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.
The Chinese have studied the Japanese bust carefully and have concluded that a sharp reevaluation of the renminbi is not the way to go. While a one-off revaluation could ease inflation pressures in China, the Chinese central bank is likely to continue its gradualist approach — as historically has been the norm.
Considering all of this, I believe that the Goldman prediction is more accurate than the IMF prediction. While I am a strong believer that China will overtake the U.S. in total economic output sometime in the next 20 years, the timeframe will more likely be in the next decade instead of the next five years. Given the demographics and sheer number of people in China, it is only a matter of time before the country becomes the world’s largest economy.
China is already the No. 1 consumer of many commodities — the most important of which is oil — while the Chinese trade surplus has been shrinking in the aggregate due to increased domestic consumption that benefits many western companies. With its rapid GDP growth rate at almost 10%, the Chinese economy has become a driver of global growth — and there are plenty of ways to take advantage of China’s rise.
China Rising Play #1 – Gold
The global economy needs to rebalance. China and the East in general need to consume more, while America and the West needs to save more. In the meantime, there is huge friction in the currency markets as the Chinese have accumulated more than $3 trillion in forex reserves. This is putting big pressure on the U.S. dollar as they seek to rebalance their holdings. In this environment, it is easy to see how gold bullion will continue to rally as long as this pressure on the dollar persists.
Gold bullion may be at all-time highs, but inflation-adjusted highs are at about $2,500 –and I don’t think the bull cycle for gold is over. Although some are calling for a sharp pullback in the precious metal, I’m not seeing any signs of a bubble here. The run so far in the past several years has been relatively slow and steady, missing the sharp spikes typical of a bubble.
Corrections in the long-term uptrend in gold are buying opportunities, and the SPDR Gold Trust (NYSE: GLD) remains the best way to play gold’s climb.
China Rising Play #2 – Luxury Goods
Sales of luxury goods are growing the fastest in Asia and are not expected to slow anytime soon. Luxury goods are a status symbol and the fastest economic growth of any major economy in the world is in China, which creates the largest number of new consumers.
Wealthy Chinese prefer designer fashion goods with large logos. I like to call this the “bling factor.” These wealthy Chinese are shopping for status items that they can show off to their friends and relatives.
No surprise that Louis Vuitton Moet Hennessey (OTC: LVMUY) is still the most popular brand among wealthy Chinese. The company just reported that quarterly revenue rose 17% to 5.25 billion euros. Excluding acquisitions and currency shifts, sales climbed 14%. Japan accounts for about 8% of the luxury goods maker’s total sales, and sales there fell 9% in the quarter, but sales in the rest of Asia were exceptionally strong. With the Japanese economy likely to rebound later in the year, LVMUY shares are headed higher.
Other popular fashion labels for high-net-worth Chinese include Hermes, Zegna, Armani and Chanel. And Italian fashion house Prada plans to have an IPO this summer in Hong Kong to raise its awareness among Chinese consumers.
China Rising Play #3 – Oil
One of my favorite oil companies is China National Offshore Oil Corporation (NYSE: CEO), which reported stellar numbers for the first quarter in 2011. The shares are trading near all-time highs even though oil is not quite there yet, as the company is expanding rapidly.
For the first quarter, revenue jumped 59% — to 48.5 billion yuan from 30.5 billion yuan — a year earlier because of an increase in production and higher international crude oil prices. Total net production in the first quarter rose 27% to 85.2 million barrels of oil equivalent.
The company, which has no major refining operations, relies mainly on oil production for its profits. This is important, as in China, fuel prices are regulated, which squeezes margins for oil refiners. Last year, CNOOC reported that its net profit rose 85%, while this year, estimates call for a 36% gain in earnings. I remain bullish for CNOOC shares as oil continues to move higher through the summer. (Get four more oil plays to profit from rising prices here.)
China Is Beating Us At Our Own Game
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