Change and Crisis in China

Change is hard.  Especially when your entire livelihood is built around what you’re trying to change.  In China, the economy has long revolved around the official credit mechanisms provided by the banking system.  Ordinary citizens have very limited access to investment vehicles other than regular deposits, and the state keeps deposit interest rates artificially low, making credit cheap.  In turn, those banks lend at very cheap rates to businesses.  The overall effect is to pick the pockets of regular savers and plow the money into investment.  The cheap money has driven China’s economic growth.

There are a few problems, however.  First is that some or much of this money might be “malinvestment”, unproductive investment that seems to make economic sense due to artificially cheap credit.  The second is that these businesses then provide investment vehicles for normal citizens, starved for investment opportunities due to the state-mandated interest rates.  You then have regular citizens investing in shady unregulated debt products, and regularly losing heaps of money.  Thirdly, it’s not just regular citizens – large institutions looking for high-yielding products are invested in these same financial assets.  Some find it uncomfortably reminiscent of subprime mortgages in the United States.

There is a nice little complication there, however.  The banks aren’t really private, and they’re not really state-owned.  The relationship is altogether more complex than that.  The upshot to this is that access to credit is pretty unequal.  The favored, be they Party elite or associates, can get access to that cheap capital.  They can then turn around and pass that loan on to anybody they fancy while taking a hefty commission. So cutting the party short means taking that income stream away from a class well-placed to resist it.

And so these problems have only festered and gotten worse and worse.  As the Chinese government makes moves to liberalize the capital markets, the financial markets react with panic each time and the gestures are quickly walked back.   That being said, complaints about “kicking the can down the road” are usually overwrought and it’s often a perfectly fine strategy.  But it certainly seems like the Chinese government is sitting on top of a latent but very large financial crisis and is actively trying to decide when to deal with it.

This is the sort of thing one should keep in mind when reading long-term forecasts about Chinese growth.  Will this crisis topple the Chinese economy?  No, probably not.  But no one sane should want to trade the American political economy for China’s.

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