by Nomi Prins
Despite a small recovery from the week’s lows, Chinese shares recorded their biggest monthly fall in seven years. The Shanghai Composite Index had shed 22.6 percent of its value since early January, posting its worst month since October 2008. Things were looking very much like they had in the United States during the first leg of the financial crisis.
Given the precarious nature of the markets, Premier Li Keqiang called IMF head Christine Lagarde on the morning of January 28 to reassure her that China would use the yuan to promote exports and not provoke a currency war.188 He promised to keep the yuan stable and improve communications about the currency with financial markets.189
On January 31, a money-conjuring injection from Japan proved an unlikely gift to China. Asian stocks rallied sharply after the BOJ’s decision to further lower rates, pressing the yen to a six-week low. Crude oil prices stabilized, causing commodity-linked currencies to rise.190 It appeared that the BOJ’s moves, coupled with the Fed backing off on rate hikes, achieved stability.
Zhou wasn’t going to adopt a wait-and-see mode. It was time for him to act, too. Enacting its own easing measure, the PBOC injected more than RMB 600 billion (US$91.22 billion) into the markets in early February.191 The PBOC had cut interest rates six times since November 2014, reduced the percentage of reserves banks must hold, and sold RMB 629 billion in December. The decision to inject more money hinged on the poor results of the Chinese economy in Q4 2015, which showed its weakest growth since the financial crisis.
As a result, a degree of normalcy returned and lingered for months. In that placidity, on May 20, 2016, the Chinese government conducted a series of new appointments. PBOC governor Zhou retained his position as the longest-serving central banker among major economies.192 His focus turned to Europe, where an influx of refugees coupled with economic angst and hostility toward elites would soon cause a tear in the EU. A month later, the yuan hit a five-year low against the dollar as the US currency gained amid growing fears that Britain might leave the EU and economically destabilize the region as a result.193
THE NEW DEVELOPMENT BANK (BRICS DEVELOPMENT BANK)
China took advantage of G7 money-conjuring policy to expand its global footprint in much the same way the United States had done during the twentieth century. But its process was different. Whereas the United States expanded from a military perspective first, then by acquiring pieces of enterprise in emerging countries, China opted for long-term loan-based infrastructure partnerships. This contrasted with the method used by private US banks, which funneled in speculators seeking the flavor of the month or year and quick returns on capital, with the US government augmenting their businesses with military or political support. China’s philosophy was to dispense capital over a greater horizon period, mostly to sustainable energy and other construction projects.
During 2015, funding to Latin America from the state-run China Development Bank and the Export-Import Bank of China hit a near record of $29 billion—nearly triple the 2014 amount. The sum eclipsed 2015 funding from the World Bank and Inter-American Development Bank combined.194
China’s focus was on infrastructure that would benefit China, such as the $10 billion Bi-Oceanic railway financed through the China–Latin America Industrial Fund (CLAI Fund) and China Railway No. 10 Engineering Group (CREC) that would transport commodities from Rio de Janeiro to Peru’s Pacific port of Arequipa.195 China’s own high-speed railway system was state-of-sustainable-energy-art.196
The New Development Bank (NDB) was part of China’s overall strategy of collaborating with other emerging nations on development projects, spearheaded by BRICS for BRICS. The NDB signed its first loan agreement with the government of India to finance a $350 million project to develop and upgrade major district roads in Madhya Pradesh.197
The NDB plan was to raise $1.5 billion through issuing bonds between 2016 and 2018. To make those bonds most appealing to investors, the NDB secured an AAA rating from two Chinese credit rating firms.198 The structure of the NDB and capital allocation to long-term projects was a far cry from the way G7 money-conjuring nations had rendered cheap capital available with no strings attached to big banks and their speculator clients and collaborators.
On April 10, 2016, at the annual conference of the Inter-American Development Bank in the Bahamas, Zhou noted that Latin America was incapable of resisting a global economic slowdown—without China’s help, anyway. He emphasized cooperation and mutual coordination regarding trade and investment policies as well as the importance of both sides to each other: “In recent years, thanks to joint efforts, relations between China and the LAC [Latin American countries] have developed in multiple fields. In 2014, during a visit to the region, President Xi Jinping [had] set the ambitious goal of raising China-LAC trade volume to US$500 billion and China’s direct investment volume to US$250 billion in ten years.”199
China was the second-largest trading partner of Latin America. Thus, Zhou believed China should have flexibility in implementing its monetary policy.200 He condemned the protectionism in trade that was beginning to form, and he called for countries to become more active in securing a global recovery. He routinely sought to focus attention on the problems of the international monetary system leaning too heavily on the US dollar and defended the expansion of the IMF’s special drawing rights basket as a way to diversify from it.
According to the April 2016 IMF report on the regional outlook for Asia and the Pacific, the IMF was keen for China to take over the money-conjuring mantle if the United States abandoned it. It warned, “Further interest rate hikes by the Federal Reserve could lead to a further tightening of global liquidity and capital outflows from emerging Asia and other emerging market economies.”201
Regarding China, however, it noted that “monetary accommodation (following a series of interest rate and reserve requirement cuts in 2015) and an easing bias to monetary policy as well as the announced on-budget fiscal stimulus should provide some offset.”202 The IMF actively wanted China to be a counterbalance to the United States and, yet, appeared to be advocating for it to deploy the same monetary policy strategy that the US Fed had adopted since late 2008.
In early June 2016, US Treasury secretary Jacob Lew gave an interview before speaking at the US-China Strategic and Economic Dialogue in Beijing. He stressed that China must improve monetary policy communication as it assumed a more relevant role in the global economy. Lew said that China’s decision to devalue the yuan in August 2015 was “something that was confusing and not well communicated, and it gave rise to fears that China’s economy was in a much weaker place than it actually appears to be or was perceived by policy makers to be.”203
On June 24, in the wake of the Brexit vote,204 Zhou told the IMF at the Michel Camdessus annual Central Banking Lecture series that the PBOC was aware of rising tensions regarding China’s economic and monetary policy. But there were bigger fish to fry. Given the seismic shift that Brexit could possibly cause in the European Union and in the United Kingdom, and their currencies and trade agreements, he wanted to make it clear there was no place for repetitive, swirling accusations about China’s policies. He affirmed, “We are paying close attention to international discussions on Chinese monetary policy and will adjust our policy in a dynamic way to meet the demand of China’s economy, reform and development.”205
As part of the official program of events, just before noon, Zhou had a candid conversation with Christine Lagarde.206 She welcomed him with heartfelt praise in her introductory remarks.207 She said he was “first and foremost” a “friend” she had known for a long time and that her respect and admiration for him has “only grown over time.” She called Zhou a “central banker of the very best caliber” and “too modest” to take credit for all his accomplishments with respect to China. She praised China for its growing leadership in the financial arena and for leading the G20 with “wisdom, determination, and elegance.”
Lagarde underscored that the inclusion of the Chinese currency in the SDR w
as a result of many years of hard work and that Zhou had “steered China’s monetary policy throughout this impressive transformation.” If China was a ship, she said, it would be “a large container ship” of “the new mega class.” China accounted for the same share of global output as all the other EM countries combined, representing 30 percent of global investment and housing five of the world’s biggest banks in terms of assets.
She commended his ability to combine a “global vision” with “Chinese wisdom” and noted that underneath his “very calm demeanor” was a “world-class intellect” and an “energetic personality with wide-ranging interests.” She praised his being an avid player of badminton and tennis—which demand “stamina, agility, speed, precision and strategic skill,” all of which “come very handy for a central banker.” She lauded his deep appreciation for Western classical music and opera and even that he had coauthored a book titled Journey of Musical Operas. “Sharp, talented, well rounded, open-minded,” he was a key player “in helping China navigate the next phase of its transformation.” After the lecture, Lagarde presented Zhou the gift of a pair of badminton rackets.
Zhou, in turn, thanked Lagarde for her “comprehensive introduction,” humbly deflecting her praise of him. He addressed the issue of the central bank’s independence, noting that sometimes it fell under pressure because of its multiple aims,208 which could create tension with other government agencies. “If a central bank has multiple objectives, it may be harder to be immune from the political reality,” he said. “Ultimately the transition to a market economy will by and large be completed.”209 He vowed to focus on problems with systemic risk and China’s shadow banks and to ensure traditional financial institutions maintained their prominent role in financing development.210 In a transitioning economy such as China’s (from centrally planned to market oriented), this needed to be taken into account. He noted that the PBOC’s medium-to long-term goals were “financial stability,” which had high priority, and to “promote reform and open up financial markets.”
This was a significant moment. Zhou had been reluctant to point out philosophical differences between the PBOC and the government given their past alignment. The Western press had alluded to them, but China had not, nor had Zhou himself.
Lagarde and Zhou’s warm relationship was genuine, largely resulting from their mutual respect and support for each other’s goals. Lagarde advocated growing the power base of emerging countries within the IMF structure, and Zhou was grateful for a Western ally whom he could count on.211 This personal alliance in a shifting global hierarchy underscored the role Lagarde played in reshaping superpowers and how much power the IMF wielded in the process.
On June 27, 2016, the yuan fell to a five-and-a-half-year low against the dollar as a result of Brexit—another political-economic opportunity for China, which caused more established currencies to rally as the British pound tanked. The PBOC tolerated the currency’s weakening after the Brexit vote by setting a much weaker midpoint.
President Xi Jinping confirmed China’s strength in the global turmoil on July 8, when he told a group of Chinese economists in Beijing that China’s economic growth was “basically stable and in line with expectations.”212 He vowed that China would push ahead with “supply-side structural reform and continue to implement prudent monetary and proactive fiscal policies.” He also cautioned that the transition from old to new economic growth engines would take time.
China wasn’t just funding Latin American and African projects, pushing to enter the IMF’s SDR basket, and increasing domestic stimulus but also inserting itself into European matters while the United States was in presidential election mode. While the United States focused on the political and media posturing between candidates, China tried to take over some of the US influence in Europe.
“Eurasian regions are facing opportunities as well as severe challenges such as terrorism and refugees, which require respect and cooperation from all sides,” Chinese premier Li Keqiang said at a July 15, 2016, Asia-Europe summit in Mongolia. He took a shot at the United States, warning that world powers should not stir up regional conflicts. He implicitly wanted the United States to stay out of the conflicts surrounding the South China Sea and let China deal with them.213
Disputes had intensified around the area, through which about $5 trillion in maritime trade moved per year, including 80 percent of China’s crude oil imports.214 China lays claim to much of that space, and other Asian countries, such as the Philippines, Malaysia, Brunei, and Taiwan also have claims. The Philippines was concerned that China was building structures on an area called Scarborough Shoal, which China had seized in 2012, and had enlisted the United States to back it after The Hague declared some of China’s artificial islands illegal in July 2016.215
The eleventh Asia-Europe Meeting (ASEM) summit had kicked off in Ulan Bator, Mongolia, on July 15, with fifty state leaders convening to discuss common issues, including antiterrorism, trade, and cultural exchange cooperation across Eurasia. Li noted Eurasia faced both “great opportunities and severe challenges” from terrorism and the refugee issue and that “all sides… [should] explore new paths to further promote Eurasian cooperation.”216
He pledged China’s commitment to address these challenges and to contribute to peace and prosperity in Eurasia and the whole world. Li used the forum to emphasize the positive performance of the Chinese economy during the first half of 2016, saying “vibrant, new business forms are booming and new growth momentum is accumulating.”217
China’s growth contribution to the world economy surpassed US figures. As of 2016, almost one-third of the world’s GDP growth was due to China.218 China’s external direct investments hit $1 trillion for 2015, with $300 billion going to Asia. Its five largest banks’ overseas loans had increased by $400 billion since 2010, hitting $677 billion in 2014. More growth was expected given the government’s “go global” policies, internationalization of the renminbi, and grand regional development initiatives.
The Silk Road Economic Belt and 21st-Century Maritime Silk Road would develop new infrastructure connecting Asian, European, and African nations.219 The related “One Belt, One Road” infrastructure initiative, with more than $1 trillion of projects, would also connect those continents and bordering seas, upgrading trade routes, roads, railways, ports, and maritime routes with diversified and sustainable development.220
By 2016, China had accounted for about one-half of regional growth and was the top trading partner of most major regional economies in East Asia and ASEAN.221 During 1990–2016, the region grew about 6 percent per year, but so did its inequality.222 One of the most equal economies in 1990, China’s inequality came to be ranked higher than that of most other regions.
According to economist and Peking University professor Michael Pettis, inequality was the biggest issue keeping demand contained: “Even if China’s middle class was growing, their demand as part of GDP was not growing as quickly.”223 Meanwhile, total debt as a percentage of GDP rose. China needed a soft landing. Ironically, that meant that China’s continued rise was based on optimizing the balance of crafted money and fiscal policy. As much as it wanted autonomy, it was caught in the money-conjuring mania.
During the July 24, 2016, G20 meeting in Chengdu, China, despite Japan’s insistence they be a focus, Chinese exchange policies were not a main topic. Brexit was.224 Even with an economic slowdown and a lower yuan, the finance ministers and central bankers seemed more worried about Brexit than Chinese policies. As an official at the summit told Reuters, “China’s growth problems and exchange rate decline have not been much of an issue here. Japan with its concerns has been left a bit alone, no one wanted to join in.”225
While the yuan had fallen 5 percent against a basket of currencies since the last G20 meeting, the yen had become stronger and faced more volatility; it was still considered a safe haven even with Japanese rates in negative territory. Japanese finance minister Tarō Asō agreed with US Treasury secretary Jack Lew on t
he need for structural exchange rate reform in China. Despite that, US criticism about the yuan decreased compared to that of other periods. Lew complimented China’s improved transparency and noted market factors were indeed moving the yuan. With the European Union and United Kingdom suddenly more uncertain quantities, it made no sense for the United States to badger China.
The Fed’s decision on July 31 to keep rates unchanged also sent the yuan lower. The move followed the PBOC’s decision to strengthen its daily fixing by the most since June 23.226 By early August, the PBOC reiterated plans to keep monetary policy “prudent” during the year, even though it faced calls for further monetary easing from researchers at China’s top economic planner in order to help lower business costs and boost investment.227 The PBOC offered multiple other tools to maintain high liquidity levels and keep reasonable credit growth instead.
The PBOC’s methods included a half-point cut in the financial institutions’ RMB deposit reserve ratio, the use of open market operations to facilitate medium-term lending facility (MLF), pledged supplementary lending (PSL), and other tools to provide liquidity. These were all derivations of tools in the Fed’s artisanal money toolbox. The body vowed to continue to “promote the internationalization of the RMB and the yuan global acceptance significantly.”228
The PBOC released a statement on August 15, 2016, urging investors not to focus too much on short-term conditions and affirming that the diverging pace of credit expansion did not mean a loss of strength of monetary policy.229 The PBOC was concerned about corporate leverage and did not want to make changes in monetary policy again but was under pressure to be more clear and transparent in its communications.
Nevertheless, the decision-making process remained clouded. The PBOC was not totally disconnected from the central government, and Zhou was not the final voice of policy decisions. The bank still operated somewhat randomly. It had had no fixed schedule for policy decisions, did not publish votes or meeting minutes, and rarely provided scheduled press conferences. Zhou himself had already downplayed communication as a tool, but pressures from the IMF, which called for more transparency, provoked some changes in the central bank’s attitude.
