Yahoo Finance World on edge as Chinese yaun enters danger zone: 'Ever more angry'
China is facing an 'insoluble problem' as it desperately tries to revive its flailing economy.
As the saying goes, when policymakers start panicking, markets stop panicking. This is captured the popular markets phrase that past a certain point, policymakers will do "whatever it takes" to stabilise falling markets for their economy.
Never have we seen a more spectacular example of this than in China in the past several weeks. Following years of bear markets in stocks and property, recent pledges for stimulus have triggered a mad scramble for Chinese assets.
It is spectacular, but there are reasons to be cautious that China can't do "whatever it takes"
The Chinese yuan
The first limitation is the Chinese currency.
Owing to past episodes of excessive stimulus, such as 2015, the Chinese yuan has become an endemically weak currency.
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This has already forced it to close its capital account, limiting outflows of money from its economy.
Beijing has along term plan to internationalise the yuan. That is, to turn the yuan into a reserve currency so that China use capital markets in the long term to compete with the US empire.
A closed capital account is the very opposite of this, scaring investors that will not be able to get their money out when the time comes.
This has played a role in the withdrawal of capital from China over the past six to seven years.
If large stimulus is required to keep the Chinese economy growing, including very low interest rates, then outflows of capital will increase as as the yield advantage contracts.
This means that China can only reduce interest rates at the same pace that the US Federal Reserve does, or its currency will collapse despite the capital flow limitations.
So, interest rates can't be low enough for "whatever it takes" to stabilise asset markets.
Perhaps even worse, the value of the yuan is now a political issue in developed economies. Every time it falls, massive protests arise in US industry, and increasingly Europe.
Policymakers respond with tariffs, such as those just placed upon Chinese cars in Europe. Or those proposed by both sides in the US election.
This is hardly favourable to a mercantilist economy such as China's.
Political economy is China
There is second reason why Chinese stimulus will remain incremental and not do "whatever it takes".
China has spent many years developing an economic model that suppresses household income to the benefit of corporations and exporters, the largest of which are state owned enterprises.
China does this not just because it prefers supply side economics. It fits with the principal goal of the Chinese Communist Party (CCP), which is to retain power.
If Beijing were to undertake structural reforms such as privatisations, wage growth policies, and a proper welfare system to unleash consumption, it is effectively decentralising its economy away from CCP control.
This comes with the downside of CCP members losing their path to riches, as well as the risk that households will also acquire a taste for decentralised political power.
These outcomes are anathema to the CCP so, again, "whatever it takes" is a non-starter,
What we will get
None of this is to say that we won't get Chinese stimulus of sorts.
But, like previous rounds, it will be supply-side focused and this runs into the insoluble problem that China is built out.
China already has more than enough houses, roads, railways, bridges and factories to last a century for a falling population.
Beijing is well aware of this and does not want to make the debt burden associated with wasteful investment any worse, lest it kill off productivity as well.
After two decades of debt-charged growth, the Chinese economy is painted into a corner.
From here, the odd bout of stimulus that can meet the above limitations will not be enough to slow its growth interminably.
Alas, this is likely to lead to an ever more angry China seeking to blame everyone but itself.
David Llewellyn Smith is the editor-in-chief and publisher of MacroBusiness.
