40 Years of Chinese Economic Reforms and Gold / Commodities / Gold & Silver 2019

The economicdevelopment of China is one of the most important events in the history of theworld. In an unprecedentedly short time, millions of people have been taken outfrom poverty. But, as no country has ever developed so fast, that great storyraises important worries.

We invite youto read our today’s article about the great progress China made in the lastforty years and find out whether it’s too good to be true and it must end withsome catastrophe, triggering rally in the gold prices.

One of thebiggest risks for the global economy which can materialize this year is theslowdown of China’s economic growth. So, it is wise to analyze the currentstate of the Chinese economy – itsimplications for the gold market and what will happen next. As December2018 marked the forty years of market reforms in China, we will adopt along-term perspective, explaining how China transformed itself from a poor,backward and isolated country to the world’s economic power. We will examinewhat the global economy and the precious metals market can expect in China’sfifth decade of reform and development.

“Emancipate the mind, seeking truth fromfacts and unite as one to face the future” – these are the famous wordsDeng Xiaoping said in December 1978, triggering China’s economic reform andopening to the international economy. Initially, the changes were rathermodest, in line with the “bird-cage economy”. The market was compared to a bird,which had to be contained, as otherwise it would fly away. The planned economywas still in force, but with market experiments. The reforms were implementedgradually, often started in only a few regions – the leaders expanded them uponproven success, in line with the country’s motto “crossing the river by feelingthe stones.”

But when theSoviet Union collapsed, China decided to speed up its transformation. Thegovernment did not merely reform the socialist economy, but it opened theeconomy and included market mechanism wherever possible. The next turning pointwas in December 2001, when China joined the WTO. The country then received anew powerful impulse for modernization, rapidlychanging its status of a developing state into a reviving power. In 2009,China became the largest exporter on the globe (and in 2014 the largest tradingstate) and one year later, the second economy in the world.

At the turn2014/2015, a tectonic shift occurred. The incoming capital to China turned outto be smaller than the capital outgoing China, while the IMF admitted that China is already the largest economy in the world,when using the GDP adjusted for purchasingpower parity (see the chart below).

Chart 1:China’s Official Real GDP (blue line), China’s Alternative Real GDP (greenline) and US Official Real GDP (yellow line) in millions of 2017 PPP US dollarsfrom 1968 to 2018.

In the face ofall these successes, the Chinese leaders rejected the previous strategy ofbuilding power quietly, offering China and the world new, highly ambitiousprograms, such as the Belt and Road Initiative – an infrastructure programworth 1.4 billion dollars, several timesmore than Americans allocated to the famous Marshall Plan after the World WarII.

The countryalso set three ambitious goals to realize the Chinese Dream. First, bymid-2021, for the centenary of the Communist Party of China, the existingeconomic model, based on investment expansion and export, is to be replaced bya sustainable development and strong internal consumption. Second, by 2035,China will become a global leader in innovation. And, third, by the end of2049, for the centenary of the People’s Republic of China, the country wants toachieve “great renaissance of the Chinese nation”, through a reunification withTaiwan, creating the leadingcivilization on the globe.

These are quiteambitious plans, aren’t they? No wonder that the current global hegemon wokeup. After all, the trade wars are not (only) about trade or tariffs, but (also)about dominance, hegemony and primacy in high technologies. 

China’seconomic rise over the last 40 years thanks to the systematic adoption ofstructural reforms has been extraordinary. However, as the country faces manychallenges, the pace of economic growth hasbeen declining in recent years, as one can see in the chart below.

Chart 2:China’s real GDP growth (official estimates – blue line, left axis, in %;alternative estimates – green line, left axis, in %) and the gold prices(yellow line, right axis, London P.M. Fix, annual average) from 1968 to 2018.

One of thebiggest challenges is the transitionfrom the export-led to a domestic-consumption-driven growth model. Giventhat exports account for a decent part of GDP growth, the slowdown seems to beinevitable. But the question is: will China follow in Japan’s footsteps,entering a multi-year stagnation? Possibly, but investors should remember thatbefore Japan fell into stagnation, it had already reached high-income status interms of GDP per capita, while Chinaremains significantly below the threshold.

What does itall imply for the gold market? Well, China has experienced tremendous progresssince 1968, lifting hundreds of millions of people out of poverty. Itfascinates but also terrifies. This is why some people argue that theJapanese-like stagnation is inevitable, while other prophet that China willbecome the next global hegemon, with US dollar replaced by Chinese yuan. And, of course, both scenarios are considered tobe positive for the gold prices (either due to the global slowdown, or thedemise of the greenback).
           
However, the truth is in the middle. China willnot replace the US. The Red Dragon just returned to the prominent role in theglobal economy that it played long time ago. We will have two- or multi-polarworld, but do not expect China to dethrone US anytime in the near future,especially that America has finally adopted a more confrontational stancetowards China. Sorry, gold bulls.

And the country is not likely to fall into stagnationeither. The slowdown is projected to be gradual (and, after all, theeconomic growth at 4-6 percent is still relatively fast). This is becauseChina’s governance system – characterized by centralized policymaking and decentralizedexperimentation and implementation – is relatively flexible and, according tosome analysts, better-suited to rapid decision-making than dysfunctional andpolarized politics under democracies.

Having saidthat, it’s clear that China will not be exempt from the iron law of regressionto the mean in the long run. We are not naïve – and we do predict a slowdown inthe economic growth. Actually, this is already happening. The World Bankforecast the GDP growth in China for 6.2 percent in 2019, a decline from 6.5percent in 2018.You see, the country is going through painful structuralreforms, just when the US decided to tighten its trade policy, while PresidentXi Jinping boosts his authoritarian rule, and the debt burden is mounting(Chinese households’ debt to GDP ratio has soared from around 18 percent in2008 to over 50 percent in 2018). All these factors increase the risk ofcrisis. The boom fueled partially by debt will have to finally come  to an end. When it happens, it will affectthe whole globe, including the goldmarket.

Investorsshould not underestimate the Chinese ability to sustain growth, but thechallenges for Beijing get bigger each year. The industrial profits haverecently fallen for the first time in three years, while the car sales havedropped for the first time in nearly 30 years. The simultaneous slowdown inboth largest economies in the world – the US and China – would, if sharper thanexpected, increase the odds of an abrupt global slowdown and upset the stockmarkets. The yellow metal should shine,then.

Thank you.

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Arkadiusz Sieron
Sunshine Profits‘ MarketOverview Editor

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