Since 1978, China has engaged in an unprecedented and wildly successful experiment, moving gradually from a command economy to one based on markets; in small steps transforming a system where administrators controlled the goods that were produced to one where prices allocate resources.
The day has come for China to become more closely integrated into the global financial system, and this has a number of implications. The most important is that as prices and quantities of financial assets [rather than goods] are determined in markets, bureaucrats lose a great deal of control. But, as recent events clearly demonstrate, Chinese authorities are reluctant to let go.
Capital controls make it possible for China to maintain a fixed exchange rate while policymakers could adjust interest rates to stabilise their domestic economy. These same capital controls are incompatible with the objectives of making Shanghai a global financial centre. The devaluation of the yuan earlier this month by the People’s Bank of China’s [PBOC] has not allowed any form of stabilisation as the downward spiral continues.
Fewer people are willing to work the long hours for the low wages offered by manufacturing and more people are moving towards the cities for work. Policymakers in China look to be quite unhappy about the constraints this is creating. The government needs to alleviate the pressure to save on its working population.
All eyes are on what the authorities will do to next.