Alibaba's Other Big Problem: China's Financial Policies

Alibaba has become so big that it's performance has become an economic proxy for whatever policies the Chinese government imposes. This is good news when things are going well, but...JL

Tim Worstall reports in Forbes:

The government deliberately limits what citizens may do with their own money. They do this in order to lower the cost of capital to favored sectors of the economy, meaning choice is repressed. This happens on a very large scale. Alibaba and other companies, like Tencent, who have big ambitions in the Chinese financial market face a macroeconomic problem
Alibaba and other companies, like Tencent, who have big ambitions in the Chinese financial market face an interesting macroeconomic problem. That’s China’s penchant for financial repression. This does not, by the way, mean Party goons beating up capitalists in the street. That’s something that hasn’t happened in China for decades. No, it’s a technical term from financial economics, meaning that the government deliberately limits what citizens may do with their own money. They do this in order to lower the cost of capital to favored sectors of the economy, meaning choice is repressed. That this happens on a very large scale in China is why there’s such a desire to disintermediate this system. It’s rather like a castle: the higher the walls around it, the more difficult it is to attack it. But also the higher the walls, the greater the plunder once those walls have been breached.
The walls here are the financial regulations which lead to that repression. The plunder isn’t so much plunder as the righteous profit that can and will be made by being able to offer Chinese citizens something closer to market rates on their savings and investments.
And the determinant of who and whether such schemes will be successful depends upon the vigor with which China’s rulers defend those current walls of the financial system.
This isn’t quite about those new rules that China has brought in about online payment systems:

China’s $90 billion mobile payments industry might soon face a nasty roadbump.
On Friday the People’s Bank of China issued draft proposal for a new set of laws that could deeply hinder the nation’s booming online finance industry, currently dominated by the web giants Alibaba and Tencent.

Those new restrictions are no doubt annoying and boring but they’re not massively important in the scheme of things. This is slightly more worrying though:

The new rules also forbid payment companies from opening accounts on behalf of financial institutions, as well as financial intermediaries involved in peer-to-peer lending, crowdfunding, wealth management, or foreign exchange. Instead these companies’ funds must be held at commercial banks.

How worrying no one knows as yet because the precise details are still a bit hazy.
But now to give the economic background. China has, or China’s citizens have, a simply vast savings rate. Somewhere between 40 and 50% of GDP is saved each year (the US figure is more like 5%). There’s good reason for this: There’s not much in the way of a state health care system nor retirement system. So, people are rationally saving in order to smooth out their lifetime consumption. But there’s also another side to this, which is that financial repression. Here it’s that the state doesn’t really allow people to save their money in sensible ways. There’s significant restrictions on being able to invest such savings abroad for example. Yes, there’s been those recent stock market loosenings but look how that’s been turning out–a speculative frenzy, not a pensions investment. And interest rates at the state-owned banks, really other than property the only other option, are deliberately set so as to be lower than inflation most of the time.
Thus people who are saving don’t get any of that lovely compound interest to boost their retirements: quite the contrary, they lose money by sticking it in a bank. The reason for this is so that the state banks have vast sums which can then be lent to the State Owned Enterprise (SOEs) at low interest rates again. That these companies do gain access to low cost capital is thought to be a political and economic imperative and is the justification for that financial repression.
The two side effects of this are that Chinese savers lose money on bank deposits and also the private sector companies find it almost impossible to get those low interest loans from the state banks. Those private sector companies are borrowing elsewhere, in somewhat murky markets, and paying very much higher interest rates than the SOEs.
This is that castle, the walls of which many people would like to breach. If it were possible to disintermediate around those state banks, take the deposits of the savers and lend them into the private sector, then the private sector could borrow more cheaply and the savers might actually get a positive return. This will eventually happen because without it happening China will get stuck in the middle income trap as a result of capital misallocation.
This sort of disintermediation is just what Alibaba and Tencent have been doing. You can now save money into a money market fund on your mobile for example. And that’s what that is: Taking money from the savers and providing it at market interest rates to private sector borrowers. Both sides benefit and so of course do the intermediaries.
But, and here’s the but, that obviously undermines that careful system of financial repression which provides cheap finance to the SOEs. So, the big question for the companies that wish to provide such disintermediation is how forcefully the state is going to defend those castle walls of the current financial system. I don’t know and I’d hazard a guess that you don’t either, but it is the big economic question surrounding how successful those new financial services are going to be. If the state allows them to continue then they’ll be very successful indeed because that repression is at present severe. However, if the current meddling in online payments and who can provide custodian services (which is really what is meant above) to those peer to peer lenders and so on extends out to curbing the ability of further disintermediation there’s obviously going to be a block on how large those new financial services can grow.
There’s that economic point there, that China does indeed repress people’s financial and savings choices and then there’s the political decision to make about whether to defend that system or to allow it to be bypassed, disintermediated, by the online companies. It would, in the long term, be hugely beneficial to China’s economy for the state to get out of the way but there would indeed be a short term cost, and a heavy one, to the SOEs. Going to be interesting seeing which way they go.
Which leads to an interesting little speculation. It’s a standard observation that when people earn more on their investments then they save less. No, I know, we don’t normally think of it that way. If you’re getting 10% instead of 1% then you’ll save more, right? But that’s not really quite how it seems to work out. This is from the lifetime savings hypothesis: We save in order to smooth out our income over our lives. We think we’ll have 15-30 years in retirement therefore we save now while we’re earning so we can consume then. In this model (and this does seem to explain household savings behavior pretty well) when the return on our savings goes up we save less. Because we need to save less now in order to finance that future retirement, some of the weight is being taken by the returns on our savings.
This is the same sort of thing that gives us the wealth effect. When, for example, house prices crash, as they did in the US, the savings rate goes up. Because we all rather work out that we’re not going to be able to pay for our retirements through the flipper making a gazillion dollars in profits for us.
This means that if China does allow savers access to market interest rates on their savings, that is, it dispenses with the financial repression, then we would expect to see the country’s vast savings rate fall. And that’s actually rather what people would like to happen at present. The general view of the macroeconomy there is that it needs to become very much less reliant upon the capital investment being financed by those repressed savings and generate a great deal more of it’s economy and growth from consumption by the citizenry. And that’s just what lifting the repression would do: people would save less and consume more if they weren’t limited to below inflation interest rates from the state banks.
So, allowing the online companies to disintermediate would rather solve what is perceived as being, well if not one of the country’s problems, something that it is desirable that the country do. But, of course, there are those who benefit from the current system (largely those associated with the SOEs) and thus as a political system it’s not an obvious slam dunk.
As I say, it’s going to be interesting seeing which way the political decision is going to go. Myself, I would say liberalize the heck with it. But then I do tend to say that about most things so perhaps I’m not quite the one to make that decision.