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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3 Responses to On The Rise of China

  1. Wen says:

    The one child policy officially only applies to 36% of the population. State employees are the only class to whom the rule strictly applies. In fact, a family who want a 2nd child can have one but must pay a ‘fine’ to govt officials. The fine is quite steep in urban centres like Shanghai, but is only a few hundred dollars in most places. If you don’t want to pay the fine, you can go to Hong Kong. We had our 3rd son in a HK private hospital. Every mother there was from China. So this policy, which really only began in 1980 and which has been greatly exaggerated in the western media, may not be the economic determinant you state. In addition, different attitudes and virtually no labour laws mean that workers may continue into old age; others may begin work at younger ages. And the ‘demographic time bomb’ may just go off like a wet Chinese firecracker.nIn China, we had a census this year. Big banners everywhere. Slogans. TV interviews showing people from all walks of life dutifully filling out forms given them by smiling, helpful gov’t agents.nNobody gave me a form. Nobody gave my neighbours a form. In fact, I don’t know anyone who was included in the census.nI’m guessing the statistics will be like most stats in China–made up by some gov’t workers while they sip noodles and play computer games at work.

  2. Kirk Kinder says:

    Cale,nnInteresting stuff, and I agree with most of what you said. I think the call for China to overtake our GDP will go the way of the call for Japan to do the same in the 1980s. I don’t know if I agree with your population argument though as we are also going to see an aging population that will affect our economy (just look at SS and Medicare shorfalls that are coming). While we certainly are bringing in citizens, we need to do a better job of keeping the foreign students who become doctors, engineers, etc. Right now, most of the folks coming in are landscaping or opening 7-11s. That affects productivity. nnI think the main reason they won’t catch us is productivity. An economy’s growth is based on two factors: population growth and productivity. Let’s call the growth an even Steven for arguments sake. Where we will hold ground is productivity. China’s economy has grown significantly due to its increased capacity utilization. However, capacity will eventually fill up. At that point, productivity has to be the driving force for growth. You can argue all you want about the Communist government promoting growth and making the right decisions, but I say it will eventually be shown to be total bunk. Productive economies cannot be controlled by a central planner. They will make enormous mistakes that will retard their growth. Chanos arguments that you cite are great examples. Their housing and credit bubble is immense. They have printed as much money as we have since 2008 with an economy only the third our size. The Communists are not better at allocating capital than our system even with our increasing government interference. nnWhen 2016 comes, we will probably find this is another fallacy unless China really allows free markets and the rule of law to flourish, and I don’t see the government giving up that much control…not without a fight.