In a financial crisis, credibility counts
In the past seven years, the world’s three largest economies – China, the United States, and Europe – have seen massive government intervention in financial crises. The US Federal Reserve bailed out Wall Street in 2008. The European Central Bank saved the eurozone in 2012. And in July, Chinese authorities spent more than $500 billion to prop up stock markets in Shanghai and Shenzhen that had lost a third of their value. These were heroic reactions and rare in history.
All three interventions were a test of credibility for leaders in their ability to manage a crisis as well as their understanding of economic fundamentals. Economics is hardly an exact science. It is laden with disputes over policy. Yet the one undisputed necessity is trustworthiness. Can regulators, central bankers, and others pull the right levers to restore and maintain confidence in an economy?
The US has steadily recovered from its crisis while the European Union appears on top of its troubles with its weakest economies, such as Greece. In China, however, the ruling Communist Party faces a long march to regain credibility. Over the past year it told Chinese to invest in stocks, only to create a financial bubble that finally burst in early July with the biggest drop in prices since 2007. Party leaders then used the brute force of state controls to stop the selling of stocks and to buy up shares.
These events have cast doubts on the ability of President Xi Jinping to bring about deep reforms, such as privatizing state-run enterprises and shifting capital to innovative companies. “Such actions put policy credibility and effectiveness into question,” stated Standard & Poor’s credit agency. At the least, the intervention goes against Mr. Xi’s pledge in 2013 to let market forces play the “decisive role” in the economy.
Much of China’s economy remains sound. Only 7 percent of Chinese hold stocks compared with about half of Americans. But in a country whose leaders seek stability at almost any cost, the stock market crash shows the need to resolve a tension between market freedom and the party’s desire to control the economy for political ends.
In coming days, party leaders will gather for their annual summit at the Yellow Sea resort area of Beidaihe. This secretive enclave sets the agenda for the next five-year economic plan. To regain legitimacy, the party will need to make tough decisions on reforms that can restore the confidence of investors, both Chinese and foreign.
Credibility, like the value of a currency, is an invisible commodity, one built on the qualities of trust and competence. Prosperity depends on it. And it does not derive from power and authority but from wisdom and gentle persuasion. If the world’s three largest economies can master it, the global economy will be better off.
