China's Economic Ascendancy (Part 2)

Includes: FXI, PGJ
by: James Quinn

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Economic Growth

The 1800’s had the usual ups and downs economically. But, there were a few themes that dominated. GDP grew consistently, with a big spike in the 2nd half of the century. The 1800’s were also characterized by deflation. The U.S. was able to generate tremendous growth using virtually no government debt, except during the Civil War. The National Debt stood at $2.3 billion in 1872 and dropped to $1.7 billion by 1888. Lastly, the U.S. currency was rock steady because it was backed by gold. The National Currency Act of 1863 established the dollar as the national currency. The National Banking Acts of 1864 and 1865 created the infrastructure of our national banking system. In 1865 there were 1,643 banks in the U.S. By 1896 there were 11,500 banks operating in the U.S. Financial panics occurred when expansion and over-investment got out of hand in 1873 and 1893. They were violent and short.

The GDP per person grew moderately in the 1800’s as the population of the country exploded. As the Industrial Revolution progressed, GDP per Capita accelerated. The late 1800’s were a time of good deflation from excess supply, driven by new technology. The new inventions (light bulb, telephone), railroads and machines powered by oil created tremendous productivity and excess capacity. The economy grew an extraordinary 4% per year in real terms between 1870 and 1896, as wholesale prices fell 50%. Tremendous growth and progress were achieved while deflation reigned. The U.S. also learned that there can be economic benefits to war. The Spanish-American War began in 1898. The U.S. gained control of the former colonies of Spain in the Caribbean and Pacific. The war increased the business and earnings of American railroads, increased the output of American factories, and stimulated industry and commerce.

Data compiled by the Federal Reserve Bank of Minneapolis paints a fascinating picture about inflation. During the entire 100 years from 1800 to 1900, there was inflation in only 22 of those years. There was deflation during 39 of those years, and zero inflation in the other 39 years. Most of the inflation occurred during the War of 1812 and the Civil War. An item that cost you $100 in 1800 would have cost you $50 in 1900. It does appear that tremendous economic growth can be achieved without inflation. This has not been what has been preached since 1913. In the 98 years of the Federal Reserve’s existence, the United States has had 86 years of inflation and 12 years of deflation. The massive inflation has generated false growth in GDP, especially since Nixon closed the gold window in 1971.

The U.S. achieved phenomenal growth with no inflation and utilization of very little public debt. Except for the spike during the Civil War, political leaders kept a lid on government spending. All revenues were generated from excise taxes and tariffs. There was no personal or corporate income tax during the 1800’s except for a brief period during the Civil War. The U.S. entered the 19th Century with public debt at 10% of GDP and departed the 19th Century with public debt at 10% of GDP. Today, it stands at 80% of GDP and accelerating upwards. These low debt levels gave the U.S. a tremendous competitive advantage over the UK. With a vast global empire, the UK had public debt exceeding 250% of GDP in the early 1800’s and had to utilize considerable resources to paying that debt down throughout the 19th Century.

The U.S. dollar was stable during the entirety of the 1800’s, except during the brief inflationary period during the War of 1812 and the more dramatic inflationary period during the Civil War. The stability of the dollar was constant versus gold from 1870 until FDR seized all the gold in the country in the early 1930’s, when it collapsed by approximately 50%. Since Nixon closed the gold window in 1971, the dollar has collapsed another 47% versus gold. Stating that we have a strong dollar policy has been a bold faced lie.

China Rising

The United States began its long trek to becoming a worldwide economic powerhouse during the 19th Century, leading to domination of the 20th Century. The dominant power at the start of the 19th Century was the United Kingdom. Today, they have the 6th highest GDP, just ahead of Italy. In 1970, U.S. GDP was $1 trillion and has risen to $14 trillion today. China’s GDP in 1970 was $92 billion. Today, it is $4.2 trillion a 4,450% increase in 28 years. China has been growing their GDP at an 8% to 10% pace for over a decade. They now have the 3rd largest economy in the world, and will pass Japan as the 2nd largest economy on the planet within the next 5 years. Sometime between 2030 and 2050, China will overtake the United States as the largest economy in the world.

The tremendous growth is being driven by the migration of millions of people from farms to the cities. By 2007, 594 million Chinese lived in urban areas. The United Nations has forecast that China's population will have about an equal number of people staying in the rural and urban areas by 2015. In the long term, nearly 70% of the population will live in urban areas by 2035. According to Professor Lu Dadao, president of the Geographical Society of China (GSC), China’s urbanization took 22 years to increase to 39.1% from 17.9%. It took Britain 120 years, the U.S., 80 years, and Japan more than 30 years to accomplish this.

This rapid urbanization will create huge infrastructure growth as more roads, sewers, houses, manufacturing plants, power plants, public transportation, and office buildings will need to be built. This trend is identical to the U.S. trend in the 1800’s. The urbanization has caused pollution, illness and congestion problems. These issues also occurred in the U.S. during the 1800’s. The efforts to solve these problems will create even more growth. The manufacturing of goods for America will slowly be replaced by production for its own internal demand. Eventually, China will not be as dependent on the U.S. for its economic existence.

The population of China is currently 1.3 billion, more than 4 times the size of the U.S. population. China’s population is not expected to grow much, if at all, between now and 2050. This is a dramatic difference from the U.S. in the 1800’s, as immigration and high birthrates drove the population upward. The birthrate in China of 1.7 is not high enough to even maintain its current population level over the long-term.

Most of the arguments that I hear regarding why China will not pass the U.S. economically relate to their aging population. After examining the current age distribution and the projected distribution between now and 2050, there is very little difference between the U.S. and China on a percentage basis. It is clear that young populations lead to more vitality, growth, and invention. As the chart below details, 20.1% of the Chinese population is under the age of 15. In the U.S., 21.4% of the population is under the age of 15. Now here is where the rubber meets the road. Because China’s total population is 1.3 billion, 20.1% under 15 years old equals 267 million people. Their youth almost equals the United States’ entire population. The U.S. only has 60 million people under the age of 15.

Age structure:
0-14 years: 20.1% (male 142,085,665/female 125,300,391) (2008 est.)
15-64 years: 71.9% (male 491,513,378/female 465,020,030) (2008 est.)
65-over: 8% (male 50,652,480/female 55,472,661) (2008 est.)

By 2050 the U.S. demographic picture will only be slightly better than China’s on a percentage basis. In addition to the fact that China starts with a population 4 times the size of the U.S., they will benefit greatly from the shift from a rural society to an urban society. The U.S. already has 80% of its population living in non-rural areas. By 2050, China will likely reach a similar percentage. This means that approximately 600 million people will move from rural areas to urban areas in the next 40 years. This figure is mind boggling. In addition, the people moving are likely to be young. The old people will stay on their farms and subsist as they always have. The youthful urban population will drive progress and advancement.

The piece of the pie that is missed by many is the rapid education of China’s youth. In 1978 there were virtually no Chinese students enrolled in Post-graduate programs or studying abroad. Today, there are close to 1 million Chinese students in Post-graduate programs and in excess of 100,000 students studying abroad. One third of all the graduate students in U.S. Science and Engineering programs are not U.S. citizens. With 267 million children under the age of 15 combined with rapid urbanization and desire for advanced education, China is an economic juggernaut. There will be no denying them the economic crown by the middle of this century. It is inevitable.

The ascendancy of China does not necessarily mean that the United States will descend. The United Kingdom entered the 1800’s with a tremendous amount of public debt. Through economic growth, fewer military conflicts, and control of spending, they were able to reduce their debt from 250% of GDP to 50% of GDP by 1900. The current U.S. economic position appears to be more dire than that of the UK in 1800. With total debt exceeding 350% of GDP, a global empire with troops stationed in 120 countries, two ongoing wars, a National Debt that will reach $14 trillion in the next two years, $56 trillion of unfunded future liabilities, and a rapidly aging populace, the ability for rapid economic growth is nil. We’ve lived above our means for decades and now we’re broke.

Americans have a lot of fight left in them. If we go straight and kick our spending and debt habit we can push off the day of reckoning. If we continue on the reckless current fiscal path, the Chinese, among others, will catch and pass us before the middle of the century. Our standard of living will enter permanent decline and we will become the Great Britain of the 21st Century. The choice is ours.