One of the recurring themes of a hoped for recovery is “China will get us out of this.” With an estimated foreign exchange reserve of over $2 trillion, the hope is that China will spend, stimulate and pump the world economy into better times. As the world’s fastest growing major economy, many investors look to investing in China as a new source of stock market growth, hoping that the middle kingdom is lined with gold and ten-baggers. But how much of our collective expectations about investing in China is fact and how much of it is fiction?

I do not remotely pretend to be an expert on China. However, I have visited it twice in the last 5 years include a recent business trip and there’s is a real Wizard of Oz effect to certain parts of the Chinese economy which worries me in the short to medium term (see below). For the long term, one definitely has to be in China as a place of business and as a place to invest but let’s consider a few fundamental things about China.

WILL CHINA RESCUE THE WORLD ECONOMY?

Despite all of its impressive growth, China’s GDP is still a third of the United States (an estimated $4.222 trillion vs. $14.33 trillion- all stats courtesy of the CIA Factbook unless otherwise stated) and still smaller than Japan’s (although that will change soon).

More importantly, China GDP per capita is only $6,000. In other words, China’s economy does not rely on a productive citizenry but on a large citizenry- a quantity vs. quality output. The United States, with approximately a third of China’s population, produces a GDP of $47,000 per capita.  Brazil, a developing economy we should focus on more, has a GDP per capita of $10,000.

As a columnist noted, China’s growth continues to rely on foreign capital and technology. To suddenly think it will start out-flowing capital ignores the fundamental truth that China is still a net importer of capital and where it is exporting will not help the western economies- China is becoming a major player in Africa (oil, oil, oil).

The scary stat, as strange as it is to consider, is that China has an alarmingly modest population growth rate for a rapidly developing nation. Population growth is estimated to be 0.655% whereas the U.S. has a population growth rate of 0.975%. In other words, demographically speaking, the seeds for its eventual economic leveling has already begun and China has to begin tackling the same issue as the U.S.- how to take care of an aging population.

Put this together and China is still an economy that needs to pull its own people up before it can help the world economy. In other words, China is not the white knight for the world economy. Despite its massive reserves, it probably needs the money to help itself first before others.

A FEW THINGS TO CONSIDER BEFORE INVESTING IN CHINA?

(I completely realize the broad generalization of lumping all Chinese companies into a simple “should I invest in China” question but indulge me. This is a blog not my Ph.D thesis)

In 2006, I was sent to China to find someone who could manufacture steel rods cheap. I ended up in Guangzhou. If you have ever done business in China, you know you can’t just approach a manufacturer directly. You have to find a professional sourcer.

My sourcer ended up saying something  to me that has stuck ever since (to paraphrase): “Chinese businesses are good at making parts but the value add of putting together the parts into something larger is not there yet and may not reach North American standards for 10-15 years.”

In other words, despite what the media likes to think (and how many writers have been to China without a government official by their side?), China still has much developing to do and, if you are investing in a Chinese company, it is equivalent to investing in a penny stock company in North America. You don’t know whether this will be a ten-bagger or if there is actually revenue behind the company.

The thing that worried me more was when I visited Beijing (remember this was before the Olympics). Beijing is built on ring-roads which makes a direct trip from airport to downtown, well, circular so you end up seeing a lot of the city.  In my cab ride in, I saw block after block of finished BUT COMPLETELY EMPTY office towers. I was told that a lot of office towers were built on government money without any consideration of actually locking up tenants.

So one wonders how much growth is real growth or government programs to keep people employed (rural unrest is a huge political issue for a party historically built by the peasants; over-employment by government in low productivity ventures is common to keep the political peace; I saw 22 workers in Shanghai fixing a sidewalk- 2 people operating the machine and 20 watching)?

Now, I readily admit that was 3 years ago and a lot of the Beijing construction was for the Olympics but my over-whelming sense touring China (and I visited 4 major urban centres) was that a lot of things were being built for the sake of being built so is the growth actually increasing productivity or is it growth for growth’s sake?

I wonder if the Chinese stimulus program just isn’t pouring gasoline into the fire and, eventually, fundamental economics like demographic declines, falling real estate absorption rates, rising commercial inventory and modest productivity growth will not catch up to China?

Of a greater significance, Francis Chou, noted value investor, was recently quoted as taking a pass on many Chinese stocks given transparency issues: Chinese publicly traded companies have a reputation of being less than candid in their disclosures and regulators have no desire to slow down growth.

WOULD I INVEST IN CHINA?

Despite all of that, would I invest in China? YES.  The above stories are more cautionary tales than anything else. China is not the pot of gold the media makes it out to be. However, you can’t ignore the fundamental momentum of an ecomomy of that size. Eventually, it will iron out the productivity issues and its wild west economic practices and, with such disciplines, be a true economic super-power (plus, if it can secure African sources of oil, it just solved an issue the U.S. is grappling with).

However, I temper my “yes” with a few caveats. I would not buy a China specific funds or ETF. It is too many eggs in one basket in an immature public market. I would tend to buy broad based ETF’s that track some Chinese indexes to spread risk.

China is also not a short-term play. It eventually over-take U.S. GDP- but estimated in 2040. If your investing horizon is short, I would stick to the tired and true domestically. The ride up will be very bumpy- it often is in anything that develops rapidly- so you have to have the stomach for a few specutular wipe-outs along the way.

Finally, many U.S. businesses do conduct business in China and this is often a way of investing into China without investing in China. However, Chinese cultural pride and nationalism runs strong (as well it should for such a culturally rich country) and it remains to be seen as the economy matures whether nationalism will dictate that local consumption habits be for domestic brands rather than multi-nationals (it is western arrogence to assume that everyone will wear A & F, shop at Home Depot or drink Gatorade). If you believe in this scenario, the safer play may be to buy commodities since you can’t manufacture finite resources which cannot be extracted in China.

Regardless of whether or not you invest in China, visit it. It is a wonderful experience with as much culture as Europe (for much cheaper cost). Thanks for indulging me in a trip down memory lane.