Is This The Century Of China?

Includes: FXI, GXC, PEK
by: Shaun Connell

The 19th Century was the century of Great Britain. The 20th Century was the century of the United States. So will the 21st Century be the century of China?

A couple of years ago, most pundits were in agreement about Chinese dominance being unavoidable. And they're probably not completely wrong -- China's economy will likely continue to grow whether your bearish or bullish on the country.

But the economy of China has several fundamental structural flaws that, if are ignored, will crippled their ability to have "their own" century.

Corruption and Scandal

I don't have a dime invested directly in China, and don't plan on doing so in the future. Investing in Chinese growth is better done by investing in companies the export goods and/or resources to the Chinese economy.

The level of Chinese corruption is enough to make even the shadiest Wall Street exec blush.

Just 6 years ago was probably one of the more important scandals. The chief statistician of the country/government was sacked for billion-dollar plus bribery and other crimes related to their version of social security.

And no, this wasn't just an isolated incident happening half of a decade ago. Rampant corruption is just part of Chinese economics, with the Corruption Perception Index putting China at 75. That's not good.

This is likely not going to go away anytime soon, and is almost certainly part of the culture of power in the country. Censorship, the culture of the rich and powerful being darker than other countries, and the insanely large wealth gap all contribute to the corruption.

This alone isn't probably going to stop the Chinese economy from growing, obviously, but it certainly will lead to malinvestment, uncertainty, and more risk for huge financial crises and fallout.

Politically-Caused Income Inequality

Income inequality is incredibly misunderstood. Technically, while I was a broke college student living in a dorm, Warren Buffett was infinitely richer than I was. But the living standards aren't insanely different.

I was able to eat what I wanted, have tons of leisure time, access the Internet, access cable TV, and have a great material life. This is true even for plenty of people on food stamps in America, though that doesn't mean poverty is "easy" or something.

In China, the difference between the broke and the rich is often a question of life and death. The poor really are poor, living in complete squalor, without the ability to access economic mobility like we're simply used to in America.

This is absurdly important, because a strong economy needs a stable middle class in order to have some sort of cushion in case foreign demand drops. In China, for example, they simply produce more than their poor can afford to consume.

This doesn't mean the people couldn't consume if prices disappeared -- but prices exist for a reason, and the poor simply don't have the capital necessary to increase expenses.

The middle class, thankfully, is growing rapidly, though there's no scientific way of knowing how large it is because we can't trust government data completely.

So why the crazy income inequality? It's not created by capitalism or the free market -- it's created by the communist party and the rampant corruption talked about earlier.

This is the real root of the problem, as the Mises Institute points out, is the political elite:

"Forget supply and demand; in China, the system serves the country's political elite. While the oligopolies that dominate the economy appear to be private, these entities are really state controlled and operate under a patronage system that pervades all aspects of the Chinese economy."

The financial system, economic system, regulatory system, and political system is backwards and corrupt to the point that an American style of economic growth is essentially impossible.

It's also part of a self-causing cycle, because the lack of small business infrastructure -- credit reporting infrastructure is weak -- and the fact that the banks are far more open to loaning money to the larger corporations.

There's a lot of criticism of US corporations like Apple for outsourcing to China an "causing" their economic woes. Make no mistake about it: it wasn't Steve Jobs who was creating the income inequality in China; it was Hu Jintao and his cronies who put their boot on the necks of the people.

Stimulus and Manipulation

There is absolutely no telling how much of the Chinese economic growth over the last several decades has simply been government malinvestment.

Rumors and stories of empty cities, empty skyscrapers, and pointless projects not based on the economic demands but political demands flood almost all conversations about the Chinese economy.

This outright ignorance of the purpose of prices will not come without a, well, price. I've written about his in the past -- prices in the free market are signals that tell us how resources ought to be allocated. The more they are politically manipulated, the more malinvestment there will be.

China's one huge example of this. The standard of living is better for some by sheer nature of how much wealth is being generated by people working in factories rather than sustenance farming, but there's also untold amounts of wealth also being destroyed through malinvestment.

The recent stimulus measures, the low interest rates, and the monetary "easing" are all more examples of this. Their economy is sloppy, filled with insane amounts of malinvesment, and a recovery is possible, but will likely include the same structural flaws.

Is This The Century of China?

China's economy is likely far more broken, damaged, and fraudulent than most people probably think. The notion that China is more capitalist than the United States is simply flawed -- their corporatist system would make our own in the US embarrassed at the boldness.

Over the next decade, there's no telling what the economy will look like, because we haven't yet seen whether the current slowdown will be an actual crash or not -- and that's the most important question of the next 1-5 years. But that's just the relatively short-term look.

But looking further down the road than just ten years, yes, the Chinese economy will grow by absolutely insane amounts. Their middle class is exploding, even in the midst of the corruption that exists. It's estimated that more people are in the middle class in China now than even live in the US. The definition of "middle class" is different, but it's an important trend to watch. Their middle class is the group that isn't just eating and working, but also has money to spend on products including from the United States.

Everyone wins when the world's middle class growth through increased production. Patriotic Americans should be elated at the living standards of the Chinese increasing.

And business opportunities still exist throughout the country, though it's often more concentrated in some areas more than others. For example, in rural areas, things have often changed either just a little or not at all -- in urban areas, it's just a different world than 15-20 years ago.

In the end, the above obstacles will likely exist in spite of the coming Chinese century, but will not stop the Chinese growth. This isn't a short-term prediction or a short-term trend -- this is a question of long term economic trends for what China will look like when even I'll be -- hopefully -- an old man.

It's possible that something could occur to stop China in its tracks, but that's true for essentially any economy.

What This Means For Investors

Still, there are absolutely huge investment opportunities. Even if there is "malinvestment" going on with their building projects, that doesn't mean those selling the shovels and hammers aren't getting paid in real money.

That's why it's important to watch for the Chinese economic "recovery", because once their demand for copper picks up -- whether for "real" growth or not, those of us looking to invest in copper miners that export copper to China will greatly benefit.

The same goes for coal, iron, steel, gold and a variety of other commodities and commodity producers.

Companies like Freeport-McMoRan (FCX) could also do wonderfully over the long-term because they'll be benefiting from Chinese demand over time. In the short-run, they've gotten hammered, though. I've been waiting all year to pull the trigger, and will still be holding off until I see good news from China.

People looking to invest directly -- something I haven't and won't do because of the corruption discussed earlier -- have a lot of opportunities in the way of stocks and etfs, including FXI, GXC, and PEK.

Understanding China and You

The geopolitical climate of the world will be extremely different in 30 years. The US prosperity machine is not sustainable. The rise of China seems inevitable, as much as their evil government tries to manipulate it for their own gain.

As we move further into the century of China, investors should be looking for ways to prosper from the long-term trends. I know that's what I'll be doing.

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