Some Thoughts On China And The Us Economy

A blog by Frederic Slade, CFA, Director, Investments – June 17, 2014

Background
China has evolved from a closed-off society to one of the world largest economies and trading partners. What are some of the key implications of China’s rise in prominence for the US economy at present and going forward?

Beginning with economic and market reforms introduced in 1979, the Chinese economy has posted some of the following statistics:¹

China’s Gross Domestic Product (GDP) annual growth has been 10% per year through 2013, although the growth has slowed to around 7% recently (still very high compared to other countries).
China’s estimated GDP in US dollars increased to $9.4 trillion in 2012 (56% of United States GDP)
China has become the world’s second largest economy, ahead of Japan and behind only the United States.

Trade Deficits
China has also become one the United States’ largest trading partners, accounting for about $630 billion, or about 15% of total US trade activity in 2013 (imports plus exports). China has also become the world’s biggest merchandise exporter and the world’s largest manufacturer.²

Although China has been growing at an impressive rate and presents a huge potential consumer market for US goods and services (population of 1.4 billion), China has continued to run trade deficits with the US (i.e. China has been exporting more to the US than they have been importing from the US).

What are some of the main reasons behind these trade deficits?

Although China has the world’s largest population, its income per capita lags behind other countries. In 2013, China’s per capita GDP was $6,960, or 13.1% of United States per capita GDP. China, therefore, has less income to spend per person.
The Chinese currency, the Renminbi (RMB) is considered to be undervalued since it is not allowed to float as is the case with most other currencies. As a result, the Chinese currency has less buying power in US dollar terms. Conversely, Chinese goods and services have become cheaper for the rest of the world. A floating currency would help bring the US trade deficit with China back into balance.
Among the world’s largest economies, China has the world’s highest savings rate as a percent of their GDP, while China’s private consumption as a share of GDP is the lowest among the world’s largest economies. This creates less spending on other countries’ goods, including the US. China has moved to encourage more consumption by its citizens through economic and social policy.
Although progress has been made, trade barriers still exist for US goods being exported to the United States, including Chinese government subsidies and the need for more protection of intellectual property rights.
There is and will be competition from “home grown” companies. An example is the Chinese internet and retail giant Alibaba Group, which is soon expected to have the largest IPO ever by a technology company.

Investing in China’s Stock Markets
While it has become easier for US investors to invest in the Chinese markets, China remains an emerging market (on par with Brazil, India and Russia), with greater volatility, regulatory control and investor uncertainty than developed markets such as the US and Japan. Institutional allocations to overall emerging market stocks have been relatively low, about 5%. Chinese stocks can be accessed through local shares, companies listed on US stock exchanges and Exchange Traded Funds (ETFs).

Summary
Although there are a number of trade, market, economic and social issues associated with China and its economy, China will continue to be a growing and major force for the United States, the world economy and global capital markets. Stay tuned.

Notes
1. Wayne M. Morrison, “China’s Economic Rise: History, Trends, Challenges, and Implications for the United States”, Congressional Research Service, February 3, 2014.
2. United States Census Bureau, Top Trading Partners – December 2013.

NOTE: Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Past performance is not a guarantee of future results.

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