But China's model is not like ours; it's far more Hobbesian than Jeffersonian. The Communist Party is sovereign and adheres to the Marxist concept that all profits belong to the state for the benefit of the working class. But Google has recently discovered firsthand what the protesters at Tiananmen learned the hard way: There is a dark side to absolute power.
The party's Politburo remains openly concerned about controlling the message and minimizing dissent. Officially, the Tiananmen Square massacre never happened. There is no political freedom, a poignant distinction between China and the capitalist West. Yet China has enjoyed increased prosperity in the past 25 years. To the degree that citizens benefit from these economic gains, one could conclude that there's been an increase in economic freedom. Even though workers typically earn about 3% of what is normal in developed countries, by the millions they choose factory work over subsistence farming.
The American experience of building a democratic society from scratch will never be duplicated. But China's economic growth has to make you wonder whether another people with a different history and a different model might evolve in such a way as to liberate the creativity and decency of the human spirit while protecting the citizenry from power's oppressive tendencies. Is capitalism's view too narrow?
For years, traditional economists have forecast the implosion of China's centrally planned economy because it ignores "market signals" such as price, consumer demand and interest rates that help allocate capital most productively. Yet the country's steady growth persists. The outside world does not know by what complex process China's economic decisions are actually made, and that should probably bother us as investors.
Transparency is a big issue. State-controlled bank balance sheets are widely disbelieved. And we know that China's accounting is different. For example, when they authorize $100 billion for an infrastructure project, it immediately becomes part of reported GDP. We also know that huge capital allocations have gone toward what capitalists would deem enormously wasteful: The largest mall in the world is practically empty after five years, as is a brand new, upscale city built to accommodate a million residents.
Outlook And Investment Response
America faces two clear challenges to economic growth: too much debt and low-cost imports. We think debt will be managed down but that interest rates will rise and GDP growth will be grudging for some years.
Our investment policy response at Financial Advantage follows this course:
Cash reserves kept at a minimum (5%) until interest rates rise.
Diversified income securities (40%), emphasizing high quality and shorter durations.
Growth opportunities (40%) emphasizing the stocks of U.S. businesses with very strong balance sheets, essential products and services, overseas growth and competitive advantages that will allow them to gain share against weaker companies in a flattish economy.
Tactical investments (15%) to supplement stock and bond holdings, for example, gold, inverse ETFs, paired trades, special situations and momentum trades.
We're avoiding Chinese shares. The consensus is that there will be uninterrupted growth in China, but that ignores two big risks: the weakening of demand for its exports (due to stagnation and protectionism in the West) and possible growing unrest at home. We will gradually increase our modest (5%) emerging market investments to take advantage of weaknesses but we prefer countries whose citizens have more influence in the political process.