The recent stock-market crash has highlighted the financial tensions in China’s leadership’s current growth strategy.
It also highlights the changing relationship between state and capital in China.
In recent years, China has become home to one of the largest and most rapidly growing ‘shadow banking’ systems in the world.
One reason why this is particularly interesting is that shadow banking entails financial entities and instruments that are no longer directly controlled by the state or subject to its bank or regulatory controls.
The shadow banking system in China has been a major conduit for the issue of new debt, including by local governments.
By some estimates, the value of outstanding debt in China rose from 130 to 250 percent of GDP between 2008 and 2014, over half of which has been attributed to the shadow banking system.
Moreover, most of this shadow banking activity has emerged from within the state owned or government system—from the huge state-owned commercial banks and from local governments, all of which have established ‘off-balance sheet’ investment vehicles to evade existing regulatory controls.
The popular view about this shadow banking linked-debt in China is that it is unsustainable ‘liquidity’ growth, which reinforces patterns of unwarranted investment—such as real estate or stock market speculation.
There is of course, much truth to this view.
One way to approach these questions is to try understand the extent to which Chinese financial institutions experience the ‘survival constraint’ associated with liquidity, how they are getting around this constraint through innovation and how this interacts with structures of state governance and involvement in money flows to create a distinct pattern of liquidity relations.
These questions are the focus of a new research project that aims to develop a Money View analysis of dynamics between financial innovation and central banking in the recent evolution of China’s financial system.
This research project has been based in the Department of Political Economy at Sydney University. The project is a collaboration between Michael Beggs and Luke Deer in Sydney, Chris Jefferis in Berlin and Yu Yuxin in Shanghai.
This project is funded by a 2015 grant from the Institute for New Economic Thinking (INET), which was set up after the 2007-8 global financial crisis to promote new thinking in economics.
We have adopted the ‘money view’ term from Perry Mehrling, for whom it describes a tradition of practically oriented economists interested in the shifting forms of money and financial intermediation (such as Minsky, Wojnilower, and Kauffman).
It is a tradition outside the main line of current macroeconomic thinking on money, distinguished by:
- the importance it gives to liquidity and the money market where ‘the coherence of the credit system… is tested and resolved as cash flows meet cash commitments’;
- its focus on the interconnection of balance sheets and the need to understand the evolution of both asset and liability positions at a relatively disaggregated level, rather than netting them out into aggregates; and
- its attention to the interdependent evolution of central banking and financial innovation, and the need for historically and institutionally specific theory.
We are seeking to draw on the money view to map the institutions, technologies, and forms of credit and governance systems involved in China’s financial system, and to explore the potential for financial instability and tensions in the country’s regulatory structure.
From the perspective of the money view, one striking question about China is the extent to which state ownership of financial institutions obviates the ‘survival constraint’. For most institutions, matching cash inflows to outflows one way or another is an imperative.
Yet the imperative to manage liquidity has been somewhat attenuated in China, where the state is part or full owner of many of the financial institutions: it can decide – by coordinated internal management decisions or by regulation – to suspend the right of creditors of a financial institution to recall funding, mandating that credit be rolled over.
For instance, China’s central bank has stepped in to restructure local government off-balance sheet debts through the through the creation of a new local government bond market, into which existing debts will be rolled over into new maturities at lower government-influenced interest rates.
Yet the money view does not expect a stable, exogenous money supply – and in this respect, growing balance sheets in China are not unique. First, this is because modern central banks usually let their balance sheets expand and contract passively to maintain stable money market interest rates.
Second, private banks expand and contract their balance sheets (and therefore the deposits that make up most of the money supply for non-bank units) in pursuit of their own financial interests.
Third, financial innovation can also lead to large changes in asset and liability positions of both formal and shadow banking entities, especially through changes in the types of money-instruments held.
Standard macroeconomic theory reacted to the breakdown of stability in money-demand functions, and the recognition of central bank accommodation, by moving away from monetary aggregates to simply focus on the interest rate as the key policy instrument. The system of interlocking balance sheets and monetary flows has become a black box. For the money view, this is to throw out the baby (liquidity) with the bathwater (liquidity preference as a stable demand function for an exogenous monetary aggregate).
The money view research program opens the black box to analyse liquidity as emergent from interdependent balance sheet strategies, following the structure of claims and the flow of funds between units.
Financial innovation also influences balance sheets by impacting on the asset and liability positions. One example of these issues involves Alipay, the retail payments arm of the e-commerce giant Alibaba – and Alipay accounts for half of all electronic retail payments in China.
In late 2013, Alipay established a linked-investment fund called Yu E Bao, which offered a return of eight per cent on investments as little as one yuan by investing in China’s money markets at well above the official interest rate of 3.5 per cent.
Within three months, Alipay had the equivalent of US$80 billion in funds under management and the central bank came under sharp political pressure to check the growth of unregulated online asset management funds – because of the perceived risks of disintermediation from the state bank system.
China’s central bank is also under pressure from the deepening of economic and financial internationalisation. There are some parallels here with the dilemmas facing policymakers in the West in the later years of the Bretton Woods international monetary system.
China has learned from US history and while Mehrling treats the monetary hierarchy as a somewhat organic product of US financial development, a result of the historical pattern of growth, in China it is more formalised. This is to say that China is pursuing a strategic growth path using controls that were not afforded to the US to orchestrate hierarchical money flows, putting in place the institutional infrastructure of a modern financial system, including public institutions at key pressure points.
While none of this means China’s government can control volatility, the Chinese government is looking to orchestrate the development of a market-based system of finance to make sure that it happens in sync with the internationalization of the Chinese economy.
This aspect of the money view leads to the research program of mapping the hierarchy, understanding the interrelationships between the balance sheets of units operating at different levels, and tracing the cyclical and secular evolution of the structure.
We will also explore how financial innovations in China and central bank policy interact with other key aspects of the Chinese economy such as national economic strategy, capital flows and the governance system.