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Tom Holland

According to the internet, the world is going to end in 2012. 
Apparently this date with destiny is foretold by something called the Mayan long count calendar. 
The Maya, in case you missed them, dominated central America between 1,000 and 2,000 years ago. Quite how advanced their civilisation was is debatable. The Maya never invented the wheel. They did, however, develop an extended calendar, and that calendar comes to a full stop on December 21, 2012 - the end of days.
If the world does end in 2012, it will be a shame for China. That's because 2012, according to a forecast published this week, will be the year in which China overtakes the United States to become the world's biggest economy.
Blimey! It doesn't seem long ago that Goldman Sachs stirred things up by predicting that China would overhaul the US soon after 2040. Then PricewaterhouseCoopers published a report arguing China could take the lead as early as 2025.
Now the Conference Board, a US-based research association, is forecasting that China could leapfrog the US economy as soon as 2012. That should be good news for China (provided the world doesn't end first, of course). Unfortunately, however, there are some problems with the forecast.
The Conference Board didn't make its prediction based on expected economic outputs compared at common or garden market exchange rates, the sort of comparison we are all used to. Instead it compared forecasts for the gross domestic products of China and the US adjusted for differences in the purchasing power of their two currencies.
Lots of analysts perform this sort of trickery. They argue that similar non-traded services - haircuts, say - have much the same value in different countries, but that market exchange rates distort the true purchasing power of currencies. As a result they apply an adjustment to bring the currencies to purchasing power parity, or PPP.
For example, the current market exchange rate for the Chinese currency is 6.63 yuan, while the purchasing power parity rate is reckoned to be around 3.85 to the US dollar; 72 per cent stronger than the market rate.
If you apply this adjustment, the Chinese economy does indeed look as if it will soon overtake the US. The first chart below is based on International Monetary Fund forecasts, and shows that China is poised to pass the US - if not as soon as 2012, then very likely by 2016. 
But there are big problems with using the PPP adjustment to compare the size of different economies. For one thing the price data on which the PPP calculation is based are notoriously dodgy. When the World Bank last updated its data for China based on a 2005 survey, it came to the conclusion the Chinese economy was 40 per cent smaller than it had thought. That survey is now five years old, so the margin for error in today's assumptions could be almost as large.
But that's a relatively small quibble. The big problem is that the whole idea of using purchasing power parity to compare the economic output of different countries is deeply flawed.
That's because the assumption that a haircut is worth much the same in Chengdu as in Chicago doesn't hold water. The higher price of the Chicago cut factors in a whole range of economic differences, including higher minimum wages, stricter health and safety standards, tighter environmental controls, higher energy and insurance costs, more advanced infrastructure and better public education. In other words, a haircut is more expensive in Chicago than in Chengdu because the US is a more developed economy than China. Pretending it isn't for the sake of a comparison makes no sense.
That doesn't mean market exchange rates are perfect. They aren't. But given that they are the rates at which goods and services are traded, they are the best we have.
And as the second chart shows, if you use market exchange rates you get a very different picture of the relative size of the US and Chinese economies. China is still gaining on the US quickly, but it is coming from much further behind.
Even if you assume anaemic growth in the US, project forward China's strong trend growth rate and factor in an annual 5 per cent appreciation of the yuan, China will be hard put to catch up with the US much before the end of this decade.
So it's probably a good thing for China that the world won't end in 2012, because the Conference Board forecast is just as silly as the internet prophecies of doom.



Another ridiculous prediction for 2012