Indirectly, it affects us even more through its impact
on our other trading partners, especially Europe, and also by
propelling China forward as a global power at all levels, not just
economically.
Less well understood is the critical role that China's banks play in all this.
Almost
half of China's economic output each year goes into investment in
infrastructure, residential and commercial construction, the building of
factories, etc.
Much of this investment is financed by
borrowing, making the financial system critically important to
maintaining China's very high growth rates.
Banks dominate that
financial system, much more so than in America's more developed economy,
where banks provide only about a third of all credit. The rest comes
from financial markets and from non-bank lenders.
In particular,
four massive banks that are each majority-owned by the Chinese state,
tower over the scene: ICBC, China Construction Bank, the Agricultural
Bank of China, and Bank of China.
The
fundamental purpose of any financial system is to allow the "real"
economy to function better; we do not create banks because we like their
buildings, with all those pillars, or enjoy the beauty of a well-turned
trade.
Finance assists the rest of the economy by helping ensure
there are enough funds available for everyday transactions and for
worthwhile investments in the future. Further, the funding must be
available at reasonable cost.
On the flip side, the financial system is intended to ensure that families and businesses can invest their excess funds to earn a good return.
Unfortunately, China's financial system is currently struggling to fulfill these fundamental goals effectively.
Credit
is too cheap and too readily available for state-owned enterprises
engaged in wasteful projects or which are simply bad competitors,
encouraging those companies to hold dangerously high levels of debt, and
risking the need for large government bailouts if the economy falters.
On the other hand, private enterprise, the most dynamic part of the Chinese economy
and the major source of new jobs, has difficulty obtaining bank funding
and usually has to turn to other, much more expensive, sources.
Further,
bank deposit rates have been running below the inflation rate for
years, sometimes dramatically so. This matters because bank deposits are
where the Chinese hold much of their savings and investments.
Chinese experts and political leaders realize their economy has reached a crossroads where the old approaches have hit their limits and a new model needs to be developed.
The World Bank recently put out an excellent study
on this topic, in tandem with an important Chinese state think tank.
Its analysis confirms that of many other experts, showing that China
needs to take another major step forward in its three-decade long
process of economic reform, including substantially changing how its
financial system works.
Done right, the changes can be an
important part of a transition to a society that continues to enjoy high
economic growth, but on a more sustainable basis.
This
new model revolves around improving living standards so that Chinese
consumer spending will help drive the economy, with investment in
buildings and infrastructure slowing down and exports becoming less
critical.
If the reforms are blocked or perverted by the strong
vested interests that have developed in recent years, or if China
mishandles the delicate deflating of its housing bubble, China could
find itself with substantially slower, more volatile, growth and bouts
of inflation, leading to social unrest which could slow the economy even
further.
America's trade deficit with China could expand
strongly again, growth around the world could flag, and political or
even military risks from a less stable, and probably more nationalistic,
China could rise sharply.
Written by: Douglas J. Elliott
Douglas J. Elliott is a fellow in economic studies at the Brookings
Institution, where he specializes in analyzing the global financial
system and its regulation.
Source: CNN News