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Do Economic Statistics Adequately Reflect the Size of the Asian Economies?

Officially, the US has a GDP of about US$11 trillion, while Chinas GDP amounts to US$1.1 trillion and India's to about US$500 billion. Moreover, whereas the world's GDP stands at about US$32 trillion and the advanced economies have a combined GDP of US$25 trillion (G7: US$21 trillion), the emerging Asian economies (including China and India, but excluding Hong Kong, Japan, Singapore, South Korea, and Taiwan - countries that are classified as advanced economies) have a GDP of just US$2.2 trillion. However, if we look at some production figures, it becomes obvious that the US economy is nowhere near ten times as large as the Chinese economy or more than 20 times the size of India's GDP. Neither do the G7 countries have a GDP ten times larger than the emerging Asian countries. According to The Economist's World in Figures 2003 directory, China ranks as the world's largest producer of cereals, meat, fruits, vegetables, rice, zinc, tin, and cotton. It is the world's second-largest producer of wheat, coarse grains, tea, lead, raw wool, major oil seeds, and coal, the world third-largest producer of aluminium and energy (measured in million tonnes of coal equivalent), and ranks between fourth and sixth in the production of sugar, copper, precious metals, and rubber. India ranks among the top three producers of cereals, fruits, vegetables, wheat, rice, sugar, tea (number one for the latter two), and cotton. Indonesia ranks among the top four producers of rice, coffee, cocoa, copper, tin, and rubber; while Thailand is the world's largest producer of rubber, and Vietnam the world's second-largest producer of coffee.

"So what?" some readers may think, since these are just commodities and thus are irrelevant in post-industrialized societies! However, if we consider that China is already the world's largest manufacturer of textiles, garments, footwear, steel, refrigerators, TVs, radios, toys, office products, and motorcycles, just to mention a few product lines, and if we then add the industrial production of Japan, Taiwan, South Korea, and India, we get a totally different picture of the size of the Asian economies than is suggested by statistics based purely on nominal GDP figures, which don't take into account the difference in the price level between different countries. In fact, statisticians, in order to account for the fact that in some countries the price level is far lower than in the Western industrialized countries (such as is the case for most emerging economies), have calculated the GDP level based on purchasing power parities (PPP). And while I have some doubts about the methodology of PPP-adjusted GDP figures, it is nevertheless interesting to see how large the emerging economies are when based on this measurement. Asia (including China, Japan, India, South Korea, Indonesia, Taiwan, Thailand, the Philippines, Pakistan, Bangladesh, Malaysia, Hong Kong, and Vietnam) has a PPP-adjusted GDP of US$14 trillion, which is 50% larger than the US's PPP-adjusted GDP of US$9.6 trillion. In fact, by this measurement, Asia, in which we should probably also include Central Asia, Australia and New Zealand, as well as parts of Far East Russia, would be by far the world's largest economic bloc. And while, as just mentioned, I have some reservations about PPP adjustments, in general I think that it is fair to say that the PPP-adjusted figures reflect a far more realistic picture of the size and importance of the Asian economic bloc with its 3.6 billion people (61% of the world's population) than do the nominal GDP figures, which suggest that the US has a GDP ten times that of China.

One of the reasons why I have chosen to discuss the size of the Asian economies, their impact on commodity prices and on resource-based countries and basic companies aside is that if we compare the true size of Asia with the extremely low weighting some Asian countries have within the MSCI World Free Index, it becomes obvious that some big changes are likely to take place in future. The combined weighting of the entire Asian region with 3.6 billion people and the world's largest economic bloc is just 3.4% excluding Japan and 12.1% including Japan! This low weighting of Asia compared to the US raises two important questions. Is Asia ex-Japan really worth around 5% of the world's entire market capitalization (5% would include shares, which at present cannot be bought by foreigners), and is the US worth 11 times the Asian market capitalization ex-Japan? I, for one, doubt it! This particularly because of the low price level in Asia compared to the US and also because of Asia's bulging foreign exchange reserves, which are approaching $ 2 trillion. Should the day come when Asians have more confidence in their own economic bloc (which I think will happen in the next few years), we could see a massive shift of assets from the US to Asia, with Asian financial assets and Asian currencies rising very strongly relative to US financial assets and the dollar. In other words, I think it is only a matter of time before Asian currencies and Asian assets, including real estate and stocks - will appreciate relative to US financial assets and US properties.

There is one further point worth mentioning. If an individual or a financial institution asked a traditional fund manager (who inevitably follows the index weighting quite closely) to invest their funds that have been allocated to equities, they would end up having more than 50% of their money in the US and just 11% in Asia including Japan, a region which, as I have explained above, is already the world's largest economic bloc with 3.6 billion people and the world's most favorable growth prospects (moreover, they would have a maximum of 5% of their money in Asia ex-Japan, with 3.5 billion people and which includes the world's fastest-growing economies - China India, and Vietnam). He would also end up with less than 1% of his assets in combined China, India, Indonesia (the latter a country with the world's fourth-largest population), Bangladesh (eighth-largest country), Pakistan (sixth-largest country), Thailand, and the Philippines. Somehow, I think that such an asset allocation, which implies that the index-benchmarked investor would own just 1% of a region which is inhabited by half the world's population, simply doesn't make any sense at all and exposes the absurdity of indexing as it is practiced today.

In fact, I believe that investors should allocate at least 50% of the money they invest in equities to Asia where valuations are far lower and growth prospects more favorable than in the US.

But, while I am very positive about Asia from a number of points of view (the size of the economy, growth potential, low valuations, and low weighting within the MSCI Index), I also have to admit that near term I am far less optimistic. I simply feel very uncomfortable about the US economy and the entire financial system, and feel that the US stock market has at best entered a sharp correction phase or may at worst, experience a crash - if not now, then following another brief bout of strength. And since the recent strength in the Asian markets has been driven largely by foreign buyers, a US stock market correction or, in the worst case, a crash would almost certainly spill over into Asia and lead to some pronounced weakness but not likely to new lows. It is for this reason that I have turned more cautious on Asia from a near term point of view. In the US, I am particularly concerned that rising interest rates will have a negative impact on the housing market and on financial stocks, which make up more than 20% of the S&P 500. Housing stocks, which have been formidable performers since 2000 (up fivefold), should from now on under-perform, as the decline in refinancing activity will slow down the industry. Moreover, the Philadelphia Bank Index appears to be tracing out a head and shoulders formation and financial shares such as Fannie Mae look poised to decline sharply. I may add that while financial stocks look likely to weaken in the US, in Asia financial shares appear to be strengthening. In sum, I like Asian assets including real estate and equities and I remain of the view that investors should avoid the US. Thus, you might consider hedging your Asian bets by shorting the US!

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