Wow! There are now rumors that Chinese net credit growth in January was substantially higher than the already-astonishing rumors of RMB 1.2 trillion I reported last week. I will get to that at the end of this entry, but I wanted first to discuss a possibly important issue related to credit intervention.
It is probably not at all controversial to suggest that the way governments in the US, China and elsewhere respond to the current crisis will determine economic growth prospects for the next decade and more, but it is probably also worth repeating this point as often as possible. In the panic to respond swiftly to some of the short-term problems facing policymakers, it would be easy for them sometimes to forget the longer-term impact of current policy responses, and so saddle us for many years with unwanted consequences.
Over the weekend I was reading a paper by Gonzalo Fernández de Córdoba (Universidad de Salamanca) and Timothy J. Kehoe (University of Minnesota), called “The Current Financial Crisis: What Should We Learn from the Great Depressions of the Twentieth Century?” Basing their work on Great Depressions of the Twentieth Century, published in 2007 by the Federal Reserve Bank of Minneapolis, in which Timothy Kehoe and Edward Prescott, together with a team of 24 economists from around the world, analyze a number of “great depressions” experienced by various countries in the 20th Century, they try to determine the impact of policy on the subsequent severity of the contraction.
Although I always worry about ideological predispositions in these kinds of analyses (one group of economists always seems to find that government intervention made things worse, while another always seems to find that in fact specific policies helped), some of the examples they use – in Latin America primarily – involve countries and histories with which I am pretty familiar, and at least this part of their analysis rings true to me.
Based on the data analyzed in the book, they conclude that massive public interventions in the economy to maintain employment and investment during a financial crisis will, if they distort incentives enough, make things much worse. I guess that probably wouldn’t come as a very controversial statement to anyone, but what interested me was that they seemed to focus especially on ways that governments have intervened in credit markets and in investment decisions. Two examples were especially illuminating, Mexico and Chile – which both experienced massive crises beginning in 1982, the year which usually signals the beginning of the LDC Debt Crisis (or the “lost decade”, as Latin Americans call it). Their policy responses in the financial sector were radically different:
In 1982 in Chile, banks that held half of the deposits were suffering severe liquidity crises. The government took control of these banks. Within three years, the Chilean government had liquidated the insolvent banks and reprivatized the solvent banks. The government set up a new regulatory scheme to avoid mismanagement. These new regulations allowed the market to determine interest rates and the allocation of credit to firms. The short-term costs of the crisis and the reform in Chile were severe, and real GDP fell sharply in 1982 and 1983. By 1984, however, the Chilean economy started to grow, and Chile has been the fastest-growing country in Latin America since then.
In 1982 in Mexico, the government nationalized the entire banking system, and banks were only reprivatized in the early 1990s. Throughout the 1980s, in an effort to maintain employment and investment, the government-controlled banks provided credit at below-market interest rates to some large firms and no credit to others. Even the privatization of banks in the early 1990s and the reforms following the 1995 crisis have not been effective in producing a banking system that provides substantial credit at market interest rates to firms in Mexico. The result has been an economic disaster for Mexico: Between 1982 and 1995, Mexico experienced no economic growth and has grown only modestly since then.
The differences in economic performance in Chile and Mexico since the early 1980s have not been in employment and investment, but in productivity. In Chile, unproductive firms have died and new firms have been born and grown. Workers and capital have been channeled from unproductive to productive firms. In Mexico, a poorly functioning financial system has impeded this process.
GDP per working age person in Mexico declined substantially in the 1980s and only began recovering by 1988, but a second banking crisis in 1995 eroded much of the recovery and as of today it has still not reached its 1982 peak. In Chile, the decline at first was much sharper. In two years GPP per worker in Chile dropped by around 20%, which it took six years to happen in Mexico. However productivity growth surged thereafter so that by 1988 it had fully recovered to 1982 levels and as of today it has doubled. Chile, as most of us know, has been for the past twenty years the fastest growing country in Latin America, even though it as among the worst hit by the debt crisis.
The main point the paper seems to want to make is that intervention in the allocation of credit had a huge impact on the way the country was able (or not) to recover from the crisis and regain productivity growth:
Japan suffered a financial crisis in the early 1990s and followed similar sorts of policies as Mexico, keeping otherwise insolvent banks running, providing credit to some firms and not others, and using massive fiscal stimulus programs to maintain employment and investment. Japan has stagnated since then. Finland also suffered a financial crisis in the early 1990s and followed similar sorts of policies as Chile, paying the costs of reform and letting the market dictate the allocation of credit to the private sector. The Finnish economy has grown spectacularly since then.
What implications this might have for Chinese policy-making in response to the current crisis? Again, we always need to protect ourselves from conclusions that owe more to ideology than evidence, but at the very least we should consider the possibility that massive intervention in the banking system, for all the short-term countercyclical benefits (i.e. banks are forced to expand, to satisfy policy interests, rather than contract, to satisfy commercial interests) can create serious enough distortions that Chinese growth for the next decade or so might be sharply constrained. In their words:
We need to avoid implementing policies that stifle productivity by providing bad incentives to the private sector. With banks and other financial institutions in crisis, the government needs to focus on providing liquidity so that banks can provide credit at market interest rates, and using the market mechanism, to productive firms. Unproductive firms need to die. This is as true for the automobile industry as it is for the banking system. Bailouts and other financial efforts to keep unproductive firms in operation depress productivity. These firms absorb labor and capital that are better used by productive firms. The market makes better decisions than does the government on which firms should survive and which should die.
Of course someone will inevitably argue that it actually makes commercial sense for Chinese banks to expand loans now, since there is likely to be an implicit, or even explicit, guarantee that makes most new lending essentially risk-free. Yes, of course, but that doesn’t change the underlying logic. Banks will be channeling capital to companies not based on their economic prospects but rather based on the guarantee, and so little commercial distinction will be made between healthy and unhealthy borrowers. My guess, and not a particularly controversial one I suppose, is that the provision of implicit or explicit government guarantees will have more to do with a company’s impact on employment than its economic prospects.
I don’t want to overstate the relevance of market versus government allocation of credit, but by the late mid-1980s, when I first started trading Latin American debt, it was pretty clear that Chilean banks were in much better shape than were Mexican banks, and were much more independent (Mexican banks were not privatized until the early 1990s). I specialized primarily in Mexican debt and bonds until I ended up running the Latin American trading desk, so losing my country focus, but it did always seem to me that the Mexican financial system was a lot less prudent than the Chilean, and government “guidance” had a very big impact on credit allocation.
Before someone suggests that perhaps poor guidance leading to credit misallocation might be less of a problem in well-governed China than in poorly-governed Mexico, I would argue that much of China’s recent growth came about because of the massive expansion in credit, and while the sheer size of the expansion guaranteed that there would be many years of bubble-like growth, we will only now, over the next three to five years, discover whether or not the capital was indeed misallocated on a massive scale. I think it was.
The paper makes a point of saying that the difference in subsequent GDP growth between countries that intervened heavily in credit allocation versus countries that didn’t was not a function of different levels of employment, but rather different growth rates in worker productivity. There were no noticeable differences in employment levels between countries that followed one strategy versus the other.
In that case one can make the argument that if the goal of policy is to minimize social disruption, the “Mexican model” may actually be better than the “Chilean model” because while neither model created a noticeable difference in employment levels, in Mexico an economic contraction roughly similar in magnitude took six years, versus the two years it took in Chile. Mexico may have achieved this socially less disruptive adjustment at the expense of sharply lower levels of productivity growth over the long term, and perhaps this is the tradeoff that governments face in dealing with crises. Japan, it seems to me, also chose a socially less disruptive model, in exchange for a lost decade of growth.
In other words the best policy advice for the government to maximize China’s growth prospects, based on the Fernandez and Hehoe paper, is probably politically unpalatable. It would involve acknowledging that too much capital was allocated to production, and that a period of consolidation is necessary. Unfortunately this consolidation means that capital migrate in a major way from less productive users to more productive users, which is just a bloodless way of saying that a lot of companies are going to have to be allowed to fail, and banks and financial markets should be weaned away from political control and encouraged to make their own commercial decisions.
But should this happen in the midst of a global crisis? On the one hand, in China – and probably most other countries – real reform only seems to occur after a crisis, and so this is an important opportunity to get things right. On the other hand global conditions are too ugly for China to allow bankruptcies to take their swiftest course, and so undermining the social pact, so a strong case can be made for intervening heavily now and reforming later. Ultimately this is a political question that the Chinese must make: is there a tradeoff between long-term growth and short-term instability, and if so, which should China choose?
As I noted at the beginning of this entry, hot off the press is some related news about credit intervention. In an entry last week I mentioned the astonishing RMB1.2 trillion increase in loans that had been unofficially reported for January. This was a full 50% more than the previous monthly record, and nearly one-quarter of the total increase in 2008 (to be fair however January is traditionally always a big month for new lending).
Although this was seen widely as good news for the economy, since credit expansion will probably goose up the short-term GDP and employment numbers, I of course worried about exactly how much of this was real and, more importantly, how much of this will end up as future NPLs. It seemed to me that even the most prudent and commercial banking system in the world cannot expand at this rate without shoveling in an awful lot of garbage, and loan expansion of this base represented a gamble on the duration of the global contraction.
Well, it seems I was wrong. Reuters has just announced that net new lending may have actually been and even more surprising RMB 1.6 trillion – twice the previous monthly record and an amazing one-third of credit growth in all of 2008. We will know by February 15 at the latest, when the PBoC publishes lending data, but if this is true (and the report was seen as highly credible by one of my friends at Reuters) it will probably goose the stock market up further while making people like me more worried then ever. Since for me much of the Chinese growth explosion of the past several years was caused by a badly allocated credit boom, the idea that the solution to a slowdown is to jack up the credit boom even further is very worrying. It is a little like the idea that the best way for the US to adjust to the decline in its debt-fueled household consumption binge is to replace it with a debt-fueled government consumption binge, although perhaps the US and China would choose very differently in the possible trade-off between long-term growth and short-term social stability.
At any rate if this number is true, and if these credit growth levels persist, at least it suggests China is very serious about contributing its share of global fiscal expansion. This should be part of China’s negotiations with the US on trade relationships.
[...] Read the rest of this great post here [...]
Very interesting excerpts from the paper.
Pardon me for being dull, but aren’t the conclusions of the paper more relevant for US banking reform than for China?
I wonder though if a case could be made for muddling through banking reform a bit to give (real estate) markets time to recover instead of liquidating the banks at fire-sale prices. I seem to recall this was the approach of Korea after the 97 crisis.
OT: Chinese GDP forecasts
http://blogs.wsj.com/economics/2009/02/08/dissecting-chinas-gdp-yields-confusion/
This blog has a link to a Carnegie presentation with 2009 forecasts (slide 8). I will very much appreciate your thoughts on these forecasts.
http://www.carnegieendowment.org/files/Albert_Keidel%20PPT.pdf
Michael, The Shanghai and the Shenzhen markets have been moving up since February 2 after the long Spring Festival Holidays. As soon as PBOC publishes lending data February 15 I would expect there will be a pullback based on “buy the rumor and sell the fact”.
I fully support the argument that excessive policy intervention in the banking system to stimulate employment and investment will create a “bailout bubble” making the situation worse. Excessive and badly underwritten lending will unduly expose banks to unneccessary NPLs. I am worried at the end of the day banks themselves may need to be bailout just like those in the US.This had happened before in China and history always repeats itself. China have taken many years to clear up the NPLs of Bank of China, China Construction Bank and ICBC before they went for IPO. Why create the same problem for them now?China doesn’t have to follow what the US is doing as Zhou Xiao Chuan had said ” we have many tools..”.
The comparison between Mexican and Chilean banks is very well known in economic circles and was used as a strong argument in favor of the government-bad, privatization-good ideology that went into developing the economic system that is right now falling apart.
Clearly the Mexico versus Chile comparison needs to be rethought in light of current events. Someone really has to explain why the US banks are falling apart whereas Chinese banks seem to be in relatively good shape. Clearly the world as we thought it worked in 2007 was wrong.
Personally, I think that looking at the ownership misses the big problem which is mispricing of risk and the cost of capital. If you keep the cost of capital and risk too low and the direct it at favored industries, you tend to end up with a mess. The mistake was to think that privately owned banks would be better at pricing risk and capital than state owned banks. In the case of China, while you had an wildly expansionary monetary environment, the cost of capital from the state banks was not particularly low, and in fact was kept quite high in order to recapitalize the banks.
One of my answers is that people put too much emphasis on total factors productivity growth at China’s current stage of development. Most of China growth is driven by capital expenditure and in this environment, increases in total factors productivity right now are of secondary importance. This doesn’t mean that China doesn’t have to worry. Eventually capital driven growth will slow down, and if China doesn’t have a good financial system, then it will hit the same limits that the Soviet Union did in the 1970′s. But that discussion involves building institutions over the next decade.
As far as the immediate issue, one has to ask if the cost of capital in China is being kept artificially low right now, and given the number of people out of work, it’s a hard argument that it is.
Finally, as far as bankruptcy goes. One problem in a lot of developed literature is that there is insufficient thought given to the process of bankruptcy and restructuring. The purpose of bankruptcy in developed nations is to liquidate, but rather to preserve maximum value of investment.
Pettis: Since for me much of the Chinese growth explosion of the past several years was caused by a badly allocated credit boom, the idea that the solution to a slowdown is to jack up the credit boom even further is very worrying.
The underlying source of Chinese growth over the last few years has been moving people out of agriculture and into manufacturing and services. You can take the most inefficient and unproductive factory, and by moving a farmer to it, you’ve increased productivity and hence economic growth. Basically, 70% of the population of China is doing work that could be done by 5%. If you take someone out of agriculture and have them do anything, you’ve increased productivity.
Another source of growth are the state owned enterprises which are much more productive than they were a decade ago. It’s very difficult to argue that their growth is due to easy credit since they have been pumping credit into the banking system rather than sucking credit out of it.
Curiously the businesses that are having problems are those in the export sector. It’s not the state owned enterprises that are shutting down and unprofitable, it’s the private and semi-private export oriented businesses. I have a suspicion that when we take a look at what happened, we’ll find that the SOE’s didn’t get particularly cheap credit, but the export oriented businesses, because they had access to dollar credit, did.
I think that one of the blind spots that this will reveal is that people assumed that because “state=bad” and “private=good” that the state owned enterprises were more prone to credit excesses than the private export based industries, when in fact credit was preferentially flowing into the export sector.
Whether this is an “optimial allocation of capital” runs into a problem. The maximum you can expect the Chinese economy to grow is about 15%/year. There is so much surpressed energy, that you can have different allocations of capital and still hit the maximum expected growth.
Pettis: It is a little like the idea that the best way for the US to adjust to the decline in its debt-fueled household consumption binge is to replace it with a debt-fueled government consumption binge, although perhaps the US and China would choose very differently in the possible trade-off between long-term growth and short-term social stability.
First of all, the reason that you want low deficits and good banks in the good times is precisely so that in the bad times you can ramp up credit. China can massively expand the amount of credit because the banks are in good shape. The US can’t because the banks are broken, and the only option the US has is massive government spending. Once you get out of the crisis, then the really hard part begins. Dealing with NPL’s in China’s situation and dealing with deficits in the US situation. But you worry about the water bill after you’ve put out the fire.
Also I don’t think that there is a choice between growth and stability. Right now the US and China are in rapid downward spirals, and having people lose faith in institutions can be extremely damaging for long term growth. Also, industrial and economic restructuring requires large amounts of money and credit to shut down old businesses and start new ones, and keeping the balance sheets in good shape in the good times allows you to have credit available when things go bad.
I think the relevant comparison for China is China-1993 versus Russia-1993. Because the government didn’t do “shock therapy” it had the political capital to undertake massive amounts of economic restructuring in the late 1990′s. By contrast, by the mid-1990′s no one in Russia trusted the government, and is it was impossible and still is largely impossible for Russia to undertake much structural reform.
If you make to clear to the people that the government will at least try to take care of them, you will get much less public resistance to economic changes.
Just reread some half forgotten papers on Mexico and Chile and it confirms my recollection that the authors may be oversimplifying things. Here are some facts that don’t fit….
1) from 1945 until 1982 Mexico have very impressive rates of growth following state directed import substitution policies that didn’t work from 1982 onward,
2) nationalization of banking and state direction of credit was one about five or six things that were going on in the early 1980′s. In additional to allocation of capital, you also had cuts in public spending, liberalization of trade, a drop in the oil market,
3) In 1992, you had a new Mexico government that embarked on an ambitious program of privatization that let to another banking crisis in 1994.
So nationalization didn’t work. Privatization didn’t work. You could argue that nationalization was so destructive that it destroyed privatization later, but in that case why did those same policies seem to work in the 1970′s?
The big thing that catches my eye in comparing Chile and Mexico is how capital rich Chile is versus how capital poor Mexico is. It’s not clear to me that Chile allocates capital better than Mexico, but it is clear that Chile has much more domestic capital that Mexico. It’s also not clear to me that Chile’s gains in productivity are due to “wiser investment” as opposed to “more investment.”
So what strikes me is that after 1982, the Mexican government engaged in a number of policies that discouraged domestic savings while Chile engaged in policies that encouraged savings. The other impression that I get is that privatization isn’t a cure-all or even a cure at all. Before 1992, Mexican banks were a state-owned mess, and after 1992, I got the impression that they were a privatized mess.
[...] Will China have to choose between social stability and long-term growth? (Pettis) [...]
Michael, thanks for bringing us the paper and you personal interpretation and correlation to China’s own economic problem. I do believe in the power of market, but I think the paper only indicates that the argument”Public intervention at credit market during crisis always made things worse” is convincing if you talk from the probability side, but it is not absolutely right. There are exceptional examples, and we cannot rule out the possible failure of a “shock therapy”, which would be devastating for China.
And speaking more practically, I think the problem China should focus now is to take effective measures to prevent these loans to garbage project — heavy investment in infrustructure is certainly not the best choice, but there is space for doing that. Railway network, obviously, needs to be invested, but given the notorious efficiency I don’t think it will attract investment from private sector, and without political pressure, no banks would be willing to give them the loans they need. Of course, the more such kind of projects we can find, the more distortion there is in China’s economy, however, as you’ve pointed out, we can only pray that government won’t be too silly in spending money now that the “shock therapy” is politically unpalatable. Thanks God, China has such a lot of undevelopment areas.
BTW, I have quite a deep concern that China might suffer from another round of severe inflation if such credit growth continues, let’s say, for even merely a quarter.
One thing I’ve learned is to be very suspicious when someone tells a simple economic story with a simple economic lesson.
Something else to complicate things a simple story, is it’s far from clear that Mexico privatized industrial corporations less than Chile. In 1982, the Chilean government took over the banks and many industrial corporations, and they only very slowly privatized them during the 1980′s. Significantly, the Chilean government chose not the privatize the state copper monopoly. At the same time, the Mexican government in the 1980′s sold off and closed major public industries.
One thing that complicates things further is that copper prices in the 1980′s were high whereas oil prices were low.
As far as the current burst of credit. A lot depends on the details. 1) Who is the credit going to? 2) What is the likely amount of NPL’s resulting?
One thing that strongly influences my thinking is that I don’t think that the vast increase in NPL’s in the early 1990′s was a mistake but rather was a “necessary evil”. If the government had just cut credit to the SOE’s in 1993 as some people had suggested (i.e. shock therapy), then what would have likely happened would have been a massive collapse of the economy, and China would have ended up like Russia.
Instead, the Chinese government provided massive amounts of credit to the SOE’s, and this allowed them to linger for a while as the they were restructured. The purpose of massive amounts of credit to defunct enterprises and out of work employees is not to keep the enterprises open, but rather to shut them down. Once you’ve shut everything down and restructured things, the next step is to repay all your debts as quickly as you can, so that you can do the same thing the next time you need to restructure the economy.
The big counterexample to the notion that there is some trade off between social stability and long term economic growth, let me point out that both Russia and China made a series of key economic decisions in the early 1990′s. China got both. Russia got neither.
Kobe: Your fear is not unfounded but looking at today’s PPI data I am equally nervous about a round of severe deflation.
Michael,
I think the question should be will China realise that they will have to choose between them. Not whether they have a choice.
Michael,
1. regarding the strong credit growth, I wonder whether that was also distorted by loan extended to borrowers who during the tightening period had to go through underground channels to raise funds at much higher cost. The result of banks’ “reintermediation” should lead to higher deposit growth and loan growth, therefore exaggerate the real picture.
2. I as a hedge fund investor have noticed recently that poorly rated Chinese companies using loans from local banks to back their overseas issued debt at 50cents on the dollar. This on surface will translate into strong domestic credit growth but poorer loan quality for banks and little real impact on economic growth. Btw, these companies got loan due to local govt support for employment concerns.
3. By observing listed companies on micro level, I have to say most profitable and well-run companies are right now cutting back on capex and reducing banks loans while the always poorly run ones with constant negative cash flow (autos sector for example) have chosen to rely on govt funds injection to survive and expand. Regarding the debate on whether public or private is more profitable raised by Twofish, I think we need to recognize that with a longer time horizon, avg ROE for Shanghai and Shenzhen listed companies (the earlier listed ones are dominantly SOEs unfortunately) are below cost of capital. The better performance of most large SOEs in recent years are mainly due to the multi-year economic boom, industry monopoly, and most important of all the soaring commodities prices which particularly boosted energy and resources sectors. Can we expect the same type of return in a deflationary environment?
Flora: I agree with you that listed companies can’t expect the same type of return in a deflationary enviroment coupled with loads of uncertainties in the markets across the world. The situation is getting more complex each day and I believe it can’t be resolved in the near future. I would expect the situation will get worse particularly in the US before it can get better.
Flora: This on surface will translate into strong domestic credit growth but poorer loan quality for banks and little real impact on economic growth.
There are two factors here. Productivity improvement and demand management. If you look across several decades you need to boost productivity. However, if you look at the short term, then economic growth depends on demand management. If you don’t get past the short term, you’ll never get to the long term.
Flora: think we need to recognize that with a longer time horizon, avg ROE for Shanghai and Shenzhen listed companies (the earlier listed ones are dominantly SOEs unfortunately) are below cost of capital.
When we talk about average, what do we mean? There are lots of small SOE’s that are relatively unprofitable, but could me made more profitable by combining into larger enterprises. China doesn’t need as many auto companies as it has. This matter because if you weight the companies on the stock exchange by number, you get a different answer than if you weight be something else.
When we talk about “long term”, what do we mean?
If you look 10 to 20 years from now, then economic growth is going to be driven by productivity improvements (industry consolidation and technology improvements). Over the next decade, you can and probably will get massive productivity gains, simply by moving people off the farm. Moving someone from agriculture to a badly run factory creates economic growth. You can then save some of the gains of that growth, to make the factory better run.
The problem with a lot of economic discussions is that people are looking for a perfect model that will work for all time, and such a model doesn’t exist. Economic policies and growth models that make sense now, won’t make sense ten years from now and vice versa.
Flora: The better performance of most large SOEs in recent years are mainly due to the multi-year economic boom, industry monopoly, and most important of all the soaring commodities prices which particularly boosted energy and resources sectors.
It actually didn’t in some cases. High oil prices hurt Chinese oil companies, because they were subject to price controls.
Profits were generated by the economic boom. Yes and so? The important thing was that in the 1980′s the SOE’s couldn’t make profits even in economic booms.
As far as monopolies goes. Companies were able to boost profits by massive industrial consolidation, which allowed them to cut costs and achieve economies of scale, what J.P. Morgan did with US industries.
Discussion of monopoly only make sense if you can show that Chinese companies are charging more for output than margin demand, and this doesn’t seem to be the case. The prices charged by Chinese companies for goods and services don’t suggest monopoly pricing, and absent monopoly pricing, all of the industrial consolidation in a very good thing if it results in lower production costs, and economies of scale.
The industries where you have persistent losses are those (like autos) where you don’t have industrial consolidation often in part because of local protectionism.
Flora: Can we expect the same type of return in a deflationary environment?
No you can’t. But in a deflationary environment, no one makes money. That’s why you want to get out of a deflationary environment.
Glen M: I think the question should be will China realise that they will have to choose between them. Not whether they have a choice.
I don’t think that this is the question. There have been numerous times historically where people have been asked to suffer short term for the long term good, and it turns out that they ended up suffering both short term and long term because the economic model that said that there was a trade off was wrong.
The political reality is that there are limits to which people are willing to suffer short term, and those limits need to be respected. So massive lending may and probably will lead to more NPL’s. At that point you just can’t give up, you then look at the problem to see what you can do to mitigate the problem.
Twofish: The solution is to have an effective risk management mechanism. China being a trade surplus nation needs to be careful in the rebalancing act failing which China is repeating the same mistake made by the US during The Great Depression. Recently there is rumour in the market that PBoC will cut interest rate again and the stock markets in China are responding to this news positively. Cutting interest rate in China will not work to boost consumption as the consumers credit market is very small. It will only aggravate the situation as it will boost production and create further over capacity.
[...] Pettis reviews bank crisis literature: Quick Nationalization, and then reprivatization of the “good banks” left over. Basically, you want to nationalize early, and then reprivatize the good banks early. Avoiding [...]
Loo: The solution is to have an effective risk management mechanism. China being a trade surplus nation needs to be careful in the rebalancing act failing which China is repeating the same mistake made by the US during The Great Depression.
One problem is that different people have different ideas on what mistake the US made in the depression. I agreement the monetarist/Keynesian view and disagree with the Austrian/Chicago views. Part of the reason for this is that the Austrians and Chicago schools don’t have a (at least to me) convincing explanation of how the world finally got out of the Great Depression through World War II. Also Chicago school and Washington Consensus formulas based on structural adjustment have tended to destroy developing economies.
It was easy to point to Mexico/Chile and argue for neo-liberal solutions in 1990, but after 1992, it becomes harder to do that.
Loo: Cutting interest rate in China will not work to boost consumption as the consumers credit market is very small. It will only aggravate the situation as it will boost production and create further over capacity.
1) If it’s small, then it can be expanded.
2) I think boosting production is a good thing. You deal with a demand shock not by decreasing production but by increasing demand.
And whether boosting production is good or bad depends on what is being boosted. If all of that credit goes to creating new steel plants, that’s probably not a good thing. If it is used to build more earthquake proof schools, that is a good thing. If the credit is used to prop up businesses that are not going to be profitable even in the best of times, this is bad. If credit is used to keep cyclical businesses going, and then to shut down old businesses and start new ones, this is a good thing.
A lot depends on how well the banks allocate credit, and if the government says you much loan $X billion, and the banks respond by loaning that $X billion in areas were they can make the most money and minimize losses, that’s a good thing.
The problem with responding by cutting production is that the equations never balance. As you cut production, you cut employment, as employment gets cut demand gets cut, and so you spiral to the bottom.
Finally, you hit political reality. The Chinese population will simply not tolerant a massive economic contraction, and if you try to impose a massive economic contraction on the public, they will overthrow you and find someone else with different policy, and the political disruption will cause more economic damage than just not contracting the economy. One thing that has helped the US greatly is the process for “overthrowing the government” (which is what happened) in the US is much more developed than in China.
All economic policies have bad consequences and risks, and I distrust economists that can’t point to the bad consequences and risks of their policies. One big risk is ‘the economy might not work the way I think it does.’
The relevant question right now is “should China choose between social stability and long term growth” because even if there is a trade off, there is no choice here. If your recommendation is “contract the economy” you will get fired and the government and public will look for someone else, because this is not an acceptable answer.
The relevant question is “what are the bad consequences of maintaining social stability and short term economic growth, and how can we reduce those bad consequences?”
Twofish: I am all for maintaining social stabilty at the expense of a small degree of short term economic growth. I am bullish as far as China long term growth is concerned. Here I would like to quote Warren Buffett, “the 19th century belongs to England, the 20th century belongs to America but the 21st century belongs to China”.
Twofish: I am all for maintaining social stability at the expense of a degree of short term economic growth. No country on this planet can have economic growth i.e. short or long term without social stability.
it’s unbelievable, here we are in the middle of a recession in china and guys like twofish still have their rosy glasses on
[...] Let’s check in with Michael Pettis to get his views… [...]
Finnish economy thrived _not_ on bank policies but on (mere coincidentally) getting Nokia and forest/paper/wood clusters to pickup ball and push it above any dreams (mind you, Nokia shareholders in Finland sold almost everything in middle-end-of 90s) – if you look into graphs representing key economy factors of time, you see strong correlation between those cluster hiccups and economy having painful contractions. On the psychological side, many Finns had believed in Nokia miracle so much they can’t admit the other side of coin even now, when Nokia runs-house-on-batteries.
[...] great strides in recent years, the riots that erupted over the weekend serve as a reminder of the potential for instability, as well as the tremendous gaps that exist between the country’s modern urban areas (such as [...]