China is without question one of the biggest and most important markets for global investors to understand. Whether you’re a Bull or Bear on Chinese stocks, you need to understand how the Chinese economy will affect the companies in your portfolio, wherever those companies may be located.
Investors also need to be able to filter through the reams of incessant hype about China that flood the newswire, blogs, and television airwaves. While there is clearly massive opportunity in China, there is also an extraordinary amount of pure hype and sheer nonsense out there waiting to steer you off course.
For an intelligent, skeptical view on China, it’s hard to find a better analyst than Derek Scissors of the Heritage Foundation. Scissors debunked a number of popular myths about China’s stimulus package last month on Motley Fool.
Scissors is at it again in the latest issue of Foreign Affairs with “Deng Undone”. The scope of this article is more ambitious, taking on the question of exactly how real much of China’s market “reform” has been.
Former U.S. Treasury Secretary Henry Paulson, a perennial optimist, wrote in September 2008 that “China’s leaders today are committed to reform, at least so long as it improves the country’s political and economic stability.” But this is true only if one accepts a very dubious definition of “reform” and ignores overwhelming evidence that reform has stopped. Price liberalization, the core of market reform, has been partly undone. Privatization was stalled at first and then explicitly reversed. Initiatives to increase corporate competition are also being rolled back. The Chinese state is increasingly encroaching on even the relatively open external sector by restricting incoming investments and imposing taxes on exports.
The central government has recently reversed the outstanding progress in the liberalization of prices that China made during the first two decades of reform. The price of labor (wages) remains largely free from government interference, but that is manifestly not the case with the price of capital (the interest rate), for which the People’s Bank of China sets a compulsory and narrow range. Government intervention constantly distorts the prices of basic assets, such as land, often by simply forbidding or promoting transactions. The State Council sets and resets the prices for all key services: utilities and health care, education and transportation. Although the exchange rate has been loosened up over the past three years, the People’s Bank of China sets the daily value at which the yuan must be traded against the dollar. And currency fluctuation is still starkly limited: the daily movement of the yuan against the dollar is not allowed to exceed 0.5 percent. The market in China has never really determined the sale prices of many ordinary goods by itself, and the tendency over the past few years has been to further extend price controls for goods. The state’s complete control over grain distribution has distorted wholesale grain prices; a recent bout of inflation has prompted restrictions on the prices of retail food as well.
None of this is to say that investors should avoid China. But, as with any investment, it’s important to understand all sides of the story before you make your decision. Whether you agree with him or not, Scissors is a must-read for anyone considering an investment in China.
