Even the Price of Tea Is Controlled in China

I'm a big fan of emerging market equities. Naturally, I have studied China because China puts the “C” in BRIC.

What's Not to Like About China?

• China is financially strong: with one of the world’s highest savings rates, and large foreign currency reserves.
• China is fervently pro-growth. The Chinese economy has been the one of the fastest growers over the past decade.
• China has an abundant supply of cheap labor. It is pro-industry to the detriment of labor.
• China is not hampered by costly environmental or worker safety regulations.
• To promote exports, China has kept the Yuan low.

I’m Sure That Even the Price of Tea Is Controlled

Derek Scissors, writing in a recent issue of Foreign Affairs in the article “Deng Undone”, documents how nearly everything is tightly controlled from the price of grain to the price of electricity:

Price liberalization, the core of market reform, has been partly undone. Privatization was stalled at first and then explicitly reversed. Initiatives to increase corporate competition are also being rolled back. The Chinese state is increasingly encroaching on even the relatively open external sector by restricting incoming investments and imposing taxes on exports.

The central government has recently reversed the outstanding progress in the liberalization of prices that China made during the first two decades of reform. The price of labor (wages) remains largely free from government interference, but that is manifestly not the case with the price of capital (the interest rate), for which the People’s Bank of China sets a compulsory and narrow range. Government intervention constantly distorts the prices of basic assets, such as land, often by simply forbidding or promoting transactions. The State Council sets and resets the prices for all key services: utilities and health care, education and transportation. Although the exchange rate has been loosened up over the past three years, the People’s Bank of China sets the daily value at which the Yuan must be traded against the dollar. And currency fluctuation is still starkly limited: the daily movement of the Yuan against the dollar is not allowed to exceed 0.5 percent. The market in China has never really determined the sale prices of many ordinary goods by itself, and the tendency over the past few years has been to further extend price controls for goods. The state’s complete control over grain distribution has distorted wholesale grain prices; a recent bout of inflation has prompted restrictions on the prices of retail food as well.

High Dividend Yield Chinese Equities

I like the idea of high dividend yield Chinese stocks. Consider Huaneng Power (HNP), a large, boring electric utility. Over a year ago Huaneng Power had electrifying prospects, with a shocking dividend. Its balance sheet was charged with plenty of profits, easily supporting its then current dividend yield, north of 6%. Certainly not a stock with high-voltage potential, but a profitable electrical utility growing as fast as the Chinese economy.

When coal prices rose, and the downturn hit, Huaneng was zapped with a calamity. To stay profitable, it needed to raise its electricity prices. Because higher electricity prices are detrimental to the economy during a downturn, the regulators blocked the rate increase.

This is unlike Western Electric Utilities which is allowed to pass along higher prices to its consumers. Huaneng announced a dividend cut to 2%. I promptly discharged the majority of my position. I got out when the getting was good.

China’s Market Cap Is Dominated By:

• State-owned companies
• State-controlled companies
• Highly speculative companies

State-Owned:

In a recent article, Seeking Alpha author William Gamble bashed the capitalization-rich Chinese state-owned companies:

My advice is to never buy stock in a state owned company. …. Why wouldn’t you want to own shares in the Industrial and Commercial Bank of China (HKG 1398 SHA 601398), the world’s biggest bank? The world’s largest telecom operator is China Mobile (CHL), in one of the world’s fastest growing market. Who would not want the safety of a telephone company in a dynamic market? The combination of oil and China seems irresistible, especially for an investor in PetroChina (PTR). … There is no life insurer anywhere larger than China Life. …

Even worse, sometimes for reasons only known to the government, entire sectors or managers can be reorganized and not for the benefit of minority shareholders. In 2008 the entire Chinese telecommunications industry was reorganized. The three firms, China Mobile, China Telecom (CHA), China Unicom (CHU), swapped operations and merged with smaller carriers. It was China’s fourth reorganization. Also in China, round robins of executives in different companies in the same industry are not uncommon. In 2004, China’s three top telecommunications providers, China Mobile, China Unicom and China Telecom, all swapped senior managers. Among China’s airlines, China Eastern Airlines (CEA) got the Chairman of China Southern Airlines (ZNH). China Eastern also received a new president from Air China. The old president went to Air China as deputy president. Since many of the managers of state owned corporations are or will be bureaucrats, it may make little difference. The president of Chinalco (ACH), Xiao Yaqing, was kicked upstairs to become named vice secretary general of the State Council, China’s cabinet.

State-Controlled:

As Derek Scissors points out: much of the economy is State-Controlled.

Highly Speculative:

Chinese Herbal Medicines? Not suitable for this prudent investor.

Great Story, Risky Investment

Heed well Derek Scissor’s and William Gamble’s negative comments about the "Free Market" in China. It is difficult to make a profit in a tightly controlled economy. I still hold a small amount of HNP. I don’t invest in BRIC anymore, now I invest in BRIc.

China gets a lowercase “c”.

FULL DISCLOSURE: Author is long a small amount of HNP and Chinese indexed instruments. You should consult with a professional before investing.

Comments

[Sober Realist:]

Nice article on the limitations of investing in such a centralized command economy. China is export dependant and lacks a developed internal market. It's top down decision-making prevents new, innovative approaches to problems. The one-party rule also preserves the corruption that is endemic in the system. With a gini coefficient of .46, the masive income disparity in China is approaching that of some impoverished African countries. Their vast cheap pool of labor will come back to bite them. Note also that due to China's massive environmental problems, cancer has become the number one cause of death in the country. Their water problem is now at a crisis level.
www.businessweek.com/g...

Jun 23 09:33 AM

[Living4Divi...:]

I appreciate your comments on the article, Thanks Sober Realist

Jun 23 10:14 AM

[HaavBline:]

Don't invest in another country if you don;t have sufficient knowledge of that country.

Don't pick up advice randomly from people without a proven track record in INVESTING in specific countries. Foreign policy researchers are not investors. Neither is 'consultants' who are a track record of being totally wrong and missed the big picture and big opportunities.

If you don;t understand this, better stay with the proven strategy of buying 'blue-chip, industry leader', 'secure-dividend' companies in the most 'investor-friendly', 'open-free-market' country in the world.

I'll bet 2, 3 years ago, this meant loading up with 'proven quality stocks: Citigroup, Wachovia, GM, AIG, GE, ......

Jun 24 12:33 AM

[prairiedog555:]

I trust the Chinese more than US for investing. In China Madoff would have been hung or shot within a week, along with the CEO's and boards of AIG Citi ect.
Here the rich are given a pass. I have a consultant in China that I talk with every day. People who cheat, steal or poison consumers are hung. We don't hear about it, you must go to BBC for real news, all we hear about is Jon and Kate BS.
I am sick, as a shareholder, to hear of the abuse of CEO's and board members with their lavish perks. I feel cheated. I had hoped Obama might do something about it but I guess it is business as usual.

Jun 24 06:37 AM

[Living4Divi...:]

Nice point , HaavBline

On Jun 24 12:33 AM HaavBline wrote:

>
> If you don;t understand this, better stay with the proven strategy
> of buying 'blue-chip, industry leader', 'secure-dividend' companies
> in the most 'investor-friendly', 'open-free-market' country in the
> world.
>
> I'll bet 2, 3 years ago, this meant loading up with 'proven quality
> stocks: Citigroup, Wachovia, GM, AIG, GE, ......

Jun 24 07:58 AM

[cameroni:]

Got to agree. The words "openness and transparency" don't seem to translate well into the Chinese "managed economy". What is public about a publicly held company that gets micromanaged by the top bureaucrats?

I have so many doubts I hardly know where to begin. I will keep my distance until those companies get responsible, follow international protocols, disgorge themselves of government cronies and act like real business's.

We often complain about data being manufactured and manipulated here at home. But most of the time we are just splitting hairs. At least here in North America we know the pitfalls of statistical management and there are clear cut rules for how the counting is done, (or not done).

The CPI, unemployment figures and calculations for inflation come immediately to mind. The closed circuit of Chinese methods is beyond frustration though. They don't even hide their figures. they just don't give you any real numbers to start with.

Like I said, openness and transparency are yet to be resolved.

Jun 25 03:58 AM

[Living4Divi...:]

Cameroni - I couldn't have put it any better.

In the US - CPI & GDP figures are fudged - but at least one has reasonable figures available elsewhere by which to do a correction of US official figures.

As for openess and transparency in corporate accounting. Well, we don't have alot of that here in the US either.


On Jun 25 03:58 AM cameroni wrote:

> Got to agree. The words "openness and transparency" don't seem to
> translate well into the Chinese "managed economy". What is public
> about a publicly held company that gets micromanaged by the top bureaucrats?
>
>
> I have so many doubts I hardly know where to begin. I will keep my
> distance until those companies get responsible, follow international
> protocols, disgorge themselves of government cronies and act like
> real business's.
>
> We often complain about data being manufactured and manipulated here
> at home. But most of the time we are just splitting hairs. At least
> here in North America we know the pitfalls of statistical management
> and there are clear cut rules for how the counting is done, (or not
> done).
>
> The CPI, unemployment figures and calculations for inflation come
> immediately to mind. The closed circuit of Chinese methods is beyond
> frustration though. They don't even hide their figures. they just
> don't give you any real numbers to start with.
>
> Like I said, openness and transparency are yet to be resolved.

Jun 25 11:12 AM