Readers may well have missed the news that Ukraine is currently putting together a new coalition government led by reformist Julia Tymoshenko.

“So what?” you may ask. “I can’t know everything. And besides, how do you ever expect me to make a buck out of Ukrainian politics, a murky affair at best?”

Well, let me tell you a secret to emerging markets investing: The really big returns are made by spotting new markets as they begin to emerge, and then surfing the long wave of their emergence. The story of the independent countries that split from the Soviet Union is mostly a sad one, but there are a few gems beginning to emerge. There isn’t much to plunge into yet, particularly as a U.S. investor, but they’re well worth keeping an eye on.

Beginning first with all those confusing ones called “-stan” – I have to look up whether there are four or five of them. Uzbekistan, Tajikistan and Turkmenistan are backward dictatorships with few redeeming features, only modest amounts of resources and close ties to Vladimir Putin’s mob in Russia.  Kyrgyzstan is an emerging semi-democracy, with an almost functioning free market. Alas, it has only 5 million people, a puny Gross Domestic Product (GDP) of $10 billion, a modest growth rate, and no oil.

Kazakhstan’s the one with the oil. Unfortunately, it also has one-party government, high corruption and close ties to Putin. Nevertheless, with 15 million people, a much chunkier GDP of $53 billion and a growth rate of 10.6% in 2006 there’s money being made there. It has oil pipelines to the Black Sea and to China, so it’s not dependent on Russia to get its principal export to market. An international consortium led by Italy’s Eni SpA is currently drilling at the Kashagan oilfield, a huge project expected to have cost $130 billion by the time it comes on-stream in 2010. Since the Kazakh oil company Kazmunaigaz is state owned, Eni, itself (E), which has a price-earnings ratio of only 10 (well, NOBODY trusts the Italian government, which owns 39% of Eni), is worth looking at – what’s more, you get to share Eni’s new investment in Libya, another fun place with lots of oil!

The Baltic States – Estonia, Latvia and Lithuania – are well known; all three are now members of the European Union (EU), and have enjoyed rapid growth. They’re small, though, and there’s not much for U.S. investors to buy there. Estonia is the most exciting, with a growth rate of around 8%; Latvia, with a similar growth rate, also has a huge balance of payments deficit, which is rather worrying. Lithuania is growing somewhat less fast, and is the least glossy of the three.

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Armenia and Azerbaijan fought a war with each other only a decade ago, which doesn’t fully rule them out, but is still a factor to be considered. Armenia has a population of 3 million, a GDP of $6 billion, and a 13% growth rate; Azerbaijan has a population of 8 million, a GDP of $14 billion, and had an astounding growth rate of 34% in 2006 – that’s what opening a new oilfield will do for you. Unfortunately, neither country has any companies with American Depository Receipts (ADRs), nor does there seem any obvious way to play them – BP PLC (BP) is the most important oil company in Azerbaijan, but it’s a small part of its business.

Then there are the two non-Baltic, ex-Soviet republics that are showing signs of becoming real democracies: Georgia and the Ukraine (though Armenia and Kyrgyzstan are fairly close).

Georgia is small – 4.6 million people and a $5.3 billion GDP – but it has a splendid pro-free-enterprise government under Mikheil Saakashvili and a growth rate of 9.3% per annum that is dependent on real effort, not just oil prices. The other good news about Georgia is that it is the least corrupt country in the former Soviet Union (except for the Baltic states). Alas, that’s a bit like saying someone’s the least evil mobster in the Bambino crime syndicate, but at #79 on Transparency International’s Corruption Perceptions Index, Georgia is only just below India and China. The Bank of Georgia is probably the best way to play the country; regrettably that is listed in London (BGEO) but not in the US.

The Ukraine is much larger: It’s got 46 million people, an $82 billion GDP, and had a decent growth rate of 7% in 2006. For those who haven’t been following, Ukraine’s shaky democracy has recently been the scene of a huge tug of war between the pro-Russian east and the pro-Western, pro-democracy west. The Orange Revolution of December 2004 was supposed to mark the victory of pro-free market forces, but President Viktor Yushchenko proved feeble, and his first democratic government, with Julia Tymoshenko as prime minister, experienced its demise.

Since then, there has been an uneasy coalition between Yushchenko, as president, and the Putin-supported Viktor Yanukovich as prime minister. However, in last month’s election Tymoshenko – once again allied to the remnants of Yushchenko’s support – won a small-but-decisive majority and now seems poised for form a government.

Julia Tymoshenko made an oil-and-gas fortune in the 1990s, and is a very tough cookie. Imagine a cross between Madonna and Hillary Clinton and you have her style. (Amusingly for onlookers, there was a very old-time-Chicago series of delays in counting the election results, as first Donbass, controlled by Yanukovych, and then downtown Kyiv, controlled by Tymoshenko, had unexpected delays in announcing their results – in each case, a landslide for the local favorite with suspiciously high turnout!).

Putin hates her, which is a worry since Russia, through Gazprom, has the ability to turn off Ukraine’s heating every January. Fortunately, in doing so, they turn off half the EU’s heating as well, so there may be limits on how rough Putin wants to play.

However, Tymoshenko understands how a free economy works, and is determined to clean up the corruption in Ukrainian business, so prospects for Ukraine’s emergence currently look good. Don’t forget, the country has a 99.4% literacy rate and 15% rate of college graduations, yet a per capita GDP of only $7,800 – even at purchasing power parity – so there’s a hell of a lot of room for growth.

Like the other ex-Soviet states, Ukraine doesn’t have a lot of ADRs. It makes sense for a country with EU ambitions to list its shares in London first, but the hugely expensive requirements of the Sarbanes-Oxley Act must also be a factor. Even when ADRs are available, they don’t trade – the big electric power company Centrenergo (CTEUY.PK), for example, last traded 3 months ago. What’s more, there aren’t any mutual funds with more than a small share of their investments in Ukraine.

That’s bound to change, however, as the country opens up. We at Money Morning will keep an eye on the Ukraine, and will report back to you if and when their rapid growth inevitably brings investment opportunities. When that happens, the Ukraine will probably be well-worth buying.

Even in the apparent basket cases of the non-Russian former Soviet Union, there are growth opportunities and investments worth buying. The wise emerging-market investor must cast a wide net.

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• The Bank of England said yesterday (Wednesday) that it would inject  $20 billion into the long-term money markets next week because of the ongoing worldwide credit crunch. The British central bank is addressing liquidity issues in the so-called “Interbank” market – where commercial banks lend to each other. The money will be injected next week via a bidding process and will be payable after three months. Three more auctions will be held over the next three weeks, the BoE said – without specifying the amount of additional liquidity that will be involved. Commercial banks – like the highly troubled Northern Rock – are nervous about lending to one another because of fears about bad debts linked to the subprime mortgage market in the United States.

• Wholesale steel prices in China – the world’s No. 1 consumer of the alloy – soared 12.2% in August from a year ago as China’s government shuttered smaller mills and put the brakes on industry investment. Korean steelmaker POSCO (PKX) is expected to benefit.

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• Shares of Tenaris, an Italian steel-pipe producer surged as much as 5% yesterday, on speculation that global steel giant ArcelorMittal (MT) was looking to buy the company, The Economic Times reported. Shares of Tenaris were trading at the equivalent of $24.74 each, while the reported takeover price was $30.52 per share, according to published reports.

• Japan’s Mitsubishi Heavy Industries Ltd., plans to enter the Russian power-plant market utilizing a joint venture with Renova Group, a conglomerate, the Nikkei Daily reported yesterday. The partnership should be announced within days, and will make Mitsubishi Heavy Japan’s first heavy-equipment company to enter this Russian market, Nikkei reported. Russia’s state-run utility, Unified Energy Systems, plans to invest roughly $56 billion by 2010.

• Hewlett-Packard Co. (HPQ), the world’s No. 1 PC maker, said yesterday that it will double its Taiwan employment – from 300 to 600 – between now and 2009, a key element of its plan to boost its product-development activities in that country. Ted Clark, a senior vice president and GM of H-P’s mobile computing and global business unit, told Reuters that “part of our strategy is to increase local hires and expand Taiwan operations.” H-P’s notebook-computer business currently has four design centers – in Taiwan, China, German and the United States. Taiwan has emerged as the global epicenter of the PC-manufacturing business, with such contract-manufacturers as Quanta Computer, Asustek, and Compal Electronics building 80% of the world’s laptops. Hon Hai Precision Industries Ltd, is also headquartered in Taiwan.

•  Hyundai Motor Co., will introduce a premium car in China in April in an attempt to land wealthy customers and build market share in the world’s No. 2 auto market, South Korea’s top automaker said yesterday. Hyundai will introduce the premium model in the world’s No. 2 auto market in April. It has yet to announce the price of its so-called “BH” model sedan, although Chinese media reports have pegged the price at about $53,180, Hyundai spokesman Jake Jang told The Economic Times, adding that “we aim to sell 3,000 units of the BH in China in 2008.” Hyundai – the world’s No. 6 automaker by sales volume with affiliate KIA Motors Corp. factored in – has experienced sluggish sales in China, something the new car model isn’t expected to immediately fix. But the move should help upgrade its brand image, so that consumers start to see that it’s more than just a builder of dependable, low-priced cars. The “BH” will also be sold in the U.S. market.

• British aerospace company Smiths Group PLC and General Electric Co. (GE) yesterday announced that they’ve ended plans for a Smiths GE Detection joint venture, a plan that was announced on March 21. The two companies said they “now believe the interests of both businesses are best-served by their remaining independent.”

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Global mining giant Rio Tinto PLC. (RTP)  has agreed to provide a credit facility of up to $350 million to Ivanhoe Mines Ltd. (IVN), its partner in Mongolia’s Oyu Tolgoi copper-gold project.

The credit agreement is part of an interim-funding deal to keep mining project-development work moving, and will also lead to Rio Tinto boosting its maximum possible stake in Ivanhoe to 46.65% – from the previously agreed upon 40%.

Rio Tinto paid about $300 million last year for its initial 9.95% stake in Ivanhoe. It will gain an additional 9.95% when it pays another $388 million when the partners all cement a long-term investment agreement with the government of Mongolia.

"An equitable investment agreement is essential if Mongolia is to attract sustainable international mining investment," Bret Clayton, chief of Rio Tinto’s copper business, said in a statement. "This will encourage further exploration, development, employment and skill training programs."

Ivanhoe said the credit facility would permit site preparations and final design work to continue through the coming months. The huge project is aiming to produce more than a billion pounds of copper and 330,000 ounces of gold a year.

Related News and Story Links:

• MarketWatch.com:
  Rio Tinto Provides $350 Million Credit Facility to Ivanhoe Mines.
• CNNMoney.com:
  Alcoa Sells Stake in Chalco take for $2B.
• Money Morning News:
  Battle for Commodity Foothold Continues with Alcan Buyout.
• Money Morning News:
  Rio Tinto Gets Canadian Clearance, $40 Billion in Loans for Alcan.
• Money Morning Investment Report:
  Fund Manager Prefers BHP, Which is Striking it Big in India.

Emerging-markets investing can be a strange business.

Most of the time, the process is fairly simple, and profitable. All one must do is to:

• Identify the two or three best prospective countries.
• Examine the economic and political prospects of each one (as well as the prospects of the accompanying companies).
• Decide which market will do the very best over the long haul.
• Make the investment.

Most of the time, profits are the net result. But it can make for a wild ride. Usually you really have to keep your eye on that “long-haul” objective, so that you can ignore the short-term fluctuations, some of which are caused by the most inane things imaginable. But if you stick to my emerging markets checklist, you will not only find that you’re usually “fine;” you’ll discover that you’ve typically got a nice profit, besides – meaning over time, you will actually do quite well.

The Bad Seed

Every now and then, however, one or more countries run by some really “Bad Actors” have their securities markets beaten down so far that their stocks are selling for maybe a quarter of their asset value. At that point, the savvy emerging market investor knows there’s an opportunity. But there’s also a conundrum – and a choice to make:

• Do you play the savvy and morally sensitive investor, and steer clear, despite the obvious profit to be made?
• Or do you play the savvy and swashbuckling investor, hold your nose, buy the beaten-down shares of some of that country’s major companies, and hope to profit from the almost-inevitable bounce?

You see, a country is not like a company. Speaking in the 1970s, famed Citibank Chairman Walter Wriston observed that “Countries can’t go bankrupt.”  Of course, Citi found that precept was rubbish when all its Latin American debt was in default and it had to be bailed out by the Federal Reserve in 1991.

Nevertheless, while investors in Bad Actor Debt will generally lose their money, Bad Actor Equity is often a quite profitable speculation. If the companies in a country are solid, not overleveraged, involved in decent businesses and without too much exposure to the banking sector – which Bad Actor Governments tend to loot – these may well emerge in fairly good shape once the clouds of the financial crisis dissipate. Indeed, if the Bad Actor Currency collapses, Bad Actor Exporters should do quite well and be very profitable for a few years to come.

Russia is a prime example – and may represent the ultimate Bad Actor Investment.

As you’ll recall, that country about went bust in August 1998, and anyone who had invested in Russian stocks lost nine-tenths of their money. The RTS dollar stock index of Russian stocks, which had peaked at 550 in 1997, bottomed out at 50 in September 1998. During late 1998 and 1999, Russia appeared to be descending into anarchy.

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Time to buy! As is well known, from the anarchy emerged the sinister – but highly capable – Vladimir Vladimirovich Putin, and Russian stocks rebounded. By January 2000, the RTS Index was trading over 100. By 2001, it was fluctuating around 200. And by mid-2002, it was at 350.

A very nice since 1998, but no point going in at that stage, right? Everybody was optimistic about Putin, and the Russian economy had recovered nicely in 2001 and 2002. Even the Russian state budget was in better shape after the government had introduced a flat tax. If you had known in August 2002 that over the next five years Russia’s largest company would be dismembered and its CEO sent to a Siberian jail, that the two largest foreign investments in Russia – those of Royal Dutch Shell PLC and BP PLC – would be largely expropriated with laughably small compensation, and that Russian foreign policy would turn into a re-run of the Cold War, you would have avoided Russian investments like the plague, wouldn’t you?

You’d have been wrong. Even though the RTS index in 2002 was well back towards its 1997 speculative peak, in the last 5 years it has risen from 350 to around 2,000, a profit of more than 400%. Just buying the huge oil company Gazprom – surely the most completely obvious investment if you were going to buy Russia at all – would have netted you eight times your money as shares raced from $5 to $40.

At this point? Heaven knows. Probably the only thing that would make the Russian stock market go up even more would be for the country to start World War III and win it. At 40 times its 1998 price, the market is surely fully valued, while private property has no rights in the country and local businessmen run the perpetual risk of an unfriendly knock on the door at 3am. At any rate, with Russia part of the fashionable “BRIC” collection of Wall Street’s favorite emerging markets, even the most devout Russian optimists can hardly claim the place is undiscovered.

Take another example: Argentina. In 2001-02, Argentina defaulted on its international debt, while the currency collapsed from $1 to $0.25 overnight. Most local savings were forcibly converted from dollars into pesos and a hard-left anti-American government came to power, vowing to pay not a penny to the unfortunate Italian bondholders who had invested in Argentine debt. Nobody but a madman would have invested in the place, surely?

Well, guess what? Argentina’s Merval stock index, which bottomed at 200 in 2001 and stood at 390 in August 2002, after the worst of the storm had passed, is today just over 2,000. Again, a 400% – or even 900% m – for investing in a country that is truly appallingly run, with price controls everywhere, the head of the Statistics Office fired because she wouldn’t falsify the inflation figures, and the leftist president’s dozy wife poised to win election in her own right in October.

Whereas my investment recommendation on Russia today would be fairly neutral, on Argentina I would be heavily negative. It doesn’t have Russia’s geopolitical or natural resources strengths and it’s even worse run because the Argentine government is less well organized than Putin’s mob. My guess would be that Argentina is heading for another nasty crisis in the fairly near future – at which time it may again be time to pile in for a quick buck.

Regrettably, there aren’t any good “hold your nose and invest” opportunities at hand right now.

Venezuela will be a good one when it runs out of money – its Orinoco tar sands are the world’s largest and most valuable oil deposits. However it hasn’t run out of money, yet, and the local stock market has done well, because it enables the unfortunate Caracas middle class to get their savings out to Miami. Bolivia and Ecuador would be good examples, but they are too small to have anything worth investing in. Good opportunities may arise when and if the U.S. subprime mortgage crisis spreads to emerging markets, but that hasn’t happened yet, and doesn’t appear to be imminent. Money Morning will keep an eye open, however, and alert you when the Bad Actors Guild sets up shop somewhere, and turns a disaster into an investment opportunity.

So, for the moment, you’ll have to stick to investing in well-run countries, with good growth prospects. How boring!

Related News and Story Links:

• Money Morning News Analysis: Why Libya and Algeria Could Be Europe’s Solution For Oil.
• Wikipedia: Vladimir Putin.

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I finally understand the Irish fascination with the color green.

Having descended, in part, from some fine Irish stock myself (my mother’s maiden name was “Herron,” formerly “O’Herron”), I’ve always been entranced by Irish legends and lore, history and heritage, and custom and culture.  The color green is a key ingredient of this Irish cultural stew – as anyone who’s ever donned a funny hat and a shamrock pin and drank green beer on St. Patrick’s Day can attest. Green is the color of the uniform that Irish football teams don to do battle on the gridiron. It’s the color of the mother country’s landscape.

And when Ireland was battling Great Britain for independence in the late 18th Century, green signified sympathy – which actually drove Britain to make it illegal for folks to wear anything green.

Green is the national color of Ireland – in more ways than one. And the modern motivation has a lot to do with the so-called “greenback” – otherwise known as money.

The Buck of the Irish

If you’re a business owner or investor, and are looking for an overseas market with a lot of promise, Ireland clearly deserves a look.

According to one investment-research report I studied, Ireland is home to roughly 1,100 multinational companies; the $60 billion worth of products these firms export account for nearly 90% of Ireland’s overall yearly total.

Europe in general is a big target for foreign direct investment (FDI) by companies involved in healthcare and drug care, and almost a third of that amount gets invested in Ireland. Indeed, nine of the world’s top 10 drug companies have operations in Ireland, which manufactures most of the Botox drug treatment, or the Pfizer Inc. (NYSE: PFE) Viagra drug, destined for distribution Europe.

Digital technology is also a huge element of the Irish economy. Ireland is the world’s biggest software exporter – even ahead of the United States, which is home to such software giants as Microsoft Corp. (Nasdaq: MSFT), and Oracle Corp. (Nasdaq: ORCL), to name just a few. Those two companies, combined, have a market value of nearly $360 billion.

U.S. companies have long been big investors in Ireland. Indeed, the Irish-American connection remains particularly strong. Intel Corp. (Nasdaq: INTC) has invested $5 billion in a huge chip fab in Ireland. Other big U.S. investors in Ireland include Dell (Nasdaq: DELL) (which alone is responsible for 5% of Ireland’s exports and 2% of Irish GDP), Hewlett-Packard (NYSE: HPQ), and Apple Computer Inc. (Nasdaq: AAPL) has chosen Cork for its chief European software-development and support center. [For a list of some other Irish companies, click here].

Thanks to a truly admirable savings rate – not to mention property values that have soared into the stratosphere – the Irish have become the wealthiest people in Europe, according to a Bank of Ireland (NYSE: IRE) research report released this week.

According to the bank’s yearly report, “The Wealth of the Nation: How Ireland’s Wealthy Will Invest in the Next Decade,” the Irish economy’s total wealth on a per-capita basis places the country second among the world’s eight most-developed nations: Behind No. 1 Japan, and ahead of both the United Kingdom and the United States.

Ireland’s per-capita net wealth rose from $225,400in 2005 to $263,000 last year, a remarkable 16.7% increase, the bank said. The report defines net wealth as property, bank deposits, pensions and investments. Overall net wealth rose $169 billion, or 18.6%, to $1.078 trillion.

The author of the report is Pat O’Sullivan, senior economist at the Bank of Ireland’s Private Banking Group. Much of last year’s surge in wealth was fueled by 20% growth in the value of residential real estate, an important element of the Irish consumer/investor’s personal wealth.

The report doesn’t provide any short-term forecasts. But in response to a journalist’s question at the press conference where the bank released the report, Senior Economist O’Sullivan said the rate of growth will be slowed substantially this year, thanks to slight slumps in share prices and a bit of a retreat in the residential real estate market, “probably in the mid-single-digit” range, which equates to roughly 5%.

Overall, Ireland’s net wealth (which excludes debt) has risen more than 400% since 1995. From last year’s $1.078 trillion, O’Sullivan predicts that net wealth will reach $1.245 trillion in 2010 (an increase of 7.4% from his earlier 2010 estimate of $1.159 trillion, and an estimate based on a “soft-landing in the real estate market this year.” He forecasts net wealth of  $1.556 trillion by 2015.

That compares favorably with some projections from the highly respected think-tank, the McKinsey Global Institute, which in a report released earlier this year said that global wealth would soar from $118 trillion in February 2005 to $200 trillion in 2010 – with much of that gain coming from outside U.S. borders. That’s an increase of $82 trillion, or 69.5% in only a five-year period.

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Millionaires Everywhere

If you’re planning to become a millionaire, and want to move into a neighborhood with others of your “own kind,” chances are you’ll find a pretty nice one in the Emerald Isles.

In a nation of 4.2 million people, estimates say that there are as many as 100,000 millionaires. At that level, O’Sullivan says that would imply that millionaires make up about 2.5% of the Irish population. For comparative purposes, in both the United Kingdom and the United States, millionaires represent about 0.7% of their respective populations, he said.

Using some basic statistical analysis, O’Sullivan ratcheted down his estimate for Ireland to 30,000 millionaires. That’s up 10% from 2005, the report said.

Now, before I break down the net-wealth ranges of this group, let me take a minute to show you an interesting little fact that might make for some interesting conversation at your next staff or board meeting, dinner party, or night out with friends. We’ll call it “Irish Millionaire Trivia,” and the basic question is as follows: How do you define an Irish millionaire?

Well, that’s easy, according to the Bank of Ireland’s O’Sullivan: Those folks are Irish residents with a net wealth of 1 million euros or better.

Makes sense, right? After all, a millionaire in the United States is a person with a net wealth of $1 million or better.

Do you see the interesting conundrum here?

You see, because of exchange rates, a U.S. millionaire who went over to Ireland or onto the European continent would no longer be a millionaire ($1 million USD. = 745,225 euros…. too bad, Charley, you’re OUT of the club……).

And it hardly seems fair that a European investor has to actually have $1.34 million in U.S. dollars to make the club (1 million euros  = $1.342 million USD). But it’s just one of those fascinating little bits of international financial trivia one uncovers while engaged in some late-night financial analysis.

But since we’re playing in the Bank of Ireland’s ballpark tonight, we’ll stick with their rules. Ireland’s millionaire population breaks down as follows:

• 27,000 millionaires with a net wealth in the range of 1 million euros to 5 million euros ($1.34 million USD to $6.72 million USD).
• 2,700 millionaires with a net wealth in the range of 5 million euros to 30 million euros ($6.72 million USD to $40.27 million USD).
• 300 millionaires with net wealth in excess of 30 million euros ($40.27 million USD).

While Irish household debt rose 20% to $220.3 billion, this was more than offset by the following:

• A 15% gain in cash savings.
• A 26% increase in privately held stocks.
• And an 11% gain in the value of pensions.

According to O’Sullivan, Irish consumers save about 14% of their disposable income – the top rate of any country in Europe. German consumers placed second with 10%, and the British saved just 5%. As for the Americans, well, they save just 1% of their disposable income.

Investors can look at direct investments, such as the bank or some of Ireland’s other public companies. Or you can look to benefit indirectly, invest in firms such as Apple or Dell, which are benefiting from their involvement with the Irish economy.

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Global investors should take heed: Japan’s economy continues to be much stronger than it looks.

When the world’s No. 2 economy reported its second-quarter performance on Monday, the figures were largely viewed as a disappointment; they showed economic growth of only 0.1%, or 0.5% on an annualized basis. That’s down from a revised growth rate of 3.2% for the first quarter, and was well below the median estimate of 0.9%, according to a survey of 27 economists surveyed by Bloomberg News.

With growth having slowed even more dramatically than economists expected, investors are fretting that it’s now much less likely that Japan’s central bankers will boost interest rates when they meet for two days next week.

Unfortunately, those fretting investors are focusing on the wrong elements of Japan’s prospects.

The Case for Japan

There are many sound strategies for investing internationally. One, which we advocate wholeheartedly here at Money Morning, is to “follow the money” – that is, ferret out the investment flows that point to the best profit opportunities. Another is to track what other noted global investors are doing, and following in their footsteps.

But one of the best is to pick out a country with terrific prospects, and then look for the best investments that nation has to offer. This so-called “top-down” approach to investing can be quite effective.

Especially when the country in question is as solid and promising as Japan.

In breaking down the second-quarter growth figures, we see that Japan’s consumption growth slowed from a 3.2% rate in the first quarter to a 1.6% rate in the second. Private-sector investment, on the other hand, was strong; it grew at a 4.8% annualized pace, up from 1.2% in the first quarter. (Don’t forget that Japan – unlike the United States – has no population growth, so a 2% growth rate in Japan is reflective of real growth; whereas in the U.S. market, a 2% economic growth rate represents true growth of only 1% – net of the 1% annual growth in the American population.)

Thus, in many respects, Japan’s economic position is the reverse of the U.S. economic position of 2005. Whereas U.S. consumption in 2005 was strong, it’s actually fairly weak in Japan, growing no faster than the overall economy. Conversely, whereas the U.S. economy of 2005 had to struggle against weak investment totals, investment in Japan today is quite strong, as this key Asian nation re-equips itself after 15 years of recession.

Housing, too, was a strong contributor to the U.S. economy’s overall vitality in 2005. But in Japan, it is very weak today, with private residential investment down in the second quarter at an annual rate of 12%.

In terms of government spending – always an interesting area to analyze – the United States of 2005 and Japan of today are uncannily once again mirror images of one another. Whereas public spending was increasing rapidly in the United States in 2005, it is flat in Japan, where public investment actually plunged by an 8.4% annual rate in the second quarter. This accounts for much of the decline in GDP growth, and reflects the tight fiscal policy in the Japanese budget propounded by Prime Minister Shinzo Abe at the beginning of the year.

Public-spending restraint is never popular, but in Japan’s case it is vital to rebuild public finances, and to allow the private economy to increase at a healthy rate. One of Japan’s major problems in the 1990s was that the rapidly expanding public sector was growing faster than the economy, leaving little or no room for private-sector expansion. This position is now reversing, as the public sector shrinks its share of the economy and the private sector correspondingly expands. Japan still has public debt of about 160% of GDP, but most of that is held in various domestic savings funds.

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Some Top Plays on Japan

So it depends what you like. If you like a country where people spend more than they earn, government expands more rapidly than the economy, house prices and investment roar ahead and business investment is sluggish because of massive overbuilding in a bubble a few years earlier, you’ll prefer the 2005 version of the United States.

If, on the other hand, you prefer a country where people save, private consumption is restrained, housing is subdued, the government is keeping a tight rein on wasteful spending, and business investment is booming after a 15-year recession, you’ll prefer Japan. It’s all a question of investor tastes.

I know which way my tastes run. For those who agree with me – and who like to carefully manage their risk – I would suggest the streetTracks SmallCap Japan ETF (AMEX: JSC). As this illustrates, on the whole I prefer smaller companies, which can benefit from continued growth in the Japanese economy without being buffeted by international problems. But there are some very interesting larger plays, too.

Of the larger companies, Toyota Motor Corp. (NYSE-TM) warrants a close look, if only because it’s trading at a very modest 13 times earnings – and because it’s steadily eating the global lunch of U.S. stalwarts General Motors Corp. (NYSE: GM) and Ford Motor Co. (NYSE: F). It’s also worth taking a very close look at Canon Inc. (NYSE: CAJ); while it’s true that this stock is trading at 30 times earnings, which is expensive, remember that Japanese shares historically trade at rather steep valuations.

For the truly adventurous, consider a look at Omron Corp., the world’s leader in fuzzy logic control systems, a business we don’t really have in the West. Alas, in the U.S. market, Omron is quoted only on the pink sheets (OTC: OMRNY). But it does trade actively in both Frankfurt and Tokyo (TYO: 6645).

[Once again we’ve come across a solid overseas stock that U.S. investors can’t easily access. Money Morning newcomers would do well to spend a few minutes checking out two recent research reports: “Global Investing: Has Wall Street Rigged the Game?” and “International Investing: Why U.S. Investors are ‘Boxed Out’ of Big Global Profits.” Both reports are available for downloading directly from the Money Morning web site. And, naturally, both are free of charge.]

Japan: A Play on China

Lastly, whenever you discuss the investment allure of Japan, there’s also the question of China. As we know, China has a bright long-term future. But share prices have been on a torrid run for an awfully long stretch, which I believe substantially elevates risk. Japan is a solid investment in its own right, for all the reasons we’ve articulated [If you’d like additional reasons, you absolutely must check out our 6,000-word investment research report: “Global Investing: The Three Best Investments in Asia Today.” It, too, is available at no cost to subscribers to our free Money Morning global investing news service.] But, for the risk-averse, Japan is a solid indirect play on China (as are the other two markets we detail in our Asia research report). Many of Japan’s major manufacturing companies have established operations in Mainland China, which offers such benefits as lower wages and a close proximity to the headquarters operations of the big firms.

Martin O. Hutchinson is the Chief Global Investing Strategist for Money Morning, as well as an advisory panelist for The Money Map Report. An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial market.

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As I stare at my trading screens today, I’m reminded of that Hans Christian Anderson fable in which the Emperor has no clothes.

In case you don’t recall that story from your childhood, the “Emperor” walks around naked while all his subjects “admire” his invisible garments. Finally, a young boy states the obvious and all hell breaks loose.

We’ve had the equivalent of that this morning on the heels of an overnight statement by BNP Paribas (EPA: BNP), France’s largest listed bank, which said “the complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly, regardless of their quality or credit rating.”

At the same time, BNP froze some $2.2 billion of mortgage-exposed funds and also barred redemptions. Even though this represents a scant 0.5% of total BNP funds under management, the damage was done – and continues as I write this. A few hours later, a separate European fund worth 750 billion euros ($1.03 trillion) was frozen. And a Dutch bank pulled a new one after it, too, got trashed thanks to additional sub-prime losses.

Meanwhile, Germany’s Bundesbank held an emergency meeting for those banks involved in the IKB rescue and the European Central Bank (ECB) has promised to step in and “ensure smooth function of markets,” which is central-bank-speak for: “We’re preparing to bail out your tail-ends” – albeit in much-less diplomatic language.

Considering that the ECB has already pumped a staggering 95 billion euros ($131 billion) into the Eurozone banking market, the sub-prime credit woes finally are getting the attention they deserve. In fact, this is the single-largest liquidity intervention in the Eurozone banking system since immediately after the 9/11 terrorist attacks in the United States.

I’d expect a similar intervention here in the U.S. financial markets, but “Team Bernanke” seems to be asleep at the wheel.** People I regularly talk with on an “off-the-record” basis at trading houses around the world are literally pulling their hair out in frustration. The fallout from this could be far worse than the idiots inside the Beltway realize or even understand. The U.S. economy may not be a Ferrari, but it’s also not Chitty Chitty Bang Bang: Somebody has to guide it and steer it or there’s going to be one hell of a wreck.

[**As a side note for any conspiracy buffs out there, my reference to Team Bernanke is an admittedly snide – though public – reference to the European equivalent of the mythical U.S. Plunge Protection Team, which has long been rumored to exist, but which seems to operate in the shadows of our own financial markets…but that’s another story for another time.]

For now, the real question is this: How long will this downdraft last, and how bad will it get?

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Personally, I believe we’re in for a long and nasty stretch. As I’ve been saying for months, now, this has a long way to play out. Keep watching the headlines and you’ll see story after story about hedge-fund flameouts. And if you keep a running tally on the loss totals as they’re announced, you’ll soon become very worried about the staggering dollar figures that are mounting on your little scratch pad (and if it’s that little, you may well be on Page 10 or 11 by the time the cold chill takes hold). As if that’s not difficult enough for the regular retail investor to stomach, the extraordinary volatility we’ve seen in recent weeks will only continue, with the wildest gyrations accompanying each new breaking story. That’s great for a trader like me, but is very disconcerting for someone looking to be a true “long-term investor.”

I realize that I sound a bit like Dr. Gloom and Doom (unfortunate, given that this is my introductory investment note to all you new readers), but you can take some solace in this one important fact: From a historical standpoint, this kind of periodic “backwashing” of the capital-markets’ pipes is actually a good thing for your investment portfolio.

And the reason is actually quite simple. One of my Contrarian-oriented colleagues here at Money Morning loves investing adages, and one of his favorites is the old French saying: Achetez aux canons, vendex aux clarions – which translates roughly to “Buy on the cannons, sell on the trumpets.”

And as I like to say, history shows time and again that investors with the “intestinal fortitude”  (i.e. “guts”) to wade in and buy at the points when all hope appears lost are almost always the biggest winners when the sun is shining brightly again. If you buy on panic, you’re likely getting bargain-basement prices, and that can only magnify your gains when the markets inevitably rebound.

I’ll let you know when the dust settles…and when the outlook appears bright once again – at least in my opinion.

And I’m looking forward to sharing my opinions with all of you. I hope you’ll find them useful.

Contributing Editor Keith Fitz-Gerald, a brand-new addition to the Money Morning research team, is one of the world’s foremost experts on the Asian markets, especially China and Japan. A professional trader who works with wealthy investors and institutions, Fitz-Gerald is also a truly global investor: He and his family split their time between Portland, Oregon, and Kyoto, Japan.

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Many markets in continental Europe haven’t exactly been the best places to invest over the past 20 years. And unless there are some big changes in France, Germany and Italy – and relatively soon – the future profit opportunities may continue to be as bland as day-old white bread.

Yes, France seems to offer some real promise – thanks to Nicholas Sarkozy, the country’s new, reform-minded president. But Germany and Italy are headed nowhere fast.

There’s a reason that investors in this part of the world have such big problems. And maybe the best way to explain it is this: Europeans just won’t euthanize the stupid. In France, Germany and Italy, the unions are very powerful and the masses generally seem to believe that well-established institutions should be rescued, because their failure would be so disruptive. Economically, if you let the stupid live, there’s no incentive for companies to act intelligently. Let me show you what I mean…

The German bank IKB Deutsche Industriebank AG was bailed out on Monday by other German banks to the tune of about $11 billion. Why the need for a bailout, you ask? Simple: It lost a bundle in the US sub-prime mortgage market, where it had a total exposure of $17 billion.

IKB was unquestionably stupid. It’s a medium-sized part of the Byzantine German banking system, part owned by other banks, which are themselves part owned by state and regional governments. It was primarily a corporate lender to medium-sized German companies, a role it filled pretty well.

As part of this role, it no doubt needed a U.S. office; after all many German companies export here, though in general only the large companies such as BMW and Siemens have U.S.-based operations that need financing.

Having opened that U.S. office, IKB’s mistake was to go beyond arranging introductions and having good lunches, and try to make money in a market in which they had neither an expertise nor a natural business.

If you’re a management hotshot who’s been made head of IKB’s U.S. operation and given a profit budget, you’re going to find it difficult to make that budget. The easiest way to do so, in a period when the markets are active, is with high-risk loans, generally sold to you by aggressive investment bankers.

The high-interest-rate payments and fees on the loans come in first, and make your budget, while the loan losses take some time to develop – hopefully not before you’ve been transferred back to Germany (with a pat on the back and a promotion for your “fine performance” dealing with all those undisciplined Yanks).

Normally, an internal “credit committee” is supposed to keep a bank from taking on too many risky investments. However, when already-complicated U.S. loans are then sliced and diced into collateralized loan obligations – and then sold to investors, like IKB – it becomes very difficult for the domestic credit committee of a German bank to figure out just what they’re getting into. Thus if the deal looks profitable, they generally allow it.

In IKB’s case, the most attractive possibilities seemed to be in the U.S. sub-prime mortgage market. For a time, IKB’s U.S. lending venture was profitable; indeed in 2006-2007 it had a far higher return than the other parts of its business.

It couldn’t last, however: The inevitable eventually occurred, and the bank was swamped by growing credit problems.

It’s an old story, but it’s also quite common. Indeed, it’s very likely that other foreign banks will face problems of their own, either in the sub-prime mortgage market, or in the leveraged buyout (LBO) market, where U.S. investment banks have been equally aggressive recently.

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In the U.S. market, when a bank gets stung like this, authorities let the bank go belly up – unless it’s so big that the entire system might be endangered. Even when the problem is industrywide – as is true of the current sub-prime mortgage crisis – regulators and lawmakers are typically reluctant to sweep away the problems with one big bailout.

In Europe, however, the philosophy varies from one market to the next. Britain and Scandinavia take a fairly U.S. approach. In Eastern Europe, so much has gone bankrupt in the transition from Communism that they’re used to it, so they also take the U.S. approach.

But continental Europe just can’t bear to see its big companies fail. When Credit Lyonnais, the big French bank, lost gigantic amounts of money in the Michael Milken/Drexel Burnham Lambert junk-bond collapse of the early 1990s, French taxpayers essentially wrote a big check to save it, and it stayed in business until it was taken over by Credit Agricole a decade later.

Germany has “specialist banks” that fill carefully defined niches (German giant Deutsche Bank, for instance, was formed as a specialist bank for foreign trade in Berlin when it was founded in 1870; now it’s a global investment bank). So any specialist appears irreplaceable: If IKB disappeared, for instance, how would mid-sized firms find financing? Since IKB’s main business remains perfectly solid, it was natural for Germany to organize a bailout.

The problem with bailouts is that they reward stupidity. It’s not just in banking: Italy bailed out its Fiat automaker a few years ago, and it is now quite profitable. But these bailouts reward failure; they provide extra resources to banks and companies that make huge mistakes. This, in turn, encourages management to reinforce failure – if bailouts only happen when bankruptcy threatens, you’d better make sure that any losses are really big ones so that you grab politicians’ attention.

Countries that reward failure caused by stupidity get more stupidity, and less brilliance, since that spark of cleverness and innovation gets suppressed. The reason: Big, stupidly run companies that were subsidized to avoid failure can’t help but crowd out small companies that are now at a competitive and financial disadvantage. That’s the marketplace reality of this “we-can’t-let-it-fail” philosophy.

Even when some of these countries have excellent capabilities in particular area – and perhaps even a competitive or economic advantage, the higher taxes and onerous cost structures built up by these “failure-subsidy payments” prevent true success from being fully realized and adequately rewarded. And don’t even get me started talking about productivity – a key factor that separates winners from losers, no matter if we’re talking a single company, or an entire country. Brilliance and innovation are artificially suppressed, so productivity growth tends to be very sluggish.

In much of Europe, the market forces aren’t permitted to work their magic. Every now and then, a good investment opportunity arises in France, Germany or Italy. But there are nowhere near as many as there should be. That’s why you’re much more likely to make money in Asia, or in the United States.

Where market forces are allowed to work, profits are more likely to follow.

Martin O. Hutchinson is the Chief Global Investing Strategist for Money Morning, and an advisory panelist for the monthly investment newsletter, The Money Map Report. An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets

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If you ventured a guess at which countries paid their senior management the most, what would be some of your choices? The United Kingdom? Japan? Surely the United States would be high on the list, right?

Wrong.

A recent Hay Group Research report showed that management in Russia, Mexico, Ukraine, Thailand, Poland, Malaysia, Lithuania, Romania and Austria all have higher disposable incomes than the United States, which ranks 24th on a list of the 47 countries in the survey.

Topping the list are the oil-rich – and tax-free – states of Saudi Arabia ($229,325) and the United Arab Emirates ($223,939). The United States weighs in at average of $104,905 in disposable income for its senior managers (which the Hay Group defines as either a department head, or the head of a corporate function).

“Companies are operating in an increasingly open and competitive global economy, and emerging markets are offering managers higher disposable incomes than established countries — which is making these locations an attractive prospect for management talent,” said Iain Fitzpatrick, Director Reward Information Services for Hay Group North America.

“This makes sobering reading for companies in Western Europe and the U.S., who face not only local competition for managerial talent, but an increasing threat from buoyant new economies.”

The Hay Group, a global management consultancy group, compiled the report by comparing detailed cross-country pay information of 47 countries in North America, South America, the Middle East, Africa, Europe and Asia Pacific. It then factored pay, cost of living and taxes to reveal disposable income — the true indicator of purchasing power.

That makes it less of a surprise that the United Kingdom ranks 40th. Its high cost of living whittles the average manager’s disposable income to $86,367. 

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The reasons the United States and United Kingdom are both so low on the list are fairly simple, though multi-layered. First, managers in wealthy countries not only compete with themselves, but also with other countries whose growing economies are demanding more and more upper-level managers to move that growth along. And in many of those countries, the living costs are essentially peanuts compared with the higher-cost U.S., U.K. and Japanese markets.

It’s not that executives in these three countries are paid less. Rather, their money doesn’t go as far in their homeland than underdeveloped countries. And in Canada, 42nd on the list, not a penny of its “low” $81,613 has to be spent on health care.

Given all these considerations, it’s no surprise that seven of the Top 10 countries are in Asia. But China isn’t one of those seven, however. It only ranked 12th, with managers there making an average of $126,218.

“Chinese companies have realized the need to attract management talent as economic acceleration continues apace, having a significant upward impact on managers’ pay,” said Hern Yin Goh, Reward Information Services Manager for Hay Group China.

It’s not as surprising to find India well down the list. With buying power of just $92,750, India ranks only 36th – underscoring why that country’s highly educated work force is a coveted outsourcing target for multinational corporations looking to escape such high-cost markets as the United States and Japan. In India, major corporations are setting up everything from customer-service call centers to design-and-development units for computer software and high-speed microprocessor chips.

As that continues, however, India may find it tough to maintain its competitive edge as a low-cost sanctuary with high-value labor.

 “India benefits from a large tier of well educated, English-speaking local talent, making management pay more immune to the international market,” the Hay Group China’s Yin Goh noted. “That said, managers’ pay is increasing at double-digit rates in India — between 15% and 20% — so it is unlikely to stay at the bottom of the pay table for long.”

To see the full report, go to: http://www.haygroup.com/Downloads/sg/misc/World_Pay_Report_2007.pdf

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When Britain’s Barclay Bank PLC (NYSE: BCS) boosted its bid for Dutch Bank ABN AMRO Holding NV (NYSE: ABN) to more than $93 billion in the world’s largest-ever takeover battle, it did so thanks to a financial boost from state-run investment funds in China and Singapore.

The $20 billion investment in Barclays by the China Development Bank and Singapore’s Temasek Holdings is merely the latest in a series of deals announced in the past few months by equity funds that export-rich countries have established to invest their rapidly soaring currency reserves.

In the midst of a private-equity-led takeover boom that sent U.S. stocks into record territory, watchful international investors cheered as such countries as China, Singapore and Dubai unveiled these funds. These new players, investors reasoned, would help keep stock prices high, if not send them even higher.

But let me tell you how I see this: I’m not at all sure that, as a shareholder, you should welcome them. Let me explain…

Foreign Reserves 101

Traditionally, a country’s foreign-exchange reserves were held by its central bank as a kind of contingency fund. For instance, the capital might be used to fend off a financial crisis – if the international bond market went into a tailspin, for example. Conservative institutions by nature, central banks invested these reserves in safe, short-term investments such as U.S. Treasury bills, maybe diversifying as far as the Treasury bond market, or even into Federal Agency bonds.

But with the massive growth of Asia, and the soaring oil prices of recent years, some countries have seen their reserves get so big that no imaginable crisis could ever cause the entire amounts to be used. Singapore and some Middle Eastern countries reached that level as far back as the 1970s. More recently China, with an estimated $1.3 trillion in reserves (an amount that’s rumored to be growing by an additional $200 billion every six months), and Japan, with $900 billion, have decided to direct part of this hoard into longer-term investments, figuring they’ll get much-better returns than are available via T-bills.

At first glance, this development will leave you feeling as if you want to jump for joy. Singapore’s Temasek Holdings has invested part of that country’s dollar reserves since 1974, and now has about $80 billion under management. Kuwait, Dubai and Saudi Arabia have strategic investment funds that have become quite huge in the past few years, as oil prices have surged.

And now China has announced that it intends to invest a substantial portion of its ever-spiraling reserves into stocks, as well as “strategic” foreign assets. You’ll find Japan’s investment pool is even more mouth-watering: In addition to its $900 billion of foreign exchange reserves, it is considering foreign investments for the $1.6 trillion held by Japan’s Postal Savings Bank and the additional $1.3 trillion that’s in its Government Pension Investment Fund. On a note that I find a bit more sinister, Russia said it will strategically invest a portion of its $250 billion in reserves.

We’re talking about a gigantic amount of money here – between $5 trillion and $6 trillion in total, for those of you who stopped counting. Even if most of this capital gets invested through private deals like China’s $3 billion investment in The Blackstone Group LP (NYSE: BX) in May or the Barclays deal, it still allows Blackstone to buy more companies, or Barclays to make a higher takeover bid than would otherwise have been possible. What’s more, if there’s $6 trillion to invest, there aren’t enough really special private deals to go around. At some point, the investment manager will surely have to pick up the phone to the trading desk and yell, in the classic Hollywood manner: “Buy!! And keep on buying ‘til I tell you to stop!” Surely that must be great for all of our stock portfolios, correct?

Not necessarily, as it turns out.

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Public-Sector Contestants, Private-Sector Rules

If we could depend on these folks to buy stocks indiscriminately – in essence, placing a giant-suction pump atop the market, and slurping shares across the board to higher levels – we could at least expect a nice short-term jump in share prices. However, what you and I must keep in mind is that these folks aren’t free-market operators: The funds are run by politicians, and several are steered by governments most of us wouldn’t want to live under – and definitely not governments any of us would want to “fail” under.

The problems of having major companies owned by the likes of China or Russia have now dawned on the EU bureaucrats and the Bank of England, both of whom have sounded the alarm regarding the dangers of strategic assets being controlled by foreign governments.

In that context, it wouldn’t seem that Barclays – a fairly simple commercial bank, despite its heft – would be problematic. And yet even the Financial Times, a committed friend of free-capital movements, raised this most-vexing question: What if Chinese interests took over Barclays altogether, and then proceeded to lend out the deposits of British savers with the same care they’ve lent out their own money back at home in China?

There are at least $1 trillion in bad debts sloshing around in the labyrinthine Chinese banking system. I don’t know about you, but I surely wouldn’t want to see British savers being forced to bail out a rotting mess like that. Or, in an example a bit closer to home, consider the U.S. banking system, where bank accounts are insured by the federal government? Taxpayer bailout, anyone?

Because the funds – and the countries that back them – run the gamut in terms of size, experience and ultimate objectives, it’s tough to apply a single yardstick in evaluating them. Singapore, for instance, is probably fine. True, the country has a reputation for flogging teens that drop bubble-gum wrappers on the sidewalk, or mischievously set off car alarms. But none of that will affect its investment results. And those results have presumably been decent, given that it’s been around for more than 30 years. Besides, it’s “only $80 billion” that we’re talking about here. And that’s not even enough to finance the ABN AMRO buyout on its own.

Dubai, on the other hand, has had to navigate some rougher waters. The Middle Eastern country – the home of the world’s only “7-star” hotel and the world’s tallest building  – saw its investment fund get into trouble last year when it bought the British-owned Peninsular and Oriental Steam Navigation Co. (which, alas, no longer runs ocean liners “port-out, starboard home” through the famed Suez Canal, but instead held the management contract on roughly two-dozen of U.S. ports).

The Dubai fund’s DP World business unit requested – and received – the approval of U.S. regulators to assume management of the American ports. But after some major huff-and-puff by Congress, which opposed the deal on security grounds, Dubai agreed to sell the U.S. port contracts to a U.S. firm, which turned out to be the asset-management arm of insurer American International Group Inc. (NYSE: AIG). In the end, both U.S. relations with Dubai and Dubai’s appetite for U.S. assets were dented. For details on Dubai’s shrewd new private-equity plays in Europe and Asia, click here.

As you can see, at best it’s a crapshoot, and at worst it’s a can of worms.

At one extreme, Singapore and Japan are so benign (and, in Japan’s case, so cautious), that as an investor, you would welcome both as fellow shareholders. But at the other end of the spectrum, Russia’s track record is currently so bad that you’d probably find yourself just waiting for it to loot the company, or to pull some other shenanigans that would wreck your investment. China and Dubai are somewhere in between, although we’ve already seen how easily they, too, could spawn problems in your investment portfolio, or with your national economy.

Overall, it looks to me like the emergence of state-run venture funds is a trend that we’re going to have to deal with for some time to come. Aside from the occasional messy political spillovers, and the occasional required investment disclosures, they’ll often be able to operate well below the radar of the world’s supervisory bodies.

That will make them exceptionally tough – if not impossible – to regulate. And that makes it highly probably that you’ll wake up one day to discover one’s become your partner. The decision of what to do then will be entirely up to you.

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