Is China Overplayed or Ripe for the Investment Picking?

by David Fessler, Advisory Panelist, Investment U
Monday, December 27, 2010: Issue #1415

It’s the 21st century’s greatest economic growth story.

With the United States and many other major nations buckling under the weight of growth-stifling debt loads, China just keeps cruising. Since 2003, it’s powered forward with annual growth of 8% or more every year – a trend that has seen massive amounts of investment pour into the country.

Just look at the chart below (which comes courtesy of the CIA’s annual World Factbook) to see what I’m talking about:

Foreign Direct Investment, Net Flows

But is China’s growth story all that different from the western economic powerhouses? The answer is a resounding “yes.”

However, after a dizzying run, there are signs that China is now beginning to feel the effects of such an extraordinary growth binge. Let’s take a look at the issues that China is facing…

The Birth of a Manufacturing Monster

China laid the foundation for its growth boom back in the 1970′s, when it restructured its economy. A large part of that included decentralizing its fiscal system, which led to the rapid growth of a more diversified banking industry.

After that, the development of its stock market, increased autonomy of state-owned enterprises and the opening of its doors to foreign trade led to the China we know today.

By contrast, the impressive economic growth of several Western European nations in the 1990s came largely from massive accumulations of debt. By that time, however, China was already exporting far more than it was importing – a trend that has continued to the present day.

It was a brilliant move. The Chinese government took 50% of the capital it was raking in and reinvested it overseas. That had the effect of adding to the Western financial bubble, and ultimately to its own coffers. As a result, China now sits on a pile of cash estimated to be over $2 trillion.

Gobbling Up Market Share Across the Board

Needless to say, China’s ability to take raw materials and turn them into finished goods is legendary – and continues unabated. The country now accounts for…

  • 43% of the global textile industry.
  • 39% of the clothes market.
  • 43% of the footwear and leather areas.

China also supplies 28% of the world’s electrically powered machinery. And it manufactures 80% of the world’s mobile phones. And most of the progress has come at the expense of Western countries, which have repeatedly called “foul” over China’s undervalued yuan currency.

But the government’s tight currency control is all part of China’s carefully crafted plan. By not allowing the yuan to rise against the U.S. dollar, Chinese goods remain dirt-cheap.

So could it all backfire on China?

Beijing, We Have a Problem

It’s no secret that Westerners are learning some hard lessons about the dangers of too much debt. But Chinese citizens have the opposite problem: They save too much money.

China has one of the highest savings rates of any country. State-mandated population controls and the fact that virtually nobody is on welfare translate into the average Chinese citizen socking away about 25% of his paycheck every month.

If China is to grow organically, the Chinese are going to have to start spending more. And that means Chinese policy makers should slow the country’s growth by letting the yuan rise. Setting those wheels in motion is the prudent thing to do, as it’s simply a reflection of China’s economic strength.

But by keeping the yuan artificially low, China is inviting protectionist moves from other nations. Europe already imposes an import tax on Chinese-made shoes and U.S. companies are calling for similar measures.

But according to Tim Condon, an economist at ING, China is using all the wrong tools to fix the problem: “So far, the authorities appear determined to manage it by doing everything except fix the root cause – a substantially undervalued currency.”

China has another problem, too…

Hello, Inflation

Sitting at 4.4%, Chinese inflation is already nearly 50% higher than the government’s official target rate of 3%.

As we know, curbing inflation is difficult in Western countries… but it could be particularly difficult in China, where a significant part of the economy isn’t as tied to market forces and old approaches are still evident in many areas of the country’s economy.

Adding to the inflation problem are all the savers looking for greater returns on their money. They’re investing in gold and real estate in China, both of which are approaching speculative levels. In response, the government has already begun to slow down bank lending and is making it more costly to buy and sell gold.

As a result of the artificially low yuan, many Chinese stocks now appear overvalued, trading with P/E ratios of 60 or more. And these high P/E’s imply continued fast growth – something that clearly isn’t sustainable in the long run, especially with Western economies still in an anemic state of recovery.

So is China still a worthwhile destination for your money?

China’s Still Got Its Mojo

According to Jonathan Schiessl, manager of the Chindia Fund at Ashburton, investing in China will double your money in roughly nine years, whereas it could take as long as 36 years to do the same by investing in the United States. Pretty compelling.

In addition, I’ll be analyzing the Chinese government’s next “Five-Year Plan,” due for release next spring. This will detail the sectors that China wants to grow – and where the opportunities will be.

Right now, however, I’m keeping an eye on China’s energy sector – and specifically, green energy.

For example, did you know that China has spent nearly four times as much as the United States on green energy technology? It’s primarily focused on efficiency-related technologies and processes, in addition to splashing out almost $35 billion in 2009 on low-carbon initiatives. That was double the United States’ expenditure and the largest of any nation.

In short, as the world’s economy heads towards an uncertain future in 2011, China’s economy still remains a top investment destination, regardless of its currency and inflation issues.

Good investing,

David Fessler

Editor’s Note: It’s no surprise to see China placing emphasis on green energy, as demand continues to soar and it strives for as much energy as it can get. And it’s not just restricted to China either – the sector continues to offer massive investment potential, as the global population climbs and energy demands rise with it.

I’ve identified the energy and infrastructure sectors as two of the hottest long-term global investment opportunities, which is why my Peak Energy Strategist focuses specifically on uncovering the major trends and stocks from the United States and around the world.

I invite you to join me in 2011, as I give you the names of the companies best placed to capitalize on these trends. You can find out more here.