September 04, 2007
Real Competition: China and Global Securities

by Andrew Corn

Being in Boston last week (but not out of touch, although I could be with portfolio manager Vijay Bachani as usual at the helm of the portfolios), I am experiencing the history of our early big rivalry. No, it is not the Red Sox and Yankees although that is a big deal here in Boston. It is the British Government versus the British colonists. They were rivals too, perhaps an economic story for another post.

The big competitor to our future business dominance in my opinion continues to be China. In the past, the fear here in the States has been almost solely based on manufacturing. It is the Chinese ability to produce goods with cheaper labor. Many here worried that pirating of patents and the thousands of Chinese students being trained in the U.S., and Western Europe would allow China to surpass the U.S. in manufacturing capability. I do not believe that it has at this point, but it has surpassed the U.S. in orders for manufactured goods, especially from the U.S., and now the globe. The eventual formula of solid engineering, cheap labor plus relatively lax government regulations would equal manufacturing that is impossible to beat.

The world has been somewhat right, and I think that in another 20 years we will truly see where this is all going. Setbacks happen. Pollution, toxic materials and faulty manufacturing cause backlashes that produce setbacks for the Chinese, but the trend keeps moving forward.

Like all eventual dominant markets and industries, booms and busts are natural events in the life cycle of eventually stable economic models. Look at the Internet, transportation and energy industries for historical reference points.

Historically the feeling in the U.S. is that the U.S. always worked harder, smarter and longer hours that the rest of the world, and therefore we would ultimately prevail. The worker/management partnership was unspoken yet completely understood. This partnership has fallen apart and so much of our hands on work have been outsourced to other countries, especially China.

This week I read a piece by Belinda Cao on Bloomberg: "China Sells $79 Billion Bonds to Set Up Reserves Fund." The essence of the piece is that China is entering the investment business. They actually raised money by selling billions in bonds to set up an investment company to help manage the $1.33 trillion of currency reserves they currently sit on.

The immediate lack of interest by the mainstream media underscores the superiority complex we have in the U.S. The underlying attitude here seems to be that, after all, cheap labor does not produce good investment professionals of any type: bankers, portfolio managers etc.

The new fund has already purchased a $3 billion stake in Blackstone Group LP (BX) in May. The stock has dropped, but the long term trend shows China making a smart investment in smart people and investors:

Chinese investors held $405 billion, or 18 percent of foreign-held U.S. Treasuries at the end of June, second only to those from Japan. Blackstone's shares, bought by a company on behalf of the planned fund, have fallen 26 percent since it listed on June 22.

The bond sale will ``help reduce the size of foreign- exchange reserves and improve the returns,'' according to the ministry's notice. Longer durations will help to ``diversify bond types and the duration structure,'' the statement said.

A record trade surplus has pushed China's reserves to an all-time high, flooding the banking system with excess cash and spurring lending. The central bank has raised interest rates four times this year to help mop up the funds.

The investment company will officially start business in September, Shanghai-based China Business News reported on Aug. 14. Lou Jiwei, a former vice minister at China's finance ministry, was appointed this year to start up the new company.