A Battle Over Money in Beijing

WSJ

Economic policy is a flashpoint in China’s political succession fight.

China's Premier Li Keqiang at the 1+6 Roundtable on promoting economic growth in Beijing on July 22. ENLARGE
China’s Premier Li Keqiang at the 1+6 Roundtable on promoting economic growth in Beijing on July 22. Photo: Associated Press

A succession struggle is underway in China ahead of next year’s Communist Party Congress. And this time the central fight is over monetary policy instead of ideological slogans. The outcome has implications for China’s response to slowing economic growth.

On one side is Premier Li Keqiang, who controls the machinery of government through the State Council and is supposedly in charge of running the economy. He emphasizes the health of the economy and the need to keep it growing as rapidly as possible.

Mr. Li’s right hand, Vice Premier Zhang Gaoli, said in March that he saw a “rosy outlook” for the first quarter, and after some difficulties were overcome, next year would be “blue sky and gentle water.” Officials under the State Council argued for more monetary easing so the economy can make a U-shaped recovery, as Beijing did in previous slowdowns.

On the other side, China’s supreme leader Xi Jinping has wrested control over economic policy within the Party away from Mr. Li. On May 9 an “authoritative person,” widely believed to be Mr. Xi’s chief economic adviser Liu He, attacked the notion of a rosy outlook. He predicted the economy would follow an L-shaped trajectory and not recover for one or two years.

China’s economy, in this view, has become too reliant on loose monetary policy and credit expansion. Mr. Xi’s camp emphasizes the need for “supply side” reforms to reduce overcapacity in heavy industry and deflate asset bubbles. Allowing the central bank to cut rates aggressively now would only make the situation worse. That explains why the central bank has left rates unchanged since last October, even as inflation has slowed.

At times the Xi camp’s diagnosis of the problems in the Chinese economy sounds like the talking points of American investor Jim Chanos and other China bears. The landscape is dotted with “zombie companies” that need to be closed. After decades of denying that Chinese real estate is a bubble, the state media now warn that price rises are unsustainable.

But instead of predicting a crash, Mr. Xi’s advisers predict that China’s economy will continue to grow at a slower rate and would emerge stronger in a couple of years. Whether or not that is right, he stands to benefit politically.

If the economy does muddle through, Mr. Xi can take credit for prudent management. He may be able to replace Mr. Li with Wang Qishan, who has a strong economic background and is in charge of fighting corruption.

If bad debts do emerge that tip China into a recession, Mr. Xi can put the blame on Mr. Li for failing to manage the risks properly. Mr. Li belongs to the same Communist Party faction as the last supreme leader Hu Jintao, under whom most of the debt was accumulated. So Mr. Li and his allies could be purged for pursuing dangerous economic populism.

While Mr. Xi has amassed greater power than his predecessor, he still faces resistance. The National Development and Reform Commission issued a report that recommended cutting interest rates and lowering bank reserve requirements. The NDRC, which is under the State Council, removed the report from its website the same day. But large state-owned companies will also lobby for monetary stimulus as they are squeezed by slow growth, and their managers are Party cadres with ministerial rank.

Even though Mr. Xi has so far failed to push economic reforms and his motives may be political, his tight money policy will have positive effects on China’s economy. Asset bubbles and excessive debt need to be squeezed out. The bankruptcy of zombie companies will make room for entrepreneurs to grow new firms.

But once a credit bubble pops, it can be hard to know when to reverse policy and ease monetary policy. After Japan’s bubble economy burst in 1990, the Bank of Japan waited several years to act, fearing that it might reinflate the bubble. That led to a liquidity trap that the country still hasn’t escaped.

Perhaps Mr. Xi and his advisers won’t make the same mistake. But monetary policy is now a central part of a succession struggle, as next year’s Party Congress is supposed to choose the two leaders who will rule China from 2022-32. Mr. Xi has nailed his colors to the mast of tight monetary policy. The difficulty he would face in making a quick policy change shows how China’s outdated politics hamper the management of a modern economy.

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