Recently, Burton Malkiel, Professor of Economics at Princeton and the author “A Random Walk Down Wall Street,” hosted a conference call to review the economic prospects of China. Malkiel provided some very interesting analysis of the Chinese economy—including both positive and negative developments for the country. The positive findings include:
- China’s economic growth rate over the past 20 years has averaged close to 10%. In contrast, the growth rate of the U.S. economy is currently about 2% per year. Over most of the past two decades U.S. Gross Domestic Product (GDP) has achieved between 3.5 and 6.5% year-over-year growth. In 2009 while U.S. GDP turned negative (-1.7), China had 8.7% growth.
- Experts at the International Monetary Fund think that China will pass the U.S. as the country with the largest share of the world’s GDP by 2015 or 2016.
- By 2054, Goldman Sachs predicts that China’s GDP will be nearly $70 trillion. The GDP of the U.S. and India will each be under $40 trillion.
- The Chinese have a very strong balance sheet. They currently have over $3 trillion in reserves and Chinese banks are in much stronger financial position than U.S. banks.
- China is in the process of implementing a universal health care program, which many think will actually help them increase consumption.
- Consumption by individuals in China is responsible for one-third of their GDP. By contrast, individual spending in the U.S. is responsible for 70% of our GDP.
Some economists are concerned that China’s economic growth will get ahead of itself, and become too speculative. They are worried because:
- Investment by the Chinese government and outside investors has led to enormous overcapacity.
- High levels of bank lending (even after China increased its interest rates) may produce asset price bubbles and could lead to a financial crisis.
- China currently suffers from overbuilding in steel, shipbuilding, cement and in infrastructure projects. They recently stopped building on their high speed rail network and right now have “highways, railways and bridges to nowhere.”
- By one estimate, the Chinese have 20% excess capacity in their economy. Although this development is easier to absorb in an economy with 10% annual growth than it is for a similar situation in the U.S. with 2% growth.
To fix these issues, the Chinese government has instituted a variety of measures including:
- Increasing bank reserve requirements and lowering leverage limits
- Requiring 40% down payment for people who want to get loans
- Working to keep “non-performing loans” as low as possible
Will these reforms help stop a major economic catastrophe? Burton Malkiel thinks that it is likely that they will reduce the severity of any Chinese economic “hiccup.” He also thinks that smart investors will bet on China over the next 20-30 years because of its size, sophistication, growth rate and room for growth.
Our Take on Investing in China
Even without investing in China-specific funds, investors have exposure to the Chinese growth story through multi-national companies (GE, McDonald’s, Microsoft, Pepsi, etc.) While we don’t recommend investing in China-specific funds at this point, we do believe that an allocation to emerging markets investments is an important piece of a globally balanced approach.
China currently represents 17-18% of the MSCI Emerging Markets Index. Therefore, if you have as much as 10% of your overall holdings in emerging markets stocks, your ownership of Chinese headquartered companies is less than 2% of your overall portfolio. Exposure to Chinese revenue through global companies could easily double the influence of China on your investments. Over time, as China extends control as the driving force of the global economy, a home-country bias toward U.S. stocks will be naturally – if not intentionally – reduced.
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