If the mainland were to devalue, it is claimed, there could well be another round of competitive devaluations two years after the onset of the Asian financial crisis and nip the recovery in the bud.
But Beijing is not about to devalue the yuan. Massive US dollar holdings at the People’s Bank of China and an appreciating yen should forestall any immediate devaluation.
Moreover, tight capital controls lock the door on speculation against the yuan.
If anything, the yuan should be appreciating against the US dollar, given China’s large and persistent trade surplus with the United States.
The immediate concern with whether or not the mainland will devalue should not divert attention from a more fundamental issue — namely, the need for the mainland to move towards full convertibility of its currency and create a competitive, private capital market.
If the mainland is to become a major player in the global economy, it needs real, not pseudo, financial markets — and private, not state, ownership.
The non‐state sector is crowding out state‐owned enterprises (SOEs) on the mainland, but the future of the non‐state sector (which now accounts for more than 70 per cent of industrial output value) depends on its ability to attract domestic and foreign capital.
The problem is that even though non‐state enterprises are more productive and more profitable than SOEs, the central Government has channelled most investment funds into the state sector and continues to restrict foreign banks and non‐bank financial institutions from entering the domestic market.
The mirror image of the dismal performance of the SOEs is the deteriorating condition of state‐owned banks (SOBs). Capital adequacy ratios are far below international norms, and non‐performing loans now account for as much as 40 per cent of all loans.
According to Nicholas Lardy, author of China’s Unfinished Economic Revolution, “China’s major banks are even weaker than most official data suggest”. When proper accounting methods are used, he finds that “these banks’ capital adequacy is negative, and they are insolvent”.
Pumping more money into loss‐making SOEs by insolvent SOBs is a recipe for disaster. It is time for Beijing to let go of the last vestige of Soviet‐style central planning and allow a private capital market to develop that can put the nearly 40 per cent of money the mainland people save into productive investments.
It is time to take away the financial morphine that has kept SOEs and SOBs alive and let new domestic and foreign firms supply the capital necessary for a prosperous and stable economy.
Ultimately, there is no third way — Beijing must decide between state ownership and private ownership, between coercion and freedom. Clinging to an artificial exchange rate is merely a symptom of the real problem facing the mainland — the lack of private property rights and freedom of contract.
Denying people the right to freely convert the yuan into whatever currency or investment they prefer — at a freely determined exchange rate — is an infringement of a basic human right.
What the mainland needs is an institutional infrastructure that protects, not destroys, private property rights.
As long as market socialism prevails, rather than market liberalism, China will remain less wealthy and less free than it could be.
The lesson of the Asian financial crisis is that pegged exchange rates will fail. The mainland has been able to withstand that crisis by imposing capital controls — that is, denying its citizens the right to free convertibility.
Sooner or later, however, it will have to make a choice between a rigidly fixed exchange rate and a market‐determined rate that allows monetary autonomy.
If the latter route is taken, the People’s Bank of China must be bound by a monetary rule that safeguards the long‐run value of the yuan.
In either case, the mainland eventually will have to allow full convertibility of its currency and a free capital market.
The sooner Beijing moves in that direction, the faster it will put the economy on a track of long‐run prosperity and stability.