<B />John Mauldin<br /></b>Investment Advisor<br /> Millennium Wave<br /> Advisors LLC <br /> Arlington, Tex.<br /><a href=http://www.johnmauldin.com target=_new>johnmauldin.com</a>

John Mauldin
Investment Advisor
Millennium Wave
Advisors LLC
Arlington, Tex.
johnmauldin.com


In 2003 it consumed one-half of the world's cement, a third of the steel, a quarter of the copper, and one-fifth of the aluminum. Automobile sales in the country doubled that year and grew dramatically the next. China has gone from being an exporter of oil to a voracious consumer. Its energy needs will triple over the next few decades, and it is moving rapidly toward the use of nuclear power. China's Gross Domestic Product this year will top that of the U.K., and is expected to surpass Germany's by 2010 and Japan's by 2015, and equal the U.S. GDP by around 2040. Some economists predict China's burgeoning middle class will reach 250 million this year and possibly 350 million by 2009, making the Chinese consumer market larger than the population of the United States.

Impressive as all of this sounds it must be put into context. Today, the U.S. GDP per capita is roughly $40,000; China's is just $1,213. About 35 years from now China's GDP per capita will still trail that of the U.S. by 60%. In China, an annual income of about $3,000 is considered adequate to purchase a car, so the definition of "middle class" is relative.

Much of the current boom can be attributed to construction and foreign investment taking advantage of low labor rates, an edge China should enjoy for many years to come, but eventually will fade. For now, China's workforce is in high gear.

Some 20 million people each year migrate from China's farms to coastal regions in search of higherpaying jobs, and most have found them. Still-low labor rates have attracted large numbers of manufacturers from around the world. That presents both opportunity and danger.

Workers now expect economic and job growth, though a "normal" 3 to 4% growth rate would not create enough new jobs to maintain the momentum; higher rates could bring inflation and a bust. China's government has been able to hold annual economic growth to only 9%, but worries remain that such actions will result in a recession.

Further, while the banks of China are improving, they are far from strong. Over 13% of loans are nonperforming and some observers believe the real number may be double that. Deserving entrepreneurs have difficulty raising private capital. And many analysts believe that the Renminbi (RMB) is undervalued by 20 to 30%, giving China an unfair trade advantage.

Financial concerns aside, China has begun to embrace frontline technology and reap its benefits. China now makes computer chips, carbon nanotube threads, and is pioneering safer nuclear power technology. Last year Wired magazine named China "the first cloning superpower." It just put a man in space, is using bioengineered crops, and has made advances in stem-cell research.

Still, China's R&D expenditures just a few years ago were 1.1% of GDP, or about $12.5 billion. The U.S. spent 2.8% of its GDP or $281 billion, much of it private money. Moreover, the U.S. spends 200 times as much on biotech research than China. Most of China's R&D is fairly basic and directed at more immediate needs. In contrast, most U.S. R&D is devoted to pure sciences, which often lay the foundation for major future advances.

Ultimately, its bid to become an economic superpower will depend more on basic research than on the ability to engineer me-too or me-slightly-better products. For all its progress, China is still at least a decade — possibly much more — from seriously competing with the U.S., Europe, and Japan on a scientific basis, that despite the fact China graduates 250,000 engineers and scientists annually compared with 50,000 in the U.S.

That is not to say China will not become an economic powerhouse by the middle of this century. It will, but not at the expense of the U.S. or Europe. European and U.S. social services which cannot be funded without huge tax increases or cuts in benefits, will do more to harm the ability of their future generations to thrive than any possible "threat" from a thriving China and Asia.

In the 1970's there were concerns that lower labor costs in Japan would sink U.S. manufacturing, which, of course, turned out to be false. Japan now complains about cheap labor in China, though it continues to build plants there. In 20 to 30 years China may be lamenting how cheap labor in the Islamic democratic republics is taking away its manufacturing base and jobs.