At the beginning of 2013, I published a post on the state of the four most developed economies in the world: the USA, the Euro-Zone, Japan and the UK. On that occasion, I complained that unfortunately I had not been able to provide any coverage about China, among other countries. This post attempts to rectify this gap.
The main problem I had when I started looking at China was the very superficial level of my knowledge.
“China’s a developing economy. It’s growing fast because it has a lot of relatively easy catching up to do. This is facilitated by an authoritarian regime which is particularly good at galvanising resources and doing this sort of thing. The same political system will become problematic when catching up is over, growth becomes driven by innovation which require political stability of a non-repressive kind. Debt dynamics are likely to become a driver which could create an unsustainable credit situation. Opening up the financial system is likely to be considered a solution to this problem. This is where the trilemma of international economics will come in play and where potential desiquilibria are likely to emerge, with a number of possible bubbles showing up.”
That was what I knew. No detail.
While that’s broadly correct, the detail is fascinating and important. It shows how China has been allocating resources inefficiently due to a system of institutionalised authoritarianism that subordinates most economic decisions to the interests of the political elites and the survival of the one party-system. As they become older and more productive, the majority of the population saves more but these funds are then channelled by uncompetitive banks and more innovatively by broader financial markets to feed real estate bubbles and investment in manufacturing in order to meet the targets set by the Chinese government. The financial system, while sophisticated in its tools, provides very limited value for depositors due to lack of competition. Capital controls are used to manipulate exchange rates, in a stubborn confusion of exports as an intrinsic means to growth rather than its consequence. Although bond markets remain the remit of domestic investors, the government is more than satisfied to see GDP increase thanks to FDI. All of these imbalances raise inflation and threaten the country with financial instability leading the central bank to raise interest rates. As inflation eventually reacts to the increased interest rates, GDP will be dragged down with it, thus creating a need to lower them back down again. Chinese leaders, in their hope to maintain stability and the status quo that has served them fail to see the changing times… Or perhaps they do not. There are some strong indications that the PBoC will continue to have a strong presence in financial markets, supporting them while the authorities slowly and selectively bring in foreign investors. It can then bail them in when bubbles are popped and markets are restructured, if only it can maintain social stability along the way.