China's Biggest Investment Risk Is Political

Includes: FXI, GXC, TAO
by: Carlos X. Alexandre

I dedicate a good amount of time tracking down stories about China mostly because the wonder country of the 21st century, as some put it, raises a lot of questions. I can recognize that opportunity exists everywhere on the Globe, even in poor economic areas. But the reason I continue to pursue the Chinese story is because most of the mainstream investment community only sees a large population with many needs, and as the standard of living improves, the simplistic thinking goes, the extrapolation is that everyone will eventually become a Western type consumer.

But as Patrick Chovanec correctly pointed out in his Seeking Alpha article “China's Slowdown Will Not Land Softly,” “China’s economic growth is still overwhelmingly dependent on an ongoing investment boom that has been fueled by cheap and easy credit.” And without a doubt, that will end.

One aspect about China, which is far more concealed, in contrast with what transpires through the ongoing demonstrations in Europe and, to a smaller degree for now, in the U.S., is the economic and political discontentment. Yet the signs are there, and the struggles are real, which adds significant political risk to the economic landscape compared with Western economies for obvious reasons.

Political risk as it pertains to investment is a topic that is covered in academic finance curricula, but is often treated as a footnote, because the risk itself is hard to quantify, difficult to understand, and, in all honesty and especially in America, we cannot relate to the issue from personal experience.

I reported on China’s subsided housing plans in a previous article, “China's Debt Problems Will Amplify Global Woes.”

Yet, and as reported by Caixin, the city of Beijing is planning a 50 billion yuan bond to build subsided housing. All proceeds from the issuance will be used exclusively for the construction of 200,000 subsidized housing units, which are scheduled to break ground this year, according to a source from the National Association of Financial Market Institutional Investors.

But according to Caixin Online recently, the article “Migrant Workers Still Excluded from Beijing Public Housing” addressed claims printed by the Global Times, a Chinese publication. Caixin quoted Chen Zhi, and the words are extremely hard to consolidate with China’s vision and purported dedication to the well being of its citizenry.

"It's not fair for the government that any migrant worker can ask for a cheap place to live," said Chen Zhi, Deputy Secretary-in-Chief of the Beijing Real Estate Association. "Many migrant construction workers or housekeepers live a happy life actually, with a monthly salary of 5,000 to 6,000 yuan ($939) and accommodations already offered by their workplace. And at the end of the year they can send most of their money home. People shouldn't magnify their miseries," he said.

The Caixin article then questions the claim about the salaries of migrant workers, while pointing out that rent in subsidized housing costs 1,800 yuan per month, and “housing prices can be 27 times the average annual household income.”

I'm not sure where he got the 5,000-6,000 yuan number. People's Daily in March this year reported that 47 percent of migrant workers in Beijing make less than 2,000 yuan a month, and 13 percent earn a "high salary" of more than 3,000 yuan per month.

In the U.S. the average house price is roughly 4 times the average household income, and even then we’re experiencing extremely difficult times. And these observations, in conjunction with China’s GDP of 9.1%, bring into focus the official claims and the opinions of many, because from a common sense perspective, well… it doesn’t make sense.

But considering the claims about the growth engine that China has become and its undeniable ascent to global leadership, according to some, Premier Wen Jiabao added to the pile of questions, as reported by Reuters.

China will make job creation a more urgent priority in the face of slowed economic growth and weakened exports, Premier Wen Jibao [sic] said in comments published on Sunday, also warning that efforts to tame housing prices were at a critical point.

In view of the fact that, according to the Chinese government, unemployment is 4.1%, Mr. Jiabao’s comments do not jive with the advertised statistics, and the underlying message centers on the percolating political risk that will further manifest itself as the global economic woes pick up speed. And the risk is best illustrated by the issues addressed by Wen Jiabao, especially the last one in the list because that’s where the fuse will be lit: “Inflation, housing costs, weakened demand from rich economies, and the pressure to secure jobs for millions of university students and rural migrants.”

I am willing to bet that the ongoing official practices that are seldom reported, as highlighted by Blomberg's article "Communist Land Sales Hurting China’s Poor," will continue adding fuel to the fire.

Bulldozers razed Li Liguang’s farmhouse four years ago after officials in the Chinese city of Loudi told him the land was needed for a 30,000-seat stadium. What Li, 28, says they didn’t tell him is that he would be paid a fraction of what his plot was worth and get stuck living in a cinder-block home, looking on as officials do what he never could: Grow rich off his family’s land.

Finally, Caixin reported that "Dropping Real Estate Prices Draw Protests."

Over the weekend, about 300 homeowners living in Shanghai's Pudong district gathered at the China Overseas Property Group Co. office to demand that the company refund or cancel their purchase contracts, following news that the developer had reduced prices for the development from 22,000 yuan to 16,000 yuan per square meter.

And I am also certain that global leadership will never come from China, because as it stands, there's nothing to be used as a model.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.