In the days ahead, the financial pages will convulse with excitement about China’s reserve-currency milestone. On Saturday, Beijing’s desire to unseat the dollar got a big boost as it formally secured the International Monetary Fund’s good housekeeping seal.
But as the yuan enters the IMF’s top-five currency basket, it’s worrisome to see the man behind this breakthrough effectively sidelined. No, Zhou Xiaochuan, People’s Bank of China governor for nearly 14 years, isn’t losing his job. Nor has President Xi Jinping curtailed Zhou’s travel or speaking schedule. Gone, though, is talk of the reform domino effect that internationalizing the yuan was supposed to unleash.
That, all along, was Zhou’s grand design. The 68 year-old is a disciple of Zhu Rongji, China’s most important change agent since Deng Xiaoping’s market-opening campaign in the late 1970s. As premier from 1998 to 2003, Zhou’s mentor increased transparency and accountability and tossed more than 40 million workers to the curb amid a huge state-owned enterprise purge. He was instrumental in China entering the World Trade Organization, which was a Trojan horse of sorts to ensure the nation would open up to a curious world.
Adding the yuan to the IMF’s basket was Zhou’s WTO-like gambit. Once inside the IMF’s “special drawing rights” framework, Beijing has no choice but to strengthen the financial system, address excesses in credit and debt, reduce opacity and loosen the capital account. The step, as IMF head Christine Lagarde said in January, “is a clear indication of the reforms that have been implemented and will continue to be implemented and is a clear, stronger representation of the global economy.”
But then you read the IMF’s recent warning about debt levels that “must be addressed immediately” and shake your head. You see the Bank for International Settlements fretting about a “credit to GDP gap” worse than those before the U.S. subprime crisis or Asia’s implosion in 1997. You mull concerns of private economists that China is nearing a “Minsky moment” when debt accumulation ends disastrously. You look at Xi’s sunny talk of giving “market forces” greater weight and Premier Li Keqiang’s assurances to recalibrate growth engines from investment to services and ask where’s the proof? Put it all together, and you have a currency that’s not ready for prime time.
The IMF didn’t err in embracing the yuan, but it’s important to keep perspective. While China is the biggest trading nation, yuan transactions are borderline negligible. In U.S.-China trade, for example, just 2.4 percent of payments are in Chinese currency. While that will now change to some extent, Beijing is putting the cart before the proverbial horse — Gov. Zhou’s own Trojan horse, that is.
Motivation matters, and Beijing’s yuan-internationalization motivation is still up for debate. For Zhou, globalizing the currency is about exposing China to outside forces and prodding Xi’s team to strengthen the economy’s foundations and fundamentals. For Xi’s team, it often seems, it’s about geostrategic influence — part of Beijing’s outreach efforts. Right after Xi’s visit to Zimbabwe last December, Robert Mugabe made the yuan legal tender there. China’s yuan diplomacy drive is just getting started.
But nothing about this campaign makes Xi’s Communist Party more nimble on upgrading the economy, its institutions more transparent, state-owned giants any less dominant, mainland executives more shareholder friendly, the media freer, the internet less constrained or unsustainable debt and credit growth any less prevalent. It doesn’t make China any less wedded to a 6.5 percent growth target. In fact, lowering China’s capital account defenses could backfire and make Xi even less willing to trust market forces.
The events of 2015 traumatized Beijing. The freefall in Shanghai shares took global bourses down with them. As Xi positions himself as the strongest leader since Deng, the last thing he wants is for China to be blamed for the next Lehman moment. For all his lip service about bold reform and a new, more innovative China, Beijing has mostly circled the wagons — pulling state-owned enterprises into the mix — to project an image of stability and continuity. That just means a risk-averse Beijing doubling down on debt-fueled growth as Zhou’s reform dreams fall by the wayside.
Another problem with China’s vulnerabilities is that we really don’t know what we don’t know. Fitch warns that the bad debt troubles facing mainland banks are ten times beyond what the government admits. But the estimated $2 trillion-plus bailout all this might necessitate strikes me as highly conservative. The biggest risk is local government debt, which now far exceeds Germany’s annual economic output. It’s emblematic of how Beijing is putting growth ahead of reform.
Amid all the hype about yuan hegemony, it’s important to remember that the really hard work is only just beginning. Well, hopefully.
William Pesek, executive editor of Barron’s Asia, is based in Tokyo and writes on Asian economics, markets and politics. www.barronsasia.com