• China’s economy can influence global growth through its voracious appetite for a range of commodities from grains to energy to metals produced by a multitude of nations
• The global economy can, in turn, influence the pace of growth in China as the country depends on demand from nations across the world to consume its exports of finished products from furniture to machinery and appliances
• If China’s growth slows later this year as expected by many analysts, it could have repercussions for economies that depend on China as a major export destination
• The strength of China’s yuan could hinge on export growth, influenced by both China’s COVID-19 policies as well as on how fast global consumers switch their demand back to services from goods as economies reopen   

The reforms set in motion the rapid expansion of the Chinese economy, which was valued at $14.7 trillion in 2020 by the World Bank. But 40 years ago, the Chinese economy was in its infancy, valued at a mere $191 billion in 1980. Within the next 20 years, the size of the Chinese economy had crossed the trillion-dollar mark for the first time in 1998. It was seen by many analysts then as the awakening of a sleeping giant, with its vast resource of people acting as the catalyst for future growth.

In contrast, the U.S. economy was valued at almost $21 trillion in 2020, and was about one-tenth that size in 1980 at $2.85 trillion – nearly 15 times the size of China’s economy at that stage. Over the years that gap narrowed. In 2020, the U.S. economy was about 1.5 times the size of the Chinese economy. As the Chinese economy was posting double-digit annual growth rates, starting from a smaller base, the U.S. economy grew a slower pace consistent with its being a mature economy.

How did China’s economy prosper and become a major player on the world stage? It’s vast labor pool provided the foundation for growth, focusing on exports and wresting the title of World’s Second Largest Economy from Japan, which also thrives on exports but has higher production costs. In fact, China is the top supplier of goods to the United States, and is the third largest market for U.S. products, with the countries locked in a symbiotic trade relationship despite the occasional political flare ups.

Exports have been the centerpiece of the Chinese economy, and their growth over the years have been significant. In 1990, China was exporting a mere $60 billion worth of goods and services. Exports began to take off in earnest in 2002, from $256 billion to $1.61 trillion in 2008. Exports were set back during the recession that year. The recovery began in 2009 to top $2 trillion in 2011 and $2.7 trillion in 2014. A slowdown in exports in 2015 marked China’s slowest annual pace of growth in more than two decades.

China’s labor force has been instrumental in the country’s growth, powered by the massive movement from rural to urban areas over the last several decades. In the 2020s, though, the rural to urban migration is expected to slow. And, the overall labor force is now shrinking (Figure 3), with more people leaving the workforce then are entering it – the result of an aging population and the one-child policy that was abandoned in 2016. China now allows couples to have three children per family, but the effects of this could take a generation or more to bolster the working population. And, many Chinese in their 20s and 30s were born into one-child families, and plan on having a one-child family themselves. The overall demographic result is a rapid increase percent of Chinese in the over-65 category (Figure 4).

Most recently, China’s economy has slowed sharply in late 2021 and early 2022 to below 5% growth rates and China isn’t alone in experiencing a slowdown. The International Monetary Fund (IMF) expects global growth to moderate from 5.9% in 2021 to 3.9% in 2022 (down from its January forecast of 4.4%), largely reflecting its scale-back in forecasts for the U.S. and China. The IMF cites renewed disruption from the pandemic and financial stress among property developers for a 0.8% mark down. The bank, however, upgraded its forecast for 2023 to 3.8% from 3.6% due to “a mechanical pick up after current drags on growth dissipate in the second half of 2022.”

China made a strong recovery from the pandemic slump amid a surge in exports of manufactured goods as demand shifted away from the services sector during lockdowns. But as economies reopen, at their own pace, there are expectations for consumers to return to a life of dining-in at restaurants, entertainment events and enjoy once again domestic and international travel. In the past, China’s government has used generous fiscal policies to shore up any slack in the economy. But, over the long-term, this could be a challenge due to large debt relative to its GDP.

Because China maintains relatively strict regulations on the flow of capital into and out of the country, export growth plays a much more important role in exchange rate dynamics than for most countries. And, it has been the strong pace of China’s exports which has underpinned its yuan, strengthening over the past two years against the U.S. dollar from 7.10 yuan to the dollar to the 6.30-6.40 range. But the recent lockdowns in China had the yuan weakening to the lowest level in a year against the dollar (Figure 5).

The yuan’s relative strength contrasts with the slump of the Japanese yen to 20-year lows against the greenback, which is also at multi-month highs against a basket of currencies including the euro, British pound and Canadian dollar, among others. For countries allowing a relatively free flow of capital, the recent driver of exchange rates versus the U.S. dollar has focused on the shift in Federal Reserve policy from near-zero rates to raising rates, and from balance sheet expansion to shrinkage. The Fed’s shift away from accommodation and toward a more neutral monetary policy is in contrast to the European Central Bank, which still maintains a negative short-term rate policy, and the Bank of Japan, which continues to hold both short-term and long-term rates near zero. Hence, the dynamics of the Chinese yuan are less swayed by shifts in monetary policy and more driven by its export growth.

Will the yuan maintain its relative strength against the dollar or will it weaken further? It is an open question, but if the past is any guide, export growth will be key, rather than shifts in monetary policy at the Fed. And, there are several scenarios for export growth. The pandemic brought a shift in spending in the U.S. and in Europe away from services and towards goods, many of which are produced and exported by China.  Within China, the degree of lockdowns due to COVID at port cities, such as Shanghai, may also slow exports by delaying shipping.

As Europe and North America move toward a more open and less restrictive management of COVID-19, essentially shifting from pandemic to endemic, many analysts expect a return to more personal income being spent on services, that is restaurants, travel, etc., and less on goods. To date, however, even as economies have re-opened, spending on goods remains elevated relative to services. Then there is also the relationship of Chinese exports to global growth. If global growth slows, as the IMF suggests it might, then Chinese exports may decelerate as well. In sum, the Chinese yuan may be in the crosshairs of any change in consumption patterns back toward goods or a slowdown in global growth.