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This book highlights the difficult policy choice that must ultimately be made during China's structural reform according to the theory of the Impossible Trinity, between exchange rate and monetary policy autonomy.

Inhaltsverzeichnis

Frontmatter

1. The Impossible Trinity in China

Abstract
The Impossible Trinity, also known as the trilemma, is a policy-choice problem based on the Mundell–Flemming model (Mundell 1963; Flemming 1962), which states that it is impossible for a country to have control of all three of the following variables at the same time (Figure 1.1): a fixed exchange rate (i.e. control of the exchange rate); an open capital account (i.e. control of the capital account); and an independent monetary policy (i.e. control of the interest rate). It is both a hypothesis based on the uncovered interest rate parity condition 1 and an empirical finding showing that governments that have tried to simultaneously pursue all three goals have failed.
Chi Lo

2. Opening a Can of Worms

Abstract
Opening the capital account is like opening a can of worms for Beijing’s senior leaders, as they would need to implement a whole range of deep-rooted structural reforms that could threaten the stability of the Communist Party. Why does China still want to walk into the Impossible Trinity and “suffer” the consequences? Do the Chinese leaders know what challenges and risks they are facing? One potentially detrimental risk is massive capital flight, which has its structural roots in the corrupted system that China’s senior leaders are aiming to rectify.
Chi Lo

3. Betting on the Role of the State

Abstract
Making all the structural changes under the pressure of the Impossible Trinity inevitably questions the role of the state versus the market. My conjecture of President Xi Jinping’s interim reform strategy of power re-centralisation (see Chapter 2) suggests that a re-thinking about the role of the government in the future economic development process might be under way in the core leadership. The latent force behind such reassessment is a conventional wisdom that says that China would only succeed in reforming itself by fully embracing the market. This should put the Chinese Communist Party on the defensive.
Chi Lo

4. The Incentive Problem Standing in the Way

Abstract
Despite the central leadership’s strong reform motive, the economic system is plagued by incentive incompatibility problems. This has resulted in a battle between positive and negative forces that are influencing reforms. On the one hand, the central reform determination delivered some macroeconomic success on restructuring the economy even before the Xi Jinping administration. There is evidence for China engaging in massive creative destruction in the 1990s. Mr Xi is trying to build on this success by intensifying structural changes. On the other hand, incentive problems are obstructing his government’s efforts to make deeper changes to resolve the Impossible Trinity policy puzzle.
Chi Lo

5. Power Struggle or Genuine Reform

Abstract
In addition to reform resistance and inherent incentive problems in the system, China’s senior leaders know that time is not on their side. With a sense of urgency, as discussed in Chapter 3, President Xi Jinping and his inner circle have embarked on one of the most ambitious economic and social reform programmes in history to remake the country. What is unclear to outsiders (including the Chinese majority who are not in the political inner circle) is how many of the reforms, including the anti-corruption campaign, are real strategic moves to change the system and how many of them are part of the power struggle between the old corrupted faction and the new reform leaders.
Chi Lo

6. From Financial Repression to Liberalisation

Abstract
Politics aside, evolution in China’s financial system is posing daunting challenges to China’s structural and policy reforms in its preparation for opening up the capital account under the Impossible Trinity. Understanding the evolution of the Chinese financial system is imperative for understanding the challenges that China is facing in in pursuant of its “Chinese Dream”.
Chi Lo

7. Monetary Policy Reform Fraught with Risks

Abstract
As financial liberalisation intensifies, China needs to reform its monetary policy framework commensurate with structural changes in the economy to ensure effective policy management in preparation for capital account convertibility. Without sufficient monetary policy tools, China will not be able to manage the economic volatility stemming from its transition to a market-driven model under the Impossible Trinity paradigm.
Chi Lo

8. Systemic Risk (I): Shadow Banks and Local Debt

Abstract
As the Impossible Trinity descends upon China, exposing it to external shocks and policy choice dilemma, a major concern has emerged about systemic risks derailing its structural reform programme. The main worry focuses on China’s shadow-banking market, to which the official banking system is tied. Some observers even see Chinese banks as the world’s biggest systemic risk (Wall Street Journal 2014). There is also a worry about local government debt, which amounted to about one-third of China’s GDP in 2013. Owing to its rapid rate of growth, at an estimated 67 per cent a year between 2010 and 2013, some analysts worry that local government debt has grown so fast as to become a major national burden and an international concern (Economist 2014).
Chi Lo

9. Systemic Risk (II): Property-Market Bubble

Abstract
Compared with its shadow-banking and local government debt, China’s property market correction (which started in 2013 and is ongoing at the time of writing) is potentially a much bigger risk to both the domestic and global economies. Arguably, it is also China’s biggest policy challenge during its financial transformation as macro policy cannot tackle the micro problems in the sector, where there is no property bubble on a national scale but only bubble pockets in large cities. Aggravating this challenge is structural reforms, which are increasing financial stress in the property sector. If Beijing mishandles the property market risk, its correction could easily crush the economy, thus derailing structural reforms that are needed to transit towards a market-orientated system as the Impossible Trinity unfolds.
Chi Lo

10. China’s Future Monetary Policy

Abstract
This final chapter will focus on examining China’s monetary policy evolution and exploring the alternatives for its future policy framework as it moves towards the Impossible Trinity eventuality. China’s economy may be many years away from full operation in the new paradigm, where capital account convertibility will force Beijing to choose between controlling the exchange rate and the interest rate. However, the process of moving towards it has begun slowly. As discussed in the previous chapters, during this transitional stage, China will be facing daunting challenges on making the necessary monetary policy and economic structural adjustments to tackle the inevitable policy choice between monetary autonomy and exchange-rate control when its capital account is fully opened.
Chi Lo

Backmatter

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