The Arcandor Disaster

According to a leaked PWC paper, Arcandor managed to burn a cool 1 bn € of equity during the last six months. And apparently, various major irregularities/discrepancies are still under discussion.

The 3/09 financials were supposed to be published last week, but have been delayed until the middle of June.

(Source: Handelsblatt, picked up via Egghat)

Edit: As discussed in an earlier post, equity declined by 500 m € in the 3 months to 12/08. So if they lost 1 bn € over 6 months, it seems that they are losing money at a constant quarterly rate of 500 m €...

The Future of the Car Industry

The Economist is running a leader on the future of the car industry.

It argues that the world will have 3 bn cars in 2050, as compared to 700 m cars today. China alone will have nearly as many cars as the entire world today.

No way.

Based on current projections, the world will have around 9 bn people in 2050, and China's population will be only slightly higher than today.

So those numbers would imply that worldwide, there would be 1 car for every three people (i.e. more than one car per household), and in China, there would be 1 car for every two people (roughly as many as in Western Europe today).

Apart from the (IMHO) rather unrealistic implied assumption that car ownership will soon begin to skyrocket in places like Africa, Pakistan, Bangladesh and North Korea, there is one glaringly obvious problem:

Based on today's technologies, the world will struggle to keep the current 700 m cars fueled much earlier than 2050. Quadrupling that number will be totally impossible based on fossil fuels of any kind.

If electric cars do take off, the question is only shifted to power generation: How can the world possibly hope to create so much electric power to sustain both other uses of electricity (presumably also growing fast in the much richer world envisaged by The Economist), and 3 bn cars?

It's a ridiculous pipe dream, in my very humble opinion.

New Developments Regarding Opel

According to Der Spiegel, the combined equity investment of Magna and Sberbank will be as little as 100 m € according to the MoU. The press used to quote a figure of 500 m €, but apparently, 400 m € of this will be in the form of a collateralized loan, which will only be converted to equity years later (it's not clear on what basis and under what terms and conditions).

And according to the FTD, Opel will have to pay high licence fees to GM for the Intellectual Property:

3.25 % of revenues until 2015, 5 % thereafter.

This adds up to 6.5 bn € over the next 10 years, and comes on top of a cash purchase price of 300 m € for the 55 % of the shares bought by Magna and Sberbank (somewhat at odds with the 100 m € investment figure quoted by Der Spiegel).

Wow. 6.5 bn €. Based on 45,000 Opel/Vauxhall employees Europe-wide, that's 150,000 € per job.

Wouldn't it have been a lot cheaper to go with Fiat and use Fiat technology, which would be free once Opel is merged into Fiat. Their technology can't be that much worse, can it?

China's Electricity Output

I just love the way Chinese bureaucrats phrase their data releases:

"China's power output shipped via major grid networks fell around 3.5 percent in May, narrowing from a 3.55 percent decline in April, according to data from the State Grid Distribution Center. Reasons for the decline are unclear. "

Yes, it's technically correct to say that the drop in power output "narrowed". But wouldn't it be more sensible to say that the decline in May was basically the same as the decline in April?

(Quoted from Caijing, an excellent source for China economic/business news)

Edit:
A good background discussion of this topic on China Stakes.
(Link picked up via Naked Capitalism.)

The European Airline Industry

The airline industry is in big trouble: Passenger numbers are falling, losses are piling up, and companies are fighting for survival.

All of them?

No, there is one exception:

Ryanair just announced the results of the year ending 3/09. Passenger numbers were up strongly, and according to its investors presentation, Ryanair is now Europe's biggest airline both by passenger numbers and by market value of its equity (though I am not sure if they included the various subsidiaries of Air France and Lufthansa when calculating their total passenger numbers). Ryanair did post a moderate loss, but that was mostly due to oil hedging contracts, which were hard to get right with the oil price fluctuating all over the place.

What's their secret?

The traditional players rely heavily on their business class passengers. Unfortunately, their numbers have been declining rapidly, whereas leisure trips have held up reasonably well. But traditional airlines cannot compete with budget airlines on the price of economy class tickets if their business class seats are half empty. Their business model does not work that way.

Another part of the reason is Ryanair's aggressive use of low-cost secondary airports. These airports struggle to cover their costs, and are willing to accept cut-throat pricing for their landing fees.

Anyway: For the moment, leisure trips are very affordable - even for penny-pinching consumers - due to the low oil price.

However, if (or rather: when) the oil price goes beyond 100$/barrel again, ticket prices will have to rise, and the low end of the market will also suffer.

Savings and Investment: The Singapore Experience

I recently posted on China's savings and investment rates, and how they are extremely high by international standards.

Singapore used to be a country famous for its sky-high savings and investment rates, so I thought it might be useful to check how these numbers changed over time as Singapore's economy matured.

The data (according to Statistics Singapore) surprised me:

- The savings rate dropped from 54 % in 1997 to an average of 40 % in 2002-07 (though it was back on an upwards trend from 2005 onwards, increasing from 38.5 % to 46.8 % in 2007).

- The investment rate dropped much faster: It went from 39 % in 1997 to an average of only 20 % in 2003-07 (again, there was an upwards trend from 19.9 % in 2005 to 22.6 % in 2007). In other words, Singapore's investment rate wasn't particuarly high during the last few years. It was more or less equal to Germany's.

- The trade surplus skyrocketed: It went from 13 % in 1997 to nearly 30 % in 2005-07. That's right: Singapore has been running a trade surplus of 30 % of GDP!

If this is an indication of how things will develop in China (i.e. savings rate dropping a bit, but investment rate dropping much faster once a "long-term sustainable capital stock" is reached), there is a major problem brewing:

Singapore is a tiny country, and the world doesn't really care if it runs a large trade surplus or not. China, on the other hand, cannot possibly run a trade surplus of 20 % or more of GDP. The current 8 % or so are already considered a major problem, and as China's economy keeps growing, a constant 8 % would already turn into an ever larger absolute number.

If China's investment rate eventually comes down into the 20-30 % range, the savings rate must also drop by nearly half. There is no other way. And as speculated previously, I suspect that higher government debt is the only feasible way to get there.

China's Savings

China is saving a lot.

And it is investing a lot.

Both its savings and its investment rate are among the highest worldwide.

But is it investing so much because there are so many savings?

Or is it saving so much because there is such a huge demand for investment?

A bit of both actually:

- The household savings rate is very high (most estimates put it at around 30 % of disposable income), so Chinese households obviously want to save.

- But at the same time, most corporate investments are "self-financed" (77 % of fixed investments in 2007 were self-financed, and only 15 % were financed via domestic loans, says the Statistics China Yearbook), i.e. companies pay for them out of their own cash-flow instead of distributing funds to shareholders. In other words: They are saving because they want to invest.

Obviously, China's investment rate can't stay sky-high forever.

What will happen when it eventually starts to come down?

- Insofar as corporate cash-flow is concerned, it can in principle be distributed to shareholders, and thereby becomes available for consumption (-> private shareholders) and government spending (-> state owned enterprises).

- But if household savings rates stay high, there will still be excess savings. Currently, household savings make up 15 % of GDP (rough estimate based on: household income = 50 % of GDP, household savings rate = 30 %). Currently, these are channelled into the trade surplus (close to 10 % of GDP) and to finance corporate investments (via bank loans). If more corporate profits are distributed, this might increase household savings further (as it increases household income as a percentage of GDP, and as shareholders tend to be high-income households, which usually have an above average savings rate).

China's trade surplus can't stay at close to 10 % of GDP in the long run: As its economy keeps growing faster than the rest of the world, the rest of the world's trade deficit with China would keep growing in % terms, and eventually, this will become unsustainable.

So China has only two ways of dealing with its excess savings:

- Either entice households to save less (by reducing their motivation to save, or by taxing them more harshly, thereby taking away the money they might otherwise save)

- Or increase the government deficit (which is still much lower than in Western countries, and extremely low compared to Japan)

My guess is that it will opt for the latter, just like most of the rest of the world has already done long ago.

(Intensive discussion of savings and investments in China can be found at Michael Pettis. Some thoughts on China's investment rate in an earlier post of mine.)

More on the "Bad Bank Law"

Today's press is full of articles criticizing the proposed bad bank law (for example this article on Spiegel Online).

The gist: As banks will ultimately still be responsible for their toxic assets, it's not attractive for them to place them in a bad bank, and it doesn't help their capital base either. Therefore, it is expected that the whole concept will turn into a flop.

Sure. If you want to give banks an incentive to remove problem assets, and if you want to improve their capital base without massive capital increases (either by "normal shareholders" or via nationalization), you need to buy those assets from the banks at attractive prices, i.e. way above fair value. In the process, bank shareholders win, taxpayers lose. The law commendably tries to avoid this wealth transfer, but the inevitable consequence is: This doesn't really help the banks. What they need is fresh capital, and the law doesn't offer them a way to get it.

Der Spiegel has also finally discovered another very valid point:

The plan only deals with "toxic securities", as if American subprime stuff was the only problem facing German banks. Good old-fashioned non-performing loans are not covered. Unfortunately, those non-performing loans are now starting to roll in, and will soon turn into a flood: Germany is in its worst recession ever, and bank loans have a nasty habit of becoming non-performing during recessions.

Is China Investing Too Much?

Just about every outside observer seems to agree that China is investing too much.

And the numbers sure look that way:

- China's gross investments make up close to 50 % of GDP.

(Edit: Checked the official national accounts data, and the exact number was "only" 42-43 % in 2004-07)

For comparison:

- Germany records around 20 %

- The US barely manages 15 %.

Already back in the 90s, Krugman famously argued that Asia's "tiger economies" were using more and more capital to achieve their high growth, whereas total factor productivity remained pretty constant. Based on this finding, he argued that the Asian "growth miracle" wasn't particularly miraculous after all.

However, high amounts of capital investment don't necessarily imply inefficient production or overinvestment. This is only the case if the return on the capital employed is not good. Countries can have a different economic structure: For instance, the US has comparatively little capital-intensive manufacturing, whereas Germany has lots of it. This probably explains why Germany has a higher investment rate than the US, even though the US economy has been growing faster than Germany's.

However, the difference between 15 % in the US and 20 % in Germany is dwarfed by China's 50 %. Can such a gargantuan investment rate possibly be adequate and sustainable?

Well, there might be a reason to argue that indeed it can be:

- Germany's economy is basically stagnating (average real growth over the last ten years has been barely more than 1 % p.a.)

- China's economy has been growing at roughly 10 % p.a.

When an economy grows fast, the capital stock also needs to grow fast. This means that new investment as a percentage of GDP must be higher in high-growth countries, otherwise the capital stock will shrink as a percentage of GDP.

Let's illustrate this with numbers:

- Assume that on average, investments have a useful life of 15 years

- In a stable economy such as Germany, a 20 % investment rate implies a total "equilibrium capital stock" of 300 % of GDP (20 % * 15 years).

- Assume China's economy is structurally the same as Germany's, i.e. also has an equilibrium capital stock of 300 % of GDP.

- If China grows at 10 % every year, it needs to grow its equilibrium capital stock at 10 % as well. As the capital stock is assumed to be 300 % of GDP, 10 % growth implies that 30 % of GDP need to be newly invested every year on top of replacement investments.

- China's replacement investments will be lower than Germany's 20 %, as the economy has grown fast, so what used to be 20 % of GDP is far less by the time the investments have reached the end of their useful life. So China's replacement investments are probably more like 10 % of current GDP.

=> Based on the assumptions above, China would have equilibrium investments of 40 % of GDP as compared to Germany's 20 %. The difference is needed to keep the capital stock constant in % of GDP while the economy is growing at 10 %.

(If the average useful life of investments is longer than 15 years, equilibrium investments will be even higher than 40 %. If the useful life is shorter, they will be below 40 %.)

So China's high investment rate doesn't necessarily mean that there is a huge degree of overinvestment and lots of capital is wasted: A high investment rate is perfectly in line with a capital-intensive economy (similar to Germany's) which needs to expand its capital stock to keep up with high overall growth rates.

(Note: I do not intend to make the claim that China's investment binge is fully appropriate. I agree with most other observers that China seems to be overdoing things investment-wise. But based on the thoughts outlined above, I do believe that the extent of the overinvestment is probably less than commonly suspected.)

Component Shortages in the IT Industry?

According to this article, Asia's electronics industry is now suddenly suffering from shortages of key components:

"A shortage of electronic components such as chips and displays threatens to derail a nascent recovery in Asia's technology sector spurred by China's stimulus plan.

But many tech companies, especially makers of memory chips and displays, have sharply trimmed output since late last year or were too cash-strapped to invest in new production equipment in the sector's downturn, leading to shortages of key components.

'Tight supplies are creating a headache for many computer vendors,' said Alex Huang, vice-president of Taiwan's Mega International Securities. 'So it remains a question mark if you ask me how strong the recovery will be in the next few months.'

AU Optronics Corp, the world's No 3 maker of LCD panels for PCs and flat-screen TVs, said that it has a shortage now and can only meet 70 per cent of its orders even if it runs at full capacity in the next three months.

It is a double blow as many leading PC companies have seen their profit margins weaken as they sell more cheaper netbooks."

To me, this makes no sense:

If there really is a shortage of key components, this implies a constraint on the number of orders that can be fulfilled. If demand is higher than possible supply, then prices will obviously increase sharply, both for components and final products. If this is not happening (and the "double blow" argument seems to suggest that it isn't), this can only mean that demand isn't exactly red hot either.

So my interpretation is: The price war in certain component sectors was crazy over the last 6 months. Now, things are getting a bit better for suppliers (among other reasons because some competitors have exited the market, most notably Qimonda), so prices are recovering, but are still way below pre-crisis levels. Meanwhile, end-product demand is also picking up a bit, but not enough to allow producers to increase prices. Sufficient components would quickly become available again if prices rose high enough, but demand still isn't big enough to justify a real price recovery.

So what they really mean is: "At the (low) price we are willing to pay, there are not enough components". That's a bit like saying: "There's a shortage of oil" because you only want to pay 20 US$ per barrel, but suppliers insist on 50 US$...