By Jamil Anderlini in Beijing
May 14, 2012

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In an unguarded moment in 2007, the man anointed to take over next year as the helmsman of the world’s second-largest economy revealed his doubts about China’s economic growth statistics.

The country’s official gross domestic product figures are “man-made” and therefore unreliable, Li Keqiang told the US ambassador at the time, adding with a smile that he regarded them as being “for reference only”.

When evaluating the speed of economic growth Mr Li, who is expected formally to replace Wen Jiabao as China’s Premier next March, said he focused instead on three sets of data – electricity consumption, rail cargo volumes and disbursement of bank loans.

If Mr Li’s assessment is correct the Chinese economy is in a lot more trouble than headline GDP figures have indicated until now.

Less closely watched economic data released in recent days, including figures for electricity, rail cargo and bank loans, have all shown a steep drop in activity that appears to have caught policymakers by surprise.

China’s GDP statistics are only released every three months and in the first quarter of this year they appeared to show a continuation of the gradual decline that has been under way for the past year.

An 8.1 per cent expansion in the first three months from the same period a year earlier was a clear deceleration from 8.9 per cent growth in the fourth quarter of last year but it could hardly be considered a “hard landing” for the high-flying Chinese economy.

Following this relatively strong reading, most analysts and government officials declared that growth had bottomed out in the first quarter and the rebound would begin in April.

“Sell-side analysts and Chinese officials wanted to believe the story that this was just a little dip and the economy would come roaring back,” says Patrick Chovanec, a professor of business at Beijing’s elite Tsinghua university. “But those forecasts were mostly a triumph of hope over reason.”

China’s electricity consumption in April hasn’t been published yet but electricity output increased just 0.7 per cent last month from a year earlier, compared with a 7.2 per cent increase in March and an 11.7 per cent annual increase in April 2011.

Rail cargo volumes in the first few months of the year increased by low single digits or about half the pace they were growing this time last year and banks extended far fewer new loans than expected.

“China’s been riding an investment boom over the last three years that everyone recognised was unsustainable and now we’re seeing what unsustainable looks like,” Mr Chovanec says. “The unravelling of this investment boom is happening with nothing to replace it and that means China is in store for much lower GDP growth than we’ve become accustomed to.”

Much of the current slowdown has come from the slumping real-estate market, where government efforts to rein in a credit-fuelled bubble are starting to look a little too effective.

Investment in real estate, which directly accounts for about 13 per cent of GDP, has dropped precipitously in just the past few months, with construction of new residential floor space falling 4.2 per cent in the year to April from the same period last year. That compared with growth of 5.1 per cent in the first two months and 16.2 per cent growth in new starts this time last year.

A 51 per cent drop in sales of Chinese bulldozers in March from the same month a year earlier reinforces the picture of plummeting construction.

But the slowdown is coming from more than just a downturn in real estate.

Chinese exports and imports in April were much weaker than predicted, with imports expanding just 0.3 per cent from a year earlier, compared with the average analyst forecast of about 11 per cent growth.

Leading commodity imports slowed sharply while industrial machinery imports fell significantly, indicating a “worrying downturn in industrial investment”, according to Stephen Green, an economist at Standard Chartered. “In the absence of further policy easing, we expect growth to continue to slow for the remainder of the second quarter,” he says.

Many analysts believe the Chinese government has already waited too long to stimulate the slowing economy. The purge of Chinese leader Bo Xilai last month and the resulting political turmoil is one reason why Beijing has not acted sooner but some economists say its options for boosting growth are more limited than in the past.

In response to recent dismal data, the central bank on Saturday cut the portion of deposits that banks must hold in reserve to encourage more credit to flow into the economy.

But the huge flood of easy credit and government-backed investment unleashed after the global financial crisis has left Beijing with limited firepower this time round amid concerns about resurgent inflation and bad loans at the state-owned banks.

As he prepares to take office next year, Mr Li must be hoping his assumptions were wrong and that China’s GDP figure is the more accurate reading. Otherwise he may be faced with a deteriorating situation that he has relatively little power to address.

For seven years, the United States has allowed its fixation on the renminbi’s exchange rate to deflect attention from far more important issues in its economic relationship with China. The upcoming Strategic and Economic Dialogue between the US and China is an excellent opportunity to examine and rethink America’s priorities.

Since 2005, the US Congress has repeatedly flirted with legislation aimed at defending hard-pressed American workers from the presumed threat of a cheap Chinese currency. Bipartisan support for such a measure surfaced when Senators Charles Schumer (a liberal Democrat from New York) and Lindsey Graham (a conservative Republican from South Carolina) introduced the first Chinese currency bill.

The argument for legislative action is tantalizingly simple: the US merchandise trade deficit has averaged a record 4.4 percent of GDP since 2005, with China accounting for fully 35 percent of the shortfall, supposedly owing to its currency manipulation. The Chinese currency, insists a broad coalition of politicians, business leaders, and academic economists, must revalue or face sanctions.

This reasoning resonates with the US public. Opinion polls conducted in 2011 found that fully 61percent of Americans believe that China represents a serious economic threat. As such, the currency debate looms as a major issue in the upcoming US presidential campaign. “Enough is enough,” President Barack Obama replied, when queried on the renminbi in the aftermath of his last meeting with Chinese President Hu Jintao. Obama’s Republican challenger, Mitt Romney, has promised to declare China guilty of currency manipulation the day he takes office.

But, however appealing this logic may be, it is wrong. First, America’s trade deficit is multilateral: the US ran deficits with 88 nations in 2010. A multilateral imbalance, especially one that it is traceable to a saving shortfall, cannot be fixed by putting pressure on a bilateral exchange rate. Indeed, the US’ major threat is from within. Blaming China merely impedes the heavy lifting that must be done at home, namely, boosting saving by cutting budget deficits and encouraging households to save income rather than relying on asset bubbles.

Second, the renminbi has now appreciated 31.4 percent against the dollar since mid-2005, well in excess of the 27.5 percent increase called for by the original Schumer-Graham bill. Mindful of the lessons of Japan, especially its disastrous concession on sharp yen appreciation in the Plaza Accord of 1985, the Chinese have opted, instead, for a gradual revaluation. Recent moves toward renminbi internationalization, a more open capital account, and wider currency trading bands leave little doubt that the endgame is a market-based, fully convertible renminbi.

Third, there has been significant improvement in China’s external imbalance. The International Monetary Fund estimates that China’s current-account surplus will narrow to just 2.3 percent of GDP in 2012, after peaking at 10.1percent in 2007. US officials have long bemoaned China’s saving glut as a major source of global instability. But they should look in the mirror: America’s current-account deficit this year, at an estimated $510 billion, is likely to be 2.8 times higher than China’s surplus.

Finally, China has evolved from the world’s factory to its assembly line. Research shows that no more than 20 percent to 30 percent of Chinese exports to the US reflect value added inside China. Roughly 60 percent of Chinese exports represent shipments of “foreign invested enterprises”, in effect, Chinese subsidiaries of global multinationals. Think Apple. Globalized production platforms distort bilateral trade data between the US and China, and have little to do with the exchange rate.

Rather than vilifying China as the principal economic threat to the US, the relationship should be recast as an opportunity. The largest component of US aggregate demand, the consumer, is on ice. With households focused on repairing severely damaged balance sheets, inflation-adjusted private consumption has expanded at an anemic 0.5 percent average annual rate over the past four years. Consumer deleveraging is likely to persist for years to come, leaving the US increasingly desperate for new sources of growth.

Exports top the list of possibilities. China is now the US’ third largest and most rapidly growing export market. There can be no mistaking its potential to fill some of the void left by US consumers.

The key to realizing that opportunity lies in access to Chinese markets, all the more significant in light of China’s upcoming pro-consumption rebalancing. Historically, China has had an open development model, with imports running at 28 percent of GDP since 2002 nearly three times Japan’s 10 percent import ratio during its high-growth era (1960-1989). As a result, for a given increment of domestic demand, China is far more predisposed toward foreign sourcing.

As the Chinese consumer emerges, demand for a wide variety of US-made goods, ranging from new-generation information technology and biotech to automotive components, could surge. The same is true of services. At just 43 percent of GDP, China’s services sector is relatively tiny. There is enormous scope for America’s global services companies to expand in China, especially in transactions-intensive distribution sectors, wholesale and retail trade, domestic transportation, and supply-chain logistics, as well as in the processing segments of finance, health care, and data warehousing.

The US needs to refocus the US-China trade agenda toward expanded market access in these and other areas, pushing back against Chinese policies and government procurement practices that favor domestic production and indigenous innovation. Some progress has been made, but more is needed, for example, getting China to join the World Trade Organization’s Government Procurement Agreement. At the same time, the US should reconsider its antiquated Cold War restrictions on Chinese purchases of technology-intensive items.

For a growth-starved US, the opportunities of market access far outweigh the currency threat. The long-dormant Chinese consumer is about to be unleashed. This plays to one of America’s greatest strengths, its zeal to compete in new markets. Shame on the US if it squanders this extraordinary chance by digging in its heels at the upcoming Strategic and Economic dialogue.

The author is a member of the faculty at Yale University, formerly chairman of Morgan Stanley Asia, and the author of The Next Asia.

Project Syndicate

Published: May 2, 2012

WASHINGTON — The pace of appreciation of the Chinese currency against the dollar has slowed in the last year, ensuring that China’s manipulation of its exchange rate remains a central topic as Treasury Secretary Timothy F. Geithner arrives in Beijing for the annual dialogue between the nations.

While praising the Chinese government for its progress, Treasury officials have promised to maintain the pressure.

“The process of correcting the misalignment of the exchange rate remains incomplete,” Mr. Geithner said in a speech in April. “The Chinese currency needs to appreciate further against the dollar and the other major currencies.”

The Chinese government has been holding back the pace of appreciation, which makes Chinese goods relatively more expensive and American goods relatively cheaper.

With bond yields spiraling in Italy and Spain last winter, the World Bank and International Monetary Fund warned of recessions across Europe, sluggish growth in the United States and Japan and the possibility of hard landings in fast-growing emerging economies, like China’s.

Economic issues have been overshadowed by diplomatic ones in advance of Mr. Geithner’s meetings Thursday, which will include Secretary of State Hillary Rodham Clinton and officials from the upper echelons of the Chinese government. Last week, Chen Guangcheng, a blind human rights lawyer, escaped from Chinese security forces and sought refuge in the United States Embassy in Beijing. On Wednesday, he left the compound, but his fate remained unclear.

A senior administration official in the American delegation, who spoke on the condition of anonymity to avoid disturbing diplomatic relations, said that the incident had not seemed to disrupt the economic dialogue, even as it had taken some attention from it.

Officials on both sides, who had spent about two months negotiating before the meetings, were determined to pursue their respective agendas, and early sessions were congenial, the administration official said.

“Both sides are bending over backward to not make strong statements about the issue,” said Nicholas R. Lardy, a China specialist at the Peter G. Peterson Institute for International Economics, a Washington-based research group. Mr. Lardy said in a call with reporters that he expected open talks but little progress.

Mr. Geithner’s central goal is to encourage changes to make the Chinese currency and financial systems more responsive to market forces, with exchange rate and interest rate controls as main points of American concern.

The renminbi has appreciated about 30 percent against the dollar since 2005, adjusting for both economies’ rates of inflation.

Beijing had halted the currency appreciation during the financial crisis from summer 2008 to mid-2010 to help increase the competitiveness of Chinese exporters and maintain China’s rapid pace of economic growth. But the government allowed the currency to resume its upward drift in 2010, to applause from the Obama administration.

The rate of appreciation initially spiked. But about 18 months ago, it started to fall, and the currency remains too cheap relative to the dollar, according to the Congressional Research Service.

The American official taking part in the dialogue said that in response to the widespread worries, the Chinese government might have halted the renminbi’s appreciation or even allowed the currency to fall in value relative to the dollar over the winter. But that did not happen, the official said, for which Washington gave China’s government credit.

Moreover, last month the Chinese central bank widened the currency’s trading band to a daily range of 1 percent from a range of 0.5 percent, letting market forces play a bigger role in determining the value of the currency versus the dollar.

The appreciation of the currency and other changes by the Chinese government have started to rebalance the country’s economy.

China’s current-account surplus, a measure of how much more the country exports than it imports, fell to less than 3 percent of economic output in 2011 from about 10 percent in 2010. Its trade surplus has fallen as well. And as the government has eased certain controls, more Chinese companies are investing overseas.

But an International Monetary Fund report released in April warned that the changes have not been a result of increased consumption as a share of Chinese economic output, which the fund and the Obama administration describe as vital for the world economy.

Instead, the results were because of trade and currency dynamics. “Sustainable rebalancing will depend on China’s successful transition from investment-led to consumption-led growth,” the report said.

The official said that given the brightening global outlook, Washington expected the currency appreciation to continue, and would press for that and a variety of economic and financial changes at the meeting.

In the April speech, Mr. Geithner focused on changing China’s financial system: loosening state controls on interest rates, leveling the playing field so that private companies can compete with China’s state-owned enterprises and allowing the value of the renminbi to be determined by market forces.

Progress on the currency issue is expected to be slow but consistent.

“For so long, that’s been the flash point in the bilateral relationship,” said William R. Cline, a former Treasury official now at the Peterson Institute. But the global recession seemed to convince China that absolute reliance on exports for growth was a “risky strategy,” he said.

The administration has applauded China’s efforts to let its currency appreciate, but it remains a hot-button issue in Washington.

The Senate last year passed a bill punishing China for undervaluing its currency but the bill never passed the House.

Moreover, Mitt Romney, the presumptive Republican presidential candidate, has repeatedly promised on the campaign trail to name China as a “currency manipulator,” a term the Obama administration has avoided.

A version of this article appeared in print on May 3, 2012, on page B1 of the New York edition with the headline: China Curbs On Currency Still an Issue.

Foreign Firms in China May Face Lower Transaction Costs, More Currency Risk

By VIPAL MONGA

Financial executives say pending Chinese government rules intended to expand the yuan’s use in trade could cut some of the hidden costs of doing business in China, but might also expose foreign companies to more foreign-exchange risk.

The People’s Bank of China, the country’s central bank, said in February that foreign companies trading with Chinese companies will be able to pay or bill them in yuan. The government hasn’t set a timetable for the change, but bankers and corporate executives expect it to take effect this summer. The new rules would upend a system in which China has used the U.S. dollar as its main currency for foreign trade. Just 67,000 China-based enterprises are allowed to accept yuan payments from foreign entities.

Under the existing system, Chinese companies absorb the foreign-exchange risk, a cost they often pass along to their partners without notifying them. By eliminating those tacked-on costs, the new rules could make transactions cheaper and more transparent.

The latest trade-settlement rules still need to be fleshed out by Chinese authorities. But companies are beginning to prepare for their implementation.

Stereo-gear maker Harman International Industries Inc. HAR -1.87%has already heard from some of its suppliers that they will request yuan payments after final passage of the rules. “It’s setting up a more normal currency-exchange regime,” said Terry Stack, treasurer for Harman, which has been expanding its business in China. “It will make it easier to do business.”

According to the Hong Kong Monetary Authority, some 9% of trade with China is denominated in yuan. The percentage has risen from 0.7% in the first half of 2010, just after China took its first steps to allow some companies to accept payment in yuan.

Kuresh Sarjan, Asia-Pacific head of Bank of America Merrill Lynch’s trade-finance group, a unit of Bank of America Corp., BAC -1.26%said that trading in China’s local currency could cut prices for Chinese exports, and shorten delivery times, because suppliers wouldn’t have to go through the cumbersome process of converting dollars to yuan through China’s tightly controlled banking system.

Chinese companies that supply goods to foreign customers often charge them a premium for dealing with those administrative hassles, as well as for the foreign-exchange risk that comes from dealing in U.S. dollars. That risk is increasingly significant as the yuan rises against the dollar.

Michael Vrontamitis, head of transaction-banking products for Asia at Standard Chartered STAN.LN -3.90%PLC said China’s current financial rules can delay payment for a Chinese company paid in dollars by seven to 10 days. During that time it gets no interest on the money while running the risk the dollar will weaken, cutting the number of yuan it gets per dollar. He added that few Chinese companies make the costs of those delays and the currency risk transparent to customers.

According to a survey by Western Union, WU -1.84%many companies pay a 3% premium on average to their Chinese partners to account for foreign-exchange risk. Alfred Nader, vice president of corporate strategy and development at Western Union, estimated that American businesses paid roughly $2.4 billion in fees last year to account for the risk.

One treasurer at a U.S. industrial-products company said his company pays a foreign-exchange premium of between 5% and 10% to suppliers, but added that it was difficult to know exactly how much because the cost wasn’t broken out in contracts. Chinese suppliers generally “won’t acknowledge building in the cushion,” he said.

Giving foreign companies the ability to manage foreign-exchange risk in Hong Kong and elsewhere outside China, rather than leaving them dependent on counterparties inside the country, is attractive for some companies, because they expect to be better able to negotiate costs, said Ann Lin Khoo, a Hong Kong-based cash-management product manager in J.P. Morgan Chase JPM -1.32%& Co.’s treasury-services group.

However, that shift would put the foreign-exchange risk on non-Chinese companies, leaving them to develop new strategies for a currency they previously didn’t have to hedge. In anticipation of this, the Hong Kong exchange said in April that it will be introducing yuan futures in this year’s third quarter, as a way to allow investors to hedge their exposure to yuan. But some executive worry about how effective that market will be.

“We looked at the Hong Kong [yuan-futures] market, and it’s not a real liquid market,” said Jeff Lasher, CFO of footwear company Crocs Inc., CROX +0.65%adding that the illiquidity could make buying yuan futures expensive, and limit any cost savings. Mr. Lasher said that, while a more flexible trade-settlement regime will benefit Crocs, it has no plan to change the way it does business with the operators of four factories that make its footwear in China.

“We’re concerned about where the [yuan] is headed, and that’s stronger against the U.S. dollar,” he said. He added he is content to let his Chinese counterparties handle the foreign-exchange risk, even if it means paying a slight premium.

Overcoming such inertia could be the largest challenge to quickly establishing the yuan as the currency of choice for business in China. According to Western Union’s survey, 42% of U.S. companies—by far the largest market for Chinese exporters—are reluctant to switch to using yuan for trade. That compares with 23% of European companies, and 8% of those in Japan.

Printed in The Wall Street Journal, page B4
A version of this article appeared May 1, 2012, on page B4 in some U.S. editions of The Wall Street Journal, with the headline: Yuan Tries Out a Bigger Role.

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Fair play or foul?

The Chinese yuan now looks close to its fair value

Apr 21st 2012

AT ITS peak, of over 10% of GDP in 2007, China’s current-account surplus offered firm proof that the yuan was undervalued. The evidence is much less conclusive now. China’s currency is 30% stronger in real trade-weighted terms than in 2005, when its peg to the dollar was scrapped. Partly as a result, the country’s current-account surplus fell to 2.8% of GDP last year.

Even the International Monetary Fund (IMF), which has been consistently more pessimistic than most economists (see chart), has slashed its forecasts for the surplus. The fund now expects it to dip to only 2.3% of GDP this year, and then to rise gradually to just above 4% of GDP by 2017 (compared with predictions in April 2011 of 6.3% and 8%, respectively). It may still be overegging things, even so. The IMF assumes that China’s real trade-weighted exchange rate will remain constant over the period. Because China has higher inflation than America, this oddly implies a steady depreciation in the yuan’s nominal rate against the dollar of 10% over the next five years. The forecast surplus would be smaller if you instead assume that the yuan’s nominal exchange rate will stay constant.

The most common method for judging a currency’s fair value is to estimate the exchange rate needed to bring a country’s current-account imbalance to a “normal” level. The Peterson Institute for International Economics, a think-tank which has done lots of work in this area, reckons that a surplus or deficit of less than 3% of GDP is acceptable. The IMF’s new forecasts imply that China’s surplus will average 3.2% over the seven years to 2017. If this is so, it is hard to argue that the yuan is significantly undervalued.

Chinese officials have already said that the yuan is now close to its fair value. So far this year it has been broadly flat against the dollar. But that does not rule out further appreciation. First, although its overall trade surplus fell last year, China’s surplus with America rose to a record $202 billion, more than accounting for its total surplus (China ran a deficit with the rest of the world). To defuse mounting trade tensions, the Beijing government will remain under pressure to let the yuan climb against the dollar. Second, even if the yuan’s value is “correct” today, faster productivity growth than elsewhere means that China should continue to allow its real exchange rate to rise.

Most economists expect the yuan to resume its rise soon, but at a much slower pace than before and with greater flexibility up and down. On April 16th the People’s Bank of China (PBOC) doubled the size of the yuan’s daily trading band against the dollar to plus and minus 1% from a fixed midpoint. The immediate impact may be small: the yuan rarely hit its previous limits anyhow, and the PBOC will still set the midpoint each day. But it is a modest, welcome step towards allowing market forces to play a bigger role.

Source:

http://www.economist.com/node/21553041

Peter Morici

Twitter @pmorici1

Sunday, Beijing announced it was widening the daily trading range for the yuan to one percentage point. This news has been heralded as another indication that China is liberalizing its currency, and the yuan may now be fairly valued.

This may be dead wrong.

In May 2007, when no one would dispute the yuan was undervalued by a wide range-by my reckoning some 40 percent-China widened the trading range to 0.5 from 0.3 percent to no substantial effect.

Theoretically, if market pressures require, the new band should permit the currency to appreciate or depreciate one percent each day but in the past, official intervention has frustrated this process.

Mostly, Bejiing did not let the yuan appreciate 0.3 or 0.5 percent each day when those bands applied. The resulting pace of appreciation was substantially less than private market forces and these trading bands should have required as evidenced by Beijing’s accumulation of some $3.__ trillion in foreign currency reserves. We have no reason to believe things will be any different with a one percent band, should upward pressures on the yuan reemerge, as those likely will.

In recent months, the value of the yuan has appeared quite stable, despite persistent Chinese trade surpluses. The reported February deficit was a one off, not repeated in March, owing to the annual nadir in exports associated with the Chinese New Year. And, historically partner country statistics would indicate China’s trade surplus is larger than officially reported.

Capital flows also influence the underlying market value of the yuan-the value that would be attained in the absence of persistent official intervention. Recent revelations of working conditions in Chinese factories, rough treatment of foreign investors’ intellectual property, new restrictions on foreign investment in sectors like autos, and concerns about a Chinese property bubble, solvency of banks and growth prospects, together, may be contributing to a drop off in foreign investor interest in China. Both foreign and domestic businesses may be holding off a bit on expansion plans and looking for other options in Asia.

Also, Chinese officials have liberalized a bit on the capital account-permitting Chinese exporters to keep some of the dollars they earn from foreign sales, and permitting private firms to be more aggressive in acquiring assets abroad-and these are creating some temporary downward pressure on the value of the yuan.

All of these capital account pressures on the underlying market value of the yuan are likely temporary and on the basis of the trade account, the yuan remains overvalued.

When assessed in terms of differences in productivity growth and inflation between the United States and China, the yuan appreciation permitted by authorities since May 2007, has not changed the fundamental undervaluation-the currency has been permitted to appreciate in line with net changes in productivity and inflation, and the underlying undervaluation of the currency remains in tact.

Hence, over the long term, the yuan is likely still undervalued by some 40 percent.

Peter Morici is an economist and professor of business at the University of Maryland and former Chief Economist at the U.S. International Trade Commission.

Peter Morici

Professor

Robert H. Smith School of Business

University of Maryland

College Park, MD 20742-1815

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pmorici@rhsmith.umd.edu

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By TOM ORLIK and BOB DAVIS

BEIJING—China’s first-quarter economic growth slowed to a lower-than-expected 8.1%, the lowest since the first quarter of 2009, as a slowdown in exports and real-estate investment complicated China’s efforts to guide its economy to a soft landing.
China’s growth was still above the 7.5% target set by the government, and its economy remains a bright spot in a world economy looking for drivers. China’s resilient growth and strong public finances stand in contrast to the U.S. and Europe, where unemployment remains elevated and high public debt limits the scope for a stimulus.
BEIJING—China’s first-quarter economic growth slowed to a lower-than-expected 8.1%, the lowest since the first quarter of 2009, as a slowdown in exports and real-estate investment complicated China’s efforts to guide its economy to a soft landing.
China’s growth was still above the 7.5% target set by the government, and its economy remains a bright spot in a world economy looking for drivers. China’s resilient growth and strong public finances stand in contrast to the U.S. and Europe, where unemployment remains elevated and high public debt limits the scope for a stimulus.
But the 8.1% figure—compared with expectations of 8.3% growth according to economist surveys—is a marked slowdown from 8.9% in the fourth quarter of 2011.
The release of the growth figure, by China’s National Bureau of Statistics on Friday morning in Beijing, comes as China already shows signs of moving policy more toward supporting growth, continuing its shift away from taming inflation.
Song Yu, China economist at Goldman Sachs, said the growth rate was disappointing. “Growth in the first two months was weak. We had some loosening of monetary and fiscal policy in March but it wasn’t enough to save the quarterly number,” he said.
China already shows signs of shifting policy toward supporting growth. Above, a shipyard in Taizhou, China, that has seen a slowdown in orders.
Still, an increase in the contribution of consumption to growth provided a positive counterpoint. Consumption contributed 76% to GDP growth in the first quarter, up sharply from 51.6% in 2011. The share from investment—including infrastructure, real estate and other big projects—fell to 33.4% from 54.2%. Those numbers suggest that attempts to rebalance growth away from dependence on capital spending and toward a bigger role for consumption may already be showing results.

Markets in Shanghai and Hong Kong were mildly positive Friday morning, in part reflecting the belief that the government could move more aggressively to ease policy by boosting lending. The Shanghai Composite Index was up 0.2%, while Hong Kong’s Hang Seng Index was up 1.5%.
First-quarter performance is of concern to foreign companies and economies dependent on supplying China with raw materials.
Residential property sales were down 15.5% year-to-year in the first quarter, as the government’s efforts to tame high house prices took a toll. Weak demand threatens a further deceleration in the housing construction that is China’s main domestic driver of growth.
A spokesman for China Vanke Co., China’s biggest real estate developer by revenue, said the company would adopt a cautious approach to investment. “When it comes to new projects we will be following the principle that it is better to miss an opportunity than to make a mistake,” the spokesman said.
Companies dependent on real-estate construction are feeling the effects. Last month, an executive from mining giant BHP Billiton BHP -1.70%said China’s demand for iron ore, used in steelmaking, is flattening out, which hurt markets. The Australian dollar, which fell 5% in March, has continued to slide in April, partly on fears of reduced Chinese commodity demand.
Even a moderate slowdown in China’s growth will leave some sectors facing an overcapacity problem.
David Beatenbough, vice president of research and development for Guangxi LiuGong Machinery Co., 000528.SZ +2.02%a major Chinese construction-equipment maker, said the industry is rife with overcapacity, with about 100 manufacturers of wheel loaders alone. “There will be a strengthening of strong players,” Mr. Beatenbough said, “and some of the weak ones will be eliminated.”
Inflation in March rose, with the Consumer Price Index up 3.6% compared with a year earlier, from 3.2% in February. But analysts expect prices to trend lower in the months ahead—giving the government more room for policy maneuvering.
There are already signs of a shift to support growth. New lending rose sharply in March, with the banks issuing 1.01 trillion yuan in new loans ($160 billion), up from 710 billion yuan in February. Wang Tao, China economist at UBS, saw this as a leading indicator that investment and growth should rebound in the second quarter.
Public spending also appears to be swinging into pro-growth mode. In a note to clients, Ms. Wang says that fiscal deposits fell sharply in March, a sign that the government is moving quickly to disperse funds to public projects. Higher public investment will take up some of the slack from lower spending by private real-estate developers.
—Andrew Galbraith, Esther Fung and James Glynn contributed to this article.

It wasn’t supposed to be this way. In 2000, the United States forged its current economic relationship with China by permanently granting it most-favored-nation trade status and, eventually, helping the country enter the World Trade Organization. The unspoken deal, though, went something like this: China could make a lot of cheap goods, which would benefit U.S. consumers, even if it cost the country countless low-end manufacturing jobs. And rather than, say, fight for an extra bit of market share in Chicago, American multinationals could offset any losses because of competition by entering a country with more than a billion people — including the fastest-growing middle class in history — just about to buy their first refrigerators, TVs and cars. It was as if the United States added a magical 51st state, one that was bigger and grew faster than all the others. We would all be better off.

More than a decade later, many are waiting for the payoff. Certainly, lots of American companies have made money, but many actual workers have paid a real price. What went wrong? In part, American businesses assumed that a wealthier China would look like, well, America, says Paul French, a longtime Shanghai-based analyst with Access Asia-Mintel. He notes that Chinese consumers have spent far less than expected, and the money they do spend is less likely to be spent on American goods.

There is a long list of missteps, French says. Home Depot, for example, overestimated the desire for D.I.Y. home projects and high-end materials in a country with an unbelievably cheap labor force and a thriving black market. Kodak learned it couldn’t forever dump its unsold film on a consumer base looking to make their first cameras digital ones. The Gap had to learn that a thriving middle class does not want to dress shabby-chic. In general, French says, European companies have done much better than American ones because they’ve had to practice selling across borders and cultures for decades.

Many U.S. executives also assumed that as China got richer, its citizens would spend more of their income. But the opposite has happened: the country’s savings rate is now climbing faster than its spending. China’s households save more than a quarter of their money, while Americans save less than 4 percent.

Some argue that this is because of millenniums-old Confucian frugality. Others say it’s more prosaic. When China joined the W.T.O. in 2001, it famously conceded that it would break “the iron rice bowl” — to get rid of the millions of decent-paying (for China) government jobs with fairly generous (for China) benefits. Partly as a result, a successful professional in Shanghai knows that she will have to bear any future health care or retirement costs for herself and, because of the one-child policy, for her parents and grandparents too.

Yet probably the greatest barrier to Chinese consumption is the policy of China’s Central Bank. Every month, the United States buys around $35 billion in goods and services from China and sells around $11 billion back. That, of course, leaves a $24 billion trade deficit. Currencies work like any other salable good in that they adjust based on supply and demand. Every month, the United States is demanding a lot of renminbi and China is demanding few U.S. dollars. The natural result should be for the dollar to get weaker as the renminbi gets stronger.

But China’s government prevents that adjustment by artificially increasing the demand for dollars, spending much of that $24 billion surplus on U.S. Treasury bonds. This sounds boring, but it effectively makes all Chinese exports somewhere around 25 percent cheaper and all U.S. imports to China, effectively, about 25 percent more expensive. Sure, we get to buy cheap stuff made in China, and by selling so many Treasury bonds, our interest rates — like those for credit cards or mortgages — are lower. But the long-term impact is disastrous. Many economic analysts, from Dean Baker on the left to David Boaz on the right, argue that all that easy money from China helped make the housing bubble much bigger and last longer, which created a far bigger crisis when the bubble finally burst.

The currency intervention also functions as a massive inequality-creation machine. U.S.-based behemoths, which own or use many of those exporting Chinese factories, benefit, as do their shareholders. And because more than 90 percent of U. S. stocks are owned by the wealthiest 20 percent, the spoils are disproportionately concentrated at the top. Meanwhile, lower wages, lost jobs and crippled manufacturing employment fall on the less wealthy. The economists that I spoke to estimated that China’s currency policy has cost the U.S. between 200,000 and 3 million jobs. Of course, the wide range suggests that these are little more than educated guesses. But a broad picture does emerge. U.S. manufacturing employment has fallen by around 6 million over the last decade. If China had allowed its currency to adjust naturally, life might be much better for many former American factory workers.

Now is a particularly good time to put pressure on China’s economic planners. Many market analysts fear that China’s economy is slowing down considerably, a prospect that suggests the country will keep the renminbi weak for years to come. Given this, it may seem odd that China’s currency policy isn’t the beginning and end of every single political stump speech. After all, it’s probably the one thing that, if changed, could instantly bring both jobs and more equality to this country. I can’t think of any other economic agenda that would receive the support of unions and big business, free traders and protectionists, Wall Street Occupiers and Tea Partiers.

Every president since Clinton has been trying to persuade China to float its currency. A number of Republican presidential candidates, including Mitt Romney, support pressuring China. But candidates always talk tough. Presidents opt for a gentle, nudging approach. They know that China, alone, gets to decide.

Adam Davidson is the co-founder of NPR’s Planet Money, a podcast , blog , and radio series heard on “Morning Edition,” “All Things Considered” and “This American Life.”

By ESWAR PRASAD
The Chinese currency invariably provokes overwrought reactions. One view is that it will soon knock the dollar off its pedestal as the dominant global reserve currency. The other is that China is taking enormous risks by letting capital account liberalization get ahead of domestic reforms.
Irrespective of government policies, China’s capital account is becoming more open over time as rising trade and financial integration create more channels for getting around capital controls. Rather than resist the inevitable, the government has embraced gradual change, relaxing but not eliminating controls on both inflows and outflows. The objective is full convertibility, unrestricted capital flows but with some “soft” administrative controls and regulatory oversight.
The government is also positioning its currency for a broader role in global trade and finance. Hong Kong provides the ideal testing ground for putting the yuan in play through trade settlement transactions as well as yuan-denominated deposits and bonds.
Some central banks have signed currency swaps with China’s central bank and begun adding yuan to their foreign exchange reserve portfolios. Thus, given its sheer economic heft, China is successfully promoting the yuan’s international use without fully opening up the capital account or allowing the currency to float.
For reserve currency status, an open capital account and a flexible exchange rate are essential. But even that is not sufficient.
What then determines a currency’s status as a reserve currency? Size, as measured by a country’s shares of global GDP and trade, counts for much. But it is not crucial—Switzerland is hardly a behemoth while the Swiss franc is a reserve currency.
And contrary to popular misconceptions based on the U.S. dollar, current account deficits, which reflect the net provision of financial assets to the rest of the world, are not essential. Major reserve currency economies including the euro area and Japan have run current account surpluses or at least a balanced current account for a long time.
Good monetary and fiscal policies that preserve a currency’s value are important, but the major advanced economies are hardly paragons of smart policy. This has posed little threat so far to their reserve currency status.
The crucial factor is financial market development. Historically, each reserve currency has attained that status under unique circumstances and spurred by different motivations. But in all cases foreign investors have been able to buy high-quality assets, typically government and corporate bonds, denominated in the country’s currency.
Paradoxically, for want of other safe assets, the high and rising level of U.S. government debt is cementing the role of the dollar as the dominant reserve currency. This safety could well be a chimera if the U.S. debt position becomes unsustainable. So the rush to U.S. Treasurys at times of global financial turmoil may reflect a flight to liquidity rather than safety. The U.S. trump card is that its financial markets remain unmatched in their breadth, the range of financial instruments available to foreign investors, the amounts of each such instrument, and the volumes of trading in those instruments.
Building up more debt would hardly be the right approach for China to challenge the dollar’s dominance. Reforms like developing financial markets and making the exchange rate more flexible, which are key for China’s own balanced economic development, are a more sensible approach. Financial market development takes time. For all the dynamism of the Chinese economy, over the next decade the yuan will evolve into a reserve currency that erodes but doesn’t displace the dollar.
An intriguing possibility is that we are seeing a Trojan horse strategy in play—reform-minded policy makers using the goal of making the yuan a global currency to promote much-needed domestic reforms to improve the balance and sustainability of China’s growth. Uniting the country’s citizens behind this nationalistic objective would build popular support for reforms needed to make it a reality—a better banking system, broader financial markets, a more flexible currency and other reforms. The path of China’s growth and the yuan’s role in the global economy will depend on those policy choices.
Mr. Prasad is a professor at Cornell University and a senior fellow at the Brookings Institution. This article is based on his new Brookings study “The Renminbi’s Role in the Global Monetary System,” with co-author Lei Ye.