Introduction. Interaction between China and the West’s financial system will greatly affect global financial system regulation. The symbiotic relationship between the financial and the non-financial (‘real’) economy is at the heart of political economy. Regulating the financial system in order to serve the common interest is a crucial task of public policy. How this can be best accomplished is a profound and unresolved issue. A key question is the extent to which financial institutions control or are controlled by public policy. During the Asian Financial Crisis (AFC) few people could imagine the transformation that would take place in the financial systems both in China and the West. The different philosophical background in relation to money and finance strongly influenced the path taken in the West and China.

The West. In the West there has been fundamental opposition between those who regard the pursuit of ‘money to make money’ as immoral and sinful, and those who regard the unfettered pursuit of money as the foundation of a successful economy and a free society. In fact, for most of the West’s history there has been minimal restraint on the financial sector.

In the seventeenth century ‘regulatory capture’ of government by the financial sector began its long journey. In the USA by the late nineteenth century a small group of banks were hugely influential in government policy-making. They attained their peak influence in the 1920s, unleashing rampant financial speculation that culminated in the Great Depression.

From 1945 until the 1970s increased regulation and supervision meant that banking became almost a regulated utility, with moderate profits, little risk and low competition. The financial and the ‘real’ economy were more or less in balance. This was the most stable period in Western financial history, with more rapid growth of GDP than before or since. Throughout this period there was sustained ideological attack on tight financial regulation.

After the 1970s growing industrial concentration in the real economy stimulated parallel development in the financial sector, which strengthened the sector’s ‘voice’. The ‘revolving door’ between government and finance, alongside other channels of influence, notably academic economists, facilitated ‘regulatory capture’ of policy-makers and regulators by powerful financial firms. A sequence of policies freed financial firms from the existing constraints, providing them with rich profit-making opportunities. Both before and since the global financial crisis (GFC), monetary policy has focussed upon consumer price inflation. Asset price inflation, including house prices, is outside the responsibility of central banks. Nominally ‘independent’ central banks regularly made marginal adjustments to the policy rate of interest in response to changes in consumer prices while the ‘fire’ of asset price inflation raged around them in de-regulated financial markets. The relentless increase in debt and asset prices relative to the ‘real’ economy produced a revolutionary advance of ‘capital markets’. Investment in the real economy, including infrastructure, languished alongside the boom in capital markets and financial ‘investment’. A thick web of financial interests pressured governments and regulators to sustain asset price inflation. A significant part of the population was happy in the ‘wealth illusion’ and the associated increase in borrowing capacity, happy to vote for governments that dared not ‘take away the punchbowl’ of asset price and debt increase.

The relationship of finance and the real economy changed dramatically. The symbiotic inter-play between increases in asset prices and debt was the core mechanism responsible for the GFC. This mechanism has not altered subsequently. The most significant ‘secular trend’ since the 1980s has been the relentless rise of asset prices and debt alongside the relentless fall in real interest rates. In the 1960s and 1970s the total global stock of debt was roughly 130% of global GDP. By 1997 it had reached 235%, rising to 280% in 2008 and by 2018 it stood at 318%. The policies to resolve the financial crisis intentionally ‘re-ignited asset prices’. The relationship between finance and the real economy is even more unbalanced than before 2008. The West’s financial system overlooks an abyss. A ‘snap back’ in asset prices and interest rates would undermine financial, economic and social stability, with the potential to overflow into international relations, most significantly in the West’s engagement with China.

China. Since the Zhou Dynasty China’s approach to ‘making money from money’ has almost always been pragmatic and non-ideological. The bureaucracy has viewed profit- and money-making as a positive force to be nurtured and respected. Apart from the era between 1956-76 the government has not attacked commerce and finance. However, the idea that commerce and finance should control government policy and practice is anathema in China’s political tradition. The only point at which this was the case was during KMT rule (1927-36) when finance and government were deeply intertwined and served the interests of a small group of powerful families (Jiang-Song-Kong-Chen). In Chinese political theory and practice the meritocratic bureaucracy should be independent of control by commerce and finance, which should be regulated in the common interest. The bureaucracy has shaped the country’s ideology and value system. The most highly respected social position is that of the educated scholar official, the ‘gentleman’(junzi), who earns his place in the bureaucracy on merit. The highest moral duty of the gentleman is to serve the interests of the mass of the population not the interests of finance.

Since 1978 China has sought to find a Middle Way (zhong yong) in financial reform, encouraging commerce and money-making whilst experimenting with regulation of finance to serve the welfare of the whole society. The space to ‘make money from money’ has greatly increased. Some of the world’s richest people in the world are Chinese. However, the ideology and regulatory structure is ultimately controlled by the bureaucracy, which has become steadily more professionally capable in its management of the financial system. The CPC is at the core of the reform. Restructuring, modernisation and flotation of the country’s main financial firms has been pursued alongside a continued role for state ownership and control through the CPC. Regulation includes the CPC’s selection and evaluation of financial sector leaders and the leading role of the Party Committee contained in the articles of association of financial firms. Both the PBOC and CBIRC are under CPC control.

Since the GFC China has achieved an‘infrastructure revolution’, including electricity, telecoms, water, sewage, roads, high-speed rail, ports, air transport, health and education. The revolution was financed mainly through support from the state-owned banking system. Infrastructure construction and its material components (cement, steel, aluminium, chemicals and machinery) were supplied mainly by state-owned enterprises under the State-owned Assets Supervision and Administration Commission (SASAC). The ‘infrastructure revolution’ contributed directly to mass welfare. It was crucial to business prosperity in the vast indigenous non-state sector as well as for global firms operating in China.

China’s financial firms have radically improved corporate governance, information technology, risk control and human capabilities. China has five of the world’s top ten banks ranked by market capitalisation. The performance of China’s biggest banks is at least equal to their international peers and they occupy an entrenched position within the Chinese market. It seems that they can be confident of withstanding competition from the leading international firms on the ‘global level playing field’.

Two different systems. China remains substantially isolated from global capital markets. In 2018/9 it announced measures to open up its capital markets. Despite the GFC, Western financial firms, led by those from the USA, dominate global financial markets. They account for the top 50 asset management firms, the top 20 investment banks, the top 10 firms in foreign exchange dealing, wealth management, trade finance and infrastructure finance, and the top four asset custodians. Western firms also dominate the ancillary activities that are essential to capital markets, including legal services, audit, consultancy, data provision, and ratings agencies. The core information technologies in China’s financial sector are purchased from leading Western (mainly American) suppliers.

In many respects the operational mechanism of China’s financial firms is different from global firms. SOEs are still the principal customers for the five big banks. Non-interest income is still a relatively small share of their revenues. Their international operations are relatively small. The proportion of non-Chinese employees is small. Senior executives are paid relatively low salaries. The role of the CPC is enshrined in the banks’ articles of association. These differences mean that the struggle between Chinese and foreign firms on the ‘level playing field’ of global capital markets will be long and complicated.

The way in which these two different systems interact is critical for the world’s financial system. The philosophical foundation of China’s financial system is different from that of the West. As China’s capital markets open up, the global firms can make a valuable contribution to modernising the country’s financial system. However, they must accept that regulation of the country’s financial system is under the leadership of the CPC in order to serve the interests of the mass of the Chinese population. They cannot expect to exercise ‘regulatory capture’ over the governance of the Chinese financial system. The international institutions that influence the way in which money is governed are still controlled by the high-income countries. The voice of China and other developing countries in these institutions is almost certain to increase. The eventual shape of global governance of ‘money’ is unclear, but is likely to look very different from today.

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