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China's looming Olympics disaster
Jubak's Journal3/18/2008 12:01 AM ET


The Beijing games are supposed to showcase China's stature on the world stage. But they're producing protests at home and may shut down big hunks of the nation's economy.

By Jim Jubak
On March 10, Haile Gebrselassie, the world record holder in the marathon, pulled out of August's Beijing Olympics. The city's notoriously bad air pollution posed a threat to his health over the 26.2-mile course, the Ethiopian runner said.

It says a lot about the disaster that's unfolding for the Beijing games that the withdrawal of an Olympic favorite caused hardly a ripple. And why should it when bigger stories are brewing? It's possible that:

A forced shutdown of Beijing's factories and power plants during the games will throw China into an economic downturn.

Diversion of safe food to the Olympic Village will cause food riots elsewhere in China.

The transfer of 80 billion gallons of water -- equal to the annual water consumption of Tucson, Ariz., a city of 535,000 -- from Shaanxi and other provinces in northwestern China will shut down factories and agriculture in the region.

Yes, the Beijing Olympics, which were supposed to showcase China to the world, are still likely to provide exactly the kind of prestige-building extravaganza that the country's leaders had hoped for. But domestically, the games are quickly turning into an economic and political disaster. Once upon a time -- maybe six months ago -- investors (including yours truly) looked on the Olympics as a guarantee that China's stock market and economy would keep chugging along through the summer. "Safe until August" was the mantra.

Now, it increasingly looks like the games themselves could be the catalyst for a significant downturn in China's stock market and economy.

Steps haven't been enough
Observers already knew that China was serious about cutting air pollution in Beijing and that, if necessary, the government would shut down factories and power plants. Pollution had been one of the reasons China lost its 1993 bid to host the 2000 Olympics, and this time around, the country promised the International Olympic Committee that it would clean up Beijing's act before the games.

Officials converted coal-fired furnaces to natural gas. Factories have been relocated to the suburbs. Millions of trees have been planted to break the winds that blow dust in from the plains north and west of the city. Older taxis have been replaced with 80,000 newer models that produce less pollution. Heavy trucks are permitted to enter the city only at night. The city expanded its subway system and built a rail line to connect the airport to downtown.

And it still hasn't been enough. Thanks to China's rapid economic growth and Beijing's own stunning growth -- the local economy is up 144% since 2000 -- car ownership has soared. The city has 3 million vehicles and is adding 400,000 cars and trucks a year. Power plants burn cleaner, low-sulfur coal, but they burn a lot more of it: 30 million tons in 2007. A building boom has added 1.7 billion square feet of construction since 2002, contributing to the city's problem with dust. Daily concentrations of particulates in Beijing equal those in New York, Los Angeles, Washington, Chicago and Atlanta combined.

Desperate for solutions
The only way for the government to deliver anything close to the air-pollution targets it has promised is to enforce a Draconian short-term fix: Shut down the sources of pollution for the duration of the games. Some coal-fired power plants, cement factories, steel-making plants and chemical plants in Beijing, Tianjin and four neighboring provinces will be shut for 30 days before the Olympics begin Aug. 8. Ten major polluters have already been shut, according to the State Environmental Protection Administration.

Some factories that remain open will not operate at full capacity. For example, Shougang, this year China's second-largest producer of construction-grade steel, will cut production in half, to 4 million metric tons.

Video on MSN Money
Oil shows inflation fears

The headlines screamed when short-term oil futures hit $110 a barrel. But the price of oil for future delivery -- as far out as 2016 -- has topped $100 as well. That's a clear sign, MSN Money's Jim Jubak says, that the oil market expects inflation to be an issue for a long time.

Water pollution is, in some ways, easier to fix. Just pump in enough clean water from surrounding areas to meet the needs of the 16,000 athletes and officials who will arrive in Beijing for the games (and to make the city look lush and green for an international TV audience).

One tiny problem: The city and surrounding region aren't exactly swimming in water. Beijing sits at the edge of the water-poor northern China plain, more than 90 miles from the sea and distant from any of China's major rivers. To make up for the deficit in surface water, Beijing has relied on wells, but the city has pumped water out faster than it is replaced from natural sources. The groundwater level under the city has fallen 75 feet in the past 50 years.

Farms without water
To get water for Beijing, surrounding provinces have been ordered to ship the cleanest water to the capital. In some farm areas, that means no water from local reservoirs and limited irrigation supply from local wells. Farmers in some areas have been ordered to grow only corn, which takes less water but fetches a lower market price than rice or vegetables. Compensation to poor farmers required to ship water to the richer city: about $30. And even that isn't paid to everyone.

No wonder local officials have been screaming. An Qiyuan, a member of the Chinese People's Political Consultative Committee for Shaanxi and former Communist party chief for Shaanxi, went public in the foreign press with a demand for compensation. "We still need to live," he told the Financial Times, "so I say the government needs to compensate Shaanxi. If you don't compensate the masses, then how can they survive?"

Continued: Ham-handed public policy

The theme of starving the poorer countryside for the benefit of the wealthy cities hits an especially sensitive nerve. The fruits of China's boom have gone disproportionately to city dwellers and the country's coastal regions.

In 2006, Chinese government figures put annual per capita household income at $1,475 for urban households and just $450 per capita for rural households. That inequality has become painfully obvious because inflation, which hit a 12-year peak in February, has come crashing down hardest on China's poorest. Although overall inflation is running at just 8.7% annually, food costs soared 23.3%, according to the National Statistics Bureau. The price of pork, a staple source of protein, has climbed 63% since February 2007. The price of cooking oil has risen 41%.

Ham-handed publicity
It doesn't help stem public outrage that the government just doesn't seem to get it. In October, as pork prices were starting to soar out of control and stories about tainted food supplies were causing increasing worry, the government staged an elaborate public-relations event to showcase the special pigs that Qianxihe Food Group (branded as Lucky Crane in English) would supply for the Olympics. At 10 special farms, carefully chosen pigs were being raised with only the purest food, air and water. The pork, according to the China Meat Research Center, will cost at least twice as much as pork now on the market in China.

Think about how that goes over in a country that has recently witnessed deaths as crowds rushed to buy cheap cooking oil. This pork will be absolutely safe to eat, but most Chinese won't be able to afford it.

All this might not matter to overseas investors if the Chinese stock market wasn't looking so wobbly right now. Hong Kong's Hang Seng Index ($HSIX) is down 17.6% from the start of 2008. The more volatile mainland Shanghai market is down 25% since the start of the year. Recent initial public offerings haven't performed as expected: The March 10 IPO for China Railway Construction climbed 28% in its first day of trading in Shanghai. That's shabby compared with the 163% first-day gain for PetroChina (PTR, news, msgs) on Oct. 29.

What might be wrong with China's stock markets is, in part, a reflection of rising anger at the national government in the run-up to the Beijing Olympics.

Growing distrust of government
The government owns huge numbers of shares in what are nominally private companies. Roughly 88% of the shares of PetroChina, for example, are in government hands.

Through reforms introduced a few years back, millions of shares that were legally locked up can now be sold by the government and its various agencies. The faith among investors was that Beijing wouldn't do anything to tank individual stocks or the market in general by selling too many of these shares. The government would keep the float for these stocks tiny and thus ensure constantly rising share prices.

Video on MSN Money
Oil shows inflation fears

The headlines screamed when short-term oil futures hit $110 a barrel. But the price of oil for future delivery -- as far out as 2016 -- has topped $100 as well. That's a clear sign, MSN Money's Jim Jubak says, that the oil market expects inflation to be an issue for a long time.

The government, as far as I can tell from the figures I've been able to find, doesn't seem to have broken faith with China's investors on this issue. I don't see any evidence of big sales of shares by government entities. But what we're seeing in China right now is a rising sense among investors that they really can't trust the government to do the right thing by them and a worry that the government may, whatever its intentions, not be the infallible manager of all things economic and financial that investors had been counting on.

A long, crucial to-do list
That's a fear that overseas investors should think about, too: China's government is about to try to slow runaway inflation while readjusting the value of the country's currency, keeping the economy growing at better than 8% a year, reducing income inequality and rebuilding some parts of the medical and educational infrastructure. Asking any government to handle all that without a slip is asking a lot.

It's a fear that the government isn't going to be up to it, rather than any evidence of a meaningful slowdown in economic growth, that is fueling the malaise in China's stock markets right now.

And the danger is that the Beijing Olympics will feed into that growing fear. Worried investors, of course, sell. And worried investors who have lost faith sell the hardest.

Continued: Updates and developments


Update to Jubak's Picks
Sell Jacobs Engineering (JEC, news, msgs): The financial markets and the economy continue to deteriorate, and shares of Jacobs have dropped below technical supports. I'm simply not willing to hold them with their downward momentum in the current market, so I'm selling them out of Jubak's Picks with today's column. I think I'll have a chance to repurchase these shares at a lower price later in the year.

A relatively minor part of the company's business has big exposure to a slowing U.S. economy. Government spending on such projects as water and wastewater systems will slow because of budget gaps created by falling tax revenues. This segment accounts for just 8% of Jacobs' revenue, but with the company facing tough year-to-year growth comparisons, I think a shortfall in this segment will be enough to send the stock's price down from even current levels.

As of March 18, I'm selling these shares with a 22% loss since I added them to Jubak's Picks on Oct. 30. This sell moves my cash position in Jubak's Picks to 47% of the portfolio. (Full disclosure: I will sell Jacobs out of my personal portfolio three days after this column is posted.)

Development on a past column
"A painful fix for the credit crisis": I've said some pretty negative things about the Federal Reserve on the run-up to and during the current financial market crisis, so I think it's only fair to say that when it brokered the Bear Stearns (BSC, news, msgs) deal with JPMorgan Chase (JPM, news, msgs), the central bank got the major part of it right.

The buyout will just about wipe out Bear shareholders -- JPMorgan plans to pay just $2 a share for a stock that was trading at $88 at the end of 2007 -- including executives and partners at Bear Stearns. I think that sends the right message: If you take on risk, you should reap the reward and the losses.

And, according to the data, Bear Stearns was laying on risk with a shovel. As of February, 15% of the Alt-A mortgage-backed securities the company had underwritten were delinquent by at least 60 days or in foreclosure. The industry average was just 8.4%. (Alt-A mortgages are those considered a grade less risky than the subprime mortgages that started the current crisis.)

If you make an investing mistake, you take the loss. It's the market's way of keeping players focused on risk and reward. (The Fed is also extending a $30 billion line of credit to JPMorgan in the deal. That's ultimately taxpayer money at risk, but at least the Fed has taken control of the Bear Stearns assets that collateralize this loan.)


MSN Money's Jim Jubak will be among more than 100 investment experts on hand for The Money Show in Las Vegas from May 12 to 15. You can hear from the experts in more than 250 free workshops while sharing tips and tricks with other active investors. Admission is free for MSN Money readers. To sign up, call 1-800-970-4355 and mention priority code No. 009554, or register online.

Editor's note: Jim Jubak, the Web's most-read investing writer, posts a new Jubak's Journal every Tuesday and Friday. Please note that recommendations in Jubak's Picks are for a 12- to 18-month time horizon. For suggestions to help navigate the treacherous interest-rate environment, see Jubak's portfolio of Dividend Stocks for Income Investors. For picks with a truly long-term perspective, see Jubak's 50 Best Stocks in the World or Future Fantastic 50 Portfolio. E-mail Jubak at [e-mail] the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Jacobs Engineering. He did not own short positions in any stock mentioned.
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