growth in China: the bullish case

Hurricane Irene has come and gone. Here at home we’ve got electric power, which makes us better off than most. There’s a local state of emergency in effect, during which driving isn’t permitted. You wouldn’t get far in any event, since many key streets are still flooded.

But we lost internet access at about 1am Sunday morning. Comcast customer service, apparently unaware either of the hurricane or its propensity to lose service in even a light rain, says the company has no idea why service has been interrupted or when it will be restores–only that it won’t be soon. That last makes sense, given the large number of trees knocked over by high winds and the extensive flooding. Still, you don’t come away from the conversation with a feeling the company is on top of the situation. Welcome to Comcast.

Given that I’m not going to write on my phone, and I won;t have a tablet until m current Financial Times subscription runs out, I’m writing this on the back porch (using LibreOffice). At worst, I’ll post it from a Starbucks or a Panera tomorrow.

I spent part of the day reading the latest issue of Foreign Affairs (Sept.-Oct 2011). Two competing articles on the growth of the mainland Chinese economy caught my eye.

The bullish one. For China anyway, is “The Inevitable Superpower,” by Arvind Subramanian, a Senior Fellow at the Petersen Institute for International Economics.

Mr. Subramanian opines that China and the US are neck and neck today as superpowers. On the three key variables for assessing superpower-ness, US has the edge in size of GDP, but China is the clear winner in the strength of government finances and the global influence of its trade.

Long before the end of this decade, however, China’s economy will surpass that of the US. Even figuring that China’s growth rate drops by a third and the US picks up its pace a bit, by 2030 Mr. Subramanian figures China will account for 20% of world GDP, or a third more than the US’s share. The Middle Kingdom will also be as dominant a power as the US was in the decades right after WWII—when it was, economically speaking, the only game in town.

By that time, Mr. Subramanian concludes, the US will have to dance to any song the Chinese piper plays—like it or not. And the US may not like the tune that’s called at all.

As experienced portfolio managers all know, an analyst has enough trouble making precise predictions one year in advance, so actually changing your portfolio based on a possible outcome three decades hence would be folly, even if you were 100% convinced it would come to pass.

On the other hand, Wall Street strikes me as being unusually myopic at the moment. If we focus on the one area where the US leads China–economic size–and do some simple arithmetic, we can come up with an eye-catching result that I don’t think is on the radar screen of many investors.

If an economy grows at 10% per year, five years later it’s 60% larger than it started out. In contrast, if an economy expands at 2% per year for five years, it’s 10% bigger than before. Put a different way, before 2016 is out, the mainland economy could be larger, on a purchasing power parity basis, than the US. If we consider, as well, that the EU will doubtless be in the tortoise camp over that span while other emerging economies will come close to matching China’s growth rate, what we are calling emerging markets could together easily be 50% larger than the developed world—and be in much healthier financial shape.

Implications? Throughout my investing career, emerging markets have been viewed by investors from the developed world as high-beta plays on the developed-world business cycle. In the late 1980s, an economist friend from Japan pointed out to me the potential importance of intra-developing-world trade in creating the possibility of a self-sustaining business cycle in the developing world. The big question has always been when that might occur, and how that would affect the typically high cyclicality of emerging markets equities.

This is a more complex question than it appears on the surface, since developed world investors create this cyclicality by moving in and out of emerging equities as they try to time the US/EU business cycle.

At the very least, we’ll have an answer soon.

That’s it for today.

Tomorrow the bearish China case, “The Middling Kingdom: the Hype and the Reality of China’s Rise,” by Salvatore Babones of the University of Sydney.

 

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