To Sell or Not to Sell

Startup companies in both the U.S. and China face the same question at some point: whether they need to sell themselves. But they have different answers.
Born into an immigrant family, Frank Paniagua is a typical Silicon Valley adventurer. When his family moved to the U.S. from Spain, they even didn’t have enough money to pay for Pagiagua’s tuition. So he started doing part-time jobs. But he wasn’t washing dishes at a restaurant or teaching Spanish at school. He had a bigger idea: establishing new companies.
With that idea, he started his career path in another way: setting up a new company, and then selling it to make money.
Paniagua co-founded the Video Electronics Standards Association; he founded RasterOps for Worldwide OEM Sales; he founded KidWise LearningWare, a child education company; he founded Eskape Labs and AutoNetworks, two Internet companies, and he founded IXMICRO, a hardware company.
Among those companies, RasterOps and VideoLogic went to initial public listing, and EskapeLabs, IXMICRO and AutoNetworks were sold to private investors.

Why China Won’t Have a Similar Financial Crisis

Editor’s Note: As the financial crisis in the United States spreads around the world, China appears to be safe. With government-owned land, higher quality mortgages, a closed financial system and huge foreign exchange reserves, the country is unlikely to face a similar economic crisis.

As the financial crisis in the United States spreads around the world, investors are scrambling for a safe place to dock their money. They can at least find one – China, where a similar financial crisis is highly unlikely for several reasons.

First, slumps in real estate values, which directly triggered the current credit crisis in the United States, aren’t likely to occur in China.

Unlike most countries in the world, in China, the government owns the land. That means Chinese homeowners spend the majority of their income paying for a house on land they don’t actually own. A homeowner simply buys the right to use the land for a certain period of time – 70 years in the case of residential properties.

The government benefits the most from a booming real estate industry by selling and re-selling land, and it will lose the most if the housing market tumbles. Revenue from auctioning land surpassed 900 billion yuan ($132 billion) in 2007, according to the Ministry of Land and Resources, or nearly 20 percent of the country’s fiscal income last year.

That explains why China has seen several stock market crises in the past 10 years (the most dramatic one is happening now), but not one single crisis in the housing market. It doesn’t mean, of course, that China’s house prices will rise indefinitely, but it does mean that the government has strong incentives to intervene in the market.

The government has powerful means. The most obvious one is a limited supply of land. China has 1.3 billion people living in an area as big as the United States. Over the past few years, new cities have been built and more people have moved to urban areas. But the majority of the Chinese still live in rural areas, and their demand for better housing will provide strong support for the property market.

Spending within their means

Another reason why China won’t suffer the same fate as the United States: Mortgage assets owned by Chinese banks are of a much higher quality. House buyers usually shell out a down payment of 30 percent for their first apartment, and the government requests that buyers of a second home pay 40 percent down. Sub-prime mortgages with zero-down payments are now allowed in China.

And unlike the United States, Chinese homebuyers tend to prepare enough savings for a monthly mortgage payment before they decide to buy an apartment. Allowing spending to surpass savings is seen as an embarrassment in China. The Chinese take advice from their elders seriously: never spend beyond your means.

High down payments and low loan default rates have enabled China’s banks to keep their troubled mortgage assets under control. Troubled mortgage loans in the Industrial and Commercial Bank of China, the nation’s biggest bank, stood at 1.84 percent in the first half of the year, according to Xinhua, China’s official news agency.

Indeed, in China most bad loans come from government-guided lending to state-owned companies. By some aggressive estimates, bad loans could stand above an average of 20 percent in China’s biggest four banks. But an implosion of big banks is also very unlikely. The government has already used its massive foreign reserves to help bail out bad loans for big banks. Allowing its banks to fail, which could create havoc in Chinese society and even endanger the ruling of the communist party, is the last thing the government wants to see.

Ammo for the financial system

Finally, a similar crisis won’t happen in China because the country has a closed financial system and $1.8 trillion in foreign exchange reserves.

The 1997 Asian financial crisis didn’t spread to China because the country maintained its fixed foreign exchange rate. It used its reserves to guarantee that speculators wouldn’t succeed in betting that China would de-peg its currency.

Ten years later, China’s foreign reserves, the biggest in the world, are giving the country more ammunition to fight a similar crisis. In fact, the country is facing a very different dilemma compared with that of most developed countries: a stronger currency instead of a weakening one, and foreign capital inflows instead of massive outflows.

So while China is not likely to see a similar financial crisis, the country has to fight a different set of challenges – how to control inflation when foreign capital is flooding the country as foreign investors bet that the yuan will keep rising – and how to maintain a robust exporting sector when the rest of the world is slowing.

But no matter what happens in China, a credit crunch probably won’t be a concern.

In fact, the country has too much money, and it doesn’t know how to spend the money in a more profitable way. The value of China’s holdings of U.S. bonds is declining, and its initial attempt to direct investments to foreign equities, such as BlackStone, has been a total failure.

U.S. Treasury Secretary Henry Paulson, who is set to look for buyers for the new $700 billion debt, should approach China before that country finds something better to do with its money.

Ying Zhao worked in China as a business reporter before she came to the United States in 2006. She covered Silicon Valley for the China Business News, a Shanghai-based newspaper. She is now studying business journalism at the Graduate School of Journalism at the City University of New York.

China Will Look to Rescue Itself, Not the U.S.

Editor’s Note: Now that the United States has passed the biggest rescue plan in history to bail out its struggling financial industry, U.S. Treasury Secretary Henry Paulson is set to visit China to ask the Chinese government to open their coffers. But this time, getting money from the Chinese will not be as easy. Ying Zhao worked in China as a business reporter before she came to the United States in 2006. She covered Silicon Valley for the China Business News, a Shanghai-based newspaper. She is now studying business journalism at the Graduate School of Journalism at the City University of New York.

As the U.S. financial industry suffered the biggest turmoil since the 1930s, rumors spread that the Chinese government, which holds about $1 trillion of U.S. debts, had ordered state-owned banks to stop buying American bonds. Although the Chinese government immediately dismissed the rumors, and reaffirmed its confidence in the United States, the rumors are sending out a clear signal: this time, China won’t be a willing rescuer of the United States.

The Bush administration predicted that the federal government’s deficit of the next fiscal year, starting in October, will stand at a historic high of nearly $500 billion. And adding the new $700 billion bailout plan, the United States’ public debt ceiling will be raised to $11.3 trillion from $10.6 trillion. With its vault empty, the administration has to hit up such countries as China and Japan. China, holding the world’s largest foreign reserves of $1.8 trillion, might be the first country Treasury Secretary Henry Paulson will visit for money.

In fact, the Wall Street Journal has reported that pressure from China played a role in the U.S. government’s bailout of Freddie Mac and Fannie Mae, the two giant government sponsored enterprises. The two mortgage companies owe China more than $200 billion. By bailing them out, the United States is showing China that the U.S. government is standing ready to guarantee its debt.

Overall, the U.S. debt held by China is the world’s second largest after Japan, according to data from the Treasury. About 45 percent of foreign bonds held by China is related to the United States, according to Jiang Jianqing, chairman of China’s biggest bank, Industrial and Commercial Bank of China (ICBC). But will China trust the United States as much as it did before the financial crisis? The answer is clearly no.

“We aim to be a strategic investor,” said Jiang. “The ICBC will take good care of its purse, and has no interest in fire sale [of U.S. bonds].” And, he added, “Both China and the world’s financial markets have focused too much on the U.S.”

Meanwhile, China has its own trouble at home: a tumbling stock market, rising inflation and a slowing economy. Instead of gobbling up U.S. bonds, China may use its massive foreign reserves to boost its own economy. Instead of holding U.S. dollars as the dominant foreign asset, the country is very likely to replace them with the Euro, Japanese assets and gold.

What action China will take this time could be determined by China’s policies during Asia’s financial crisis a decade ago. In 1998, the then Chinese Premier Zhu Rongji vowed not to devalue China’s currency, the yuan, to attain an 8 percent growth rate in gross domestic product (growth was 9.3 percent in 1997), and to contain inflation to below 3 percent. By boosting government investment, and at the same time holding a modest monetary policy, Zhu delivered what he promised. Facing similar external challenges this time, it is more than likely that China will take the same course.

China’s two-digit economic growth speed has slowed to around 9 percent in the second quarter of this year. Just two weeks ago, the benchmark Shanghai stock exchange index slumped to below 2,000 points. Meanwhile, inflation rates stay above policy-makers’ comfort level.

Because of declining consumer spending in the United States, one of China’s major export destinations, many Chinese exporters are suffering from shrinking revenue. In provinces such as Guangdong and Zhejiang, some manufacturers have had to declare bankruptcy.

Facing mounting economic challenges, China is making all efforts to stabilize the Chinese economy. Wen Jiabao, China’s incumbent premier, said recently in the World Economic Forum that “the biggest contribution we can make to the world economy under the current circumstances is to maintain China’s strong, stable and relatively fast growth, and avoid big fluctuations.”

China has unveiled a number of initiatives to shore up its stock market and bolster investor confidence. The government used its foreign reserves to purchase shares in three of its largest banks. State-owned enterprises will also be encouraged to buy back their own shares.

To boost the economy, China’s central bank unexpectedly cut its base lending rate on Sept. 15 and lowered the ratio of funds that banks must set aside as reserves. Ting Lu, an economist at Merrill Lynch, said the Chinese government could cut tax and spend more money on infrastructure and housing. That means China will use more money in its domestic development, instead of buying low-yield U.S. bonds.

Also prohibiting China from investing in the United States is China’s inexperience in foreign investment. By putting $3 billion of China’s hard-earned savings into the initial public offering of Blackstone, a U.S. private-equity firm, China suffered the biggest holdings loss, about $1 billion in six months, as Blackstone’s share prices tumbled.

The Chinese government is learning the hard way. It recently abstained from buying a big chunk of shares in Morgan Stanley, a large U.S. investment bank, which allowed a Japanese bank to step in as Morgan Stanley’s rescuer. Going forward, China will become more cautious on its U.S. investments.

However, dumping U.S. assets is also unlikely, as it will only further upset their value and make China lose more money. China, then, is likely to maintain a more neutral position. It will become more scrupulous. But it could also implicitly promise not to dump U.S. assets.

The debate in China over foreign investment isn’t focused on whether it should invest in overseas markets, but on how to invest. China may use its reserves to buy foreclosed real estate in the United States, or make loans to the U.S. government. Or it could buy shares in companies with stable profits. The key is maximizing the revenue, not cleaning up the mess for the United States.

This is my first English publication in New America Media.