The Real China Story: It’s What Premier Wen Didn’t Say That Matters (FXI, CAF, YZC, VWO, FXP)

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March 8, 2012 1:40pm NYSE:CAF NYSE:FXI

Keith Fitz-Gerald:  According to Premier Wen Jiabao on Monday, China is only going to grow at 7.5% this year. But this isn’t the bombshell most Western analysts think it  is-even though the markets sold off on the day and may continue their temper  tantrum later this week.


It’s actually what Premier Wen didn’t say that really  matters. As is so often the case in China, it’s what goes on behind the scene  that is far more interesting – and actionable.

In that sense, Premier Wen’s comments aren’t really news at  all, but rather recognition of the symbolic priorities attached to Chinese  growth.

As I have talked about at length in the past, China needs to  do three things this year: 1) keep growth in line, 2) promote monetary  stability and 3) be flexible with regard to inflation.

What makes Wen’s 7.5% GDP figure significant is that in  dropping it by half a percent, Premier Wen is not saying, but, in fact,  telegraphing two things:

  • China’s domestic growth priorities have now  trumped growth through exports and manufacturing in terms of relative  importance; and,
  • The Communist Party expects to shift spending to  lower brow projects like ordinary train lines, rural roads, education and  technical infrastructure.

Having spent more than 20 years doing business in Asia, I’ve  learned that Chinese leaders almost never say anything in public they haven’t  already baked into the cake.

This stands in stark contrast to our own politicians who  frequently write checks with their mouths that they can’t possibly cash.

Understanding the China Story

No. China’s leaders are acutely aware of “face” and the  risks of losing it. So it’s what hasn’t been said that’s actually far more  important here.

The real message is that China expects to maintain growth  above 6%, the internal Party Elite’s real target, and continue to develop  employment opportunities that will keep its 1.3 billion people fed, clothed and  housed – so they don’t revolt.

Never mind Iran’s “Red Line.” This is the one that matters.

Understand the importance of 6% and you will understand  China in a way that Washington doesn’t.

Exports, imports, the yuan, the ghost cities, and hard  landings…

None of these things hold a candle to what Beijing considers  its most important issue–ensuring China’s own survival.

Truth be told, I expect China to easily beat the 7.5% target Premier Wen Jiabao put forth on Monday and grow 8.5% to 9.0% by the time the  record books are written.

Admittedly it won’t be without some pain, but then again nothing ever is. Lest we forget, our country stood at the edge of the same  precipice in 1900.

And despite multiple boom and bust cycles, world wars,  assassinations, debt and more, the Dow rose more than 22,000% over the next 100  years.

China will have cycles of its own, but like the U.S. its  long-term trend is much higher-not lower.

Why There Won’t Be a Chinese Collapse

If there is to be a cost this year to China’s GDP, it’s  actually found in China’s $1.7 trillion in local debt.

That’s the amount the central government rolled from banks  onto local government balance sheets last February as a means of avoiding  centralized default.

But don’t confuse that with a collapse.

With a staggering $3.2 trillion in reserve, China has put away a tremendous amount of money for a rainy day. China can literally  recapitalize its banking system several times over and have change left over.

On the other hand, we owe more than $211 trillion to  ourselves according to CBO figures I’ve examined and which Boston University’s Lawrence Kotlikoff has referenced with great fanfare.

We could no more recapitalize our banking system than the man in the moon without cratering it or driving ourselves so far into debt we will never be able to pay it off–which ought to sound uncomfortably familiar.

Despite the dire warnings from noted China apocalypse theoreticians like avowed short seller Jim Chanos, China’s property debt remains very conservative compared to the mess in our own system. There’s very little if any of the securitization there that we have here. This means Beijing can lower deposit costs and guarantee a comparatively wider spread between borrowing and lending rates.

It is an option our government doesn’t really have in  practical terms, though that’s what Team Bernanke’s Zero Interest Rate Policy is intended to do.

Some suggest this is going to be like an imputed tax that  kills growth because Chinese wage earners are going to have to subsidize the results of insolvency by making up the difference via the kind of wealth  transfer we’ve seen here.

I’m not so sure that’s the case in China – at least not immediately.

According to CLSA Asia-Pacific Markets, China’s non-performing loans ratios remain near all-time historic lows.


So don’t let the $1.7 trillion figure scare you. Chances are  it’s not the boogey man everybody makes it out to be. China’s Non-Performing Loan to loan ratio is  under 1%.

What this means, in very practical terms, is that China  actually has room for further fiscal and monetary easing.

In fact, according to The Economist, which analyzed 27 emerging markets and ranked the countries in terms of inflation, excess credit, real interest rates, currency movements and current-account  balances, China has a lot of room to  ease if necessary.

As my long time good friend Frank Holmes, CEO of U.S. Global Investors, put it recently, “the  heart of a China bull beats strong.”

An Important Shift in China’s Plans

And that’s what brings me to the second part of Premier Wen’s comments.

While the world’s tallest buildings and world’s fastest  bullet trains get all the news, his commentary suggests Beijing will shift its  next Five Year Plan to focus on items that provide higher social returns for ordinary citizens rather than the uber-wealthy minority.

That makes sense given that China’s historical growth rate targets have averaged 7-8%, but real growth has been nearly 10%. In 2011, for example, China posted 9.2% GDP  growth versus the 8% officially projected.

Also, if you recall that one of China’s key objectives is to get its booming property markets under control, a lower official growth figure  makes sense because it accommodates the reverse – a drop in property values and  deliberate decreases in property sector investments.

Put another way, what Wen Jiabao didn’t say but what he  implied with his forecast is that Beijing is going to continue to stomp on the  brakes this year.

That is something our government wishes were an option  instead of throwing $14 trillion into the hole we’ve dug for ourselves with  only a few measly percent in GDP growth to show for it.

And finally, while most analysts want to doom China to failure, the other thing to read into Wen’s statement is that China’s next government will come to power at the end of this year and enjoy a banner first  year in office.

By dropping projected GDP to 7.5%, Prime Minister Wen is essentially giving Beijing’s next Party Elite a Sunday pitch he knows they can hit out of the park.

In closing, there are all kinds of reasons you can find not  to invest in China, ranging from the same old tired arguments about democracy,  capitalism, state spending and more.

But be aware that you risk making the most expensive mistake of them all – falling prey to your own bias.

Top Chinese Plays If You’re Just Getting Started

However, if you’re able to put your bias aside and consider  Premier Wen’s unspoken message, here are three ways to invest in China’s  future.
They include:

  • The iShares FTSE/Xinhua China 25 Index (NYSEArca:FXI) – FXI is an ETF that  tracks 25 of the largest and most liquid Chinese companies as represented by  the FTSE China 25 Index. It’s heavily skewed to Chinese financials and is  non-diversified. So expect some volatility and begin nibbling in on days like  Monday or Tuesday when traders run the other way under the mistaken assumption  that China’s glory days are over.
  • The Morgan Stanley China A Share Fund (NYSEArca:CAF) – There are  two ways “into” China – H Shares traded in Hong Kong and A shares traded in  Shanghai and Shenzhen. The former are relatively easy to purchase while the  latter can be tremendously difficult. Fortunately, the Morgan Stanley China A  Shares closed end fund is available. Down off its 52-week high of $29.95, CAF  is trading at a 10.83% discount to NAV according to Morningstar. Traders are  running the other way which means it’s beaten down, unloved and has potentially  more upside.
  • Yanzhou Coal Mining Co (NYSE:YZC) – Natural gas prices, fears of reduced global demand and generally weaker coal markets are  depressing YZC along with much of the sector. Do your best to ignore this and  instead focus on this company’s 3.68% yield while trading at a comparatively  low 6.4x trailing earnings versus the average S&P 500 company, which is at  14.1x earnings.

And, finally, remember that  the genie is out of the bottle on this one. China couldn’t put it back— even if it tried.

Fears of China’s bubble bursting remain greatly misunderstood and overblown.

Related: Vanguard Emerging Markets ETF (NYSEArca:VWO), ProShares Ultra Short FTSE/Xinhua China 25 ETF (NYSEArca:FXP).

Written By Keith Fitz-Gerald From Money Morning

Keith Fitz-Gerald is the Chief Investment Strategist for Money Map Press,  as well as Money Morning with over 500,000 daily readers in 30 countries. He is one of the  world’s leading experts on global investing, particularly when it comes  to Asia’s emergence as a global  powerhouse. Fitz-Gerald’s specialized  investment research services, The Money Map Report and the New China Trader, lead the way in financial analysis and investing recommendations for the new economy. Fitz-Gerald is a former professional trade advisor and licensed CTA who advised institutions and qualified individuals on global futures trading and hedging. He is a Fellow of the Kenos Circle, a think tank based in Vienna, Austria, dedicated to the identification of economic and financial trends using the science of complexity. He’s also a regular guest on Fox Business. Fitz-Gerald  splits his time  between the United States and Japan with his wife and two children and regularly travels the world in search of investment opportunities others don’t yet see or understand.


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