Why Is China Letting the Yuan Fall?
There’s been a lot of speculation about China’s recent currency moves,
but it’s business as usual for global capitalism.
by Geoffrey McCormack
(originally published on 8/15/15 in Jacobin magazine)
China’s stock market collapse and this week’s multiple currency depreciations are big news — and rightly so. But much of what has been written on the topic has been largely descriptive rather than diagnostic.The recent volatility on the Shanghai and Shenzhen exchanges and the Chinese state’s currency devaluation are symptoms of important changes in China’s underlying economy, and thus warrant careful consideration.The Chinese state’s move to restrain the growth of the stock market bubble in June and its subsequent maneuver to reinflate it shortly thereafter were both attempt to manage the symptoms of growing economic instability, but neither addressed its underlying causes.
Since its integration into the world economy under the leadership of the Chinese Communist Party and its adoption of increasingly generalized commodity production, China has become subject to the same laws of motion and patterns of crisis as other capitalist countries around the globe. While its industrial and financial system is complex and unique in many ways, it is ultimately a capitalist economy governed by the profit motive and, as such, is prone to experiencing recurrent patterns of crisis.
Capitalism is governed by the unrelenting drive for profit. If profits grow, businesses invest actively in machinery, equipment, buildings, and structures, but if profits stagnate or shrink this kind of investment suffers. Paradoxically, investment in capitalism depends on growing profits, but the system has difficulty maintaining them, and falling profits or random contractions of demand tend to undermine net new investment in industry.
The reasons for insufficient profitability vary, but the results are fairly predictable — capitalists turn to financial speculation, scouring the markets in search of higher returns, often in riskier avenues. In the United States, waning profitability in 1997 led to the dot-com bubble and its subsequent collapse in 2000. This was followed by the inflation of the housing bubble. Like the United States, dried-up fields for profitable investment in trade and industry led to speculation in China in the new millennium.However, whereas the US went from stock bubble to real estate boom, the Chinese economy has gone from real estate boom to stock bubble.
The growth of industrial profitability in China, while volatile, has slowed overall in the years following the global financial crisis.In 2007, profits grew by 39 percent, but in 2008 and 2009, when demand was depressed in the world economy, profit growth dropped to 12.5 and 13 percent, respectively. In 2010, the mass of profit grew by 53.5 percent, only to falter again the following year when it grew by 16 percent. In 2012, profit growth was below 1 percent, and in 2013 it was 10.5 percent. In 2014, profits crossed a critical threshold and grew negatively.
As a result of faltering returns on investment, the rate of capital accumulation — the growth of the stock of machinery, equipment, buildings, and structures — steadily decreased as well. For example, in 2007 the stock of machinery and other forms of capital grew by 21 percent, but according to the latest figures, in 2013 this rate slowed to 11 percent.In other words, in the seven years following the outbreak of the crisis, capital accumulation slowed by 10 percentage points. This underlying weakness in investment is the result of diminishing returns to capital, due to overaccumulation and depressed demand in the world economy.
Waning capital accumulation has pushed down output and employment growth in China. In 2007, GDP grew by 14.2 percent, while in the second quarter of this year, it grew at an annualized rate of 7 percent — a decrease by half. In the context of weakening profitability and depressed growth, China’s debt quadrupled to 282 percent of GDP in 2014, and significantly, corporate bonds made up the largest portion of this debt at 125 percent of GDP.
By comparison, US corporate bonds made up only 67 percent of GDP in the same year, while Canada’s comprised only 60 percent. In China, the debts of materials companies were 5.3 times their profits at the end of last year, for energy companies they were 4.4 times, and for industrial firms they were 4.2 times core profits. This high level of corporate debt is important because it indicates ongoing problems of profitability and has contributed to the instability of the Chinese economy. Notwithstanding waning profitability since the onset of the global slump, profit growth remained positive over the course of the past two decades, saving 2014, in which profits shrank by a whopping five percent. This downturn in profitability was the decisive factor precipitating the inflation of shares on the Shanghai and Shenzhen stock exchanges.
In the face of negative returns on new capital projects and Chinese capital controls, investors quickly abandoned conventional fields of investment and dumped large sums of cash into the mainland exchanges. Gao Hong of Jinxi Axle Co. expressed the sentiment of Chinese firms: “The risk for these (capital) programmes is so high and the rate of return so low that we have to make the best decision for our investors (by) purchasing bank products. Last year, we made profits thanks to the sale of CNR shares.” In other words, in the face of flagging profits, Jinxi Axle Co. and other Chinese firms secured alternative returns by putting money in the banks and by wheeling and dealing in shares. Aggravating the situation further, low interest rates reduced the incentive to save money in the banks and lowered short-term borrowing costs. The disincentive to deposit funds and the incentive to borrow money cheaply further encouraged debt-fueled speculation in stocks.
The pecuniary surge in the stock market resulted in a sudden increase in the value of shares, as fever struck the better-paid sections of the Chinese working class hoping to make an easy yuan. Margin trading — borrowing funds from a broker to purchase stocks — amplified this process and the value of shares soared. Towards the peak of the bubble, stocks in Shenzhen were trading at over 60 times earnings, almost twice their level at the end of last year. In June, after months of warning signs, panic finally eclipsed optimism when Chinese regulators began constraining margin lending, triggering a precipitous decline in share prices. In the context of depressed world demand, stagnant profits, and growing financial speculation, the Chinese state has undertaken extraordinary measures to shore up profitability, capital accumulation, and economic growth. In the past three days, it has depreciated the renminbi by nearly five percent — the largest devaluation in its history. This dramatic devaluation is not surprising considering it occurred at the same time that industrial profits shrank for the first time on record.
The gravity of shrinking profits and accompanying instability has not been lost on the Chinese state. The policy of currency depreciation aims to make Chinese exports more competitive on the world market, thereby stimulating profitability and capital accumulation. The dramatic reduction in the value of the yuan is an unambiguous sign that the Chinese state is struggling to cope with critically low profits in trade and industry — the same weakness that led to the recent financial bubble. The crash wrought havoc on the individuals and families that poured their life savings into the stock exchange in the hopes of securing a modicum of future security absent any significant social safety net. Tens of millions of Chinese workers have been affected — and many have lost everything. Amid the deluge of commentary and rising indignation about the financial losses and currency depreciation, it is important to remember that the latest drama to unfold in China is a regular occurrence in capitalism. It is a grim reminder of the system’s exceptional ability to create insecurity and horror seemingly without effort.