My Comments: The author of this article has a blog about investments that is both entertaining and informative. As much as anything, he doesn’t take himself too seriously, which is a fault many of us have. It’s long, but a good one…

by Jeffrey Dow Jones

Turns out our newsletter last week on China was rather timely. Shortly after publication, we got the latest data on Chinese industrial production. It missed expectations and fell to the weakest level since May of 2009. Suddenly PIMCO’s below-consensus call for mid-7% growth doesn’t sound so crazy anymore.

China is a rapidly growing economy and it’s going to continue to grow. Later this decade it will be the largest on the planet. There are 1.3 billion people over there! Their economy is changing in a meaningful way. My concern about China is that of an investment and the concern is very specific.

I don’t want to be a long- or medium-term investor over there for three reasons:

1. By definition, its economic model — producing cheap stuff and selling progressively more of it to the world — is not sustainable. The more China grows from this, the more successful their economy, the more expensive it becomes for them to keep using that model. This is the essence of what they’re bumping up against right now and it’s the reason why the latest 5-year plan, the “Twelfth Guideline,” has a very different direction.

2. They seem to have made relatively little progress transitioning the economy to one supported by internal consumption. There isn’t much of a middle class in China, and both direct and tangential exposure to their real estate bubble is going to create some big problems.

3. Its demographics are very troublesome. Their population is peaking. China’s population has doubled in the last 50 years and it should fall around 10% in the next 50. That doesn’t mean their economy will stop growing, because GDP-per-capita has plenty of room to run. But it does mean that the favorable demographic tailwinds will now act as a headwind. Their population is getting top heavy, too. Ask Japan how much fun it is when your population not only isn’t growing, but is also getting older.

Anyway, this latest bump in the road is more indicative of a global slowdown. It says more about the rest of the world than it does about China. But it is a reminder how leveraged China is to the economic health of everybody else. That’s what will move the Chinese stock market up and down on a cyclical basis, while the three factors I listed above will drive its longer term performance.

The Whale gets Harpooned

The other major story in the last week was JP Morgan. I doubt you missed it, but in case you did, their latest investor call created something of a fiasco in the marketplace. They revealed a $2 billion loss on some bad “hedges” going awry.

I’d been reading stories about the “London Whale” — a shadowy trader at a major bank who was making enormous bets, distorting the credit markets, and pissing off a lot of hedge funds — for a few weeks in the FT and Bloomberg. It was a neat story, kind of a cloak-and-dagger soap opera, but I had no idea it would lead to this! This is real money. Real news.

It vindicates just about all of the criticism of the banking industry in the last few years. With various bank stocks up 40-90% since last October, a lot of investors were excited that all was clear in the banking sector once again. Most banks have been making pretty good money since the bailouts. It seems we now have an answer to the question, “at what cost?”