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The Earning Power of Art

Red Hill China — Thu, 27 Oct 2011 09:59:46 GMT

art,art stock,There has been a lot of commotion, in the art markets, these days, about new art investment vehicles. They include art funds, art stocks, and outside guarantors of auction stock. We even recently commented about art funds, in another piece. In the mean time, we keep hearing about more people jumping into the fray. In China, more and more people seem to be getting into the auction business, which has its shady side, and opening art stock funds and exchanges, too. And there is an art stock exchange, in France, and an exchange-traded fund, in Russia.

So, let us step back, first, to look at the basics of finance. Finance is the allocation of funds over time under conditions of risk. The salient feature of financial theory is that an investment is worth the present value of its expected future cash flows, discounted back to the present at the investor’s required rate of return. Ex post, a return can come from some kind of cash flow, like dividends, partnership distribution, and interest, and or capital gains. The focus is on percentage annual return on investment, which is dollar return divided by investment. Returns can be further enhanced with hedging and leverage. The object is to get high return on investment, while minimizing risk.

For traditional investments, like stocks, bonds and commodities, the asset backing the security contract is capable of generating cash from sales of a product at a fairly certain price, in the regular economy. A company makes earnings by making and selling computers and from its net cash flow it can pay interest to bondholders and dividends to stockholders. A stockholder leverages his returns through the bondholders and margin borrowing. He can also make a capital gain or loss when he sells his holdings. A buyer of wheat futures can leverage his holdings and sell his wheat to a miller at delivery time.

Of course, the traditional investment industry has spawned many new products. There are options, real estate investment trusts, securitized mortgages, investment funds, investment advisors, investment analysts, investment consultants, funds of funds, to name a few. From its primary businesses: collecting brokerage fees, investment banking fees, and income from proprietary trading, all low risk or no risk businesses, the investment business has grown with the growth of its products. For the most part, those additional products are simply repackaging of the original traditional products; the ultimate packaging among them, over-the-counter derivatives. The broker-dealers, the sell-side, are the real professionals. In addition, there is a buy-side of investment products, which includes large institutional investors and retail. Indeed, more and more, over the past quarter century, the buy-side has tried to subsume or move more into the businesses of the sell-side with many examples of disastrous results leading to a number of financial crises.

In art, income is mostly in the form of capital gains. The institutional investors are museums, foundations and other large collectors, including corporations. Some of those institutional investors are capable of generating some cash flow from effective rental of art by selling admission to viewings and trading in exhibitions to generate further rental income. Many museums do not do much trading in art but get loans and gifts from collectors. Art dealers are the central professionals, and auction houses act as wholesale exchanges, mostly as brokers, but not as dealers.

Art dealers maintain inventories of art. They also do IPO’s of new art and act as market makers for their artists. They also act as brokers for other dealers and collectors. They can get one hundred percent interest-free leverage with no downside risk, in some of the transactions and services that they perform. They can earn commissions and make capital gains. They might also generate income with charges for exhibitions or other space rental and from art rental.

Thus, art can generate capital gains as well as ordinary income. It can also be highly leveraged. An art dealer can be short against the box, long and short the same thing, which can be done only by broker-dealers in securities, too, with a percentage spread locked in, in his business as a broker-dealer in art. Moreover, dealers offer a display area, both in galleries and online. Art auction houses can also take advantage of some of the same type of leverage. In the case of guarantees, they are giving a put option to the seller. Normally, dealers do not offer puts.

Art derives its value from quality of workmanship, scarcity, and its use for display or interior decoration. In display in museums, it generates ticket income or rental income from rentals to other museums. Museums can also trade in art. However, it seems that the income that many museums generate is insufficient to sustain their display businesses, in that many receive supplemental funding from donations, loans and gifts, and some have even had financial problems or closures, recently. For interior decorating, some antique fixtures, like beds, chairs and couches, serve functional purposes for interior outfitting. Others, like paintings and sculpture, are purely for visual satisfaction and enjoyment but are, by no means, necessary for nest building. Marketing and relative valuation give art its value. First art is valued relative to other art. Then, art is valued relative to other investment assets and necessary items of living. Thus, the value of much of art is tenuous, and there are examples of artists whose art has been in one day and practically worthless, the next. There has also been much volatility in art prices of even established artists.

So, art funds are basically an attempt to leverage art, by using other people’s money, not the manager’s. However, although the fund manager can make fees, the only way that the fund can earn returns for investors is from sales of art. The only way that investors can get money is from distributions of fund proceeds, if any, after sales are made, unless they can sell or cash out their fund investment, which is in most cases restricted. Investors also cannot enjoy the benefits of leverage or hedging. Moreover, how will sales of their art be effected? The choices for these funds are selling privately or through auctions or dealers. Moreover, unlike liquid investments, like stocks, art sales usually cannot be done on demand. Foot leather is required for private sales, sales through dealers can take time, and sales to dealers or through auctions houses are at discounts to retail value. Thus, there are severe limitations on both returns and risk management for investment in art funds. In the end, they provide a source of income for the creator and manager, just like other packaging in the investment business does. They also fit a perceived need or profile, just like other investments designed by the investment community.

Art stocks have popped up in several cities, in China, over the last year. The stocks cover portfolios of an artist’s works. The initial experiences were blowout pricing and closure of trading. An art stock exchange was also opened in France. Now, these vehicles could be used by collectors, art funds and dealers, alike, if there were the ability to sell art stocks short. Then, you could hedge your actual art portfolio. Problems are: the ability to short, liquidity of the markets, limited number of artists and works covered, and mismatch of the portfolio versus a work held by an investor.

In conclusion, art is useful for display, either for earning money from pay-for-view or for personal enjoyment. However, funds take advantage of neither of these aspects of art but only seek to benefit from capital gains. Moreover, like funds of stocks, art funds will stay invested in art, in up markets and in down, and the ability to liquidate in down markets is much more limited than, say, for stocks. After all, liquidity is defined as the ability to quickly sell an asset without much loss in value by the time a sale can be effected. Funds also cannot take advantage of other tactics that are available to professional dealers, like maintaining partial monopolies on art and zero-cost leverage. Although that market does not have dept, at this point in its development, the art stock market could be used by real investors, in art, to hedge their positions. In the absurd limit, however, if all art were held by funds and securitized, it would no longer have any intrinsic value.

Chinese Insurance Drill

Red Hill China — Thu, 27 Oct 2011 09:59:03 GMT

Since I came to China, I have gotten into discussions about insurance on a number of occasions. Insurance is just beginning, in China, but it's not trusted by the people. Indeed, most people who are rich enough to afford a car don't even have car insurance: they just negotiate, sometime for hundreds of thousand of Yuan, in case of an accident, injury or death.

At the university where I teach finance and econ they offer to get us health/accident insurance or we can get our own. Several people have gone for the Chinese insurance [suckers], but have reported bad experiences. One kept going to a clinic, handing in the bills, which the insurance company, each time, told her that the bills were improper bills, and they wouldn't pay them.

More recently, an instructor did have an accident for which his out of pocket costs were around Y50,000, and handed the bills into the company. The insurance company asked him how much he paid for his premium, to which he replied, Y1,300. Insurance company said: here's your Y1,300; we're canceling your policy.

We have a friend who works for a foreign insurance company and whose spouse is in the government. Even the friend said we should never buy Chinese insurance, advising us to buy Hong Kong insurance because it is reliable but much less expansive than the foreign brands.

Several months ago, also, the China insurance regulator reprimanded a few of the large insurance companies for improper accounting/reporting/.managing reserves/premiums, but the businesses are not really proper insurnce businesses, at all, from everything we have heard.

Chinese really have to learn to play fair, not cheat, not make or offer fakes, not try to overcharge, be honest, and many other things. Without trust and fairness, China will never become any kind of financial or economic power.

The China Moon Cake Arbitrage

Red Hill China — Sat, 17 Sep 2011 09:31:21 GMT

Each year, China celebrates one of its most important holidays: Mid-Autumn Day. It occurs in September, on the night of the full moon, and represents the beginning of the Fall. Celebration includes, family gatherings, walks to look at the moon, and moon cake, a cake created just for that day, like fruit cake during the Western Christmas-Chanukah-New Year season.

Moon cake is a big part of the celebration, and stands at department stores begin to pop up several weeks before the day. Another more subtle activity is moon cake arbitrage, It begins with moon cake makers selling gift certificates to Chinese companies, many of which are government agencies or companies, who give them to employees. Just about everyone in the country gets a moon cake from their work, it seems.

The moon cake manufacturer sells the gift certificates, en masse, to a company for, say a 30% discount, on Y200 cakes. Then, moon cake arbitrageurs stand around the vicinity of the ,moon cake stands and offer to buy the certificates for Y80. And they sell them back to the company for Y120.

Thus, the arbitrageur makes a 50% return on his capital, and the moon cake company, who is effectively short moon cake certificates, covers its short at a return of about 20%. Almost all of the parties, the original short seller, the moon cake maker, the receiver of the free gift certificate, and the moon cake arbitrageur, make money. All funded by the companies who buy moon cake gift certificates for their employees.

Craig Mattoli of Red Hill Capital Writes about the Chinese Art Market in China Economic Review

Red Hill China — Mon, 05 Sep 2011 05:55:51 GMT

We were recently asked to write an article about the Chinese art market for China Economic Review. The final edited version to fit space is in the September 2011 issue. You can read it at
Painting by Numbers

Craig Mattoli: Art Authority - article in July's Tianjin Plus magazine

Red Hill China — Sun, 10 Jul 2011 17:31:56 GMT

Tianjin Plus Magazine recently interviewed Craig Mattoli about the art market. The interview can be seen on page 23 of the July 2011 issue, which you can download at Tianjin Plus July 2011.

Inside Caixin's Overvalued Yuan: a Variation on the Index Game

Red Hill China — Wed, 17 Nov 2010 07:49:00 GMT

An article in Caixin Magazine, lately, presented figures and purported to use purchasing power parity (PPP) to show that the Chinese Yuan (RMB; Renmin Bi = the people's coin) was actually overvalued, not undervalued as the rest of the world seems to think. If we take a closer look at their argument, we can see that it is more like lying with numbers or a variation on the index game played by brokers and fund managers.

In the article, the author uses BMW and Ben and Jerry's ice cream, as comparable items for looking at purchasing power parity value of the Yuan. The concept of purchasing power parity argues that if I can buy a pound of potatoes for USD1 and walk across the border to Canada and buy a pound for CAD1.25, then, the proper exchange rate should be CAD1.25/USD. For a better calculation, one should include all goods and services that could flow across the border. Otherwise, there is an arbitrage, and arbitrageurs would take advantage of it. Indeed, that is exactly what has been going on in the Chinese export market, for many years: it was driven by PPP arbitrage [see some of our other articles: PPP Aritrage and You're Missing the Point, on our In Country China Page ].

The trick that the author of the Caixin article used was to use goods that need to be imported and carry import fees. Even MacDonald's and Starbucks, operating in China, enjoy the benefits of the export arbitrage effect, as they pay international prices for raw materials and local prices for labor, rent and power, and charge higher than local prices. A mocha cafe costs around Y30, give or take, which is around $4-5, which is probably comparable to prices in the US. A double dip of ice cream at Hagen Das costs about Y50, equals about $7-8, but at the newer, more local additions to the China ice cream shop scene, a double dip is about half the price, and a local homemade gelati place used to charge Y8, a little over $1. One can find many similar examples of foreign companies or companies of foreign-type products taking advantage of the disparity of the Yuan.

Let us look at some other examples, which are part of my everyday experience. I can buy a local lunch, in Guangzhou, for around Y5, which is less than US$1, but it costs me 6 lunches to buy a 1/2 liter bottle of Listerine. Moreover, in the US, I could buy the one-gallon bottle of Listerine made for Walmart for under US$5, which is what it would cost me for lunch at MacDonald's, in the US. I rent a loft space in Guangzhou, a a major modern Chinese city, which had China's largest building, the Baiyun Hotel, in the late 1970's, and which has a current population of about 10 million. The space is in an exclusive part of town, Dong Shan Kou, and is around 1500 square feet; rent is Y6,000/month, less than US$1,000. I rented a similar loft space in NYC, in the late 1980's, only half the size of this, for US$1,500. I rented an apartment in NYC ten years ago, one-third the size, for US$3,000/month. I can buy a pound of homemade Chinese egg noodles for about Y4, but, if I want to buy Barilla, it costs about 3-5 times as much. At an Italian Restaurant/cooking scool, in my neighborhood, a pound of homemade pasta is over Y100, which is a price that some nouveau riche Chinese might pay to impress their friends, but is otherwise completely crazy. When I first came here, six years ago, I needed a replacement battery for my Gateway Computer, and no one but Gateway made the battery. By the time it got here with shipping and import fees, it cost me US$300, over Y2,000. That was the last time I bought something from outside of China.

Indeed, we could have even more fun by using by taking things like Converse Chuck Taylor high-top sneakers. You can buy fake ones [they swear they are genuine] for Y50 or for Y200: take your pick, they both last about one month. Are thyere real ones? Who knows, but I gave up after those two pairs. I now buy imported shoes from reputable stores, and I pay about double the price that I would pay for the same shoes, in the U.S. However, I get the quality of the brand, and they last several years of constant use. I can buy Cocacola's locally-made Minute Maid orange juice for anywhere between Y3 and Y10, depending on the store. Marlboro cigarettes, in my neighborhood, are priced at Y6, Y9, Y10, Y15, or Y20. Part of the differential is country of origin; part is whether or not the tax stamps are real; and part is whether they are fake [it's easy to copy a package] or real, if any are real. We could then base PPP on whichever priced Marlboro we want, depending on what we want to "show".

The real point about PPP and the Chinese Yuan is that you have a choice: use the fact that the Yuan is actually drastically undervalued, or be stupid and showy and buy Hagen Das, whose local advertising is...if you really love me you'll buy Hagen Das for me [sucker].

A link to the Caixin article is http://english.caing.com/2010-11-16/100199156.html .

The Lights are not on because it's No one's Home

Red Hill China — Wed, 04 Aug 2010 03:51:00 GMT

A recent statistic was released by the Chinese media and later denied by the power companies. The statistic was that 65 million electric meters registered zero usage over the last six months. There have been stories, in both the local and Western media, over the last year or so about all of the unused space, both residential and commercial, in China, as many people discuss the real estate bubble, here. There are whole towns built in the middle of nowhere with no one to move into the offices or apartments. Another truth that has made the headlines during that period is that many people buy apartments, not to rent out, but only because they believe that they can make money on an eventual trade. Some stories even gave estimates of occupancy rates, in major cites, for both commercial and residential space, indicating that there is a lot of space that is unoccupied. If this current statistic is a true indication of what is unoccupied, it means that there is enough unoccupied space to house 200 million people, or 80% of the population of the USA

Andy Xie, the former head economist of Morgan Stanley, who now writes for Caixin Magazine, wrote an article about the current topic for which we include a link for your further reading: http://english.caing.com/2010-08-03/100166589.html

Another Comment on Overpricing in the Chinese Yixing Zisha Teapot Market

Red Hill China — Sat, 02 Jan 2010 05:24:00 GMT

When we first began exploring the teapot art market, in China, we discovered that many artists and dealers set prices of teapot art, relatively and unreasonably high, versus other forms of art, like paintings and traditional sculpture. As investors in and collectors of art, in addition to being a dealer, in art, we were offended by this practice, which, often, is a phenomenon, in prices of many goods available, in China.

Our response to this overpricing in the teapot market has been multifaceted. First, we have endeavored to make connections with artists, directly, so, that we know what the prices are from the source. Then, we have included the art, only of artists whose prices are relatively reasonable. In addition, we have written several articles about this overpricing phenomenon, published in both English and in Chinese, to try to make people aware and wary. In the beginning, in fact, we put a link to one of our articles on a tea forum of Adagio Teas, in the U.S, and there were so many complaints from dealers, who were apparently overcharging on teapot prices, that the article was closed by the moderator.

It appears that we are still a thorn in the sides of some teapot dealers because, in the last month or so, we have gotten calls from artists telling us that other dealers are complaining about our prices being too low and that they cannot compete with us. In the case of one of the artists, we took his overpriced teapots off the website, at least, from the Chinese part of the website, which is the only part that he can read, because he insisted that we make the price four times the price that we had on the site. We left those teapots on the English version of the site at the original prices that we had on them. This week we got our second call from an artist, and we told him that the problem is not our. The real problem is that the other dealers are overcharging on prices out of greed. If the prices that we charge can earn us a reasonable margin on his art, other dealers could also be satisfied with that level of profit margin instead of insisting that we follow them in trying to rip off customers. In fact, we even give genuine dealers a discount on our retail price, so, there is no reason for other dealers to complain that they cannot compete with us. Indeed, we have, on a number of occasions, seen teapot art that we offer at Leona Craig Art, priced by other dealers for as much as ten times the price that we charge. What those other dealers really mean when they complain about our prices is that they can no longer charge the excessive, rip-off prices for the teapot art that they were accustomed to charging before we at Leona Craig Art entered the market.

As art dealers, we will always get a dealer price on any art, be it paintings or teapots, because it is our business to buy larger amounts of art, to promote, and to sell art, and we get compensated for that either by getting an inside dealer price from artists or by investing, risking our own capital, and holding art for a number of years to make a return on investment from price appreciation. More generally, it is the business of the arbitrageur to make returns from the differences of prices in two markets, in this case, retail versus wholesale art markets and recognizing emerging artistic talent before others have caught on. In fact, the teapot artists who we represent, in the Leona Craig Art Gallery, also sell their teapots in the retail market. As a result, most of them suggest that we charge a lower price than they charge to retail customers because they give us a dealer price, in the first place, and they want us to be able to compete with them in the retail markets, in the second place.

At Leona Craig Art, we want to promote art and the art markets: we do not want to promote bubbles in the art market. In a country where ethical standards are, in general, lacking, and greed is rampant, we want to stand out, not only for our selection of great art, but also for our integrity, honesty, and fair dealing. We do not want to end up like those teapot dealers, who are complaining about us, and have our customers come back to us after realizing that they have been ripped off when they find out what the prices should really have been. Therefore, we will continue to promote only the art of artists who have both artistic talent and ethical practices in pricing their art.

To see our current offerings in teapot art from Yixing China, the capital of Chinese teapot art, please, visit the Leona Craig Art Gallery Teapot Section.

Chinese Business Tactics: Penny Smart; Pound Foolish

Red Hill China — Fri, 21 Aug 2009 14:51:00 GMT

A tactic that I see all too often, in Chinese businesses, is being penny smart but pound foolish. I see it at the local businesses, in my neighborhood, where the merchants over charge on price and lose volume of business. They figure that the higher the price, the less they will have to sell to become rich. I see it at the college at which I teach, where the administration provides a poor educational and play experience for its students, and it has shabby class rooms. They charge a high price, but graduating students tell me that they tell their parents' friends, who ask., not to send their sons and daughters there. The school could have an enrollment of ten times its current size, if they would spend some money on enhancing their student's college experience; indeed, that was the estimated size when the project was first done, 6 years ago.

My most recent experience was a real mind-blower. I wanted to buy my girlfriend some art books about a number of arts, through the ages. I was expecting to spend several thousand Yuan. My first thought was to go to the Guangzhou Museum, down the Street from me, so, I went there, first. I entered the lobby; told the woman at the ticket counter that I wanted to go just inside the entrance to the book store; and I was told that I needed to buy a Y15 ticket to enter the museum. I tried to reason with her, but it was wasted breath. In the end, I went to the other large museum, in Guangzhou, on Er Sa Dao Island, and they called someone from the bookstore to escort me in. Guess they are not all penny smart and pound foolish, but the vast majority of businesses that I come into contact, daily, are.

The Treacherous Waters of Business in China

Red Hill China — Fri, 31 Jul 2009 05:05:00 GMT

As you may have read in our other articles, blogs and reports, there is much dishonesty, fueled by greed, in China. There are fake DVD’s, software, LV bags, and teapots, to name a few. Every time, I go to a store or market, most of which do not put price labels on their items, the price can sometimes be as much as ten times the actual price. Indeed, many Chinese business owners charge too high prices, even to Chinese customers, because they believe that the higher the price, the sooner they will be able to retire: the truth is, usually, the sooner they will be out of business.

Moreover, the rules for establishing a business are tilted heavily against foreigners. For example, to register a corporation, a foreigner needs to have ¥1,000,000, while a local needs only ¥30,000, and a local can even go lower by doing the equivalent of a DBA for a total cost of around ¥2,000 for fees only. The red tape, in the case of a foreigner, can take as much as three quarters of a year, too. Moeover, even if you look at the companies that are listed on the exchanges, in China, the weight shifts from private to government enterprises with less than 50 of about 1,500 listed companies from the private, as opposed to government, sector.

Over the years, we have heard many personal accounts of those who have done business, in China, and some recent experiences cause to write this blog entry. The first comes from a Chinese person that we work with, in our Leona Craig Art business. That person had given up a previous partner and entered a new partnership with a friend whom was believed to be in a position to promote the business. They both did separate things, and our friend believed that there was some synergy. This week the friend called my protégé and told her that she had discovered that her partner, whom she had taken to the art studio where she gets her art, was going behind her back, getting art, and secretly selling it to her customers. The same day we read an article (http://bit.ly/89Mez) about a German advertising company that had set up an outpost, in Beijing, and discovered that seven of its key employees had set up their own company and were siphoning off all of the best contracts. There have been many similar cases, over the years.

At Red Hill Capital, we have been involved in investing in underdiscovered and inefficient markets for several decades. We have never been fans of the Chinese stock markets because of the lack of transparency of information, in China, to begin with, and because of the multi-tier stock scheme for Chinese listed companies that gives the least rights to foreign owners, in addition. Being in country for half a decade, we have heard first hand stories and we have seen those that have made the news, like the Sanlu milk scandal that left their foreign minority owner, Fonterra of New Zealand, out several hundred million. Just last week, GM would not sell a division to a Chinese company because they did not want to have their intellectual property stolen, in the bargain. Also, within the last several week, there have been news reports about Chinese spies trying to steal information and technology, in both the U.S. and Germany. On the other hand, China recentlt arrested the lead engotiator from Rio Tinto of Australia, which supplies China with much needed iron ore. He has been charged with spying and, at the time of publication of this blog entry, has been held in custody for about a month, and the offical charges still haven't been released to the public. Moreover, his arrest just happens to come after Rio Tinto rejected a bid by the Chinese to buy a large stake in the company.

As we have said, in a number of reports, we believe that China will not be the economic giant that some think they will. Those opinions are based on what we see, here, in education and in ethics. What we do acknowledge is that China will be a big market, and, if they ever open up, in both information flow and fair playing field for foreign businesses, it will be a place for many foreign businesses to set up plants and to give all of these people jobs. However, the more we see and hear, the more we believe that day is far off, but China should really change their attitude and let it come because we can help, if only they would let us.

© 2009 Red Hill Capital Corporation, Delaware, USA; all rights reserved

The Bubbles are Coming: This Time Even More Will Come to the Party

Red Hill China — Thu, 30 Jul 2009 02:19:00 GMT

If you follow us on twitter and read all of our blogs, article board articles and reports on our website, you will have a sense of what we feel about the Chinese economy. We took down our report about the Chinese stock market after it had crossed the 200-day moving average, a few months back. In the mean time, in the economy, the government has been pouring back money into the economy, some of which has been loosening up of lending standards.

Since that time, credit card loan bad debt has risen to highs. The stock has increased about 90 percent, and we have been seeing the same inexperienced friends jumping on that bandwagon, recently, like they did during the crescendo to the last stock market bubble, and real estate prices are rising again. Moreover, in the past few weeks, there have been many IPO’s, which also skyrocketed on debut, which is another classic sign of a market top, as people tend to go public when they think the market is nearing a top because they can sell out their interests to other investors at the maximum. Also, we have written about how much saber rattling and barking the scared dogs have been doing lately, which is another sign of fear on the part of the barkers.

Exports, which have driven the economy, are dead. Over 21 million people lost their jobs, by the beginning of the year, about one million businesses, in Guangdong, the engine of export growth closed their doors, many of our friends who had thriving export businesses have closed up shop and gone home, and 60 percent of current college graduates cannot get jobs. So, the government has been trying to pump money into the domestic economy, which it can do because it also controls a lot of the economy. Recently we read that about one-third of China’s GDP will come from new loose loans, which is not a good sign. The central bank has been raising caution for over a month, but, here, in China, the government controls the economy. All of this points to the possibility of bad news for the economy, including stock markets, real estate, banks, and the entire economy.

It’s always tricky to time bubbles. In fact, we began advising people to get out of the Chinese stock market well over a year before the last bubble burst. Now, many companies are doing IPO's, which companies tend to do when they think the market is high (you don't lay off your stake in a company when you think the market is low). Since the vast majority of companies listed on the exchange are government owned or affiliated (out of the approximately 1,500 lasted Chinese companies, less than 50 are private sector companies) the government may be waiting until those IPO's are out of the pipeline before the tigthening comes. Although we cannot be sure of the timing, again, especially since the government is not exactly transparent with their economic figures, we believe that the handwriting is on the wall. The bubbles are coming, and they will burst in many places. So, don’t be foolish like many of our friends have been, last time and this. Remeber what the Baron de Rothschilde said when asked how he got so rich: "I sold too soon."

We list some additional refernces for further reading:

Asia Sentinal "Cracks in China's Foundation" http://tiny.cc/7tFJO
Foreign Policy "Insider's View to Washington's China War" http://tiny.cc/aFXSq
http://tiny.cc/wJIKa
Debt sales for Augusthttp://tiny.cc/mFVcP
MS Analyst believes China will cut loans H2 http://tiny.cc/E1NR9
MIT professors viewpoint http://bit.ly/uKOes
China Central bank says it will use market tools http://tiny.cc/99QPJ
Overnight MM rates up http://tiny.cc/59T38
FP article about loose loans/bubble http://bit.ly/vy3by
Remind me when will the Asian Century begin http://xi.gs/06oz
1.63 million new securities accounts opened, in China, in July http://tiny.cc/jaot9
Everbright Securities IPO priced about 30% above analysts expectations http://tiny.cc/d0iTr
Oppenheimer alanyst predicting 18% drop in Chinese stocks next 3 months http://tiny.cc/hPMBq

More Indirect Indicators about the China Export Market

Red Hill China — Sun, 26 Jul 2009 07:56:00 GMT

The way that we examine economic activity, and everything else, for that matter, is not by looking at official statistics, alone, but also at the microscopic data that we come face to face with, on a daily basis. We are in Guangzhou, the capital of Guangdong, which has been the major area driving the export market.

Over the past year and a half we have reported things, like almost a million businesses closing in Guangdong and over 20 million migrant workers, who worked here losing their jobs and going back to their hometowns, in the north and west. We also reported about the traffic at the cafés on Xiao Bei Lu, which is a major shopping area for those in the export business.

Our neighborhood is one where many foreigners live or hang out. Two more indications that we have seen, recently, are: one of our good friend who had a thriving export business for about six years has closed up shop and moved back to his home country. In our old apartment complex, which has many small stores that cater to Westerns have closed over the past few months, and yesterday, one of our friend at the local wet market, there, which sells fresh meats, seafood, vegetables, and other such goods told us that her business is down eighty percent, just over the last few months. She told us that the reason is that most of the foreigners who lived there, which we have been noticing over the last year, have moved out and gone back to their own countries.

Education, Technology, and Economic Development: China versus the U.S., Germany and Russia

Red Hill China — Sat, 25 Jul 2009 06:03:00 GMT

China has gotten itself onto the world economic stage through an undervalued Yuan and low tech products. Sure, they have a few companies, like Haier, whose two-piece air conditioners are innovative, but, lately, the government is pushing to shift its industrial might to higher tech. Indeed, that is the underlying motivation for the new employment rules that went into effect, last year, which put over 20 million migrant workers out of jobs and about a million businesses, in Guangdong, out of business. I suppose it is the misguided justification for Lenovo’s purchase of IBM’s microcomputer business, a few years ago (IBM, on the other hand, has flourished since then because of their change in emphasis; Carly Fiorina of HP lost her job as CEO over her purchase of Compaq, almost a decade ago).

The bigger problem that China faces, in this attempted shift, as we see it, is the education system. As part of Mao’s cultural revolution, all comrades were supposed to be equal. Women were de-feminized (see our blog entry, in Leona Crag Art Blog: Why are Chinese girls so popular), and academics were imprisoned because Mao did not like the ivory tower. The result is that, today, the education system, in China, is very poor. Students are taught to memorize, and, even at the college level, students are pretty much told what they need to memorize to pass exams. The whole system is devoid of creativity, which is the benchmark for innovation and development of the pool of knowledge, which is the key to technological development.

We can compare this to the German-U.S.-Russian experience. In the first half of the twentieth century, Germany had many good scientists. People, like Max Planck, Erwin Schrödinger, and Albert Einstein were all German and were responsible for the beginning of modern physics, including quantum theory and relativity. During WW2, many of them immigrated to the U.S., and after the war, the U.S. and the former Soviet Union split up the leftovers.

Even though the Soviet Union was communist-socialist, they were smart enough to recognize the value of education, in general, and science, in particular. Over the past century, as a result, there were many great physicists from Germany, U.S., and Russia. As a result of the Chinese communist policies towards education and academia, there is a dearth of scientist and creative minds, today, in China, even though China’s population far exceeds those of these other industrial and scientific giants (even a blind pig finds an acorn, once in a while).

We, now, also read reports about Chinese trying to steal technology from both Germany and the U.S. That was also the case with Japan, several decades ago, but countries have gotten, at least, somewhat smarter about keeping their technology secrets. For China to become a technological giant will take a total revamp of their education system unless they happen to get lucky from the law of large numbers.

© 2009 Red Hill Capital Corporation, Delaware, USA; all worldwide rights reserved.

The Bully

Red Hill China — Sat, 18 Jul 2009 09:26:00 GMT

In the past month or so, we have seen the true China shine through. Never mind that the growth of the Chinese economy, having been built at the expense of Western & Eastern people, alike – Westerners because it was made possible by strict control of the undervalue of the Yuan vis-à-vis the international market; Easterners because of poor work conditions and pollution - has been made possible, mostly, by a free Western World. And having told the world, during and after the 2008 Olympics, last August, that it would loosen the flow of information, there have been many recent examples to the contrary.

Towards the end of May, in fear that there would be too much chatter on the internet about the 20th anniversary of the Tiananmen Square debacle, China shut down sites like twitter and fanfou, twitter’s Chinese clone. Of course, these days, there were many who got through the blockade of the Great Fire Wall, using clones, proxies, and VPN’s. Then, after that was past, China announced, then, retracted a new rule that would have required that all computers sold in China would come with mandatory censor-ware (spy-ware). The reason for the software was supposedly to keep kids from getting to porno sites, but the program also had more sinister capabilities. Of course, the retraction may have had more to do with the fact that people actually found code, in the program, that was lifted from a program for parent control, made by a U.S. company, right down to code that had the U.S. company’s name in it. Then, China turned it’s wrath on Google, and it was blocked for several days, supposedly because porno could be found, on it.

As soon as those bumps in the road passed, there were race wars in Xinjiang, a Muslim area, annexed to China as one of its autonomous regions (the other being Tibet; the two comprising one-third of the landmass of “China”). Again, the kneejerk reaction was to close down social networking and other sites, like twitter, fanfou, and facebook. That only heightened the dread and resulted in false reports on the phantom network, which again got around the Great Fire Wall. As of the writing of this post, those sites are still blocked.

In the mean time, China has detained the head of Tinto Rio, an Australian iron ore firm and his assistants, purportedly on stealing national secrets. Note that Rio Tinto had just rejected a large investment in it by a large government controlled Chinese steel maker. Moreover, the men were detained for three days without informing anyone that they were being detained. The move has unleashed an international cry foul, and the government has still not made charges against them any clearer except to say that bribery might have been involved. Of course, the whole law in that area is rather vague, and, technically, foreign firms are not allowed to even take someone out to dinner. In the meantime, a Chinese, in the U.S., was convicted of stealing defense department secrets over a number of year, while working for Boeing.

To add to the fray, one or several Nigerians were either injured or died trying to escape a surprise passport inspection at one of the local clothing market areas, and as a result, a hundred-strong group of their fellow countrymen surrounded the local police station in protest, something completely new in China but which has had potential festering for some time. Many of my African friends have left either Guangzhou, in particular, or China, completely, saying that, while China seeks to rape their countries of natural resources, it turns around and discriminates against Africans doing business or living in China, and they are not happy with the disparity.

And to top it off, a blogger, in China, who wrote some blogs about corruption and false police reports, in Fujian Province, was taken away by the local police, a few days ago, and had not been heard from since (all the while, he was telling about his arrest on twitter via his telephone). Later reports said that a number of bloggers had been jailed.

Doing business and investing require good information and disclosure. These, along with other reasons that we have discussed in our posts on our blogs plus some private information, are the reasons that we are cautious to invest in businesses, in China. It is already difficult enough, just to get fair treatment in purchasing goods to resell, in the West, but when it comes to the intricacies of business practice and law, rules and avenues of disclosure, lack of protection of copyrights and trademarks, and the unfair playing field for foreigners versus locals, in Chinese business, we would rather sit on the sidelines and wait for the climate to greatly improve before we jump in. All the while, the barking dogs try to make their case that China should somehow displace the U.S. and the U.S. dollar as the economic and financial force in the world (good luck on that one: it's not quantity of people, it's quality).

Although the world puts up with such shenanigans, as parents might with a screaming spoiled child, China will have to learn that they cannot get everything it wants, out of some misguided thoughts of entitlement. Although you can cheat or get lucky with accruing monetary wealth, the other two things that must be earned, respect and trust, can not be bought or bullied. Even the run-of-the-mill nouveau riche person has learned that.

C.L. Mattoli, CEO
Red Hill Capital Corporation, Delaware, USA
© 2009; all rights reserved.

Computer Logic

Red Hill China — Thu, 09 Jul 2009 02:05:00 GMT

My protégé wants to buy a new laptop. Her present one, an IBM, is getting old and slow. I explained to her that micro-computers have been commoditized for about 20 years and that any good brand will do, but she wanted to do her own research. First, she wanted to buy an IBM, and I explained that there is no more IBM, in the portable computer market, because they sold that business to Lenovo. I also explained to her that Compaq is owned by HP. With that knowledge, she went shopping.

When she came back she gave me a debriefing. First, the Lenovo salesman insisted that their ThinkPad is really IBM and that all of the same people, parts, and plants were used to make it as when it was really IBM. Personally, I don't know if I buy that, but other of you, the readers, may comment on that. More surprising were the answers that she got, while visiting an HP outlet. There, she told the salesman that many of her friends had told her that there were problems with HP-Compaq. In fact, the salesman told her that there really is a difference between HP and Compaq, in China. He had her touch a Compaq laptop to feel how hot it was; then, an HP to compare how cool it was. He went on to tell her that the real difference was that HP were made in Shanghai, while Compaq was made at a plant in Suzhou, and that HP was a much better quality machine.

I remember how everyone thought that it was not a smart move for HP to buy Compaq, back in 2001. In fact, the head of HP eventually lost her job over it. I felt the same way about Lenovo buying IBM, but at least that might have helped to give a Chinese computer company a bit of legitimacy, both in country and outside. However, when I see how each has treated their purchases, I think that HP-Compaq is the real loser.

Entry on Red Hill Capital Blog about Trading Systems

Red Hill China — Sat, 27 Jun 2009 12:33:00 GMT

We did a blog entry on the Red Hill Capital blog, today, about trading systems, pyramid schemes, greed and arbitrage. You can read it at http://blog.redhillcapitalco.com/2009/06/26/mythical-trading-systems-pyradmid-schemes-greed-and-arbitrage.aspx

Recent Leona Craig Art Blogs about the Art Markets

Red Hill China — Fri, 26 Jun 2009 03:07:00 GMT

We added two blog entries about the art markets on our Leona Craig Blog, this week. One is about recent reports concerning the firming of art markets, of late, including our recent personal experience at the Leona Craig Gallery. The other takes a closer look at the recent evening auctions of Impressionist & Modern Art at Sotheby's and Christie's, in London.

You can view them at http://blog.leonacraig.com/

Barking Dogs: China's Aspirations to be a Financial Powerhouse

Red Hill China — Fri, 05 Jun 2009 16:28:00 GMT

There has been a lot of saber rattling, this year, from Beijing about the U.S. dollar, U.S. Treasury securities, and the Chinese Yuan. We even read an article saying that as the Yuan becomes a major reserve currency, it will be good for the value of Chinese art. Our opinion of all of this can be summed up as: what a load of crap! The truth is that the Chinese are just jockeying for attention and recognition, and, like, in most cases, they want it without the requisite hard work that it takes to become truly successful and respected. It is like a child trying to get attention or a barking dog.

First of all, the only reason that the Chinese have been successful in the exports markets is that the Yuan is underpriced, so Chinese products are cheap to the West, on the one hand, and Chinese people, in general, cannot afford to buy Western products, which they would love to buy, on the other. While people might pay lip service to the miracle that is the Chinese economy over the last two decades, in which it has gone from an agrarian economy to one, in manufacturing, that has had its costs to the rest of the world, in a number of ways. It has been done, first of all, at the expense of the environment, not only of China, but the whole world. The pollution from China is so great that it can be seen from space, and there are deposits of heavy metals on the Rocky Mountains of America from prevailing winds. Its cheap products have put millions of workers from other countries out of jobs, not because China is producing superior goods or labor, in any industry, but because the underpriced Yuan has made it difficult to compete, on price, in the international market. Even more, while the Chinese workers have benefited from the industrialization by getting a job and barracks-style living arrangements, they had not gotten other benefits that other workers around the world see as common. In fact, they have not even had the benefit of the free flow of information from the outside world, which could have shown them what there labors were truly worth in the international market place, and, in the end, the real profits have been made by other people.

Now, China has been setting its sites on becoming more than just a large machine that produces cheap goods. It wants to replace its low-tech industries with high-tech, and it wants to gain international respect, but it has a long way to go and many obstacles to overcome. In addition to the stated goal by the government to turn from low to hi tech and the recent employment legislation that puts pressure on low-tech industries to the point that about a million businesses closed their doors, last year, we saw Lenovo buy IBM’s microcomputer business. However, to move into hi-tech requires a solid educational system, which the Chinese do not have, and Lenovo’s purchase shows how little the Chinese understand about hi-tech: a similar purchase of Compaq by HP, back in the beginning of the decade, was already considered such a poor business move that the CEO of HP lost her job over it. Time Warner thought that it would be even smarter to buy AOL; now, the marriage is over. Some technologies have already become fungible. It is new innovative technology that is true hi tech, and that takes innovative minds, trained in an creativity-based grade-to-graduate-school education system, not rote learning.

The other barking that China has been doing lately is trying to talk down the importance of the dollar and suggesting that its currency should gain more acceptance, in the international community. For example, in the fall of 2008, China suggested that it might not buy any more U.S. Treasuries. Beyond the folly of such a remark, trying to provoke, it could only have done harm to its own existing huge position in U.S. Treasuries because by talking them down, they would have suffered paper losses, at least. In truth, China did go so far as to sell some Treasuries, in January of 2009, but it began accumulating them, the next month, as did other entities, in China, besides the government.

As far as concerns China’s aspirations to become a reserve currency, those are sheer fantasy. First of all, as it stands, the Yuan is in a pegged currency, not allowed to freely float against other currencies in a market or even to be freely traded in markets. In such an exchange rate regime, the central bank is the only buyer and seller of the currency, which also means that a person cannot open an account outside of China and freely keep and trade the currency. Albeit recently, the central bank has exchanged RMB with foreign central banks, it is more like window dressing to give evidence of its international currency ambitions. Am additional problem of the combined undervaluation of the Yuan and the sole buyer position of the central bank is that the massive foreign currency reserves held by the central bank (about half of total assets in the last data released by the China Central Bank) would come down substantially, in value, in the event that the Yuan was allowed to freely float and move to a more reasonable purchasing power parity valuation.

Of course, when it comes to thinking about revaluing the Yuan, we also have to think about the large position in U.S. T- securities that the Chinese government owns. Again, if the Yuan were to appreciate, all of those holdings would decrease in value. Indeed, in the last year there have been a number of articles, in the Chinese press, about how the U.S. tricked the Chinese into buying Treasuries. However, it just shows, once again, that there is a lack of understanding and forethought about the intricacies of international finance, within the government financial sector, in China. It is the same lack of forethought that led the Chinese to try to denigrate the integrity of Treasuries recently: apparently not having thought out the financial consequences, for China, of negative comments about securities in which they hold a large position (only a crazy professional trader would do such a thing; not a rational one).

The compelling quality that is needed in a reserve currency, though, which China has a long way to achieving is confidence since that is all that modern currencies, which are backed by nothing by words and respect, since currencies went off the gold standard, in the 1970’s. In a system that is completely controlled by the government, including the free and fair flow of information, that will be extremely difficult to accomplish. Indeed, beyond the fact that information flow is controlled and censored by the government, even the statistics that the government releases about economic and financial data has been questioned by a number of authors, over recent years.

The same can be said for China’s desire to have Shanghai become the future financial hub of the world. That, again, takes respectability and confidence and, in addition, requires a knowledgeable pool of financial professionals plus a large network of contacts. Italy invented financial markets and instruments during the Middle Ages. Over the intervening 600 years or so, the center of the financial world has migrated to Amsterdam, then, London and, then, New York; each of those shifts was preceded by several hundred years of base building, paving the way with accumulated knowledge, relationships, capital, and trust, before the shift was putatively accomplished. Based on those statistics, alone, a shift to Shanghai is not in the cards for at least another century or two.

All in all, China and its protestation and campaigning for recognition in the real world of technology, money and finance is simply a naughty economic child vying for attention from its upright parents and the neighbors. Instead of being a barking dog, trying to convince passersby that it is ferocious, it should realize that anyone who knows dogs will know that it is just starving for attention. Indeed, their recent words and actions demonstrate that they are not ready even to begin to long trudge that long road that has taken others to where they want to go but, again, seek to find a shortcut, which may have worked in its drive to industrialization, but will not work in its lobbying for financialization or respect among the respectable.

Wen Jia Bao Speech at Qing Hua University

Red Hill China — Tue, 05 May 2009 14:10:00 GMT

Over the weekend Wen Jia Bao gave a talk to students at Qing Hua University. One thing that he told them that the employment situation, in China, is not so great right now and that they would be better off trying to go to graduate school, rather than trying to get jobs, in the current economic environment. Not too encouraging.

We have heard similar talk about students who are recently graduating from university and finding it difficult to get jobs, in Hong Kong, over the last several months from the Hong Kong television news.

New Red Hill Blog and Initial Entries

Red Hill China — Tue, 05 May 2009 13:20:00 GMT

We recently opened a new blog for our parent company, Red Hill Capital Corporation, Delaware. We will move the general investment and strategy discussions to that blog, and we will report to the readers of this blog when we have put something on that blog that may also be of interest to them. In that regard, the first two entries discuss: 1) real estate investment, in China, and 2) initial investment considerations for any business. You can get to the new Red Hill Capital Co. Blog at http://tiny.cc/pwxoz .