Crane hunting is the craze for foreign investors traveling in China.
Seemingly every morning an American wakes up bright and early in his five star hotel built in the coastal cities expressly for the purpose of pampering foreign investors with expense accounts. He fortifies himself for his expedition with bacon and eggs, eschewing the congee favored by the locals. “Nothing like a good old American breakfast to prepare one for a hunting trip,” he may say to himself. With that, he drains the last of his coffee and heads for the revolving hotel-top restaurant on the 30th floor.
There, ensconced in a comfortable chair with a Coca Cola and a good window view, he gazes out at his quarry – cranes. Beautiful long-necked creatures, perched, some sleeping, some now stirring to life as the sun rises, waking them. The American starts counting as the restaurant revolves, simulating motion while spinning on a fixed point. When the full panorama has been swept, he writes down in his notepad “100 construction cranes spotted from revolving restaurant, Shanghai growing faster than imaginable, note limitless opportunity. Note for future reference: if each Chinese ate just one more egg each morning, demand for grain and poultry would increase by…”
Epistemological errors are common throughout the financial industry. An epistemological error is a flaw in one’s understanding of what is knowledge and what is not, epistemology being the study of human knowledge: what one can know, and how one goes about it. The above story illustrates an error that has popped up a lot in my recent observations, that of making hasty generalizations based on a few concretes.
In observing China, it is particularly necessary to integrate observed facts into their proper abstract context. For example, if one observes that a major skyscraper is being built, one must know whether it is being built because market demand is driving a public company to build, to create value for its shareholders, or whether it is being built because the son of a Chinese official got a loan from a government bank, with authority based on a five year plan to increase international prestige, the son pocketing all the cash flows, whether the building makes economic sense or not.
If one speaks of “over a billion consumers” one must realize that only one billion producers can be considered consumers, since they are able to pay for what they consume, and that over half of China’s population currently live rural, agrarian lives, still substantially under the control of their local communist bosses, and in the non-agricultural sector, state firms continue to dominate and sap the economy. Only dramatic changes in China’s current politico-economic structure will allow this population to become economically useful.
At an investment conference my firm hosted last year one of the guest speakers, representing a well respected economic forecasting firm, gave an excellent presentation on the relationship between economic freedom and market performance. In it, he mentioned that China still ranked low on the list in terms of economic freedom, despite what one often reads and hears about the country in the financial press. Later in the conference, another speaker, a newsletter writer, challenged him, saying that the first speaker had never seen China’s growth in person, and so had no basis for discussing the subject! In fact, this irate speaker had written in his newsletter two years prior an article in which he described himself sitting atop his hotel’s revolving restaurant, counting over 100 cranes.
The irony was that this newsletter writer who so prided himself for his first-hand observations, wrote his article the exact same month that I came back from China with some colleagues, one of whom also published a story of sitting in a revolving restaurant counting over 100 cranes. No matter. The B-share market fell by over 36% the next year anyway.
The moral of which is: True knowledge requires integrating both observable facts and rational theory into a total non-contradictory whole. Or, leave crane counting to the bird watchers, and leave forecasting to those who attempt to rationally integrate knowledge.
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