Where China Goes From Here

Global investors feel hung out to dry.

Photographer: Zhang Peng/LightRocket via Getty Images

For years, China's leaders have wanted the world to acknowledge their economy's leading role in the global system. This week they got their wish. Sadly, the circumstances weren't ideal.

The crash in global stock markets began with gloom about China's prospects and muddle over what the authorities in Beijing intend. Global markets may be calming down, but the confusion hasn't gone away. The Chinese government and its critics all need to think a bit more clearly about what is going on.

In the past few days, China has been a whipping boy for everyone from Japan’s finance minister to U.S. Republican presidential hopefuls. Its central bank is accused of waging a currency war with its devaluation of the yuan two weeks ago. Before that, critics chided Chinese authorities for perpetuating a stock-market bubble by intervening extensively in equities; this week's sell-off accelerated when the government declined to prop them up.

The world doesn’t seem quite sure what it wants from China's leaders. Critics scold Beijing for boosting stocks, then panic when they don't. They insist market forces be allowed to set the yuan, then howl when those forces push it down. They tell China to accept slower growth as the price of rebalancing its economy, then clamor for stimulus when the economy slows.

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To be sure, there's confusion in Beijing as well. Leaders have promised to shift the economy onto a more sustainable growth path that's based less on exports and more on services and domestic demand. But they've held to an unreasonably high growth target, presented confusing data to suggest all is going well, had difficulty tackling bad debts, and continued to juice the economy with misdirected public spending.

There's an underlying tension in that mix: The leadership is sincere about its desire for markets to allocate capital more efficiently, yet mostly in order to preserve the power and position of the Communist Party. When those two imperatives conflict -- as when the stock market's initial slide threatened to erode faith in Beijing's economic stewardship -- the party’s needs often come first.

That dynamic undermines the progress achieved by genuine reforms, such as exposing the yuan to market pressure. China's long history of holding its currency down, combined with a recent plunge in exports, gave observers every reason to believe that a steeper devaluation was in store. The secrecy surrounding Chinese policy and data made the situation worse. Many analysts naturally assume the mainland's woes must be worse than the recent run of bad figures would indicate. The devaluation suggested panic -- and encouraged panic in return.

Beijing’s reluctance to surrender more fully to market discipline is understandable given the daunting list of challenges leaders face. But they're only storing up problems for the future.

The government is paying the price now for having artificially boosted stocks earlier. The central bank is thought to be spending an estimated $40 billion a month to keep the yuan from falling further and prevent capital flight. Authorities are reportedly considering raising an additional $161 billion in bonds to fund new infrastructure projects. Some of these may make good sense, but the fact that Beijing is directing the program raises doubts.

What’s to be done? The government should continue to pull back gradually from its commanding position in the economy -- and as it does so, it should be clearer and more convincing about its commitment to reform.

Chinese leaders, and their critics just as much, should be clear that the stunning growth rates of the past are gone for good (the "New Normal"), and focus instead on stability around more modest and realizable ambitions. Beijing should strive for honesty in data -- the sine qua non of market confidence. And party leaders should accept sell-offs in stocks, defaults among weak companies and other ordinary events of market-based economies as signs of economic maturity.

More forthrightness now would buy China goodwill from markets when the government really does need to intervene -- as the U.S., Japan and the European Union have all repeatedly judged to be necessary. Chinese leaders should remember that the currency that matters most is their credibility.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.