Thursday, January 14, 2010

Thought of the Day

                                                                                                                                                                              Sydney M. Williams


Thought of the Day
January 14, 2010

Knowledge that Jim Chanos has chosen to short China has become ubiquitous. Mr. Chanos has been a highly successful short seller and his opinion is always worthy of consideration, though I marvel and wonder that he allows his investment ideas to be so publically disseminated.

Thomas Freidman, in a column in yesterday’s New York Times, entitled “Is China the next Enron?”, questions Mr. Chanos’ thesis. (I find it hard to believe that a man such as Mr. Chanos, known for his diligence, has not considered these observations.) Mr. Freidman’s essential point is that, while agreeing China has problems in “spades”, “It [China] also has a political class focused on its real problems, as well as a mountain of savings with which to do so (unlike us.)”

That sentence highlights China’s real problem – a political class focused on addressing its economy, the exact opposite of what has produced two hundred years of unparalleled economic growth in the Western world – the willingness of creative individuals, operating in a society that supports personal freedom, to take risk. It is the ability to function freely that solves problems – not government bureaucrats. The Soviet Union and Communist Eastern Europe were the most recent examples of failed States that tried to control industrial production and the flow of goods and services to consumers. Tom Freidman hints at the resolution to China’s problems, but fails to make the link. He points out that China has 400 million internet users, half of whom, he claims, use broadband. In spite of current censorship in China – enough to cause Google to consider giving up $600 million in revenues – the internet is a great force for democracy, and ultimately will bring down the totalitarian dictatorship which is Chinese Communism.

The willingness of the Chinese government to embrace capitalism suggests an understanding of the powerful, long-term, forces of freedom; reluctantly, they will be dragged toward democracy. It will be at that point that China will realize its full potential.

Unknowns breed risk, and in China there are a lot of unknowns. Has infrastructure run ahead of development? How controlling and/or corrupt is the government? Transparency is an issue (as it is in our derivatives markets.) How significant is the social unrest in last year’s 80,000 demonstrations?

It is far beyond my capabilities to weigh in on the merits of investing in China. My only experience was a, very brief, visit a year and a half ago, but I was struck by the youthful dynamism and confidence of the people in Shanghai and Beijing. There is a feeling that one is at the start of a long and important journey. It is an exciting place.

China has allowed capitalism to flourish. But capitalism constrained by Mr. Freidman’s bureaucrats over individual freedom will not unleash the “animal spirits” that allow creative responses to specific problems. A necessary component of capitalistic growth is, unfortunately, recession, the healthy part being that it eliminates excesses. There will be economic downturns, which not even China’s leaders will be able to prevent. One cannot rule out future Tiananmen Squares, but there is little doubt as to the long term trajectory.

Over the past ten years China’s economy has compounded at 10%. In contrast, the Shanghai Index has compounded at less than half that rate – 4.5%. Not knowing anything as to the valuations, those numbers suggest to me that there is at least some degree of skepticism built into the market.

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