These days China seems to be the answer to an increasing number of questions about the source of future customer growth for businesses in Vancouver.
What is driving coal demand at Westshore Terminals Income Fund (TSX: WTE-UN)? Who will arrive to build positive year-over-year visitor numbers for newly public Whistler Blackcomb Holdings (TSX:WB)? Where are the buyers coming from that continue to keep West Side housing prices in the seven digits? China, China, China.
There have been stories of this sort before. The Soviet Union in the 1960s was going to bury us, economically speaking. But after shining brightly for the decade after the launch of Sputnik, Soviet Russia descended into a long and dark winter. Japan in the 1980s had apparently uncovered a “third way,” whereby a coherent and centrally directed industrial strategy created super-charged competitive advantage for its keiretsu conglomerates. Yet only after the burst of Japan’s bubble economy did we discover that we had once again mistaken leverage for genius.
Will China turn out to be different?
My first-hand knowledge of the Chinese market relates to four years in the middle of the last decade when I covered Asian equities for a national mutual fund firm. In November 2003, the first time I arrived in Hong Kong, I recall watching in amazement from a taxicab window the miles and miles of container terminals. Unlike Montreal or Vancouver, where cranes seem to sit idly for hours at a time, every part of the Hong Kong port was humming and active. It was the epicentre of the last global boom.
I met often with managers of businesses, some from state-controlled enterprises and the rest from Hong Kong-based listed companies.
The meetings with the state-controlled enterprises were all the same. I would ask a question like, “Why are you doubling capacity when customer demand appears to be flattening?”
And the answer would never be satisfying. It became clear to me that managers of Chinese state enterprises, a huge proportion of that country’s economy, cared mostly about activity levels and thought little about earning returns on capital.
Where we did find fertile territory was in the beating capitalist heart of Hong Kong. Investments in China’s largest indigenous fast-food chain Café de Coral and Li Ka-Shing’s Hong Kong Electric were made alongside bright, capable managers exploiting good opportunities. But these opportunities were limited both in scope and in number. I remember being surprised at how difficult it was to find high-potential investment opportunities in an economy that was growing in excess of 10% per year.
It sure would be nice if planeloads of wealthy Chinese consumers would show up and bolster earnings for our resort operators, and it would be nice if booming demand for resources from China turned around the fortunes of our forest industry and sent metal producers into overdrive. And while I do believe China will be a positive factor through 2011 for many Vancouver businesses, my view on China over the next three to five years is much more cautious.
My reasons for concern are varied. China’s export boom cannot be sustained unless the capital currently deployed earns a fair return, something that appears unlikely at this juncture. China’s single-child policy has created one of the most top-heavy population pyramids this side of Japan, which will drag on future growth. A bursting property bubble, although apparently contained to a handful of big cities, is a further headwind. Given that housing prices in Shanghai and Beijing are now as much as 25-times average income in those cities, a China housing bust could be spectacular.
Offsetting these problems is the large U.S.-dollar cash pile China has amassed in its attempt to control its currency. China also has a smart and well-trained workforce that is paid much less than the real value of its labour. The currency is undervalued and should appreciate. The outlook is not all bad, in my view. But neither is it bullet-proof.
Should you bet your business on China trade in 2011? Perhaps. But only if it makes sense in your market niche.