Share markets' verdict on Chinese and US economies
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There has been intense debate among economists on the relative performance of the US and Chinese economies - in real terms now the world's two largest economies. But for many people far more important and interesting is the profitability of investing in their financial markets.
The chart below shows the movement of share prices so far this century, in dollar terms, of the Shanghai stock exchange compared to the three main US share market indexes– the Dow Jones Industrial Average, the S&P500, and the NASDAQ. In each case it shows percentage change since the first day of trading in the century up to 24 December 2009.
The judgement made by share markets over a decade is clear. With the century now a fraction under 10 years old, those investing in the Shanghai Composite over that period would have made a profit of 170.9 percent. Anyone putting their money into the Dow Jones Industrial Average would have lost 4.3 percent; if they had invested in the S&P500 they would have lost 19.5 percent, and would have lost 41.4 percent on the NASDAQ.
The annual rate of return, measured in terms of share prices, on the Shanghai exchange was 11 percent, compared to a negative figure for the US indexes. Furthermore, these are prices in current terms - that is not considering inflation. If inflation is taken into account the losses on the Dow, the S&P500, and the NASDAQ would have been significantly greater while the gains in Shanghai would have remained high.
This 11 percent annualised return in share price terms on the Shanghai index also far exceeds the dividends paid on US shares. Therefore, taking 'total returns' into account, that is including dividend payments as well as share price increases, makes no significant difference to the comparison – as is confirmed by calculations carried out by Yan Wang, chief China strategist at BCA Research, a respected independent macro-economic research team.
There is a relationship between the emphatic market judgement on the superiority of China's economic performance over the US during the last decade, and the debate among economists regarding the long term economic performance of China and the US and the relative success of the economic stimulus packages they adopted to deal with the international financial crisis.
The apparently obscure issues which economists debate – savings rates, national accounting identities, investment ratios – are in reality intended to answer one decisive practical question. Which policies produce the best economic results? Strip out secondary issues and there are two fundamental positions on China's economic performance. The first, supported by the present author and others such as Jim O'Neill, chief economist of Goldman Sachs, Professor Danny Quah of the London School of Economics, Mark Weisbrot, and Yan Wang of BCA Research is that China's economic stimulus package has been successful and China's strong economic performance will continue.
The other view, that China's long term economic performance and/or stimulus package will be unsuccessful, is held in extreme forms by authors such Gordon Chang, Societe Generale analyst Dylan Grice, and in a milder form by Stephen Roach, Chairman of Morgan Stanley Asia. Professor Michael Pettis of Peking University has formulated that side of the 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 opposite: 'China will be the first major economy out of the crisis and it will emerge from it before the US.' These are two clear and diametrically opposed opinions which have now been tested by the facts.
Few people who have studied the relationship between economic fundamentals and share market performance believe that the two move together in a one to one fashion in the short term and of course there are short term fluctuations. But over a prolonged period, such as a decade, the performance of share markets does reflect underlying economic strength. The relative dynamic of the Chinese and US share markets reflects the evident macro-economic fact that in economic terms China has far out-performed the US.
This, furthermore, relates to the fundamental issue, of importance both to economists and financial investors, of the efficient allocation of capital. For economists the most fundamental test of efficient capital allocation is the development of 'total factor productivity' – the overall measure of how an economy's efficiency is improving. A recent article in The Economist notes that the most up to date analysis of this concludes, confirming many previous studies, that the rate of increase of total factor productivity in China is the highest in the world – the most recent estimate is that its rate of increase is four times that of the US.
But 'efficient allocation of capital' can also be used in the more popular senses of 'what is the financial return on your investment?' Where do you get the better return on your money? In that sense money put into the US stock market, in terms of share prices, over the last 10 years was entirely misallocated – you lost money on it. Money put into Chinese shares was far better allocated – those who put their money into China's shares, on average, made large gains.
All this casts a deeply practical light on the debate among economists on the relative performance of China's and the US economies. Those who argue that China's economic performance is not stronger than that of the US have to argue against not only a mass of macro-economic data and economic theory, but have to maintain that financial markets made a gross error in judging China's economic performance considerably superior to that of the US. The great outperformance of China's share markets over those of the US is not the most theoretically sophisticated argument regarding the relative economic dynamics of the two countries. But to most people it is not simply the most financially practical but the most convincing.
Certainly those who, believing the US economy would outperform China's, did not advise that a better return would be obtained from investing in China's share markets than in the US lost their clients a lot of money. This is not only a theoretical argument but a deeply practical one from a financial point of view.
The author is Visiting Professor at Antai College of Economics and Management, Shanghai Jiao Tong University. From 2000 to 2008 he was Director of Economic and Business Policy to the Mayor of London, a post equivalent to the current position of Deputy Mayor. He was previously an adviser to major international mining and finance companies.
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