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Rumors of China's Demise Are Exaggerated

|Includes:iShares China Large-Cap ETF (FXI)

The more I get to know the US, the more I am convinced of one thing: US and China are much more alike than most people on both sides of the pond want to admit. Nobody believes me.

Here's one example: rumors of both countries' demise are a perpetuity, both inside and outside of each country. Recently, a favorite theme in western media, both mainstream and peripheral, is that this whole China thingy is a farce. It'll blow up any minute now.

China has many many problems and faces many many challenges. But rising labor cost, just because Foxconn raised wages, is not one of them. Labor shortage will not be a problem in China for many years. Urbanization just started. Illiteracy level is quite low compared to other emerging economies. Migration up the value chain in Chinese industry will take decades. This is decidedly different from India's narrow (and over-) reliance on software, which quickly ran into the bottleneck of qualified labor, which resulted in diminishing quality and rising cost. China can keep cranking out cheap crap, with gradually improving quality (as has been the case for the past 20 years), for years to come. As Arthur Kroeber recently told Marc Faber:"You have no idea how big China is."

No doubt Chinese real estate has been overheating and Chinese banks do have lots of bad or potentially risky assets. But it will never be anything like the spectacle of the 08 crisis, or even the ongoing Spanish crisis. There's little leverage in the system. When (not if) real estate bubble bursts, the rich class will be hurt but it'll be a huge welcome relief for vast majority of the populace. With the richest 1% Chinese holding 41.4% of wealth, you can see why it's a good thing. And the banks will survive ok, too, because there's little leverage and no tangled web of derivatives-linked counterparty risk. Financial sector in China is so antiquated it's a beauty. (And a real risk is Harvard-educated economists are trying to catch up too quickly.)

Rising inflation and overheating economy are also real risks. Beijing got into a bit of panic in 2008 -- their understanding of the crisis, both before and after, was very poor in retrospect. The effort in stimulating domestic demand went so far as giving everybody some scrip to buy stuff and ordering shopping centers to put on discounted sales in some municipalities. There was a massive money printing that was never detected by western China experts. But now, the Eurozone crisis is a Mao-send to China, perfect timing, too. It's actually conceivable that the inflation problem will solve itself if another round of global demand destruction materializes, which I think is a given. But if Beijing acts too quickly on inflation, they risk repeating the 08 mistake, only in reverse direction.

Oh, another similarity: the anointed China experts in the US are generally speaking as ignorant as the anointed US experts in China. Not for their intelligence or knowledge, but perspective. Both countries are so big, diverse, and complex, you really need to live in the other one for at least ten years to have any meaningful understanding -- and not just in ivory towers or office buildings, but also in neighborhood bars.

Disclosure: Long FXI

Stocks: FXI