The Chinese economy is not easy to understand. So I am always on the lookout for things that can help make it more understandable. This 12 and a half minute segment by Tyler Cowen is excellent.
I have one disagreement and one thing to add. The disagreement is that I don’t think “capital flight” has to be a big problem for the Chinese economy. The Chinese Yuan may need to depreciate; they have been using up reserves at a rapid clip to try to prop it up, which has to stop at some point, despite the large reserves they start with. But because China’s government and Chinese firms owe relatively little debt in any foreign currency, such a depreciation due to outward capital flows shouldn’t cause any huge problems. Indeed, it will help increase net exports, in line with the principles I discuss in my post “International Finance: A Primer.”
Nevertheless, the Chinese economy would be more balanced if Chinese households start doing more consumption spending. Many economists and foreign observers have recommended that China shore up its social safety net to reduce precautionary saving and thereby foster consumption. The additional point I wanted to make is that allowing higher interest rates on savings accounts might spur consumption in the Chinese case, where the marginal propensity to spend of the banks and their owners on the other side of that particular borrower/lender relationship might be lower than the households doing the saving–especially if the Chinese government tells those banks to keep doing a given quantity of lending, or if the rate at which Chinese banks lend is disconnected from the rate at which they pay interest to depositors. (In general, to see the effects of an interest rate change, try the kind of analysis I illustrate in “Even Central Bankers Need Lessons on the Transmission Mechanism for Negative Interest Rates.” This Chinese case is unusual. For almost all borrower-lender relationships, a cut in interest rates is stimulative and an increase in rates is contractionary.)