The Perils Of Prediction: China is smaller

According to new World Bank figures, China’s GDP is overestimated by 40 percent. China is a much smaller economic power than once believed. It’s not nearly as big, not nearly as important, not nearly as imposing. The World Bank had previously calculated China's output was worth $8.8 billion in 2005 at purchasing power parity. China's economic output in 2007 was worth $2.24 trillion at market exchange rates. smaller than TEXAS!

Theme #1 "The 21st Century Belongs To China"

Reality Check: Well, if the 21st century will belong to China, it'll take a lot longer than we thought. As of two weeks ago, China's economy is a whopping 40% (!) smaller than the World Bank had originally thought. And as the air is being let out of the Shanghai stock bubble, it’s becoming apparent that a huge percentage of Chinese companies' profits are from -- you guessed it -- investments in other Chinese bubble stocks. That still says nothing of the bad loans on the books of Chinese banks that make the U.S subprime loan problem look like a rounding error. Two years ago, Price Waterhouse estimated China's bad debts at just about $1 trillion -- before the Chinese government forced it publicly to recant its estimate.

Contrarian Prediction: China is the next Soviet Union

From the 1930s through the top of the 1950s, the Soviet Union was growing so fast that if economic trends were projected forward, Soviet GNP would pass that of the United States in 1984 -- a year with ominous literary overtones. Sound familiar? With China's economy smaller in real terms than California and Texas combined, you don't need to brush up on your Mandarin just yet.

Theme #2 "The U.S. economy and the U.S. dollar are yesterday's news."

Reality Check: In what is a classic case of psychological projection -- seeing your own weaknesses in others -- the most strident calls for U.S. decline come from Europe. Yes, the dollar has fallen by more than 40% against the euro -- to just about where it was in 1995 against the euro's predecessor, the German Deutschmark. And what about subprime woes? Relative to the size of the U.S. housing market and to the overall economy, the problem still is much smaller as a percentage of GDP than the S&L crisis (remember that?) was in the 1980s. Also, before you spend too much money upgrading your bunker, recall that the U.S. economy expanded at a 4.9% rate in the third quarter and productivity expanded by the same amount -- reaching the highest level in four years. The federal budget deficit, as a percentage of GDP, is down to 1.2%. And the United States also just regained its crown as the most competitive economy on the planet.

Contrarian Prediction: The 21st century will belong to the United States. Given the extraordinary negative sentiment against the United States and the U.S. dollar, the U.S. economy and stock market are probably due to begin a long period of outperformance, led by a rising dollar and a sharp rally in financials. The United States may continue to deteriorate in the housing sector, but the dollar will recover once investors realize that subprime woes notwithstanding -- prospects for the U.S. economy are (yet again, distressingly) very good.

Theme #3 "Global markets and commodities are the top investment opportunities as far as the eye can see."

Reality Check: This is the toughest one for me, since I really believe this one. But here's some self-inflicted tough love. Commodities are trading at all-time highs and emerging markets now are considered safe havens. In that way, both asset classes are much like technology was seven years ago. Because countries like China use six times as many inputs to produce the same unit of economic output, once developing economies slow down, the air will be let out of the commodity bubble with alarming rapidity. And for all their terrific prospects, emerging markets are a series of booms and busts. The development of the world's most successful emerging market -- the United States -- was no different. As John Paul Smith put it in yesterday's Financial Times: "Even if the secular story is valid, if the price is wrong, stay clear."

Contrary Prediction: The rise of emerging markets seems as set in stone as technology was in the 1990s. But just as Cisco was briefly the world's most valuable company in 2000, it's unlikely that we'll be seeing another Chinese company hitting the $1 trillion mark -- as PetroChina did in November -- anytime soon. And there are just too many books out there on how economies that are the size of U.S. states are set to dominate the global economy by 2050. That alone is enough to make me nervous.