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Breaking Out the Good China, Part 3

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Does the upside potential outweigh the risks of investing in China?

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Editor's Note: This is part 3 in a multi-part series. Part 1 can be found here. Part 2 can be found here.

On the day last week when the Dow crept into positive territory for the year (then up by 0.8%) the Wall Street Journal reported that the Shanghai Composite Index closed up 79.4% for the year. (Both decimal points are in the correct place.) Investor sentiment appears to be predicting that China's recent growth is sustainable.

In 2 recent articles dated June 10, 2009 and July 10, 2009 respectively, Anthony Chan, Asian Sovereign Strategist, Global Economic Research of AllianceBernstein, concurred. He expressed the firm's opinion that even if the current investment-led recovery in the Chinese economy -- a large part of which is in the development of infrastructure ($130 billion for 2009 alone, 60% already spent at the end of June) -- loses momentum in late 2009, the economy will continue to be spurred by recently introduced government policies intended to tap Chinese households' high level of precautionary savings, thus substantially increasing consumer spending and the further development of the residential housing market.

Based on what I observed, this is a dubious proposition. In my most recent article on the Chinese economy, I erroneously reported that China plans to build 7 tunnels under the Yangtze River, connecting Shanghai and Huangpu. Actually, the tunnels will be under the Huangpu River. More importantly, recourse to the July 7 2009 edition of the Shanghai Daily reflects that the number of new tunnels to be constructed will be "at least 9."

Referring to these, as well as to an eventual recovery of Chinese exports as "the Second Wave of Chinese Growth Drivers," Mr. Chan stated (July 10, 2009):

"At a more complex level, the market may not yet fully understand and appreciate China's underlying growth potential and dynamics in the context of the economic reform and restructuring that has taken place over the past 30 years and which has been unprecedented in terms of scale, breadth, and speed. Arguably, China -- with a huge population which is experiencing a massive shift in demographic and income profiles -- is only halfway through its urbanization and industrialization process. In our view, there will be many more 'green shoots' of economic restructuring in China which will result in significant capital accumulation, improved productivity, and economic growth, and these will compensate for any loss in growth caused by policy mistakes or sectoral imbalances."

Mr. Chan also provided the following statistics and conclusions (June 12, 2009):

"[T]here is broad evidence to show that consumerism in China is alive and well. This includes double-digit growth in cosmetic and jewelry sales and in purchases in electronic/video products, clothing, and footwear. Residential property sales surged a huge 49% year-on-year in May, which has triggered a similar pace of growth in the sale of furniture and home decoration materials. The sale of motor vehicles has picked up remarkably to an average of 30% year-on-year in April-May from 3.6% in the first quarter of 2009. Moreover, consumption of services has remained strong, including a 23% year-on-year increase in mobile phone subscriptions in March and a 15% year-on-year rise in passenger air traffic during the first quarter."

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