China: how will its mass urbanization impact the global economy

China’s impact on the global economy is hard to overstate.

Not only is it the world’s second largest economy (by country, not region), but also the source of a huge amount of incremental growth over the last 15 years.

I’ve seen estimates that over 50% of the demand for iron ore and copper comes from China. Almost 50% of worldwide steel is produced in China. I once read that China has used as much concrete in 2011 and 2012 as the U.S. used in the 20th century! I don’t know if such estimates are specifically accurate, but their magnitude gives you a flavor of how China has impacted the global economy. In short, the economic crisis since 2008 would have looked a lot worse without China.

Given that, it’s important to consider the impact of China on future economic growth. 

One of the dynamics going on in China is the move from a more production-based to a consumption-based economy. China is approximately 34% consumer-based versus 70% in the U.S. China has built an economy, predominantly from the top down, that has mostly produced goods for other countries, like the U.S., Europe and Japan. But that source of growth was limited. You can only take market share for so long before you need to become your own source of growth.

China is trying to make that transition, but getting a command and control economy to do that without large disruptions is very difficult. 

One aspect of such a transition is having hundreds of millions of Chinese farmers move from the hinterland to cities. In cities, they can work in factories and produce much more than they can on the farm. That higher productivity leads to higher consumption, thus achieving China’s goals. 

But, how do you move hundreds of millions of people from farm to city. In the west, and Japan, that transition took place over many decades, and mostly organically (by organically, I mean through free market forces, not through government fiat). Those transitions led to disruptions, just as it will in China.

China, however, is trying to do this much more quickly and on a much more massive scale. China wants to move around 235 million people to cities over the next 20 years. For perspective, that’s the size of the 10 largest cities in the world now (from Tokyo at 37 million to Mexico City at 20 million). Can you even imagine trying to regrow 10 of the largest cities in the world, over the next 20 years? (for more information, read Stratfor’s article on the subject)

Achieving such a task is Herculean, and it will impact the global economy.

How? I don’t know. It could all happen smoothly, which I consider unlikely. It could occur with either international or domestic war, as such pressures have created throughout history. It could happen in fits and starts with massive swings in economic growth from boom to bust. No one knows, really, but it bears watching.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China: how will its mass urbanization impact the global economy

Got Growth?

The U.S. economy has really taken it on the chin over the last 2 years.

U.S. Gross Domestic Product shrunk the most since the Great Depression. Unemployment hit double digits for the first time since the 1970’s. Our housing market dropped like a stone.

Added to this, the world economy turned down pretty much because of the economic collapse in the U.S. This makes sense when you think about it; the U.S. economy is larger than the next 3 largest economies combined. How could the world keep growing when it depends so much on U.S. consumers and capital markets?

At the height of the crisis, many Europeans seemed to bask in the glow of American failure. They seemed to wag their fingers at us and say, “I told you so!”

In some ways they were right, but not in the most important ways.

You see, the U.S. economy returned to growth last quarter, a whopping 3.5% annualized growth rate. This was far faster than anyone, including yours truly, predicted 9 – 12 months ago. And, economic growth in the current quarter looks good, too, projected at around 2.5%.

Amusingly to me, the European Union grew in the third quarter, too, but at only 0.4%. I’m not surprised we aren’t hearing as much from European know-it-alls.

Why such a big difference in growth? I’m sure every economist and armchair economist has an opinion, and I do too: I think it’s mostly due to our more flexible labor markets.

America has its share of problems, but we still have one of the most flexible and adaptive economies in the world. One reason for this is that U.S. companies are relatively free to hire and fire when compared to places like Europe or Japan.

This is not a one-sided benefit for employers, it benefits employees, too, who can quit and find better employment when they want. I think not being able to quit is as bad a sin as not being able to fire.

Contrary to popular belief, what will get U.S. and world economies growing again will not be stimulus, but adjustments of the economy to new economic realities. And, it’s unlikely bureaucrats in any government position will be able to see this before businesses and entrepreneurs.

The places where labor and business flexibility are stifled, like Europe and Japan, will be mired in slow growth until they change. The economies that are flexible and adaptive, like the United States, will return to growth more quickly and will re-establish high growth rates.

That doesn’t mean the U.S. will grow faster than Brazil, China, India, Korea or a host of other emerging markets, but compared to any developed market, I’ll place my bets on the good ole U.S. of A.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The economy’s white knight

There’s been a lot of talk about what will pull the world economy out of the funk it entered a year ago.

Most of the focus has been on the U.S. consumer and what they can do to pull us out of our economic malaise. After all, consumer spending is usually 60%-70% of the economy.

Others, instead, focus on the governments of the world, whether U.S., Chinese or European. To this way of thinking, the economies of the world have come off the tracks, and only government can get them back on the again and moving forward.

But, I think this misses the most likely source of future economic growth: businesses.

Consumers are tapped out, they have to pay off debt and build up savings. Most governments are tapped out, too, they are simply borrowing from others in hopes that spending now will produce growth sooner rather than later. The financial sector, which can usually spur growth with lending and investment, is even more highly in debt than consumers or governments, so they don’t seem likely to be the impetus for growth.

Businesses, on the other hand, are in relatively good shape. Businesses faced a very tough recession in 2000-2002, and they have since lowered their debt and learned to react quickly and decisively to tougher economic times. They tend to be leaner and more flexible than they were a decade ago, and many have large cash hordes they can put to work.

In my opinion, this is where growth will come from sooner than any other place. In fact, I believe it’s already happening.

Now that demand seems to be stabilizing, businesses will start hiring again. The U.S. economy needs to shift from a consumption to a production focus. China needs to shift from a production to a consumption focus. Businesses will lead the way in this shift because they will see the most profitable ways to benefit from the new landscape. The smart businesses, the lean and flexible ones who see the future first, will expand production and meet business demand first. They will then have the profits to hire and expand more. And, thus, the upward cycle will grow and expand.

This will not happen quickly. Production won’t go from 30% of the U.S. economy to 50% overnight. And, 30% of the economy will not make up for the 70% of consumption all at once. It will be a slow, steady growth that will build a more stable, more production focused economy.

This will be a good thing. For, as Jean-Baptiste Say said almost 200 years ago, supply creates its own demand. Production, after all, must precede consumption–you can’t consume what hasn’t been produced. Having an economy more focused on production than consumption will grow more steadily and resiliently.

The economy’s white knight is riding to the rescue, and below the radar of almost everyone. Businesses will lead the way.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

One clunker of an idea

I usually try to stay away from political commentary, but the “cash for clunkers” idea needs to be addressed from an economic standpoint.

If you haven’t heard about it, the “cash for clunkers” program gives cash to people who trade in their low mile per gallon vehicles to purchase newer, higher mile per gallon vehicles. From the way I understand it, you get $3,500 to $4,500 (depending on the mileage of the vehicle you purchase) for “cashing in” your “clunker.”

Now, let’s trace this idea from beginning to end and understand what’s going on. The government is paying people cash to throw away functioning cars. Where does the cash they are giving away come from? It comes from issuing government debt.

That means the government is raising money from someplace (China, Japan, Middle East, U.S. investors) that would otherwise have been invested in some other way, and using it to pay people to throw away functioning cars. Why?

(I’m sure it has nothing to do with the fact that the U.S. government has become a huge investor in Chrysler and GM. Note: I’m being sarcastic).

One reason is that most economists look at economic growth in terms of new things being sold instead of return on investment. Gross Domestic Product (GDP), which is the figure most economists and government employees watch, will show an increase because of the cash for clunkers program. GDP increases whenever things are sold, the government spends money, or we export more than we import.

Using this magical math, the economy grows any time consumers or the government spends, whether or not that’s positive return on investment spending.

But, let’s think further about this issue. Say you buy a car because of the cash for clunkers program. Because you are now making payments on a new car, and those payments are almost certainly higher than the payments on your clunker, then you have less money to spend on other things. In other words, spending has simply been taken from one place and put in another. GDP will show a spike because you spent a lot money today on a new car, but then you’ll have payments plus interest in the future which you can’t spend. Is that positive return on investment growth? Not likely.

Plus, the government has incurred debt to finance this spending. That won’t show up in GDP figures, so everything seems peachy. But, borrowed money needs to be paid back, with interest, and where will that money come from? It’s simply been borrowed from the future!

When I make an investment, the issue isn’t just: does growth occur? I must get a return on investment more than what was put into it.

Suppose I bought a company for $100,000 and had to put $10,000 into it in the first year. Suppose I only netted $5,000 in earnings. No one would consider that a wise investment. Suppose I put $15,000 into the business the next year and made $7,500. That would be growth, right, from $5,000 to $7,500, but I don’t think anyone would rejoice in putting in $25,000 and getting $$12,500 back over 2 years.

So, why would someone consider it a good investment to borrow money to pay people to buy something they don’t need? I don’t get it.

By such reasoning, it would make sense to burn down all the houses in my neighborhood so we could spend money to build new homes. If that’s considered economic growth by someone, then cash for clunkers makes sense.

But, to me, it doesn’t.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The stock market is all about expectations

The stock market has rallied strongly since March. Why has the market rebounded in the face of weak economic data? The reason: because the market is all about expectations.

The stock market is a reflection of investor expectations about future economic profits. When investors expect economic conditions to improve and companies to make growing profits, the stock market tends to go up.

Recent economic reports do not show a growing economy, but they do show that the economy is declining less quickly. Why is that a good thing? Think about an airplane in a nosedive. Before it starts to climb again, it’s rate of descent needs to slow. Then it levels off before it climbs. The rate of descent must get less bad before leveling or climbing can occur. Same with the economy.

The market has rallied since March not because economic data or profits have grown, but because things are getting bad less quickly. If it turns out that profits level off at a low level, keep declining slowly, or climb at a slower rate than people expect, the market will decline. In other words, the market will decline if economic growth and company profits don’t meet or exceed investors’ current expectations.

How likely is it that economic growth and company profits will miss, meet or exceed expectations? I have no idea, but in the short run that’s the $64,000 question. If you invest long term, pick good investments, and pay the right price, you don’t need to guess this outcome.

But, it’s an interesting question to ask. Do you expect strong economic growth over the next year? Do you think consumers are ready to start spending again despite 10%+ unemployment? Do you think recent government efforts to spur economic growth will work? Do you think company profitability will rebound by around 50% like the market is expecting?

After listening to conference calls over the last 3 weeks, I have to admit to having an opinion (for what that’s worth). Almost every company I’ve listened to has beat profit expectations by cutting costs and missed expectations in terms of sales. In other words, they are missing expectations for selling products, but meeting profit expectations by firing people and not spending for future growth. That doesn’t sound sustainable to me.

The market seems to be basking in the glow of potential, not actual growth. If that growth turns out to be ephemeral, look out below!

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

China’s precarious position

One of the major reasons for the market’s continued rally is China.

China has been buying up commodities, especially copper, and that has caused a resurgence in the price of copper. Because copper is such a fundamental unit in overall economic demand, many are taking the surge in copper prices as a sign that underlying economic demand is rebounding and set to run for quite some time.

But, is the demand from China fundamental, or is it due solely to economic stimulus from China’s government? Even if it is due to government stimulus, does that mean such demand will or will not continue? These questions are not easy to answer.

China’s banking system is not very sound because so many loans are given out as political favors. On the other hand, the Chinese save a huge percentage of their income, some say 20-40%, which is three to seven times higher than here in the U.S. (and that’s the highest U.S. saving rate of around 6% since the 1990’s). Savings become investment over time, and investment can make up for a lot of bad loans.

China is also experiencing political unrest. China’s highly centralized government is fighting to balance the interests of 600 million people living on the east coast (who benefit from free trade) with the interests of 700 million people living in China’s interior (who are mostly dirt-poor farmers). This is a delicate balancing act, and, without high economic growth, likely to get much more difficult.

China’s economy is very dependent on exporting products. Because worldwide demand is down so much, China has little to export. They are trying to shift their economy more from exporting to internal demand, but this will take a lot of time and effort, and success is by no means assured.

If China succeeds in their efforts to keep growth going, then expect higher commodity prices and increasing growth for the world economy. If China can’t keep the growth engine going, then expect commodity prices to tank and for the world economy to muddle along.

China is likely to be the main driver of short to intermediate economic growth for some time.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

It’s stimulus check time!

That’s right, boys and girls, it’s that time again to get the economy going with stimulus checks!

But, wait a minute. Where do those stimulus checks come from anyway?

Does the government have a magical money tree that creates value? No, probably not that.

Does the government take in more money in tax revenue than they spend? No, not that, either.

Does the government borrow from others by issuing government bonds? Yes, that’s the one.

Okay, so who buys those bonds? Is it savers, foreign and domestic? Yes, indeed.

So, that means the money is going from people saving to people spending, right?

So, the way to get the economy going, forever after, is to stop saving and start spending? Hmmm…that’s some interesting logic.

Let’s take this to its logical conclusion. Growth comes from consuming, according to this thinking.

So, if we just consume everything we’ve produced, we’ve maximized growth?

That doesn’t seem to make sense.

Oh yeh! Now I get it! The way to grow is to save some of what you produce, and then use those savings to produce more next time around.

For example, the farmer who eats his seed corn will never grow production. But, the farmer who saves a bit his corn each year as seed for the next year will produce larger and larger crops each year as he saves more and more seed corn.

The only way to have growth is not to consume all you produce, but to save some of it over time and plow that saving back into production. You can’t eat corn you haven’t produced. You have to produce before you can consume. Production, built from saving, is the way to growth–not consumption.

So, what in the heck is borrowing money from savers and giving it to consumers going to do? Reduce future growth. Does that sound like a good plan for getting the economy growing again?

Only if you measure growth by adding up consumption.

I think I’ll put my stimulus check into savings. Then, maybe, we’ll have a snowball’s chance in hell of competing with the foreigners we’re selling the asset of our country to.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.