The Case for China

The rise of China as Asia’s dominant economic and political power raises a number of issues. It is obvious that with a population of 1.2 billion, China will be the largest consumer in the world for most goods and services. Already today, China has more refrigerators, mobile phones, TVs, and motorcycles than the United States, and it is only a matter of time before it will have huge markets for just about any product. As a result, its resource requirements will rise very substantially, and Chinese purchases of oil, coffee, copper, grains, and so on will move commodity prices dramatically.

Just consider the following. Asia, with a population of approximately 3 billion people, consumes 19 million barrels of oil daily. By comparison, the United States, with a population of 285 million, consumes about 22 million barrels of oil – that is a per-capita consumption more than 10 times that in Asia. However, consumption in Asia is now rising rapidly. China’s oil demand has doubled over the last seven years to around 4.5 million barrels a day.

But it is not only in the oil market that Chinese economic growth will be felt. Take, for instance, the per-capita consumption of food in China – which I won’t compare to food consumption in some Western countries where a large percentage of the population suffers from obesity. If we look at consumption of meat, milk, fish, fruits, and poultry in China, Taiwan, and Hong Kong, it becomes obvious that the rising standard of living in China will lead to very meaningful increases in its purchases of agricultural products in the years to come; sometime in the future, it will have a similar per-capita consumption pattern to those in Hong Kong and Taiwan.

China’s Growth Prospects: Coffee

Or compare the per-capita consumption of coffee in China with that in Western countries. Annual per-capita consumption of coffee in Germany amounts to 8.6 kg, in Switzerland to 10.1 kilograms, and in Japan – where coffee consumption has increased rapidly in the last 30 years – to 2.3 kilograms. In China, per-capita consumption is just 0.2 kilograms. If China’s per-capita consumption rose to just 1 kilogram (a little less than in South Korea), then China would have a total consumption of 1.2 billion kilograms compared to a total consumption of around 70 million kilograms in Switzerland!

What I wish to emphasize here is that if standards of living continue to rise in China, the country will have a huge impact on the world’s commodity markets and is likely to push up commodity prices very considerably. In fact, I regard the purchase of a basket of commodities as the safest way to play the emergence of China as the world’s dominant economic power.

You may, of course, question my optimism about China’s growth prospects and point to the large number of problems China is facing. These problems relate largely to its financial system, large bad loans at state-owned banks, underfunded pension fund liabilities, corruption, and the growing wealth inequity between its rural and urban populations. But I believe that, while substantial in scope, China’s problems can be dealt with.

However, I remain convinced that, sometime in the future, China will experience a serious financial crisis, which will then force its policymakers to deal with the bad loan and pension fund issues. You, however, should not be overly concerned about this financial crisis. The American economy of the 19th century also experienced a series of crises, and even a civil war, and yet its economy performed admirably well between 1800 and 1900. Moreover, all rapidly growing economies experience terrific temporary setbacks from time to time.

China’s Growth Prospects: The Catching-up Effect

But in terms of China’s long-term prospects, I should like to remind you that the U.S. economy also expanded rapidly in the second half of the 19th century – and (this) in a deflationary environment. This was due to several factors, including a rapid increase in its population (rising from 37 million in 1867 to 76 million in 1900), the opening of new territories facilitated by the railroadization of the country, and the application of new inventions to manufacturing, which boosted productivity dramatically.

Thus, when we compare the U.S. economy in the second half of the 19th century to China at present, we should not overlook the fact that, in 1850, the U.S. economy was well behind the United Kingdom and the Continent in terms of industrialization. Therefore, a catching-up effect came into play.

This is evident when we compare the growth of industrial production in the United States, Germany, and the United Kingdom from 1875 to 1890. In the case of the United States, industrial production grew on average by 4.9% per annum, compared to just 1.2% for the United Kingdom and 2.5% for Germany. America’s strong growth in the second half of the 19th century was typical of an emerging economy and is comparable to strong per-capita GDP growth in China between 1978 and 1995, averaging more than 5% per annum, while the world’s per-capita GDP growth only averaged 1.11% over the same period.

Moreover, by 1885, the United States, which had hardly any industries at the beginning of the century, led the world in manufacturing, producing 28.9% of the world’s manufactured goods, while Britain had been displaced to second, with 26.6%, and Germany to third, with 13.9%. Also, while the United States had produced hardly any cotton around 1800, its plantations supplied five-sixths of the world’s cotton by 1860!

The point is simply this: if the United States could become the world’s dominant economic power by the end of the 19th century from extremely humble beginnings, I think that, with the acceleration of the pace of change that allows regions that open up to industrialize in no time, it is quite probable that within just 10 to 20 years China will be by far the world’s most important economy – no matter how many crises it will have to deal with in the interim.

Regards,

Marc Faber,
for the Daily Reckoning
February 3, 2003

P.S. One problem I can foresee, however, is that, because of its size and increasing economic and military importance, China will grow out of proportion for a harmonious balance of power in Asia. When, in the future, China has become Asia’s largest trading partner, with respect to both its exports and imports, it will not only be an economic hegemon, but will also replace the United States as Asia’s most influential political power. That such a transition will at some point lead to serious tensions between the United States and Japan on one side and China on the other is obvious, but the trend towards China’s dominance in Asia is well established and, in my opinion, unstoppable.

P.P.S. At the same time, as discussed above, China is becoming a major buyer of commodities and will become, in due course, Asia’s largest trading partner. The emergence of China as a major buyer of commodities should support commodity prices, and if, in the future, the global economy should resume 1980s-like synchronized growth, commodity prices could soar.

In fact, grain prices, after having built an extended base since 1998, have been rising explosively since June. We therefore still believe that commodity prices are bottoming out and will outperform Western financial markets in the years to come. The purchase of commodity futures, including coffee, cotton, rubber, copper, gold, silver, sugar, etc., is recommended.

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When George W. Bush took the Oval office on January 20, 2001, stocks as measured by the Wilshire 5000 were valued at $14.7 trillion.

Their value two years on? $9.9 trillion. A loss of $4.8 trillion.

Your editors note from time to time that “markets make opinions”.

Now, as if to prove our point, comes an article from some pompous windbag named Allan Sloan, who is apparently Newsweek’s Wall Street editor, trying to pin the collapse in the stock market on the latest fool to inhabit 16 Pennsylvania Avenue.

“The S&P 500 has fallen more in Bush’s first two years,” says Sloan in a piece about as thought-provoking as dinner with Britney Spears, “than any other president since the modern stock market emerged. During Hoover’s first two years, which included the Black Thursday crash in October 1929, the S&P 500 fell 29%. Not as bad as Bush’s 33%.”

We recall wondering…sometime after the famed “Pregnant Chad” episode in Florida made the U.S. electoral process the favored punch-line at dinner parties from Caracas to Bagdad…why on earth Bush didn’t ask for a recount. After all, wasn’t it obvious that the 43rd president, regardless of his political pedigree, would have to nurse the nation’s worst debt hangover since 1929?

As Sloan points out: “Unemployment is up more than 40% (to 6% from 4.2%) since Bush took office; gigantic projected federal-budget surpluses have turned into deficits; the dollar has fallen sharply against the euro.”

Still, Sloan cleverly calls it the “Bush Market” – as if presidents can determine stock prices, or the shoe sizes of their children in advance. The only good thing Sloan can see is that interest rates are low enough to “juice” consumer spending…meaning, we presume, he’s happy the American Consumer is still willing to buy things he doesn’t need with money that he doesn’t have and hasn’t thought about paying back yet.

But it doesn’t stop there. For Sloan, the worst thing that can possibly happen now…is a tax cut. “Bush is not the first president to want to cut taxes – but he is the only president to in at least 140 years (and probably ever) to suggest cutting taxes as we’re heading into war.” As Sloan laments, “with the economy in the dumps, tax collections falling and federal expenditures ratcheting up, the projected surpluses have melted away faster than your 401(k)…”

For the record, we have no problem with the man wanting to express his beef with the President. After all, we still pay lip service to free speech, and Bush, the fool, wanted the job enough to send his henchmen down to Florida to take it.

But rather than questioning the need to go to war at all or why exactly federal expenditures are “ratcheting up,” Sloan seems to thinks all you need is a different set of wonks calling the shots in the mosh pits of Washington’s policy think-tanks, and the market would miraculously rebound…consumer balance sheets would dry off…and corporations would begin posting profits again.

“Markets are pretty savvy over the long run,” Sloans sums up amazingly…to which we might agree, especially following some rather disturbing evidence highlighted by a Bloomberg article this morning (more below…). But Sloan’s ‘analysis’ of the economy – at least in this hatchet piece – is as about as perceptive as drunk falling for a transvestite who’s forgotten to shave.

Eric, what’s the latest on Wall Street?

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Eric Fry, reporting from New York…

– The mercury finally edged above 32 degrees here in New York, but the frigid conditions persist on Wall Street. Meanwhile, Mr. Capital Gains remains suspended in the cryogenic freeze that has housed him for the last three years. Sadly, no one has yet figured out how to bring him back to life…

– Last week, the Dow Jones Industrial Average slipped 77 points to 8,053 and the Nasdaq pulled back by 1.6% to 1,320. Last week’s losses brought January 2003 – which started out so hopefully – to an inglorious close. The S&P 500’s early 5% gain withered away, becoming a 2.7% loss by month’s end.

– “It was the second straight January in which the major indexes lost ground,” Barron’s observes. “Those dusty Wall Street guidebooks hold that the direction of the market in January foreshadows the entire year’s movement…There are better reasons to be concerned about a down year than that.”

– We can think of a few reasons right off the top of our furrowed foreheads: stocks are still pricey; the dollar’s a basket case; the economy stinks; and investors no longer possess neither the will nor the way to add substantially to their stock holdings. And let’s not forget the mega- billion dollar War on Terror that our nation is waging.

– “It’s likely both the Dow and the S&P will re-test their October lows (7,286 and 776 respectively), and, failing that test, eventually set a much lower low.” That’s the unequivocal, and dire, prediction of Strategic Investments editor, Dan Denning. “If we go back to pre-bull market levels (1995),” he says, “we’d see Dow 3,800 and S&P 450. This is why it makes sense for you to own long-term put options on the Dow and the S&P.”…Food for thought.

– [Editor’s note: Dan recently test-drove a highly leveraged strategic play on oil service companies earlier this week in Strategic Trader Alert. Readers following the trade could have made 58% gains in 2 days. But he’s betting these oil service plays are just getting warmed up.

– While stocks put in a lackluster performance in January, commodities shone – and especially the shiniest of commodities. Gold rallied about $20 higher during the month. The increasingly precious metal continues to defy its myriad skeptics and to amaze its growing legions of fans. But has it picked up too many fans for its own good? Is gold’s newfound popularity something that gold bulls ought to worry about?…Maybe just a little.

– Most sentiment indicators for the gold market are showing extreme bullish readings, which often means the market is due for a sell-off…over the short-term at least. (On the other hand, the sort of investor who is buying gold to protect against a declining dollar doesn’t care one whit about the sentiment indicators).

– Item number one from the bullish sentiment files: The “speculators” on the Comex have amassed their largest net- long position in gold futures contracts in years. The speculators are considered the “dumb money”. So whenever they start buying heavily, it’s usually a good idea to sell them all the gold they want. “There have been only two occasions in the past 10 years that the net long position of Comex stocks has been at the current level (almost 200 tonnes),” Mineweb observes. “They were during the price peaks of 1993 and 1996.”

– Item II: Gold stocks have not been keeping pace lately with the rallying gold price. About nine months ago, the XAU Index of gold stocks touched a peak 89.0. Today the XAU is trading 12 points lower at 77.0, even thought the gold price is about $50 higher than it was nine months ago. Such “negative divergences” often presage a sell-off in the metal itself.

– Item III: Gold investment conferences have become nearly as popular as Eminem concerts, although the two events tend to draw different types of crowds. The recent Vancouver Gold and Investment Show was swamped with attendees, just like it used to be a decade ago, when $800-gold was still a recent memory. “Three months ago, we never would have expected this kind of crowd,” said the gold show’s organizer.

– Notwithstanding gold’s troubling short-term indicators, the metal’s long-term prospects still gleam brightly. As long as the Fed vows to combat deflation by dropping dollar bills from cargo planes, gold’s investment potential is assured.

– Crude oil is another commodity that refuses to back down. Whatever happened to all those hefty reserves of oil we used to have? Remember when the gooey black stuff was selling for $12 a barrel and all the “experts” would talk about a “world awash in oil?” Evidently, the stuff’s a little harder to come by than we thought.

– Crude oil has climbed to $33.51 a barrel – up about 10% so far this year – and U.S. crude inventories remain relatively scarce. In addition, the American Petroleum Institute and Energy Department reported hefty declines last week in distillate and gasoline supplies. In other words, oil and gasoline both have plenty of reason to continue rallying.

– Better fill up the tank before it’s too late…

[Editor’s note: For a different take on what’s in store for commodities – and notably for gold and oil – see John Myers’ article ““]

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Back in Paris…

*** Even following a rather homely January, as a recent Bloomberg article points out, the markets are likely to have a long way to go before they come back to bull market peak levels – regardless of which party is occupying the bully pulpit. And it’s not just in the U.S…

“However bad life has been since 2000,” remarks writer Matthew Lynn, “a comparison with the 3 years from 1972 to 1975 shows it could get worse. The FTSE-100 Index has about halved since 2000. The Dow Jones Industrial Average is down by about a third over the past three years.

“Between 1972 and 1975, stock prices in Britain, France and Italy suffered falls of almost 80%. Stocks in the U.S. and Germany dropped about 60%.”

Adjusting for inflation, Lynn suggests, “the British market took until May 1987 to recover in real terms, a wait of 15 years. The U.S. market took until August 1993…a wait of 21 years. The Canadian market took until October 1996, a wait of 24 years.”

That’s a longer time-frame than any party hack can account for…or even remember. But we don’t doubt that will keep Sloan and his ilk from trying.

Cheers,

Addison Wiggin
The Daily Reckoning

P.S. Bill’s bound for London on the Eurostar today…but he’ll be checking back in tomorrow.