To borrow a phrase from Antonio Gramsci, the late Italian Marxist, China’s attempt to break US President Donald Trump’s momentum meant moving from a war of maneuver to a war of position. This favors team Trump because it weakens China’s negotiating posture; having to field policy resolution means replacing components of China’s favorable mercantilist regime. It is intractable because Beijing cannot and will not seek alternative political resolutions that would displace the preeminence of the party in China’s political economy.
Banking, financial and monetary reform can be accomplished by specialized technocrats, but an actual functioning internationally integrated market outside China’s command economy isn’t a viable option for President Xi Jinping. Team Trump needs to understand the limits of Chinese reform.
Calls for freer trade and the end to capital controls are essential to restructuring China’s economy. Former Central Bank governor Zhou Xiaochuan and his successor have publicly sought the convertibility of the yuan; a key moment in rebalancing out from dependency on investment and high domestic savings. Capital controls keep money within the mainland, but at a deep political cost. Chinese financial repression depresses the cost of capital while Beijing continues to subsidize investment strategies at the expense of household spending. If China wants to rebalance out from an export-based model embracing domestic services, it must end all financial repression. By so doing it prevents the US Treasury from receiving the flow of funds that underwrote our housing boom.
China dealt with the 2008 US crisis by pushing sovereign debt. But that bill has come due in the shape of dismal growth, stagnating wages and high fixed costs of debt servicing. Beijing’s leadership isn’t about to make that mistake again. The way forward is total reform, albeit apolitical.
China dealt with the 2008 US crisis by pushing sovereign debt. But that bill has come due in the shape of dismal growth, stagnating wages and high fixed costs of debt servicing
What team Trump needs to acknowledge is the irreparable political damage already done since he launched the US-led tariff war. Beijing has openly sought to rebalance toward consumption and domestic services with faster productivity growth. The government has publicly forced the closure of zombie state-owned enterprises. Xi has publicly ordered banks to refrain from lending to insolvent politically connected firms. The impact exposed the need for China to develop and sustain an indigenous private sector, namely companies that function independently and efficiently. In a word: innovation.
To accomplish this feat, Central Bank leadership needs dependent, credible pricing signals from markets. It starts with liberalizing domestic interest rates. This means the free movement of capital disciplining firms without government micromanagement. Team Trump needs to acknowledge that this kind of rebalancing, related to scale, is hampered if the yuan is under assault. Weathering capital outflows exceeding $100 billion a month isn’t sustainable, so China’s leadership should continue seeking currency stability while monitoring favorable global monetary conditions so as to keep credit loose.
The true downside to the art of rebalancing isn’t just political but strategic. As China seeks to openly solicit foreigners into the mainland, team Trump must keep a profoundly cynical but realistic option – namely that Beijing opens itself toward reform to disperse inevitable losses.