Must-read: Rob Johnson: “The China Delusion”

Must-Read: The extremely sharp Rob Johnson is in the camp of those who think that China’s principal short-run problems of problems of macroeconomic management–that investors are not confident that their investments in China will remain profitable–rather than the more-fundamental problems of political economy: the fear by investors that their investments in China are insecure. There’s a return-problems camp. There’s a risk-problems camp. Rob Johnson is in the first:

Rob Johnson: The China Delusion: “China’s transition from an export-led growth strategy to one propelled by domestic consumption…

…is proceeding far less smoothly than hoped. For some people, visions of the wonders of capitalism with Chinese characteristics remain undiminished…. The optimists’ unreality is rivalled by that of supply-siders, who would apply shock therapy to China’s slumping state sector and immediately integrate the country’s underdeveloped capital markets into today’s turbulent global financial system. That is a profoundly dangerous prescription. The power of the market to transform China will not be unleashed in a stagnant economy, where such measures would aggravate deflationary forces and produce a calamity.

The persistent downward pressure on the renminbi reflects a growing fear that Chinese policymakers have no coherent solution to the dilemmas they face. Floating the renminbi, for example, is a dangerous option. After all, with the Chinese economy undergoing wholesale economic transformation, estimating a long-term equilibrium exchange rate that will anchor speculation is virtually impossible, particularly given persistent doubts about data quality, disclosure, and opaque policymaking processes.

But if the current exchange-rate peg to a basket of currencies fails to anchor the renminbi and prevent sharp depreciation, the deflationary consequences for the world economy will be profound. Moreover, they will feed back on the Chinese export sector, thus dampening the stimulative impact of a weakened currency.

The key to stabilising the exchange rate lies in creating a credible development policy. Only then will the pressure on the renminbi, and on China’s foreign-exchange reserves, subside, because investors will see a clear way forward.

Establishing policy credibility will require diminishing the muddled microeconomic incentives of state control and guarantees. It will also require reinvigorating aggregate demand by targeting fiscal policy to support the emerging economic sectors that will underpin the new growth model…