A severe slowdown in China is viewed as among the greatest risks facing the world economy this year, and Thursday’s dismal news on Chinese manufacturing output exacerbated these fears. But the really important news from Beijing pointed in the opposite direction: Bank lending in China, instead of slowing dramatically as many economists had expected, accelerated in January to its fastest growth in four years.
This means China is unlikely to act as a brake on the global economy in the months ahead — despite the recent weak manufacturing figures. It also suggests that predictions of a credit crunch or financial crisis in China will likely prove wrong — or at least premature.
To welcome stronger bank lending in China is not to deny that credit growing at double the gross domestic product growth is unsustainable and will ultimately have to be curbed. The Chinese authorities themselves clearly believe this. The government and the central bank want to reduce credit growth and to replace the unregulated, opaque “shadow lending” system with properly supervised, well-capitalized modern banks.
The government has two other economic objectives, however, that it sees as equally or more important.
The three priorities were clearly set out at the Communist Party Third Plenum last November. First, the Chinese economy must be restructured away from over-dependence on infrastructure investment and exports, toward private businesses that increase the quantity and quality of consumer goods and services.
The second priority — though many observers would argue that this is the overriding objective — is to ensure that restructuring occurs in an orderly manner, without risking a severe slowdown that might threaten the Communist Party’s monopoly of power. In practice, the government has quantified this objective in “target” of 7.5 percent GDP growth.
China’s third major economic objective is reforming financing and restraining excessive credit growth.
The problem, which Chinese leaders and economists were long reluctant to acknowledge, is what happens if these three objectives clash. What if restraining credit growth causes a severe economic slowdown? Or if clamping down on shadow banking starves private enterprises of the working capital for growth? Or if aggressive industrial restructuring becomes incompatible with financial stability?
In the past few months, the answers to such questions have become clearer. While Chinese leadership remain genuinely committed to all three major economic objectives — industrial restructuring, economic stability and financial reform — they now acknowledge that progress may not be possible simultaneously on all three fronts.
Policy will therefore have to be prioritized. And the financial reform objective is proving a less important priority than industrial restructuring and maintaining an acceptable rate of growth.
Whenever possible, China will likely try to move ahead on all three objectives. But if there is a serious conflict, maintaining an adequate growth rate will trump credit restraint and financial reform.
This is a sensible ordering of priorities — both for China and for the world economy still desperately short of growth. Yet even if China is determined to keep its economy expanding and avoid a credit crunch, is it capable of doing this?
After all, the U.S. government allowed the failure of a medium-sized investment bank to degenerate into the greatest financial meltdown in modern history. Why, then, should we expect China do any better?
Partly because Washington did not really try to avoid a financial crisis. On the contrary, the Treasury deliberately pushed Lehman Brothers into bankruptcy, to demonstrate that there were limits to government bank bailouts. Some Chinese officials, particularly central bankers, have recently made similar statements, suggesting reckless lending must be disciplined and “moral hazard” curbed.
Does this suggest that China could “do a Lehman” and reverse the order of policy priorities — putting a financial clean-up ahead of economic growth?
This is where the debate about Chinese policy gets really interesting — and confusing.
Like other central banks, the People’s Bank of China, if left to itself, would probably favor curbing excess lending and moral hazard — even if this jeopardized economic growth and industrial restructuring.
Though China is seen as a monolithic authoritarian state where only one view prevails on any important issue, economic policy is in fact subject to intense debate — sometimes as open as the clashes between U.S. Keynesians and monetarists or between southern European governments and the Bundesbank.
As a result, mixed messages flow constantly from China. These are particularly confusing for financiers whose instinct is to treat central bankers as more authoritative than politicians. In China, this is completely wrong, since the People’s Bank of China is not independent and can take no major decisions without the political leadership’s consent.
Occasionally Western-educated PBOC officials who crave independence may overstep the mark and make controversial decisions without government approval. Whenever such freelancing leads to a risk of crisis — as it did last month when the central bank almost allowed a panic in shadow banking — the Chinese Communist Party reasserts itself and a government bailout is arranged.
Which leads us back to the question of whether China, with its primitive financial system, has the tools to maintain financial stability if it really wants to. The answer is almost certainly yes.
A relatively primitive financial system, dominated by state-owned banks that are really just arms of the central government, is actually easier to stabilize than a complex market-driven network of private financial institutions. State-controlled banks may be inefficient at allocating capital — but they cannot be forced into insolvency unless the government itself is insolvent. And the Chinese government is perhaps the most solvent financial entity in the world.
The central government has a cast-iron budgetary position that is more than adequate to underwrite the bailouts of insolvent banks and local governments. Even more important, China has the world’s largest trade surplus, total control over cross-border capital flows and $3.5 trillion in foreign exchange reserves.
Anyone betting on a Lehman-style meltdown in the Chinese financial system will need $3.5 trillion to call Beijing’s bluff.
Anatole Kaletsky is an award-winning journalist and financial economist who has written since 1976 for The Economist, the Financial Times and The Times of London before joining Reuters.