Beijing's Financial Lessons for Washington

China is signaling an intention to scale back the financial stimulus package Beijing employed in a successful effort to mitigate the effects of the current global recession. On 23 November 2009, the China Banking Regulatory Commission issued a warning that domestic banks must strictly comply with capital adequacy requirements or be subject to restrictions on market access, overseas investment, and business expansion. The China Banking Regulatory Commission declared banks should maintain a "stable and sustainable" lending pace, but went on to warn it would use enhanced inspections to detect potential problems associated with the nation's subsiding surge in loans.

To understand the significance of this seemingly mundane announcement, one has to recognize the central role domestic banks have played in China's stimulus campaign. About the same time Beijing decreed China would engage in this government-led spending program, the Chinese Communist Party also sought to prompt personal and commercial spending by temporarily loosening controls over lending. The result, over the last 10 months Chinese banks have inked agreements providing for almost $1.3 trillion in new loans -- roughly 50% more lending than Beijing had planned for the entirety of 2009.

How was Beijing able to pull this feat off? First, the Chinese banking system was/is in relatively good shape. Having managed to largely resolve the non-performing loan problems that plagued Chinese banks in the late 1990s and first half of this decade, Beijing's financial managers were apparently wise enough to avoid the mortgage-related debacle that nearly shuttered every Western lending window in late 2008. Second, unlike the U.S. banking system that demands independence in good times but depends on taxpayer largess on rainy days, Chinese financial institutions are relatively strictly regulated and expected to actually meet these standards.

A case in point -- capital adequacy requirements. Commonly referred to as the capital adequacy ratio -- capital adequacy requirements dictate how much money/assets a bank must have on hand to cover potential losses, thereby protecting depositors and bolstering confidence in the banking system. In the West banks seek to meet the international capital adequacy ratio of 8%. Suffice it to say, this has been a real challenge for no small number of Western banks over the last 12 months. In China the state-mandated capital adequacy ratio is 11%...and there are rumors it could climb to 13% in the coming months. While the China Banking Regulatory Commission denies these rumors, such a move would certainly serve to help reduce lending. (This would not be an unprecedented action; Beijing ordered the capital adequacy ratio climb from 8 to 10% at the end of 2008.)

With this data firmly in hand, let's return to issue of the moment -- China's apparent decision to start scaling back her stimulus program. Indications of this plan first started to appear on my screen in July 2009, when Chinese banks began to issue fewer loans. It became much more apparent in September and October. Chinese banks halved September's lending rate during the month of October -- trust me; this type of curtailment is not serendipitous. Rather, I would contend Beijing is busily trying to prevent a housing or stock market bubble that could derail China's economy with an impact similar to the turmoil caused by our once-over inflated real estate sector.

All this seems like good common sense, even if it flies in the face of Adam Smith's "invisible hand." The Chinese Communist Party has clearly come to the realization that tight regulation of the domestic financial industry is good for consumers on a micro- and macro-economic scale. Too bad Washington seems unable to reach a similar conclusion. (Watching Senator Dodd's efforts on this front is best likened to skipping stones on a large body of water...strangely satisfying but completely unproductive.)

As the New York Times so brutally reminded us this morning, we have much to learn from Beijing. You see, the Chinese Communist Party wisely crafted a stimulus plan that called for up to 75% of spending be financed by banks and state-owned enterprises -- not the central government. Having allowed our "masters of the universe" to craft securities and derivatives that defied regulation or logic...and thereby nearly cause the collapse of our financial system, Washington had no such option. Instead, we are spending our children's inheritance at a pace that ensures they will never achieve a comparable standard of living.

Think about these figures--pulled right from the New York Times. In 2009 we will spend $202 billion to service the national debt. In 2019 that figure will exceed $700 billion. As the Times so eloquently puts it, this "additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security, and the wars in Iraq and Afghanistan." And my bet is that things are going to get worse.

My morbid fascination with the debate over fixing this nation's health care system caused me to stumble across this worrisome comment from Senator Richard Durbin (D-IL). Speaking on Meet the Press, Durbin declared, "We have to finish [health care] in the Senate or its going to be maybe a long lunch break over Christmas. We've got to really focus, refocus our attention--all of our attention on getting people back to work." I would agree this is an honorable intention. But the fix is likely an emphasis on short term results--trying to drive unemployment down before the 2010 elections--with little thought to long-term consequences. In other words, even more federal stimulus spending created though additional borrowing. I can see the deficit and debt figures climbing even as we speak.

I just wonder how far down this path Congress will get before our primary creditor -- Beijing -- starts reminding us of the need for fiscal responsibility. I suspect the answer is not very far. No, I am beginning to believe we have a lot to learn from China -- particularly on the issues of fiscal responsibility and regulation of the robber barons on Wall Street. The Chinese Communist Party...yes, the Chinese Communist Party...seems to have learned that lesson in less than 30 years of reform and opening. Washington -- more specifically, the American taxpayer -- would be well-served to do likewise.