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Chinese GDP Surpasses USA (*when Measurement Adjusted)
A story has been echoing around the financial news for a few weeks. One article about it, It’s official: America is now No. 2 by Brett Arends at MarketWatch, came to my attention. Arends asserts that the Chinese economy is now larger than the economy in the US. Here’s what he said.
“We’re no longer No. 1. Today, we’re No. 2. Yes, it’s official. The Chinese economy just overtook the United States economy to become the largest in the world.”
With GDP data from the IMF, we can easily see that the US economy is bigger than China’s. The IMF estimates 2014 GDP at $10.4T for China and $17.4T for the USA. So how does Arends claim the contrary? He uses different data that IMF adjusts. By this methodology, the Chinese economy is “really” $17.6T.
Really?
Although Chinese GDP is lower when measured in yuan and converted to dollars, Arends and others claim that this isn’t right. Goods and services are cheaper in China. So they don’t think we should convert yuan to dollars using the market exchange rate. They use a concept called Purchasing Power Parity (PPP). PPP is used to determine a different exchange rate for the yuan than the market rate. This is how they arrive at a “real” Chinese GDP of $17.6T.
We have long been trained to accept purchasing power as the means of adjusting the dollar from historical periods. For example, JP Morgan was worth $68M at his death in 1913. To calculate what that’s worth in today’s dollars, most people would refer to the Consumer Price Index. They use CPI to adjust the $68M figure from 1913 to a $1.6B modern value. As I wrote on Forbes, that approach is wrong. They should use gold which, unlike the dollar, is the same in 1913 as in 2014. Morgan was worth 3.4M ounces of gold, which is $4.1B today.
Adjusting the Chinese economy by PPP is simply applying the consumer price idea to a whole economy. If we use prices to adjust dollar figures from historical periods in the US, why not use them to adjust foreign but contemporary dollar amounts? If we can use consumer prices to measure the net worth of a man who died in 1913, then it seems like we can use them to measure the economic output of China also.
The approach is fatally flawed, because the value of a currency isn’t derived from prices. As an analogy, suppose you are using a steel meter stick to measure a rubber band. When you stretch the rubber band, it gets longer. This is not equivalent to saying that the meter stick gets shorter. You do not measure meter sticks by how many rubber bands fit end to end. Measurement is one-way.
Money is the meter stick of economic value (though this principle is clouded in paper currencies, because they are falling). Prices rise or fall for non-monetary reasons. Prices may be cheaper in China for a variety of reasons, such as lower wages. Money measures these changes, not the other way around.
By the same principle, prices may be higher in New York than in Phoenix. Does anyone dare to say that these are different dollars? Should we adjust New York dollar downwards towards the Phoenix dollar, based on PPP? How about the Scottsdale dollar (Scottsdale is a ritzy suburb) vs. the south Phoenix dollar?
Standards of living certainly vary based on local prices, but that is a separate issue. The dollar is the same in New York as it is in Phoenix. We say that the dollar is fungible—a dollar is a dollar is a dollar, and each is accepted in trade the same as any other.
Arends uses the Starbucks venti Frapuccino as an example, which he says is cheaper in Beijing than in Minneapolis. A cup of coffee produced in China cannot be sent to Minneapolis where it will fetch a higher price. However, money is unlike coffee. It can go from Beijing to Minneapolis instantly. That’s why there is one price for the yuan globally, but a different price for coffee on every street corner. Bulk commodities are of course more transportable than cups of coffee, but even they cost time and money to transport.
It’s an essential property of money that it is quick and cheap to send it somewhere. Money will always move from where it has less value to where it is valued more highly. The result is that money’s value is consistent everywhere.
This consistency allows us to convert the yuan to dollars, to compare Chinese GDP to American GDP. This is perfectly valid (well, if you accept that GDP itself is valid), because the comparison is instantaneous. We do not have to worry about the falling value of either currency that occurs over longer periods of time. We could use gold to compare the Chinese economy to the American, but it’s not necessary in this.
The price of Frapuccino in China may be important to caffeine addicts who travel to Beijing, but it cannot be used to adjust a currency or a country’s GDP.
Chinese GDP is a lot smaller than American GDP. Will that change? Maybe, but it’s not the job of economists to embed such speculative assumptions into the data.
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China should enjoy its very temporary ascendance.
Over the next 15 years China will enter Japan-type territory as Japan finally comes out of its demographic problem and starts growing its economy again. The US demographic also turns positive within 10 years.
China is sunk for decades after 2025.
Get ready for another century of US dominance.
#2? #1?
Plundered, yes.
An American, not US subject.
Since I don't understand these calcs very well, I have just a small question...
what number does the USA get (T's) if you calculate the USA economy after exchanging USD to CNY? At least it would be an interesting exercise.
is china on the hook for $3/4 of a quadrillion in currenecy, and credit derivatives, does that affect gdp, or is that more krugman owing krugman economics.
i just went to the debt clock, and noticed something strange, i think.
the $ 3/4 of a quadtrilion in derivatives are decreasing about a million every 10 sec., while the 2000 derivatives are increasing about a million every 10 sec., is there a reason for this, does lowering 2014 #'s, and increasing 2000 #'s make this ponsi look better?
In my opinion, industrial production (manufacturing + mining + utilities/energy production) is by far the best metric of an economy's true power. And on that count China pawns the USA by a significant margin.
Never bought this "services" mumbo-jumbo. As if having expensive lawyers + expensive hairdressers + expensice government employees makes an economy a powerhouse.
What is happening is what so many predicted beginning about 7 years ago when this change became apparent - the making of excuses, the massaging of data to keep the USA at number one, downplaying GDP, saying it does not count (now that we are not #1).
The Chinese want to play victim and fly under the radar as long as they can.
The Americans want to cling to the last days of superiority as long as they can.
This is happening now, has been for a few years.
It will be reality over the next decade. Better get used to it. Update your language now.
""The United States of America, the second largest economy in the world and with a shrinking status on the global stage, voted in Congress to decommission all but 2 of their legacy aircraft carriers today in a partisan vote split along party lines..."'
Get used to it, it is here it is coming...
Aren't they supposed to be replaced by new ones?
http://en.wikipedia.org/wiki/Gerald_R._Ford-class_aircraft_carrier
Thank you.
No it isn't.
If I look out my window and the traffic outside resembles that in a country with a nominal GDP of 12,000-20,000 USD, then having said nation with an adjusted PPP of 11,800 makes sense.
People in China live as well as, or better than, the people in Mexico and Mexico has a nominal GDP of ~10,600USD, so a PPP per capita for China of 11,900. People in China often have larger homes on larger acreage, with larger apartments in nicer buildings that are more modern than Mexicans. They have as many autos, the autos are newer and nicer and better kept and cared for.
Lived in both countries.
http://www.reuters.com/article/2014/12/05/us-usa-china-corruption-idUSKC...
"The majority of them are related to crimes of corruption or economic malfeasance," he said. "The list is not precisely clear in terms of the details of the nature of the crimes, the evidence or the whereabouts" of the accused...
...China has vowed to expand a "fox hunt" for corrupt officials and business executives beyond its borders but it does not have an extradition treaty with the United States, which China has said is one of the most popular destinations for so-called economic fugitives.
Western governments have balked at setting up extradition agreements with China because rights groups say torture is widely used by Chinese authorities and the death penalty is common in corruption cases.
The U.S. official said China was seeking many more suspects in U.S. territory than the United States was looking for in China.
Xu Hong, a senior Chinese Foreign Ministry official, said last week China was considering suing people suspected of committing financial crimes who had fled to the United States and elsewhere with billions of dollars.
No way American politicians are going to sign extradition agreements with countries where corrupt public officials are executed.
A good education on the PPP concept. Using one metric GDP and extrapolating it to whatever matter to you like currency strength, etc is shallow.