China’s naked emperors

The bubble is about to burst and they’re stumbling

Politicians who preside over economic booms often develop delusions of competence. Jeb Bush imagines he knows the secrets of economic growth because he happened to be governor when Florida was experiencing a giant housing bubble and he had the good luck to leave office before it burst. We’ve seen it in many countries: Remember the omniscience ascribed to Japanese bureaucrats in the 1980s before the long stagnation set in.

This is the context in which to understand the strange goings-on in China’s stock market. The price of Chinese equities shouldn’t matter all that much. But the authorities have put their credibility on the line by trying to control the market and are in the process of demonstrating that, China’s remarkable success over the past 25 years notwithstanding, the nation’s rulers have no idea what they’re doing.

China is at the end of an era of superfast growth made possible in large part by a vast migration of underemployed peasants from the countryside to coastal cities. This reserve of surplus labor is now dwindling.

But China’s economic structure is built around the presumption of rapid growth. Enterprises hoard their earnings rather than return them to the public, which has stunted family incomes; at the same time, individual savings are high, in part because the social safety net is weak, so families accumulate cash just in case. As a result, Chinese spending is lopsided, with high rates of investment but a low share of consumer demand.

This was workable as long as torrid economic growth offered sufficient investment opportunities. But now investment is running into falling returns. And what happens if investment drops but consumption doesn’t rise fast enough to fill the gap?

China needs reforms that spread purchasing power, and it has been making efforts in that direction. But these efforts have fallen short. For example, it has introduced a national health care system but many workers fall through the cracks.

Meanwhile, China’s leaders appear to be terrified — probably for political reasons — by the prospect of even a brief recession. So they’ve been pumping up demand by force-feeding the system with credit, including fostering a stock market boom. Such measures can work for a while but big reforms are needed and aren’t moving fast enough. The result is a bubble that wants to burst.

China’s response has been to prop up stock prices. Large shareholders have been blocked from selling; state-run institutions have been told to buy shares; many companies with falling prices have been allowed to suspend trading. These are things you might do for a couple of days to contain a panic, but they’re being applied on a sustained basis to a market that is still far above its level.

China officials may, in part, be worried about financial fallout. A number of players in China borrowed large sums with stocks as security, so the market’s plunge could lead to defaults. This is especially troubling because China has a huge “shadow banking” sector that is little regulated and could easily see a wave of bank runs.

But it also looks as if the Chinese government, having encouraged citizens to buy stocks, now feels that it must defend stock prices to preserve its reputation. And what it’s ending up doing, of course, is shredding that reputation at record speed.

Lately, state-run media have been assigning blame for the stock plunge to, yes, a foreign conspiracy, which is even less plausible than you may think: China has long maintained controls that effectively shut foreigners out of its stock market.

So what have we learned? China’s economy remains a powerhouse. The problems of moving to lower growth are major, but we’ve known that. The big news isn’t about the Chinese economy; it’s about China’s leaders. Forget everything you’ve heard about their brilliance. Judging by their current flailing, they have no clue what they’re doing.