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The New Economy

China money move: Beijing addresses a glaring weakness

China money: The yuan will now be worth more against the dollar, boosting Chinese consumers' buying power.

By Scott BoydContributor / June 21, 2010

A Chinese clerk counts US dollars in exchange for China money, the renminbi, at a bank in Hefei in central China June 20. By allowing Chinese currency to appreciate, Beijing is strengthening the buying power of its consumers, who have been a long-term weak spot in the nation's economy.

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China's currency made it first gains against the dollar Monday because, for the first time in nearly two years, it will no longer be pegged to the greenback.

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The appreciation in the Chinese yuan drew cautious optimism from US officials and cheered American manufacturers, who now will be more price-competitive with Chinese factories.

Less visible but equally important, the currency move addresses a glaring long-term weakness in China.

For years, critics of the Chinese economy have pointed out that it is too dependent on exports and government infrastructure spending. The lack of a strong consumer base was China’s Achilles’ heel, they said. By letting the yuan strengthen and, thus, putting more value in the hands of Chinese consumers, the government is beginning to develop that base, which will help stabilize China and insulate it from the ups and downs of international trade.

This shift is a long-term process, however. The recent global recession illustrates how vulnerable China’s economy continues to be. As foreign orders for China’s products evaporated, and lacking a strong domestic market to take up any of the slack, China’s factories were forced to reduce staff levels and cut production.

How did China’s leaders react? Why, in the same manner as other governments around the world – they threw money at the problem. Initially, China committed to spend $586 billion by the end of 2010 to keep the economy moving. However, when accounting for the total amounts injected into the economy through direct infrastructure spending, as well as liquidity made available to the banking system, the actual amount has almost doubled.

Not only did China pour in more government money than America’s $787 billion stimulus package, it invested it in an economy that is less than two-fifths the size of the US economy.

Of course, it’s hard to argue against success, and the latest growth figures from China indicate that the economy continued to expand in April at an annualized rate exceeding 12 percent. Property values also increased again in April – this time by a record 12.8 percent compared to April 2009. This reality has forced the government to admit that speculation is verging on the hysterical.

Recognizing the potential for disaster should the property bubble burst, Chinese authorities have implemented several changes in an attempt to cool the market.

But China’s critics are not asking if China’s market is hot. They wonder why it’s hot?

In other words, how much of China’s reported growth is “real”, and how much can be traced to government spending? If government largesse is indeed responsible for most of China’s growth, then the prospects of China leading the way to a global recovery, as so many are counting upon, could be misguided.

Rather than begin to reduce its stimulus as other nations are now contemplating, China appears to be expanding it. The development of new roadways and massive transportation projects continue at a breakneck pace.

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