Finance

By Arthur Kroeber

Is China’s credit binge a financial time-bomb waiting to blow the country’s much-vaunted economic miracle to smithereens?

Beijing has long bet that the problem of bad loans can be solved by pushing off the day of reckoning into the future, with rapid economic growth reducing the size of the problem.

So far that calculated bet has proved a sound one.

But the unprecedented expansion in bank credit this year, coupled with last month’s decision to roll over for another decade the bonds used to finance the first non-performing loan (NPL) workout of 1999, make it a good time to submit this policy to a stress-test.

By Arthur Kroeber

We had the somewhat qualified pleasure last week of attending the spring meeting of the International Institute of Finance — the assemblage of the great and the good of the world banking industry— which this year was held in Beijing.

Although as usual for such events there was a certain amount of high-level pabulum, two clear messages emerged from the cogent presentations by Chinese speakers.

Last week we wrote that China was unlikely to make a substantial contribution to discussions about reorganising global economic governance.

Hours after our post went up, it was neatly contradicted by Zhou Xiaochuan, governor of the People’s Bank of China (PBoC), who published an essay on the bank’s website suggesting the creation of a new supra-national reserve currency to replace the US dollar. This was followed later in the week by another essay on how to secure global financial stability, and an article by a PBoC research institute on how to improve global economic regulation.

This was a salutary reminder that the Chinese government (or at least some members of it) can be a bit more agile than foreigners typically believe. It also sent a signal that China, unlike Japan, will not be satisfied with the status of a second-rate power. Japan in the 1980s expended enormous energy in fighting bilateral battles with the US but did little to make itself relevant to global economic decision-making. China has a long-term vision of its rightful place in the world and will work on a variety of fronts to secure that place.

That said, the PBoC papers are interesting more for their political than for their economic content. Their immediate aim was to establish a stance ahead of this week’s G20 meeting in London. The essence of that position is:

  • the root cause of this and previous financial crises was the special position of the dollar as the world’s reserve currency (and not, therefore, the “Asian savings glut”)
  • the self-regulation model for financial supervision touted by the US has been proved bankrupt 
  • global financial regulation (eg the Basel II accords on bank capital) needs to be made less pro-cyclical.

The second and third points fall well within the realm of conventional wisdom these days. But discussing them enabled Chinese officials to exact a little payback for all the sanctimonious hectoring they have had to endure from arrogant US officials over the years about the superiority of the American financial system.

Invoking a supposed principle of “oriental philosophy” that self-criticism is essential to self-improvement, the PBoC research department paper called on the US to exhibit remorse for its errors, stop blaming other countries for its problems, and reject the “prevalent complacency” that allowed its financial excesses to overwhelm the world. Such sermonising, though excusable, adds little to the sum of world knowledge.

Mr Zhou’s global reserve currency idea is more interesting. This is not because the proposal is likely to lead anywhere. There is almost no chance of that – as we suspect Mr Zhou knows.

But as a political statement it is ingenious. By arguing that the IMF should become the issuer of a new global reserve currency, Mr Zhou cleverly positions China as a champion of strengthening a rules-based multilateral system of global economic governance, rather than as a bare-knuckled aspirant hankering to knock off the current kingpin bully. Many have feared that China’s rise must be de-stabilising and that China will have no stake in “playing by the rules.” By identifying – accurately – the moral hazard and instability risk inherent when a single national currency serves the global reserve function, Mr Zhou articulates China’s national interest in promoting and participating in a rules-based, multilateral system.

This argument is directed at a domestic as well as an international audience. Some in the Chinese government fantasise that China’s big surpluses give it power, and that the renminbi can swiftly replace the dollar. Mr Zhou knows better, and is trying to steer the domestic debate in a more useful direction.

The second political purpose of Mr Zhou’s paper was presumably to suggest some conditions for China’s participation in the expansion of the IMF’s capital, which is a keenly-desired outcome of the G20 process. The rich countries want China to stump up US$100bn-US$200bn, largely to enable the IMF to bail out the bankrupt economies of eastern Europe. China rightly questions what benefit it would derive from paying such tribute. An expansion of its voting rights in the IMF is a paltry prize, both because it would take at least a decade under current rules to give China a voting share commensurate with its economy’s size, and because the IMF is marginal to global economic decision-making. By proposing a vastly stronger role for the IMF, Mr Zhou indicates that China deserves and seeks real influence, not meaningless trappings.
 
The global currency idea itself, however, is impracticable. Mr Zhou proposes that the IMF’s special drawing rights (SDRs) be converted into a global reserve currency, supported by large-scale issuance of SDR-denominated bonds. One obvious question is who would decide on the volume of SDR issuance – ie the size of the global money supply? The IMF is not set up as a central bank. The Bank for International Settlements is another possibility; but any multilateral institution would suffer from a diversity of masters with different political agendas and thus would find it difficult to shift monetary conditions decisively in times of crisis, which is an indispensable attribute of a central bank.

This points to deeper objections: reserve currencies are a reflection of political as well as economic power, and they are determined not by negotiation but by market activity. They are subject to “network effects” similar to those that apply for computer operating systems – the more people gravitate to a standard, the more incentive other people have to follow. Once a standard is established it is exceedingly difficult to dislodge.

Despite the current crisis, America’s political hegemony is secure and its ability to guarantee the long-term value of its debt securities is still superior to that of any imaginable political collective overseeing a global currency. The dollar’s position as the main reserve currency is still secure. But China has served notice that the US will need to work a bit harder to justify its “exorbitant privilege.”

Dragonbeat is no longer updated but it remains open as an archive.

Readers of the Dragonbeat blog can now go to www.ft.com/dragonbeat to read the new Dragonbeat weekly column for insightful commentary and analysis on China.

Full list of the FT’s blogs