The Importance of China

So, the global economy is falling apart, but not in the way people expected. Under the de facto arrangement sometimes known as “Bretton Woods II,” emerging market countries pegged (officially or unofficially) their currencies to developed world currencies at artificially low rates, having the effect of promoting exports and discouraging consumption by emerging market countries and promoting consumption and discouraging exports in developed countries. Of course, the classic example of this was China and the U.S. The U.S. trade deficit and Chinese trade surplus created a surplus of dollars in China, which were invested in U.S. Treasuries and agency bonds, keeping interest rates low and indirectly financing the U.S. housing bubble and consumption binge of the last decade (and, therefore, growth in Chinese exports).

The general fear was that U.S. indebtedness would lead China to diversify away from U.S. assets, causing the dollar to fall and U.S. interest rates to rise, hurting the U.S. economy and making it harder to finance the national debt. This may yet happen someday. But instead of demand for Treasuries collapsing, it’s been demand for every other type of asset that has fallen. Treasury yields have collapsed and the dollar has appreciated about 20%. Still, despite this increased purchasing power, the fall in U.S. (and global) consumption is having a severe impact on growth of the Chinese economy. Even though the Chinese government has signaled that it will do everything in its power to keep growth above 8% per year (down from 11-12% in the past few years), the slowdown has severely constrained the ability of the urban manufacturing sector to absorb internal migration from the countryside, and there are signs of a reverse migration that is aggravating the problem of rural poverty in China. Although China may seem to have all the cards – high economic growth, large foreign currency reserves – it could yet turn out to be a major loser of the global economic crisis.

This is of course just a brief introduction. For more I recommend Brad Setser, among others: some of his posts are here, here, and here.

4 responses to “The Importance of China

  1. Advocatus Diaboli

    The (mainly) untold importance of China is geo-strategic, with economic undertones. For many years now China has had a growing presence in Africa. It has stepped up its activity there to gain greater access to oil, minerals and also trade. Some African countries that feel they have fallen out with Western powers have really warmed to this notion.
    In the meantime, the US and the EU are actually decreasing their presence and investments in the region. This is surprising given that the African continent offers enormous growth opportunities and in the future, (Southern) Africa will become a new manufacturing hub. Countries like South Africa can easily compete with Asian tigers, which are becoming increasingly expensive as manufacturing bases.
    The point is China seems to be the only large nation that has realized this. Its government is also providing funding to Chinese entrepreneurs to set-up shop in Africa. In the meantime, the West watches itself in the mirror…

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