Want to learn how to make money investing in China? Know this rule!

SIZE DOES MATTER.

Just ask any Chinese person. They know that the reason every corporation in the world is running to do business there is the prospect of selling to 1.3 BILLION people. That's 25% of the world's customers . . . er . . . population - all in one place.

But the fact is that just because such a big market exists doesn't mean you'll be able to profit from it. Sure, somewhere inside the country the next "Bill Gates" is creating the Chinese version of Microsoft (SYM: MSFT). And in another part of the country, a Chinese Michael Dell is building the next version of Dell Computer (SYM: DELL).

But finding - and profiting - from these opportunities carries as much risk as it does reward.

George Soros, the famed investor and member of the Forbes 400 list, is fond of saying that he’s not a “security analyst or a stock analyst.” Instead, he likens what he does to being an “insecurity analyst.”

Mr. Soros’ recent political aspirations aside, his point is well taken: it pays to carefully look at everything that can go wrong with an investment before committing a single penny to it. It is in light of this that we offer you our 5 Most Important Rules to Investing in China.

But these rules don't only apply to China. They apply to any developing country at any time in its economic development. Why have rules? Because we believe that something can always go wrong. Feel free to call us paranoid: Experience has taught us (often the hard way) that a fool and his money are lucky enough to get together in the first place.

INVESTING IN CHINA RULE #1:

BEFORE YOU INVEST IN CHINA BE AWARE THAT DOING SO CARRIES SIGNIFICANT POLITICAL RISK.

With everybody so bullish on China these days it's sometimes easy to forget that China is still a developing country with a Communist political system. Not only do people forget this, but many folks seem ready to anoint China as the world's greatest superpower.

They assume a growth trajectory that shoots straight up with no internal or external interference. Having spent my entire lifetime studying both financial and political history, I have one thing to say to those people:

Not so fast, folks. In fact, the people who are offering China the crown of "superpower" would do very well to read a bit of history themselves. And since human nature doesn't change, history tends to repeat itself over and over again.

That's why I find the recent talk about China becoming more and more irrational the longer I hear it - just like the peak of every bull market throughout history.

Perhaps the most disturbing thing I've heard recently has been pundits on television suggesting that China will prove to the world that you don't have to choose between the Western model of democracy/capitalism OR the old Soviet model of communism/socialism.

China, they argue, is proving that you can have a communist political system and a capitalist economy all under one roof. I call it the "INDIA ARGUMENT" because the people touting it believe that India's slow democratic decision-making holds it back from the fast economic growth China currently enjoys.

That sounds an awful like the DOT-COM argument of, "But this time things are really different."

BELIEVING SUCH FOLLY IGNORES HISTORY AND IS VERY RISKY.

Let me explain why:

Right now all major decisions are centrally planned, through the Communist party. But as economic growth spreads across the land, the balance of power will SHIFT AWAY FROM the Communist party INTO THE HANDS of the capitalist companies/people creating all the jobs and making all the money.

That means that the hundreds of politicians who run the country now will see their power shift to thousands of corporate participants; into a system of decentralized decision-making. This shift in the balance of power is what will enable Corporate China to demand a bigger say in how Political China is being run.

It's at this point that Political China - whose primary goal is to create jobs and provide stability - will realize that it needs to do what Corporate China wants in order to maintain stability.

Take Intellectual Property Rights as a simplified, but revealing example. Currently, we take for granted here in the US the right to protect our intellectual property. CEO's and entrepreneurs know that if they invent a product, competitors can't steal it without repercussion.

Sure, it might take a long court battle, but recourse usually comes. In the US, we know that if anybody steals our property we can utilize an independent judiciary to get it back.

If Corporate China can't get the same assurances, then that will stifle growth, because they won't invest big sums of money for fear of losing it. Without investing in new products, jobs won't be created. Without jobs, the economy suffers. When the economy suffers, Political China is at risk of losing its power.

Thus, creating an independent judiciary that will, at the very least, protect capitalist intellectual property, must be done to insure stability of the country. It's one of the bedrocks of a market-based system. The problem is that it conflicts directly with a one-party Communist system.

Let me explain:

For an independent judiciary to protect intellectual property, truth and transparency are required. For a Communist party to maintain control, secrecy is required. Obviously this is a conflict between Corporate China and Political China that will be won by the group with the most power.

That group will be the people that provide jobs (stability). I have no doubt that in the long-term, Corporate China will run the country and the government will become a tool of Big Business - just like in the US. But in the short-term, shifting the balance of power from one group to another poses significant political and financial risks to investors.

That's because history has proven time and time again that people don't easily give up the reins of power. Except, of course, in the case of our country. We could thank George Washington for that special gift.

RULE #2 IS COMING NEXT WEEK: STAY TUNED

Remember - You Are What You Read.