Thursday, March 24, 2011

Shigeru Ban's Take on Japan's Rebuilding

Today's New York Times has an encouraging article about architect Shigeru Ban and his use of paper as a construction material for housing victims of natural disasters. Mr. Ban has been doing this work internationally since 1995, and his work spans locations such as Kobe and Chengdu after earthquakes.

In addition to the "poetic" (to quote the Times) quality of his materials and ideas, I liked what he had to say generally about what needs to be done to help homeless Japanese, particularly the elderly. In a response to a question about "innovative" solution for shelters, Mr. Ban says, "We don't need innovative ideas. We just need to build normal things that can be made quickly and easily." Nicely said. There's no need for commissions, multi-year studies, and comprehensive national housing plans...just get rebuilding. He also believes that private initiatives can help in the Japanese context. Let's see if the Japanese government can get going; there are plenty of creative people with experience, who can help. Here's one of them.

Wednesday, March 16, 2011

Cembalest and JP Morgan on Japan

Michael Cembalest is Chief Investment Officer for JP Morgan Chase Private Bank, and I always enjoy reading his global investment research bulletins. His current piece has some great insights about Japan from the geopolitical and historical sides. He shows that after the WWII, when Japanese industrial production hit its nadir in 1946, it took just six years to recover to the normalized prior high, and Japan was not advantaged like Europe by the Marshall Plan.

As economic writers have talked about "Lost Decades," and we read consistent gloom about the demographics, high savings rates, and interest on government debt being fifty percent of revenues, here is an excerpt from the recent JP Morgan Chase bulletin:

"Japan faces a lot of challenges, such as poor demographics, ongoing deflationary pressures and the worst debt dynamics in the world. However, as we wrote last August, Japan’s domestic debt market is held 93% domestically, rather than relying on the kindness of strangers (like the U.S. or parts of Europe). Japan also has the ability to mobilize the investment accounts of nationalized banks and insurance companies (Yucho, Kampo), which have accumulated over 300 trillion yen of JGBs in the last decade."

Not relying on the kindness of strangers or on their currency being a global reserve currency is a big deal. Cembalest also puts together their Middle East research to say that Japan, and the world, should not feel a secular sting from rising energy prices:

"Japan is the world’s third largest oil importer, the largest importer of thermal coal, and the largest importer of liquid natural gas (2). One would think that with 6%-7% of the electrical grid permanently offline (3) and another 7% of the non-nuclear grid temporarily affected, that energy prices would be surging across the board. But there are 3 caveats contributing to lower crude oil prices:

** First, to replace lost electricity, Japan needs ~300 thousand barrels per day of oil equivalents (mostly for diesel generators). In the context of the global oil supplies and 3.5-5.0 mm bpd of spare capacity, this should be manageable, particularly since much of Japan’s incremental energy imports will take the form of liquid natural gas
** Second, the decline in economic output associated with a disaster like this tends to depress energy demand
** Third, the Saudi Day of Rage passed without much incident, and Qaddafi has retaken most of the oil facilities. On our conference call today, Vali Nasr highlighted that this calm should not be interpreted as a broad sanction for the status quo. Saudi Arabia is still caught between what he described as 3 pincer movements of Shi’a populations (in Yemen, Bahrain and Saudi Arabia’s own Eastern Province; see chart on last page) looking for some combination of wealth, political freedoms and religious autonomy. But for now, the stability of oil exports in the Gulf region looks secure. As we discussed on the conference call today, the history of supply interruptions based on weather or geopolitical events mostly points toward a recovery in exports once the immediate event has passed. Only in the case of the double-barreled 1979 Iranian Revolution followed by the war with Iraq, did we see a country experience a sudden and unrecoverable decline in oil exports." Source: "Matter over Mind," JP Morgan Chase, Inc. ,2011.

On the philosophical side of things, there's often nothing like a crisis to bring people together. After 9/11, I always felt that one of the terrorists' misjudgements was to have planned their heinous strike on New York, which they felt to be the center of global capitalism. It is also the singular, global metropolis with a virtually unlimited well of resourcefulness, grit, fortitude, compassion and openness to working together for a common cause. When the disaster struck, petty squabbles and power grabs were forgotten; for the rest of the country, the old "let Manhattan drift out to sea" sentiments were replaced by the feeling that "we're all New Yorkers now." The images of President Bush throwing a baseball from the mound at Yankee Stadium vividly showed everyone that we had taken the blow and that, as a nation we wouldn't be overcome, even by a well conceived strike at the heart of our greatest city.

If the political leaders are up to it in Japan, a similar, great national unity and drive to rebuild can come out of the current crisis. Even as Japanese society has become secularized in the press, there are deep spiritual traditions among the populace that can provide a firm foundation for the months and years ahead. All the people will be looking for is leadership from the major parties. Emperor Akihito's remarks were of more than symbolic importance, as he is a revered figure to the Japanese; his urge to "live strong for tomorrow" is an aphorism straight out of Japanese martial arts traditions.

It certainly is in the tradition of U.S. international engagement to help a major trading partner, and Western European leaders should also follow suit. Hopefully, GE is sending their best teams of reactor engineers and scientists to learn from what went wrong with the containment vessel design and safeguards, and to also help their customers right things without looking at their lawyers for approval. There will have to be much grieving, since no one knows what the death tolls are; there's also a lot of uncertainty about the levels of continuing radiation exposure and their spread, but let's hope that this crisis and its aftermath can be a catalyst for Japan coming out of its economic desert experience, which would benefit the entire global economy.

Sunday, March 6, 2011

What's Next For China?

Back in December, I posted a reflection on on the terrible track record of long-term forecasts, and it was mindless euphoria about the Chinese economic miracle that stimulated that post. David Beim of the Columbia University Graduate School of Business has written a paper for the NBER, "The Future of Chinese Growth," that brings a thoughtful eye to the consensus forecasts.

China's economy has had a thirty year run, ended 2010, where real GDP growth averaged 10% per year! This is extraordinary by any measure. Beim points out that this performance was driven by two, high octane sub-periods. The first was the explosion of Chinese entrepreneurship launched by Deng Xiao-Ping in the 1980's in which the central government subsidized and sponsored private enterprises in China's villages. These efforts distributed their benefits widely throughout the country and were domestically focused.

Beim identifies the next phase as being driven by the annexation of Hong Kong and by the political accession of politicians with Shanghai loyalties. These two forces led to the development of large, coastal-oriented enterprise clusters that were export-oriented, with mainland China supplying large, efficient production and distribution facilities and cheap provincial labor, with the Hong Kong Chinese supplying management expertise and finance. Continuing huge capital investments financed by Chinese banks fueled the export boom that has brought us to where we are today. The benefits of this phase have accrued to a new elite, and this drive was one hundred percent export oriented.

Invoking the neo-classical growth model of Solow and Swan, Beim shows that China is already experiencing diminishing returns to capital, and he suggests that Chinese banks may be ignoring balance sheet issues associated with their cowboy underwriting standards during the export-led boom. Everybody, even the popular press, has written about the need for the Chinese economy to shift to domestic consumption growth. Beim's thesis is that this will be easier said than done. If this is the case, it would seem that the bubble inside the Chinese miracle could end badly. It's definitely thinking outside the box.

Thursday, March 3, 2011

Framing The Issue of Educational Reform

Mainstream media have framed discussions about educational reform as referenda on the qualifications and salaries of public school teachers. Of course, everyone knows this is misleading and off the mark, but it serves to obfuscate the real issues and to polarize the debate, ensuring that nothing gets done.

As Bill Gates found for himself when he undertook to study the question, it's what Gates Foundation scholar Marguerite Roza calls a "wicked problem." He's speaking about the issue today in a public forum.

It begins with the convoluted way in which public education is financed. School districts are funded locally through the property tax system, which seems eminently reasonable and logical. However, then the states get involved in parcelling money back to localities. For this, the states are entitled to set all manner of regulations touching things like class sizes, teacher compensation, teacher educational requirements and tenure systems. Whatever costs this crazy quilt of regulations imposes on localities, the local taxpayers absorb, without any direct influence or control. The final layer are Federal regulations affecting everything from school lunches to requirements for innumerable special interest programs. For all these additional regulations that impose costs on local taxpayers, the Federal government only contributes about 9% of an overall school district's funding.

By now, the system has drifted far away from the basic service of delivering a quality education to students on a local level, with transparency and accountability to the local taxpayers who still supply the bulk of school district funding.

Another fundamental issue is financial transparency. We argue incessantly about details of US GAAP financial disclosures for corporations, delving into minutiae and trying to standardize internationally. In public sector education, for reporting at the school district level, there is no transparency at all. Gates Notes has some interesting research on this topic.

According to Gates Foundation staffer Marguerite Rozas, it's impossible to determine at any level how much is spent actually educating students in mathematics for example, or how much is spent to achieve outcomes in the subject. At best, Rozas reports, there are categories like "Instruction," which cover more than fifty percent of a school district's budget, but it's not possible to drill down from this mega-category into anything useful. At best, we can come up meaningless national averages, like the United States spends $10,000 per student, which we then compare to equally meaningless numbers from other countries. We then talk about funding gaps.

Rozas points out that districts have no way to compare what is spent for mathematics in different schools in a district, which might give clues as to effective or ineffective resource allocation within a district. In local districts, there is often a disconnect between teachers and administrators, who are rarely former teachers. These administrators come from a variety of backgrounds, and they enter the field by getting a postgraduate degree in educational administration. Administrators should be culled more from the ranks of successful teachers who have been soldiers before they become generals.

Congratulations to the Gates Foundation for taking on these issues. If Bill Gates needs help figuring out how money is raised and spent for public education, then we definitely have reporting and transparency problems.

Wednesday, March 2, 2011

Kings of the Blues

It seems like everywhere I turn on the radio, someone is recording with B.B. King, and the endless tributes deservedly flow to a blues master. I recently rediscovered a disc from the neglected Albert King, with his Flying V guitar, "Lucy." I guess that I hadn't listened to his discs in a while, and it struck me how raw Albert's sound is compared to that of B.B. King.

The guitar tone is not big and round, like B.B.'s Lucille. Albert's guitar tone is stinging, and his voice and diction are less urban and more back country. I heard a song, "Angel of Mercy" that knocked me back in my seat. It's an unforgiving portrait of credit crisis and unemployment told by a great blues master in his best voice, singing his heart out. Lucy throws in her accents and fills at just the right times. This is a classic that time has forgotten, in my opinion. Albert's use of horns, and an organ to give a nice bottom to the band is also something that distinguishes his style. Give it a listen and tell me what you think.

The King who has really fallen by the wayside is Freddy King, from Gilmer, Texas. He's probably my favorite in the pantheon. His loud, reverb heavy guitar backed by a great piano player and small band is a unique signature. I was blown away when I first heard Eric Clapton's solo on "Hideaway," which is on the first album by John Mayall and the Bluesbreakers. Years later, I found Freddy's original solo, which Eric had ripped off, note for note, even with the heavy reverb! That's how it goes for the innovators. Freddy King is always worth a listen.

Tuesday, March 1, 2011

Best Buy's Chinese Expansion

The headlines characterized Best Buy's closing of its Chinese stores as a pullback from globalization. But, as much as shareholders pine for their portfolio's big retailers to go global, especially in emerging markets, does it make sense? I would say, "No."

When Best Buy arrives in China or India, what is the comparative advantage that it brings to these kinds of large, fragmented markets? Domestically, it has a strong brand identity (that great yellow sale tag, big stores, low prices, the latest technology), buying power, efficient distribution, and a low margin--high turn business model. In India, for example, the domestic market constraints, such as inefficient customs, transportation and low labor productivity hamstring a retailer like Best Buy and make it as mediocre as any local competitor.

In a country that doesn't have a high regard for "intellectual property," an Indian competitor can open a store called "Best Bye" with the same format, layout and yellow tag, and there goes the brand identity. Price breaks from manufacturers now occur at much smaller break points than in the past, so a local big store probably gets similar pricing, except perhaps on a private label product. Store construction times and construction materiel procurement are nowhere what a Best Buy is accustomed to in the U.S. Labor productivity in markets like India is low, turnover high, and training times are long.

Grey markets are prevalent in emerging markets, which have largely been purged in developed markets. All in all, the guts of the low margin, high turn model are eviscerated in India and China.

Local entrepreneurs find it much easier to deal with the bureaucracy and corruption than do Western, public retailers, with corporate codes of ethics. So, at the end of the day, the lack of the social, political and physical infrastructure--things which U.S. companies take for granted--all conspire to level the playing field for local, well financed entrepreneurs. Although Best Buy might have to look elsewhere for its growth potential, shareholder interests are better served by pulling the plug on China.