Pao Mo Reloaded

Karim Rahemtulla with his own doubts on the Pao Mo* bubble…

[* "Pao Mo" = bubble in Chinese]

China is touted everywhere as the investment destination of the century. Don’t believe it. My experience tells me that the only people who can really make money in China are the Chinese…or at best those who have real, extensive, on- the-ground experience in the country.

My first journey to China, about ten years ago now, was courtesy of an all-expenses-paid research trip funded by an investment group out of Florida. The outfit wanted me and a gaggle of other editors to give some coverage to the ‘China’ story. Yes, my friends, China was a story ten years ago as well.

This was before the Asian Financial Crisis, when Chinese companies were going public in their local markets with the help of some shady Hong Kong business types. Hong Kong, if you were not aware, was born of illicit trade…and it hasn’t changed since birth. It’s just cleaner, not as smelly and you now can say thanks in English before getting ripped off.

Chinese Investment Opportunites: Coming of Age

As my plane landed in Cheng-Du, in the Sichuan Province, I noticed that it was quite dark outside. I am more used to seeing the lighting grids that illuminate most U.S. cities when I travel. There was not a single light in sight. It’s hard to be all lit up when you don’t have electricity in the rural areas! We landed. As we walked through the customs and immigration lines, I noticed that one of the agents had pulled over a cadre of Japanese businessmen and was giving them a good amount of grief. I guess old memories die hard in China.

The first thing I noticed outside the terminal was a huge sign for Jeep Cherokee – remember, this was circa 1995. A huge Mercedes pulled up and whisked us to our hotel. I was beginning to get the feeling that China had really come of age. The hotel was arguably the best hotel I have ever stayed in, five star all the way. Satellite TV, electric shades, marble baths – these guys really knew how to live.

The next morning, I was ready for the tour of the steel mill that we were scheduled to visit. You see, the mill used to be owned by the state and was now privatized and owned by a Hong Kong-listed company. Bicycles – I have never seen so many. Cars? I have never seen so few. As we navigated through crowded streets, it was apparent that China would have to do a lot more than a few hundred billion in trade to get up to speed as a First World country. All around us, poverty made its sometimes pungent presence known fully and completely. A chicken in every pot? How about just a pot first?

We reach the steel mill and were greeted by a huge turnout of employees and staff all wearing their Sunday best and smiling. They could smell the profits reeking from our First World clothes. The Chinese had a weird sense of fashion. The up and comers wore Western suits – with the labels still showing – the sign of prosperity. We were led around the factory, given a tour of the smelter, offered bamboo hard hats (I still have mine) and warned of the dangerous environment. Apparently the amputees had the day off for this tour.

As we toured the facility, many of the upper-level executives who spoke very good English began to cozy up with us. The plant was spectacular, no? It was now the lowest-cost producer of steel in China – ever since the state let go. We were now on our way to see the local communist party head who agreed to give a little speech to mark our visit. We entered an building that was set up like a small amphitheater. The officials welcomed us with smiles and nods. I held on tight to my wallet. The head red said nothing of significance or worth remembering. But as he wiped his hair back, I noticed that he was wearing a real Rolex watch. (As a one-time watch enthusiast, I can spot the real thing from a mile away – it’s all in the magnification.) I asked myself how a Communist Party official could afford such a luxury on barely $20 a month for a salary. Then I remembered that I asked myself the same questions in 1982 when I visited Russia as younger, more naïve young man. He must have gotten rid of the manila envelope by now.

Chinese Investment Opportunities: Unsuspecting Foreigners

The meeting ended. We were invited to a party with the party. At the party, the officials and executives were getting very friendly and anxious. They began extolling the virtues of the steel mill, its huge profitability and the capitalist changes taking place in China. No one was biting. They loosened their ties and announced that it was time for some "woolong ye" (not to be confused with "falun gong.") It was barely 2pm and out of nowhere appeared a bevy of beauties with bottles and glasses. Woolong ye is the Chinese equivalent of moonshine…I guess. I don’t drink alcohol (before 6 pm anyway) and so I refused to partake in this party with the party.

These Chinese were not shy about showing their fondness for hooch. It was too late. An hour had passed and I was the only sober one in the room, probably in the entire plant. They started to spill their guts – figuratively. The plant was not owned by the Hong Kong company. It was still owned by the state…ha ha. The company executives in cahoots with Mr. Rolex had "leased" the plant to the Hong Kong company so they could pitch it to unsuspecting foreigners (read Americans who love a bargain) and then turn over their shares in the this public company at a nice profit. If a few of the analysts and writers on the trip wrote about this Hong Kong small cap that also traded on the Nasdaq bulletin boards – their retirement would be set in stone, or better yet, U.S. dollars. Then, they could tear up the lease agreement and the state would be none the wiser. I mean, how many people are there in China? A billion two, three? How easy is it to pull a fast one?

It’s all in the numbers.

The trip ended badly, in more ways than one. I left feeling that I had wasted my time. As I mentioned before, I came to the conclusion that the only people who would make money in China then were the Chinese. If you want to invest in China, be careful and look to experience. It is one of the few countries where I would gladly pay a fund manager like Mark Mobius a point or two to lead the way.

Fast Forward to 2004. Just days ago, China Life, a wildly successful Chinese Life Insurance company, saw its shares tank. In fact, they are down 30% in about a month. The decline worsened as news came that an investigation into the company’s parent company yielded lots of irregularities. I wonder if the company’s CEO wears a Rolex?

Next stop – India.

Karim Rahemtulla
February 11, 2004

Where was George W. Bush?

The question came up at dinner last night. We dined in Madrid at El Ampare, a marvelous restaurant. While we were eating a delicious ox sirloin, helped down by a tide of rich rioja, the conversation turned to politics.

Our dinner companions were Spanish and Argentine…but American politics is an irresistible topic almost everywhere.

Of great interest to everyone is the way in which the two parties in the U.S. have switched roles. The democrats’ front-runner, John Kerry, puts himself forward as a war hero…with scars to prove it. Where was G.W. Bush when their hero was getting shot at, Kerry’s supporters what to know?

We will return to our dinner conversation below, but first…we take a look at the world of money. Our book was translated and released in France a week or so ago. The last report from the publisher was that 53 copies had been sold. The book was a hit in America – where it made the top of the NYTimes business bestseller list. This rather surprised us; we did not think so many Americans would want to read about the ruin of their own economy.

In France, by contrast, we imagined book buyers would line up to gloat over America’s decline. Not so far; reviewers tell us that we must be way off-base. ‘Everyone knows the U.S. is in full recovery,’ they say.

The recovery is an imposter, we point out. But, so far, the French media – like their American counterparts – seem unconscious of the threat of a meltdown.

It may be an odd recovery, they reply, but it is good enough for us.

The trouble with the recovery is that it had not enough trouble to recover from. Now, without the fuel of pent-up purchasing power, it runs out of gas. Without enough worries to grip onto, stocks should have no wall to climb. Without a dense fog of gloom over Wall Street…the sun has nothing to break through.

Business profits are up, say the positive-thinkers. But they are up for the same corrupt reasons that the recovery is a fraud. Americans don’t find new and better-paying jobs. Instead, they find new and more costly houses. Loading themselves up with mortgage debt, they buy more and more from overseas – on credit, to be sure. American businesses don’t need to hire more people – because they are not really producing much more. Both the hiring…and the cost of hiring…falls outside of the U.S. economy. American businesses get the temporary advantage of a new credit-induced spending boom, with no offsetting new employee cost. Profits go up, especially profits made from financing all this spending.

But how do people get rich, dear reader? They do not do so by mortgaging their houses in order to buy the things they want. No, they get rich by making the things that other people want to buy. The old virtues…thrift, industry, discipline, forbearance – that is what it takes. Now, as always.

A reviewer in London recently objected to the moralistic tone of our book. Modern economists hate the idea that they cannot tinker their way out of a crisis. Of course, today, they can make things better. But only by undoing the damage they did yesterday.

Here’s Addison, with more news:


Addison Wiggin in Paris…

– Dear reader, we will share a little secret with you. Bill, as you know, travels frequently. On many days, the Daily Reckoning is assembled here in the DR HQ after Bill has written his leading thoughts and e-mailed them to us from afar. Sometimes, he is…how shall we say this politely?…out of touch. Today was one of those days.

– You see, while bemoaning the slack sales of the French edition of Financial Reckoning Day over his huevos in Madrid this morning, the French office was (and is) all abuzz. Sales are extraordinary. In fact, the French FRD is currently the best-selling book in France, according to its ranking. We tried to reach Bill by phone to tell him, but did not succeed…and so, you will actually get the news before he does.

– Of course, this has nothing at all to do with the stock market or the economy, but we thought you might enjoy the irony…as we have.

– Meanwhile, the worst-case scenario for the U.S. economy – growing unemployment and a dollar crisis – looks like it’s in a holding pattern awaiting comments from Sir Easy at today’s Humphrey-Hawkins address before Congress. As we mentioned Monday, the January jobs report was nearly 50,000 jobs shy of most analysts expectations. The dollar has fallen nearly 2 pennies and gained back 1 since the G7 issued its own incomprehensible press release over the weekend. But now we wait again…

– During the semi-annual Humphrey-Hawkins, Greenspan humps his butt up Capitol Hill to give the elected few a view all his own. Provided we’ll be able to unpack his comments after he’s made them…we’re expecting to hear more on one of two subjects…ummmm, jobs or the dollar. Prescient of us, eh? Then again, he could give us his recipe for making a strong cosmopolitan, and we wouldn’t really be the wiser, would we? [Ed note: as we go to press, Greenspan has just given his address…and investors seem to like what they think they’ve heard. The stock market, gold, and bonds are all rallying sharply. Details tomorrow.]

– Perhaps for a clearer, spin-free diagnosis of what’s happening to the U.S. economy, we should choose our speech givers more carefully. Peter Bernstein, author of The Power Of Gold and economic consultant, spoke before roomful of students last Friday at the National Association of College and University Business Officers…and sounded every bit the Daily Reckoning reader, or at least commiserator.

– "As [Bernstein] sees it," writes’s Chidem Kurdas who was there, "Asian economies are gaining while the United States is losing jobs. Moreover, Asian populations are saving and lending to Americans, who need to borrow to finance excess spending. Mr. Bernstein questioned the long-term viability of the ‘we buy and they finance’ arrangement and identified the growing federal budget deficit as a major reason for international imbalance.

– "Another concern is the continuing growth of income inequality in the United States. The recent increase in profitability comes at the expense of workers, with the share of employee compensation falling, Mr. Bernstein said, claiming that people are forced to hunt for bargains and that is what makes Wal-Mart an icon of the American economy.

– "Bernstein’s worst-case scenario involves growing unemployment and a dollar crisis. Acknowledging that such dire warnings in the past typically have not come to pass, he advised holding stocks in case this forecast is wrong, but at the same time preparing for the worst.

– "Think of the non-equity side of your portfolio as a hedge, not a volatility reducer, he recommended. Because hedging is expensive, he advocates using instruments such as gold that would provide the greatest upside if economic imbalances generate shocks. ‘The hedge should give you the biggest bang for the buck if I am right,’ Bernstein said."

– "Is Alan Greenspan Behind China’s Bubble Too?" asks Bloomberg’s William Pesek, a journalist rapidly growing in our esteem. Pesek suspects, as do we, that the Fed’s commitment to keep rates at their 1958 low for a "considerable period," followed by their "patience" in changing their bias, has fueled speculation in Asian assets to such a degree that China can’t afford relax the yuan’s peg to the U.S. dollar…

– Our friend Richard Duncan, author of "Dollar Crises: Causes, Consequences, Cures," suspects that somebody other than Greenspan is behind the wheel. "The amount of new yen," writes Duncan in an op-ed in the Financial Times, "that Japan ‘printed’ and converted into dollars during January 2004 alone was enough to finance 13 per cent of the U.S. budget deficit."

– Mr. Duncan’s point? While all eyes in the financial media are focused on profligate spending by the Bush administration and historically low rates set by the U.S. Fed, Japan is still taking the cake when it comes to government intervention in the markets. "By accident or by design," Duncan notes, "Japan is carrying out the most audacious endeavor to conjure wealth out of nothing since John Law sold shares in the Mississippi Company in 1720."

– Duncan: "In mid-2003, economists at the U.S. Federal Reserve published a paper explaining why the Fed was not ‘out of bullets’ despite having cut short-term interest rates to 1 percent. That paper stated that ‘the Fed could even implement what is essentially the classic textbook policy of dropping freshly printed money from a helicopter,’ if necessary, to stimulate the economy.

– "Today, that helicopter is in the air. But, strangely, it is not the Stars and Stripes that is painted on its side, but rather the Rising Sun. That much is clear. What still is not quite discernible, however, is who is actually in the pilot’s seat."

– A better question yet: can it be piloted at all?

– One thing is sure, the money is still fluttering its way down into the vicinity of Wall and Broad in Lower Manhattan. The Dow rose 34 points yesterday to 10,613…still inching its way closer to the January 27th high of 10,748. The S&P and Nasdaq tacked on 5 and 14 respectively.


Bill Bonner, back in Madrid…

*** "Just a few weeks ago," began a dinner companion, "it looked as though Bush had the race for re-election won. He was way ahead. Now, it looks like it might be a real race after all."

We have not kept up with the news. But from what we were able to tell from last night’s conversation, the democrats’ attacks are starting to sting. We will bring federal deficits under control, they promise.

Of course, only conservative republicans would care about the budget deficit…

But attacks on Bush’s military prowess have been sharp. How the wheels of poetic justice grind – slowly, but surely. Bush puffed himself up as a warrior president. "Bring ’em on," he taunted his enemies. And now the Democrats bring on his Vietnam-era record.

While Bush was hiding out in the National Guard or AWOL on the beach at Ft. Lauderdale, our man was doing his duty, they say.

But that is the delightful thing about politics. No lie is so powerful as the one that is wrapped in deceit and covered under a manure pile of humbug. While John Kerry brings out his war record, the master-mind of the war itself – Robert MacNamara – appears on college campuses finally admitting that the whole war was a blunder.

The Indo-China wars tripped up millions, of course – French, and then Americans. Honest farm boys went to war in good faith on bad advice. There were Yale graduates, too. Aiming for the White House, they might have hit a Vietnamese peasant once or twice.

The Daily Reckoning