The Alchemists: Three Central Bankers and a World on Fire (50 page)

Governor Zhou’s Chinese Medicine

A
mid purple neon lights, the sixty-two-year-old man with a round face and graying hair stepped up to address the crowd, on a stage that could have been set for a rock concert rather than a speech by a central banker. Everything was big and splashy: A chandelier the size of an elephant hung from the ceiling; the event’s sponsors included BMW and the Boston Consulting Group. It could have easily been in Las Vegas or Dubai.

But this was Beijing, at the base of the city’s tallest skyscraper, the China World Trade Center Tower III. When Zhou Xiaochuan, the governor of the People’s Bank of China, spoke at the Caixin Summit economic conference on that November day, he couldn’t have contrasted more with the usual image of Chinese leaders, who typically make public appearances against a red backdrop of faded solemnity. When Zhou walked onstage, he was also setting foot into the new China, a world of big buildings, big money, and, if Zhou does his job well enough, a big imprint on the financial life of people across the globe.

The rise of a great world power almost always goes hand in hand with its rise as global financial powerhouse. And behind the scenes of every great financial power is an effective central bank. London was the financial capital of the world during Britain’s reign as a nineteenth-century imperial power, which was made possible in no small part by the Bank of England. New York supplanted London as the world’s financial capital after World War I as the United States emerged as the great global power of the twentieth century. It’s no coincidence that the Federal Reserve System was created in 1914.

China’s ascent is perhaps the most remarkable economic trend of the last generation. The nation produced $330 worth of goods and services per person in 1991, adjusted for inflation. In 2011, that figure had reached $5,430. Behind those numbers are hundreds of millions of people who can now feed themselves reliably, endure less backbreaking work, and enjoy more of the comforts of the modern age than their parents’ generation could have dreamed of. China passed Japan to become the world’s second largest economy in 2010, and with a population four times that of the United States’, will almost certainly become the world’s largest within a generation.

But whether Shanghai can become a great center of global commerce on the order of New York or London—and if so, what this twenty-first-century financial capital will look like—is very much in question. The tasks for Zhou and his successors at the People’s Bank of China aren’t easy ones. They must wrest power and influence away from the nation’s political leaders to build a financial system that takes full advantage of all the lessons learned by Western central bankers over the centuries. Yet they must ensure that the system they build suits a Chinese culture and economy that are quite different from those of the United States and Western Europe.

That Friday in 2010, on that neon-lit stage in Beijing, Zhou offered a fitting metaphor for the differences between Chinese and Western economic policy. “
A drug from Western medicine
, which is based on theory and clinical trials, usually contains one ingredient and has a quick effect, while a prescription of Chinese medicine includes various ingredients that work together to treat a disease,” he said. “A Chinese doctor will adjust the composition of the treatment according to the patient’s condition, removing herbs, adding new ones and adjusting the dosage of some ingredients. Overall, the adjustment is based on the feedback from the patient.

“Chinese medicine probably is not as comprehensive or logical as Western medicine,” he added. “Some drugs with large side effects may be removed, or reduced through trial and error. This is learning through experience, with endless adjustments.” In other words, Chinese economic policy is forever a work in progress, an effort to use a wide range of tools in concert to maintain good health—or, more literally, a prosperous and peaceful nation. The global crisis that erupted in 2007 in the United States and spread to Europe repeatedly threatened China’s booming economy, endangering the “harmonious society” that has been the foremost goal of current Chinese leadership.

In a narrow sense, Zhou’s job was to make the Chinese renminbi as central to global commerce at the U.S. dollar. But his greater challenge was to shape an economy more resilient, a prosperity more durable than those of the crisis-stricken nations of the Western world. And he had to do it all without the authority that central bankers in the more advanced industrial nations have.

But then nobody ever said that taking center stage would be easy.

•   •   •

T
he chairman of the Federal Reserve is easily among the half dozen most powerful U.S. public officials, and arguably number two behind the president. The president of the European Central Bank at times seems like the most powerful person in all of Europe. But the governor of the People’s Bank of China is, by most accounts, not even among the couple dozen most powerful Chinese officials. This fact is often lost on Westerners.
Forbes
listed Zhou as number fifteen
on its list of the “World’s Most Powerful People,” and
Foreign Policy
placed him number four
on a list of global thinkers, one spot below Barack Obama and one above Ben Bernanke, rankings that make China experts scoff. To understand why, one must know how the People’s Bank of China differs from central banks in the West.

Created in 1948, the PBOC in its early decades wasn’t China’s central bank so much as its
only
bank, the state-owned financial institution responsible for making credit available to state-owned companies. Starting in 1983, as China was beginning its shift toward a hybrid economy of liberalized markets and state control, four different state-owned banks were spun off from the PBOC. In 1995, the institution was formally made the nation’s central bank in its modern form. Like its counterparts in most countries, the PBOC carries out a wide range of tasks for the Chinese government, including printing and circulating cash, executing the government’s interest rate and foreign exchange policies, and backstopping banks. The trillions of dollars in reserves that the Chinese government holds to guard itself against ups and downs of the global economy are held in accounts at the PBOC.

But while the PBOC does many of the same jobs as central banks in the West, that doesn’t mean it has the same power. In the Chinese system, the concept of an independent central banker—the central-bank governor as an independent actor who can make whatever decisions he believes best for the nation—simply doesn’t exist. Zhou and his predecessors were technicians, functionaries charged with carrying out the policy directives that come down from higher up. The nine members of the Politburo Standing Committee, led by Chinese paramount leader Hu Jintao (until late 2012) and Xi Jinping (his successor), make the biggest decisions. Zhou had status as one of thirty-five members of the State Council, the administrative arm of the government. But his was only one voice, alongside those of officials representing many other interests—manufacturing, agriculture, the military, and so on. Zhou is said to have briefed the State Council on the condition of the economy every two weeks and make recommendations as to whether interest rates should be raised or lowered. But the decisions are authorized by a small, more exclusive group within the State Council and, ultimately, the Standing Committee.

“I was in a museum one day when I realized it’s just like the imperial era, when the emperor received draft edicts from his advisers,” said one Chinese central banker, “If the emperor approved, he would stamp them with the imperial seal. Today, the PBOC sends guidance upwards. But nothing happens without that stamp from the top.”

Even among people who devote their lives to studying Chinese policymaking—analysts, diplomats, academics—the details of how the central bank’s decisions actually get made are murky. It is presumed that Zhou and PBOC staffers have at least some say. “I think they’re part of the intellectual debate, but I don’t think they’re part of the power structure,” said an academic with deep relationships within the PBOC. As a U.S. official experienced in dealing with China matters put it, a Chinese diplomat to Washington can learn more about how decisions are made at the highest levels of the U.S. government by reading a few days’ worth of the
New York Times
and the
Washington Post
than a U.S. diplomat to Beijing can from years of assiduously cultivating government sources.

This secrecy has created an atmosphere of fevered speculation and even distrust around the PBOC.
In August 2010, there was a strange rumor circulating
in Asian financial circles and redistributed by the political analysis firm Stratfor: The PBOC had suffered massive losses on its portfolio of U.S. Treasury bonds and Zhou had defected to the United States to escape punishment from Chinese authorities. One particularly implausible detail was that Fed vice chairman Donald Kohn had threatened to retaliate against any punishment of Zhou by disclosing the Swiss bank account holdings of some five thousand Chinese officials. China dealt with the rumor by shutting down Web sites repeating it and publishing indications of support of Zhou in state-run media. It was all nonsense, but the absence of the kind of transparency that’s standard in Western democracies means there are no reliable independent arbiters of fact. By contrast, when there was a rumor in financial markets that Alan Greenspan had been gravely injured in a car accident when he was Fed chair, his spokesman was able to shut it down by simply confirming to news services that Greenspan was sitting unhurt in his office.

To understand the PBOC’s policies throughout the crisis, then, one has to understand the political system and political culture in which it operates. Every government has a wide range of tools it can use to influence the economy—most significantly, taxing and spending, regulation, domestic monetary policy, and international currency policy. The major Western democracies have delegated those different tools to different arms at the state: Taxing and spending is the province of elected officials. Regulation is generally carried out by executive agencies. And monetary policy, experience has convinced the Western nations, is best left in the hands of independent technocrats who are largely separate from politics.

The Chinese system essentially puts all these tools of state power over the economy in the same hands, at the highest levels, aiming to use them in concert to realize the government’s overarching goal. And that goal, more than anything, is self-preservation. Communist Party leadership in China has an implicit deal with the country’s 1.2 billion citizens: Leave us in power, and we will maintain rapid growth that will result in steadily rising standards of living.

In the fall of 2008, when the world financial system was convulsing in the ugly aftermath of Lehman Brothers’ bankruptcy, the advantages of the Chinese method of making economic policy were evident. As the Western economies collapsed, so did demand for the clothing made in Zhejiang Province, the toys made in Wenzhou, the dishwashers made in Foshan. The implied deal between the Chinese government and its citizens was at risk of ripping apart. How many unemployed factory workers would it take for the masses to hit the streets to make their dissatisfaction known?

On November 5, the government announced a new fiscal stimulus of ¥4 trillion, or about $587 billion—or about 12.5 percent of Chinese GDP that year. (The U.S. stimulus package enacted in February 2009 was not only much later coming, but also only 5 percent of that year’s GDP.) But more remarkable than the scale of China’s response was the way it deployed every tool of government power at once. Zhou’s PBOC, which just a few months earlier had been fretting about high inflation and an overheating real estate sector and trying to tighten the availability of credit in the economy, abruptly reversed course. It slashed the required ratio of reserves held by Chinese banks as well as the interest rate on deposits. Local governments were ordered to ramp up their spending on public infrastructure. The PBOC relaxed quotas that had held back bank lending, and so the four giant state-owned banks happily loaned money to those local governments and state-owned companies on a mass scale.

“
They had a red rubber stamp
, stamping on every project that they came across,” said Northwestern University professor and veteran China watcher Victor Shih, at a conference. “Once you have this paper from the [National Development and Reform Commission], you’d take it to the bank and say give me money.”

Compare that to the crisis response in the United States. In both countries, monetary policy was loosened to try to combat the economic downturn. Both countries enacted fiscal stimulus, though with the messy realities of democracy, the American Recovery and Reinvestment Act became a contentious partisan issue. And because banks are under direct government control in China, the nation’s leaders were able to force them to lend, whereas the privately owned banks of the United States, reeling from crisis, were pulling back at the time the economy needed them most. Another difference: In late 2008, when experts and scholars began criticizing the U.S. stimulus package for funding wasteful projects, Chinese media were ordered to stop publishing negative coverage. The U.S. effort was vociferously and repeatedly attacked in the American media.

It all worked. The Chinese economy bottomed out in the fourth quarter of 2008, six months earlier than the U.S. economy did, and it returned to its precrisis growth path of nearly 10 percent almost immediately. Democracy and free speech are among the greatest achievements of Western civilization, but in moments of financial panic, authoritarianism has its advantages.

Zhou and the PBOC were good soldiers in this initial phase of responding to the crisis, even at the risk of the banking system becoming overextended and inflation rearing its head. “
From other countries we’ve already learned this lesson
: We’d rather act quickly and decisively,” Zhou said in an interview with a Chinese publication in March 2009. But later that year, with the Chinese economy having decisively rebounded, the opposite problem was starting to afflict the nation: There was too much bank lending, with a great potential that many of those loans were going to unworthy projects that would leave the banks with big losses in the future. Banks were doing as they were told, making loans to local governments on a mass scale, comfortable that the national government would cover any losses, but in the process they were creating longer-term risks for the Chinese economy, very likely starting to inflate the next bubble.