China's conundrum

In response to a post on the economic relationship between the US and China titled "How George Bush got a cost free trillion dollars for the US economy", my thoughts are as follows:

While I realize your post is a rant, I have to take issue with the idea that Chinese leaders are acting out of stupidity. You state that “China’s economic growth has been export-driven. This is largely a result of a deliberate policy of the Chinese government. They looked around at Japan, South Korea, and Taiwan and they decided that the way you become a rich country is by exporting things to the rest of the world. To that end, the Chinese leadership seems to have decided to do whatever it takes to help their export sector.”

That is a reasonable statement of China’s economic policy. You point out that Japan has had a similar policy and essentially say “Look where Japan is now”…

I think that up until now, the Chinese policy of subsizing exports has been rational in that at the time that Deng decided to implement this policy China had no coherent domestic economic systems at all, and therefore no domestic market to build the country’s economy on. So China took what it had, which was cheap labor, and used that to build up a manufacturing and export sector. Still, a rational policy. Today, I believe that Chinese leaders are perfectly aware of the negative consequences of the massive buildup of foreign reserves and dependence on exports.

The problem is that it will be extraordinarily difficult to shift to a more balanced economic system without serious financial and social shocks. It’s not a question of stupidity, but rather of having difficult choices to make. If the yuan is allowed to float it will rise relative to other currencies and exports to the US will plummet as the price of Chinese goods goes up, damaging the export sector which is the source of the highest paying jobs in China. That would likely lead to serious social unrest in China. Plus, the rise in the value of the yuan would leave the PBoC with capital losses on all of the US debt that they have piled up.