WORLD GROWTH AS WE SHOULD COME TO KNOW IT

In recent weeks, much of my written commentary has been about the improving cyclical state of the US economy and what that might mean for markets and the rest of the world. As the US remains the world’s largest single national economy, it is obviously key. However, while the US remains also the home of the world’s largest absolute consumer, as readers should know well, I don’t believe this is the structural story of our time. The structural story of our time is that of the emergence of the middle classes and their consumption in the “Growth” economies of the BRIC nations along with some of the bigger N11 economies, especially Indonesia, Korea, Mexico and Turkey.

This past week has witnessed a number of powerful developments in some of these countries again, and it is important that investors continue to develop their awareness of these forces.

CHINA POWERED AHEAD IN 2010.

According to news wires, this weekend, the Deputy Head of the all-important National Development and Reform Commission (NDRC) has said that China grew by 10.1 pct in real terms last year, taking the economy to around $6 trillion, a bigger level than I thought for now, and a size that is now comfortably larger than Japan.

There are a number of simple ways to think about the sheer magnitude of this rise of China. And, it is worth pointing out that as the RMB appreciates, then the $ value of China gets even bigger.

At around $6 trillion, China is now more than two times bigger than either France or the UK in US$ terms. Back in 2001 when I dreamt up the BRIC acronym, China was less than $1.5 trillion, actually smaller than France or the UK. I have often been fond of saying to people, China has created the equivalent US$ GDP of two new United Kingdom’s in the past decade. In fact, at $6 trillion, it would be equivalent to three UK’s of their 2001 size. Or, about 1/3 of another United States as it existed back then.

At this base size, if China grows around 10 pct in US$ terms this year – which is highly likely, an underestimate as this would be achieved with no inflation, 7 pct real GDP growth and a 3 pct annual rise of the RMB against the Dollar), China will create  more than another Indonesia or Turkey next year. To translate this into our new terminology for what constitutes a “Growth Market”, China will be creating another Growth Market all by itself this year. At the implied consensus 15 pct nominal $ growth, this will be creating more than one Netherlands equivalent, or nearly another South Korea, or more than half an India, or nearly half a United Kingdom.  Quite impressive by any standard. 

There remains a remarkably large number of people out there that are either unaware, don’t believe, or think that the story of the Chinese consumer is unsustainable. Many of the true skeptics cite the reported GDP data that shows personal consumption is not much more than 35 pct of GDP. Most true China data experts tend to doubt that consumption is in fact this low, but for the sake of the point I am about to make, let’s assume it is true. At 35 pct, this translates into a US$ value of 2.1 trillion. Back in 2001, assuming the same 35 pct, the consumer would be around $490 billion. Therefore, over the past decade, the Chinese consumer’s US$ value has risen by around $1.6 trillion.

This, and remember, I am assuming the base numbers of the pessimists, is about 15 pct of the current level of US consumption. It is also about the size of the overall Indian economy today.

I could make so many points to refute the China consumption skeptics, but that is for another day. I shall make only one here today. The reason why the level of reported consumption seems to be a relatively small share of GDP is not necessarily because the Chinese consumer is repressed, cautious, etc. Rather, it is simply because other parts of GDP rose even faster in the past decade. Look back at the simple numbers above. If overall Chinese GDP rose by $4.5 trillion in the past decade, and the consumer rose by around $1.6 trillion, that means the rest of the economy rose by nearly $3 trillion. This was the power of Chinese exports and investment, which is unlikely to be repeated going forward.

Looking ahead, it will be much easier for Chinese consumption to rise as a share of overall GDP. Firstly, exports and investment will not rise as much. Secondly and partly because of that, policymakers are undertaking many policies to stimulate consumption for a bigger proportion of China’s population.

One final way of recognizing the power of China is related to the topical subject of their external balance of payments. Ahead of the forthcoming State visit to Washington DC, friends of those in high places should especially pass this on. China’s trade data for the last month of 2010 was also reported last week, and for the year as a whole. China reported a trade surplus of around $184 bn. Importantly, this was around 3.8 pct of GDP. Three years ago, it was closer to 11 pct.

Look below the surface and see the import figures. In 2010, China’s total imports were $1,359 billon. This was an increase of $389 billion over 2009. In one year, China imported more than the total value of South Africa, or about ¼ the US$ value of India. Who says China grows at other’s expense?

Chinese imports were about 22.7pct of total GDP assuming the $ 6 trillion figure for GDP. The US will have imported around $ 2,300 billion in 2010, which as a share of GDP is somewhat less, at 15.7pct. China is set to become a much bigger importer than the US even before it gets close to its size.

INDIA. THE MIND BOGGLES.

Now if the above isn’t enough, here is the most startling single story I heard so far this year. John Sawtell, one of the senior Goldman Sachs research analysts in Europe, sent me an email about the remarkable story of an Indian airline company called IndiGo last Wednesday. Neither one of us had known of their existence until this point. Last Wednesday, it was announced that this company had made the single biggest airline order in history. Airbus said that they had received an order for 180 A320’s from them totaling around $15 billion. According to the story, this new company has indicated it might need 4,000 aircraft within 15 years. With this one single order, according to John, it takes them to 2/3 the size of Easyjet. All of this fits with the mind boggling stories I heard firsthand when I was in Jaipur for a few days last November. I wrote about this on my return. Their new airport supposedly was built in not much more than a year, and the Aviation Minister told me that there is going to be another 400 of those in the future.

As 2011 unfolds, India has some difficult weeks ahead as it tries to deal with the challenge of inflation as well as a modest balance of payments deficit.  But, given the power of their underlying story, even if the current moment might not be the absolute best time to be investing, smart policy behavior will allow this remarkable underlying story to unfold.

Now, India is not yet in the league of China, but in its own  way, the past decade has seen their contribution grow dramatically. Today, India is probably an economy of around $1.6-1.7 trillion. Ten years ago, it was less than $500 billion. The $1.1-1.2 increase is the equivalent of creating another Italy of 2001 in 10 years, one and a half Canada’s, or three of Australia.

Going forward, as I have written about before, India is quite likely to grow at a faster rate than China.

GROWTH ECONOMIES POWERING THE WORLD TREND.

Now look at this weekend’s Financial Times front page. “BP signs $7.8 billion deal with Rosneft.” Announcing a share swap, the two companies said they are going to explore jointly in the Russian Arctic continental shelf. This is an alliance involving a company that has faced many challenges in recent years including some in Russia. This follows news late last year of a substantial acquisition in Russia by Pepsi Cola.

Later this month, we plan to publish a paper outlining more how investors should approach these Growth Markets. With the kind of dynamic discussed above, for investors to still treat many of them as “Emerging Markets,” just doesn’t make sense any longer.  If you combine their current GDP, but still acknowledge the revenue growth of western multinationals in the Growth Markets and account for the volatility of companies’ performance, it seems clear that investors should increase their neutral weighting to these economies. If you are actually excited about this dynamic world, then the increase in allocations should be sized accordingly.

WORLD MARKETS.

Last week was another decent week for global equity markets, and it was a pretty good one for bond markets also. What was especially striking was the strong rally in European markets as the mood about the European Monetary Union took a turn for the better, or perhaps I should say, less worse. I had been thinking about writing about the EMU issue again this week, but the BRIC news is simply so powerful, as often, I just can’t ignore it. Putting it all together, if the most popular “worry of today” is taking a sustained turn for the better, then I am not sure quite what next the bears are going to find. Whether the EMU is indeed through the worst is a topic for the near-future, but against the background of the improving US and the never-ending emergence of the BRICs, I am far from convinced that it is as important globally as many think.

Jim O’Neill
Chairman, Goldman Sachs Asset Management