November 19, 2008

China Vs America: Comparing Size

"Is China really the world's biggest economy? I thought the USA was bigger."

Only if you fall into the false assumption that a bigger GDP represents a bigger economy. For the sake of American pride in the size of their, ahem, economy, lets take a look at how we measure economics, with respect to China Vs the Unites States.

1. The GDP is based in American dollars, and does not accurately portray the true strength of the Chinese economy due to the artificial weakness of the Chinese Yuan.

The Chinese Yuan is pegged to the US dollar and artificially deflated in order to keep their prices low when sending manufactured goods to the USA, Europe, etc. Right now $1 US = 6.83 Yuan, but if it wasn't pegged it would be worth a lot more. Therefore China's GDP would be worth a lot more too.

You can't trust anything measured using the US dollar because its value is inflated due to its use as a reserve currency. Banks these days are switching to the Euro as their reserve currency and you will note the US dollar lost 17% of its value in 2007. It will be interesting to see how bad its fared in 2008. The value drop however only helps China's exports, while effectively maintaining its GDP value.

2. Bigger can also mean more influential in terms of exports. China trades more than the USA does (even when measured in US dollars). Compare a list of countries by their export values and Germany is at the top of the list, followed by China, the USA and then Japan.

3. Lastly the American economy is largely based on speculation, booms and busts. Considering the current market conditions I shall use a real estate metaphor:

Imagine a house worth $250,000, but due to multiple people having too much credit and wanting to buy the house they end up bidding on the house and boosting the sale price to $375,000 instead (50% above its actual value). The couple that wins the house settles in and starts mortgage payments, but 1 year into their payments the housing market collapses and the value of their house plummets to $125,000. At this point the couple realizes they're paying 3 times the real value of the house and decide to default on their mortgage. The bank ends up owning a property that when sold will garner them a net loss of $250,000.

Do this same or similar scenario a couple million times and you get the current credit crisis the United States is in. The problem is market speculation drives up prices of houses, oil, gold, grain, etc., but when those prices collapse it creates market instability. It would be safe to say that sizable percentage of the US economy is based on nothing more than speculation and false credit.

4. A strong manufacturing base is a clearer indicator of economic strength. If you take the population of Chinese workers in factories and compare that to the United States there's no competition, China is clearly the bigger manufacturer. China may sell their products for less, but thats not a bad thing because it serves to boost their exports.

Conclusions: The USA is still very much an important player in the world economy, but are they really the biggest? Depends how you measure size. The American dollar and indeed the American economy is based on speculation so any measurement would be wholly inaccurate. China's population, exports and industrial growth are clearer indicators of an economy in the lead.

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