The great Henry Paulson-led expedition to China ended a few days ago, and beyond the purchase of a few nuclear reactors, it's not clear that any policy movement took place. Indeed, the most notable event of the trip was what Fed Chairman Ben Bernanke planned to say but did not actually say:

Federal Reserve Chairman Ben S. Bernanke urged China to let its currency gain at a faster pace to end a "distortion'' that benefits exporters.

Bernanke in a speech at the Chinese Academy of Social Sciences edged away from his prepared remarks, which called an "undervalued'' yuan an "effective subsidy'' for exports. Using the subsidy label would have implications for China's compliance with World Trade Organization rules and could feed Congressional pressure to impose trade sanctions, analysts said.

Bernanke doesn’t connect the surge in China’s exports to the real depreciation of the dollar, and the real depreciation of the RMB, but I will. The RMB's link to the dollar is a bigger political issue in the US than in Europe, but China’s exports to Europe have actually grown faster than its exports to the US over the past few years....

The RMB’s de facto link to the dollar has become a major distortion in the world economy. But I do worry that the issue has now been framed in a way that makes any appreciation of the RMB – a move that many think is in China’s own interest – appear to be a concession to the US.

I also worry though that China’s emphasis on its own sovereign rights -- including its own sovereign right to peg to the dollar and subsidize the US Treasury -- misses a key point. China is no longer a small part of the world economy. China, inc single-handedly may finance about 1/3 of the US current account deficit in 2007. Its domestic policy choices increasingly impact the world. China's policy choices are a growing concern of the rest of the world.

Right now, China is worried about too much growth and an overheated economy, not too little growth. A stronger RMB could substitute for administrative controls on investment. Rather than leading to slower growth, a stronger RMB might help to rebalance the basis of Chinese growth.

In the past few months, China has used a host of measures -- limits on bank lending, delays approving big projects and the like -- to slow investment. With strong exports and a rapidly rising trade surplus contributing strongly to China's current growth (see Nick Lardy), China in sense has been forced to take steps to curb domestic demand growth to keep China's economy from overheating....

If exports weren't growing so fast -- the World Bank expects net exports will contribute 3 percentage points to q3 growth in China -- China's macroeconomic policy high command would have more scope to let the components of domestic demand rise more rapidly. There would be less of a (macroeconomic) case for restraining investment. China could let the banks lend out some of the spare cash, rather than forcing them to lend those funds to the central bank. And the government could take a host of policy steps to stimulate consumption without worrying about overheating.

So, the question is, why isn't China pursuing this course of action? A few possibilities:

1) Interest group politics exist in China, and the export lobby is very powerful. That's the implicit argument in this Steven Weisman piece for the NYT:

American officials and specialists on China have said that Wu Yi, a vice prime minister and the country’s highest-ranking female official, might not have the inclination, or the influence, to challenge the party apparatus that is tied to the sprawling state-owned export industries....

“I’m not expecting any miracles,” said Yu Yongding, director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences in Beijing.

“This visit by Mr. Paulson will have some influence on Chinese political leaders, but China always prefers gradualism,” he said....

“I have been arguing for a change in economic policy for years, but my voice is quite lonely,” Mr. Yu said. He added that however understanding Ms. Wu might be, she and the Communist Party are largely beholden to China’s export sector, which accounts for more than a third of the country’s economy (emphasis added).

2) The Chinese leadership is worried about domestic political stability: Howard French's story about Shenzen in today's New York Times

Shenzhen owed its success to a simple formula of cheap land, eager, compliant labor and lax environmental rules that attracted legions of foreign investors who built export-based manufacturing industries. With 7 million migrant workers in an overall population of about 12 million — compared with Shanghai’s 2 to 3 million migrants out of a population of 18 million — Shenzhen became the literal and symbolic heart of the Chinese economic miracle.

Now, to other cities in China, Shenzhen has begun to look less like a model than an ominous warning of the limitations of a growth-above-all approach.

While grueling labor conditions exist in many parts of China, Shenzhen’s gigantic plants, employing as many as 200,000 workers each, have established a particular reputation for harshness among workers and labor advocates. Monthly turnover rates of 10 percent or more are not uncommon, labor groups say.

The tough working conditions, in turn, have helped spawn one of the most important labor developments in China in recent years: large-scale wildcat strikes and smaller job actions for better hours and wages....

Increasingly short of workers, factories recently have increased assembly-line wages by as much as 20 percent. But even so, critics say, Shenzhen’s boom has spread little wealth.

While the city is dependent on migrant labor to keep its factories running, onerous residency rules discourage migrants from settling here permanently and make it difficult for them to obtain public services from education to health care.

“The government has evaded its responsibilities toward migrant workers,” Jin Cheng, a member of an influential local civic forum, Interhoo, said bluntly.

The resulting rootlessness has fed a wave of crime of a sort hardly ever seen elsewhere in China. Gunfights, kidnappings and gang warfare are rife, and crime rates are skyrocketing.

Although the city does not publish crime data, the Southern Metropolitan News, one of the most reputable Chinese newspapers, reported that there were 18,000 robberies in 2004 in Baoan, one of six districts in Shenzhen. By comparison, in Shanghai, a city of around 18 million, there were only 2,182 reported robberies for all of 2004, according to figures compiled by the city....

“Shenzhen may seem prosperous,” a worker said, sitting in his bunk in a steamy dormitory, “but it’s a desperate place.”

While the story makes it clear that China's government and regions have rejected Shenzen model going forward, the problem is that it's still the policy in Shenzen and other coastal megalopolises. Shifting away from this paradigm will not be easy, and China's administrative controls are of limited use. If crime and labor unrest are a problem with 10% growth, what happens if growth slows down?

It would be a grand irony if Marx's prediction of a proletariat uprising were to take place in China.

3) China views the world through a relative gains lens. This is what realists have been claiming for some time. The problem with this argument is that China's growth is too export-dependent -- a realist would be much more comfortable with domestic-led growth. Still, it's a possibility to consider.

Readers are encouraged to offer their answers to the China puzzle.