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Marcuard’s Market update by GaveKal Dragonomics
Rightly or wrongly, much of the recent tumult on global financial markets has been blamed on China. Many of the market’s substantive worries (economic collapse, financial collapse, competitive devaluation) are overblown. But markets trade as much on policy signals as on economic reality, and there has clearly been a breakdown of communication between Beijing and the rest of the world. The underlying dilemma is that the policies that are good for China are bad for the rest of the world — at least in the short run — and vice-versa. The signaling problem is that the Chinese authorities have not made clear whether they want to do what’s right for China, what’s right for the rest of the world, or neither.
Let’s start with what would be good for China. Everyone knows that the Chinese economy has depended too much and for too long on extensive investment in heavy industry and residential property. It requires a more balanced growth model based on services, consumer spending and high-technology manufacturing. To achieve this, capital must increasingly be allocated by market mechanisms, rather than by state fiat; support for bloated state-owned enterprises must be withdrawn; and local governments must be reoriented away from debt-financed infrastructure spending and toward the provision of social services.
Over the past three years, Beijing has tried to orchestrate this transition, but only fitfully. It has cut back credit growth and reined in excessive investment. But the broader promises of deregulated markets, a severely reduced role for SOEs, and fully marketised pricing of capital and other key inputs (such as energy) remain unfulfilled.
We are increasingly of the view that this mediocre result arises not because a bold and visionary reform programme has broken up on the reefs of political opposition, but because the main aims of China’s leader Xi Jinping are political and geo-strategic, while his economic goals are contradictory. The lack of clarity in economic vision was evident in the November 2013 Third Plenum reform roadmap — which called for markets to have a “decisive role” in resource allocation, but also reaffirmed the “dominant role” of the state sector.
This basic indecisiveness about how to balance the roles of state and market has been exposed by the policy gyrations of the past six months. First the government egged on an unsustainable stock-market bubble; then when the bubble popped, it intervened massively to prop up prices; and this week it abandoned its intervention and let the market crash downward. On the exchange rate, Beijing paired its -1.9% devaluation with a statement that henceforth the renminbi rate would be determined mainly by the market; since then it has intervened massively in both onshore and offshore markets to prevent the market from pushing the exchange rate down further. China now gets the worst of both worlds: it is roundly denounced for a competitive devaluation that it has done its best to prevent; and these preventive efforts are denounced as a betrayal of its promise to let the market rule.
So far so bad; but now let us look at what the rest of the world would like from China.
It wants, first, a more balanced Chinese economy that does not rely so much on infrastructure spending. On the other hand, it wants China to keep infrastructure spending as high as possible, in order to keep commodity prices high. It wants China to deleverage so that it can have more sustainable growth, but it also wants massive monetary and fiscal stimulus — more leverage — so that global growth will not be impaired. It wants China to have a market-driven exchange rate, but only if the market pushes the renminbi higher.
Clearly, China cannot give the rest of the world what it wants today — more infrastructure spending, more leverage, and an exchange rate that only goes higher — without grievously damaging its own prospects for tomorrow. It would be reasonable for Xi Jinping and his colleagues to point out that since 2009 they have done more than enough to sustain global demand, first through the world’s biggest stimulus program, and then by swallowing a 14% real currency appreciation in the past year, as Europe and Japan merrily tried to devalue their way back to prosperity.
But Xi & Co. are not in a position to make that argument, because they have failed to articulate a policy direction that encourages the rest of the world to view China as a credible and trustworthy partner. Are they for a more open, market-oriented China, or a closed empire of state-owned national champions? Impossible to say. Do they want China to be a constructive participant in joint global economic decision making, or a free agent that acts in its own self-interest without regard to the consequences for anyone else? Again, it is very hard to say. Until these directional signals are made clearer, any policy action that Beijing takes—no matter how technocratically well intentioned—is likely to be viewed with mistrust, and to cause even more volatility in unsettled markets.
