THREE SWEEPING EVENTS IN CHINA
by Martin D. Weiss, Ph.D.
Editor, Safe Money Report & MoneyandMarkets.com
March 19, 2007

Suddenly, just in the past week, China has jumped ahead with three sweeping reforms to solidify its growth, bolster its financial markets, and more rapidly transform itself into a 21st century market economy.

Each step, when taken separately, is fuel for more growth. All three, when combined, are electrifying.

Whether or not these reforms bring more political freedom to China remains to be seen. But they’re likely to set off a chain reaction of further legal changes, and ultimately, an end to nearly all vestiges of communism in China’s economy.

Reform #1
Chinese National Legislature
Passes New Property Law

This is a law that has been hotly debated for fourteen long years ... vehemently opposed by old-guard leftists in the highest echelons of power ... and repeatedly voted down by those who wanted to retain the government’s wanton legal rights over private property.

But this past Friday, those forces were roundly — and profoundly — defeated. And in their place, we witnessed a new surge in the power of the merchant middle class, entrepreneurs and even farmers.

Surrounded by flowers in the Great Hall of the People on Thursday, Vice Chairman Wang Zhaoguo, put it in this context:

China is an increasingly prosperous society. And in this society, personal wealth must have legal protection. The country’s economic and social changes make the law absolutely necessary.

The 2,835 deputies of the National People’s Congress listened intently. And the next day, the majority ruled to pass it, forever changing China’s legal landscape.

Passage of the law won’t impact on-the-ground realities all across China’s vast territory overnight. Enforcement will still be an issue for months, perhaps years.

But until now, local officials have had the right to seize businesses, farmland and even homes with virtual impunity. They’ve been able to sell off those properties to large commercial interests or speculators. And as a result, small- and medium-sized enterprises in many sectors, especially in rural China, have been squeezed or even squashed.

Your take-away from this change: If you thought China’s growth has been impressive even without laws protecting personal property ... and even without the enthusiastic participation of the masses ... wait till you see what can happen as this reform unleashes the entrepreneurial spirit of hundreds of millions of Chinese citizens that, until now, have been held back or left out!

Reform #2
New Phase in the Development
Of China’s Financial Markets

For the first time, China will now allow trading in stock index futures and options.

This may not sound like a major change to most people. And to some, it may sound like adding a new layer of speculation. But if handled properly, these instruments can have a very positive impact.

China already had three futures exchanges — in Shanghai, Dalian and Zhengzhou. But they were exclusively for commodities like copper, aluminum, rubber, fuel oil, soybeans, corn, and sugar.

Therefore, anyone dealing in commodities had a way to protect their business by hedging with futures ... but institutions buying stocks had to take their chances.

As long as the stock market was tiny, no big deal. But now China’s stock markets have been growing by leaps and bounds. Just since the end of 2005, the total value of China’s stock markets has tripled — to more than U.S. $1 trillion. And still there was no way for investors to hedge effectively.

With this new reform, all that is changing. Last September, China already set up its China Financial Futures Exchange in Shanghai. And now, on April 15, the new rules on stock index futures and options go into effect. It could add another good measure of confidence and stability for both domestic and foreign investors.

Reform #3
The Largest Investment
Fund of ALL Time!

China has just created what could soon be the largest investment fund in history.

When it was his turn to speak at the Great Hall of the People, Finance Minister Jin Renqing made the fund’s goal absolutely clear: To tap into China’s $1.1 trillion in foreign reserves ... to invest a big chunk of that money in stocks ... and to create a massive, unprecedented new wave of investment.

Some pertinent facts:

• Economists expect the Chinese government to allocate $200 billion to $400 billion to the new fund.
  
  
• The largest mutual fund in the U.S., the Magellan Fund, has “only” $50 billion or so on assets. So right off the bat, the new Chinese fund would be four to eight times larger than anything we’ve ever seen in the U.S. financial markets.
  
  
• Already, the Magellan Fund is so large that it must tip-toe into the markets, lest its heavyweight buying power drive up the price of the stocks that it’s adding to its portfolio. Since the new Chinese fund will be many times larger, even if its managers move slowly ... and even if they diversify across a wide range of stocks in China and around Asia ... they’re still likely to put great upward pressure on their values.
  
  
• China’s Finance Minister said Beijing is following the lead of Singapore’s Temasek Holdings, which has poured billions into Singapore Airlines and Singapore Telecom ... has invested heavily in banks, shipping and real estate ... and has pumped billions more into Asian economic giants like China, India and South Korea.
  
  
• The stocks and stock markets that Temasek has touched have risen substantially, sometimes by a factor of up to 12 to 1. But even with its massive $90 billion in assets, Temasek is small by comparison to the $200-$400 billion expected in the Chinese government fund.

Put yourself in the shoes of the Chinese government officials who are currently managing their vast reserves, and you’ll see this phenomenon from their perspective:

You’re in charge of investing China’s reserves. But right now, you’ve got nearly all of your $1.1 trillion sitting in U.S. Treasuries plus other cash-equivalent assets. It’s the largest hoard of liquid cash in the history of mankind. Yet all you’re getting out of it is a meager 3 percent interest per year.

Meanwhile, for the past 32 years, your counterparts in Singapore, managing Temasek Holdings, have been getting an average annual return of eighteen percent.

So you’re green with envy. And for many months, you’ve been asking the simple question: “If they can do it, why can’t we?” Well, now you have the answer: “You can. And you will!”

No End to the Great Cash Drain in the U.S.!
No End to the Great Cash Pile-Up in China!

Meanwhile, back in the U.S., the Commerce Department has announced our worst trade deficit in history for the fifth year in a row:

• The red ink in the current account (the broadest measure of trade) was $856.7 billion in 2006.
  
  
• That means that every single day of the year, holidays included, $2.3 billion is being drained from the United States and winding up in the coffers of foreign corporations, foreign investors and foreign central banks, especially China’s.
  
  
• Our deficit is now at a record 6.5 percent of the total economy, a continuing — and worsening — drain on U.S. growth and U.S. corporate earnings.
  
  
• Even investment inflows — which had been positive in every single year since the great crash of 1929 — have turned negative. Instead of investment money flowing into America to the tune of $11.3 billion in 2005, now it’s flowing out, with $7.3 billion leaving last year alone. This puts the U.S. dollar in even greater jeopardy.

In contrast, China’s trade surplus surged to a record-smashing $178 billion last year, up by a hard-to-believe 74 percent from the previous record of $102 billion set in 2005.

And now, just in the first two months of the year, China has chalked up a surplus of almost $40 billion, about $28 billion more than the same period last year.

At this rate, China’s stockpile of cash, already at $1.1 trillion, should easily exceed $1.3 trillion by the end of the year — still more cash fuel to energize China’s new investment company.

Overall conclusion: Despite bumps along the way, expect a continuation of the megatrends that propelled China’s 11 percent growth last year ... that drove Shanghai’s stock index up by over 130% in 12 short months ... and that are continuing to spread their impact worldwide.

Good luck and God bless!

Martin

© 2007 Martin D. Weiss, Ph.D.
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