By: David A. Smith
You must not fight too often with one enemy, or you will teach him all your art of war.
Whenever a government decides to intervene in the financial markets – and modern governments are already intervening, for reasons good and bad, and with results more effective or less effective – they set off a chain of events that neither the acting government nor anybody else can foresee through to their conclusion. But usually, as with President Nixon’s Wage and Price Controls, the results backfire.
But we’ve already cut back on shaving … pits too
It wasn’t for the wage-price controls – something else intervened
As a result, both Bloomberg Business (January 14, 2016) and a similar article and editorial in the Economist’s January 16 issue suggest that China’s efforts to prevent capital flight will fail unless the Middle Kingdom does the one thing that up to now has been ruled out of bounds.
That’s a head-scratcher
E. In the end, China will have to devalue the yuan
China’s economic governance has been built on a premise that would turn Karl Marx in his grave: that the country can always run an industrial productivity surplus because people and machines make much more valuable products than it costs to have them do so. In short, it’s not the capitalists who control the means of production, and not the abstract Platonic philosopher-king government, but rather the state-owned-enterprises (or said in reverse, the government-controlled monopolists). If you and your friends have control at the top (laws, police, media, business) and can deliver either the reality or at least the widely held belief that things are getting better, then that strategy can keep the lid on, and underneath that lid can conceal a host of inefficiencies and corruptions:
Against lax lending
Gunther Schnabl, a professor at the University of Leipzig, says that lax lending merely keeps zombie enterprises on their feet: “If you do not have a hard budget constraint, you do not have an incentive to put forward dynamic, innovative investment.”
Even so, the most insular nation eventually succumbs, the more so now when social media and the ubiquity of the Hollywood-ized view of American decadent consumerism make the seepage of an acquisitive mindset inescapable. So unless Chinese wants to wall itself in unreality like North Korea, it must make peace with the global markets, and that means getting voluntary foreign inflows to balance voluntary domestic outflows.
That is harder to do than it sounds:
One option is to lure money back by making the country more inviting to both Chinese and foreign investors. That would involve:
Should I really release you?
1. Decontrolling interest rates.
2. Halting directed lending to heavily indebted state-owned enterprises and local governments.
Neither of those will come easily to President Xi, because the former goes against his instincts and the latter against his friends and political entourage:
We smile at you only as long as you’re the money train
But doing so would:
3. Loosen the Communist Party’s control over the economy.
4. Harm some powerful domestic constituencies, like long-favored companies and provincial chiefs.
To do the right thing by repudiating the self-interest of those around whom you have consolidated your power? That takes guts, and guts come from either megalomania, vision, or desperation. So President Xi has shown neither of the first two, and he seems unready to accept the third, especially when he can staunch the flow, for the time being anyhow, simply by giving his central banker the simplest direction: Buy yuan.
The IIF projected in October that the government would need to sell off more than $220 billion of its reserves last year to meet the demand for foreign currency. The actual number was probably closer to half a trillion. The nation’s stockpile of foreign exchange reserves has dwindled to about $3.3 trillion.
While that sounds a huge number, it’s not, especially when you look at this chart.
Spending $600 billion propping up the yuan for only 1¾ years
It can’t be easy for Xi to suffer the indignity of losing a fight against the world’s financial markets. That’s one reason to think he’ll try to escape the trilemma by restoring at least some controls on capital.
Markets have no ego. That’s part of why they win.
The cushion is shrinking. “Considering China’s foreign debt, trade, and exchange rate management, it needs around $3 trillion in foreign exchange reserves to be comfortable,” says Hao Hong, chief China strategist at Bocom International Holdings.
Mr. Hong, described by Bloomberg as the “man who called China’s boom and bust,” is quoted as saying, “all roads to hell are paved with positive carry [a shortage of global dollars].”
It fairly makes my hair stand on end
To University of Macau economist Vinh Dang, the answer is obvious: Because flexible monetary policy is essential and China is too big to wall itself off from the world, “exchange rate control must be given up,” he wrote in an e-mail.
In the long run, that has to be right, but before the long run there is the short run.
And the short run can be bumpy.
F. There’s ain’t no political soft landing
If I’m right – and your blog subscription money back if not! – then China’s fundamental premises of domestic policy are tottering.
Reality can be fooled only if we can wall ourselves away from the world
One of the big questions for the global economy in 2016 is what Xi will do next to stop the flight of capital, which threatens to sap funds from China when growth is already weak.
You can stop the flight of people much more readily than you can stop the flight of capital. Which is why, among other things, that dictatorships function best in countries of extreme poverty. (And of course, dictators believe in theft and plunder, both of which kill economies, so even if they take over a rich country, within their lifetime they will impoverish it.)
HI blog posts on China and on foreign investment in US housing
The ultimate in ‘this time it’s different, Jul 18, 2011: 2 parts, Monopoly SOEs
A little learning is a dangerous thing, October 27, 2011: 2 parts, Hukou system
Capital’s bolt hole, December 22, 2011: Influx of money into New York residential
Old before rich? May 2, 2012, 2 parts: Economy like India, age pyramid like Japan
Ex-mittances, August 17, 2012: French capital buying Manhattan condo’s flats
A theory of China’s cities and housing, August 23, 2012: 7 parts. Read this one first.
Just outrunning the currency bears, September 24, 2012: Dollar as ‘least bad’ currency
China’s whistling tea-kettle, November 9, 2012: Flight of private capital
Runaway money train, July 22, 2013 4 parts: Monetary policy out of control
Urbanization, meet displacement, June 13, 2014: Chinese buying Australian homes
Live-in safety deposit boxes, February 10, 2015: Using apartment as bolt holes
Money is optionality – which is why dictators and autocrats fear it.
So the temptation to amp up command-and-control will be great. True, a clampdown would jeopardize China’s ambition to become an equal of the U.S. in global finance. But it would insulate China from the ungovernable swings of the global financial markets,
Yet here’s the thing: in the modern global-economy world, no country can insulate itself from other countries’ currencies. Everybody is either borrowing foreign and spending domestic, or vice versa, more or less all the tie. And in that world, all currencies will be constantly rising and falling, like any other commodity.
Embracing the uncertainty – surfing the chaos – is the province of the zen capitalist (if there is such a person).
Definitely a capitalist
Kevin Yan, an analyst at Stratfor, a geopolitical intelligence firm based in Austin, agrees with Alicia Garcia-Herrero, chief economist for Asia and the Pacific at Natixis Asia, that the short-term trend is toward closing China off from the world, but he’s more optimistic about the long term. “It’ll be opening and closing, opening and closing, but slowly moving in a positive direction, probably over the next 5 to 10 years,” Yan says.
Two foreign investments per green
To us that sounds plausible; to China that sounds nervewracking.
The worst thing China’s leaders could do now would be to fall back on the tired old trick of supporting employment by building roads, bridges, and apartments.
Yet building, ever building, is the only thing you can do inside a country, and then you wind up with pre-packaged wastelands like Ordos.
And you get nakedly shorted:
There goes a billion pounds
Global financial markets, investor George Soros once memorably said, are more a wrecking ball than a pendulum.
I shorted them because they were shortable
He should know, he used it that way, making a billion dollars by shorting the pound in the ERM.