Why China is right to be wary

Three incidents from recent financial history are very useful to understanding China's pace of economic reform, and its attitude toward the West.

I was reading Richard Bookstaber's A Demon Of Our Own Design over the holidays, which looks, among other things, at the history of financial product innovation. It reminded me again of how relevant past crises are to today's markets.

Three incidents in particular, and the lessons taken from them, are very useful in understanding some of the more worrying stories about China.

You may remember a couple of recent spats involving big state-controlled Chinese companies refusing to honour derivatives contracts they had signed with Western firms. There was a lot of grumbling about China not playing by the rules and damaging its appeal to foreign businesses. That may be true (although probably not in finance, where investors seem to have staggeringly short memories).

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But as the Chinese authorities know, Western banks ruthlessly took advantage of the naivety of Japanese banks and companies as the country's bubble peaked in the zaitech (financial engineering) craze. You can see these defaults as a warning that China won't tolerate similar funny business.

Then there's the Plaza Accord of 1985 and its aftermath. Back in the early 1980s we had a weak yen and strong dollar, favouring Japanese exporters over American firms. So Japan and the US, plus Britain, France and Germany, agreed to weaken the dollar versus the yen. Over the next two years, it fell by 50%, until the slide was brought to a halt with the Louvre Accord in 1987.

Many analysts have blamed the shock this caused to Japanese manufacturing and the loose monetary policies that Japan then adopted to combat that, for creating the bubble. Understandably, China is not keen for the same to happen, hence its refusal to revalue the renminbi faster in spite of complaints from America.

Finally, there's Russia and its shock-therapy approach to changing from communism to a form of free-market democracy that saw the economy and society fall apart in the early nineties. Many have argued that it had no other choice. Regardless, China undoubtedly sees Russia's fate as a salutary lesson in changing too much, too quickly.

Cris Sholto Heaton

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.