Communists Invade Private Equity

The Daily Reckoning PRESENTS: High and low, Chinese and foreign devil, Ashkenazim and goyim…everyone now expects to get into heaven without ever dying…and to be the one sucker in history to get a better-than-even break. Bill Bonner explains…


“The beginning of a dark age devoted to barbaric affluence…”
– Michael Oakeshott

Last week, the People’s Bank of the People’s Republic of China told the Chinese people that thenceforth it wouldn’t be quite so free and easy with The People’s money. Having previously told the people that it was glorious to get rich, they might have warned the people that getting rich without working is not always as easy as it looks. But they let the opportunity pass without mentioning it.

The Middle Kingdom is an old place. But it is fairly new to the ways of modern market capitalism. In fact, the ways of modern market capitalism, circa 2007, are new to us all. No man alive has ever seen quite this level of happy delirium.

Still, the Chinese – who have never seen a market crash up close…or even a real bear market…or an economic depression that wasn’t caused by their own politicians – are especially guileless…and easy marks. The whole country bustles with the hope of easy money. Widows and orphans line up at brokerage accounts to open day-trading accounts – 300,000 new accounts are opened every day. Though Shanghai stocks are up 180% in the last 19 months, they’re still buying. Trading volume was recently clocked at 10 times the rate of six months ago. And Mr. Hua, quoted above, expects nearly 50% gains per year from his stock account!

When the announcement of tighter bank reserve requirements came out, the people greeted it with alarm. Chinese stocks sold off. Then, a few days later, investors recovered from their brush with sanity and bid up stocks to a new record high. Asia’s richest and shrewdest investor Li Ka-shing concludes: “[this] must be a bubble.”

“We have actually now bubbles everywhere,” Marc Faber, who oversees $300 million in assets at Marc Faber Ltd., told Bloomberg News in Zurich on May 21. “We have bubbles in real estate, in equities, in bonds, in commodities, in art prices and totally useless collectibles. So, this bubble is huge and includes just about any asset in the world.”

High and low, Chinese and foreign devil, Ashkenazim and goyim…everyone now expects to get into heaven without ever dying…and to be the one sucker in history to get a better-than-even break.

Let The People have their illusions. The Chinese leadership has a folly of its own. China is buying a giant piece of a giant bubble, shares in the private equity giant, Blackstone.

Blackstone is in the business of making deals, and clearly has the wind at its back. The lenders from whom it borrows, and the public from whom it buys and to whom it sells, act more like patsies than counterparties. Japan and Switzerland lend at almost zero interest. And then investors, from whom Blackstone presumably bought an asset at a bargain price, take it back, after Blackstone has worked its magic, at top dollar.

And the deals are coming fast and furious. In the United States, new securities issues increased 13% in the first quarter – led by Mergers and Acquisitions, which were up 23.6% from the same period the year before. Total equity underwriting rose 42.6% over the first quarter of 2006.

And now, here comes the investor with the largest cash pile in the entire world – China – into the private equity market.

And here we pause to draw breath. We have before us a group of unreformed Marxists buying shares in what must be capitalism’s most capitalistic institution. “What does it mean?” we are tempted to ask. We don’t know, but we think we hear the deep laugh of the gods, who appreciate irony more than slapstick.

“The capitalists will sell us the rope we use to hang them,” predicted Lenin. But it isn’t that simple. Instead, the Chinese sold the rest of the world – particularly Americans – glass thingamajigs and plastic gew-gaws, taking America’s paper money in exchange. Now, the government of Mao and Zhou and Deng has about $1 trillion on hand. What can it do with that kind of pile? Forget flea markets and holiday sales. This is enough to buy a controlling interest in all 30 of the Dow Jones Industrials. A little over ten years ago, it would have bought the entire Dow, lock, stock and barrel, with change left over.

The Chinese are not dopes. They’ve had their long spell of political madness. They’ve turned their interest to money and now they’re going a little mad there too. So, they are not buying rope…but assets. The communists won’t hang the capitalists at all. They will merely replace them, becoming rentiers themselves, by giving back their dollars in payment for America’s remaining factories, brands, resources, and companies. And then, maybe the new owners will let us shine their shoes and do their laundry.

But even more interesting than the practical effects of this move is the theory behind it. Democracy, Communism, and Modern Portfolio Theory all rest on the same claptrap – that The People are geniuses and saints. All the theories agree – there is no higher source of wisdom, virtue, or pricing than the will of the heaving masses. If the voters want to do something foolish, who can tell them not to? And if stock buyers put a price of $40 on Blackstone shares, no other price really counts.

What is remarkable is that every punter knows it’s not true. Every one of them tries to make money by taking advantage of the masses’ imbecilities. An investor buys a stock like he takes a homely mistress, believing he sees something in her that the rest have missed. Every bet he makes says: “I’m smarter than the whole lot of you.”

Blackstone’s business, too, rests on the presumption that The People have erred. The company pretends to ‘add value’ by finding a company that the people have mispriced. Blackstone buys it, then reorganizes it, borrows against it, and pays itself millions in fees. After this shake up, when the company finally comes to rest in the peoples’ own brokerage accounts again, it is presumed to be a more valuable enterprise.

But is there any asset or investor left on this whole planet that has not already been shaken up…and now trembles with money lust? Is there a single fragile leaf left anywhere on this sorry ball that does not flutter in the hopes of turning to gold?

“Those who in the Elysian fields would dwell

Do but extend the boundaries of hell.”

That is Oakeshott too.

Bill Bonner
The Daily Reckoning
May 25, 2007

Editor’s Note: Don’t forget – you can hear Bill (along with all of your favorite DR editors) speak at this year’s Agora Financial Investment Symposium in Vancouver, British Columbia. This year’s theme is “Rim of Fire: Crisis & Opportunity in the New Asian Era” – and it’s your first look at investment opportunities, global market concerns, and the best investment bets across the globe.

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount – just click on the link below:

Empire of Debt

Yesterday brought news that the Americans were on a house-buying spree in April…with the biggest surge in 14 years. What caused so much house-shopping? Analysts were quick to explain it – the biggest decline in prices since 1970.

The biggest decline in 37 years sounds impressive. But reading on we discover that the median house is only down a couple percentage points from its all-time high. Not exactly a “Going out of Business Sale.” You wouldn’t think a 2% discount would bring out so many buyers.

Someone ought to talk to the buyers:

“Hey…don’t you know that houses are still near an all-time high? Don’t you realize that if the housing follows typical market patterns, your house will lose 30% to 50% of its value in real terms over the next 10 years?”

If you wanted to be very conservative about it you could mention yesterday’s prediction from the chief economist at S&P, who said he expected an 8% drop in house prices in ’07 and ’08.

“Where have you been, pal?” comes the answer. “My house doubled in price in the last five years. Sure, it’s a little slow now, but everyone knows you can’t go wrong in real estate. They’re not making any more of it.”

No point in trying to argue with him…but we will try to nudge him in this direction.

In China, we are told, a new government agency, the State Foreign Exchange Investment Company, could, “effectively create the world’s largest hedge fund.” What does that mean? It means that the Chinese fund’s investment of billions of dollars in the financial markets could send the asset boom booming even more.

And also from China, comes a report on how the Chinese reacted to former Fed chief Greenspan’s prediction that they were headed for a “dramatic correction.”

“Ignoring warnings,” says the headline, “Chinese rush into stocks.”

Not all the Chinese are flush with cash, of course. But just as being broke and unemployed is no barrier to home ownership in America, having no money doesn’t keep the Chinese out of the stock market.

Reuters reports:

“Chinese banks are prohibited from lending money to buy equities, but there are big loopholes.

“Some big banks have signed pacts with state-owned companies enabling staff with secure jobs to take out unsecured loans of as much as 200,000 yuan ($26,300) for up to a year, bankers said.

“Hua Chao works for one such firm. He borrowed 150,000 yuan from a bank last week and quickly moved it into his brokerage account.

“‘I only need to pay 9,000 yuan interest for the loan I got, but I think I can make at least 70,000 yuan a year by investing that money in stocks,’ Hua, an office worker, said.”

Hua..hua…hua…we cannot speak Chinese, but we can laugh in any language. What a poor naïf…he thinks he’s going to make almost 50% annual gains on his stocks. Someone should set him straight.

“Hua…Hua,” you might begin.

“What you laughing at?”

“I’m not laughing, I’m just getting your attention.”

“Then, what so funny?”

“You are, you silly turnip. Don’t you know that the best you can hope for in a balanced portfolio is real gains of about 3% to 7% per year?”

“Are you kidding me? Last year, China’s stock market went up 100%. It’s already up 70% this year. You Americans are stupid. You’re yesterday’s news. You’re has-beens. You’re just jealous because the Chinese economy is growing four times as fast as the U.S. economy. And the Chinese have money. We have 1 trillion dollars. Now we don’t have to fight America. We can buy it.”

Alan Greenspan is (for once) right! And who cares? The Dow sold off only 84 points…even after the world’s most famous economist came out publicly and said that it’s most go-go market was headed for a crash.

You can never know the future, dear reader. But there is nothing in the future that is not, somehow, prefigured in the past. You can trace every oak tree back to a sapling…and back to an acorn. Every big galout you see on the street began life as a tiny baby. And every market trend has a beginning and an end.

There’s no magic…no real science…and no guarantees, but if you look hard enough you can sometimes see where you are in the cycle of things.

In markets we have two clues – the two P’s. Prices and Psyches. As to prices, we decipher them by looking at how much revenue a given investment will produce. Generally, at major bottoms, you can buy an asset for 5 to 10 times what it will return each year. At major tops, on the other hand, you’ll have to pay over 20 times annual earnings.

At bottoms, people are sure that prices are still too high…and that they’re coming down more any minute. Later, after prices have run up a bit, they become more confident. Eventually, they fully commit themselves at much higher prices and are sure they will never come down.

One both scores – prices and popular psychology – markets worldwide appear to be much closer to a major market top than a major market bottom.

So, we’ll hoist our old, tattered Crash Alert flag again this morning.

More news:


Addison Wiggin, reporting from Baltimore…

“The solar energy industry is now worth over $15 billion. And it’s growing 40% annually.

“‘Public concern over global warming, the environment, and rising electric bills,’ reports Fast Company magazine, ‘as well as government tax credits and better technology are projected to drive that market as high as $75 billion by 2010.’

“‘There really isn’t a national brand,’ gushed Elon Musk, the former chief of the online payment service PayPal. ‘So there’s a tremendous opportunity. This is bigger than the Internet.’

“Hmnn… we like alternative energies as much as the next guy. But can you say ‘speculative bubble’?”

For the rest of this story, and to find out how to clean ‘filthy food’…and more, see today’s issue of The 5 Min. Forecast


And more views:

*** “This is the stupidest American administration in history,” says an old British diplomat, sotto voce. “Stupider than the Nixon crowd?” someone asked. “Stupider than the Carter administration?” asked another voice.

“I’ve worked with them all. This is by far the dumbest bunch ever in Washington.”

Stupidity in Washington must hard to measure. As in the sewers of the nation’s capital, there is plenty of awful stuff floating around, but it doesn’t stay in one place long enough to size it up accurately; instead, it ebbs and flows.

Poor George W. has grabbed ahold of a something and he can’t let go of it. Everywhere he goes, people point and whisper – there’s the idiot that got us into Iraq. Even if his team had a good idea or two – not that we’ve heard any – on any other issues, the Iraq war gets in the way.

Bush’s popularity has fallen to a level not seen since 1979. Then, Jimmy Carter was the unpopular president. Now, Carter has some choice words for Bush 43:

“I think as far as the adverse impact on the nation around the world, this administration has been the worst in history,” Carter told the Arkansas Democrat-Gazette in a story that appeared in the newspaper’s Saturday editions. “The overt reversal of America’s basic values as expressed by previous administrations, including those of George H.W. Bush and Ronald Reagan and Richard Nixon and others, has been the most disturbing to me.”

In retrospect, Carter was not so bad. He got us into no disastrous wars. He launched no major, costly programs that we can remember. He did his job…and left when his time was up.

*** Asia may be growing like a weed, but at least America still has a lead against its closest competitors in Europe, right? The old world is a rigid, socialized, slow, expensive, dull, snobby museum, right?

But what’s this? For the first time in six years, says the OECD, Europe will grow faster than the United States. Last year, U.S. GDP grew at a 3.3% rate. OECD economists say it will do only about 2.1% this year – thanks largely to the slow-down in housing. Europe is expected to grow by 2.7% this year.

Usually, American GDP grows faster than Europe simply because the U.S. population is increasing more rapidly. Many countries in Europe have little – or even negative – population growth. So, a slower rate of GDP growth in Europe still could represent a higher rate of individual wealth gains.

Another thing to remember is that European growth seems to be healthier growth. Industries expand, wages go up, people make money. Automobiles from Germany, perfumes from France, chocolates from Belgium, handbags from Italy – Europe has well-established brands that give it a positive balance of trade with the rest of the world.

American growth, by contrast, has largely been a consequence of consumer spending…and the money consumers have been spending has often been borrowed – from overseas. Each year, Americans go further and further into debt in order to keep their economy growing.

The real, net effect of these trends is hard to gauge. Our guess is that Europeans are steadily getting richer compared to Americans.

*** Meanwhile, the rich from all over the world are boarding trains, planes and automobiles to Europe. Some come as tourists. But many come to live. They buy houses in London…or villas on the Cote d’Azur. The International Herald Tribune tells us that prices where F. Scott Fitzgerald used to hang out have been going up by about 15% per year…from Menton to Saint Tropez.

One of the most desirable locations is St. Jean-Cap-Ferrat, where you should “expect to pay $30 million or more for a decent property,” according to a real estate agent.

If that’s too much, you can go up into the hills, where you can get a villa for as little as $1.3 million.

*** On the same page of the IHT we are given an opportunity to buy a “tropical lifestyle” on the island of Mauritius! “Elegant, plantation-style villas” are for sale for $800,000 to $2 million.

Yes, dear reader, all over the world, the rich are splashing out. Warhol’s can of Campbell’s soup sold for $5.5 million. Houses in the middle of nowhere sell for millions. What next?

*** No sooner had we posed the question than the answer came to us. Marxist theory tells us that capitalism is eventually undone by its own ‘contradictions.’ Of course, it’s all hooey. But we recalled it when we read in today’s news that Goldman Sachs (NYSE:GS), one of the sparkliest crowns of capitalist creation, is now introducing a new market – in private equity.

Huh? Yes, we asked the same question. How can you have a public market in private equity? We don’t know, but the Wall Street Journal reports that Goldman has introduced the GSTRuE – a market where investors will be able to buy and sell stocks that aren’t public.

Round and round the wheel-a-deal turns. Buy, sell, take it public, take it private, take it public again! Oh what a wheel of fortune! Whee!

*** This just in: A Doll’s House

Bellingham, Washington was locked down after a woman spotted a man carrying a plastic leg into a hospital. She thought some evil was…er…afoot.

The Associated Press reports:

“Police barricaded streets near a branch of St. Joseph Hospital after that woman called to report a man with an assault rifle walking into a medical office building. The assault rifle turned out to be a prosthetic leg, Bellingham Police Deputy Chief David Doll said. Police searched the building floor by floor.

“When no suspect was found, police evacuated the building and the woman who reported the incident spotted the office worker who had carried the leg, The Bellingham Herald reported. ‘Everyone did everything right,’ Doll said. ‘Like we hoped, it turned out to be a good situation today.’ The scare brought a response from several agencies, including the Whatcom County Sheriff’s Office, Western Washington University Police and Washington State Patrol. A U.S. Customs and Border Protection helicopter patrolled the area to check the building’s roof.”