Q&A With Keith: The Real Answers in China Are Never That Simple

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Q – The Chinese copy everything. Companies can't make money there, especially lately.

A – That's simply not true. Domestic Chinese companies have made plenty of money. So have foreign companies like McDonalds, ABB, Coke, and even GM, which have been fabulously successful there because they've taken the time to localize their products.

Not many people know this, but the ultimate sign of executive status is a jet black Buick minivan in Beijing at the moment. How's that for a contradiction?!

As you might imagine, I get a lot of questions about China – it's topical and it's very important to our future.

Most are really just reincarnations of concerns voiced since 1970 when China first began to open up. In that sense, they're really nothing new.

So rather than tackling the same old "they'll never succeed because they're not democratic" or "ghost cities" arguments that seem to incessantly make the rounds, let's frame them in terms of what's in the news lately and dig into the subtleties that escape most Westerners.

And, let's start with one of the questions I get the most.

Q – Is China going to have a "hard" or "soft" landing?

A – This one stumps me. Where have the people asking this question been? China's had a soft landing for the last four years. They are already there – the economy is slowing, debt is rising, and the urban migration may be closer to an end than people think.

The fact is that nobody can define what a Chinese soft or hard landing actually is because Western metrics don't apply. It's just a catch phrase that gets bandied about in the media.

That's why I believe this question is really a matter of perspective. For example, there is no question China faces huge challenges, but those challenges are no different than many we've faced here in our own past.

During the last century we experienced two world wars, multiple recessions, a depression, and a presidential assassination — and still the Dow rose more than 20,000%.

China will, too. The genie is not going back in the bottle.

As I recall, many people in England thought that America was a pretty silly venture at one time. And don't forget that the world thought Japan was good for nothing more than cheap tin toys following WWII.

Looking at China through Western lenses is a mistake.

The losers are those who show up simply expecting to "show the Chinese a thing or two" by virtue of their success in Western markets.

In their rush to condemn China, people have conveniently forgotten that European markets were problematic to crack, too.

It wasn't all that long ago, for instance, that executives anxious to sell into Germany via the Internet didn't understand that many German consumers still prefer cash. Eventually they began to understand that the payment framework was a big deal and the key to profitability.

With regard to imitation and copycats, both frustrate Western executives unused to the practice, which has existed for centuries as a matter of China's cultural fabric.

In reality, both speed up the product development cycle and sales.

Companies that are unprepared or do not have the right partners cannot compete no matter where in the world they operate (an argument, by the way, that is laid out very well by Kal Raustiala and Christopher Sprigman in their new book, The Knockoff Economy (Oxford University Press).

People may not like how the Chinese handle things, but that's a different story and one that requires a different set of responses.

Q – Export growth is failing, therefore China must be failing…right?

A – Nope. The inconvenient reality is that China is still operating at 3-5 times the speed of Western economies, which will be extremely lucky to eke out 1% growth this year despite the trillions thrown into the hopper.

I find that people who voice the connection between exports and China's complete collapse are often voicing their own frustrations about the lack of growth in the West, or perhaps outright jealousy that it continues practically unabated there.

Even if the data is completely faked, Chinese demand backed by 1.3 billion people completely outstrips anything we have in the West and creates a tailwind that will last for decades. Like every country that's gone before it, this will involve ups and downs both political and economic. It will not be a flawless nor smooth journey by any stretch of the imagination.

The challenge – and what makes so many people so uncomfortable — is that China's goals are now intertwined with the world's fiscal future.

Q – Doesn't Bo Xilai's recent removal imply that China's leadership is more fractured than ever?

A – I hear this one a lot lately.

By way of background, in case you are not familiar with him, Bo Xilai was China's version of a political rock star.

Rising from meager beginnings as Dalian's mayor, he became one of the most powerful men in the Communist Party as its Secretary in Chongqing and a member of China's Central Politburo. He was widely considered to be in line for President of the People's Republic of China.

Unusually charismatic for a senior Chinese politician, he seemingly could do no wrong…right up until his top lieutenant and police chief sought asylum in the American consulate in Chengdu and exposed all sorts of conduct unbecoming of a senior politician.

It didn't help that his wife, Gu Kailai, was charged and subsequently found guilty of murdering British business man Neil Heywood, possibly with Bo's help.

Contrary to what most Westerners believe, the speed and totality of Bo Xilai's dismissal is not a sign of weakness.

Instead, it reflects significant strength because it suggests that the Chinese leadership is consolidating power and closing ranks to keep the system strong, just as they have over 2,000 years of history whenever a dynastic structure was threatened.

And yes, before somebody gets going on that one, I consider the Communist Party to be another dynastic structure for all intents and purposes, even though technically speaking it's something entirely different.

Q – There's no way the dollar can lose out to the yuan as the world's reserve currency. Besides, the amount of trading allowed now is so small that it can't possibly have an effect on the U.S. dollar and the euro…Right?

A – I know this is the perception, but the reality is different.

First, the United States has gone from the world's single biggest creditor to the greatest debtor in the history of the world. We owe ourselves more than $222 trillion at last count, according to Boston University Professor Lawrence Kotlikoff and the CBO. The dollar is a disaster enjoying temporary strength by virtue of the EU crisis.

Second, it's already well under way. China has quietly set up hundreds of billions in bilateral yuan swaps with nations all over the world to safeguard against the global financial crisis, strengthen the yuan outside the normal currency pairs, eliminate currency risk and strengthen trade ties.

As of last February, China had signed agreements with 18 nations, the most recent of which is the $30 billion bilateral contract with Brazil.

Lest you think this is isolated to second tier players, it's worth noting that the Bank of England was actively considering such an agreement until March when it was kyboshed. Germany is also rumored to be considering the possibility.

At the same time, there are also new "panda-bonds" being floated that further tie the international community into yuan. Shanghai, meanwhile and on a related note, has set up futures markets already trading in yuan-denominated instruments.

Citi just became the first Western bank to launch a yuan-denominated credit card, obviously with a local partner.

The implications are clearly global and already in process. The dollar is already being supplanted. It's only a matter of time before traditional dollar-based markets find themselves outgunned by the amount of yuan-based trade that bypasses traditional currency channels. The same can be said for the euro, although on a lesser scale…so far.

Not only that, but I believe there is a good argument to be made that the establishment of these agreements actually takes a lot of pressure off the dollar, too.

At the end of the day, what Western leaders and bankers fail to grasp is that a parallel currency exchange mechanism is being built right under our noses.

So what should you do?

That's up to you, but the way I see things you've only got one decision to make. Imagine the Dragon is coming to lunch next Tuesday; ask yourself if you want to be at the table or on the menu?

Then, consider this bit of common sense advice from the legendary Jim Rogers: it's far easier to get rich in China with its tailwinds than it is to get rich in America with its headwinds.

And place your order – unless you actually fancy being barbequed.

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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. Ben Zadegan | September 4, 2012

    Hi Keith,

    Thanks for your great article, and the Q&A, on Chinese economy. I'm a constant reader of your pieces, which I always find informative and insightful.

    How do you see China can alleviate the following two weaknesses:

    1- approx 60% of China's estimated $3.3 Trillion in foreign reserves are USD-denominated, including Treasuries and cash. So, wouldn't a fall in the USD valuation (say, against gold) be detrimental to China as well? How do you think China can / will get rid of those USD-denominated reserves?

    2- China owns only around 1,100 ton of gold, according to the WGC's Q2 2012 report. We know that when the USD will lose its status as the world reserve currency, any "stable currency" must enjoy a good degree of gold backing, as the USD did back in 1945 (the Breton Woods Monetary Accord). How is China going to achieve this for the Yuan. How does buyout of the LME by Hong Kong Exchange coming in to the picture? Will China use the LME as a platfrom to get rid of its USD-denominated reserves, and perhaps purchase as much gold as possible via the LME ebing run by the HKEx? Isn't this why we see gold price has been on constant increase since the last week of July, when the LME Board approved the buyout?

    Thank you indeed for your insight and your comments on my questions.

    Kind regards,

    Ben

  2. E.K.Whan Tong | September 4, 2012

    American poiticians of ALL stripes never fail to single out China as blaameworthy for American setbacks. The simpliest solution to all their woes are economic sanctions – which in the end penalises the American consumer and American businesses more than having any impact on China in the longer term.

    China's "Friendship" with tha African nations also come under scrutiny born of jealousy and ill-will, but as the new colonisers they are providing much more by way of infrastructure, airports and roads, and amenities such a schools and sports stadia. than the Europen colonisers who wrested the land from the "natives"leaving them " laws that made them less than their "masters".
    Within our generation China was herself a victim of this white race domination. Like I said, the new colonisers have to thread carefully.

    E.K.Whan Tong

  3. enthusceptic | June 8, 2013

    England is the biggest part of the United Kingdom – you must have heard about the UK – but only one of the parts.

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