The Fastest Growing Economy in the World

By Michael Lombardi

Surprising analysts, who had expected China's economy to start slowing this year like the economies of other countries, China reported yesterday that its economy grew by 10.6% in the first quarter of 2008.

China's economy has now grown by more than 10% in each of nine consecutive quarters. Many economists predict that 2008 will be the year China surpasses Germany as the world's third largest economy... a big feat for a country whose output per citizen is a mere $2,500 per annum.

Economic growth in China continues to be unprecedented. The country just revised its 2007 GDP, saying that its economy expanded by 11.9% in 2007, which is higher than the 11.4% GDP growth previously announced. As for continued investment, factory and property spending in urban areas shot up 26% in the quarter ended March 31, 2008.

China's economic growth has been so strong that, again yesterday, the country's central bank increased the percentage of deposits that general banks and lenders must set aside as reserves to a new record 16%.

How does China's growth affect us investors here in North America?

To cool the economy in China, the government there will need to raise interest rates further, allowing the country's currency, the yuan, to increase in value against other world currencies -- the U.S. dollar, in particular.

A higher yuan will result in higher prices for Americans buying cheap imported Chinese goods. Will we really see a difference in the prices of electronics and other goods we import from China? Not really. Even as the yuan increases, technological advancements in Chinese factories will make any increase in the cost of imported goods to North American negligible.

The big problem that I see is the continued accumulation of U.S. dollars by China. Time goes by quickly and, not too far down the road, China will be sitting on $2.0 trillion in U.S. dollars. What will it do with that money? Will China at some point want something other than U.S. dollars for the goods its ships to the U.S.?

From an economist's point of view, too much supply and not enough demand brings prices down. And that is exactly what is happening with the U.S. dollar. The long-term trend of a falling U.S. dollar (not just in yuan, but in euros, pounds and gold) is far from over. From a consumer's point of view, a lower priced dollar will make travel outside the U.S. more expensive.

As investors, since 2003, I have been suggesting that there is an opportunity for us to buy shares of quality foreign companies in non-denominated U.S. dollars. That strategy has proved itself well and profitably. I also believe that it still to be a prudent strategy, especially for investors looking at quality foreign gold stocks.

Michael Lombardi, CFP, MBA
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