China in your hands, part 2

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China is now the number two economy in the world, and some are predicting it will soon become the number one economy. Seven or eight years ago, I was in Singapore for a world economic forum held there, and at that time, there was a piece of research circulating that said that China would become the world’s number two economy in about ten years time. It actually ended up becoming the number two economy just a couple of years later than that, so the prediction was completely wrong.

Paul Gambles continues his views on China: We went and checked for ourselves at the time, but we couldn’t find a single piece of research that talked about China becoming the number one economy. People weren’t even thinking about it as a possibility. Most of this research was coming out of America, and it was inconceivable to many people that China would become the number one economy.

Right now, we’re seeing predictions that some time in the 2020s, we’ll see China become the world’s number one economy. If the last predictions were anything to go by, then it could actually happen much sooner than that.

China is growing so quickly and America is so flat that that’s definitely a possibility, but I think what we need to see in the short-term is just how bad the landing will be in China (and I don’t think soft is an option – I think it will be either hard or very hard) depending on what’s underneath when we look at it. I think that depending on what happens there and what happens with the developed economies’ recovery will determine in the short-term how quickly China becomes the number one economy in the world.

However, the bigger question is how will two billion Chinese be able to adapt to that and that’s why I think the question of whether China will become a fully fledged democracy, whether it will become a free market, and whether it will become completely open. I’m sure at some stage it has to happen, and when it does, that will probably coincide with China becoming the leading economy in the world, but it’s hard to imagine China would become the world’s number one economy while it’s still so controlled and so manipulated and it has such a difficult relationship with the rest of the world.

However, we’ve seen many reforms over the last twenty years. It’s easy to complain about the problems that are in China from a free market point of view, but if you look at how far China has come over the last twenty years, China has made huge steps forward with WTO membership and the RMB now being traded in Hong Kong, and soon to be in Singapore and London. China is opening up; there’s no doubt about it. It has opened up economically and I’m sure on the back of that, eventually it will open up politically, and when that happens I think that’s when China will be ready to become the world’s number one economy.

Foreign Direct Investment (FDI) has been a really important component to Chinese growth and Chinese productivity. The problem now is that FDI seems to be slowing down because the rest of the world is a lot less attracted to investing in China than it was.

Also, China doesn’t need much more foreign investment. China’s sitting on one and a half trillion Dollars, which is a bit of a problem for China because it has to do something with that money, so we’ve seen a lot more out-bound investment from China in the last few years because it has been recycling a lot of those Dollars.

A lot of those Dollars came in as investment and some of those Dollars came from trade, but China’s exports are very much slowing down now. It’s not able to export to the States as much. We all know the situation in Europe and that has meant that latterly, China’s not exporting to Europe as much either, so China is having to look at a much more domestic model from a trade point of view, and that will also have an impact on foreign investment into China as well, but I think one of the key things that people tend to forget when they look at China is the fact that there are one and a half trillion Dollars in US assets, and that’s not purely a good thing; there’s a downside to that as well.

To us it looks a little bit like Japan during the 1960s, 70s and 80s. Japan was selling an awful lot of exports internationally, primarily to America, and Japan was forced to do what China has done – it was forced to sterilise the foreign currency receipts. China has built up one and half trillion Dollars in the same way that Japan what at that stage was the largest global holding of U.S. T-Bills and US Dollars, and China has had to do the same. If it had spent those straight away, it would have increased the value of the RMB or it would have increased inflation – one or the other, so it’s only option really was to sterilise those Dollars and to hold US assets. Now with Japan, we’ve seen what’s happened over the last twenty years – Japan has got 200% gross debt/GDP because it’s had to fund the holding of US Dollars.

To be continued…

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]