Bungling Bei­jing's stock mar­kets

The Pak Banker - - OPINION - Paul Krug­man

China is ruled by a party that calls it­self Com­mu­nist, but its eco­nomic re­al­ity is one of ra­pa­cious crony cap­i­tal­ism. And ev­ery­one has been as­sum­ing that the na­tion's lead­ers are in on the joke, that they know bet­ter than to take their oc­ca­sional so­cial­ist rhetoric se­ri­ously.

Yet their zigzag­ging poli­cies over the past few months have been wor­ry­ing. Is it pos­si­ble that af­ter all these years Bei­jing still doesn't get how this "mar­kets" thing works?

The back­ground: China's econ­omy is wildly un­bal­anced, with a very low share of gross do­mes­tic prod­uct de­voted to con­sump­tion and a very high share de­voted to in­vest­ment. This was sus­tain­able while the coun­try was able to main­tain ex­tremely rapid growth; but growth is, in­evitably, slow­ing as China runs out of sur­plus la­bor. As a re­sult, re­turns on in­vest­ment are drop­ping fast. The so­lu­tion is to in­vest less and con­sume more. But get­ting there will take re­forms that dis­trib­ute the fruits of growth more widely and pro­vide fam­i­lies with greater se­cu­rity. And while China has taken some steps in that di­rec­tion, there's still a long way to go. Mean­while, the prob­lem is how to sus­tain spend­ing dur­ing the tran­si­tion. And that's where things have got­ten weird.

At first, the Chi­nese gov­ern­ment sup­ported the econ­omy in part through in­fra­struc­ture spend­ing, which is the stan­dard rem­edy for eco­nomic weak­ness. But it also did so by fun- nel­ing cheap credit to state-owned en­ter­prises. The re­sult was a run-up in these en­ter­prises' debt, which by last year was high enough to raise wor­ries about fi­nan­cial sta­bil­ity.

Next, China adopted an of­fi­cial pol­icy of boost­ing stock prices, com­bin­ing a stock-buy­ing pro­pa­ganda cam­paign with re­laxed mar­gin re­quire­ments, mak­ing it eas­ier to buy stocks with bor­rowed money. The goal may have been to help out those state-owned en­ter­prises, which could pay down debt by selling stock. But the con­se­quence was an ob­vi­ous bub­ble, which be­gan de­flat­ing ear­lier this year. The re­sponse of the Chi­nese author­i­ties was re­mark­able: They pulled out all the stops to sup­port the mar­ket - sus­pend­ing trad­ing in many stocks, ban­ning short-selling, push­ing large in­vestors to buy, and in­struct­ing grad­u­at­ing eco­nom­ics stu­dents to chant "Re­vive Ashares, ben­e­fit the peo­ple."

All of this has sta­bi­lized the mar­ket for the time be­ing. But it is at the cost of ty­ing China's cred­i­bil­ity to its abil­ity to keep stock prices from ever fall­ing. And the Chi­nese econ­omy still needs more sup­port.

So this week China de­cided to let the value of its cur­rency de­cline, which made some sense: While the ren­minbi was clearly un­der­val­ued five years ago, it's sig­nif­i­cantly over­val­ued now. But Chi­nese author­i­ties seem to have imag­ined that they could con­trol the ren­minbi's de­scent, tak­ing it a cou­ple of per­cent at a time.

They ap­pear to have been taken com­pletely by sur­prise by the mar­ket's pre­dictable reac- tion; namely, the ini­tial de­val­u­a­tion of the ren­minbi was "the first bite of the cherry," a sign of much big­ger declines to come. In­vestors be­gan flee­ing China, and pol­icy mak­ers abruptly piv­oted from pro­mot­ing cur­rency de­val­u­a­tion to an all-out ef­fort to sup­port the ren­minbi's value. The com­mon theme in these wild pol­icy swings is that China's lead­er­ship keeps imag­in­ing that it can or­der mar­kets around, telling them what prices to reach. And that's not how things work.

I'm not say­ing gov­ern­ments should never in­ter­fere with mar­kets, or even set lim­its on prices. There is, as I've writ­ten in the past, a strong case for rais­ing the min­i­mum wage and in gen­eral for pro­mot­ing higher wages for Amer­i­can work­ers; there's an even stronger case for ef­fec­tive fi­nan­cial reg­u­la­tion.

There's even a case for oc­ca­sional in­ter­ven­tion to prop up as­set prices. Three years ago, the Euro­pean Cen­tral Bank's prom­ise to do "what­ever it takes" to safe­guard the euro - gen­er­ally in­ter­preted as a prom­ise that it would buy gov­ern­ment bonds if nec­es­sary - worked won­ders. Back in 1998 the Hong Kong Mon­e­tary Au­thor­ity pur­chased large amounts of stock to beat back a hedge fund at­tack on its cur­rency, and scored a no­table suc­cess.

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