China Quietly Rolled Out a Very Big Bang
In 1984, I came to China as a grumpy, uninquisitive backpacker, dragged from crowded bus to uncomfortable hostel to inedible meal by two student friends who spoke Mandarin. The highlight of my trip was a visit to Maxim’s, supposedly the only Western restaurant in Beijing. The coffee tasted like nectar, and I survived another week. The idea that China was five years into Deng Xiaoping’s great opening shamefully passed me by.
I thought of Maxim’s as I waited for a plane at Haikou Meilan International Airport earlier this month, nursing a cappuccino at yet another Starbucks; opposite me was a Jimmy Choo shop, each shoe worth several times the cost of a hostel three decades ago; on the other side stood a mountain of Lindt chocolate. These Western luxuries weren’t there for international visitors. Haikou is a provincial airport—the place China’s middle classes pass though on their way to the beach.
For the past month, everything to do with the Middle Kingdom has been seen through the prism of China’s trade relations with the U.S.—and the chaotic tweeting of Donald Trump. At Haikou, I was on my way back from Xi Jinping’s speech at the Boao Forum for Asia, China’s humid (and slightly shambolic) version of Davos. Xi’s success was being judged less on what China’s leader actually said than whether the reforms he outlined had satisfied his American counterpart. So when the Donald tweeted his pleasure, the markets’ concerns subsided.
Putting off a trade war (if that is what Xi managed to do in Boao) is no small accomplishment. But in terms of deeper change, the more significant announcement came at a side panel the next day. Yi Gang, the new governor of the People’s Bank of China, unveiled a string of reforms giving far greater freedoms to foreign banks, insurers, and investment managers. Hitherto limited to joint ventures, foreign financiers will be allowed to hold majority stakes by the end of June—and all restrictions on ownership will go in three years. While China has embraced Western-style consumerism, its financial sector remains a bog, unable to satisfy the banking, insurance, and retirement needs of its growing middle classes.
Technically, the mild-mannered Yi was just setting a more explicit timetable for reforms announced last November. And don’t expect Trump to make much of them: Nobody in the Midwest cares much about whether JP Morgan Chase & Co. or Goldman Sachs Group can operate more freely in China. But this could turn out to be the Chinese equivalent of Britain’s Big Bang.
When Margaret Thatcher became prime minister in 1979, the City of London was a relatively insular, bowler-hatted affair. Exchange controls were in place. The City had its freewheeling parts—such as the euro markets—but the stock market was carved up by British brokers and jobbers, with Hogwartian names such as Ackroyd & Smithers. The Big Bang swept away many of these rules, let foreigners in, and created the modern cosmopolitan City of London, which until Brexit looked like a challenger to New York.
China starts from a very different position—it’s the world’s second-biggest economy. But its financial system faces many of the same restrictions as Britain’s did—not only that foreign ownership is banned. There’s a tortuous system of licenses and strict rules on capital flows, and nobody cares that local consumers get a lousy deal. This is basically a state-run industry. Until recently, you could face the death penalty for taking deposits without the proper licenses.
Thatcher’s reforms were rooted in ideology as well as economics. China’s are being driven by a group of Western-educated technocrats. Liu He, the vice premier with purview of economic policy who has a master’s degree from Harvard, has been given unusual autonomy by President Xi. Other reformers include Governor Yi, who studied in America; Guo Shuqing, a former visiting scholar at Oxford, who heads the PBOC’s Communist Party Committee and runs the nation’s banking regulator; and Fang Xinghai, the Stanford-educated economist overseeing the opening of China’s stock market as deputy head of the securities regulator. Wang Qishan, the de Tocqueville-quoting vice president, is also sympathetic.
It’s unlikely we will ever know how many of the reforms announced by Governor Yi were always in the works, but Trump’s belligerence seems to have accelerated them. At the very least, Liu’s technocrats have shown a skill in taking advantage of the trade crisis.
There’s no shortage of people in China keen to play down the changes—not least Yi himself. He reacts in horror to the idea of a Big Bang. China is all about gradual change. And in the short term, not much will change. Foreign banks, insurers, and money managers won’t be rushing in just because China is taking off the limit on foreign ownership. They will still need to get licenses, which may be slow in coming. Many foreign companies are happy with their local tie-ups. One leading Chinese hedge fund manager doubts whether foreign investment managers will ever master the Wild East of Chinese equities: Their main selling point will be the ability to get money out of the country. (“Though if they can do that,” the hedge fund manager says, “I will be a customer.”) The most recent estimate, from UBS AG, shows foreign companies had only 1 percent of the brokerage business at the end of 2016—though they’ve done slightly better in insurance and banking. Foreigners had 1.3 percent of the banking market and 5.2 percent of insurance.
But the lesson of financial revolutions is that they’re cumulative. Yi talked about reform of the financial sector being linked to reform of the capital account and the currency. In May, China becomes part of the MSCI global indexes. There’s a flood of foreign money interested in investing in the world’s fastest-growing large economy and an equally huge amount of Chinese money wanting to get out. To get Western funds, Chinese money managers will have to follow the same rules about transparency.
In finance, local knowledge counts for a lot; but it can be bought. The British jobbers and brokers who thought the Yanks would never beat “Caz”—the long-established stock brokerage Cazenove—or the suave corporate financiers at Morgan, Grenfell & Co.—were right for a while. Foreign companies lost a fortune in the early parts of Big Bang. But Caz is now part of JP Morgan Chase and Morgan Grenfell disappeared into Deutsche Bank. It’s hard to imagine China letting foreigners buy its biggest banks, as Britain did; but again, foreigners won’t have to do that much to start changing Chinese markets.
At the very least, for competitive reasons, the pay gap between Chinese bankers and Western ones will narrow. At the moment, the head of the Industrial and Commercial Bank of China, China’s biggest bank (and the world’s most profitable), is paid $100,000 a year; at JP Morgan Chase, Jamie Dimon earns that every 27 hours.
One of Thatcher’s least appreciated qualities was luck: She looked set to be a one-term prime minister until an Argentine generalissimo was stupid enough to invade the Falkland Islands. China’s reformers have three problems where they will need a lot of luck.
The first is that finance is by its nature a somewhat explosive business. Few banks seemed more stable in Britain than Barings Bank—until it collapsed in 1995 as a result of the dealings of a rogue employee in Singapore. The idea of, say, the Agricultural Bank of China, one of the oldest in the People’s Republic, wandering into derivative trading isn’t an appetizing one.
Second, the technocrats already have a financial crisis to deal with: China’s mountain of debt. Lending has grown by almost 100 percent of gross domestic product in the past nine years—the same sort of increase that took place in the U.S. before 2008. You don’t have to go far up the coast from Boao to find unfinished empty apartment blocks. Banks have hidden a lot of the bad stuff off their books in the form of opaque instruments channeled through trusts and other financing vehicles.
Cleaning this up is an immense task. Some Chinese talk about the need for a controlled explosion—the government should let something significant go bankrupt to send a message to investors and other borrowers. That’s a tricky business, even in the West, as the U.S. government discovered when it let Lehman Brothers fail. In China’s opaque circle of influences, even private companies have their political protectors.
And that leads to the third problem. The technocrats are extremely clever, but they’re not politicians. Their mandate comes not from the ballot box, but from the permission of one man. Xi has given them autonomy. A big bankruptcy, a securities scandal, or even just the arrival of Wall Street salaries may make him pause. He wouldn’t be the first ruler to make scapegoats out of his know-it-all grand viziers.
So China’s Big Bang may splutter a bit. But once you begin these things, they create their own momentum. Thatcher was fond of saying, “There is no alternative.” China has an aging population that needs products such as pensions and life insurance. What may soon be the world’s biggest economy needs a financial sector to match—and a financial center. It would be odd if one of the main impacts of Trump’s trade war ends up being the growing sophistication of finance in his main opponent. But as anyone who went to the Beijing branch of Maxim’s in 1984 will tell you, things can change a lot.
Micklethwait is editor-in-chief of Bloomberg.