There is a freneticism animating Beijing’s governing class, a deft feeling of loss that is only explained as failure. Throughout the fiscal crisis and its aftermath that rocked the United States in late 2008, many working families knew of sources of growth outside the state.
However, in China, the central bank quickly moved into monetarist mode in acknowledging the supremacy of the quantity of money, and when that benchmark didn’t work it moved to acknowledge that the reduction in required bank reserves would help sustain credit. Now the People’s Bank of China has moved toward an interest rate regime focusing on interbank short-term lending.
By loosening credit, the PBOC hopes to avail domestic growth even as it contradicts itself through stricter regulation of debt while demanding that banks rein in off-balance-sheet loans. China’s own move toward normalization has institutionalized inconsistency to the point of paralysis.
For decades China relied on sterilizing incoming capital flows in the hope of ceasing to import inflation. This was intrinsically tied to its whopping trade surplus with the US. Now with an increasing current-account surplus, the PBOC has been obliged introduce another regime change by cutting reserve requirement ratios among state banks. When that failed it moved to swap corporate loans into equity. All of this has happened during a backdrop of capital controls that sought to stabilize the yuan.
So, what should President Xi Jinping do the address the faltering of the Chinese economy? He should welcome the development of an indigenous Chinese secondary bond market. This is the sign that embodies the transformation of China out of its current malaise.
It would mean acknowledging a foreign moral repository officially at odds with Keynesian ideology and its incident needs to command and control.
As of this writing China’s ratio of debt to gross domestic product is over 260%. China is maxed out; growth will not be conjured by command nor by credit. China’s growth will come when Beijing’s commanding political class acknowledges the art of market maintenance. Even Paul Volcker has said that timing, positioning and manner matter for the central bank. This is a deft acknowledgment of tacit knowledge, something the antecedents of John Maynard Keynes knew well.
Currently, China is declaring itself open to foreigners. But the reality is far more cynical; by opening its official state-operated agencies to foreigners, it hopes to spread inevitable losses by openly encouraging incoming foreign capital flows.
The game plan now is to welcome incoming foreign currency to fortify the PBOC, while stabilizing the yuan during partial liberalization of China. As American economist John B Taylor has revealed, a nation can control two of the three legs of its monetary-policy stool – it can control either its exchange rate, interest rate or monetary regime, but not all three. If China welcomes foreigners, it must permit the moving of capital in and out of the country or use its interest-rate policy to support the yuan and not the economy.
A volatile yuan doesn’t necessarily mean institutionalized weakness for China. Marked change for President Xi would mean floating the yuan and sustained management of the economy. The art of maintenance means controlling the backdrop of your economic fundamentals in a direction of fits and starts.
By bringing China closer to the norm of established First World political economies in its maintenance of its political economy, Xi will discover something astonishing: new capital, functioning governing institutions and citizens grateful to acknowledge a dominant political class that succeeds in deft challenges.
The liberalization of China doesn’t have to be threatening.