China must stop its destructive market interventions while it can
Christopher Lingle says Beijing’s ultimately vain efforts to strictly control its exchange rates, while allowing the US to borrow more freely, worsens its own debt problems and contributes to global volatility
China’s economic and political leaders are locked in a battle with foreign exchange markets that they are likely to lose, eventually. Their instinctive response to pressures from net capital outflows, volatile stock markets and imbalances caused by export-led growth is more market intervention.
For example, after the policy-driven devaluation of the renminbi in July 2015 sparked an aggressive market-driven depreciation, the People’s Bank of China burned through hundreds of billions of dollars to stop it from collapsing, using up almost 14 per cent of its dollar reserves. Meanwhile, the renminbi exchange rate against the US dollar has depreciated by nearly 8 per cent since May 2015.
Some might argue that China can easily afford such losses, given that its stock of foreign exchange reserves is still the largest in the world. But it is worth remembering that, in 2008, Russia spent US$220 billion over the course of six weeks in vain support of the rouble.
For its part, China’s actions on foreign exchange markets have made the US dollar stronger than it should be and US interest rates lower than they should be. In this sense, these interventions serve the interests of America’s profligate politicians and feckless central bankers at the Federal Reserve, at a high cost to China’s own economic interests.
Consider that China helped finance America’s fiscal deficits and pump-priming by the Fed by being one of the largest net purchasers of US Treasury securities. As such, Beijing helped keep Treasury bond yields lower than they might have been so the US government could borrow and spend at a lower cost.
And so, China’s authorities can promote the health of its own economy by abandoning an exchange-rate obsession over the value of the renminbi against the dollar and intervening less, not more. It turns out the primary villain in the tale is China’s dependence on export-led development that is the basis for continuing controls over exchange rates and capital flows.
While the dollar peg brought large and growing foreign exchange reserves to satisfy a hard-currency fetish, it helped fuel domestic inflationary pressures and ballooning debt. And capital controls required Chinese exporters to swap hard-currency earnings with the People’s Bank for freshly printed yuan as bank deposits or government debt. These arrangements will eventually do more harm than good by leading to an intolerable rate of inflation and/or an unsustainable burden of public-sector debt.
As it is, China’s total debts have risen sharply since 2008, beginning with it large fiscal “stimulus” spending of 4 trillion yuan (about US$570 billion). Since 2007, total debts have quadrupled, from US$7 trillion to US$28 trillion by mid-2014, pushing China’s debt-to-GDP ratio to 282 per cent.
Although government debt-to-GDP is only about 41 per cent, most of the “corporate” debt (now about 125 per cent of gross domestic product) is owed by state-owned enterprises. As such, this is really public-sector debt. Meanwhile, much of the threefold increase in household debt (to 65 per cent of GDP) is in the highly inflated property market.
The economic imbalances and distortions arising from China’s export-led growth policies were bad enough – especially since such imbalances led to Japan’s export-led economy collapsing in 1989, with the export-led economies of East and Southeast Asia suffering a similar fate in 1997.
Added to China’s woes are the imbalances brought about by a reliance on credit-driven growth, for example, “bubbles” and volatility in the housing sector and stock markets brought on by excessive liquidity.
It turns out that China’s self-proclaimed “market socialism” is in fact a poisonous cocktail of neo-mercantilism (that is, export-led growth) and Keynesian stimulus policies. Alas, the resulting hangover is set to bring a painful end to the “Beijing consensus” as well as President Xi Jinping’s (習近平) “Chinese Dream”.
Ironically, as the US dollar has become stronger, China is selling its foreign exchange reserves on the cheap, relative to the likely future higher values. Meanwhile, since US interest rates may rise soon, attempts to sell off Treasury securities will come at a capital loss since yields on bonds move inversely to their selling prices.
China’s effort to maintain “markets with Chinese characteristics” involves a set of costly policies, including support for the value of the renminbi vis-à-vis the dollar. While Beijing must be seen as the primary author of China’s economic discomforts, these woes will worsen as the glut of global liquidity retreats and interest rates begin to rise.
Christopher Lingle is visiting professor of economics at Universidad Francisco Marroquin in Guatemala and research fellow at the Centre for Civil Society in New Delhi