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January 21, 2011

China's economy in a bubble

POLITICS - The economy of China is in a massive bubble and when it blows it is going to spell devastation to the world economy. In terms of economic value China's economy is three times "heavier" than the USA. I say "heavier" because I want to make a point about size and strength and "economic weight".

In China's case their economy is largely about their ability to throw their weight around. If China does something, ie. build 3D cellphones with projectors on them, within 5 years even little kids in New Jersey will have them. China is a manufacturing juggernaut and whatever they do or build will become the new status quo.

And unfortunately you can't measure economic weight in dollars or GDP. Its arguably better to measure it in economic transactions. You can't measure it in literal weight because a tonne of cellphones is probably going to be more valuable than a tonne of plastic toys. And for the same reason you can't measure it in dollars or cents because exchange rates and market prices fluctuate too much. Instead by measuring the volume of transactions what you see is that China is approx. six times the size of the USA in terms of economic weight.

Now part of that is because China's economy grew 9.8% in the fourth quarter of 2010, while the USA is stagnating in a recession recovery mode (they haven't released numbers yet). And the other part is China has over 4 times the population of the USA, but most of it is because China is such a huge manufacturing megapower.

If you measured based on GDP in dollars China has $9.9 trillion USD in GDP (per annum) and the USA is $14.3 trillion USD... but we also know that China's currency the Yuan is undervalued by about 33 to 50%, which means their real GDP should be close to $20 or $30 trillion.

Plus add to this the fact that the USA owes China over $3 trillion USD for its national debt and you realize the US's economy is pretty weak compared to China.

However China's glorious present is not without a few problems. China's economy has been growing so rapidly (up 10% GDP every year for the last 20+ years) that there is now abundant evidence to suggest that China's economy is in a bubble.

We already know China's real estate market is in a bubble, mostly due to foreign investors who keep sending their money to China to be used to build office towers and condos that are sitting empty because of speculation that they will someday be sold or rented. In Shanghai half of the office towers are sitting empty because there simply isn't enough paper-pushing jobs at this point. (A wiser person would have invested in building factories instead.)

One way to measure an economy is to measure electricity usage. In China 75% of electricity is used in manufacturing. In the USA its only 22%.

It really makes you realize how few products the United States actually makes any more.

Depending on who you talk to you will get different views on the size of China's economy. We agree much of it is speculation because its very difficult to measure these things in currency. According to Arvind Subramanian of the Peterson Institute for International Economics, the value, in U.S. dollars, of total goods and services produced will be dramatically different in a developing country like China.

"In a developing country," says Arvind Subramanian, "the amount it would cost you to get a haircut or go to a doctor would be much cheaper than what it would be in the United States."

When the size of the Chinese economy is measured by how many haircuts or doctor visits it would buy, the numbers change. (In other words measuring the transactions, like we said above.)

"If you make that purchasing-power correction," Subramanian says, "I find that the Chinese economy is $14.8 trillion, which is larger than the American economy."

So he and us differ on the amount China is actually worth.

It should be noted that Subramanian was using an older value for China's GDP, a value of $5.7 trillion, instead of the $9.9 trillion China's GDP is currently worth. To correct his error however we just have to apply mathematics... 14.8 / 5.7 X 9.9 = 25.7.

Using his numbers China's real GDP is $25.7 trillion, almost twice the size of the American economy.

We argue its still better to measure in base transaction numbers.

Subramanian's and our assessments differ dramatically from calculations made by the International Monetary Fund. Most economists are hesitant to say that China's economy has surpassed the USA's, regardless of the measurement (this might explain why Subramanian was deliberately using outdated numbers for China's GDP).

A recent survey by the Pew Research Center showed that most Americans are convinced that China is already the dominant economic power on the planet, by a margin of 47% to 31% percent (and 22% who don't know or care).

That means that 53% of Americans either refuse to believe China's economy is bigger, or they simply don't know enough about economics to know any better.

"We've been brainwashed," says Robert Aliber, professor emeritus of international economics at the University of Chicago. "The general sense that China is an economic powerhouse is far-fetched," he says.

Aliber agrees that, by purchasing-power measurements, the Chinese economy is probably a lot bigger than the GDP figures suggest. He points out that much of what China adds to the world economy is cheap labor, something which is undervalued and extorted and that most Chinese still live in poverty. On a recent trip to China, Aliber noticed that many urban apartments are unoccupied, so their value is unproven.

"Somebody has to buy these apartments," Aliber argues, "or their prices will decline. China is at the near terminal stage of a massive housing bubble."

If that bubble bursts, China's economic figures won't look so good.

In related news...

President Hu Jintao heads back to China today, his state visit to Washington having underscored his country's status as the United States' top economic rival — or even its master.

Hu Jintao got the red carpet treatment this week, but was it because he is just a rival? Or is it because the USA owes China so much money and likely needs more?

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