China’s explosive stock markets took a beating today on the news that the government had moved to tighten credit. Signs abound of a frothy market in the Middle Kingdom: money had rushed in from real estate (another bubble) into stocks in recent weeks, only to flee back out again as the country’s securities clearing house imposed stricter rules on what can constitute collateral for borrowing. The Wall Street Journal:
“The new rule is to prevent risks from building up further as a result of high leverage in the market,” said Xu Hanfei, analyst at Guotai Jun’an. Mr. Xu added that the combined outstanding value of repos on the country’s two exchanges has surpassed 700 billion yuan (US$113.47 billion).
Chinese authorities seem to be serious about shifting away from the growth-at-any-cost model that powered the country to three decades of record expansion—an economic miracle that made China a major global player but has left the country with a legacy of bad debts, out of control local government policies, and pollution. Now authorities seem to be trying to put the country on a slower but more sustainable growth path—a difficult but necessary transition that will no doubt exacerbate social tensions in the short term, as citizens used to rapidly increasing incomes will face slower progress.And there are other risks as well. The orderly liquidation of an asset bubble is very hard to accomplish in the best of circumstances, as it’s all too easy for the retreat to turn into a rout—financial panics and crashes often come when overextended economies begin to slow. In a country like China, a major economic crash could have serious political repercussions, something that has in the past led Chinese governments to turn the spigots back on when signs of trouble appeared.This time, the government appears to be planning for a more serious bout of reform. We have written earlier about signs that the Xi government was battening down the hatches—tightening the central government’s control of the party through a mix of ideological campaigns, personnel changes and a serious purge. These moves put Beijing in a better position to see the reforms through and to withstand the inevitable pain and pushback. The recent shift to a less confrontational foreign policy also makes sense from the perspective of a government worried about the home front.And the timing for attempting a correction is propitious: the fall in world energy and other commodity prices will help offset the effect of any further tightening of Chinese financial policy, cushioning the blow and raising the odds of a soft landing.Nobody, not even the technocrats working to steer China safely through this latest turn of events, knows how things will turn out. But the long-postponed turn to slower but more sustainable growth in China is one of the biggest stories of the year, and the fate of this experiment will help shape world events in 2015 and beyond.