June 22, 2003

Notes: Fads and Fashions in Thought About Corporate Control

Countries studied at this conference: Canada, France, Germany, Britain, Italy, Japan, Netherlands, Sweden, United States. China, India. The first nine have all done very, very well, in spite of having substantially different systems of financial organization and corporate control. That suggests that it is unwise to claim that there is one philosopher's stone right structure for finance, and that all other financial structures are poisonous.

We have, after all, lived through a number of fads and fashions in what the "right" organization of financial systems happens to be:

  • The Japanese Model: Remember the Japanese model? The days when Japan's version of the German "universal bank" system--the keiretsu--was the clearly superior mode of financial organization and mechanism of corporate control? When it allowed for effective corporate supervision and patient capital? How the short-termism of Wall Street wsa destroying American industry?
  • The Eclipse of the Public Corporation: Remember Michael Jensen and the eclipse of the public corporation? The claim that the public corporation with diversified shareholding was an outmoded, obsolete, disfunctional form of corporate organization?
  • Takeovers as Salvation: Takeovers to keep boards and managers on their toes...
  • The Venture Capital-Fed Entrepreneurial Genius of Silicon Valley: In which we talk about how big companies can't innovate, and how American venture capitalists are the key intermediaries in promoting worldwide economic growth.
  • Triumphalist Anglo-Saxon Equity Diversification and Transparency: In which we talk about how countries that do not adopt Anglo-American-style financial markets are doomed to high costs of capital and to being shunned by worldwide investors.
  • The Post-Bubble Economy: In which we talk about how the insane gyrations of Wall Street and its overvaluation of telecom stocks forced us to waste $80 billion dollars digging holes in which to place still-unlit fiber-optic cables.

Posted by DeLong at June 22, 2003 10:38 AM | TrackBack


"In which we talk about how the insane gyrations of Wall Street and its overvaluation of telecom stocks forced us to waste $80 billion dollars digging holes in which to place still-unlit fiber-optic cables."

What an odd comment. "Forced us, forced us?" I am puzzled, WE were forced to waste $80 billion dollars digging holes? I would have thought that the coterie about WorldCom and Global Crossing and Enron [remember the fiber-optic trading], and others had a bit to do with the waste. Perhaps a bit of transparent or honest accounting would have been a help for those of us who were forced to waste $80 billion.

Funny, I was not a finagler at WorldCom or happy telecom banker Citigroup. I was not forcing Bernie and Sandy and Jackie and Kenny to waste other people's billions while pocketing theirs. Get the story right.

The forcing gyrations are evidently still revelling. Who was forcing Guidant to commit felonies by way of implanting faulty stents? Who was forcing AstraZeneca to commit a felony cancer medicine scheme [yesterday]? Shall I continue?

Get the story right.

Posted by: lise on June 22, 2003 11:05 AM

By the by, have we been paying attention to just how often health care companies in America and Europe have been involved in "scams" lately? Oh, I know, just a few points off Guidant shares, and a raft of law suits to be settled by insurance and a charge. Still, there must have been some odd lessons learned in corporate ethics classes.

Posted by: lise on June 22, 2003 11:19 AM

I well recall academic papers - and some colleagues - extolling the benefits of Japan's keiretsu model but the model was about far more than universal banking and taking a longer term view in financing investment. The keiretsu model included other fundamental features such as cross-shareholdings between keiretsu group members and partnership trading between vertical links in supply chains to reduce market risks and uncertainties and in pooling R&D.

Whatever painful outcomes have stemmed from Japan's bubble economy of the 1980s, there is little doubt that some features of the keiretsu model were hugely successful in making substantial productivity gains in some sectors, notably in auto manufacturing - hence Jones, Womack et al: The Machine That Changed the World (1990). The persistent competitive threat of Japan's exporting industries in international markets was taken sufficiently seriously in America to have prompted a series of commissions and studies, like ML Dertouzos et al: Made in America (1989), as well as technology programs, supported by Federal funds, like SEMATECH, initiated in 1987 by Caspar Weinberger, Reagan's defense secretary.

The problem economists have is in identifying which elements of the model were crucial to the outcomes beneficial to Japan, how much to Japan's notorious informal trade barriers and how much to the relaxed pressures on Japanese companies from international competition through an under-valued exchange rate sustained over long periods.

Posted by: Bob Briant on June 22, 2003 02:03 PM

Interesting comments. Would you still consider Japan's currency under-valued? Given the international industrial competitiveness of Japanese businesses, and the high rate of domestic saving, I can never decide whether the trade surplus shows the currency is under-valued.

Of course, the Japanese central bank has been buying up dollars for months to keep the currency from appreciating as the Euro has.

Posted by: jd on June 22, 2003 02:40 PM


Chinese Connection. One of the most aggressive buyers of U.S. Treasuries in recent months has been China's central bank. Data collected monthly by the U.S. Treasury can be used to derive net purchases by all Chinese investors. Over the past 12 months, Chinese net purchases totaled a record $37 billion. Over the past three months through April, they purchased a record $71 billion, at an annual rate (Figure 5). My guess is that the Chinese central bank accounts for most of these purchases. Data compiled by the International Monetary Fund show that China's international reserves excluding gold soared to a record $321 billion in March, up $90 billion from a year ago (Figure 6).

While the trade-weighted dollar is down 18% since the beginning of last year, the Chinese Renminbi remained flat relative to the dollar. Clearly, the Chinese central bank has pegged this exchange rate by aggressively buying the dollar and investing the proceeds in U.S. Treasuries. Apparently, they haven't "sterilized" this increase in their assets by selling Chinese bonds. So monetary base is growing rapidly in China and so is the M1 measure of the money supply, which rose 18.6% last year, the latest available data.

"Ed, when do you expect that the Fed's easing will boost capital spending?" This is a question I hear often from investors. My answer: "It's happening already, but mainly in China!" Of course, the Chinese are reciprocating the favor. Their central bank's actions have helped to push interest rates down in the United States. This has provided a huge boost to housing sales and to mortgage refinancing activity. We in turn buy Chinese made goods to furnish our homes.


As their economies grow and develop, an increasing share of their trade is with each other. This is gradually reducing their dependence on the U.S. export market. It's also reducing their need to hold dollar reserves -- i.e. to prop up the greenback.

Now that they’re back on their financial feet, so to speak, Asian central banks also have a choice – they can hold their wealth in their own currencies, in dollars, or in euros. (The yen may also become an option someday, if the Japanese ever extract themselves from their deflationary sinkhole.)

These kind of changes usually don't happen quickly -- at first. But the Association of Southeast Asian Nations+3 (the emerging countries of Asia, plus Japan, China and South Korea) recently recommended that its members begin issuing cross-border debt denominated in their own currencies, instead of in dollars. Sounds like an esoteric financial wiggle, right? Something you might read about in the back pages of the Financial Times.

But the implications are huge. If these countries begin to restructure their own debts into their own currencies, their central banks (and commercial banks) will have much less need to hold dollars. As Arun Motianey, director of investment research for the Citigroup Private Bank, recently pointed out, this means:

Not only would there be downward pressure on the dollar -- that is easy to predict -- but more significantly, there would also be a reduction in the appetite of foreign investors to hold dollar assets, particular dollar bonds, let alone buy much more . . . Reducing the US dollar's paramount position in international reserves would force the US into a major debt workout.

The key player here is China. For several decades, China has kept its currency, the yuan, pegged to the dollar. Because China now has the largest single current account surplus with the United States (it passed Japan about six years ago) this means China’s central bank needs to buy a lot of dollars – month in and month out -- to maintain the peg. It also means that one of the largest owners of those "custodial" accounts at the Federal Reserve, the mothership of capitalism, is Red China.

But, the domestic money creation required to buy all those dollars is beginning to create inflationary pressures in China – even as the rest of the world struggles with deflation.

The PBOC (China’s central bank) has been issuing bills to mop up the yuan it issues in exchange for the foreign-currency inflows, but Ma said this has cramped the central bank's room for monetary policy maneuvering.

"If you are forced to adjust domestic liquidity because of capital inflows under a fixed exchange rate regime, you don't have any flexibility," he said . . .

Another way out would be to slow the inflow of foreign reserves by revaluing the yuan, a policy advocated by Goldman Sachs, among others, to help ward off global deflation.

China isn’t likely to do that -- at least not in the short-term. It’s still trying to restructure its state-owned industries, and doesn’t want to increase unemployment by undercutting its own export competitiveness. But in the longer run . . .


A pullback could have disastrous effects. The biggest danger isn't that opposition abroad to a new U.S. military offensive would spark an organized campaign to dump U.S. assets. Such a possibility is remote.

The triggering event could be much more mundane: an assessment by investors abroad that the U.S. favors a sharp devaluation of the dollar to help pay off its escalating trade and budget deficits. (Heading off such a possibility is one reason President Bush keeps arguing the U.S. wants a "strong dollar," even though the U.S. isn't backing up his words with currency interventions.)

"There's no precedent for a country being the world's largest military force and the world's largest debtor," says Jeffrey Garten, dean of the Yale School of Management.

Posted by: kenny on June 22, 2003 03:06 PM


The seminar addressed the sensible hypothesis that a decline in capital flows to emerging countries tends to aggravate existing weaknesses within individual economies. The mechanics here are quite straightforward: In order to invest, emerging nations need foreign savings to supplement their own, still-meager resources. The lower the inflows from abroad, the less the potential for growth, and the poorer the outlook for creditworthiness. Moreover, in some cases, a “sudden stop” in inflows (a phrase coined by Guillermo Calvo, the highly-respected Chief Economist at the Inter-American Development Bank) can push a country into acute economic and financial distress.

Now, here is the puzzle: how does one reconcile the expectations derived from the well-documented fall in inflows with actual developments in the asset class as a whole? After all, the recent fall has been accompanied by an overall improvement in creditworthiness, a broadening in the base of EM investment grade countries, a compression in spreads, and greater institutional and retail acceptance of the asset class.1 Consistent with these factors, JP Morgan’s EM index (the EMBI-Global) returned 15% year-to-date and 22% over the 12-month period (as of May 20th). More importantly, the annualized return for the last three years (which includes Argentina’s 2001 default) amounts to 15%; the annualized five year return number (which also includes Russia’s default in 1998) is 10%.

My feeling is that the reconciliation has three inter-related dimensions. First, emerging economies have reduced their sensitivity to changes in the level of capital inflows through more aggressive “self insurance.” Second, the reduction in inflows has been influenced not just by EM-specific developments, but also by factors impacting the traditional providers of capital flows. Third, and consequently, the evolution of the capital inflow story per se is impacting more the volatility than the overall level of spreads.

Come with me as we explore these issues in more detail—issues that characterize a transition phase for capital flows to emerging markets. In the process, we will touch on the nature of capital flows (levels and changes in composition), the growing dominance of mark-to-market providers, and the manner in which many sovereign issuers have adapted their patterns of self insurance.

Posted by: kenny on June 22, 2003 03:14 PM

" * Takeovers as Salvation: Takeovers to keep boards and managers on their toes... "

I don't know about "salvation", but keeping firms open to bid on the market still looks like pretty sound policy, while protecting inept managements and underutilized resources in place doesn't -- see Japan among others, inlcuding plenty of examples here at home. I mean, that's just another form of protectionism for special interests.

" * Triumphalist Anglo-Saxon Equity Diversification and Transparency: In which we talk about how countries that do not adopt Anglo-American-style financial markets are doomed to high costs of capital and to being shunned by worldwide investors."

Considering the flow of international investment funds to this date, that's hardly been refuted. And the main problem with the Anglo-Saxon model recently seems to have been that things weren't transparent or diversified enough.

"* The Post-Bubble Economy: In which we talk about how the insane gyrations of Wall Street and its overvaluation of telecom stocks forced us to waste $80 billion dollars digging holes in which to place still-unlit fiber-optic cables."

Overvaluation was a management "fad" or "fashion"? Like people thought known overvaluation was a good thing? I don't get it.

But in any event, $80 billion of overvaluation in telecoms may look like pretty small rice cakes compared to a bust of the Japanese bond bubble. Now *there's* some overvaluation. A couple minutes use of a standard bond price calculator reveals that if "normalcy" ever does return to Japan and they get an inflation rate of just 2% their long bonds will lose about 70% of their value and their entire bond market could lose 40%. If they merely end deflation and attain 0% inflation their long bonds could lose 50% and the whole market 30%. And there is *no upside* to these things to compensate for all this risk.

This week's Economist reports that the balance sheet of the Bank of Japan itself could be impaired if interest rates go up, it now owns so many bonds. In the front-page story of today's Barron's one international investor calls Japanese bonds "the short of a generation" and while another corrects him saying they're "the short of a century".

But they did engineer this intentionally, so maybe it is a continuation of the fad of Japanese management.

Posted by: Jim Glass on June 22, 2003 04:26 PM

jd - The prima facie case for the historic under valuation of the Yen is the persistence of Japan's current account surplus, its large foreign currency reserves - second only to China's as I recall, and the huge currency realignments autumn 1985 through spring 1987, which were far greater than can be accounted for by changes in fundamentals over a period of only about 18 months.

The sources of Japan's competitive advantage in international trade have been much researched and debated in an extensive literature. Even so, the definitive causes seem to me to remain elusive and I don't believe I have any penetrating new insight to contribute. What I do think is that we cannot simply conclude the keiretsu model obviously failed as demonstrated by the stagnation of Japan's economy since 1992 - although I am willing to buy the thesis that Japan's universal banking system stoked the 1980s bubble. Depicted in a different way: there was an embedded tradition of cronyism in banking which lead to all those "non-performing assets" on bank balance sheets. Most of America's banking sector has proved to be altogether more robust despite the infamous failed S&L associations in the early 1980s. That said, the reasons for the high productivity in much of Japanese manufacturing are worth exploring and I say that without starting with any presumption favouring partnership links or cross shareholding in supply chains.

When I was looking into the auto industry more than a decade back, the leading American auto manufacturers were highly vertically integrated compared with their Japanese counterparts - recall the original vision for Ford's River Rouge Plant: iron ore in one end and autos out the other? It is therefore quite remarkable that Japanese auto manufacturers attained their reputed high productivity and quality levels, with the resulting competitive strengths in international markets, despite comparatively low vertical integration. How come when scale economies in production are supposed to be especially significant in auto manufacture? At least there is one puzzle. Another is why auto manufacturing as a mature industry was not, contrary to Raymond Vernon's product-cycle thesis, hived to industrialising countries to a far great extent than it has been.

Btw I am emphatically not arguing a case that Japan's prowess in manufacturing is due to the national industrial strategy of the Ministry of International Trade and Industry (MITI) as made popular by Chalmers Johnson. Indeed, the auto industry is a good counter example for the industry from the late 1950s fought off attempts by MITI to bring the industry within its sphere of influence.

Posted by: Bob Briant on June 22, 2003 04:36 PM

So can we read the notes?


Posted by: Vivek on June 23, 2003 12:16 AM

So can we read the notes?


Posted by: Vivek on June 23, 2003 12:16 AM

So can we read the notes?


Posted by: Vivek on June 23, 2003 12:16 AM

So can we read the notes?


Posted by: Vivek on June 23, 2003 12:16 AM

So can we read the notes?


Posted by: Vivek on June 23, 2003 12:16 AM

I disagree with your characterization of 'Takeovers as Salvation: Takeovers to keep boards and managers on their toes...' as a fad. The reality of the huge burdens of debt, the economies of scale layoffs and the obscene greenmails paid were understood to the trading and non-trading public alike. The only ones touting the pro-takeovers line were the pundits and the guilty. The pundits because of the gossipy, breathless reporting they got to do night after night, and the guilty because, well, they were guilty.

Posted by: vachon on June 23, 2003 07:57 PM
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