The Canary in China’s Central Bank

How quickly will China follow through on the ambitious package of economic reforms its government adopted last November? With quarterly growth in the country’s output at a five-year low, at least according to official statistics, it’s the trillion-dollar question. That’s how much economic activity might be unleashed by breaking open state-dominated industries and taking the brakes off capital markets. And the first part of the answer may come down to a choice between two men.

One of the most eager reformers in Beijing is Zhou Xiaochuan, the longtime governor of the People’s Bank of China, the country’s central bank. He wants to remove controls on interest rates and allow the renminbi to float freely on international markets, with the goal of giving China a convertible currency — money that traders and investors can buy and sell as often as they want and will accept as they would dollars or euros. At times, his rhetoric has even pushed beyond the comfort level of the Politburo, China’s 25-member leadership council.

Zhou has been in his job since 2002, and his term ends in 2018. His goals for the modernization of China’s monetary policy are in sight, albeit on the horizon. But already there is talk of replacing him — and not for the first time. His tenure predates Xi Jinping’s regime, which began in 2012, and Xi may want a closer ally at the helm of China’s monetary policy. So if Beijing replaces Zhou before 2018, who might his successor be?

For years, the logical choice appeared to be Yi Gang, a U.S.-trained academic and internationally respected expert on capital markets and exchange rates. Yi has run the State Administration of Foreign Exchange, the government’s currency board, since 2009, and as such he has been at the vanguard of Zhou’s agenda — though his rhetoric has arguably been more cautious. If China had wanted its central bank governor to stand among the likes of the U.S. Federal Reserve’s Janet Yellen and the European Central Bank’s Mario Draghi, Yi would have fit the bill.

But now it seems that may not be the case. Guo Shuqing, the governor of Shandong province who is a friend of Zhou and is believed to be a trusted advisor to Xi, apparently has the inside track to the job. He’s known as a reformer too, but he may have been sent to Shandong to cool off after some vigorous work at the China Securities Regulatory Commission.

Ending Zhou’s term early in favor of Guo might be a sign that Xi was more concerned about consolidating his power than about implementing reforms quickly and working in a collegial fashion with the global central banking community. Guo might be more welcome in Beijing drawing rooms, but Yi would have more to say at Jackson Hole.

If Yi is the pick — and he receives the support from Xi that such a pick would imply — then the demand for renminbi-denominated assets will be likely to spike in response to expectations of looser capital controls, a floating (and perhaps somewhat higher) exchange rate, and a greater opening of the Chinese market in general. The resulting inflow of capital and foreign investment could raise China’s economic growth rate by a couple of percentage points; rapid and full implementation of the reform package might even push the growth rate briefly back into the double digits.

But if Guo is the next governor, things might take more time. In that case, the speed of reform might only be enough to cushion the slight decline in economic growth that China has experienced during the past several years. And indeed, Xi may be in no hurry to bring his own plans to fruition. The question is whether he needs a new central bank chief to ensure reform takes his preferred pace.

Xi’s priority so far seems to be to create an image of a strong, modern, and even inspirational leader who reflects his growing nation. His marquee program is a crackdown on corruption, which is also a handy way to exert control over provincial and municipal officials. Although it’s not the first such campaign China has seen in recent years, Xi may be reluctant to rattle the cages of the vested interests in China’s economy much more. He probably has eight more years to help the Chinese economy progress, and he may value stability and rising stature — both for China and for himself — above sharp increases in incomes. He may prefer to be known as a steady guiding hand or, better yet, another father of his country, rather than as an iconoclast or agent of change.

This attitude will suit the vested interests just fine. The longer Xi takes to privatize state-owned enterprises, many of which have grown to enormous size because of constant agglomeration, the more their managers will be able to enrich themselves. The same goes for the bankers, shadow and otherwise, who have exploited the controls in China’s capital markets. They will surely try to give Xi even more reason to drag his feet.

The problem is that Chinese economic growth is slowing rather more quickly than expected. Continued weakness in the global economy has slackened the demand for Chinese exports — as has the gradual appreciation of its currency, overseen by Zhou and Yi — and the International Monetary Fund has had to lower its forecasts for China’s GDP half a dozen times in the past three years.

Fortunately for Xi, there are other options in case the headline-grabbers in the reform package fail to become reality. Another one of the proposals, a land reform, would give peasants ownership rights and the opportunity to borrow against or sell their plots, perhaps to start a business or move to the city. Loosening rules on internal migration would make urbanization, along with the greater economic prospects that result, easier for many millions of Chinese.

Both of these measures would speed the process of putting labor next to capital for greater productivity and economies of scale. They might also release some of the political pressure building across China, chiefly among the displaced villagers and poorly treated migrant workers who are responsible for tens of thousands of organized protests every year.

But first, the central bank’s governorship must be resolved. Picking the head of a central bank is a momentous decision in any country, let alone the world’s second-biggest economy. This time, the succession may also be a concrete indication of Xi’s thinking about reform: fast or slow.