Simon Johnson at Baseline Scenario, whose work I’ve immensely enjoyed reading over the years, posted a wonderful excerpt from his testimony before a Congressional panel about how best to put pressure on China to revalue the yuan (see Should We Fear China?).

China is the largest holder of official foreign currency reserves in the world, currently estimated to be worth around $2.4 trillion – an increase of nearly $500 billion in the course of 2009 (on the back of a current account surplus of just under $300 billion, i.e., 5.8 percent of China’s GDP, and a capital account surplus of around $100 billion).  These reserves are accumulated through arguably the largest ever sustained intervention in a foreign exchange market – i.e., through The People’s Bank of China buying dollars and selling renminbi, and thus keeping the renminbi-dollar exchange rate more depreciated than it would be otherwise.

…There is a perception that China’s large dollar holdings confer upon that country some economic or political power vis-à-vis the United States and, in particular, that Chinese reserves prevent us from putting pressure on that country’s authorities to revalue (i.e., appreciate) the renminbi.  This view is incorrect and completely misunderstands the situation.

Simon then provides some compelling evidence for why China’s reserves do not provide it much economic or political leverage vis-à-vis the United States. And because of that, he suggests that the U.S. ought to apply more pressure on China with respect to its mercantilist policies.

There is still an open question of how best to push China to revalue the renminbi.

1. Bilateral negotiations, as championed for example by former Treasury Secretary Paulson, have achieved essentially nothing since 2002.  This is not a promising way forward.

2. The International Monetary Fund (IMF) has proved itself incapable of calling China to account.  The IMF’s much vaunted “Surveillance Decision” is a failure and the general Fund mandate of “multilateral surveillance” has (again) proved to be a paper tiger.  Working with the IMF on this issue is not worth any additional effort by the US government.

He settles for what’s behind door number 3.

3. China is obviously a currency manipulator and should be so labeled by the US Treasury in its next report to Congress.  China’s threat to react by selling Treasuries is – as explained above – at worst a bluff and at best a way to help the US with a depreciation of the dollar.  This bluff should be called.

I largely agree with Simon’s points. China’s posturing with respect to the dollar is largely a bluff. It is obviously not in China’s best interest to sell, or diversify out of, its dollar holdings. Moreover, even if it were to spite itself and follow through on such a plan, it’s not entirely clear that would be such a bad thing for the U.S.

That said however, it’s still unclear to me why China might be willing to reconsider its policy and revalue the yuan. For example, Simon writes:

It is in the interests of both the United States and global economic prosperity that China discontinues its massive intervention in the market for renminbi.

Although I agree that it is in the best long-term interest of the U.S. and other countries throughout the globe for China to revalue its currency, it isn’t entirely clear to me that such a maneuver is in the  near-term interests of China, …or maybe even the global economy.

Think about the short-term shock to the Chinese economy, which depends upon exports for a good portion of its GDP. By many accounts, exports make up some 25% of Chinese GDP. A revaluation of the yuan makes Chinese exports relatively more expensive thereby decreasing foreign demand for Chinese-made goods. This negatively impacts local production and creates a feedback loop through to domestic employment and wages. In the extreme, this threatens social stability, and China is certainly not the poster-child for social stability.

Not only that, but given the foreign interests and investments in China, it is not entirely clear to me that a yuan revaluation that catapults China into recession would not result in a global contagion effect. Supply chains are so interconnected around the globe that an upward price movement for intermediate and finished goods coming out of China could have dire consequences for Western companies that rely on Chinese-sourced goods (just ask Wal*Mart).

So although I agree in principle with Simon’s points, the Chinese government (and by extension, the global economy) finds itself between a rock and a hard place when it comes to the revaluation of the yuan. A sudden revaluation to competitive levels could come with socially and economically undesirable near-term adjustments. I therefore think it’s best we proceed with caution…

For those of you following GM developments, it appears that the sale of Saab to Spyker has now closed (see Spyker Closes Purchase of Saab).

Spyker Cars of the Netherlands closed a deal to buy Saab from General Motors for cash and shares worth $400m, saving the Swedish car brand from closure and ending a sale that has dragged on for more than a year.

Saab said on Tuesday it had exited liquidation proceedings, and that control of the brand had been returned to Jan Ake Jonsson, its chief executive. The carmaker had been in administration since February 2009, when GM said it planned to sell or wind it down as it prepared to file for bankruptcy protection in the U.S.

The deal…will save 3,400 jobs at Saab’s operations in Sweden and more at its 1,100 dealers. Saab and Spyker will now operate as sister companies under the umbrella of Euronext-listed Spyker Cars NV.

In other GM news, the agreed upon deal to sell Hummer to Sichuan Tengzhong Heavy Industrial Machines of China has fallen through (see GM to Close Hummer After Sale Fails).

General Motors said on Wednesday that it would shut down Hummer, the brand of big sport utility vehicles that became synonymous with the term gas guzzler, after a deal to sell it to a Chinese manufacturer fell apart.

The buyer, Sichuan Tengzhong Heavy Industrial Machines, said in a statement that it had withdrawn its bid because it was unable to receive approval from the Chinese government…

Tight financial markets also hurt the deal. When the commerce ministry did not bless the transaction, the well-capitalized Chinese banks became reluctant to lend money…

Interesting. Although Saab is certainly the more promising of the two GM castoffs, if you would have told me as little as six months ago that the Saab deal would close and the Hummer deal would collapse, I would probably have laughed it off as the low probability outcome.

GM was having real difficulty finding a buyer for Saab. The process was fraught with several starts and stops, included various “interested” buyers (e.g., Koenigsegg, Spyker), had the on-again/off-again support of the Swedish government, and survived the collapse of several negotiated agreements.

By contrast, the deal with Sichuan Tengzhong seemed swift and sound. I did not foresee cause for concern, even with the regulatory delay. And given the Chinese appetite for Western assets (see Chinese Acquisitions in the Auto Industry) and the government’s easy money policies (especially in housing, see Is China a Bubble Economy?), the deal looked like a pretty sure bet.

I can’t help but wonder then about the broader implication of “well-capitalized Chinese banks” becoming “reluctant to lend money”…

The Economist recently summarized an interesting a study co-authored by James Westphal (Michigan) and Melissa Graebner (Texas) that appeared in the Academy of Management Journal (for the Economist summary click How Firms Fool Equity Analysts, for information about the full research article visit the AMJ website). According to the Economist:

How do you pump up the value of your company in these difficult times? One tried and tested way is to hoodwink equity analysts, according to a new study of 1,300 corporate bosses, board directors and analysts.

The authors found that chief executives commonly respond to negative appraisals from Wall Street by managing appearances, rather than making changes that actually improve corporate governance: boards are made more formally independent, but without actually increasing their ability to control management. This is typically done by hiring directors who, although they may have no business ties to the company, are socially close to its top brass.

The tactic pays off with appreciably higher ratings. At firms that make a strenuous effort to persuade analysts that such board changes have boosted independence, and thus made management more accountable, the likelihood of a subsequent stock upgrade rises by 36%, the study concluded. The chance of a downgrade, meanwhile, falls by 45%.

In Governance modules of Corporate Strategy, it is important to stress the difference between inside/outside directors and independent/non-independent directors. The take-away: OUTSIDE ≠ INDEPENDENT. They are not mutually inclusive. Unfortunately in practice, it seems that analysts don’t treat them accordingly.

A friend and colleague from Oxford (Mike Barnett, Director of the Saïd Business School Center for Corporate Reputation) sent me a brief Op Ed he penned about the challenges Toyota faces in preserving its reputation for quality (see Toyota Can Still Save Reputation). Mike writes:

A good reputation is a dangerous thing.  If no one thinks highly of you, and you do something bad, it makes little difference. You have nothing to lose: but if you are standing high on a pedestal and you do something bad, causing you to wobble and waver, you have a long way to fall.

Toyota was high on a pedestal, reputed for its superior quality, and then life-threatening defects captured media attention.  How far will Toyota fall?  It depends upon how quickly Toyota can capture the conversation.

To stop its descent and recover its reputation, Toyota must give people something positive to talk about.  Errors are inevitable, especially in something as complex as automobiles; recalls are a regular feature.  It is the hesitance and delay in initiating a recall, not the recall itself, which has made this into a bigger reputation destroyer than it might have been otherwise.

Toyota has an opportunity to show that, even though it may sometimes mess up, it will always make good.  This will turn the conversation to, “Hey, even when Toyota hits a bump, it is always looking out for the customers’ welfare”, and away from “Toyota screwed up and won’t admit it, so I can’t trust them”.   Do this, and the public is quick to forgive, or at least forget.  Where Toyota does not want to get bogged down is in publicly battling over fault with its sticky pedal supplier.  Avoid the Ford-Firestone trap, as the conversation will continue to drag on in the negative.

Interesting. And some wise advice.

Toyota is taking some well-deserved heat for its delay in issuing a recall in the face of evidence that problems existed with its accelerators. In fact, Toyota long maintained that there was nothing wrong with its accelerators. At first it cited driver error, until the evidence suggested that there could not possibly be so many horrible drivers. Then they shifted the blame to faulty floor mats. Strike two.

At this point, Toyota would be wise to issue (and reiterate) mea culpas. Toyota cannot apologize too much. It should then, as Mike Barnett suggests, handle the situation in an honest and transparent way – keeping the public apprised on an almost daily basis. And once it identifies the defect, claiming that a solution has been found is not enough. The problem (and its solution) must be described in detail, and in a way that customers can understand. They need to detail what happened, and why. They then need to describe how their fix remedies the problem in a non-technical way.

Halting production until they find a solution is certainly a good (however costly) first step; but along the way, Toyota ultimately needs to redeem itself in the eyes of the consumer. It is important for Toyota to understand that how it bounces back is not simply a function of how quickly it can find a fix, but also in how quickly it can win back the public trust.

There was a fascinating read in the New York Times last week about Microsoft’s lack of innovativeness (see Microsoft’s Creative Destruction, ht Sean). Interestingly, Dick Brass, the author of the piece, and a former Microsoft employee, does not attribute Microsoft’s technological tribulations to a lack of talent on staff or a dearth of ideas. Although there have been some high-profile exits, he argues that the pool of talent at Microsoft is on par with that of the broader tech community, and that there have been some ground-breaking technologies developed within Microsoft. The problem is that many of the innovations never see the light of day. This is because, according to Brass, Microsoft has a corporate culture that breeds internal turf battles that quash innovation.

AS they marvel at Apple’s new iPad tablet computer, the technorati seem to be focusing on where this leaves Amazon’s popular e-book business. But the much more important question is why Microsoft, America’s most famous and prosperous technology company, no longer brings us the future, whether it’s tablet computers like the iPad, e-books like Amazon’s Kindle, smartphones like the BlackBerry and iPhone, search engines like Google, digital music systems like iPod and iTunes or popular Web services like Facebook and Twitter.

It [Microsoft] employs thousands of the smartest, most capable engineers in the world…And yet it is failing, even as it reports record earnings.

Microsoft has become a clumsy, uncompetitive innovator. Its products are lampooned, often unfairly but sometimes with good reason.

What happened? Unlike other companies, Microsoft never developed a true system for innovation. Some of my former colleagues argue that it actually developed a system to thwart innovation.

Full disclosure: I have never worked for Microsoft, so I cannot verify whether Dick’s story is reflective of Microsoft’s reality. However, this outcome is not uncommon to large, bureaucratic organizations, …especially monopolists.

Anyhow, I’ve provided the teaser. I encourage you to read the article in its entirety. Fascinating stuff!!

If the accounts I’ve been reading are true (see Growing Prospects for Bailout for Greece), Greece might be the beneficiary of an imminent bailout. As reported by Bloomberg:

Olli Rehn, who takes over as European Union economic affairs commissioner tomorrow, said support for Greece will be discussed in coming days. Michael Meister, a German legislator from Chancellor Angela Merkel’s Christian Democrats, said lawmakers in that country are considering financial assistance.

The EU (in particular France and Germany) ought to be very careful in how it approaches the bailout so as to prevent moral hazard. And in this case I am not referring to moral hazard in the sense that the bailout provides Greece an incentive to behave badly again in the future, but moral hazard in the sense that Portugal, Ireland (maybe Italy too), and Spain now have the incentive to continue to behave badly. After all, if France and Germany come to the rescue of Greece, it sends a signal to other fiscally troubled European nations that they are likely to receive similar treatment, …and especially for the more consequential economies of Spain and Italy (see Euro Perspective).

If the EU comes to the aid of Greece, what incentive does Spain, Portugal, Italy, or Ireland have to bring their fiscal house in order. In fact, what’s to prevent them from going on a bigger fiscal bender? For after all, although Greece represents only a small fraction of European GDP, allowing Spain and Italy to falter could be disastrous for the Union.

The New York Times ran a feature article on Sunday about China’s dominance of the alternative/clean energy space (see China Leading the Race to Make Clean Energy). Although the author points to some interesting stylized facts, not one suggests cause for concern.

China vaulted past competitors in Denmark, Germany, Spain and the United States last year to become the world’s largest maker of wind turbines, and is poised to expand even further this year.

MY COMMENT: So what? Does this make them the technological leaders in that space? No! Why? Because most of the technological advances in alternative energy (the knowledge creation portion of the value chain) are a product of the West – Europe and the U.S., …and to a lesser extent Japan and Korea.

China has also leapfrogged the West in the last two years to emerge as the world’s largest manufacturer of solar panels.

MY COMMENT: Again, why is this a bad thing? See above.

President Obama, in his State of the Union speech last week, sounded an alarm that the United States was falling behind other countries, especially China, on energy. “I do not accept a future where the jobs and industries of tomorrow take root beyond our borders — and I know you don’t either,” he told Congress.

These efforts to dominate renewable energy technologies raise the prospect that the West may someday trade its dependence on oil from the Mideast for a reliance on solar panels, wind turbines and other gear manufactured in China.

MY COMMENT: Nonsense. To the extent that China is reliant on the knowledge/technology developed in the West to manufacture equipment, it’s good for both sides. Western alternative energy firms have a market in which to sell their valuable knowledge and Chinese producers have a market to sell the output from the factories that use those productive knowledge inputs. This is how international trade works. In fact, without demand from the Chinese market, development costs for firms in the West would be much, much higher. This allows our alternative energy firms not only to prosper, but to create jobs in the nascent sector.

So although the title of the Times article is appropriate – China certainly is “making” more clean energy in the manufacturing sense, the West is specializing in the higher value-added, higher margin, higher growth activities (see Globalization Discontents and Globalization Revisited). I don’t know about you, but I’ll take the latter.