U.S. policy hastens China’s ascent

When leaders of the world’s No. 1 and No. 2 economies get together as they did in Washington this week, people increasingly ask which one is which.

Conservative pundits breathlessly warn that China’s fast-growing economy is on the verge of surpassing the U.S. to become No. 1 in a sure sign of U.S. economic decline. Many U.S. voters think that already has happened, according to public opinion polls, though it is not projected to happen for years to come.

The U.S. remains the world’s largest economy by far, with $14.7 trillion in total output last year compared with $6.9 trillion in China, according to the International Monetary Fund.

Yet the irony is that Washington’s prescriptions for policy change in Beijing — pressed repeatedly in this week’s summit between the superpowers — would only hasten the day China becomes the new global leader.

If the U.S. gets its top wish and China allows its currency to rise rapidly against the U.S. dollar to reflect its increasing economic strength, China would overtake the U.S. more quickly because the size of its economy would appear much larger in dollar terms.

“Be careful what you wish for,” said Geoff Dyer, Beijing bureau chief of the Financial Times, noting that China may have suppressed the value of its currency by as much as 40 percent to maintain its competitive edge in trade and keep exports to the U.S. cheap in dollar terms.

“Maybe the fact that the currency has been kept so artificially low has obscured just how far China has already come,” he said. “With a much stronger currency, China would loom even larger in the U.S. consciousness. It would reinforce the perception that China is not just a rival for the distant future but is swiftly becoming an economic and military match for the U.S.”

’A wake-up call’

Beijing has acceded to Washington’s wishes in a small way in the past year and allowed the yuan to rise against the U.S. dollar by 5 percent — a rate of appreciation that Treasury Secretary Timothy F. Geithner applauded, but said needs to accelerate.

Currency disputes aside, conservative commentators such as Americans for Limited Government President Bill Wilson warn that China is on the verge of overtaking the U.S. under a measure that more honestly accounts for the size of both economies.

He points to figures published by the IMF that show China’s economy nearly rivals the size of the U.S. economy when currency distortions are removed and the purchasing power of Chinese citizens is taken into account.

Since lower wages and prices enable the yuan to buy nearly as much goods and services in China as the dollar buys in the U.S., the IMF’s alternative way of estimating the size of China’s economy puts it last year at $10 trillion, not far below the U.S. figure.

By 2016, according to the IMF’s adjusted measure, Chinese output of $19 trillion would surpass U.S. output of $18.8 trillion, and its 18 percent share of the global economy would overtake the U.S. share of 17.8 percent.

Arvind Subramanian, an analyst at the Peterson Institute for International Economics, said Americans should not nurture complacency by focusing on the enormous gap between U.S. and Chinese economic power when viewed through the prism of an overvalued U.S. dollar.

He thinks even the IMF’s adjusted calculations of China’s output, which show it rapidly gaining on the U.S., actually underestimate the power of the Asian giant. Mr. Subramanian calculates that China’s economy surpassed the U.S. economy some time last year.

The different ways of looking at China’s economy are not just “theoretical” but “have real-world significance” and should serve as a “wake-up call” for Americans, he said.

“The economic advantage China is gaining will only widen in the future” because China’s economy is growing more than three times faster than the U.S. economy, he said. Moreover, China already is the world’s largest exporter and the biggest foreign holder of U.S. Treasury debt, giving it significant leverage over the U.S. and world affairs.

That raises the likelihood that the 21st century will become a “Chinese century” dominated by China just as the 20th century was an “American century” dominated by the U.S., he said.

“The combination of economic size, trade and creditor status will confer on China a kind of economic dominance that the United States enjoyed for about five to six decades after World War II,” he said.

“America’s ability to influence China will be seriously diminished,” he said. “And the open trading and financial system that the United States fashioned after World War II will be increasingly China’s to sustain or undermine.”

’The Japanese model’

Others are not so alarmed by China’s rapid ascendance and say the Asian tiger is more of a pussycat.

Michael Pettis, finance professor at Peking University, said China is the one that should avoid becoming overconfident. That is because China followed the “Japanese model” to achieve its impressive rates of growth, driven by exports to the U.S. and the rest of the world and nurtured by an undervalued currency.

But that model, while effective at industrializing the economy and bringing it up to modern standards, turned into a major bust in Japan and other Asian countries once they reached the limits of such export-led growth, he said.

“This model always runs into the same fatal constraints: massive overinvestment and misallocated capital. And then a period of painful economic adjustment,” he said, pointing to Japan’s “lost decade” that started in the 1990s and continues to this day.

Many economists see echoes of Japan in China’s overbuilt and overvalued real estate and stock markets today. Fear that those overheated sectors are developing into a bubble that may soon collapse have haunted global markets this year.

“The Japanese model steals wealth away from the household sector to subsidize growth” among exporters, builders and government-led industries, Mr. Pettis said. “Once the train gets going, it has been very difficult to correct course because too much of the economy depends on hidden subsidies to survive.”

Yukon Huang, an analyst with the Carnegie Endowment for International Peace, said the threat of overheating and inflation is forcing China to find a new, more sustainable source of growth by looking inward to its 1.3 billion consumers.

The transition to more domestic-led economic growth like that in the U.S. is enhanced by letting the yuan’s value rise, giving consumers more purchasing power even as it holds down the prices of imported goods such as oil and copper.

This will lead to slower growth than China has experienced in the past decade and will slow its ascendance on the world stage, he said.

“China is gaining ground rapidly and will likely surpass America in the aggregate in the next 20 to 30 years,” he said. “But of course this depends on how fast China continues to grow and whether the United States can retool itself fast enough. A lot can happen during this period.”