Re: China

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

Your example of the airline in Australia ironically supports Greenspans
observation.  Airlines nowadays hardly own any physical assets.  The planes are
leased from financial institutions such as GE.  Airlines are in the business of
selling airplane seats between destinations.  They own asccess rights to gates
at airports, approved air routes, reservation and ticketing systems, labor
contracts, maintainance operations,  etc., all conceptual assets.  Greenspan's
observation about conceptual assets is on target. albeit his warning of
vulnerability is disproportionately misplaced.  The risk is much higher than he
admits.  He keeps using past record toproject future vulnerability.  Any risk
manager knows that accidents are  always waiting to happen.  The fact that it
had not happened in the past does not mean it will not happen in the future.
Low probability is only a source of comfort if the impact is not fatal.  Also,
what he did not say, but admited by implication, is that finance capitalism is
operating with increasingly less reliance on capital. Capital has become a
notional value.  Credit is no longer based on equity but on circular hedges.
Debt to equity ratio is no longer a relevant consideration.  Practically all
major businesses nowadays have negative real equity. Their creditbility relies
on market capitalization with unsustainable P/E ratios.
Even now, during what many on Wall Street contend is a savage bear market, the
Standard & Poor's 500 index changes hands at about 25 times earnings. It would
have to fall by another 41 percent to reach the median valuation prevailing
since 1957.  Such decline can happen in a peridod of a few days, even with
circuit breakers and trading curbs.

The danger of financial terrorism, the finacial equivalent of the attacks on the
WTC towers that caused their collapse in less than an hour after impact, remains
very real.

Henry C.K. Liu

Sacha Vidler wrote:

> This talk about 'physical' assets being in someway more dependable than
> 'conceptual' assets is redundant.  The value of a firm is determined by its
> market power in customer and supplier markets - its ability to maintain
> margins.   Example: The value of one Australian airline was seen
> unambiguously to jump last week when another collapsed.  Where is the
> 'physical' component there?  More generally, the genuinely 'physical'
> element of value of any major corporation is rather small when compared to
> non-physical intangibles such as IP, and the various features of incumbency
> as market leader, such as established relations with customers.
>
> Do debt-equity ratios or 'leverage ' still have value when the value of the
> equity component fluctuates so widely?
>
> ----- Original Message -----
> From: "Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>
> To: <pkt@xxxxxxxxxxxxxxxx>
> Sent: Wednesday, March 06, 2002 4:22 PM
> Subject: Re: China
>
> > There is increasing evidence that the threat to China is not democracy or
> market
> > economy but the peculiar US version of these institutions. The 19th
> century
> > industrial capitalism that Marx observed no longer exists.  Finance
> capitalism is
> > a system in which capital is only a notional value upon which to build a
> gigantic
> > mountain of debt.  Representative democracy in the US mode is a legalized
> > constitutional device to disfranchise the poor and weak.
> >
> > This is acknowledged in the testimony of Chairman Alan Greenspan Federal
> Reserve
> > Board's semiannual monetary policy report to the Congress, before the
> Committee
> > on Financial Services, U.S. House of Representatives on February 27, 2002:
> >
> > "From one perspective, the ever-increasing proportion of our GDP that
> represents
> > conceptual as distinct from physical value added may actually have
> lessened
> > cyclical volatility. In particular, the fact that concepts cannot be held
> as
> > inventories means a greater share of GDP is not subject to a type of
> dynamics
> > that amplifies cyclical swings. But an economy in which concepts form an
> > important share of valuation has its own vulnerabilities.
> >
> >  As the recent events surrounding Enron have highlighted, a firm is
> inherently
> > fragile if its value added emanates more from conceptual as distinct from
> > physical assets. A physical asset, whether an office building or an
> automotive
> > assembly plant, has the capability of producing goods even if the
> reputation of
> > the managers
> > of such facilities falls under a cloud. The rapidity of Enron's decline is
> an
> > effective illustration of the vulnerability of a firm whose market value
> largely
> > rests on capitalized reputation. The physical assets of such a firm
> comprise a
> > small proportion of its asset base. Trust and reputation can vanish
> overnight. A
> > factory cannot.
> >
> >  The implications of such a loss of confidence for the macroeconomy depend
> > importantly on how freely the conceptual capital of the fading firm can be
> > replaced by a competitor or a new entrant into the industry. Even if entry
> is
> > relatively free, macroeconomic risks can emerge if problems at one
> particular
> > firm tend to make investors and counterparties uncertain about other firms
> that
> > they see as potentially similarly situated. The difficulty of valuing
> firms that
> > deal primarily with concepts and the growing size and importance of these
> firms
> > may make our economy more susceptible to this type of contagion.
> >
> >  Another, more conventional determinant of stability will be the economy's
> degree
> > of leverage--the extent to which debt rather than equity is financing the
> level
> > of capital. The proper degree of leverage in a firm, or in an economy as a
> whole,
> > is an inherently elusive figure that almost certainly changes from time to
> time.
> >  Clearly, firms find some leverage advantageous in enhancing returns on
> equity,
> > and thus moderate leverage undoubtedly boosts the capital stock and the
> level of
> > output. A sophisticated financial system, with its substantial array of
> > instruments to unbundle risks, will tend toward a higher degree of
> leverage at
> > any given level
> >  of underlying economic risk. But, the greater the degree of leverage in
> any
> > economy, the greater its vulnerability to unexpected shortfalls in demand
> and
> > mistakes.
> >
> >  Indeed, on a historical cost basis, the ratio of debt to net worth for
> the
> > nonfinancial corporate business sector did rise, from 71 percent at the
> end of
> > 1997 to about 81 percent at the end of the third quarter of last year,
> though it
> > is still well below its level at the beginning of the recession in 1990.
> The
> > ratio of interest payments to cash flow, one indicator of the consequence
> of
> > leverage, has crept up in recent years, reflecting growth in debt.
> However, owing
> > to lower interest rates, it remains far below its levels of the early
> 1990s.
> >
> >  Although the fears of business leverage have been mostly confined to
> specific
> > sectors in recent years, concerns over potential systemic problems
> resulting from
> > the vast expansion of derivatives have reemerged with the difficulties of
> Enron.
> > To be sure, firms like Enron, and Long-Term Capital Management before it,
> were
> > major players in the derivatives markets. But their problems were readily
> > traceable to an old fashioned excess of debt, however acquired, as well as
> to
> > opaque accounting of that leverage and lax counterparty scrutiny. Swaps
> and
> >  other derivatives throughout their short history, including over the past
> > eighteen months, have been remarkably free of default. Of course, there
> can be
> > latent problems in any market that expands as rapidly as these markets
> have.
> > Regulators and supervisors are particularly sensitive to this possibility.
> > Derivatives have provided greater flexibility to our financial system. But
> their
> > very complexity could leave counterparties vulnerable to significant risk
> that
> > they do not currently recognize, and hence these instruments potentially
> expose
> > the overall system if mistakes are large. In that regard, the market's
> reaction
> > to the revelations about Enron provides encouragement that the force of
> market
> > discipline can be counted on over time to foster much greater transparency
> and
> > increased clarity and completeness in the accounting treatment of
> derivatives.
> >
> >  How these countervailing forces for stability evolve will surely be a
> major
> > determinant of the volatility that our economy will experience in the
> years
> > ahead. Monetary policy will have to be particularly sensitive to the
> possibility
> > that the resiliency our economy has exhibited during the past two years
> signals
> > subtle changes in the way our system functions.
> >
> >  Our most recent experiences underscore this possibility, along with the
> > persistence of a long list of older, well-tested, economic verities.
> Inventories,
> > especially among producers and purchasers of high-tech products, did run
> to
> > excess over the past year, as sales forecasts went badly astray; alas,
> technology
> > has not allowed
> >  us to see into the future any more clearly than we could previously. But
> > technology did facilitate the quick recognition of the weakening in sales
> and
> > backup of inventories. This enabled producers to respond forcefully, as
> evidenced
> > by output adjustments that have resulted in the extraordinary rate of
> inventory
> > liquidation we experienced late last year."
> >
> > Henry C.K. Liu
> >
> > Warren Mosler wrote:
> >
> > > Their risk is that their 'Western Educations' block sound policy.
> > >
> > > w
> > >
> > > "Henry C.K. Liu" wrote:
> > >
> > > > The most encouraging part is the government's decision to continue to
> raise
> > > > wages by 30% a year.  Also, anticipating a contraction of export, a
> new
> > > > ecoomic policy to stimulate domestic consumption and development will
> keep
> > > > growth above 7%.  A record deficit of 309 billion yuan ($36.68
> billion) is
> > > > projected for 2002.
> > > >
> > > > Henry C.K. Liu
> > > >
> > > > Warren Mosler wrote:
> > > >
> > > > > China's Zhu Vows to Keep Up Government Stimulus Spending, Create
> More
> > > > > Jobs
> > > > >                      Chinese Premier Zhu Rongji said the government
> will
> > > > > keep up a spending campaign to stem rising
> > > > >                      unemployment, boost farmers' income and sustain
> > > > > growth in Asia's second-largest
> > > > >                      economy. More...
> > > > >
> > > > > Fyi,
> > > > >
> > > > > This could be how China passes us by.
> > > > >
> > > > > w
> >
> >