How China’s stunning economic growth impacts everything from how much you pay for gas and burgers to what you can earn investing.
In this podcast, you’ll learn:
- What does BRIC mean?
- Why you need to understand China’s growth in order to truly comprehend the global economy.
- How fast has China’s grown over the past thirty years.
- What percent of the world resources does China consume.
- How continual growth of developing nations will impact the price of commodities.
- Why individuals should lower their environmental footprint.
- What economic model has China used to grow their economy thirty times over.
- How China controls their currency how it impacts trade.
- How and why is China rebalancing their economy.
- Why I’ve invested in China.
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The Rise of China – Is It Sustainable?
How did China, a poor but extremely populated country that is governed by the Communist party, manage to expand their economy thirty times over in thirty years?
Recall that economic growth measures a nation’s output from one period to the next in terms of goods and services produced.
A poor, centrally planned country that is trying to significantly ramp up economic growth by producing more output faces a conundrum. Not only is there a lack of economic incentives for individuals to start businesses to produce output, but households are too poor to purchase what is made.
China’s Growth Model
China’s solution to this problem was to pass liberalizing reforms that allowed individuals to start their own businesses instead of working with state-controlled collectives.
Many of those businesses, knowing their citizens were poor, focused on leveraging low wage rates in China to produce exports that could be sold cheaply overseas.
In addition, local and regional government entities facilitated the movement of goods and workers by investing heavily in infrastructure, such as roads, bridges, mass transit systems and buildings.
To encourage business and infrastructure expansion, China allowed businesses and local government entities to borrow at extremely attractive interest rates, well below the rate of inflation.
At the same time, the interest received by households on their bank savings was also below the inflation rate. That meant citizens were losing money every year after adjusting for inflation. As a result, Chinese households routinely saved twenty to thirty percent of their after-tax income for education, healthcare and retirement.
Of course, the ramp up of production and infrastructure investment meant that construction and factory jobs were abundant, which provided households with income that could be saved.
In a normal environment, if a country runs a large trade surplus by exporting huge volumes of goods, their currency will appreciate in value as exporting businesses exchange the foreign currency they earn from selling goods overseas for the domestic currency.
As the home currency appreciates, a nation’s exports become less competitively priced and the large trade imbalance is reduced.
China has avoided this fate by keeping their currency pegged to the dollar. The Peoples Bank of China (“PBOC”), the Chinese central bank, achieves this by acting as the foreign exchange market.
Chinese exporters convert their foreign currency holdings into the Chinese yuan at their local bank. The local banks in turn, exchange the dollars, euros and other foreign currency with the PBOC.
Where does the PBOC get yuan used in the exchange? It simply prints it.
This results in a large supply of new money flowing into the Chinese economy, pushing up domestic inflation. It also means Chinese-made goods available overseas are underpriced because exchange rates are not allowed to adjust. This puts downward pressure on prices in the United States and other countries.
Finally, it means the Chinese central bank has huge reserves of dollars and euros that it invests in U.S. and European government debt and other foreign investments, such as real estate.
Transitioning the Chinese Economy
This pattern of encouraging infrastructure investment and exports by keeping interest rates and currency exchange rates artificially low has been phenomenally successful in growing the Chinese economy.
It has also led to corruption, over-investment in some areas, real estate bubbles, and bad debts that threaten the banking system.
China is now attempting to transition its economy so it becomes more consumer driven.
Former Chinese Premier Wen Jiabao said to “unleash domestic demand holds the key to long-term and steady development of China’s economy.”
That will be a herculean task because much of China’s economic growth has been at the expense of its households. Chinese households have been forced to subsidize business and government entities by accepting below market interest rates, high rates of inflation, and overpriced imports.
Transitioning to a consumer led economy will require consumer friendly reforms, and there are many influential business leaders and government officials who prefer and have benefited handsomely from the existing economic growth model.
President Xi Jinping appears to be trying to head off opposition to the needed economic reforms by initiating an aggressive anti-corruption campaign.
At the same time, 64% of Chinese millionaires have either emigrated from China or plan to do so according to a report by Huran, a wealth research firm.
China’s economic progress has been spectacular, but this next phase will be much more difficult.
What Will Unlimited Growth Cost?
One of the most compelling stories of the past thirty years is the rise of China as a global economic force. In three decades, the Chinese economy has grown from a tenth the size of the U.S. economy to 60 percent its size.
In 1980, China was a poor but populated country with just under one billion citizens. Gross domestic product (“GDP”), a measure of a nation’s output, was $303 billion expressed in today’s dollars according the International Monetary Fund (“IMF”).
On a per-person basis, the Chinese economy was even smaller as GDP-per-capita was $307 versus $12,575 for the U.S.
Today, China’s GDP is $10 trillion or $7,332 per person compared to $17.5 trillion or $55,000 per person in the U.S.
China remains a poor but populated country of 1.3 billion citizens. Still, its economic growth has been stunning.
What does it take for an economy to grow that rapidly?
Lots of cement, coal, steel, and pigs.
In 2010, China consumed 53% of the world’s cement, 47% of its coal, 45% of its steel, and 47% of its pigs, according to data compiled by the investment firm GMO from various sources including Barclays Capital, Credit Suisse, Goldman Sachs, the IMF and the United Nations.
Surprisingly, China has about 240 million vehicles on its roads, about the same as the U.S., but it consumes only about half the amount of oil as the U.S. (Source: China Ministry of Public Safety, U.S. Bureau of Transportation and the U.S. Energy Information Administration).
The day will come, though, when China will have significantly more vehicles than the United States and consume more oil. The U.S. has 791 vehicles per 1,000 people whereas China only has 79 vehicles per 1,000 people (Source: OICA).
China ranks 83rd in the world in terms of its standard of living as measured by nominal per-capita-GDP. The U.S. rank 8th (Source: IMF).
Developing countries, such as China, India and Brazil, aspire for their citizens to have the high standard of living experienced by the United States. They want to have a bounteous supply of food (including beef where China only consumes 10% of the world’s supply) and the ability to drive wherever they want, when they want.
Most countries have a long way to go to approach the United States’ standard of living as average per-capita GDP in the world is only $10,500 versus $55,000 for the U.S.
Consider how much cement, steel, coal, oil, beef and pigs it will take to bring the world up to the U.S. standard of living.
Pigs are a renewable resource. Coal, oil, copper and many other commodities are not. There is a limited supply.
When demand for commodities outstrips new supplies then prices have only one way to go-up.
In his book Small Is Beautiful, E.F. Schumacher writes, “From an economic viewpoint, the central concept of wisdom is permanence. Nothing makes economic sense unless its continuance for a long time can be projected without running into absurdities. There can be growth towards a limited objective, but there cannot be unlimited, generalized growth.”
Our global economic system is based on unlimited growth, not permanence. We are a throwaway society as we race to produce and consume as much as we can as cheaply as possible.
Perhaps technological advancement will allow developing countries’ standard of living to catch up with the U.S. without wrenching price increases for non-renewable commodities, such as oil, coal, and copper.
But given the disparity between rich and poor nations, the current consumption levels by China and with other developing nations following a similar path, I’m not counting on it.
Wouldn’t it be more prudent for us as individuals to learn to live in a way that is less resource intensive now instead of waiting for commodity prices to force our hands?
How would our lives be different if they were tilted more toward permanence and less toward consumption?
Next week, I’ll explore in more detail how China managed to grow their economy so quickly.One way we prepare is by scaling our exposure to risky assets to our ability to recover when a market sell-off occurs.