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Economics: A New Economic Order:
New York: July 24, 2006
By John R. Stephenson

The U.S. rules the roost. Whatever happens in the U.S. is of primary importance to investors around the world. That's because the U.S. is the largest and most important country economically and militarily whose currency is the reserve currency of the world. Inflation, the price of oil and the state of the U.S. consumer all figure into our investment decision-making. But what if that U.S.-centric view of the world is wrong? What does that imply for investors?

It is wrong. That's because the U.S. economy is no longer driving the global economic bus. The rapidly growing economies of China and India are re-making the world economic order — a circumstance that will likely leave many U.S.-centric investors scratching their heads.

That's because we've had it good for so long. As recently as a decade ago, the American economy was the engine of global economic growth. In the 1992-2000 time frame, the U.S. economy, driven by a boom in technology, accounted for some 25 to 35 percent of the increase in global GDP — more than that of any other single country. Today, the story is a different one.

Rather than slowing, the Chinese economy seems to be slipping into overdrive — growing at some 11.3 percent in the second quarter of this year. The Indian economy is no slouch either with growth rates in the second quarter of this year clocking in at some 9.3 percent.

The story in the U.S. is one of inflation. At home, the Federal Reserve seems intent on stamping out inflation and has continued to push interest rates higher, a move that threatens to pop the housing bubble that has developed in the major coastal cities. But while the Fed continues its focus on short-term economic indicators, a new world order is forming which is increasingly making U.S. economic policy less relevant than it was even a decade ago.

The world economic growth is being driven increasingly by Asia. While Americans are fed a constant diet of economic babble about how Asia's economic growth is largely dependent on American consumption, the facts say something entirely different. Chinese exports to the U.S. make up only 8 percent of China's GDP — hardly a show-stopping number. China's middle class consumers and red-hot investing spending have replaced the Wal-Mart factor as the key driver of their economic growth. This solid domestic demand in China should continue to shield the Chinese economy from any economic slowdown that the U.S. might experience.

In industry after industry, China is starting to show signs of economic might. The Chinese automobile industry has grown by some 200 percent over the last five years (current production of six million cars annually) without exporting a single car to the U.S.

While the U.S. remains an important economic power, the U.S. has accounted for just 15 percent of global GDP over the last three years. China, at less than half the U.S. size (economically speaking), has made a greater contribution to the global economy since 2004.

Figure 1: Global GDP Growth By Region

Source: CIBC WM

Not only is China growing at a rapid-fire clip but so too are other major economies around the world. Russia and the Middle East are growing at a furious clip fueled in part by record profits from their oil fields. All around the Middle East, construction cranes dot the landscape as huge oil revenues have been funneled into massive construction projects. Russia alone grew at some 6.4 percent last year and this year should clock in at nearly 7 percent growth.

Not only that, but economic laggards such as Japan and Europe have started to show signs of economic life. Growth in Japan looks likely to hit the 3 percent mark this year as rising wages and a 15-year high in consumer confidence seem to be signaling an end to a decade-long slump.

In Europe, the unemployment rate has hit a five-year low while at the same time the manufacturers index has hit its highest level since August of 2000.

What all this means is that even if interest rate hikes do halt growth and cause an eventual slowdown in the U.S., the world economy should continue to chug along with overall economic growth clocking in around 5 percent — strong growth by any measure.

While the U.S. continues to be an important engine for economic growth on an absolute dollar basis, its impact on the commodity markets remains muted. That's because in the world of commodities, it is Asia, not America, that drives the bus. But try and tell that to commodity traders who every week fixate on the release of the U.S. crude and gasoline inventory numbers to set the tone for trading in the week ahead.

While the U.S. is still the largest single largest crude oil market in the world, demand growth has been averaging less than 1 percent a year over the past five years. Compare this with the demand growth in the rest of the world and you begin to see that while the U.S. will remain important in the world of oil and natural gas, it is increasingly the countries at the margin where demand growth is the highest that will set the world's price for oil.

Figure 2: Global Crude Oil Consumption Growth

Source: IEA

Not only is Asia demanding more and more oil, but the overall level of demand is very small when compared with more developed economies. When measured on a per capita basis, consumption of oil in China was only 7 percent of what the average American or South Korean would consume. While oil consumption on a per person basis remains modest, this is changing in a hurry. Why? Because Chinese consumers are demanding more of what we in the west have — cars and creature comforts. Chinese auto sales are up some 45 percent in the first half of this year.

In base metals such as copper, zinc and aluminum, China has already surpassed the U.S. as the world's largest consumer. As with oil, base metal consumption in China is minimal when measured on a per capita basis but huge as an overall number. If China continues to develop and evolve, as we believe it will, it is inevitable that consumption of base metals and oil in China will eventually reach the same per capita level of consumption that we have seen around the rest of the developed world. This is good news for countries and companies that supply a hungry world with oil and base metals.

Figure 3: China's Per Capita Consumption of Base Metals

Source: CIBC WM

While U.S. investors may fret over rising interest rates and slowing economic growth, the world has never looked better for global investors, particularly for commodity-oriented investors who will be the beneficiaries of a changing world order. A world order where rapidly industrializing countries will be the ones setting the prices for oil and base metals. The U.S. economy will increasingly become more service oriented and will be a price taker rather than a price setter in many of the world's commodity products.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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