Discussing Macro Economic Events

A few comments on the news today regarding China.

• What appears common from all news sources is that by 2029/2030, China could eclipse the US as the world’s largest economy. As far as I can tell, this would require China to sustain an 8% growth rate for 20 years, assuming the US will sustain a 3% growth rate over the same period.

Really? I mean - really?

I have no doubt that China could pass the US as the world’s largest economy at some point in the future.  But doing it by sustaining a further 20 years of 8% annual growth? This is the same logic that got us into the housing crisis: assuming linear or consistent growth patterns that appear wildly out of balance with what will probably be a lot more random of a future.

Secondly, what no article did was discuss what this new economy would look like:

• Assuming the US and China had similar size economies, could China sustain a 6-10% current account surplus annually? This would mean in dollar terms a current account surplus annually of $800 million to $1.4 trillion.
• Where would this surplus come from? Japan does not run a current account deficit, neither does Europe on a whole. So that would point to the US, a consistent current account deficit country.
• But the US, while running a current account deficit, has never run a deficit this high. The highest the CA deficit has reached is roughly 6%.
• Current account deficits this high would point to one thing: A currency devaluation. Not just a gradual adjustment, but probably a shock. But a shock would not be good for China, which pegs its currency to the Dollar and relies on the US as one of its largest trading partners.
• A massive US devaluation would boost exports doing three things simultaneously - boosting US growth, decreasing its current account deficit, further increasing US growth, and finally, decreasing Chinese growth by increasing its imports.

All three effects would make it further difficult for China to overtake the US, especially assuming consistent growth under current policy regimes. Consistent growth doesn’t assume a shock, as discussed above. See the last two years as a current example. A faster way for China to overtake the US is to not only grow fast, but let its currency appreciate, as what we’re really discussing is GDP in Dollar terms. Letting its currency appreciate may slow down the export machine, but hopefully it will provide greater per capita wealth across the population.

Click below for the LSE report on the Future of Finance.

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