China’s economy began its metamorphosis into what it is today with reforms initiated by Premier Dengxiao Peng in the 1970s and 1980s that included the crucial opening up of parts of the country to foreign investment, sowing the seeds for a flourishing private sector within a centrally planned economy (Figure 1).

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.

During the 2008 sub-prime mortgage recession, the U.S. economy contracted from $14.7 trillion to $14.4 trillion in 2009. It rebounded to $21.43 trillion in 2019 before slipping during the pandemic of 2020. Together, the U.S. and China account for 43% for the global economy valued at around $85 trillion in 2020, reflecting their influence with every twist and turn of their own respective pace of growth.

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.

Having been reliant on exports for its exponential growth for decades (Figure 2), China is now moving to make domestic consumerism its hallmark, just like the U.S., to tap into its growing middle class and its attendant affluence. China’s per capital income has surged from just $194 in 1980 to $10,434 in 2020, uplifting millions from an agrarian economy in a massive shift to industries and an urban lifestyle.

The global dependence on China as a “factory to the world” became evident during the height of the pandemic when supply chains were snarled by its lockdowns, and the subsequent rise in inflation as a sequestered world shifted its demand from services to manufactured goods produced primarily in China.

Thus, began a corporate push to diversify centers of production away from China to other countries in Asia, which could take years to materialize.

China is the most important external market for the U.S. agricultural sector, importing vast amounts of soybeans and corn for its livestock industries. More broadly, its top five trading partners are the U.S., Hong Kong, Japan, Vietnam and South Korea. China has extensive investments in resource-rich countries in Africa and Asia to provide the minerals and other resources Chinese industries require to keep them humming along.

In 2020, the top U.S. export to China was electrical machinery valued at $17 billion, followed by soybeans at $15 billion. Top U.S. imports from China were electrical machinery worth $111 billion, with furniture and bedding coming in fourth at $23 billion – which increased significantly in 2021 when American consumers switched from the service sector amid the lockdowns to remodeling their homes and buying new furniture and other manufactured products.

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 has been dealing with its troubled property sector by cutting benchmark mortgage rates to bolster home purchases, while at the same time the Peoples Bank of China (PBOC) has reduced short- and medium-term lending rates to bolster an economy that faltered in the fourth quarter of 2021 to 4% -- its slowest pace in decades except for the early 2020 lockdowns.

The IMF projects China’s growth to slow down to 4.4% in 2022 from a projected 7.9% in 2021 due to “to the rapid withdrawal of policy support, the lagging recovery of consumption amid recurrent COVID-19 outbreaks despite a successful vaccination campaign, and slowing real estate investment following policy efforts to reduce leverage in the property sector.”

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.