A lively debate in recent years has been might China “become Japan,” falling into a chronic malaise from which it can’t extricate itself. It’s a specter that’s morphed from “if” to “when” — with when being the past 12 months.
President Xi Jinping’s men thought they’d escaped 2015’s woes, only to see the floor fall out from under them in the first 10 days of this year. The root causes of instability that’s panicking global markets can be traced back to Jan. 1, 2015, when Xi opted for a muddle-through policy akin to Tokyo’s in the late 1990s. The question now is if China can be more successful than Japan in digging itself out?
Tokyo’s 1997-1998 policy decisions, arguably when the Japan of popular imagination — an unbeatable force destined to eat the West’s lunch — became a mere shadow of itself, offer clues for Asia’s biggest economy. In my 2014 book ” Japanization ” I traced the point of no return to November 1997 and the collapse of Yamaichi Securities.
It came at a fantastically inconvenient moment, just as the Asian crisis was claiming its biggest victim: South Korea, then the 11th biggest economy. With Seoul days away from a $57 billion bailout, the question quickly became whether Japan, then the No. 2 economic power, might be next. Japan was, after all, not too big to fail but too big to save. The blowup of Yamaichi, a century-old Japan Inc. icon, sent a wave of panic through the concurrent two-day Asia-Pacific Economic Cooperation Forum summit of 18 world leaders. Japan would stand its ground, then-Prime Minister Ryutaro Hashimoto assured U.S. President Bill Clinton and other world leaders.
And it did. Tokyo reminded the world its bureaucrats are second to none in a crisis. Yet the post-Yamaichi playbook put Japan on the path toward a deepening lost-decade cycle that current leader Shinzo Abe is still trying to end. At the time, Tokyo put all its energy into papering over cracks with massive stimulus and bailouts, borrowing with abandon, pressuring the central bank to drop interest rates to zero and propping up stocks, protecting underperforming executives, championing short-term growth over long-term reform. Now, 18-plus years later, deflation persists; Japan has the world’s largest public debt; interest rates are negative — and there’s no end in sight to a malaise fanned by complacency and timidity as the working-age population dwindles.
This will all sound very familiar to students of China’s 2015. Twelve months ago, Beijing’s strategy seemed to be to buy time with massive credit infusions and other initiatives to restructure the economy and boost purchasing power. “Unfortunately, China pursued only the first half of that strategy, buying time and then squandering it,” Nobel laureate Paul Krugman wrote in his latest New York Times column. “The result has been rapidly rising debt, much of it owed to poorly regulated ‘shadow banks,’ and a threat of financial meltdown.”
Krugman, it’s worth noting, is a student of Japan’s malaise. As far back as 1998, he was exploring the “liquidity trap” imperiling Japan’s outlook. And Krugman, an early proponent of Abenomics back in 2013, has since lost faith in the prime minister’s political will to break the deflation-and-debt cycle. Yet, as Krugman now points out, a China crisis would become a systemic one, unlike Japan’s. “If China does deliver a bad shock to the rest of the world, we are remarkably unready to deal with the consequences,” he wrote on Jan. 8.
Can China avert Japanization? Yes, if Xi’s team acts boldly to stop relying on excessive investment for growth and shifts gears toward a services and consumer demand-led model. Trouble is, the best window for such a transformation — 2014 to 2015 — just closed. There was no better time than 2014 to rein in shadow banks, bring state-owned enterprises down a peg and encourage a startup boom. Ditto for 2015, when Beijing could’ve yielded to “market forces” and let Shanghai stocks fall where they may. Now, any move Xi makes to tackle China’s worst excesses will prove far more difficult and resonate globally. Last week’s 6 percent-plus plunge on Wall Street is a case in point.
Unfortunately, the odds favor Xi doubling down on the Yamaichi playbook. Whatever buying there is in Shanghai stocks these last two days reflects Tokyo-like government intervention, not rational investment decisions. And there should be no doubt that Beijing’s “National Team,” its answer to Tokyo’s intervention apparatus and Washington’s “Plunge Protection Team,” is on the case to ensure growth stays near 6.5 percent this year, debt defaults are kept to a minimum and stocks don’t crash. In other words, China will spend much of 2016 punting its problems forward.
Yet signs of strain are bubbling to the surface, and not just in equities. The yuan’s 1.5 percent drop last week reverberated around the globe for good reason. Investors had long been accustomed to China lowering the yuan to boost exports, Japan-style. They’re less used to markets guiding it lower as traders bet against China’s prospects, as punters did last week. No one believes China’s gross domestic product data. But the ominous signals emanating from currency markets are impossible to ignore. And the burn rate on Beijing’s once massive foreign-exchange reserves (down more than 13 in 2015 to $3.3 trillion) suggests strains from an estimated $843 billion that fled China between February and November are increasing.
Beijing is still trying to beat the “impossible trinity,” the theory that you can’t simultaneously control exchange rates and monetary policy while freeing capital flows. It can’t. And as we’ve seen with the yuan, any sign of increased outflows is scaring markets and exacerbating the problem.
The answer is acting assertively to restructure the economy and repair the bad-debt-heavy national balance sheet. Increasingly, though, Xi’s government is acting like Tokyo’s, circa 1998, and courting Japanization instead of reform.
William Pesek, executive editor of Barron’s Asia, is based in Tokyo and writes on Asian economics, markets and politics. www.barronsasia.com