It looks like 1998 all over again in China

Of all the reporting trips I made in my Washington days, flying with Lawrence Summers to Beijing so he could kiss Zhu Rongji’s ring ranks among the most fascinating.

Anyone who has spent inside of five minutes with Summers knows he’s not the groveling type. But this was in January 1998, when Summers was deputy secretary of the U.S. Treasury, and Bill Clinton’s White House feared China would devalue the yuan and toss more fuel onto Asia’s already blazing crisis. As we landed in Beijing, Zhu, China’s reformist premier-in-waiting, was the man to see first. Summers won pledges from Zhu not to weaken China’s currency and to keep Hong Kong’s dollar pegged to the U.S.

I’m reminded of the experience not just because Zhu is back in the news with a new book of speeches, letters and commentaries. Or because Summers may soon be named Federal Reserve chairman, just as Zhu once ran China’s central bank. It comes to mind because the economic challenges China faced in 1998 are eerily similar to those it faces today.

Looking at the raft of China’s problems, one might imagine the 15 years separating Zhu’s inauguration as Chinese premier in March 1998 and Li Keqiang’s in March of this year had never happened. Now, as then, economists worry China’s economy might collapse, a mountain of nonperforming loans might go bad, state-owned enterprises are stifling innovation, and social unrest might overwhelm Beijing.

Back in the late 1990s, Zhu was the first visit of every foreign policy maker for a reason. He was the face of “new China” ― a boisterous, confident, English-speaking technocrat who understood free-market language and was beyond reproach as a reformer.

On that Beijing trip in 1998, Summers told me that he viewed Zhu as China’s answer to Paul Volcker. And Summers would be proved right. Just like the former Fed chairman who defeated the inflation of the late 1970s with harsh monetary medicine, Zhu tossed more than 40 million people out of work to trim back the influence of state-owned companies.

Zhu saw China’s 2001 entry into the World Trade Organization as a Trojan horse of sorts. Joining meant opening the economy and financial industry to foreign investment and, to a certain extent, international conventions of trade, intellectual property and environmental management. Likewise, Zhu didn’t view the internationalization of China’s currency as a tool of financial hegemony but as a means of forcing change.

Everything changed when Zhu and his boss, President Jiang Zemin, retired in 2003. Their respective successors, Wen Jiabao and Hu Jintao, feared modernization would jeopardize growth and fan social unrest. Whereas Zhu was a protege of Deng Xiaoping, who opened the economy in the 1970s and 1980s, Hu and Wen were cut more from the Mao Zedong mold. Reform died, free speech was curtailed even as Google and Facebook spread across the globe, and state-owned enterprises reasserted their dominance over the Chinese economy.

If Zhu had been marooned on a desert island during the Wen-Hu years and returned to Beijing today, he would be excused for thinking little had changed. In fact, Zhu would find things worse off.

The world tends to obsess over the wrong metrics. Yes, China is now the globe’s second-biggest economy, has $3.5 trillion in currency reserves, boasts an aircraft carrier, and spreads its largess the world over to win energy contracts and friends. But over the last 10 years, China’s economy has regressed as the state companies Zhu tried to tame used cheap capital to expand their grip. They now impose a significant drag on growth.

So far, Li has displayed only one flash of Zhu-like bravado: a sudden clampdown on credit in June that drove the benchmark interest rate to a record 12.45 percent. The target was a shadow-banking sector that has seen phenomenal growth and escapes regulatory supervision. The sector has encouraged an explosion of debt among state companies and local governments, while a plethora of wealth-management products obscures the true level of liabilities.

Since then, Li has acted far more conservatively. Why? For one thing, vested interests have grown as rapidly as debt over the last 15 years. Things were plenty corrupt in Zhu’s day, but there were far fewer Communist Party millionaires and billionaires defending the status quo at all costs.

The bigger difference may be pure nerve. Zhu developed a reputation as a risk-taker during his days as mayor of Shanghai, where he made it easier for foreigners to start businesses. And, as the world is learning from his new book, Zhu’s pragmatism kept the Tiananmen Square protests in Beijing from spreading to China’s biggest city. Li rose to office with a lower profile and a reputation for caution.

On that flight back to Washington in 1998, Summers recounted something Zhu had told him. The premier noted that the crisis then slamming Indonesia, Malaysia, South Korea and Thailand had educated China about the dangers of economic models that didn’t work. Fifteen years on, Chinese leaders seem to have forgotten those lessons. Li might want to pick up Zhu’s book and refresh his memory ― fast. 

By William Pesek

William Pesek is a Bloomberg View columnist. ― Ed.

(Bloomberg)