The baton passes to China

By Walter T Molano

China's ascent is occurring faster than anyone imagined. The first-quarter gross domestic product (GDP) growth rate of 11.1% year on year was a surprise for many, but not for all. China is on fire, marking the fourth consecutive year of double-digit expansion.

The Chinese economy is inflating to a size that is commensurate with its proportion of the global population. Given that China has about 22% of the world's population, the economy can easily double before reaching equilibrium.

This expansion can manifest in one, some or all of the following ways: growth, inflation, or currency appreciation. Given that the government is allowing the yuan to appreciate gradually and the inflation rate is low, most of the expansion is going to occur on the growth side. Therefore, we should not be too surprised by the torrential pace of economic activity.

Fortunately, the global impact of the Chinese revival has been positive. Global trade grew 15% year on year in 2006, reaching US$11.76 trillion. China led the way, increasing exports 27% year on year. Imports jumped 25% year on year, boosting the demand for commodities and industrial products. Copper imports surged 60% year on year at the beginning of 2007, after experiencing a slump at the end of 2006.

Overall, China's copper demand is expected to rise 8% year on year to 4.2 million tonnes. However, the Chinese are importing more than raw materials. In fact, Chinese exports fell to third place in 2006, after Germany retook the second position. The growing needs for machinery, industrial products, consumer goods and luxury items are forcing the United States, Germany and Japan to increase their embarkations toward China.

Indeed, China is now Japan's largest trading partner, representing 17% of exports. China was the destination of less than 4% of Japanese exports in 1990. Interestingly enough, Japan is becoming less of an important trading partner for the Chinese. In 1990, Japan represented 17% of total exports. Today, the figure is only 11%.

China's inclusion into the World Trade Organization, its move into higher-value-added sectors, and its integration into the global marketplace have allowed it to diversify its trade partners. This is the reason the Japanese are adopting a more conciliatory approach with the Chinese. Prime Minister Shinzo Abe recently visited China, marking the first Japanese state visit there in five years. It is also the reason the Japanese are not allowing their currency to appreciate against the US dollar. It is not so much that they don't want to lose competitiveness against the Americans. It's that they do not want it to lose market share in China - where the currency happens to be closely linked to the dollar.

The ascendancy of China is a good thing for many emerging-market countries. Brazil is one of the main beneficiaries. The burgeoning exports to China are pushing up Brazil's international reserves. At the end of last year, analysts speculated that Brazil's international reserves could hit the $130 billion mark by the end of 2007. International reserves were $113 billion at the end of February, and they will probably crest through the $130 billion mark by the end of the first semester. Other commodity producers, such as Argentina, Russia, Peru, Kazakhstan and Chile, are also thriving. This is creating an emerging-market boom that is unparalleled, but it is not a fad.

Some numbers are alarming. The Shanghai stock market was up 235% over the past year and a half. The Shenzhen market was up 289% during the same period. The Shenzhen market trades at a multiple of 60, Shanghai 38 and the Dow 17. Nevertheless, the Chinese market underwent a great deal of deregulation over the past two years, witnessed a tidal wave of new issues and ended a five-year slump. Given the growth potential that lies ahead, valuations may not be as lofty as some argue. Unfortunately, a shakeout may be inevitable.

Nevertheless, the baton is passing to China. It is now setting the tempo for the global economic orchestra. The transformation is still in the early stages. China will soon move into higher-value-added sectors, such as automobiles, aerospace and pharmaceuticals. A larger swatch of the population has to be incorporated into the new economy. That means that sunny skies lie ahead for most emerging-market countries as they help feed the ravenous needs of the new rising superpower.

(Copyright 2007 Walter T Molano, The Emerging Market Adviser.)