In 1949, just a few short years after the end of World War II, the armies of Chinese revolutionary leader Mao Zedong moved into Shanghai and the existing Chinese government under Chiang Kai-shek decamped to Taiwan.

Under Zedong, China pursued hardline Communism for the next 30 years, with limited liberalization thereafter. Taiwan opted for a free-market economy, and the country has been a haven of low-tax capitalism ever since.

Taiwan – formerly known as Formosa – has been a full democracy since 1987. There are two main parties: There’s the Kuomintang (KMT), the actual heir to Chiang Kai-shek’s former Chinese government, and also the Democratic Progressive Party (DPP).

In 2000, after 50 years of KMT rule, the DPP took power under President Chen Shui-bian. Both the DPP and the KMT are firmly capitalist and committed to small government; it’s in the area of foreign policy where they differ. The KMT is quite keen on reaching accommodations with China, while the DPP is inclined to proclaim Taiwan’s full independence.

With its breakaway from China, Taiwan has diplomatic relations with only 24 countries, the largest of which is Costa Rica, but so what? The country undoubtedly saves money by employing fewer diplomats and we’ve already seen that its businesses flourish in the international marketplace. The only danger is that China might get rough, but since Taiwan has U.S. protection, we see that as a pretty remote possibility. Besides, as we’ve also demonstrated, Taiwan is rapidly helping China get rich; there can’t be much of a motive to mess around with an already-good thing.

At last week’s legislative elections, the Kuomintang won a big majority, grabbing 81 seats, to only 27 for the DPP. A presidential election is scheduled for March 22, at which the principal candidates will be Ma Ying-jeou of the Kuomintang and Frank Hsieh of the DPP.

As the presidential election looms, each side has accused its opposition of bribery. While corruption is certainly an important political issue, it isn’t much of an economic concern: Taiwan ranked 34th on Transparency International’s 2007 Corruption Perceptions Index, below Singapore (4th), Japan (17th), and the United States (20th), but above South Korea and Malaysia (tied for 43rd), China and India (tied for 72nd), and Thailand (84th).

There’s one other important point to note: Taiwan is uncorrelated with all of your other holdings, a real bonus from a diversification standpoint, and one that makes our already-strong investment case for this country even better.

[For analysis on four Taiwan profit plays, please click here]

News and Related Story Links:

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PetroChina Company Ltd. (PTR) became the world’s first trillion-dollar company on Monday, when its initial public offering (IPO) soared to three times its issue price on the Shanghai market. It more than doubled the value of its Hong Kong shares. 

Moreover, the Shanghai stock market is up 160% year to date, a truly stellar performance. The only problem is that China is looking a tad overbought. And right now I prefer the "other" China, the one with a growth rate double that of the EU and U.S. markets. It’s also one that’s a screaming bargain.

Here’s what I mean …

Growth and Riches Combined

The "other" China is actually Taiwan. Although its shares are up "only" 15% in 2007, it’s a considerably better value than China at current prices. Its stock market is trading on a price-earnings ratio of less than 15. What’s more, the country is 100% democratic, with two economically sensible parties, a presidential election in December, and a congressional election in March. [As far as I can see, it doesn't really matter which side wins; they're both good].

If you want to chase performance, go ahead and run after China, but for me there’s something irresistible about a bargain.

Taiwan’s economic growth, at 5.1% over the last four quarters, looks unexciting compared with China’s 11%. But you have to remember that Taiwan is a hell of a lot richer, with per capita gross domestic product (GDP) around $30,000, just above the average for the European Union. That means it has to grow more slowly, because it already has most of the "niceties" of a modern Western civilization. It just can’t achieve an extra spurt of growth by getting them.

Nevertheless, Taiwan’s productivity growth at 4.1% per annum is more than double that in the EU, and around double that of the United States.

With productivity gains this big, Taiwanese companies are steadily becoming more competitive across the globe, as their costs decline. And that explains the country’s balance of payments surplus and international reserves of $271 billion. We’re talking about a country that’s not about to run out of money, whatever chaos erupts in the rest of the world economy.   We’re also talking a country with an immensely impressive high-tech capability.

One attractive feature of Taiwanese companies is their close connections in the Chinese economy. For example, Hon Hai Precision Industries ( HNHPF) may trade on the pink sheets in the U.S. (reducing its liquidity), but it’s also the world’s largest contract electronics manufacturer, with sales of $28 billion in 2005, six times 2001 sales, and profits of $1.3 billion.

Hon Hai’s products include Mac minis and iPods for Apple Inc. (AAPL), motherboards for Intel Corp. (INTC) and all three of the new game consoles that are battling it out in world markets. Once it figures out how to make a product, it’s highly likely production will be moved to one of its 10 manufacturing facilities in China. Hon Hai is on a price-earnings ratio of 24, but I think that’s a stone cold bargain for its growth, both past and potential.

If you’re skittish on pink-sheet stocks, you can always buy the Taiwan market as a whole, though the iShare MSCI Taiwan Index (EWT), which trades on a price-earnings ratio of 15, and yields 1.8%. [ Nine percent of that index is represented by Hon Hai, so you don't miss it altogether].

Alternatively you can go for Taiwan Semiconductor Manufacturing Co. Ltd. (TSM), one of the world’s leading semiconductor manufacturers, which is trading at a forward P/E of 13. A 3.4% yield doesn’t hurt here, either, making it pretty attractive for a tech stock. [For comparison, Intel is on 25 times earnings and a dividend yield of 1.7%].

OK, China’s the economic behemoth of 2050 and your kids are all learning Mandarin. But your money may be even happier in the "other" China – the one that’s already rich and stable.

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