SPY EYES

Contrary to western propaganda, China has a firm control over its economy. Prudent planning, astute strategizing and futuristic forecasting has brought Chinese economy from the downtrodden and battered in the 1950s, to the current state where it is second only to the US but according to the IMF, likely to overtake it by 2016. Economic historian Angus Maddison estimates that the Soviet Union at its peak produced only a third as many goods and services as the US; Japan's economy at its peak was still less than half the size of the US economy. China's ascension has been startlingly different, in speed and size. If it grows at anything like the 10 per cent rate it has averaged since 1980, its economy will be far bigger than that of the US within a generation. China's growth has been unprecedented. In 1980, when its economic reforms were just starting, the IMF estimates the US produced more than 10 times as many goods and services. Even 10 years ago, when China overtook Japan to become the world's second-biggest economy, the US still produced three times as much.

But since then China's share of global output has doubled, while that of the US has shrunk rapidly. From 25 per cent of global output in 1986, the US share has shrunk to less than 20 per cent and a projected 17.8 per cent by 2016. China produced just 2.2 per cent of the world's output in 1980, but this rose to 7 per cent by 2000, 14 per cent now, and is projected to top 18 per cent by 2016. By 2016, the IMF estimates, China will be producing more in a fortnight than it did in a year when the reforms began. Over that period, its output would have risen to 30 times its starting level; US output would have risen to 2.7 times its 1980 level.

However this rapid rise does not come without pitfalls, but it is heartening to note that Chinese economists and planners have taken cognizance of the dangers lurking ahead. There are concerns about inflation, excess investment, soaring wages, and bad bank loans. Prominent academics warn that China could fall victim to the dreaded “middle-income trap”, which has derailed many a developing nation. Strategy and commitment have been applied to forestall any disasters. Since 1953, China has framed its macro objectives in the context of five-year plans, with clearly defined targets and policy initiatives designed to hit those targets. The recently enacted 12th Five-Year Plan could well be a strategic turning point – ushering in a shift from the highly successful producer model of the past 30 years to a flourishing consumer society. Seared by memories of turmoil, reinforced by the Cultural Revolution of the 1970’s, China’s leadership places the highest priority on stability. Such a commitment served China extremely well in avoiding collateral damage from the crisis of 2008-2009. It stands to play an equally important role in driving the fight against inflation, asset bubbles, and deteriorating loan quality. A domestic saving rate in excess of 50% has served China well. It funded the investment imperatives of economic development and boosted the cushion of foreign-exchange reserves that has shielded China from external shocks. China now stands ready to absorb some of that surplus saving to promote a shift toward internal demand.

Over the past 30 years, the urban share of the Chinese population has risen from 20% to 46%. According to OECD estimates, another 316mn people should move from the countryside to China’s cities over the next 20 years. Such an unprecedented wave of urbanization provides solid support for infrastructure investment and commercial and residential construction activity. China has taken enormous strides in building human capital. The adult literacy rate is now almost 95%, and secondary school enrollment rates are up to 80%. Shanghai’s 15-year-old students were recently ranked first globally in math and reading as per the standardized PISA metric. Chinese universities now graduate more than 1.5mn engineers and scientists annually. The country is well on its way to a knowledge-based economy. More importantly, Chinese planners are willing to prove the doubting Thomases wrong and are prepared to risk the slowing down of its economy deliberately, to shake off the aftereffects of inflation.

Investors are apprehensive of the supposed rising inflationary trends in China; their apprehension is that Chinese central bank will end global growth. The most recent inflation digits of China: 5.3% may be considered spiraling since the annals of Chinese history are replete with social, economic and political upheaval. However, despite its extraordinary growth record since Deng Xiao Ping opened China in 1978, China’s per-capita GDP is just $4,399 ($7,481 purchasing power adjusted), less than one-tenth of the $48,157 U.S. level. China requires 30 to 50 years of uninterrupted high growth to bring the living standards of Chinese up to current developed country levels. That's why its central bank, the People's Bank of China, has raised reserve requirements for Chinese banks five times so far this year to more than 20% today and adopted a number of other policies to curb price increases, such as selling food from government stockpiles.

Another factor to comprehend is that China’s inflation is not high across the board–it has been driven by two factors: rising food prices and rising energy and industrial commodity prices. So-called "core" inflation, excluding food and energy, is still quite low, productivity is growing 10-12% per year, and there is widespread excess capacity in Chinese industry that is keeping finished goods prices in check. According to Dr. Rutledge, the Chairman of Rutledge Capital, a CNBC economics contributor, and a former Reagan economic advisor, since China's currency is, effectively, pegged to the dollar, notwithstanding western bickering of keeping the exchange rate low, soaring global food, oil and commodity prices, expressed in dollars, are the culprit. Both can be traced to U.S. policy mistakes. The Fed tsunami that increased bank reserves by 17x since 2008 is driving global energy and industrial commodity inflation. And Fed policy, along with its misguided ethanol policy that has diverted 40% of U.S. corn production into ethanol, have more than doubled corn prices in the past year. Ultimately, it will be US that will suffer and not China, whose economy is steadily progressing.