China’s Reform Canary

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The debate in China over economic reform has just become more interesting. Central Bank Governor Zhou Xiaochuan on Monday called for freer trade and an end to capital controls as essential to restructure the economy, The Wall Street Journal reported. Coming on the eve of the Communist Party Congress, this could be an important moment. Mr. Zhou is right that a convertible currency—the yuan—is key to rebalancing China’s economy from its long-time dependence on high savings and investment. Capital controls keep savings within China’s financial system, depressing the cost of capital and subsidizing investment at the expense of household income. This combination, known as financial repression, has contributed to the massive increase in lending over the past decade. Total debt in the economy soared to 280% of GDP by some estimates. Moody’s and Standard & Poor’s downgraded China’s sovereign debt this year because of the rapid increase in borrowing, which is historically linked to financial crises. Read more. (Subscription required.)