Putting China's Role in Perspective

KENTWOOD, Mich. - July 16, 2015 - PRLog -- China’s global role has been increasing over the past several decades, as it has rapidly become the world’s second-largest economy and second-largest equity market.¹ But how does its growing presence affect you as an investor? Many people seem concerned about China’s size, but we think its ongoing growth offers opportunities despite current challenges. And contrary to some headlines you may have seen, we don’t think you need to worry about the yuan replacing the dollar.

Rising Chinese Living Standards
China’s economy has been growing by about 10% annually for more than 30 years. If it continues to grow near 7% per year, it could become larger than the U.S. economy in the mid-2020s. Keep in mind, China is no stranger to this position. Before 1800, it had been the largest economy in the world for several centuries.²

China is a developing economy, not a developed economy, with economic output per person at just under $7,000 compared to more than $50,000 in the U.S., according to the World Bank. The growing number of Chinese consumers with better incomes to spend has made it the largest single market for autos, computers, shoes and, most recently, iPhones. As living standards continue to improve, we expect wealthier Chinese consumers to keep shopping as well as to continue demanding cleaner air, better working conditions and greater freedom.

Like many investors, you already may be well-positioned to benefit from these trends, with international investments and others including U.S. or foreign companies that sell to Chinese customers and/or buy from China. And we think these investments are attractive today, so talk to your financial advisor about what is appropriate for your portfolio.

Source: World Bank.

China’s Challenges Today
China’s growth rate has slowed to less than 7% this year. While that’s strong growth, the country still faces challenges, including:

•  A rapidly aging population and rising wages
•  Falling housing prices
•  Highest debt-to-GDP ratio among developing countries

Policymakers have taken numerous steps to combat slower growth, including lowering interest rates. Since the government continues to have a great deal of control over the economy, we think it can manage these challenges during the transition to slower growth.

A Long Way to Go
As it grows bigger and wealthier, China is also playing an increasingly important role in world economic and political affairs. It wants to flex its newfound muscles in various ways. However, remember that China is still a developing country with many obstacles. That’s why we think a lot of the fears about China are overblown.

China is taking steps for its currency, the yuan, to have a larger role in global finance. One goal is to have the International Monetary Fund (IMF) recognize the yuan as a reserve currency, which may occur later this year. But we believe that won’t have much impact on the dollar. According to the IMF, about 80% of world trade is in dollars, and while the yuan is the second most-used currency at about 9%, the euro is close behind.

In addition, we don’t believe increasing the yuan’s use should have much impact on the value of the dollar, which changes in response to economic conditions here and abroad. Over the past year, the dollar has risen sharply compared to most other currencies because the U.S. economy is relatively strong, while China limits changes in the yuan’s value. Over time, as China removes restrictions, we expect the country and its currency to have a bigger role in international finance. But China still has a long way to go.

What Should You Do?
Many investors may have benefited indirectly from the growth of China and its consumers. Despite its progress, we still don’t recommend investing directly in China by buying Chinese stocks because of concerns about the government’s control of the economy and markets, as well as regulatory and legal structures. But don’t let fears about China’s size or role in the world keep you from investing internationally and domestically – you may miss opportunities that are right for you. In our view, an appropriate mix of stocks, bonds and international equity investments can help keep you on track toward your goals, regardless of what happens in China.

Kate Warne, Ph.D., CFA
Investment Strategist

1 Source: Bloomberg.
2 Source: The World Economy: A Millennial Perspective by Angus Maddison, OECD.
Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.