Tuesday, November 22, 2011

China vs. India vs. US - more details

I focus a great deal on demographics and the interplay between macro regions on this blog.  There is a reason for this: I believe that apart from individual firm analysis, the most important structural questions an investor has to ask himself are about the future nature of markets - particularly financial markets.  Moreover, I believe that the investing climate in which we are operating is and will remain, driven by macro questions as governments rewrite social contracts that have mostly been stable since the 1940s.

Changing demographics influences work, output, production, consumption and ultimately the propensity to save, invest and to assume risk - these are the key factors for the investment environment.  Within that environment, of course, we also have to pick firms with good economics, but these factors will help to understand the ever-uncertain future prospects of a firm.

I also write about demographics and about global growth becuase I believe that much of the information in the public sphere is written with particular agendas in mind - and that most of that is not aimed at investors.  Most people are China bulls - either because they think it good that the US lose its preeminence or because they are horrified at the prospect and want to issue cautionary tales to Americans to avoid a declinist destiny.  Mostly the arguments are political, or are driven by investment banks who want to have an easy job of selling securities to gullible investors.

I am decidedly on the side of the China bears - and mostly because of demographics.  There seems to be increasing evidence that my forecast makes sense.

Awhile back I made a prediction about China, India and the US. I argued that China will become the worlds largest economy before 2030, and based this on some simple calculations from the Economist. I further argued that China would only hold this position for a short time before it was eclipsed by India, which has grown slower, and started later, but is recently accelerating and which also has better demographics (and a better education system) than China.

But perhaps my most surprising prediction was that by 2050 China would rank third, because it would again be passed by the United States.  Now, I have some more evidence that this may indeed happen.

An economic think tank that focuses on demography and economics has concluded that China's growth rate, which has already slipped from double digits to high single digits (with the usual investment banks and bulls arguing that slowing growth is an indication of economic health.  Funny, I never hear them saying this about the US).  According to John Mauldin, this think tank Global Demographics, has further argued that growth will slip to the high sevens, about the level India is experiencing now (though India's economy is much smaller than China's) and after 2016 will likely fall to the 5% range - and to the 3% range after 2021.  (Higher √≠nflation means that China's economy will still grow larger than the US in nominal terms).

But this means that the US will have a chance (if it can restore historical growth rates) to essentially keep pace with China.  Likely the US will grow at slightly less than 3% because its own demographic profile will be less favorable than that over the past nine decades, but China will not keep outstripping US growth significantly, and the long-term favorable demographics of the US, coupled with its strong R&D and productivity gains mean that the US will be poised to surpass China by 2050.  India will be a bigger challenge for the US.

Of course, such dramatic slowing of economic growth will no doubt lead to significant political unrest, as Chinese, having grown accustomed to a world in which everyone is much better off each year than the year before (at least among the urban middle class) will find the economy's inability to keep up with their expectations a sore point - and one which will undermine the legitimacy of the CCP.

It also means that beyond 2021, investors will have to look to other regions for economic leadership.  Of course, China will be a very large economy and growing solidly, but so will the US - except that the US will not have the political risks associated with China.  Expect asset prices and investor appetites to wane.