Banks and free markets

You might not have noticed, but in general, we’re supporters of free markets. However, we blamed at least part of the crisis on a rigid free market ideology, leading to badly regulated markets in the sector that can least afford it, the financial sector. There are a couple of other interesting examples.

Just when the rigid free market ideology started to get a hold on policy makers, in the 70s, a country which flauted many of the policy prescriptions, Japan, seemed on the way to become the next economic superpower. These free marketeer ideologues were completely at a loss to explain Japan’s success.

From a theoretical perspective, Japan is very interesting and we might discuss it some other time. However, this time we want to talk about China.

The funny thing is, when the so-called Washington consensus, the institutionalized version of the rigid free market ideology, advocated to all countries in the world to liberalize their capital markets, China didn’t oblige, notwithstanding the openness of its economy (trade with the rest of the world is a surprisingly large part of it’s economy, far larger than for the US, for instance).

When a host of Asian countries suffered from large amounts of capital flight and succumbed to an economic crisis that was not unlike the present one (the so called Asian crisis in the mid 1990s), China’s economy withstood the storm, and the fact that it hadn’t liberalized its capital flows was a major, perhaps even the biggest contributor to that success.

And now, the funny thing is, we see something similar. Although China’s exports are faltering, it’s real estate market is facing some severe headwinds and Dr. Doom, aka Nouriel Roubini, is predicting his usual stuff, but now for China as well, Chinese banks are still standing.

The wisdom always was that allocating resources, especially such crucial resources like capital, couldn’t be left to the hands of state bureaucrats, it should be left to the ‘market’. But we already explained yesterday that the ‘market’, at least the one in the United States, didn’t do a very efficient job (to put it mildly) because regulations and incentives were all wrong, and markets are prone to irrational herd behaviour.

So Chinese banks (which are state owned) hardly suffered from the sub-prime crisis and related dud assets, contrary to many (if not most) of its capitalist counterparts. However, there is more. While policy makers everywhere are wringing their hands, exhorting their (private) commercial banks to start lending again, Chinese banks do as the’re told, and do just that, they lend money.

Despite world turbulence and a cooling of Chinese real estate, lending is up 19% for the year to December. Now, of course there are a few projects that should not have received credit, that’s what happens when other elements play a role than just expected returns. But at least credit is up, and the capitalist West does not have a lot of ground to stand on from which to jaunt at this. As if their banks allocated capital in such a rational way lately..

To have state banks in the midst of a severe crisis can have advantages..