Strangely enough I think I am among the least disappointed people about Premier Wen’s speech this morning during the opening of the National People’s Congress. Like most people I think there was very little of substance in the speech except the usual statements about boosting consumption, maintaining growth, and promoting social welfare – all easier said than done – and I have already argued many times, in a recent blog entry, for example, and in today’s WSJ Op-Ed piece, that China’s development model and financial system make it very difficult for China to boost consumption in the short term except by boosting investment, which is both slow and contrary to China’s role in the global crisis.
The main thing I got from his speech is that while Premier Wem claims that China is ready significantly to expand its stimulus, for now policymakers plan to wait and see what are the effects of the current stimulus spending. This makes sense, I think, because there is a real risk that continued deterioration in the global environment and rising domestic unemployment may panic the government into throwing everything they can into the stimulus mix.
And if they do, what will that accomplish? Global demand is contracting so there is no way to get around the fact that Chinese overcapacity will have to decline, and since it cannot decline sufficiently via a sharp increase in net domestic consumption, it will inevitably decline in the form of reduced production, especially as the threat of protection, which Wen explicitly addressed, rises.
I think to a certain extent this was recognized by the premier. According to Xinhua’s coverage of the speech:
When delivering a government report to the annual session of the Chinese legislature, he said that the global financial crisis continues to spread and get worse. Demand continues to shrink on international markets; the trend toward global deflation is obvious; and trade protectionism is resurging.
“The external economic environment has become more serious, and uncertainties have increased significantly,” he said. “Continuous drop in economic growth rate due to the impact of the global financial crisis has become a major problem affecting the overall situation. This has resulted in excess production capacity in some industries, caused some enterprises to experience operating difficulties and exerted severe pressure on employment,” according to the Premier.
But what if policymakers try to force the problem away? The risk is that they cause a massive increase in investment in the hopes of boosting employment, but if this boost comes as a consequence of building even more capacity, there are, in my opinion, likely to be two very dangerous outcomes. First, they will enter next year with even more excess capacity, and second they will have weakened the banking system further and increased government direct and contingent indebtedness.
If the world recovers quickly, then none of this will matter. But if it doesn’t, China will face 2010 with even more excess capacity and in a much weaker fiscal position to combat the contraction.
There were a few worrying aspects to the speech. Recently there has been an increasing chorus among exporters demanding RMB depreciation, and three days ago Commerce Minister Chen Deming said that February’s trade figures would be much weaker than January’s. According to an article in the South China Morning Post:
Mr Chen did not rule out the possibility that the country would adopt some trade protection measures but said it would resist out-and-out protectionism. “Trade protection does not equal protectionism. Some measures are allowed under the [World Trade Organisation] framework,” he said.
I am not sure I understand how trade protection is different than protectionism, except perhaps in a strictly legalist sense that will hold little water in the global debate. I would propose, if anyone wanted my opinion, that the world’s leading exporter by far of overcapacity – and the only major country that has seen its trade surplus surge during the crisis – does not need to push exports, especially not via any form of protection, legal under WTO rules or not.
More worrying, at least superficially, it seems that it was not just Chen who is making these kinds of noises. The People’s Daily, in reporting today’s speech by Premier Wen, had an article with the kind of headline almost designed to catch my eye: “Wen’s report urges unslackened efforts to promote export.” According to the article:
China “must not slacken efforts” to promote export amid a sharp decline in external demand and growing international trade protectionism, Chinese Premier Wen Jiabao said Thursday, pledging reinforced government support.
…”We will continue to diversify our export markets and compete on quality, enhance traditional export markets, and energetically open up new markets,” said Wen. The government is to take a series of measures to relieve the difficulties of exporters and to ensure steady growth in foreign trade, according to Wen.
The rest of the article was a little less worrying, suggesting mostly anodyne feel-good measures
A central government fund for trade development will be increased, eyeing to cultivate brand-name export products and support small and medium-sized enterprises in expanding their international markets, Wen said. To improve the country’s financial services for importing and exporting, the government will expand the coverage of export credit insurance, and encourage financial institutions to develop export credit, he said.
The government will adjust the prohibited or restricted commodity categories of processing trade, and encourage the relocation of export processing industries from the eastern to the central and western regions, Wen said.
Perhaps all of this is more designed to ward off continued attacks by a frantic export sector than to represent a real attempt to force export growth. Let’s watch the trade figures over the next few months. China has only just begun to feel the impact of sharply declining exports, and is suffering a lot less than most other Asian countries. This should change soon.
Pettis: If the world recovers quickly, then none of this will matter. But if it doesn’t, China will face 2010 with even more excess capacity and in a much weaker fiscal position to combat the contraction.
Why? If the world doesn’t recover quickly, then you don’t want China to get trapped in internal deflationary spiral. You want to keep domestic demand high so that things don’t fall apart if exports collapse.
Exports are important, but not nearly as important as domestic demand.
*MPettis:* Global demand is contracting so there is no way to get around the fact that Chinese overcapacity will have to decline, and since it cannot decline sufficiently via a sharp increase in net domestic consumption, it will inevitably decline in the form of reduced production.
That’s just wrong. Global demand is contracting therefore you need to increase domestic demand. This can be done by increase consumption, government spending, or investment, or a combination of all three.
The problem isn’t general overcapacity, and I’d argue that the problem is *never* general overcapacity, but misallocation. If you have correctly allocated industries, but too little demand, you just print money.
If you have misallocation, you can too much in one industry and too little in another (fewer exports, more services). You want to keep total production high, but you do want to move things from export industries to domestic industries, and this reallocation of resources is going to take a lot of cash and some pain. It’s better that you make the cash available now rather than wait until later.
If it turns out that we are doing to have a long global decline, then the government to start now to prepare to start shutting down export factories and starting new businesses in their place. This means making massive amounts of credit available.
I guess my only question on this is that there would seem to be some modest steps that could be taken fairly quickly to rebalance the economy and stabilize the social/political atmosphere; giving education vouchers to parents, increased unemployment benefits, new retirement benefits, and healthcare vouchers. All of which would help rebalance consumption/production and ease social tensions. So why aren’t they being announced?
Granted the lack of household credit and the need to provide land ownership reform are necessary steps that will take much longer to enact or see effects from. But, it would seem that the other reforms above could be implemented in relatively short order, and just starting to do so would be a big confidence building measure with China’s trading partners. No doubt they would not be sufficient to offset the fall in external demand, but it seems like folly to use that as an excuse to delay their implementation.
[...] has some thoughts from economists on what he did say and what it means. For my money though go to Michael Pettis’s China Financial Markets. He’s a realist, he lives in China and once again puts things in proper [...]
I hope Minister Chen is aware of article XII of the WTO GATT and of the letter signed by influential Rahm Emanuel to the House Committee on Ways and Means. Even within the legal confines of the WTO, there are many options available for the US pursue to address its imbalance of trade. Jobs are quickly replacing homes as the larger concern.
I agree with your statement on “waiting to see the effects of 1st stimulus”. It seems to be a smart policy. But I am still disappointed that there are not detailed policies on education and safety net spending. While I saw several times that in the foreign Medias some kind of “rural training program” had been mentioned, but I never heard about it from my Chinese friends.
About your response in the last post, I would agree that China’s fault is that we should have spent more on social welfare/education and spent earlier, then maybe we could rely less on export. But hey, the theory of “China’s savings cause U.S.’s problem” is just ridicules. And you can replace China with Japan or Mideast or Germany. I just do not think that theory is credible. I mean, unless there is a negative interest rate, I do not see why people can justify their reckless borrowing behaviors.
About the music, I am not an expert in that field you can see. Really cannot tell the difference between the music played in your bar and heavy metal, I will stop here in case that I make more mistakes. Anyway, your bar is good, and I will visit it next time when I am in China. Best wish to your festival.
Have you had a chance to look at this post by Macro Man where he argues that “So if revenues are falling and a big net spend is about to ensue….why, then the government must be about to adopt the Western model and increase borrowing very sharply. Given that the major buyers of government debt, the banks, have been increasing loan issuance instead…well, then surely Chinese yields must be ripping higher?
Uh…..no. While yields did rise in January, that appears to have been largely in synpathy with a global phenomenon (the “Barron’s bounce” for yields.) Since then, yields have been trickling lower, as the chart of the 5 year rate below demonstrates”
http://macro-man.blogspot.com/
Twofish’s comments are simply off here. Sure, he has the identity write for domestic demand. Let’s look at it: if the government stimulus is relatively small in terms of real fiscal impulse, consumers behave rationally and increase spending more slowly during a downturn, then that leaves investment as a driver, and there is a lot of new investment in infrastructure and industrial capacity (look at any regional stimulus program and national industrial ones and it is clear that officials are doubling down on their bets in non-export related sectors, which themselves already face over-capacity), and the end result is as predicted above. Sure, you want to spend as much as possible to keep things moving along in the short-term until the external environment improves, but one major downside risk is that the economy will stall later as a result of structural distortions. There is a big difference between stimulus and a structural shift, and the past five years has shown that the shift Mr. Fish talks about has been going very very slowly, and the most likely means of stimulus could actually detract from such change. Best case is a return to the status quo ante in many places, including China.
The other thing to note is that we have to pick out what is stimulus and what is structural in the Wen plan. The structural features will include one-off social spending initiatives, which do not amount to fixing the social safety net, which they have been talking about for a decade with awful results. Ideologically China is at an awkward point because it still clings to the rhetoric of socialism, but is experiencing what I call “cultural mean reversion” that views social giveaways and safety net programs with antipathy. Look at Hong Kong, this happened long ago when they dismissed Keynes at the same time that the world was embracing him. Sure, Hong Kong is small and structurally different, but culturally, it is an important reference point for the future. Peasants are peasants, and were on their own in pre-Communist China. Social protections do not have deep cultural roots in China, and they are actually shallower than the threads of socialism that are still around. Welcome to a Confucian aristocracy, with the grandsons and granddaughters of the revolution in charge, and by the way they own everything.
I heard a interesting comment from today’s news in the noon that Mr.zhou xiaochuan said publicly about the surge lending in January was a much quick and strong reaction to the financial crisis. But he then said this reaction may be too powerful to effect the substantial economy in this country and there will be rooms to adjust this policy in a small area.
I feel funny about what he said. Fully understood your discussion, I realize that the confliction between short term and long term interests was puzzling the policymakers a long time. One is to recover industries and supply employments, the other is to care the global crisis and international trade imbalance. What an embarrassing situation they have now.
This is a very difficult test to us I think. And I eager to know what you think about Mr.zhou’s words for this lending policy.
Twofish.
Chinaproduced four times more (!!!!) truck in 2008 than the US.
It is a serious overcapacity,and it mean for me that: the biiggest issue in China is not the export,but the over investment.
Fatbrick.
If you want to give a loan to a homeless,you can do that.
But after it you have to accept the high level off loss due to this operation.
China didn’t cared about the quality off the investments , because it was not an investment,but only a tool to make slave positions in the export industry.
Currently they try to keep the absolute level of investment AND to the same silly thing again.
February air cargo data just came out: Year-on-year air cargo volume is down 28 %.
When January data was released, the government said it was bad due to CNY being in January. February would automatically be much better. But a 28 % yoy-reduction in spite of many more working days does not sound good.
Though I suppose air cargo is only a tiny portion of overall trade flows (the high-end, high-value-per-kilogramm sort of trade). And it’s not clear how the decrease breaks down into domestic/export/import.
Stimulus plans are good in any country when the economic situation is bad but in China I am very worried about one thing and this is about corruption. RMB 4 trillions is a lot of money and there are people out there waiting for this opportunity to pocket a portion of it in the course of implementing the stimulus plan. I very much hope policymakers in China have to closely monitor and audit the stimulus money carefully and impose heavy penalties on those who pulled a fast one. I know Premier Wen has mentioned this in his speech but this is not enough. A task force along the line of the ICAC in Hong Kong will be a kind preventive measure but making sure people in the task force are not as corrupted. I would recommend that the task force is only answerable to Premier Wen.
Liu Mang: Sure, you want to spend as much as possible to keep things moving along in the short-term until the external environment improves, but one major downside risk is that the economy will stall later as a result of structural distortions.
It very well could but……
1) worrying about the long term is useless if you don’t survive the short term. If you have a demand collapse and get trapped in a deflationary spiral, then you worrying about long term structural distortions doesn’t help,
2) China is extremely underdeveloped, and it is much easier to find useful things to spend money on,
3) by thinking some about how the stimulus is spend you can reduce (but not altogether eliminate) long term structural distortions. The key here is how you choose to structure credit, and not whether or not you issue credit.
One reason I have this view is that there is a tendency to use credit collapses as times to do “structural adjustment” in development countries. This is invariably bad policy.
Liu Mang: Peasants are peasants, and were on their own in pre-Communist China. Social protections do not have deep cultural roots in China, and they are actually shallower than the threads of socialism that are still around.
I think that you overestimate how flexible culture is. The idea that government had a fundamental responsibility to manage the economy and provide social safety wasn’t very strongly accepted in the United States until the 1930′s. If people benefit from things, then the culture will change.
Liu Mang: Welcome to a Confucian aristocracy, with the grandsons and granddaughters of the revolution in charge, and by the way they own everything.
I don’t know of any society in which sons and daughters of the rich and powerful don’t have an advantage, and the amount of nepotism in China doesn’t strike me as higher than in the United States.
Having said that, the sons and daughters of the rich and powerful usually find it in their interests to have a somewhat open class system, because if you prevent social mobility then people outside the system will find leadership to overthrow it. By absorbing people into the ruling class, you make sure that all the people that could lead a revolution are in the government system, and anyone outside is leaderless and therefore harmless.
In both the United States and China, education is the primary means of social stratification, and the United States is run by graduates from a relatively small number of schools (Harvard, MIT, Stanford, UC Berkeley, etc.), and these schools have admission policies that intentionally are designed to maintain the aristocracy while at the same time having enough social mobility so that most people choice to join the aristocracy instead of trying to overthrow it.
bomlat: China produced four times more (!!!!) truck in 2008 than the US.
Which isn’t necessarily a bad thing since most people in the US who have trucks have them whereas a lot of people in China who want trucks don’t.
bomlat: It is a serious overcapacity,and it mean for me that: the biggest issue in China is not the export,but the over investment.
And I think this is where talking about overinvestment rather than misinvestment causes problems. It may be that China is producing too many trucks, in which case it is better if China stop producing trucks and start producing something else.
If China simply cannot produce do anything better than trucks, then it should produce trucks. So the order of preference is:
1) produce something other than trucks – might I suggest railroad cars
2) produce trucks
3) produce nothing
Talking about overinvestment rather than misinvestment leads to the idea that 3) is better than 2), which it isn’t.
This also applies to steel and concrete. Now it may be the case that there is overproduction in those areas, but you have to provide more information than “China produces a lot” to argue that it should produce steel, concrete, and trucks, and at the same time you have to answer the question “what can China produce that is more useful than steel, concrete, and trucks?”
If you can’t think of anything then produce steel, concrete, and trucks. Personally, I think that China is massively overinvested in “hardware” and underinvested in “software.”
While I previously posted this in the “Chinese real estate” thread I think that it is pertinent to the discussion towards the Domestic Economy.
http://www.pekingduck.org/2009/03/chinas-luxury-mall-calamity/
“I’m predicting The Place and many of its sister ghost malls, shunned by customers overwhelmed by so many malls to choose from, each selling the same crap that no one can afford nowadays, are going to experience a catastrophe, if they haven’t already, and will ultimately become burnt-out, boarded-up shells. In turn, this is going to throw a lot of fuel on China’s current financial crisis. Real estate will be further cheapened, and the general misery unique to times of deflation will set in. Brother, can you spare a dime?”
/snip
It may be that there is to much capacity in internal demand right now. The domestic economy is not just about the products but also the infrastructure that supports it. It appears to have been subjected to a speculative bubble.
I agree with your view that caution is needed to see how the stimulus package works before moving on to additional significant programs. As with annual “State of the Union” and “Speech from the Throne” presentations, it was not realistic to expect great detail. The government no doubt has developed plans to boost existing social spending on housing, unemployment, education, water and the environment, all of which are badly needed, can have stimulus impact and add value over the long term. Questions remain about which constitunency will “win” — the “old infrastructure” type spending group, or the group that recognizes the incredible changes that have occured in the last decade and want greater spending/stimulus for social benefits, small and medium size businesses, and the service industry.
The Government of China effectivley collects up all the national excess savings and investment flows, converts them (mostly) to dollars and then force feeds them back to the US by buying treasury securities resulting in a continuing increase in their reserves. It is not clear to me exactly how they are financing this, but it is clear that they are financing this.
If, instead of force feeding the excess savings back to the US, they started directly spending the money on internal consumption within China, the excess production/trade surplus problem would necessarity begin to go away. I doubt that there is a shortage of things to spend the money on that would benfit the people of China? Why is there such a huge reluctance to spend the money rather than continue to pile it up?
On a different topic, it was just reported that the Republicans in the US Senate are suggesting that leigislation require companies receiving TRAP funds to lay off foreign workers first in the event of a downsizing. Just the type of dumb move that will create a backlash while damaging US companies.
bomlat,
I do not see the relevance between your comment and my post. But if you talk about the quality of investment, maybe first you need a definition of that.
Michael,
Stop continuing to discredit your profession. The CAUSE of the current crisis was the lack of and lax regulations and unscrupulous business practices, and the stupidity of the borrowers who expected to get rich on paper despite the writings on a simple piece of paper. Plentifulness of liquidioty was simply a CONDITION that existed (no more than it was raining last night).
It was sad to have seen my good friend (who turned to be a RE agent after being laid off in Hi-Tech in 2002 here in Silicon Valley) pushing houses onto me in 2005-2008. I continued to query him why nobody else was (implicitly including himself) not looking at the data that I was looking at in 2005. He shied away, but it was ALWAYS A GOOD THING to buy the house from him regardless of the data; amazingly he still says the same thing to me today whereas I expect prices here will drop another 20-25%.
Hyman Minsky was a theoretician and a good one at that. Stop using his analysis as an excuse; we have way past his time and we know a lot about markets and what to do. I am sure you heard about anti-cyclic policies. Curiously, in the past 8 years what we had was a pro-cyclic remedy. A case in point is in Canada, where there is also a housing bubble in some key markets, which is now bursting, but nothing like the US and the banks are healthy.
According to the Economist, a report from the IMF about the financial crisis argues, in papers released on Friday, that the “main culprit” was deficient regulation of the financial system, together with a failure of market discipline. Olivier Blanchard, the IMF’s chief economist, said this week that global imbalances contributed only “indirectly” to the crisis”.. Their argument supports the view that the deficit country financial and regulatory systems failed to invest the funds from surplus countries efficiently, effectively and prudentially. Their conclusions also support an “armchair economist’s” view that it seems illogical to conclude that China, Germany, the oil-producing surplus states “forced” deficit countries to take their money which required those countries to then deploy the funds in unacceptably risky “investments” rather then deal with the difficult actions needed to address the issues underlying their own unstainable deficits. If they had done so, it presumably would have reduced demand for surplus country products thereby “encouraging” those countries to increase domestic demand much earlier, which is both a political and regulatory failure.
Twofish, I think you are simply assuming away the problem. The government says the point of the fiscal stimulus is to boost domestic demand enough to make up for declining foreign demand. In spite of the fact that China has been attempting to boost domestic consumption for five or six years, and especially in the past six months, with the only result being that both consumption and trade have moved in the wrong direction, you still assume that this time it will work. Maybe it will, but as I pointed out in this and previous posts, I think there are very strong structural reasons to believe that it will take many years for China to get a significant and efficient boost in domestic consumption. And if the big fiscal bet is as misconceived and useless as I think it will be, China will be left with much less ammunition to fight its way though a prolonged crisis. The idea that the current crisis justifies any policy, no matter how likely it makes imbalances worse and recovery far more difficult next year, as you imply in your later comment, does not make sense to me if its chances of working are very low.
OGT, there are discussions about many of the steps you mention but there is very little agreement on whether they would work or, more importantly, work quickly enough or in sufficient magnitude. With Chinese net exports equal to roughly one-half to two-thirds of US net demand, a very rough back of the envelope calculation suggests that a contraction in net US consumption equal to 1% of US GDP would require a 3.4-4.6% expansion in net Chinese demand, and of course US consumption seems to be contracting much more than that and very quickly. My bet is that Chinese exports are going to start falling quickly very soon, by which I mean even more quickly than in December and January, when Chinese export contraction was much slower than the rest of Asia.
Tyaresun, a more interesting issue for me is what the projected 3% deficit really means in terms of spending. Part of the figure represents a net increase in fiscal spending and part represents a cut in tax rates – both of which are expansionary – but it seems to me that half or more of the deficit will simply be caused by falling tax revenues. In that case although it may come across as expansionary in the GDP ? C + I + G + X – M identity, I don’t think it really boosts demand.
Xiaouchen, what I found most interesting about Zhou’s comments was his explanation for the surge in bills financing in January. He argued that it was caused by the fact that SMEs are unable to finance themselves long-term but were finally able to get some short-term financing from the big banks in the form of discounted notes (perhaps as part of policy measures aimed at expanding lending to SMEs). This is probably part of the explanation, but it is pretty obvious that much of the surge in bill financing was false lending arising out of the arbitrage between the bill discount rate and the deposit rate (basically companies could earn risk-free money by discounting bills and putting the proceeds in a bank deposit). The fact that the PBoC forced up short-term rates to close the arbitrage loop late in February suggests that they, too, thought this was an issue.
WaitingOut, sorry, but while I admit that it doesn’t necessarily prove that I am right, I nonetheless always feel a lot more confident about the quality of my analysis when I find that I am being called out by a meathead.
PB, although many (although certainly not all) in the IMF argue about deficient regulation, one of the predictions I made in my 2003 Foreign Policy article (“Will Globalization Go Bankrupt?”) is that, as in every other globalization collapse, analysts and lawmakers will systematically mistake the causes of the crisis. In the 1930s the most popular culprits were investment trusts, universal banking, fraud, Jewish conspiracies, and the rejection of gold parity (and also, of course, the anyway imminent collapse of capitalism as predicted by Marx). Much later Eichengreen and Freidman separately pointed to different aspects of monetary policy as the real source of the crisis and most of us now focus in addition on imbalances during the 1920s including the recycling of German war reparations payments. This doesn’t make the IMF predictions wrong, or me right, but it does suggest that the immediate consensus, especially those opinions that are uninformed by a long-term view of financial history, is suspect at best.
Fatbrick.
My point is simple: China didn’t brought that big pile of treasury to be able to pay out the health care of the elders in 2020, but to push down the exchange rate.
It was a short sighted and dangerous policy,as we can see it now.
The result of it was the reckless lending,but it was like a flood :in a free economy it will found the weakest poiint.
Your starting point is that in the US there is a central planning body which decide that who can get a loan.But there is nothing like that.
Check the shadow banking in China.
That is the other result of this policy,the liquidity found it way to the customers.
Off this topic, but there’s another nice piece about Michael and D-22 by James Fallows in The Atlantic:
http://www.theatlantic.com/doc/200903/michael-pettis
No picture, but the description is pretty good. One of the many good things about reading here is being reminded of real life.
Michael: he government says the point of the fiscal stimulus is to boost domestic demand enough to make up for declining foreign demand. In spite of the fact that China has been attempting to boost domestic consumption for five or six years, and especially in the past six months, with the only result being that both consumption and trade have moved in the wrong direction, you still assume that this time it will work.
This is confusing demand and consumption. The Chinese government has never had much success at increasing consumption, but it’s had any difficulty at all in increasing demand by increasing government spending or investment. You can increase demand without increasing consumption by increasing investment or massively increasing government spending.
There are huge biases in the Chinese economic system that favor large amounts of investment (i.e. all the people that make money when concrete is poured), and the challenge for the government has always been to cool the economy rather than heat it up.
There is no particular reason to think that the Chinese government will have any problem in increasing demand. The big concern is whether this demand go to pay for useful things, but that is another issue.
Pettis: The idea that the current crisis justifies any policy, no matter how likely it makes imbalances worse and recovery far more difficult next year, as you imply in your later comment, does not make sense to me if its chances of working are very low.
This is where the notion of “imbalance” causes problems because by thinking terms of “balance” causes policy decisions which I think are plain wrong. If you don’t spend massive amounts of money now, it will make recovery harder because it digs you deeper in the hole.
A crisis does not justify any policy. Crises make it important to undertake correct policies, and the problem is that with all due respect I think that a policy of holding back stimulus is just plain wrong. Holding back stimulus would be justified if there was a good chance of a recovery this year. Since there is good chance of a sustained fall in demand, you need to start spending massive amounts of money now, so that domestic demand (not consumption but demand) does not collapse when export demand does.
If it was the case that you we would be out of the woods this year, then you *don’t* want massive stimulus, because when exports don’t collapse you whipsaw and you have a massive inflation problem, and end up with useless infrastructure projects.
Pettis: As in every other globalization collapse, analysts and lawmakers will systematically mistake the causes of the crisis.
That’s because there are usually a hundred things going on, and it’s easy to find a cause. If you look deeply at economic history, then a lot of patterns start come out, but even they people will disagree about the cause of the mess.
One reason that we shouldn’t be too quick to judge is that it assumes that *we* know what really caused the problems, and the fact that intelligent people are still arguing about these issues says that we probably don’t.
Personally, I think that lack of financial regulation was pretty important because I’ve looked at financial history, and the pattern I see is that underregulation and overleverage turns a minor problem into major crisis.
Michael Pettis is always challenging. With this and some previous posts the resultant discussion seems to be getting hooked up on a few factors – and the whodunnit Q – at the expense of a broader outlook.
Aside from the flow of goods from China to the U.S.A. and paper in the other direction and back again and the intermediation and regulation involved with these various sets of flows, there is also the matter of stocks: the assets and debts being accumulated, and the associated human capital and institutional infrastructures.
Whilst the flows are malleable, the stocks are much less so. For example, the comments suggesting that China should just invest more in education and health seem to treat this like buying shares. Furthermore, investment doesn’t equal return as U.S. experience shows all too well with both education and health
As Pettis says elsewhere, we cannot rely on the infinite leverage of U.S. households (I would add, for both consumption and house purchase) Consequently, both asset allocation and pricing in China and in the U.S. based on this leveraging are wrong. This means an enormous amount of repricing or writing off of the value of assets, including some human capital. Where the debt to fund the assets took the form of equity, then that gets written off too. One could say that is what world sharemarkets have been doing for the past 6 months.
But as industries and workers struggle to adjust and with massive sums of non-equity forms of debt involved, governments get drawn in to fund the gaps.
If markets could adjust smoothly and swiftly, governments would scarcely need to step in. Given the (extreme) stickiness involved, government intervention can only work in the medium to long term if it is directed at helping to make that tough adjustment in asset allocations and prices. However, in both the U.S. and China this is not the case. It’s just too hard.
Adjustment is made more difficult by the status of the U.S. $ as world reserve currency as both means of exchange and store of value. In particular the Yuan- $ exchange rate are driven by a number of conflicting considerations. For the moment, most of these work against the necessary asset and debt repricing. (I’ve discussed the signalling between the U.S. and China, e.g. here.
Thank you, I learn a lot from you and google the word “discounted notes”. Now I understand the arbitrage between discounted notes rate and deposit rate and know why PBoC had to forced up the short-term rate. One of the articles showed up this problem(in chinese sorry):
http://www.caijing.com.cn/2009-02-03/110052465.html
Read this,if you have some interests.
Dear Prof. Pettis, I’ve been reading your blog for a while but this is first time I comment here.
You have been emphasizing a lot about China’s overcapacity leading to trade friction. While I don’t disagree with that, I do want to question the magnitude of the effects of China’s continued export. China’s exports are mostly light manufacturing goods like toys, garments and other labor intensive goods which the modernized west simply lack the competitiveness nor the will to do.
Putting it in a daily life example: China’s continued overcapacity is more likely to drive down the price tags in Walmart or Footlocker, perhaps a little bit on iPhones as well but that can hardly harm the Americans and Europeans because they have never been competing with China in those areas in the first place.
In fact, I opin that further loose credit going into China’s manufacturing sector means continuously decreasing price of consumer products which would actually suit the lowering consumption power of the developed world. Though it will serve no good for the Chinese factories because I swear most of them have already been running with extremely thin margins, and I have always argued that profits of these factories come from its labors rather than customers.
The only issue I can see is, officials of the west only look at the account numbers without digging into the context behind the numbers. I agree this is a very likely scenario, given the competence of government officials we have grown to know of… However, in that case this is more of a communication and/or trade negotiation matter rather than a real problem.
Thanks a lot, Michael. For the explicit insult. At least I work in a profession that still has much of its credibility; after all we have your cell phone and the satellite TV you watch to our credit. You are only destroying your credibility of what remains of the part of the prescription that you are still right. Way to go, bankers of the world, even those turning into professors.
Ha ha meathead is a very good word which I didn’t know before. Since ignorant and excited TV business shows were as much causing the financial euphoria as any banker I don’t know why Mr. Waiting feels he should be praised while Professor Pettis was insulted. From my knowledge Mr. Pettis has worked much harder for many years to warn about the dangers of the bubble than those very stupid television shows. Perhaps Mr. Waiting knows more about his televison industry than he knows about economics and history. That is a good thing.
Waiting Out, the whole issue of the origins of liquidity and its impact in creating credit bubbles is very complex and much debated among serious economists, and although I am not fully in agreement, my understanding is that this argument is widely accepted among financial historian, of which group Pettis is a pretty prominent member. It is great that you have been able to cut through this debate quickly and effortlessly and figure out that the whole discussion is so wrong that you are justified in insulting those not in the know, but another possible argument is that you shouldn’t be worrying your pretty little head over these things and go back to designing an innovative color scheme for a new cellphone.
Michael is doing a great job and I have plenty of respect for him. I agree with Jack Ross that the credit bubbles is a very complex issue and is much debated among serious economists. If one doesn’t agree with Michael on this issue is perfectly normal. However, it would not be normal if everyone agrees with him.
Michael, when I am in Beijing I will surely want to meet with you at your bar. Can you drop me a note in private to let me know the address. Thanks.
I generally try to approve all comments that are not wholly irrelevant, but some of the recent ones are veering off track. Let’s drop it, please.
Kalasend, I will try to respond to your comment in today’s blog entry. Dr. Loo, I would be happy to meet. My email is michael@pettis.com
Still, the important question is not who is or might be a meathead. The all important question is how the stimulus plan now envisioned in China and the plans being formulated for China’s economy gibe with the documented facts and data which describe environmental reality in China today and in the near future. For some strange reason, most economists seem to believe that they can continue to argue their positions without including real world data which is being coughed up by physical science researchers, on a daily basis. The evidence is continually mounting and coalescing around some very dire predictions for the economy being caused by some very significant ongoing changes to China’s environment, including water resources, land usage, demographics, you name it.
Any economist or blogger blogging about the China economy who fails to take into account the all important environmental feedbacks from the real world in China which necessarily impinge on China’s economy may not be a meathead, but any talk without environmental input then might become just idle chatter, and in the long-term, not much use at all.
Of course it is not easy to try to integrate economic theory/hearsay with hard data about China derived from the physical sciences. But this must be done, in an interdisciplinary way, in order to make any real worthwhile sense of what is happening in China.
By the way, ‘meathead’ is a jocular term with very little if any disparaging connotations. But the term ‘economist’ or ‘banker’ these days, well, what good can be said about them?
Still, the important question is not who is or might be a meathead. The all important question is how the stimulus plan now envisioned in China and the plans being formulated for China’s economy gibe with the documented facts and data which describe environmental reality in China today and in the near future. For some strange reason, most economists seem to believe that they can continue to argue their positions without including real world data which is being coughed up by physical science researchers, on a daily basis. The evidence is continually mounting and coalescing around some very dire predictions for the economy being caused by some very significant ongoing changes to China’s environment, including water resources, land usage, demographics, you name it.
Any economist or blogger blogging about the China economy who fails to take into account the all important environmental feedbacks from the real world in China which necessarily impinge on China’s economy may not be a meathead, but any talk without environmental input then might become just idle chatter, and in the long-term, not much use at all.
Of course it is not easy to try to integrate economic theory/hearsay with hard data about China derived from the physical sciences. But this must be done, in an interdisciplinary way, in order to make any real worthwhile sense of what is happening in China.
By the way, ‘meathead’ is a jocular term with very little if any disparaging connotations. But the term ‘economist’ or ‘banker’ these days, well, what good can be said about them? The staid banker of yore is not part of our present culture.
[...] No, I was not disappointed by Premier Wen’s speech mpettis.com/2009/03/no-i-was-not-disappointed-by-premier-wen%E2%80%99s-speech – view page – cached March 5th, 2009 by Michael Pettis | Filed under Economic growth, Labor and — From the page [...]