Earlier this week, news broke that the International Monetary Fund (IMF) predicted that the “Age of America” will end and the U.S. economy will be overtaken by China’s economy in real terms, adjusted for purchasing power parity, by 2016.
For some, this new paradigm is hard to imagine, given that we’ve all lived in a world dominated by the United States. However, the idea of China being the world’s biggest and most influential economy is something that I’ve discussed for years.
The idea that China would surpass the U.S. as the world’s foremost economic power first gained prominence in 2003, when my former colleagues at Goldman Sachs (NYSE: GS) under Jim O’Neil predicted that the emerging BRIC — Brazil, Russia, India and China — economies will surpass the U.S.-led G6 developed economies by the middle of the century.
According to the original BRIC report, the Chinese economy would surpass the U.S. economy by 2041. And more recently — as China’s strong economic growth continued unabated while the U.S. economy slumped after the 2008 financial crisis — Goldman revised its forecast, now predicting that China will overtake the United States by 2028 in real, non-purchasing power adjusted terms.
Why the 12 year difference between the IMF and Goldman for when China will overtake the U.S. economy? Because the IMF prediction assumes that every dollar in China buys nearly three times as much goods and services than in the United States, because of the purchasing power parity between the two exchange rates.
So the accuracy of the forecast largely depends on whether the IMF purchasing power parity assumption is valid. As someone who spends a lot of time in both China and the United States, I believe that the IMF forecast has actually overestimated the purchasing power of money in China. While it might have been true back in 2008, at today’s prices, money just doesn’t go as far anymore in China.
While many goods and services are cheaper in China than in the United States, the old adage “you get what you pay for” applies. For a direct apples-to-apples comparison, the cost of living for a typical American middle-class lifestyle — with a three-bedroom house and a car in the garage — is probably more expensive in China than here.
In addition, the Chinese have learned from the actions of Japan in the 1980s. Back then, the Japanese were forced to revalue the yen sharply in order to curtail their perennial trade surpluses. The shock from a sharply higher yen caused the Japanese central bank to ease monetary policy aggressively, creating mammoth stock market and real estate bubbles. After those bubbles burst, the Japanese have been having a very hard time in the past two decades to put their economy back on the right track, in addition to their big demographic problem.