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The Lottery of China's "Captalist" Economics


Analysis based on supply and demand, and selecting stocks based on the notion of survival of the fittest isn't optimal in China. So what is?

Imagine showing up to your local Ford (F) dealership to purchase a car, only to be turned away because you weren't a lucky winner of the latest government license plate drawing.

Sound crazy? Welcome to China.

In late December, the government banned all car sales in Beijing until the new lottery system is ready to name the next 20,000 license plate applicants from a drawing. Chinese car policies implemented to curb demand, in total, are expected to slow sales growth 10% to 15% in 2011, compared to a 30% increase in 2010.

Just days later, the government instated a 35% decrease in export quotas for rare earth metals for the first part of 2011. In the few days following the announcement, China Shen Zhou Mining & Resources surged 135% and Qiao Xing Universal Resources (XING) rose 96% as the government's move will lower global supply and increase rare earth prices.

Taming high inflation through price controls, reluctance to allow the renminbi to fluctuate naturally; examples of the strong hold the Communist Party maintains over the country go on and on.

Wild market swings that follow policy announcements and drastic industry growth fluctuations in response to government regulation provide evidence of the government's influence in the market.

In October, when the 12th Five-Year plan was revealed, Chinese tech stocks rose 4.7% in one day based on the government's call to increase information technology 's role in the general economy. Consumer stocks increased 4.1% in response to the government's vow to focus on domestic consumption and increase household income. Both were large daily swings for industry averages based on a generalized outlook.

Tampering with the economy has allowed China to achieve great feats since opening its doors to the global economy during the past 30 years, such as lifting more than 300 million people out of poverty and building an empire of cash.

And in current times, government control sometimes appears helpful.

No one wants to be told whether they can purchase a car or not, but have you taken a cruise through Beijing lately? A country adding 1,500 cars per day needs to have some sort of mechanism that curbs demand when infrastructure development can't keep up, as evidenced by multi-day traffic jams.

By not implementing price controls, the divide between the wealthy and the poor would quickly gap even wider. Currently rampant inflation is deeply affecting lower wage earnings, while the wealthy aren't batting an eye. In fact, they're actually buying more.

On the other hand, history tells us there are longer-term implications when a central government interferes with natural supply and demand and strict price controls can be viewed as a delay tactic to future hyperinflation when lifted. Furthermore, it's possible the scenarios that seem to need control are a very direct result of the government's control in the first place.

China's economic status -- typically dubbed a "pseudo-capitalistic" society is greatly misunderstood and a hotly debated topic. But whether or not you believe the government's role in China's economy is needed or a recipe for disaster, the bottom line to remember is that, despite signs of capitalism, China remains a planned economy. The government can do what it wants, when it wants, to get the result it wants.

For investors, this means that paying attention to government moves is vital. As we begin the 12th Five-Year plan, investors seeking exposure to China must familiarize themselves with the policies articulated in the plan.

Performing analysis based on the law of supply and demand and selecting stocks based on the notion of survival of the fittest isn't optimal in China. For example, a fundamentally weak company can remain a key player if it wins government support and cooperates in the achievement of a planned state goal.

Last week, Tim Geithner once again pleaded that China relinquish some of its economic control. The government has taken a lot of heat for its reluctance to pull away from such central governing and many question the sustainability of economic growth and stability if China refuses to change.

Therefore, China will be on a mission to ensure that its planned goals are met to prove to the world that its method of organizing an economy is superior. Regardless of where this will lead China in the far-out future, monitoring the government's every step and forecasting what policies the government may need to implement could help clue you in on profitable short-term trades in China.

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