The Trillion-Dollar Bureaucrat
He may be the most important central banker in the world. But is China's Zhou Xiaochuan really in charge?
The longest-serving leader of a central bank of a major world economy is not to be found in Europe, or North America, or Japan. It is a 65-year-old man named Zhou Xiaochuan who was recently reappointed to the job he has already held for a decade, namely governor of the People’s Bank of China (PBOC). The surprise reappointment gives him a chance to finish the immense task on which he has labored for his adult life: no less than creating a modern financial system that can power China’s booming economy forward without the crises, bubbles, and busts that have become all-too-regular features. And while he’s at it, he will try to make the Chinese currency, the renminbi, as central to global commerce as the dollar is now and the pound was a century ago. And he will have to do it while exercising considerably less power than his counterparts at the world’s other major central banks.
Zhou’s tenure at the PBOC has coincided nicely with China’s emergence as an economic power. When he took the helm of the central bank in 2002, China produced $1,135 worth of goods and services per person, in present-day dollars. By 2011, that figure had reached $5,445. Behind those numbers were hundreds of millions of people who could suddenly feed themselves reliably, endure less backbreaking work, and enjoy more of the comforts of the modern age than their parents’ generation could have imagined. China passed Japan to become the world’s second largest economy in 2010; it will almost certainly become the world’s largest within a generation.
The work of the country’s central bank, led by Zhou, has been a crucial if often overlooked part of that story, as it has helped maintain steady growth in a nation buffeted by global forces. But he has had less success in creating a financial system that can lay the ground for the next generation of growth, one in which capital flows to the businesses and projects that have the best prospects, not the best political connections. To maintain China’s breakneck growth, Zhou and his successors must wrest power and influence away from the country’s political leaders to build a financial system that takes full advantage of all the lessons Western central bankers have learned over the centuries. Yet they must ensure that the system they build suits a Chinese culture and economy that are quite different from those of the United States and Western Europe.
Created in 1948, the PBOC in its early decades wasn’t China’s central bank so much as its only bank, the state-owned financial institution responsible for making credit available to state-owned companies. In 1995, the institution was formally made the country’s central bank in its modern form. Like its counterparts in most countries, the PBOC carries out a wide range of tasks for the Chinese government, including printing and circulating cash, executing the government’s interest rate and foreign exchange policies, and backstopping banks. The trillions of dollars in reserves that the Chinese government holds to guard itself against ups and downs of the global economy are held in accounts at the PBOC.
But while the PBOC does many of the same jobs as central banks in the West, that doesn’t mean it has the same power. In the Chinese system, the concept of an independent central banker — the central-bank governor as an independent actor who can make whatever decisions he believes are best for the nation — simply doesn’t exist. Zhou and his predecessors were technicians, functionaries charged with carrying out the policy directives that come down from higher up. The seven members of the Politburo Standing Committee, led by Chinese paramount leader Hu Jintao (until late 2012) and now Xi Jinping (his successor), make the biggest decisions. Zhou had status as one of 35 members of the State Council, the administrative arm of the government. But his was only one voice, alongside those of officials representing many other interests — manufacturing, agriculture, the military, and so on. Zhou is said to have briefed the State Council on the condition of the economy every two weeks and made recommendations as to whether interest rates should be raised or lowered. But the decisions are authorized by a small, more exclusive group within the State Council and, ultimately, the Standing Committee.
Even among people who devote their lives to studying Chinese policymaking — analysts, diplomats, academics — the details of how the central bank’s decisions actually get made are murky. It is presumed that Zhou and PBOC staffers have at least some say. "I think they’re part of the intellectual debate, but I don’t think they’re part of the power structure," said an academic with deep relationships within the PBOC. As a U.S. official experienced in dealing with China matters put it, a Chinese diplomat to Washington can learn more about how decisions are made at the highest levels of the U.S. government by reading a few days’ worth of the New York Times and the Washington Post than a U.S. diplomat to Beijing can from years of assiduously cultivating government sources.
This secrecy has created an atmosphere of fevered speculation and even distrust around the PBOC. In August 2010, there was a strange rumor circulating in Asian financial circles and redistributed by the political analysis firm Stratfor: The PBOC had suffered massive losses on its portfolio of U.S. Treasury bonds and Zhou had defected to the United States to escape punishment from Chinese authorities. China dealt with the rumor by shutting down Web sites repeating it and publishing indications of support of Zhou in state-run media. It was all nonsense, but the absence of the kind of transparency that’s standard in Western democracies means there are no reliable independent arbiters of fact. By contrast, when there was a rumor in financial markets that Alan Greenspan had been gravely injured in a car accident when he was Fed chair, his spokesman was able to shut it down by simply confirming to news services that Greenspan was sitting unhurt in his office.
To understand the PBOC’s policies throughout the crisis, then, one has to understand the political system and political culture in which it operates. Every government has a wide range of tools it can use to influence the economy — most significantly, taxing and spending, regulation, domestic monetary policy, and international currency policy. The major Western democracies have delegated those different tools to different arms at the state: Taxing and spending is the province of elected officials. Regulation is generally carried out by executive agencies. And monetary policy, experience has convinced the West, is best left in the hands of independent technocrats who are largely separate from politics.
The Chinese system essentially puts all these tools of state power over the economy in the same hands, at the highest levels, aiming to use them in concert to realize the government’s overarching goal. And that goal, more than anything, is self-preservation. Communist Party leadership in China has an implicit deal with the country’s 1.3 billion citizens: Leave us in power, and we will maintain rapid growth that will result in steadily rising standards of living.
In the fall of 2008, when the world financial system was convulsing in the ugly aftermath of Lehman Brothers’ bankruptcy, the advantages of the Chinese method of making economic policy were evident. As the Western economies collapsed, so did demand for the clothing made in Zhejiang Province, the toys made in Wenzhou, the dishwashers made in Foshan. The implied deal between the Chinese government and its citizens was at risk of ripping apart. How many unemployed factory workers would it take for the masses to hit the streets to make their dissatisfaction known?
On Nov. 5, the government announced a new fiscal stimulus of about U.S. $587 billion — or about 12.5 percent of Chinese GDP that year. (The U.S. stimulus package enacted in February 2009 was not only much later
coming, but also only 5 percent of that year’s GDP.) But more remarkable than the scale of China’s response was the way it deployed every tool of government power at once. Zhou’s PBOC, which just a few months earlier had been fretting about high inflation and an overheating real estate sector and trying to tighten the availability of credit in the economy, abruptly reversed course. It slashed the required ratio of reserves held by Chinese banks as well as the interest rate on deposits. Local governments were ordered to ramp up their spending on public infrastructure. The PBOC relaxed quotas that had held back bank lending, and so the four giant state-owned banks happily loaned money to those local governments and state-owned companies on a mass scale. It all worked. The Chinese economy bottomed out in the fourth quarter of 2008, six months earlier than the U.S. economy did, and it returned to its pre-crisis growth path of nearly 10 percent almost immediately.
Zhou and the PBOC were good soldiers in this initial phase of responding to the crisis, even at the risk of the banking system becoming overextended and inflation rearing its head. "From other countries we’ve already learned this lesson: We’d rather act quickly and decisively," Zhou said in an interview with a Chinese publication in March 2009. But later that year, with the Chinese economy having decisively rebounded, the opposite problem was starting to afflict the country: There was too much bank lending, with a great potential that many of those loans were going to unworthy projects that would leave the banks with big losses in the future. Banks were doing as they were told, making loans to local governments on a mass scale, comfortable that the national government would cover any losses, but in the process they were creating longer-term risks for the Chinese economy, very likely starting to inflate the next bubble.
Wu Xiaoling, a former vice governor of the PBOC who left the bank in 2007 and has thus been able to speak more freely on recent events than Zhou, said in an opinion article that in July and August of 2009, "astronomical lending" levels were "masking catastrophe." The PBOC started quietly tightening its regulatory policies over the second half of 2009. On January 18, 2010, the central bank was sufficiently alarmed by the latest numbers on lending that it reportedly gathered senior bank executives together for an hour and a half to issue a "stop order" demanding that they cease making loans. The PBOC backed up the words with penalties: Banks that failed to comply would face higher reserve requirements, essentially making them less profitable and choking off the flow of money into the economy.
The Chinese government, including the PBOC, had accomplished something remarkable. First, it had shielded its nation from the ripple effects of the Western financial crisis, to the extent that the global downturn caused only temporary damage domestically. And then, as its excesses of stimulus started to threaten new bubbles and inflation, it had immediately turned off the spigot. Harmoniousness had been preserved.
Over the last decade, Zhou, whose Ph.D. dissertation at Tsinghua University focused on "control theory," has aimed to make the PBOC a more typical central bank. He has disproportionally hired haigui, or "sea turtles," who like himself, traveled to the West and then returned. (The term is a pun: Gui, the word for "return," sounds like the word for "turtle.") Having spent two years at the University of California, Santa Cruz, Zhou is deeply connected to Western culture: He drinks good French wine, enjoys European classical music and opera, and in his office at the PBOC sometimes listened to Voice of America radio broadcasts in English. Like Tim Geithner, Mervyn King, and many other economic policymakers in the West, he also plays tennis. (In a doubles match against then White House economic adviser Larry Summers in 2009, Zhou and Summers jokingly bet that the winner could set the renminbi-to-dollar exchange rate.)
In Zhou’s decade as governor of the Chinese central bank, there was remarkable progress made toward creating a more liberal, market-oriented national financial system. In the early 2000s, China was at a crossroads. It didn’t want to get stuck being merely the factory for the rest of the world and providing only middling wages for its citizens (a situation known as the middle-income trap). A modern financial system would be required to fund the industries of the future and allow China to assert its influence across Asia and the world. The nation’s old system, however, had worked marvelously to bring hundreds of millions of people out of dire poverty since the 1980s. It’s difficult to turn away from a system that’s working, whatever its limitations.
In the debate over China’s economic future, Zhou and the PBOC pushed for a freer flow of capital across borders, interest rates set by markets rather than by the government, and less intervention in global currency markets to lower the value of the renminbi and hence advantage Chinese exporters. The Chinese government set as a goal making Shanghai a global financial center by 2020, and work by Zhou and the PBOC would be essential if that were to come true, particularly because of the need to develop a deep and liquid bond market.
The central bank successfully argued, as part of the campaign to make the renminbi a more international currency, for loosening capital control rules to allow "dim sum bonds" — that is, bonds traded in Hong Kong but denominated in the Chinese currency — starting in 2010. And in 2012, the PBOC and securities regulators relaxed rules to make it easier for corporations and municipalities to issue debt for even longer periods of time.
Zhou and the PBOC, in other words, were persistent and opportunistic in pushing for the development of the Chinese bond market, using loopholes, the need for stimulus spending amid the crisis, and Chinese financial nationalism to get his way. The PBOC has also been one of the most consistent promoters of renminbi internationalization, the idea that China’s currency should one day stand alongside the dollar, the euro, and the yen as an important currency of global trade.
In an essay published in early 2009, Zhou openly pondered what "kind of international reserve currency we need to secure global financial stability and facilitate world economic growth," suggesting that the supremacy of the dollar was a major factor in the world financial crisis.
The statement reflected a general angst among Chinese leaders — evident after the Fed’s 2010 announcement of a second round of quantitative easing — that their massive holdings of U.S. debt had left them uncomfortably exposed to the vicissitudes of the American economy.
Unspoken but unmistakable was the conviction that a greater role for the renminbi would be an inevitable part of some new global currency regime. In October 2009, the PBOC created a new department, the "Monetary Policy 2" division, to study renminbi internationalization. It is headed by a consummate sea turtle, a Stanford Ph.D. and Harvard Law graduate named Li Bo.
In recent years, the PBOC has created swap arrangements with many other central banks of the Pacific Rim, including those in South Korea, Indonesia, Thailand, and Australia. "The main purposes of the swap agreement are to support trade and investment between Australia and China, particularly in local-currency terms, and to strengthen bilateral financial co-operation," the Reserve Bank of Australia said in its announcement. There was talk in 2012 that other central banks from developed countries, such as Japan and even England, might soon enter similar arrangements. That should allow banks in those countries access to Chinese currency should they need it, part of a deliberate effort to smooth the process by which more global trade happens in the r
enminbi rather than the dollar.
In public communications, Zhou and the PBOC soft-pedal the idea that they’re trying to make the renminbi a major global currency. In official documents, the phrase used for the phenomenon is not "RMB internationalization," but rather what would be translated as "the RMB going out" — which is to say going out into the world beyond China. Zhou in a 2012 interview said that renminbi internationalization was "the will of the market rather than a government-backed move."
But there is clearly a deliberate effort under way, even if it’s a reversal of the usual sequence by which states ascend to great financial power. Typically, as prominent Chinese economist Fan Gang put it, internationalization of a currency begins with a flexible exchange rate system, followed by a liberalization of capital flows that makes the states an attractive place for international investment, which leads to widespread use of the currency. China is supporting the use of the renminbi in international transactions before fully liberalizing other aspects of its economic policy. Zhou, in one interview, was blunt about why: "If some areas need to be reformed, but it is impossible to do, we can first reform other aspects, and then push forward reform of those aspects which are difficult to advance."
There’s a more cynical way to cast the same idea, a theory of what Zhou and other Chinese reformers are up to that’s widely accepted among Western China watchers and policymakers — even if Chinese officials dismiss it, as one central banker put it, as a "conspiracy theory." Zhou and the PBOC face steep political resistance to liberalizing Chinese finance and wresting more power for the technocrats at the central bank for its own sake. But when they cast their arguments in terms of China’s national greatness, when the question isn’t about the petty battles of this bureaucracy versus that one but making Shanghai to the 21st century what New York was to the 20th and London was to the 19th, their political masters are more likely to listen.
The question is, are they? Zhou’s Western tastes and academic background may have limited his influence outside the central bank. "Within the PBOC, Zhou Xiaochuan has a very high authority," said one former official of the central bank. "But outside the financial system, he lacks — I wouldn’t call it ‘ability,’ but the ‘style’ of how traditional Chinese bureaucrats take care of things in the process of interfacing with other ministries and crafting policy. Sometimes, with such a strong academic background, it’s unavoidable that you get a little more academic. But to be a bureaucrat, you not only have to be technical, but you have to be able to work together with people while reaching your own goals."
There also remains a measure of distance and doubt between Zhou and the central bankers of other major economic powers — despite the fact that he speaks excellent English and often joins them for intimate gatherings held six times a year in Basel, Switzerland, which include particularly exclusive Sunday-night dinners among the top central bankers. Some of the doubt comes from his limited authority; other central bankers know he doesn’t have the power to act on his own, that his actions must be approved by his nation’s high political authorities. In other words, he couldn’t commit to a coordinated policy even if he wanted to.
This lack of independence from the party has shown through on occasion. On Oct. 10, 2010, during the annual meetings of the International Monetary Fund and the World Bank, Zhou said that China wouldn’t be raising interest rates within the year. Nine days later, the PBOC hiked its benchmark interest rates by a quarter percentage point. Some in the media accused Zhou of "trickery," but more likely, he simply hadn’t yet been told of the decision by the Standing Committee. Similarly, knowledgeable sources say, the PBOC wasn’t informed of a June 7, 2012, interest rate cut until very shortly before it was to be announced, possibly even the same day. One senior official of a Western central bank said that while there’s implicit trust among counterparts at the likes of the Bank of England or Federal Reserve that news of an upcoming policy change won’t leave their close-knit community, they worry about sharing information with a representative of the surveillance state that is China. Might information about an upcoming policy move told to the PBOC governor make its way to the portfolio managers who oversee China’s vast reserves? There has been no evidence that it has happened, but some Western central bankers don’t have total confidence it couldn’t.
Zhou’s term as governor for the PBOC was set to expire in December 2012, after a decade in office. China economy watchers spent the better part of the year trying to read the tea leaves as to whether he would enjoy a comfortable retirement or be promoted to a higher office in the new government coming in, with the conventional wisdom on this question going back and forth several times over the course of the year. The answer turned out to be "neither." The new government of Xi Jinping instead elected to leave him in place, choosing continuity in an institution that is crucial to the future of finance in a country of 1.3 billion people. In his first decade as governor, Zhou shaped the course of modern China, despite limited authority. He helped avert a deep economic downturn. He helped persuade his political overlords to reverse easy money policies as a bank lending bubble emerged. He made great strides in encouraging the development of China’s financial markets and the freer flow of capital across his country’s borders. At a time when the Western economies were flailing, their entire philosophical underpinnings coming into question, China was an unlikely source of strength for the global economy. And that success, at least through 2012, was vindication for Zhou and his band of haigui technocrats.
But the country still has deep-seated economic problems and risks that may curtail its emergence as a preeminent economic power, which will be the fundamental challenges for Zhou in the next few years, and then for his successors. The boom of the past decade was rooted in investment, particularly in infrastructure and housing. Might billions of yuan have gone toward projects that weren’t in fact economically justified and will never pay off , leading to bank losses and a new crisis? Might the run-up in housing prices have gone far beyond what’s justified by fundamentals, as it did in many Western countries in the mid-2000s? And while large, state-owned enterprises have had easy access to bank lending, small and medium-sized businesses, at least those without deep political connections, have had a much harder time gaining access to capital. Zhou has tried to change that, with only mixed success.
Beyond this is the question of how far China’s financial system as it exists now can take the country. It was quite effective through the years of global crisis. But as messy as market capitalism can be, the system that evolved in the Western powers over the centuries has created more wealth than any other. Even after its great recession, in 2011, the United States had a per capita economic output nearly six times that of China’s. The crisis certainly exposed the weaknesses of free-market capitalism. But as reformers like Zhou try to create a new economic and political system in China, they face a great challenge. They may have little desire to simply replicate the financial system of the United States and Western Europe. But for all its faults, that is also a system that has driven a level of affluence that far oustrips China’s. Can Zhou — and China — replicate the parts of the Western financial system that are useful? That is to say, to develop secure vehicles for savings that allow citizens to save for retirement, along with banks that channel that savings into productive investment? Can t
he unique aspects of China’s culture, politics, and economic system be merged with the pieces of financial infrastructure that have helped create untold prosperity for people who live in the more advanced industrial nations, such as a market-based system for allocating capital and a powerful, independent central bank? The economic future of billions depends on the answer.
Adapted from The Alchemists: Three Central Bankers and a World on Fire, by Neil Irwin, published by The Penguin Press (Available April 4, 2013).