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China's Pyramid of Power

China celebrated another achievement last week, as Mo Yan became the first Chinese citizen to win a Nobel Prize for literature.

The selection of Mo was praised by a Chinese nationalist tabloid as a sign that mainstream China could "no longer be refused by the West for long."

Mo grew up in Shandong province in northeastern China, and during the Cultural Revolution, he left school to work in the fields, finishing his education in the army, according to The Guardian. The author draws upon his rural upbringing in his novels, mixing historical perspective with mythical elements.

His real name is Guan Moye, but he chose "Mo Yan" as a pen name meaning "don't speak," to reflect the culture in which he grew up.

The new Nobel laureate is of the same generation as the new leaders set to take over the Politburo Standing Committee next month after the convening of the 18th National Congress of the Communist Party of China.

This group of men (and one female contender) are "old enough to remember the suffering of the Cultural Revolution, but also young enough to fully experience how China has grown through Deng [Xiaoping]'s opening of the economy to market forces," says CLSA China Strategy research.

They've seen vast political reforms take place, transforming China "from a country ruled by the contradictory personal whims of Mao to one ruled through institutions and rules," says William H. Overholt in The Washington Quarterly.

During these decades, "freedoms blossomed, affecting everything from clothing to haircuts to job or marital choices to social and political speech," says Overholt.

As a result of these policies, they've been able to witness China's incredible growth, with GDP averaging 10 percent per year and more than 500 million people moving out of poverty over the past 30 years.

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

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.

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?!

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Winning the Race for Resources

The world watched in awe as American swimmer Michael Phelps became the most decorated Olympian of all time.

I've read he's been training in the pool for an average of 6 hours a day, 6 days per week, which equates to about 30,000 hours since age 13 and about 10,000 calories burned during a training day. It's inspiring to see the incredible results of his tremendous sacrifice and commitment.

Investing in global markets requires the same sort of stamina, especially at times like this week, when the month's reading on the manufacturing industry was not encouraging. The J.P. Morgan Global Manufacturing PMI of 48.4 for July was the lowest since June 2009.

However, I believe there are encouraging pockets of strength to energize and inspire investors.

For example, we're coming up on the anniversary of the first stimulus move that kicked off the global easing cycle.

On August 31, 2011, Brazil unexpectedly cut rates by 50 basis points, and since then, ISI says 228 stimulative monetary and fiscal policy moves have been initiated across several countries, including the Philippines, China, France, and Colombia.

In June and July alone, there were nearly 70 moves-the most since the world began this massive easing.

Generally, by the time central banks make a fiscal or monetary easing move, economic deterioration has already occurred.

Even with these moves, it still takes several months for the stimulative measures to take effect and work their way through.

China Makes Its Move

But while the world wades in the shallow end of the pool waiting for the economy to warm up, Asia has taken a deep dive into the energy space as they've recently announced acquisitions of Canadian resources companies.

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Where the Chinese are Putting Their Money

American investors have been in love with the China story and Chinese stocks for more than a decade.

And, there's a lot to like if you know what you're doing and where to look.

But there's an even greater opportunity when you look in the places no one else is looking...except for the Chinese.

China faces a labor crisis. It's not what you think.

They have lots of workers. Some are very skilled, others highly educated. But the ones working in the factories by the millions possess little but what they can do with their hands.

Their wages are not enough to buy the very purses they sew or bicycles they assemble. That is changing, slowly. The change is becoming painful for Chinese factories.

You see, China does not have factories that have huge margins for profit.

The country has succeeded by being the lowest-cost producer in the world, selling its wares at razor-thin margins to quash any competition.

The resulting success has made China a global powerhouse...but it has also resulted in an unintended consequence: inflation.

China is one of the few emerging countries that I have been to where the government offers few subsidies. Take gasoline, for example. It costs over US$5 per gallon for gas today in China.

That's more than the U.S., and it's a lot more than India, which subsidizes fuel.

The price for everything is going up for the local population, so now they're demanding higher wages.

And they're getting higher wages, which means even lower profits for factories already stressed by a global economic contraction that has end customers unwilling to pay more.

There is a fix. And that fix is going to make you money. It's where the Chinese are putting their money -- lots of it.

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Forget About the Trade Deficit, Now is The Time to Invest in China

You may have heard that China just posted the biggest trade deficit figures in over a decade .

Naturally, this caused the usual suspects who have been waiting - some would say hoping - for a Chinese crash to jump up and down with excitement.

But not so fast guys... one set of figures doesn't tell the entire story.

The truth is the $31.5 billion trade deficit is actually a sign that things inside China are growing and that imports are becoming a more viable part of China's future than ever before.

It's exactly as I've been telling Money Morning readers for several years now.

Up some 39.6% year-over-year, the numbers are far ahead of expectations and a good deal higher than the 15.3% contraction China experienced in January.

True, exports climbed at only 15.3% versus the 18.4% expected rate, but that's still plenty positive at a time when the so-called developed world is on track for overall growth of 1.3% according to The Conference Board.

Get used to it.

As China's wealth rises and its internal consumption strengthens, imports are going to decouple from exports and deficits like these will be the norm.

If anything, these numbers reinforce the notion that investors should be actively looking to China and be accumulating Chinese investments.

What Smart Investors Recognize about China

What's changed?

For starters, how China processes its imports. It used to be that the majority of stuff we sold them was fashioned into exportable goods that came boomeranging back to our shores as finished products.

In other words, we sold China handles and steel and they sold us shovels.

Maybe I'm exaggerating, but not by much. Today, more of China's imports now go straight to domestic consumption than we've ever seen before.

What's happening is not magic. There is no rocket science. No hocus pocus.

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The Real China Story: It's What Premier Wen Didn't Say That Matters

According to Premier Wen Jiabao on Monday, China is only going to grow at 7.5% this year.

But this isn't the bombshell most Western analysts think it is-even though the markets sold off on the day and may continue their temper tantrum later this week.

It's actually what Premier Wen didn't say that really matters. As is so often the case in China, it's what goes on behind the scene that is far more interesting - and actionable.

In that sense, Premier Wen's comments aren't really news at all, but rather recognition of the symbolic priorities attached to Chinese growth.

As I have talked about at length in the past, China needs to do three things this year: 1) keep growth in line, 2) promote monetary stability and 3) be flexible with regard to inflation.

What makes Wen's 7.5% GDP figure significant is that in dropping it by half a percent, Premier Wen is not saying, but, in fact, telegraphing two things:

  • China's domestic growth priorities have now trumped growth through exports and manufacturing in terms of relative importance; and,
  • The Communist Party expects to shift spending to lower brow projects like ordinary train lines, rural roads, education and technical infrastructure.
Having spent more than 20 years doing business in Asia, I've learned that Chinese leaders almost never say anything in public they haven't already baked into the cake.

This stands in stark contrast to our own politicians who frequently write checks with their mouths that they can't possibly cash.

Understanding the China Story

No. China's leaders are acutely aware of "face" and the risks of losing it. So it's what hasn't been said that's actually far more important here.

The real message is that China expects to maintain growth above 6%, the internal Party Elite's real target, and continue to develop employment opportunities that will keep its 1.3 billion people fed, clothed and housed - so they don't revolt.

Never mind Iran's "Red Line." This is the one that matters.

Understand the importance of 6% and you will understand China in a way that Washington doesn't.

Exports, imports, the yuan, the ghost cities, and hard landings...

None of these things hold a candle to what Beijing considers its most important issue--ensuring China's own survival.

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A New Robotic Horde Means Big Business for iRobot (Nasdaq: IRBT)

Don't let the recent sell-off in iRobot Corp. (Nasdaq: IRBT) shares get you down about robotics.

The truth is, this small-cap robotics leader just reported record results for 2011.

Shares of iRobot only fell when the company warned that tight defense budgets could curb sales of "warbots" until the second half of the year.

iRobot investors who are concerned that the drubbing is a reason to worry about the future of this industry are making a very big mistake.

Here's why.

An Asian electronics firm alone will field nearly 1 million new robots in less than five years. And in a moment I'll give you the details behind this robotic horde....

But first I want to make sure you know why I'm so bullish about this emerging high-tech field.

After all, in the Era of Radical Change, robots and other smart machines will transform the world in ways we still don't fully understand.

A Robotic Leap Forward

I realize that robots have been around for at least 30 years in factories. I actually saw some of the earliest versions in use at a General Motors Co. (NYSE: GM) plant in the early 1980s.

But today, the robotics industry continues to register one advance after another...

You see, we've reached critical mass in key areas. Today we have better software, chips, programming, and artificial intelligence.

All these high-tech advancements add up to a new generation of robots that can perform highly complex jobs.

Now, even low-cost Chinese workers who steal jobs from Americans face pressure from this new generation of "workerbots."

Just ask the workers at Foxconn International Holdings Ltd., a firm based in Taiwan that makes products for big computer firms.

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The Heart of a China Bull Still Beats Strong

My debate with Gordon Chang on China's future at the Vancouver Resource Investment Conference was a stimulating, intellectual exercise.

A healthy market needs a compromise between the bid and ask, and discussions between people who strongly disagree is a great way to promote critical thinking.

Critical thinking is vital to our investment process as a means to ensure that we question assumptions.

A lack of critical thinking sometimes leads to bubbles, such as the one taking place in the parabolic rise in the number of articles foretelling China will experience a "hard landing."

Last fall, more than 1,000 articles questioned the possibility of a "China crash," according to data from BCA Research. This is twice as high as the number in 2004, when fear articles reached 500.

Gordon's bearish pronouncements only added to the extremely negative groupthink surrounding China's economy.

Money Morning Chief Investment Strategist Keith Fitz-Gerald, a long-time friend of mine, wrote an excellent article comparing today's doomsday sentiment of China to the naysayers who forecast the demise of the U.S. during the market bottom of March 2009.

Throughout the past century, U.S. stocks went through many secular bear markets.

Keith points to the 1929-1932 period when the Dow Jones Industrial Average declined by nearly 90%, along with pointing out the Dow's loss of more than 52% from 1937 to 1942.

Also, in 1901, 1906, 1916 and 1973, there were four "40-plus% declines," says Keith.

Americans have also endured two world wars, the Great Depression, presidential assassinations and the deadliest terrorist attack ever seen on U.S. soil. What's important for investors to remember was that each significant market decline presented a "great buying opportunity" with U.S. stocks rising double-, or in some cases, triple-digits, writes Keith.

And, over the past 100 years, the Dow gained an outstanding 24,000%.

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Ben Bernanke is Every Gold Bug's Best Friend

After prices fell 10% in December, many investors wondered if the bull market in gold was running out of steam.

That was before Federal Reserve Chairman Ben Bernanke swooped in with a "red cape" and fired the bulls back up.

Since the Fed reassured the world that interest rates will remain at "exceptionally low levels" for another two years, gold has jumped more than 3%.

UBS AG (NYSE: UBS) described the situation simply, "if investors needed a (further) reason why they should be long gold now, they got it yesterday ... a more accommodative policy is a very good foundation for gold to build on the next move higher."

To gold bugs, two more years of near-zero, short-term interest rates means negative real interest rates are here to stay, and this has historically been a strong driver for higher gold prices.

Bernanke and the Fed aren't the only central bankers in the fiscal and monetary bullring.

Brazil has cut its benchmark interest rate a few times and China lowered its reserve rate for banks in December. According to ISI Group, 78 "easing moves" have been announced around the world in just the past five months as countries look to stimulate economic activity.

One of the main weapons central bankers have employed is money supply, which has created a ton of liquidity in the global system. Global money supply rose 8% year-over-year in December, or about $4 trillion, according to ISI. I mentioned a few weeks ago how China experienced a record increase in the three-month change in M-2 money supply following China's reserve rate cut.

Together, negative real interest rates and growing global money supply power the Fear Trade for gold. The pressure these two factors put on paper currencies motivates investors from Baby Boomers to central bankers to hold gold as an alternate currency.

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The Madness of Crowds: How to Play Bonds, China, and Gold in 2012

Yes, I know that markets are irrational.

I read Charles Mackay's 1841 classic, "Extraordinary Popular Delusions and the Madness of Crowds" long before it ever became fashionable.

Even so, when you think about it, 2011 must set some kind of record.

As investors, that means we need to decide whether this madness will continue in 2012 and which direction to take.

Take the madness in the bond world, for instance.

Long-term bonds of a country with an out-of-control budget deficit and a worrying trade deficit are currently yielding 1.6% below inflation.

In other words, year after year, investors are willing to pay 1.6% of their capital to hold them. On top of that, investors have been so keen on this miserable asset in 2011 they have bid up its price by no less than 26%.

Conversely, China is revolutionizing the world economy.

Year after year, China puts up growth rates of 8% or more, and the latest data suggest that will continue throughout 2012.

What's more, Chinese stocks stand on a bargain-basement price-to-earnings (P/E) ratio of less than 8-times earnings. Yet, in 2011, investors shunned these bargains, giving the Chinese market a pathetic return of minus-22%.

It is Madness I Tell You

Do you see what I mean when I talk about irrational?

To a Martian, these statistics would be proof that earthly markets had lost their collective minds. That's not just a random walk - it's a deliberate stroll that will destroy your wealth.

For investors, it raises the question of how long this irrationality is going to last. Will this extreme irrationality persist in 2012, or will it reverse?

The first conclusion to be drawn is that current markets...

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China Fears Much Ado About Nothing

Markets in Hong Kong, Vietnam, Taiwan and Korea were closed last week as people across Asia celebrated Moon Festival, one of the culture's most beloved holidays along with Chinese New Year. Moon Festival's origins center around a husband (Houyi) and wife (Chang'e), who were sentenced to live eternally separated on the sun and the moon.

Chang'e, representing "Yin," lives on the moon and Houyi, representing "Yang," lives on the sun. Once a year, on the night of the Mid-Autumn Festival, Houyi visits his wife and that is the reason why the full moon burns brightly on this night.

For many, the yin and the yang illustrate the importance of having balance in life. Investors must find the right risk/reward balance. Businesses must find the right capital spending/revenues balance. And, we all must strive to find the right work/life balance.

China's Economy Finds Balance

Balance is also a crucial goal for China's economy - the economy must not grow too quickly or risk a sharp correction. Just this year, China has weathered an epic battle with inflation, drought and floods, poor global macroeconomic conditions, massive accounting/corruption scandals and a tragic accident on one of its marquee achievements-the country's high speed rail system.

We've discussed the tremendous build-out of China's high-speed rail system before. And earlier this month, I was lucky enough to see what traveling at the speed of China feels like firsthand. I was on a train that averaged 185 miles per hour during the 923-mile trip from Shanghai to Beijing. I've traveled to all corners of the world and have seen many things during my travels, but viewing China's explosive growth as it flies by you is something I will never forget.

China remains the beacon of hope for the global economy, the largest and, many times, the "sole engine of the world economy," BCA Research says. China's real gross domestic product (GDP) is forecasted to grow 8.9% in 2011 and 7.8% in 2012, according to ISI Group. This is a slower rate of growth compared to recent years but "doesn't look like an economy struggling under tighter credit conditions," GaveKal research says.

The key to China's economic growth isn't "how fast?" or "how much?" The most critical question is "what's driving it?"

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Chinese Homebuyers Throw a Life Raft to the U.S. Housing Market

From New York to Honolulu, Chinese homebuyers are swooping in to help salvage the U.S. housing market.

Indeed, California, Florida, New York, and even Hawaii have seen a marked up-tick in home sales to Chinese buyers who are exporting their country's real estate boom to the United States, according to Bloomberg News.

Increased regulation at home and education and investment opportunities are chief among the reasons real estate in the United States - as well as the United Kingdom, Australia, and Canada - has piqued Chinese interest.

According to a survey by the National Association of Realtors, Chinese buyers accounted for 9% of foreign home purchases in the 12 months ended in March of both 2010 and 2011. That's up from 5% in 2009.

"The purchase restrictions in China drove them overseas, while they look for investments to counter the inflation," Mo Tianquan, founder and chairman of Beijing-based SouFun Holdings Ltd. - a company that runs China's biggest real estate Website and organizes buying excursions abroad - told Bloomberg. "Some of them will buy homes considering better education opportunities for their kids, while others look for immigration options."

Take Cupertino, Calif., for example. Sales of existing single-family homes in Cupertino rose 21% in the first quarter from a year earlier, largely due to an influx of Chinese shoppers who are making huge cash purchases.

"We're seeing a huge number of all-cash transactions, and most of those are from mainland China," Nina Yamaguchi, managing broker at Coldwell Banker's residential office in Cupertino, told Bloomberg. "The thing that draws the Asians here is the schools are so highly touted. Cupertino is certainly not beautiful. It doesn't have wonderful architecture."

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The Japanese Economy: How Its Post-Earthquake Weakness and Scuffles With China Contribute to a Global-Market Reversal

In our ongoing search for possible "inflection-point" catalysts - financial stimulants that could help turn global markets upside down - the Japanese economy has to be a prime candidate.

In the last part of the 1980s, Japan was the world power - so much so that investors on the U.S. trading floors of New York each day watched the Tokyo markets with a mixture of awe and fear. An oft-cited investing aphorism of the day explained this very clearly by holding that "when Tokyo sneezes, Wall Street catches a cold."

Not long after, the Japanese miracle ended, the stock-and-real-estate markets crashed, and that Asian country fell into a funk known as the "Lost Decade" - a misnomer, since the economic malaise that's lasted virtually ever since is actually more than 20 years long.

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Latin America Looks to Strengthen U.S. Trade Relations and Step Back From China

The United States has long referred to Latin America as its "backyard", and held a strong economic influence on its southern neighbors.

But someone else is moving in.

China's trade with Latin American countries has surged over the past few years, weakening the region's economic relationship with the United States. Now some of those nations - especially Brazil - want to strengthen U.S. ties to reduce their dependence on the world's second-largest economy.

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China's Five-Year Economic Plan Calls For Slower Growth

China will take steps to cool off its red-hot economy in the next five years largely by increasing domestic consumption and de-emphasizing exports, Premier Wen Jiabao announced in an online chat with the country's citizens on Sunday.

Wen, China's leading economic official, said the government's official target for average gross domestic product (GDP) growth over the next five years will be reduced to 7% annually, down from a target of 7.5% in the past half decade.

China needs to slow economic growth to curb soaring food and housing prices and to restructure its economy, even as most developed economies around the globe struggle to sustain expansion.

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