When commenting on the recent Chinese stockmarket meltdown, Glenn Reynolds wondered if a prediction posted on Samizdata some time ago could be coming to pass. Whilst exposure for Samizdata on Instapundit is nice, I think Mr Reynolds is wrong if he perceives this stockmarket wobble to be a potential opening salvo of the economic holocaust presaged on these pages early last year. Far from heralding the collapse, it will delay the inevitable.
In spite of a widespread belief in China’s embrace of free-market capitalism, enormous economic distortions characterise modern China’s economy. For example, why is it that, relative to China’s economic footprint, the Chinese stock market is rather pathetically stunted – especially in light of the vast savings pool the Chinese people have accumulated? As mentioned in the above article, the Chinese are great savers and they tend to deposit these savings into bank accounts because alternative investment opportunities are limited compared to those offered to a Western investor. Consider the following:
Why does the Chinese investor not sink his surplus funds into foreign commodities? Because he is restricted from doing so.
Why does he not invest in Chinese stocks? Because he (probably correctly) views the Chinese stock market as being distinctly ropey.
In light of these state-imposed distortive realities, what does one do with one’s savings? One puts them in the bank, of course. Predictably, the banks are awash with deposits. Under these circumstances, the principles of fractional reserve banking have been taken to the extreme in China, allowing the central government to durably zombify huge segments of the otherwise bankrupt state-owned industrial sector by forcing the “big four” state-owned banks to continuously loan depositors’ money to these failed state enterprises, in the full knowledge that these loans will never be repaid.
This fiscal expedience allows the central government to postpone the nasty (and potentially regime-threatening) hangover that inevitably follows a sustained attempt at central economic planning like that witnessed during the Mao era. Unfortunately, it cannot continue indefinitely. Firstly, it provides no market incentive – the only incentive that works – for the wayward state-owned enterprises to reform. If they do not reform into conventional free-market actors, they will always require such charity. Secondly, this charity can only continue if Chinese bank account holders continue to top up (or at the very least maintain) their balances.
Of course, the central government knows the above only too well. If China Inc. in its current incarnation is to survive, it is critically important that the Chinese do not withdraw too much of their savings from the state-owned banks to invest in other pursuits, as this will cause the banking system – and “socialism with Chinese characteristics” – to collapse. The central government probably engineered the recent stockmarket fluctuation to buttress the perception of insecurity that shrouds potential investment targets like Chinese stocks, and are no doubt well pleased with the message that was subsequently delivered to the average Chinese investor. This does not mean that the current Chinese economic model is now secure – it will unravel at some point in the future. However, that point has been postponed with a ‘hair of the dog’-type solution, which will make the eventual hangover even more severe.
The central government has merely bought some time.