Asia

No need to panic as China slows

People had become used to Chinese real economic growth being above 10% a year over the past three decades. Anything below that results in desperate sounding headlines, as if we’re all doomed. But slowing to a lower average growth rate in China is inevitable in the future. And there’s no need to panic.

World GDP was $71.7 trillion in 2012, according to the International Monetary Fund (IMF). (A trillion is 1000 billion, or 1 million million.)

China’s GDP was $8.2 trillion that year, second only to the USA with a GDP of $15.7 trillion. That means China made up 11% of the global total.

World GDP grew at 3.7% a year between 1999 and 2011, adjusted for inflation. If it continues to grow at that rate – which may be optimistic – it will reach $148.3 trillion by 2032, after 20 years.

If China grows at 10% a year its GDP will reach $55.2 trillion, with compounding. That would be 37% of the global total.

Right now China’s population is 1.35 billion people in a world of 7.1 billion men, women and children. That means 19% of the humans occupying this planet are Chinese. In 20 years China is projected to have 1.39 billion people in a world of 8.4 billion, meaning its share will fall to 16.5%.

Can China really go from 11% of the world economy to 37% in just two decades? And achieve that as its population falls from 19% to 16% of the world total? I think it’s highly unlikely.

…Chinese person’s average share of the economy (GDP per capita) was a little over $6,000.

In 2012 each Chinese person’s average share of the economy (GDP per capita) was a little over $6,000. That compares with a global average of $10,100. In the USA the figure was around $50,000 and in developed European countries like France and the UK it was around $40,000.

So you can see straight away that China is still a poor country in relation to the global average. And it’s a really long way behind the levels of economic output per person in developed countries.

In fact China’s GDP per capita in 2012 is very close to Taiwan’s back in 1989, which was 23 years ago. Taiwan sits alongside China, and of course is populated by Chinese people. Looking at how Taiwan has developed over the past couple of decades should give us valuable insight into how China is likely grow in the future.

In 2012 Taiwan’s GDP per capita was $20,600, or about 3.4 times as big as China’s, but still less than half the level of the most developed nations. Over the past 23 years, Taiwanese GDP per capita grew at a rate of 6.6% a year. Taiwan is now known throughout the world as a centre of manufacturing, particularly in the technology sector.

Now let’s see what would happen if China achieves, over the next 20 years, the same GDP per capita as Taiwan, adjusted for inflation. Taking account of modest population growth as well gives average future economic growth for China as a whole of 6.4% a year.

This looks much more reasonable to me. China’s real GDP is currently growing at 7.5% a year, according to official figures. (And by the way, that’s the kind of growth rate that most governments in the world would love to be able to report. It’s way ahead of every other large economy. So again – why the hysteria about it being too low?)

…we should get used to Chinese growth being in the 7-8% range in coming years…

So I reckon we should get used to Chinese growth being in the 7-8% range in coming years, trending down to the 4-5% in range 15 to 20 years time. Taiwan averaged just over 5% (compound) over the three years 2010, 2011 and 2012.

Sometimes growth will be a bit above the range, sometimes below. China is not unique. It will have business cycles of growth and recession just like everywhere else. But averaging out over the whole two decades somewhere between 6% and 7% a year seems reasonable.

No need to panic as China slows

My expectation of steadily slower trend growth in China is nothing to worry about. But commentators seem to be in a panic that slower Chinese growth means the end of the boom in demand for commodities, and permanently lower prices. Or that the entire global economy could collapse.

Of course commodity prices will still swing around as they always do. But if you understand compounding you’ll also understand that slower rates of demand growth don’t necessarily mean smaller absolute increases in demand, measured in tonnes or barrels or whatever unit applies.

I’ll use an example to make it clear. Let’s say demand for coal in a country is 1 billion metric tonnes a year. And let’s say that demand grows by 10% a year for 10 years. In the first year that would add 100 million metric tonnes to demand. At the end of the period the total demand would have gone up to 2.6 billion tonnes, an increase of 160% (with compounding).

Since I’m on the subject of coal, China’s actual demand is around 4 billion tonnes a year. It grew 153% between 2000 and 2011. So nowadays it’s nearly the same as the rest of the world combined, as the following chart shows:

China’s coal demand

Chinas Coal Demand

Going back to my example, now let’s say demand growth in this country suddenly drops to 6% in year 11. This means it would increase by 156 million metric tonnes (6% of 2.6 billion).

Did you see what happened there? Despite the much lower growth rate in year 11 the total increase in demand was still much bigger than the figure in year 1. In fact it was 56% bigger in this example.

And remember, I’m talking about the annual increments here. The new demand on top of existing demand. In other words slowing growth in China doesn’t mean commodity demand will evaporate. And in absolute terms it’s likely to keep growing much faster than a decade ago.

There are other reasons to be cautious about investing in the Chinese stock market right now. I’ll return to those another day. But in my view slower Chinese economic growth than we’ve been used to is inevitable.

And it’s no reason to panic.

Until next time OfWealthers,

Rob Marstrand
robmarstrand@ofwealth.com

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.