The China Delusion

NEW YORK – China’s management of its exchange-rate peg continues to rattle global financial markets. Ongoing uncertainty about renminbi devaluation is fueling fears that deflationary forces will sweep through emerging markets and deliver a body blow to developed economies, where interest rates are at or near zero (and thus cannot be lowered to defend against imported deflation). Fiscal gridlock in both Europe and the United States is heightening the angst.

But the current bout of exchange-rate anxiety is really just a symptom of the fact that China’s transition from an export-led growth strategy to one propelled by domestic consumption is proceeding far less smoothly than hoped.

For some people, visions of the wonders of capitalism with Chinese characteristics remain undiminished. They are certain that, after more than three decades of state-directed growth, China’s leaders know what to do to turn their slumping economy around.

The optimists’ unreality is rivaled by that of supply-siders, who would apply shock therapy to China’s slumping state sector and immediately integrate the country’s underdeveloped capital markets into today’s turbulent global financial system. That is a profoundly dangerous prescription. The power of the market to transform China will not be unleashed in a stagnant economy, where such measures would aggravate deflationary forces and produce a calamity.