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Charles Burton is an associate professor of political science at Brock University in St. Catharines, Ont., and is a former counsellor at the Canadian Embassy in Beijing.

China's aggressive move to manipulate the value of its currency tells us two things: Its economy is in much

deeper trouble than had been thought, and Beijing's crackdown on corruption is turning out to be a double-edged sword.

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China stunned world markets this week by abruptly devaluing its currency 2 per cent on Tuesday, then letting it slide further on Wednesday, instantly rendering Canadian goods and services more expensive in China, making Chinese exports cheaper for Canadians to buy, and leaving our trade deficit even worse from a Canadian perspective.

The cheaper yuan also makes Chinese goods more competitive abroad than those of other Asian exporting countries. This will probably lead those countries to also devalue their currencies – more bad news for Canada. And imported oil will become more expensive in China, which has all sorts of commensurate impacts for China's airlines and manufacturers, global commodity prices and the Canadian economy in general.

We already knew things are not well with China's economy. Exports plummeted 8.3 per cent year-over-year in July; the manufacturing sector is badly underperforming expectations; and China's stock market is in crisis, increasingly dependent on government support that cannot be sustained indefinitely. But the surprise devaluation is a strong signal that the economy is in even worse shape than the Communist leadership had believed.

It is not a decision Beijing will have taken lightly. For one thing, it will surely lead to even more capital flight, Canada being a prime destination for Chinese citizens seeking a haven for their wealth. It will also discourage foreign investment in China; nobody wants to board a sinking ship.

This week's developments threaten the entire global economy. So what can China or even the World Bank or IMF do to turn this situation around?

Economist Friedrich Hayek wrote, "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design." But Mr. Hayek was a champion of classical liberal economics, and China's state capitalism operates quite differently. The bottom-line factor in China's economic decline seems tied to the political, not economic, policies of Xi Jinping's leadership since he became General Secretary of the Chinese Communist Party in 2012.

The hallmark of Mr. Xi's rule has been a massive clampdown on officials in government or state-owned enterprises who have accumulated great wealth beyond their very modest state salaries. Initially, this was seen as just another campaign to purge political factions that had been discomfited by Mr. Xi's assumption of power. After all, politicians on the outs in China are routinely convicted of corruption and sent to prison.

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However, Mr. Xi's anti-corruption campaign is very popular with most people in China, and shows no signs of slowing down. But, ironically, the anti-corruption crusade meant to squeeze China's culture of business corruption is also squeezing China's economic growth.

Incarceration is a looming nightmare for the burgeoning ranks of Party elite whose families live beyond their legitimate means, and who have yet to "fall into the web," as the Chinese press puts it. Tranche after tranche of wealthy Communists in the state and military are being subject to confinement, torture, interrogation and the seizing of their assets. The Xi regime is even pressing foreign governments to deport corrupt Chinese officials who have sought refuge abroad – and are offering co-operative foreign governments a cut of the seized assets.

With the penalties for bribery, insider dealings, tax evasion and holding large sums of cash too high to risk being involved in many conventional Chinese business ventures, "political entrepreneurs" are finding it prudent to sit things out for the time being. And because many corrupt business networks have been decimated by the arrests of their key players, these will take some time to revive. Meanwhile, economic activity has slowed, and the national numbers look worse and worse.

For Xi Jinping's economic advisers, it's a classic Catch-22: In a state economic system where corruption is what oils the machine of business activity, how do you keep things going when the incentive of ill-gotten wealth is suddenly supplanted by the prospect of torture, prison and family ruin?

China's economic slowdown is not just due to economic factors; political moves also play a significant role. On the one hand, the Chinese political system is threatened by unchecked corruption on the part of the Communist political and business elite. On the other hand, people support the continued authoritarian rule of the Communist Party because it has been able to deliver high economic growth rates and a stronger nation.

China's closed-state capitalist political economy is just not sustainable without transparency, accountability and the genuine rule of law by an independent judiciary. Even Mr. Hayek would have to agree that the People's Republic of China is just as subject to the universal laws of economics as every other nation in the world.

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The problem for the Chinese Communist Party is that, in the end, the liberal economies only sustain in liberal democracies.

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