A long-term perspective indicates that China's economy is evolving from an emerging market into a significant, developed market economy in a manner that might resemble the paths taken by its regional neighbors, South Korea and Japan. With those two countries as a model, we believe that investors should be able to take advantage of long-term opportunities as China likely evolves beyond its “state capitalist" economic system.

According to the World Bank, China's GDP growth rates have averaged 7.32% over the last five years — and each year has been lower than the last. While China's growth is trailing off, we should not let short-term challenges obscure long-term potential.

1

China is Transitioning to the "Age of High Mass Consumption"

We believe that China's economy is beginning the transition from a maturing economy focused on consumer durables and domestic consumption, as well as large-scale investments in infrastructure, to one that is marked by high mass consumption and greater allocations to security and social welfare.

2

Declining Growth May Point Toward a Higher Standard of Living

According to Zheng Liu, Senior Research Advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco, declining growth rates in South Korea and Japan coincided with higher GDP per capita. We can identify a similar trajectory in the Chinese economy if we set our starting point in the 1980s.

3

Lower Growth in China May Have a Positive Effect on the Global Economy

Sustained growth rates above China's current rate of 6.9% can crowd out resources and capital from the rest of the world over time. Global imbalances due to high prices on scarce commodities are likely to be disruptive to rich and poor nations alike.

“Maintaining a long-term perspective will allow investors to stand firm and more readily spot and take advantage of the opportunities that are likely to emerge from the growth drivers of China's evolving economy.”

In the 1960s, Japan's per capital real GDP was about $6,000, with an average growth rate of 10%. In the decades since, growth has fallen to just 1.25%, while GDP per capital has soared to over $30,000. South Korea tells a similar story. During the 1970s, the country experienced average growth surpassing 12%, with GDP per capita well below $5,000. As growth fell to 3%, GDP per capita rose to approximately $30,000.

A Need for Patience
Further Integration With the Global Economy is Necessary

In order to facilitate its evolution to a fully developed economy that is capable of meeting the needs of its increasingly affluent populace, China will need to overcome the spending challenges it is currently facing by tapping into the capital of global investors who are eager to get access to Chinese equities.

To Truly Evolve, China Will Need to Allow Its Currency to Float Freely

Currently, the price of the renminbi (yuan) is allowed to shift no more than 2% from the price that is fixed by the Chinese central bank on a daily basis. However, there are indications that Chinese policymakers could allow the renminbi to float in the near future, letting markets determine the appropriate exchange rate.

Keep an Eye on the Next National Congress

In the fall of 2017, the Communist Party of China will hold its 19th National Congress. How President Xi Jinping addresses efforts to shift away from state capitalism and toward a more market-based economy will be of particular interest to investors curious about the prospect of China's economic future.

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