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There is Nothing Small in China

Bear with me on the title of this edition; I think it will make some sense as the article unfolds. I’m writing this article from Shenzhen, China where I have been invited to speak at the 5th Annual China International Derivatives Forum. I have been to China a number of times over the last twenty years; however I had never been to Shenzhen. Since this conference focused on China’s economic outlook for 2010, and I feel more strongly than ever that our financial health in the US is inextricably linked to China’s, I accepted the invitation.

In preparation for this conference, I sent my hotel reservation request to the conference venue, the Wuzhu Guest House in Shenzhen. I did not know quite what to expect of this venue, but I pictured a small, inexpensive, clean hotel on the outskirts of the city. Well, it is clean and inexpensive and on the outskirts of the city, but I got the “small” part very wrong. For example, it is at least a two block walk from my hotel room to the ballroom where the meetings took place; no exaggeration, and all under one roof. The conference room was massive; a three story ceiling with eight chandeliers each as big as a mid sized automobile. There were a total of three conferences taking place simultaneously in the hotel, each with between 600 and 1000 registrants. These facts set the tone for what I was to realize over the two days of meetings.

The most interesting aspect of meetings such as this in China is that one gets two perspectives on every issue: the actual perspective and the official state sanctioned perspective. What I have noticed over the years is that those presenting the “actual” perspective (economists, finance professors, investment bank researchers) have become bolder in how much their views diverge from the official “state” perspective. One presenter actually quipped “please don’t report my findings to the state committee,” but I felt he was being more serious than funny. It is very clear at these meetings that the state council members are present, as they are given VIP treatment, seated in the front row, and often given time to speak on the issues. Although China has embarked on the journey to capitalism they have encountered some very rough seas.

The primary topics for this meeting included unemployment, the housing crisis, government stimulus programs, and improved regulation of the financial services industry. Sound familiar? The only way you knew you were in Shenzhen and not in Chicago discussing our domestic economy was that the conference was conducted in Chinese with simultaneous translation. The issues and the problems are that similar. What is the only apparent difference? The magnitude of the problems: it really hit home that with a 400% greater population than the US, their problems are 4 times as great as ours.

This is not to say that China itself is not doing well, as they have increased their Gross Domestic Product (GDP) year over year for many years. They have invested the fruits of those efforts in more than $1 trillion of our government bonds. The GDP of a country generally is a great indication of how robust or tranquil the economy is, and therefore usually indicative of how well people are doing. However, China is the only major economic power where substantive increases in GDP have not provided a corresponding increase in the standard of living. Therefore, it is accurate to say that China is doing well, but not to say that the Chinese people are doing well, at least not all of them by any stretch of the imagination. This fact is very much on the minds of the people, as rival economies of Japan and South Korea boast a direct correlation between increases in their GDP and increases in the standard of living. For example, South Korea has translated year over year increases in GDP of 8% to an increase in the standard of living (most notably wages) of 8%. China has had multiple years of double digit increases in GDP while the standard of living (wages) has remained flat.

Unemployment in China is “officially” stated as 4.6%, yet anyone connected to the jobs market here will tell you that it is actually closer to 10%. Moreover, unemployment is accentuated by an unwillingness of workers here to take lower paying jobs such as clerks or factory workers. Again, sound familiar? In the US we have officially hit 10% unemployment nationwide, even higher in the rust belt states such as Michigan and Ohio. Yet many jobs at fast food restaurants and retail stores go unfilled. I am not suggesting that a family could exist on the wages paid by one of these jobs, but I draw the comparison because we are not much different from the Chinese and that fact may help us to survive the economic wars that lie ahead.

Government stimulus in China has been put into effect through a $586 billion dollar plan announced in recent weeks. Many here in China would agree that the effort is merely a show of some support for the global economic crisis, as $586 billion hardly dents the economic problems of 1.2 billion people. By comparison, the US has dumped nearly $2 trillion into the bailouts and other stimulus efforts while we serve just over 300 million people. Also, there are some within China who believe the Chinese stimulus package is to cover multiple years with no additional funding, so its impact will be called further into question. Nevertheless, this most likely means that the Chinese economy is decelerating faster than was commonly believed. It also means the Chinese “state officials” are not at all willing to let growth slow far enough to risk social unrest. It will take some time to discern whether they succeed in the latter objective.

The global financial crisis was triggered globally largely by defaults in various mortgage securities, primarily on US residential property. China has found itself in the midst of a huge housing bubble as well; one which actually makes the US bubble pale by comparison. There is a huge gap between the “middle class” in China and the poverty levels. The middle class has marked their realm with multiple purchases of homes and apartments, almost all of which was done as speculative investments. There are estimates that many individuals own 20 or more properties, most of them empty and most of them now valued far below the original purchase prices. This buying spree was fueled not only by new found wealth, but also by the lack of any real costs beyond the debt service on the mortgage. There are no property taxes in China. Imagine the burden that could be lifted from the average US homeowner if he no longer paid real estate taxes on his property.

Chinese government policies, Chinese unemployment levels, Chinese housing bubbles: how do any of these issues affect our financial well being?

It should be very clear to all of us that we are entrenched in a “global” economy. We no longer control the international trade routes; we no longer command the stature that once was placed on holding US dollars as opposed to any other currency. (Please see last month’s article on the dollar if you have not yet had the opportunity). At this point China is our largest competitor, closely followed by a well organized trading block called the European Union. In my opinion, the US has a small window of opportunity to get our financial house in order while our largest competitor faces seemingly insurmountable near term hurdles. The window is small because they will get it right eventually, and then we will be trying to catch up from behind; an unenviable position whatever the race.

I have stated before that we need to accentuate our positive economic strengths, most importantly in the fields of agriculture and technology. Longer term investments in these areas will prove to be sound in my opinion. We need to focus on production and sale of products which will continue to grow in demand year after year. Eventually, the huge gains in Chinese GDP will translate into an improved standard of living for many more of their people than it has thus far. At that time we will be best served by being the market of choice as a reliable source for food and technology. Consult with the BCU Investment advisory team or a financial advisor of your choice to implement a specific investment plan. At this point, as we look at both the near and long term prospects for the US economy in the scheme of global trade, we are fortunate that there is nothing small in China; particularly the economic problems.

©Patrick J. Catania 2009 The views and opinions expressed herein are solely those of the author and do not necessarily reflect those of Baxter Credit Union, its Board of Directors, or its employees. The author is responsible for the content. Readers should consult with, and seek professional advice from their own attorneys, accountants, and financial advisors with respect to their individual financial needs and circumstances. We welcome your feedback and ideas regarding this service. To submit a comment or idea for a future article, please email us at member.feedback@bcu.org