An explosion over the weekend killed three employees at a plant for the company that makes Apple ipods and ipads. Although this is showing up in technology trade magazines, it is also making to more general media web-sites.

The Students and Scholars Against Corporate Misbehavior (SACOM) released a 20-page report (PDF) on May 6 on working conditions in Foxconn facilities across China, including the Chengdu facility where Friday’s incident occurred.

Previously the site discussed our outsourcing of labor tragedies but it will continue to build as the ‘low price’ producers neglect worker safety if they can. We get upset about reports of slave labor making products but what if the labor is slave to a broken system?

Financial analyst presents on Yahoo TechTicker that we’re under attack from Chinese companies. Due to lax regulatory control in China and greed and fraud in the USA we’re being invaded by phoney companies through what is called a “reverse merger”. This is where a non-listed company buys a listed company on one of the USA stock exchanges. It end-runs most of the scrutiny and regulatory filings that are required when first becoming listed.

Here’s a recent list of companies that shortly after their merger, and getting the money from public investors, had significant problems:

The past two months have brought a spate of de-listings and trading halts for these companies — at least 24 according to the SEC. Forbes’ Walter Pavlo recently detailed a smattering of them:

• • China Electric Motor — Shareholders lawsuit filed claiming underwriters violated federal securities laws by issuing materially false and misleading information.
  • China Natural Gas — Class action lawsuit alleges directors and officers issued materially false and misleading statements. CFO of company resigned in late 2010.
  • Duoyuan Printing — SEC investigating company for fraud, NYSE delisted April 4, 2011
  • China MediaExpress Holdings, Inc. — Deloitte quit as auditor because “no longer able to rely on the representations of management”. CFO resigned. Stock trading halted March 11
  • China Agritech — Shareholder lawsuit pending. Dismissed its auditor Ernst & Young.
  • China Sky One Medical — Under investigation by SEC.
  • Orient Paper, Inc. — Reauditing previous financials due to license issues with previous auditor (Davis Accounting Group)

Watch the video here

or read more about this at the Reformed Broker blog where he discusses the “Red Collar” crime wave.

The headline for the AP wire story is intriguiging, watermelons uncontrollably bursting, but it points to further systemic problems to poor regulation and criminal producers driving out legal ones.

As the report mentions:

Watermelons have been bursting by the score in eastern China after farmers gave them overdoses of growth chemicals during wet weather, creating what state media called fields of “land mines.”

… the report underscores how farmers in China are abusing both legal and illegal chemicals, with many farms misusing pesticides and fertilizers. …In March last year, Chinese authorities found that “yard-long” beans from the southern city of Sanya had been treated with the banned pesticide isocarbophos.

China leadership is recognizing, even if belatedly, that it has a problem. Their local media is now allowed to cover the food problems. Be clear, there would be no local reporting if the central leadership council did not want it to happen.

Though Chinese media remain under strict government control, domestic coverage of food safety scandals has become more aggressive in recent months, an apparent sign that the government has realized it needs help policing the troubled food industry.

But, what is happening to the exploding watermelons produced with tainted chemicals and fertilizsers? They’re being fed to pigs and fish. Sounds like its still in their supply chain. What happens when food produced with illegal pesticides (and for them to be illegal in China they must be REALLY bad) make it into humans?

Economist Nouriel Roubini, who’s been nick named “Dr. Doom” – not the Marvel comics character but for his stating the obvious outcome of economic trends, recently wrote on pending problems in China. They are problems now for the world as they cause unemployment outside of China but will be bad for China in the not too distant future because of their solution. More suffering ahead.

China has grown for the last few decades on the back of export-led industrialization and a weak currency,  …

China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns,

Several Chinese policies have led to a massive transfer of income from politically weak households to politically powerful companies. A weak currency reduces household purchasing power by making imports expensive, thereby protecting import-competing SOEs and boosting exporters’ profits.

When anyone not in China reads words like these, they need to translate “boosting exporters’ profits” means “importing employment” which means “exporting unemployment”. China’s leadership, since there is no state supported safety net has to keep employment high to protect their jobs. What Roubini is pointing out, through extending the trend lines, is that the malinvestment (one of those economics terms where people do dumb things because of mis-aligned incentives) will implode. Think USA housing bubble or the dot-com investment bubble before it. Until then, we’ll have high unemployment outside of the China.

From Welling Weeden, an investment advisory service, interview with Paul McMculley Chief Economist at PIMCO. The interview is prescient in that it was done in July, 2005.

When given the statement:  “Mass production’s pointless if masses can’t buy what’s produced” he responded:

Henry Ford’s $5 a day wage was the most beautiful Keynesian thing ever invented. It was based on a very simple insight: “If the guys making these cars can’t afford to buy cars and there is limited number of rich people, how can I grow my company?”… “He set the wage not because he thought that the guys deserved the raise, but because if he didn’t give them raises, he couldn’t sell his damn cars.”

Part of the housing and debt bubbles was from China mis-pricing their currency keeping it artificially low. We are now seeing the fall-out from this trend. China’s underpriced currency allowed them to undercut manufacturers in Mexico, which undercut manufacturers in the US. With all the money received they had to recycle it. They could have recycled it into China but instead recycled into the US by buying our loans. We used the loans to buy their goods. The problem with this is that the debtor, the US, has to ‘make a profit’ at the end of the day to pay back the debt. Most of what we were making was silk purses out of sows ears (i.e., financial alchemy that turned sub-prime consumer loans into AAA-rated, almost as good as US government debt.)

The Chicago  Daily Herald is reporting on an FBI bust of a group of faked rare coins. As the report notes:

“Legitimate traders are being duped into buying these coins believing they are genuine,” said David Murphy, CBP Director of Field Operations in Chicago.

The article continues about other fake products coming in:

Since the beginning of the year, agents at O’Hare have seized more than 1,700 false drivers licenses that were shipped from China.

What’s at issue here is that we, the world, have a country – China – that doesn’t care what its businesses do to others so long as it does not harm China’s ruling party (note – its ok to fake foreign coins or driver licenses or DVD or Coach purses or Rolex watches …. but it is not ok to have open searches on the internet).

At the turn of the last century, i.e., early 1900’s, there was great press about a terrible tragedy. It was a fire at the Triangle Shirtwaist Factory in 1911. It was a sweatshop in New York city’s garment district. A fire started and when employees tried to escape many of the exits were chained shut or the fire escapes, if they existed, were dilapidated. The fire caused 146 deaths.

Why is this relevant to this blog? Although there has been very little reporting of it, see this article at the Columbia Journalism Review of how under-reported,  there was a fire at a garment plant in Bangaladesh where 29 workers died in December, 2010. The factory made clothes for the Gap, Abercrombie & Fitch, JC Penney, Target, and others. Thus it is quite possible that clothes from this factory are in your closet. Regulation in the US tightened up fire codes and worker safety here but US manufacturers can’t compete on price with countries with lax regulations. Thus, in the effort to save dollars the wholesalers and retailers have driven production to where there is the least regulation even if it causes toxic drywall, unsafe toys, or unsafe working conditions. US manufacturers can’t meet the ‘China price’ because they have to comply, rightfully IMHO, with environmental and safety conditions. This is not ‘competitive advantage’ as economists would argue but regulatory arbitrage (go to the place with the least costly regulations even if its not safe). Note too – where work was shipped to Mexico, and then China (thus the phrase ‘China price’) but now Bangaladesh and Vietnam. There is a continuous devaluing of the working environment. Think about that when you next buy a shirt.

We’ve covered this before but ProPublica has a story up on how tainted drywall from China is killing children at a Fort Bragg. See the article here but the ‘money’ quote to me is:

The federal government is woefully unequipped to help them with a product defect as expensive and widespread as this one.

Part of the reason for this blog is the systemic problems posed by globalization, specifically with China. Regulatory systems that were designed for internal production or amongst countries with like regulations and standards do not hold up to cross-border production with countries with lower standards.

Dan and Janet Tibbetts’ home in Bradenton, Fla., was built by Lennar Homes with Chinese drywall. Lennar removed the drywall, but left behind the corroded wiring beneath it. The Tibbetts now worry that the wiring is a potential fire hazard. (Photo by Brian Blanco/Special to the Herald-Tribune)

Another blog that I find to have some insightful, if counter to main stream media thinking, is Mish’s Global Economic Trend Analysis. He’s been on some of the problems in/with China and hits on one today about China’s industrial policy to steal technology (China use nicer words such as co-innovate or re-innovate with the only ‘co’ or ‘re’ being “we take your technology and use it to compete against you”.) Mish call’s this the equivalent to the TV series Star Trek ‘Borg Strategy’ – assimilate everything it encounters until it dominates.

The US Chamber of Commerce is now publishing white page reports about China’s industrial policy. This should be required reading for all, not just those in business. Anyone doing technology transfer with China should plan on having the technology appropriated. Maybe this makes sense if you’re giving them old or dated technology but if a company gives them new or state-of-the-art then they’re getting near term profits but losing the company long term. China plays a long game (remember, they now own Hong Kong). Rather than praising companies that enter China with technology, they are probably long term stock shorts.

For more on this from the Wall Street Journal, although they soft peddle the implications, see
U.S. Firms, China Are Locked in Major War Over Technology.

Bloomberg news reports on the impact to China’s Gross Domestic Product (GDP) from China’s manufacturers’  damage to the environment. Their conclusion, the damage is so great that they will have to spend up to 2% of their GDP on cleaning up the mess just to keep it from getting worse. They’ll have to spend 4% to try to get ahead of the damage they’ve already done.

China, the world’s worst polluter, needs to spend at least 2 percent of gross domestic product a year — 680 billion yuan at 2009 figures — to clean up 30 years of industrial waste, said He Ping, chairman of the Washington-based International Fund for China’s Environment. Mun Sing Ho, a senior economist at Dale W. Jorgenson Associates and a visiting scholar at Harvard University in Cambridge, Massachusetts, put the range at 2 percent to 4 percent of GDP.

Failure to spend that much — equivalent to the annual GDP of Vietnam — may cost the Chinese economy half as much again in blighted crops, health costs and pollution-related expenses, He said: “The cleanup can’t catch up with the speed of pollution” if spending is less.

China gave the world false savings in ‘cheaper’ goods because the producers did not have to pay the full cost of the damage that was being done. It wasn’t labor price advantages that took the work to China, it was not having to comply with environmental laws in place in the developed countries.

In a recent post, economist Michael Pettis takes this analysis further on the implications for China. 

This article suggests that a significant portion of Chinese growth came with a destruction of value that should have been deducted from that growth.  After all, if you create net $100 of chemicals, but in so doing you pollute a nearby river to the extent that future economic production associated with the river is reduced by $100 (there will be less fishing, perhaps, or less agricultural production, or less usable water, or more health care costs), then the net value you created is 0, not $100, although of course you as the polluter might earn $100 today while the rest of the country loses $100 over the future.

When you add the impact of misallocated investment and environmental degradation, the necessary cumulative adjustment to Chinese GDP might be huge.  For example, if the two adjustments combined range from 2 to 4 percentage points annually, over one decade China’s “true” GDP (whatever that means), would be below the official numbers by anywhere from 16-31%.  Over twenty years official GDP would be overstated by 31-52%.  That means that we are massively overstating GDP today and will experience very low apparent GDP growth for many years in the future as the official number returns to some reasonable approximation of the real number.