China's Economy Not a Bubble Says NIA

Jan 21, 2010, 17:44 ET from National Inflation Association

FORT LEE, N.J., Jan. 21 /PRNewswire/ The National Inflation Association today released the following article to its members:

It was announced today that China's GDP grew 10.7% last quarter over a year ago, its fastest pace since 2007. There is now speculation that China's central bank will start raising their benchmark interest rate in order to tighten lending in the country. In fact, China's central bank last week raised reserve requirements and Chinese authorities have ordered some of China's largest banks to curb lending for the rest of January.

NIA believes China's moves to tighten bank lending will strengthen the long-term future of their economy. In the short-term, interest rates will inevitably rise and their GDP growth will decline, but we won't see a collapse in asset prices in China.

Certain pockets of the Chinese economy may have mini-bubbles, such as the Real Estate markets in Hong Kong and Shanghai. However, even if Real Estate prices in certain major Chinese cities were to decline substantially, it won't be enough to send China's economy into a tailspin like Dubai. Dubai's economy was built on Real Estate speculation, while China's economy has been built on a solid foundation of manufacturing and savings.

There are some claims being made by people like James S. Chanos that China is in danger of producing huge quantities of goods that it will be unable to sell. NIA believes China's population of 1.3 billion people will be perfectly capable of purchasing their own goods that they produce, if the Chinese government abandons their currency peg to the U.S. dollar and allows the yuan to appreciate. China's currency peg is responsible for most of the global economic imbalances that exist today. It is forcing the Chinese to acquire U.S. treasuries, fueling the 'dollar bubble' in the U.S. and artificially suppressing the standard of living of Chinese citizens.

When China first chose to peg their currency to the U.S. dollar in 1994, China had a much smaller, less-mature economy. Due to a lack of population centers and distribution networks, China was dependent on the strength of its exports. Today, China is investing heavily into its infrastructure by building high-speed rail lines, dozens of new airports, and high-tech power distribution systems and electricity grids. At the same time, our infrastructure in the U.S. is decaying and we don't have any savings to repair it.

China is not trapped into maintaining its currency peg to the U.S. dollar. China's exports to the U.S. and Europe now account for less than 1/2 of their total exports. China has been rapidly increasing exports to countries like Australia, that can purchase their goods by trading valuable commodities instead of printed money.

It is impossible for China's economy to be a bubble when the Chinese stock market is still about 50% lower than its all time high. There are many Chinese stocks that have 20%+ revenue growth and trade with price/earnings ratios below 10, with comparable companies in the U.S. that have zero or negative revenue growth yet trade with price/earnings ratios of 20. These valuations should be the other way around, but the perception today is that China is still a "risky" emerging market.

China's economy is still in its infancy. China's oil consumption per capita is less than 1/10 the U.S. and most Chinese households don't own a car, while the average American household has 2.3 cars. China has saved and lived below its deserved standard of living, allowing Americans to live beyond their means for an extended period of time. This imbalance must soon be dramatically corrected.

China has many of the same characteristics the U.S. had just before it took its world superpower status from the U.K. in the 1920-30s. The U.S. was propelled to its superpower status because it was the world's largest exporter of goods and the world's largest creditor nation. Today, China exports the most goods and is the world's largest creditor nation with $2.3 trillion in foreign currency reserves. China will have many ups and downs in the decades ahead, but over the long-term we believe China is positioned to capture the U.S.'s status as the world's superpower.

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SOURCE National Inflation Association