China's leaders struggling to bridle Frankenstein economy
The world has grown used to the idea China's leaders are masterful stewards of their gargantuan economy.
They steered brilliantly around the iceberg of the 2008 financial crisis, maintaining growth of near double-digit rates. So when People's Bank of China chief Zhou Xiaochuan began clamping down on excessive liquidity last week, some observers viewed him as a Chinese Paul Volcker.
Now the worst was over, Zhou seemed to indicate, it was time for China to rein in lending and prevent a credit bubble from swelling.
Then reality intervened. After the overnight repurchase rate zoomed to a record 13.91 per cent, Zhou had to back off, hastily injecting fresh funds to stem the turmoil.
Indeed, unease this week underscores how limited Zhou's powers actually are. Over the past decade, China's economy has grown addicted to credit growth, with state-owned banks encouraged to finance new skyscrapers, highways, airports, dams and ghost towns to pump up gross domestic product. Free-flowing liquidity - mostly to state-owned enterprises - kept stocks and real estate buoyant, foreign investors bullish and China's 1.3 billion people away from Tiananmen Square.
Zhou can't cut off the money now without banks suffering. And the danger is that nobody really knows how healthy China's state-owned banks are, or how big its shadow-financing system has grown. When Stephen Green of Standard Chartered in Hong Kong called China's credit system "a big black box, and it's quite scary", he wasn't exaggerating.
How can anyone trust China is growing at a rate of 7.7 per cent, as the government claims, when variables in its data tabulation are a mystery? The US shadow-banking system, with its off-balance-sheet vehicles and murky dealings, helped drive world markets off the rails in 2008. Imagine the damage an entire shadow economy could cause if it unravels.
China's leaders avoided bursting one bubble in 2008 by creating new ones. Yet China cannot forever delay its day of reckoning. Total credit may reach 200 per cent of GDP this quarter, up from 130 per cent in 2008. Mainland banks are adding assets at the rate of an entire US banking system every five years.
Traditionally, Beijing has viewed opacity as a tool for policing funds between banks and companies. That murkiness is now proving dangerous. The central bank needs to confirm it will rein in interbank liquidity, explain the means by which it plans to do so, and indicate what the endgame is.
At the same time, Zhou is fundamentally helpless: he cannot be effective unless the country's political leadership decides the Communist Party is going to get out of the banking business. If the government wants to reduce the role of state-run companies in China's economy it must privatise the banks first. Putting off that hard task has turned the Chinese economy into a Frankenstein monster.
It's a powerful creature born of unorthodox experiments, and its makers are increasingly losing control.