Economy & Finance

WHen China hosted economic policymakers from the G-20 countries in Shanghai earlier this year, Chinese leaders hoped to present their vision for a new international economic order in which Beijing would take a place commensurate with its wealth. Instead, they found themselves reassuring the G-20's jittery central bankers that China's turbulent economy was not headed for a hard landing and that Beijing would not further devalue the yuan.

It's popular to be bearish on China now. A few of us knew what was coming before it became obvious – the economy is in the process of stagnating. The only solution is a return to market-driven, politically difficult reform. Such reform must be focused primarily on rolling back the state sector.

This piece was originally published by Foreign Affairs. It is based on a longer, annotated version entitled How New and Crafty is China's "New Economic Statecraft"? According to conventional wisdom, Chinese president Xi Jinping has launched a more ambitious and geopolitically game-changing era of Chinese foreign economic policy. And Beijing is certainly promoting new economic initiatives, from the creation of the Asian Infrastructure Investment Bank (AIIB) to the rollout of the One Belt One Road (OBOR) initiative. But China's international economic grand strategy under Xi is not new. It is an extension of Beijing's long-standing Peaceful Development framework from the mid-1990s, which asserts that China's own development and stability is contingent on shared prosperity with its international economic partners, especially those in the developing world. In fact, the Peaceful Development strategy has not been uniformly successful, and Xi's expansion of it is likely to create unexpected challenges for China and the world.

Due largely to botched exchange rate policy, China has seen foreign reserves shrink considerably from a mid-2014 peak. This suggests Beijing is being forced to sell US Treasury bonds, which some worried would drive up American interest rates. It has not turned out that way. Official Chinese foreign exchange reserves peaked at $4 trillion in June 2014 and fell all the way to $3.2 trillion this past January. This is being portrayed in some quarters as a crisis; it's not.

January's global stock market rout was initially triggered by mounting concerns over China's shrinking industrial sector. But such concerns are unjustified. By now, it is clear that Beijing is doing everything in its power to rebalance its economy from industrial to service-based. In 2013, services overtook the industrial sector in both total size and pace of growth, and they now account for almost 50 percent of China's GDP. Yet the analytical tools that we use to assess China's performance haven't caught up with the structural changes now under way, which means that observers can easily get China wrong.

Shanghai will welcome finance ministers and central bank governors for the first major meeting of China's G20 presidency at the end of this week. It should be an instructive meeting for a variety of reasons. As I point out in the latest G20 Monitor, the global economy continues to face significant short and long-term challenges. This year is likely to be characterized by disappointing growth and persistently high unemployment. The IMF predicts that the global economy will grow at 3.4 percent in 2016, while the OECD just downgraded its 2016 growth forecast from 3.3 percent to 3 percent.

It was always a ridiculous contention, and it seems even less reasonable now. Not even a year ago, consensus thinking saw China's yuan on the verge of replacing the dollar as the world's premier reserve currency. Now the flood of funds out of China, and the yuan's declining value, have stifled all such talk and even such thinking. No doubt circumstances will continue along current lines for a while to come. Still, today's negative attitudes are setting the stage for a rebirth of pro-yuan speculation, perhaps pretty soon. It will be wrong again.

The U.S. trade deficit with China hit a critical milestone in 2015. It now stands at a mind-numbing $1 billion a day, and that $365 billion annual trade deficit continues to rise with the lift of China's illegal export subsidies, sweatshop labor, pollution havens and undervalued currency. The failure to understand that America's Chinese import dependence has now reached critical mass as a national security issue comes from the very mind-numbing magnitude of the numbers involved. Let's see, however, if we can put the size of the U.S. trade deficit with China into some perspective; and let's start with the F-22—the only U.S. fighter jet with the agility, speed and stealth to overcome the latest Russian air defense systems and newest Chinese and Russian fighters.

Just how much economic trouble is China in? To judge by global markets, a lot. In the first few weeks of the year, stock markets around the world plummeted, largely thanks to fears about China. The panic was triggered by an 11 percent plunge on the Shanghai stock exchange and by a small devaluation in the renminbi. Global investors—already skittish following the collapse of a Chinese equity-market bubble and a surprise currency devaluation last summer—took these latest moves as confirmation that the world's second-biggest economy was far weaker than its relatively rosy headline growth numbers suggested.

Headlines about China's economy have been uniformly alarming. Every time equity markets in the west plunge, Beijing's woes are cited as a factor with its plunging equity indices, rising debt ratios and exchange rate under pressure. Even with more sensible interventions, or perhaps none at all, increased volatility in the country's financial markets is becoming the norm as its economy becomes more globalised and subjected to the same market pressures as other nations.