The news was out last week that China's economic growth in the first quarter was as strong as ever. The message was the same as it is every quarter (boring!), but it's nonetheless important because China's rapid growth is the most important foundation of the capital markets today. It's expected that China will continue to fuel volume growth for basic materials (including energy), will keep our interest rates down by exporting deflation and low-cost capital, and will expand the world's consumer base through its own urbanization trend.
Certainly it's hard to bet against China in the long run, but there are potential bumps in the road ahead. Social and environmental turmoil could become a bigger factor. It's never a great sign when a country's banking system is poorly run and essentially bankrupt. Extreme capital investment cycles typically cause lots of pain when they run their course - Japan's pain lasted 15 years and the technology sector has suffered terribly over the last 5. Over-investment has already rendered the Chinese steel and auto industries unprofitable. And ultimately profits rule in the capital markets.
And what about the customers? Hopefully we've learned from the telecom bubble that it's important to monitor the customers of China Inc. Firms like Nortel came apart because their customers weren't making a go of it. And what made it worse, Nortel was financing these failing businesses to help them buy more equipment. China's customers are much more diversified than Nortel's, but there are some similarities. U.S. consumers continue to spend like drunken sailors and China is lending them the money (by buying U.S. bonds).
I don't know if China's growth trend will continue uninterrupted or if it will go through a cyclical downturn like everyone else. I do know that I'm not as confident as the market consensus is and the foundation of my portfolio isn't based on the China theme. Even if the consensus proves to be right, I think it will be hard to make money off of that view.
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