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China's More Fragile Than You Think
04/16/2009 12:01 am EST
William Gamble, president of Emerging Markets Strategies, sees trouble ahead for this hot-money darling.
Many, perhaps most, investors are convinced: China is the rising superpower, the capitalist dynamo, the opportunity of a lifetime.
As the developed nations print IOUs, China's propensity to save and its $2-trillion foreign-reserves stash begin to seem downright sensible. The government has made aggressive plans for a domestic stimulus to take the sting out of the export slump. Investors have responded, lifting Shanghai shares to a 34% gain thus far in 2009. "Emerging Markets Go on a Tear," trumpets The Wall Street Journal. When it comes to China, even "Dr. Doom" himself-economist Nouriel Roubini-is a cautious optimist.
This is bound to end in tears, warns William Gamble, a lawyer who helps corporate clients navigate emerging markets. As a writer and investor, he predicted last year's collapse and profited from it. If nothing else, his views provide a healthy antidote to the emergent hype.
Q. When did you turn bearish on emerging markets and why?
A. I turned bearish in May 2007, five months before the peak of the Chinese markets. I am still bearish. There are many, many reasons. The most obvious is cited by the World Bank. They pointed out that export-based economies are not going to grow until the developed countries start to import. [But] American consumers have lost an estimated $12 trillion.
Q. Is China really as unattractive as your recent blog post implies? The market's performed awfully well over the last six months.
A. Almost everything I wrote in my book, Investing in China, in 2002 has come true. Markets are about choice. To make a good choice you need accurate, timely, and complete information. To get it you need protected speech, free press, good regulators, etc. Even then markets fail.
The Chinese market is what the Yale economist Robert Schiller would call a "story." There is a general belief that China will always grow. The rise in their stock market was based on enormous faith in the government policies. But as we have seen, no government's policies are good forever. The problem in China is that they cannot change and adapt.
Q. If the problem is the legal inadequacies and the political inertia in China and elsewhere, aren't these age-old concerns that didn't stand in the way of rapid development and big bull markets in the past? What's different this time?
A. Yes, they are age-old concerns. For example, globalization is not new. But it is based on law, not technology. The great growth that has occurred in the past 20 years occurred in my view in part because there was a general consensus about the needs of capitalism. This unfortunately is under threat.
In his book The Rise and Decline of Nations, [the great economist Mancur Olson] hypothesized that economies are slowed by special interest groups. The only thing that limits the power of special interest groups is the law. A market is economically efficient and can sustain economic growth when the legal infrastructure limits power rather than extends it. You have to have debate and open markets to come up with the right formula.
Q. Doesn't China have a big-time incentive to adapt once again, now that the exports demand just isn't there?
A. There is a vast disparity of wealth in China. The people who are running the show have done very well. Why should they change the model? The alternative should be to increase consumer demand. But this requires changing all sorts of laws that benefit the people in charge. Economists have been telling Japan to build a more consumer-based economy forever. They have consistently failed to change their model.
What economic model works forever? Over time if there is no change, the economic growth slows as happened in the old Soviet Union, pre-Thatcher UK, present-day France and pre-1992 India. China also cannot go up market because they do not protect intellectual property. They do not protect intellectual property because piracy makes up over 8% of GDP. Besides, the Chinese may have over trillion in dollars, but the bad debts in their banking system are probably much higher. Of course they sure aren't going to tell us. What banker or government would?
Q. What sort of emerging markets exposure would you recommend at this point?
A. Little. The risk is too high because of the lack of reliable information. I believe that the US system is the most flexible. The US market, because it provides the best information and the most efficient legal system, will allow capital to be rapidly reallocated to more efficient sectors. For many reasons, this will take more time in emerging markets, probably until after 2010. Later in 2010 the appetite for risk will increase, making emerging markets more attractive.
Q. How have your experiences overseas influenced your views?
A. I have been traveling overseas since I was eight. I received part of my education in France and have traveled to over 40 countries. I have crossed the Sahara on a motorcycle and climbed Mt. Kilimanjaro.
If I have discovered one thing, it is that people are people. I was reading an article about how an American company, AES (NYSE: AES), lost its business because of government interference in Kazakhstan. It wasn't the workers, for whom AES had nothing but praise. It was a problem with a government without legal limits. Without law, any contract, any stock certificate, any deed is just a piece of paper. Without law, investors cannot control risk. If you can't control risk, you should not invest.
Q. Thank you.
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