Kim Kyung-Hoon / Reuters A man sits in front of an investment company's advertisement board bearing the image of Chinese Yuan at a financial district in Beijing, July 10, 2015.

China Hits the Wall

The Yuan Devaluation and the End of the Economic Miracle

For the first time since 2008, economic alarm bells are ringing in China. Hard on the heels of a two-month stock market rout, the Chinese yuan lost nearly five percent of its value in just two days. The stock market might have rebounded, but the economy is still in trouble. Three and a half decades of easy profits from one-way bets on China's reintegration with the outside world have come to an end. China is now part and parcel of the global economy, and the normal laws of economic gravity apply in China, too. The first of those laws is that there's no such thing as a free lunch.

There is a financial crisis brewing in China, but the usual bugbears of the stock market, declining exports, and even the yuan crash are only appetizers, not the main course. The coming crisis has much more to do with demographic stagnation, capital flight, and the decision in 2013 to give the market a “decisive” role in China's economic development. These trends will combine over the next few years to make it increasingly difficult for administrators at all levels of the Chinese government to meet their financial obligations.

Investors look at computer screens showing stock information at a brokerage in Shanghai, August 13, 2015.

Investors look at computer screens showing stock information at a brokerage in Shanghai, August 13, 2015.

The problem in a nutshell is that as China develops into a middle-income country, the social demands placed on its government are rising faster than the country’s GDP. The recent slowdown in GDP growth has only exacerbated a long-standing trend. Social luxuries such as free public education, adequate health care, and old-age pensions are expensive, and as Americans and Europeans know all too well, their costs tend to rise faster than inflation. China's rapidly aging population will require more and more of these services in the future.

THE TAXMAN COMETH

So far, China has kept up with expanding budgetary demands through improved tax efficiency and large-scale asset sales. These are both one-time fixes. In 2008­–09, China restructured its value-added and corporate income taxes, reducing most headline tax rates while improving the efficiency of collection. Revenues from these in 2013.

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