May 2012

A PUBLICATION OF CHILTON CAPITAL MANAGEMENT

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Before Chinas Rise

Samuel Rines

The Last Rise to Power he beginning of the 20th century saw two powers, Britain and Germany, vying for dominance in Europe. The German economy was a juggernaut, manufacturing more than its European counterparts. Britain was still an economic powerhouse, and Germany could not compete with Britains financial infrastructure. The British still held the largest empire, and their naval prowess was unmatched. France, not the military or financial machine of Germany or Britain, lagged behind in manufacturing, but led the continent in auto production. The continent, in short, was crowded with powers. Britain and France had held a dominant position on the continent since time immemorial, and the arrival of the new German power in the middle of their The Anticipation of Power traditional turf was a shock to the status quo. For the next half century, the US was the The ultimate outcome, World War I followed dominant power, and the USSR was its ideological closely by World War II, was tragic. These were pest. The 21st century saw another potential countries with histories of warfare and mistrust, challenger to the US system, as China became and the shattering of the comfortable normalcy the manufacturing powerhouse of the world. was enough to ignite the continent. Seemingly endless amount of cheap labor fueled On a separate continent and a world away, incredible economic growth rates in a country the US was isolated from much of this tension. with limited free market policies. The remarkable The US was in the process of creating a vast automobile industry, andalthough not oblivious economic rise of China, and its increased presence in regional and foreign affairs, has prompted a to the happenings in Europedid not have the debate about the current and future position of treaties to tie them immediately to the conf licts. China in world affairs. The transfer of power from The US had successfully pursued a policy of non-

intervention, and did not intend to change this paradigm without reason. The European powers, decimated by the two wars and the intervening global depression, found the balance of power shifted. The end of the wars left a power vacuum that the traditional powers could not fill. An unparalleled military and economic build out marked the rise of the US during the wars, and its still intact infrastructure allowed the US to develop economically without a significant capitalist challenger. The US assisted in rebuilding Europe, and began constructing military bases around the world. US business interests expanded dramatically, and the US became the dominant world power in the wake of the European wars.

The end of the wars left a power vacuum that the traditional powers could not fill.

Britain to the US is exhibit A in this analysis. However, there are glaring differences between this, and the anticipated US-China transfer of power. Historians and political scientists point to the tendency of waning empires to expire in a last gasp of war. A superpower tends to view economic deterioration as a threat to its superior position in world affairs and to react violently. Wars are the traditional arbiters of power shifts, and history tends to be an honest soothsayer. War and economics are inextricably tied to one another. Historically, the blueprint for a power shift seems to be a relative economic decline, followed by increased political tensions, and finally military conf lict. Economically, the modern parallels to the German-British scenario are weak. The Germans had surpassed the Brits in terms of economic output and had developed strong domestic industries in some of the leading technologies of the day. China, to be generous,

The world is not on the cusp of seeing China as its largest economy, and the US is likely to maintain its top position well into this century.
has a Gross Domestic Product hovering around half that of the US. The world is not on the cusp of seeing China as its largest economy, and the US is likely to maintain its top position well into this century. If the US-China relationship is to follow the traditional route, there is time to understand its dynamics. China does not have a straight line to parity with the elite economies of the West. The development of modern economies generally follows a path from agricultural and mining, to manufacturing and general industry, to services and information. In order for China to become a legitimate economic contender, it must make the leap from manufacturing to a service and knowledge based economy. The sheer size of its population is a hindrance to this shift. An economy based on delivering services (indicative of an economy spurred on by domestic consumption) cannot develop without a welleducated society. However, educating the masses is a daunting task for a country of a billion plus

people. A significant portion of Chinese still live a subsistence farming lifestyle. They lack the scale and technology of US and European agriculture. Possibly the greatest advantage the US economy enjoys is the US Dollar. The Dollar is the reserve currency of the world, and its benefits to the US are almost beyond measure. Global financial transactions of all types, from oil to gold, are settled in Greenbacks. In the end, China has multiple hurdles to overcome before it qualifies as a hegemonic, or even super-regional, economic power. The US, in the near-term, will continue to be the dominant economic force. Aside from the Chinese economic uncertainties, there remains the question of the ultimate ending of the US reign. War, and in some cases war debt have often heralded the final moments of a dying power. But modern history tells us a story that does not synchronize with a simplistic view of war to failure. The US-China relationship is not analogous to the situation in Europe that sparked the world wars. The European powers were contiguous, and had a history of contemptuous relations. The US and China do not have such a history, and the distance between the two nations mitigates the likelihood of any conf lict. There is something far more intriguing about the lessons from recent history. When the US took the mantle of world power from Britain, it was not the result of a war for superpower status. Instead, the US avoided the brunt of the conf lict, and retooled its war-based industrial infrastructure to produce goods for American (and world) consumption. It was domestically untouched, while the old powers found their cities and industrial capabilities crippled. A war between the US and China would have the much same outcome. Modern warfare is devastating. There is no reason to think a military conf lict between the US and China would be inconsequential to the viability of both economies. Instead, a modern war, years down the road, would create yet another power vacuum. A passing of the torch from the US to China is not going to happen in the near-term. A reading of modern history tells us that superpower status changes hands only when there is an equivalent economic or military foe. The US is still a much larger and more mature service based economy. As the world hurtles towards the middle of the 21st century, there are hosts of economic issues for China to contend with in its charge to become a first world economic force. China will remain, at least for now, a peaceful, regional power. The

inauguration of China as heir apparent is a dramatic and popular topic. But, it misses the essential point that China is not there yet. These are the years before Chinas rise.
SAMUEl RInES is an a nalyst and Economist at chilton capital m anagEmEnt in houston, tExas. dirEct quEstions or commEnts to: srinEs @chiltoncapital .com ZACH BECk is thE E ditor of chilton currEnts and an opErations spEcialist at chilton capital m anagEmEnt in houston, tExas. for furthEr information on chilton capital m anagEmEnt stratEgiEs and sErvicEs, plEasE contact christophEr l. K napp, cKnapp@chiltoncapital .com for rEprints contact srinEs@chiltoncapital .com www.chiltoncapital .com/currEnts