Turning round “the ship of state” is a greatly difficult task. Like a ship, countries and economies have enormous momentum behind them, in the form of trading relationships, business practices, and economic structures and agreements, and to alter these takes considerable time. Economies aren’t just numbers; they are aggregates of human efforts, of labour. It’s always down to people and relationships, and altering behaviours is a difficult process. Similarly, the markets like to have a sense of financial trajectory, a sense of where the economy is headed (the better to have a sense of where to invest). It’s when markets are faced with uncertainty, as with the ongoing euro-area financial imbroglio, that squeals of protest come through. Futurology is often a silly pastime, and it’s the easiest thing in the world to look at anticipations of the future which turn out to be erroneous, but governments do best when they articulate their economic frameworks clearly and confidently, and follow up with decisive action.
The Chinese framework until recently has been clear. The yuan has been appreciating at around 0.5% a month. The reserve requirement ratio (the proportion of a bank’s capital kept in reserve, in case of credit crunches or other problems) has been steadily rising to reduce liquidity. Supply-side restrictions on property ownership, such as requiring a 50% deposit on a second apartment, have been ratcheted up. These moves were all designed to cool the overheated Chinese property sector, which was reaching truly fearsome levels of bubbledom, and to gently encourage a move away from manufacturing for exports to the domestic market. These moves followed the Chinese custom of incremental reform, and with their pragmatic rationale seemed to have the approval of the markets.
However, events in the Chinese economy have been moving faster. Signs of distress in the housing market emerged during the autumn, with developers starting to offer sometimes large discounts to encourage buyers, who were starting to get thin on the ground. With developers highly leveraged, they needed to sustain sales to maintain cash flow, but with sales volumes considerably down (Business China cited a 57% drop in Tianjin’s November transactions, year-on-year), cost-cutting was the only way round it. Prices though were plunging faster than many would have liked: the Shanghai showroom which offered 25% discounts was smashed up by those who had paid the full price less than a month previously. This, though, isn’t the major problem it would be in western economies (as we’ve seen from the troubles in the US and the UK). China has a far less developed secondary market (the market for previously-owned properties), and would-be buyers are generally far less leveraged, tending to pay large deposits or even in cash. Most property owners assume that the government will ensure that prices do not drop too far, and without anywhere to invest except from stocks and property, it’s likely that there is a reserve of would-be owners waiting for prices to fall.
But such rapid falls in prices, alongside the endless troubles in the euro area which are depressing the European economies and their appetite for imports from China, evidently caused the People’s Bank of China (PBOC) some concern, despite Premier Wen Jiabao’s repeated statements that the government intended to curb rampant housing inflation. On November 30, the bank reduced the reserve requirement ratio for the first time since 2008, cutting it by 50 basis points from a record high of 21.5%, thus adding CNY 400bn of liquidity to the Chinese economy by freeing up capital for new loans.
This marked a clear change in China’s tightening policy and was (perhaps coincidently, perhaps not) concurrent with similar actions from the euro zone, Brazil, Indonesia and Thailand. Given the rise in unemployment and the dispersal of the low-cost manufacturing to cheaper countries like Laos and Vietnam, this may be a good idea. But on the other hand, it seems to indicate the unwillingness of the Chinese governing class to alter the current economic system without suffering the birthing pains of a new approach. If the role of a central bank is to remove the punch bowl before the party really gets going (a phrase attributed to William McChesney Martin, Jr., a former chairman of the Federal Reserve), then the Chinese economy has just been handed another round. The Chinese economic dependence on property is well-known (a recent poll of Chinese with between US $78,520 and US $157,000 in investments revealed that property made up 75% of their assets), yet the day of reckoning is always postponed.
A parallel might be the British experience of the early 1980s. Under the premiership of Margaret Thatcher, the British government greatly reduced the size of the state sector, cut the power of the trade unions, and let the pound float freely (it rose considerably with the new abundance of North Sea oil). The aim was to change to British economy from being over-manned and subsidy-dependent to one which was far leaner and meaner. This was done, but at some considerable cost: unemployment more than doubled by 1983, and some areas of the UK, like the north of England and the greater Glasgow area, have never recovered. Even now, Thatcher’s name is a curse in parts of the UK. Yet the UK economy, despite the recent travails, did reform, with considerable gains in productivity.
What the Chinese economy needs to do is well known. But whether it can be managed is another thing.
Published in Business Tianjin