Strong Economic Growth in
China and the United States
Means a More Balanced
“in 2003 the United States, with a
population totaling only 4.7 percent
of the world, was responsible
for around 30 percent of the
total world output.
James F. Smith,
Jim Smith, a highly As one looks around the world today, few of future inflation so high that the Bank of
respected economist sources of strong economic growth are visible. England has been taking steps to curtail
in the real estate and The world’s second largest economy is Japan. growth by raising short-term interest rates
industrial sectors, is It has had essentially no economic growth for and thus slowing the rate of growth of the
the Society’s Chief 15 years and almost all the strength it is money supply.
Economist. This showing now is from a few export industries. On a global basis, this leaves about all the
article is one of his Almost all that growth is from exports to heavy lifting on economic growth up to two
ongoing contributions China and, to a much lesser degree, the countries, China and the United States.
to Professional United States. Japan will not recover until it Fortunately, both are well placed to accept
Report on economic pays off its loans from the collapse of the real this responsibility.
conditions affecting estate and stock market bubbles in 1990 China has become the manufacturing
commercial real enabling banks to return to the business of platform of choice for the world, and the
estate in the United lending money. United States has continued to set new
States. The big three countries of the Euro Zone records for imports. While the U.S. current
are Germany, France, and Italy. Germany is account deficit is unlikely to get much larger,
the world’s third largest economy, and it will we will remain the world’s largest importer
be lucky to post one percent real growth in its for years to come.
gross domestic product (GDP1) this year.
France and Italy rank numbers five and Predictions for the Global
six on the global economic scoreboard, and
they are both quite weak. Both need major Economy
reforms of their labor markets (the 35-hour The single best source for anyone who wants
work week in France is a huge hindrance to to know about the most likely path for the
its competitiveness) and pension programs global economy is the World Economic Outlook.
(more than one quarter of Italy’s population This enormously useful and well-written doc-
is collecting a pension today as men can retire ument is published twice a year (currently in
with a full pension at age 55 and women at April and September) by the staff of the
50). International Monetary Fund. Each issue costs
The United Kingdom is the world’s $49 or you can download it free at
fourth largest economy, and it has been grow- www.imf.org.
ing at an annual rate of more than 3.5 percent For many years, the book has included
this year. In fact, growth is so strong and fears detailed analyses of some particular economic
problems that could have major impacts on the near- to medi- money supply) in China has grown more than 16 percent so
um-term outlook for the global economy. The latest (April far in 2004. Inflation, as measured by the consumer price
2004) book analyzes four issues: structural reform in industri- index, rose to a year-over-year rate of 5.3 percent in July.
al countries, which is a big problem area for most of Western The Chinese government restricted FDI in some areas and
Europe and Japan; credit booms in emerging markets; global the central bank, the People’s Bank of China (PBC), issued
implications of the federal budget deficit in the United States; orders to banks to curb or eliminate loans to certain indus-
and China’s emergence and its impact on the global economy. tries: aluminum, cement, steel, and, of special interest to
Data released by the Bureau of Economic Analysis (BEA) SIORs, commercial real estate. The PBC has also raised reserve
of the U.S. Department of Commerce (www.bea.gov) on July requirements twice this year. Those changes will slow money
31 showed that the United States had nominal gross domestic supply growth for a few months, but they act as one-time
product of $11.0 trillion (eleven thousand billion) in 2003. This shifts.
means that in 2003 the United States, with a population total- The world can only watch and wait with bated breath.
ing only 4.7 percent of the world, was responsible for around Forecasters are unanimous in their view that China will thrive
30 percent of the total world output. and prosper in the long run. The concern of the moment is
Thus, per capita GDP in the United States in 2003 was how it will come through the next year or two.
$37,839. According to the IMF, per capita GDP was $1,060 in A big slowdown in Chinese growth rates would eliminate
China in 2003. the primary source of strength in the Japanese economy. It
would lower world commodity prices and throw an even big-
Will China Have a “Hard” or ger scare into the people who worry about the federal budget
deficit in the United States.
“Soft” Landing During my visit to China in 1992, I was asked (on a televised
Economic growth in China over the past 25 years has been session) about the chances that China would succeed in its
nothing short of astounding. The late Deng Xiao-Ping set a dramatic effort to achieve the goal of quadrupling its econo-
goal in a famous 1979 speech of quadrupling China’s econom- my by 2000. My response was that while this would be a very
ic output by the year 2000, which required a sustained growth unlikely outcome for any other country, it was highly likely
rate of 7.2 percent a year. that China would exceed this goal because so many people
While many global observers scoffed at the possibility of and so many resources, both domestic and foreign, were
attaining such an extraordinary feat, the facts proved them all being devoted to making it happen.
wrong. Real economic growth in China exceeded nine percent Of course, it did happen. We can only hope China will be
a year and has been greater than 10 percent a year for the past as successful in getting through the current transition period.
China has had two slowdowns during this 25-year period The U.S. Economy Still Looks Terrific
of dramatic economic growth. One was in 1989 and one was
A Look at Growth Rate
from 1993 to 1996. Both periods had some inflation scares
The overwhelming consensus among economic forecasters is
(inflation was 14.7 percent in 1993 and 24.1 percent in 1994,
that, in 2004, the United States will experience its best year for
but fell to 2.8 percent in 1997) and some slowdown in growth.
real GDP growth since the awesome 7.2 percent of 1984,
However, after both episodes, China resumed its strong
which was the highest growth rate of any year since World
War II except for 1950 (8.7 percent) and 1951 (7.7 percent). As
No one knows how the current situation will turn out for
reported by the BEA on July 31st, real GDP growth was 4.5
the Chinese economy. George Forstot, my former colleague in
percent in the first quarter of 2004 and three percent in the
the strategic planning department at Union Carbide
second quarter, both at seasonally-adjusted annual rates.
Corporation, used to begin the annual long term economic
Fixed investment grew at a 4.5 percent seasonally- adjust-
outlook meeting by reminding the attendees, “Forecasting is
ed annual rate in the first quarter and a robust 11.1 percent in
very difficult—especially if one is talking about the future.”
the second quarter. This is a good sign for future growth as
On August 2, the giant global bank and investment bank-
new investment is necessary for firms to remain globally com-
ing firm, Credit Suisse, released a paper entitled, “China Hits
petitive. Strong increases in investment spending can be
the Economic Brakes.” 2 In it, they explain that they have low-
expected to continue for some time because corporate profits
ered their forecasts for real GDP growth in China to 8.8 per-
have been very high (as a share of national income) for more
cent in 2004 and 7.0 percent in 2005.
than a year and are likely to continue to be.
The basic problem for the Chinese economy today is for-
Real GDP in the first half of 2004 was a robust 4.9 percent
eign direct investment (FDI) coming in at too rapid a pace.
higher than the first six months of 2003. This is very strong
For example, China attracted more than $55 billion in FDI last
growth indeed for the world’s largest economy.
year that helped drive investment to a clearly unsustainable
Although non-farm payroll employment is still below its
45 percent of GDP. The first half of 2004 saw FDI flows up 12
March 2001 peak—the date identified as the start of the 2001
percent from the same period in 2003.
recession that ended in November 2001— it has been growing
In turn, this FDI pushed up the rate of growth of the
since August 2003 and should hit a new record either late this
money supply to unsustainable levels. Milton Friedman, who
year or by early 2005.
received the 1976 Nobel Memorial Prize in economic science
for, among other huge contributions, teaching us all that infla-
tion is always and everywhere a monetary phenomenon, Sales Are Up
would say this is trouble. Retail sales, which account for about one-third of GDP, have
The broad M2 money supply (a measure of the total been setting new records every month for more than a year
now on a seasonally adjusted basis. Not too surprisingly, dis- The final factor behind housing demand is financial. The
posable personal income is also at record levels and consumer National Association of REALTORS® publishes a Housing
confidence levels are quite high. Affordability Index every month. This measures the ability of
a family with a median income (around $55,000 today) to pur-
Maunfacturing Index Is Up chase a median-priced home ($191,800 in June) with a twenty
One of the best forward-looking indicators for real GDP percent down payment and a 30-year, fixed-rate mortgage.
growth is the manufacturing index released on the first busi- That index has been around 140 throughout 2004, which
ness day of every month by the Institute of Supply means that a family earning a median income has about 40
Management (ISM). This ISM index was reported on August 2 percent more money than they need to buy a median-priced
to have hit 62 in July, up from 61.1 in June and the ninth house.
straight month greater than 60. That has not happened since a Current 30-year, fixed-rate mortgages have an interest
12-month string from July 1972 to June 1973. rate around six percent. Most analysts think it would take a
Any number greater than 50 on this index signals growth mortgage rate of about eight percent to put a major dent in
in the manufacturing sector. Any number greater than 42 pre- housing affordability. That would take 10-year U.S. Treasury
dicts growth in the overall economy. security yields of 6.5 percent or so, which is extremely unlike-
The current level suggests real GDP growth well above ly.
five percent in the second half of 2004. This would be wel- History shows that in all developed countries, long-term
come news for the rest of the world. government securities yield about three percentage points or
Industrial production peaked in June 2000. It is only now 300 basis points above the long-term expected inflation rate.
setting new records. The ISM index suggests many more are Central bankers all over the world have learned that the most
in store. important contribution they can make to maximizing econom-
ic growth is pursuing a policy of price stability.
The Small Business Component By this they do not mean zero inflation, but rather a rate
of inflation so low that business people and consumers do not
The Small Business Optimism Index, compiled for the
take inflation into account when making economic decisions.
National Federation of Independent Business (NFIB) every
While the central banks of many countries such as Australia,
month by their chief economist, Professor William C.
Canada, Switzerland, and the United Kingdom, have explicit
Dunkelberg of Temple University in Philadelphia, has been
inflation targets, the European Central Bank and the Federal
higher than 100 for 16 months, breaking the old record for
Reserve System in the United States do not.
such a string, which was set in 1983-1984. On August 10, NFIB
Nevertheless, most analysts believe that the Federal Open
reported the July index at 105.9 (1986=100). Furthermore, small
Market Committee (FOMC), the part of the Federal Reserve
business owners keep reporting very strong plans for hiring
System that sets monetary policy in the United States, would
and investment. Since more than 60 percent of the new jobs cre-
like to keep inflation in the one to two percent range. If they
ated every year in the United States are in small businesses,
succeed, 10-year Treasury securities should generally be in the
this is very good news.
four to five percent range and 30-year, fixed-rate mortgages
Housing Demand should be in the five to six percent range.
Although some analysts want to worry about a “housing bub- These levels of interest rates would not constrain housing
ble” in the United States. This seems unlikely. demand at all. The United States should continue to see
The U.S. Bureau of the Census reported on July 29 that the strong housing markets for years to come.
seasonally adjusted home ownership rate in the United States Every quarter, the Federal Reserve Board measures the
was 69.3 percent in the second quarter of 2004. This was a assets and liabilities as well as the financial flows of con-
new record, up from 68.1 percent in the second quarter of sumers, businesses, governments, pension funds, and all other
2003 and 68.7 percent in the first quarter of 2004. participants in the U.S. economy. This “Flow of Funds” report,
There are three reasons why it is unlikely that we have a the Z.1 release, is published every quarter. 3
housing bubble in the United States. The first two are demo- The latest report was released on June 10. It showed that
graphic. The same Census Bureau report showed that the as of March 31, 2004, households owned $15.2 trillion worth
peak home ownership rate (82.4 percent) is for households in of houses, against which they had borrowed $6.9 trillion.
the 55-64 age group. It declines very slightly to 81.1 percent This meant that consumers in the aggregate had unborrowed
for the 65 and older age segment. home equity of $8.3 trillion, a new record.
The U.S. economy has been dominated by the baby boom Indeed, the increase in the value of our homes has more
generation, the 77 million people born from January 1, 1946 than offset the decline in the value of consumer holdings of
through December 31, 1964 for more than fifty years now. stocks since the March 2000 peak. Total assets of consumers
They will be the prime movers behind housing demand for and nonprofit organizations were a record $55 trillion on
the next 20 years or so. March 31, 2004.
A second demographic factor in future housing demand After subtracting total liabilities of $9.8 trillion, consumers
revolves around immigrants. For reasons that no one has yet had a record net worth of $45.2 trillion. This was 534 percent
satisfactorily explained, immigrants of the same income and of disposable personal income.
educational attainment levels as people born in the United It was also 3.9 times total GDP ($11.4 trillion). This should
States tend to buy their first homes ten years later than these make all those people who complain about excessive con-
peers. Since the United States has had an immigration boom sumer debt to rethink their position.
for the past 15 years, this factor will also boost demand for
housing for the next decade at least.
Oil Prices Aren’t Worth Worrying In the “Crumble” scenario, oil prices fall quickly to $22 a
barrel and stay there until 2006. The U.S. grows at four per-
cent in 2005 and the world at 4.2 percent in this scenario.
Many people have begun to worry loudly about the impact of The “Crunch” scenario has oil prices remaining in the
high oil prices. In The Wall Street Journal survey of forecasters $35-40 a barrel range for two years. That scenario would only
released on August 13 (www.wsj.com), the consensus for reduce the U.S. and world real GDP growth by 0.3 percent in
growth in the third quarter dropped to 3.8 percent from 4.4 2005.
percent in the July survey and to 4.1 percent from 4.2 per- Oil simply doesn’t have anything like the importance to
cent in the fourth quarter, all at seasonally adjusted annual the United States economy it did in 1973, when the first oil
rates. My forecast of six percent for the third quarter is shock helped create a long and deep global recession. The
unchanged and remains the highest among the 53 survey par- United States demand for oil has fallen from about three per-
ticipants but my 4.4 percent forecast for the fourth quarter is cent of GDP in 1970-1973 to only 1.9 percent in 2003. China is at
only a little above the average. four percent. Thus, worrying about oil prices should not be an
A special question in the same survey asked what level of issue. It’s better to worry about terrorism or demographic trends
sustained oil prices “would tip the United States back into in developed countries if you need something to worry about
recession.” Only 15.4 percent of us were in the $80 or more in relation to the economy.
camp. No one was less than $50, but 32.7 percent of the sur- My forecast for real GDP growth for the United States in
vey participants picked the $50-59 range and a further 28.8 2004 is 4.7 percent. We should be able to average 4.2 percent a
percent selected the $60-69 range. year real GDP growth in 2005 through 2008. If these forecasts
Research from the Organization for Economic Cooper- prove accurate or nearly so, then the 2004 through 2008 peri-
ation and Development shows that each $20-a-barrel increase od would be the best years for U.S. economic growth since 1962
in oil prices reduces United States real GDP growth by one through 1966. That would be really good news for the global
percent. Therefore, it would take a sustained price of more economy. O
than $100 to push the United States into a recession, and no
one has a forecast that ridiculous. Even prices greater than $30 Endnotes:
a barrel are enough to cause both increased supply and 1 The total value of all goods
decreased demand responses. They have worked that way for and services produced for
the past 30 years. That is why the OPEC target is $22 to 28 a final demand within the
barrel—when the price goes up past $30 we figure out ways borders of a country after
to conserve oil or we find more from non-OPEC countries. A adjusting for price changes.
good example of this phenomenon is the emergence of
Kazakhstan as a major oil producer. 2 http://emagazine.
A recent analysis by Global Insight, the world’s leading credit-suisse.com/article
economic forecasting organization, compared the global 3 www.federalreserve.gov
impacts of three oil price scenarios labeled “Crisis,”
“Crumble,” and “Crunch.” In the “Crisis” scenario, oil prices
climbed to $65 a barrel for two quarters before falling to the
mid-$20 range. That scenario would reduce U.S. real GDP
growth by one percentage point (to three percent) in 2005 and
would push Germany and Italy back into recession.