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 ínflation 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.
Good blog.
ReplyDeleteI'm bearish on China and India for some of the reasons you cited. However, although demographics takes a long time to change, I think China may actually be able to reverse its aging population somewhat. A lot of China's poor demographics stems from the one-child policy (as well as infanticide and mismatch of male-female ratio, which also plagues India). China can loosen the one-child policy and indeed, it has started loosening it.
My problem with the emerging market bull case is that little consideration is given to politics. General consensus often involves taking some growth rate and projecting it far into the future, as if nothing bad will happen along the way. I don't think China and India will surpass USA for a long time because their political systems are weak. All it takes is a crisis or a war or a disease outbreak or something, and the whole system can fall apart.
In contrast, even if USA faces problems, its strong political system, along with a focus on liberty, free markets, and democracy, can survive much better.
On another note, I think investors in USA will outperform emerging markets in the long run (at least for several decades) because USA is more capitalistic and companies are run more efficiently. That is, return on equity in USA is higher than almost any other country (over a long period of time). In countries like China, it's not clear if companies are even earning their cost of capital.
I agree entirely with your view of the strength of the US. I still believe it is the single best market in which to invest, for the reasons you cite.
ReplyDeleteThere is simply no other market with the depth of managerial and entrepreneurial talent, and that is why returns on equity are so favorable in the US (though tax structure helps).
You are also right to question the stability of the political system. It has never really faced true adversity, at least, not since Mao, and the system is quite different since then.
More generally, authoritarian political systems have difficulty innovating. I don't believe China will be capable of training the managers it needs to succeed with new generations of technology, and this will be a major reason for the slowdown of Chinese growth.
However, demographics will play a role in this. Even if China were to eliminate the 1 child policy, it would take 16-20 years before the new generation entered the workforce. In the meantime, childrearing would cause more women to take at least temporary departure from work and actually acclerate the decline in the workforce that now must happen starting in 2012.
Moreover, even if the policy were elimianted, it is not clear that the Chinese would return to high levels of childbirths. Many other countries, including developing countries, have experienced rapidly declining fertility, without a government polcy. Raising births back to replacmement levels might turn out to be quite difficult.
All of which is to say that all of the macro factors continue to favor the US, declinist commentators like Thomas Friedman notwithstanding.