Economic commentary linking Adam Smith, Chinese growth, and US history

| JIMMY C. CHANG, CFA Chief Investment Yesterday Once More; Tomorrow Never Knows Strategist 212.549.5218 jchang@rockco.com China’s housing boom once again fueled global growth, but how long will it last? consequential publication in 1776? With this article being published around July 4, you would probably think we are hinting at the US. Declaration of Independence. That would be a good response, but unlike the laws of physics or mathematics, there is not exactly a right answer to such a question. One could also point to a book published on March 9, 1776, that has had a transformative impact over time. It has a long title: An Inquiry into the Nature and Causes of the Wealth of Nations, and is generally referred to as The Wealth of Nations. This seminal work supposedly took Scottish economist and philosopher Adam Smith 10 years to complete, and was based on notes and observations spanning 17 years. It challenged the mercantilist and physiocratic economic theories that domi- nated the intellectual debate during the mid-18th century. Mercantilist theory held that countries grow wealthier by maxi- mizing domestic production and exports, and was the basis for European imperialism. Physiocratic theory postulated that the wealth of nations was derived from the value of agricultural and land development, and could trace the inspiration to China’s agrarian traditions. The Wealth of Nations marked the birth of modern capitalism and also had an influence on our Founding Fathers. James Madison cited the treatise in arguing against the need for a cen- tral bank in 1791; Thomas Jefferson referred to it as the best book on money and commerce. In February 1977, in celebra- tion of America’s Bicentennial, the Federal Reserve Bank of Richmond published the paper The Relevance of Adam Smith. It pointed out the striking similarities between the intellectual spirit of The Wealth of Nations and the Declaration of Independence. Both railed against the heavy hand of the state, and emphasized individual liberty and the harnessing of indi- vidual self-interest to the welfare of the greater society. | et us begin with a trivia question—what was the most So it is perhaps a tie between these two publications. One gave birth to modern economics that created the greatest prosperity GLOBAL FORESIGHT THIRD QUAPTER 2017 in human history, and the other marked the founding of argu- ably the most powerful and wealthiest nation ever. Do Not Bet Against the House At around the time that America celebrated its Bicentennial, China reached a historic turning point. Chairman Mao passed away in September 1976, and a month later, the arrest of the Gang of Four marked the end of the decade-long Cultural Revolution. Deng Xiaoping then returned to power and embarked on reforms that powered roughly 10% real GDP growth per annum for the next four decades and lifted more than 800 million people out of poverty. Today, the Chinese economy is the largest in the world based on purchasing power parity. Interestingly, China’s rise had little to do with Adam Smith’s free-market capitalism. While China’s unprecedented economic ascension was indeed fueled by unleashing the energy and the profit-seeking self-interest of the individual, its development has always been shaped by the government's heavy hand. Successive Five-Year Plans, which first started in 1953, continued to guide social and economic development, and key industries remained mostly state-owned. Some argued that China has been pursuing a mercantilist policy in building up its manufacturing base to drive exports and accumulate foreign exchange reserves. Indeed, its share of global exports has remarkably grown from about 1% in 1980 to around 15% by 2016, the largest in the world. Some claimed that China even produces more sombreros than Mexico. In the wake of the Global Financial Crisis in late 2008 and early 2009, China realized that the country’s growth model could no longer depend on external demand, and responded by unleashing massive stimulus for infrastructure projects. It worked so well that China’s growth skyrocketed, asset prices shot up, and the housing market became overheated. Globally, China’s reflation and the Fed’s quantitative easing generated an echo bubble in commodities and emerging market stocks. HOUSE_OVERSIGHT_012084