Profit from Fast-Growth BRIC Economies:

Brazil, Russia, India and China

A Special Report by Nicholas A. Vardy

Editor, The Global Guru, Global Stock Investor and Global Bull Market Alert

$19.95

Profit from Fast-Growth BRIC Economies: Brazil, Russia, India and China Copyright 2007, by Nicholas Vardy. All rights reserved. No quotes or copying permitted without written consent. IMPORTANT NOTE: This special report is for information and educational purposes only, based on current data as of December 2007. Do not buy or sell any investments listed until you have read the latest investment information by Nicholas Vardy. Become a subscriber to Global Stock Investor for the most current information about BRIC investments and Nicholas Vardys current stock recommendations.

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Table of Contents
Introduction ..............................................................................................................1 Booming Brazil: An 11x Return Dancing the Samba..........................................2 Investing in Russia: The Russian Bear Flashes Its Claws...................................5 India Turns 60.........................................................................................................7 China's Stock Mania Revisited: The Anatomy of a Financial Mania................9 Conclusion...............................................................................................................13

Introduction
Giant financial groups such as Citigroup and UBS may be reeling from the fallout of subprime loans and the collapsing U.S. real estate market. Meanwhile, global stock markets have been rallying to record highs. For emerging market equities, this summers credit crunch was a mere blip in a five-year bull run. The MSCI Emerging Markets Index is up more than 56% during the past 12 months, and it has soared by almost 33% since bottoming on Aug. 16. Asia has been particularly strong with new record highs in Hong Kong, Singapore, Seoul and Sydney. But it's the BRIC markets Brazil, China, India and Russia that have been the stars. Chinas Shanghai Composite is up 419% since the beginning of 2006, Indias Sensex is up 103% and Brazils Bovespa is up 88%. China, Brazil, India, (along with South Korea, Hong Kong, and Mexico) each have had more than 30 days worth of record closes in 2007.

The Booming BRICs: Brick Solid?

As with the Japanese bubble in the 1980s, and the technology bubble of the late 1990s, the bulls' arguments for why "this time it's different" is seductive. The bulls are betting that the credit squeeze and economic uncertainty gripping the United States and Europe won't spread to emerging markets. Despite a tough real estate market in Sarasota, Fla., Beijing and Bangalore have been doing just fine, thank you. The solid economic fundamentals, rising domestic consumption and high commodity prices mean that BRICs are less vulnerable to external shocks than in the past. Even if emerging markets are not as decoupled from Western economies as they'd like to think, the financial strength of companies, governments and consumers will cushion the impact of the credit turmoil and U.S. economic downturn. And here's what really is different this time: the U.S. and European economies account for an ever-decreasing proportion of global GDP. China's galloping 10%+ growth rate (at least for now) accounts for a higher percentage of global growth than does the United States. Indeed, taken together, emerging economies account for a greater percentage of global growth than developed economies. That's for the first time ever.

The Booming BRICs: Partying Like It's 1999

A couple of jittery days in October and the bears are already out in force. But the better parallel to the current state of global equity markets is October 1998, when Alan Greenspan cut the federal funds rate to inject liquidity into the markets after the nearmeltdown of the Long-Term Capital Management hedge fund. At that time, it was large technology stocks and dotcoms that soared. The NASDAQ Composite index gained 40% in three months, and tripled (!) in less than 18 months as it partied through 1999. With some emerging market blue chips jumping more than 50% since mid-August, the most worrisome thing is the level of consensus. As an analyst from Morgan Stanley put it: "Bulls will say that this uptrend is unbreakable after all the trouble that has been thrown at it. Emerging markets will be seen as the new growth engine that cannot be derailed." 1

Signs of froth abound. The Chinese IPO market is looking like the dotcom of the 2000s. The average first-day return for Chinese IPOs in 2007 is 192% with triple-digit percentage trading gains becoming routine. China is leading the world in IPOs for the second year running to raise more than $64 billion so far in 2007. Surging economic growth and low returns on savings mean that there are billions of dollars seeking a home in the stock markets. Dominated by retail investors, the Chinese domestic stock market is little more than an open casino. Overlay the chart of the iShares FTSE/Xinhua China 25 ETF (FXI) to the NASDAQ in the late 1990s, and the resemblance is striking. Paradoxically, it is at times such as these that global markets turn into a game of musical chairs. Traders with a sense of history know that 1987 and 1998 both created bubbles. But the party went on for more than a year. That's plenty of time to lock in a solid bonus and rack up big trading profits. Even analysts predicting it will all "end in tears" feel they'll be able to pull their money out of the market as soon as the bubble seems ready to burst. That's sheer hubris. The achievements of the BRICs are real enough. But in financial markets, as the French say, "Plus a change, plus c'est la mme chose" -- the more things change, the more they say stay the same.

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Booming Brazil: An 11x Return Dancing The Samba

"Brazil is the country of the future... and always will be," Charles De Gaulle declared wryly in the 1950s. De Gaulle would be surprised to know that Goldman Sachs has designated Brazil alongside Russia, India and China (the BRIC Economies) as one of the four top leading global powers between now and 2050. But it's more the size of its stock market gains during the past five years that has caught the attention of U.S. investors. Thanks to the combination of a soaring stock market and an appreciating currency, U.S. investors have made 11x their money in Brazil during the past five years. No wonder the Brazilian market has been raising investors' eyebrows and opening their wallets. Brazil even seems immune to the credit woes afflicting global markets. Bovespa Holding SA, owner of Brazil's biggest stock exchange, has risen 43% since trading started Oct. 26, even as the overall index has gained 1.4%.

Booming Brazil: From Economic Basket Case to Booming BRIC

"Wow! Brazil is big!" exclaimed U.S. President George W. Bush, after being shown a map of Brazil by Brazilian President Lula da Silva in November 2005. Indeed, it is. You could fit 12 of Bush's home state of Texas into Brazil. Geographically, Brazil is about 90% of the size of the United States, and its population of 187 million is equal to the United Kingdom, Germany and Italy combined. Brazil also has epitomized Latin America's roller coaster economies during recent decades. Half a century ago, Brazil was one of the most rapidly growing economies in the world. In the early 1970s, Brazil grew a China-like 9.8% a year during half a decade's time. But then each period of rapid growth was followed by sharp economic slowdowns and dizzying inflation. For much of the 1980s, Brazil grew by less than 1% a year. Between 1986-96, the annual average rate of inflation for Latin America as a whole was more than 180%. But much like an economic St. Augustine, Brazil has repented its economic sins. It has ramped interest rates to whip inflation and cut government spending using the budget surplus to pay back Brazil's external debt. Inflation which at one point reached 80% a month now is moving firmly into the low single-digit percentages. In 2006, Brazil recorded a trade surplus of $46 billion, and its foreign reserves are forecasted to reach $170 billion by the end of 2007. And thanks to income boosted by the commodity boom, the Brazilian government is one of the few in the world running a primary budget surplus about 3.7% of GDP. Truth be told, Brazil also has been lucky. The inflow of dollars from the commodities boom has allowed Brazil to pay off foreign creditors early. Those payments include $15.5 billion going to the International Monetary Fund (IMF). Yet compared to its rivals, Brazil's economy has been a slothful tortoise, rather than a nimble hare. During the past few years, Brazil's economic growth has averaged just 2.6% a year a long way from the 7.7% annual average GDP growth of emerging markets. Brazil also pales in comparison to BRIC rivals India and China with their 9-10% growth rates. 3

Yet that, too, is changing. Just recently, the Brazilian government announced that the country's economy grew by 5.4% in the second quarter, compared with the same period in 2006. That's more than twice the annual average during the past 15 years. And economic growth has been broad based across agriculture, services and industry. Both business investment and demand from consumers has been robust, driven by a high rate of job creation, the rapid expansion and falling cost of consumer credit.

Booming Brazil: Energy Pioneer

Brazil is also a global leader in alternative fuels, and stands firmly on the cutting edge of the ethanol boom. Its traditional oil industry has also made remarkable strides. A decade ago, state-controlled oil company Petrobras was so backward, it had earned the nickname "Petrosaurus." Workers were 25% less productive than the industry average, and Brazil depended on imports for nearly half of its oil. Yet during the past decade, the company has doubled oil production to boost its reserves by about 50%. The tripling of spending on research and development during the past five years has paid off with the recent discovery of the Papa-Terra field that was found in the Campos Basin, which contains at least 700 million barrels of crude about 10% of Brazil's current reserves and the biggest global oil find during this decade.

Booming Brazil: The Future is Bright

Skeptics such as Harvard economist Ricardo Hausmann point out that rising foreign reserves and fast economic growth have more to do with an unusually robust commodities boom than market-friendly, economic reforms. He attributes 80% of the improvement to good international commodity prices and high global growth. Brazil still needs to solidify the base for a sustainable economic growth. Taxes still are too high. Public spending needs to be redirected to infrastructure projects. Corruption, regulation and bureaucratic red tape need to be cut. Brazil also needs to increase its education standards to compete head on with BRIC rivals India and China. Yet Brazil has found an unlikely fan in Yale University Professor Robert Shiller, who recently scrutinized the Brazilian market. He concluded that unlike in many other markets, Brazilian stock prices have tracked record earnings. That makes Brazil his top pick in the world. Brazilians themselves gush about their success. "Never in the economic history of Brazil have we had the solid fundamentals we have now," boasted President Lula da Silva in a recent interview. Comparing Brazil's economy with the one when Lula took over in 2002 "is like looking at two different economies," says Vinod Thomas, former head of the World Bank in Brazil. With the Brazilian stock market up 11x in the past five years, it's not a success investors can afford to ignore.

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Investing in Russia: The Russian Bear Flashes Its Claws

Scan the international headlines over the past several months and it's hard to avoid noticing that Russia is sharply stepping up its anti-Western rhetoric. Investors in Russia's stock market are taking notice. The main indicator of the Russian stock market has set a new record. As of the close on November 6, 2007, the RTS Index made up 2268.92 points. The last RTS Index record was on Oct. 29, when it reached 2226.02 points. The highest point intraday on Oct. 29 was 2232.58. Futures contract on RTS Index with settlement in December of 2007 closed on Nov. 7 at 2290.00, which is higher than the RTS Index on the same day by 21.08 points. These numbers reflect the optimism Russian stock market investors feel about the current stock market situation. Experts expect the RTS Index to reach 2290 points in mid-December 2007.

Investing in Russia: The Court of Tsar Putin

Empowered by a rebounding economy and rising nationalist feeling, Vladimir Putin's chutzpah has reached unprecedented levels. Over a long-winded dinner at a fancy Moscow restaurant this past spring, he asserted that U.S. plans to deploy a missiledefense system in Europe will force Russia into a new arms race. In words eerily reminiscent of the cold war, Putin threatened that if the United States goes ahead with its missile-shield plan in Europe: "We will have to get new targets in Europe... Which weapons will be used... ballistic missiles, cruise missile or some completely new systems thats a technical matter." In response to a question about whether he was a "dyed-in-the-wool democrat," as former German chancellor Gerhardt Schroeder once called him Putin responded without apparent irony: "I am an absolutely pure democrat. The real tragedy is that I am the only one. Elsewhere in the world, there just aren't any others...," he added sarcastically, as he cataloged human-rights issues in the United States and Germany. "Since Mahatma Gandhi died, there's just nobody left to talk to," joked the former KGB agent. Although the Bush administration seems to be in denial, Russia has clearly started to play by its own rules. State-controlled Gazprom's veiled threats to cut off Europe's gas supplies make headlines monthly in the London press. Oil giants BP and Shell are under constant threat of having their licenses revoked. And what happened when tiny Estonia refused to pay obeisance to the Russian bear? It suffered a massive cyber attack from Russian computers. European Union and NATO membership offer no protection in the Internet wars. The poisoning of Alexander Litvinenko in London last fall with Polonium-210 confirmed that cloak and dagger style assassinations are not beyond the Kremlin's tactics. As a former KGB agent in London pointed out to me last month, with a Polonium pill costing $10 million, there is no doubt that Litvinenko's assassination received the Kremlin's tacit approval. 5

Investing in Russia: A Country Rotten to the Core?

The state of affairs in Russia is worse than grim at least that is the picture painted by Russian journalist Roman Shleinov at a lecture I attended in London. Head of the investigative department of Novaya Gazeta, a leading opposition newspaper in Russia, Shleinov noted that corruption in Russia is so rampant that business is impossible without it. When Shleinov's newspaper whose backers include Mikhail Gorbachev publicly exposes cases of corruption, both Russian authorities and the public react with apathy. No public investigations are launched because no ones hands are clean. And if a journalist gets too intrusive, they are murdered like Shleinov's colleague, Anna Politkovskaya. Here was the most shocking statistic of the night: Shleinov claims more than 2,000 journalists have been killed in Russia during the past decade under suspicious circumstances. That's more than the number of troops killed in the first two years of the Iraq war. And unlike a cowboy Western, there are no guys with white hats. Exiled oligarchs such as Boris Berezovsky or jailed CEOs like Mikhail Khodorkovsky are completely indistinguishable from those sitting in the Kremlin, according to Shleinov. Nor can the Western cavalry come to the rescue. The only thing the Russians regard with more suspicion than their own corrupt officials is offers of Western help unanimously viewed as covers for Western plots to overthrow Russia. Chekhov and Dostoevsky offer a better insight into the Russian mindset than the latest Kremlin rhetoric.

Investing in Russia: Whither the Market?

Corruption notwithstanding, Russia's stock market has ranked at the very top of performance tables for much of the past six years. But 2007 was different. While global markets have been roaring ahead, Russia was the worst-performing major market in the world. This can only be chalked up in part to the negative press surrounding Russia. Russian companies also have been unloading stock on the market as never before. About $24.8 billion of shares have been sold in 2007 as of early June and up to $12.8 billion still is in the pipeline. The total figure last year was $21.8 billion, which itself was more than the total issued in the prior eight years. Valuations also have been aggressive, and shares have performed poorly in the after market. That situation has left a bad taste in investors' mouths. The oil sector which makes up about 60% of the index has been weak as oil output has been stagnating. Oil giants such as Lukoil and Rosneft are spending money handover-foot trying to find oil in ever farther-flung areas of the country. Even gas monopoly OAO Gazprom is threatened by rising costs in future developments. Once a one-way bet, Gazprom's stock price is down 27% from its peak. Overall, it's hard to avoid the feeling that the Russian market has its best days behind it. Russia's biggest investor Bill Browder of Hermitage Capital Management is diversifying out of Russia. This is just as U.S. retail investors now have the opportunity 6

to get in through a new Russian ETF (RSX) launched in May 2007. The smart money is exiting, just as the retail money is entering. That is perhaps the best indication that it's near game over for those hoping to make a mint in the Russian stock market.

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India Turns 60
India's stock market also has been on fire, with the Sensex up 103% since the beginning of last year. And even after the recent correction, local investors have almost doubled their money in past months. Foreign investors have done even better, their returns boosted by an appreciating rupee. When India won its independence 60 years ago, expectations about its future were abysmally low. Winston Churchill famously described India as a mere "geographical expression" a land that was "no more a united nation than the Equator" with more than 35 languages and each language spoken by one million people. Although the country belied predictions of disintegration, India was an economic tortoise for much of its history. Growing at just 3% a year until the 1980s the famous "Hindu rate of growth" the notion that India could ever rise to the level of an economic superpower seemed a distant prospect. The turning point came in 1991 when then-Finance Minister (and current Prime Minister) Manmohan Singh introduced wide-ranging economic reforms that began to unleash India's enormous potential. By all outward indications, the reforms have been a spectacular success. India's GDP growth in 2006 touched 9.4% to make the country the second-fastest growing economy in Asia. India today ranks as the world's fourth-largest economy (in purchasing power parity terms) and has created more billionaires than any other country in Asia. India's stock market also has been on fire, with the benchmark BSE Sensex index peaking at 15,776 for the first time in July 2007. And even after the recent correction, local investors have almost doubled their money in the past 12 months. Foreign investors have done even better, their returns boosted by an appreciating rupee. Viewed in this context, the recent stock market wobbles are a mere ripple in an apparent inexorable path upward. Indeed, India is booming. More than 6.8 million mobile phone subscribers are added each month to make India the fastest-growing cell phone market in the world. By 2025, India's middle class will jump more than tenfold to almost 583 million people. And thanks to the legacy of the English language left by the British, Indians now can cross the globe and integrate with ease into the world of global commerce to give the country's elite a tremendous advantage over other Asian rivals such as China.

The "New India" in Perspective

Positive press notwithstanding, it's important to keep perspective on India. In real terms, 7

India's economy today still is an economic minnow less than half of the size of California. Only one in 50 households has a credit card. Only one family in six has a refrigerator. What about India's much vaunted "middle class" of 300 million? A narrower definition families making more than $4,400 per year puts that figure at just 58 million. And before it takes on the mantle of global economic champion, India must overcome many challenges. India is still a very poor country, where 260 million people that's close to the entire U.S. population each live on less than $1 a day. The child malnutrition rate is higher than sub-Saharan Africa. Half of Mumbai's population of 14 million live in slums and lack sanitary drinking water facilities. And India's socialist past still weighs heavily on its economy. India today accounts for a smaller share of global merchandise exports than it did in 1947. India's Achilles heel in terms of economic development is its poor infrastructure. There are pockets of excellence in India, such as the gleaming Silicon Valley-style campuses built by big software-development firms in Bangalore. But India's rival to Silicon Valley suffers from traffic jams, overflowing hotels, power interruptions and an inadequate airport. A 1,340-mile trip between major urban centers such as Kolkata (Calcutta) and Mumbai (Bombay) takes eight days with an average speed of 7 mph and 32 hours of waiting at toll booths. And Indian red tape and bureaucracy is legendary. A new shop must get, on average, 15 licenses from 11 government bodies, and securing them takes six months. The International Finance Corporation (IFC) lists India 116th out of 155 countries in terms of ease of doing business. That's 25 places below China and two behind war-torn Iraq. And although India has become the Saudi Arabia of outsourcing, growth is showing signs of ebbing as labor shortages and sky-high salaries are starting to bite. It now is cheaper to hire expatriate managers in India than a domestic counterpart. The country is facing a shortfall of about 500,000 skilled knowledge workers by 2010 unless drastic action is taken.

A Global Bull Market Champion Between Now and 2020?

Yet there are plenty of reasons to think that India will continue to generate big profits for investors over the next few decades. First, the Indian government remains firmly committed to the 15-year-old process of economic reforms. India's Planning Commission expects the economy to grow by 9% during the 11th five-year plan period (2008-2012). With its high savings rate and young population, that number seems as attainable as ever. Second, Indian elites have a strong work ethic and emphasis on U.S.-style education. Fathers might have gone to Oxford or Cambridge. But their sons now have Harvard, Stanford and Wharton in their sights. Combine this motivation with common law-based legal traditions and institutions, and you have factors that oil the wheels of commerce in ways that don't show up in economics textbooks. 8

Third, the spate of cross-border takeovers involving Indian companies confirms that Indian companies now are players on the global stage. Tata Steel's $11 billion acquisition of Corus, the Anglo-Dutch steel group, and Vodafone's $11 billion purchase of a controlling interest in Hutchison Essar, the fourth-largest Indian mobile operator, have been among the biggest M&A deals of the past year. Indian expatriate Lakshmi Mittal has cobbled together the world's largest steel company, Mittal Steel, to personally join the ranks of the world's top five wealthiest men in the process. India has much left to do to fill current high expectations. Even if income and spending levels triple by 2025, India barely will have caught up with present day Egypt. But India's openness to technology, favorable demography, tradition of democracy, and high caliber top leadership may yet allow it to displace China as the #1 economic growth story of the 21st century.

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China's Stock Mania Revisited: The Anatomy of a Financial Mania

The current stock market mania in China's mainland has as much in common with the Tulip mania of the 17th century, as it does with the Internet boom of the late 1990s. In particular, the run-up of the Shanghai index is remarkably similar to the recent meteoric rise and collapse of the Arab markets. Both took root in a country that had little or no experience with a stock market. And, a "this time it's different" atmosphere pervaded, a set of new fangled heroes drew in millions of unsuspecting small investors, and those who came late to the party ended up suffering devastating losses after the inevitable crash. Like the Arab markets, the Shanghai market is closed to foreign investors. But as the 9% drop in the Shanghai index on Feb. 27 shows, unlike the collapse in the Middle East, the impact of the Shanghai swoon can be felt all the way to Wall Street and even the biggest China Bulls around admit that China is in a bubble. Anecdotal accounts of China's current mania are distressingly familiar. Investors are queuing to open accounts at local securities houses, as applications are five times as high as a year ago. Students and pensioners crowd around computer terminals watching ticker signs go by. A self-appointed "stock god" like Lin Yuan lectures hundreds at Peking University to reveal his secrets on how he has made some 400 million yuan ($52 million) in the market. One out of three university students in China is playing the markets. New technology Internet and mobile telephony has only exacerbated the mania. Broadband penetration means that housewives, pensioners and students all are on the same playing field. Many employees spend their workday trading through e-mails and instant messaging. Companies have introduced fines to deter employees from spending their time trading stocks online. It has all been in vain. Mobile-telephone users trade shares simply by pressing buttons on their handsets.

There are now more than 91 million accounts held by individuals at brokerages or in mutual funds. About 10% of these accounts were opened in just the first three months of 2007 and 10 times as many accounts were opened in first quarter 2006 as for all of 2005. Online trading is spreading rapidly, and more recently individuals have been opening stock-trading accounts at the rate of about 90,000 per day 35 times the pace of a year earlier. Since China doesn't permit brokers to offer margin trading, China's stock market newbies have started pawning personal assets to invest in shares. Some are pledging their homes as collateral for personal loans. Beijing residents in 2006 pawned houses valued at 1.5 billion yuan ($195 million), much of it in order to buy shares. Pawnshops in Shanghai confirmed that their business was now dominated by loans against apartments to fund stock buys. Like the merchants who sold picks and shovels to prospectors in the California Gold Rush, it sure is good business. The pawnshops charge a monthly interest rate of 2.5-3% for loans backed by apartments. One pawnshop even has taken out advertising space on taxi windows.

China's Stock Mania: What Is to Be Done?

Few of today's speculators recall that this is China's second stock market mania. In the first three years after stock trading began in China during 1990, the Shanghai index jumped six-fold. Trading got so heated that riots broke out among people hoping to get in on initial public offerings. The stock market became a playground for manipulation and scandal throughout the 1990s. The market drifted into virtual irrelevance, before it came back to life at the end of 2005. Today, the Shanghai market may have already peaked. The bottom has already dropped out of the markets twice in 2007 on Feb. 27 and April 19 on the back of rumors of a government crackdown. China's leaders are worried, but essentially helpless. Local players have ignored interest-rate rises and increases in banks' reserve requirements. And there's little the government can do to control the Chinese obsession with gambling. It's no surprise that the same year that Shanghai more than doubled, the casinos in Macao recorded higher revenues than the Las Vegas Strip. Here's my prediction. The China stock mania will end in tears as has every other stock market mania in history. Indeed, place the long-term charts of the Shanghai index alongside the NASDAQ, and the patterns are eerily similar. The Chinese authorities will try to intervene unsuccessfully. And when the bubble pops, the negative effects will be profound. Students and pensioners stayed on the sidelines last time around. This time, they will be the most affected. If tens of millions of urban Chinese lose their shirts, they'll be looking to the government to bail them out or else, they will turn very angry. Not even Chinese mandarins have power over the laws of financial speculation.

Cracks in the Great Wall of China

China's economic growth surged to an 11-year high of 11.9% in the second quarter. Asia's new economic giant is on course to chalk up its fifth-straight year of double-digit percentage growth. And after leapfrogging the United Kingdom in 2005 to become the 10

world's fourth-largest economy, China is set to overtake Germany for the #3 spot by 2007. Eye-popping economic growth rates notwithstanding, China's reputation for economic invincibility has taken a serious knock recently. The media barely noticed when Chinesemade drugs contaminated with diethylene glycol led to the deaths of dozens of people in Panama in 2006. Only when pet food containing the wheat gluten tainted with the chemical melamine was blamed for the deaths of dogs and cats in North America did the mainstream public sit up and take notice. Suddenly tales of toxic fish, defective folding chairs, juice containing unsafe additives and popular toy trains decorated with lead paint inundated the media. My favorite? Chinese candy tainted with formaldehyde, an embalming fluid. But even I was surprised when a recent Business Week cover story, "Broken China," declared that "China's $1.2 trillion in foreign reserves the most ever amassed by any country and soaring trade surplus may seem like signs of strength, but they're actually evidence of an over-reliance on exports, weak domestic consumption, and a primitive financial system. That's a startling about face for a publication that only six months ago was going gaga over China's newfound superpower status.

Cracks in the Great Wall of China: Honeymoon Over?

Even once furor fades over defective Chinese exports, it's unlikely that China will ever regain the uncritical acclaim it enjoyed over the past two years. The world is coming to realize that the very same policies that generate eye-popping GDP figures threaten China's future prospects of developing into a modern economy. Developmental economists have known this for a long time. "Extensive development" putting up a factory on land and producing bad quality shoes is easy. "Intensive development" manufacturing quality products, distributing, marketing and branding them is hard. And there's just something about the Chinese export scandal that made Americans feel a bit queasy. Yes, in the 1960s and 1970s, "Made in Japan" and "Made in Korea" were synonymous with shoddiness. Yet when Japan made shoddy goods, it was because it was on a learning curve. But the fact that mainland Chinese deliberately substitute cheaper toxic materials in medicines to save money crossed the line. There are other reasons why the bloom is fading off the Chinese rose. China's $1.2 trillion in reserves is matched by the amount of bad debt in its banking system. That's close to 50% of its GDP making the U.S. savings and loan (S&L) crisis or current subprime lending woes look like a rounding error. China is also becoming a country of exaggerated expectations. In spring of 2005, Starbucks CEO Howard Shultz noted on CNBC that in three years (2008) the company would probably have more cafes in China than in the United States. Today, the number of the company's U.S. cafes still exceeds those in China by 10 to one. China spends more than Japan on R&D, but its highest profile "invention" ever was a knock off of a Motorola chip. As Zhu Jian-Gang, director of Carnegie Mellon University's electrical 11

engineering department, pointed out to Business Week: "China is spinning its wheels... They do a lot of research, but it isn't important"

Cracks in the Great Wall of China: A More Balanced View

Communist political systems and economies tend to consistently overestimate their economic achievements and underestimate the costs that the culture of corruption has on future development. That's how the Soviet Union's rump economy (Russia) went from a global superpower to one whose economy shrunk to the size of Florida. Even after six years of torrid growth, Russia today only has returned (in real terms) to the economic level of Texas. James Kynge a Financial Times reporter who first went to China in 1982 authored "When China Shakes the World," the FT/Goldman Sachs book of the year in 2006 that offered a balanced (and sobering) view of China. Oddly, no one writing cover stories for business publications seems to have read this book. James Mann, author of "The China Fantasy: How Our Leaders Explain Away Chinese Repression," writes about the reasons for this: "The biggest problem is that the media coverage of China tends merely to reinforce whatever is the reigning stereotype or image, or "frame," of China in any particular decade or era. In the 1950s, the coverage in the United States was of Chinese as disciplined automatons. In the 1980s, it was "China goes capitalist." In the early 1990s, it was "crackdown in China." Now, it's "China rising" (and "China gets rich"). Once an impression gels, then the extended press coverage by which I mean, TV specials, news magazine covers, newspaper features all either repeat the impression or at least play off it in some way or another."

Cracks in the Great Wall of China: How to Mend Them

Defenders of China point out that the country cannot be held to Western standards. Tell that to the families of the Panamanians who died of contaminated Chinese-manufactured medicine. Operating in a corrupt, economic system still dominated by state-owned enterprises, Chinese companies just may be uniquely bad. Contrast them with Indian firms, which are genuine private-sector enterprises and compete on the global playing field. Except when they are assembling goods for Western manufacturers, most Chinese companies sell only in the domestic market and none compete on the highest global level. The elephant in the room is political change. Its nave to assume that China will build the financial, legal, and administrative systems required to become a modern industrial society without the death of the Communist party. Yes, party apparatchiks have the power to revoke the licenses of food and drug firms and shut down factories. But that's hardly enough for China to become an economic superpower with its own Coca Colas, Nikes or Apples. For that to happen, the Chinese Wall must do more than crack. It must crumble.

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Conclusion
Although motivated by an effort to unglue the credit market, the Fed's easing has given a huge boost to global equities especially in markets like Hong Kong where the local currency is effectively pegged to the U.S. dollar. The equation is simple: The more the dollar drops, the more global equities rally. Not surprisingly, many Asian currencies are hitting record highs against the U.S. dollar. The Australian dollar has rocketed to 18-year highs, while the Singapore dollar has touched 10-year highs. The Brazilian real, which has soared 18% in 2007, and the Indian rupee's sharp appreciation against the U.S. dollar during the past year, have turbocharged U.S. dollar investors' returns in those markets. And while the BRICs and emerging markets aren't the bargains they once were, they still are below historic highs in the 1990s and, aside from China, are nowhere near bubble levels. Indeed, emerging market companies have been buying back their own shares on every market dip. So have you, the U.S. investor. According to Emerging Portfolio Fund Research, of the $19 billion total net inflows to emerging markets so far in 2007 through mid-September, $14 billion occurred in the final five weeks. You also poured money into global funds with net inflows of $96.94 billion into world equity funds so far in 2007, while you took $9.6 billion out of U.S. equity funds. Brazil's local stock exchange, the Bovespa, reported that investors have injected $1.2 billion into the market in September alone. Sincerely,

Nicholas A. Vardy Editor, The Global Guru, Global Stock Investor, and Global Bull Market Alert P.S. My subscribers at Global Stock Investor know the benefits of diversifying into global stocks, particularly the BRIC countries. My subscribers are racking up big gains that other investors can only dream about in everything from Brazilian discount airlines, Russian oil, Indian outsourcing and Chinese companies. Join them today to turbo-charge your own profits.

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