Bungling Beijing's stock markets
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.