Finally Official: China Takes the #2 Spot

by Damien Ma

Japan has confirmed it. China indeed emerged from 2010 as the world's second largest economy after the United States, at $5.88 trillion to Japan's $5.47 trillion. (In case you're wondering, that's just above 1/3 of the U.S. economy.) Last time when China overtook Japan in a single quarter in 2010, I asked the question "so now what?" Judging by some of the latest reactions from a small sampling of Chinese, helpfully compiled by the WSJ, they seem to largely reflect my previous sentiment. Anything but celebratory, the new status seems to only highlight the deficiencies, large and small, that have accompanied that stellar GDP performance. 

This kind of self-deprecation is commonplace, and you hear Chinese officials often describe Chinese industry as "big but not strong," like a pliable giant that could stumble and easily hurt itself. And of course, the dearth of international Chinese brands has proven a huge conundrum for policymakers in China. At a hotpot dinner over the Chinese new year, I engaged with others in one of my favorite topics to explore: why China's cultural appeal (or "soft power") is not commensurate with its seeming economic heft. Since Japan is being used here for comparison, it seems to me that Japanese cultural products had much broader appeal and resonance globally at a similar stage of development. Not to mention the eventual "just-in-time" industrial model that found wide favor and spawned imitators. 

It's certainly not for the lack of talent and creative energy in China. Check out, for example, these guys rap battling in Beijing. It looks like a scene straight outta 8 Mile, except replace a pale Eminem with a frizzy-haired Xinjianger Ma Jun (he might even be Uighur -- marginalized minority, liberated in hip hop?) schooling the other guy on stage. 

2010 Iron Mic Freestyle Battle Finals - Yugong Yishan, Beijing, China - 2010/10/27 from Matthew Niederhauser on Vimeo.

Or what about this four-year old Chinese kid flooring an audience on the streets of LA with his Michael Jackson moves (the kid seriously breaks it down around the 2:15 mark).  

One reaction, given the current breathless commentary on "China does it best" might be "Oh no, the Chinese are outmaneuvering us in rap and street dancing! They're training an army of 4-year-olds to erode our comparative advantage in spontaneity and bottom-up creative output! What's next, stealing our Broadway jobs??!!" I think Gary Shteyngart captured this exaggerated view of Chinese omnipotence best in his recent "Super Sad True Love Story", in which the denizens of a spiritless New York live in mortal fear of the Chinese central banker arriving to take his country's money back (which Ben Bernanke apparently revealed to be an eye-popping $2 trillion). 

But in fact, these episodes demonstrate the acute resilience of American soft power and appeal. There's not much "indigenous innovation" in those videos, only talented co-optation of what was pioneered in the American urban cauldron. And those migrant worker DIY rockers I wrote about rode to fame on a cover rather than an original, and now seem to be facing copyright troubles. Nonetheless, these grassroots creative elements are highly encouraging. I hope sooner rather than later, China will be exporting products that are um ... more effective than that ad in Times Square during Hu Jintao's visit.  

Note: the rap battle video is from photographer Matthew Niederhauser, who has done some great work on documenting the underground music scene in China. He has more at his site. 

Damien Ma is a China analyst at Eurasia Group.

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Its quite a big deal for China to officially pass Japan as the world's second largest economy in GDP terms. However, while the US may be clearly in the cross-hairs of the rising Chinese economic juggernaut, it will be many generations before China supplants the US as the epicenter of popular culture.

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Fed's Kocherlakota: Markets misinterpreted FOMC’s decision

From Minneapolis Fed President Narayana Kocherlakota: Inside the FOMC

The FOMC’s decision has had a larger impact on financial markets than I would have anticipated. My own interpretation is that the FOMC action led investors to believe that the economic situation in the United States was worse than they, the investors, had imagined. In my view, this reaction is unwarranted. The FOMC’s decisions were largely predicated on publicly available data about real GDP, its various components, unemployment, and inflation. I would say that there is no new information about the current state of the economy to be learned from the FOMC’s actions or its statement.

Kocherlakota points out that the Fed's balance sheet was falling quicker than anticipated because of the high level of refinancing as mortgage rates have declined.

But Kocherlakota fails to note that the mortgage rates have declined because of the weaker economy - and the Fed appears to be behind the curve in adjusting their views lower.

Kocherlakota is forecasting that real GDP growth in the 2nd half of 2010 will be about the same as in the first half:

Based on estimates from our Minneapolis forecasting model, I expect GDP growth to be around 2.5 percent in the second half of 2010 and close to 3.0 percent in 2011. There is a recovery under way in the United States, and I expect it to continue.

Although Kocherlakota forecast is possible - and is a weak recovery - I think the economy will slow in the 2nd half.

And I think the growing view isn't that the economy is worse than investors had imagined, but that the Fed is once again behind the curve on the economic outlook.

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Has the market been overreacting to the FOMC's most recent announcement that it will be freezing its balance sheet at current $2.5T by using returns from mortgage-backed securities bought following the collapse of Bear, Lehman and AIG to buy 5- and 10-year treasuries, maintaining its loosy-goosy monetary policy?

Dubbed QE2-lite the FOMC announcement outlined a hybrid of the more radical and oft predicted 'QE2' expansion of the Fed balance sheet, which presumably would have grown to $5T, all in an effort to fight off deflation and unfreeze long-suffering credit markets in the western world. If this sounds like its a 'last-resort' strategy, that's because it is precisely that.

I believe the markets are beginning to prove that the LARGE fundamental underlying problems suffering the international economic and political systems are no longer distant matters for another generation, they are immediate mortal threats to mankind and we are stuck with the current crop of partisan-obsessed talking heads who we all know are bound to fail us terribly whether tomorrow or a year from now..

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