Pao Mo in action... why China is the "biggest opportunity we investors have ever seen," but still a beast to treat with caution... from Daily Reckoning
THE PERPETUAL CHINESE BUBBLE MACHINE
by Lynn Carpenter
The last jerk who smirked and muttered, "those inscrutable
Chinese" aloud was probably acting in a 1940s Charlie Chan
movie.
The last person who thought it was probably a reporter.
Sometime this week.
Every time you catch a bit of news on China, that
inscrutable thing seems to ooze between the words... there's that gee-whiz, tsk-tsk, head-shaking tone to it all. And often, outrage.
Among investors, one half seems to think China is easy
pickings. The other half thinks it's, well, too inscrutable to risk. Both are wrong.
Successful investors will need to understand how China
progresses. But it's not inscrutable. The Chinese do what
they do for a reason - and their reasons always make sense
in context.
Let me say it plainly. China is the biggest opportunity we
investors have ever seen. (I trust none of us is over 150
years old.) The last one that was this big and as likely to stay at the top for a long time was a young country called America.
But here's the deal: Right now, it's a bubble. Most of the
headline stocks are already priced to fall - in fact, if you can name a Chinese stock off the top of your head, you
probably shouldn't invest in it.
Americans are getting their first chance to see a Chinese
bubble up close. Most of the investors who were caught in
the 1992 and 1994 Chinese stock crashes lived in Asia, not
America. Those crashes centered on China's state-owned
enterprises.
China began listing stocks in 1990. At first, it made it
easy for state-owned enterprises (SOEs) to go public. It was much more difficult for China's newly developed private companies to get a stock listing.
But who cared? Capitalists were so starry-eyed over the
noble experiment of "Commie" groups going honest that they
bought whatever they could willy-nilly. The theory-heads
egged them on, blathering about how getting government out
of business was so right.
Unfortunately, right ideas can make wrong investments. Those who bought the rafts of new Chinese stocks bid some lousy businesses up to levels that would make a dot-com tycoon proud. With the same result.
Going forward, we have two kinds of investments coming our way now. There are still many more SOEs coming to market. In fact, until this July, the Shenzhen market had a three-year freeze on IPO's. It was only SOEs coming to market.
China still has some 30,000 to 60,000 SOEs to manage, and it would like to lift the burden of many of these from the
state's shoulders by continuing to privatize them. I would
be very cautious about investing in these without seeing
plenty of good data and a solid business plan.
Meanwhile, Chinese citizens who have started private
businesses from the ground up are eager to get their babies to market, too. They are listing in China again, as well as Hong Kong and the United States. These often make very good investments while new. But these businesses are quickly bid to the moon... you need to discover them early in the process.
Understand this: China is intent on developing strong
businesses, but it is still reluctant to let private
enterprise go ahead too rashly. The Chinese Communist Party cannot let business become so important that would threaten governmental power and control. Capitalism is a tool, not a religion here. The basic system is still socialist and will be for a long time yet.
Also, with high unemployment, a number of credit-bloated
banks, a still-rudimentary commercial banking system and
difficult tax problems, China must keep tapping the brakes
and moderate its pace. It cannot afford enough boom to court a bust. Any country would do the same if it foresaw the problem.
And every time China reins in business, trade or public
opinion, it is going to catch a blast from the media. You
better just expect it and remember that this is a process,
this getting rich thing. It is not something a country does seamlessly overnight.
Nevertheless, China's recent growth is impressive. For the
last three years, the global economy grew only 2% a
year... but China's expanded 8% a year, and should grow at
that pace for some time yet. How? The answer: exports.
China has what every country wants but not all can get:
growing exports. It took three things: a change in the
economic system with government's blessing, places and ways to make trading easier and lots of workers willing to labor cheaply. Capital and technical know-how go without saying.
The change in government had to come first. Under Deng
Xiaoping, former head of the Chinese Communist Party, China slowly turned away from Maoism and decided that "to be rich is glorious." By the way, the current head of the Party, Jiang Zemin, was Deng's chosen successor. So the trends Deng set in motion before he died in 1997 continue.
You as an investor should catch this important point about
China's fast-growing economy, though. As you know, when a
company is very small, it's easy for it to double sales.
When it sells a billion dollars worth of widgets a year and has captured the top spot in its market, it's not so easy to keep doubling.
We think of China as huge. And so it is in terms of its
size, population and world stature. But economically, in
1978 when China began to open to trade, it was very small,
given its size and resources. It is still well back of
"fully industrialized" status across the country.
China's average household income last year was $4,400.
That's low. If it were evenly spread, it would be low for
most people. But it's not. The average in the eastern cities is three times as high as in the western provinces. Plus, an estimated 150 million unemployed migrants from the poorer west have traveled east. They hover around China's great cities seeking jobs, any jobs. They work cheap.
And each time China closes down an SOE and throws it into
the private sector, people lose jobs. SOEs tend to have too many workers. That's another reason China must go slowly in privatizing. If it goes too fast, it will make
unemployment so bad it could topple the government.
Privatizing China's thousands of SOEs piled up the fuel for China's expansion. It was finding a place to trade that set it on fire.
In 1978, China decided to set up special zones within the
country to ease foreign trade and investment and allow
Chinese to develop their own businesses. The first five
special zones were created in 1980. By 1984, 14 more cities joined the list. Then in 1985, China decided to expand the network to include large swaths of the east coast and the Yellow, Yangtze and Pearl River basins.
Westerners rushed in, knowing nothing. They found that one
day, all was well. Contracts were signed, money invested.
Then, suddenly, contracts were cancelled and sunk money was lost.
That's when you started hearing the cries that China has no rule of law. It's true, strictly speaking. China follows the opposite system: the rule of men. A true system, but the two don't mesh easily.
Europe followed a rule of men for much of its history, too. Kings, queens and local nobles once had this same power system. Power was a matter of the right connections, the right alliances. In China as in an older Europe, laws may exist, but whoever is in power gets to decide how and when to apply them.
This is very important to China. A matter of dignity. It is changing, but it is still key to doing business there. With its larger role in international trade, China is accepting the role of the written contract. But other, subtler points to a rule of men persist and shape how things are done in China. Where there is a rule of men, personal relationships are extremely important.
Not all Western companies will succeed in China, and those
that do have learned how important it is to understand who
is due what. They realize that certain things are expected
in return for help... not necessarily a bribe as in other
countries, but a bit of recognition, an introduction, an
invitation, a courtesy... whatever.
The other point about a rule of men is the way it handles
change, as the people who hold power (now the Communist
party on down to any local officials) decide whether and when to enforce it. One way to creep up on change is to hold back the power. For instance, as we already saw with the currency, officials might "overlook" taking more than
allowed outside the country. That way, things can change
without declaration. If they work, progress is made and the laws may catch up later. If they don't, the law can suddenly be enforced and those in power can quite honestly claim that they never passed a bad policy and are only affirming the way things have always been.
There's more change going on in China than the popular press can even tell us. Much of it will continue to happen below the radar.
But overall, China is an extremely attractive investment
now. It has joined the World Trade Organization, and it will adopt rules and practices that foster smooth trade. Not always smoothly, but eventually. Its politics will continue to offend democratic sensibilities at times. But it desperately needs money. And that makes the long-term outlook for its development of more industry and trade is very strong.
Not long ago, half China's GDP was spent covering the debts of its inefficient and bankrupt SOEs. China can't afford to go back. But you as an investor can't afford to neglect China's history and culture, either. It will go forward in its own fashion. |
