China Dreams

Does putting money on the Middle Kingdom still make sense?

By Roya Wolverson Monday, Mar. 28, 2011
    • Da Shi/Color China Photo/AP

    Chongqing skyline

    Roughly three decades ago, rising Japan was a national obsession in the U.S. Business gurus like Peter Drucker were declaring Japan "the most extraordinary success story in all economic history," and the U.S. was awash in fancy Japanese cars and newfangled electronics. Americans were at once frightened and wowed by the new global power (remember the movie Gung Ho ?) and began flooding Japan with hotheaded investments, only to kiss their money goodbye when the country's speculative bubble burst. Today's obsession with China is eerily similar. And the parallels to Japanomania (a Far Eastern export economy, a cheap currency and a boom in stocks and real estate) raise questions about whether it all might end in tears.

    The answer for investors depends on their time horizon. China is different from Japan. For one thing, its population is 10 times Japan's. Its demographics are better. And whereas Japan's growth tumbled after less than a decade of hype, China (whose GDP of $5.9 trillion last year overtook Japan as the world's second largest economy) has spent the past 30 years growing at nearly double-digit speed and is the world's biggest exporter. It is also the world's second largest oil importer and the biggest buyer of iron and copper, luring more resources into its economic engine than any other country in the industrialized world. Indeed, many analysts expect China to overtake the $14.7 trillion U.S. economy in under a decade and to double its size in the next 30 years. Whereas Japan's middle class was reaching its peak when its economy rivaled the U.S.'s, China's rising middle class, with its anticipated economic might, has only begun to emerge. For all these reasons, famed investor Anthony Bolton, one of Britain's most successful fund managers, ditched retirement last year to move to Hong Kong and run a China fund.

    Of course, for every China bull, there is a bear. Hedge-fund heavyweight Jim Chanos, who predicted the troubles that brought down companies like Enron and Tyco, thinks China is on the verge of collapse. A boom in Chinese bank lending over the past several years has driven up real estate prices and saddled Chinese lenders with a flurry of faulty loans, which, by Chanos' estimation, could lead to "Dubai times 1,000 — or worse." China's undeveloped financial sector has prevented its citizens from growing their savings, and its laborers are becoming weary of paltry wages. That has put upward pressure on the prices of China's ultra-cheap factory-churned goods and turned up the heat on the country's authoritarian leaders.

    This litany of troubles, combined with rising inflation, oil-price spikes and a sputtering global recovery, have already taken a toll on the market. U.S. stocks, far more diversified and sophisticated, outperformed Chinese stocks by 3 to 1 last year, even though China far outpaced the U.S. in economic growth.

    So why would Americans want to invest in China? First off, it all depends on how long you're willing to stay in the game. Short-term investing in China is risky. But few economists would dispute that in the long term, China's overall trajectory is up. The regime is savvy enough to realize that to keep up its growth, it has to move away from cranking out cheap stuff sold in Walmart and improve the lot of its consumers. The Communist Party's latest five-year plan pledges to increase social services and workers' pay. And this is an autocracy that won't likely meet the same fate as those in the Middle East; Chinese youth are more intent on improving their lives through economic growth than abrupt political change, which mitigates political risk, says Edmund Harriss, manager of Guinness Atkinson's China & Hong Kong fund, based in London. Inflation is a problem, but the government is already tightening the spigot and has tackled far worse before. And China — unlike Japan, whose economic collapse came on the heels of a sharp rise in the value of its currency — is letting the yuan appreciate slowly, which keeps its cheap exports chugging while it works to rebalance its economy and put more spending money in the pockets of its people.

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