Back to Basics

Carleen and I just returned to China last Thursday after spending the holidays at our farm in New Jersey. A month seemed like such a long time when we first arrived in the States in mid-December, but it went by very quickly. And with our three-year-old grandson asking repeatedly why we have to go back to China, it was particularly difficult leaving this time around. Spring festival is fast approaching, though, and it’s kind of nice to go from one holiday to another. Besides, there is so much to do here.

Before we left the U.S., James S. Chanos, the famous hedge fund investor who built a fortune on Wall Street shorting companies such as Enron, Tyco International and Boston Market whose stories seemed too good to be true, caused quite a stir when he predicted that China is headed for a crash.

As most of the world bets on China to help lift the global economy out of recession, Mr. Chanos is warning that China’s hyperstimulated economy is headed for a crash, rather than the sustained boom that most economists predict. Its surging real estate sector, buoyed by a flood of speculative capital, looks like “Dubai times 1,000 — or worse,” he frets. He even suspects that Beijing is cooking its books, faking, among other things, its eye-popping growth rates of more than 8 percent.

In an interview in November with Politico.com, Chanos warned that “The Chinese are in danger of producing huge quantities of goods and products that they will be unable to sell.” In December, he appeared on CNBC to discuss how he had already begun taking short positions, hoping to profit from a China collapse.

In meetings I had in the U.S. with other knowledgeable American investors and market observers, I found that many shared the views held by Chanos. Like those companies whose stocks Chanos made so much money shorting, China’s economic performance just seems too good to be true.

In that context, it was somewhat refreshing to read Tom Friedman’s recent editorial, “Is China the Next Enron?” Referring to the dire predictions being made by Chanos, Friedman offered two notes of caution. First, never short a country with $2 trillion in foreign currency reserves. Second, although China has enormous problems, it also has a political class focused on addressing its real problems, as well as a mountain of savings with which to do so.

To further his point, Friedman went back to basics and cited some of the fundamentals that are driving China’s growth. These include:

• The massive investments that have been made, and that China continues to make, in infrastructure projects. For example, crash programs building subways in major cities and high-speed trains to interconnect them will benefit China well into the 21st century.
• China’s 400 million Internet users, 200 million of whom have broadband. (By comparison, America has about 80 million broadband users.)
• China’s 27 million students in technical colleges and universities — the most in the world—which brings a great deal of brainpower to the market.
• The large number of well-educated Chinese returning to China to fill management positions.
• The fact that factories don’t have to move out of China as labor and other costs rise. Low-end manufacturing can move from coastal China to the less developed, Western part of the country and become an engine for development there.

On this one, I’m in Friedman’s camp. Over my 15 years in China, I’ve heard just about every argument that has been made as to why China’s economy would collapse. Civil disturbances would plunge the country into anarchy; regionalism would cause China to break up into a number of different countries; the country’s banks would collapse under a mountain of bad debt; China’s export growth is unsustainable — and the list goes on.

To me, China’s success in overcoming its major obstacles is due to two fundamental factors. First, China has an enormous amount of human capital that is now being educated and mobilized as Friedman points out. Second, the country’s leaders developed a game plan for economic development 30 years ago and have stuck to it ever since.

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