By Nathan KowalskiInvestors have focused on China for some time. What is amazing is how difficult it continues to be to get a real read on what is happening.Recently I was in Hong Kong and I attempted to get a feel for what is really going on while I was there.Unfortunately I wandered into a Chinese maze that only continued to heighten my scepticism on China and its current situation.There are a number of misconceptions and issues, good and bad, which continue to make China extremely difficult to decipher. From my various discussions abroad I’ll attempt to highlight a few aspects that continually came up:1) Variable Interest Entities (“VIE”). You can be excused if you have never heard this term before. The Chinese and Chinese investors often don’t want to discuss this.In fact when I questioned a Chinese internet analyst he just laughed and brushed off my concern.The biggest risk for investing in China, like many emerging markets, is most arguably the rule of law.This is where the VIE muddies the situation. VIEs have been used for a number of years primarily to circumvent China’s rules that ban foreigners from investing in certain sectors such as internet and telecommunications. Essentially it involves a series of various contracts that allow a foreign investor control over companies in China that they actually do not own. For example, a host of Chinese internet companies operate this way — Sina, Baidu.com, Tudou, and Sohu.The recent case where Alibaba Group transferred assets from Yahoo without any say has highlighted that Chinese companies may be able to simply walk away from its VIE contracts with foreign partners leaving them without legal recourse.These structures have been around for about ten years but now the Ministry of Commerce in China is looking into them and it is unclear how this will pan out. Buyer beware — if you own any companies subject to a VIE.2) Questionable stats. No one seems to believe Chinese government statistics — including the Chinese. Out of all the Chinese/Hong Kong residents I talked to none of them believed or even extensively relied on government statistics.A lot of conspiracy theorists believe that the mal-investment problems and oversupply in China are being masked by government manipulating statistics that are reported. While I wouldn’t go that far, I would suggest that any stat you see coming out of China should be taken with a pinch of salt. Ask yourself why the Public Safety Bureau suddenly stopped publishing data on new car registrations in a period when they have begun to plunge?Where are statistics on vacant apartments? Why are steel industry statistics continually revised? Why is power growth almost flat year-over-year when GDP is up over seven percent? Electricity production, Macau gaming revenues, consumer spending habits and appliance and air-conditioning volumes do not necessarily suggest that the Chinese economy is collapsing, but they reliably do suggest that the economic slowdown is more pronounced than official Chinese statistics would have you believe.3) China’s economy is not controlled by the government. Most people view the Chinese economy as a command economy essentially controlled by the government. I would argue that this has fundamentally changed and that the shift in the composition of the economy actually now lends itself to be subject to more market based cyclical factors. This, of course, is bad news for those who think that the Chinese government can simply “stimulate” the economy back into action.I, for one, don’t believe that it is that easy anymore. Let me explain why. According to research conducted by Andy Rothman of CLSA, in 1958, 86 percent of urban workers were employed by state firms. This high level of government job control lasted through 1989 and remained above 70 percent. Between 1995 and 2001, however, the Chinese government essentially laid off the combined workforces of France and Italy — 46 million state-sector workers. As a result the state’s share of urban employment plunged to 28 percent in 2002.In recent years nearly all new job creation has come from private firms. As of 2010, the state’s share of total urban employment rests at only 19 percent, leaving 81 percent of Chinese workers at private companies.Private firms also drive corporate investment. State fixed asset investment has even fallen from 58 percent in 2004 to 32 percent in the first quarter of 2012. State Owned Enterprises share of exports has also plunged from 56 percent in 1997 to 14 percent in 2011.The Chinese economy continues to evolve to be driven more by private business than government mandate. While the government still plays a huge role, especially through its control of the financial system, the economy is increasingly in the hands of the private sector. I think investors need to increasingly focus on what is happening at the various industry levels and less and less on what the Chinese government says or does. Their control is diminishing and therefore their desired effect on the economy will be weakened as the “invisible hand” exerts greater influence.4) The Chinese economy is not driven by exports. This misconception is understandable given almost everything you buy in a store has a “Made in China” sticker pasted on it.The problem is that household consumption and gross capital formations are really the drivers of China’s GDP.Prior to the global financial crisis, China averaged about ten percent GDP growth but only about one percentage point of this came from growth in net exports.In 2010 net exports accounted for only four percent of overall GDP. Exports obviously matter for jobs but it’s important to realise that the economy is very much a domestic consumption and domestic investment story.The points discussed are but a few confusing examples of the Chinese story.Most investment thesis eventually acknowledge the fact that the truth is often more complicated than first believed. In my opinion, there is still “too much bull in the china shop” and only time and/or in depth research will clarify some of these confusing aspects.Nathan Kowalski is the chief financial officer of Anchor Investment Management Ltd.