Three Popular China Economic Myths in 2012

by Robert Hsu | June 26, 2012 11:00 am

Three Popular China Economic Myths in 2012

There are a number of economic myths many Americans believe regarding China. Without understanding the truth about China, American investors often face difficulty making rational decisions regarding the country. Here are three popular economic misconceptions many investors have about China:

Myth One: China relies on export-driven cheap manufacturing for its economic growth.

Truth:China is transitioning from a manufacturing economy to a diversified, service-oriented economy.

While it is true that China once relied on its cheap manufacturing labor cost for economic growth, the situation has changed since 2008. After 2009, almost all of China’s GDP growth has come from domestic investments and consumption. That was why China was able to maintain annual GDP growth above 9% in the past three years despite shrinking exports.

Myth Two: The Chinese yuan is severely undervalued against the dollar.

Truth: The Chinese yuan is fairly valued against the U.S. dollar, and the exchange rate for the two currencies should remain stable. In terms of purchasing power, 6.3 yuan buys far less in Shanghai than 1 U.S. dollar buys in Los Angeles.

While expensive tariffs on imports play a part, the higher prices in China apply to branded goods that are made in China as well. Goods like Ugg slippers, Nike (NYSE:NKE[1]) sneakers or Calvin Klein T-shirts, all made in China, cost at least 25% more there than in the U.S. Based on purchasing power parity, the notion that some goods should cost the same in two different countries at fair exchange rate, it is clear that the Chinese yuan is not undervalued.

However, lower-quality goods and services in China, especially labor-intensive services, tend to be cheaper in China. The cost of living for someone making $450,000 a year is probably higher in China, while the cost of living for someone making $45,000 a year is lower in China. That is why the yuan is not overvalued against the dollar, either.

Myth Three: The property market in China is about to crash.

Truth: Too much money in the Chinese monetary system and the lack of investment products support property prices.

After the huge run-up in China real estate prices since 2009, based on the pure affordability factor for average-income Chinese families, many China bears declared that the country’s property prices were about to crash. The fact is that Chinese real estate prices are still holding up, just with lower transaction volume.

Property price is a function of total money in a region and demand for housing. China’s economic stimulus increased the country’s money supply tremendously, and much of that money is trapped within the region because of strict foreign exchange control. This excess money, most of which is controlled by the top 5% of the population, has nowhere to go. Therefore, most of the money ended up in the country’s property market. ¬†Also, because there is no property tax in China and maintenance cost is low, prices remain strong.

After understanding the truths behind these myths, it is easier to see China for what it really is — a large economy that will continue to grow despite high property prices and slowing exports.

Endnotes:
  1. NKE: http://studio-5.financialcontent.com/investplace/quote?Symbol=NKE

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