What with the Chinese government intervening heavily in the stock markets these past couple of weeks this might not be quite the politic time to suggest that the real answer to their problems is to completely deregulate finance in that country. However, deregulation is indeed part of what they should be doing for it is indeed at least a partial solution to their problems. And no, this isn’t some way out there neoliberal buffoonery of a plan either. This is straight down the middle of the road mainstream economics. We could get pretty much every non-comatose economist to agree that it’s a good idea. Although I admit that rather fewer would think it’s quite as good an idea as I do.
The basic problem is that China still practices pretty heavy financial repression. No, that doesn’t mean that the bully boys beat up capitalists in the streets (that’s a story from many decades ago), rather it means that they deliberately limit the savings options of China’s citizens. Yes, they have been loosening those regulations but they need to go a lot further.
The basic point is that the Chinese banking system is entirely dominated by state owned banks. And these have their interest rates set for them by the centre. And those interest rates have been consistently negative in real terms for a few decades now. That is, the interest received is less than inflation. Saving in cash or in a bank is thus a way of losing money. These regulations have been loosened in the past couple of years and companies like Alibaba and Tencent are doing very well offering money market funds (and certainly some analysts think their long term hopes are tightly bound to the success of their financial arms). These pay much better interest than the state banks because they then lend on to the private sector, where interest rates are higher. The state banks tend to lend to the state owned enterprises (SOEs) the subsidy of which is the entire point of the system of financial repression.
Which is a problem for the overall balance of the economy:
Their angst poses dual problems for China’s leadership. The ruling party bases its legitimacy on delivering high rates of growth and employment. It also hopes to encourage consumer spending as a new engine of growth as the manufacturing sector slows and to nudge the economy away from an investment-driven model. Eroding confidence threatens both goals.
Household savings rates can be as high as 50% of income (by comparison in the US it’s perhaps 5% or so) and saving and or investment has in recent years been 40-50% of the entire Chinese economy. And the thing is, those low interest rates paid to Chinese savers help in making the savings rate that high.
Yes, I know, we don’t normally think of it that way: surely people will save less if they lose money by saving? And if interest rates rose they would save more? True in many circumstances but almost certainly not this one.
Recommended by Forbes