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For many U.S. and British economic commentators, recent developments in China have been only slightly less scary than the seemingly endless Greek debt crisis. Supposedly if the Chinese stock meltdown gets much worse, China could be headed for the sort of depression the United States suffered in the 1930s – and perhaps bring the rest of the world with it.
My advice to the commentators is to keep their “Made in China” headgear on. Not only is China not destined for any great depression but, as the top China watcher Pat Choate has pointed out, it can reliably be expected to continue to outperform for many years to come. Moreover, far from being part of the problem, China’s swooning stocks are actually part of the solution.
The commentators may find all this too paradoxical to credit, but then hot-air balloonists were probably similarly nonplussed by reports from Kitty Hawk in 1903. Pace Anglophone conventional wisdom, China does not owe its success to free-market capitalism. Quite the contrary.
China has embraced a powerful new system whose counterintuitive workings often make a mockery of Anglo-American economic dogma. Top Chinese leaders would prefer you did not know all this: the longer Americans remain in the dark about the reality of the Chinese economy’s true workings, the better. Chinese leaders are after all heirs to the tradition of the author Sun Tzu, who famously preached that all warfare was based on deception.
Let’s note at the outset that there are implicit contradictions in Anglophone reporting of the China stock crash.
One version has it that the fundamentals of the Chinese economy are ex-ante badly out of whack and that a Chinese depression is preordained. In this version, stock investors are merely anticipating a real economy disaster.
A second, more widely espoused, version gets the direction of causality the other way around: an economic depression is threatened if the authorities don’t act promptly to prop up the stock market.
The first version can be dismissed out of hand. The idea that the investing public or even some inspired subsection of it can anticipate major economic turning points is bunk. If it were otherwise, the world would be full of billionaires who grew rich through so-called market timing. In reality the number of successful market timers is vanishingly small. Successful investors – Warren Buffett is the quintessential example – generally don’t attempt to predict secular market movements but merely search for individual stocks that look likely to outperform.
As for the second version – that a Chinese stock crash could cause a depression – this is inspired by a widely touted but erroneous belief that the 1930s Great Depression was caused by the Wall Street crash. Supposedly the crash set off a self-feeding process in which a massive loss of consumer confidence induced U.S. industry to slash both jobs and investment. Although this interpretation was authoritatively debunked in 1963 by Milton Friedman, who showed that the real cause was overly restrictive Federal Reserve monetary policies, it remains deeply imbedded in the American press’s consciousness and is clearly a factor in how commentators see the current Chinese stock swoon.
Of course, the press is right about one thing: Chinese stocks are down about 30 percent from their peaks of a few weeks ago. To understand why this is not a problem you need to start with a look at Anglophone ideology. For Anglophones, the key to achieving fast economic growth is to get prices right. By this they mean not least establishing an efficient stock market-based financial system. By contrast, as James Fallows has pointed out, East Asian leaders believe in “getting prices wrong.” What he means is that government officials constantly override the market where this may deliver desirable outcomes such as increasing the flow of savings to industry.
Viewed in this light, Chinese stock markets are easy to understand. Far from aspiring to be pale imitations of the New York or London stock markets, they are run unashamedly as giant casinos in which government functions as the house, and enjoys the benefit of a lucrative house fringe. It is not too difficult to imagine that for the house one profitable maneuver might be to foster pronounced boom-bust stock cycles of the sort that have characterized Chinese stocks for decades (Chinese stocks suffered a far bigger tumble in 2008 than in recent weeks).
At the beginning of the cycle, various Chinese government entities load up on shares at low prices. Then they unload near the top. The victims are ordinary investors who tend to buy near the top and sell close to the bottom. To say the least the government is unsympathetic to such investors, who, of course, are seen as the merest of speculators. Basically they are sheep to be sheered but, for the most superficial of political reasons, the government has been going through the motions of propping up the market.
Underlying all this is a larger system of dirigiste bank-based finance. Not only are all the major banks substantially government-owned but so are all the major corporations.
One final point: while stock market crashes are feared in the Anglophone world in large measure because of fears that they will poleax consumer demand, a shortage of consumer demand is rarely if ever a problem in East Asian-model economies. Quite the contrary. This is because of another fundamental aspect of East Asian economics: consumption is systematically suppressed, a policy that broadly stimulates the propensity to save. At times when consumer demand flags, policymakers can readily ease up on artificial controls on consumption. Consumer credit provides an example. While consumer credit is generally tightly controlled, the controls can be relaxed at short notice, with immediate powerful effects in boosting demand. That said, so far at least New China seems rarely if ever to have had occasion to resort such tactics. As an export-driven economy China has consistently been able to find overseas demand for its goods.