The most shocking thing about the world's reaction to China's decision to devalue the yuan was that anyone should have been surprised. For those who have watched China's deteriorating economic growth since late 2014 and the ineffectiveness of monetary easing by the People's Bank of China, the country's central bank, currency devaluation appeared to be not only logical, but also inevitable.
Since recording its last double-digit rate of 10.4% in 2010, China's economic growth has slowed by 3 percentage points over four years to 7.4% in 2014. In response, Chinese policymakers injected massive amounts of credit into the economy. Although estimates vary, total credit growth from 2011 to 2014 probably equaled 100% of Chinese gross domestic product, raising the debt-to-GDP ratio to around 280% at the end of 2014, according to McKinsey, the business consultancy.
Undeterred by the prospect of creating a financial crisis, the Chinese government continued to double down on monetary easing. Since last November, the PBOC has cut interest rates four times by a total of 115 basis points and lowered the reserve ratio (the amount of cash banks are required to hold) three times by 150 basis points.
This injection of new credit did not do much to revive China's investment growth, but it did help inflate a gigantic stock market bubble that temporarily created a mirage of prosperity.
Unfortunately, the bubble started to collapse in mid-June, forcing Beijing to launch an aggressive and hugely expensive rescue operation to prevent share prices crashing. Meanwhile, the economy deteriorated further. In July, Chinese exports fell 8.3% while its purchasing managers index reading was 47.8%, the lowest in two years.
Residential and business buildings are being built in Zhangjiagang, Jiangsu Province, on Aug. 5. © Reuters
Lessons
If we have learned anything about how Beijing deals with difficult economic challenges since the 2008 global financial crisis, it is about its leaders' attitude of "whatever it takes" and "shoot first (ask questions later)." The decisive factor in any decision has always been maintaining economic growth.
To be fair to President Xi Jinping and Premier Li Keqiang, they inherited an economic mess in late 2012. A decade of prosperity fueled by explosive export growth, following China's entry into the World Trade Organization and a resulting real estate and infrastructure investment boom, dampened appetite for reform and created an economy saddled with debt, a property bubble and immense manufacturing overcapacity.
After becoming head of the Communist Party in 2012, Xi knew that the party's long-term survival and his own political fortune would rest on reviving growth through structural reforms. Exactly a year after his appointment, Xi launched an ambitious long-term blueprint for economic reforms.
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