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How savers became the losers in China's economic boom

A Chinese woman poses for photos near a sculpture depicting the Chinese yuan note at an art district in Beijing.

Ng Han Guan/Ng Han Guan/Associated Press

Don't be fooled by China's spectacular economic growth in the last decade. Its economy is now suffering from serious financial repression, and only the liberalization of interest rate and currency policy can ensure continued healthy GDP growth, a prominent U.S. economist has warned in Beijing.

"There is a way forward, it will require this gradual reform of the financial sector," said Nicholas Lardy, a senior fellow at Washington, D.C.'s Peterson Institute for International Economics and author of Sustaining China's Economic Growth After the Global Financial Crisis, in a talk to journalists and academics.

"Financial repression is basically redistribution. It is taking money out of somebody's pocket and giving it to somebody else," he warned. "It's low interest rates, it's undervalued exchange rates, underpriced energy. The coastal provinces have gained at the expense of the inland, the export-import competing industries have gained at the expense of service industries. Commercial banks have done very well …. Savers, that is households, are the losers.

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Mr. Lardy's arguments are not surprising, given that he comes from a land that has long argued that China has deliberately undervalued its currency, the yuan, to support its export industry by selling cheap goods abroad. Nor can the U.S. throw stones at China's current glass-house of imbalances; Mr. Lardy acknowledges that it, too, is using ultra-low interest rates as a tool to cope with economic difficulties.

But Mr. Lardy warns that all China's outward economic progress of the last decade has come on the back of a financial system in which the People's Bank of China, in supporting the yuan amid a rising trade surplus, eventually bolstered its foreign exchange reserves to a massive $3.2-trillion.

"No other major trading economy has ever intervened so heavily in the foreign exchange market as heavily as China has in the period 2004 to 2011. Absolutely unprecedented," he said. The cost of that intervention, and the resulting sterilization of its current account to prevent instability at home, has passed a debt burden onto state banks, which, in turn, have passed the burden onto consumers in the form of low deposit rates. With real interest rates at effectively negative values, property becomes the only reasonable method of investment.

The result? A massive property bubble now slowly deflating under government regulation, and limited success with efforts to stimulate household spending, as inflation and artificially low interest rates eat away at consumers' disposable incomes.

What's needed, he argues, is higher deposit rates and a more flexible – presumably appreciating – currency, which will eventually help rebalance the economy away from investment-driven growth toward services, creating jobs and wealth, while giving consumers more reason to spend the money in their pockets.

"Property is not likely to continue to be the driver of economic growth that it has been over the last five or six years," he said. "The most important thing the government can do is to gradually liberalize deposit rates."

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