The China Colossus: A Maturing Economy?

The global financial markets were agog last week at the news of China’s decision to modify its long established monetary policy. According to the People’s Bank of China, the government intends to relax its peg of the yuan to the U.S. dollar and gradually permit the value of its renminbi currency to fluctuate in value.

Some pundits scoffed at the gradual nature of this implementation period, noting with skepticism that the policy declaration could simply represent a public relations gesture in advance of the world’s G-20 meeting in Toronto. They noted, with some justification, that a vague promise to implement a gradual change of policy can hardly be considered an iron-clad commitment.

Nevertheless, when viewed in context with other economic circumstances that are now impacting China, it becomes easier to assert that this policy declaration is no mere public relations ploy. Instead, it may represent a clear indicator that China itself is rapidly evolving from an emerging third world economy into a maturing modern economy.

Centuries vs. Decades

You may, of course, be startled by the speed of China’s economic evolution. After all, the United States needed two full centuries to progress through its period of mass industrialization, beginning with the development of water powered textile mills in New England and extending through the emergence of today’s digital information economy. And even Japan needed 130 years to evolve from the closed Shogun society that confronted American Commodore Matthew Perry in 1853, to the economic marvel that challenged the United States for global dominance in the 1980s.

China, in contrast, waited until 1972 to first welcome an American President on an official state visit to Beijing, and then waited another seven years to first make a reciprocal visit to Washington DC. Although its economic modernization program did not begin to produce noteworthy advances in standards of living until the following decade, it is today the world’s third largest economy, and is projected by many to overtake Japan and the United States as well.

Nevertheless, its Gross Domestic Product per capita continues to trail the G.D.P. levels found in most of the mature western economies. And Chinese representatives themselves acknowledge that the nation is still climbing the global technology ladder. So even though China’s rise into the Top Three global economies was accomplished in a very brief period of time, is it reasonable to now consider the colossus a truly mature economy?

The Cost of Success

One of the unpleasant side effects of achieving success in any field is the cost burden that inevitably follows it. Newly elected heads of state, for instance, often complain about being placed in protective bubbles that isolate them from their own electorates. And sports stars similarly complain that huge compensation contracts create unattainable expectations of future glory that result in fan backlashes.

Likewise, the success of any national economy inevitably gives rise to serious problems. Some geographic regions may grow more affluent than others, leading to internal strife and disruptive population migrations. Labor leaders may square off against their corporate managers to secure higher wages and better working conditions. And citizens, confident in their abilities to secure the basic necessities of life, turn their attentions to cultural issues such as education, the environment, and national pride.

America, for instance, was overwhelmed by such challenges after achieving its position of economic dominance in the twentieth century. Its civil rights and labor movements, the migration of northerners into the Sun Belt region, and the launch of Earth Day, the Women’s Rights movement, and even its Race to the Moon can be understood in terms of managing the costs of economic success. But can China’s recent decision about currency valuation be perceived in similar terms?

Maturing if Not Already Mature

China has certainly experienced many similar events and conditions. The concentration of wealth in its eastern cities, for instance, has led to wide scale migrations of rural residents in search of employment opportunities. And labor unrest has occurred as well, with automobile factories shutting down over wage disputes, and with highly publicized employee suicides plaguing an electronics component manufacturer.

For the past decade, though, there have been no major public uprisings on the mainland in support of human rights or environmental protections. Nevertheless, such protests have indeed occurred in Hong Kong. Furthermore, China has invested billions in an Olympic Games, a World Expo, a Moon Landing program, and other projects that have been designed to foster a sense of national pride.

Despite its stature as the third largest economy in the world, China’s relatively low levels of per capita income and technological sophistication may indeed signify that it is not yet a fully mature economy. Nevertheless, if not yet fully mature, China’s economy is certainly rapidly maturing, and thus its decision to permit its currency to float may simply represent an inevitable step in the direction of maturity.

Is There Gold In the Economy’s Future?

During the great American gold rush of the late 1840s, prospectors sold their life’s possessions to dash into the Western hills of California and Nevada to search for tiny nuggets of gold. By finding a gold mine, they believed, they could guarantee themselves a lifetime of stable wealth.

Over the years, though, the value of gold itself has not always remained stable. For instance, although the precious metal was worth well over $800 an ounce in January 1980, it collapsed in value below $300 an ounce in 1999. But then, during the past decade, it soared well past $1,000 an ounce and actually surpassed $1,200 an ounce last week.

What is it about gold, though, that has created such faith in its ability to function as a storehouse of wealth? And why has its value fluctuated so dramatically during the past three decades?

Throughout Human History

Though gold is simply a compound that is mined from the earth, it is also a precious metal that has been treasured throughout human history for its shiny quality and its malleability. Because of these characteristics, it is considered an ideal compound for jewelry and other decorative, artistic, and industrial products.

The ancient Egyptians and Romans both relied on gold for such purposes. Gold also appeared prominently in the Old and New Testaments, such as in the story of the golden calf that was created by Moses’ brother Aaron, as well as in the description of the streets of Heaven as being paved with gold. More recently, governments from the United States to South Africa have issued gold coins as storehouses of wealth, and the word “gold” itself has been used to connote value and stability for everything from macadamia nuts to greeting cards.

But even though these historical precedents may explain why gold maintains its popularity in the 21st century, they cannot explain why the precious metal’s value has been so volatile during the past thirty years. Indeed, to make sense of its fluctuations in value, it is necessary to understand the volatile nature of our global system of floating currencies.

Gold as a Reserve Currency

In response to the global devastation of the Second World War, the world’s finance ministers met at the Mount Washington Hotel in Bretton Woods, New Hampshire in 1944 to develop a new monetary system. They created an interlocking network of national currencies, with each sovereign nation entrusted with the management of its own currency. Global transactions, though, were generally priced and consummated in U.S. dollars because the American economy produced 35% of the world’s economic output at the time.

Over the years, though, different nations adapted different strategies for managing the value of their respective currencies. Many empowered their national banks and government treasury departments to permit their currency values to be determined by free market traders, although they periodically attempted to influence those values through strategically timed interventions. Other nations, ranging from China to Venezuela, have at times attempted to peg their currency values to the value of the American dollar. And yet other countries, such as the members of the European Union, have planned and achieved monetary union.

Throughout the years, though, the United States dollar has maintained its role as the world’s reserve currency for global transactions. Although some business and government leaders have advocated for the adoption of a truly global reserve currency, no one has yet devised an effective mechanism for replacing the American dollar with a more stable and reliable repository of wealth.

But then where have global traders turned when the dollar itself appeared to be shaky? The answer, it seems, has always been gold.

Roller Coaster Gyrations

Indeed, the major “roller coaster” gyrations of the value of gold during the past three decades have generally reflected the health of the American economy at those times. Gold prices soared in 1980, for instance, when the American economy was reeling from a decade marked by political upheaval, a costly and debilitating war in Vietnam, energy shortages, and massive unemployment and inflation. It then plummeted in 1999 when the American economy seemed incomparably powerful, with a balanced federal government budget, record employment levels, and an internet-enabled technology boom.

Today, of course, the American economy has been weakened by a recent economic crash, a tired banking system, and a fallen housing market. Thus, once again, gold prices have soared past their all-time highs in nominal terms and towards their historical highs in real inflation adjusted terms.

And thus exists the exquisite irony that lies at the base of our contemporary monetary system: we still rely on gold as our reserve currency of last resort, even though it is simply a natural metal that originally gained prominence many millennia ago because of its shininess and malleability! Nevertheless, if you wish to attempt to predict how gold’s value may trend in the future, you’ll first need to predict how the American economy will perform during that time.