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December 25, 2006

Chinese Professor Predicts More Good Times for the Chinese Economy and China

posted by MR WAVETHEORY at 12/25/2006 03:40:00 PM
Wharton: Taken on a day when the city of Phily actually got sun.

If you're having a great time after having had a grand Christmas holiday dinner, you may want to read the cheery news coming out of China. Knowledge@Wharton did a recent survey on China and found that policy wonks are predicting a 9.25% growth rate for the economy in 2007 which is higher than the official prediction of 8%. The Chinese are making some incredible predictions about their economy. The highlights.

Chinese policy makers are predicting 9.25% growth in 2007.

Meanwhile, predictions from economists within China suggest that their country's economy is on solid footing. According to Zheng Chaoyu, director of the Institute of Economic Research at Renmin University in Beijing, in 2007, China will experience low inflation and a 9.25% growth rate, higher than the official prediction of 8%, but not as high as 10% "because the fixed-asset investment growth rate will continue to drop, and the export growth rate will be lower due to such factors as RMB appreciation." Zheng also thinks that the government will continue its "moderate and stable finance and currency policy.... No drastic changes are expected."

China is predicting 10% increases in annual wages for the next few years. The report by the State Information Center is entitled China's Macro Economy and Policy: 2006 and 2007 and if you read the full report, you see that things will be even better for the average Chinese worker, who will see a 10% increase in wages annually for the next few years. That is simply astonishing.

Zheng believes that the upward trend of FDI in China will be sustained in 2007. "We have a huge market and cheap labor, which is most attractive for foreign investors." Labor costs, he acknowledges, are "on the rise but will not have a [negative] impact in the short term." Long term, he adds, it is unclear whether productivity growth will counteract the impact of higher wages. His report assumes that wages will be growing at 10% annually.

Now, if you are mathematician and finance type, you know the rule of 70 which states that if you take the number 70 and divide it by the growth rate X of something, you get the number of years it takes to double something. So, if you take 70 and divide by 10%, then you get 7, implying that in seven years, wages for the average worker in China will double. Consider for instance the US, where wage inflation has been between 1.4% and 3.5% for the last 5 years:

2001 = 2.7%
2002 = 1.4%
2003 = 2.2%
2004 = 2.6%
2005 = 3.5%

All things being equal, that means the average Chinese is seeing triple the improvement in wages than the average American! This has some pretty big implications for private equity and venture capital investors.

In 7 years ...

  • the farmer riding the bike today could be driving a car
  • the manufacturing worker making auto parts could be running a global car company
  • the student eating pork buns at a xiao-chi stand could be eating KFC (they already are)
Imagine what Chinese consumers will be able to afford 7 years from now! I predict the Chinese consumer will be the biggest icon of conspicuous consumption 7 years from now.

China's RMB will appreciate at 6% between 2006 and 2010.

According to a report he contributed to, titled "China's Macro Economy and Policy: 2006 and 2007," the annual RMB appreciation rate will be at 6% between 2006 and 2010. "Our estimation is probably too bold," he notes. "But since the beginning of exchange rate reform, the actual exchange rate change was 2% to 3% higher than many people's expectation."

Translation: If you invest in China, you will earn at least 6% - that's at least 6%! I like the sound of that! Compare that to the 4.625% return on US Treasuries and you know where my money is going!

What Will Real Investment Returns Be In China?
Alas, if you believe the report (sometimes you cannot trust everything they say), then real investment returns will be phenomenal in China for the next 5 years.

Here is the definition of the real return from Economics 101:

Real returns = GDP Growth + Productivity Improvement - Inflation + Foreign Exchange Gains

Plug in the variables (assume 0% productivity improvement to be conservative, and 2% inflation based on government data):

Real returns = 9.25% + 0 - 2.00% + 6.00% = 13.25%

The magic number is 13.25%. A 13.25% real return for investments is huge, considering that the 10-year US Treasury yield is at 4.625%. That is 2.8X the US rate.

Being Thankful for Beer and Champagne!
Tsingtao's is China's largest brewery founded in 1903 by German settlers, taken over by the Japanese in WWI, and reverted back to the Chinese.

If there is anything I will be thankful for this holiday season, it's the tremendous growth of the economy in China! I hope all those Chinese workers have a great holiday, because although they might be drinking Tsingtao Beer this holiday season, they will be drinking Dom Perignon in 7 years! OK, maybe not Dom, but in 7 years time, they will be drinking champagne, probably an expensive Chinese champagne!

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