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Economics: China and America - Global Partners?
New York: September 13, 2004
By John R. Stephenson

They may seem like an unlikely pair of economic allies, but lately, China and America have been the economic engines of growth for the entire planet. In fact, half of the world's economic growth between 1996 and 2003 can be attributed to both U.S. demand (consumption) and Chinese production. The U.S. consumer has been encouraged by loose monetary government policies to spend at a prodigious rate (75% faster than anywhere else in the developed world). The big problem with American consumption? Wages have failed to keep pace with inflation and with consumption leaving the American consumer with twin evils — low savings levels and high debt levels.

The Chinese economy has been driven by rapid industrialization. This rapid industrialization has been accompanied by a dramatic increase in the demand for base metals and other commodities as well as a huge migration of people from rural China to the industrializing coasts. To date, some 200 hundred million Chinese have left the poverty of western China behind and moved to the coastal region in search of economic opportunity. So robust is the growth that Goldman Sachs has forecast that, in less than 40 years, China will overtake the U.S. to become the world's biggest economy.

In oil, as in base metals, China's appetite has seemed, at times, insatiable. With commodity prices being set at the margin, the incremental demand from China for all commodities is indeed significant. In the sixteen years since 1988, the worldwide demand for oil has risen from 64.95 million barrels/day to 82.15 million barrels/day with European demand up 16%, U.S. demand up 18% and China's demand up 175%. Of course, China started from a much lower base of demand, however, their demand has risen over the eighteen year period by 3.98 million barrels/day versus the U.S. who experienced an absolute demand growth of 3.08 million barrels/day. China (7.6% of world production total) has currently surpassed the oil consumption of Japan, the world's second largest economy. Not only is the Chinese demand for oil large, but it is likely to remain strong for some time with various economists estimating that the worldwide demand for oil will likely increase by 25%, all at a time when production remains flat.

Not only is China a major factor in the escalating price for oil, but the country is also challenging the suppliers of base metals (copper, lead, zinc etc.) to keep up with its surging demand as the country industrializes. Over the last few years, China has accounted for 100% of the world growth in copper, 95% of the world demand growth in steel and 99% of the world demand growth for nickel. This huge leap in economic progress is coming from a nation that represents one-fifth of the world's population and is united by a single culture and history. The Chinese are a relatively homogenous group with a high level of commercial acumen, excellent work ethic and they are prodigious savers (saving on average more than 40% of their incomes).

In order to grow the Chinese economy, the government has focused its efforts on expanding the export sector — so much so that fully 46% of their GDP is spent on the export sector of their economy. During 2003, some 58% of China's imports of goods and services came from Asia with only 8% percent coming from the United States and 13% from the European Union. In fact, China runs a trade deficit with the other Asian countries which is more than made up for by the huge trade surplus it is running with the United States. In short, dollars are flowing from the United States to China and then into the rest of Asia.

In order to continue to consume, American consumers have turned toward borrowing to support their habit. The figures are truly staggering. Total household debt has soared from $7 trillion at the end of 2000 to $9.5 trillion in the first quarter of 2004, up some 36% and the amount of outstanding mortgage debt has risen by 43% during the Bush administration's first term. As well, debt at both the state and local government levels is up some 33% since the end of 2000.

With the Chinese focus on the export sector of their economy and an indebted U.S. consumer being the recipient of the vast majority of these exports, the stage is set for a possible worldwide recession in 2005. With the American consumer so linked to the Chinese producers, a difficult and possibly unsustainable relationship exists. In the 1980's, Japan embarked on an export-driven economic bubble that eventually collapsed but at the height of the bubble, the Japanese economy diverted far less than the 46% of GDP that the Chinese economy spends on the export sector. To avoid a possible worldwide recession in the years to come, the American consumer will need to defy the odds and continue spending whereas the Chinese economy will need to transition from an export-led economy to a consumption-driven economy.

 

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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