The Tycoon Report

Why China May Use the U.S. for Cheap Labor One Day.

Want to learn how to make money investing in China? Don't invest without these 5 rules. This Week we discuss Rule #2: INVEST IN CHINA DURING THE NEXT ECONOMIC "DOWNTURN."

 Rapid Growth. Dozens of corporations investing billions of dollars of capital. Parents shifting the priorities of their children. Colleges adding the subject to the cirriculum. Businesspeople taking a "gold-rush" mentality to discover more, more more...

Today I happen to be talking about China. But I could be talking about the Internet boom in the 1990's. Or the railroad boom of the 1850's. Or the Steel boom. Or the Oil boom. Or, of course, the Dutch "tulip" boom in the 18th Century.

Yes folks, booms throughout history - regardless of time or place or product - all have one element in common - human nature. And that one element - human nature - always insures that there is another common element in all booms throughout history: A BUST.

Why?

Because people tend to get overexcited about the prospect of fast money and big riches. And when they do, they run to the opportunity in droves. And right now untold amounts of international businesspeople are investing to profit from the duality that is China - 1.4 Billion low cost workers who also happen to be 1.4 Billion potential consumers.

This basic fact leads me to Rule #2 of investing in China:

INVEST IN CHINA DURING THE NEXT ECONOMIC "DOWNTURN."

I say this because China has a history of boom and bust cycles during the past 20 years of its rapid growth and a recession in China may happen sooner then most people think.

Let me explain why:

It's easy to get money from a Bank in China. More then any other source, they've fueled the extraordinary economic expansion that is the envy of the world. However, they are also one major cause of the overheated growth, inflation and other excesses that have accompanied each of the booms of the past two decades.

THE CYCLE BEGINS

The story seems to be repeating itself in the current cycle.

In the past two years, banks have been making a record volume of loans, leading to 100%-300% growth in investment in some industries. The current round began in 1999, when investment picked up after years of stagnation.

Capital spending, the benchmark for industrial activity, has more then doubled during the past five years. Supporting such growth was a doubling of money supply, with M2 (the broadest measure of money) also doubling during the same period. That's excess liquidity floating around the system all over the place.

What's particularly troubling though is that many of the people taking advantage of this excess liquidity don't know what they're even doing. In fact, most new loans have been made by provincial governors, mayors and other local officials for their pet projects.

How can this happen? Most of China's banks are state-owned and staffed by career bureaucrats who have difficulty refusing to fund projects initiated in the name of promoting local development. In 2003 alone, investment in new projects increased by a year-on-year record of 71%.

In the same year, local governments planned to build 122 exhibition halls, 45 of which claimed to be “either the biggest in Asia or in the world” according to press releases. Many folks fear that the majority of these multi-billion projects, funded by medium to long-term bank loans, will be half-aborted.

And the madness, like any boom throughout history, has infected consumers who have bought a record number of properties and cars. In Shanghai alone, where property prices have on average doubled in the past few years, buying a second property for investment purposes is especially popular.

Originally, banks were happy to lend to individuals, as a way of diversifying their client base from inefficient state firms. But this is starting to get out of control.

There is a tendency of “blind loan expansion among banks, which is likely to lead to new financial risks”, according to Tang Shuangning, deputy head of the China Banking Regulatory Commission (CBRC), which was set up last year to regulate banks.

IRRATIONAL EXUBERANCE?

China's central bank certainly thinks so.

Taking a page out of the Alan Greenspan/ U.S. Federal Reserve playbook, the central bank has taken strong steps to reduce liquidity in the system. In April 2004, the central bank raised the reserve ratio of banks, from 6% to 7.5%-8%. In March 2004, it raised the rediscount and short-term refinancing rates by 0.27% and 0.63% respectively.

It also squeezes another source of liquidity, foreign-exchange inflows, with the purchase of $10bn to $15bn of foreign exchange each month.

To tighten property speculation, the government released the now famous "Document 121," tightening lending requirements on property loans. For those of us who remember what happened to the U.S. economy after the FED started its tightening cycle in 2000, will be forgiven if they patiently wait to invest in China.

History has proven time and time again that they will be able to buy assets for far less then they could today.

Remember - You Are What You Read.