|
Getting Rich Is Glorious
by: Jim Trippon
Nearly
three decades ago Chinese premier Deng Xiaoping lit the fuse,
touching off the biggest economic explosion of our times with
four revolutionary words: "Getting rich is glorious!"
Deng
made his unprecedented policy statement while initiating historic
capitalist reforms, loosening central control of the Chinese
economy, and weakening the monopoly of the public sector.
At Deng's command the entire nation, still stagnating under
a centrally planned Marxist economic system, jumped headlong
into the capitalist race.
Walk
the streets of Shanghai today and you will see a new China
- a China that even Deng wouldn't recognize. During my most
recent visit to China, I couldn't help marveling at the dramatic
changes engulfing every city.
Once
China was considered a backward third-world nation. Now it
is paying the price of its own economic success. As skyscrapers
and cranes fill the air, traffic is filling the streets and
highways. Pollution, progress and rising energy prices signal
China's entry into the league of major industrialized nations.
The
new China is far from perfect, but it is an economic miracle.
It is already common knowledge that China's economy is the fastest growing in
the world. Previous measurements by a diverse range of experts
reported that the Chinese economy was expanding at a phenomenal
rate of approximately nine percent every year for the past
two decades. But some economists have argued that the Chinese
economy has really been growing much more aggressively. These
analysts have consistently estimated an economic growth rate
of more than eleven percent.
The
shape of the world economy is changing so quickly that it
will soon be unrecognizable to those who are not following
the China story. If we extrapolate the new picture of China's
economic growth into 2006, we expect that China will emerge
this year in the undisputed number four position as the world's
fourth largest economy! It will surpass the United Kingdom
in size, leaving only Germany, Japan and the U.S. greater
than China in terms of GDP. (In fact, China has already surpassed
the UK in terms of exports to the United States).
China
still has a long way to go before it eclipses the United States'
economy, which had a GDP of $11.7 trillion last year. But
the day is coming. There are now predictions that China will
overtake the U.S. in 2035, five years earlier than previously
expected.
The
World Bank has another way of measuring economic scale, the
"PPP" method: Purchasing Power Parity. In terms of total purchasing
power, the Chinese economy is now the second largest on the
planet, once again following only the United States.
What
does all this mean to investors? Cynics and pessimists will
point out that China's economic output per person is little
more than $1,700. In terms of income per person, China was
ranked 134th in the world in 2003 according to the World Bank.
This is a classic question of the pessimist seeing the glass
as half empty and the optimist seeing the glass as half full.
We see the glass as half full, not so much because we are
optimists, but because we are investors.
We
care about participating in a major growth event. We also
care about diversifying our holdings at a time when the U.S.
economy is feeling the strain of high deficits, trade imbalances,
currency devaluation and inflation. Despite its phenomenal
growth, the Chinese economy has avoided inflationary eruptions
and major investment bubbles. However, investing in China
means accepting volatility along with participation in an
unprecedented global growth story.
The
nation's vice-finance minister, Li Yong, says the country's
economy is set to beat the government's own forecasts by a
substantial margin. Li says the economy is on track to reach
9.5% growth this year. That is a remarkable 1.5% increase
over the government's previous 8% prediction.
How
large an increase is this1.5%? The CIA estimates that China's
GDP reached $8,182,000,000,000 last year. If the finance ministry
is correct, China will generate an increase of approximately
$160 billion above targeted growth this year. Indeed, some
developed European economies only manage to grow by 1.5% in
a good year.
Add
to this growth estimate a correction about Chinese stock market
in the first quarter of 2006. New calculations indicate that
the economy grew by 10.3% on an annualized basis during the
first three months of the year.
Is
it too much? The Finance Ministry says it may opt for a second
round of interest rate increases in China this year in order
to bring growth under control. Another quarter percent rate
increase within China is nothing for investors to fear. It
is a sign of responsibility from a government that is under
enormous pressure to encourage growth with all possible speed.
The
government has set a goal to lift hundreds of millions of
citizens who remain in poverty to a decent standard of living.
But throwing the gates open to unlimited growth would invite
severe inflation. Part of the Chinese economic miracle is
the nation's ability to maintain very rapid growth for two
decades without falling victim to hyperinflation.
Although
China is still regarded by many as a lumbering, bureaucratic
giant, it is truly a nation being transformed from within.
Recently the International Institute for Management Development
based in Lausanne, Switzerland issued the latest issue of
the World Competitiveness Yearbook. The surprise of the year
was China.
Last
year, China ranked 31st in competitiveness among the largest
60 economies in the world. This year, the nation's economy
has risen to number 19, a remarkable achievement for a country
still throwing off the legacy of a centrally planned, Marxist
economic model. Government efficiency has been ranked, amazingly,
as 17th among world economies. This puts China far ahead of
Korea which ranked 38th.
Macroeconomic
regulation (such as government controls to prevent severe
inflation) have been credited with building a solid basis
for a strong, efficient economy. But the scrapping of excessive
government control has been equally important to economic
efficiency. Thousands of useless and counterproductive rules
left over from the days of central planning have been jettisoned
for good.
The
Chinese
economy still faces challenges. It must shift from a growth
model driven by very high investment levels to a demand-driven
model. In other words, the Chinese must become consumers of
their own products. They must learn to spend and borrow wisely
rather than socking away trillions in unproductive bank deposits.
China
must also become less reliant on U.S. consumption. As the
value of the American dollar continues to plummet relative
to the currencies of other developed nations, the pressure
will increase to free the Chinese currency from its peg to
the dollar. Floating the renminbi (or yuan) may cause some
disruptions, but currency reform is inevitable. (The U.S.
gave China some maneuvering room when the Commerce Department
refused to label China a "currency manipulator" on May 11th
of this year.)
Unfortunately,
rapid growth often goes hand-in-hand with volatility. A number
of indicators show that Chinese
stocks as a group (GRAPH HSX INDEX?) gave up many of their
gains from January of this year during the past month. At
the China Stock Digest we are proud of the gains we have realized
with Chinese investments and relieved that we have stuck with
value plays.
We
are sometimes asked why the China Stock Digest isn't more
active in Chinese Internet stocks? After all, some investment
gurus are touting gains that seem almost miraculous, supposedly
brought about by investments in China's Internet sector.
The
Chinese stock Digest has researched the Internet sector and
made its "buy" recommendations based on a comparison of risk
and reward. We are aware that there are more than 100 million
Internet users in China, and the sector is expected to bring
in about $2 billion in revenues this year. But by Chinese
standards, these are small numbers. Our analysis indicates
that the sector is too immature and unstable to warrant the
inherent risks. The fantastic claims made by some Chinese
Internet stock promoters do not stand up to serious scrutiny.
Some time ago we noted that China was in the midst of an Internet
bubble and steered clear of that sector.
The
world's third largest computer maker, Lenovo, also ran into
financial turbulence after a buyout of IBM's pc business.
Even low cost Chinese companies have difficulty competing
in the cutthroat world of personal computers. We put a sell
on Lenovo and are relieved today that we did. Even in a hyper-growth
economy there are no sure things. (LENOVO CHART?) As we predicted,
some highly touted Chinese Internet companies have delivered
even worse results for their investors. (SHANDA CHART)
The
key is to buy good companies. We recommend companies that
will participate in the best of the Chinese growth story without
exposing investors to undue risk.
The
good news is that many blue-chip Chinese
companies pay regular and reliable dividends. Substantial
and dependable dividend payments have a soothing way of leveling
out the bumps in a volatile market. A solid dividend as high
as 7% helps take the sting out of market volatility.
In
the long run, we believe the Chinese big cap/value market
will bounce above worldwide indices because of the continued
growth of internal and external consumer markets.
Much
has been said about setbacks to emerging market stocks as
interests rates rose and global commodity prices plunged.
The good news for China investors is that China has not suffered
the bear markets that other developing nations have endured.
In a recent ranking of stock price drops country-by-country,
China stood among the best performing economies including
the USA, Canada and the UK.
Compared
to China, emerging market stars like India, Russia and Kuwait
have taken a back seat. They are deep in "bear" territory
while China has endured the market setbacks with little more
than a scratch.
In
fact, one of the country's leading economists predicts that
the national economy will slow only fractionally during 2006.
Yao Jingyuan, the chief economist at the powerful National
Bureau of Statistics, expects China's gross domestic product
will expand at a rate between eight and nine percent during
the coming year.
That's
a healthy clip but not inflationary. We believe that continued
growth in economic production and demand will continue to
stimulate the performance of our preferred investments while
stopping short of overheating the economy.
Let's
examine another shift in the economy: It is widely believed
that China's export boom will begin to ease off. The country's
trade surplus is expected to come in at $100 billion during
2005, more than triple the previous year's $32 billion surplus.
Even if the country's export growth rate moderates, there
will probably be continuing friction with China's trading
partners, especially the United States. The U.S. consumes
about 40% of China's exports according to the World Bank.
There
are profound issues swirling around China's export surplus.
Most Chinese trading partners agree that the national currency,
the yuan is being kept artificially low. The low valuation
of the Chinese currency makes exports more attractive to foreign
buyers, and some say that gives China an unfair advantage.
The
most radical voices in the U.S. Congress are demanding tariffs
of 27.5% on all goods imported from China. They argue that
would be a fair and justified step to protect American jobs
because they say 27.5% is exactly the amount they believe
the Yuan has been undervalued.
Whatever
the merits of their arguments might be, any such action is
highly unlikely to happen. The consequences would be disastrous
on both sides of the planet. If punitive tariffs were imposed,
Chinese exports would be slashed. China's ability to purchase
U.S. Treasury Bonds and its ability to sustain America's indebtedness
would be crippled. The consequences for the American economy
would be as severe for the United States as they would for
China. There may be a lot of bluster coming out of Washington,
lately but few politicians would ever risk such a potentially
suicidal step.
We
don't see such a disaster on the horizon. Much more likely
is continuing pressure from China's trading partners to adjust
the Yuan. If history is any guide, these changes will be relatively
slight and measured.
Final
Approach:
Because
China is in transition from communism to capitalism, no decision
is driven solely by economic realities. The People's Republic
of China (PRC) remains a "dictatorship of the people" to put
it in the gentlest possible terms. The state is a majority
shareholder in most of the country's biggest enterprises.
By
contrast, financial reporting on our government's role in
the American economy is usually centered on the latest rate
hike from the Federal Reserve or the latest tax decision from
Washington. But the Chinese government reaches far more deeply
into every aspect of that nation's economic and political
life. The government demonstrated its seriousness about maintaining
political control last month when it imprisoned two journalists
for ten years for having the temerity to report on a land
dispute that reflected badly on Beijing.
The
government is equally serious about maintaining economic stability.
In a country that is still transitioning from Soviet-style
centrally planned economics, the pronouncements of officials
and carefully placed hints from bureaucrats in the state controlled
media can have far-reaching consequences.
Although
China has emerged as a $2 trillion economy, it is still managed
to a large degree by the state. That's why we at the China
Stock Digest pay such close attention in these pages to the
words of the Chinese government. Finding companies that will
succeed in China means much more than looking over a balance
sheet. Investors need to know the political climate that will
affect the companies they have a stake in.
As
China takes its place as the world's future economic colossus,
economic realities will become increasingly difficult to control
from Beijing. But for now, the central government is a central
player in the development of the economy. It is has the power
to make or break companies that we have invested in. As long
as that's the case, we'll be paying very close attention to
the words of Beijing bureaucrats as well as the numbers emerging
from the boardrooms of Shanghai and Shenzhen.
Conclusion:
The
rise of Chinese consumerism may begin to reduce the trade
imbalance that has struck fear into the hearts of many American
economists. The United States is unlikely to become competitive
with Chinese labor costs in the foreseeable future. America
must invent new services and knowledge based products that
will appeal to China's growing middle class. However, there
is one major caveat.
America
remains a powerful innovator. China has the potential to become
a powerful partner to American innovation and knowledge-based
industries. But this will not happen unless China shows it
is serious about theft of intellectual property. Neither nation
will benefit if American software, music and films are stolen
and sold for a pittance on every street corner. As China's
economy shifts increasingly to a service-based and knowledge
based foundation, they too will benefit if intellectual property
rights are paid more than lip service.
Because China has a population of 1.3 billion people, we have not
yet begun to explore its full potential. True, the emergence
of China will put new pressures on world energy supplies.
Chinese industrial development has become notorious for its
disregard for worker safety and environmental protection.
In 2006 we will be on the lookout for investment opportunities
that will participate in China's effort to generate new energy
sources, to manage pollution and to build new service industries.
The
world is entering a new phase of economic development that
will be neither simple nor brief. We at the China
Stock Digest have no doubt that China will emerge as the
world's largest economy. We know it cannot achieve this goal
without ongoing capitalist reform and investment.
As
unabashed capitalists, we intend to invest our resources with
the plain intent of seeing Chinese enterprises grow and seeing
our investment dollars grow right along with them. Our job
is to find the winners early and to help our subscribers share
in our research. We are also on the lookout for enterprises
that are failing, and we have pledged to send out "sell" signals
quickly when necessary.
We
believe that nothing helps economies grow like enlightened
capitalism. And, nothing returns profits to investors like
well-informed capitalism.
The
most populous country in the world is in transition from communism
to free market capitalism. We are committed to building a
mutually profitable relationship. My associates at the China
Stock Digest and I are committed to becoming a highly profitable
partner in the emergence of the largest economy the world
has ever seen.
|
