The author of this blog has a new article on share prices in China and the US this decade, and their implications for analysis of the performance of the two economies,at the website china.org.cn. The article can be found here.
Readers of this blog may be interested to know that its author has an article in India's Economic Times. It deals with why India and China are the two economies that have most successfully come through the international financial crisis, the impact of this on the world economy and its potential impact on mutual relations between the two. It can be found here.
Last week's post
on the relative performance of China's and US shares so far this
century, showing an investor would in dollar terms have lost 6% on the
Dow Jones Industrial Average, lost 44% on the NASDAQ, and gained 186%
on the Shanghai Composite, attracted a certain amount of correspondence. One was from Yan Wang, chief China strategist at BCA
Research, a respected independent macro research team based in
I had used share prices in my article because it was clear that the
11.1% annual increase over the last decade years in China could not
have been offset in terms of total return, i.e. including reinvested
dividends, paid on US shares so it was sufficient to establish the key
point - that the market judged China's economy and companies far
outperformed US ones in that period. Investment in US shares was, to
use a terminology usually utilised elsewhere, 'misallocated' compared to
investment in China's shares.
Yan Wang, however, sent the graph below showing the total return on
Shanghai A shares and the S&P 500 over the same period. In each
case the base equal to 100 is the first day of trading in 2000. Two
things are evident from this. First taking total returns instead of
share prices makes no difference to the picture - the return on China's
shares continues to be well over 150%. Second the loss on the S&P
500 in total returns is even larger than the measure I had taken of
prices on the Dow Jones Industrial Average.
The pattern is clear. US shares this century have not only been a
bad investment, yielding a negative return, but China's shares have
been an extremely good investment yielding, in price terms, an annual
The evident conclusion which flows from the statistical data sent by
Yan Wang, which is of course added by the present author, is to
reinforce that share markets confirm, from a different angle, what the
econometric studies on total factor productivity show - that capital is
allocated far more efficiently in China than in the US. Those who,
without evidence except statistically entirely irrelevant anecdotes,
claim the opposite are not only engaging in very bad economics they are
simply losing their clients money.
The debate about China’s economic performance is, for economists, about macro-economic performance and related fundamental questions of economic theory. If they chose to invest in China’s markets that is, for them, secondary. For most people, naturally, the order of priorities is the reverse. It is about making money - economics is relevant only insofar as it indicates how to do this.
Nevertheless the two are evidently related. The theoretical discussion about China’s economy, which has been going on for the three decades since its reform process started, is therefore simultaneously about economic theory and financial returns.
Given this it is interesting to see how financial markets have judged this debate. Economic theory shows China's economic performance should succeed. What is the longer term judgement of financial markets? As three decades ago there was, of course, no share market in China Figure 1 shows a comparison over the course of this century of the return in dollars on China’s main share index, the Shanghai Composite, and on the US Dow Jones Industrial Average and NASDAQ.
The pattern is evident. So far this century, now only a fraction under 10 years old, anybody putting their money into the Dow Jones would, up to 4 December this year, have lost 6% in dollar terms, have lost 44% on the NASDAQ, and would have gained 186% on the Shanghai Composite. A rather emphatic market judgement. Taking into account inflation the losses on the Dow and the NASDAQ would have been significantly greater. This shows by what a huge margin the share market judges China has outperformed the US. The market judgement is in line with the findings of economic theory.
These financial facts therefore cast an interesting light on the debate that has been going on regarding the prospects for China’s economy. Leaving aside rather extreme views such as those of Gordon Chang, who for many years has been predicting the imminent collapse of China, or Societe Generale analyst Dylan Grice, who holds that China's is the largest bubble in the entire history of the world, Professor Michael Pettis of Peking University has formulated one side of this discussion with commendable clarity: ‘I continue to stand by my comment… that the US would be the first major economy out of the crisis and China one of the last.’ The author of this blog has argued, both here and elsewhere, the exact opposite: ‘China will be the first major economy out of the crisis and it will emerge from it before the US.’
Behind such conclusions at a macro-economic level lie many questions of economic theory that have been long discussed. The present author wrote a long article on China’s economy 17 years ago, in 1992, entitled ‘Why the Economic Reform Succeeded in China and Will Fail in Russia and Eastern Europe’ the conclusion of which is self-evident. At that time an alternative argument was presented that Russia and Eastern Europe, by following ‘shock therapy’, would be economically successful while China was supposedly only carrying out timid half reforms and would therefore fail.
Seventeen years later the facts have judged these two diametrically opposed analyses. Under the impact of ''shock therapy' Russia, overwhelmingly the dominant economy of Eastern Europe, suffered the greatest decline in production ever suffered in any country in peacetime. Large parts of Eastern Europe had only fairly recently recovered from 'shock therapy' before being hit by the international financial crisis and the performance of even the best of them does not remotely compare to China - which throughout this entire period of almost two decades enjoyed the most rapid sustained growth of any country. It was China which the facts proved to be well judged and successful regarding its economic policy.
The financial consequences of such different analyses were in many cases direct. As the author lived in Moscow in 1992-2000 he was able to see the consequences first hand. George Soros amongst others, misled by talk of 'robber barons' becoming 'legitimate' and of 'reformers' in Russia, by which was meant those who led Russia into this economic disaster, lost $2 billion. Soros put $1 billion into acquiring the mobile telecommunications company Svyazinvest in what he later described as the worst investment of his career - the present author remembers the episode vividly as he wrote a paper during the bidding battle advising what a disastrous investment it would turn out to be in light both of the specific character of Svyazinvest and in particular the overall economic conditions in Russia. Shock therapy was a catastrophe in Russia not only for its economy but for foreign investors compared to the success of China. In Russia, also, correct macro-economic theory and making and loosing money were closely related.
What conclusions, therefore, follow from the stellar performance of Chinese share markets compared to those in the US? First, they throw further light on the question of the 'efficient allocation of capital'. The most important and scientific test of this is, of course, the development of total factor productivity in the economy. As a recent article in The Economist notes, the most up to date analysis of this concludes, confirming many previous studies, that the development of total factor productivity in China is the highest in the world - the latest estimate is that it is four times that of the US.
But 'efficient allocation of capital' might also be used in a more popular sense of 'where is the return on investment in a financial sense' - where do you get the return on your money. In that sense money put into the US stock market over the last 10 years was entirely misallocated - you lost money on it. Money put into Chinese shares was extremely well allocated - yielding a total return in dollars of 186% or 11.1% a year.
The number of people who wish to go through the macro-economic arguments in relation to China - savings rates, national accounting identities, investment ratios - is strictly limited. But insofar as the financial markets have a vote they cast it only on one side. Those who put money into US shares this century lost money. Those who put their money into China's share's made lots of it.
It is not the most theoretically sophisticated economic argument regarding the relative dynamic of the economies of China and the US.
But to most people it will still be the most convincing.