Regional Policy Reorientation and its Dilemmas: China’s Past Affecting the Future

Developing the coastal regions for so long during the Mao period has left a huge disparity between the economies of the interior and the coast. The gap is so large that even though the interior in some areas is growing at the same rate as the coastal regions, the absolute gap only grows larger because of the disparity of their starting points.

While the six and seven five-year plans were based on the system that economic development would diffuse into the center from the coastal regions, this was not a good idea in the long run and did not work out. This plan was laid out it what’s called the “latter step theory” which though that the interior could absorb what was going on in more developed areas. This had not worked because the infrastructure was not there in the interior to even transferring these new technologies.

Even after this was seen not working, in 1988 under Deng Xioping, they used the “modification of regional development policy,” which continued again with the diffusion policies of the past. The only good thing that came out of this time period was the eighth five-year plan, which helped to focus more on industries instead of just building up regions. Price reforms also came along with this plan. He also started the Yangtze River Valley Development Program, which was intended to integrate China’s interior and coastal regions, but ended up not working.

Only when Jiang Zemin came into power did the serious problems of the growing disparities between coastal and interior areas become a major issue. This situation brought about the ninth five-year plan, which discussed the growing disparities and called for three-component solution. First, larger investments would go towards the building up of the interior. Second, continued support for underdeveloped areas, and encourage coastal cities to transfer resource intensive and labor-intensive industries to move their locations. This plan emphasized to investors the abundance of natural resources, and the amount of labor available in the interior. While this was a good plan, there ended up being many problems complete this.

Budget deficits have grown and were being taken care of by excessive money creation and borrowing which led to increased inflation and debt to foreign nations. Even though a fiscal contracting system was being used during the 1980’s it put pressure on the central government’s budget. This increased inflation gave reason to reshape the fiscal foundations of China. This was needed if China wanted to continue the same growth pattern.

In order to start fixing problems there needed to be better interaction between the center and the local people. Public interest needed to be put in front of specific interests of individual provinces. There would also be a new system for collecting taxes. Instead of the contracting system they would be moving to a tax assignment system, which created separate local and central taxation systems.

Rural enterprise development was also very important to fixing regional policies. This would help with moving overseas investment to the interior and pushing coastal provinces to help out poorer interior provinces. There are they key components of the program. First, new credit policy was put into place so that more money in loans could be given to rural areas. Second, better tax incentives were given to industries in the interior to spark production. Third, there would be a transfer of labor-intensive industries to the interior. Many of these advantages and investment vehicles would be phased out by 1995 when business has reached a solid point.

Even though many changes have been incorporated into policy reform, deficit remains a problem for the central government and has prevented a major shift in regional development. Overseas investments need to be increased in the interior in order to close the inequitable distribution of wealth, and growth needs to increase ten fold in the interior to compare to the coastal regions.

Rural China left behind

After having the opportunity to visit a rural farming community in China it made me realize many things about China’s impressive growth. It is not an efficient growth, but an inefficient one. We see skyscrapers and massive Olympic structures being constructed every month but this is only a small part of China. Outside the two great cities of Beijing and Shanghai some small communities with de-collectivized farms hardly have any paved roads, and some have none at all. While we see this huge growth in China now, I do not believe that this growth is sustainable. My main reasons are as follows:

1. No infrastructure between inner and coastal China exists. During my visit to a small village the people said the one paved road was a gift from the government last year. It cost 2.2 million RMB or the equivalent of almost $300,000 USD. This was also one of the first villages in the area to receive a paved road. The scary thing about this fact is that the village is only about 1.5 hours outside the Beijing city limits. They had been transporting the food produced on their land via small carts to the closest village 5 miles away. From there they could transport their food on paved roads to the city. For the first time small communities are getting roads that will finally bring buses to and from the big cities.

2. Beijing’s growth has been very rapid and resulted in many people losing their homes. 60 million people have been pushed off their land because of the growing city. While this number seems bad, it is even worse than some may imagine. China’s version of social security for rural residences is based on a system of land holding. Families are given plots of land that they can farm on. This land is considered enough to support themselves, but when this land is repossessed, they are given no other form of support other than a small sum of money, that does not compensate for the true value of the land.

3. De-collectivization has worked well over the past few decades, but this system is not efficient or effective for China’s growing population and booming economy. These small farms cannot feed 1.3 billion people. While food can be imported, that comes at a price that is much higher than farming within the country where food can be produced and sold at artificially low prices.

While China continues to grow, I think that the huge amount of growth we have been seeing cannot be sustained at the same pace as in the past. There are many obstacles that China must overcome in order to continue to grow, which I will be covering later.

Venezuela is Taking Another Step Closer to Dictatorship

If you have any monies in Venezuela I would think very very hard about it taking those monies out. Venezuela is taking another step closer to becoming a dictatorship. As I commented earlier it looked like Venezuela was moving in this direction.

President Hugo Chavez was granted free rein Wednesday to accelerate changes in broad areas of society by presidential decree — a move critics said propels Venezuela toward dictatorship.

Jason talked about KRY and I think he should become concerned.

Venezuela’s foreign minister on Thursday said the country is considering nationalizing its mining industry, a week after President Hugo Chavez announced plans to bring the electricity and telecommunications sectors under state control.

I am lucky in that my sister lives in Ecuador and I get insight into South America. I have been watching Chavez for a very long time now and what he has done is slick. About a year ago my sister thought he was great and doing good things. Now he scares the bezeers out of her. (NOTE: Chavez and Correa have become buddy buddy and that concerns her) 

In the book Pragmatic Programmers they illustrated that there are two ways to boil a live frog. The first is to throw the frog into boiling hot water which causes the frog to immediately jump out. The other way is the clever way is to put the frog into cold water and then slowly increase the temperature. By the time the water temperature becomes too hot the frog will be boiled. This is what Chavez is doing/did with Venezuela.

Chavez is doing/did a slow switch from democracy into a communist dictatorship. Granted the transform is not quite complete, but he is already discussing the scrapping of term limits.

Opposition leader Julio Borges called for the 4 million Venezuelans who voted against Chavez not to be left out of decision-making, particularly as he pushes for constitutional changes including scrapping the term limits that would end his presidency in 2013.

When people thought, oh gee soon Chavez will be out due to term limits. Ha! I knew Chavez would stay because power has consumed him. Now people are supporting Chavez because Chavez is giving out money. But one day this will end and then he needs to use force. It is on that day Chavez has officially become a dictator!

Some Interesting Details

Some people look at PE ratios, cash flows, and so on. I try to find the small details, small things that have big ramifications (1,2,3).

Today many of the leaders that the West dislikes met in a single place. The fact that most of the South American leaders were in Ecuador was not a surprise. What is a surprise is that Iran’s Mahmoud Ahmadinejad was there.

This is one of those things that we as investors need to keep an eye on. I asked my sister what this means, and she said two things:

  1. There is a drive to get some discipline in OPEC. The leaders in OPEC are concerned about the falling prices. I can understand this because the oil leaders became drunk on high priced oil and with low prices a hangover is ensuing.
  2. The South Americans are driving towards a European Union type integration. The South Americans want a common currency and free trade deals with the EU.

For me it means we better get our butts into gear regarding alternative fuels! Alternative fuels is the only solution to keep OPEC at bay. I figure we have some leeway, but not much. I also figure IF something comes out of this meeting and if volatility returns to oil we are in for massive stock sell-off.

End of Year Calculations

Based on seven months of investment our ROI is 26% as that is when I jumped in this year. I have to say that I am very happy about this. This ROI is based on funds, stocks, and bonds throughout Europe, and the America’s.

As of today my positions are as follows:

  • 66.8% Cash
  • 16.8% Bonds
  • 16.3% Stock Funds

As you can see we are sitting on cash. My opinion is “Cash is king!” I have locked into profits and am waiting for the down swing.

I am nervous because on Friday the books close and the profits are calculated. After Friday I am expecting a pullback. I am thinking the pullback will happen between then and beginning of February. My guess is that fourth quarter earnings will be below expectations and will cause a sell off. Earnings will be good, but due to the fact its the 4’th quarter people will be disappointed.

My investment strategy for next year are guaranteed investment products. You might have seen these products in that they say you can gain, but have nothing too loose. They offer more upside than fixed income products, but they loose nothing.

Here are my thoughts for 2007:

  • First half world-wide market bearish.
  • Second half neutral, and the big if are the South American, European and Asian economies.
  • I am optimistic (not bullish) on the European and Asian economies. A big concern is if the non-American markets can break the habit of following the American markets. Traders are saying it will happen 2007.
  • Second half American market bearish due to falling real-estate prices and consolidation in the American consumer. What I even wonder about is if traders will sell equities to cover losses in real estate?
  • I would not touch real estate with a ten foot pole. I would wait to buy real estate once the Fed has lowered the interest rate one or two points. At that point in time you will get cheaper rates and a dropping of rates means the Fed wants to get the economy revved up again.

I am not bearish in the recession sense. I am bearish in the consolidation and soft landing sense. The market had a very good run since end of May and a break is needed. I am also very very cautious because so many are now saying, “Oh now is the time to get in…” Well the contrarian in me says, “now is the time to get out.”

USD Drop: A Butterfly Effect

So here we sit and see that the USD has dropped and breached the 1.30 mark against the Euro. The question is why? I would have responded on this question earlier, but could not. Last Friday my oldest English Bulldog Patches (11.2 years) went into the doggy hospital, and she died on Monday. Until Wednesday I have been a bit of a vegetable as Patches was my first real dog that I bonded with. So I have been oblivious to what is going on in the markets.

So why did the dollar drop? Is the answer here? Or how about here? What about here? Or what about here? Notice how nowhere you will find the reason why the dollar dropped? I find that really odd! Of course some will say, “Oh its the huge deficits of the US”, or “This drop was long in coming and finally somebody did.” Great love the comments (NOT) as they still do not make it any clearer. Many now say that this is the longer trend, and the drop will be bigger.

I am tempted to believe that this USD drop was the result of a butterfly effect.

Last night my sister called me and asked how I was doing after Patches death, and then asked how my Latin America fund was doing (NOTE: for those that do not know my sister lives in Ecuador and she is my Latin America connection). I had no idea how my Latin America fund was doing because I had not looked at my funds, but was fearing the worst due to the dollar drop. I asked her why she was concerned. She responded because Correra won.

Correra is the butterfly effect that I think caused the dollar to drop and markets to come crashing. Many of you readers will be thinking, “huh, what the heck does Ecuador have to do with the rest of the world?” Quite a bit because Ecuador is dollarized and the USD is the currency of Ecuador. As said in the referenced article:

Ecuador’s bonds however have lost almost half their total gains so far this year after the Nov. 26 runoff election results.

Correra is a weenie, like his friends Chavez and Morales are weenies. To fully understand the scope of the problem you need to read the articles: (1, 2, 3) What surprised me a bit was that Correra won and I asked my sister what happened as Noboa was in the lead. She said about a week or so ago Noboa had a Howard Dean scream moment. That cost him the election.

Here is what I think happened to the markets:

  1. Noboa has a Howard Dean Scream moment shifting the electoral from Noboa to Correra. Correra a leftist has made many anti-capitalist statements including clamping down on the financial system, making investors nervous.
  2. With the vote on Sunday looming and Correra still in the lead some money people became very nervous and moved a large sum of money out of Ecuador on the Friday before. Who did the moving I do not know, but it could have been banks, hedge funds or very wealthy people.
  3. The monies were moved to Europe and the Euro in particular. I am guessing in a bigger picture sense the amount of monies moved were small (eg a few billion), but due to the urgency of moving the money it caused the dollar to drop across the 1.30 boundary.
  4. Traders see the drop across the 1.30 boundary sense that something is happening and jump on the bandwagon. After all traders *would never* panic as a herd.
  5. As more traders jump on the bandwagon the dollar drops and causes panic because of how fast the dollar dropped.
  6. Panic sets in among traders as many chart technicians in Europe Wednesday one week ago predicted that the markets will drop by a large amount.
  7. Traders begin selling equities locking into profits and their year end bonuses.
  8. More panic and people sell left right and center.
  9. Panic subsides and selling stops.

Many of you will be skeptical of what I am writing, and you should be! Tell me if you think I am off my rocker. The reason why I think these sequence of events did happen is because the traders were trigger happy and nervous. With Jim Cramer saying, “This is the best market ever”, I myself became nervous as traders always like to take a opposite viewpoint.

So does this mean the Dollar is on a slide? I think not! I think we are in a slow-down, but things are still pretty good.

UPDATE: The traders seem to think that the dollar will continue to slide, and while I don’t agree with it, the market is always right!

Investment Tip: Airbus

Airbus is in deep do-do (2). The company that was heralded as the role model of a European Corporation, is well, getting bogged down in the reality of Europe. If there is one thing that the European governments and the American Federal government share it’s getting bogged down in details and bickering. Conventional wisdom says that Airbus is a dud stock! After all there are financial problems, A380 shipping problems, and let’s not even talk about the hen pecking between France and Germany.

The A380 was supposed to be the flagship product for Airbus. It was supposed to revolutionize air travel. The A380 will carry at least 555 with a maximum of 853 people, and that scares me. To understand the dimensions of this size, while waiting for a plane at the Frankfurt airport I was timing how fast a 747’s luggage can be unloaded. If you have ever seen the 747 unloaded there are no individual pieces of luggage, instead huge boxes are mechanically transported off the plane. A 747 can carry a maximum of approx 524 people, and unloading this particular 747 required 28 minutes. Extrapolating passenger count, I am guessing an A380 will require about 45 minutes to empty. Think about that, imagine waiting over an hour for your luggage to come rolling down the conveyor belt!

Now imagine trying to board a plane of such dimensions. The A380 is an example of cattle class where the only solution to boarding will be to herd people. And of course the airports that are already stressed with too many travelers are going to have a field day with a dozen A380’s on the tarmac. The economics of this beast for traveling is horrible, and I for one am going to avoid this beast like the plague.

Yet I am bullish on EADS, Airbus, and the A380. The reason why I am bullish relates to a topic my sister and I discussed. It seems Ecuador is trying to become one of the world’s largest rose producers. As I talked to her about this a light-bulb went off. Roses cannot be shipped by water, but have to be shipped by air. And companies like Fedex, and UPS do quite a bit of shipping. Recently UPS expanded its European operations at the Cologne/Boon hub. The Cologne Boon hub is a small airport, but UPS does fly quite a few flights. This asks the question are Fedex and UPS buying A380’s? Yes they are (1,2).

The fact that FedEx and UPS are interested in the A380 should tell us that shipping could be revolutionized. The A380 has intercontinental reach with a huge payload while still remaining efficient, meaning kiwi’s from New Zealand could be shipped to a local European or North American market within 24 hours. It will bring new meaning to freshness and globalization. It will also mean that I in the future could buy my computer directly from Asia, instead of a middle person in my local market. That monetary potential should make us all bullish on the A380, and the shipping companies. Though, it does not mean I will buy Airbus stock tomorrow, but might later on.

Invasions from the China Sea

I got an email from a reader at my other site asking about Geely Automotive Holdings Ltd (Google Finance). The author had already purchased over 19000 shares which might seem like a lot until you realize this is very much a penny stock. Still, the outlay for a young college student is significant and it probably brings up a topic for a good future article “Where the small investor should put his money?” We are not talking about that today because we need to answer the questions on Geely first.

The writer wanted a TA done on the stock and that is what we mostly do at HipEgg but here is the problem; Geely is not really a good stock for a technical analysis. At this point in writing I really started to go down two different paths and so I decided to split this article. If you want to do some reading on why Geely is not a good fit for a TA and some information on avoiding some TA pitfalls then go over to the companion piece at HipEgg after you are done reading here. Now on to the Geely Monster.

The car market in China is a fabulous land of opportunity and dreams. I am a bit of a car fan but I must admit that when I first started to think of cars made behind the silk curtain I was a little concerned about quality and style. I pictured an Eastern European knock off of a Fiat Uno. Fortunately this isn’t the case.

China has some good looking cars and I would assume well made. I can say that because in China they actively block foreign car manufacturers from entering. Take BMW for example. They wanted to sell cars in China but they can’t. Under the law they have to partner with a Chinese car company. In this case, BMW is in partnership with China Brilliance (CBA). CBA makes their own cars but they also manufacture a BMW line for China. CBA is learning important lessons like design, quality assurance and styling from the Germans. If and when they start to export they will probably do very well.

Information on Geely is harder to come by. Overall they do seem to be doing very well on the home front, sales are up and everyone is happy. Geely also seems to be one of the more aggressive companies looking to enter the global market place. They have already previewed an entry level model at the Detroit auto show. This car was a small 4 door with an expected base price of under $10,000 (Some have even put it at around $7500). The claim was that fuel economy would be around 33 to 35MPG which is nothing to write home about but far better then many larger vehicles. They are aiming for a release date of late 2007 to 2008 at this time.

The downside, they have yet to prove that they can pass air quality or US safety standards, although they claim to be on track to make these marks. There is also the unquantifiable problem of perception. Geely will likely be among the first, if not the first Chinese car to be seen in mass by the US public. How will a country so in love with BIG and so broke from fuel bills take a small Chinese econo-box? Hopefully we will see soon.

The long and short of it all is that I think there is potential for two or three major automotive behemoths to rise from the China coast, it will happen. I do not know if Geely will be one of those but it warrants further investigation and it is a company I would be willing to take a gamble on. Very few people outside of China have seen any of these vehicles. Information and research is harder to come by. For those interested in learning more about the products I would point you to http://www.chinacarforums.com/ . There are several companies in China now trying to position themselves for success. I think we as investors should be looking to add a little Chinese car company to our positions if we want to be successful.