China Will Not Overtake the U.S.

It’s time to uncrown the Red Dragon. China will not become the world’s largest economy in the next decade.

The claims fall apart due to flawed measurements and the serious weaknesses overlooked in the Middle Kingdom’s economy. China is still significantly smaller and less wealthy than the U.S.

“China will become the world’s largest economy in 2024,” says IHS in a new report, echoing similar forecasts which have popped up intermittently since the financial collapse in 2008.

Even the IMF does not forecast China overtaking the U.S. later this decade. By 2019 (the end-point of IMF projections), its estimate for U.S. GDP shows the U.S economy will be nearly 60% greater than China’s, $23.4 trillion versus an estimate of $14.8 trillion for China.

Unless China completely liberates its economy by 2019 to suddenly blow its GDP out by 60% within a short five-year time frame, the U.S. will still be tops.

China Claim

Currently, U.S. GDP is $16.8 trillion, while China’s is about $9.2 trillion, despite the fact China’s population is more than four times bigger.

“Over the next 10 years, China’s economy is expected to re-balance towards more rapid growth in consumption, which will help the structure of the domestic economy,” said Rajiv Biswas, chief Asia economist for IHS.

Essentially, IHS argues China’s economy will be bigger than the U.S. because its consumers are growing in number and will spend more.

Based on that premise, IHS forecasts that by 2024 China’s nominal GDP measured in U.S. dollars will be $28.25 trillion versus the US’s $27.31 trillion. IHS also forecasts total Chinese consumer spending will grow from $3 trillion to $11 trillion by 2024.

But when it comes to economic might, consumer spending, income and wealth are distinct concepts. Income is of course important in buying things and accumulating wealth, but neither income nor spending are as good a measurement as wealth, a country’s value after debt.

Cheaper Goods, Cheaper Currency Doesn’t Equal Value

Do more consumers really mean more economic power? A country’s wealth is not based on consumer transactions occurring during a calendar year. Cheaper currency to buy cheaper goods or services doesn’t equate to wealth—nor does arming consumers with more paper in their wallets. Especially when a country is devaluing its currency, which is like changing the number of ounces in a pound, as one analyst recently noted.

And China’s consumer spending power may be pinched in coming decades. For one, China’s own statistics show that in the next two decades, a fifth of its population will be age 65 or older, conserving their savings to consume mostly health care with a lot of government help. Just like Japan and the U.S., government wealth will be aimed at taking care of retirees, with fears that economic growth could then possibly downshift.

China pegs its currency to the U.S. dollar, so the two float relative to each other, either up or down. The yuan has risen against the dollar since 2005. But fiat money distorts intrinsic value, which is affected by supply and demand. For instance, if the U.S. pegged its currency to the value of gold years ago, then the purchasing power of the dollar—and the yuan-- would be a lot less today.

China's broadest measure of money supply, M2, was up 12.8% as of August versus last year. That’s the slowest growth in five months, but still a big jump.  Credit rating agencies have raised concerns that China has also been undercutting the strength of its currency via the massive growth in its under-reported state loans sold through its state-owned enterprises, regional banks and its shadow economy, which are often not reflected in official statistics.

Between January 2005 and January 2013, Chinese bank deposits roughly tripled, growing $11 trillion, to $15 trillion from just $4 trillion, Fitch banking analyst Charlene Chu has noted.  Just in one year alone, between January 2012 and January 2013, Chinese deposits rose by just over $2 trillion.  “There’s no way that we are not going to have massive problems in China,” Chu says.

“Money measures wealth, but does not create it,” as one analyst said. If printing money created wealth, there would be no poverty left on earth, Ron Paul also has said (and counterfeiting would be legal, economist Brian Wesbury would add).

But it’s the idea that China’s consumers can power its economy to beat out the U.S. that’s dubious. For one, China has a lower cost of living and has cheaper goods and services versus the U.S.

So although economists may argue otherwise it’s still dubious to use China's gross domestic product (GDP), adjusted by purchasing power parity (PPP) to argue it will be bigger than the U.S. next decade. The World Bank has used this measure to maintain China will be bigger. Purchasing power parity is only about purchasing power, that’s it, not the strength of an economy.

Because goods and services cost less in one country versus another, economists try to level the cost of living by using the measure called purchasing power parity.  This measure recognizes that earning $50,000 a year in the U.S. is very different from earning $50,000 a year in Shanghai, because the cost of living is different in each place.

“It does not make any sense to compare one country's PPP-adjusted GDP to another and say its economy is larger. Not for any country at any time,” Derek Scissors at the American Enterprise Institute says.

There are other problems in defining economic power by using average purchasing power parity to compare one country to another. For one, it telescopes down the vast differences in purchasing power that exist even within a country’s borders, certainly true of the U.S. and China (think New York City and Jonesboro, Arkansas). Just on income alone, the average American had $48,000 in 2009 income, the average Chinese had less than $4,000. Adjusted for currency differences and inflation, the average American still makes more than the average Chinese.

Paper Dragon 

To cure its joblessness and calm potential social unrest, China has built an economy on a mountain of paper debt funneled through state-owned enterprises. It has long been a member of “the worldwide bubble in government spending club” to reflate its way out of lackluster growth.

China is so top heavy with government debt that its paper pile is two and a half times the size of its economy. Veteran China analyst Stephen Green at Standard Chartered calculates that China’s aggregate debt hit 251% of its GDP as of June. Its debt sits at about $26 trillion, which is more than the entire commercial banking systems of the US and Japan combined, estimates show.

That compares to U.S. debt levels, (all in, including the Federal Reserve’s balance sheet), at a hefty 260% of GDP. However, China also recently passed the United States to become the world’s largest issuer of corporate debt.

But do China’s empty ghost towns, unused bridges and roads really equate to wealth? Does economic growth really come from the sheer piles of government money spent?

To build out its infrastructure, China is rapidly blowing out its government balance sheet, an increase of 17 percentage points of GDP since December 2013, reports Capital Economics. As of 2010, the latest data available, its fixed investment equaled a whopping 70% of GDP, according to China’s National Bureau of Statistics in Beijing.

China is still battling high joblessness. The real jobless rate is likely double the official headline, which is understated, China watchers note, just as it is in the U.S.

The state-controlled Chinese Academy of Social Sciences indicated joblessness in China’s cities hit 9.4% even before the financial crisis, and rural unemployment topped 20%. But a look at the measure of those who want jobs and do not have them shows, “China’s unemployment is double that of the U.S. even in a very weak American year,” says AEI’s Scissors.

China’s Natural Resources

China is the biggest exporter on the planet and the second largest importer of goods and commodities behind the U.S. China’s exports are about three times more important to its GDP than U.S. GDP, so being the “World’s Factory” is vital for China to keep powering its economic growth.

Natural resources are needed for its economic growth, but China is more dependent than the U.S. on foreign natural resources and supplies as it continues to suck dry its own.

China is the planet’s second-biggest oil importer, its biggest coal importer, biggest soybean importer, and it accounts for two-thirds of global iron ore trade, Scissors notes. The U.S. also has larger available coal reserves.

Meanwhile, a quarter of China’s land is desert, the U.S. has more arable land, and China is in dire need of water resources, with half the water supply of America’s.  On top of all this, pollution is a gigantic problem in China, which is sickening its population, diverting even more of its resources.

And China has still not achieved the one thing developed economies do to become economic powerhouses: Soft power from its own home-grown companies. China doesn’t not really invent things. Its business model is built on production rather than invention.

The U.S. has that wealth in the form of soft economic power, its influential brands are desired and sought after around the world. Apple, Google, Microsoft, Facebook, Verizon, Netflix, AT&T, Coca-Cola, General Electric, Intel, JPMorgan Chase, Goldman Sachs, McDonald’s, Yum Brands, Twitter, Tesla, Instagram, General Mills, to name a few. China’s most recognizable names are Alibaba, Lenovo, and Huawei. Yes, Chinese love iPhones, Xboxes, GE dishwashers, Coke, and Big Macs. But they were not invented there.

More Reasons to Not Trust the Numbers

Also, even the world’s leading experts on China have taken an unsympathetic axe to their own growth figures, skewing the results. For instance, inflation in China was zipping faster than price increases in the U.S. in the late 1990s. So what did the World Bank do?

It “retroactively cut the size of its 2005 PPP estimate of China’s GDP by more than 40%. In an instant, the Chinese economy became 40% smaller,” Scissors notes.

Moreover, in the last 10 years, inflation in China has still grown faster than inflation rates in the U.S. But “the World Bank has not yet adjusted for this faster inflation,” Scissors says. So, are the economic projections claiming that China will surpass the U.S. then out of date, and in turn should not be trusted?

National Wealth Best Measure

National wealth provides a far more accurate view of economic heft than GDP or PPP.

Credit Suisse’s measure of private wealth for countries puts American private wealth at $72 trillion, versus Chinese private wealth at about $22 trillion in mid-2013.

Is China really more powerful given that $50 trillion gap?

If China enacts more aggressive market-based reforms, the raw power of its population could help it hit the big top of the world economies. But unless it seeks economic growth based on entrepreneurialism, property rights, a strong currency to draw investment capital, and stock market reforms, unless China moves away from centralized government forces, the Middle Kingdom’s growth will continue to be hallucinatory—just as are the reports that China will soon dominate the world economies.