On Friday Chinese stock markets capped one of the best weeks in an awfully long time, with the SSE Composite closing at 1986, up 3.1% for the day and 13.7% for the week. Although a lot of local analysts have been saying that the rally is long overdue and represents confirmation that we have bottomed out economically, I think the rally was caused almost exclusively by the resurgence of rumors about the creation of a major stock market stabilization fund by the government.
The fact is the news coming out of China and the rest of the world continues to be bad and suggests, if anything, that we haven’t seen the worst yet. October retail sales in the US, which were projected to fall by an ugly 2.1%, actually declined by an even uglier 2.8%, which is being reported as the worst number since the data series began, in 1992. Consumer spending in the US, it seems, is slowing much faster than expected.
Remember, as I argued in my November 9 entry, that if US household savings revert to the average level of the last fifty years, this would represent a decline in global consumption equal to 5% of US GDP, or 17% of Chinese GDP, even making the very unrealistic assumption that global income remained steady (in fact the reduction in US consumption would probably be greater). I suggested then that my proposed 5% was likely to be conservative, and so far it seems like it might be. American household savings seems to be rising quickly – certainly as a share of income, although perhaps not so quickly in nominal terms since declining consumption is also likely to mean declining income.
Bad enough as news on the external front is for China – a country with excess savings is not going to welcome a significant rise in US household savings – news on the domestic front isn’t any better. The decline in US consumption was supposed to be mitigated by a fiscally-derived boost in Chinese consumption, but economists are increasingly skeptical about the ultimate demand effect of the RMB 4 trillion fiscal package announced last Sunday. It seems that only about one-quarter of this represents real new fiscal expenditures. The rest is supposed to come from banks, companies, and municipal government spending, even though it seems pretty certain that one of the municipalities’ major sources of revenues, land sales (which account for over 30% of municipal revenues) is likely to decline sharply. The great fiscal package seems to have been more smoke than fire.
As a demonstration of how difficult municipal land sales might be, Friday’s South China Morning Post had an article with the following example of how policy-makers continue to hope that the miracle of leverage will boost demand:
The Shenzhen municipal government will allow the winning bidder at a land auction to be held later this month to pay for the development site in three installments in an attempt to lure cash-strapped developers back to its auction hall.
The extended repayment period will allow the winning developer to complete the land purchase payment in about six months compared with the current requirement of five days. Analysts said the move was aimed at easing the financing problems confronting developers and has followed the withdrawal from auction of a number of government sites this year because of the absence of bidders. Only eight of the 28 government sites offered for sale in the first eight months of the year were sold as lenders imposed tighter credit terms on developers.
Meanwhile, and not coincidently, bank regulators are warning that non-performing loans are rising, although they have been less than clear on the extent of the problem. An article in today’s Bloomberg reports the following:
Chinese banks face rising bad loans and narrowing profit margins as the central bank cuts interest rates to boost expansion in the world’s fourth-largest economy, the banking regulator said. Lenders may suffer further losses on their overseas assets as the global financial crisis remains “far from over,” China Banking Regulatory Commission Vice Chairman Jiang Dingzhi told a financial forum in Beijing today.
…“Bad loans are already showing an upward trend, especially in the property market where the mortgage default risk is growing at an accelerating pace,” Jiang said, without elaborating. “We can’t take this light-heartedly.”
The reference to losses on overseas assets is a little funny (and perhaps characteristic) since the real problem is likely to be domestic assets, especially since regulators have assured us several times that exposure to foreign assets is so low among Chinese banks that even a catastrophic collapse in foreign asset prices wouldn’t hurt the banks directly. The article goes on to say:
China’s banking system remains “in good health” with all major indicators at their best levels ever, Jiang said. Banks’ total assets, 59.3 trillion yuan at the end of September, were five times the level of 10 years ago when the Asian financial crisis happened, he added.
Call me a pessimist, but if NPLs are rising I wouldn’t consider a good thing the fact that total assets are five times as high today as they were during the last crisis. China’s GDP has grown roughly 2.5 times since then, suggesting that every percentage point increase in NPLs is twice as costly in terms of a government bailout today than it was ten years ago. In this environment smaller balance sheets are better.
To turn to something a little weightier and more abstract, I have been re-reading Keynes and the history of the Great Depression – most particularly about the global balance of payments in the 1920s and 1930s – to get a better understanding of the current mess. I am not trying to suggest that we are likely to repeat the 1930s, but it certainly seems that the imbalances that led up to the current crisis were in many ways similar to the imbalances of the 1920s – with a few countries, dominated by one very large one, running massive current account surpluses and accumulating, in the process, rapidly growing central bank reserves. In both cases the main current account surplus countries financed the current account deficit countries with capital exports (this is just a truism – surplus countries always export capital to deficit countries except to the extent deficit countries can draw down reserves).
In the 1920s excess and rising capacity in the US could be exported, mostly to Europe, while massive foreign bond issues floated by foreign countries in New York permitted countries to run large deficits, but as the US continued investing in and increasing capacity without increasing domestic demand quickly enough, it was inevitable that something eventually had to adjust. The financial crisis of 1929-31 was part of that adjustment process, and it was not just the stock market that fell – bond markets collapsed and bonds issued by foreign borrowers were among those that fell the most. This, of course, made it impossible for all but the most credit-worthy foreigners to continue raising money, and by effectively cutting off funding for the current account deficit countries, it eliminated their ability to absorb excess US capacity.
The drop in foreign demand forced the US either massively to increase domestic demand or massively to cut back domestic production. The fact that another consequence of the financial crisis was a collapse of parts of the domestic banking system, leading to banking panics and cash hoarding, meant, as it often does in a global crisis, that the US had to adjust to a drop in demand both domestically and from abroad. But instead of expanding aggressively, as Keynes demanded, FDR expanded cautiously, and in 1937 even decided to put the fiscal house back in order by cutting fiscal spending, thereby stopping the recovery dead in its tracks.
Keynes argued at the time that the villain of the story was excess savings since industrial overcapacity required that we save less and consume more. He also argued, if I understand him correctly, that high savings reduced the multiplier effect of investment on the economy. In that sense it is a mistake to see high savings as something that leads to high investment. As long as some part of income is saved, any increase in investment generates its own savings (this may seem counterintuitive but it is the standard multiplier effect in which investment causes a boost in income, part of which is saved and the rest consumed, which causes a secondary boost in income, part of which is saved, and so on). The higher the savings rate the smaller the multiplier.
I can’t help thinking that there is an important lesson in here for us. In the 1930s it was noteworthy that the current account surplus countries like the US and the net exporters in Latin America suffered more deeply from the crisis than did current account deficit countries, especially, it seems, once barriers to trade were imposed. The extreme case of the latter was Germany. As I understand it Germany imposed trade restrictions early, in which German imports were largely paid for in export credits, so that Germany more or less ran a balanced trade account after many years of large deficits. It was the first country to emerge from the Great Depression – in fact I don’t really think there was a depression in Germany to speak of – in part, I think, because its low savings and high trade barriers permitted the investment multiplier to work very effectively.
The US, on the other hand suffered a deep crisis in the 1930s, and its imposition of trade tariffs made things worse, not just because impediments to trade are costly to the global economy, but rather because it eliminated the ability of the US to absorb expanding demand from other countries and to force other countries to absorb excess US production. Once international trade is eliminated, in other words, US excess production over consumption had to be resolved wholly within the US, and that meant that either the US engineered a substantial increase in domestic demand by fiscal means, as Keynes demanded, or that it adjust via a collapse in production. It did the latter.
I am worried about some of the conclusions I might be drawing. The first conclusion, I think, is pretty clear and I have already discussed it. Demand has to expand and it isn’t like to be households or businesses that do the job. The burden must fall on governments to expand fiscally.
On that point I think most people agree with me generally, but are less convinced than I am that the main role in resolving the global demand problem must fall on the current-account-surplus countries, whose high savings rate must decline. They have produced more than the world is currently able to consume, and if they do not boost demand significantly, they will be forced to cut supply significantly.
Not everyone agrees that this means that China and other Asian countries, more than Europe and the US, must adjust. Paul Krugman recently argued in the New York Times, for example, that the US government and the Obama administration must act dramatically to expand demand. But I worry that the global problem has never been a lack of US demand – it has been lack of Asian demand. The US has already provided a greater share of global demand than is healthy for either the US or, as we have clearly seen, for the world.
A massive fiscal expansion by the US would certainly boost global demand, but it would do so at the expense of increasing US indebtedness by far more than it increases demand for US goods (much of the expansion in demand would simply be exported to countries that continue to suffer from overcapacity) and of course it would not solve the global overcapacity problem. It might even exacerbate it. The best that one could hope for, if the US took the lead in fiscal expansion, is that Asian countries make heroic efforts to shift their economies as quickly as possible from export dependence to domestic demand dependence, but I have already argued that with the best will in the world this will be a long and difficult process, and I am not sure anyway that most countries have the political will to force the shift. China, for example, is raising export rebates and talking about depreciating the currency – hardly the actions of a country working hard to reduce global overcapacity.
The second conclusion is more worrying – a least to a liberal internationalist like me. It suggests that although a collapse in world trade might be bad for the global economy overall, the pain will not be evenly distributed, and some countries might even benefit, and in that case they may actually move to restrict global trade. Current account deficit countries will suffer much less from anti-trade policies, in other words, and may even benefit because it gives their domestic fiscal policies greater traction. This may encourage them to attack trade if the global economy gets much worse.
As things currently stand, for example, fiscal expansion in the US has a much lower multiplier because in an open economy it is not US savings that matter but rather global savings, and global savings rates are much higher than domestic savings rates. In addition, a boost in US demand is exported through the current account deficit to other countries. Will the US continue to accept these limitations off trade if the US is forced to bear the brunt of the effort to increase global demand, or will at some point protectionist legislation become irresistible?
I think this is sort of what happened in the 1930s. The US refused to bear the brunt of the adjustment which, as the leading creator of global overcapacity it should have. Countries like Germany that opted out of the system seemed to bear little of the pain. When the US government enacted Smoot-Hawley, as a way of forcing even more of the US adjustment onto the rest of the world, it made it very easy for the rest of the world to opt out of the trading system, thereby forcing the full adjustment onto the US. In fact the US ended up bearing more than its full share of the adjustment because the decline in international trade actually made things worse for everybody.
The collapse in global trade forced most of the economic adjustment onto countries, like the US, whose excess savings and rapidly rising capacity created the global overcapacity problem in the first place. The Great Depression was brutal for the US and for some Latin American countries, but not nearly as bad for continental Europe and I think barely noticed in corporatist Germany and Italy. What if current account deficit countries conclude today, like they seem to have done in the 1930s, that by restricting trade they can force most of the global adjustment onto the current account surplus countries? That would be devastating for Asian exporters and especially China.
My conclusion? I am still trying to get my arms around all of this but I guess it is not terribly optimistic. I would argue that it might not help the world much – except in the very short term – for excess-consumption countries to boost consumption significantly via large fiscal programs. It was their excess consumption that created one side of the problem in the first place, and not only will the required fiscal boost need to be substantial (since much of it will be mitigated by the high savings rates of other countries), but it won’t be sustainable. Debt will rise, and overcapacity will still plague the system.
The real fiscal boost has to come from current-account surplus countries. It is their excess savings that created the other side of the problem, and it is as important for them to boost consumption as it is for the others to boost savings if we are going to return to a healthy global balance of payments. It is far more rational, in other words, not to mention sustainable, for countries with excess savings to boost consumption than for countries with excess consumption to do so. If the latter, it will only store up more problems for later.
What is worse, if the excess-savings countries do not boost domestic demand aggressively, the political and even economic argument for a rise in trade protectionism could become irresistible.
Nice writing. You are on my RSS reader now so I can read more from you down the road.
Allen Taylor
Nice site. There?s some good information on here. I?ll be checking back regularly.
The part re: NPLs was what I was wondering too, lax credit today is cause for recrimination and regret tomorrow.
can protectionism resolve anything?
tit for tat rarely benefits anyone.
Very interesting. I suppose the main difference between now and the 1930s was that then it was the surplus country (US) that imposed protection, whereas now it is the deficit countries. Presumably you don’t see China imposing protection.
Could you expand your analysis on 2 issues: 1. What is the thinking of the Chinese leadership? Why are they not expanding demand more than they are? What should we expect from them in the future? My sense is that their vision is quite parochial, and they may not understand the global implications of their policies – or is that mistaken?
2. Western elites seem to have learnt lessons from the 1930s, and are reluctant to impose protection. Do you really see circumstances overriding that?
This post and the previous Smoot-Hawley post are incredible in their simplicity and insight. Between the two of them you construct a very straight forward line of thought that unfortunately seems far too politically expedient (for both sides of the pacific) and thus has more inevitability about it than I’d like..
Glad you’ve got a new domain, seems good – and keep up the commentary. I think you’re reading the macro pieces of the current problem better than anyone in the blogosphere. China matters – although I agree it seems like it may well be bound to repeat mistakes of the west from the past.
–Q
what happened to your guestbook?!
It has also struck me how lightly people speak about shifting the Chinese economy towards domestic demand, as though this were something that could be accomplished in a timescale relevant to the current crisis, and in the face of plenty of signals from the international economy which would typically encourage Chinese people to save rather than spend.
Having said that, until recently I was living in Nanjing, where confidence still seemed to be very high, even in the face of US developments. I’m not sure how to pin down the reason; maybe it’s trite to say so, but the Olympics and space-walk etc. seem to have crystallised a sense of irresistible national progress, even invulnerability.
Quick and responsible government reactions to the housing slump, etc. have reinforced this impression (perhaps by contrast with the Fed).
I’d be interested to know if this confidence still prevails, and if so, perhaps that is partly reflected in the surprising October retail sales growth.
Is there somewhere online with a more detailed breakdown of the Chinese stimulus package?
Hello Michael,
New commentator but long-time reader – much appreciate all your insights on the Chinese system. I’m neither an economist nor an expert in EM crises, so please take all I have to say with a pinch of salt, but I have a couple of thoughts on this piece.
1) I think many European countries actually suffered more in the great depression than the US, Germany among them. The Kreditanstalt collapse in Austria sparked a bank panic in the region, Brüning’s decision to slash government spending sent the economy into a tailspin and the cessation of US-provided loans to Germany to pay off its war reparations to Europe (which then used that money to pay their debts to US) made things even worse. Off the top of my head, GDP fell by around 40%, discrediting the Weimar Republic government (which was on its last legs by then) and bringing the Nazis to power.
2) In 1929, the US probably had little scope to increase domestic demand – PCE was around 70% of GDP (again, from memory) and consumers had run up debt levels significantly in the 20s. China doesn’t have those problems on a broad basis – although debt levels and exposure to the collapse in the stockmarket and house prices is probably significant in Shanghai etc (I have no data on this, only anecdotes, but I can’t see that it can be otherwise). Stimulating domestic consumption will be difficult though – no argument about that.
3) As you acknowledge, there are as many differences between the world today and the one leading up to the great depression as there are similarities. Then, we had just emerged from a devastating war in Europe, had had hyperinflation in Germany, the Dust Bowl struck in the US and Canada, banks were collapsing in thousands with no depositor protection and no social security network, plus the idea that we could suffer a fall in aggregate demand and need government stimulus to refloat the economy was far from accepted (hence the number of governments that tightened fiscal policy heading into the depression – I hope that mistake won’t be made again).
I’m not totally reassured … there are so many ways that things can go wrong and a situation like this so complex that anyone who believes he knows what will happen is a fool. But having been through the great depression and with the experience of Japan’s recession as well, policymakers know very well the need for fiscal stimulus and appreciate the importance of global co-operation. We are clearly going to have a wrenching adjustment in any case though.
D Murfet, there is a reason why a lot of Chinese are so optimistic, if you believe articles like this from bussinessweek.com:
“Over the next 17 years, 350 million rural residents (more than the entire U.S. population today) will leave the farm and move to China’s cities. That will bring the Chinese urban population from just under 600 million today to close to 1 billion… by 2025 China will probably have at least 221 cities with a population over 1 million, estimates Woetzel. That compares with 35 cities of that scale across all of Europe today. These new urbanites are expected to be a powerful booster of growth: Urban consumption as a share of gross domestic product will most likely rise from 25% today to roughly 33% by 2025…Meeting the infrastructure needs of the newly expanded cities will be both a challenge and an opportunity. More than 5 billion square meters of road will need to be added and as many as 170 mass-transit systems built, providing potential lucrative business opportunities for the likes of Siemens (SI), General Electric (GE), and Caterpillar (CAT). More than 40 billion square meters of floor space will be built in 5 million buildings—with up to 50,000 skyscrapers above 30 stories among them.”
You may argue the urban planners and construction equipment makers tended to exaggerate the numbers. But it at least give you some ideas about things to come, which also explains why China are still spending so much on infrastructure.
michael,
just some thoughts.
1) US has to sell some $2T treasury bonds next year. If it imposes trade restrictions, China wouldn’t be so willing to buy as much treasury bonds as it used to. Which would be quite disastrous for everybody but especially US. No?
2) I assume that Germany’s deficit was mainly from war effort. After war, that demand was gone. US’s deficit is from over-consumption. Now it is dropping but I don’t think the adjustment in consumption is in as big scale to Germany and thus fixing the deficit would be tough. Especially with high US$.
Michael,
off topic, but can you please help me with one qeustion?
If US gov has to pay higher interest to sell treasury bonds (it has $2T to sell in ’09), what happens to Fed rate?
Treasury became a big source of Fed’s balance sheet. I don’t know if Fed pays interest to Treasury, but the relationship (Treasury borrows and then lends to Fed) seems to imply that Fed rate has to increase.
If Fed doesn’t want to increase its rate (as economy is still in bad shape), isn’t the only thing Fed can do is printing more money?
Thanks.
Keynesian analysis? Oh, dear. What about Friedman’s Nobel Prize and his analysis that monetary policy, not fiscal policy, led to the crash of the Great Depression?
Also, one of the greatest hyper-inflations in history was Germany’s in the early 20C, reaching one trillion percent. The only ‘cure’ for such massive inflation is deflationary monetary policy (rising interest rates), leading to massive unemployment. Isn’t that just about the entire point of neo-classical economics, especially since Volker’s success?
Congrats on the new site and thank you for this really nice piece of writing.
So in your opinion, what specifically are these surplus countries supposed to do to boost their demand? Hopefully not fixed asset investment again, but there is not much more they can do especially in the case of China. So I guess we will see China starting to build highways and dams and bridges again soon. Well, this may work in the short term because infrastructure in China is still underdeveloped, and this might work in the mid term because China is so huge that it can always find places to build roads. But it is not sustainable in the long run because you can’t just build roads and bridges forever. Is there any prior case that a current account surplus government has successfully boosted its demand by fiscal expansion? I guess Japan tried that in the 80s but ended up in ‘the lost 2 decades’…
Judy, it may well be true that trade protection is bad for everybody, but policymakers will do what they think is in their best interests, and it is easy to make plausible arguments that in some cases protection can help a country even when it is bad for the world. At any rate experience suggests that we have an amazing capacity for blaming our problems on foreigners, even when foreigners are clearly not the problem, so the appeal of protection is sometimes hard to resist.
David, actually I would disagree with both statements, that in the 1930s it was the surplus country (US) that imposed protection, whereas now it is the deficit countries. In the 1930s deficit countries did indeed impose protection, but the foolishness of the US in passing Smoot-Hawley made it easy for everyone to do so, so it may have set off a real race to protect. Today surplus countries are still doing it. In my book export rebates and currency depreciation are all ways of forcing export capacity onto deficit countries, and many Asian countries, including China, are doing just that.
Cris, I agree with your history but interpret it as supporting my argument. Kreditanstalt collapsed in 1930 and was one of the defining moments of the German crisis, but the Nazis did not come into power until 1932, and they were the ones who imposed the export credit system. In fact the Weimar Republic had in many ways a model liberal economy, which was part of the reason liberalism was so discredited in the 1930s. It may be unfair to compare Germany with the US because it was just recovering from its own economic collapse, but one of the reasons for Hitler’s popularity was that he was seen as restoring the German economy, and many otherwise smart analysts saw Nazism as a smart and even admirable economic solution to the Great Depression.
RBG, Brad Setser has addressed this point often enough, and much better than me, so it probably makes sense to check him on this for a more detailed argument, but basically if the Chinese current account surplus disappears, so will the US trade deficit, and there will be no need for foreigners to finance it. Foreign financing is only required to the extent that a country is running a current account deficit or it wants to build reserves. The US Treasury will have no problem financing its borrowing needs, from domestic sources, especially in a slowdown.
As for your second point, Germany’s deficit resulted from the fact that war reparations included the sequestering of much of Germany’s industrial capacity. It absolutely killed Keynes that Europeans demanded reparations from Germany while at the same time insisting on eliminating its ability to run a trade surplus – the only way to afford capital exports. But to be technical, over consumption in this context simply means consuming more than you produce, and to that extent the balance of payments effect is similar. Of course I certainly don’t want to paper over differences and argue that 2008 is exactly like 1930, I only argue that balance of payments must balance.
Duoist, I think I agree with Friedman/Schwarz that US monetary policy was a major culprit, but I don’t think demand management here was irrelevant. At any rate whether the fault was monetary or fiscal, the point I want to make is that current account surplus countries cannot continue exporting excess capacity when foreign demand has collapsed, and somehow or the other they are going to have the engineer an adjustment.
Megatone, I am not smart enough to figure out the optimal way for surplus countries to boost consumption. I leave that to better economists than me. I am just happy if I can get some glimmer of understanding of the balance of payments constraints.
“Paul Krugman recently argued in the New York Times, for example, that the US government and the Obama administration must act dramatically to expand demand. But I worry that the global problem has never been a lack of US demand – it has been lack of Asian demand. The US has already provided a greater share of global demand than is healthy for either the US or, as we have clearly seen, for the world.”
Terrific article. I have a question about the above thought.
My sense of the stimulus Krugman is advocating is a long overdue investment in infrastructure, education, retraining and the like. Much of it would be focused on employing Americans in projects which are long term investments in the USA economy. This country has become shabby and degraded, not only in politics but in infrastructure and basic measures of social well being.
There is no other way for the US to invest in itself than to spend the money. What do you advocate, to meet these needs?
[...] worry Europe – and Germany. If Eastern Europe cannot borrow, Germany (and others) cannot export (Pettis’ argument about China also applies to surplus countries inside [...]
Michael:
I like the new look. Also enjoyed this post.
China (and other countries) really do have the US in a choke-hold with their competitive pegs. The US suffers from persistent wealth outflows and a hollowed out production base.
In a way, BW2 is kind of an optimal solution. With a few glaring exceptions, trade and financial deficits are allocated to those countries most able to finance them – US, UK, etc. And trade and financial surpluses are allocated to those countries most committed to pursuing them (via FX policy, etc) as well as those countries exogenously blessed with surpluses (OPEC, etc).
We can’t expect the situation to change by itself – countries running surpluses are winning even if they run the risk of losing money on their reserves, etc. Japan (via carry trade sourcing) and Russia (via export revenue funds) even show that it is possible to enjoy surpluses without compounding monetary problems at home. Ultimately, the debtors may be forced to default or otherwise actively oppose their deficits, or be driven into poverty.
In such circumstances, it may be that the best defense for the debtors is a reduction of international trade flows. In their wonderful book, Power & Plenty, Findlay & O’Rourke make the point that those countries which embraced autarky in the thirties were exactly those countries which were running persistent deficits in the twenties. If you are persistently losing, sometimes it’s best to stop playing.
Interesting stuff.
Reply from Sester on my questions. I thought I’d better share.
it is very possible to finance a large fiscal deficit domestically. Japan does it. So does Germany. Both have fiscal deficits and current account surpluses. It does tho require that a country’s private sector save more than it invests. And while the US isn’t known for its savings, i do expect savings to rise and investment to fall, effectively freeing up financing for the us government.
as for the impact of higher interest rates, tis true that if the treasury had to pay more on its short-term borrowing, it would increase the fed’s funding costs – and might require that the fed charge more.
on the other hand the fed is taking on more risk and likely making more (so long as it gets paid back), as it has replaced long-term treasury bonds with higher-yielding (one assumes) assets on its balance sheet. moreover, the fed intrinsically makes money as many of its liabilities (cash) do not pay any interest. so in effect the fed could cross subsidize the portion of its lending financed by short-term treasury sales with the profits on the portion of its lending that is financed by issuing cash.
bottom line — the real risk from higher interest rates comes elsewhere. it would increase the treasury’s borrowing cost — making it harder to finance a large fiscal deficit. and higher treasury rates mean higher mortgage rates and that won’t help housing recover.
Pettis: The reference to losses on overseas assets is a little funny (and perhaps characteristic) since the real problem is likely to be domestic assets, especially since regulators have assured us several times that exposure to foreign assets is so low among Chinese banks that even a catastrophic collapse in foreign asset prices wouldn’t hurt the banks directly.
Domestic assets are a known problem. The reference to foreign asset losses is likely to be a reference to things like bad currency bets. I do think that the big banks are likely to have minimial direct exposure to foreign asset declines, but I wouldn’t be surprised at all if we found that a major non-bank corporation, a quasi-bank, or a smaller bank ends up with huge derivative currency bets. There have already been two major situations (CITIC Pacific and China High Speed) where this has happened, and I’m sure that there are others.
The bad scenario that I can imagine is if it turns out that some quasi-bank or listed company has huge derivative bets that go bad causing panic in the financial system.
Pettis: The rest is supposed to come from banks, companies, and municipal government spending, even though it seems pretty certain that one of the municipalities’ major sources of revenues, land sales (which account for over 30% of municipal revenues) is likely to decline sharply.
The impact on land sales on municipal revenues is likely to be even more since they are regionally concentrated in the coastal provinces, and my suspicion is that these numbers don’t include profits from municipally owned property development companies.
There are likely to be major changes in the shift of power, as the crisis will allow the Central Government to assume more fiscal control over municipalities. It also likely will shift power from the coastal provinces to the interior. One other thing is that I suspect you are going to see a major housecleaning, as you end up with lots and lots of officials getting demoted and fired because of corruption. It’s a very bad position to be in if you are a corrupt official that has run out of money.
I think the sense of optimism in China comes from the fact that nothing has happened thus far that challenges people’s views on how the world works. By contrast, in the United States, if you were to go back six months and tell people that what happened, I think most people would think that you were insane.
What I detect in the US is less pessimism than fear. It’s not that people think that the worst will happen. It’s that because the impossible has happened people don’t know what is going to happen next.
Finally, I don’t think that the world as a problem with “excess capacity.” There are just too many poor people in the world so see things as a capacity problem rather than a distribution problem.
David: Western elites seem to have learnt lessons from the 1930s, and are reluctant to impose protection. Do you really see circumstances overriding that?
I don’t think that this is an elite learning lessons from the 1930′s. Rather I think that the reason that no one is talking about protection in the West is that I haven’t seen anyone make a good political case for it. I don’t see any major political group in the US that would obviously benefit from protection, and this includes the “usual suspects.” I’m waiting for some politician to explain how protection would save GM.
The only way I can see protection happening is if the world financial and economic system completely unravels, which hasn’t happened. The closest analogy for what an unraveling economic system might look like is the Soviet Union. The Soviet Union was a giant trade bloc and one thing that happened with the Soviet Union was that as it fragmented, you had suppliers in one republic unable to get parts to another republic which caused things to fall apart even more.
At this point I think things have stabilized to make this increasingly unlikely.
One other reason for Chinese optimism is that commodity prices were high last year, and this with government spending means that things have been better in the countryside than for a long time.
Also Chinese optimism is hardly universal. There seem to be a lot of sad people among exporters. I suppose this is why China might be in relatively good shape. It has a large diversified economy which means if one part falls apart, you can shift things to other parts. This is much, much harder to do if you are a small country like Iceland.
Dr. Pettis,
I wonder if there is an alternative that you haven’t considered: Western debt forgiveness. If Asia’s excess savings, sunk into American assets, is a problem, as-is America’s debt to Asia, why not just write off the mess by forgiving some or all of the outstanding debt that is causing so many problems?
No, this does not fix the fundamental problem of excess savings to excess debt ratios, but it does relieve a great deal of the short-term pressure built up in the system and provides time to work out our global imbalances in a more gradual, predictable way than trade wars(!)
This would allow Americans, free from their debt, to continue to borrow and consume. It allows Asia to continue to save and produce. I could go on, but you get the idea.
I understand the political ramifications of this solution are huge, but when weighed against the alternative – a bankrupt customer (America) and an out-of-work producer, and the resulting domestic turmoil likely to result in China, this seems like a keen if counter intuitive solution.
From a Chinese perspective, leaders may save their necks if they can convince their citizens that their savings were something of an illusion and impossible to recoup. I’m sure Americans would be willing to accept debt forgiveness, that side of the equation wouldn’t be a problem!
I’m just afraid the proposed solution, increased Chinese domestic production, exacerbated by trade wars (!) will result in vastly increased Chinese military spending (aka a form of domestic production) and take us down a road towards military conflict. I.e. if WW2 pulled the US out of the great depression, what is to prevent Chinese leaders from concluding that WW3 would do the same for their country?
[...] uma olhada nesse artigo, que comenta o estímulo fiscal dado pelo governo chinês recentemente. Eu tenho a impressão de [...]
Michael — I’m writing an overview of China’s banking system for Slate magazine (TheBigMoney.com). I was hoping to speak w/you — by Email is fine. Can you please contact me? Tnx, Dan
Good piece. I’ve put your blog on my RSS feeder.
Kevin
http://www.bullinachinamarket.com
i think the strong dollar is going to become very politicised after obama comes to office. it will get the blame for detroit and the rest of us manufacturing getting annihiliated. it will get the blame for extenuating deflation. the strongest reason to stay stumm at least for the next few weeks is the desire to finance cheaply a huge fiscal stimulus. but once that is out of the way, how can a strong dollar be in the usa’s interests?
Michael,
Some of your arguments are hardly convincing. I feel that part of your article seem to be focussed more on blaming the other side than trying to find a practical solution.
I’d like to comment especially on your remarks about the Chinese not doing their part to help solve the oversupply problem, and your accusation that they are irresponsibly exasperating the problem by raising export rebates and considering depreciating the currency.
First, regarding your comment about the Chinese not doing their part to boost consumption: Unlike what you are saying, their government has for a long time tried to increase domestic demand by convincing their citizens to spend. And if you have lived in China, you would know that they have been quite successful, especially in the big cities. In fact, at the current rate, a report by Ernst & Young has predicted that by 2015, China will surpass the US and Japan to become the world’s largest consumer of luxury goods, accounting for 29% of the world’s total. This is quite spectacular considering that Chinese culture encourages people to save.
If you are still not convinced, shouldn’t the 4,000,000,000,000 RMB make you think twice before saying the US is the only one considering massive fiscal expansion while the Chinese are sitting around not doing their share.
Next, regarding your accusation that they are considering depreciating the currency, you should know that at the current status quo, Chinese are not yet capable of replacing the combined US and Europe in absorbing the oversupply. Clearly if one is genuine about overcoming the oversupply problem, one has to also think about slowing the rate of contraction of demand from the US and Europe. The depreciation is meant to make things cheaper for the consumer and therefore hopefully reduce the speed of contraction of world demand. Although this is clearly not a long term solution, it would certainly lessen the impact of the recession on everyone, and at the same time reduce the chance of a full-blown world depression (which would definitely have been the case if the Chinese economy was to crash at this crtical moment).
Lastly, regarding the export rebates, neither the 4 trillion yuan nor the currency depreciation can alleviate the immediate problem that the government in China faces. And that is the mass collapse of factories, resulting in violent massive social unrest. In the West, the loss of a job results in hardship. But in developing countries, the same losses can potentially result in huge loss of lives. In the case of China, this can in turn lead to unthinkable scenarios, not just for themselves, but for humanity in general. The rebates are just another desperate temporary measure to prevent such scenarios. I believe these actions by the Chinese authorities are not only responsible, but also necessary (at least under the current circumstances)
Brian, you are right, and I am afraid that many countries will draw exactly this conclusion.
Twofish, domestic assets are not a known problem except to the extent that the authorities know that there are domestic assets and that their may be NPLs there. Certainly it is less of a known problem than foreign assets, in which the problem can easily be quantified by making very conservative consumptions. Most people you speak to in the PBoC and other bodies have only recently started to recognize that NPLs are getting worse, and I suspect that the extent of the problem is going to surprise everyone. Also the flurry of activity concerning the informal banks, including a lot of talk about suddenly recognizing and regulating them (much too optimistic talk), suggests that they were caught flat-footed.
Dave G., debt forgiveness follows default, and is never an easy process but usually drags on for years, and even decades when it is systematic. “Writing off the mess” involves a significant transfer of wealth from one group to another – from equity investors in indebted companies to lenders. I am not sure why the lenders would see this as a good solution, and I don’t think it would be an easy political process for Chinese authorities to explain to the very poor Chinese population that they should forgive western debt. At any rate since most of what they own is US Treasuries, and they are certainly going to get repaid, why should they?
Mark, I suspect that it is actually you who is looking to fix blame. Unfortunately much of the discussion about the global imbalance of payments has been mired in an idiotic game of trying to fix blame, and this doesn’t help. A global imbalance requires two players, and your insistence that only the US can is responsible, not China, doesn’t make any sense.
The E&Y prediction about Chinese consumption of luxury goods has more to do with predictions of income inequality than of macro-consumption, and anyway predictions are not evidence of anything. I find most predictions of Chinese growth to be absurd, and it is noticeable that in the last year everyone has been rapidly shifting their predictions down. If China really is dealing with its overcapacity problem by encouraging consumption it is hard to see why in the past five years production has grown much faster than consumption – with the balance showing up as a rising trade surplus – that definitely means that it is ‘encouraging” production a lot faster than consumption.
I am surprised you use the RMB 4 trillion expenditure as proof of consumption. First, it hasn’t been implemented, and second, no one really believes the number. I am not sure I understand the rest of your post. If you are saying that a slowdown in China can be politically and socially costly, of course I agree, but I don’t see why that suggests that it cannot happen. If there is a trade war I suspect China will be forced to adjust fully to its overcapacity problem, just as the US did in the 1930s. The fact that the process will be ugly doesn’t mean that the prediction is wrong.
Michael,
I may have used some strong words, and I appologize if that upsetted you. But would you please read my post again. I’ve never said anything that suggested that only the US was responsible. I’ve never even for a moment thought that was the case. So I can’t be the one fixing blames on anyone.
I was only responding to the parts of your article that I strongly disagreed with, especially the accusations that the Chinese were not helping and were being irresponsible. I don’t think it is a good idea to talk about trade wars and then unnecessarily portraying one side as an aggressor. This clearly has the effect of fanning the flame. Don’t you think?
As for your predictions of a trade war, I wasn’t actually commenting on that in the previous post. That may be why my comments didn’t make sense to you. But if I am to place a bet, I would be happy to bet that it won’t happen. Both Obama and Mr Hu are very calm and pragmatic people. I can’t imagine either man would go for a solution that is clearly a lose-lose situation for both sides.
Hi Michael
We met at the talk you did for the Foreign correspondents club. I’m working for Irish TV in Beijing and woud like to do an interview in the next few days if you are in town. If you could drop me a line that would be great. Thanks.
Mark,
The catalyst for a trade war will be determined by the state of the US economy, not by the hopes of politicians. If someone can convince me how China will grow domestic consumption fast enough on an average urban wage of $15/day creating jobs both in the US and China while correcting trade imbalances, then and only then a trade war can be avoided.