The Investment U E-Letter: Issue # 526
Thursday, April , 2006

Investing in Chinese Stocks: Red Capitalist Report #3... The Here and Now for Investors, plus Four Long-Term "Red" Flags For China
By Dr. Mark Skousen, Chairman, Investment U
{Part 3 of a 4-part report}

My fact-finding trip to China confirms that 1.3 billion Chinese are focused on one big goal: keep the economy booming so that by the time the Olympics in Beijing rolls around in 2008, China will be able to stage the biggest international event in its history.

It will be a gigantic coming-out party symbolizing China's industrial might and entrance to the "first world" of nations. It will mark a symbolic victory compared to the last time I was in China, in 1989, during the bloody suppression of the Tiananmen Square protests.

Every Chinese official and tour guide echoed the same sentiments: Forget about politics and try to change things - only economics and financial advancement mean anything. Even Austrian economist Dean Peng, a libertarian, told us in Beijing that he expected "no crisis" in the transformation toward democracy in China. The theme is universal: "To get rich is glorious."

And China's doing just that, largely through an export-driven market, as the following graph indicates:

I have every reason to believe China will achieve this short-term goal, and that's why I'm recommending investing in Chinese stocks, as well as Asian stocks in general, right now.

Will Chinese Stocks and its Economy Suffer Post-Olympics?

The investment opportunities in Chinese stocks are here and now. However, China faces four major challenges once the Olympic games are over which ultimately will have an effect on investors still looking to profit off the China boom:

1. Rising income inequality between rural and urban incomes:

City Chinese are earning twice as much as rural Chinese. As a result, millions of rural farmers are moving into the city, a massive immigration that could cause social strife. The government is trying to keep up with massive construction of high-rise apartments, but it may not be enough.

2. A potential financial crisis:

• 70% of private banks are in trouble in China with massive bad loans (similar to Japan in the 1990s).
• The Chinese capital markets are struggling following the stock market collapse in 2001-04.
• Currency speculation could surface.
• And if much of the investment turns out to be malinvestment (many observers think China is overbuilding and overinvesting, especially in public infrastructure projects), China could be in for a financial disaster despite its huge foreign reserves, strong revenues and low deficit.

3. Lack of accountable government at all levels, including the Chinese judiciary:

When I asked Chinese graduate students if China enjoys the "rule of law," most of them shook their head. After decades of communist rule under Mao, there is a sense that no independent judiciary or basic property rights exist today. If a government official wants to build a high rise over a piece of farmland, he does it - no questions asked.

4. Unstable geopolitics:

Growing Chinese nationalism could destabilize if an incident arises with archenemies Japan and Taiwan. Fortunately, the rapid rise in trade and investment between China and these two islands will discourage an all-out war. Yet Beijing's massive buildup of armaments and military (at double-digit annualized rates) is cause for concern. In Beijing, we saw soldiers everywhere.

Conclusion

In sum, I'm positive about China overall... and investing in Chinese stocks... for the next two years. But after that, all bets are off. I wouldn't be selling any of my gold.

Good investing, AEIOU,

Mark