THE AFTERSHOCKS OF CHINA'S 1994 FINANCIAL REFORMS

Noah Elbot

ABSTRACT


Current imbalances in China's banking sector threaten the sustainability of the country's impressive growth rates. The origin of many of these imbalances is endogenous to four major institutional reforms of China's financial system circa 1994. Policies such as the centralized control of capital flows and pegged currency rates, the short-term biased, opaque financing schemes of local governments, and the implicit guarantee and subsequent funding bias of large monopoly State-owned Enterprises connect directly and indirectly to current fault lines within China's financial sector. These institutional policies have created bubbles in the construction and real estate sectors, biased growth towards targeted urban centers and industries monopolized by SOEs, and birthed volatile investment products reminiscent of the toxic US packaged derivatives of the 2008 global financial crisis. Additionally, this paper will explore the possibility of over-investment in China, and its foundations within the banking environment. Some of the steps taken to obscure these institutional fissures have added to global macroeconomic imbalances, such as China's hoarding of foreign currency reserves and low consumption rate. However, on other fronts numerous progressive policies of the past decade have proven forces of liberalization, allowing for greater transparency within China's banking system and lead to efficiency gains in allocating resources. Despite these developments, the fault-lines within the financial system lie deep within the historical policy foundations, and as China's industries and banking system expand onto the greater world stage, the current institutional system may prove untenable.

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