Two years ago at a tutoring session for ECO200 we were learning the basics of macroeconomics just as the world economy was falling apart. At the end of the class the tutor remarked, “What you are seeing now, as the U.S. falls, is the rise of China.”
Early this month, China overtook Germany to become the world’s largest exporter of manufactured goods, and is predicted to soon overtake Japan for the world’s second largest economy. Only three years ago China was in fifth place, and a recession that stopped the rest of the world seems to have done nothing to slow its growth. While some economists and critics fear the negative impacts of this growth, others worry China may drive itself into its own recession.
To try and even begin to explain what is going on and why, we need to understand currency and foreign exchange. We can’t talk exports, especially not Chinese exports, without understanding exchange rates.
A country’s economy can have either a flexible or pegged currency. Flexible currencies, like the Canadian and American dollars, fluctuate with money markets. They respond to supply and demand. When people buy up lots of Canadian dollars, because they want to hold their money in that currency, the Canadian dollar rises. Likewise when they sell off those dollars, the dollar falls.
Economies with flexible currencies use monetary policy to stimulate or cool down markets. A pegged currency, on the other hand, does not change, and forgoes the advantage of monetary policy. This is therefore possible only in a country where the government has total control over foreign exchange, so that it can peg its currency to that of another country. So if the Chinese Yuan is set to $0.15 US, then the Chinese government will buy and sell however much American currency is needed to keep their currency low in comparison.
Why does China do this? Having a low exchange rate is very good for exporting. If your money is worth less, then other countries have a far greater incentive to buy things from you because their dollar goes further. There’s also an incentive to run factories in your country. Ultimately, other countries will spend far more money on you.
In December, China’s exports jumped to a whopping $130.7 billion US—a 17.7 per cent increase—for a total of $1.2 trillion, compared to Germany’s $1.17 trillion. This is not news in itself. It has long been predicted that Germany would lose its title as largest exporter in the face of China’s steadily growing exporting prowess. What is news is that China is growing in spite of the recession, and that the Chinese economy has proven resilient while others, such as the United States and Dubai, stand stagnant or worse.
China is in the midst of a boom while most of the world is in a bust. Aside from engaging in a serious stimulus program, the government used the state-run media to foster optimism. According to The New York Times, China’s media has essentially reported that “the Great Recession has laid bare cracks in plodding Western-style capitalism,” and that China’s recovery is a reflection of superior leadership.
What’s wrong with this picture? Well, word on the street is that this growth is in no way sustainable. Unsustainable growth leads to economic bubbles.
China has been flooding its markets with cash, and critics openly fear a housing bubble as property values steadily climb. Others fear that China has made bad lending and spending decisions that will pull the economy down in years to come. But more importantly, as China strengthens its economy, there is heavy pressure on the value of the Yuan to rise and the U.S. dollar to fall. This is only natural, given that one would want to hold onto the currency of a country which was economically strong, but it also undoes the policy that is extremely favourable to an exporting economy. Often accused of artificially devaluing its currency, China’s trade partners (especially the U.S.) are angry over the practise of keeping the Yuan low. China used to be able to excuse this practise by claiming it was a developing nation trying to compete with the west, but that simply is no longer the case.
Even the Chinese government fears the effects of unbridled growth. Two weeks ago, China ordered banks to raise both interest and reserve rates, fearing U.S.-style housing bubbles. Additionally, China ordered banks to lend less and pulled back on the stimulus in spite of U.S. requests not to. Economists feel China did the right thing. In an economy where the foreign value of currency is pegged, there is no option to deal with inflation, because of the basic nature of money markets. Inflation could be hugely problematic, as China has made no indication that it will change its currency policies any time soon.
The Chinese government has reassured the public that stimulus spending will continue. I suspect the Chinese economy is growing so rapidly, it will simply steamroll over the possible threats it faces. As an American, this stage in Chinese growth is both fascinating and a little scary. I sure hope my tutor wasn’t right when he told me this was the start of the fall for the American economy.
