The health of the Chinese economy is very important to us as a substantial part of our marketing efforts are focused on selling wine in China.
While the exceptional recent growth in the Chinese economy is rather old news, there have been many rumours about economic downturn and slowdown in China. This morning however, I came upon this article by Brett Arends on marketwatch.com announcing China’s economy as the largest in the world.
“There’s no easy way to say this, so I’ll just say it: 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. For the first time since Ulysses S. Grant was president, America is not the leading economic power on the planet. It just happened — and almost nobody noticed.”
He refers to the International Monetary Fund’s latest figures, listing China’s national economic output in “real” terms of goods and services to produce $17.6 trillion, compared with $17.4 trillion for the U.S.A.
“As recently as 2000, we (US) produced nearly three times as much as the Chinese.”
According to these numbers, measured in terms of purchasing power, China now accounts for 16.5% of the global economy while the US stands at 16.3%.
What makes a difference is the way these figures are calculated. According to
Arends, they are done using purchasing power parity or PPP, measuring actual output in stead of fluctuations in exhange rates.
A strong Chinese economy is good news for our business and I wanted to have a look at exactly what this PPP measurement entails (please see http://intl.econ.cuhk.edu.hk/topic/index.php?did=13).
“Purchasing Power Parity (PPP) states that exchange rates between different currencies are in equilibrium when their purchasing power is the same in two countries. This means that the exchange rate between two countries should equal to the ratio of the two countries’ relative price levels. If the price level of one country increases (i.e. the country experiences inflation), its currency must depreciate in order to maintain PPP.”
This is translated as the “law of one price” in which competitive markets will equalise the price of identical goods in two countries when the prices are expressed in the same currency. (Do follow the link above for a detailed explanation).
“The simplest way to calculate PPP between two countries is to compare the prices of a “standard” and identical good across countries. Every year the Economist magazine publishes a light-hearted version of PPP; its “Big Mac Index” compares the price of a McDonalds’ Big Mac around the world. More sophisticated versions of PPP look at a large number of goods and services. One key problem is that people in different countries consume very different sets of goods and services, making it difficult to compare the purchasing power between countries.”
The Economist concludes: “PPP signals where exchange rates should be heading in the long run, as a country like China gets richer, but it says little about today’s equilibrium rate. The relationship between prices and GDP per person may be a better guide to the current fair value of a currency.”