Invest in China's Geeks and Guts

Gaithersburg, Maryland- China’s role in the global economy is bigger than ever. Even amid a global depression, China’s potential is mind-bogglingly vast. What follows are some thoughts on China’s potential – and a good way to play one of China’s growth industries, even now…

If China’s economy continues to grow at its current rate, it will pass the U.S. as the world’s largest economy in 18 years. Of course, it won’t grow at its current rate for 18 years – not continuously, anyway. It will grow somewhat slower in spots and sometimes faster. What growth rate comes out in the end is anybody’s guess, but the 18-year guess will probably be off.

Then again, the guess also assumes the U.S. stays where it is. And that is also unlikely. The U.S. economy shrank last year and looks to shrink again in 2009. Meanwhile, China is one of the few big economies still growing, though at a slower pace. The result is that China will actually make up ground faster in 2009. As Ting Lu, a Merrill Lynch economist based in Hong Kong, notes: “In 2007, the gap between the growth rates of China and other big countries was huge. Actually, in 2009, the gap between will be even bigger.”

As the Great Depression II continues to lay siege to the world’s economies, China remains a coiled spring of growth. Even though China is now the world’s second- or third-largest economy, it still is a relatively poor country. And its resources are barely tapped.

The vast potential of China is hard to grapple with. Already, China has built the world’s largest building (Beijing’s airport terminal) and its longest transoceanic bridge. It has the world’s fastest train and the biggest dam. As John Pomfret, former bureau chief for The Washington Post in Beijing, observes: “It is a nation of builders, of grand schemes, of gigantism.” He calls China’s engineers “some of the world’s biggest risk-takers. Geeks with guts.”

The Qinghai-Tibet railway was another engineering feat. Chinese engineers, already considered the best railway builders in the world, built a railway on the complex and shifting permafrost linking Llasa with Golmud in China’s western hinterlands. The railway stretches hundreds of miles across a treacherous plateau.

Author Abrahm Lustgarten in China’s Great Train describes the area as one of “intermittently frozen marshes, lakes and soggy permafrost that heave and shift more actively than almost any other geologic environment on Earth.” In places, the quicksand is deep enough to swallow a tank. It is also higher than any other railway on Earth – at its peak, more than 16,600 feet above sea level. The cars of the train are pressurized as in an airplane, with oxygen pumped in.

After this stretch of the Qinghai-Tibet railway opened in 2006, the riches of Tibet started to come to light. The Ministry of Land and Resources disclosed huge resource finds – big veins of copper, zinc, lead, iron, gold, silver and other minerals.

“The new reserves make Tibet one of the richest regions in China’s territory,” Lustgarten writes, “and could shift the country’s reliance on imports of copper and iron altogether.” Tibet could hold 40 million pounds of copper – one-third of China’s total. There is more than a billion tons of high-grade iron ore.

Again, Lustgarten: “Among the discoveries in Tibet was China’s first substantial rich-iron supply, a seam called Nyixung, which alone is expected to contain as much as 500 million tons – enough to put an expected 20% of Chinese iron importers out of business.”

More than just minerals, there is also an abundance of oil. Sinopec estimates some 65 billion barrels of oil will become accessible in Tibet. “A find, that if proven,” Lustgarten writes, “would make the region one of the next great petroleum envies in the world.”

What makes these projects economic now is the Qinghai-Tibet railway. Many Canadian and Australian companies already have joint ventures in place to mine the plateau.

The economy boomed in Llasa, too, thanks to the railway. The number of restaurants and bars in Llasa increased over 20% within a year of the railroad’s completion. More than a million tourists took the train west to Llasa. Where it was once hard to find a hotel room in Llasa, over 660 hotels sprouted up after the railway. One, the Brahmaputra Grand, is a luxurious hotel with crystal chandeliers the size of Volkswagens and 50-foot tall plastic palm trees. A night here set you back $1,100.

Tibet industry up to that time was mostly in trading yak tails, fur and salt. And now, it looks as if Tibet will play the role of China’s great western frontier, much like America west of the Mississippi in the 19th century.

There will be and is an ugly side to all of this that I’ve not talked about – the suppression of ethnic Tibetans and the weakening of a very old culture. China, though, continues to build and build. As Lustgarten notes: “The western outposts are linked by an expanding transportation infrastructure – roads, power transmission lines, pipelines and railways – built at a rate that makes Dwight Eisenhower look lazy.”

But as with the rest of world, the pace has cooled. The fingers of depression wander all over the globe. No one can say how long it will take to work out of this mess.

However, some hopeful signs emerged recently. The China Electricity Council reports that electricity consumption rose nearly 7% in December, year over year. (More on that below.) If no one has doctored up those numbers, that would be the first such increase since July. And there is some anecdotal evidence that housing prices in China are on the rise again.

Nonetheless, over the long term, China has lots of room and resources to grow. We got a glimpse of the implications of that growth in the last several years – the huge pull on resources such as oil, for instance. At the moment, economic depression has set in most everywhere. But longer term, it seems foolish to bet against the great dragon in the East.


Chris Mayer
for The Daily Reckoning

January 20, 2009

P.S. I mentioned above that China’s electricity usage was up. There is opportunity in that. A slowing economy has not stopped China from investing in energy projects. China’s power demand is still growing. And China overall increased spending on power grids by 18% last year.

Chris is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer’s essays have appeared in a wide variety of publications, from the Daily Article series to here in The Daily Reckoning. He is the editor of Mayer’s Special Situations and Capital & Crisis – formerly the Fleet Street Letter.

Chris also recently wrote a book: Invest Like a Dealmaker: Secrets from a Former Banking Insider.

O! Bama!

Today’s the day…the whole world turns its weary eyes to you.

“Obama’s moment arrives,” says the International Herald Tribune.

“World needs Obama to succeed,” begins an editorial in the Financial Times.

“The Hope of the World,” says one Paris-based magazine…with a photo of Barack and Michelle on the cover.

Never before have so many people counted so much on just one man.

In the torrent of words and pictures are two thoughts: One, a sense of achievement and pride…in that Americans elected the son of an African as their top man. It is thought to mark a major step forward for the whole human race. We have risen above our prejudices…and our past. At least, that’s what they say. Two, there is an expectation…or perhaps only a wish…that this man can somehow keep the world economy from falling apart.

As to the first thought, we have no opinion. We were never able to get into the spirit of racism. In fact, we were suspicious of it. People don’t really care about race; it’s culture that matters.

But as to the second thought, we have a number of opinions…most of which you have suffered already, dear reader.

Here at The Daily Reckoning, we wish Mr. Obama well. But it is not wishes that make people wealthy. It is work, saving, innovation, and luck. And it is not wishes that fix a post-bubble economy…it is a bust. Best to let it happen.

But we are alone in that opinion…as in so many others. Everyone wishes the errors of the bubble years would just go away…that the bust would disappear. Of course, it doesn’t work that way. Instead, the errors of the last boom/bubble period – known as the ‘Great Moderation’ – get passed to the Obama Administration along with the keys to the washroom. And now, the whole world looks to the captain of the team…waiting instructions.

And here we turn to the rest of the news. Markets in the United States were closed yesterday. But Britain had its worst day in years. And today, Asian markets are trading lower…because of the problems in the banking sector.

“Blue Monday,” the Daily Telegraph calls it. The Royal Bank of Scotland has just reported the biggest loss in British history – 28 billion pounds worth. Its share price lost 67% yesterday – also a record breaker.

The Brown government is on the case…like the Obama government on the other side of the Atlantic. Last week, the Bank of America got a $138 billion handout. And Merrill Lynch got guarantees covering $118 billion in dodgy assets. This week, what fixes will her majesty’s government come up with? What magic wand will the chancellor wave to make the bust go away?

We remind readers that the Brits were America’s closest sidekicks during the boom years. As American house prices soared…U.K. house prices soared even further. And as Americans went deep in debt, the Brits went even deeper. Those were the days when the Bubble Gang robbed the banks of capital – paying out huge fees and bonuses…rewards for making the worst deals and investments in the industry’s history. RBS, for example, is in a jamb because its managers went on an acquisition spree – including the biggest banking deal in UK history, the purchase of ABN Amro for 49 billion pounds. Each acquisition was like a conquest, celebrated with champagne and bonuses. But did RBS have 49 billion? Of course not. It borrowed the money; it was a leveraged deal. And naturally, now that the bubble years are over, it’s having a tough time paying the money back. Mistakes have to be corrected after all.

And so the Brown government has stepped in. From an initial bailout of Northern Rock, which put the government on the hook for 55 billion pounds in September ’07, the taxpayers’ potential liability has grown with each step of the banking crisis. In September 2008, it was Bradford and Bingley that needed a bailout. Then, the whole sector needed credit guarantees…and a special liquidity scheme was added in October…followed by further insurance and a “toxic asset” buy-up plan a few weeks ago. Now, the total at risk is nearly 1 trillion pounds…or nearly $50,000 per UK taxpayer.

*** It was only a few months ago that Mr. Brown stood before Parliament and misspoke… “We have saved the world…” he began…before the MPs started laughing.

He meant to say that he had saved British banking with a 37 billion pound program. But even that turned out to be wishful thinking. Now, he’s back with another 350 billion pounds in rescue money. The earlier saving grace put 20 billion of the taxpayers’ money in RBS. That now looks like a poor investment; the bank is only worth 5 billion. But that doesn’t stop the politicians from putting bad money after good. Besides, they’ve got plenty of bad money…and are about to have a lot more.

Yes, dear reader…we have confidence in our central banks. And our confidence was raised even higher after reading this report in the Telegraph:

“Bank of England edges closer to ‘printing money'” says the headline.

The report continues:

“Under the scheme’s terms, the Bank will be able to buy assets including corporate bonds and commercial paper, a move which Mervyn King, the Bank’s Governor, called “an important additional tool to improve financing conditions in the economy.”

“The asset purchase facility does not in itself amount to quantitative easing or ‘printing money,’ because the scheme initially will be financed by Treasury Bills and does not involve an increase e in the money supply.”

And here’s the money paragraph…

“However, the Treasury has given the Bank’s Monetary Policy Committee the option to go down that road by extending the scheme at a later date and paying for assets with what amounts to newly created money…”

Now, all three of the Western world’s leading central banks – the Fed, the ECB and the BoA – are ready to print money. And the big question before us is how long will it take them to get the printing presses oiled and working properly?

Mr. Obama enjoys more “political capital” than any leader in history. The whole planet – and perhaps the whole galaxy – is rooting for him. What will he do with it?

As for his inaugural speech, Mr. Obama is expected to appeal to the public’s residual sense of heroic civic service.

“Ask not what the banks can do for you…ask what you can do for the banks,” he is likely to say… Just kidding, of course. That is what he is likely to do, but not say. Everyone believes the banks need more money. He is likely to give them more. How? Using the “quantitative easing” technique…otherwise known as printing up money. The banks, of course, will not lend…and people will not borrow. They’re not fools. So, then, the Obama administration will begin pumping harder…like they do in Zimbabwe.

*** Zimbabwe just released a new bill – the 100 trillion dollar note, said to be worth about 33 US dollars yesterday. Today, it is worth about $16. Tomorrow, it will be worth about $8. Within a week or two, it will be as worthless as all the other notes the Zimbabweans have printed.

Of course, we’re a long way from there. Many prices in the United States and Britain are actually falling. The feds still don’t have the printing presses working properly. But they’ll get the hang of it; we’re sure of it.

A Zimbabwe-style inflation may seem unlikely. But is a U.S.-style inflation, circa 1970s, unrealistic? That too, was caused by policy errors, says Robert J. Samuelson. The feds were so eager to promote full employment, he writes, they caused stagflation. Consumer prices were rising at a 13.5% rate by 1980. Unemployment reached as high as 11%.

Those rates weren’t the end of the world. But they were the end of an era. Stocks fell from a high in 1966 down to a low 14 years later. And bond yields went in the opposite direction. From the lows of the ’50s and ’60s…they were in the double digits by the early ’80s. Then, of course, stocks and bonds bottomed…and a new boom began.

The average bear market in stocks takes about 15 years to reach. Looking at it from our usual happy, positive perspective, we put the beginning of the bear market in January 2000. Since then, stocks are down in real terms. If the bear market were to last 15 years, you could expect the bottom six years from now….at prices probably about half what they are today.

But never before have so many financial policymakers been so determined to prevent a correction. How? By causing inflation. Our guess is that they’ll get the hang of it long before the bear market has run its course.

“Inflation could return sooner than you think,” says MoneyWeek magazine. “Instead of deflation, by the end of this year we could have the beginnings of really rapid inflation,” said hedge fund manager Jim Mellon, “which could get out of control, particularly in America.”

“It could be a year…maybe 24 months,” said an old friend yesterday. Terry Easton, who put the key question to Ben Bernanke last week, thinks Obama will follow Roosevelt’s program.

“Secretly, bankers are already being advised about how to handle a bank holiday,” says Terry. “There will be limits on how much money you can take out of a bank. And probably limits on what you can do with it.”

There will probably be controls on trading gold .. that was one of Roosevelt’s plan too. And probably a national health care program. And who knows what else.

And until they get the inflation pumps working again, look for falling prices on stocks, houses…and just about everything else. Unemployment will rise higher than almost anyone expects. The Chinese economy could implode. Fortunes will change hands…with just about everyone ending up a net loser. Businesses will go bust. Malls will be closed. Banks will be nationalized (even more than they are already).

*** It’s eve of the Feast of St. Agnes tonight…looking for a husband? This is your big chance…

St. Agnes that’s to lovers kind
Come ease the trouble of my mind…
– Keats

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. By the time you read this, Barack Obama will officially be the 44th President of the United States.

The Daily Reckoning