China’s Economy: Due for Reform

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Author: William Pottenger

In my opinion, China’s economy is one of the most obvious explanations for recent market volatility. Like many developed and emerging economies (e.g. Japan’s Nikkei 225 index and Malaysia’s KLSE index), the country’s stock market plunged dramatically starting in mid-June. According to reports from The Economist and The New York Times, Aug. 11, in the midst of market doldrums, China devalued the yuan by 2 percent, the most since 1994.

Since the Peoples Bank of China (PBOC) devalued the yuan, it has tried to bolster its currency by using capital reserves of around $4 trillion (the largest in the world). China garnished these immense funds from its blistering 9.82 percent average annual GDP growth rate from 1980 to 2014 (numbers reported by The World Bank).

China’s recent economic history has been a success story. Although China has lifted 500 million people out of poverty, it’s due for reforms in areas such as healthcare, energy efficiency and education. The country’s 12-year goals attempt to deal with social and environmental imbalances, which help to identify it as a maturing nation.

The Chinese economy now faces an interesting turning point: switching from a production growth model to a more stable consumption-based economy. Over recent years, the PBOC has gradually decreased its targeted GDP growth rates in an attempt to maneuver its way through a maturing economy. The PBOC claims to currently achieve an annual 7 percent GDP growth rate, however, economists believe that this number could be inflated.

The United States Federal Reserve will have to take the PBOC’s recent actions into account leading up to their policy meeting Sept. 16-17 on whether to raise the federal funds rate. The 2 percent yuan devaluation relative to the US dollar could be interpreted as an attempt by the PBOC to spur economic growth, but, in my opinion, this marginal devaluation is unlikely to have a major impact on China’s falling exports. It’s more likely to do with the International Monetary Fund’s (IMF) concerns that it doesn’t qualify as a reserve currency.

There are currently four global reserve currencies: the US dollar, the Japanese Yen, the British Sterling and the Euro. China wants to be added to this list, but I don’t believe that this devaluation alone is likely to change the IMF’s mind.

The IMF has advised China that it needs to allow foreign access to their stock market before the yuan is seriously considered. I believe that this is particularly unlikely to occur, considering the government’s questionable attempts to artificially uphold the stock market by restricting brokerage selling and spending $236 billion on a bail out.

All of this economic turmoil must be giving China’s President, Ji Xinping, a headache because he based his political platform off on a strong economy, which seems to be faltering. He, and the PBOC, if they want to gain the prestige of having the yuan included as a Global reserve currency, should let their stock market correct, allow foreign access to their markets, and let their currency float freely.

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