Posted 8/20/2010

CHINA IS BIGGER THAN YOU THINK

All the news reports say China's economy has reached $5 trillion. The same reports say China is now in second place behind the USA, with Japan being pushed down a notch to third place.

But China is a lot bigger than that. It is closer to $10 trillion – only $5 trillion behind the USA and twice as big as Japan's economy.

How can I say this?

Because I believe the "exchange rate figures" used in the news reports is the wrong measuring stick to use in comparing the individual Gross Domestic Products (GDPs) of individual nations.

Instead, I believe in the "Big Mac" index.

About 25 years ago an economist looked for an easy way to determine which of the world's currencies were overvalued and which were undervalued. He felt that McDonald's "Big Mac" was a standard product sold worldwide. Variations in Big Mac prices were therefore caused by incorrect currency values.

A year ago Big Macs sold in the USA for $2.67, the standard price used in the Big Mac index. But in Switzerland, the price was about $4.00 – which indicated that the Swiss franc was way over-valued. This also meant the whole Swiss economy was way over-valued.

In China, Big Macs sold for $1.32, which meant the yuan was way under-valued – making the Chinese GDP much larger than the figures used to report it.

Naturally, tradition-bound economists at the World Bank pooh-poohed the whole idea of a Big Mac index.

Fortunately the economists at the International Monetary Fund (IMF) felt there was great merit in the Big Mac idea. They set about to refine it and make it more palatable to their hide-bound brethren practicing the dismal science.

In little more than a decade, the IMF came up with a refined version of the Big Mac Index and called it "the Purchase Parity Index" – a high-falutin' term which included a measure representing all purchases the people of a country might make.

For example, if China makes ten T-shirts for $20 and the USA makes two T-shirts for $20, exchange rate measures say the two T-shirt economies are equal. But the Purchase Parity folks say a T-shirt is a T-shirt and China's T-shirt economy is five times larger than the T-shirt economy of the USA.

If China sells 100 Big Macs for $132 and the USA sells 100 Big Macs for $267, the exchange rate boys claim that America's Big Mac economy is more than twice as large as China's Big Mac economy. But is this true?

The purchase parity crowd says the economies are exactly equal because a Big Mac is a Big Mac. These means that it is more accurate to measure real output instead of dollarized output values.

This means that China's real economy is not $5 trillion, but $10 trillion.

It means that China passed Japan several years ago, not last week. It means that China will catch up with the USA much more quickly than anyone is predicting. (Refer to the Wall Street Journal chart above.)

The fact that China's real economy is twice as large as the news reports say can easily be revealed in the answers to several questions:

1. If China's economy is only $5 trillion, how can it afford to support the world's largest army of 2.4 million men and women?

2. How can China afford its extraordinary military developments in weaponry, delivery systems, submarines, cyber-warfare and space exploration?

3. How has China been able to become the world's largest resource user?

4. How has China become the world's largest producer and user of steel and coal?

5. How could China become the world's largest user of alternate energy?

6. How can China afford to make trade deals all over the world, offering money and development projects?

7. How has China managed to become the world's largest polluter?

And why has the world come to recognize the USA and China as "the big two" if China's economy is only one-third the size of the USA's?

Remember the Japanese economy has been one-third the size of America's economy for two decades and no one in the world ever referred to the USA and Japan as "the big two."

I am sorry to have to write a technical economic column because the subject is a lot more boring than spending time watching American Idol.

I only wrote this because the media have badly misled the country as to the true economic power and potential danger presented to the USA by China.

(click here for a printable version of this article)