This Is the Key to Understanding China’s Economy

By: John_Mauldin

China is facing many challenges. That’s probably not news to you.

But what we often fail to understand is this: China will deal with those challenges in a much different way than what we are used to in the West.

To solve Europe’s financial woes in 2012, ECB President Mario Draghi promised to do “whatever it takes.” Yet central bank policy was his only tool.

Xi Jinping has a vastly larger toolbox. It is hard for us in the Western world to understand that.

Xi has every tool a top-down government can have. Not only that, he has experts to wield them. And all of them are 100% aligned with his goals.

Different Game Rules

I spent a few hours with Mark Yusko last week.

Mark is a good friend of mine and the founder of Morgan Creek Capital Management. He spends a lot of time in China so I often turn to him for on-the-ground research on this market.

Every time I hear him talk about the opportunities in China, it makes me want to fly to Shanghai or Guangdong.

The country has enormous investment opportunities as well as a strong entrepreneurial culture. Entrepreneurs there can create almost anything they envision.

However, you must realize this comes at a cost. The cost is a level of government intrusion unimaginable to us in the West.

In the US, we’re debating the data collected by corporations like Facebook and Google. Their Chinese equivalents are encouraged to collect such data and share it with the government.

And in every interview that I have heard, most Chinese people simply don’t care—at least not publicly.

Playing a Decades-Long Game

Xi Jinping wants China once again recognized as a global superpower. At some point, even the leader.

The Chinese leadership are all students of Chinese history. They know where they came from. Now they want to regain what they think belongs to them.

They are playing a long game—a decades-long game.

China is investing at least as much in artificial intelligence, robotics, and Big Data as the West is. The Chinese military controls, directly and indirectly, much of it.

So when US and European military planners get, let’s just say, nervous about China’s technological advance, it is not without reason.

China also wants the yuan to be a global reserve currency. A necessity for that status is willingness to run trade deficits. It is no accident China’s large trade surpluses are beginning to dwindle.

That is a feature, not a bug. It is by design.

As for intellectual property and patent rights, the Chinese are rapidly creating their own.

China graduated 4.5 million, not counting software developers, mathematicians and other scientists. The vast majority of artificial intelligence patents filed last year were Chinese.

Their interest in protecting that property is replacing the former practice of stealing the IP shirt off your back.

Challenges Ahead

China faces numerous challenges, too.

Simon Hunt, who has been going to China for 25+ years and knows the country better than any non-Chinese person I’ve ever met, put it this way.

What should be clearly understood is that China’s economy is facing multiple changes in its structure. They include:

- Exporting companies relocating overseas because of rising domestic costs and American tactics (which won’t reduce the total imports, just the origination of those imports!)

- A shrinking labour force

- A focus on high-tech

- The need to build infrastructure to accommodate the migration of another 150 million from the countryside to the urban community [in addition to the almost 300 million that have already moved in the last 40 years, in the largest single migration in human history]

- The need to focus development on the lower-tiered cities and rural villages

- Whilst continuing the process of deleveraging the economy.

I talk often about how big China is and how fast it is growing. Often I mention it is the world’s second-largest economy after the US. I may have to change that practice soon.

Standard Chartered Bank said this month China will likely become the world’s biggest economy at some point in 2020 (by nominal GDP and purchasing power parity measures).

2020 is next year! This isn’t the far future.

Now, this won’t be the end of the world. It is simply math. GDP growth is a function of the number of workers and their productivity.

China has four times more workers who are getting more productive. At some point, their large numbers outweigh the higher productivity we have in the US and Europe. This is inevitable.

That rise won’t happen without some hiccups. And we have to remember that the US and Chinese economies are co-dependent in ways we can’t change quickly. Problems in either country will hurt the other—and both now have problems.

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