Davis Political Review

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China: Economic Crises, Currency Conundrum

By Aidan Coyne Source: Forbes

The most impressive economic feat of the last four decades has without a doubt been China’s rise from backward agricultural obscurity into the world’s greatest manufacturing nation. In 2008, when the figurative wheels fell off the global economy and countries ranging from Mexico to Greece to Russia were all clobbered by the recession, China barely broke its stride and maintained high levels of growth. Despite autocratic rule, environmental concerns and continuing “brain drain” of intellectual talent to Western nations, the miraculous and transformative performance of China’s economy seemed set to continue until China finally and indisputably claimed sole title of Earth’s market superpower.

That story began to unravel somewhat in 2015. The Chinese government released economic number showing GDP grew only at 6.9 percent, a twenty-five-year low after many years of double digit growth. Worse still, given the fact that China is helmed by an authoritarian and ostensibly Communist regime, many market analysts suspected the numbers may be even lower than what the government claimed. These economists claimed manufacturing and export data available through international agencies showed a truer, bleaker portrait of the Chinese economy. Other troubling signs emerged; the Shanghai stock exchange crashed sharply after a swift preceding rise, and Singapore stock exchange also began to sag heavily, with China blamed as the culprit given their close trade relationship.

After years of success, what could be causing this downturn? Chinese bureaucrats were charged with the difficult task of transforming the country’s economic sector from an export base, where China achieved supremacy via its low labor costs that enticed transnational corporations, into a consumer based economy, where growth is instead stimulated by the growing middle class consuming its own nation’s goods. The question was to what degree of dexterity would the Communist party handle the transition: gently (the so-called gentle landing) or roughly (the rough landing). Although China has been working hard to convince investors worldwide otherwise, evidence is piling up on the rough landing side. Labor strikes have been breaking out throughout different areas of China, rumors of “ghost cities” ,where uninhabited sky-rises have been constructed, and China has sought to distract its citizens by aggressively posturing in the South China Sea and intensifying the personality cult around current China president Xi Jinping.

The fact that China may or may not be heading into a recession is a big deal for the world in the short run, but may not be a big deal for China in the long run. One naturally intuitive idea to boost its economic performance would be China to lower the value of its currency, which is currently pegged to the dollar at an artificially high level. China, however, is convinced that doing so would set back its transition phase and might cause social unrest which would be inconvenient for the ruling regime. So instead China is gambling that it can keep its currency, the yuan, at its high, dollar pegged level by spending hundreds of billions of yuan in its 4 trillion vault of reserves. China is forced to this because billions of yuan are leaving the country as investors, both foreign and domestic, perceive other countries as safer options to place their money. China is hoping to be able to continue to spend its reserve currency for as long as it has to reassure the investing community and ride out the current storm. If it succeeds, it will be better placed to continue its project of transforming the nature of the economy. If it fails, it may be facing a bigger crisis than ever and with less financial tools to stave off the potentially devastating effects of a recession.

What is risky for China may prove beneficial for the rest of the world, at least temporarily. Global spending levels remain lethargic at best, as consumers in the United States and elsewhere have spent a greater proportion of the earnings on paying down debts, having been burned by the effects of the 2008 recession. Europe remains mired in the economic doldrums, with several countries unable to escape from the deflationary outcomes inspired by the debt crises caused by the banking failures. A downturn in Chinese spending, either now in the form of yuan devaluation or later in the form of full blown recession, would prove to be yet another speed bump for the world economy. Financial markets in particular, such as the New York Stock Exchange, would be most adversely affected as the world’s uber-rich see yet another market fail as a location to safely store their capital.

In 2016, world markets are closely integrated and the world can scarcely afford another global recession. History shows that in times of downturn, war, bigotry and upheaval reign; the economy of the Weimar Republic may well have led to bloody battlefields of the Third Reich. But if history has shown us precious little else, it is that those who confidently predict the future are often shown to be wrong. So, to find out how the Chinese economy will unfold in 2016 and beyond, there is no other option but to sit back and enjoy the show.