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Tuesday, March 17, 2009

When China and Brazil Become a Better Investment Than the U.S.

Now that most investors, both institutional and individual, have lost a large portion of their stock market holdings, all that most people want to know is how they can get their money back. The easy answer is that they probably won't get their money back, at least not over the next five or ten years. But, that kind of answer is never satisfactory.

One well-known market analyst suggests that putting money into the stock markets in China and Brazil will pay off better than keeping capital in U.S. equities. According to Reuters, Mohamed El-Erian, chief executive at Pimco, the world's biggest bond fund manager, said about China and Brazil, "The case for optimism comes from the fact that these countries entered today's global crisis with better initial conditions." (See pictures of the global financial crisis.)

In horse racing and boxing, experts will point out that a strong start does not mean a strong finish. China is a case in point. Its GDP has grown at a rate of about 10% a year for a decade. The government has done whatever it needed to do to keep the economy on track. It has underwritten the build-up of the manufacturing sector, the telecom and electric infrastructure, and a large and complex financial system. It has also sold parts of the nation's largest companies to the public to give the companies more access to capital. The communist central government says it will put about $585 billion into the domestic economy in order to stimulate consumption and business expansion.

It is hard to see how China could fail with its plans to keep its GDP growing rapidly with such an impressive arsenal. It looks almost as good as the one that the U.S. had in the 1920s and Japan did in the 1980s.

Of course, the Chinese economic leaders have read all of the analysis about what caused economic collapses in large nations during the past. China has certain advantages that have never been present in another rapidly growing country. The country has both an abundance of national resources and a large supply of workers who can be trained to work in factories. China has also grown and continues to grow with virtually no restrictions on how industry effects the environment. The World Bank estimated that 700,000 Chinese die prematurely due to poor air quality. Perhaps the best way to look at that number is that it is the price of progress.

China has obviously demonstrated that it has both the will and the capacity to exceed the growth of any other large nation in the world. But, what is rarely if ever mentioned by the government is that the nation's economic fate is not in its own hands.

Recently The Wall Street Journal reported that "Goldman Sachs estimates that China's economy grew 2.6% in the October-December period from the July-September quarter. The OECD puts the quarter-on-quarter growth for the same period at 0.3%." The numbers are telling in two ways. The first is that estimates of economic activity on the mainland are imprecise. The second is that China's growth rate may have already have slowed considerably.

None of the current explanations of China's GDP growth are able to explain the discrepancy between China's GDP growth and the sharp drop in imports among the developed nations. China does not have another set of nations that it can send its goods in order to replace the diminished demand from the U.S., Japan, and Europe. As unemployment in these regions continues to rise, and that looks like a certainty now, China's ability to send its manufactured goods overseas drops each month.

So far this year, the Shanghai Composite, the best measurement of stock values in China, is up over 20%. Those making the argument that the world's most populous nation will have a strong year can point to that number as an indication of optimism. The trouble with the theory is that when the Asian nation's economy was at its most robust, in 2007 and early 2008, the same index of China's stock fell from a level of 6,000 to 1,700 where it bottomed five months ago. This must be what the head of Pimco meant when he said that investing in Chinese stocks is the best game in town.


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