Should you buy what China buys? (page 1 of 2)

It is true that China with its extremely competitive manufacturing sector whose productivity is rising rapidly, and India with its very low cost but increasingly sophisticated service sector have a deflationary impact on the world, which certainly played a part in the "jobless" US recovery since 2001.

But, as the industrialization of particularly China is progressing at a breakneck speed, and as real incomes and standard of livings are rising rapidly, China's voracious appetite for certain goods and commodities has over the last two years also inflated some sectors of the global economy through its incremental demand. Moreover, because of the large size of the Chinese economy its growth has by itself become a driver of other countries' economy, as it sucks in imports from them.

China has a steel production capacity of 260 million tones - rising to 330 million tons in 2005, which is larger than the one of the US and Japan combined but it still requires importing steel in order to cover its growing needs. China's domestic reserves of iron ore, however, only cover the production of 90 million tons of steel, fueling a voracious appetite for iron ore from countries as far as Brazil!

In 2003, China became also the world's largest user of copper, its share of the world's copper demand having risen from 6% on 1990, to 12% in 2002 and more than 20% presently. Its cement production and own demand is five times the size of the US cement industry!

China is also a huge user of pulp and paper. No wonder, since it publishes every day 82 million newspapers compared to 55 million in the US. China has the world largest cellular phone market with 200 million subscribers and is with its 330 million smokers by far the largest consumer of tobacco.

So, should, therefore, investors buy everything China is buying? Before jumping enthusiastically into the "China investment theme" there are a few considerations investors should take into account.

China is relatively resource poor and, therefore, its need for industrial commodities will only increase over time, as its industrial production continues to expand and as net capital formation remains strong. Conversely, China has an unlimited supply of labor, as more than 700 million Chinese still live in the countryside and are now gradually moving to the cities in order to be integrated into China's industrial society.

Moreover, flushed with foreign exchange reserves and overwhelmed by a tidal wave of foreign portfolio and direct investments it has the necessary capital to fund any capacity expansion for manufactured goods. As a result, there is in China cut throat competition for consumer goods such as TVs, appliances, motorcycles, cars and cellular phones.

In 1999, China's domestic cell phone manufacturers had a combined domestic market share of just 3%. Today, 36 domestic manufacturers hold more than 50% of the cell phone market, which has become glutted and where prices are collapsing.

The problem with investing in China's huge and rapidly expanding consumer markets is that new capacities can nowadays thanks to instant communication and information as well as very efficient transportation be brought on stream in no time. Does a shortage of DRAMs develop, any quantity of new capacities can be brought on stream within 18 months, which then depress prices once again.

Moreover, if a foreign company launches a sophisticated and highly profitable new product in China, you can be sure that almost instantly numerous local Chinese companies will copy the product and flood the market, thus depressing prices and margins.