The rise of the red dragon: the non-binary political economy of decentralised public banks

ABSTRACT

This article scrutinises China’s unexpected economic ascent as an industrial dynamo despite an underdeveloped institutional framework, driven by a fusion of the Currency and Banking School arguments. Our discourse focuses on the reorganisation of endogenous money in post-Communist China, which significantly fortified the domestic economy. We employ a two-tiered framework, firstly linking the Currency vs. Banking School debate to the crucial role of domestic bank credit creation in economic development. Subsequently, we anchor this within the context of the post-Mao reforms, illustrating how ‘inside money’ is deployed in a top-down manner to real industry via a bottom-up and decentralised organisational design. The emergent Chinese political economy is in our view defined by the amalgamation of neo-statist and neo-liberal credit market policies. We detail the transformative effect of evolving domestic commercial banking trends, thereby shaping a distinctive post-Communist society.

KEYWORDS:

• Bank credit
• local banks
• post-Communist economies
• decentralised public banks
• Sino-capitalism
• economic development

1. Introduction

China's geopolitical and economic rise is credited to a ‘chaotic mélange’ of structural reforms: an alchemy of neo-statist and neo-liberal policies forming a unique Sino capitalist variety (McNally, 2019, 2020; Zhao & Ruet, 2021). The great transformation of the state sector, following the principle to ‘grasp the large, let go the small [state owned enterprises]’ (Hsieh & Song, 2015), resulted in double-digit annual GDP growth, outperforming liberal market economies: ‘[China] has achieved impressive … rates of economic growth’ (Nanto & Sinha, 2010; Acemoglu & Robinson, 2012, p. 345). All the while, Red Capitalism’s successful state-led development occurred contrary to the Washington Consensus development advice and ‘[d]espite more than three decades of economic reform, China’s financial repression still remains’, with ‘government interventions … pervasive in almost all economic activities, from determination of bank lending and deposit rates to selective allocation of credit’ (North & Weingast, 1989; Williamson, 1998, 2002; see also Babb, 2013; Kentikelenis et al., 2019; De Graaff, 2020; De Graaff et al., 2020; Chan, 2021, p. 119). This outstanding macroeconomic performance poses a challenge to IMF and World Bank development policy that remains to be fully explained.

There are a number of puzzles: The Red Dragon’s ‘weak institutions … are ill-suited to achieve economic development’ (Xu & Pistor, 2011, p. 1077). Authors claim even now that resolving 'deep-rooted structural issues [in monetary policy]’ and ‘improving governance and institutions’ are ‘essential so that monetary policy can be more focused and effective’ and the Chinese economy can transition from a post-Communist to a successful market-driven economy (Chan, 2019, p. 1). Empirical research on finance, law, institutions and growth concluded:

‘ … China is a significant counter-example to the findings of the existing literature on law, institutions, finance, and growth. Despite its poor legal and financial systems, China has one of the fastest growing economies in the world’. (Allen et al., 2005, p. 59)

Thus, Occidental economists are challenged to decipher China’s economic rise and how the Middle Kingdom surfaced as the main contestant of a US-led international order. The existence of a ‘China puzzle’ compels a review of the policies employed domestically to spearhead China’s geo-economic rise (Zhao & Ruet, 2021). Thus, we are motivated to investigate the domestic political economy elements that caused China’s incomparable economic expansion, allowing her to engage in a ‘delicate tango’ with the hegemon over the leading position in the international arena.

A popular hypothesis to answer the above question is the role of globalising business elites and shared knowledge networks (Hou et al., 2021) through US university training of the newly-bred Chinese heirs, indoctrinating them in the merits of neoliberalism (radiated by transnational institutions; see e.g. Babb, 2013; Kaleknatikis et al., 2016; Huo & Parmar, 2020). Another is the thawing Sino-American interactions between first-rank political actors since the Cultural Revolution, which generates FDI inflows to China (whose merits remain to be assessed; see Bermejo-Carbonell and Werner, 2018; Roden, 2003; Yong & Pauly, 2013; Werner, 2016). However, there is an alternative and important hypothesis concerning the money question that has been somewhat ignored by scholars (Cohen, 2016; Norrlof, 2017), likely due to the dominant hypothesis of money neutrality in traditional economics (Blanchard, 1990; Lucas, 1972). This will be examined in our article. Specifically, this hypothesis argues that the financial deepening (Knaack et al., 2020) and the dynamic institutional change (Bell & Feng, 2019), more precisely the decentralised credit allocation characterised by a local bank system, akin to that of post-war Japan (Werner, 2003, 2005), are key to the Red Dragon's geo-economic rise.

To rationalise our viewpoint, we show how Chinese policy-makers have successfully synthesised key Currency and Banking School proposals (Section 2) to form a hybrid structure of the post-Mao Chinese banking system (Section 3), grounding our research in historical analysis about the positive role of domestic finance capital on economic growth (Kaplan, 2016). Overall, our purely theoretical macro-money narrative elucidates that a decentralised monetary system supporting the real economy with bottom-up private entrepreneurship may explain the rise of China in the international order.

We arrange the rest of this article as follows: Section 2 presents the theoretical arguments in the heated Currency vs Banking School debate about the reorganisation of fountain pen money in economic development, whereby the Currency School can be seen to highlight the positive role of public money supply and the Banking School can be interpreted as emphasising the stimulating role played by a decentralised system of liquidity creation and allocation. A fused system of decentralised public banks obtains the benefits of both, as we theorise. In Section 3, we narrate how gradualist Chinese reformers managed to desegregate the binary proposals in credit markets from the two competing schools to fuel the real economy in order to elevate Asia’s sleeping giant to the summit of the international order.

2. The political economy of money revisited

The political economy and nature of money returned to the epicentre of monetary policy-making in the aftermath of the 2008 financial crisis, as its omission in economic models led to the crisis in the first place (Werner, 2005, 2012). Subsequently, the age-old Currency vs. Banking School debate re-emerged to provide a critical view on the role of credit in economic growth and its link to financial stability (Dyson et al., 2016; Ingham et al., 2016). We focus our discussion primarily on the role of money in economic growth and development.

The opposing factions in this century-old debate have recommended binary policy-choices – all or nothing – about the reorganisation of the banking sector, and its fountain pen money (or modern-day digital equivalent), in the goal to render economies unsusceptible to business cycles (De Soto, 2006; Dyson et al., 2016; Jackson & Dyson, 2012). One group of scholars and policy activists advances the idea that money creation is a public privilege and thus ought to return to its rightful owners, the public, by abolishing banks and installing all-powerful central banks as monopolist issuers of centrally planned money (Jackson & Dyson, 2012), a proposal known from earlier iterations, including in the Communist Manifesto (Marx & Engels, 1848 [2010]), and, for our purposes, in harmony with Mao’s interpretation of communism and central planning, and also with the increasing momentum towards the introduction of central bank digital currencies (Werner, 2018). The Banking School, on the other hand, is sceptical about the Sovietisation of the credit market (De Soto, 2006; Goodhart, 2017). Its adherents argue that a decentralised private sector is much more efficient in responding to the needs of the real economy (Werner, 2013). Both schools’ diverging bids to reorganise the domestic monetary order are discussed in turn below, upon which it is shown that post-Mao gradualist reformers in China, led by Deng Xiaoping, synthesised these extreme views ingeniously.

The archetype binary approach adopted by the two schools of thought, originating in the English classical economics era, centres on the domestic recalibration of the monetary institutional arrangements. This binary dichotomy resembles ‘the very black and white view’ of the role of China in trade relations (e.g. McNally, 2020; Weinhardt et al., 2020), or indeed the assessment of economies as either being market-oriented or being centrally planned. In reality, combinations of different and differentiated organisational features are possible. If the America-centric proposals of concentrating the hierarchy of liabilities to a single, universal domestic money issuer materialises, the global pecuniary order will, undeniably, be recalibrated to mirror the distorted domestic – international monetary relations (Eichengreen, 1987; Goodhart, 2017). Failure to recognise the actual key features of the Chinese political economy would only increase the likelihood of the dislodgment of the US dollar by the Chinese renminbi at the tip of the worldwide money hierarchy (Cohen, 2012), in reflection of the distorted liquidity availability in money and credit markets (McNally et al., 2017).

2.1. The modern currency school and its roots

A prominent theoretical article by Bank of England economists (McLeay et al., 2014) on money creation by private commercial banks reinforced the empirical findings of a real-time experiment, captured live by BBC journalists (Werner, 2014b, 2016). During this balance sheet test, conducted at a trifling German Raiffeisen bank (though representative of the co-operative banks that constitute the most numerous type of banks in Europe), the exact actions and accounting entries of a standard borrowing process were confirmed. The field experiment documented that borrowing from banks results in the creation of new deposits ex nihilo, thereby rejecting the financial intermediation and fractional reserve theories of banking as false accounts of the operation of the banking firm (Lucas, 1972; Beck et al., 2020; Li et al., 2020). The MacLeod (1891)-Schumpeter (Schumpeter, 1912 [1961])-Innes (1914) credit theory of money, on the other hand, corresponds to the genuine accounting practice at credit institutions (Werner, 1997; Werner, 2012, 2016; Bezemer, 2016). In the contemporary advanced capitalist polities, more than 90% of the money supply is created by commercial banks in the process of credit creation (Werner, 2005, 2014b; Ryan-Collins et al., 2012).

The hugely profitable seigniorage is, therefore, not a public privilege as once assumed (e.g. Allen et al., 2020). Seigniorage profits in Britain could amount to over 1% of GDP, estimated by Macfarlane et al. (2017) for the period 1998–2016, amounting to £23bn per annum in profits for private shareholders, while in 2017 HM Treasury received only £1.2bn from the nationalised Bank of England (although the new bank levy did recover further money from the private sector banks). It seems that the profitable business model of modern-day banks, combined with their short-termism, prompted 21st century Currency School champions (e.g. Jackson & Dyson, 2012) to recommend a true nationalisation of the money supply in the hands of a Soviet-style monopoly bank run by central planners, as earlier economists had also thought proper (Ricardo, 1824; Marx & Engels, 1848; Fisher, 1935) and had attempted, but failed to introduce with the 1844 Banking Act, claiming this would ensure democratic and sustainable credit creation and allocation. In other words, the public, we are told, will recuperate its rightful privilege over money creation and allocation by delegating the task exclusively into the hands of technocratic central planning institutions such as the Bank of England’s Monetary Policy Committee (UK) or the US Federal Open Market Committee (Jackson & Dyson, 2012). The envisaged scenario closely resembles Ricardo's proposal two centuries earlier in his Plan for the Establishment of a National Bank, which at the time did not exist due to the 100% for-profit and private nature of the Bank of England. In Ricardo's scheme, credit creation was to be delegated to five commissioners ‘in whom the full power of issuing all the paper money of the country shall be exclusively vested’ (Ricardo, 1824, p. 15). Under such a concentrated institutional framework, the central credit committee would ‘no longer … adjust the policy interest rate, but … adjust the rate of money creation’. This public control and switch to quantitative monetary policy could in theory end the business cycle as private interests would not be able to inflate asset prices to reap personal benefits (Werner, 2005). A Fisherian100% Money supply would eliminate (or in the very least moderate) national debt, reduce austerity next to a number of lesser benefits in the eyes of Currency Schoolers, as well as widen the financing capabilities of fiscal bureaucrats as argued by the growing crowd of heterodox thinkers (Fisher, 1935; Keynes, 1936; Kelton, 2020).

2.2. The modern banking school and its roots

The Banking School economists opposed the Currency School, sceptical of the success of centralised, Soviet-style credit allocation systems (De Soto, 2006). In their eyes, the formation of a Gosbank monobank system would bring with it the economic malpractices of Communist regimes in the USSR and Eastern Europe (Alesund & Djankov, 2014). Their chief point of disquiet is the inelastic credit supplied by apparatchiks reacting sluggishly to entrepreneurial animal spirits (Keynes, 1936; Goodhart & Jensen, 2015). Thus, in their eyes the rate of credit creation is the key link between bank activity and the real economy (as evidenced e.g. by Werner, 1997, 2005, 2012; Chen & Werner, 2011).

On the other hand, the Banking School sub-group of free banking supporters draw attention to the fact that imposing centralised control over credit allocation is a laborious chore (Arnon, 2011). Past regulatory attempts to limit private money creation within an incomplete legal framework (Xu & Pistor, 2003) have been in vain: ‘the Banking School may lose a few battles (as in 1844), but usually wins the war’ (Goodhart & Jensen, 2015, p. 4). The key insight of this modern Banking School is to allow private, profit-maximizing deposit-takers to retain a proportion of seigniorage profits or else a novel balance sheet channel to leverage the supply of money may ultimately appear, undermining any centralised supervisory control, since bank credit as such was never privileged at law – it is merely private company credit, while deposit money is created as a rebooking of bank liabilities from an accounts-payable liability arising from the loan contract to another type of liability functioning as ‘customer deposit’ (Werner, 2014a).

2.3. A ‘melange’: synthesising currency and banking school proposals

The alternative schemes advanced by both schools of economic thought are:

1. A 100% public money supply (Currency School).

2. A decentralised system of (private) banks, ideally without central bank (Banking School).

The ingenious synthesis of these binary policy proposals in China is the chief point of discussion below: The solution is public bank credit money produced in decentralised fashion by many small and competing local banks, but largely in public hands. This is depicted in Figure 1 below. At the same time, we discuss how newly issued money and credit is channelled to the real economy (Werner, 1997, 2005, 2012), as both schools think is proper.

Figure 1. Desegregating currency and banking school Proposals.

3. Synthesising the currency and banking school proposals: the political economy of the Chinese banking system (1960–2018)

In China, the Currency School proposal had its heyday during the economic central planning by the Communist regime during the Maoist era (1949–1976). The People’s Bank of China (PBoC) was the Gosbank, creating and allocating virtually all money in line with the Gosplan (central government’s plan) in consonance with the Gossnab (the central committee allocating all resources across the economy), whose functions were akin to the futuristic planning role of the MPC (UK) and the FOMC (USA). Any scholar with an affinity to economic history can testify to the cataclysmic socio-economic outcome yielded by a Soviet-style system (see Figure 2).

Figure 2. GDP growth, China (1960–2018).

Source: World Bank Open Database.

After Deng Xiaoping took over leadership in 1978, the Chinese economy underwent a major and multi-faceted reform, ultimately rendering him the architect of successful modern China. With him in charge, the Chinese Communist Party re-designed the discredited Gosplan economy by incorporating key features from successful, competition-oriented capitalist varieties. In contrast to the shock reforms in post-Communist economies in Eastern Europe and the USSR (Boycko et al., 1993; Alesund & Djankov, 2014), which concentrated immense wealth in the hands of a narrow elite (Rutland, 2008; Novokmet et al., 2019), the Chinese leadership adopted a gradualist approach, with Deng quoting the Chinese proverb that it is wise to ‘cross the river by feeling the stones’ (摸着石头过河).

There was a combination of top-down and bottom-up reforms as well as neo-statist and neo-liberal policies. While the policy towards state-owned enterprises was to ‘grasp the large and let the small go’ (抓大放小, Naughton, 2007; Hsieh & Song, 2015), local reformers guided the formerly centrally-planned economy towards a social democracy with Chinese characteristics as defined by President Xi Jinping later. For key markets such as energy, telecommunications and banking specific policies were designed.

In banking, the paradigm shifted from centralisation during the Soviet period to a post-Communist economy relying on the principle of subsidiarity (Mear and Werner, 2020) and decentralisation – in line with the Banking School – while at the same time upholding the vision of Currency School advocates of public ownership of banks. This dimension appears to have dominated in the Chinese reforms, quite in contrast to the reforms in post-Communist Russia, where decentralisation was far less pronounced, while the ownership dimension became more important.

Within these principles of subsidiarity and decentralisation, China embarked on an unprecedented programme of creating thousands of new banks – ranging from a few national champions to uncountable small rural, village or state level banks, savings banks, post banks, credit co-operatives, as well as specialised banks of all kinds. Banks appeared like bamboo shoots, with the pace of bank creations not relenting. While the statistics appear incomplete and on occasion contradictory, it is clear that the creation of new banks remained a policy goal even in the years after the 2008 financial crisis (see Figure 3).The recent literature on ‘shadow banks’ also recognises that the growth of financial institutions has been remarkable (Gabor, 2018; Knaack et al., 2020).¹

Figure 3. Chinese banking ecosystem (1960–2016).

The Chinese banking sector is dominated by banks that are majority-owned by the public sector or co-operatives with a public-purpose character.² It consists of four, largely public, pillars – state-owned commercial banks (SOCBs that derived from breaking out different functions from the original central bank), city commercial banks (CCBs), joint-stock commercial banks (JSCBs) and rural commercial banks (RCBs), heirs to the credit cooperatives (Andersson et al., 2016; X. Zhu, 2018) (see Table 1). Chinese public ownership stakes in the majority of bank assets (even in the commercial banks, which often have the Finance Ministry, the public China Investment Corporation, local authorities or state-owned entities as shareholders) allows the retention of money seigniorage profits in the public purse.³

Table 1. Main institutional & functional characteristics of banks in the Chinese market.

	PBs	SOCBs	JSCBs	RCCs
Institutional Characteristics
Main task	Policy lending	Commercial	Commercial	Commercial
Ownership	State	State	Mixed	Collective
Political Independence	Low	Low-medium	High	Medium
Budget Constraints	Soft	Medium	Hard	Hard
Functional Characteristics
Major loan recipients	SOEs, government agencies	SOEs, partially privatised joint-stock companies	SOEs, partially privatised joint-stock companies	TVEs and rural households
Loan size	0.5–10 billion CNY	4–7 millions CNY	n/a	1–2 thousand CNY
Main purpose	Capital construction	Industry	Industry	Agricultural sector
Maturity	Medium and long-term	Short- and medium-term	Short-term	Short-term
Market	Nationwide	Nationwide	Nationwide	Localised

Source: Andersson et al. (2016, p. 901).

In addition to his campaign to found thousands of banks, the key policy introduced by Deng was that the majority of banks lend in geographically restricted areas and are small, thus keen to lend to small firms (while large banks primarily wish to lend to large firms; see Mkhaiber and Werner, 2018). This results in job creation and high economic growth, as bank credit is largely allocated to the real economy (Werner, 2005, 2012). These newly established banks fuel the real economy in China with domestic currency lending to liberated private entrepreneurs and invigorated state-owned enterprises (Allen et al., 2005; McNally et al., 2017; Z. Chen et al., 2020). The public ownership element also allows the central bank to control the exchange rate and the capital account effectively (Wang et al., 2013; McNally et al., 2017).

While local credit officers are able to conduct due diligence on the ground by visiting many small firms, top-down credit guidance policies allocate loan growth quotas by industry (Werner, 2002, 2005; Fukumoto et al., 2010; Su, Xu, & Tong, 2023, Su, Xu, & Yang, 2023). Such ‘window guidance’ is utilised to ensure newly created credit is channelled to the real economy and priority sectors, under the watchful guard of the PBoC and the Banking Commission, with heavy penalties for missteps by rogue banks (Gang, 2018). This efficient but underutilised monetary policy tool of quantitative credit guidance settles a key concern of the Banking School – the channelling of the money supply to productive purposes (Arnon, 2011) – while conventional economic analysis favours Basel risk weights (Bezemer & Zhang, 2019), despite its obvious short-comings (Werner, 2016). Nonetheless, Table 2 below summarizes the applied Kreditrahmen (‘window guidance’) in the current Red Capitalist order:

Table 2. Window guidance framework in China.

Framework	Description
Setting window guidance targets	The PBoC determines a quota for lending growth in the banking system at the beginning of the year
Scope	Quotas assigned per industry type, counterparty size and loan growth. Banks urged to prioritise SME lending and employment creation.
Scoped Institutions	All state-owned banks and commercial banks.
Communication	Monthly meetings between PBoC local branchees and commercial banks to clarify written instructions.
Penalties	‘Rogue’ banks are disciplined through central bank intervention should balance sheet expansion exceed target quota.

Source: PBoC and Fukumoto et al. (2010).

As the central bank governor put it:

We work to support commercial banks in issuing loans to small and micro businesses (SMBs) and private enterprises by increasing the quota of central bank lending and central bank discount. (Gang, 2018)

The framework for the Chinese window guidance shadows the Japanese system prior to the 1990s (Werner, 2003). The efficaciousness of the Chinese window guidance system is bewildering to Western economists, though the underpinning principles of success are simple (Werner, 2002a, 2003; Naughton & Tsai, 2015; Tsai, 2015; Bell & Feng, 2019).Admittedly, different types of banks have diverging experiences with the implementation of green credit lending policies as recent research shows (Qi et al., 2021). Since window guidance is deployed by the central bank, via its local branches, it is meant to avoid potential conflicts of interest that provincial-level officials may be exposed to. Nevertheless, it may be true that efficiency of implementation may have been lower in China than in Japan, although the lack of transparency renders measurement difficult.

A recent empirical study on the positive effect of the decentralisation of credit allocation decisions via the expanding network of bank branches on the Chinese economy, and in particular small- and medium-sized enterprises, confirms our macro-level narration (Sun et al., 2023). The scholars employing a range of advanced statistical methods (e.g. flexible parametric survival analysis, the Cox model, the Kaplan-Meier survival function, and IV-Tobit) examine the survival horizon of more than 18.1 million Chinese SMEs from 2000 to 2010 to find that ‘[t]he survival hazard of SMEs decreases as the number of [bank] branches around them increases’ (Sun et al., 2023). In particular, they emphasise that ‘the survival of SMEs [increases] when the banks and firms are geographically close’. Economic geographers reported similar findings about the importance of the operational distance between ‘the banker and the banked’ for as diverse credit markets as that of Mozambique, Italy and USA (Beck et al., 2009; Mkhaiber & Werner, 2018; Ferri, Minetti, et al., 2019, Ferri, Murro et al., 2019).

Meanwhile, in Japan, under the auspices of US hegemonic influence, free market reforms have forced the central bank to abandon such unorthodox tools not sanctioned by Chicago – or Washington – economists. Thus, the credit guidance was scrapped in 1991 and the painful road to a low-performance economy relying on privatised and increasingly centralised capitalism has since been adopted (Werner, 2003, 2005).

The success of window guidance is yet another example of the infusion of neo-statist and neo-liberal policies under Sino-capitalism, allowing for the post-Communist economy to upgrade its production capabilities and success in the globalised and highly competitive marketplace (S. Zhu & He, 2018) and firm survival in homogenous local economies (Guo et al., 2018).

The concept of decentralised public banks fuelling local economic growth, contrary to potential interpretations in the preceding paragraphs, did not originate in East Asia, as one might infer. While Japan served to introduce it into East Asia, its roots go back to Continental Europe, particularly Germany (Werner, 2002b, 2003; Guinnane, 2011). The history of local public banks spans an extensive period and is marked by instances of both success and failure, with examples in countries like Italy, Ireland, and France (Guinnane, 1994; Richez-Battesti & Leseul, 2016; Costabile & Neal, 2018). But the most fortuitous institutional design of the implementation of public banks occurred in mid-19th century Germany through the establishment of Sparkassen (savings banks) and Genossenschaftsbanken (cooperative banks) (Guinnane, 1997, 2003; Werner, 2013, 2002b; von Mettenheim & Butzbach, 2014; Biasin, 2016). The institutional framework of these early development banks, acknowledged in microfinance literature (Schmidt et al., 2015), aimed to address socio-economic challenges faced by the developing German states at that time. The decentralised public banking system emerged as the linchpin of the German economic system, supporting the success of the Mittelstand, the many family-run small- and medium-sized enterprises. In the words of the sociologist and expert in social and class conflict, Lord Dahrendorf (OSV, 2000).

Germany has established financial institutions that are not only successful in themselves but also contribute to social cohesion. That is the great accomplishment of the savings banks [and cooperative banks]. The [public banks] are exemplary models of how to combine increasing economic well-being with freedom in solidarity.

It is precisely this type of publicly-spirited monetary institutions that have subsequently gained dominance in the post-War Japanese economy (Werner, 2003), and which were later copied by the Chinese once the economic reforms were started in her post-Communist regime, as discussed above (Fukumoto et al., 2010).

While capital allocation was duly recognised in China as a central tool to advance rapid economic development, in neoclassical economics such intervention would only harm the efficient allocation of money in the economy and thus is thought to hinder economic growth, since the benchmark for comparison is a theoretical and fictional economy that functions with perfect competition, complete markets, rational and infinitely-lived agents, perfect information and zero transaction costs (Dobson and Kashyap, 2006; Young, 2021). For instance, Chan (2021) recently expressed such concerns: she asserts that despite over 30 years of economic reform, China’s bank system still experiences significant state interference. This encompasses areas such as setting banking rates, selective credit allocation, IPO quotas, and majority ownership of large financial institutions. Such distortions, increasingly burdensome post-2008, suggest continued ‘financial repression’ in China, we are told. Dobson and Kashyap (2006) worry that ”government influences will continue to constrain bank reform, with all the performance weaknesses that such influence implies” (105).

The deep mistrust by neoclassical economics prophets of government involvement in the allocation of credit continues to persist ‘much more than in the credit allocation decisions made by commercial banks … despite the financial crisis of 2007–08 demonstrating the huge dangers of a deregulated credit market’ (Ryan-Collins, 2018). A liberalisation of the Chinese banking market, scholars advise, particularly freeing the entry of foreign entities to the ‘inefficient’ state-dominated sector, and moving the system towards a market-based economy with ‘direct financing’ (i.e. bonds, stock market, venture capital) at the expense of ‘indirect funding’ directly from the creators of the money supply, namely nimble local banks with fast decision-making, will trigger, were are made to believe, even faster economic growth in China than the world has witnessed in the past 40 years.

Moreover, a pivotal recent development in the Chinese monetary system, poised to fundamentally reshape the dynamics within the hierarchy of bank liabilities, is the introduction and rollout of the central bank digital currency (CBDC), commonly referred to as the digital yuan (Auer & Bohme, 2021; Kochergin, 2022). While the CBDC is widely promoted globally, including in the USA and Europe, as a groundbreaking development (Minesso et al., 2022), the reality contradicts this high-powered narrative, a common occurrence in the field of monetary economics. Essentially, the central bank is merely mirroring a practice already undertaken by the private banking sector for at least four decades – namely, the creation of book keeping or electronic money through lending as we discussed in the Currency vs Banking School section above (Werner, 1997, 2003, 2016). As central banks globally, including that of China, embark on developing CBDCs, they could end up engaging in direct competition with the private banking sector for customers. Admittedly, this new monetary policy tool – digital retail monies – at least for central banks, could be used to assist with the implementation of some fiscal policies – e.g. tax collection (e.g. local, national and federal) and tax payment (e.g. social benefits including but not limited to child benefits, unemployment and potentially universal basic income).

The relevance of this competition dynamic is somewhat diminished in the Chinese context, where the majority of banking services provided to economic agents in the local economy are primarily offered by government-owned banking entities (Allen et al., 2005). Furthermore, the Chinese CBDC was designed to offer a third option to digital app customers to the already dominant WePay and AliPay transactional payment systems offered by commercial companies – for all of which a bank account is necessary, therefore not directly encroaching onto the business turf of banks. With the introduction of the digital yuan, the Chinese central bank gains an additional lever to shape the local economy, complementing existing indirect mechanisms like the green credit lending policy (Su, Xu, & Tong, 2023; Su, Xu, & Yang, 2023). The digital yuan potentially serves as a further monetary policy instrument for the People’s Bank of China (PBC) to discipline non-compliant banks, particularly those diverging from established guidelines and offer an exit-strategy to the customers of the sanctioned commercial bank through the ‘programmability’ feature of the CBDCs. While such features are highly attractive to Western central planners, in China they are hardly needed and not the main motivation.

Whether this new development in the monetary system, and the underlying credit policy, in China will indeed lead to even more astounding growth is an open question. Nonetheless, our money-macro narrative centring upon the decentralised expansion (i.e. Banking School) of public banks with central bank (i.e. Currency School) window guidance steering lending to the real economy (both schools) shows that these bolster the unprecedented sustained economic growth in China. A ‘quantitative public bank easing’ with Chinese characteristics fuelled the rise of 850 million economic agents out of extreme poverty allowing the Red Dragon to lay claim to the top seat in the international order.

4. Conclusion

In this article, we identify the benefits and potential of the integration of the monetary reform proposals by two perennial schools of economic thought – the Currency School and the Banking School. By infusing the sovereign money supply as proposed by the Currency School and the decentralised banking system as advanced by the Banking School, the Chinese monetary reformers managed to create a highly successful post-Communist economy. This is a kind of Taoist yin-yang balance of the domestic monetary order.

The credit market is an example of the infusion of neo-statist and neo-liberal policies: state and private entrepreneurship supported through window-guided public credit for productive entrepreneurship (Werner, 1997, 2003, 2005, 2014a, 2014b; Gang, 2018; McNally, 2019, 2020). This credit-fueled rapid growth economy is increasingly sophisticated and allows a continued rise in living standards. As a result of the mutually re-enforcing domestic markets and industrial complex, the East Asian polity could ascend the international money hierarchy (Eichengreen, 1987; Bell, 1998; Kelton, 2020).

Likewise, our analysis implies that the evolution of the bank population, for example in Europe and the United States, may explain the corresponding rank in the international order (Keynes, 1936): In the US, a substantial and continued decline in the number of locally-headquartered credit firms is evident. Their retraction from business operations in geographically-restricted areas following the Reaganite Big Bank Reforms that weakened the native industrial complex, ironically at the expense of FDI outflows to China, opened up a vacuum at the tip of the geo-economic order. Meanwhile, under the auspices of the ECB, Europe has lost more than 5,000 mainly small banks in the past two decades. This was not by accident: The head of the ECB had declared it an official goal to reduce the number of banks,⁴ while political leadership has insisted on meeting ‘degrowth’ targets. This is consistent: In order to reduce economic growth, it is helpful to reduce the number of banks.

Naturally, our macro-money narrative can be augmented by scrutinising the evolution of the balance sheet structure of the two geo-economic powers, China and the USA, whereby disaggregating lending to the real economy and lending for asset transactions will quantify the effectiveness of bank credit policy, in line with the disaggregated quantity theory of credit (Werner, 1997, 2003, 2012, 2005; Gang, 2018). We suggest further research to empirically test our theses. Moreover, future research can also tackle some of the issues we had to leave by the side. This includes the issue whether the Chinese form of post-communist capitalism should be considered a distinct ‘variety of capitalism’, and whether in a Chinese sense or in the sense of the literature on the varieties of capitalism (Hall & Soskice, 2001).

Acknowledgments

While the authors acknowledge the source of all wisdom (Jer 33:3), all errors are theirs.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. The topic of the role of shadow banks is beyond the scope of this paper, except that it can be stated that we consider the literature on this topic to overstate the importance of such institutions: Technically, there is no such thing as a ‘shadow bank’ – a financial institution is either a bank, with a banking licence to take deposits and the power to create credit, in which case it will have a significant impact on the economy and financial markets (and in which case we are covering it in our analysis), or it is a non-bank, without a banking licence, in which case it is merely a financial intermediary without such special powers and impact (Werner, 2005; Jakab & Kumhof, 2019).

2. A more detailed analysis of the precise percentage of public ownership of banks, including by bank category, is a research project for the future. However, we feel this is not a priority issue in the case of China, due to the known majority ownership of bank assets in public hands, and secondly, because differences in ownership and hence management are likely to be less important than in other countries, because in China, largely unique in the world, all companies, whether state-owned, local government-owned, privately owned or co-operative, must have a designated supervisor from the Chinese Communist Party (CCP) on the management board, and such person is considered de facto highly influential, certainly when it comes to strategic decisions – reducing the degree of heterogeneity of business management in this respect, irrespective of the ownership structure.

3. See Z. Chen et al. (2020). Foreign capitalisation of Chinese public credit institutions is increasing, but remains small by comparison (Töpfer, 2017).

4. ‘’Europe has too many banks’, Mario Draghi has said.’ Financial Times, 22 September 2016. ‘Europe is overbanked compared with the United States, and a certain degree of consolidation is needed, says Supervisory Board member Elizabeth McCaul in an interview with www.capital.gr’ on 28 December 2023, accessed on 8 January 2024 at https://www.capital.gr/sunenteuxi/3758151/elizabeth-mccaul-ekt-sto-capital-gr-diatirisimi-i-isxuri-kerdoforia-stis-trapezes-entos-tou-2024-i-apofasi-gia-ta-merismata/. On the EU Commission’s advanced plans to reduce economic growth, see, for instance, Ryder (2023) and the coverage on EU funding for a major ‘degrowth’ research project: Horizon Staff (2023). Once unthinkable, the prospect of society driven by wellbeing gains traction. Horizon, The EU Research & Innovation Magazine. 11 May 2023 Accessed on 8 January 2024 at https://projects.research-and-innovation.ec.europa.eu/en/horizon-magazine/once-unthinkable-prospect-society-driven-wellbeing-gains-traction