Not So Big After All: It's Not All About China

Note: I am a council member of Gerson Lehrman Group (http://www.glgroup.com) where I regularly post analyses of topics in Technology, Financial Services, particularly with a Japan angle. I will occasionally repost condensed versions here, and note the connection with GLG.

A recent OpEd piece by Walter Russell Mead published in the LA Times on December 30, 2007 noted as follows: China's economy, as measured by GDP at purchasing power parity (PPP) is $6 trillion, not $10 trillion as previously thought. This adjustment is a result of a recalculation by the World Bank that has been supported by Chinese authorities.

At a minimum, this means that fears of China overtaking the US anytime soon are overblown. Even if China's annual growth rate averages about 7% per year for the next few decades (which may itself be overstated), the US is still growing at 3 to 4% per year. At those rates, China will not overcome the US until at least 2035, and that assumes nothing else bad happens.

In the revision, Japan's PPP GDP remains about $4 trillion, and despite anemic growth over the last several years, Japan does appear to be coming out of its decade long doldrums. But overall it is not good news for investors.

What this number means is that China remains a poor country, with many uncertainties for investors.Consider the following (noted recently by Peter Tasker in a column for Newsweek published Dec 10, 2007): The Chinese stock market has risen dramatically in the last few years, over 800 percent since the start of the decade.

Compare that to Japan's last bubble which peaked at 700 percent in the eight years leading up to the 1990 peak. Salaries for internationally-capable Chinese staff are skyrocketing. Interest rates and the Yuan are relatively low. Local financial liberalization has also opened up the markets to millions of new local investors, many of them with little experience in capitalism, much less financial markets. All of those are classic elements of a bubble.

China's population has only $1 trillion in liquid assets versus $12 trillion in Japan, of which 50% of the Japanese total is cash. Japan also has a much stronger economic foundation, with many companies that build of value over decades of continuous improvement. The Chinese legal system remains murky.

Japan, despite its own foibles, has a far more transparent legal regime. Add all this up and China has a long way to go. This is not to say that interest in China is misplaced. China's sheer size, and importance as a global, low-cost manufacturing center make it an important economy to consider. Indeed, the China bubble may run on for some time. Nevertheless, prudent investors would be well advised to consider hedging their China bets, and look for safe havens in the US, Japan and Europe.