Yesterday, China’s benchmark Shanghai Composite Index dropped 5.2 percent after economic data revealed wholesale price inflation jumped to its highest level in 12 years in July.

However, Taipan Daily editor Justice Litle says China’s long-term outlook remains strong – and some China plays look more favorable than they have in years. Here are Justice’s six reasons why the China bears are wrong…

Reason to Buy China #1: The Silly Season Is Over

Chinese investors went through a mania phase last year. There were tales of lines half a mile long snaking out from the doors of the local stock brokers. In April 2007 alone, nearly 4.8 million new trading accounts were opened in China — more than the prior two years combined.

All these new buyers led to a silly season for Chinese stocks. You could see it in the difference between Shanghai A-shares and Hong Kong H-shares…

At one point, companies with dual listings in Shanghai and Hong Kong were getting as much as an 80% premium on the A-shares price. This was a reflection of Chinese capital controls — it’s still tough for mainland Chinese to get their money out — and naive buyers who wanted to play at any price.

Now that the frenzy has subsided, real values are starting to show up again. The hot money has burned itself out, providing opportunities for those who see longer-term value and aren’t out to just flip a quick buck.

You see this pattern play out over and over again when a new opportunity comes to a place. Investors get excited and lose their heads, they push things way too far, and then the market comes crashing back to earth. That’s when the patient players get interested.

Reason to Buy China #2: Oil Is Coming Down

As of this writing, crude oil is more than 20% off its near-term highs. It looks like oil could be heading for the $100 mark — a possibility we pondered in “What If the Price of Oil Implodes.”

One of Asia’s greatest challenges has been keeping a lid on inflation pressures. It’s not easy to grow like crazy without seeing the price of basic goods and services rise too quickly.

Oil closing in on $150 a barrel threatened to swamp Asia with inflation on a local level — as the price of transport, food, and fuel went up — and also to cut into export profits as shipping costs rose.

With oil backing off, China and India can breathe a little easier. The fear that high-priced oil might kill the Asian miracle is lifting. That gives them more time to tap alternative energy solutions and build economic strength at home.

Reason to Buy China #3: The Locals Are Optimistic

The news reports mostly focus on the bad things — civil unrest, government crackdown, pollution and so on. That’s the nature of the beast mostly… for the most part, good news isn’t as interesting as bad.

But a recent survey from the Pew Research Center shows that most Chinese feel positive about where their country is headed. According to the survey, 86% are “content with the country’s direction.” (That’s up from just 25% six years ago.)

Perhaps even more surprisingly, six in 10 Chinese reported being satisfied with their jobs. And 70% were in favor of China’s shift toward a free-market economy.

The biggest concern in the Pew Survey? Rising prices. But that concern is addressed by the fact that oil is headed down these days — not marching higher as it had been for most of the year.

Reason to Buy China #4: The Growth Is Still There

China has had an amazing run, growing its economy at a near double-digit pace since the early 1980s. But the dragon isn’t done yet — not by a long shot.

Global Insight, an economic consulting firm, forecasts that China will overtake the U.S. as the world’s largest manufacturer in 2009. This is as much because the U.S. base is shrinking, even as China’s is growing… but that still counts as an eye-opening stat.

Plus for the longest time, China was seen as the world’s source for low-tech goods. Chinese factories were known more for sneakers, trinkets and cheap plastic toys than items of real value…

That’s all changing now as China moves up the quality food chain. Now we are seeing savvy companies like China Medical Technologies (NASDAQ:CMED) produce some of the most sophisticated high-tech devices in the world. As China gets better at enforcing intellectual property laws, its high-tech skills will only increase… and profit margins, too.

Reason to Buy China #5: Personal Savings and Domestic Demand

Perhaps even more impressive than China’s long-term growth rate is the personal savings rate.

Americans spent more than a dollar for every dollar they earned in 2006. The U.S. savings rate actually went negative. The Chinese, meanwhile, salt away 35 cents for every dollar they earn.

Just imagine how much extra money you’d have on hand if you’d managed to save 35% of your income, year in and year out, ever since you started working. Then just think of all the things you could buy with that cash.

Part of the reason the Chinese save so much is because there’s no real social safety net. But that’s changing, too: As the Chinese economy evolves, things like insurance and healthcare and retirement plans grow more affordable.

The upshot is, at some point, China’s big savers will feel a little bit more comfortable spending some of that cash they’ve saved up. And the newly minted middle class in China are already taking a hard look at things like cars, air conditioners, washing machines and so on.

As local economies grow, the locals themselves feel more comfortable spending a portion of their ample savings. That in turn leads to more domestic growth, which leads to a more positive outlook, which in turn increases spending. Chinese domestic demand is headed into a virtuous cycle that could run for decades.

Reason to Buy China #6: Huge Foreign Reserves

In balance sheet terms, China is rich… massively rich.

We’ve already seen what can happen when cities and counties go bankrupt. The residents of Orange County, California, got a nasty taste of that. Jefferson County in Alabama was on the brink this year, too. (As with Orange County in 1994, they took on some really dumb trades.)

So it’s not good when some regional authority — be it local or national — is running short on cash. China doesn’t have that problem. If anything, they have the opposite problem. Economist Brad Setser estimates that China has somewhere between $2.3 trillion and $2.4 trillion in excess reserves.

That’s a lot of dough… enough to make a 20% down payment on the entire U.S. economy! And hundreds of billions more roll in every quarter.

Point being, money can’t always prevent bad things from happening. But it sure can fix a lot of things. If China has to take extra steps to keep economic growth on track or keep the domestic demand side humming, it certainly won’t be stymied by lack of funds.

Source: Six Reasons to Buy China

The news that’s all the rage today is Westpac’s $19 billion bid for St. George. It would create the biggest bank, by assets, in Australia. So… should we care? Big five? Big four? Big deal!

Is it a big deal if you’re an investor? That depends on whether you believe the banks are a buy. If one bank is buying another bank, then at least one bank thinks banks are a buy. But why? And is what’s good for one bank good for the investor?

The question, as always, is where earnings growth is going to come from? In that light, the Westpac move is all about growing the loan book through acquisition. Growing the loan book means putting more Australian in debt. We’ll get that in a minute. But let’s take a quick look at the details first.

First, if you exclude non-recurring items, cash profits at Australia’s big five banks grew by just 1.1% in the first half of 2008 compared to the year before. During the biggest credit crunch of the last thirty years, that’s not awful. But it’s not good either. By the way, all the data that follows, unless otherwise indicated, is taken from the KPMG survey “Major Banks: Half Year 2007/08.” It’s an excellent read. Seriously.

Aussie banks didn’t face massive losses from bad housing loans (although at least one bank, ANZ, took big losses on loans to stock brokers). So what ate into profitability? The “net interest margin” declined for all five banks in the first half of ’08. The interest margin is the difference between what Aussie banks pay to borrow and what they pay out interest on deposits.

The credit crunch has raised the cost of “wholesale borrowing.” ANZ’s interest margin decline from 2.24% to 1.99%, Commonwealth Bank’s from 2.22% to 2.17%, NAB’s from 2.33% to 2.18%, Westpac’s from 2.25% to 2.05%, and St. George’s from 2.07% to 1.92%.

So here’s the question, dear reader: if you’re making less money lending money because the cost of money has gone up, how do you make more money? You make it up on volume.

Despite the decline in net interest margins, total net interest income actually increased by 9.8% in the first half to $17.6 billion. The banks managed that by growing assets by 19.9% in the first half compared to ’07. Growing assets by that much is an accomplishment during a bear market in credit. How did the banks do it?

The banks grew their lending portfolios by 16.1% in the last twelve months ended March. Consumer lending (housing, credit cards, personal loans) grew by 11.2%. Business lending grew by 24.5%. Total bank assets in Australia now exceed $2 trillion.

Now THAT’s how you grow your way out of a credit crisis. You lend more. It could, of course, be troublesome if you look at bank assets as other people’s liabilities. Debt levels are already high at the household level. For banks to grow assets, household debt levels would have to grow even more and business borrowings would have to rise as well.

The trouble with growing your assets to drive your earnings is that you take increased credit risks to do it. This was the problem for the Government Sponsored Enterprises in the States and led to massive blow outs in their balance sheets (the regulators came in late to restrict the growth in balance sheet assets).

Eager to drive earnings and please shareholders (and make some money on stock options tied to earnings growth) bank managers in the States grew the balance sheet with little to no regard for asset quality. That is one simple explanation for how a mortgage lending bubble gets started.

Here in Australia, if banks are going to continue growing assets, the housing boom will have to keep booming. This is problematic too, with housing already so unaffordable. For example, the Australian Bureau of Statistics reported today that the number of home-loan approvals fell by 6.1% in March.

Higher interest rates are discouraging demand for housing loans. Yet the banks have to loan more to make up for declining margins. But the more they loan, the bigger the risk they take that the loans will be non-or under-performing.

Is there any way out for the banks? Well, they could hope for an increase in net interest margins. This would lead to a decline in the cost of borrowing money. The banks could leave the interest rates they pay on deposits fixed, and benefit from the lower cost of funding. An end to the global bear market in credit would help, then.

Of course, there’s another way banks can grow earning without growing loan volumes. You know it well! Fees!

If profitability on loans is declining (and it is), the banks could make it up charging you more fees (not that they would ever do that). The growth rate in bank fees has actually declined, if you peruse the data from the Reserve Bank. But bank fees, as you can see from the chart below, contributed nearly ten billion to bank’s income in 2008-basically half of a full year’s profit.

Source: Reserve Bank Statistical Tables, Domestic Banking Fee Income, Table F6
http://www.rba.gov.au/Statistics/Bulletin/index.html

There’s consolation in that massive income from fees if you’re a bank shareholder getting a dividend and some capital appreciation. But if the worldwide model of growing asset values through debt is under massive attack in the U.K. and the U.S., then why would it be terribly different in Australia?

The Wall Street Journal reports that the Fed has sent agents into major Wall Street investment banks to makes sure of the banks’ financial wellbeing.

“We want to be sure that any lending we do to the investment banks will be done on an appropriately sound basis,” said Fed chief Ben Bernanke.

The Fed has is lending money to investment banks, even though it currently has no statutory regulatory power over them. Under recent proposals by the Treasury Department to overhaul the system of financial regulation in the US, the Fed would have an expanded regulatory role.

“Cynics might be excused for thinking that the so-called ‘restructuring’ and massive increase in the powers of the Federal Reserve Board were like spackling, sanding, and repainting the stable doors after the horses had bolted and gotten run over on the highway,” says Joel Bowman in Today’s Financial News.

“The extension of the ‘supervisory’ powers of the Fed to non-bank (deposit) financial houses like stock brokers), derivative dealers, insurance companies, and even to the private, high-risk investment companies of the rich, like hedge funds, is dramatic to say the least. But when it is realized that, in return for supervision, the Fed will stand behind those industries as a lender of last resort, the true revolutionary magnitude of today’s proposal becomes manifest.”