The Five Things You Need to Know About China

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Legendary investor, Bill "The Bond King" Gross made headlines recently when he said that China will one day have to contend with a bubble of its own making. Gross runs the world's biggest bond fund at Pacific Investment Management Co. LLC (PIMCO). Millions of investors reacted just as you would expect when someone of his prominence makes such a pronouncement – they panicked.

While I can see how Gross would arrive at such a conclusion, his comment about China is akin to the economist who tells us that "the U.S. economy will recover."

In either case, just when and how isn't clear.

I've detailed all of these for readers over the past year or more. But it's now time to review each of these Five China Profit Precepts in some detail:

No. 1 – Consumerism is Taking Root: According to China's National Bureau of Statistics, the country's retail spending advanced 16.2% in October and should easily hit the 15% to 19% target for all of 2009 that we projected last year. Assuming the numbers play out as expected, when 2009 comes to a close, the aggregate increase in consumer spending in China will be larger than the retail spending growth in the United States, European Union and Japan combined.
All the right catalysts are already in place. Government stimulus programs – including rebates on "white goods" and tax cuts for low-emission vehicles – helped China's car sales increase by 43.6% in October. China is now the world's largest car market, having displaced the United States earlier this year. Sales of home appliances are also up sharply, rising more than 35%. Even real estate is on the mend, particularly in China's western provinces.

At the other end of the spectrum, government spending and industrial power production are up nearly 20% in just the last quarter alone. According to Carbon Monitoring for Action, China's power consumption has nearly doubled over the last decade. Just to keep up, China builds a new power plant capable of handling Kansas City's electricity needs every nine days. And a city the size of Philadelphia every 30 days.

Given the correlation between raw power consumption and economic growth, the frenetic proliferation of power plants is clear evidence that China is growing – not slowing. Beijing wants to make sure it avoids the extended energy shortages that can only choke off economic growth.

No. 2 – China is Ready to Serve: China's service sector is now growing twice as fast as its construction and infrastructure segments. As the graphic below shows, more than 30% of China's workers are employed in service-sector (tertiary) jobs.

And that's only going to grow: Beijing has shrewdly directed huge portions of its stimulus package into the country's service sector. That's an important point. It's part of Beijing's push to stoke domestic demand, an initiative that will reduce its dependence on exports to a weakened West and transform China into a stronger, standalone economy.

The quality of the jobs employing China's workers is also on the upswing. In China's industrial (secondary) sector, for instance, non-state-owned companies employed more than 70 million people in 2008, the most recent figures available. That's equal to about 80% of the country's total industrial work force.

Then there's the fact that China has created 7.57 million new jobs in the first eight months of this year. That's 84% of the government's national target for 2009 according to Huang Zhendong, chairman of the Committee for Internal and Judicial Affairs under the National People's Congress (NPC). At current rates, China may create as many as 9.01 million jobs by the end of the year.

Compare that to the U.S. economy, which is dealing with a "jobless recovery," as well as a current unemployment rate of 10.2% that's expected to get worse before it gets better. Just yesterday (Wednesday), for example, we saw that private-sector employers eliminated 169,000 jobs in November. That figure, contained in the monthly Automatic Data Processing (Nasdaq: ADP) jobs report, was much worse than the 150,000 forecast figure floated earlier by economists.

No. 3 – There's More to China Than Exports: One of the biggest myths about China is that it lives and dies by exports. In fact, PIMCO's Gross said his bubble fears have been fueled by a concern that China is gearing itself up for an export market in which there won't be many buyers.

Truth be told, net exports account for only about 20% of China's gross domestic product (GDP) growth. Infrastructure and capital investment account for the rest. In other words, this is hardly a nation that will wither and die on the vine if the West stops buying, despite the widespread belief to the contrary.

This economic myth doesn't withstand even minimal scrutiny. First and foremost, China's markets are basically closed. So when Western pundits try to argue that a decline in exports will sink China's economy, the numbers just don't compute.

If anything, we are dangerously close to a situation in which the West's purchases become irrelevant to China's continued growth. The United States and other Western powers may need China, but as China's consumer strength grows, it's increasingly likely that the Red Dragon and its consumers won't need us.

The issue that causes Beijing officials to lay awake at night is how much the country imports to fuel GDP growth. According to BNP Paribas SA (OTC ADR: BNPQY), China imports nearly 90 cents worth of goods for every $1 in exports. That means that – at most – there's 10 cents worth of "flux" in China's economy.

Therefore, the real question investors need to answer is how much China is bringing into the country, not what it's sending out. Exports may be almost an afterthought at this stage of the game…not the do all end all they were in the late 1980s or 1990s.

No. 4 – China Has an Exit Strategy: Unlike its U.S counterpart, China included a tangible "exit strategy" with its global-financial-crisis stimulus initiatives, and is utilizing private spending to address any interim shortfalls.

On the other hand, the United States is trapped in an economic minefield of Washington's own making. But China has gotten down to brass tacks and is already taking steps to exit the stimulus programs now in effect. For instance, as I've detailed for readers in recent months, Beijing has raised capital requirements for banks, raised lending standards and generally put the kibosh on easy money. That's not to say there aren't problems, but on an overall basis China is already well ahead of the curve. Beijing is even taking steps to slow things down – tapping the economy brakes, so to speak – and can boast of GDP growth of 9% or more even after the cheap money has been gently pushed to the sidelines.

Spending patterns have undergone a needed shift, too. In the old days, public spending and that of state-owned enterprises (SOEs) significantly outweighed private investment. But now, the two have flipped and private investment is higher than both state and public spending.

It's a significant shift. The strength and direction of private spending may be the best measure of an economy's durability because it expresses investor "trust" in a country's financial system. There's clearly a lot of this "trust" already in China – and it's growing.

No. 5 - China's Capital Reserves Give it Almost Unlimited Flexibility: $2.3 trillion. It almost needs no explanation. China saved $2.3 trillion for a rainy day. Now it can spend the money as its leaders see fit. Unlike its U.S. counterpart, which may be borrowing its way into oblivion, China's government doesn't need to borrow against its future just to survive the present. It can finance its plans, snap up valuable assets from sellers desperate to raise capital, and make investments that will maintain its enviable growth rate well into the future. There's a huge difference.

No disrespect to PIMCO's Gross, but the bottom line is this: Beijing's stimulus and massive government influence has actually refined value, accelerated private investment and sped up the flow of money. And if that constitutes a bubble, so be it. There's still plenty of money to be made if you know where to look.

Westerners have been predicting China's demise for 40 years. And for 40 years, China not only refused to roll over or just go away, it has actually grown at an average annual rate of 9.28% as reflected by its GDP.

With its heavy debt load and self-made problems, the United States will be fortunate to maintain a fraction of that growth rate.

To be fair, Western pundits continue to allege that China's numbers are "cooked" – as if to insinuate that its statistics are less trustworthy than ours. They're probably right. But if the implication is that ours are somehow perfect, that's not only ridiculous, it's entirely naïve – as has been amply demonstrated by the likes of Enron, Worldcom and Bernie Madoff. And take a second look at some of the figures coming out of Washington these days.

As for the contention that China's economic and stock-market growth rates are unsustainable, I can certainly envision a near term pullback. That's normal for any financial market, including our own – which, I might add, looks mighty toppish right now.

But here's the thing: When it comes to China, we're investing for the long haul.

Bubble or not, in China you can invest, live through a pullback, and rest easier with the knowledge that there's a $2.3 trillion tailwind driving your money. Here in the U.S. market, you can invest, live through a pullback, and lay awake at night knowing that you've got a decade's worth of headwinds, a deficit of more than $1 trillion fighting any investment play that you make.

I know where I'll be putting my money.

[Editor's Note: Keith Fitz-Gerald is the chief investment strategist for Money Morning and The Money Map Report. Fitz-Gerald has pulled all his best thoughts together in his new book, "Fiscal Hangover: How to Profit From the New Global Economy." The reviews are excellent. Investors interested in purchasing a copy can do so through Amazon.com. Just click here.]

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About the Author

Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs The Geiger Index, a reliable, emotion-free guide to making big money and avoiding losses, and Strike Force, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.

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  1. Lou | December 20, 2009

    about Bernanke 'da MAN >
    NOT about China>
    but this is only way i can respond >> (pls open your TIME 'MOY' post to comments>

    my Dad made it thru '29 depression, in his 20's prime years >
    it was BAD

    Something had to be done this time > Bernanke did it

    the REAL problem isn't Bernanke >> it's GEITHNER
    Geithner has twisted and manipulated things according to his Wall St background
    Bernankie is basically an academic > acting according to his best academic understanding of solutions > not perfect but at least academic oriented

    Geithner is using his power to grow an organization that's emBEDed in investment banking BUINESS >

    his next target is the FDIC (Blair) > it's about accumulating power and control, not about solutions

    IM(humble)O > the solution is revive Glass-Steegal >
    Banks to (safe) BANKING > INVESTORS to (risky) investing
    PS >
    Suggest open 'Bernankie MOY' to comments >
    You might get 'flamed' but you can edit those out

  2. wellington | December 22, 2009

    what would happen if climate change inspectors were to visit china and close down
    all those thousands of factories emmitting gasses in space ,will it keep earning tonnes
    of money on exports i wonder

    • sabahmail2k | January 18, 2010

      That will leave the world with high inflation and we dress, eat and leave in worse condition ever.
      what will happen. why dont you try just to live lift without Made in china product.

      You wont die but you will live with only basic needs (no Life no entertainment- you dont have any extra money for it)

      what about the poor USA citizen? with out "made in china" they will have no clothes on their back and since the are already homeless, it will be cruel to the poor for the climate change inspectors to do just that. think about it.

      of course unless you a rich bastard and care less,

  3. robert baird | January 15, 2010

    VERY WELL STATED.GOOD USE OF DATA & LOGIC. THANK YOU.

  4. mario cavolo | January 15, 2010

    Based in China for 10 years, I regularly write on the relevant subjects. I'm happy to say you hit the mark nicely with this article. Good job.

    Kindest Regards, Mario

  5. Ed Solano | January 15, 2010

    "Power growth" versus "real growth": Geithner is Obama's mostlikely scapegoat if recession lingers or if "reforms" and "bail-outs" don't work in, what, a year at least. What good then is Geithner's alleged plan to increase his power base, if he's forced to return to the private sector to gain from it?

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