On The Rise of China

Around the time of my annual meeting, I was getting asked repeatedly about a handful of things the media keeps harping on. One of those things was China, and the question I’d often get was some version of, “Is the economic powerhouse that is China going to bury the U.S., or what?” That question started popping up again last week.

So, for the record, my answer to that question is, “I’m not afraid of China, and you shouldn’t be, either.” Here’s why:

It’s true that at current rates the gross domestic product of China will surpass the United States in the next ten years.  The IMF actually predicts this will happen in 2016…but it also seems to be overlooking a potential bubble in China that some very smart people are betting will soon end.

In any case, while the exact date may be subject to debate, the inevitable result doesn’t seem to be. While that rankles my big ole American ego a little, and makes me long for the days when the U.S. actually, uh, made stuff, the more rational side of me doesn’t see a wealthier China as being a fundamentally negative thing. The funny thing about countries becoming rich is that they also seem to become more stable, presumably because a wealthy, comfortable society doesn’t want to start picking fights or creating trouble. They’d rather stay focused on trying to become even richer – by creating more new stuff, and improving all the old stuff. The rise of China is really not our loss anymore than a decline in Germany would be our gain.

Now, having said that, I actually don’t see a truly rich China on the horizon. Not where it matters most, anyway – on a per capita basis. While it appears China’s total GDP will be equal to the United States’ by 2020, or possibly a few years sooner, the country’s per capita GDP will still be a fraction of ours at that time. Right now every American produces an average of $42,517 in economic value, while the average citizen of China produces just $2,802. We’re insanely more productive – all the more amazing, really, when you consider how much reality TV we watch. But while some of the major coastal cities of China look wealthy and modern, the inland is rife with poverty.

And this is where I believe China’s previous policies could finally catch up to it. Because around the same time that China’s GDP catches up with ours, it also appears the Chinese will, to be blunt, begin to die off. Demographically speaking, I mean. It’s just math, yet this seems to be curiously under-reported.

Population experts will tell you that if the women in a country have on average less than 2.1 babies, then the population of that country will shrink – unless it’s offset by higher immigration. How’s that relate to China? Remember the country’s long-standing One Child policy. Plus, communism and open borders aren’t exactly sympatico.

So largely because of that low “fertility rate” and an expected future decline in its working age population, China’s economy is going to begin to have a major demographic problem in about five years. While pundits never seem to tire of telling us that China will soon reach a population high of 1.4 billion people…they never seem to mention that the number begins to fall off a cliff right after that. And don’t confuse population with productivity, either.

As anyone who has stayed awake through Macroeconomics 101 can tell you, long-term economic growth depends on three things, really: capital, ideas, and population. And as a few population experts have quietly been trying to explain, because of that dramatically shrinking working-age population, it’s quite likely that China is going to get old before it gets rich.

Think I’m nuts? Look at Japan, which in the early 90’s seemed destined to overtake the U.S. economy, too. What happened? The Japanese ran into problems with both supply and demand in the macro sense. First, demand for goods and services in Japan collapsed when the Japanese real estate and stock market bubble burst, then the country found itself unable to recover due to serious supply issues caused by a low birth rate, aging population and essentially zero immigration.

China should take heed: a shrinking workforce is going to crimp your economy eventually, no matter how many people you start out with. And if your economy overheats too close to the point at which your working-age population begins to decline, then your problems could compound in a decidedly unfavorable way.

So, U.S. investors should relax about China. There is not only no real reason to invest in Chinese companies, but this could also prove to be the exact wrong time time to start.

Cale Smith

About Cale Smith

Portfolio Manager at Islamorada Investment Management.

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