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The Roaring Dragon


SHANGHAI, China: Today I did something I've dreamed of doing for decades: I walked into a Chinese brokerage house in Shanghai and opened an account so I could buy Chinese equities.

On April 1, Paige and I entered China across the Kazakhstan-Chinese border. We drove eastward across the Gobi Desert, along some excellent roads, stopping along the routeYining, Urumqi, Hami, Lanzhou, and Xian I've taken twice before on journeys during the past 11 years. Instead of the picture of economic disaster often painted in the Western press, we found not just dramatic improvements from my last visit but also a dynamic country on the move.

In 1988, visitors entered Hami via what was more a boulder-strewn path than a road. Today, the city is a boomtown and the road, now quite different, is packed with trucks, cars, and motorcycles, as well as goats, geese, and cattle. The story is much the same in Yining. Markets are everywhere, and its streets, too, are filled with vehicles. Throughout the country, many of the roads are as good as the Autobahn, and much of all this has been built by hand, just as were the Grand Canal and the Great Wall a couple thousand years ago.

Everywhere the Chinese are feverishly building highways, houses, shops, and factories. Looking east from our hotel room in Nanjing, the old southern capital, we counted 12 separate cranes working at skyscraper sites, not that there was any shortage of skyscrapers.

In every town and village, we found constant activity. Where once stood only a few state shops, private businesses now proliferate, bustling markets filled with Chinese eagerly working, buying and selling an astonishing array of new consumer goods -- bicycles, radios, trucks, cars, TVs, clothes -- made by both foreign and domestic manufacturers. As one small example, in Hami in 1990, no one sold motorcycles. Today three dealerships flourish.

A decade ago, hotels were scarce, at best. Today, hotels, many up to world standards, are everywhere with more being built. As for nightlife, in Hami and elsewhere, discos, karaoke bars, and nightclubs abound. Young men are dressed in suits and ties; only the older crowd wear Mao suits.

Likewise, in 1990 I found almost no gas stations and once had no choice but to beg for fuel at a Red Army outpost. On this trip, we've found an abundance of secular temples to gasoline, elaborate service stations with 10 pumps and enough arches to rival McDonald's. In Xian, we even found several Mercedes.

In short, the boom times in Ireland and Turkey pale in comparison to the dynamo that is China.

The Western press may rail against the so-called lack of human rights in China, in 8,000 kilometers of travel we were stopped only a couple of times at checkpoints. By contrast, when we crossed the Stans -- our fast allies -- we were stopped scores and scores of times by heavy-handed police. In China, I think everyone is too busy making money to poke their nose into anyone else's business.

For example, on my previous visits, I stopped at a temple or two, but never had a sense they were too important to the Chinese. No longer: we are constantly running into Buddhist, Taoist, and Confucian temples filled with people. Equally surprising is the sheer number of thriving mosques and Christian churches, many with vibrant congregations. I never know who is the more startled, Paige and I or the worshippers, some of whose families have been Christian for 200 years. We have yet to find anyone of any faith who feels repressed. Some of the oldest members can remember problems under Mao, but the younger ones are bewildered by the question.

All in all, I'm sure some rights' violations occur; they do everywhere but especially in developing countries. Even Plato wrote about them as long ago as The Republic. My sense after six weeks close to the ground, however, is the human rights' tempest in the West is a cover for those with some other agenda, such as protecting their own interests from a dynamic new country.

How did China get here? Its recent history is fascinating. In 1978, the country's leadership started moving from Soviet-style central planning to more of a market-based economy, yet all within Communist Party political control. In place of collectivization in agriculture, national leadership has stressed "household responsibility," allowing households to produce and sell, which has boosted farm production tremendously. In the same way, local officials and plant managers have been allowed far more control over their domains, and Beijing opened up the country to foreign investment. The result has been a quadrupling of gross domestic product over the past 20 years, with both agriculture and industry making enormous strides. The World Bank estimates China's GDP might have been as high as $4.25 trillion in 1997.

While successful overall, from this uniquely Chinese stew has sometimes come the worst of both systems. From the constraints of the Communist Party have come corruption and the petty hassles of bureaucracy, while capitalism has brought inflation and the corrupting influence of windfall gains. Between 1992 and 1997, growth increased as much as 10 percent annually, particularly along the prosperous coast.

The government, with some of the best national leadership in China's history, has its work cut out for it. Tens of millions of surplus rural workers have floated between the villages, towns, and cities, sustained only with low-paying, part-time work. Chinese leaders have struggled to keep afloat the large state-owned enterprises, few of which have grown with the rest of the country. In addition, the national government has a hard time collecting the revenues it needs. Corruption and other economic crimes remain far too prevalent. And finally, the leadership must contain the deterioration of the environment -- air pollution, soil erosion, and the steady fall of the water table in the north.

Will there be continued tensions between the Communist Party and the decentralized economic system? Absolutely. How will they be resolved? I believe in favor of increasing prosperity, as under Mao the Chinese tried central economic planning for decades and they know it won't work, just as after seven decades of socialism the peoples of South America came to lose their capacity to believe in economic poppycock.

So now that I’ve seen a country bursting with the capitalist spirit and opened my brokerage account, what stocks might I buy?

Two major exchanges exist in China, the first here in Shanghai and the other, south of us in Shenzhen. The two markets list a total of about 500 stocks. Many are not stocks I want to buy; they are the leftovers from the Communist era, poorly-run government companies the authorities are eager to unload on unsuspecting investors.

Other impediments also lurk. The equity shares of Chinese public companies are divided into A and B shares. The A-shares can only be owned by native Chinese. If they are careful how they go about it, these shares can also be owned by the overseas Chinese, who number many tens of millions around the world. Foreign investors who play it straight -- that is, who don't use a Chinese nominee to trade or invest -- are only allowed to purchase B-shares.

At this writing the foreigners’ B-shares are not convertible into A-shares. Whereas at one time western enthusiasm for China was so large that B-shares sold at a premium to A-shares, today Western pessimism toward China is so great that these B-shares have fallen 85 percent from their highs. Such a huge discrepancy has whetted my appetite for such wonderful bargains!

Since the Asian economic turmoil began in mid-1997, I’ve been watching and asking when would be the right time to plunge back into Asian equities. I believe that time is close at hand. My view of the rally over the past few months is that it’s a bear-market rally, that we will have another bottom, a second bottom, that will tell us the Asian market is truly ready to march upwards. My long observations of major bear markets tells me there is often a second major leg down, one which tests the prior bottom, and shakes out those who have been suckered into the first rally. I’ve thought this second leg down might be marked by the devaluation of the Chinese currency or some other turmoil in Chinasay, labor unrest and strikes.

Some years ago the Chinese formed International Trust and Investment Corporations (ITICs), government-backed investment companies, usually one to a province. These raised billions of dollars to develop much-needed Chinese infrastructure: airports, toll roads, seaports, and especially power plants. Their bonds typically paid a high rate, 15 percent to 18 percent. However, these trusts made the age-old banker’s mistake, lending long and borrowing short. ITICs were usually owned by the local provincial governments, and sometimes appeared to be guaranteed by the government, just as in the U. S. agency bonds appear to be backed by the full faith and credit of the U. S. Treasury but are not. Investors’ arguments for trusting in such semi-guarantees are that the governments involved would be too embarrassed to let such bonds default.

One of these ITICs was the Guangdong International Trust and Investment Corporation, GITIC, located in one of the most prosperous Chinese provinces. At a creditors' meeting in January, GITIC announced that with $4.3 billion in liabilities and no assets to cover these debts, it was filing for bankruptcy. The next day the Guangdong authorities announced they weren't going to meet any obligation they might have had to guarantee the losses. Over the past few months other ITICs have made similar announcements, and the national government has repudiated any responsibility to bail them out. Overseas investment houses, some of whom are insurance companies, have had to reserve massively, sometimes writing off the investment entirely, which will wipe out years of profits earned from China and put a sour taste in their mouths for more Chinese investment.

Alarmed by the way the GITIC collapse was handled, some of China's big banks have warned the government this will damage Chinese credibility abroad and hamper prospects of raising funds in international markets. They were right enough. Since January, international investing in China has backed up.

In fact, much of the early money into China has not been the wisest of money. Iveco, the Italian truck manufacturer, put its first agent in China in 1984. After investing $200 million along the way, it won’t see any profits until 2002, almost 20 years after its agent’s first arrival. Unilever arrived during the 1980s, too, and it, too, had to waive its usual investment criteria to justify the millions it spent in China. General Motors and Western banks later poured more money into the country, but the gold rush has ended. In January and February of this year, foreign direct investment fell 9.5 percent from last year, raising the possibility that in 1999, for the first time in this decade, outside investment in China may fall. Indeed, Beijing officials are now saying direct foreign investment may slump to $15 billion from last year's high of $45 billion.

For a long time some global consumer companies operated under the myth they couldn't afford not to be in China. But as the losses mount, many Western companies' boards are asking if they can afford to be in China at all. Those who rushed to be 'first to the honey pot' have not found that establishing a brand has won them the riches it once promised; in China, as in other markets, brand loyalty is fluid.

Indeed, several Western businesses have pulled out of China recently: the Royal Bank of Canada, Southwestern Bell, Marks & Spencer, and Fosters of Australia. Many new projects have been put on hold. The hype about a market with hundreds of millions of eager consumers has encountered the reality that perhaps only millions want certain Western products. Many companies have begun to regard China much as they regard any other country, as one with risks that might not pay off. They've learned that not all joint ventures work, and that all too many local partners may not be experienced in new industries.

These pioneers didn’t reckon, either, with the intensity of the local competition, nor with the government’s "buy China" policies for many industries. While China has made repeated promises not to devalue its currency, it’s hard to see how the national government can fail to devalue with all the Asian regional pressures on its value, and that prospect, too, has made foreigners cautious.

Without foreign investment, not as many Chinese jobs will be created, which naturally will have an impact on the Gross National Product. In addition, without a positive attitude toward Chinese investment those in our investment and political circles will lean more toward the containment of China rather than engagement with it. It’s a shame Clinton didn’t make the WTO deal with China on Prime Minister Zhu Rongji’s visit to the U. S., as it would have done much to rebuild the confidence of the foreign investment community toward China.

While many foreigners may have lost money through ill-conceived investments in China, you'd never know it by the bustling economic activity we observed. For a long, long time, I've been enthusiastic about China's prospects. For many years I've urged my friends to teach their children Chinese, as I believe the 21st century will be as much China's as the 19th century was Britain's and the 20th century was America's. For all these years I've been waiting patiently for the hibernating dragon to awaken.

Well, here at the end of the century and the beginning of a new millennium the huge dragon—slightly smaller in land mass than the United States but with more than four times our population—has awakened. To prepare for the right moment, which could be as early as this fall, I’m compiling a shopping list of those Chinese companies in which I will invest. I’m leaving off the inefficient holdovers from communist days, those giant labor-intensive companies that will never show a profit and whose going public was only a way of getting them off the government’s hands. As examples, I’m looking at a land company with huge holdings in raw land in the new part of Shanghai, a tire and rubber company, an appliance company, and a glass company.

Nothing high-tech here, just well-established companies in basic industries that will meet the desire of the emerging Chinese middle-class for a better life. Tire and rubber may seem hum-drum to those whose portfolios are filled with Amazon.com and AOL, but when you’ve traveled across the breadth of China today and encountered thousands upon thousands of rubber-tired vehicles -- cars, motorcycles, and trucks -- the Chinese now employ, you come to believe mountains of rubber tires will be sold.

My visits to the stock exchange and the brokerages here have taught me a several interesting things. Everybody in the stock business here is young, including the president of the stock exchange. This is a new business, one that didn’t exist 10 to 15 years ago, and the people in it are like those in software and the internet in America—no one is over 35. They are full of youthful energy, thrive on challenges and aren't afraid of long hours.

I’m not actually buying any stocks yet, simply mapping out my strategy. I’m watching and waiting for the Chinese to work out their two major problems. Their currency is not yet convertible, which will keep foreign investors from plunging in again. Once the currency issue is resolved, the artificial division between the A- and the B-shares—which if it were dissolved today would give Chinese citizens a way of sending money out of the country—should also come to be resolved.

However, the most telling piece of information I’ve learned is the government is trying to make ownership of stock more attractive to its citizens. Over the decades of my investing life, I’ve seen it over and over: When a government creates incentives -- real incentives -- for people to buy stocks, they always go up. It's particularly exciting when, as here, there's a high savings rate, and the banks are loaded with cash. The banks have grown cautious recently and won't lend, so these savings are trapped. If China's citizens are genuinely encouraged to take their money out of the banks and buy equities, the market will soar. This could happen as early as this summer, but it might take until the end of the year. Remember, too, these are only two small exchanges with no more than 500 stocks and China has 1.2 billion people!

So, I’m waiting for the Chinese to allow its currency to float against other currencies and for stock-market incentives that are rumored to come to become real. One or both should happen this year.

And how might an American investor take advantage of these opportunities?

I'm exploring investing in companies domiciled in overseas Chinese communities such as Bangkok, Singapore, Vancouver, etc. that do business in China or with the Chinese. The Chinese consider the overseas Chinese almost the same as themselves, giving those outside the country a leg up on other nationalities. Find a few of these companies in which to invest and the alert investor will have found an entry into the Chinese market.

How else to invest? In addition to various Asian mutual funds, I'm reminded of what John Templeton did in 1942. The stock market in New York was down because of the Great Depression and World War II. With a modest amount of money, Templeton bought 100 shares of each of the stocks on the New York Stock Exchange that were selling for less than $1. He held on to them for a good long while, and although some of these companies didn't survive, he had bought the vast bulk so cheaply that he made a fortune.

Today many Chinese B-shares sell on the New York Stock Exchange as ADRs for small sums. A similar strategy might be to buy all these stocks and hold them through thick and thin. In five, 10, 15 years, there's an excellent chance this will be one of the best investments a person will ever make.


Updates are available at www.jimrogers.com.

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