China Rising

Over the past 20 years, China’s economy has grown by nearly 10 per cent a year, lifting some 377 million people out of poverty. Even the rampant fraud that exists in the Chinese banking system can’t slow economic growth. U.S. manufacturers, farmers and service providers have seen exports to China grow an average of 22 per cent a year since China joined the WTO in December 2001. The rise of protectionism in America has triggered a rise in economic nationalism in China that could undercut the mainland’s promises to the WTO. China can and will backtrack on free market reforms if America fails to change its tune.

China’s economy hit an 11-year high in July 2007. It grew by 11.9 percent in the second quarter. It produced an output of $2.9 trillion in 2006. China’s economy could surpass Germany’s by the end of 2007, leapfrogging ahead of the 2010 date most economists predicted, exceed Japan’s by 2020 and become the world’s leading economy by 2040. China’s overall economy is larger and healthier than that of five G-8 members – and its people richer – than current government figures show.

By another measure, known as purchasing-power parity, China is already the world’s second-biggest economy. If exchange rates are adjusted to equalize the cost of goods in different countries, then the value of China’s total output was $10 trillion in 2006, according to estimates by the IMF. That eclipses Japan’s $4.2 trillion and Germany’s $2.6 trillion, and hot on the heels of America’s $13 trillion.

It is not just the Chinese government that has trillions of dollars in reserves. So does the consuming public – who are savers. In fact, China’s bank depositors are stuffing more money into banks than they can possibly lend or invest, endangering bank profitability and operations in general. The People’s Bank of China, the country’s central bank, has more than $3.5-trillion in savings accounts.

It is a bankers nightmare because the bank must pay interest to depositors while unable to put the cash to work to generate income for the bank. Gross national saving in China amounts to more than 40 percent of gross domestic product, suggesting that Chinese households are much more frugal than their U.S. counterparts, who are swamped by debt after chasing the American dream and designer lifestyle. Eight out of 10 mainlanders are satisfied with the way things are going in China, the 2006 Pew Global Attitudes Project concluded. The 81 percent satisfaction rate is an increase from the 72 percent recorded in 2005 ─ the opposite of dissatisfied Americans.

America is characterized by the opposite imbalance: an excess of gross domestic investment over domestic savings. If, and when, these basically symbiotic imbalances becomes unsustainable, tinkering with the yuan/dollar exchange rate will have little impact. Quite different policy changes have to be made by career politicians in Washington, D.C. to boost U.S. savings rate, while lowering China’s. To do so without triggering a recession in America and inflation in China is the challenge.

The Rise of Yuan

The U.S. dollar hit a 15-year low against a basket of currencies in August 2007. It is only a matter of time before the yuan will overtake the U.S. dollar as the most accepted currency among the world’s central banks. The People’s Bank of China has accumulated over $1 trillion of reserves. Since it has no domestic use for them, it turns around and lends them back to the U.S. and they find their way back into the housing loan market. This means that both Treasury borrowing costs and mortgage interest rates are lower than they otherwise would be. American homeowners and taxpayers are the beneficiaries. If China did comply with U.S. pressure to revalue its currency, American consumers would face a fiscal apocalypse.

China let its currency rise very quickly and quietly ─ it even broke through 7.9 to the dollar for the first time in September 2006. It appreciated at a daily rate of 0.8 percent, which works out to an annualized rate of 10 percent. That was quite a contrast to the annual pace of 2 percent to 2.5 percent during most months after China’s 2.1 percent revaluation on July 21, 2005. The acceleration came at a time when the Chinese economy settled down to sustained but controlled growth, which made Chinese officials more willing to experiment with the value of the yuan. Some China watchers gave the credit to the quieter U.S. policy advocated by Treasury Secretary Henry Paulson Jr., who with decades of China experience, pursued a much more low-key approach to the currency issue.

The fact is that at the dawn of the 21st century, the Chinese yuan is now an internationally recognized currency that is giving the dollar a run for its value. The dollar slid to a 12-year low against a basket of currencies, and a 26-year low against the British pound in July 2007. The yuan is quietly becoming a universal currency at the expense of the dollar. It delivers everyday economic values without devaluation. There is enough of the currency to finance capital anywhere and anytime – and it does.

There is even talk that the yuan may be the next reserve currency. The U.S. dollar has had a relatively short run so far as the global reserve currency. It assumed the position after World War II and the establishment of the Bretton Woods system of global monetary stability. Back then, the dollar was pegged to gold ─ at $435 an ounce ─ and was established as the fallback monetary unit that underpinned the postwar era of economic growth around the world until the Iraq war fiasco.

China, the world’s third-largest gold producer, is likely to surpass the U.S. to become the second-largest producer of the precious metal. It will produce 260 tons in 2007.

All China has to do today is pass laws that all its exports be purchased in yuan instead of dollars. The currency would then begin a serious push for reserve status. China can bring down the U.S. greenback With $1.33 trillion currency reserves it holds the ultimate bargaining chip.