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If you have a foreign bank account, foreign currency account, and are a U.S. person, you need to have reported those accounts by June 30, according to this reminder IRS press release (dated 6/17). As you can infer from the date of this post, I blew it and now have to beg for mercy from the Department of the Treasury and IRS.

Dear Department of Treasury, I beg for your mercy.

I now endeavor to help others not make this same mistake by providing some FAQs on the process of submitting the appropriately named FBAR (Report of Foreign Bank and Financial Accounts) form.

But first, some background on how I lost faith in the U.S. dollar

Image courtesy of Freaking News

• On 3/20 I posted about the new CNY exchange traded notes announced by Morgan Stanley & Van Eck Global on 3/17, as a way of hedging RMB appreciation.
• By 3/30 this year, I concluded that RMB appreciation was inexorable and might even require a “one-off maxi-revaluation” to stem speculative inflows.
• On 4/2, I posted about the decline of the US dollar’s reserve currency status as another contributing factor toward USD/RMB exchange rate.
• On 4/11, I posted that I exchanged USD for RMB at the rate of 6.9835 into my China Merchants Bank account, and that I had established an Everbank RMB account (in the US) at 6.9544. On 4/10 the central parity rate was set at 6.992.
• On 7/11, Xinhua announced that the central parity rate of the RMB was set at 6.8397 (see China Foreign Exchange Trading System website Chinamoney.com.cn (zh) for more info). So the RMB has appreciated by 2.2% in 3 months, or a 9.2% annualized appreciation rate. So clearly, putting all my spare cash in RMB (even in the 0% interest Everbank WorldCurrency Access Deposit account) is a no brainer.

USD-RMB exchange rate chart, 2008. See a pattern?

Source: Yahoo! Finance

Now back to the FBAR. I choose to pronounce this “fubar” which has another meaning in English.

Q: Who needs to file the FBAR (Report of Foreign Bank and Financial Accounts)? I mean, I really don’t have a lot of money abroad.

A: If you have a foreign account, and the value of that account exceeds $10,000, you need to file a FBAR. More at IRS.gov here.

Q: Is this part of my Federal Tax Return? Can I get an extension?

A: No and no, that would be too easy and too obvious. According to the IRS:

The FBAR is not to be filed with the filer’s Federal income tax return. The granting, by IRS, of an extension to file Federal income tax returns does not extend the due date for filing an FBAR. There is no extension available for filing the FBAR. Account holders who do not comply with the FBAR reporting requirements may be subject to civil penalties, criminal penalties, or both.

Q: Umm, how was I supposed to know about this?

A: Well did you monitor the press releases on the IRS website? The IRS published a press release IR-2008-79 on June 17 specifically to remind taxpayers to report certain foreign bank and financial accounts by June 30. An interesting fact from the press release:

Since 2000, the number of Report of Foreign Bank and Financial Accounts (FBAR) forms received by the Treasury has increased by nearly 85 percent, from 174,528 in 2000 to 322,414 in 2007. Despite this significant increase in filings, concern remains about the degree of reporting compliance for those who are required to file.

Only 322,414 were received in 2007, and I’m sure that there isn’t 100% compliance with this requirement. But even then, it seems like a very small number of U.S. persons actually have a foreign account.

Q: What’s the deadline again?

A: June 30, 2008 for the 2007 calendar year. Yes, if you haven’t done this already, you are delinquent.

Q: OK, what form do I use?

A: Form TD F 90-22.1 (pdf) located on the IRS website. If you only have 1 account, its less than 1 page long.

Q: Where do I send it?

A: Don’t send it to where you send your normal tax returns. According to the IRS, you should send it here:

U.S. Department of the Treasury
P.O. Box 32621
Detroit, MI 48232-0621

Q: No offense, but I don’t trust anything in the blogosphere these days! Where can I get the official information?

A: Yes, in general, don’t trust bloggers for legal, tax and compliance information unless they happen to be licensed professionals in the right field. So go get the real deal here:

• IRS FAQ on Report of Foreign Bank and Financial Accounts (FBAR)
• IRS copy of Form TD F 90-22.1 (pdf)
• email the IRS: FBARquestions@irs.gov
• call the IRS at (800) 829-3676

Q: Why do I have to do this?

A: This seems to be under the Financial Crimes Enforcement Network (FinCEN), an agency of the US Department of Treasury. It seems partially motivated by tax compliance and partially motivated by addressing money laundering for drug trafficing and terrorist activity.

A few weeks back on May 6, I briefly attended two sessions of Zero2IPO’s China Venture Capital & Private Equity Forum (CVCF). I wrote this post up but then the Sichuan earthquake happened and I was focused on that.

I only had time to attend two sessions that day. Here are my notes and key takeaways from first of the two panels I attended.

Session 1: Venture Capital - Behind the Scenes of 2007 China VC Industry & Projections for 2008

Elliott’s key takeaways:

• There are diverse investing styles among China VCs. Some like innovative, technology-driven deals targeting global markets. Others like execution plays targeted toward fast-growing domestic markets.

• The consensus is that early-stage has the least competition, with growth and mezzanine stage seeing high degrees of deal competition.

• Sectors that seem to be hot include: clean tech, health care, consumer products, consumer services. This is in addition to the traditional VC sectors of semiconductors, computer hardware, software, internet, and media.

• There is increasing regulatory pressure on traditional company structures like the “Sina model” and increasing barriers to foreign direct investment. An alternative joint venture structure is preferred by regulatory agencies like MOFCOM but are more onerous to set up.

• RMB funds are emerging as a new factor. They can be used to invest in new sectors, potentially in partnership with municipal governments. There are significant challenges in making this fund structure work with foreign Limited Partners.

• RMB funds also face challenge from a domestic investing environment where there is a lot of Chinese domestic money that is less demanding from a rights and preferences basis.

• The market feels a little “frothy” as there are lots of first time entrepreneurs and first time VCs. The legal and accounting support for these deals is also in scarce supply, forcing VCs to do more of the deal work themselves.

Panelists:

• Danny Lui, moderator. Zero2IPO Group, Vice Chairman Startup Capital Ventures, General Partner

• Yan Huang. CDH Ventures, General Partner
• Gary Rieschel. Qiming Venture Partners, Managing Director
• Alan Song. SoftBank China Venture Capital, Managing Partner
• Lip-Bu Tan. Walden International, Founder & Chairman
• Yang Xia. Legend Capital, Managing Director
• Joe Zhou. Venture Capitalist

Question: In 2007, how many deals have you done? How much money has gone in?

Yan Huang, CDH Ventures

We’ve invested $200 mm in 18 companies; 1/3 early, 1/3 mid stage, 1/3 inflection point. We invest in clean tech, medical device, internet, education. We focus on growth rate, not initial profitability.

Gary Rieschel, Qiming Venture Partners

We’ve made 14 investments; 10 are pre-revenue. We led 12 deals, and invested $100 mm. We are focused on early stage, where many investors are not comfortable investing.

Alan Song, SoftBank China Venture Capital

We invested in 12 companies, $75 mm. Our fund size is relatively small. Our first fund was $100 mm, our second fund was $200 mm, and today our 3rd fund is a $300 mm fund. We are still focused on early and middle stages. We are opportunistic with late stage deals, where late stage is defined as pre-IPO in China H Shares (Hong Kong stock exchange IPO)

Lip-Bu Tan, Walden International

Walden international is 40% in China, investing in 4-6 companies/year. Our focus is very early stage with 70% investment, and expansion stage with 30% of our investments. We are interested in clean tech, and often traditional businesses like a brick manufacturing machinery company we invested in.

Yang Xia, Legend Capital

We’ve invested in 16 deals, and deployed about $60 mm. We are mostly invested in early stage investments, but in three deals we invested in growth capital. We invest in information technology, design, wireless services, CRO outsourcing

Joe Zhou, raising a fund

I’m interested in clean tech, technology-driven fields like semiconductors, media, advertising, and consumer service.

Q: What industry do you like best in CN? How much money is needed for startup to get to liquidity? How much time is required to get to liquidity? What multiples are you looking for?

Yan Huang
We like clean-tech and alternative energy. An example is the solar sector. This is not a typical VC investment because it is investment-intensive and manufacturing intensive. For example, one firm we invested in, LDK, raised $100 million in six months, and went from zero to IPO in 2 years. Returns, management required, and capital needed is not typical. In this case, we got a 5X return on our investment in nine months.

Gary Rieschel
We don’t look at specific industry sectors, but at technology innovation. We’ve done study tours of: synthetic biology, pharmaceutical, clean tech. There is still very limited innovation base in China. We’re interested in healthcare, such as clinical trial outsourcing, and we’ve made four investments to date in health care. It can require anywhere from $2 mm to 40 mm in capital to get to profitability, depending on the deal. We have the most sector experience to date in healthcare.

Alan Song
We like recession proof industries. With a 550 mm urban population in China, industries like food and beverage and packaging material are interesting, and trade at 30 price-earnings ratios. A deal might require $20 million and 3-4 years to reach IPO, and our return expectations on deals are 10X.

Yang Xia
We like IC chip design/build opportunities. These deals generally require 3 rounds of capital to get from product to business success. They often take 6 years or more. there are lots of plays up and down the value chain in computing and IT.

Joe Zhou:
I don’t like hot sectors. However, we have been looking at clean-technology, semiconductor, media/advertisement, and the consumer service/direct marketing space. We’ve made three investments that went IPO. Respectively, we invested $40mm, $40mm, and $20mm, and achieved IPO valuations of $800mm, $500mm, and $250mm on that investment.

Q: RMB funds are starting to emerge. These funds allow you to make pure RMB investments into a joint venture with a local company, that then allows you to go public on China stock exchanges. What is the opportunity for these funds?

[caveat: I don’t fully understand the regulatory issues affecting RMB and foreign funds and the companies that can accept funds from RMB or from foreign funds, so these notes may not make complete sense]

Alan Song
The emergence of RMB funds is in part due to government pressure against the prevailing company structures that have been used by venture backed companies. There are two models, one called the “Rev Trip Model” (Elliott: not sure I have this correct) and the other called the “Sina model.” In the Sina model, a British Virgin Island (BVI) or Cayman Islands holding company is established, into which foreign investors invest funds. Then a Wholly Foreign Owned Enterprise (WFOE) is established in China. That WFOE then contracts with a domestic company owned by a Chinese national. The contracts between the WFOE and domestic company insure that the assets of the domestic company (such as the ICP license) are controlled by the WFOE. Officially, this structure is not allowed by MOFCOM (Ministry of Commerce). They are not supporting this and discouraging the use of this structure.

MOFCOM wants to push the use of Joint Ventures, but there are other issues with that structure. Investors receive the same stock with the same rights, and there are no priority rights that can be offered. So in a venture-backed joint venture structure, the company has another set of agreements that enforces the preferences for the investor. (Elliott: in Western venture deals, investors receive a preferred class of stock that offers certain preferences like liquidation preference, class vote on certain issues, board directors representing the class, etc.)

RMB funds are difficult to set up. Softbank was one of the first foreign VCs to create a joint venture-foreign RMB fund. But approval from multiple regulators is needed: MOFCOM, SAIC (State Adminstration for Industry and Commerce), SAFE (State Administration for Foreign Exchange), and SAST (Elliott: not sure I have this correct: State Administration of Science and Technology). But once the RMB fund is set up, then there is no case by case approval for deals. There is also a tax advantage to the structure, by setting up a “non legal person entity” which acts like a limited partnership, we only need to pay a 10% withholding when funds are … (Elliott: didn’t catch this)

In summary, RMB funds are: hard to set up, but then much easier to invest.

Joe Zhou
There are two problems with RMB funds. As a General Partner, I need to raise funds from RMB sources but it doesn’t fit with current Limited Partner base. If I take care of LP base, then there is a lengthy process of approval for the fund. (Elliott: I think this means that there is a way to set up an RMB fund that receives foreign investment, but the approval process is more onerous, both on the fund setup and also on individual investments? RMB funds that strictly receive domestic investment are more easily approved, not sure.) With foreign LPs, we need to get approval at the point of the investment and then you do capital call from foreign LPs.

RMB funds are a totally different game, because you are competing with local funds for investment. There are different capital market dynamics. For example, we invested in Unipay. There was a different investor base, they didn’t demand any rights and preferences, and those local investors were so much less demanding that we couldn’t ask for what we usually do and still be competitive.

I am going to continue to target technology plays that will list in offshore markets.

Danny Lui

Yes, there seems to be so much local money not looking for much return!

Yan Huang

The RMB funds invest into local Joint Ventures. This creates an opportunity to invest in some different sectors. We can work with municipal governments to let them into the fund as special limited partners into the core fund. Then, we can make RMB investments that can go into foreign-prohibited sectors, with the support of these municipal governments.

Question: What do you think about the overall state of VC and the model?

Joe Zhou
The next two years is the best time for investment in the sectors that we are focusing on. Not worried about market. We are moving from 80x to 50x … (Elliott: did not catch what…price-earnings ratio?)

Yang Xia
There is more money coming in and lots of Chinese money. More people are educating entrepreneurs on how to raise money. There is limited bank capital, so entrepreneurs must seek venture capital. I feel valuations are going up, as “more hunters are in the market.” There is too much money, the market is hot, and deal access is the issue. Early stage deals are more stable, but growth stage deals are crowded.

Lip-Bu Tan
The change in Taiwan and Mainland China’s relationship is creating an opportunity. Big investments from Taiwan companies are investing in China, and there are cross border opportunities. There is lots of competition, and still disjointed valuations between public markets, US venture markets, and China venture markets.

Gary Rieschel
I went through Japan from 1988-1993, and Silicon Valley from 1993-2004. What makes me nervous is that I am seeing lots of first time entrepreneurs, and first time VCs, and Limited Partners interested in going to China. In 1996, the Kleiner Perkins (KPCB) $300 million fund was the largest ever raised. Also, in Silicon Valley, the accounting and legal infrastructure is in place. Banking infrastructure is also in place. But in China, there is less capacity, so VCs need to be prepared to do more of the work. Quote: “You think its competitive in SV? Bull—. In CN, you should see what entrepreneurs do to each other.” There are also lots of challenges. For example, we were involved in “rollup from hell” wher we took four companies in clean tech from four areas with municipal government involvement and needed to negotiate a deal that made sense for all four founders and their four local government sponsors.

Yan Huang
The challenges are obvious. First, finding quality companies at a cheap price. Second, we need to work much harder - need to be lawyers, accountants, etc. and put more time into the deals. The consumer sector is strong. We invested in a soybean milk maker, a traditional industry that is growing 70%/year. Foreign direct investment is also geting worse because of RMB appreciation and hot money.

Gary Rieschel
There is no reasons why FDI would be relaxed.

Summary:

Venture capital in the US follows more clearly defined sectors–high growth, high market multiple opportunities driven by new markets and new technology. Venture capital in China is much more diverse, as the entire economy is high growth, and many sectors that are mature in the US are still at an early stage in China. As a result, there is a lot more diversity in fund strategy in China and the need to excel at pursuing that fund strategy.

Being an UpTake (formerly a Kango) for more than 400 days, I am proud to share with you that UpTake officially opens its Beta doors to everyone TODAY! Uptake is ”

a new vacation search site that has amassed the travel industry’s largest database of hotels and attractions (more than 400,000 in US) and analyzed more than 20 million online opinions from other travelers.

In the age that the “wisdom of crowds” are generated faster than ever, Uptake offers to collect and filter word-of-mouth from the web to make vacation planning easier. UpTake also got press at ReadWriteWeb, TechCrunch, SemanticWeb, SearchEngineLand, Les Explorers and the UpTake blog itself. It is only for United States for now. But Winser Zhao of SinoHotelReservation also wrote about us.
To describe the Uptake services using the geek’s vocabulary, it: uses a travel ontology and natural language analysis to extract meta-tags from the collective intelligence it has collected and returns unbiased, personalized recommendations based on travelers’ facts and feelings.” So how much do you (more…)

Just read a nicely-written article with interesting statistics about China at The Independent (via Dan over at China Law Blog).

Though China’s market reforms and subsequent economic growth started 30 years ago, it has only been the recent decade where an appreciable amount of the masses are finally grasping just how profound it is. I say “grasping” because even so, the vast majority of them have yet to appreciate or truly understand just what China’s rise to global economic and political prominence will mean, burdened as they are–understandably–by their fears and ultimately their ignorance.

Here is a good excerpt (emphasis mine):

I am not sure we in the West fully grasp the magnitude of what is happening. Intellectually we can see it affecting us but emotionally it is hard to understand that we are moving towards a world where Western ideas, our ideas, will no longer hold sway. China has other ideas. Those will increasingly co-exist alongside ours in shaping global economic and political development….We will not find this comfortable. What we think will matter less and less. But we cannot do anything about it, and in any case, consider the alternative. Would we really want a China that was failing in economic terms, with all the misery that would cause? That would surely be far more dangerous and disruptive to the world than a continuation of China’s thrilling but terrifying success story. (more…)

Warning: long post about my recent obsession (no, not the other one) with RMB appreciation. My other posts here and here.

Today, I exchanged USD to RMB at the rate of 6.9835. A milestone. It seems like just yesterday that I was calculating the rate at 8:1. (4/12 Update: on 4/3 I also made a deposit into my new FDIC insured RMB Everbank account and the rate was 6.9544.  According to Xinhua the People’s Bank of China (PBOC) set the central parity rate at 6.992.)

Here’s some more links on the subject of RMB appreciation and why it will likely continue. Here’s my quick summary:

• Foreign direct investment and hot money continues to flow in. This more than offsets the reduced trade surplus that results in an appreciated RMB. Therefore, China’s “monetary trap” will continue with the likelihood of a one-off maxi revaluation more likely.
• With a higher RMB, importers are winners, exporters are losers. In general, Chinese people should feel more wealthy, with international travel, foreign real estate, and study abroad less expensive in RMB terms.
• With a 15.6% increase in value since the peg was dropped in July 2005, China’s economy has miraculously offset that increase by generating over 20% productivity growth rate, and overall profit margins increasing from 3% to 6.5%, according to JP Morgan.
• RMB appreciation is a key weapon against inflation. But it is not the only tool. And even with the accelerating appreciation we’ve seen, it appears that inflation has not cooled and now is 13% annualized based on Q1 data.
• In fact, the RMB hasn’t really even appreciated against a trade-weighted basket of currencies. It has only appreciated because the US dollar has depreciated. So expect accelerating appreciation and increasing likelihood of a shocking one-time revaluation.

Michael Pettis: Money Keeps Pouring In

Pettis notes that Foreign Direct Investment (FDI) has increased substantially:

According to the numbers released today, FDI for the first quarter was $27.4 billion – nearly 73% more than the $15.9 billion recorded last year over the same period. So although the trade surplus declined by $4.7 billion, it was more than matched by the $11.5 billion increase in FDI

His argument is simple: even if RMB appreciation cools the trade surplus as one would expect, RMB appreciation is causing more FDI and “hot money inflows” to take the place. This further increases government USD reserves, and further accelerates what he calls “the monetary trap” that will lead inevitably to a large, maxi-revaluation of 15-20% to dramatically change investor expectations:

We are now caught in the most mechanical and frustrating part of the monetary trap in which China has been caught during the past five years. The trade surplus was the original driver of China’s out-of-control money growth, but by now the growth seems to have taken a life of its own as money piles into the country seeking to take advantage of the nearly-inevitable run-up in the value of the currency. Hu Xiaolan, the head of SAFE, said that SAFE and the Ministry of Commerce are going to investigate whether FDI has become a channel for hot money inflows. Hmmm, I wonder.

Pettis’ conclusion: a one-time maxi-revaluation of 15-20% is on its way.

ChinaStakes: April 10 report on the RMB exchange rate

ChinaStakes reports that on April 10 the RMB exchange rate to the USD dropped to 6.9920 and that RMB appreciation was “beginning to transform China from a labor power to a capital power.” This represents a 4.06% increase during Q1 2008.

What is amazing is that the RMB dollar peg of 8.28:1 was lifted July 2005, and that the total appreciation to date is 15.6%. So almost one-third of the appreciation has happened in just the last 3 months. If this isn’t accelerating RMB appreciation I don’t know what is!

Who are the winners as the RMB appreciates?

• companies that import raw materials, e.g. crude iron and ore
• companies that import high tech items, e.g. planes and capital machinery
• people who plan international travel or study abroad. (Min, Stanford is getting more and more affordable by the day!)
• people and companies who want to buy foreign real estate
• RMB denominated assets, such as China’s real estate and stock markets

Guardian.co.uk: China exporters feel pinch of rising yuan, costs

Who are the losers as the RMB appreciates?

Answer: export oriented Small and Medium Businesses.

The Guardian covers this:

Deutsche Bank analysts Jun Ma and Wenjie Lu project that 20% of “Up to 20 percent of low-end exporters could go belly-up this year as the harsher operating environment dissolves profits and demand slows in major markets such as the United States and Europe,” they said. “China’s export sector faces multiple shocks simultaneously this year. Many of these are unintended, but the magnitude of these shocks combined is stronger than we had expected,” they wrote in a recent report.

Small and Medium Businesses (SMB or SMEs) who are export oriented are the clear losers. In addition to having thin margins and competition, they are less familiar with hedging options, such as forwards contracts and options markets.

ChristineLu.com: Frank Gong, JP Morgan, at Harvard China Review Conference.

Christine Lu spoke at and blogged about the Harvard China Review Conference. She highlighed a video of Frank Gong, Managing director and China’s Chief Economist with JP Morgan Securities in Hong Kong. He framed the recent 5 year period as an incredible period of achievement in China that has allowed the government to allow the RMB to appreciate vs. the US dollar.

Here’s my summary of his points:

• The stereotype is that China is a “profitless growth story”
• During the last 5 years, that has not been the case.
• Return on Equity (ROE) in corporate sector has increased from 7 to 17%.
• Profit margins have also been rising
• Three years ago, export sector had only 3% profit margin.
• People believed that if the RMB appreciated by 3%, the export market would just go bust.
• When the peg was lifted, the first year saw only 2.1% revaluation.
• However, three years later, the RMB appreciated more than 15% vs. dollar.
• In 2008, the annualized rate of RMB appreciation is 15%, based on Q1 numbers.
• So what happened to export sector? Did they go bust?
• No. In fact, their profit margin is now 6.5% vs. 3.0% in the past.
• The export sector did not die, but became stronger with a stronger currency. They moved up the value chain and became more efficient.
• Same process has been shown with other developing countries like Japan
• For example, Japan was at 400 Yen to USD and now is 100 Y to USD.
• Even with this revaluation of the Yen, Japanese business has remained competitive.
• The same process happening to the chinese economy as companies are moving up to higher value-added work.
• What has powered this growth is 20% productivity growth rate during lats 5-7 years, the highest in the world.
• Labor cost has been rising over last 5 years. Wage growth up 10-12 %
• Oil and commodity prices also rising.
• In the face of all these changes, productivity growth has more than made up for this.

Michael Pettis: Inflation consensus inching higher

Inflation is still high in China, even with the increase in RMB. March appears to have a 8.3% year on year inflation rate. This means 13% annualized influation in Q1 2008, vs 9.2% annualized inflation rate in Q4.

Speaking of appreciation, today Zhu Baoliang, chief economist at the State Information Center, a think tank under the NRDC (China’s powerful planning agency), wrote an article in China Securities Journal, the official securities newspaper, saying that China had to speed up the rate of appreciation. He said this was needed to combat inflation. Interestingly enough the same newspaper had a front-page commentary arguing that China needed more than just currency appreciation to control inflation.

China Securities Journal is not the formal voice of government policy, but it does have the reputation of reflecting official opinion, so I assume that it must also be reflecting the ongoing debate about how aggressively the currency must be managed to deal with inflation. What does Mr. Zhu mean about a faster rate of appreciation? Since the RMB is already appreciating fairly quickly, I suppose it might be code for a one-off revaluation.

Fighting inflation is clearly a key reason why the monetary authorities need to keep driving the RMB up.

Brad Setser of RGE Monitor: Could a stronger RMB help limit food inflation in China?

Brad’s answer is yes: a stronger RMB could make food imports profitable, and that would cause domestic producers to lower prices.

Brad Setser: A RMB that isn’t appreciating cannot be killing you

Setser critiques a New York Times article entitled Seeing the Sights of Industrial China: 2 Factories, 2 Future. The article first profiles the Shanghai Jinjue Fashion Company and makes the point that low cost exporters are facing pressure because of the rising RMB. It then profiles ReneSola, a solar panel silicon wafer manufacturer. Chinese exporters believe they need to move up the value chain to survive in the face of increasing costs and RMB appreciation. ReneSola did just that and as a result claims that RMB increases resulted in “trivial” money lost.

Brad makes a simple point: the RMB is appreciating against the dollar, but is going down against the euro and yen. “It is basically flat against a trade-weighted currency basket.” And the RMB is down 4% versus the euro in Q1, according to the Wall Street Journal quoted in Setser’s post.

A few weeks ago, I wrote a brief post advising would-be entrepreneurs and business-owners looking to source from China to do their due diligence when using Alibaba to source products from Chinese suppliers. As Alibaba continues to ramp up its marketing and advertising efforts, I want to reiterate this advice.

I passed through Hong Kong’s international airport this past Monday, and was amused to find that Alibaba had blanketed the entire terminal with its advertising. Most prominent were the 16 massive banners (similar to the one pictured to the right) suspended from the ceiling across the entire reception area of the terminal. Each one featured a random “member” from some randomly significant country exclaiming how Alibaba helped them. Every one of them also “Thanks Alibaba.com!”

“Tushar, let me ask you: How do you find the ‘best quality suppliers’ when the suppliers can simply purchase their positive reputation on Alibaba?” (Note highlighted portions to the left)

Yes, let’s recommend TrustPass to ALL suppliers. That way, they will all appear to be more “reliable” and prospective buyers everywhere can rest at ease! Suppliers also get “Verified Company Status” as an extra!

Fantastic.

Oh, and just why is Alibaba on an advertising blitz, particularly in Hong Kong’s international airport?

Because the China Sourcing Fair will be held there between April 12-15 and 20-23. Not a bad idea to remind all those fair visitors that they didn’t really need to come to Hong Kong to find “the best quality suppliers.” They’re all on Alibaba.com already.

Thanks for the tip, Tushar.

More pictures: Terminal Left, Terminal Right, Tushar, Kenneth, Charles, and Eden.

Caught this GOOD Magazine feature by Thomas P.M. Barnett via China Law Blog and felt violently compelled to share this with as many people as possible. Sure, it doesn’t cover everything, but it should be a required reading for a basic foundation of non-idiocy for everyone (especially Americans) when it comes to understanding the relevance and importance of China. 

Put down your rifle (no offense, Mr. Heston), pick out another cold one, and get your read on:

10. Because Nixon went to China and your world was born.

9. Because China may be an ancient civilization, but it’s a young society that’s growing up very quickly-and unevenly.

8. Because China’s transformation echoes much of America’s past: not only the good, but plenty of the bad, and the ugly too.

7. Because China’s rapid and deep integration into manufacturing means that Chinese products permeate your life-at some risk.

6. Because China’s demand for resources is altering global markets in ways both profound and perverse.

5. Because the panda “huggers” versus “sluggers” debate is a lot of hot air-until Washington scares Beijing into raising your mortgage interest rate five points overnight.

4. Because as China builds out its infrastructure, it can set a good or a bad example to developing economies struggling to deal with fragile environments.

3. Because China is globalization’s general contractor: always happy to take the job and your money, but hard to get on the phone once you discover problems.

2. Because China will not be our biggest future enemy but our most important ally.

1. Because we’re less than five years from a new generation of Chinese leaders with whom a far stronger relationship may well be built.

I’m particularly amused that the list ends with something that could be construed as a point of hope.  

I just got a print issue of the Real Estate Issue(pdf) of the Matthews Funds Asia Now publication that gets sent out with their funds’ quarterly reports. Matthews has a number of funds, including Matthews Asia Pacific Fund (MPACX), Matthews Pacific Tiger Fund (MAPTX), Matthews China Fund (MCHFX). Disclosure: I am a small investor in one of their funds.

The publication has a series of cool charts about the Asian Residential Real Estate market that helps paint an overall picture of the market. I encourage you to download the PDF to get more charts and more commentary on comparative real estate across Asian countries.

1. China has the highest rate of home “ownership”* in Asia, similar to the United States

I was surprised to find that 80% of people in China feel that they own their own property. According to the article, some 80% of Chinese citizens own* their property, but with an asterisk-about half of the property owners only have “usage rights” not “fully transferable rights.”

Chart 1: % of population by Asian country that owns their own home or property

2. Housing is least affordable in Shanghai, compared to other major Asian cities

Based on 2006 data, the report states that average Shanghai real estate condo pricing is lower than most other cities, but is at a stratospheric 16.6 times average income. I wonder if this data is already out of date.

Chart 2: Regional Condo Pricing and Affordability in Asian Cities, 2006

By the way, because US property is generally calculated in USD per square foot and Chinese property is generally calculated in RMB per square meter, I always struggle to convert something like RMB10,000 per sq. meter into the USD per sq. foot equivalent.

Here are the conversion factors for easy reference:

• 1 foot = 0.3048 meters
• 1 meter = 3.2808 feet
• 1 sq. meter = 10.7584 sq. feet
• 1 sq. feet = 0.0929 sq. feet
• 1 USD = 7.016 RMB (for now)
• 1 RMB = 0.1425 USD (for now)

Here are some example sizes and prices with conversions:

• 90 sq. meter = 968 sq. feet
• 150 sq. meter = 1613 sq. feet
• 10,000 RMB psm (per sq. meter) = $132 psf (per sq. foot)
• 30,000 RMB psm = $397 psf
• 2 MM RMB = $280k USD

So a 150 sq. meter apartment for 30,000 RMB psm = RMB 4.5 mm = USD $641k, or $397 psf. I hear this is what you might spend to buy in the poshest, most convenient locations in Shanghai and Beijing these days! Of course the market is very segmented…these price levels represent luxury housing prices.

3. Rapid increase in Mortgage Lending is key factor in driving home ownership.

According to the article, China’s banks have over RMB $3 trillion (about USD $396 billion) in outstanding mortgages.

Chart 3: Growth of Mortgage Lending in China (in US $Billions)

Even with this growth, the chart below suggests that only 17% of middle class Chinese live in a house that is financed with a mortgage. The bulk is financed with savings and other forms of borrowing (from relatives?).

Chart 4: Middle Class Chinese Source of Funds and When They Refurbished

Chart 5: Comparison Chart of Financing Asian Real Estate

This chart compares typical downpayment, mortgage length, interest rates, availability of fixed mortgages, and capital gains rate.

There are some regulations around the downpayment amounts. According to the article, homes that are larger than 90 sq. meters need a 30% downpayment but smaller than 90 sq. meters only require 20% minimum. Also, there are transaction taxes levied on people who try to sell the home within five years of the date of purchase.

By the way, there are significant restrictions around eligibility for purchasing residential real estate. At this time, I’m told that one year residency in China is required before a foreigner is allowed to buy real estate. There may be other methods that qualify foreigners for real estate purchase, but I haven’t researched it further. This area is very dynamic and I hope to post more on this topic should I find the need to research it myself.

Regarding real property ownership, there is a detailed four part series on the 2007 China Property Law at China Law Blog. Part 1 provides a general introduction. Part 2 begins to summarize first part the law. Part 3 summarizes the second part of the law, real property ownership rights. Part 4 covers real property use rights.

4. What does a housing bubble look like in Asia? Case Study: Japan

Everything is on the up and up in China, but real estate is cyclical. The Japanese chart shows why Japanese are much less optimistic about real estate (though that may be changing). According to the article:

The protracted asset deflation has had a dulling effect on Japan’s consumer psyche that has spread throughout the economy. Unlike the U.S. Japan’s situation has long discouraged people from investing in property and made them cautious about spending in general. A generation of Japanese has lived for years with the expectation that property value only goes down. Such psychology can be slow to change.

Japanese demographics are very different from China or the US. But the Japanese example is a cautionary tale to both property owners in the US and Chinese real estate owners and speculators.

Do you think there is a property bubble in China? In what cities and at what price levels of the market?

Via Andrew Chen (via Noah Kagan) I found this great presentation by Benjamin Joffe, managing director of Plus Eight Star Ltd.

Many of the stats below are known by people knowledgeable or aware of the Chinese, Japanese, and Korean Web markets. But these stats may be eye-opening for Westerners not aware of what is going on outside of the European or American market.

| View | Upload your own

Interesting stats highlighted in the SlideShare:Why should we care about Asia?

• Japan = #2 economy
• China = #1 population
• Korea = #1 digital society

Social Networking may have started in Asia before the US:

• Cyworld, sgtarted 1999
• Mixi, started 2004
• QQ, started 1997
• Facebook, 2004

Active accounts - QQ dwarfs Facebook

• Facebook - 60 mm
• Cyworld - 20 mm
• Mixi - 14 mm
• QQ - 300 mm

Reach - QQ and Facebook are roughly on par

• Facebook - 200 mm
• Cyworld - 35 mm
• Mixi - 90 mm
• QQ - 200 mm

Revenue - QQ is by far much larger than Facebook or other SNS

• Facebook - 150 mm
• Cyworld - 200 mm
• Mixi - 100 mm
• QQ - 520 MM

Operating Profit - QQ is incredibly profitable

• Facebook - (50 mm)
• cyworld - (100 mm
• Mixi - 35 mm
• QQ - 224 mm

Revenue models are similar from network to network:

• Advertising
• Digital Goods
• Targeted Ads
• Storage
• Monthly Fee
• Personalization
• Alerts

Key features in common to all social networks

• Invitation system
• Closed/Open/Semi Closed
• Sticky features
• Payment solutions
• Mobile
• Online/offline connection

UPDATE 4/11:  I posted more links on RMB appreciation on 4/11 when the RMB crossed the 7:1 mark.

caveat: another long post on RMB appreciation that will be boring for those not interested in this topic.

I posted on ways to Hedging USD-RMB risk via Exchange Traded Notes on Mar 20 and followed up with other post on RMB appreciation on Mar 30. This topic is especially important for me as our Beijing operations are all in RMB-denominated expenses and because of other potential China related investments that I’m considering.

Here are some more links on this topic, organized in this logical argument:

1. Fighting inflation is stated focus of Chinese central bank
2. However, increasing interest rates will also drive RMB appreciation
3. Increasing RMB appreciation will increase hot money inflows
4. However, business failure and unemployment will result, which will mitigate policymaker’s interest in adjusting too fast
5. The USD will of course continue to be the primary reserve currency for the foreseeable future. Nevertheless, a new reserve currency is being born in China, and individuals and companies who do business with China should treat it as such.

Fighting inflation is stated focus of Chinese central bank

On April 1, China Daily reports that the central bank monetary policy committee signaled a focus on fighting inflation. One implication of this is an increase in interest rates:

According to some experts, the notion of “stablelize expectations” implied that the central bank might raise interest rates in the near future. “Compared with issuing bank notes, or raising reserve requirement ratio, an interest rate hike is more effective in stabilizing inflation expectations,” said Guo Tianyong, director of China banking industry research centre at Central University of Finance and Economics.

Increasing interest rates would reduce the growth in domestic money supply, which should reduce demand for real goods and reduce the prices for those goods.

However, increasing interest rates will also drive RMB appreciation

Increasing interest rates not only reduces domestic money supply, but also increases the value of the RMB relative to foreign currencies. The article goes on to say:

The central bank also said that it would continue to improve the managed floating exchange rate system, and enhance the flexibility of the RMB exchange rate.

This veiled, Greenspanian policy statement seems to telegraph further appreciation, since “flexibility” can’t possibly mean depreciation from the current level given the large and increasing imbalance of foreign reserves.

Increasing RMB appreciation will increase hot money inflows

According to the blog China Stakes, China experienced the largest foreign exchange monthly increases in Januaryever:

By the end of February China’s foreign exchange reserve had reached $1.6471 trillion, while in January this number stood at 1.5898 trillion. So in January and February China’s foreign exchange reserve grew by $61.6 billion and $57.3 billion, respectively, the two largest monthly increases ever.

During the first two months in 2008, while China’s trade surplus actually slowed, foreign exchange reserves reached 2.5 times trade surplus and FDI inflow. Usually this can be interpreted as drastic hot money inflow.

A government official, speaking privately, said, “The interest rate cuts by the US Federal Reserve, which further widened the interest spread between China and the US, and RMB appreciation are new to the situation in 2008. Interest spreads and currency appreciation can bring considerable profits. I think this is an important reason for the accelerated hot money flooding.”

I confirmed the foreign exchange reserve numbers quoted by China Stakes at Forbes.com here which goes own to explain why hot money inflows drive foreign reserves up:

The reserves, the world’s largest, have ballooned because the People’s Bank of China, in order to hold down the yuan, buys most of the dollars that flow into China. The central bank then has to sterilise the impact on the money supply by mopping up the domestic currency it creates in the process. The jump in reserves will make this job harder.

However, increased business failure and unemployment may result from RMB appreciation

The countervailing factor that Chinese policy makers need to deal with is business failure and unemployment. Bill Dodson at This is China! BLOG concludes that “Times in China, They Are A Changin’” and shares a story about a friend who was doing sourcing for a European buyer with a large order:

My friend hadn’t known if they could meet those numbers, so he didn’t make any promises at the meeting. Instead, he made calls around to suppliers he knew were still in business. “More than 6,000 factories have closed just around Guangzhou,” he said. Of course, his declaration was anecdotal; but his message was clear: A LOT of factories have closed recently in the region.

China Stakes reports on China’s Textile Exports Hit Hard by the Yuan’s Appreciation. Increasing labor costs, increased RMB appreciation, and commodity price increases, have all driven production costs by 20-30%. With reduced demand caused by slowdown in the US economy, there seems like there is a perfect storm hitting Chinese textile exporters that will cause the least efficient suppliers to go out of business, throwing workers out of work in this adjustment period.

The emergence of a new reserve currency

In my earlier March 30 post about RMB appreciation I highlighted a post by Gary Smith at Seeking Alpha about a Morgan Stanley report about why the USD would continue to be a reserve currency. However, what I found interesting about the report was the comment by Stephen Jen of Morgan Stanley that “In the long run, the most likely contender to the USD as the dominant international reserve currency, in our opinion, is likely to be an Asian currency centred on the Chinese RMB.” He offers a conceptual model for understanding what a reserve currency is. For businesses with significant involvement in China, it seems that the RMB is starting to satisfy this conceptual model.

Because the Morgan Stanley website is so poorly designed, I am going to zhuanzai to post here in a big way in case the original post disappears off the Morgan Stanley website into the dark Web:

With the narrow and broad dollar indices at their record lows, investors may now wonder if the dollar will soon lose its reserve currency status. But we caution against confusing the international role of the dollar as the supreme store of value with its two other roles – as the dominant international unit of account and medium of exchange. These latter two functions of an international currency do not change abruptly and are supported by increasing returns to scale. It will take a long time to supplant the dollar as a reserve currency, though we concede that the dollar’s lead over other currencies is shrinking (see Should Asia Hold EUR Reserves, October 17, 2002).

…Essentially, there are three uses of money: (1) unit of account; (2) medium of exchange; and (3) store of value . This is what we learned in Econ 101. But in the context of international monies, we need to consider these three uses of money from the perspectives of both the official and the private sectors.

1. Unit of account. From the perspective of the official sector, a country uses an international money as a unit of international account when it pegs to such an international currency. On the other hand, from the perspective of the private sector, an international currency is used as a unit of account in cross-border trades in goods and services, as they are often priced, invoiced and settled in currencies other than those of the two trading countries (e.g., trade between Argentina and Thailand being priced in USD). (Trade between EM economies tends to be invoiced almost fully in USD or EUR. But trade between industrial and developing countries tends to be priced in the currency of the industrial country or the USD or the EUR.)

2. Medium of exchange. International monies are also held by both the official and private sectors for ‘settlement’ purposes. For the official sector, a key reason for holding a certain international currency is for intervention purposes. For countries that are pegged to a certain international currency, usually the intervention currency is the anchor currency and so, naturally, the central bank of the pegging country warehouses most of its reserves in this anchor currency. For the private sector, a certain international currency is preferred to others because exchange rates are quoted in bilateral terms and one particular bilateral exchange rate is almost always significantly more liquid than others. For example, it is cheaper to convert KRW into ZAR through the dollar. The dollar, thus, is the medium of exchange through its role as the ‘vehicle’ currency, and the private sector holds these ‘vehicle’ currencies because of their convenience of use.

3. Store of value. Preserving and enhancing the value of the reserves and private portfolios are important to the official and the private sector, which tend not to hoard international currencies that don’t hold their value over time or are volatile.

The Dollar Has Retained Some, Not All, the Qualities

Essentially, the dollar still retains its qualities in the first two uses of money – unit of account and medium of exchange – but appears to be a poor store of value. Here are some specific thoughts we have:

First, we don’t take seriously the threat that some oil exporters will soon price and invoice their exports in EUR or RUB, instead of USD. In our view, the dollar will remain the most efficient unit of account for many internationally traded commodities. Many of the key commodity exchanges are physically located in the US. It makes little sense for individual oil exporters to unilaterally change their pricing menu to any other currency. Also, pricing and invoicing oil should not materially alter what oil exporters do with the receipts, at least in the short run. Many oil exporters have most of their external debt denominated in USD, mainly because oil prices are in USD. There will, thus, be a great deal of ‘stickiness’ in currency denomination in commodities. (In general, a change in the invoicing currency for commodities will have little effect, except that the exchange rate risk to US importers will increase, while that for EMU importers will fall.) The dollar will reign as the dominant currency in trade in commodities, in our view. Also, ‘South-to-South’, i.e., EM to EM, trade will likely mostly be priced in USD. While the liquidity and reputation of many EM currencies have significantly improved in recent years, it may take many years before Korea will accept THB in its trade with Thailand. (According to Goldberg and Tille (2008), Macroeconomic Interdependence and the International Role of the Dollar, NBER 13820, 66-85% of AXJ’s exports and imports are invoiced in dollars. Roughly a third of EMU’s exports are invoiced in dollars.)

What is interesting about the first point is that for China export businesses and for services businesses to foreign companies, it seems that the unit of account that best serves the domestic China business is RMB, and that there will be increasing pressure for foreign partners to take on foreign currency risk.

Second, the dollar’s role as the medium of exchange is well preserved, in our view. More than half of the bilateral pegs in the world are still referencing the USD. While the number of pegged regimes is declining, this is due more to these countries’ need for independent monetary policies, than to the USD pegs being replaced by EUR or other pegs. Further, the dollar remains the main intervention currency even for most countries that are not pegged to the USD (e.g., Japan). As long as the dollar is still the intervention currency of choice, central banks will need to keep the bulk of their official reserves in USD.

At the same time, with the exception of the European currencies, almost all the bilateral exchange rates are priced against the dollar. As trade globalisation and financial globalisation accelerate, these USD-crosses – ‘paths of least resistance’ – should become even more efficient. The dollar, therefore, may have even enhanced its vehicle currency status, in our view. The analogy is the use of English language. One need not debate whether this is the best language in the world; the more people speak it, the more it will be used.

This second point also suggests that the lingua franca role of the dollar will continue.

However, the dollar has a major problem as a store of value. Reflecting the still-large US C/A deficit and the financial crisis in the US, the dollar has obviously become unattractive as a store of value. (Similarly, the poor economic performance of the US in the mid-1970s and late 1980s contributed to both the weakness in the dollar as well as its declining reserve currency status during those periods. However, in both cases, the dollar eventually recovered its reserve status.) The main argument for investors not to sell the dollar now is that it already appears extremely under-valued, measured by many valuation models, including our own. Having said this, however, it is important to note that these policy and macro problems can be fixed, and a flexible economy such as that of the US should be able to re-orient itself. At the same time, what is almost not reversible, in our view, is the structural improvement in the economic and institutional fundamentals of many EM countries. To some extent, the rest of the world has copied and improved upon the American model. It is now up to the US to restructure itself to compete in a more competitive world.

In summary, Stephen Jen suggests that the dollar will remain a reserve currency for some time, but will not have a monopoly position on this role. The Euro will increasingly play a role as reserve currency and countries like China and the Middle East oil producing countries are already holding reserves in a mix of Euros, Yen and Dollars.

On a personal basis, I continue to feel strongly that the Chinese RMB (even with transaction costs, convertibility issues, and politica uncertainty) is an important part of one’s personal reserve currency, which seems increasingly wise to be diversified against multiple world currencies. However, it does seem that the dollar is now undervalued relative to the Euro so I’m not jumping into selling dollars to buy Euro.