SPENCE Asset Management

Expanding Our Horizons September 2009

The world is shrinking. When managing your investments, we can no longer confine our thinking to what lies between our country’s borders. As Americans, we can no longer assume we are the center of the universe; as American investors, we can no longer afford to assume the operations of American corporations will provide the greatest opportunity for growth. Here at Spence Asset Management, we have made it our business to gain a greater understanding of the inner workings of foreign countries. What follows is an attempt to create a brief synopsis of thousands of pages of research on The Peoples Republic of China:

Pre-Revolutionary China

Fortunately, an ancient history overview of China, written by our favorite historian Will Durant, is available. And early on, we reached the conclusion that the biggest mistake any American could make in attempting to analyze China would be to view China through the Judeo/Christian/American prism. While America’s history is relatively speaking, very short, China’s history is very long. The differences in our two nation’s backgrounds are so stark and so contrasting; the first thing necessary for gaining a better understanding of China, is to leave all preconceived American notions and moralistic baggage at the proverbial research door.

China’s background is ancient. Recorded history spans 5,000 years. When the west first encountered China, it quickly became the marvel of the western world. Reports on all aspects of Chinese society during the days of Marco Polo (1254 -1324) suggest it was by far the most advanced in the world at that time. Evidence of ancient Chinese culture suggests the people’s abilities for innovation (printing press, paper, gun powder, ceramics, and the compass) are inherent. Knowing China’s ancient accomplishments in engineering feats, including the early use of hydraulics, metals, and other mechanical processes is informative. At one time long ago, China’s incorporation of technology exceeded that of anything in the Middle East or Europe.

Unfortunately for the Chinese, like the nations dominated by Islam, (also once a marvelous cradle of advanced scientific knowledge) China began to gradually fall behind other cultures in the world, due primarily to an unwillingness of its leaders to open its culture, borders, and thought-processes so the nation could simply benefit by learning from others.

Eventually, mired in alternations between various forms of feudalism and the weakness and corruptions associated with hereditary monarchies, China became the target of imperialists in both Europe and Japan. Foreigners occupied and repeatedly humiliated the sovereignty of Chinese rulers particularly during the Qing Dynasty (1644-1911). Atrocities by outsiders against Chinese citizens became an increasingly commonplace occurrence leading up to the 20th century.

Revolution and the Ascendancy of Mao

Early in the twentieth century, revolution finally came to China. Citizen activists interested in breaking away from the chains of monarchy, feudalism, and the partitioning of Chinese territory by foreign interests sought new ideological platforms. Conveniently, the Russian Revolution broke out around the same time. Once Lenin achieved revolutionary success in Russia, Marxism quickly ascended to the top of the popular revolutionary heap in China.

There is no question that the historic partitioning of China by foreigners and particularly the brutal occupation of China by the Japanese during WWII had a profound affect on the psyche of the first three generations of Communist Chinese leaders (Mao, Deng, and Jiang). Historically aware, all leaders that have ruled China since 1949 have maintained a steadfast suspicion of any outside interference in the “internal affairs” of China. And based on the history of foreigner’s regrettable incursions into China, this suspicion seems completely understandable.

Suffice to say, the hardcore Marxist economic ideology that Mao attempted to implement in China failed miserably. As an economic system, the central-planning of basic Marxism did not work any better in China than it did in the former Soviet Union, in Eastern Europe, in North Korea, or Cuba. However, besides the mere economic folly of Mao’s ridiculous and ever-shifting economic policies, there were so many other egregious mistakes made. It is difficult to create a short list of all of the things that life under Mao did to raise the ire and destroy the underlying confidence of the Chinese people and the next generation of leaders. It was as if the entire nation and party were being held hostage by a mad man. Essentially, Mao jerked around the entire nation repeatedly with one mini-revolution after another. His Cultural Revolution could well serve as a case study of perhaps the largest state-sponsored effort at disorganization in human history. In the end, it was all about Mao and his ability to maintain control. If nothing else, Mao institutionalized the nasty habit of hero worship through fear and intimidation.

Deng Xiaoping — Modernization Begins

Not surprisingly, the man who would turn the nation by 180 degrees in the opposite economic direction (Deng Xiaoping) was unable to avoid being purged by the machinations of Mao on several occasions. Deng was not the hand-chosen successor of Mao.

For our purposes knowing the subtle intricacies of the political infighting, including the maneuvering that led to Deng Xiaoping’s ascendency to the top of the CPC leadership heap, are not important. What is important is to understand that Deng began a process that emphasized “thinking” over stubborn Marxist dogma. This process is still underway and the Chinese have become advanced thinkers.

To a great extent Deng engineered the beginning of the modernization of China. Two choices emerged in China the years directly following Mao’s death. They were:

1. The “Two Whatevers” promoted by Mao’s hand-picked successor Hua Guofeng. Essentially this choice meant, “whatever Mao said and whatever Mao instructed.”
2. Seeking TRUTH from FACTS, which was promoted by Deng. This process offered the party leaders an intellectual alternative to allowing Mao to rule through Hua from the grave.

When Deng’s practical message eventually won the internal political struggle with Hua, Deng began a slow and tedious process of weaning the party (and to a lesser extent the people) off of the “cult of personality” system. Naturally, Deng did not mind wielding and enhancing the force of his own personality from time to time when it suited his purposes. Still in the final analysis and despite the autocratic methods of Deng, he must be credited with initiating the greatest national economic transformation in human history.

Deng began the transformation by reforming agriculture and introducing market forces for the benefit of farmers all over China. The response was predictable. Incentives to increase farm production precipitated large and consistent gains year after year.

There is no question that the horrible incident at Tiananmen Square in 1989 temporarily stalled the economic and social reform processes achieved under an aging Deng. Sharp criticisms of China, by virtually all nations in the world, caused the country to temporarily turn inward and reject outside interference. But the proverbial genie was out of the Chinese bottle. Selected personally by Deng, it would be Jiang Zemin who would be given the responsibility for re-igniting the transformation of China in the post Tiananmen era.

Jiang Zemin — The Greatest World Economic Leader of the 20th Century

While Deng “initiated” reform it was Jiang who systematically implemented cataclysmic changes.

Again, without spending much time going over the inner political workings of China, it suffices to say that Jiang began to gather power at the behest of Deng as soon as he rose to power in 1989.

Like Deng, Jiang Zemin is a product of the pre-WWII era. When Jiang was a student, China was occupied and terrorized by brutal Japanese soldiers. However, unlike Deng, Jiang is an engineer, not a military figure. This is a critical piece of academic background information on Jiang that helps mightily with the understanding of his remarkable leadership.

The depth of Jiang’s talents, character, and magnetic personality are hard to overstate. Above all else, Jiang is a man who loves the process of learning. If you think of the wisest, most well-read, most practical, and most people-skilled person you have ever met, you are describing a person very similar to Jiang Zemin.

To summarize what happened under Jiang Zemin, is to understand how China has managed to position itself to dominate the 21st century world economy. No doubt part of the reason why the 21st century will be dominated economically by China is based on what the United States has failed to do. But history will give credit where it is due. China is positioned as it is, due in great part to the vision and ability to execute of Jiang.

Originally it was Jiang who caught Deng’s eye as an able administrator of Shanghai after Jiang helped shape and administer the Special Economic Zones. By the end of 1992, Jiang had a firm grip on the reins of power in China. And it was in 1992, at the behest of Deng, that Jiang boldly, almost astonishingly introduced the idea of a socialist “market” economy. Prior to this event “market” was a dirty word in Chinese politics.

In the end, Jiang has so many credits associated with his rule it is very difficult to list them all. Each item deserves more discussion than is given below.

• Jiang travelled all over the world and positioned China internationally as a trustworthy neighbor and broker for peace while simultaneously continuing to resist the temptation to engage in imperialism.
• He reformed the Chinese military and eliminated the conflicting practice of military officials corruptly engaging in private trade.
• Thanks to his scientific/engineering background, he understood the importance of and emphasized the rapid development of high technology industries.
• Jiang modernized the nation’s currency and made it convertible, thus freeing up the flow of foreign capital into China. Then, he courted international investors.
• He kept his solemn promise to allow both Hong Kong and Macau to operate as Chinese provinces under their own free market economic systems.
• He closed down and/or allowed private ownership of countless State Owned Enterprises (S.O.E.).
• While risking temporary unemployment, he was able to shed the most inefficient drags on the Chinese economy.
• He sponsored and supported the push that ultimately landed the 2008 Olympic Games in Beijing.
• He boldly called for the inclusion of entrepreneurs and other private business owners in the Communist Party. This was as revolutionary as calling for a socialist “market” economy.
• He supported widespread academic/scientific freedom and he supported the arts.
• He modernized the media and very gradually loosened the party’s reins on the dissemination of news and information.
• He led by consensus in the party rather than dictating his own personal orders to the party.
• He facilitated a smooth transition of power to the next generation of Chinese leaders including his successor Hu Jintao.
• China now boasts over $1 trillion in currency reserves, a vibrant economy, and the strongest national balance sheet in the world.

Jiang’s ideological legacy of governing is simplified in the concepts he called the “Three Represents”

1. advanced economic production
2. advanced cultural development
3. advance the fundamental interests of the vast majority of the people Thanks to the respect for Jiang’s leadership and enduring influence, these ideas were written into the Chinese Constitution in 2002.

China Today

The career of Hu Jiantao (the current Paramount Leader of the CCP) is still ongoing in 2009. Since Jiang’s gradual exit from the political stage it is worth noting that his appointees (Hu and others) mostly came from engineering backgrounds. For the investor it is comforting to know that the “problem solvers” are still in charge in China and the most scientifically educated elements of the intellectual community are well represented in Chinese leadership.

It is noteworthy that of all the leading nations of the world, China’s resume as a NON-imperialistic country, is by far the cleanest. The Chinese have even resisted all temptations to militarily force the repatriation of Taiwan.

It is also very noteworthy that while private property legal rights are crucial to economic development, and they have been enhanced and protected mightily since the launching of the first Special Economic Zones, by and large, lawyers have very little to say about the nature of economic policies that are enacted in China.

Jacobi Would be Proud.

Put in proper historical perspective, it is important to understand that the Chinese have performed a Jacobian reverse on the rest of the world, at least in terms of gaining the edge in economic competition. The leadership in China has “inverted” the economic puzzle so it could be solved. This assertion is made because we find that more than any nation on earth, the Chinese have learned that Marxism, while an admirable social ideal, is economically impractical. This means the Chinese (like the U.S.S.R., Eastern Europe, Cuba, and North Korea) have vast practical experience so that their leaders fully understand precisely what policies and practices do not work.

On the other hand, the Chinese are not naive or foolish. They wisely concede that there are instances and situations where free markets simply do not function properly. What the Chinese have managed to do is be practical. They do not endlessly waste resources debating the trite free markets versus central planning issues.

Instead, the country, through wise, honest, and practical leadership has incrementally pulled itself away from the horrors of central-planning. And as it has done so, it has steadily prioritized its cherry-picking of the aspects of market-based systems that work so well. During this transformative process the Chinese have managed to enjoy a remarkable degree of social order, domestic stability, and breath-taking increases in living standards.

Jim Spence, Registered Principal • Spence Asset Management

Spence Asset Management, Inc.
2455 E. Missouri Ave. Suite A Las Cruces, NM 88001 575-556-8500

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