This is very clearly the case for China, as I have discussed many times in this newsletter. Normally under these circumstances we would expect the losers in the system, the depositors, to opt out of depositing their savings in local banks, but it is extremely difficult for them to do so. There are usually significant restrictions on their ability to take capital out of the country and there are few local investment alternatives that provide similar levels of safety and liquidity.
Depositors foot the bill
Depositors, in other words, have little choice but to accept very low deposit rates on their savings, which are then transferred through the banking system to borrowers, who benefit from these very low rates. Very low lending and deposit rates create a powerful mechanism for using household savings to boost growth by heavily subsidizing the cost of capital.
The ones who lose under conditions of financial repression are net depositors, who tend for the most part to be the household sector. The ones who win are net borrowers, and in most countries in which financial repression is a significant policy tool, these tend to be local and central governments, infrastructure investors, corporations and manufacturers, and real estate developers. Financial repression transfers wealth from the former to the latter.Read it at China Financial Markets
What is financial reform in China?
by Michael Pettis | Senior Associate at the Carnegie Endowment for International Peace, Professor of Finance at Peking University’s Guanghua School of Management, and Chief Strategist at Guosen Securities (HK), a Shenzhen-based investment bank
Lots of good stuff in this post.
3 comments:
Pettis uses the definition of "financial repression" supplied by Reinhart (of Reinhart and Rogoff fame) and Peterson acolyte Kierkegaard:
Financial repression occurs when governments implement policies to channel to themselves funds that in a deregulated market environment would go elsewhere...a tighter connection between government and banks, either explicitly through public ownership of some of the banks or through heavy “moral suasion.”
It makes one smile to see how they just know how this must result in capital misallocation by definition. Clearly things would be better if more private financial rent extraction were allowed.
As One of Pettis' commenters said:
"I am compelled to point out that the Asian development model is still the most successful development model in lifting poor countries into the developed world by evidence. Latin American countries that followed the Washington Consensus of unregulated capital markets generally failed to grow their domestic industries like Japan and Korea did."
If you filter out the blatant neoliberal bias, I suppose Pettis does make the valid point that China needs better mechanisms for distinguishing between productive and non-productive investment.
He also seems to think that "savers are being robbed" by the low interest rate policy. "Low interest rates are effectively a form of substantial debt forgiveness granted, usually unknowingly, by depositors." The horror! Do Chinese banks really loan deposits? It really seems to chap the hide of people like Pettis that China "socializes credit" when it spends on "wasteful infrastructure." In the west we just do it when we bail out banks or allow corporations to "externalize" liabilities, but I'm sure Pettis is fine with that.
I'm thinking, sure China has problems, but at least they do invest in the real economy. When can we get some of that?
David, I agree. Higher interest rates are a redistributive force but, apart form the macro perspective where they accrue to bond holders, not depositors, it's a wash because higher costs for loans, to the eyxtent that they don't lead to less loans (which is the standard story) will just be passed on to those same despositors as higher costs.
Also, financial sector earnings are through volume * spread, not the price of credit as such, so I don't see how he connects the two. Surely he isn't implying that growth itself should be curtailed, only that there may be an inbalance between private and public sector investement? And that seems to me a: a regulatory issue owing to the command-style economy that China is and b: the flip side of the Chimerican coin, the other being cronic under investment in the US.
One obvious remedy would be higher incomes before interest instead of higher interest rates as such. The other would be not to liberalise interest rates but to allow banks to invest more in private enterprises. Which is happening, of course. The only problem being, it's all going into one ginormous housing bubble. And that's due also to a whole set of publically orchestrated incentives that makes sure that's where all the money goes. I wonder, might the new land owner and developer class be comprised of or at least in bed with party officials? At least it has nothing to do with interest rates and financial repression. Buried in that assumption is just an at best naïve dream that there is some monetary policy stance that will automatically bring about a more equitable distribution of income and resources. Hence also his use of the word 'manipulated' interest rates etc. They imply that there exists some natural rate that would balance the world.
Tom, I found this hilarious article on China written in 1999 predicting bleak future for the country due to its flirtation with Keynesian economics.
http://www.thefreemanonline.org/features/chinas-flirtation-with-keynesian-economics/
I can't help laughing at most of the pessimistic predictions the guy made. Thirteen years later, China has become an economic superpower, but the anti-Keynesian champions of free markets still continue to believe that collapse of Chinese economy is just around the corner.
It would be great if you write a blogpost based on this article.
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