal’s Economy: Still Scary

On January 12th, Portugal had its first bond auction of the year, meeting its target of EUR 1.25 billion by selling bonds maturing in 2014 and 2020. About 80% of the bonds were purchased by foreign investors. The yields paid for the bonds were quite steep, and remain unsustainable for a country whose public debt is high and rising. Portugal insists that it does not share the same weaknesses of its neighboring peripheral countries Ireland and Greece because it was not caught up in a property boom or fiscal laxity. Instead, Portugal suffered from a stead loss of wage competitiveness which began in the 1990s. During the 1990 world trade talks, tariffs on cheap textiles from Asia were lowered, hurting Portugal (AKA “the EU’s sweatshop”). China entering the WTO in 2001 added further pressure. Feeble GDP growth combined with cheap borrowing overseas has resulted in an inability to keep public finances on track. Progress needs to come from a reorganized export market with flexible rules on hiring and firing as well as lower labor costs.

Playboy: Bunny Hop

On January 10th, 84-year-old founder Hugh Hefner bought out the 30% of Playboy Enterprises he did not already own, rejecting an offer from Friendfinder (owner of Penthouse Magazine). Hefner’s offer of $6.15 per share values the company at $207MM, down from approximately $1billion in its prime. Television is currently the company’s largest revenue source (40%), and a new push will be made into online gaming with “Playboy-caliber women”. Lastly, the company is expanding its presence in Asia with a club in Macau, and a Playboy Mansion scheduled to open in 2012.

Investment banking in China: Hope over Experience

On January 17th, Morgan Stanley and JP Morgan announced that they were given permission to enter China’s domestic securities market. These are the first for an American bank since 2003. Last year, China produced $5.6 billion in investment banking revenue, over double Japan’s. More than 700 companies issued securities worth over $186 billion and thousands await approval for public offerings. China has a lucrative market due to its large pool of savings that are currently stuck in low yielding cash or a speculative property market. Companies are looking to IPO in order to gain international legitimacy as well as incentivize employees with long-term loyalty. The new approval allows JP Morgan and Morgan Stanley to take one-third stakes in joint ventures with two of China’s smaller securities firms. In addition to being forced to swim with small fish, the government has imposed further limits. For the next 5 years, both companies will be able to underwrite but not trade any securities. In essence, it is the type of joint venture the two firms would never consider in any other country.

November 27 – December 3

Cover: How to Live with Climate Change

More than likely, the earth will be 3 degrees Celsius warmer by the end of this century. The changes that will follow global warming will benefit some and harm most others.  Places that rain heavily today will be subject to increased flooding, sea levels will rise, and many endangered species will likely go extinct from changing ecosystems. On the plus side, Russia will become blessed with more fossil fuels as melting ice allows for more access to the Arctic. The easiest way for humans to adapt is to increase the overall wealth of nations.  People in air conditioning and farmers with access to better seeds tend to suffer less. This is a compelling reason for rich countries (who were the ones who caused this problem) to help out the poorer ones who are unable to help themselves. This includes not only development, but sharing green technology and helping in three specific areas: infrastructure, migration, and food.  Rich countries like the Netherlands should share how to build infrastructure that minimizes the risk of flooding as sea levels rise. Immigration policies should stop subsidizing life in vulnerable areas (like Florida), so that people are encouraged to move away from, and not into them. Lastly, the world will need better drought-resistant seeds and crops and protectionism needs to be taken down in order to create a deeper and more resilient food markets.

Conflict on the Korean Peninsula: Ignore us at your Peril

On November 23rd, North Korea fired a 65-minute long artillery barrage on the South Korean island of Yeonpyeong, killing four South Koreans (two civilians and two marines). South Korea let out a burst of retaliatory fire, but was constrained due to fear of escalation.  Only a few days before, North Korea revealed a new uranium enrichment facility, demonstrating that it could possibly be readying its nuclear weapons capability. There are two possible reasons for this attack.  The first is that North Korea wants to bully its way back to the international negotiating table.  Obama has been practicing “strategic patience” which means ignoring North Korea until they promise to stop its nuclear program.  This could be a way to get the world’s attention again. The second scenario is that the country wants to demonstrate to its own citizens (and the world) that its new leader Kim Jong Un, is just as aggressive and tough as his father, Kim Jong Il. The US stands behind South Korea and refuses to reward North Korea’s antics with the attention it seeks. This leaves China as the only country with the influence to calm down their North Korean allies. By remaining quiet, China is inadvertently emboldening the North Koreans further.

Fiat plays double or nothing with Chrysler

For the first time in 27 years, Fiat cars will be sold in the US. This is part of Fiat’s deal to acquire 20% of Chrysler in a rescue package backed by the US and Canadian governments. After a partial flotation of shares (similar to GM’s recent success), the governments will sell their stakes and Fiat will take majority control. Chrysler is America’s weakest carmaker, having been taken over first by Germany’s Daimler for nine years.  After the unhappy marriage, it was sold to the private equity firm Cerberus, which was ready to give up and liquidate the company before the government and Fiat stepped in. Sergio Marchionne, the CEO of Fiat, first wanted to buy Opel, one of GM’s European brands, but the deal fell apart when he talked about closing down factories in Germany. In retrospect, it might have been for the best. The Chrysler deal helps Fiat to step outside of Europe onto the world stage and re-enter the US market. It also helps to weaken ties to Fiat’s home country of Italy, where it struggles with tough labor laws and low worker productivity.

Private Equity buys into care homes: Wall Street goes Long on Grannies

Since 2005, there have been at least 46 buy-outs of nursing home operators. Private equity shops now own three of the top five chains in the United States. There is obviously money to be made in the ageing of populations in rich countries.  People are living longer lives, and nursing homes provide stable cash flows with much of the revenue coming from government reimbursements which are immune to economic downturns. There are however certain problems. Cost cutting is difficult without affecting the quality of care, resulting in an investigation by the Government Accountability Office (GAO) on the quality of care provided by homes owned by private equity firms. Secondly, America’s health care act includes tax incentives for the elderly to be cared for at home as well as cutting over $500 billion from Medicare. To adapt, private equity firms have started finding other more profitable uses for the homes, including post-acute care for patients who are recovering from surgery. Higher revenues from these patients may lead to a crowding-out effect.  Poorer old people who are in greater need of the care will be displaced because they are less profitable.

Private Equity in China: Barbarians in Love

There are currently 167 registered foreign private equity shops and 265 domestic fund managers in China. Estimates of unregistered firms range from 3,000 to 10,000. Private equity adds value to the economy by filling a void in a financial system dominated by state-controlled banks. China is especially appealing to Western firms as the days of cheaply financed leveraged buyouts in their home countries are over. China holds the promise of high growth, promising new entrepreneurs, and the opportunity for spectacular returns. Additionally, firms are also interested in raising capital from China through recently developed Yuan-denominated funds. Furthermore, a recent regulatory change enables insurance companies to place up to 5% of assets into private equity firms. Despite all the bullishness on China, there are certain hurdles to be overcome.

For starters, three of the common techniques used in the West will not fly in China – dismemberment, leverage, and tax-avoidance. Gaining control of companies in China is usually not possible, so typical Chinese investments consist of a non-controlling 15-40% stake. For dollar based funds, government red tape usually takes several months or even years to clear. Given the circumstances, good deals are hard to come by, especially for Western firms who are often out-maneuvered by the domestic competition. As a result, many bigger firms have started investing in public securities of large companies listed in Hong Kong (PIPEs). This cuts through much of the regulatory burden and the painful due diligence required (it typically takes twice as many people to manage investments in China as in the West). On the other hand, making public investments also makes hefty fees harder to justify. The last problem for private equity shops is their inability to realize an exit from their investments outside of the IPO market, especially considering their minority stakes. Recently the IPO markets in Asia have been strong, but any weakness could shut the only door for fund managers to realize their investments.

November 20-26

America’s deficit: Confronting the Monster

The US deficit currently stands at $1.3 trillion, or 9% of GDP. This is the second largest deficit since WW2 (last year being the largest). Federal debt is at 62% and projected to reach 87% by 2020. This places the US as having one of the worst debt levels among rich countries. What is particularly interesting is how there have been very little plans on how to tackle the problem. Germany, the UK, and even France have now started their own austerity measures in order to curb spending or raise taxes to balance their budgets.

During the first two years of the Obama administration, very little has been done to tackle the deficit problem. Two recent proposals have emerged from his bi-partisan commission on deficit cutting, both with the aim of reducing federal debt to 60% of GDP by 2020-2024. Both proposals favor spending cuts over tax increases, in line with the rest of the world.

The first cut will be on discretionary spending such as law enforcement and defense. Except that the proposals exclude defense spending which makes up half of the total. Cutting the proposed $100 billion from the remaining amount would mean “savage” cuts to federal services. Aside from defense, the largest problem is entitlements (social security, Medicare, Medicaid) which make up 60% of the total. The proposals here revolve around indexing the retirement age or retirement benefits to longevity. This means that citizens would retire later or retire with smaller benefits.

The Economist recommends taking a closer look at eliminating tax exemptions, loopholes and deductions that favor the rich. A VAT tax on consumption is also being proposed, stating that the US taxes income too heavily and consumption too little in relation to other countries. These proposals, although bold, will both require the support of the Obama administration if they stand a chance of being enacted. This is a difficult position for Obama, as the public does not seem ready to take on these problems. On the other hand, history has shown that contrary to popular wisdom, governments that do enact austerity measures are often re-elected (Denmark, Sweden, Canada, & the Clinton administration).

Rhinos in South Africa: A Horny Headache

Rhino horn is currently selling for up to $60,000 a kilo. This year, at least 260 South African Rhinos have been illegally killed, over double last year’s total. The country is home to 90% of the world’ white rhinos, and a third of the world’s black rhinos. The Yemenis have a particular fondness for the rhino horn, using them as a symbol of status and wealth ever since the oil boom in the 1970s. Currently there are approximately 4,500 black rhinos and 20,000 whites in all of Africa. Demand has picked up recently with high-end hunting syndicates using helicopters, silenced rifles, and night vision goggles getting into the game.

Japan: On the down escalator

Japan’s working age population peaked in 1995, just before the economy went into two decades of stagnation. Since that point, the speed of decline has accelerated at an alarming pace, creating a “demographic vortex”. Japan is now the fast aging country in the world, and by 2050 four out of every ten Japanese will be over 65.

What is interesting is that this same demographic profile is what led Japan from total ruins to becoming a world leader after WW2. Surging numbers of workers entering the labor force coupled with vast usage of birth control created an unusual profile of rising salaries with little to no liabilities, generating a savings boom that was recycled back into the country’s growth. Now the country is paying the price.  Japan was recently surpassed by China as the world’s second largest economy, and Goldman Sachs predicts that India, Brazil, Indonesia, Mexico, and Turkey will all surpass Japan by 2050. An unfortunate result of the demographic situation will be the effect on young people.  As companies have to pay for the burden of older workers, they will have less to spend on training younger ones. Furthermore, older Japanese seem to be largely tolerant of deflation because their savings are worth more in real terms. This creates an entrenched cycle of falling prices, which the government is unable to break, despite spending the country into one of the highest debt levels in the industrialized world. Japan’s example will be a case study for other countries who are facing similar aging populations, including Western Europe, S.Korea, and China, whose working age populations will soon start to shrink.

Teaching Chinese: Mandarin’s Great Leap Forward

Interest in learning Mandarin Chinese has surged in recent years. The Chinese government estimates that 40mm people are studying the language outside of the country. Rosetta Stone has reported a 1,800% increase in the number of Mandarin learners using its program between 2008 and 2010. The greatest market for Chinese language textbooks is in South Korea and Japan. In September, India’s education minister even proposed teaching Mandarin in state schools

Yogurt: Creamy

PAI Partners, a French private equity company is putting its shares of Yoplait on the market. The offering’s timing is optimal as the world’s demand for yogurt continues to grow, especially in regions such as China and Russia. The US is also an under-developed market with the average American consuming approx 1/3 the yogurt of a Frenchman. Yoplait is the world’s second largest yogurt producer, trailing behind Danone in almost all countries except for the US, where the two brands hold nearly equal market share. The most likely buyer is Lactalis, a French firm who may enter Yoplait into a partnership with Nestle.

November 6-12th

Really behind on Economist reading, but here goes!

Cover: The Republicans Ride In

Mid term elections on Nov 2nd showed that Americans as a whole were largely dissatisfied with Obama and his democratic administration. The Republicans now control the majority in the House and Democrats have maintained control of the Senate. John Boehner (hilarious name) has become the new speaker of the house, replacing Nancy Pelosi and inheriting a $14.3 trillion deficit and a weak recovery. It remains to be seen whether Mr. Boehner will be able to cooperate with the Obama administration or simply create a deadlock in Congress, allowing nothing to be passed, and watching the economy continue to stall.

Rocky Relations between China & Japan: Bare Anger

On September 7th, a Chinese fishing boat was detained by Japan on the Japanese controlled islands of Senkaku, which China claims is theirs. The captain and crew were quickly released on September 14th, but China was not content, demanding a formal apology and compensation. Relations between the two countries have been strained ever since. Hillary Clinton offered to mediate, but China said no thanks.  The dispute has created large public anti-Japanese protests on the streets of China in several cities. Furthermore, China stopped shipping valuable rare earth minerals to Japan. China has a global monopoly on rare earths, which are critical for the manufacturing of high tech & alternative energy products. When questioned, China said that if Japan wants rare earths, they should move their factories to China (basically implying that China will steal the technology from them).  Overall, the incident is revealing the danger of Chinese nationalism taking hold as the country tries to exert its dominance on the global scene, especially towards countries like Japan, which by historical default it hates.

Italy’s Prime Minister: A Step Too Far

Italy’s prime minister Silvio Berlusconi is too funny. The most recent story revolves around an 18 year old belly dancer named Karima el-Mahroug who was previously questioned on allegations of procuring girls for prostitution, including hosting parties at the prime minister’s villa. Ms. el-Mahroug was recently arrested on charges of theft, but was released after the police station received a call from Berlusconi. His response? “Better to be passionate about pretty girls than to be gay.” TOO FUNNY!

Homelessness: Cutting out the Middle Men

A recent study done by the Joseph Rowntree Foundation found that the most effective way to fix the problem of homelessness was to give them money. A UK Charity named Broadway spend time in the Square Mile , which has one of the highest concentrations of homeless sleepers in London. They tried a new approach of simply asking a few of the 338 homeless men and women what they needed to change their lives.  Some asked for shoes and a television, others for a caravan.  Of the 13 people who were give an average of GBP 794, 11 of them moved off the streets. Some studies show that the state spends an average of GBP 26,000 annually per homeless person via healthcare, police, and prison bills. The people said they cooperated because they were offered control over their own lives, rather than being forced into shelters or other programs.

The Global Monetary System: Beyond Bretton Woods 2

The Economist names 3 broad complaints about the international monetary system.

1. The dominance of the USD as the world reserve currency and America’s management of it. The US only makes up for 24% of global GDP, and yet a disproportionate amount of trade is conducted in dollars. This not only fails to reflect the reality of the global economy, but also causes others to suffer from America’s domestic monetary policy (hint: QE2).

2. Vast foreign exchange reserves. Over the past 10 years, emerging economies have accumulated 2/3 of the total share of global reserves. This creates economic dislocations, such as poor countries lending to rich ones (mainly the US) instead of investing in their own domestic economies.The lesson of the 1990s and more recently in 2008 taught that the best way to deal with crises was to build up massive foreign reserves.

3. As a result of the scale and volatility of capital markets, financial crises have become more and more frequent over the last few decades. Emerging economies in particular can suffer from massive floods of capital followed by sudden droughts.

Brief history lesson.  Currencies started out being tied to gold, but the system did not allow very much flexibility for governments in terms of monetary policy.  After Bretton Woods, currencies were tied to the USD, which was in turn tied to gold. This system collapsed in 1971, when the US refused to adhere to the gold peg and let everything float. Now we have no ties to gold, and currencies float freely, although many emerging economies still manage some type of peg to the USD. The result is that emerging economies have to build up reserves to protect their businesses from massive currency fluctuations. China is the epitome of this type of policy, increasing reserves by $1.5 billion from 2009-2010.

What’s interesting is the tension between the demand for reserves and the fear that the dollar will lose its status as reserve currency.  The ever-growing demand for reserves (largely held in Treasury bonds), creates a huge supply of bonds, (currently 60% of US GDP), which in turn makes the reserves less and less of a “risk-free” asset class. Instead of finding a new reserve currency (IMF Special Drawing Rights, the EUR, or the CNY), it might make sense to instead encourage countries not to pursue excessive reserve policies through various measures such as fiscal tightening (Singapore), taxes on FDI (like Brazil) or allowing a more flexible currency system (Ahem, China).

The Fed’s Big Announcement: Down the Slipway

The US Federal Reserve has announced a second round of quantitative easing, purchasing $600 billion of long term Treasuries before next June. Since then, the yield on  10 yr Treasuries has gone down dramatically from 1% to 0.5% and the S&P shot up about 14%, due to the falling USD, making exporters more attractive.  The USD fell 5% against the JPY, 9% against the EUR, and 5% on a trade weighted basis. Higher equity markets creates wealth for households, and a weaker dollar helps US firms to compete in international trade. Overall the program, although unpopular, seems to be a success (at least in the short term. The risk for massive inflation does exist, but many believe it to be minimal, as the Fed could tighten once the credit markets loosen up and spending accelerates. A side consequence of QE2 is that money is flowing outside the US into emerging economies, chasing higher yields,  pushing up their currencies, and creating more bubbles.

Microfinance in India: Discredited

SKS, India’s largest microfinance institution has its headquarters in the state of Andhra Pradesh. Recently, a string of 57 suicides has put the microlending industry into the political spotlight, holding microlenders responsible for hounding the victims to their deaths. 17 out of the 57 women who killed themselves were SKS clients.  As a result, the state government has put the brakes on microfinance institutions in the country. The central bank has promised not to intervene until all the facts are clear.