Investors Should Be Bearish on China

Why support currency manipulation, unfair industry subsidies, and stealing of U.S. trade secrets?

   

I have long advised against direct investment in China. Among the many reasons I am bearish on the country is its vastly distorted economy.

China’s is a command-style economy run by an unelected political party — the Communist Party of China (CPC). The CPC’s policies have resulted in a grand misallocation of capital. A mercantilist currency policy, perverse incentives for provincial-government officials and crude monetary-policy tools have helped inflate a fixed-asset and real estate bubble that makes the U.S. real estate bubble seem trifling.

Economic Growth: China’s Quality Problem

It should be obvious to most observers that things are not as they seem in China. The country has reported GDP growth of 9% or more in every quarter over the last two years, yet the Shanghai Composite Stock Index has plunged more than 30% during that time. If China’s economy were truly booming, Chinese shares would most likely be trending up. When it comes to economic growth, China doesn’t have a quantity problem — it has a quality problem.

China’s GDP statistics are being propped up by unproductive fixed-asset investment. The real estate sector is the most obvious example. To prop up GDP growth rates, the Chinese are building entire cities — but those cities are virtually empty.

It’s perplexing that the world has allowed a command-style economy run by an unelected political party to become such an important player in the global economy. China is now the world’s second-largest economy and America’s second-largest trading partner. If the country tanks, the world economy will suffer.

No Profit Motive: Manipulation Through Subsidies

Shanghai A Share Index 300x178 Investors Should Be Bearish on China
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China doesn’t play by the same rules or have the same motives as the world’s other large economies. It has consistently manipulated its currency to gain export market share and subsidized favored industries through its financial system to the detriment of non-Chinese companies. Take the rare-earths industry, for example. China now has an effective monopoly on rare-earths production. This isn’t because of the country’s low labor costs or a lack of reserves in other countries, it’s because Chinese rare-earths companies were provided with subsidized loans.

Rare-earths companies ramped up production in the 1980s and ’90s, driving prices down to unprofitable levels. The Chinese government was more interested in maintaining stability through high employment then, as they are today. Low prices pushed rare-earths producers in the U.S., Australia and elsewhere out of business and, with the support of subsidized loans, China’s rare-earths companies were the only ones able to remain in business at such low prices. Now, the U.S. relies on China (at least temporarily) for a supply of metals vital to its defense industry and other high-technology industries.

Hacking: “The World’s Most Active Perpetrators”

There is also mounting evidence that China has been hacking into the networks of U.S. companies and organizations. The Wall Street Journal reported recently that a group of hackers (read: the Chinese government) hacked into the U.S. Chamber of Commerce’s computer network. The Journal reports that the hackers may have had access to the Chamber’s network more than a year before the breach was discovered.

The full extent of the damage from the hacking incident will be difficult to determine, but it is possible the Chamber’s network was used to send booby-trapped emails to Chamber members (large U.S. companies) to gain access to their computer networks with the likely intention of stealing trade secrets. According to the U.S. counterintelligence chief, the Chinese are “the world’s most active and persistent perpetrators of economic espionage.”

So China unfairly manipulates its currency to gain export market share. It subsidizes favored industries, which drives companies in America and other countries out of business. And it illegally hacks into U.S. companies’ computer networks. Does this sound like a country that should be our No. 2 trading partner? How about a country you want to invest in? This is why I continue to avoid Chinese shares and advise the same for you.

The opinions contained in this column are solely those of the writer.

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