In the September 29, 2007 Economist, the author discussed the importance of China in the world economy mostly from the perspective of the potential downside. That is, given China’s unprecedented growth rate for over thirty years and her importance to the world economy, the Economist tried to put in perspective possible calamity scenarios. Although the Economist ultimately came out that China could avoid the downfalls that beset Taiwan in the 1980’s and Japan in the 1990s, I remain somewhat skeptical. That is, I remain suspicious that a communist led government with an outdated banking system can successfully meet all the twists and turns of a global economy without stumbling on occasions.
In today’s world, we cannot discuss international economics without discussing the growing strength of China. No country in history has sustained such a blistering rate of growth over three decades as China. Since 1978, China has grown by about 10% a year—more than Japan or the Asian tigers achieved over similar periods, when their economies took off. But eventually, the other Asian tigers lost steam. That is, Japan which had a growth rate of 9.5% in the two decades to 1970, slowed to 4.7% in the 1970s and to only 1% by the 1990s.
A friend of mine who recently returned from China commented that China’s construction projects involve workers around the clock every day of the year!
China has become such a power factor in global markets that it now contributes more to global gross domestic product growth rate than the United States. In essence, while we once said that when the United States sneezes, the rest of the world catches pneumonia, we now recognize that China’s economic fitness has dramatic worldwide ramifications.
Given the importance of China, what are their possible Achilles heels? First of all, China does have an inflation problem. Its consumer-price inflation of 6.5% does indicate some danger of an overheated economy. However, most of China’s inflation stems from higher food prices. That is, without food, China’s inflation is less than 1%. Clearly, however, the Chinese monetary authorities need to employ fiscal and monetary restraints to prevent their inflation rates from soaring.
Secondly, China’s stock market could be a bubble! Share prices have risen 400% in just over two years, and the average price-earnings ratio based on historic profit earnings are about 50 times. Based on the forecast of earnings for 2008, the multiple declines to 30, which is still a very high number. While a precipitous decline in the Chinese stock market would cause havoc, we should recognize that the stock market represents only 35% of their Gross Domestic Product while it represents 180% of the United States Gross Domestic Product. Also, equities only represent about 20% of the average Chinese households’ total financial assets compared to 50% in America. Interestingly enough when the Chinese stock market declined by 50% from 2001-2005, the Chinese economy remained robust.
While China has similar characteristics to both Japan and Taiwan, whose economy and stock market swooned after spectacular run ups, there are some important differences.
China, like Japan in the 1970’s, has high rates of saving and investment, low real interest rates, soaring asset prices, a big current-account balance, and upward pressure on its currency, China also has some differences from Japan. That is, unlike Japan, China’s property values while rising some 8% have not had the speculative surge of Japan. Also, house prices in China relative to real income have declined by some 25% in comparison to the 45% rise in the United States.
Lastly, what impact would a recession in America have on China since the United States represents since exports represent some 40% of China’s Gross Domestic Product? In essence, china would suffer from excess capacity and a sharp fall in profits and investment if the export engine to America falters. However, the Economist points out that seventy-five percent of China’s growth in Gross National Product stems from internal consumption not exports. In fact, when the United States had a recession in 2001 and China’s exports declined 25%, China’s growth rate remained strong. Fortunately, China is selling percentage wise more to the European Union and other emerging economies. For example, so far this year, China’s exports to the United States grew 14%. At the same time, their growth in exports to the European Union grew by 40%.
Originally published in the Sarasota Herald-Tribune
