2014-03-31

Political Battle Behind the Scenes Still Ongoing in China; Economic Reform Isn't Solely Economic Reform

The slowdown in China is not only an economic policy. As I've pointed out before in several posts, a political change is taking place under the guise of economic policy. The deflationary policies of the Xi-Li government will hit their political enemies. Deflation always reveals corruption that was hidden by rising profits. With an anti-corruption policy in place, the leadership is lining up its political enemies to fall.

One such enemy was Zhou Yongkang.

China seizes $14.5 billion assets from family, associates of ex-security chief: sources
The sheer size of the asset seizures and the scale of the investigations into the people around Zhou - both unreported until now - make the corruption probe unprecedented in modern China and would appear to show that President Xi Jinping is tackling graft at the highest levels.

But it may also be driven partly by political payback after Zhou angered leaders such as Xi by opposing the ouster of former high-flying politician Bo Xilai, who was jailed for life in September for corruption and abuse of power.
This is incorrect. He is not being punished for opposing Bo Xilai's removal, he is being punished because he was Bo Xilai's mentor. He was grooming Bo for a spot on the Politburo. Bo Xilai was trying to revive Maoism and was the head of a Red cultural push. This is the exact opposite of where the reform camp (liberals) want to go, and the pro-business Shanghai clique isn't interested in turning back the clock.

The reform camp started up financial reforms as soon as Bo Xilai was arrested. (See: Major financial reforms begin in China)

There's also the PBOC's indifference towards the pain felt by banks being hit with competition from online money markets offered by firms such as Alibaba. This is not at all surprising given the comments by Wen Jiabao only weeks after the arrest of Bo Xilai (see: Why is Wen Jiabao criticizing the banks?) I wrote:
Instead of prosecuting the booming gray market business, China has legalized it and after it succeeds, will spread it across the country. A private financial system will compete with state-owned banks for deposits. It will pay higher interest rates and charge higher rates for loans, to better credit risks, while the state-owned banks continue make bad loans to politically connected firms. Eventually, this will start impacting the state banks and instead of being regulated by politics, they will be regulated by markets. The old way to reform the banking sector was top down reform of the state-owned banks. This failed, the PBOC was blocked by the Ministry of Finance, and everything went back to business as usual after 2008. Now, a new reform effort is taking place, a bottom up approach that is more likely to succeed and far greater impact on the Chinese economy.

Those looking for a stimulus to boost the Chinese economy are looking in the wrong place. The economic slowdown is part of a much larger economic and political reform effort. This may not be the reform that Western observers want, but their criticism of China's political system has far less bite given the repeated failures in Egypt, Libya, Syria and now Ukraine. China is liberalizing in its own way, and the more economic pain that falls on the political opposition, the better. Remember that the party insiders used the state banks to enrich themselves and delay reforms post-2008, having already stopped reforms in 2005. (See: The Battle For China Continues On All Fronts) The state banks will not fail, but if they reach the point where they need a bailout, the reform minded PBOC will have enormous power to reshape the politically weakened banks.

The leadership doesn't want a runaway crisis, but economists who ignore the political dimension aren't seeing the whole picture. The current administration has much to gain politically from an economic slowdown.

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