China's Democracy Vs. U.S. Tweetocracy

|
Includes: BA, CFRHF, DE, EADSF, EADSY, GE, GLW, GNNSF, GVA, LDSVF, LMT, MTZ, NVO, OERLY, OII, PRIM, SWGAF
by: James Hanshaw
Summary

President Trump is pushing at an already opening Chinese door. It will open faster if he does not spark a trade war the U.S. has lost before it starts.

Most U.S. trade deficit problems are homegrown or made in China by U.S. companies.

China is destined to overtake the U.S. soon and become the world's largest economy thanks to focused strategies the U.S. has long lacked.

There are some excellent investment opportunities emerging for all.

A world made by copiers

In the 1970s at the beginning of what western economists later called an East Asian miracle Japan became the first industrialised nation in East Asia. It did so by copying products and stealing intellectual property rights, IP, from the west. It relied on low cost labour at home to produce low quality copies at low prices to gain sales. Its Ministry of Technology prioritised a narrow range of products that could be sold worldwide in large volumes, such as consumer electronics and cars. It placed huge barriers to entry for imports of foreign made products. Japan succeeded despite cries of anguish from the west and is today the world's third largest economy having been second to the U.S. for a long time until displaced by China in recent times. It remains "protected" at home by complex internal distribution systems but developed rapidly from low quality, low cost to making world leading products with respected brand names like Sony (NYSE:SNE) and Toyota (NYSE:TM).

That transition also meant rising labour costs, so low value added work transferred to lower labour cost countries as South Korea and Taiwan copied Japan. Both countries today also have world leaders in sectors as diverse as consumer electronics and ship building. A similar story can be told for tiny Singapore over the same time scale. Some Chinese entrepreneurs have now started making in low cost African countries products they have copied from former employers at home in China.

But this story of copying and theft of ideas did not start with Japan. An early "leader" was Switzerland. Its fine textile sector - that was reliant on low cost labour at home - became endangered by textile machines made in Britain, the country that started the Industrial Revolution that led its own people out of poverty by creating the world's first middle classes who are the main drivers of GDP growth. So it copied those machines, improved them and Swiss company Saurer became and remains the world's leading maker of textile machinery. It ousted U.S. competitors in the U.S. textile capital Greenville/Spartanburg. The British companies died long ago. ABB (NYSE:ABB) was founded by a British engineer named Brown together a German person named Boveri. Today it is one of the world's leading electrical engineering companies and Britain has nothing to compare. Watch making skills were “imported" and no one needs to be told where those products sit in the world today. Indeed Swiss Made has become a brand of its own on products across a wide variety of sectors with this tiny country having more world leading companies per capita than any other in the world, with many doing over 90% of their business outside the country. The mighty U.S. should take note!

It did at times in the past - Trump's predecessors stole the whole of the U.S. from King George of Britain! Trains were invented in Britain and copies helped join up the U.S. for the first time with railroads built there over 100 years ago still in use today. Cars were British and German inventions that the U.S. converted into the mass production items we drive today. Unfortunately, and unlike copiers elsewhere, U.S. car makers do not make products the rest of the world wants so the trade deficit the U.S. president rants about is mainly caused at home by that and not by tariffs. General Motors (NYSE:GM) - once the world’s largest car maker - has been in decline for many years and that continuing story is well told here. China’s top ten car imports in 2017 were made in Japan, England and Germany. Many of GM’s made in China Buicks are sold in the U.S. and are part of that trade deficit!

Which brings us to today's demon: China.

Made in China25

Hong Kong The yellowish-colour building right of centre in this photo of Hong Kong is the Mandarin Hotel. It is around 24 stories high. I was there for its grand opening in 1963 - celebrated by fireworks invented thousands of years before in China - when it was the tallest building in the whole of Asia!

The difference between China today and those earlier developments in the rest of East Asia is the sheer scale and speed of what is happening there that few in the west can comprehend and this provides both threats and opportunities.

One example: Rome might not have been built in a day but Shanghai almost was as is dramatically shown here.

When Japan became the first East Asian country to industrialise it set a record for the fastest sustained rise in living standards, smashing the 60 years time taken by the U.S. and the 50 years by Britain to reach industrial status. The other Asian dynamos did it even faster with South Korea taking 11 years to double its GDP compared to Japan's 35 years.

As recently as the 1980s, China was poorer on a per capita basis than Ethiopia and Mali. No one had a refrigerator, few had TV and even fewer had cars. In 2008 6.7 million cars were sold there, in 2017 24.72 million and the fast drive continues with 2.66 million cars sold there in March this year. This was achieved by then premier Deng Xiaoping setting a target that was considered madness and unachievable by western economic "experts"; quadrupling GDP in 20 years and again in the next 50, thus increasing it sixteen fold by 2050. Ignoring the views of those "experts" China supported those objectives with some simple strategies; learn how to make things (it did not matter whether ethically or otherwise), make them and sell them.

It worked. Today China is the factory of the world producing a quarter of the world's manufacturing output, up from a mere 3% in the 1980s. Its GDP grew at 10% per year for three decades, lifting 700 million people out of poverty. It beat South Korea's world record of 11 years to double GDP, doing it in only 9 years. And Deng's mad, unachievable target to grow GDP sixteenfold in 70 years took 16 years!

In the last 3 years or so that rate of growth has "slowed" to around 7%, causing many of those western "experts" to predict the Chinese economy was crashing so the S&P's chief economist put things into another perspective. In around 2014 he calculated that 6.3% GDP growth in money terms would have been equivalent to 14% in 2009. GDP growth in Britain - the world's fifth largest economy - would be 22% instead of around 2%! Since California is the world's 6th largest economy it would be growing at around 20% instead of 3%.

The lessons are beyond the learning capability of those experts who instead criticise China's vast investment in infrastructure. In a recent three year period China's construction sector consumed more cement than the U.S. used in the entire 20th century! In 10 years China has built a network of high speed rail that exceeds the total built in the rest of the world with not an inch yet built in the U.S., to my knowledge. It was railroads built before they were needed that led to the Industrial Revolution in Britain and later the U.S. Many of those ancient tracks are still in use and the whole U.S. infrastructure system is now decaying through lack of such far sighted investment. Equivalent visionaries exist today and could get the U.S. moving again but they have political and bureaucratic systems blocking the way.

I lived and worked with Chinese people for a number of years and was the only westerner when I was the CEO of leading U.S. and German manufacturing companies in the region. I learned much from them and found that most have not the slightest interest in politics or who leads them. They are driven by a work ethic and have three top priorities; make money, make money, make money. They have lived under emperors for thousands of years and I suspect the new emperor, President Xi Jinping, understands his people very well. If his anti-corruption and opening-up drive is genuine China could become a giant sized version of Singapore that under its elected "Emperor" Lee Kuan Yew and his successors became one of the most advanced and open economies in the world. The U.S. must become an integral part of this new world and in so doing it will...

Make America Great Again

The Made in China25 objective is backed up by strategies. Without strategies Make America Great Again will become just another operatic soundbite. I will not waste words expressing my distaste for President Trump's approach to addressing issues in public. He is right about many things but needs to get his facts straight on others. Among those is blaming the massive trade deficit on IP theft and the forcing of American companies operating there to hand over their technologies in exchange for market access. The fact is U.S. company practice since the 1980s has been to make goods to export from China and not to China, resulting in the sale of goods produced by U.S. companies in China exceeding both U.S. exports to China and the U.S. trade U.S. trade deficit with China! So those U.S. companies making goods in China to sell at a super profit at home - including world leaders like Apple (NASDAQ:AAPL) - are a major cause of the trade deficit Mr. Trump bellows about. As the U.S. market became saturated in recent years some of those companies turned their focus to the Chinese market, which meant 51% ownership of their company by China and IP transfer according to Chinese law. They were clear cut rules so far from China forcing them - as Trump claims - they were willing participants in their pursuit of profits. Now it has backfired on some they complain and Mr. Trump threatens a trade war to protect them. Absurd to say the least.

Another component of the deficit is clothing. with well known U.S. companies like Levi, Kohl, Walmart and Reebok getting things made by giant sourcing firms in Hong Kong who subcontract the work to low cost makers in China and elsewhere.

There is no question that protectionism has to change but some other things have to be done about China too. There is a rottenness within that western companies and investors have no chance to succeed against. Externally, I invested in around ten Chinese companies who reversed into listed shell U.S. companies aided by U.S. law firms. One by one they disappeared by transferring the assets in China to another owned by the management there, taking my and other stockholders and bond holders money with them. The mighty SEC - whose job it is to protect us - looked on and did nothing. They would have torn a U.S. company apart for doing less!

There are good signs that the rules on ownership will be changed. That happened a while ago for some financial services - Vanguard will now set up shop in China - and a recent announcement suggested that the aircraft and car sectors will be opened up too. The appointment by President Xi Jinping of Lui He as head of industrial policy and relations with the U.S. is a very professional and promising step. He should be able to balance differing U.S./Chinese cultures having studied and taught economics at Beijing's prestigious Renmin University, backed up by studies at Seton Hall in New Jersey and the Kennedy School of Government at Harvard. He is already pushing China to open up and, as we have seen, once they decide to do something they do it fast.

But those Made in China things are only one part of the problem and the U.S. needs to put "America First" and fix many things at home - fast.

My list of strategies to make "Make America Great Again" more than an operatic drama title include:

  • Politics. America's democracy and that which made it great - middle class wealth - have been highjacked by money and powerful interests. This excellent SA article shows the awful outcome of that. Lobbying, political action committees (super-pacs) myriad forms of campaign contributions and patronage have tainted a democracy that should have become a beacon to light the way for the rest of the world. It needs to be fixed otherwise China's form of democracy might become the preferred version. If China's Xi Jinping can clean up that vast country including its legal system, copying what Lee Kuan Yew did in tiny Singapore in the 20th century, then the 21st century will be China's and not America's.
  • Education. Perhaps this is the most important. The U.S. public education system is stuck in the mid 20th century. It has failed to produce sufficient scientists, technologists, engineers and mathematicians - the STEMs - and well paid jobs lay vacant in many parts of the country. This is inhibiting economic growth, pay levels, productivity, innovation and competitiveness. As one easy and instant measure it should allow foreign PhD students - many Chinese - to stay in the U.S. when they have completed their studies. Forcing them to go home means they join or start competitors of the U.S. Some parts of the U.S. are alert to the opportunities, with the Wishtenaw Community College in Michigan training new age car “mechanics” how to repair sensors in self-driving cars, but there is a mammoth task ahead as this Financial Times article on America's schools crisis shows.
  • Infrastructure. Oft talked about but nothing done about in infrastructure. Roads are clogged with traffic because little new has been built for decades. Recent news suggests bridges are actually being closed in Mississippi because they are in danger of collapsing. The air traffic control system uses old technology while other parts of the world - including China - use designed in America, GPS. Many parts of the U.S. are still not connected with high speed internet. The electrical power generation and transmission system is long overdue for renewal. Pipelines are needed to get oil and gas to ports for exports and natural gas from producing areas to using areas in the U.S. - lack of these meant LNG was recently imported from “nasty” Russia to keep Bostonians from freezing! The U.S. is thus grinding to a standstill while the Chinese, taking no heed of those U.S. economic experts, march on as this animation of their rail system shows.
  • Regulation. Mr Trump has rightly attacked the mountain of regulation and the myriad bureaucracies that now exist for their own sake. Even when an infrastructure project has been approved it can take 8-10 years before work starts. China can build half a new Shanghai in that time - watch it growing here. Entrepreneurs in other countries are building online banks. China’s Alipay and WeChat Pay are revolutionising consumer finance while the U.S. Congress squabble over Dodd-Frank rules for past era banking. Internationally the U.S. was architect of the many bureaucracies like the WTO that Mr Trump rants about, that worked well until the 1990s but now need top down restructuring, led again by the U.S. Applying Swiss Made Pareto’s 80/20 rule to those bureaucracies - only 20% of what they do is useful and can be done by 20% of the people - would fix them and the money saved could finance education and infrastructure investments. The 80% made redundant could be retrained as construction workers and truck drivers that are currently in short supply in the U.S.
  • Manufacturing. Many economists are as disdainful about manufacturing in the U.S. as they are about China’s massive investment spending. Services are the key to success in their new world. But their categorisation belongs in the old world as well because for many manufacturers high value added services account for 50% or more of their revenues. For example, Intuitive Surgical’s (NASDAQ:ISRG) robotic devices require ongoing training programmes, software updates etc. The first “lights out” factory was built by the Japanese around 1990 - computerised machine tools are loaded and unloaded by robots that do not need light to see - controlled by highly skilled technicians in an air conditioned control room located elsewhere. I was once CEO of a company whose made in Britain machines located in South America were remotely controlled from a centre in Britain. One day soon U.S. company John Deere (NYSE:DE) will operate its agricultural machinery working on farms in Australia and Brazil from a centre in Moline, IL. These services generate more income and profit over the life of the product than the sale of the original manufactured item. They need STEMs people to design and operate them.

Other U.S. companies will continue to die due to failure to adjust to the new world and this has nothing to do with China. GM, once a world leader, will not survive, nor will Ford and Chrysler. They do not make the products the world, including the U.S., wants to buy - a shrinking and home grown part of the trade deficit! Foreign companies BMW, VW (VLKAY) and Toyota (TM) export cars worldwide produced in their huge factories in the U.S. Some materials and components are necessarily imported and Trump’s tariffs are more likely to hinder than help these manufacturing companies and many others in the U.S. too.

In short, the U.S. needs to stop shooting itself in the foot, fix these things at home urgently - Pareto says this will fix 80% of President Trump's complaints on trade - and look to share in the opportunities that are opening up in a growing and rapidly changing China.

Make money, make money, make money...me too…

China’s leaders have clearly stated their next priority is increasing home consumption. The Chinese people are big savers because state pension and healthcare provisions are undeveloped in China. This will be changed with the objective of making them big spenders. China has the world’s largest population that is around four times that of the U.S. and its middle classes are already equal in size to the entire U.S. population. The potential is immeasurable as the country transitions from an export and investment driven economy to a consumer one.

China’s Made in China 2025 tells us where we can go to make money.

Significantly, it embraces promoting service oriented manufacturing and manufacturing related services industries. Ten key sectors are prioritised; IT, NC controlled machines and robotics, ocean engineering equipment and high-tech ships, railway equipment, energy saving and new energy vehicles, power equipment, new materials, medicine and medical devices and agricultural machinery.

Interesting that they share my long held view that services and manufacturing are inextricably related. I also find it very interesting that unlike the earlier Asian tigers they are not going solely for high volume activities, but also for niche sectors too:

  • Ocean engineering equipment. The U.S. has most of the world leaders and I would pick Oceaneering International (NYSE:OII) as my investment opportunity in this niche sector if they decide to participate in this in China. Deep ocean mining of minerals has been talked about for 50 years but nothing has been done because of high cost, so perhaps China wants to address that neglected opportunity and OII has the tools to help that could be made in China.
  • Medicine. A homegrown innovator with a PhD from Duke University founded Legend, a biotech company in China. Legend has developed a Car-T for a previously incurable cancer, multiple myeloma, that has attracted the interest of U.S. giant Johnson & Johnson (NYSE:JNJ). We can invest in Legend via its parent company, Hong Kong listed Genscript Biotech (OTC:GNNSF) or 1548:HKG on the Hong Kong exchange. My favourite is Danish company Novo Nordisk (NYSE:NVO). The Chinese have very successfully copied the U.S. on something that will not attract tariffs - they have become fat and diabetes is now a rapidly growing problem in China. NVO is a world leader in diabetes treatments and has a well established research centre in China that operates independently of the main one in Denmark, with the hope a Chinese solution might emerge that is totally different from the western approach. Since the Chinese had medical procedures thousands of years before the west - acupuncture being one example - this could produce an interesting outcome.
  • Agricultural machinery. John Deere (DE), this U.S. world leader is an obvious choice and it has been manufacturing in China since 2006. There is huge potential in China as farming practices are modernised.
  • New-energy vehicles. I will not touch this sector, and Chinese leaders must be anticipating growth at home to make it worthwhile. There is huge overcapacity in car making and all are developing electric vehicles. GM and Tesla will die and maybe Fiat Chrysler too. CNG/LNG fuelled vehicles will be winners too; my picks are here in "Gas is the New Oil."
  • IT. If one includes the FAANGs, the U.S. has too many world leaders to mention here. Readers will have their own favourites.
  • Aerospace equipment. There is a massive opportunity for China to build a 21st century passenger plane and finally make extinct the dinosaurs built by Boeing (NYSE:BA) and Airbus (OTCPK:EADSY, OTCPK:EADSF). Their planes fly more slowly today than the Boeing 707 I flew on from London to Sydney in 1965 and judging by their mammoth order books for current models they expect me to do the trip no faster in 2065! The Chinese like to do things fast and internal air travel alone is growing very fast too. I will not invest in weapons makers but if Lockheed Martin (NYSE:LMT) sets up a separate listed company in China to make this supersonic jet I will be the first to board. Or maybe President Xi will be first and he will zoom past President Trump limping along in his old age Boeing 747 Airforce One.
  • Power equipment will be a big winner especially, but finding good companies is difficult with General Electric (NYSE:GE) showing signs of going the way of GM.
  • New materials. Glass is hardly new, having been invented 5,000 years ago in Egypt, but U.S. world leader, Corning (NYSE:GLW) - a copier originally?! - has spent the last 165 years exploring new ways to use it and they have a strong presence in China. Swiss company Oerlikon (OTCPK:OERLY) - or, better, OERL on the Zürich exchange - is a global leader in new materials and is already well established in China. It is also getting into additive manufacturing - 3D manufacturing - that could be a disrupter for the Numeric Control tools sector China is targeting the way those tools disrupted the one man, one machine era that prevailed into the 1970s. Swiss Meyer Burger supplies to China’s huge and growing solar panel industry.
  • Swiss-made. This has become a brand of its own and China’s growing middle class (now larger than the U.S. population) and wealthy love buying and showing off expensive brands. Made in China will not do and Swiss Made is and will remain a coveted must have. This will push up the share prices of luxury goods maker Richemont (OTCPK:CFRHF) and watch maker Swatch (OTCPK:SWGNF). And their taste for Swiss Made chocolate from Lindt (OTCPK:LDSVF) will be insatiable thus creating more demand for Novo Nordisk’s (NVO) obesity products too. (More about Lindt here.)

This brings us back to:

China democracy vs. U.S. Tweetocracy

After the recent meeting in China where Xi Jinping was made president for life, a delegate was asked by a western reporter if she approved. She gushed enthusiastically, “Yes, it is good for China’s democracy”. So now we have another way of looking at democracy, the representational version of which that made the middle classes in the U.S. wealthy and strong has come to represent wealthy vested interests only and, in my view, tweetocracy is not a winning alternative formula either.

The Chinese people mostly want to make money and so do most Americans and this desire need not be a versus question that is a loser for many, as the plundering of the middle classes in the U.S. by the 1% has shown. Versus can become win win for all if U.S. leaders open their minds and China’s talk of greater transparency and changing of foreign ownership rules is genuine. China must fix its rotten legal system too. Likewise the U.S. has to fix things at home - America First - with radical and urgent action being taken on the points I mention above and especially education. I have seen from the beginning that robotics and other "new age" technologies do not mean loss of jobs - they mean different and better jobs for STEMs.

Infrastructure investment in the U.S. should go without saying - it is rotten - and money saved from fixing and slimming down old age bureaucracies and repressive regulatory systems can finance this. I have investments in Granite Construction (NYSE:GVA), MasTec (NYSE:MTZ) and Primoris Services (NASDAQ:PRIM) in the hope the U.S. finally does the "right thing."

And if the U.S. is to reduce its trade deficit it has to produce goods and services the world and its own people want to buy. It has not done this for several decades and, contrary to what those economic “experts” believe, it has little to do with price that can be rectified with tariffs. Good design, quality, brand and other factors come before price for most of our buying decisions. How many reading this in the U.S. have, or would prefer to have a Mercedes Benz (OTCPK:DDAIF) instead of the world’s cheapest car, made in India?!

There is a well proven, working model of an economy the U.S. could copy. When President Trump came to Davos here in Switzerland this year he should have used the train instead of helicoptering between there and Airforce One. He would have travelled on one of the best public transport systems in the world linking even the remotest parts of the country. He would have seen constant and massive investment in road, rail, bridge and tunnel construction; high speed internet connecting the whole country; good education for all from craft apprenticeships to PhD courses; low government debt (below 40% of GDP compared to the U.S.’s 105%); low crime (high pay, no guns, legal heroin); low taxes and small reasonably efficient bureaucracies; no participation in wars for 200 years and more world leading companies per capita than any other country, many of them doing more than 90% of their business in other countries all over the world.

In short, he would have seen why Switzerland - with a direct democracy and, despite also having one of the world’s strongest currencies - is regularly judged to be the most competitive economy in the world.

If the U.S. were to copy Switzerland, President Trump would truly "Make America Great Again”.

Britain’s Winston Churchill once said “Americans will always do the right thing, after they have tried everything else”. Since everything else has now been well tried, the time for the “right thing” must be close. Hopefully China will do the right thing too, and we will all make money.

Disclosure: I am/we are long GLW, GVA, PRIM, MTZ, OII, NVO,LDSVF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.