China
John Lee
For those that follow the NBA (National Basketball Association), you
know that Houston's Yao Ming knocked LA's Shaquille O'Neal out of the
All-Star Game's starting line-up for the second season in a row. But
O'Neal expected this, and hardly flinched when the final balloting
was announced Thursday, January 29.
"That's cool," said O'Neal, who counts himself a fan of the Chinese-born
Rocket's center. "Where he's from, there's two trillion people.
I was just happy to be there."
But China gets blamed a lot for . . .
Jobs: China steals jobs from the US.
Deflation: China exports cheap goods and depresses manufacturing
pricing power.
Inflation: China imports many basic commodities such as copper,
iron, soybeans and oil, which just caused the CRB to reach more than
a decade-high mark.
The all-star balloting does demonstrate the power of the internet.
The Chinese today are now louder both in voice and in money. Accenture,
a business consulting company based in Bermuda, once estimated in
2001 that by 2010, Chinese websites will outnumber English ones.
And now we offer our view on China.
Geography and population
Now with more than 1.2 billion people, China has the largest population
in the world-one-fifth of the total. And every year the country adds
another 12 million.
However, China only has 7% of the world's arable land and fresh
water, 3% of its forests and only 2% of its oil. And although China's
land mass is roughly the same size as the United States, it has 4.5
times the population. In addition, China's enormous population is
unevenly distributed, with 94% living in the south eastern part of
the country. In the United States, this distribution would translate
to nearly one billion people living east of the Mississippi River
Most of the affluent people live in urban cities. There are over
thirty cities with over five million in population. Shanghai, the
biggest of them all, topped twenty million in 2003. We visited Shanghai
and Hong Kong last year. There were just so many people, day and
night, that only NYC compares in terms of population density. And
in terms of marketing, one really only needs to capture these top
cities.
What about the rest of China? In rural areas, clean water and food
are a tough go for many. Public sanitation is lacking with many catching
deadly parasitic worms. The AIDS epidemic is serious with illegal
blood trading. Farming is still one of the top occupied professions
in China.
Through the transformation to capitalism, the poor are ignored and
public services are cut.
Trade
"China is now the single largest contributor of export recovery
in the Asian region," says Jonathan Anderson, a China economist at
UBS, "and provides a third of the region's bank loans." China now
assumes that economic role, buying 31 percent of the region's exports
as it currently prepares to become a source of regional funding.
To be sure, China's economic fuel in Asia is a recent phenomenon.
In 1990, for instance, China only imported 6.8 percent of the region's
exports. And in 1999, China accounted for only 11 percent of total
Asian trade. Butit is about fifty percent today!
In the past year, China has taken in 40-50 percent of Asia's exports,
accounting for all of Taiwan's, and the Philippine's, export growth
last year and over 50 percent of each of Japan's, Malaysia's, South
Korea's and Australia's. Such intake has driven more than 7 percent
of the GDP (gross domestic product) growth in Taiwan, Malaysia and
Singapore, 5.8 percent in South Korea and 4 percent in Thailand,
according to UBS figures.
But despite having a trade surplus of $56 billion with the US, China
is running a large deficit with Asia. Contrary to the belief that
China is enjoying a large net trade surplus, it just reported its
first trade deficit in 10 months- as imports to Asia's second largest
economy exceeded exports by 20 million dollars in January.
Currency
The Yuan (also known as the renminbi) is pegged at 8.28 to the Dollar.
Recently talks surfaced along the lines of China considering raising
the exchange rate by 2.5% to the dollar as soon as summer of 2004.
We are not particularly bullish on the Yuan due to China's trade
deficit and low interest rate.
Banking and Wealth
China's banking system is developing rapidly with growing deposits
denominated in both local and foreign currencies in all its financial
institutions (including foreign-funded ones). They reached RMB22
trillion at the end of last December. This is an increase of 20.2
percent year-over-year, or RMB3.7 trillion compared with a year earlier.
However, 80% of these total bank deposits today belong to just 12%
of the investing public. China only recently started offering car
loans. Credit cards are still not available to most Chinese (China
has no nationalized social security number to check credits against).
And there is little consumer debt to speak of.
There has been much talk about a Chinese banking crisis. China's
non-performing loans (NPLs) by State owned enterprises (SOEs) deserves
a closer look than we have time for right now. However, it seems
to us that NPL is a term under capitalism and surfaced as China has
been attempting to adhere to western standards and to join the WTO.
NPLs are really subsidies to SOEs which are not for profit. These
are indirect loans by the state-owned banks to the state itself and
thus should properly be included as part of the public debt. By the
end of June 2003, outstanding NPLs of these institutions stood at
2.54 trillion yuan (US$306 billion), which was 19.6 per cent of the
total outstanding loans during the period; 3.51 percentage points
down from the beginning of the year.
With 2003 GDP clocked at $1.4 trillion, NPLs were 20%of that figure,
considerably lower than the public debt to GDP ratio of many other
countries. The US national debt ($7 trillion) is about 60 percent
of GDP ($11 trillion). US private-sector debt is about 250 percent
of GDP. Moreover, it is also clear that the Chinese banks will never
be allowed to fail in a way that hurts depositors. There is, in fact,
universal implicit insurance for bank deposits. Thus it is purely
technical that Chinese state banks have a capital/loan ratio problem.
In the end, NPLs are just another inflation scheme to fund government
works. The USA has two powerful tools to avoid NPLs. One is the US
tax code, which gathers income to fund public works, and the other
is the so-called 10-yr treasury note-in which the US has $trillions
outstanding. Since Chinese treasury notes have lesser appeal than
American ones, and the Chinese don't believe in paying taxes, China
has to resort to state bank loans to the state itself to fund its
public works. So in the end it's really the same pie. The US can
never earn enough to pay its treasury debt, just like SOE's can never
earn enough to pay their loans off. Think of the US's $10 billion+
per year farm subsidies programs, or the $billion plus Amtrak bailout.
These would have to be included in the NPLs in China but not under
the US system.
So why is China going through the hoopla to create an NPL problem
and pretending to be solving it?
The Chinese are quickly learning the American Way understanding
in today's world that it's far quicker and easier to absorb others'
wealth than to generate it. The grand China plan is as follows:
• Join the WTO and adhere
to the international banking code.
• Take NPLs off the banks'
balance sheets through AMCs (asset management companies; a stolen
chapter from Enron).
• Dispose NPLs to foreign
banks, such as Morgan Stanley, for 10 cents on the dollar.
• Increase the performing
loans amount so that a lower percentage of NPLs will show in
total loans outstanding.
• Prime state banks for IPOs
to receive $tens of billions in foreign capital.
The result is everyone's eyeing for Fidelity's Magellan, Pimco's
bond funds and the purse of CALPERS. China already has over dozens
of ADR's at the NYSE and NASDAQ, with a combined $200 billion in
market capitalization (LFC, SHI, HNP, SNP, PTR, CHINA, NTES).Industries
span from life insurance, utilities, chemical, oil, and dot coms.
Soon you will hear ICBC (Industrial and Commercial Bank of China)
alongside JPM and Citibank.
Watching some hamburger-flipping Americans who own 3000 sq. ft homes,
the Chinese are quickly realizing that money will come easily once
they step into the American financial gates. Take a few dozen state
officials claiming the ownership of a steel factory, working with
a Hong Kong banker to structure capitalization manufacturing some
earnings reports, drafting a prospectus and then you have $1 billion
in market cap. on the NYSE. We encourage you to visit Vancouver,
Canada to get a glimpse of these wealthy Chinese and their money
at work.
There are two things to consider when buying Chinese ADRs:
• Officially no money can
be taken out of China. You can invest money in China but you
can't take it out
• To think the NYSE will protect
you when your ownership of the company is in question, think
again. We had Enron,
SBC, WorldCom and Qwest easily dodging auditors-and Fannie Mae
and Freddie Mac still can't produce reliable and certifiable
quarterly
and annual reports.
Today, with dividends next to nothing, investors will never earn
back the capital they initially invested-Chinese ADR's or not. GE,
at last count, had $290 billion of debt and less than 10 billion
in cash.
Consumption
Consumer consumption stands at around 45% of GDP (vs. 66% for the
US). This shows the potential of China as a source of demand for
goods and services. However, in the near term, China has too much
excess raw resources and manufacturing capacity. The State Council
this year has ordered a halt in investment in three key industries:
steel, cement and electrolytic aluminum. At this juncture we would
caution investments in commodity stocks. We think the end of the
first leg of the bull run of PD, NRD, and N are near.
But over the long term we are bullish on China. If global consumption
of Chinese goods tails off, there are ways to spur domestic demand.
Easy money and credit is always welcomed by the public. Easy credit
boosts consumption, creates inflation and results in higher prices
and concludes with a tougher recession. We will wait and see how
the Chinese government tackles the cooling economy and loss of jobs
that's to follow with the current red-hot Chinese economy.
Conclusion
We think the new Chinese leader Hu-Jin Tao is an ambitious one.
He has befriended the Thais, Vietnamese, Russians, Europeans, Cambodians,
Koreans, and Japanese. He lent several $hundreds of millions to Asian
partners. He has played the leading role in taking in Asian exports.
With no storage problems, he wisely bought up all the natural resources
from abroad. And he is making huge efforts to clean up China's capital
markets to attract foreign investment. We will research more of Mr.
Hu and share those insights with our subscribers in future issues.
Data were taken from the following sites:
http://www.pbs.org/sixbillion/china/china.html
http://abcnews.go.com/wire/World/ap20040219_2158.html
http://www.time.com/time/asia/magazine/article/0,13673,501031208-552154,00.html
http://www.atimes.com/atimes/China/FB10Ad05.html
http://www1.chinadaily.com.cn/en/doc/2003-08/09/content_253508.htm
http://www.channelnewsasia.com/stories/afp_asiapacific_business/view/70534/1/.html
http://www.publicdebt.treas.gov/opd/opds012004.htm
http://www.icbc.com.cn/e_index.jsp
http://www.tdctrade.com/econforum/sc/sc010402.htm
http://www.atimes.com/atimes/China/FB14Ad03.html
http://www.atimes.com/china/DF01Ad05.html
http://www.pbc.gov.cn/english/xinwen/detail.asp?col=xinwen&ID=354
