Slowing exports are obscuring strong domestic growth driven by the burgeoning middle class, says Jim Trippon, editor of China Stock Digest.

Jim, you hear all sorts of stories whether China is growing or it’s not growing or it’s doing well. It’s coming out of the slow growth period or it’s not coming out of it. Exports or imports are down. So give us some clarity and your view, because you have a ground-eye view of these things.

That’s right. You know in China Stock Digest, we actually have full-time offices and staff in Hong Kong and in Shanghai. And this year, 2012, is a very interesting year for China, because for the first time in history, their economy is exceeding $10 trillion.

This year it’s going to be an $11 trillion economy. And within the next five years, China will actually surpass the United States. So a lot of the stuff you read in the media comes from people that really don’t understand what’s going on on the ground.

Yes, the exports have been down in China...and yet their economy is growing at over 8%. How is that possible? Well, what’s happening is that the Chinese consumer is becoming wealthier and wealthier, and that’s translating into internal growth that is pushing their economic development.

So they’re building their middle class, essentially, and sort of the growth story we had here in the 50s and 60s is what China is undergoing at this point, where the real growth story is internal and not external anymore. It’s not the manufacturing that they ship around the world, but really what they’re building and demanding of themselves.

That’s right. And that’s a wonderful opportunity for us as an investor to go in there and cherry-pick some of the best companies in that story.

But it’s also a little bit scary for the future of the United States, because what’s going to happen is when they no longer need to sell to us, they can raise their prices. They can let their currency appreciate, and we’ll see significant consumer inflation here in the United States from that.

Right, and then they’re also holding a lot of our debt, and then we have to worry about what they’re going to do with that at that point, too.

And they’re not happy about our Treasury policy. They really aren’t.

And right now, it’s such an equal relationship to a certain extent. That you know they’re not happy, but we’re buying enough of their product that they can’t really do too much about it...but when that changes, yeah, their opinions are going to matter a lot more to the US economy.

Absolutely, and I think we already are seeing that change. So as we look forward, really, what a smart investor here in the United States will do is look at where can I pick up a winner.

Because in China, you can go there and you can buy stocks literally at half the valuation that you would pay here in the United States for the same type of company, for the same type of growth. I’m talking about large cap companies with solid earnings, real accounting, real financial statements. You can do much better there from our perspective than you can do here.

And regarding transparency and the way their market is structured and reporting and things of compliance and things of that nature, has that gotten better? Because I think that there is some concern from the US investor...because it seems so far away and seems a little bit more abstract with different accounting principles. So, could you address that a little?

Oh, absolutely. So in China, really, it’s a story of two countries. You have the companies that are traded in Hong Kong or New York that have to comply with US accounting standards.

And particularly the larger ones of those, the top 100 to top 200 companies, most of them use big four accounting firms—Price Waterhouse Coopers, Ernst and Young, folks like that—that really know financial statements. So for those financials, the quality of the accounting and the quality of the disclosure is really top notch. Now, when you get to the mid-cap and small-cap companies, or the companies that perhaps trade over the counter on the bulletin board, it gets a lot sketchier.

Remember, they’ve only had a modern financial system in China since 1979. We’ve had a couple of hundred years to get our act together. They’ve had like less than 50. So they’re still in that process. But the largest companies in China are world class in terms of their financial accounting and disclosure.

Do you have a couple of names that you like?

Oh, sure. There are a couple of plays that we really like right now.

One of them, and it’s not a company I’ve really recommended a lot in the past, because their valuation has always been so high, but they’ve come down recently and they have a great position in the space, is Baidu (BIDU). Baidu is the Google (GOOG) of China.

What I like so much about Baidu is that not only has their valuation come down a bit, but they’ve lost their biggest competitor, because basically Google has exited China and is no longer a force in that market. So as the paid search business grows in China, a big beneficiary of that is going to be Baidu.

Right, and you know, if you don’t have to compete against Google, that’s pretty good competition to wipe out right there.

Yeah, I think Google, like many other US companies, really stepped in it when they went into China, because they didn’t really adjust for local conditions. And my attitude is if you’re going to go to a foreign country, you better learn how they operate and operate like they do. Or you’re not going to be effective.

Yeah, I remember Walmart (WMT) when it stepped into Argentina, the same thing happened. They thought their model worked everywhere and it didn’t.

Right. It’s kind of arrogant of us to assume that our way of doing business has to work everywhere else. We really need to study where we are going and adapt to the local customs.

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