Posted 7:58 AM by Dil
03-Nov-03

A more cautious approach toward Asia and commodity prices
Marc Faber

"Asia is firing on all cylinders. Consumer spending has more than recovered from Sars. In an increasing number of countries investment too is picking up. China is roaring ahead as a source of demand for both consumer and investment goods and, after a soft summer, export growth has picked up again. Add in a recovery in the United States, our bullish forecast for Japan and some signs of life in the EU and you have an economic environment that is better than has been seen for years and maybe the best since before the Asian crisis", so says CLSA in its fourth quarter Asian Economic Research bulletin, dated September 11, 2003. I agree! Asia is experiencing economic boom conditions although no everywhere and not for every sector of the economy. Moreover, what concerns me regarding the view of CLSA is the statement that the economic environment in Asia "maybe the best since before the Asian crisis". Let us hope that these "boom conditions" will not end the same way they unraveled in 1997!

Over the years, I have been immensely impressed by China's economic development, the relatively smooth and peaceful progress of its society post communism and the rise of standards of living in that country. More recently, I have also been impressed by the changes that have taken place in India over the last two years and which are likely to ensure future trend-line GDP growth in the 5-6% range or even higher. But, as the economist Clement Juglar wrote in the 19th century, "paradoxically as it may seem, the riches of nations can be measured by the violence of the crises they experience" and, therefore, I am now more cautious about China's and Asia's economic prospects as well as about the potential for commodities to rise much more in the near term. There are several reasons for this more cautious view.

Whereas CLSA actually predicts economic growth in China to accelerate in 2004, I take a more conservative approach and believe that its growth will slow down considerably or even be temporary interrupted by a mini crisis. In addition, since China's rapid economic expansion had a very beneficial impact on Asia by sucking in imports from the region, I have to assume that any slowdown in its growth rate would also have a negative impact on the rest of Asia as well as on commodity prices.

Let me explain. Unlike in the US, growth in China is driven by net capital formation and exports. Like in the US, growth in China is also driven by strong consumption growth and consumer credit growth, albeit unlike in the US in unsaturated markets. In recent years, China's fixed investment growth has been accelerating and accounts now, according to some experts, for 42% of GDP. Now, let us assume that this figure is grossly overstated and that capital formation only accounts for say 20% or 25% of GDP. The problem does, however, not relate to the size of current capital spending in China, but to the fact that is has expanded rapidly over the last few years and that large over-capacities have come about in almost every sector of its economy (according to Chinese statistics fixed investment growth is up 30.5% year-on-year in the first nine months of 2003). In other words, it would appear that China's current economic boom has much to do with significant over-investments, which were so common in the American economy of the 19th century and repeatedly led to vicious downturns. Now I am the first one to admit that the Chinese learnt very quickly from the US government how to doctor economic statistics and, that therefore, the year-on-year growth in fixed investments could be much lower than Chinese statistics would have us believe. However, if we consider that housing and the construction of commercial structures has been booming and that FDIs were strong, it is possible that fixed capital formation jumped massively in 2003. The fact, however, is that overcapacities now exist and that inventories have risen strongly. In this respect it is interesting to note that Motorola just sold its loss making one billion US dollar waver fabrication plant in Tianjin to China's Semiconductor Manufacturing International Corporation (SMIC) for a 10% stake in that chipmaker (SMIC is only three year old and is China's first made-to-order chipmaker!). I may add that Motorola's MOS-17 wafer-fabrication plant had been running at less than 10% of its capacity, as demand for locally made chips failed to meet Motorola's "great" expectations. That large over-capacities exist is also evident from China's stable or declining consumer good prices given the country's strong growth rates. In the case of China we can really talk about a deflationary boom! But excess capacities aside, which may lead in 2004 to slower fixed capital investment growth rates, or even a slight decline, I have other concerns regarding the Asian region as well as commodity prices. Recently Chinese import growth of 40% year-on-year (compared to 30% export growth) would suggest that some inventory building is taking place. Indeed inventories have been soaring, which is not surprising considering that commodity prices have been rising strongly. Now visualize the following situation. Since industrial production in the industrialized countries is flat to down, there is no doubt that it was the incremental demand coming from China that pushed up commodity prices since 2001. In turn, rising prices did not go unnoticed to China's authorities and corporate sector, which immediately reacted to rising prices by building up their inventories and in the process created higher demand than would have been the case without the inventory build-up! In fact, for China to build up its inventories is more than logical. By doing so, it diversifies it foreign assets out of US dollars, warehousing costs are not a factor, and it reduces the politically sensitive trade surplus. But, the flipside of this is that if industrial production and fixed capital investments slow down the rate of increase in the demand for commodities will suddenly diminish or at worse, Chinese demand could even temporary decline. I wish to stress that in order to get a meaningful slowdown in the aggregate Chinese demand there is no need for capital spending to decline. A slower growth rate or flat fixed capital formation will do the trick via the multiplier, and acceleration principle. I am, therefore, leaning towards the view of the research tem at ABN-AMRO who believes that, "the market is too complacent over China's over-investment problems and the country's need to tighten". According to ABN-AMRO, "some argue that China is not overheated on the ground of low CPI inflation rate. They miss the point that China's current overheating is caused by excessive investment. The resulting excess capacity will be deflationary, rather than inflationary. The market hopes for fine-tuning. This is wishful thinking. The severity of the problem is already well beyond what fine-tuning can solve, and also the system and tools that allow the government to fine-tune the economy simply do not exist. History tells us that China has never achieved fine-tuning…There are two options for the Chinese government: 1) try to engineer a slowdown now and hopefully it will be a soft landing (not fine-tuning), or allow the investment ratio to continue to rise until it blows up."

A slowdown in the growth of net capital formation aside there are other reasons to take a more cautious approach towards China. If, US consumption slows down as the stimulus of the tax cuts and the housing refinancing boom disappear, then export growth not only of China but also of the entire Asian region will cool down. Moreover, Chinese domestic consumption is already showing signs of slowing down somewhat, as at least some markets are becoming increasingly saturated.

Finally, what disturbs me the most is that every magazine or paper I open has some favorable comments about China's economic development and China's positive impact on commodity prices, and that there has been widespread speculation in just about any stock that has something to do with China. Just consider the three Nasdaq listed internet companies, Net Ease, Sohu and Sina which are all up over 2000% from their lows a year ago and combine all that speculators can dream of - high tech, telecommunication and China.

Regarding commodities, I continue to believe that we are at the beginning of a multi year bull market. In other words, after the more than 20 years old bear market, commodity prices have, in my opinion made secular lows and will rise considerably more in the years to come. However, the commodity theme has become rather popular and a meaningful setback would not come as a surprise to me. Prices for industrial commodities such as Steel, Alumina, and Nickel have exploded on the upside, while cotton has doubled over the last twelve months and is now at a five-year high. And while it is possible that the current first leg within a long-term bull market in commodities may have some further upside potential, investors should fully realize that "China and commodities" have become a very well known and popular theme among the investment community!

I concede that I could be wrong about the coming slowdown in Chinese growth. In this case commodity prices will rise further in the next six to twelve months. If, however, commodity prices continue to roar ahead, then the likelihood of accelerating inflation rates around the world is very high unless companies are prepared to accept lower margins as a result of rising material costs. And if inflation should accelerate, higher interest rates will begin to weight on equity markets and contain the current bull market.

In the meantime the investment case for Asia remains intact, although stock markets may be near term very overbought. Thailand is up by 85% over the last 12 months and Indonesia by 113%, albeit from an extremely depressed level. The worst performing markets over the last twelve months are the Philippines - up 22.1%, Singapore - up 23.3% and Malaysia - up 24.6%, all markets we still like on a relative basis. In the case of Indonesia and Thailand, I would wait, as in the case for commodities, for a correction to unfold before making major new commitments. In fact, I believe that emerging markets -following their superb performance over the last twelve months - are due for a significant correction, as the US stock market looks increasingly vulnerable.

The problem I have is that I don't find many bargains today anywhere, except maybe among precious metals, which are partly commodities and partly the only really "hard currencies", whose supply cannot be increased meaningfully. Platinum prices are at a 23-year high. Thus, it is entirely possible that also gold and silver will fly to the upside in the next two years.

Posted 7:43 AM by Dil
02-Oct-03

"Do economic statistics adequately reflect the size of the Asian economies?"
Marc Faber

Officially, the US has a GDP of about US$11 trillion, while China’s GDP amounts to US$1.1 trillion and India’s to about US$500 billion. Moreover, whereas the world’s GDP stands at about US$32 trillion and the advanced economies have a combined GDP of US$25 trillion (G7: US$21 trillion), the emerging Asian economies (including China and India, but excluding Hong Kong, Japan, Singapore, South Korea, and Taiwan - countries that are classified as advanced economies) have a GDP of just US$2.2 trillion. However, if we look at some production figures, it becomes obvious that the US economy is nowhere near ten times as large as the Chinese economy or more than 20 times the size of India’s GDP. Neither do the G7 countries have a GDP ten times larger than the emerging Asian countries. According to The Economist’s World in Figures 2003 directory, China ranks as the world’s largest producer of cereals, meat, fruits, vegetables, rice, zinc, tin, and cotton. It is the world’s second-largest producer of wheat, coarse grains, tea, lead, raw wool, major oil seeds, and coal, the world third-largest producer of aluminium and energy (measured in million tonnes of coal equivalent), and ranks between fourth and sixth in the production of sugar, copper, precious metals, and rubber. India ranks among the top three producers of cereals, fruits, vegetables, wheat, rice, sugar, tea (number one for the latter two), and cotton. Indonesia ranks among the top four producers of rice, coffee, cocoa, copper, tin, and rubber; while Thailand is the world’s largest producer of rubber, and Vietnam the world’s second-largest producer of coffee.

“So what?” some readers may think, since these are just commodities and thus are irrelevant in post-industrialized societies! However, if we consider that China is already the world’s largest manufacturer of textiles, garments, footwear, steel, refrigerators, TVs, radios, toys, office products, and motorcycles, just to mention a few product lines, and if we then add the industrial production of Japan, Taiwan, South Korea, and India, we get a totally different picture of the size of the Asian economies than is suggested by statistics based purely on nominal GDP figures, which don’t take into account the difference in the price level between different countries. In fact, statisticians, in order to account for the fact that in some countries the price level is far lower than in the Western industrialized countries (such as is the case for most emerging economies), have calculated the GDP level based on purchasing power parities (PPP). And while I have some doubts about the methodology of PPP-adjusted GDP figures, it is nevertheless interesting to see how large the emerging economies are when based on this measurement. Asia (including China, Japan, India, South Korea, Indonesia, Taiwan, Thailand, the Philippines, Pakistan, Bangladesh, Malaysia, Hong Kong, and Vietnam) has a PPP-adjusted GDP of US$14 trillion, which is 50% larger than the US’s PPP-adjusted GDP of US$9.6 trillion. In fact, by this measurement, Asia, in which we should probably also include Central Asia, Australia and New Zealand, as well as parts of Far East Russia, would be by far the world’s largest economic bloc. And while, as just mentioned, I have some reservations about PPP adjustments, in general I think that it is fair to say that the PPP-adjusted figures reflect a far more realistic picture of the size and importance of the Asian economic bloc with its 3.6 billion people (61% of the world’s population) than do the nominal GDP figures, which suggest that the US has a GDP ten times that of China.

One of the reasons why I have chosen to discuss the size of the Asian economies, their impact on commodity prices and on resource-based countries and basic companies aside is that if we compare the true size of Asia with the extremely low weighting some Asian countries have within the MSCI World Free Index, it becomes obvious that some big changes are likely to take place in future. The combined weighting of the entire Asian region with 3.6 billion people and the world’s largest economic bloc is just 3.4% excluding Japan and 12.1% including Japan! This low weighting of Asia compared to the US raises two important questions. Is Asia ex-Japan really worth around 5% of the world’s entire market capitalization (5% would include shares, which at present cannot be bought by foreigners), and is the US worth 11 times the Asian market capitalization ex-Japan? I, for one, doubt it! This particularly because of the low price level in Asia compared to the US and also because of Asia’s bulging foreign exchange reserves, which are approaching $ 2 trillion. Should the day come when Asians have more confidence in their own economic bloc (which I think will happen in the next few years), we could see a massive shift of assets from the US to Asia, with Asian financial assets and Asian currencies rising very strongly relative to US financial assets and the dollar. In other words, I think it is only a matter of time before Asian currencies and Asian assets, including real estate and stocks - will appreciate relative to US financial assets and US properties.

There is one further point worth mentioning. If an individual or a financial institution asked a traditional fund manager (who inevitably follows the index weighting quite closely) to invest their funds that have been allocated to equities, they would end up having more than 50% of their money in the US and just 11% in Asia including Japan, a region which, as I have explained above, is already the world’s largest economic bloc with 3.6 billion people and the world’s most favorable growth prospects (moreover, they would have a maximum of 5% of their money in Asia ex-Japan, with 3.5 billion people and which includes the world’s fastest-growing economies - China India, and Vietnam). He would also end up with less than 1% of his assets in combined China, India, Indonesia (the latter a country with the world’s fourth-largest population), Bangladesh (eighth-largest country), Pakistan (sixth-largest country), Thailand, and the Philippines. Somehow, I think that such an asset allocation, which implies that the index-benchmarked investor would own just 1% of a region which is inhabited by half the world’s population, simply doesn’t make any sense at all and exposes the absurdity of indexing as it is practiced today.

In fact, I believe that investors should allocate at least 50% of the money they invest in equities to Asia where valuations are far lower and growth prospects more favorable than in the US.

But, while I am very positive about Asia from a number of points of view (the size of the economy, growth potential, low valuations, and low weighting within the MSCI Index), I also have to admit that near term I am far less optimistic. I simply feel very uncomfortable about the US economy and the entire financial system, and feel that the US stock market has at best entered a sharp correction phase or may at worst, experience a crash - if not now, then following another brief bout of strength. And since the recent strength in the Asian markets has been driven largely by foreign buyers, a US stock market correction or, in the worst case, a crash would almost certainly spill over into Asia and lead to some pronounced weakness but not likely to new lows. It is for this reason that I have turned more cautious on Asia from a near term point of view. In the US, I am particularly concerned that rising interest rates will have a negative impact on the housing market and on financial stocks, which make up more than 20% of the S&P 500. Housing stocks, which have been formidable performers since 2000 (up fivefold), should from now on under-perform, as the decline in refinancing activity will slow down the industry. Moreover, the Philadelphia Bank Index appears to be tracing out a head and shoulders formation and financial shares such as Fannie Mae look poised to decline sharply. I may add that while financial stocks look likely to weaken in the US, in Asia financial shares appear to be strengthening. In sum, I like Asian assets including real estate and equities and I remain of the view that investors should avoid the US. Thus, you might consider hedging your Asian bets by shorting the US!

Posted 7:29 AM by Dil
18-Sep-03

"They will buy more"
Financial Post

China is booming. How can you benefit? To find the answer to that question, the Financial Post sat down this week with four of the world's most knowledgeable investment experts.

Marc Faber, author of "Tomorrow's Gold -- Asia's Age of Discovery," editor of the Gloom, Boom and Doom Report and special advisor to Dynamic Mutual Funds was in Toronto. Joan Zheng, Greater China chief economist for J.P. Morgan, spoke to us from her office in Hong Kong. Chen Zhao, managing editor of Bank Credit Analyst Group's China Analyst was in Montreal. And Mark Mobius, managing director of Templeton Asset Management Ltd., joined us from Spain.

The global teleconference was organized by Dynamic Mutual Funds and stickhandled by Levi Folk, an independent fund analyst. Below, our four experts give their views on China's rapidly industrializing economy and reveal how you can make the most of the situation.

Q. What opportunities does China hold for an investor with a long-term perspective?


Marc Faber: The Chinese economy is probably about 50% to 60% of the U.S. economy already and in many sectors of the economy, China is larger than the U.S. China produces more steel than the U.S. and Japan combined and they are still importing steel. The markets for motorcycles, refrigerators, TVs, VCRs, handset telephones is larger in China than in the U.S. So in terms of units of production and units of consumption, China is already a huge economy and such an economy, obviously with 1.2 billion people that is growing anywhere, who knows, 5%, 10% per annum trend-wise, offers investors all kinds of opportunities.

I would also like to point out that as of today, if you went to a portfolio manager ... your portfolio would be benchmarked according to the Morgan Stanley world index. You would have 53% of your money in the United States but you would only have 8% in Japan and 3% to 3.4% in the rest of Asia, which would include Pakistan, India, China and those countries that have a combined population of 3.5 billion people. I don't think this adds up. I think people should have much less money in the United States, maybe only 20% of their money. I would have no money in the U.S. and 50% to 60% in Asia, ex Japan.

Q. Could you tell us a bit about who is investing in the region, Which multinationals? Which countries? Why?


Joan Zheng: I actually had a chat with the chairman with the American Chamber of Commerce in Beijing and he said that [of] the American companies, at least about 70% are making profits in China, like Motorola, GM, Coca-Cola. He also said that ... 40% of American companies actually are getting higher margins in China last year than in the U.S. and over 80% of American companies based in China said they would reinvest in China.

Faber: Wages in China are averaging about 7% of what they are in Taiwan and South Korea and probably about 3% of what they are in the U.S. and in Japan and then you don't have all the employee benefits that accrued or that are a cost to corporations in the U.S. like health care and so forth and retirement. So, basically, you can produce anything in China probably at least with 50% lower costs than in the United States and also at much lower cost than in Taiwan or South Korea.

Q. Why is the Chinese domestic market geared towards consuming Asian goods and not U.S. goods, because we know that China runs a large trade deficit with the U.S.?

Faber: Most American goods ... cannot compete with foreign goods. Take cars: A Chinese [person] is not going to buy an American car. He is going to buy, if he is rich, a Mercedes, a BMW, a Volvo, and if he is very rich, a Rolls Royce or a Bentley, and if he is middle class, he will buy a Japanese car. Moreover he can buy domestically manufactured cars by all the major car manufacturers. So, actually, the U.S. imports at an annual rate of US$125-billion of Chinese goods but they only export at an annual rate of US$22-billion to China and that won't change. The Chinese could revalue their currency by 50% and this relationship wouldn't change.

The reasons they are buying from other Asian countries is that their purchases are principally components for electronics and resources. In other words, oil and agricultural commodities, iron ore, copper and so forth.

Chen Zhao: There is a global kind of rationalization in manufacturing. You know that the Asians, the Japanese, the Koreans, the Taiwanese, the Hong Kong people, all those investors, all those Asian investors, they have put a lot of money in China.

I would say probably since the 1990s, you have a surge in Chinese exports to the U.S. At the same time, the rest of Asia exports to the U.S. plateaued, and declined in some cases. So this is really a structure shift. If you take Asia as a total, as a whole, yes, their market share in the U.S. did increase but not as dramatically as if you look at the Chinese exports to the U.S.

Why do foreigners want to invest to China? A lot of people are emphasizing cheap labour. It is a very important part of the Chinese competitive source but it is not only the one. There is a lot of countries that have got a lot of cheap labour but it doesn't mean anything. You have to have cheap labour, at the same time your economy has to be industrializing. This combination really makes the whole story more attractive.

If you have an industrializing economy, you know that the income level is growing and at the end of the day people will buy more. So that is why all these western car makers are making cars in China. Those automobiles are not made for exports. This is a classic example of an industrializing economy or per capital income growth and [that] then creates a new market.

Q. What about specific countries, sectors or shares for individual investors?


Zheng: So far, what we are have been seeing is that those targeting in global markets have been very successful because the domestic markets are growing but they are still quite segmented. So luxury goods and services are doing very well. So, for example, GM is doing well, and Honda ... and companies which are getting into luxury services like private education.

Faber: I think the 1990s were heaven for the multinationals because they went into countries like China, Vietnam, Russia and they have faced very little competition because the local companies, they didn't have the financing. They didn't have the know-how or the marketing skills and so forth. So basically the Coca-Colas, the Gillettes of this world, overnight they grabbed anywhere between 50% and 80% of a market but over time, partly as a result of the outsourcing process, locals have actually learned. They have acquired the technology, or stolen the technology, and they are now producing competing goods.

I think from here onwards, you should own the local companies ... The largest computer seller in China is not Dell, Compaq or HP or IBM, but it is Legend, and I think everywhere we see this trend of local companies taking market share away from the multinationals and therefore I would rather focus on the local companies.

An additional point is [that] in China, you have maybe 200 or 300 breweries today. In 10 years time, maybe there will be 10 less so there will be a consolidation in the industry where the strong companies will acquire weaker companies and therefore, I think that there will be also an opportunity to own a company such as Tsingtao and maybe eventually they will have a 50% share of the market such as Anheuser Busch has in the United States.

Zhao: One way to do it is to really look at different countries. If you think about Hong Kong in the '70s and '80s, Hong Kong was a very depressed economy. The manufacturers there faced intense competitive pressure. The economy was dying, everything was bleak. What happened then was that the Hong Kong manufacturers moved to Southern China. [It made things worse for a while] but after the process Hong Kong had a boom. They had a profit boom. They had a property market boom. Their economy was upgraded.

Who is the next Hong Kong, where the economy can benefit from China's industrialization process? One is, for example, Taiwan. I mean if you look at Taiwan, what is going on in Taiwan today is exactly like what went on in Hong Kong in the '70s and '80s.

The Taiwanese are the most -- have been the most aggressive investors in China. So now you have got about half a million Taiwanese businessmen operating in Shanghai.

Zheng: I still feel it is better to go through foreign companies with investment in China because then at least you can avoid accounting, although it is true that locals can copy very quickly.

I feel Taiwanese investors actually have the best chance to succeed. Not only do they have common country, language [but] also in terms of how to deal with the bureaucracy -- very well trained at home -- they already also have the first mover advantage.

Faber: China is basically resource poor so they have to import oil, palm oil, timber, copper, iron ore and so you know, for me, the easiest way to play China is to buy today coffee because first of all, the coffee price -- last year, the lowest price in real terms ever is very, very depressed by any standard and if the Chinese just go to the per capita consumption level of say the Taiwanese or South Korean, they will take up the entire coffee crop of the world.

Per capita oil consumption in China is only about one barrel compared to 17 or 18 barrels in Japan and South Korea and over 20 barrels in the United States. So you can actually play Chinese growth by buying commodities and forgetting about all the legal problems and market share problems the individual companies will have in China and about their profitability and so forth.

I personally wouldn't buy the electronic manufacturers of Taiwan because we had the hi-tech bubble and now we have a strong recovery on Nasdaq and I suppose that tech stocks, by and large in the world, especially in the U.S., are overvalued and when they decline they will pull down again the Taiwanese tech companies and the South Korean ones. So I would rather play China through natural resource or companies in Asia and Indonesia in Malaysia that are selling to China.

In the case of Malaysia, exports of palm oil have risen from 6% of total exports to now 26% of total exports.


Q. Is this what we see happening right now, why we have seen a spike of commodity prices?


Faber: Well, basically what we had was a weak global economic environment since 2000 and in spite of that, commodity prices are up in many cases by more than 100% from their low. In other words, somebody has been buying commodities and this somebody has been principally China. So if you are optimistic about the world like all the American economists and you believe that there will be synchronized growth, then commodity prices will go up much, much higher than they are today over a period of the next five to 10 years.

In addition to that, if you are optimistic about the world and about Asia, oil demand in Asia, which is now at the present time daily 90 million barrels, that will double in the next five to 10 years to anywhere between 35 to 50 million barrels. That will push up the price of oil much more than anybody thinks and you basically have these more than 20-year bear markets in commodity -- they have bottomed out in the period 1999 to 2001 and have now entered a major bull market, in my opinion.

Zhao: I totally agree with Marc on this one. I think the commodity story is the Chinese story over the next five to 10 years. Oil prices were at US$25-some a barrel during the recession [of] 2001, 2002 when the ... the developed economies were extremely weak. Who held up oil prices during this period? Only the Chinese economy was growing very rapidly. So that to me explained the whole story.

Q. Mr. Mobius, what Chinese companies do you own?


Mark Mobius: China mobile, China Petroleum and some of the H shares in Hong Kong like China Travel.


Q. How quickly can we see a middle class emerging as a key consumer for foreign products?


Zheng: Well, what I did was I used the first official survey on China's household asset and income distribution as well as financial investments and I calculated in a very rough manner. At the moment, you have 27 million households which can already afford to buy cars. So it is not a small number, although the size of the economy is still 30% smaller than California.

Q. What is going to prompt the average Chinese person to spend more money?


Zheng: [If] we look at overall regional sales or consumption growth, in fact, it is not strong by China standards. The reason is because you have a social welfare system still in transition. You have education costs rising very rapidly. So households need to save, save for old age care, for kids' education, for possible job losses, all those. So I think this will take at least another three years for this marginal propensity to consume to rise again, so that will be the time for us to see more consumption.

Q. What are the perils of investing in China? What about management, corporate governance and the banking sector?


Mobius: There is a lack of global knowledge in particular fields. Not enough managers in China who are capable of understanding what is happening globally, so you have to find people who understand these concepts. Also, they haven't had the experience of working in profit making enterprises, so the inefficiencies are very, very high, and that is the pool of management we have to draw upon, so it takes time and effort to get these people up to speed.

[As for corporate governance] that is a problem that is not specific to China. It was a problem for [investors in] Enron and WorldCom, we saw it with Bre-X, I am sure you remember that, it is a problem everywhere.

In emerging markets it is a little more salient because the punishment system and the justice system is not very good, so people commit the same crimes.

Zhao: A lot of people are saying that the Chinese banks will face a lot of problems. Yes, no question about it and a lot of people are also saying well, the Chinese banking has got too many [bad] loans ... that the banking system will collapse. This argument is completely rubbish. Think about the history of the world. There has never been a country where it runs a current account surplus that has a collapsed banking system. The reason is very simple. As long as you do not rely on foreign borrowing, the central bank can always bail out your banking system. The simple mechanism is just to print money, right?

Think about Brazil, why Brazil got into a crisis, why Argentina got into a crisis, why Mexico got into a crisis: The reason is that they borrow heavily and all of a sudden when foreign favour starts to put money somewhere else, the whole financing system collapsed, whereas this problem does not exist in China.

The problem with the Chinese banking system problem today is that they have too much liquidity. It is pretty much like the Japanese system. It will never collapse as long as Japan runs a huge current account surplus. Yes, they will have pretty lousy profits, that is true, but they will never collapse. So the crisis story, that is a horror story that is based on nothing but western journalist sensationalism.

Q. What about the U.S. current account deficit and the yuan? Will China have to revalue its currency?


Zhao: The Chinese sell a lot of stuff to the U.S. At the same time, they are buying U.S. treasuries. It serves the purpose for the Chinese. They export to the U.S. They solve some problems with the unemployment in the manufacturing business. It serves the U.S. too because the Chinese purchase of U.S. treasuries is a major force to hold down interest rates in the U.S., which in turn helps to sustain the spending power of the consumer. It will help the capital spending recovery, too. So really there is no reason whatsoever for the Americans to press the Chinese to revalue.

Q. But isn't [the low yuan] a drag on U.S. growth?


Zhao: No. The argument for the Chinese revaluation is that the Americans basically think -- some of the Americans think -- that Chinese exports are killing the manufacturing jobs in the U.S. That is totally wrong. The decline in the manufacturing business in the U.S. started in 1949. There has been a 50-some years trend. The American economy has moved into a post-industrial age. It is a natural evolution for America to reduce its manufacturing content in its economy, otherwise -- think about it -- if Chicago was still making textiles, the American per capita GDP would probably be still at $2,000.

Another point, what [goods do] Americans buy from China? Those goods are not manufactured in North America anyway. So if the Americans do not buy from China, they will have to buy the same goods from somewhere else at higher prices.

At the end of the day, you will not reduce your current account and trade deficit. That is the bottom line.
The final point I want to make is the Bush administration, they have to be careful what they ask for. If they get it, once they get it, they may not like it, right?

The fact that the Chinese are intervening today means that they are ... trying to create some inflation. So my point is this. When the Chinese inflation reaches 3%, 4%, sometime next year, they will reevaluate the currency by themselves. You don't have to push that, but once they revalue that currency, the Americans will probably face some kind of a shock because once they revalue, they will no longer buy [U.S.] treasuries. Once they stop buying treasuries, your interest rates will go up. Then you will have a lot of problems. So the Bush administration really has to think this through very carefully.

Q. Are we going to see China importing services from the U.S. as trade barriers come down?


Zhao: There is some misperceptions. The Chinese imports from the U.S. have gone up something like 40% a year. The rate of growth is very fast, of course, from a very low level.

Posted 7:01 AM by Dil
A very Merry Christmas and a Happy New Year to all our website visitors.

First, I wish to thank all our website visitors for being part of a group of people who look at the world with scepticism and are intellectually demanding. This forces me to maintain as high a standard for our comments as I am capable of. Every day, I receive a great number of emails, some of which contain enlightening comments or challenging questions. Naturally, I don’t have all the answers, since only the ignorant have an answer for everything, and it’s usually only time that reveals the outcome of any problem or issue. But even once an outcome is known, we still don’t know what would have occurred if we had taken a different course of action. Take, as an example, the war in Iraq. As my readers will probably know, I was opposed to the invasion and I still believe that it was a mistaken course of action. But I sincerely hope that future events will prove me wrong and that, as a result of the invasion by American forces - for whom I feel very sorry for the casualties and pain they have endured - in time, the Iraqi people will have a far better life than before. Only then can we consider the invasion to have been a success and worth the heavy casualties of the coalition forces, which undoubtedly must bring a lot of grief to the families of those soldiers who have been injured or killed. But my point is that, even if the invasion proves to be a failure, we still wouldn’t know what would have happened if it hadn’t taken place. Possibly, if Saddam had remained in power, the outcome would have proven to be far worse and led to a far larger number of casualties.

Every day, we are confronted with issues and problems for which there are no simple or clear answers. Of course, I am privileged in the sense that I can draw on the knowledge of many extremely bright economists, strategists, businessmen, political observers, fund managers, and even writers and poets, who all make a contribution to my, and also my readers’ knowledge. In fact, one of the commentaries I enjoy the most is sent to me every Sunday by Dr Mardy Grothe, the author of a highly recommended book entitled Never Let a Fool Kiss You or a Kiss Fool You: Chiasmus and a World of Quotations That Say What They Mean and Mean What They Say and of Oxymoronica: Paradoxical Wit & Wisdom From History’s Greatest Wordsmiths, to be published in March 2004 (www.chiasmus.com and www.oxymoronica.com). Chiasmus is a reversal in the order of words in parallel phrases, such as “one should eat to live, not live to eat”, whereas Grothe defines oxymoronica as “a collection of apparently illogical or self-contradictory observations that contain deeper meaning or hidden truths”. In Grothe’s new book, the reader will find an anthology of quotations that are noteworthy because they are false on one level and true on another, such as when Ava Gardner said, “I am deeply superficial.” According to Grothe, “in normal discourse, ‘deep’ is the opposite of superficial. But when paired together, the marriage of opposites arrests our attention and tantalizes our thinking. Such is the nature of all well-constructed oxymoronic observations.”

Dr Grothe’s work was introduced to me by Dean Le Baron, of Batterymarch fame, a few years ago, and the good doctor has kindly given me permission to use here some of the examples he has collected over the years. In the following I shall use some of his chiastic and oxymoronic phrases and mix them with some other quotes that I have collected. On the subject of war, since we were just discussing the dilemma posed by the Iraqi occupation, many illustrious people have made insightful pronouncements. William Tecumseh Sherman warned, following the American Civil War, that “it is only those who have neither fired a shot nor heard the shrieks and groans of the wounded who cry aloud for blood, more vengeance, more desolation”. Karl von Clausewitz observed that “there is a point beyond which perseverance can only be termed desperate folly”. And during the Vietnam War, Henry Kissinger made the following chiastic observation, which has some relevance to the current situation in Iraq: “The conventional army loses if it does not win. The guerrilla wins if he does not lose.” Even the comedian and best-selling author Will Rogers had a relevant comment regarding the invasion of Iraq: “You can’t say civilisations don’t advance - for in every war they kill you in a new way.”

As far as terrorism is concerned, we should remember Pearl S. Buck’s words: “When hope is taken away from people, moral degeneration follows swiftly after.” And to complete our quotations on war, here is H.G Wells: “If we don’t end war, war will end us.”

On leadership, the 17th-century mathematical genius Blaise Pascal, who at the age of 20 invented a revolutionary calculating device for his father which many regard as the first digital calculator, made two remarkable oxymoronic observations: “There are only two kinds of men: the righteous who believe themselves sinners; and the sinners who believe themselves righteous” and “Men never do evil so completely and cheerfully as when they do it from religious conviction.”

Further on the subject of religion, Robert Ingersoll (a major force in the development of the Republican Party and one of the greatest orators of his age) made the following chiastic observation: “I am not so much for the freedom of religion as I am for the religion of freedom.” On the same subject, George Bernard Shaw, who won the Nobel Prize for Literature in 1925, remarked: “I’m an atheist and I thank God for it.” On the subject of leadership, his view was: “He knows nothing and he thinks he knows everything. Clearly, that points to a political career.”!!! On politics, Paul Valery noted: “Politics is the art of preventing people from taking part in affairs which properly concern them.”

In terms of investments, I hope that all my readers had a good year, as most asset classes, with the exception, of course, of the US dollar, increased in value. But as George Bernard Shaw put it: “The most important thing about money is to maintain its stability; You have to choose (as a voter) between trusting to the natural stability of gold and the natural stability and intelligence of the members of the Government. And, with due respect to these gentlemen, I advise you, as long as the Capitalistic system lasts, to vote for gold.” And since I am continually asked for investment advice, let me remind our readers of Diderot’s words: “The best doctor is the one you run for and can’t find.” Jean Jacques Rousseau had this to say: “The ability to foresee that some things cannot be foreseen is a very necessary quality.” And just in case some of my readers didn’t have a good year in terms of their investments, let me remind them of what Will Rogers said: “Good judgment comes from experience and experience comes from bad judgment.” Moreover, since behavioural finance is back in fashion, don’t forget that, according to Edmund Burke, “All men that are ruined are ruined on the side of their natural propensities.” Regarding one’s ability to forecast the future, we should never forget that, as Mardy Grothe wrote, “Illusion is one of the most pervasive realities of life” and “The greatest self-deception is to believe oneself free of self-deception.”
Dr Grothe’s comments are particularly applicable to our Fed chairman, Alan Greenspan, who, in 1966, made the following comment regarding the speculative boom of the late 1920s:

The excess credit which the Fed pumped into the economy spilled over into the stock market, triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in breaking the boom. But it was too late: By 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenchment and a consequent demoralizing of business confidence.

In Gold and Economic Freedom, Greenspan wrote “... that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other”. Lacking much intellectual integrity, Alan Greenspan was never a great forecaster either. My friend Bill Fleckenstein recently quoted Greenspan as saying, on January 7, 1973, two days after the stock market had peaked out and as it began a two-year decline that would see its value slump by 50%: “It is very rare that you can be as unqualifiedly bullish as you can be right now.” Greenspan would have been well advised to remember that, according to Bertrand Russell, “the degree of one’s emotion varies inversely with one’s knowledge of the facts - the less you know, the hotter you get”, as well as Winston Churchill’s view, which he expressed in a discussion: “I think we differ principally in that you assume the future is a mere extension of the past whereas I find history full of unexpected turns and retrogressions.” Voltaire thought that “doubt is not a pleasant state of mind, but certainty is absurd”. Along similar lines, our friend Peter Bernstein wrote: “In their calmer moments, investors recognize their inability to know what the future holds. In moments of extreme panic or enthusiasm, however, they become remarkably bold in their predictions; they act as though uncertainty has vanished and the outcome is beyond doubt. Reality is abruptly transformed into that hypothetical future where the outcome is known. These are rare occasions, but they are also unforgettable: major tops and bottoms in markets are defined by this switch from doubt to certainty.”

In 2003, momentum investing and trend following was back in fashion, as is evident from the recent strong performance of semiconductor stocks, and of companies with either extremely high valuations or no earnings at all. But as Lord Cairncross, a Fellow of the Royal Statistical Society, observed, “A trend is a trend, but the question is when will it bend? Will it alter its course due to some unforeseen force and come to a premature end?”

At a recent conference, a friend of mine, whom I regard as one of the smartest fund managers I have ever met, told me that he had had a “bad year”, having been too bearish. After maintaining short positions for too long, he eventually closed them out at significant losses. I believe that his investment misadventure in 2003 mirrors the relative underperformance of many hedge funds, which had large short positions in high-tech and telecommunications stocks over the last 12 months. I hope that my friend will find some consolation in the words of Mark Twain, who wrote: “It is strange the way the ignorant and inexperienced so often and so undeservedly succeed when the informed and the experienced fail.”

A financially prosperous year aside, I hope that all our readers also enjoyed good health and found happiness, and that 2004 will bring them much the same. Personally, I had a satisfactory year, although I was saddened by the deaths of three friends whom I greatly admired and from whom I had learned a great deal. The formidable economic historian Charles Kindleberger, and two legends of the investment world, Leon Levy and Larry Tisch, all passed away in 2003. All three men had been immensely successful, albeit in different fields, but they had remained remarkably humble and were extremely generous in donating their time and money for good causes and charities. I shall always remember Leon Levy for his great intellectual capabilities and savvy business acumen. Moreover, I well remember how, some 15 years ago, when I was still in charge of Drexel Burnham’s Hong Kong office, our receptionist called me and said that two unannounced visitors from the United States had just arrived and wanted to see me. In those days, we frequently had clients from Drexel’s US offices come by our office, check on some quotes, and send messages via our system to their account executives in the US. My first reaction was therefore to think that these visitors, whose names didn’t register, would do just that and so be a waste of my time. Still, I reluctantly agreed to meet with them. The two gentlemen came into my office, where we proceeded to chat about Hong Kong and Asia. Then, when the discussion turned to the US economy and the US stock market, it struck me that my visitors were to my great surprise very well informed. Moreover, as occurs once in a while in life on meeting someone, there was some chemistry and good feeling between us. So, when I was escorting my visitors to the door and they asked me to join them a little later for lunch at the Mandarin Grill, I accepted their invitation. However, as I was making my way back to my desk, I realized that I didn't even know their names. I asked my receptionist, who hadn’t understood their names properly but said it was something like “Tisch”. And indeed, at lunch, I learned that the two low-key and humble gentlemen who had just popped into my office were Larry and Preston Tisch. I was familiar with their company, Loews, because it, along with other conglomerates such as Gulf and Western, Rapid America, LTV, ITT, and Litton, had been enormously popular in 1970 when I started working on Wall Street.

Over the years, Larry and his sons and I became very friendly. I shall always remember how when I once complimented Larry on his astounding business success, he humbly and self-deprecatingly observed that he had just been lucky in buying Lorillard Tobacco in the 1960s, whose large cash flow had enabled him to make many mistakes and still survive. And when I started my own business in Hong Kong, one of the very first telephone calls I received was from Larry’s son Jimmy, who immediately offered me his support. Larry was extremely frugal in his personal life, but, like Leon Levy, extremely generous when it came to charities and universities. These two highly successful businessmen can best be described in the wise words of Edmund Burke, who wrote: “If we command our wealth, we shall be rich and free; if our wealth commands us, we are poor indeed” and of Albert Camus: “You are forgiven for your happiness and success only if you generously consent to share them.”

In terms of happiness, I hope that my readers will take to heart the words of William Saroyan, who said: “The greatest happiness you can have is knowing that you do not necessarily require happiness”; of Albert Schweitzer, who wrote: “Success is not the key to happiness. Happiness is the key to success”; and of George Orwell, who wrote: “The essence of being human is that one does not seek perfection.” Moreover, as Pliny the Younger wrote, “In health we should continue to be the men we vowed to become when sickness prompted our words.”

We all have ambitions and are full of hopes, but we should not forget the line in the classic tale Heidi, by Johanna Spyri, “Oh, I wish that God had not given me what I prayed for. It was not so good as I thought.” As Mardy Grothe remarked, “Be careful what you wish for, it might come true.”

At a recent conference in Germany, an evidently successful but slightly arrogant young businessman made some comments to the effect that to think about the future and to make any forecasts was bunk and basically useless. I was at first somewhat taken aback, because I suppose that I agreed with him to some extent, but I equally thought that this young man should consider the words of Confucius: “If a man gives no thought about what is distant, he will find sorrow near at hand”; although, even if we are well prepared for all eventualities, as Mark Twain wrote, “A thing long expected takes the form of the unexpected when at last it comes.”

Moreover, as Mardy Grothe recently commented, when Matthew Prior wrote a poem describing every poet as a fool, Alexander Pope retaliated with the following chiastic verse, where one might substitute “financial analyst” for “poet”:

Sir, I admit your gen’ral rule
That every poet is a fool;
But you yourself may serve to show it,
That every fool is not a poet.

Finally, I wish to thank all our readers for their support, loyalty, and encouragement. I should also like to take the opportunity to thank the many economists, strategists, analysts, fund managers, and readers of this monthly letter whose collective knowledge, advice, and suggestions have greatly benefited me and enabled me to compile this report. Thomas Mann wrote that, “a writer is somebody for whom writing is more difficult than it is for other people” and I admit to often feeling that way when putting my thoughts on paper. I also feel that 2004 may be a far more challenging year in terms of investment returns than 2003 was, as investors’ expectations are now running far higher than they were 12 months ago. Still, even if 2004 doesn’t enrich us as much as 2003 has done, I hope that all my readers appreciate that one can also become rich by moderating one’s needs and be, as Art Buck remarked, “financially secure when you can afford anything you want and don’t want anything”.


Yours sincerely
Marc Faber