The pace of economic change in China has been exceptionally rapid since the start of its economic reform in 1978 under the influence of Deng Xiaoping. Since then its Gross Domestic Product (GDP) has grown at an unprecedented 9.5 percent a year, making China’s the longest and most sustained growth experienced by any country within modern history. Such growth has been a result of various aspects, including a profound change within China’s economic policies, reform of the state-owned sector, and rapid growth of physical and human capitol. China also has the advantage of a good infrastructure, an educated workforce, and most importantly an extremely open economy. However, as the country’s economy rushes forward, so does the pile of social and economic contradictions threatening the future growth of China. To begin, China lacks a stable macroeconomic environment necessary for a strong medium-term growth, resultant of China’s fixed foreign exchange rate. China also runs the risk of political and social instability caused by the widening of geographic income inequalities. Environmentally speaking, the country is also the world’s largest consumer of raw materials and leads the way in emissions of carbon dioxide. This paper will address these issues with respect to their causes, the impact they have on China (and where applicable globally), as well as discussing the issues involved within resolving them. China’s Exchange Rate Regime
China, as have other Asian countries, has long managed its exchange rate by intervening in foreign exchange markets to limit appreciation of its currency in order to sustain a growth-oriented trade surplus. To put it more simply, China has undervalued its currency, and this is evident upon observing the recent large build up of foreign exchange reserves in China. From 1994, when China adopted a fixed exchange rate-pegging its currency to the American dollar, to 2001 China’s current account surplus totaled an average of only 1.8 percent of its GDP. This number rose to an average of 3.1 percent in 2002-03 and then to 4.2 percent in 2004. China has also had a capitol account surplus, one that averaged 1.3 percent of the GDP in 1999-2001, rising to 3.2 percent in 2002-03, and then to 6.7 percent in 2004. In order to keep its currency, the Yuan, pegged ay 8.29/dollar, while facing such significant surpluses on current and capitol accounts, China’s authorities have had to purchase large amounts of foreign exchange and reserves have risen respectively. In all, China’s foreign exchange reserves have risen to more than double since early 2002, reaching an outstanding $480 billion, most of which is in American government securities. Some economists argue that such management distorts trade and investment flows, that the refusal of China to allow its exchange to rise against the dollar hinders “the adjustment in global exchange needed to reduce America’s current-account deficit.” The same economist, also believe that in time, however, China will lose its “appetite” for the dollar. However, there are those who reject such views, and believe that China, as well as other Asian countries, will continue to finance America’s current account deficit for another decade, if not more. The present conditions of China remind such economist of the Bretton Woods system, which prevailed for some time after the Second World War. They base this argument on two principles: “First, it will allow foreign firms to invest in Chinese factories, using cheap labor to earn fat profits. Second, the Chinese government will invest a large chunk of its export earnings in Treasury bonds, helping to finance America’s current-account deficit.” Such a relationship, however, between China and America (and the world) is questionable and overall flawed. To begin, it is unlikely that keeping a cheap Yuan is part of China’s long-term strategy. Until recently, China’s trade-weighted exchange rate was being pulled up by the...
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