Author: Stephen Tunley - CEO Balmain Funds
The generally accepted wisdom is that ‘Empire USA’ is on the way down and ‘Empire China’ is on the rise.
But how far and how fast will this change occur? And how will it impact Australian investors?
In this article, Balmain gives a big-picture twist on what is currently being reported in the media.
History will likely record the 2008/2009 global financial
crisis that started in the US and hit it the hardest as the ‘tipping
point’ between the rise of China and the fall of the US.
While US wealth, military might, cultural dominance
and intellectual/technological power still reigns supreme and will
likely continue for some time, the GFC’s inability to significantly hurt
China has elevated this emerging superpower onto a higher level.
China’s GDP is currently one third of the US. (see table below). Should China’s GDP growth continue
at 10% per year (as it has for more than a decade), its economy will double in seven years. At 7% growth
per year, it will double in 10 years.
Source: Austrade, International Data Comparisons, /IMF
In comparison, US GDP fell 2.4% in 2009, a year which marks the
widest gap between the growth rates of the two countries. On present
trends, China will be the world’s largest economy in 15 to 20 years.
‘On present trends.’ That is a key phrase. There are ‘big picture’
developments taking place that make ‘present trends’ likely to change
and it is these you need to understand and maintain a watching eye on.
Think bio-tech, high-speed trains, wireless communications, nuclear
power stations, Internet businesses, electric cars, solar batteries. New
advances in technology are enabling emerging nations such as China to
‘leap-frog’ to advanced status very rapidly.
In fact, China already surpasses the US in areas of infrastructure
such as high-speed trains. While the US has the bulk of intellectual
capital, (inventions, patents, and particularly military technology),
China’s army of researchers (926,000 vs 1.3 million in the US ) and the
nation’s ability to rapidly copy commercialised products (iPad clones)
is likely to close the gap and do so rapidly. (as another example,
Chinese and Indian engineers already represent a significant proportion
of engineers working in Silicon Valley.)
China’s one-party state and centralised control (in an IT age
allowing faster information gathering and feedback) has (so far) been
able to successfully manage the nation’s economy. Decision makers are
able to usurp individual interests for the ‘national good’ and can make
decisions faster without a democratic process to slow it down. (Memo to
local villagers - a nuclear power station will be built in your
backyard. Thank you.)
Central party bosses can give instructions to state-run industries
(Memo to Tangshan steel mills - cut your production by 1/3 to 2/3 for
rest of this year) and long-term planning can take place without the
getting re-elected every three or four years.
China has the financial resources to keep spending on domestic
infrastructure, (transport, energy, dams, housing, etc) whereas the US
is now constrained by budget deficits and massive debt. (See comments by
Niall Ferguson, a British historian). China’s ability to keep spending
will give the country more options on how it grows its economy.
China’s one-child policy is social engineering on a massive scale.
The oldest of these are now entering their 30s, meaning a new generation
of ‘little emperors’ (and fewer little empresses) have arrived in the
labour market. The labour pool will progressively shrink as older
workers retire and are replaced by fewer one-child generation employees.
This ‘sudden’ (demographically speaking) drop in the number of
working-age people, who will share the same amount of resources, will
mean higher prosperity.
But what of the future massive number of retirees versus workers?
What about health/aged care? China’s future aged-care policy will also
likely be social engineering on a massive scale. Retirees over the
coming 20 years are likely (and are used to) ‘eating bitter,’ a Chinese
phrase for enduring hardship. This is unlike the high expectations of
Western baby boomers for government funded health care, aged care and
pensions. Unlike the US, aged care in China won’t be as big a problem,
at least in the near future. (But see ‘the downside’ below)
So far, China’s rapid economic development has been focused on
coastal areas. The vast hinterland (58% of the population is considered
rural) including regional cities is now increasingly being developed.
What is the country’s potential? A simplistic but useful exercise is
to compare the US GDP per head (US$47,702) with China’s (US$3,999). If
China were to reach US levels of ‘wealth’ (measured by GDP per head),
the nation’s GDP would grow by a factor of 12, meaning its current GDP
of US$5,365 billion would grow to US$64,380 billion in today’s dollars.
(In comparison, the US GDP is currently US$14,800 as Table 1 above
Then the US sneezes, Australia catches a cold. We increasingly need
to replace ‘US’ with ‘China’ in this statement as the correlation study
in table 2 below demonstrates.
This table shows that the correlation coefficient between the
Australian and US GDP growth rate was a close 0.92 during the 1990s but
has since dropped to 0.65. Meanwhile the correlation between Australia’s
and China’s GDP growth rate has become much closer at 0.98.
The Reserve Bank of Australia also made note of this closer
Australia/China correlation in a presentation on September 16, 2010. “A
decade or so ago, we spent a lot of time puzzling over why quarterly
movements in Australian GDP were so highly correlated with quarterly
movements in US GDP. We don’t puzzle over this anymore – not because we
solved the puzzle, but because the correlation has fallen. At the same
time, the correlation between quarterly movements in Australian and
Chinese GDP has steadily increased. Clearly what happens in the
Australian economy is now more dependent upon what happens in China than
has been the case at any time in our past.”
We all know China is by far Australia’s biggest export market. Our
booming China-driven resource sector (and increasingly agri-business
sector) is driving a two-speed economy in Australia and also a two State
economy, WA and Queensland versus the other States.
As China’s prosperity rises, so too will demand for luxuries. (Less
‘eating bitter,’ and more… please send us your beef, lamb, wool,
seafood, wheat, sugar....) Chinese demand for tourism, education, and
financial services will also represent opportunities, although Australia
is not unique in its ability to supply these services.
(Note the expanding services recently provided by Chinese airlines into Australia to meet the growing
demand from Chinese tourists.)
With China so important to Australia, we need to know more about the country, its history, and its culture,
so when news about China takes place, we can put it into context and respond accordingly.
‘Getting news about China’ is another key phrase to be attuned to.
With Chinese press controlled by government, and official government
statistics being ‘open to interpretation,’ news about China is not
always accurate or complete.
Other downsides include:
Human nature is human nature, even if it has Chinese
characteristics. Greed and fear drives much of Chinese investments too.
Take the overheated residential Chinese property market. It happened,
even with central government pulling at the levers, although it seems
the levers have recently eased ‘bubble’ talk. It will be interesting to
see which management system (central control vs. democracy) will be
better at managing a large modern economy.
Little emperors become big emperors. A generation of spoilt kids (a
generalisation perhaps but still relevant) becomes a generation of
spoilt adults, with high expectations. The rich/poor gap,
coastal/hinterland gap, freedom of expressions gap and gender imbalance
gap needs to be managed, as internal harmony is critical
to a single-party state. (the people have no-one else to elect to vent
The US will not merely stand still and watch China take over.
Threats of protectionism and trade wars would generate market volatility
(we are already seeing this with the US’s increasingly strident demands
to see the Chinese currency re-valued up). China is still an exporting
nation (for now) and needs the US and Europe as major clients (thus it
benefits from a weak currency relative to its trading partners).
However, China can counter with its holding of US Treasuries, the mass
selling of which will cause chaos – a financial rather than nuclear
‘Mutually Assured Destruction’ (MAD).
US government decision making (in the long term) is a result of many different democratic viewpoints.
Chinese government decision making comes from a narrower set of decision makers – for better or worse.
As prosperity increases in China, more exports from a wider range of
Australian industries will mean more income, but this also has a risk
as Australia ends up with a concentrated buyer model with both attendant
risks and benefits. (that is, Australia has ‘all its eggs in one
basket’, that basket being China)
Australia’s relationship with China (and to a lesser degree India and
Japan) has also created the two speed economy we currently experience.
Have a look at the chart below on the Australian stock market
without resources and you get some insight as to what risks exist to
Australia. The chart shows the disparity between the booming resource
sector and the rest
of the market.
We expect to see a huge growth in demand from China for agricultural
products in the period ahead as well. As our trade grows with China,
look for significant Chinese interest in purchasing businesses and
real-estate (remember Japanese interests buying tourism properties in
Queensland in the 1980’s). In particular, China’s search for food
security will likely result in more Chinese interest to buy large-scale
Australian farms and this may not be palatable to those that question
whether this serves our National Interest.
So what are things to look out for in the period ahead as Empire US declines and Empire China rises?
Declining value of the US dollar, stocks and bonds as pressures on
the US economy becomes better recognised. Persistently high US
unemployment will likely force US politicians to boost US exports and
import replacement industries, and to ‘get tough’ on China.
There will be more US pressure on China to revalue its currency,
which China will likely resist as it will potentially harm its export
industries. There could even be a re-emergence of tariff wars and other
trade restrictions. When combined with China’s large holdings of US
Treasuries, and the risk of mass selling as part of political
negotiations, this is likely to set financial markets on edge should
US/China tensions escalate.
However, the reality is that China will continue to grow and the US
will struggle to do so. As they say in Africa “when elephants fight –
the grass gets crushed”, so Australian investors need to look to
understand these issues, inform themselves and be prepared to make the
changes necessary to profit from what will
This change will likely see Australian/China trade and investment
increase, and perhaps there will be a new MAD – Mutually Assured
Development – between the two countries.
At Balmain, we believe at all roads lead to income. From Australia’s
national perspective, we need to know where our national income is
coming from and the risks related to this. And this means to know
China...at least as much as we know the current superpower, the US. Do
Soviet Union – an abrupt end in 1991 but which began in the
1980s when despite its military ‘strength’ that made it a super-power,
its economy was progressively getting weaker.
British Empire – loss of its colonies (and the revenues
generated) after WW11, led to the empire being eclipsed by the US. No
collapse, just a slow decline relative to the US
Japanese ‘Empire’ – While only an ‘empire’ in an economic
sense during the late 80s, (when Tokyo property was reportedly worth
more than all of the State of California, and when its stock-market was
booming as a result of its successful export industries), the country
has since faced a gradual economic decline –its ‘lost decade’ now
entering its 3rd ten year period!
The information contained in this document is of a general nature and does not
constitute financial product advice. This document has been prepared without
taking account of any person's objectives, financial situation or needs.
Because of that, each person should, before acting on this document, consider its
appropriateness, having regard to their own objectives, financial situation and
needs. In preparing this paper BFAL has relied upon and assumed, without
independent verification, the accuracy and completeness of all information
available from public sources or which has otherwise been reviewed in
preparation of the paper. The information contained in this paper is current as
at the date of this paper and is subject to change without notice. Past
performance is not an indicator of future performance.
Neither BFAL, its associates and related entities, nor any of their
respective directors, officers and employees, give any warranty as to the
accuracy, reliability or completeness of the information contained in this
document. Except insofar as liability under any statute cannot be excluded,
neither BFAL, its associates and related entities, nor any of their respective
directors, officers and employees, accept any liability for any loss or damage
(whether direct, indirect, consequential or otherwise) arising from the use of
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