THERE WAS A time when even financial markets in China were believed to be responsive to firm instruction and Party discipline. Yet China has become much more market driven in many spheres than it once was, even, incongruously, as President Xi Jinping has sought to exert greater control over every aspect of the body politic.
The trouble with markets, as has been seen in the Shanghai and Shenzhen exchanges in recent weeks, is that they have a mind of their own. Stock markets, in particular, can express it in stark and cantankerous ways.
July’s attempt to prop up stock prices that had started to blow off a lot of excessive froth — by cajoling 21 securities firms to hold stocks — was brushed aside like a mistress’s hair from a jacket; so, too, was the more recent directive to the country’s massive pension funds to act as the buyer of last resort.
This was not markets just thumbing their nose at any old government intervention. This was a direct challenge to the proposition that the Party leadership could be trusted to stop the stock markets fall. By extension, it could also be trusted to keep the real economy from slowing too quickly even while making the transition from the old model of infrastructure investment- and export-led growth to one driven by domestic consumption.
That transformation is a Herculean task of macroeconomic management demanding extensive structural reforms, although a task that both Japan and South Korea have earlier undertaken, if not on the scale required in China. It is one, though, that challenges many vested interests that profited richly from the old ways and stood to lose much from the reforms needed.
One thing that this recent stock market crash has inadvertently advertised is how deep and widespread are the pockets of opposition to reform — a contrast the the narrative of inevitability and Xi’s expanding control portrayed in state media.
The arguments of what countermeasures to take against falling stocks, the currency, and slowing growth have become a proxy battle for the bigger one over reform. Xi has championed reform as necessary to ensure the Party can continue to deliver economic wellbeing for China’s population and thus retain its mandate to rule.
He, correctly in the view of this Bystander and many other outside observers, believes that the old growth model is unsustainable if China is to continue to develop as a wealthy economy. If there turns out to be any substance to the gossip the Prime Minister Li Keqiang is to be a scapegoat for the slowing economy and stock market fall — then that would indicate deep divisions over the path to rebalancing on a scale that would rattle global markets.
The precipitousness of that path, which we have frequently referred to here as a glide path to slower growth, is what is now so concerning. We have always regarded its trajectory as being the object of the leadership’s management, but equally have cautioned that it would not, inevitably, be as smooth as the leadership would like.
There are many potential bumps: property bubble, equities bubble, shadow banking crisis, and local government debt bomb. All remain manageable, but the stock market’s fall raises the risk of a credit crunch.
What is now at stake is trust in the government’s capacity to manage the markets and the economy more broadly.
Ever since Deng Xiaoping started to open up the economy at the end of the 1970s, the government has been able to marshal the capital needed to direct the economy and absorb the external shocks to distorted markets. The assumption that that will continue to be the case is now being tested.
The banking system as a closed conduit of state-disposed capital is under stress. The Catch 22 is that it has to be if the financial system is to be opened — as, in turn, it has to be if rebalancing is to be successful.
All of which brings this Bystander back to a fundamental question: can China do something that no other developing economy has ever achieved, liberalise its financial system without doing the same with its politics.
Last October we said:
The trick for Xi remains to align the political realities he faces with the underlying structural slowing of economic growth, but without getting too close to the feared hard landing of the economy that would undermine his political position. As we have noted before, every mini-stimulus ratchets up a notch the difficulty of introducing the policies needed for rebalancing because they don’t address the underlying causes of unsustainable booms and the vested interests that benefit from them. And that needs a political solution before it can get an economic one.
That remains the case.