Yu Yongding

A rising China’s place in the world economy

After 30 years of breakneck growth, China overtook Japan to become the world’s second largest economy in 2010. The reaction in the West to this stunning success has been mixed. It boils down to one question: what role will China play in the world?

In future the rest of the world should expect China to play a more active role in areas such as climate change, poverty alleviation, global infrastructures, and reform of the international monetary system, In its long history China has remained an inward-looking country, a tendency most obviously expressed in its Great Wall. Despite occasional bellicose reactions to what it regards as provocations, China harbors no ambition to become a hegemonic power.

But as Zbigniew Brzezinski notes, a “drift into escalating reciprocal demonisation” is the worst possible outcome of for Asia’s stability, as well as for American-Chinese relations. Avoiding this will fate will require careful economic management, especially as the world welcomes 2011 without any shortage of challenges.

An uneven and unstable global recovery, the threat of protectionism and fiscal pressures all require strong and coordinated action. China can and must play a critical role – just as it did during the global financial crisis, when China did more than any other economy to pull the world out of the recession.

China will remain an important engine of global growth for years to come, but its economy is changing too. Over the next four years China will accomplish a paradigm shift from export and investment-driven growth to a more balanced pattern. As a result growth rates may be significantly lower, if more sustainable.

The Chinese government has already identified escalating inflation, currently at 5.1 per cent, as the most important near-term risk. Global liquidity overhangs have led to rising input costs, but China’s recent credit binge is probably the main culprit. High investment growth and strong export performance has constrained production capacity. With abundant liquidity and strong demand, inflation is inevitable.

The tug of war between real estate developers and the central government is still ongoing. To avoid a Japan-style boom and bust, China must stabilize property prices, while acting to satisfy the public’s demand for affordable housing. Crucially, China must be willing to make short-term sacrifices, such as asset price adjustments or temporary employment losses in certain sectors, to guarantee the long-term stability. Its extremely strong fiscal position and low debt can ease any pain, ensuring domestic demand does not suffer dramatically.

These are tough choices. Failure to cool the economy will have serious consequences for China’s long-term growth. But a hard landing would shake confidence in emerging markets, and set back the global economy by many quarters, if not years.

America’s attempts to blame an undervalued Renminbi for its economic woes are by and large without merit. A stronger currency would benefit the US, but also help China promote structural adjustment and contain inflation. China must also choose between maintaining large current account surpluses and lower reserve accumulation, meaning having fewer dollars to plough into the US government securities. Lower reserve accumulation means less central bank intervention in the foreign exchange market, which in turn means tolerating greater appreciation.

In any case, China’s current account surplus-to-gross domestic product ratio has been dropping fast, due to factors such as the real appreciation of CNY. Capital flows will remain a problem when China is trying to rein in inflation and asset bubbles. Like other emerging economies, China has to strengthen its management on cross-border capital inflows, even though some of these flows are not speculative in nature.

China’s leadership has stated repeatedly in the past that nothing will be done to destabilize sovereign bond markets. Nevertheless, the US and eurozone must act responsibly towards creditors.

China has been supportive of the eurozone, but must urgently seek clarification as to whether its holdings of periphery debt will be part of any restructuring plan. Currently, according to market observers, the numbers for Ireland and Greece don’t add up. Until such clarification is provided, or the Eurozone comes up with a permanent resolution mechanism, China should give no commitment to supporting the Eurozone through direct government bond purchases, as this risks throwing good money after bad.

America must change course too. At present the US is debasing its currency through more quantitative easing, while President Barack Obama’s recent tax deal failed to address the deficit in a way which would allay the fear of its creditors. As a result 2011 could be the year where China sends a clear message to the US: do not expect any more munificence.

The lack of alternatives to the dollar as a reserve currency has bred a false sense of security within the US. Yet when China reduces its current account surplus and diversifies away from US dollar assets, a reduction in Chinese buying will be felt in Treasury markets,

Some in Washington might dismiss this as bluffing, but surely a healthier US fiscal balance is in everyone’s interests? Like China, the US must make sacrifices. There is much to be done in 2011. China should be bold and face up to its responsibilities, but we will also demand that rest of the world reciprocates.

The writer is an academician with the Chinese Academy of Social Sciences and a former member of the monetary policy committee of the Chinese central bank

Yu Yongding is a former member of the monetary policy committee of the Chinese central bank.

This post is also available in: Chinese (Simplified)

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