China Confronts the Market
CAMBRIDGE
– China’s current economic woes have largely been viewed through a
single lens: the government’s failure to let the market operate. But
that perspective has led foreign observers to misinterpret some of this
year’s most important developments in the foreign-exchange and stock
markets.
To be sure, Chinese
authorities do intervene strongly in various ways. From 2004 to 2013,
the People’s Bank of China (PBOC) bought trillions of dollars in
foreign-exchange reserves, thereby preventing the renminbi from
appreciating as much as it would have had it floated freely. More
recently, the authorities have been deploying every piece of policy
artillery they can muster in a vain attempt to moderate this summer’s
plunge in equity prices.
But some important
developments that foreigners decry as the result of government
intervention are in fact the opposite. Exhibit A is the August 11
devaluation of the renminbi against the dollar – a move that invoked for
US politicians the old adage, “Be careful what you wish for.” The
devaluation – by a mere 3%, it should be noted – reflected a change in
PBOC policy intended to give the market more influence over the exchange
rate. Previously, the PBOC allowed the renminbi’s value to fluctuate
each day within a 2% band, but did not routinely allow the movements to
cumulate from one day to the next. Now, each day’s closing exchange rate
will influence the following day’s rate, implying adjustment toward
market levels.
The authorities
probably would not have moved when they did had it not been for growing
market pressure for a depreciation that could help counteract weakening
economic growth. In fact, bolstering growth might have been the primary
motivation for the country’s political leaders, even as the PBOC
remained focused on advancing the longer-term objective of strengthening
the market’s role in determining the exchange rate.
But the two
motivations are consistent: market forces would not be placing downward
pressure on the renminbi if China’s economic fundamentals did not
warrant it. The American politicians who demanded that China float its
currency may have anticipated a different outcome – somewhat
unreasonably, given that market forces reversed direction in mid-2014 –
but one can hardly blame the Chinese for taking them at their word.
To be sure, China
remains far from embracing a free-floating currency, let alone a fully
convertible one, which would require further liberalization of controls
on cross-border financial flows. Unification of onshore and offshore
markets is more important than a floating exchange rate in determining
whether the International Monetary Fund will include the renminbi in the
basket of currencies used to determine the value of its reserve asset,
the Special Drawing Right. Much commentary on the subject has
underestimated the importance of the criterion that the currency be “freely usable.”
Nonetheless, many are fretting that China’s exchange-rate adjustment has triggered a “currency war,”
with other emerging economies devaluing as well. But, more than a year
after the economic fundamentals swung against emerging markets (and
especially away from commodities)
and toward the United States, this adjustment was due. Though the
Chinese move likely influenced the timing, other devaluations would have
inevitably taken place. Warnings about competitive devaluations are misleading.
Exhibit B in the case
against attributing financial developments in China to government
intervention is the stock-market bubble that culminated in June.
According to the conventional wisdom, the authorities consistently
intervened not only to try to boost the market after the collapse, but
also during its year-long run-up, when the Shanghai Stock Exchange
composite index more than doubled. The finger-wagging implication is
that Chinese policymakers, particularly the stock-market regulator, have
only themselves to blame for the bubble.
There is undoubtedly
some truth to this story. It seems clear that the extraordinary run-up
in equity prices was fueled by a surge in margin financing of stock
purchases, which was legalized in 2010-2011 and encouraged by the PBOC’s
monetary easing since last November. Likewise, there was plenty of
support for the bull market in government-sponsored news media, for
example.
But what many
commentators fail to note is that China’s regulatory authorities took
action to try to dampen prices over the last six months of the run-up.
They tightened margin requirements in January, and again in April, when they also facilitated short-selling by expanding the number of eligible stocks.
The event that ultimately seems to have pricked the bubble was the
China Securities Regulatory Commission’s June 12 announcement of plans
to limit the amount that brokerages could lend for stock trading.
This is precisely the kind of counter-cyclical macroprudential
policy that economists often recommend. But, whereas advanced economies
rarely implement this advice, China and many other developing countries
do tend to adjust regulation, including reserve requirements for banks and ceilings on homebuyers’ borrowing, counter-cyclically.
One could criticize
the Chinese regulator on the grounds that the effect of its moves to
increase margin requirements did not last long; or one could criticize
it on the grounds that its moves caused the recent crash. But, either
way, these measures were intended to stem the rise in market prices,
rather than to contribute to it.
This is not a trivial
point. Nor is the fact that the PBOC’s interventions in the
foreign-exchange market over the last year have aimed to dampen the
renminbi’s depreciation, not add to it. Given this, it is facile to
blame China’s problems on government intervention.
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