Syzygeist

Wadsworth on China

Yesterday (Monday October 18th) I watched an old friend and very wise man, Jack Wadsworth, interviewed on Bloomberg TV on the subject of China – its currency, economy and relations with the US.
I have known Jack since he was running Asia for Morgan Stanley in the mid and late 90s. I first saw him at a party for clients and was struck by the thought that if a war started and we all had to join the Navy and Jack had command of a vessel, I would want to serve on it. (I still feel that way.) Jack has run his own venture capital firm that has started about 30 new companies in China in the last half decade. He knows whereof he speaks.
On Bloomberg he had the same air of quiet composure, concern, confidence and good humor that always seems to characterize him. He did his best to persuade his interviewer that the real issue is not whether China adjusts her currency upward as Americans and their politicians would like, but whether America recognizes a labor rate differential in the world that requires our adjustment.
The idea is pretty straightforward – if a country competitor has labor rates that are roughly one-tenth of yours, you have a problem. Their currency adjustment alone is not going to fix it. You have to address it.
I listened to Jack trying patiently to explain this in the mini-bites of information that modern television news coverage allows. I have been involved with Jack in numerous meetings to discuss this issue: how the US-China dynamic should concern all of us, because if it goes off the rails, we (the world economy) all go together.
With U.S. mid-term elections approaching, a rising political theme is that China has to do something about its currency in our favor, and then somehow things will be different, better, “fixed.” Most troubling is the ring of 1930s protectionism implied – or actively expressed – if “they” don’t do what we want.
Jack’s quiet message – though I doubt it was heard through the veil of “tell me a happy truth that makes us feel better” – was simply that China cannot solve our problem. Its currency may be 5-10% undervalued, but we have a 10-1 imbalance to consider.
I would feel encouraged if I thought the American body politic can face this music and begin to dance together, but I do not. The Obama administration, public employee unions, the unemployed, Tea Party activists etc are not likely to come together with an attitude of “America has a problem that it must fix.” Wall Street and those profiting from currency market machinations could care less, as they will win no matter who loses. (Okay, some may lose there, but not the ones who should.)
Rather, we will seek outside causes for our ills and play a blame game as further difficulties come home to roost. The Greeks protest austerity. The French strike to defend their retirement age. And the US will find its own ways to defend the status quo. I predict we will look to others to blame instead of into the mirror, failing to consider that we have seen the enemy and it isn’t “them.”
What does that mean? Our currency will keep getting weaker, unemployment will remain at these levels or worsen, stock and currency markets will continue to fluctuate, and the hole the US has been digging will deepen, the reckoning yet to come.

View the clip of Jack Wadsworth speaking about China on Bloomberg here.

The Zone of Expectation

At the encouragement of a key client with whom I have been actively working for the last two years, I am starting the New Year with a fresh blog. Count me among those who fear there are too many blogs out there. We are information over-rich and over-run, and short on time. Could we please have one simple insight once in a while that actually helps?

Don't count on one here. But I am emboldened by a recent exercise undertaken just before Christmas with a crowd of Morgan Stanley-Asia executives who are variously still with the institution, or not, since they last worked together there in 2004. A scenario look into the near-term future produced what for me was - is - a real insight.

The topic that drew us together - and an interesting framework of uncertainty that we employed - was the dynamic between China and the US. These have been the two fierce pedalers (not to be confused with peddlers) of the global macroeconomic bicycle. 

That the bicycle nearly fell over in 07-08 was a function of the faltering dynamic - the US economy, fueled by consumer credit, buys low-cost-labor Chinese manufactured goods, and the Chinese accept dollar-denominated assets in return. And the global financial world turns.

With the value of financial assets suddenly plunging, and the dollar weaker, and credit shut off to US small businesses (the growth engine of the US economy), everything had to pause, and the bicycle began to tremble. That it did not fall over (yet, some would say) was credit to government liquefaction - governments print money and pump it into the economy fast.

Morgan Stanley Asia Chairman Steve Roach was on Bloomberg television moments ago to warn that the worst may be far from over - that the governments that pumped money in should begin to suck it out - now - to avert another dreaded bubble, and the bursting that necessarily follows. (Roach had been invited to our convocation at the Asia Society, but he had been unable to attend. Still he sent stern warnings about an over-stimulated Chinese economy and troubles to come.)

The insight that came to me during the session was an echo of history. In a Japan 1997 Morgan Stanley scenario exercise, a roomful of similar Japanese and Asia market experts proclaimed two key uncertainties: whether the Japanese economy would recover or decline, and whether Japan's governmental institutions would instigate meaningful reforms (or remain mired in bad practices.)

The scenario technique produced its own "zone of expectation" from the collective insight. This zone suggested that, as one participant put it, "there is no plausible upside for 3-5 years." Based on that view, Morgan Stanley ducked a proposed acquisition of Yamaichi Securities (the one that cost Merrill Lynch $1.2 billion in losses) and stayed highly profitable in the next three years in largely merchant banking activities. It paid off richly not only to see how things might not get much better but to commit to that view and behave accordingly, which Morgan Stanley Japan did under the leadership of Thierry Porte at the time.

At the Asia Society, the group discovered a similar "zone of expectation" for the global economy. Given the issues facing China and the US, the zone that emerged was implicitly negative, suggesting that for the next 1-3 years both economies might struggle and their relations might be corrosive if not combative.

Ignore this zone at your own risk.

This is just one scenario, of course. But I found myself thinking that I (and others) should take seriously the collective intelligence and intuition gathered in the room - representing about 1.5 centuries of recent financial market/Asia experience. Consider that the group might have seen clearly, if through a glass darkly, that the negatives for now outweigh the positives.

So what? Be cautious about the "Asia rescue" story that is being told, and "recovery is here" proclamations. The scenario treatment can bring to bear enormous collective insight in ways that top-down organizations, individual "experts" and off-the-shelf consulting approaches do not. So my opening salvo in 2010 is - "recovery buyer" beware.