An anxious superpower is confounded by a troubled economy. For a generation, its growth has been envied; now that growth is decelerating sharply. For decades, it has shaped and guided its economy via tight control of its banks; now that lever is malfunctioning. For years, it has carefully managed its exchange rate and limited the flow of capital across its borders; now the dam is cracking. To anyone who keeps up with the news, the superpower would seem easy to identify: China. But for those with a long memory, it could just as well be the United States of the Nixon era.
Like China today, the United States of the 1970s experienced an abrupt economic slowdown. Its economy had expanded by 4.4 percent a year, on average, during the go-go ’50s and ’60s, but growth slowed by about one-quarter during the following decade, to 3.2 percent a year. Even though growth of more than 3 percent may sound robust by today’s standards, at the time it felt ghastly. Time magazine lamented in 1974 that “middle-class people are being pushed into such demeaning economies as buying clothes at rummage sales”; a year or so later, its cover asked, “Can Capitalism Survive?” In September 1975, after President Gerald Ford survived two attempts on his life in quick succession, an adviser named Alan Greenspan responded with a memo about the “nihilism, radicalism, and violence” that seemed to grip some Americans. When New York City flirted with bankruptcy, its plight was taken as a symbol of broader moral and cultural decay.
People are happiest when they experience better-than-expected progress. The U.S. deceleration of the 1970s brought on a national melancholia, culminating in 1979 with Jimmy Carter’s hand-wringing in what came to be known as his “malaise speech,” even though Carter never used that term. In today’s China, where the government hates nothing more than to express weakness, the signals may not be so obvious: Xi Jinping is not about to don a cardigan and ruminate about “a crisis that strikes at the very heart and soul and spirit of our national will.” But China’s economic slowdown is nonetheless likely to take an insidious toll on the Chinese psyche. The country’s growth has slowed from an average annual rate of about 10 percent in the 2000s to an estimated 6.9 percent in 2015. And although the new rate remains impressive relative to that of most countries, the deceleration—and hence the shock to expectations—is sharper than that experienced in the United States four decades ago.
Indeed, China’s slowdown may be especially tumultuous because its society is under acute stress. Pollution, inequality, corruption, and precipitous urbanization have complicated the country’s growth miracle: A range of studies finds that economic progress has yielded surprisingly few gains in self-reported life satisfaction; in fact, among poor Chinese in urban areas, life satisfaction since 1990 has declined. Slower and more balanced growth, involving a shift away from dirty manufacturing, may eventually ease some of these stresses. But the slowdown’s immediate effect will be greater insecurity, as companies that had bet aggressively on limitless growth find themselves lumbered with unprofitable factories or empty apartment blocks. Many will lay off workers or go bust.
If China’s slowdown were temporary, this might not matter much. But the country’s deceleration is likely to become more severe. China’s growth has been founded upon exports, yet there is a limit to how much China’s trade surplus can expand without triggering a protectionist backlash. China’s growth has also been powered by favorable demography, but as today’s missing children become tomorrow’s missing adults, the ratio of workers to dependents will deteriorate and the demographic dividend will give way to a demographic tax. Most crucially of all, China’s growth has been built on an extraordinary level of investment, recently financed by an extraordinary level of debt. But, as we shall see presently, this road to riches leads over a cliff. China’s economic miracle is very likely at its end.
Downshifting is always painful, but politicians often make it more painful—and ultimately more destabilizing—than it needs to be. That was certainly the case in the U.S. in the 1970s, and Chinese leaders would do well to learn from America’s experience. The first and most important lesson is to accept the slowdown gracefully. Denial and resistance only make the problems worse.
Like China’s current leadership, Richard Nixon feared the political fallout from a slowdown, and so resisted hard. He bullied the Federal Reserve into conjuring up a stimulus, just as China’s ruling State Council recently directed the People’s Bank of China to cut interest rates. He propped up the defense contractor Lockheed, much as China’s government supports large state-owned enterprises. He unleashed government-sponsored lenders to shovel credit into the economy—for the mortgage-finance companies Fannie Mae and Freddie Mac, substitute China’s state-owned banking behemoths.
Inevitably, Nixon’s efforts to force growth above its natural level stoked inflation, to which the president responded with almost-communist control measures: A new Price Commission, led by Donald Rumsfeld, tried to freeze prices by diktat, drawing unenforceable distinctions between apples and applesauce, popped and unpopped corn. Not surprisingly, the controls cracked after a short period; inflation resumed, and the rest of the 1970s were a stagflationary nightmare. In sum, by denying the inevitability of the slowdown, Nixon helped set the country on a path to double-digit inflation, wiping out savings and eventually forcing the Fed to respond with extremely tough medicine, which inflicted back-to-back recessions on Americans at the start of the 1980s.
In today’s strange economic circumstances, inflation poses no immediate threat to any major nation, China included. But if China’s leaders follow Nixon in resisting an inevitable slowdown, the penalty will show up elsewhere. By trying to boost growth with low interest rates and government-directed lending, China will add to its debt burden, which already jumped from 134 percent of GDP in 2007 to 217 percent in the second quarter of 2014, according to McKinsey. In itself, that ratio is manageable, but the trajectory isn’t: The debts of the government, and of the banks that are effectively a part of it, are expanding at about twice the rate of the economy, according to the China watcher Michael Pettis—which is to say that debt is piling up much faster than the country’s ability to repay it. Like the U.S. four decades ago, China will discover that a reality-defying stimulus only makes matters worse.
The second American lesson for China concerns financial reform. Again, this was a challenge Nixon refused to face squarely, even though most economists urged him to be bold. By the time of his inauguration, America’s outdated system of capping bank-deposit rates—the same sort of system that still exists in China—had been rendered dysfunctional, and for reasons that contemporary China watchers would quickly recognize. Once upon a time, the caps had usefully forced down banks’ cost of capital, allowing them to make cheap loans to the industries that fueled growth. But as the U.S. economy developed and the financial system grew more sophisticated, new types of savings vehicles sprang up, offering market-linked interest payments; because those market rates were more attractive, savers voted with their wallets. As deposits migrated from banks to upstart rivals, small businesses, which relied on bank loans, found credit hard to come by. Home buyers faced a similar credit crunch.
Acknowledging the case for change, Nixon appointed a financial-reform commission in 1970. But the president found the commission’s ideas toxic. “There’s going to be a lot of crockery broken,” a White House aide warned him: The reformers were suggesting freer competition, which would end the credit droughts in key patches of the economy—but also push weaker (yet politically vocal) lenders to the wall. Seldom eager to elevate principle above politics, Nixon decided to do nothing. In the absence of an intelligent reform plan, finance was left to modernize haphazardly. Excluded by regulation from the mortgage business, banks experimented with foreign ventures—and squandered their shareholders’ capital on drunken Latin American lending. Unable to coast on cheap deposits, savings-and-loan associations tried to compensate with racier investments. The resulting savings-and-loan crisis would eventually cost U.S. taxpayers more than $100 billion.
China today is in a similar quandary. Caps on deposit interest rates allow banks to vacuum up cheap capital and lend it to favored companies; if the government messes with this system, much crockery will be broken. But the status quo is unsustainable. The artificially low returns to savers represent a vast hidden tax on Chinese families, crimping consumption and forcing China to rely unhealthily on investment spending to power growth. And because politics determines who gets the cheap loans that are made possible by capped deposit rates, capital flows to political cronies rather than to the innovators who have the best ideas. The result is a machine for expropriating savers and then squandering the proceeds. Sooner rather than later, China needs a financial system that generates fewer bad loans, makes better use of savings, and frees consumers to become the engine of the nation’s economic growth.
The final American lesson for China concerns the exchange rate. In the postwar era, the United States pegged its currency to gold, much as in recent years China has mostly pegged its currency to the dollar. But in August 1971, as part of his attempt to boost growth, Nixon abandoned the gold link, allowing the dollar to fall precipitously against the currencies of America’s trading partners. China now seems tempted to pursue a cautious version of this strategy, and for similar reasons: Devaluing a currency and thereby boosting exports is seductive. But exchange-rate regimes work best when a currency is either truly fixed to a peg or allowed to float freely; the middle ground is treacherous. If a country begins devaluation but stops short of allowing its currency to reach its natural level, investors will expect the currency’s value to fall further, and will therefore withdraw money from the country. As that happens, their expectations may well become self-fulfilling.
Nixon thought he could follow devaluation with a new, refixed exchange rate. But his efforts failed embarrassingly, compounding the volatility of the dollar. Likewise, China discovered last summer that a modest depreciation can create expectations of more depreciation, triggering a burst of capital flight. A renewed exodus of money in November suggested that the danger was still present. The currency turmoil in January underscored the point.
Nixon’s setbacks in the 1970s serve to remind Westerners not to judge others too arrogantly. But at the same time, they stand as a warning. When navigating big economic transitions, halfhearted policy adjustments are usually inadequate, and the costs of timidity will be more than just financial. In the U.S. the costs included a decline of public trust in institutions, a spate of national self-questioning, and eventually an embrace of radical remedies: aggressive deregulation, monetarism, deficit-fueling tax cuts. If China cannot navigate its deceleration more deftly, Xi’s successor may one day be reduced to addressing his countrymen about lost national confidence. Perhaps a Chinese magazine will even pose the question “Can Communism Survive?”