There’s a persistent notion that China is the modern examplar of laissez-faire neocapitalism, a comment which is the pseudo-intellectual equivalent of blindly declaring that Obama is a socialist. Certainly there are very unregulated activities that occur outside of the highly regulated official economy, and some degree of influence between the two. The interaction is very complex, particularly as the central government intentionally tries to introduce (pseudo) market reforms to certain aspects of the economy. Interests rates are very important, since they influence the lion’s share of saving and investment decisions, insofar as we believe that large scale centralized planning breaks down without access to appropriate information about relative scarcity. In recognition of this, the PBOC has tried to introduce ex-regulation price mechanisms into the system.

Austrian Business Cycle Theory (listen here), as I understand it suggests that changes in interest rates that are not motivated by underlying supply and demand (for money) lead to boom and bust cycles by causing businesses and investors to misallocate capital. Low interest rates make projects that previously seemed unproductive suddenly seem profitable (and vice-versa). This is a problem since, within the Austrian (and real) world view, capital is much more complex than K and H, and far less homogenous: can’t turn your Chinese speaking amateur market analyst into a computer scientist overnight. To address this, Austrian theorists suggest that a society needs to adopt a stable monetary base – say a gold standard (an astoundingly foolish idea, since it’s inedible) – or move to free banking (a great idea, since it’s the only conceivable way I could someday hope to issue a currency called the ‘Skreeblio.’)

This IMF working paper by Porter and Xu suggests that China’s market determined interest rates – repurchase agreement rates, interbank rates (CHIBOR and SHIBOR), and bond yields – are heavily influenced by the set of interest rates that remain regulated by the central bank (deposit and loan rates). Full paper here, summary at VoxEU:

… administered interest rates are key determinants of both the level and volatility of the market determined interbank rates. Despite the growing reliance on open market operations (using PBC paper), and direct instruments that should influence base interbank liquidity, the interbank rate is not particularly influenced by them. Consequently, short-term interbank lending rates are not able to act as an independent benchmark for asset pricing, or an independent indicator of macroeconomic or financial conditions. Further liberalizing interest rates, would allow the interbank rate (and other interest rates) to better provide essential price signals, better allocate capital, and strengthen the tools for macroeconomic management.

Some Austrians have virulent critiques of the Fed; they would certainly have a field day with the People’s Bank. It will be fascinating to see if this model works long term. More generally I wonder what an Austrian would say about China’s stratified heavily regulated official / very unregulated unofficial economies, existing in tandem (quite a bit of work about this was done regarding Russia during the late Soviet period?)