China’s economy
The
yuan and the markets
Strains
on the currency suggest that something is very wrong with China’s
politics
Jan 16th 2016 | From
the print edition
“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.
Daily dispatches:
China's stockmarket mess
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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