NIKKEI ASIAN REVIEW
Without economic reform, loan mountain could yet hold back Beijing
William Pesek April 16
The emperor is rich, but he cannot buy one extra year. Xi Jinping is turning this old Chinese adage upside down. He surely has extra years — the Communist Party just made him effectively president-for-life. But riches?
Officials argue that Xi’s pockets are as deep as ever. Look no further than Beijing’s $3 trillion-plus of foreign-exchange reserves and other vast state wealth. But increasingly, China’s treasure trove is being eclipsed by a Great Wall of public debt which could yet dely or even block Xi’s global ambitions for Asia’s biggest economy.
This concern was largely missing from Christine Lagarde’s public speeches in China last week. On the surface, the International Monetary Fund managing director painted an optimistic picture of global growth into 2019. There is a “sunny sky” out there, as she put it. Lagarde also said, brightly, that the internationalization of the yuan “is now picking up again” and should “continue to do so.” No doubt, Lagarde was flicking at Xi’s lofty pledges at the recent Boao Forum, China’s answer to the World Economic Forum in Davos, to accelerate the opening of China’s financial sector.
But there is a disconnect here: China is not nearly as ready for international prime time as both Xi and the IMF suggest. In fact, Xi may be putting the cart before the proverbial horse in ways that imperil global stability.
Consider the IMF’s own numbers. Since 2007, the year the credit-market tightening that undid Lehman Brothers began, public and private debt globally have risen 40% to at least $164 trillion. China alone produced 40% of that increase. And China’s debt accumulation could accelerate further.
So far Beijing has managed the credit mountain well. But the risks are multiplying. One danger: an escalating trade war. U.S. President Donald Trump promised one on the campaign trail back in 2016, and, wow, is he delivering. Xi’s China has been quick to retaliate — and take the geopolitical high ground. At the annual Boao conference last week, Xi stressed “dialogue rather than confrontation” and pledged to open markets and protect intellectual property rights. Yet Xi thinks in decades, and Trump is sure to grow impatient. The odds of Trump or Xi backing down in the long run are miniscule.
Another threat: Beijing faces a classic diminishing-returns problem. After 11 years of runaway credit and debt growth, new stimulus loses its potency. To sustain 6.5% economic growth, Xi’s Middle Kingdom will need to provide ever bigger financial-steroid jolts. It is telling that China’s bonds are outshining stocks, a sign that traders are betting on slower growth and lower inflation. The benchmark 10-year bond has fallen 18 basis points this year.
To maintain political support at home, Xi might be more wedded to rapid growth than ever. Any serious attempt to tackle the bubbles in credit, debt, and property would drive the gross domestic product growth rate toward 5%, or lower. Allowing such a downshift necessitates a level of political courage Xi has yet to demonstrate.
That gets us back to Xi’s cart-and-horse dilemma. Since 2007, the party Xi now dominates has thought of capital liberalization as a reform all its own. The more open and integrated China is, the thinking goes, the more the economy will thrive. From there, the yuan’s utility in world trade increases exponentially, challenging the dollar’s linchpin status.
As Xi said at Boao: “We should promote trade and investment liberalization and facilitation, support the multilateral trading system. This way, we will make economic globalization, more open, inclusive, balanced and beneficial to all.”
Xi, however, appears to be forgetting the “balanced” part.
He said nothing about curbing Beijing’s credit and debt addictions, taming shadow-banking institutions or making companies more shareholder-friendly. Nor did he talk about making the government more transparent, giving his anti-corruption drive greater focus or creating clarity where the public sector ends and private enterprise begins. External liberalization alone will not drive these crucial reforms, improve the quality of mainland assets generally or produce an independent and competitive banking sector. Bold, potentially destabilizing, domestic policy changes are needed to achieve these domestic goals.
How does Xi’s inquisition against the freedom of the media and cyberspace square with pledges to bow to market forces? Xi may be the strongest Chinese leader since Mao Zedong. In many ways, though, China is more of a black box for foreign investors than it was under Xi’s predecessor Hu Jintao. Nor can Hong Kong, an economy China should emulate, guarantee multinational companies that Xiconomics will not spread there, too.
The good news, optimists say, is that Xi recently devised a three-member dream team to fix the vulnerabilities. On it are new People’s Bank of China Governor Yi Gang and his boss, Guo Shuqing, a party secretary overseeing broader PBOC strategy. Both men, reformers in their own rights, report to new Vice Premier Liu He. Together, they will address China’s asset bubbles without crashing the world’s second largest economy.
The bad news is that Beijing’s dream team is hamstrung. They can only focus economic growth on services and innovation as much as Xi lets them. Meanwhile, Trump’s trade war changes the calculus, perhaps reducing tolerance for the disruptive structural upgrades China Inc. needs. Giving the reformers more freedom to take action would mean giving the horse a chance to lead the cart.
Trump complicates China’s whole economic transition in another way: Washington’s own debt excesses. Trump was elected in November 2016 railing against runaway public borrowing. In just the last few months, though, he has signed into law a $1.5 trillion tax cut the economy did not need and a $1.3 trillion spending bill larded up in ways the IMF abhors.
Lagarde took a not-so-veiled swipe at American largesse. “The U.S.,” she said, “could help tackle excessive global imbalances by curbing gradually the dynamics of public spending and by increasing revenue — which would help reduce future fiscal deficits.” Beijing is the biggest holder of U.S. Treasuries (about $1.2 trillion). The bigger worry, though, is that a loss of faith in Washington’s fiscal policies will generate volatility that hits Chinese markets. A surge in U.S. yields, a run on the dollar or a stock plunge akin to Shanghai’s in 2015 would hit the Chinese trade-reliant economy hard. It also could knock China’s lopsided financial system off balance.
Given Trump’s erratic nature, such market volatility, including in China, seems inevitable. That should catalyze Xi to accelerate domestic reforms to increase transparency, ensure capital is doled out rationally and spread the benefits of Chinese growth — and do so before increasing China’s global footprint. In Beijing on April 12, Lagarde cautioned against financing unsustainable overseas ventures that “lead to a problematic increase in debt.”
China can certainly flex its muscles with the Asian Infrastructure Investment Bank, the Belt and Road scheme and its increasing dominance in the South China Sea. But a rising superpower must get the basics right at home first. Otherwise, it will tend to export financial risks.
China’s riches might not last very long if it persists in putting the quantity of growth before quality. That means producing demand organically, by increasing productivity through innovation, not with debt-fueled stimulus. As China’s political ambitions gallop ahead of economic fundamentals, optimists might want to hold their horses.
William Pesek is a Tokyo-based journalist and author of “Japanization: What the World Can Learn from Japan’s Lost Decades.” He has written for Bloomberg and Barron’s.