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Get article background GLOBAL tremors in the currency, bond and commodity markets greeted China' s announcement that the yuan will no longer be pegged to the dollar. No longer is it just Washington that has the power to cause shockwaves. For many people, the tremors reflected the view that China is the root caus e of America's trade deficit, and that the revaluation is a partial cure . China is not the main caus e of the American trade deficit. On the other hand, China is behind almo st everything else going on in the world economy. For China is beginning to drive, in a new and pervasive way, economic trends that many countri es assume to be domestically determined. Americans like to slap the made in China label on their huge trade defi cit. Yet not only is China's forecast current-account surplus of around $100 billion this year only a fraction of America's likely deficit of $8 00 billion, but, as chart 1 shows, most of the increase in America's tra de deficit has come from outside China. The main cause of America's trad e deficit is a lack of domestic saving, not unfair Chinese competition. As for last week's revaluation, the announcement marked a significant bre ak with the past. China has long been under pressure to revalue its curr ency from countries that claim the undervalued yuan gives Chinese export ers an unfair advantage. After pegging the yuan to the dollar for a deca de, China has shifted to a managed float against a basket of currencies, with an initial revaluation against the dollar of 21%. It may be just a token move aimed at warding off American protectionism. Or it could be the first of several revaluation s, marking the end of the so-called revived Bretton Woods system, unde r which China and other Asian countries have bought billions of dollars in foreign-exchange reserves to hold their currencies steady against the greenback. Either way, the tiny revaluation by itself will have little impact on Ame rica's huge trade deficit. Indeed, even if the yuan is allowed to rise b y another 5-10% over the next 12 months, as many economists expect, that would hardly make a dent in the deficit. Nevertheless, it is still an i mportant change in China's exchange-rate regime, representing a step tow ards a market-based system. And, as such, it could have implications for the dollar, bond yields, and American consumer spending. To view China's global impact mainly in terms of its exports and its trad e surplus is to misunderstand, and to underestimate, the profound forces behind China's growing influence. Everyone knows that most TVs and T-sh irts are made in China. But so, in some ways, are developed countries' i nflation rates, interest rates, wages, profits, oil prices and even hous e pricesor at least they are strongly influenced by what happens in Chi na. Of course, China is not the only fast-growing emerging economy that is ma king waves around the world. But China really does loom much larger: its contribution to global GDP growth since 2000 has been almost twice as l arge as that of the next three biggest emerging economies, India, Brazil and Russia, combined. Moreover, there is another crucial reason why Chi na's integration into the world economy is today having a bigger global impact than other emerging economies, or than Japan did during its perio d of rapid growth from the mid-1950s onwards. Uniquely, China combines a vast supply of cheap labour with an economy that is (for its size) unus ually open to the rest of the world, in terms of trade and foreign direc t investment. The sum of its total exports and imports of goods and serv ices amounts to around 75% of China's GDP; in Japan, India and Brazil th e figure is 25-30% (see chart 2). As a result, the dragon's awakening is more traumatic for the rest of the world. Doubling the world's workforce Most analysis of China's growing importance focuses on its rising share o f global output and exports. That, in turn, fuels fears that China is st ealing production and jobs from the rest of the world. It is true that China's trade surplus has increased sharp ly this yearmainly because the government's efforts to cool fixed inves tment have cut back imports. But over the past decade, China's imports h ave risen at the same pace as its exports. So China is giving a big boos t to both global supply and demand. China's impact on the world economy can best be understood as what econom ists call a positive supply-side shock. Richard Freeman, an economist at Harvard University, reckons that the entry into the world economy of China, India and the former Soviet Union has, in effect, doubled the glo bal labour force (China accounts for more than half of this increase). T his has increased the world's potential growth rate, helped to hold down inflation and triggered changes in the relative prices of labour, capit al, goods and assets. The new entrants to the global economy brought with them little capital o f economic value. So, with twice as many workers and little change in th e size of the global capital stock, the ratio of global capital to labou r has fallen by almost half in a matter of years: probably the biggest s uch shift in history. And, since this ratio determines the relative retu rns to labour and capital, it goes a long way to explain recent trends i n wages and profits. In America, Europe and Japan, the pace of growth in real wages has been u nusually weak in recent years. Indeed, measured by the growth in income from employment, this is America's weakest recovery for decades. Accordi ng to Stephen Roach, an economist at Morgan Stanley, American private-se ctor workers' total compensation (wages plus benefits) has risen by only 11% in real terms since November 2001, the trough of the recession, com pared with an average gain of 17% over the equivalent period of the five previous recoveries (see chart 3). In most developed countries, average real wages have lagged well behind productivity gains. The entry of China's vast army of cheap workers into the international sy stem of production and trade has reduced the bargaining power of workers in developed economies. Although the absolute number of jobs outsourced from developed countries to China remains small, the threat that firms could produce offshore helps to keep a lid on wages. In most developed c ountries, wages as a proportion of total national income are currently c lose to their lowest level for decades. The flip side is that profits are grabbing a bigger slice of the cake (se e chart 4). Last year, America's after-tax profits rose to their highest as a proportion of GDP for 75 years; the shares of profit in the euro a rea and Japan are also close to their highest for at least 25 years. China's emergence into the world economy has made labour relatively abundant and capital relati vely scarce, and so the relative return to capital has risen. It is iron ic that western capitalists can thank the world's biggest communist coun try for their good fortune. China's main impact on the world economy is to change relative prices and incomes. Not only are the prices of the goods that China exports fallin g; the prices of the goods that it imports are rising, notably oil and o ther raw materials. China is already the world's biggest consumer of man y commodities, such as aluminium, steel, copper and coal, and the second -biggest consumer of oil, so changes in Chinese demand have a big impact on world prices. China has accounted for one-third of the increase in global oil demand si nce 2000 and so must bear some of the blame for higher oil prices. Likew ise, if China's economy stumbles, then so will oil prices. However, with China's oil consumption per person still only one-fifteenth of that in America, it is inevitable that China's energy demands will grow over the years in step with its income. There is currently only one car for every 70 people in China, against one car for every two Americans. That implies a huge increase in oil demand , which could keep prices high for the foreseeable future, because of sc arce global spare capacity. China's consumption per person of raw materi als, such as copper and aluminium, is a...
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