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It might not be an Asian century after all

And the United States might pull out of its present funk as it did in a sudden twice during the past century: in the first years of World War II, and during the first Ronald Reagan administration.

For the past two decades, the United States wasted the lion’s share of its resources, first in pursuit of the Internet bubble and then in service of the housing bubble. The country’s smartest kids were groomed for investment banking from childhood – literally. Now that the bubble has popped, it can’t be excluded that Americans will go back to fundamentals. America always does the right thing, Winston Churchill observed, after it has exhausted the alternatives.

Nearly four years after the crash, the market value of China’s economy languishes at around half its January 2008 level, while the American stock market has recovered to almost 90% of its pre-crash peak. Why should that be the case, when China is growing at 9% a year and America at 2% or 3%, with an administration hostile to business and the world’s highest corporate tax rate?

A simple answer is that it is safer to buy the stocks of American companies that sell to China than to buy Chinese companies. The world learned in 2008 that even the freest and most transparent large economy, the United States, might crash due to the negligence and cupidity of regulators, congress, ratings agencies, and financial institutions. Without an open and rambunctious democracy that responds to errors and corrects them in the full light of day, modern capital markets don’t work.

Another way to gauge China’s problem is that its gross domestic product (GDP) quintupled over the decade through 2010, while its stock market doubled – so that market capitalization has fallen sharply relative to GDP. The value of Chinese companies represents a much smaller proportion of the Chinese economy than it did in 2000. America’s stock market is worth roughly what it was a decade ago, while nominal GDP is half again as much. The ratio of market capitalization to GDP also shrank in America, but not nearly as far.

America has had its share of corporate fraud, for example, WorldCom and Enron. But investors by and large trust American corporations to report their earnings accurately, with the exception of the banks, who are a long way from recovering trust. China still looks like the Wild West to overseas investors, and not without reason: China is a great leap away from Western standards of governance and rule of law.

Growth is not a small consideration: if you put $1 into the Chinese market in January 2000, you would now have $2, but $1 invested in US stocks would still be $1. What is troubling is that just three years ago, the Chinese investor would have had not $5, but $2.

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