SPEAKING
FREELY Investing in China: Fool's
gold? By Thomas I Palley
Speaking Freely is an Asia Times
Online feature that allows guest writers to have
their say. Please click hereif you are interested in
contributing.
Americans tend to
disregard history. Henry Ford, founder of the Ford
Motor Company, famously declared bluntly, "History
is bunk", while US novelist Gore Vidal calls the
US "the United States of Amnesia". Usually, this
disregard has few consequences, but sometimes not.
That may be so with investing in China, where
history suggests profits will be far below
expectations, possibly making
those investments fool's gold.
China's
history is completely different from that of the
United States and it has left deep imprints on
China's politics. Therein lies the trap for
investors and policymakers who ignore history and
wishfully think market forces will inevitably make
China just like the US.
One critical
factor is China's attitude to foreigners. That
attitude is captured by the Great Wall of China,
which provides a metaphor for the country's long
history of isolationism and xenophobia. A second
critical factor is the legacy of China's
humiliating defeats in the unjust 19th century
opium wars with Great Britain. At the time,
Britain had a large trade deficit with China,
owing to British demand for tea, and it demanded
the right to sell Indian opium in exchange. When
China refused, Britain used military force to open
China's market, and the ensuing sale of Indian
opium resulted in massive addiction.
This
historical experience has made China nationalistic
and profoundly averse to foreign exploitation,
which is why history is so relevant for investing
in China. As a result, China will never allow
itself to be exploited by foreigners. For
investors, the trouble is that China views making
profits from the Chinese market as a form of
exploitation.
When foreign investments are
for exports, China has viewed the profits as being
earned abroad. Difficulties only arise when the
goal is production for the domestic market. This
explains why profitability on such investments has
historically been so low, and why so many
joint-venture investments with Chinese partners
have failed. It also helps explain China's
persistent refusal to enforce foreign-owned
patents and copyrights that apply to medicines,
movies and music.
The lesson is that
companies are likely to be disappointed regarding
hopes of profiting from China's massive domestic
market.
That has special relevance for
American banks and insurance companies. China will
allow these companies to invest in and modernize
its financial services infrastructure, but the
profit pay-off is questionable. The same holds for
auto companies, which China will allow to transfer
technology and build modern plants. As long as the
production is for export, those plants will be
allowed to earn large profits. But once they start
selling in the Chinese market, profits will likely
shrivel under burdensome restrictions and theft of
technology, ideas and designs.
Stock
market investors face a different case of fool's
gold, with stock prices being artificially
inflated by China's under-valued exchange rate and
capital controls. That makes prices vulnerable to
changes of policy.
The under-valued
exchange rate has contributed to China's massive
trade surpluses, and China has had to buy dollars
and sell yuan to prevent its exchange rate
appreciating. That has expanded China's money
supply, and Chinese investors have bought stocks
to earn higher returns and protect against
inflation, driving up stock prices. Capital
controls have also played a critical role by
limiting investments available to Chinese
citizens. Since money cannot leave the country,
they have been forced to buy local stocks. Hence,
the explosive appreciation of the Shanghai stock
market, which has spilled into the Hong Kong
market.
China's government has profited
from this bubble, as it has been able to sell
state-owned companies at high prices. Wall Street
has also bought into the bubble, telling Main
Street investors that the appreciation of Chinese
stocks reflects China's growth prospects rather
than its artificial market.
However, come
the day that China allows external investment by
Chinese citizens, Chinese stock prices are likely
to suffer as local investors move to diversify
outside of China. That potentially makes long-term
investing in China's stock market another case of
fool's gold.
The bottom line is that when
it comes to China, investors would be wise to
remember all that glistens is not gold.
Thomas I Palley is the founder
of the Economics for Democratic and Open Societies
Project.
(Copyright 2008, Copyright
Thomas I Palley)
Speaking Freely is
an Asia Times Online feature that allows guest
writers to have their say. Please click hereif you are interested in
contributing.
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