Chinese Economy Now Largest in the World

February 2015
For decades, the U.S. has had the largest economy in the world, and by a wide margin. Though other countries, such as China and India, have had much more rapid growth in recent years, the U.S. GDP still dwarfs that of any other country. In fact, it’s almost double China’s, at least in terms of nominal GDP. However, the International Monetary Fund (IMF) recently reported that China is the world’s largest economy in one regard: purchasing power parity (PPP). 

First, some background: When comparing the size of economies, normally each country’s GDP is converted to U.S. dollars using current market exchanges rates to create an easy means of comparison. A country’s GDP expressed in U.S. dollars using this method is called its nominal GDP. It is in this regard that the U.S. still towers over every other country. The U.S. nominal GDP is roughly twice the size of China’s economy using this method and multiple times the size of every 
other country. 

But economists have pointed out that nominal GDP doesn’t give us the whole picture. The same goods or services in one country don’t cost the same in another, even taking into account market exchange rates. This is especially true in underdeveloped countries, where goods and services are often much cheaper. Tourists often recognize this concept intuitively when going to a restaurant or market in a less developed country than their own and noticing their money goes much further. Purchasing power parity applies this concept on a much larger scale.  One country may have less money (nominal GDP) than another, but the amount of goods and services that money could buy within that country (PPP) is effectively the same. 

In terms of PPP, the IMF reports that China currently outputs $17.6 trillion in goods and services annually, while the U.S. outputs $17.4 trillion. This may come as a surprise for many who had heard that China’s economy won’t become the world’s largest until 2020 or later. That’s still true, as those estimates are based off nominal GDP estimates, not PPP estimates. Most tend to regard nominal GDP as the more important measurement, because it better states the position of the country in a global economy. However, the reason the PPP estimate is so significant is that the time that China will become the largest economy by any measure is not so far off. 

This isn’t to say that China’s economy is similar to the U.S. economy—far from it. The U.S. still has much more purchasing power globally, even if it has less inside its own borders. While China may be able to purchase more domestic goods, like cars, missiles or soldiers, than the U.S., the U.S. has greater access to foreign goods due to the strength of the dollar. China also has a much larger population than the U.S. This means that while the country’s economy is large, its per capita GDP is drastically lower than the U.S. Additionally, China is still mostly a communist state, and many of the companies are state-run with limited access to foreign investment. However, that is changing as China has been becoming more public. Just last November, China’s Shanghai stock exchange linked up with the Hong Kong exchange to become open to foreign investors. It’s too soon to tell how well the exchange will do, but the long-term implications are significant. 

Does this mean Americans need to start converting their dollars to Yuan and learning Mandarin? No. But it does mean that the global economy, as always, is changing in big ways. If things continue in the direction they are heading, America will soon lose its tenure as the world’s economic leader—in size, at least—and China will step in to take its place.
Remember that past performance may not indicate future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, strategy, or product referenced directly or indirectly in this newsletter will be profitable, equal any corresponding historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. You should not assume that any information contained in this newsletter serves as the receipt of personalized investment advice. If a reader has questions regarding the applicability of any specific issue discussed to their individual situation, they are encouraged to consult with a professional adviser. 

This article was written by Advicent Solutions, an entity unrelated to Guidestream Financial, Inc.. The information contained in this article is not intended to be tax, investment, or legal advice, and it may not be relied on for the purpose of avoiding any tax penalties. Guidestream Financial, Inc. does not provide tax or legal advice. You are encouraged to consult with your tax advisor or attorney regarding specific tax issues. © 2014 Advicent Solutions. All rights reserved.

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