A Tale of Three Cities

Robert Hsu, December 01, 2007

Even though we're investors in China and the amazing growth happening there now, we also need to be alert to current global influences and past history lessons that could inform our investment strategy. Here's an example of what I mean:

Over the past month, I have visited three of the world's great cities -- Rome, London and Shanghai. Rome was the greatest city in the world 2,000 years ago. And London was undoubtedly the "capital of the world" 150 years ago, when the British Empire dominated the world. Shanghai, on the other hand, is rapidly blossoming into one of the great international cities of the 21st century. Each of these cities and their histories offer a case study of the effects that inflation, taxes, demographics and global trade have on a country.

Although Rome still looks magnificent, the so-called "Eternal City" has been in relative decline for the past 500 years. The Italian government runs a highly inefficient social welfare state with endless bureaucratic red tape and high taxes. Italians have gotten around the red tape and expensive taxes by developing a large underground cash economy. It's estimated that nearly 30% of Italy's economic activities are not reported to the government.

In Rome today, the cost of living is high and many middle-class families choose not to have children. Italy, along with Japan, has the lowest birth rate among developed countries in the world. With more people retiring than entering the workforce, the country's aging demographic creates a drag on its economic growth. The combination of high inflation and unemployment make life difficult for many average Romans. Despite their economic difficulties, Italians still have a sense of entitlement that erodes their global competitiveness. By contrast, because the Chinese have endured severe hardship over the last century, they take nothing for granted.

As is typical of many Italian cities, Rome has plenty of high-end designer boutiques and low-price mass-market clothing stores, but few mid-priced shops. Many Italian-made luxury goods are too costly for the masses, and, as a result, shoppers are buying cheap imports from China. The market share of Chinese-made goods has increased dramatically in Italy, and nowadays more Chinese-made shoes are sold in Italy than Italian-made shoes!

Italians are adept at designing great-looking luxury products in everything from clothing to cars. Italian fashion companies with strong brand names like Armani, Prada, Gucci and Ferragamo, have benefited from the economic emergence of Asia. At the Gucci boutique in Rome, there were more Asian customers than Italian customers. Many Asians love Italian luxury goods, and they are increasingly able to afford them thanks to the China Miracle.

It's an irony that more average Italians are now buying Chinese-made goods and more Chinese are buying Italian-made designer goods. But that's what globalization is all about, and China is certainly capitalizing on this opportunity.

Rome, however, is unable to capitalize on this global boom in luxury goods as well as its northern neighbor, the Italian fashion capital of Milan. Aside from tourism, Rome doesn't have any major industries that are competitive globally. The Italian capital is simply no longer the international center of culture and commerce that it once was.

The Italian government is also unfriendly to wealthy foreign investors. My friend Bernie, a successful hedge fund manager and former Goldman Sachs colleague, used to spend several months each year in Rome. Bernie makes millions each year, and he bought a condominium in Rome for personal use. However, because of his constant battles with the Italian tax authorities, he told me that he won't go back to Italy again. This is one mistake that China won't make because its government recognizes the importance of global trade.

In contrast to Rome, London is attracting global multimillionaires like Bernie and is quickly reemerging as one of the greatest cities in the world. One of my favorite cities, London is also the major financial center of Europe. It has a tax system that attracts wealthy expatriates from around the world. In an era when more than $2 trillion in investments move around the world each day, London is a favorite destination for global investors and their money. Arab sheiks, Russian oligarchs, Hong Kong property tycoons, Indian entrepreneurs, American hedge fund managers and other groups of the new international super-rich all have a strong presence in London.

Unlike the United States, the UK taxes residents only on the income they earn within the country. If a London resident makes his or her money from outside of the UK, the person doesn't have to pay income tax to the British government. In addition to a favorable tax system, London offers great shopping, fabulous nightlife, sophisticated cultural venues, good restaurants, offshore financial services and many of the other perks that global multimillionaires and billionaires enjoy.

As a global financial center, London surpasses New York in its ability to attract international money. London is number-one in offshore hedge funds, foreign exchange trading, international stock listings and global private banking. All major global investment banks and commercial banks have strong operations in London.

In addition to the ability to attract wealthy foreigners, the availability of talented financial professionals, strong legal and accounting systems and attractive infrastructure all play a role in London's strong position in international finance.

London also has a number of prestigious graduate programs in business that produce skilled financial professionals in only one year -- as opposed to the two-year MBA programs common in the U.S. Many young professionals today don't want to put their careers on hold for two years to attend more school.

As a result, top Chinese students are increasingly choosing European graduate business schools over U.S. programs. At both New Oriental Education and E-House, the chief investor relation officers received their graduate business degrees from the UK instead of the U.S.

Despite the July 2005 terrorist attacks in London, the city continues to maintain a friendly attitude towards foreign visitors. European investors are also interested in investing in China, and London is the center of investment activities in Europe. I gave a presentation to our European subscribers in London a few weeks ago, and the event filled the house to the brim. I found that our London-based subscribers are highly sophisticated when it comes to global investing, and I truly enjoyed talking with them about the current global market.

By focusing on economic growth and welcoming foreign money, London is making the right moves in this era of globalization. As a result, the city is now more prosperous than ever. In contrast, Rome scares away international investors with high taxes, and the city now has only faint traces of its former glory.

I have no doubt that China is watching these cities and others as it decides what kind of country, financial power and example it wants to become.

China is on the Right Path

Rome and London have much to teach us about what makes a successful financial capital. As a global investor, I like to invest in countries that have the following traits: 1) a strengthening currency, 2) a pro-growth government, and 3) a foreign investor-friendly environment. China and many other Asian countries have all three traits going for them.

That's why we will continue to invest in China, and why we will continue to focus on governments that are more interested in creating wealth than redistributing it.

During the last century, the Chinese have learned the hard way that forced redistribution of wealth will usually only make everyone equally poor. They've had enough of this way of life, and now they're ready to prosper under the new era of non- Communist rule.

To learn more about China's tremendous growth and investment opportunities, visit my China Strategy website and register today!