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Recent protests in France were so successful that China is now considering a retaliatory strike against French products.

In the meantime, I caught an article written by a former activist from Poland:

I remember 14 December 1981. Arm in arm with trade union leaders, Andrzej Seweryn, Zbyszek Kowalewski and I were leading a demonstration protesting against the introduction of the martial law in Poland. We had 100,000 Parisians behind us, nowhere else did as many people take to the street.

How I was proud of that city then. And today I’m proud of it again.

I don’t support boycotts, nor are you likely to find me at a protest rally, but it does seem that actions in France have caught China’s attention — and isn’t that interesting?

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While many have reported that China manufacturing is on its knees, I want to assure that a great many of the country’s factories are doing just fine. I visited one manufacturer recently and was not surprised to hear that revenue increased 35% in 2007. While some manufacturers are falling on hard times, others are finding that opportunities abound.

Speaking of which, at one point in my meeting, I was told that the supplier were almost finished with construction on a new plant. I asked where the new factory was going to be located and was told four hours away by car. Four hours! The plan to build a factory four hours inland sounded ridiculous, and I told the factory owner so.

The original factory was located in a city where prices were high, I was told, and the factory wanted to build where property values would appreciate faster. What they were looking for was a real estate play. I expressed doubt about the scheme and was taken to school: The company had acquired land for US$1mn and completed construction on a plant that cost around US$3.5mn. Before the project was completed, they had a new real estate appraisal done, and the updated value of the property came in at $3mn for the land and $7mn for the plant. The value of the property had increased over 100%, I was told, before the project was even completed.

Manufacturers in China built new factories all the time; not always was the move about the need for additional capacity. They built new factories because foreign buyers were cautious and only placed orders after seeing that a factory was impressive looking. Sometimes a nice factory was built in the hope of hooking investors. I figured that the factory owner in this case might want to build and flip the property in this one case, but the goal was even more short-term. The plan was to take the increased property valuation and go to the bank with it. They expected to take out a loan for the increased value of the property.

“But what can you do with the money you borrow?” I asked.

“Anything,” he said.

China banks loan money to industrialists but then don’t push for repayment. Factories are taking advantage by borrowing money and then making minimum payments while they put the money to work. This is a golden opportunity for those in China who have access to capital. Interest rates are low, and real estate valuations in many corners are climbing rapidly. I was told that only a fool couldn’t figure out how to make money on an arbitrage opportunity like this one. The factory owner then detailed some of the company’s real estate holdings outside of manufacturing. They were significant, and they were poised to grow fast.

Questions I came away with were: (1) Was this the reason for reports that manufacturers were looking to move inland? (2) Could this be how some could afford to make products for next to nothing and still find success?; (3) Could factories that have access to capital be responsible for pushing out those that did not?

Those who might read this will wonder whether the suggestion is that we are in the middle of an industrial real estate bubble. Another consideration is whether all of this might somehow impact non-performing loans. There is nothing to worry about for the moment on either front, but if the pattern continues unchecked, asset inflation and non-performing loans will almost certainly be among China’s most significant economic challenges down the road. For now, let the good times roll!

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Received an email from someone on Wall Street, who saw the last post and suggested that I clarify a distinction between the financial economy and “the real economy”. Since the difference has not been much talked about, and because it is important, I wanted to add his comments separately:

One point that I think needs to be borne in mind is the difference between the financial economy and the real economy. In China’s case, the financial economy is not integrated into the global economy (you can’t move large sums in to invest or repatriate or invest-out large sums without bureaucratic approval and good reasons), which is one reason people say Western financial conditions have limited impact on China.  This is why many large financial firms are clamoring to get into China, not only because it’s a promising new market but because it represents diversification in the way few overseas markets do these days.  As far as the real economy of imports and exports etc. goes, I think there’s little doubt that China is significantly integrated into the global trading system, for good and for ill.

Speaking of these comments about a global system — for good or for ill — I wanted to turn China gamers onto a book that addresses the risks associated with an increasingly interconnected global economy. Here is a description of the book, End of the Line, by Barry C. Lynn:

Lynn observes, “Our corporations have built the most efficient system of production the world has even seen, perfectly calibrated to a world in which nothing bad ever happens.” Yet, bad things happen all the time, from natural disasters and wars to human error. The American people are relying on a global industrial system, which has serious structural flaws, and Lynn offers a thought-provoking perspective on the system’s winners and those at risk. We learn that while academics, investors, and customers view the global production system with enthusiasm, it is a disaster for many, including pension and health-insurance beneficiaries, and it shifts the power over wages and work environment from workers to investors. In reality we already live in a global system, and the author recommends using economic tools to correct the system’s failings. Since we are participants in a production system that is not controlled by any one company or any one country, this will be a challenge.

If you are a fan of The China Game blog, please pass the link to others. For reference, you can catch the RSS at: http://thechinagame.com/feed/

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Many are saying that a downturn in the U.S. economy will necessarily have a negative impact on China. David Frum, a former speech writer for George W. Bush, reflected this sentiment at NPR:

“Probably no major economy has ever depended so much on one partner as China now depends on the United States. Eighty percent of China’s GDP derives from international trade, and the United States is far and away the top destination for Chinese merchandise exports.”

At the other end of the argument, some suggest that China is immune to our economic woes. The China economy is not “coupled” with the U.S. economy, they insist. Oddly enough, these comments are coming from the same sort who suggest that China’s rise necessarily lifts the U.S. economy (it is as if China’s economy were connected to the U.S. by a one-way valve — China can pump up our economy, but even our biggest problems cannot deflate theirs).

There is an overemphasis placed on the U.S. economy’s significance in China’s equation, and it needs a rethink. International trade may account for most of China’s GDP, and we may be China’s most significant trading partner, but the U.S. takes only one-fifth of China exports. That’s all – and we account for an even smaller proportion of profitability for China manufacturers.

The U.S. is a modern and well-coordinated economy. Its businesses enjoy economies of scale and its supply chain networks are efficient. One of the greatest ironies in the global economy is that products sold in the U.S. – the world’s wealthiest country – are often priced lower than the same products sold in many lesser developed economies. I once manufactured a product in China that retailed in the U.S. for a dollar and on a trip to Brazil found the same item selling for close to five dollars.

American importers purchase in large quantities, and because they do (and for other reasons I won’t go into here) U.S. importers receive significant discounts. The liberal argument is that we should feel sorry for China. The prices we are paying are too low, they say, but this claim takes in only a limited view. The reality is that China manufacturers earn a higher margin on products they produce for other markets, and that extra margin offsets some of the discounts we receive.

At a typical Chinese factory, a single buyer from the U.S. might account for as much as half of the factory’s book of business but almost none of its bottom line. The bulk of the supplier’s profitability instead comes from a large number of smaller customers — mostly non-U.S. — who willingly pay higher prices.

Since factories earn less profit on their U.S. accounts, it stands to reason that a downturn in the U.S. economy would affect China less. What needs to be taken into account is not a direct bilateral link, but the more complex dynamic between the U.S. and the global economy. A recession in the U.S. should affect China only to the extent that such a downturn affects the world more broadly.

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