China and Risk in the Same Sentence? Believe It.

Shocking. Some caution on China from the financial community. I can't believe it. About time. China is a fantastic story and their economic growth is an incredibly welcome development, but from an investment point of view, it has been all euphoria without any regard to risk. To invest in China for the long term (I'm not talking about people trying to scalp a tidy gain over a few months or even a year or two), you have to conclude that a few thousand elderly communist men will make few serious economic policy errors. That is a stretch in my book. Granted such men do hire world-class advisors from all over the world to consult on China's ecomonic policy, but the fact remains that economic policy is overconcentrated in the hands of people who are almost destined to make an economically disastrous blunder at some point. This is no different from investing in the US, from an occurence standpoint - as this interview with Milton Freidman points out, we have too much economic policy-making power concentrated in the hands of a few people - but China's version of this risk is vastly greater given the potential impact of economic policy errors. China's political system is not as flexible as ours, we have a greater ability to react and force political institutions to maneuver us out of policy errors. This heightened sensitivity to shock is the main risk that investors face and, to a great extent, it is largely ignored.

None of this has to be the case though. The Chinese people are inveterate capitalists (most executives who do business in China will tell you that the Chinese are the real capitalists, it's us that are the socialists) and if left to operate in a democratic, free market system, their growth would be even more phenomenal and would come at much lower risk. But that would mean different people would be in charge, and there essentially is the sticking point.