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An Economic Miracle

China commenced its transition to a global powerhouse in 1978, as Deng Xiaoping ushered in sweeping economic reforms. In the three decades from 1980 to 2010, China achieved GDP growth averaging 10%, in the process lifting half of its 1.3 billion population out of poverty. The Chinese economy grew five-fold in dollar terms from 2003 to 2013, and at $9.2 trillion, it was easily the world’s second-largest economy at the end of that period.
But despite a slowing growth trajectory that saw the economy expand by “only” 7.7% in 2013, China appears to be on track to surpass the United States as the world’s largest economy sometime in the 2020s. In fact, based on purchasing power parity - which adjusts for differences in currency rates - China may pull ahead of the U.S. as early as 2016, according to a report on global long-term growth prospects released by the Organization for Economic Cooperation and Development in November 2012. (It should be noted that such bullish estimates about China’s long-term growth prospects are viewed with considerable skepticism by a growing number of economists and market watchers.)
China’s rapid growth since the 1980s has been fueled by massive exports. A significant chunk of these exports goes to the U.S., which overtook the European Union as China’s largest export market in 2012. China, in turn, was the United States’ second-largest trading partner until July of 2019, and its third-largest export market, and by far its biggest source of imports. The tremendous expansion in economic ties between the U.S. and China - which accelerated with China’s entry into the World Trade Organization in 2001 - is evident in the more than 100-fold increase in total trade between the two nations, from $5 billion in 1981 to $559 billion in 2013.

U.S. China Trade War
In 2018, The Trump administration, which has routinely accused China of manipulating its currency to boost its exports, launched a series of tariffs against Chinese imports. China retaliated with tariffs of its own on U.S. imports, and the world's two largest economies have ratcheted up trade tensions through the summer of 2019. On August 5th, 2019, China lowered the value of the Yuan below its 7 to 1 peg against the dollar in response to a new series of U.S. tariffs on $300 billion worth of goods set to go into effect Sept 1.

China’s Currency Policy
A cornerstone of China’s economic policy is managing the yuan exchange rate to benefit its exports. China does not have a floating exchange rate that is determined by market forces, as is the case with most advanced economies. Instead it pegs its currency, the yuan (or renminbi), to the U.S. dollar. The yuan was pegged to the greenback at 8.28 to the dollar for more than a decade starting in 1994. It was only in July 2005, because of pressure from China’s major trading partners, that the yuan was permitted to appreciate by 2.1% against the dollar, and was also moved to a “managed float” system against a basket of major currencies that included the U.S. dollar. Over the next three years, the yuan was allowed to appreciate by about 21% to a level of 6.83 to the dollar. In July 2008, China halted the yuan’s appreciation as worldwide demand for Chinese products slumped due to the global financial crisis . In June 2010, China resumed its policy of gradually moving the yuan up, and by December 2013, the currency had cumulatively appreciated by about 12% to 6.11.

The true value of the yuan is difficult to ascertain, and although various studies over the years suggest a wide range of undervaluation - from as low as 3% to as high as 50% - the general agreement is that the currency is substantially undervalued. By keeping the yuan at artificially low levels, China makes its exports more competitive in the global marketplace. China achieves this by pegging the yuan to the U.S. dollar at a daily reference rate set by the People’s Bank of China (PBOC) and allowing the currency to fluctuate within a fixed band (set at 1% as of January 2014) on either side of the reference rate. Because the yuan would appreciate significantly against the greenback if it were allowed to float freely, China caps its rise by buying dollars and selling yuan. This relentless dollar accumulation led to China’s foreign exchange reserves growing to a record $3.82 trillion by the fourth quarter of 2013.


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