China leads economic Olympics
By the early hours of Friday, August 8, as the firecrackers and razzmatazz open the Beijing Olympic Games, many will reluctantly realise that the world has a new economic axis.
China is draining raw materials and appears to be winning the economic Olympics. This is not simply a matter of cheap jeans and computer games.
In fact it may, conversely, cost the West dearly. So while we argue about free trade, it is not necessarily fair trade and we should be aware that our future wealth and privileged lifestyle faces a serious challenge.
We must not forget that China has been out in front before. In the year 1000AD it was the world’s richest country.
Measured in current terms — in other words year 2000 dollars — the Chinese were at that stage earning $466 per annum per head, while over in Europe we earned just $426. By the year 1500 Europe was a little ahead but by 1950 China had completely lost ground to the US, where the figure was a massive $9,561 per annum per head against China’s $448. Now, however, the situation is reversed, with China making huge growth per annum.
In the last seven years it has grown at 10% each year versus 2.07% in the US. If this continues China will overtake the UK in 20 years and the US in 30.
What we are watching is an Asian style, export led, economic boom. The short-term aim has been to create millions of new jobs in modern urban industries in order to mop up the numbers of surplus rural, mostly agricultural, workers who continue to flood into the cities. One of the effects of this has been a mammoth requirement for business credit - not least because many Chinese firms suffer from low returns on their capital.
So somehow China has to bring in US dollars and engage with Western banking systems. As most will be aware, China is fixed to the US dollar.
But there is a paradox here in that whilst there is a huge demand from China, there is at the same time a huge US current account deficit.
So while China may be seen as supporting the West with its savings surplus, the real dependency is the other way round. To be more precise, China needs Western consumers more than a savings surplus, to solve its surplus industrial capacity.
Looking at this from an investor’s perspective for a moment, many see fast growth and profit as synonymous. But this is wrong.
They are not, as was amply demonstrated in the 1980’s in Japan and in the tech boom of the 1990’s. So China still has a poor return on capital and has to spend more than half of its GDP on new capital investment.
This in turn has resulted in the overproduction of manufactured goods, which end up in our markets and the ongoing effect of this is that our industries have ceased to make things and we have been forced us to accumulate cash whilst exporting jobs.
So what of profitability, which is, after all, what gives the return on any investment? Only profitable companies will generate good levels of dividends for shareholders.
This being the case, where should we invest our precious savings? I would argue that because Asia desires so strongly to catch up with the West and will thus continue its demand for commodities, looking East for at least part of your portfolio would seem to make sense.
Nicholas Watts is an independent financial adviser with Positive Solutions Financial Services which is regulated by the Financial Services Authority. To contact him, use the website www.realwealthmanagers.co.uk