China was the Promised Land for investors in the past few years. Will the 2008 summer Olympics revive China or push it closer to an economical and political ‘nowhere land?’

The good news:

Unlike Athens in 2004, there are no concerns about delayed construction projects. The main 91,000-seat arena, known as the Bird’s Nest, was declared ready last month. Infrastructure, such as subway lines, a stunning new airport terminal and new buses and taxis were also introduced earlier this year. Cleanliness and security of the city also seem to be on schedule.

The pre-Olympic challenge:

It turns out though, that getting the city’s ecological environment – air quality in particular - ready for the games is more like a marathon than a sprint. A marathon that should have started years before China won its Olympic bid in 2001. In the seven years since Beijing was awarded the Olympics, the nation’s industrial output has increased 80%. Decades of careless pollution have left a carbon footprint that couldn’t be erased in just a few years.

China had promised to meet the World Health Organization’s air quality standards, and has spent $17 billion on that effort. Over 200 notoriously polluting plants and factories making everything from chemicals to furniture to building supplies have either been shut down told to cut back pollution or have been relocated.

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To compound the problem, dust storms in nearby deserts throw tons of dust into the air, and because Beijing is surrounded by mountains on three sides, pollutants stay trapped like soup in a bowl.

Have things gotten better?

Better? Yes. Good enough? We’ll see. China uses a government index with a range from 1 – 500. Below 50 is ranked “good” and above 251 “hazardous”.  Under 100 is considered a “blue sky day” or a day of acceptable air quality. For most of June, Beijing averaged 88, which is still double the typical levels in most Western cities and well above World Health Organization guidelines on some types of pollutants.

Is air the only problem?

Unfortunately not! Air, water and soil are all polluted to some extent. 16 of the world’s 20 most polluted cities are in China. More than 70% of China’s rivers are contaminated, half a billion people lack access to potable water. China produces a third of the world’s garbage. Birth defects have risen 40% since 2001; this too has been linked to pollution. The German rowing team was contemplating leaving Beijing before the Olympics even started. The river water was so polluted that the athletes wore masks, afraid the water would splash in their face.

What other risks are there?

The Olympics were expected to be a platform to showcase the “economic miracle of China”. Based on the news coverage leading up to the Games, not only economic aspects will be showcased. Despite strict media censorship, some uncomfortable, little secrets (Tibet, Darfur, child labor, etc.) are bound to seep out.

What happens after the Olympics?

Once tourists, spectators and athletes are gone, locals are still left to deal with the same issues.

The success or failure of the efforts to “clear the air”, at least temporarily, have implications that reach beyond the Olympic Games.  Scientists from around the world are studying the antipollution efforts to see what works and what doesn’t and how much it costs. The conclusions could affect other fast growing economies with similar patterns of industrialization, such as India.

What does this mean for investors?

The explosive growth of China is reflected in the Shanghai Stock Exchange (the largest stock exchange on the mainland of China), which soared from 1,000 in 2005 to over 6,000 in October, 2007. Concerns about the rapid expansion have resulted in a correction to below 3,000.

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The Hang Seng Index, composed of the 40 largest stocks traded on the Hong Kong Stock Exchange, went from 13,300 in 2005 to almost 32,000 in October, 2007 before it fell to just below 22,000.

The iShares FTSE/Xinhua China 25 ETF (NYSEarca: FXI) went from $17 in 2005 to $79 (split-adjusted) in October, 2007 before falling to $25 earlier this year. In June, iShares launched FXIs ‘bigger brother’, the iShares FTSE China (HK listed) ETF (Nasdaq: FCHI) which consists of 88 holdings compared to FXIs 25 holdings.

The months leading up to their respective all time highs were reminiscent to the US tech bubble which came to a crest in early 2000. The Nasdaq (PowerShares QQQ, Nasdaq: QQQQ) reached 5,000 before falling to 1,200.

The correction in Chinese equities has been nearly as steep as its decline; still the bottom might be elusive as China is coping with a sluggish global economy. Domestic problems include:  1) Increasing inflation 2) Eventual expiration of cheap labor 3) Eventual environmental accountability and 4) The effects a rising Yuan would have once the artificial fixing stop working.

We will be watching closely whether the media coverage of the Olympics will highlight China’s industriousness and amazing organizational skills or brand them as a political bully that is dealing careless with their natural and human resources to further economic success.

Public perception might very well be a deciding factor in China’s economic fate. To that end, you can be sure that Beijing’s restaurants won’t be offering dog meat on their menu.

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