Lloyd George: Asia's pendulum man

Robert Lloyd George recently spoke at a lunch held by the Hong Kong Retirement Schemes Association. The chairman of Lloyd George Management - a fund management firm based in Hong Kong with $5.5 billion under management - Lloyd George himself is regarded as one of the world's more visionary fund managers. He is based in London now, but lived in Hong Kong during the 1980s and in 1991 penned the book "The East West Pendulum", a book whose general thesis was that economic activity and dominance was swinging back to Asia from the West - ie a reversal of the pendulum swing that occurred in the 18th century. Below we print in full his speech:

My subject today is the East West Pendulum, which I have tried to update since I first published it in 1991. The theory I published in 1991 went like this: if you go back to the time when Marco Polo was the first European to visit China, he was very impressed by the high technological, cultural and economic levels in the time of Kublai Khan. I have estimated that China's GDP per capita was two times higher than Europe's at that time. Plus so many inventions and discoveries were made in China centuries before they were made in Europe.

I saw the crossover point when China became an inward-looking Middle Kingdom, and the British sent an embassy in 1793. The British led the Western movement to open China at that time and you had a rapid decline in Chinese income in the 19th century - partly due to trade flows and the outflow of silver to pay for opium. Meanwhile you had the US emerge as a world industrial power, and also Japan. This went on all the way to 1950s when China had its revolution and ejected foreigners, and Western European countries were withdrawing from Southeast Asia. Since then the ascent of economic progress in Asia has meant that West and East reached rough parity at around the time of the millennium.

Obviously it will be difficult for Asia to overtake the West in terms of per capita income (because of the size of populations in Asia), but in absolute term it is possible. I do feel that China will be a leader in science and technology and that is not a view that is commonly accepted. Most people assume China just copies Western inventions. That is a stage we are going through, but the number of patents and innovations that come from China in next 10-20 years will be large.

I myself am astonished by the speed of the changes in China. I wrote the East West Pendulum in 1991 just after Tiananmen Square and Japan was dominant and many people were writing books about Japan buying the rest of the world.

I stuck my neck out and said I thought China would overtake Japan and become the leader of the region. And in the last 10-15 years things have happened so much more rapidly than I could have imagined.

If we look at China's GNP in 1990 it was $350 billion and today stands at $1.5 trillion. Foreign trade has grown by a factor of 10 times, and per capita income has grown by six times. Deng Xiaoping had a target to quadruple income and then quadruple it again by 2020. That is an achievable target.

I am so impressed when I now visit Chinese companies. There has been an enormous improvement in corporate governance and responsiveness to shareholders. It is not perfect, but if you think of how short a time the Chinese capital market has existed, it is a huge change.

My own view about China's impact on the world is that it is not deflationary any more. I share the view of Jonathan Anderson at UBS. I believe China is a bullish story for the world economy, and won't put everyone else out of business. I think China is one of the reasons why the world economy keeps surprising us with higher than expected growth and lower than expected inflation.

My own view of the investment climate is that indirect investing in China is the most interesting approach. The people who are really making money are the suppliers to China. For example, BHP Billiton in Australia has 60% of its sales to Asia and China is a big new customer. Indeed, Australia is probably the single biggest beneficiary in this region of China's growth. We run global emerging market portfolios from London and everything we do is governed by China. For example, we invested in a Chilean copper company that is listed in London because Chile had concluded a bilateral deal with China and copper is one of the big products.

Another indirect investment story is Hong Kong and particularly real estate. Clearly Hong Kong is the funnel for Chinese capital and Hong Kong retail and Macau casinos are clearly very big beneficiaries.

Machine tools from Japan is another area that has benefited. Indeed, Japan has been a major beneficiary of China's growth.

And in the longer run, travel and tourism are a big beneficiary of China's growth. There are 10 million Chinese going abroad today, versus an estimate of 100 million in a decade. I wonder - even with the A380 being built today - whether airlines and hotels will be able to deal with such flows.

We would also argue that one of the major shifts in the past 12 months has been from deflation to inflation. One of the leading indicators of that is Chinese factory wages which are rising very rapidly. The surprise is how quickly Chinese production costs have started to rise and that will be translated through to companies like Walmart. I would argue there is now a mildly inflationary influence emanating from China.

In the 1980s it will be remembered that the Japanese were buying up Van Goghs. With the Chinese there is some of that too. I went to a Sotheby's auction and that a beautiful Qing dynasty scroll that was advertised at a reserve price of $10,000. In the row behind me there there were six gentlemen from Beijing who eventually paid over $200,000. That's an interesting index of what is happening. Chinese treasures are returning to China. Equally Chinese money will go into foreign property and foreign companies - the Lenovo IBM deal and the purported CNOOC Unocal deals are two early indicators of that. We are going to see so much more M&A activity out of China - with a key theme being the acquisition of natural resources.

So what is our outlook? We see a US dollar recovery, because the dollar is oversold, but that doesn't change the long term trend of the dollar's decline. That will affect commodity prices, and we think there could be a liquidity squeeze with interest rates rising in the US. This liquidity squeeze is going to take people by surprise.

In Asia, we still have steady growth and it will two to three times higher than Europe's and US's. We have a consumer boom spreading more and widely around the region. That consumer boom is the key to our stock picking this year.

We believe that a new Asian asset class is in the process of being formed now, that being the real estate investment trust (REIT). The figures for the US and Australia are large, and REITs are becoming more popular in Japan, Singapore and Hong Kong. REITs are a welcome diversification for individual investors, have a good yield and obviously play to Asia's preference for property ownership.

One of the keys to investing is picking the small and mid-cap companies that will grow into the Microsoft's of China in the next 10 years. We were lucky enough to do that in India - we bought Infosys 10 years ago. If you can find those companies and stay with them for five to six years that is the best form of investment. In these cases it is very important to get to the know the owners/promoters and their long term vision.

We have a concentrated portfolio of 40 companies and we try to make bets outside the benchmark - because the benchmark is always backwards-looking anyway.

The Oil theme

Another key theme from our perspective is the oil price. If you watch what is happening in the Middle East there is no way you can conclude there is political stability there. Saudi Arabia may also have hit the peak of production. Last year I predicted oil at $60 a barrel and many thought I was mad.

It went to $50 last year and I think we could be looking at $60-80 this year. The impact of higher oil prices should be the highest risk factor in your investment decisions. I feel that like the 1970s we are going to have very high energy prices for a long time.

Where are we now? The US has grown stronger but has an $8 trillion debt and a weakening dollar, and has taken all these military responsibilities on that are costing a lot of money. So as long as they are supporting what I call their "empire" the US is going to have a huge deficit.

Meanwhile the European Union is quite difficult to predict at the moment. We have got to 25 members and it could go to 33. I think this is unsustainable. I don't think Europe can afford the agricultural policy it has and the euro will run into severe problems. So I am pretty cautious about Europe.

Asia, to me, still looks very attractive thanks to the growth of free trade agreements, and an Asian currency block could occur. In contrast to 15 years ago we are looking at China, not Japan, leading that currency block.

The pendulum is still swinging back to Asia and I am convinced it is a secular movement. It has much further to go and will happen faster.

Will there be a crisis in the US in the next decade?

It is a surprise to most people that the US has been able to go on so long with these deficits. They do have this unique advantage of being the issuer of the world's currency so everybody has to own it and everybody else is financing America's deficit. And when you are in the US, the attitude is who cares about the value of the dollar.

I think this can go on longer than we expect. And if you look at history the dominant military power usually has a dominant currency. So unless America's military position weakens considerably, the dollar will continue to be the dominant currency.

The euro is clearly not going to take over, nor is the yen. There isn't really a strong alternative to the dollar so they can go on amassing debt for much longer than we expect, and without a crisis.