China

Much of the attention paid to China lately is negative.  People are expecting a hard landing for its economy, and the notion that it will dominate the 21st century is paid little attention anymore.  Today's Daily Dispatch from Casey Research was a nice deviation from that trend.

When Slowing Growth Is a Good Thing

By Sara Nunnally, Editor, Macro Trader, Contributing Editor for Inside Investing Daily

How long have we been asking if China will have a hard or a soft landing after the Great Recession? If growth in the Far East will really dry up, or just experience a temporary blip?

Cases for both sides have been made, with pictures of empty malls and apartment buildings contrasted with massive—and much needed—infrastructure projects.

Here's the bottom line…

Growth in China has been slowing.

But this is a good thing, and it should have been expected.

One of my favorite books on the subject is Michael Spence's The Next Convergence: The Future of Economic Growth in a Multispeed World. In it, Spence talks about what happens when a developing economy transitions to a middle-income economy:

"Middle-income transition refers to that part of the growth process that occurs when a country's per capita income gets into the range of $5,000-10,000. At this point, the industries that drove the growth in the early period start to become globally uncompetitive due to rising wages. These labor-intensive sectors move to lower-wage countries and are replaced by a new set of industries that are more capital-, human capital-, and knowledge-intensive in the way they create value."

Spence says that most countries try to hold on to the old ways they've done business, and governments throw subsidies and tariffs at the problem in an effort to remain competitive. We've done that here in the US with a lot of our agricultural commodities.

Nearly all manufacturing-based economies that transitioned into modern economies experienced slowing or even halted growth for a period of time.

These growing pains are part of the process of becoming an advanced economy. Low-wage industrial manufacturing gives way to technologically advanced research and education, as well as a larger service industry that will accompany a boom in domestic consumption.

And that domestic consumption is going to be huge.

It's a numbers game, and China's population is still growing.

It has the largest population in the world, with more than 1.349 billion people.

Here's how that figure breaks down:

• 0-14 years: 17.2%
• 15-24 years: 15.4%
• 25-54 years: 46.7%
• 55-64 years: 11.3%
• 65 years and over: 9.4%

The median age is 36.3 years. This is a demographic sweet spot, in which there is a high proportion of working-age people supporting a smaller pool of dependents.

Leith van Onselen, chief economist of Macro Investor, writes:

"Such an advantageous age structure has effected almost all of the world's major economies and produced a population structure optimal to economic growth—that is, where the largest segments of the population were neither young nor old, but in the middle (i.e., working age)."

That's just where China is sitting… right in the middle.

And this middle-income transition means there will be fewer labor-intensive jobs and more knowledge-intensive jobs. This is important because people who work in knowledge-intensive jobs live longer, contribute more to the economy, and are generally more active later in life than those who spent their working lives doing hard labor.

So as China's population ages—and it already is, due to the country's one-child policy—its workforce will contribute more years of employment to the economy.

That adds up to a lot of consumption. In the past two decades, 380 million Chinese people have flocked to urban areas. GDP in cities has quadrupled.

But spending is climbing even faster. From McKinsey Global Institute:

"In China, for instance, spending on dining out starts to take off at annual incomes of around $3,000 per household and, by about $9,000, is on a firm and steep upward trajectory. Spending on transport and communications starts increasing strongly as incomes reach around $6,000 per annum. The recent growth in Chinese consumer markets reflects these inflection points. Between 2004 and 2011, per capita sales of electronics and video appliances rose fourfold and clothing and shoes rose fivefold in real terms, outpacing a 3.4 times increase in per capita income during that period."

Would you bet against those numbers? I sure wouldn't.

I said it's a numbers game, and it is… but it's also all about timing. We all know that China is slowing. But how quickly and how steeply will its economy fall? There is no one answer.

China's transition will hit manufacturing and exports first. If you're brave enough to short China, these sectors are your best bets. At the same time, consumer-based companies and services should ramp up as GDP per capita increases.

So slow growth won't be hitting all areas at once. You'll have to pick and choose your battles.
But for me, I'm not going to stand in front of the demographic train that's boosting population in China's six megacities by 34.37 million people by 2025. That's a jump of nearly 38.5%. In that same timeframe, GDP per capita for these megacities will jump by 134%.

Choose your battles wisely…