Staying in control of a rampant economy is not easy but the Chinese government shows that it has the necessary firepower.
While investors follow the movements of central banks with one eye, their other eye would most likely be following the fortunes of China. The rapid rate of expansion in the Chinese economy seen over the past couple of decades may be coming to an end with the era of cheap labour seemingly coming to an end. But the centralized government in China has so far shown itself apt at managing the Chinese economy through its growing pains (see Why China need a slowdown? for related story). Despite mounting concerns over economic growth in China, Your Neighbourhood Economist believes that the Chinese government has both the necessary firepower to point the economy in the right direction and the willingness to use it.
In its current state of development, the economy in China is still very much like the Wild West – lots of small firms battling it out in a gun fight to see who comes out on top. This analogy does not hold so well when taking in consideration the giant state-owned companies which dominate parts of the economy or firms such as Huawei or Baidu who have already grown to the point where they are mostly above the fray. But China is a world away from having a few large firms dominate each industry as would be the case in most Western countries. As such, competition is fiercer with big rewards awaiting those that can prosper. The Wild West analogy also reflects the relative state of lawlessness in China where firms don’t have to worry as much about issues such as pollution, labour standards, and respect of intellectual property.
To add to the lawlessness, politics in China can seem at times as it is run by a bunch of gunslingers. The higher levels of government are choreographed pieces of political theatre but politics at lower levels is more of a grubby battle. Ambitious officials in regional government in China need to impress in terms of economic growth or social stability and can often become a law unto themselves whether it be taking land from farmers to build factories or getting local banks to splash out on loans to businesses. This incentive to create booming local economies can act against central government diktats even though both levels of government are controlled by the communist party.
Banks themselves have also managed to avoid the rule of law and operate with a degree of impunity. The government sets maximum rates for savers and minimum rates for borrowers with a big gap inbetween to help banks generate a profit. This suits the major banks which are government owned but savers miss out due to meagre returns on any cash stashed away. But banks keen to attract more deposits have come up with schemes to offer higher pay outs for investors and this extra cash has enabled the banks to lend even more.
The relative autonomy of local politicians and banks in China has fuelled a lending binge that has gone a bit out of control. The ratio of debt to GDP has reached 200% which is well past the point when people start worrying. The leaders in China have tried a softer approach such as signalling their disapproval but to little effect. But the Chinese government has never shied away from stepping on toes and decided to bring out some big guns to put pay to the wayward banks. At a time of year when all of the scheming by banks had left them short of cash, the central bank in China left banks to sort the cash shortfall out themselves despite typically acting as a source of funds in the past. The lack of money resulted in banks scrambling for cash and interest rates surged upward briefly topping 25% in the middle of June (search for SHIBOR spike for more info). This created turmoil among Chinese banks, for whom not only were the central bank’s actions a complete surprise but the intentions behind the move were also a mystery.
Some interpreted the actions of the central bank to be a brutal way of knocking banks into line but it will probably prove to be more fruitful than the policies of the their Western counterparts. Whereas other central banks have struggled to maintain stability (see Why is the economy still stuck in a rut? for more on the limited influence of monetary policy elsewhere), China’s central bank is not afraid of drastic action to shake things up even if it will result in a bit of temporary chaos. The spike in interest rates is expected to have put many banks into trouble but will be good for the banking system as a whole if it helps to reign in lending. Officials in China are conscious of the need to keep the economy growing so that the Communist Party can maintain its grip on power. It is this focus on the big picture rather than the fickle concerns of voters that will keep the Communists in power in what is destined to soon be the world’s largest capitalist economy.