The debate raging throughout the Chinese leadership isn’t confined to monetary policy but instead strikes at the heart of China’s political economy. Just as stagflation required a political response, China’s rebalancing remains deeply political, constraining Beijing’s leadership. As Keynesian types say, China’s problems are structural.
Reformers like former Central Bank governor Zhou Xiaochuan have called for an end to capital controls and a faster pace of liberalization. His aim was to openly confront the political and institutional constraints preventing the opening of China. This thinking aimed to reshape China’s closed autarkic economy towards market-based incentives. It hasn’t happened and China suffers because of it.
Zhou and his reformers are correct to take aim at the convertibility of the yuan. The key to rebalancing China’s economy out from its political dependency on high domestic savings and investment requires that Chinese political leaders openly acknowledge an ethics foreign to command-side economies; namely price signals and other uncontrollable socio-political variants that underwrite growth. It means acknowledging other sources of growth that predate Keynesian economic thought. By continuing with a closed financial system, Chinese leadership continues to depress the cost of capital while subsidizing domestic investments at the expense of household income. In my view, this kind of financial repression isn’t tenable anymore. Just ask Barack Obama and his highly credentialed cohorts that run the halls of Harvard.
The opening of China’s westward flank in the Belt and Road Initiative was sought to address this overcapacity. But prevailing technocracy isn’t going to save China; its time for wholesale rethinking of the sources of growth for China.
To begin, Beijing needs to recalibrate in liberalizing its capital account. This would mean grounding its economy toward consumption; this would mean a reliable base of taxation for immediate investment toward higher forms of productivity growth. By seeking to address the political sources that underwrite reserve currencies, an open, transparent yuan and capital account will plow new social vortices into research and development. The birth of the private sector will mean the demise of insolvent politically favored SOE’s.
The insight of reformers is simple, direct and ugly. It means relinquishing political control of government-led micromanagement of China’s financial economy. The linchpin of permitting unmanaged growth means giving Chinese savers the ability to seek higher returns abroad. It means acknowledging the supremacy of market signals for capital.
Addressing Chinese imbalances is the only way out. Consolidating power will make this process easier, but the political risks are real and must be addressed. If President Xi Jinping really seeks Chinese growth and prosperity, he needs to strengthen the hands of reformers. If he does, he’ll find a willing partner in the West to assist in the rebalancing.