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The Coming Asian Bottom


With all the turmoil in Asia, I am constantly asked whether investors should again jump in there, and if so, when.

The answer requires a review of the broad sweep of global economic history for in that history can we see the future. The 19th century belonged to the U. K., while the 20th has been that of the U. S. Today, however, our children and grandchildren should be learning Chinese because this century will belong to the the Chinese. Almost nobody in Washington and academia understands this, but it's going to happen whether any of us likes it.

As recently as 1945, the British actually thought they could prevent the U. S. from dominating the 20th century. Little did they know it was hopeless to try, because the forces of history had already conspired to make us the century's greatest and most powerful country.

Today, world superpower status is gradually changing again, just as it has continually throughout world history, and we are as blind to the change as the British were in 1945.

The Chinese still call themselves communists, and indeed they were real communists from 1949 until 1979. However, as we all know, in 1979 Deng Xiaoping said 'this is not working, communism is failing. Let's try something new.' He started deregulating the economy by opening up the countryside, by allowing the peasants to grow as many melons or as much cotton, rice, whatever, as they wanted, and the peasants went to it with a vengeance.

Naturally this market approach spread to other parts of the economy, because once you start opening up a country, you can't stop it. Indeed, the Chinese have a long tradition of entrepreneurship, and they're good at it.

So, since 1979, the Chinese economy has been on the rise. The government has done all the things you and I would do if we were going to open up a closed economy. You don't do it overnight. There are 1.3 billion Chinese, and you can't change a society of that size all at once. Yet for the past 17 years, China has been growing at more than 10 percent a year. It's mind-boggling, unprecedented, for any country, much less one of such size, to grow at such a rate.

In March, after taking office, China's new prime minister, Zhu Rongji, who had guided economic policy for the previous five years, laid out his plans to Western journalists, in itself a departure from old norms. He explained how he will continue China's awesome progress by setting and keeping ambitious benchmarks for sweeping social changes. First, he pledged to make ailing state-owned industries solvent. Second, he promised to overhaul the country's weak banking system. Third, he said he plans to privatize housing, which for decades has been built by the public sector and is about as sacred a cow as exists in China. Finally, he promised to redesign the government by cutting its staff by half.

And he promised to accomplish all these reforms within three years.

All this from the man who last year promised the problem of money-losing state enterprises would be solved within three years, and who insists he's on target.

This is the type of bold, secure leader a powerful country will put at the top at this stage of its development. It's significant that Prime Minister Zhu spoke after the recent 15-day National People's Congress, which sets policy for the next five years and apparently strongly endorsed Zhu's plans.

As the new century unfolds we'll see continued growth in China. The World Bank calculates that by 2010, China will have the largest economy in the world, and while I have my doubts about the World Bank&'s ability to get anything right, certainly by 2020 China's GNP will be the world's largest. An economy larger than that of the U. S! By anyone's definition it will be a superpower, and the world's largest. The Chinese, with all the workers, soldiers, and talent they could possibly want, fed by a gigantic market within and huge markets nearby, will throw their weight around, not only in Asia but also throughout the rest of the world.

Every region in the world has a vigorous economy that fuels its growth. In the U. S., it's California; in Europe, it's Germany; and in Africa, it's South Africa. In Asia, it's China.

But it's not only China that's changing. Deng Xiaoping started his changes in 1979, and in 1989 the Berlin Wall fell, a crash of bricks and rubble so loud it was heard around the world, a crash so important it will reverberate for decades to come. After that fall, everybody world-wide realized statism didn't work and that communism was a prescription for bankruptcy. Today nobody in the world wants to be a socialist.

The statist-versus-capitalist strife of the 1960s and 1970s is over and done with. In our lifetime, we have witnessed one of the world's great cultural shifts -- a major, major change -- and yet most of us can only dimly perceive its long-range consequences.

Another major change has occurred under our noses in Japan. Right now Japan is the richest country in the world. Whether your measure of national wealth is foreign-currency reserves, creditor status or any overall basis, the Japanese have the money.

If you had asked the question as recently as 1978, only 20 years ago, the world's five richest countries would have included only one Asian nation. Today, the list includes three or four Asian countries and maybe one or two Western countries. In two decades, the world has changed that much in an incremental, gradual process that we can scarcely see.

Ah, you say, I see where he's going. The best place to invest is in Japan, because in spite of their recession they have a strong balance sheet.

Well, no, I'm not saying that. I'm not investing in Japan right now because, one, the Asian crisis is not over yet, and two, the Japanese have a serious demographic problem and a serious banking problem. Still, they're not going bankrupt; they're too rich.

As a result of their losing World War II, the Japanese had few babies between 1940 and 1960. When people are at war, they don't have many babies, and if they lose that war, they tend not to have many babies, either.

So, there's a huge gap in Japan: a lot of old people, a lot of young people, and not so many in between. Naturally, young people have a different set of interests, needs, and attitudes than older people. Among the differences is that older people want security of their assets and high interest rates; younger people, as borrowers, want to take venturesome loans and pay low interest rates. In addition, the political system has stalled, with massive corruption and bureaucrats too narrowly focused on their fiefdoms and abstruse theories than on the country's true fiscal problems. These are some of the reasons the Japanese have not been able to solve their banking mess which has been made all the more horrible because for almost a decade they have refused to face it directly.

Still, Japan is too rich to simply disappear. The U.K. provides an historic parallel. In 1920, the U.K. was the richest country in the world, and no one thought anything could come along to change that. Today, while the the U. K.'s status has diminished in the parliament of nations and it no longer is the superpower it was, its people still do well, make money, have fun and raise families. Japan's many problems may well take it down the same path, but it's so rich that it will take decades to hit any sort of horrible bottom. However, Japan will not be the place where investors will make a killing.

Back to the larger picture. Asia's population is some three billion people, 60 percent of the world's total. It has three of the world's largest countries: India with just under a billion people, Indonesia with about 200 million, and China with 1.3 billion. That's 2.5 billion energetic people in three countries with dynamic demographics and strong, centuries-old traditions of capitalism and entrepreneurship. The beguiling allure of statism is now firmly past. Planet-wide, everyone understands that to do well your own efforts are all that matters, that the era of the political leader as Santa Claus is finished. Asians are now people who work hard, obsessive about attaining what those in Europe and the U. S. have had for decades.

Now, why do I say China is going to be the largest, most powerful country in the world in the 21st century?

One reason is the population, a full 25 percent of the world's total. Yes, that also was true 50 years ago but today, not to sound too mystical, China's leaders have unleashed a pent-up spirit that's building every year. And the Chinese, young and old, do strange things: they work from dawn to dusk, they save and invest over 35 percent of their income and they discipline their children -- practices that are bizarre to many Americans. The high savings and investing rate is critical to building an economy. Furthermore, a large percentage of that population is young people, providing energy and ideas to newfound economic strength. Indeed, except for Japan, the terrific demographics in all of Asia outstrip not only Japan but also Europe, the U. S., and Canada. In European countries, because their societies have such aging populations, most of the social-security systems are going to be bankrupt within 10 years.

In short, as a result of their work ethic, low wages, and inevitable restructuring, the Chinese will have the world's most competitive cost structure. They're going to flood the world with goods and put muscle on their balance sheet, much as we did after World War II.

Yes, Asia -- China and the rest -- has some problems right now. But historically, that's part of growing to superpower status. Remember, if this were 1898 in the U. K. and we were talking about the next great places in the world, promising countries to which we might emigrate if we wanted to prosper, most of us would have pointed to the Western Hemisphere or to Russia or to Germany. In 1898, most of the smart emigrants went to the Western Hemisphere, and most of the extra smart ones went to Argentina, because it was widely recognized as the next great place. You may have heard phases such as 'as rich as a Texan' or 'as rich as an Arab' but in 1898 they said, 'as rich as an Argentine' because the ranchers there had taken advantage of the new science of refrigeration to send millions of pounds of beef every year to Europe, which paid dearly for it.

At the time, the brightest European emigrants didn't come to the U. S. because we were a debtor nation, had serious internal political problems, and exhibited little morality. In those benighted times -- a far cry from today's strict morality at the top of our government -- U. S. Senators could be bought by any business interest with the money to pay them. In Europe, it was thought that we had no rule of law. Here corruption reigned and we assassinated our leaders, much the way we view some South American countries today. Yet -- yet, yet, yet -- we and not Argentina became the richest, most powerful nation in the world in the 20th century.

History tells us these setbacks always happen in the rise of great nations. In fact, it happened as recently as modern Japanese history. If you had bought into Japan in 1955 and held on for 30 years, you would have been a financial genius and you would have made millions. However, in 1966 the Japanese financial system went bankrupt, totally kaput. The government of Japan had to bail out every bank and support the stock market by buying stocks day after day after day.

Still, it was only a temporary setback, even if at the time it was an immense disaster. If you knew these things, how the fortunes of nations behave, you would have continued to invest in Japan because it was destined to become the world's richest country by the end of the century. Such bull-market setbacks always have to be put into historical perspective.

As with the United States 100 years ago and Japan a generation ago, turmoil in Asia today is no more than a short-term setback on the road to an exceptionally bright future in the next century. If an investor doesn't grasp these facts, he is swimming upstream against history.

Yet, like everybody, I don't want to buy into a set of markets until I'm relatively sure they've gone down as far as they can. At the moment I have no shorts in Asia because it's made a dramatic bottom: in dollar terms its markets went down 70 percent, 80 percent, and 90 percent. These may not be the last bottoms, but they are certainly significant bottoms, and I've covered my shorts. I've actually bought a few things, but I'm not big in Asia yet. Naturally that brings up the question of when.

However, I don't think these markets are yet ripe for buying. My experience of looking at markets around the world and throughout history, whether we're talking about stocks, bonds, currencies, real estate, or commodities, is that you almost always see a second bottom.

We've all heard the terms 'double bottom' and 'dead-cat bounce.' When a market goes way down, loses say 80 percent, there comes a time when there is a sigh of relief, or just a sigh of desperation or exhaustion. Some faint good news at last kindles more buyers than sellers -- J. P. Morgan is going to bail us out, or the IMF, or the banking system isn't in as bad a shape as we'd thought. So the cat bounces one last time before giving up its ninth ghost.

And this is what I'm waiting for in Asia, for the second and final bottom that I expect in such situations. First, I don't think all the economic problems have played themselves out. The banking mess in Japan is still a mess. The governments in Thailand, Indonesia, Malaysia, and South Korea are still dazed and haven't laid out workable plans for going forward, much less begun to execute them.

Second, Indonesia is still unstable politically. Of course, like so many holdovers from colonial days, Indonesia is not a real country, and never has been. All those many islands were declared one nation by the Dutch, and despite Indonesia's being the fourth largest country in population and the second or third largest country geographically -- nobody yet has an accurate count of its islands, somewhere between 10,000 and 15,000 -- it will collapse as a political entity. This will not be the end of the world -- it may well be the end of Suharto's world -- as every Indonesian will still be working hard to make a living. After this split happens, it will present wonderful opportunities for investors because Indonesia has extraordinary assets waiting to be developed.

Third, while China will be the next great country in the world, it will still endure serious setbacks along its way to superpower greatness. One huge problem it faces are its neighbors who compete with it in world markets, whose currencies and cost structures have recently dropped by fifty to eighty percent. As a consequence, there's going to be some kind of turmoil in China, but whether it's a devaluation or demonstrations or political change, I don't know, yet something negative will happen.

That will be my buy signal. When I see on the front page of any decent Western newspaper that there is turmoil in China, that's when I plan to buy Asia again, as by then the three problems I mentioned above ought to be well on their way to working themselves out.

Maybe the economic problems won't be fully resolved, but by then Asian stock and other financial markets ought to be depressed by huge amounts, and this should be the last and real bottom. I will then invest in a big, big way. Just where I will invest, I can't say, because I have no idea precisely how the Asian markets will behave.

I keep my mind on the fact that there are three billion people out there, three billion people working night and day to have everything the West has taught them -- through the education miracle of nightly television -- that people can have. I will look for companies with strong balance sheets, those most likely to survive. I will try to find sectors with the wind at their backs in terms of supply and demand, industries that have low inventories, high demand, and low production capabilities. The companies I buy could be in Australia, New Zealand, and even Canada, where there are lots of expatriate Asians who are exploiting the natural resources of their new home countries and selling into Asia.

Indeed, I may invest in expatriate Chinese companies, overseas Chinese companies, as they are called. Lots of them exist in Singapore, Bangkok, San Francisco, and Vancouver, companies run by Chinese, who naturally understand China, and which will do well in China.

Another way to play this double bottom in Asia is to buy raw materials. At the moment I'm long rubber futures because rubber comes from Asia, and everybody there has dumped his inventories of rubber to obtain hard currency to pay his bills. This is not to say that I predict great things for rubber; by the time you read this I may be out of rubber. I only put it forward as an example.

Another example is the recent chicken scare in Hong Kong. On top of the panic in the Hong Kong stock market, there was a panic in the chicken market; they had to kill all the chickens in Hong Kong because it was feared they had become infected with a disease that would infect people. Figuring it couldn't get much worse for Hong Kong chicken companies than this, I bought shares in the strongest chicken company I could find at what I hope is its bottom.

Sooner or later -- in weeks, months, or years -- the Asian markets will hit their second bottom, throughout history a common feature of almost all market crashes. Often this second and final bottom is a bit lower than the initial bottom, and its dropping through the prior bottom frightens off even hearty investors. The initial collapse should be a ringing bell to call an investor to do his homework, to gather balance sheets and gain information and insights as to the collapsed market's best companies and the region's strongest competitive advantage. If the savvy investor plans what to buy after the initial collapse, when the second and final bottom finally arrives he can step into the market with confidence, amazed that such bargains are offered him. Assets bought in such times can offer investors returns many, many times their cost.

The major fact for the savvy to keep firmly in mind is that a gigantic change is taking place in world history, and that the next global winners are going to come out of Asia. As we march into the 21st century, any investor who doesn't understand this global shift is going to find himself gradually falling farther and farther behind. Those investors who aren't afraid to stare directly at massive historical shifts will always have a much greater chance of doing well than those married to by-gone realities. Do your homework now and be prepared for the second -- and the best -- bottom in which to pick up bargains.


Updates are available at www.jimrogers.com.

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