THE NEXT EMPIRE

James Boxley Cooke (The Daily Reckoning) - September 27, 2003

Everyone in the West has long talked about China in terms of its massive potential. But the future is now.

Many different elements - as you'll soon see - are combining forces. And China is beginning to realize its potential as a world economic superpower. Let's take a closer look at some promising developments in China over the past several years...

We've seen diplomatic breakthroughs, such as the U.S. designation of China as a "most favored nation," and its entry into the World Trade Organization. And just as importantly, we've seen Hong Kong's growing free-market influence on the motley politics driving the mainland economy. We've seen small businesses springing up from the Chinese countryside like mushrooms. In fact, we've seen every indicator that the people of China, including its huge middle class, are ready for a full-scale economic revolution.

China is not only the world's most populous nation, with over 1.3 billion citizens; it's also Asia's fastest-growing major economy. And has been for over a decade. Even with the current global economic slowdown, China is still likely to grow at more than 7% a year. That's a huge number for an economy this size. And it represents huge potential profits for us as investors.

I think the potential for the newly capitalistic Chinese economy is absolutely enormous. And while there are certainly political risks to keep less intrepid souls at bay, even a small investment in this region has the potential to make a big impact on our portfolios in the months and years ahead.

Take, for example, the thoughts of legendary hedge-fund manager [and friend of the Daily Reckoning] Jim Rogers, who enthused last year that no country's economic prospects excite him more than China's. In a Barron's interview, Rogers said, "The 21st century is the century of China... Everybody should teach their children and grandchildren Chinese.

"There is no question China is going to dominate all of Asia," Rogers added. "...and the whole world, eventually."

Strong words. But I think he's right. As I've said often, the development of China may well be the single-biggest investment story of the decade ahead. I suggest investing now, rather than trying to play catch-up later.

One vehicle we recommend is the closed-end Templeton Dragon Fund, managed by Mark Mobius. It's traded on the New York Stock Exchange, and gives us broad diversification inside China with the best emerging-market manager in the business.

As Oxford Club advisory panelist Lynn Carpenter writes, "One of the nice things about a closed-end fund is that - unlike a regular mutual fund - the assets under management don't fluctuate daily depending on contributions or withdrawals. Since the assets are stable, the manager of the fund can invest the assets for the long-term, without having to worry about redemptions."

That's key. We want Mobius putting money to work when he sees opportunities, not when retail investors decide to send him cash. The same is true on the sell side. We don't want him pulling the trigger just to meet shareholder redemptions.

Yet for all its potential, many investors still blanch when it comes to investing in this part of the world, noting that China is still a communist nation with a notoriously corrupt bureaucracy and only a gradually evolving rule of law. Are there enough positives to justify risking his capital in this part of the world?

Yes, indeed.

Sure, China is an area fraught with risks. It's no place for an investor for whom preservation of capital is paramount. But for more aggressive investors, it is a potential bonanza. Let me start with the basics. In 2001, China grew at more than seven times the rate of the U.S. economy, despite the fact that the country's population is more than five times as large. Yet the vast majority of U.S. investors remain oblivious to the investment implications, even though the economic story is front-page news.

According to Andy Xie, a leading economist at Morgan Stanley in Hong Kong, "China's rise as a manufacturing base is going to have the same kind of impact on the world that the industrialization of the U.S. had, perhaps even bigger."

In fact, China is already the world's fourth-largest industrial base, behind only the U.S., Germany and Japan.

Already China makes:

* More than 50% of the cameras sold world-wide
* More than 35% of the televisions sold world-wide
* More than 30% of the air conditioners sold world-wide
* More than 25% of the washing machines sold world-wide
* More than 22% of the refrigerators sold world-wide

These numbers allow you to see the enormous impact that China is already having. But that impact is only just beginning. China's entry into the World Trade Organization is accelerating these economic trends at light speed.

Why? World Trade Organization membership cuts production costs, forces down tariffs, and removes obstacles to selling overseas. That, in turn, is drawing record direct investment in China.

Over $600 billion has been invested over the past two decades. And while individual investors and brokers are still asleep at the wheel, Fortune 500 companies are falling over themselves to take advantage of what's happening in the world's most populous country. For instance:

* GM purchased more than $1 billion in spare parts from China in the last few years and plans to increase that figure dramatically in the near future.
* Ford announced recently that it plans to boost its purchases of auto parts in China to as much as $1 billion annually starting this year (2003).
* General Electric expects purchases from China - both parts and finished goods - to hit $5 billion annually in the next three years.
* Wal-Mart concedes that more than $10 billion in Chinese- made goods are sold in its stores every year.
* Motorola says its total investment in China will hit a record $50 billion this year.

As you can see, the biggest investors in the U.S. - the Fortune 500 - are already plowing money into China.

With the exception of Hong Kong, however, markets inside China are too wild, unregulated and risky for us to gamble our capital there directly. For these reasons, the best 'safe' investment vehicle for our members remains the Templeton Dragon Fund.

The fund is broadly diversified between Hong Kong, Taiwan and China and, as I mentioned before, managed by the world's leading emerging market manager, Mark Mobius. In my view, the Templeton Dragon Fund is the safest, most-liquid way to obtain a pure play on the growth of China.

I remember our Club's Investment Director, Alexander Green, speaking at an investment conference at which he called China perhaps the single-biggest investment opportunity of the decade ahead. At once, a hand in the audience shot up. "Everyone comes back from China awestruck about the growth that's occurring there. But, in my opinion, China will never become a real investment opportunity until it quits relying on exports and starts developing its own domestic market."

Tell that to General Motors, I say.

For the year ended December 2002, GM reported that it sold over 264,000 vehicles in China, a 325% surge over 2001. And its goal is to have launched at least four new models in the world's fastest-growing auto market by the time this year is through.

"Growth potential remains enormous in China," said Phil Murtaugh, chairman of GM China. "We will respond with an unprecedented series of product launches and continue to seek additional opportunities."

(Incidentally, industry experts estimate that GM's profit margins are at least twice as high on cars it makes in China as on similar models made in the U.S.)

For years investors have talked about the enormous potential of China's gargantuan market. But, in the end, it always seemed to boil down to potential and little else.

There's a good reason for this. China has a well-deserved reputation as a fickle and ornery place for foreigners to do business. China's enigmatic legal system has only recently begun to honor property rights. Chinese entrepreneurs have often distinguished themselves primarily by aggressively pirating Western products like software, compact discs and cell phones. And foreigners have often tripped themselves up by overpaying for licenses, industrial land and office space.

But things are changing, rapidly and for the better. Just a year after China joined the World Trade Organization, and two decades after it began allowing foreign companies to invest locally, multinationals are quickly capitalizing on China's fabled market.

Chinese consumers - in droves - are now buying products from both domestic and foreign manufacturers. As the NY Times reported: "Already, the Chinese buy more cell phones than consumers anywhere else. They buy more film than the Japanese. They now buy as many vehicles as the Germans."

* For companies like Siemens and Motorola, China has become the single-most important market for mobile phone handsets and other equipment, accounting for billions of dollars in annual revenue.
* Japan's Toshiba now says it sells two-thirds of what it makes in its 34 China-based operations to the Chinese. Local sales were more than $2.5 billion last year.
* McDonalds and Kentucky Fried Chicken have 700 China-based restaurants between them and open scores of additional stores each year. * Eastman Kodak controls an estimated 63% of the domestic market in China for rolled film.
* Even Starbucks has found plenty of urban tea drinkers ready to spend $2.50 for a latte.

Yes, foreign companies are doing very well in China. But, for most of them, it's still a small percentage of their total sales and profits. And the Chinese are too smart to let foreign companies rake in all the dough. There is tremendous opportunity for local Chinese companies as well.

And American entrepreneurs are rapidly moving in. The Wall Street Journal confirms it. As Leslie Chang recently reported: "Last year China became the biggest recipient of foreign investment, for the first time surpassing the U.S. Foreign investment jumped almost 13% in 2002 to $52.74 billion. Even SARS, of which more than 60% of all reported cases worldwide appeared in mainland China, so far appears not to have dented the country's essential appeal: cheap labor, improving technology, and a fast-growing consumer pool."

In the future there will come a day when investors everywhere wake up and recognize China as "the opportunity of a lifetime." Dozens of mutual funds will spring up, offering myriad ways to capitalize on growth in China. Stockbrokers will call their clients and pitch their new China products with enthusiasm. "Business Week" and "Fortune" will run cover stories about the phenomenal growth in Chinese capital markets. Even your friends and colleagues will start telling you about the unprecedented investment opportunity they see in this nation of one and a quarter billion.

And that, my friends, is when we'll be getting out.

Sincerely,

James Boxley Cooke, for The Daily Reckoning Editor's note:

James Boxley Cooke is a former executive with T. Rowe Price, one of the oldest and most respected names in mutual fund management, with over $200 billion in assets under management. He is currently the Chairman of the Oxford Club.