How Big Can China Get?

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We hear a lot of hype about China's growth prospects, but how big can China really get?

If you believe the hype ... huge!

Like the U.S. when it was still in its big-boom phase, China has a trade surplus, its populace saves like squirrels, and it is a net lender to the world (not a borrower). To hammer the point home, China recently surpassed Japan as the largest foreign lender to the U.S. itself.

Add all that to China's four-times-as-big-as-the-U.S. population, a burgeoning middle class, and a desire to stoke domestic consumption, and you've got an unbelievable engine for growth.

That is, if you believe the hype.

The reality
It's easy to project into the future. A few decades ago, everyone figured we'd get around in flying cars just like the Jetsons by now. That is, if the world didn't end in 2000. Doing a quick Google search, it appears we'll be "having sex and marriage with robots by 2050," and that natural redheads will be extinct by 2100. True story.

Let's step back a bit. What would it mean for China to replicate the U.S.'s growth? For the 70 years beginning in 1938 (the year before World War II started), the U.S. grew its real GDP by about 3.75% annually. That may seem low, but it allowed us to grow our GDP more than 13 times over.

To give you an idea of China's current prospects, the International Monetary Fund predicts the country will grow its real GDP by 7.5% in 2009 and 8.5% in 2010, driven partially by its economic stimulus. Contrast that with our economy, which is trying to rally from a 5.5% drop in real GDP in the first quarter.

Where are the growth investments?
Because of these amazing growth projections, there's a lot of investor interest around profiting from China's potential growth. Stop me if you've heard these investing theses:

• Aluminum Corp. of China (NYSE: ACH) -- aka Chinalco: Even though Rio Tinto (NYSE: RTP) spurned its overtures in favor of a joint venture with BHP Billiton (NYSE: BHP), commodities plays like Chinalco and PetroChina (NYSE: PTR) are long-term growth winners.
• Baidu (Nasdaq: BIDU): The search engine purveyor is the Chinese Google (Nasdaq: GOOG)!
• Ctrip (Nasdaq: CTRP): The Chinese Expedia. As that middle class we talked about grows, they'll want to travel more. And that's before factoring in opportunities to court non-natives.

All interesting, but like China's growth prospects in general, all worthy of skepticism. China's growth is analogous to the growth of the Internet. It's likely a long-term growth trend and there will be huge long-term winners. But we have to choose wisely as there will be more losers than winners. To invest thoughtfully in individual companies in China, you have to answer these questions positively:

• Do you understand the competitive and regulatory environment in China?
• Are the long-term macro trends sustainable? Are the data we're using to determine this materially reliable?
• Is growth being achieved for growth's sake or as a wise investment of capital?

Our Global Gains team is going to China (again) in a few days to make sure it has updated answers to all these questions. They're also going there to meet with the management teams of small, promising Chinese companies -- the international hidden gems. Fortunately for the rest of us, they'll be sending back free real-time reports from the field so we can learn along with them -- if you'd like to be included, simply provide your email address in the box below.