Communist China Only in Name

The larger-than-life portrait of Mao Zedong was clearly fodder for the millions of Chinese peasants and workers watching last week’s grand parade on television. Because those occupying the podium at the Gate of Heavenly Peace knew full well that the ideals and agendas of the 1949 revolution had long been abandoned. And despite President Hu Jintao renewing his commitment to socialism, China is in no danger of turning into a proletarian state at any point in the next few decades.

On the contrary, there is every reason to believe that Mao Zedong is turning in his grave. Foreign and domestic equity has flourished in China’s special economic zones since the early-1990s and, of late, land ownership laws have been amended to encourage private holdings.

Last year’s global meltdown may well shattered China’s near-term growth targets. But the IMF now forcasts that a GDP expansion of 9% for 2010 is within the realms of reality, given, in particular, Beijing’s aggressive infrastructure spending plans.

Many governments in the region expressed concern that the Beijing celebrations were dominated by a display of military hardware. But the message to international investors was crystal clear: do not doubt our ability keep dissent in check. The loss of jobs in late-2008/early-2009 has certainly created the potential for social unrest in the Chinese hinterland; however, fears of a second Long March are unfounded. “This is the era of state capitalism, and this state is fully capable of maintaining law and order to defend the gains it has made,” said a Toronto-based Chinese dissident. “Under state capitalism, the state itself is both the commander-in-chief and the capitalist-in-chief.”

Critics of Vladimir Putin point to the similarities in the current economic systems of China and Russia. (In fact, many Republican’s have warned that Barack Obama is taking America along the same route). Some students of state capitalism have also made structural linkages between the state-controlled economy of China on one hand and Islamist Iran and the dictatorships of Central Asia, the Middle East and Africa on the other; but that is a subject for another forum.

For our present purposes, if state capitalism is the new ideology of our times, it is important to ascertain the prospects for private equity in environments which represent half-way houses between a free market and a centrally-planned socialist economy. Templeton’s Mark Mobius says that he is still buying Russia’s OAO Gazprom (OGZPY.PK) because it is trading at half the valuation attributed to Houston’s ConocoPhillips (COP); for the record, the Kremlin controls over 60% of Russia’s US$1.3 trillion economy and has a majority stake in Gazprom.

“Comparative valuations in Russia and China will always appear attractive since one major equity holder in those markets, i.e. the state, can afford to wait for years before recording capital gains,” explained a Mumbai mutual fund manager who finds another Russian resource major, Lukoil (LUKOY.PK), very attractive at current levels.

The China story is based on Beijing’s ability (or otherwise) to keep the economy firmly on track. Amongst Hong Kong investment circles, China is a straightforward “10x10”, i.e. 10% GDP growth for at least 10 years. “If you are playing China long term, overheating is not a concept which figures in your strategy,” a director of a China-specific hedge fund wrote in a private circular to his partners. “The Communist Party, communist only in name, is determined to stay in power and to keep China competitive at any cost.”

Due to the state’s military strength, and the willingness to use that strength if and where needed, state capitalism as a system in certainly sustainable. International asset managers are not going to ignore the relatively profitable opportunities state capitalism offers today merely on account of any human rights considerations. The challenge is to pick genuinely “undervalued” winners.

This writer’s skepticism of the relative value scenario is due to the fact that, under state capitalism, the state controls the dissemination of data and information. Key claims laid out in forecasts are almost impossible to verify. And abrupt changes to existing legislation can alter the valuation fundamentals at short notice.

Disclosure: Short OGZPY.PK and LUKOY.PK

Comments

[Alphameister:]

>>This writer’s skepticism of the relative value scenario is due to the fact that, under state capitalism, the state controls the dissemination of data and information. Key claims laid out in forecasts are almost impossible to verify. And abrupt changes to existing legislation can alter the valuation fundamentals at short notice.<<

And the difference in the U.S. is......??? If China craves long-run credibility, as it surely does, it cannot be overly cavalier in its management of economic data. And the physical evidence of dramatic long-term growth is there for all to see.

As China moves gradually in the direction of greater capitalism and a debt-burdened US moves more strongly in the direction of socialism, I see the the gap between their respective growth rates being even more pronounced in the years ahead. The day will come when Chinese stocks/ADRs will command significant valuation premiums versus their US counterparts.

Oct 05 08:57 AM

[kotelyan:]

You should check an early history of the USSR in the 1920-1930-ies. It was called "New Economic Policy" proclaimed by V.I.Lenin, that was openly objected by Trotzky, and later - Stalin, who has successfully returned it to the "proletarian state" when it served its purpose of building modern industrial base with the new technologies brought from the US and Germany.

Oct 05 09:01 AM

[Billy1iron:]

Sorry Alphameister, your personal politics cost your comment some credibility. Providing better services for the majority of a country's people and reigning in corrupt and predatory companies and financial practices is not a tenet of socialism but one of democracy - the premise on which this country is built.

Oct 05 09:23 AM

[notsosmart:]

there were leaders who said we can do business with herr hitler.its your money.if you trust china & russia go ahead & invest.they move the goalposts at will & there is nothing you can do about it.while we make a fuss over dirty air china increased its coal use 6.9% last year & its the dirtiest air.i was there a few years ago & could not wait to leave.you think these 2 countries care about the health of their citizens? think again.those are different stock markets & unless you are an insider-beware.

Oct 05 01:06 PM

[Tony Daltorio:]

Sorry - but both the numbers coming from corporations and governments in countries from Asia, Europe and Latin America are much more trustworthy than what comes from the Wall Street banksters and their minions in Washington.

I urge every investor to greatly limit their exposure to the United States, its plunging currency and the bubble in its bond and stock markets.

Oct 05 03:14 PM

[Gedankonomist:]

This comment (cited below) is a perfect example of how the educational establishment in this country has dumbed-down our population.

First of all, define "personal politics." What is this "personal politics?"

Second, the US is not a democracy, it is a REPUBLIC! Democracy is majority rule. And majority rule does not necessarily imply "reigning in corruption." More often than not, it means the exact opposite. Especially if your population is a bunch of doofuses who are easily manipulated by the boob tube and and an educational establishment controlled by those who run "predatory and corrupt" companies.

On Oct 05 09:23 AM Billy1iron wrote:

> Sorry Alphameister, your personal politics cost your comment some
> credibility. Providing better services for the majority of a country's
> people and reigning in corrupt and predatory companies and financial
> practices is not a tenet of socialism but one of democracy - the
> premise on which this country is built.

Oct 05 04:22 PM

[ArtfulDodger:]

You used to be right, but I'm sorry to say that the left has turned us into a statist democracy.

Good comment, though!


On Oct 05 04:22 PM Gedankonomist wrote:

> This comment (cited below) is a perfect example of how the educational
> establishment in this country has dumbed-down our population.
>
> First of all, define "personal politics." What is this "personal
> politics?"
>
> Second, the US is not a democracy, it is a REPUBLIC! Democracy is
> majority rule. And majority rule does not necessarily imply "reigning
> in corruption." More often than not, it means the exact opposite.
> Especially if your population is a bunch of doofuses who are easily
> manipulated by the boob tube and and an educational establishment
> controlled by those who run "predatory and corrupt" companies.<br/>
>
> On Oct 05 09:23 AM Billy1iron wrote:

Oct 06 05:37 AM

[ArtfulDodger:]

Good comment, Alpha. I agree and have invested thusly.


On Oct 05 08:57 AM Alphameister wrote:

> >>This writer’s skepticism of the relative value scenario is due
> to the fact that, under state capitalism, the state controls the
> dissemination of data and information. Key claims laid out in forecasts
> are almost impossible to verify. And abrupt changes to existing legislation
> can alter the valuation fundamentals at short ounterparts.

Oct 06 05:39 AM

[ArtfulDodger:]

I hate to agree with you, but I fear you are right. Good points!


On Oct 05 03:14 PM Tony Daltorio wrote:

> Sorry - but both the numbers coming from corporations and governments
> in countries from Asia, Europe and Latin America are much more trustworthy
> than what comes from the Wall Street banksters and their minions
> in Washington.
>
> I urge every investor to greatly limit their exposure to the United
> States, its plunging currency and the bubble in its bond and stock
> markets.

Oct 06 05:40 AM

[Andrew Butter:]

All very neat but explain this, 80% of China's exports are generated in SEZ from companies that are 50% to 100% foreign owned.

Their main operating cost is the cost of labor which is "exported" from China (mainland) to the SEZ.

The government only controls one part of the equation, the cost of Chinese labor, the rest is outside their control.

The advantage the SEZ have is that if or when (like now) they can't export to USA and Europe, they have a captive market to support them.

Oct 06 05:42 AM

[Crocodilian:]

The problem with state capitalism is that the regulator and the regulated are one and the same. And so are the plaintiff and the arbitrator. Valuations in Russia are low because they must discount the risk of arbitrary expropriation.

Like Venezuela, Putin's Russia is a place where foreign investors face a "head we take it, tails its yours" deal. BP invested heavily in oil exploration in Sakhalin, which turned out to be a terrific oil find . . . only to have the Government decide that "we'd like that, please".

Valuations will always remain low in countries where the rule of law is weak, and the state is predatory: you pay a premium for transparency and fair play, you demand a discount for political/event risk.

Oct 08 06:05 PM