By Andrew Browne at The Wall Street Journal
SHANGHAI—When the financier George Soros attacked the British pound in 1992 and famously “broke the Bank of England” he was trading on a conviction that the currency was misaligned.
Britain devalued after squandering its reserves in a vain defense. Mr. Soros walked off with $1 billion or more. To the surprise of many, though, the U.K. economy soon picked up once the pound found its proper level.
China’s raging battles with currency speculators are unlikely to end as happily for the country. That’s because turmoil in the currency markets reflects a much more perilous imbalance than an overvalued yuan: China is now lopsidedly dependent on ever larger inputs of local bank credit to keep sputtering growth from declining further.
The country is already littered with “zombie” factories, empty apartment blocks that form ghostly suburbs, mothballed power stations and other infrastructure that nobody needs. But yet more wasteful projects are in the pipeline, even as the government talks about cutting industrial overcapacity.
“That’s the misalignment—everything else is noise,” says Rodney Jones, the Beijing-based principal of Wigram Capital Advisors, who was a partner at Soros Fund Management during the 1990s.
If debt keeps piling up at the current rate, China faces an eventual financial crisis, perhaps leading to years of subpar growth, mirroring the fate of Japan after its bubble burst in the early 1990s.
Mr. Jones argues that global equity markets haven’t properly adjusted to this risk, even after a 16% decline in U.S. dollar terms from their May peak. “The world will have to learn to live without demand from China,” he says. “It’ll come as a shock.”
A sharp devaluation won’t fix these distortions, and might even make matters worse if, as likely, it were to trigger financial mayhem in China’s trading partners. An alternative—further clamping cross-border currency controls—would be a humiliating retreat from Beijing’s policy of making the yuan more international.
Or Beijing could allow a free float of its currency, which ascended to its current, unsupportable, level due to its peg to a surging dollar, even as the country’s economic fundamentals declined. But any precipitous yuan fall is risky.
Financial authorities don’t intend to allow markets to pass judgment on an out-of-whack yuan and, more fundamentally, the government’s fumbling of the economy. They’ve pledged to maintain the currency’s “basic stability,” although they face an uphill task: The yuan lost 4.5% against the dollar last year, and many traders think it has nowhere else to go except down.
To be accurate, part of the yuan’s weakness is due to the central bank’s new method of managing its value against a basket of currencies. It’s no longer a one-way bet, and so investors are diversifying.
Nor should China’s economic bright spots be overlooked. The Boston Consulting Group recently highlighted one of them: rich young spenders whom it predicts will push China’s consumer market up to $6.5 trillion in sales by 2020, an increase of 54% from 2015.
Moreover, the impact of China’s slowing growth on the world can be exaggerated. Australia’s Prime Minister Malcolm Turnbull told anxious American business executives a few days ago that his country’s economy, heavily dependent on sales of iron ore, coal and other raw materials to China, is doing just fine even though prices are plunging. He dismissed China’s market gyrations as “bumps” on its journey from manufacturing and investment to consumption and services.
Still, a speculative run on the yuan in offshore markets signals growing pessimism in the capacity of China’s leaders to avert a drastic slowdown.
The smart Chinese money is every bit as nervous; the central bank is struggling against a tide of capital heading for the exits. Individuals are shipping out portions of their wealth. Some corporations that borrowed offshore in dollars are repaying the money early, adding to the outflow.
And China is hemorrhaging reserves to try to prevent the yuan from falling even more sharply. DBS Bank says authorities have spent $663 billion of the reserves on this effort since June 2014. They now stand at $3.3 trillion.
International financial leaders are growing increasingly worried that currency chaos in China could tip the already fragile global economy into recession. Some blame the mess on the poor communication skills of Chinese market regulators, rather than a symptom of deeper malaise. In Davos last week, International Monetary Fund chiefChristine Lagarde said Chinese officials need to do a better job explaining their exchange-rate mechanisms.
But the problem stems from higher up. President Xi Jinping has centralized economic policy-making in his own hands, and he doesn’t take criticism well. Late last year, as economic uncertainty climbed, the Communist Party issued disciplinary instructions outlawing “improper discussion” in its ranks, shutting off yet more feedback loops.
As is often the case when the leadership feels besieged, state media is lashing out at foreigners. Last week, Xinhua News Agency blamed “reckless speculations” and “vicious shorting activities” from overseas for the turmoil, and warned of unspecified “severe legal consequences” for those responsible.
Such threats, if carried out, will only exacerbate the crisis of confidence. Speculators aren’t just shorting the currency; they’re selling China itself.