A laborer walks on scaffolding at a residential construction site in Qingdao, Shandong province, China on November 18, 2015. (© China Daily China Daily Infor)

When China's stock market tumbles — as it did this past week — world markets can't help but feel the effects. But how worried should we be about China's economy? It may be the second largest in the world, yet it remains opaque and misunderstood. Here are five common misconceptions.

1. China’s stock market losses reflect an ailing economy.

The dramatic declines in the Shanghai Composite Index this past week were linked to a report that the manufacturing sector is contracting and to broader concerns about China's economy.

But while China’s growth has indeed slowed, the country’s stock markets don’t say much about the overall health of its economy. The total value of all stocks traded on the Chinese exchanges amounts to only around one-third of its GDP (compared with 100 percent or higher in advanced economies such as the United States). Most of the traded stocks represent firms in the manufacturing and construction industries, which have certainly hit a rough patch. But the services sector, household income and consumption are holding up fairly well.

Additionally, while the Shanghai market is off nearly 40 percent from its June 2015 peak, it hit that peak after a massive run-up in the first half of the year, partly because of government cheerleading of the stock market. So the levels of China's major stock indexes are now roughly where they were one year ago — and at a level not that different from the gains an investor would have seen in the S&P 500 over the same period. That said, investing in the United States would certainly have not been such a heart-stopping ride.

2. China’s economic growth is driven primarily by cheap exports.

When Americans think of China, they may think of cheap consumer goods made by low-wage workers. The U.S. trade deficit with China continues to rise and is likely to top $350 billion for 2015, an all-time high. "China is killing us," Donald Trump likes to say.

But the value of exports from China is diminished by how much it imports in raw materials and intermediate goods. For instance, researchers found that only about 4 percent of the value of a "Made in China" iPhone is attributable to Chinese manufacturers. Components imported by China from countries such as Germany, Japan and South Korea account for most of the phone's value. Net exports — exports minus imports — have made only a modest contribution to China's growth over the past decade.

The main economic driver has been investment in physical capital, including factories and infrastructure such as roads and railways. Such investment has accounted for more than half of China's growth in the past decade.

Moreover, China is no longer a low-wage economy, as its wages are now rising faster than those in countries like Bangladesh and Vietnam. Even in its manufacturing sector, China has started moving up the value-added chain, shifting from a focus on low-cost, low-tech goods such as shoes and textiles to more sophisticated products with a higher technological content.

3. China is actively manipulating its currency.

Complaints about China's currency gaming are common among American lawmakers. "China has manipulated its currency for a long time," Sen. Charles Grassley (R-Iowa) said last summer. ". . . Administrations under both Democrat and Republican presidents have been too timid about taking action, and China has taken advantage in the meantime." On the other side of the aisle, Sen. Chuck Schumer (D-N.Y.) argued: "For years, China has rigged the rules and played games with its currency, leaving American workers out to dry. Rather than changing their ways, the Chinese government seems to be doubling down."

Except that this recent fusillade from Capitol Hill was prompted by China doing exactly what the United States has been asking it to do: ease up on management of the renminbi’s exchange rate, relative to other currencies, so that its value can be more freely determined by market forces. What the United States didn’t anticipate was that Beijing would cleverly do this when it was convenient for China but not for its trading partners. Rather than changing its policy at a time when the renminbi might appreciate, which would hurt China’s exports by making them more expensive, the government picked a time when market forces were pushing the currency downward, which helps China’s exports. China wasn’t being underhanded; it was protecting its interests.

Since August, China's central bank has been intervening in foreign exchange markets — but to keep the renminbi's value from falling too much, not to keep it from rising too fast.

4. China cooks the books to make its economy look stronger.

Many analysts consider China's GDP growth statistics to be purely figments of official imagination. As Tim Worstall wrote for Forbes, "Informed observers don't believe a word about what we're being told." Reported GDP growth is usually suspiciously close to official growth targets. And although China's official growth rate is 7 percent, some Western economists estimate it at 3 percent or less.

There are many legitimate questions about China’s GDP growth data measured from quarter to quarter. Recent figures on electricity consumption, freight volumes and bank lending all point to much weaker growth than the composite data suggests. Over longer periods, however, the growth data is probably a more reasonable representation of what is happening in the economy and lines up with other indicators such as household income and spending.

Now that China is such a large economy, it can’t be expected to perpetually grow at rates of 10 percent or more. In the short term, it can use monetary and fiscal policy measures to keep growth in the range of 6 to 7 percent. But unless China actively pursues market-oriented reforms, it will be difficult to sustain high growth beyond that, especially with an aging and shrinking labor force.

5. The renminbi’s new status threatens the dollar’s dominance.

In November, the International Monetary Fund announced that it would recognize the renminbi as an official reserve currency. The move compounded fears that, as reported by Britain's Telegraph, "US economic dominance [is] at an end as China's currency rises."

Not quite. China's renminbi has certainly become an important international currency. About a quarter of China's trade is now priced and settled in renminbi, and the IMF estimates that about 1 percent of global foreign exchange reserves are held in renminbi-denominated assets, which is more than the shares of some well-known reserve currencies such as the Swiss franc.

However, the U.S. dollar still accounts for nearly two-thirds of global foreign exchange reserves, a share that has in fact increased slightly since the financial crisis.

International investors, including foreign central banks, will continue investing in renminbi for diversification purposes. But for its currency to seriously rival the dollar, China will have to earn foreign investors’ trust. This will require not just economic reforms but also broader legal, institutional and political reforms. None of these is on the horizon, so for now, the dollar’s position is secure.

Twitter: @EswarSPrasad

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