WHAT if we could just be China for a day?” mused
Thomas Friedman, an American columnist, in 2010. “…We could actually, you know,
authorise the right solutions.” Five years on, few are so ready to sing the
praises of China’s technocrats. Global markets have fallen by 7.1% since
January 1st, their worst start to the year since at least 1970. A large part of
the problem is China’s management of its economy.
For well over a decade, China has been the
engine of global growth. But the blistering pace of economic expansion has
slowed. The stockmarket has been in turmoil, again. Although share prices in
China matter little to the real economy, seesawing stocks feed fears among
investors that the Communist Party does not have the wisdom to manage the move
from Mao to market. The rest of the world looks at the debts and growing labour
unrest inside China (see article), and it shudders. Nowhere are those worries
more apparent—or more consequential—than in the handling of its currency, the
yuan.
China’s economy is not on the verge of collapse.
Next week the government will announce last year’s rate of economic growth. It
is likely to be close to 7%. That figure may be an overestimate, but it is not
entirely divorced from reality. Nevertheless, demand is slowing, inflation is
uncomfortably low and debts are rising. The bullish case for China depends
partly upon the belief that the government can always lean against the slowdown
by stimulating consumption and investment with looser monetary policy—just as
in any normal economy.
Yet China is not normal. It is caught in a
dangerous no-man’s-land between the market and state control. And the yuan is
the prime example of what a perilous place this is. After a series of
mini-steps towards liberalisation, China has a semi-fixed currency and
semi-porous capital controls. Partly because a stronger dollar has been
dragging up the yuan, the People’s Bank of China (PBOC) has tried to abandon
its loose peg against the greenback since August; but it is still targeting a
basket of currencies. A gradual loosening of capital controls means savers have
plenty of ways to get their money out.
A weakening economy, a quasi-fixed exchange rate
and more porous capital controls are a volatile combination. Looser monetary
policy would boost demand. But it would also weaken the currency; and that
prospect is already prompting savers to shovel their money offshore.
In the last six months of 2015 capital left
China at an annualised rate of about $1 trillion. The persistent gap between
the official value of the yuan and its price in offshore markets suggests
investors expect the government to allow the currency to fall even further in
future. And, despite a record trade surplus of $595 billion in 2015, there are
good reasons for it to do so, at least against the dollar, which is still being
propelled upwards by tighter monetary policy in America.
The problem is that the expectation of
depreciation risks becoming a self-fulfilling loss of confidence. That is a
risk even for a country with foreign-exchange reserves of more than $3
trillion. A sharply weaker currency is also a threat to China’s companies,
which have taken on $10 trillion of debt in the past eight years, roughly a
tenth of it in dollars. Either those companies will fail, or China’s
state-owned banks will allow them to limp on. Neither is good for growth.
The government has reacted by trying to rig
markets. The PBOC has squeezed the fledgling offshore market in Hong Kong by
buying up yuan so zealously that the overnight interest rate spiked on January
12th at 67%. Likewise, in the stockmarket it has instructed the “national team”
of state funds to stick to the policy of buying and holding shares.
One step back,
two forwards
Yet such measures do nothing to resolve a
fundamental tension. On the one hand, the state understands that the lack of
financial options for Chinese savers is unpopular, wasteful and bad for the
economy. On the other, it is threatened by the ructions that liberalisation
creates. For Xi Jinping, the president, now in his fourth year in charge, that
dilemma seems to crop up time and again (see Briefing). He needs middle-class support, but feels
threatened by the capacity of the middle class to make trouble. He wants
state-owned enterprises to become more efficient, but also for them to give
jobs to the soldiers he is booting out of the People’s Liberation Army (see article). He wants to “cage power” by strengthening the
rule of law and by invoking the constitution, yet he is overseeing a vicious
clampdown on dissent and free speech.
It is easy to say so now, but China should have
cleaned up its financial system and freed its exchange rate when money was
still flowing in. Now that the economy is slowing, debt has piled up and the
dollar is strong, it has no painless way out.
A sharp devaluation would wrong-foot
speculators. But it would also cause mayhem in China and export its
deflationary pressures. The poison would spread across Asia and into rich
countries. And because interest rates are low and many governments indebted,
the world is ill-equipped to cope.
Better would be for China to strengthen capital
controls temporarily and at the same time to stop stage-managing the yuan’s
value. That would be a loss of face for China, because the IMF only recently
marked the yuan’s progress towards convertibility by including it in the basket
of currencies that make up its Special Drawing Rights. But it would let the
country prepare its financial institutions for currency volatility, not least
by starting to scrub their balance-sheets, before flinging their doors open to
destabilising flows. Mr Xi could embrace more complete convertibility later,
when they were less vulnerable.
One reason the PBOC is rushing towards
convertibility, despite the risks, is that it feels that it must seize the
chance while it has Mr Xi’s blessing. But better to retreat temporarily on one
front than to trigger a global panic. That might also lead to some clearer
thinking. There is a contradiction between liberalisation and party control,
between giving markets their say and silencing them when their message is
unwelcome. When the time is right, China’s leaders must choose the markets.
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