Since the entry of the U.S.A. into World War II the U.S. has been the most powerful nation on earth. But how long will this continue. As another piece on the changing shape of the global economy we show how China’s growth has moved even faster than we thought it would.    

In this piece [again thanks to the Economist] we will describe just how far China has come and how dependent on China the $’ strength really is becoming. Yes, China needs a strong $, or it will endanger the value of its reserves, whose real value currently lies in its buying power in the world, not its exchange rate value to the Yuan. Is there an ‘unholy alliance’ between the U.S. and China over their investment of trade surpluses back into the U.S.$? [If this is so the U.S. is resolving only a short-term problem [Trade deficit] and China is ensuring it protects its long-term development. The winner in the long run has to be China.

In terms of the U.S.$, China is passing the U.K. at the moment, as we said in our last piece, but in terms of Purchasing Power Parity [what is produced] China has already passed Japan and is well on its way to equaling the U.S.A.  

During the past five years America has accounted for only 13% of global real GDP growth, using purchasing-power parity (PPP) weights. The real driver of the world economy has been Asia, which has accounted for over half of the world's growth since 2001. Even in current $ terms, rather than PPP, Asia's 21% contribution to the increase in world G.D.P. exceeded America's 19%. But current $ figures understate Asia's weight in the world, because in China and other poor countries things like housing and domestic services are much cheaper than in rich countries, so a $ of spending buys a lot more. If you want to compare consumer spending across countries, it therefore makes more sense to convert local currency spending into the $ using P.P.P.’ rather than market exchange rates.

Asia is running a combined current-account surplus of over $400 billion, implying that it is contributing much more to world supply than to demand. If America's demand stumbles, the growth in Asia's exports and output would also plunge, so the story goes, but is this true?

Since 2001 the increase in emerging Asia's trade surplus has added less than 1% a year on average to the region's average growth rate of almost 7%. Contrary to the perceived view, the bulk of Asia's growth has been domestically driven.  

• It is true that domestic demand (investment and consumption) has grown more slowly than G.D.P. over the past year everywhere except in Malaysia (see chart 1). But in most cases the gap has been small, especially in China, India, Japan and Indonesia.

• It is true that exports account for 40% of China's GDP, but those exports have a large import component; only a quarter of the value of China's exports is added locally. The impact of a slowdown in export growth would therefore be partially offset by a slowdown in imports.

• It is therefore true that China's GDP growth has come mainly from domestic demand, which has been growing by an annual 9% in recent years!

Is China's consumer spending feeble? Several recent reports highlight that according to official figures spending has fallen from 50% of nominal G.D.P. in 1990 to 42% today. But this partly reflects an even stronger boom in capital spending. Real consumer spending has been growing at an average annual pace of 10% over the past decade—the fastest in the world and much faster than in America (see chart 2).

• There is also good reason to believe that official figures understate consumer spending in China because of their inadequate coverage of services China’s GDP was re-evaluated. Purchases of homes by the Chinese have risen rapidly since they were first allowed in 1998, but these are also excluded from the figures. If they are added in total household spending has not fallen as a share of GDP.

• Is Chinese saving as high as we all believed? The saving of Chinese households has in fact fallen from 20% to 16% of G.D.P. over the past decade. The main reason why China's total national saving rate looks so high (at close to 50%) is that Chinese companies have been saving a much bigger slice of their profits.

The I.M.F. estimates that in Asia as a whole (including Japan as well as the emerging economies) real growth in consumer spending has averaged a healthy 6.3% a year in 2005 and 2006. This suggests that Asian consumers can help sustain fairly robust GDP growth in Asia even if America's economy takes a dive.

Not only is growth in China and the rest of Asia chiefly domestically led but America's share of Asia's total exports has fallen from 25% to 20% over the past five years. Regional trade links within Asia have also deepened thanks partly to growing Chinese demand. Goldman Sachs reports that five years ago China's imports for domestic use were only half as big as those for the assembly and re-export of products, but now they are roughly the same size.   So strong domestic demand in China sucks in more imports.

China's exports to America have fallen from 34% of its total exports in 1999 to 25% now (adjusting for the re-exports which are made through Hong Kong). Chinese exports to the European Union are now almost as big as those to America and are growing faster.

H.S.B.C. estimates that slower American growth will hurt China, India and Japan much less than it will the smaller Asian economies, such as Singapore, Taiwan and Hong Kong, that are more dependent on foreign demand. China, India and Japan account for three-quarters of Asia's GDP and so, given the deeper regional trade links, they should help to support demand in the whole region. If America's GDP growth slows next year to 1.9%, from 3.5% in 2006, as HSBC expects, then Asia's growth is tipped to slow from just above 7% this year to just below 6% in 2007. Weaker exports will badly hurt some industries, but overall, the region will continue to grow at a reasonable pace.

Could Asia withstand a sharper American slowdown? Hong Liang at Goldman Sachs estimates that if America's G.D.P. growth drops to zero by the end of 2007 then China's annual export growth could plummet from 26% in early 2006 to a decline of 2% by late 2007. After taking account of the impact of slower export growth on imports and domestic demand (i.e. slower growth in investment), Ms Liang estimates that China's G.D.P. would still expand by 8%. That is significantly down from this year's growth rate of over 10%.

China is today tightening policy so as to slow down its runaway economy: weaker external demand could be partly offset by reversing these measures.

In summary, if America suffers a slump, the economies of China and the rest of Asia would slow, but they are unlikely to be derailed. More importantly, the steady shift of wealth to the East has moved to the point where it is not only unstoppable, it can be self-sustaining. Therefore, the East has moved from dependence on the West to independence from the West, already!

And gold in the picture?

 As we said in the last issue, the benefits to the gold price will come from the destabilization of the monetary system, as the structural shift in the balance of power affects the monetary system.  For years professional commentators have been warning of the demise of the $. This would require its sale by only a small percentage of surplus holders in the day-to-day foreign exchanges.  Just the prospect of this is sufficient to take gold to new highs. Not only would investors seek to buy but holders would be unwilling to sell. 

© 2006 Julian D. W. Phillips
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