Subscribe Feed (RSS)The death of the Asian development model
April 25th, 2009 by Michael Pettis | Filed under Asian development model, Banks, Consumption and production, Fiscal stimulus, NPLs.One of the few areas in which the Chinese fiscal stimulus package is unquestionably having a positive effect is on growth forecasts – although mainly because forecasts seem to be coincident indicators more than leading indicators. In the past couple of week Morgan Stanley raised its 2009 forecast for Chinese GDP growth from 5.5% to 7.0%, while Goldman Sachs upgraded growth forecasts from 6.0% to 8.3%. UBS has raised its forecast from 6.5% to between 7% and 7.5%. RBS has jumped from 5% to 7% and Barclays is up from 6.7% to 7.2%. On the other hand Standard Chartered, worried about the sustainability of the “rebound,” has kept its 2009 GDP growth forecast at 6.8%, and the IMF is still at 6.5%
At any rate I’ve never provided my own forecast of Chinese growth partly because I am not smart enough to come up with an economic forecast and partly because it always seemed to me that in the short-term Chinese growth was going to depend very heavily not on economic conditions but rather on the hard-to-predict outcome of the fierce policy debate taking place in China. As I see it, one side of the debate – which seems to include people around the PBoC and the National Bureau of Statistics, along with many of the more prominent of the think-tank policy critics – is arguing that as difficult as it is, the crisis is a good occasion to force China to change its development model and financial system in a direction that will provide China with a healthier basis for stable, long-term growth. They are eager to see policies aimed at switching resources from production to consumption, even at the expense of a short-term increase in unemployment, and they tend to see the recent surge in credit and investment not as solutions to the crisis but rather as policies that will make things worse for China in the medium term.
On the other hand a different group of policymakers and power brokers – who include, I think, the Ministry of Commerce, the important exporter constituencies, and above all the powerful provincial and municipal leaders – are much more concerned with enacting measures that immediately address the expected rise of unemployment in the short term. These measures include pouring money into investment – mainly into infrastructure and the SOEs – and of course the huge increase in bank lending. They often point out that these policies saved China after the 1997-98 crisis, and so can save China again.
As an aside, and without wanting to take the 1930s analogy too far, this debate in China is a little like the split in the 1930s between the internationalists in the US who favored hard money (incorrectly, I think) and a rapid liquidation of overcapacity (painful but probably correct), and who vehemently opposed measures, including tariffs and competitive devaluations, to boost employment via boosting the export of overcapacity, versus the large and powerful constituencies, dominated by local congressmen, miners, farmers and many industrialists, who stressed immediate moves to weaken the currency, boost production, and resolve US unemployment even at the expense of the global system. In part because the 1929 stock market collapse thoroughly discredited bankers and economists, and in part because politicians are always more likely to be influenced by large domestic constituencies than by internationalists, the latter group pretty resoundingly won the debate, at least in the early part of the crisis, and clearly not to the US’s obvious benefit.
Although the debate is much less transparent in China today than it was in the US in the early 1930s, I think the latter group – the domestic constituency and provincial leaders – is once again winning the debate, at least for now. It is probably no surprise to regular readers of my blog that I largely disagree with this camp, and the main reason I didn’t want to forecast very low 2009 GDP growth numbers with much confidence is because I doubt the former group will win the debate. As I see it, the massive expansion in credit and investment we are experiencing is simply more of the same set of policies that, especially over the past five years, have pushed China ever deeper into the Asian development model, and to the extent that they are successful they will keep pushing China, which I think of as exemplifying the Asian development model on steroids, in the same direction. Beijing, in other words, is increasing the dosage of steroids. (I think I am mixing metaphors all over the place.)
The reason I think this is a mistaken strategy is because I would argue that the Asian development strategy is dead, and over the next three to five years it will become increasingly evident that 2008 was the year it died. I may be wrong, of course because it is doubtful but not inconceivable that the great consumption party in the US can resume for a few more years. It would not be the first time that what seemed like an unstoppable correction in the trade imbalances was interrupted. To a certain extent we already saw a dress rehearsal for this event in the 1987 crash, around which time the US trade deficit, which had risen to around 3.5% of GDP the year before (a level which seemed unimaginably high at the time), began its inexorable reversion, to the point where the US achieved a small surplus in the early 1990s.
The period during and after the 1987 crash more or less marked the end of that stage of the Japanese miracle, although by then Japan was so caught up in the monetary expansion that had begun with the automatic monetizing of its massive trade surplus with the US in the early 1980s, that an internal bubble kept the local party going for another 2-3 years before it, too, finally ended, and ended disastrously – although many people, especially here in China believe, mistakenly in my opinion, that the bubble was set off by the Plaza Accord.
But the Asian development model didn’t really die then (although the temporary shift in US consumption may have created the serious dislocations that helped lead to the 1997 crisis). At the time the US was itself caught up in great productivity and liquidity growth cycles that kept the model alive by causing a surge in US growth and, later, an even more rapid surge in US consumption.
The rise of US savings
What does the structure of US growth have to do with the Asian development model? As I see it the Asian development model involves polices that aim directly or indirectly at boosting savings and channeling huge amounts of subsidized resources (usually subsidized by savers, and so constraining consumption) into investment and manufacturing capacity. Some people call this mercantilism, and in many ways it does correspond to certain classic mercantilist policies, but I am wary of defining it this way because “mercantilism” is such a loaded word.
At any rate because the combination of consumer constraint and producer subsidy meant that growth in production was likely seriously to outstrip growth in consumption, the Asian development model necessarily involved generating large and consistent trade surpluses – either Asian countries exported the difference between consumption and production or they would have been forced to run up ever increasing inventory. Of course for small countries, running trade surpluses didn’t matter too much – and it made sense to have a strong external outlook because domestic markets weren’t big enough to create the necessary efficiencies and economies of scale to justify the huge investment, and their individual trade surpluses were easily buried within overall global trade.
In other words for small countries the need to export is not likely to be a constraint since they can always generate trade surpluses without creating significant global trade distortions. But when large countries, or a large grouping of countries, have policies aimed at generating trade surpluses they run into a very strict constraint – that some country or group of countries must be capable and willing to run large corresponding trade deficits. Without this willingness to run trade deficits, the Asian development model must inevitably run into brutal 19th-Century-style cycles of rapid production growth leading to overinvestment crises.
This is the main vulnerability of the Asian development model – its dependence on an importer of last resort. We don’t often think of this as a weakness because for so long the US was seen as the automatic importer of last resort, so much so that we didn’t even consider it a constraint. But we may have gotten lazy in our thinking. Many people who should know better simply write off US consuming habits as something endemic to American culture, and we just assume it as a universal constant, but in fact US consumption levels, like those of every other country, respond to changes in conditions, and these are about to change.
There are at least two reasons for the change. The first has to do with specific policy initiatives, and the second with changes in underlying economic conditions, especially household balance sheets. To address the first, I will refer to President Obama’s economic speech last week when he said: “We must lay a new foundation for growth and prosperity — a foundation that will move us from an era of borrow and spend to one where we save and invest, where we consume less at home and send more exports abroad.”
A New York Times editorial draws from Obama’s speech at least one important implication for the future growth of China and Asia:
In a series of comments in recent weeks, Mr. Obama has begun to sketch a vision of where he would like to drive the economy once this crisis is past. His goals include diminishing the consumerism that has long been the main source of growth in the United States, and encouraging more savings and investment. He would redistribute wealth toward the middle class and make the rest of the world less dependent on the American market for its prosperity. And he would seek a consensus recognizing that an activist government is an acceptable and necessary partner for a stable, market-based economy.
…Embedded in that approach is a far-reaching implication: that the rest of the world should no longer count on the United States to snap up imported goods or run up large trade deficits. It is by no means clear that Mr. Obama has the policy tools needed to bring about that kind of change; we are, after all, fundamentally a consumer society. His advisers point to his support for innovative ways of increasing personal savings.
We should never underestimate the immense flexibility of the US and its ability to restructure itself at a pace far faster than most other countries can manage (anyone who grew up in the dismal 1970s will remember the dramatic – and seemingly improbable – US economic transformation of the 1980s), and if the Obama administration is serious about creating conditions for an increase in US savings, it probably wouldn’t be a good idea to bet heavily against success..
Negative US consumption growth?
More importantly, during the past decade while the US was growing rapidly, the US trade deficit surged from just over 1% of GDP to over 7% of GDP. When consumption growth exceeds GDP growth, which must happen when the trade deficit is growing, it necessarily implies a build-up of debt, and sure enough, debt levels in the US surged while savings collapsed to zero and the trade deficit grew rapidly.
Those days are almost certainly over. Even without Obama’s desire to create conditions for an increase in US saving rates, US households have to increase their savings and rebuild their balance sheet, which means that we have several years ahead of us of deleveraging and increased savings. It also means we have several years ahead of US consumption growing more slowly than US GDP. I don’t think anyone is expecting much net growth in US GDP for the next three or four years, and so it is not at all implausible that we will see negative growth in US consumption and, as a consequence, a collapse in the US trade deficit, which may even turn into a trade surplus. The pace of this transition will largely depend on US fiscal policies aimed at slowing, but not eliminating, the contraction in demand.
If the US is no longer the importer of last resort, and if no one else can replace the US in that role in the medium term (I stress medium term because in the long term the demographic changes in Europe and Japan – and China for that matter – may well result in rising trade deficits in those countries), then any development model that necessarily results in production growth exceeding consumption growth – high savings development models, in other words – will run into the trade deficit constraint. They must run surpluses to grow, but if no one else runs sufficiently large deficits, they simply cannot run those surpluses.
This is what I mean about the “death” of the Asian development model. The not-so-hidden but also not-always-explicit assumption behind Chinese growth – with China, as I wrote earlier, representing the Asian development model on steroids – is that large and growing US trade deficits were vital to its success. But if the US is now entering a period of contracting deficits, the model is dead.
This is why I am worried about recent fiscal and credit policies. It is not just that these policies are slowing down the rate at which China will adapt to the new world of lower US trade deficits. More importantly perhaps is that the only obvious replacement for US demand – domestic Chinese demand – will itself be sharply constrained by current policies, especially credit policies.
Why? Among other things because if the explosion in new lending (loans are up 15% in the first quarter of this year) leads, as it almost certainly will, to a subsequent explosion in non-performing loans, in the next few years just as China is expanding its production and struggling with US reluctance to absorb its rising excess capacity, the resolution of the NPLs will itself constrain Chinese consumption. Resolving future NPLs, in other words, will reduce future domestic consumption growth in China, just as the current resolution in the US of bad loans and shattered household balance sheets must come with reduced US consumption growth.
This is because if China’s banks see an explosion in non-performing loans it will have to pay for that increase in the coming years in one or both of two ways. The central government can recapitalize the banks by giving them money, which they have raised by borrowing or increasing taxes, or the regulators can keep deposit rates very low as a way of subsidizing bank profitability so that they earn their way out of the NPL losses. They did both after the last banking crisis, and will probably do both again. There is a third thing they can do, appropriate the money from SOEs, but I suspect that there won’t be nearly enough to resolve the NPLs – the World Bank estimates that the last banking crisis cost China 55% of GDP.
Both strategies will represent, ultimately, a large transfer of income from households to banks, and in either case it will also represent a continued drag on consumption growth in the medium term. If the government borrows to bail out the banks, it will divert resources from the real economy and so slow income growth. If it raises taxes, it will reduce disposable income and so reduce household consumption growth. If it keeps interest rates low it will again reduce disposable income (interest income is an important source of income) and so slow consumption growth (in China lower interest rates tend to increase the savings rate).
Since it is unlikely that the US will be in a position in the near future to return to the halcyon days of large trade deficits, and since no other economy can replace the US in the role, turgid consumption growth in China will translate directly into turgid GDP growth for many years. Rising non-performing loans are not a small threat to China’s long-term growth. If the Asian development model is dead, China will need domestic consumption growth more than ever, and this is cannot be the best time for China to try to revive the production-enhancing model in a way that may limit future domestic consumption growth.
By the way in their next meeting the Guanghua Students Monetary Policy Committee will debate whether or not the PBoC should cap loan growth. I will report the arguments and conclusions of these remarkably sophisticated students.
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To me it is like those guys r trying their best to hold it up, waiting the rebound of the US to take place(Wishful thinking to me cos i am with u on the point that for the US house hold saving rate to revert to the mean, it takes a long time). So it is a big question mark whether or not they can afford to wait till then, or wait till the other importer of last resort to come up to take over the torch from US. If they really can(U never know), then we could still resume our ho-ho game, again at the expense of all Chinese people…
In short, Chinese Government’s will and capability vs time. It is very likely that they can not survive till then but there is also a slight chance that they can beat the time. So I would not use the term of “The death” even though i agree with you…
[...] abcdefghily created an interesting post today on The death of the Asian development modelHere’s a short outlineIn part because the 1929 stock market collapse thoroughly discredited bankers and economists, and in part because politicians are always more… [...]
Indeed! Michael, what can the US government do to increase savings rate? Tax credit to the middle-class for putting a certain percentage of wage income in retirement accounts? Also, as you argued earlier, the US would have to take a stand on Chinese dumping, which will get substantially worse in the near future.
What the Chinese government should do now is to buy back all private lands. Nationalize all lands, and establish a centralized, land-based taxation system. This system will be super stable, because any financial crisis can be dealt with by raising the land utilization tax slightly. All large scale land transactions will be conducted through auction, and the proceeds go to the government too. Nobody has to pay rent for land, and nobody can get rich by being a landlord. Real estate prices will be cut by 30-60% and become affordable immediately.
[...] bookmarks tagged development The death of the Asian development model saved by 5 others grantdwalker1 bookmarked on 04/25/09 | [...]
The US must and will eventually increase combined net savings rates of individuals, business, and governments. The large trade deficits must also eventually be reduced or eliminated. These principles seem clear since the imbalances of recent years are not sustainable over the long term. When and how can this happen?
If the required increase in US savings rates is not accompanied by a substantial reduction in the trade deficit, the result will be a crushing of the remaining US manufacturing base. The resulting negative feedback will deepen and lengthen the recession. To avoid a disastrous long term recession the US manufacturing base cannot take the brunt of the adjustment. What is needed in the US over the longer term is not just a reduction of consumption but also an increase in production. But, how can this happen? In a true free trade world trade imbalances should naturally right themselves, for example through changes in exchange rates, wage rates, and standard of living among countries. But this is not happening. Why? I believe that is largely because the policies and practices of the persistent surplus countries are in fact not “free trade” at all (oil exporting countries being a possible exception). How can US manufactures increase production relative to consumption in the face of practices of persistent surplus countries under the guise of “free trade.” Glen M provided examples in comments to mpettis March 9, 2009 article. Some excerpts:
I will give you some examples. The manufacture of fasteners (screws, nails, etc.) is highly automated. Labour cost in the production of which is infinitesimal. Why is it that China can under cut western producers by 40-50% (NB. that is why Europe recently placed high duties on such imports)? The reason they can is that Chinese producers do not pay market prices for the raw materials. The same goes for other products. Here is an example that steel pipe producers experienced…..
“In late 2005, early 2006, the Chinese were selling galvanized, finished, threaded pipe for about $580 a ton,” Bolt said. “My company [Wheatland Tube] was paying $600 a ton for steel and $200 a ton for zinc, and they hadn’t turned on the furnace and a worker hadn’t walked in the door yet. The only way the Chinese could do that was by government subsidies, government interference in the market.”
I have read similar stories about other products and trade practices. These and the obvious manipulation of the currency illustrate some reasons why US manufactures simply cannot compete under the current “free trade” practices. The US cannot simply decide to increase savings by consuming less and producing more unless something is done differently.
In my opinion a paradigm shift in the free trade rules is needed. Simply stated, a large persistent trade surplus without good reason should be considered as a free trade violation subject to sanctions. Such a policy should certainly help push the debate in China discussed in the article towards a more reasonable and sustainable conclusion. Some additional work would be needed to define details of such a policy. For example “Good reasons” to run a trade surplus might include: need to pay off a large external debt, low foreign exchange reserves that need to be rebuilt, or exports largely consist of non-renewable resource (e. g. oil). Things that are not “good reasons” include: increasing domestic employment, desire to buy up or control other countries.
If a country wants an export based model to build up its economy that is OK. Take the money generated by exports and use it to build up industries, improve infrastructure, and otherwise benefit the country. The key is simple: spend the money generated by exports rather than piling it up as excessive reserves. If all the money earned from exports is spent internally the trade surplus will necessarily drop towards zero. Certainly a country can do things to encourage people and businesses to spend the money (on consumption, investment, and hard assets such as permanent improvements to land). But, to the extent this is not successful; the government must be prepared to spend the excess (cash) savings for them. The most beneficial way to spend it may be subject to a lot of debate (like we have seen in comments to many of the recent articles). By “spend the money” I do not mean use it to buy up the existing assets or debt of other countries. Using the money to construct new production or other assets in other countries is OK, but continued systematic buying up of a substantial amount of existing businesses or other assets primarily to get rid of excess reserves is not OK.
With respect to responding to the current economic downturn it should be noted that the trade surplus countries have a flexibility that the deficit countries do not have. They have the money and they can spend it. This is a luxury the deficit countries do not have unless they continue to borrow further and run up their deficits even further. Because of the status of the dollar as a primary reserve currency, the US has been able to do this on a temporary basis but cannot do much more.
Michael: I agree with you that NPL is a real threat and I have said it many times in the past in your blog. PBoC should as soon as possible cap loan growth before the time bomb explodes. When it explodes another financial crisis will be created before the current one is over. Banks in China will compete with banks in the US to see who will have the most toxic assets. Apart from the big 4 banks in China there are many smaller banks in China and if one of the small banks gets into trouble then the crisis will begin. The China and Hong Kong stock markets will react as if heaven is falling down.
You mentioned a few options China would do to bail out which at the end of the day needs money. As a last resort I will not be surprised China will have to start selling (instead of buying) their Treasury etc. If China did so it would then put pressure to the US and the vicious cycle will start all over again. The US money printing machine will malfunction.
Prof. Pettis I think your blog is excellent, but this latest entry is simply outstanding and I commend you for making public such high quality information and contextual economic commentary.
I would like to ask you if you see any mirroring in the Chinese currency swaps and loans with (formerly) emerging economies with the currency swaps policy of the FED with the Coalition of the ZIRP-ing (UK, ECB, Japan, Canada, Australia, Switzerland etc)
Do you think this may be a sign of a future regime of balanced trade fundamentalism based on bilateral currency swaps agreements or is it a sign of impending global (outside of US) deflation?
Michael: Your summary of the events of the late 1920s and early 1930s is accurate, but it omits the one point of agreement between the internationalists and their opponents in the United States. Neither side was willing to accept default by either the Allies or the defeated powers who had borrowed American capital. There was complete political agreement in the United States on that point; the foreign debtors must pay. That insistence gave the debtor nations the choice of either (1) outright loan default or (2) printing more domestic currency and adjusting the gold exchange value accordingly. The second choice offered the happy corollary of also destroying the value of domestic savings. Not surprisingly, both America’s allies and its former enemies chose outright default. It seems harsh of you to blame this on the gold exchange standard, however. It is a bit like forgiving the robber who shot the store keeper and indicting the handgun. The debts accumulated by the allies and the post-war borrowers among the defeated nations were only made possible by the abandoning of the gold exchange standard in the first place by both the Europeans and the Americans. Even a believer in an expanded money supply, William Jennings Bryan, knew that the abandonment of all credit standards could only lead to financial disaster. As Wilson’s Secretary of State Bryan objected to loans to the allies as both a violation of neutrality and an abrogation of the rules of international finance. The difficulty with the present situation is that, like Americans in 1930, the Chinese are unlikely to accept any significant downward adjustment in the valuation of their accumulated pile of foreign debts. And, like the Americans on both sides of the political fence in 1930, they are likely to get the worst possible outcome – an outright default in the form of a forced equity conversion.
[...] his post, The Death of the Asian Development Model, Michael Pettis lays out his argument for why China’s low-consumption-high-trade-surplus [...]
This is an important piece.
we should let it translated and get it circulated all over the zhongnanhai..
I don’t think this is a fair analysis, Michael. Eloquent and informative, but ultimately biased.
You seem to insist that Chinese government policy will inevitably take on one of two forms… the fact that you speak of a “winner” in the debate between these two camps is proof that this concept is ingrained in your thought process, and you’re been repeatedly and consistently trying to identify which of the two policies will ultimately win. Every time you find a piece of evidence that suggests government policies are being used to prop up production, you see it as proof that particular camp is “winning”.
And yet when it comes to the United States, you’re willing to read the tea-leafs in precisely the opposite direction. You take one sentence out of President’s Obama’s inspirational yet vague speech about eliminating “consumerism”, and interpret that as inevitable government policy. How about the hundreds of pieces of other evidence, all equally relevant, that suggests elements of the current administration seems intent on reinflating the bubble?
I for one wouldn’t see either situation in such absolutes. Both governments, as all well-functioning governments should, seem to be trying to identify a middle path. The Obama administration is wise to use programs like TALF to provide credit to broad swatches of the American public, in order to lessen the impact of the current slow-down. The Chinese government is equally wise to prop up its man-power intensive productive industries. The consequences of not taking these short-term policies would be painful for both countries.
And yet in the medium to long term, both governments would be wise to attempt a fundamental restructuring of their economies. There isn’t a single “winner” amongst the policy experts, here.
On another note… I don’t see that growth in China’s trade surplus necessarily implies an equal amount of growth in the US’s trade deficit… there’s still significant pieces of the US/EU’s import pie that China can grab from *other* trade-surplus countries. The container ship subsidies that were discussed on this blog a few weeks ago, for example… how does increased production capacity for container ships negatively affect American/European economies? I certainly don’t see that it does… but on the other hand, it could very likely affect Korean ship-builders. That would ultimately only be to the advantage of American/European consumers, however.
The world is filled with negative news these days.The Mexico swine flu is spreading and it has the potential to develop into a flew-blown pandemic across the world. There are signs that it is now hitting the US and it would put salt on to the wound created by the financial crisis. China and Hong Kong can’t afford to be hit after the experience of SAR in 2003.
PS – Sorry for the typing error. It should read as “full-blown” and not “flew-blown” pandemic.
the economic transformation of the 1980s….. 80 million boomers, males and females, entering their prime working years…. I can “remember” that. and it makes another transformation 30 years later not such a tough call either.
Victor, over the years there have been numerous proposals, including several interesting ones from behavioral finance specialists, on ways to increase the savings rate. Tax credits, or similar measures like lowering the income tax and raising sales taxes, while regressive, should damp consumption. Ultimately I suspect that the savings rate will go up not because of changed policies but because of the need to rebuild balance sheets. Polices aimed at boosting savings, however, if successful will mean that higher savings rates will persist even after balance sheets have been repaired.
Dr. Loo, Chinas can only sell reserves if it is running balance of payments deficit, in which case it must do so automatically and not as part of a strategy. If it “decided” to sell reserves it must force a switch from balance of payments surplus to balance of payments deficit, which it can only do by allowing the RMB to appreciate substantially. Remember with the rest of the world buyers of RMB and sellers of dollars, the PBoC cannot suddenly switch from being a buyer of dollars to being a seller of dollars without forcing a huge adjustment in the value of the RMB. This means that unless they are willing to countenance a sharp revaluation and the collapse of exports, they have no choice but to continue accumulating dollars.
CLN, thanks for your comments. Frankly I pay little attention to the currency swaps partly because the amounts are quite small and largely because they really represent official transactions that are providing “aid” to countries that need increased dollar reserves in a way that is politically satisfying to China. Argentina, for example, does not want RMB reserves to protect the currency from capital flight. It wants dollars. As someone who knows Argentina very well and has been there dozens of times, I can say with some confidence that Argentine businessmen worried about the peso do want to exchange it into RMB, which can only be settled on the mainland. They want US dollars. The RMB swap, which is actually a swap facility, and hasn’t yet been drawn, in principle allows the BCA to conserve dollars by using RMB instead of dollars to pay for Chinese imports.
Steven, yes I agree. It is interesting that many of the “Asian miracle” counties, including China, saw their miracle years occur at the same time as they entered demographic sweet spots, only to see the miracle fade as they moved into demographic sour spots. It may just be a coincidence, but I suspect not.
LetUsHavePeace, although I might be guilty of having helping spread the USA 1930/China 2008 analogy, I also do not want to fall into the trap of taking the analogy too far. European war debts and German reparations were far in excess of what the former belligerents could have paid, and one of the links in that chain (Germany borrows from the US to pay reparations to the Allies, who then use the money to repay the US war debts) was extremely susceptible to interruption because, as Keynes pointed out several times, while France insisted on German reparations, it also insisted on measures to ensure that Germany could not possibly run trade surpluses sufficiently high to pay the reparations, so the whole system could only function as long as there was unlimited lending available in the New York bond markets – which pretty much ground to a halt between 1929 and 1931. By the way much of Germany’s obligations were gold indexed, which is why they resisted devaluation to the bitter end (on that subject I have just finished Adam Tooze’s absolutely brilliant and very long book on the “making and breaking of the Nazi economy”, called The wages of destruction – a book I strongly recommend, even to people who have no interest in Nazi economic policy-making, for its huge insights into the complexities of command economies and managed trade).
The position today is very different. First of all I am not sure there is going to be a substantial downward adjustment in the value of PBoC dollars, except in terms of RMB, and that adjustment must occur not because of US policy mistakes but rather as the wholly inevitable outcome of a trade policy dependent on a significantly undervalued exchange rate. Secondly, even if there is, there is no question of the Chinese accepting or not accepting it. Frankly there is nothing they can do, especially since one of the main reasons the dollar has adjusted so much against the euro has been that so many countries, especially in Asia, and especially China, have pegged their currencies at low rates against the dollar and so have forced the brunt of the dollar’s needed adjustment on floating currencies, mostly in Europe.
By the way I am very skeptical of excited talk about credit risks in USG obligations. The US is so far from bearing an unbearable debt load, and if savings rates in the US rise, the world is likely to be awash in investable savings.
CCT, I accept your criticism of being biased. I am congenitally skeptical. I have had a long career looking for the kinds of vulnerabilities that others miss, and I don’t intend to change, especially when it is so easy to find commentators on China who are far more optimistic than I have been. But in this case I disagree with your characterization. The choice of whether or not to engineer a rapid expansion of loans and fiscal spending is pretty linear. There is clearly a conflict between short-term and medium-term policies, and people much more knowledgeable than I am about Chinese elite decision-making are pretty firm in seeing a fierce debate between the two main camps. The historical analogies should convince us that this shouldn’t be a surprise.
The more the government engineers policies aimed at boosting production and investment to reduce current unemployment, the more they will have to deal with the consequences in the future. By the way for me the proof that one or the other side is winning has nothing to do with selective evidence. I simply look at the net performance of the trade sector. On average China’s trade surplus should decline at roughly the same rate as the world trade deficits, plus or minus some variation for special circumstances – although you shouldn’t fall into the trap of assuming that every special circumstance favors China. The fact that the trade surplus is actually rising, against all logic, in conjunction with massive lending and fiscal programs and rising intervention in the economy, must imply something about the types of policies that are being implemented. If a heavy wagon is rolling downhill, I am willing to be skeptical about intervention, but if it starts to roll uphill, I confess I am going to be biased towards assuming that someone is pushing it.
As for taking one sentence out of Obama’s speech, I didn’t do it because it is the only thing Obama or the USG has said on the matter, but rather because the point of my piece is to discuss what I think will happen and a single, evocative line on policy is enough for that purpose. In fact there has been quite a lot of discussion in academic and government circles about the need to engineer higher savings rate – even before the crisis, although the crisis has made it much more urgent – and it is hard to talk to Treasury officials nowadays without getting the impression that they are taking the idea very seriously.
By the way your line “Both governments, as all well-functioning governments should, seem to be trying to identify a middle path” implies far more generosity that I would be willing to grant. Well-functioning governments are perfectly capable of making bad decisions, and have done so many times before. The trick is whether or not there are formal mechanisms that can force them into reversing those mistakes quickly.
Dear Prof. Pettis,
My father was one of the very, very first US intellectuals to go to China when Madame Mao still ran the show. My family has been very involved with developing China. I was one of the earlier teachers of how finances, banking and capitalism works in tandem with historical processes.
The Chinese, since 1982, have hired a large number of people like you to teach them more stuff. You must realize, even though they are milking you for information, they see very clearly, your weaknesses.
One area you seem unable to understand is the logic of historical forces: any nation, during a global contraction following a global credit bubble bursting, MUST defend ITSELF from the crash with any means possible.
They do NOT save the entire planet. THIS IS IMPOSSIBLE. They must save their own governments from the collapse. This means doing things that get theorists very angry. For example, the ONLY thing the US could do when the European borrowing spree from 1914-1929 collapsed into repeat bankruptcies of major manufacturing giants [GERMANY]—the US could not allow all of Europe [GERMANY] to flood us with their exports.
We had to protect ourselves. This is why barriers shot upwards. They had to do this. After the US system broke down when we hit the US Hubbert Oil Peak in 1974, we fixed this collapse of our currency and our system by pushing for ‘free trade’ which destroyed our industrial base, warped our domestic economy totally out of kilter, drove up our public and private debts and on top of all this, created the hideous monster that is destroying global finances today: the interest rate OTC derivatives trade.
This monster grew from one billion dollars in 1982 to $600 TRILLION today. This is, by far and away, the biggest financial bubble ever seen in human history. And the toxic fuel, the oxygen that caused this thing to go from $30 trillion to $600 trillion was the ZIRP Japanese carry trade.
Which ended on 7/17/7. This is why the corrupt bankers where all howling about ‘no liquidity’ starting back then. Every part of every system was heavily leveraged by Japanese carry trade liquidity.
I am not teaching in your school in China because the Chinese government and I had a huge blow-out in 1989 when I got amnesty for all Chinese students studying in America that year. It was an epic battle! And I won so they told me, I can never be published in China or teach Chinese students.
Well….you are! I suggest you put your money where your mouth is and teach a class on the Tiananmen Square massacre. Explain to the students, how the Chinese in America gathered in front of the UN and camped there for a month. And how we forced President Bush to give them amnesty. I assure you, the Chinese will fire you and march you off campus.
It would be a most excellent lesson for everyone. I will support you when you hold your press conference. And do accuse the US government with COMPLICITY with the Chinese communist dictators. Our government conspired to move most US industries to China via the ‘free trade’ scam.
Thanks in advance, Elaine Meinel Supkis
Michael
You stated: “Chinas can only sell reserves if it is running balance of payments deficit, in which case it must do so automatically and not as part of a strategy. If it “decided” to sell reserves it must force a switch from balance of payments surplus to balance of payments deficit, which it can only do by allowing the RMB to appreciate substantially.”
IMO allowing the RMB to appreciate is not the only way to accomplish this. They can do it by a strategy to spend the excess net national savings rather than add them to reserves.
If the sum of net personal savings, business saving, foreign direct investment, and government savings (or deficits) equals zero, then the trade surplus and need to buy treasuries must necessarily trend towards zero. This results from the necessity for overall balances to balance as you repeatedly and correctly point out in your writings.
If individuals and businesses do not reduce net cash savings it may be necessary for the government to run a large budget deficit; however, the debt will be internal. Clearly the government has the money (e. g. the $2 trillion of accumulated reserves). It is hard to understand why they have such great difficulty in spending it, especially the new money continuing to come in.
Michael: Thank you for your thoughtful response and the recommendation of Adam Tooze’s book. I think your analogy is more powerful than you allow because, like the Allies and Germany, the United States simply does not have the ability to repay at par all of its sovereign obligations, if you include those to its own banking system’s insured depositors. If circumstances force the U.S. authorities to choose between defaulting on bank deposits and converting FNM, Freddie, Citi and AIG debt obligations into “equity” (sic), the Obama Administration and Congress will surely open Door #2.
While you bring up some good points, I have to disagree with the thrust of the article, which seems to narrowly focus on trade deficits (or lack thereof) as the primary facet of the asian development model. In fact, the modernization of institutions, infrastructure, and the opening-up of China to trade and investment are large factors in China’s development model, and should not be ignored in any analysis that attempts to describe it.
Professor Pettis: Your insights on World Imbalances are thought provoking and honest, albeit “congenitally skeptical”. Two factors might make you less pessimistic.
Relative demographic trends: the consensus is that the “desired” US savings rate has to rise — but to what degree is a key determinant of the length of the recession. The USA is now entering the first phases of the “baby bust” as the “boomers” enter retirement. According to the “life cycle theory” — seniors’ should reduce their savings rates or at least not raise them. Hence, demographics should mitigate a crash landing for US consumption — although the predictive value of models are poor.
On the other hand, China is still passing through the sweet spot of the demographic cycle — and this still has 10 -15 years to run. This should help to boost consumption and to lower savings for a time.
A second huge factor that you do not mention is the USA public sector dis-savings aggravated by unfunded wars — plus their ancillary costs (military hardware and especially health care costs and pensions). The latter will hopefully wind-down with a sane government in place and with greater burden sharing of the Afghanistan morass — thereby easing the stress on private savings.
World economic imbalances will similarly be eased by China’s rapid increases in military spending (as they do not increase productive capacity in your vocabulary) — although these resources would have a much better pay-off in better rural access to basic health and education facilities and setting up a social safety net.
Finally, your views of an inevitable explosion of NPLs may be a tad pessimistic. This implies that the recapitalisation of the banks (including foreign capital), cleaning up their bad assets in “bad banks”, floating the big ones on the stock market, appointing foreign directors, setting up better oversight, an independent, competent regulatory agencies, and better governance mechanisms over the past 5-7 years have been a total waste of time. The irony is that these best practice have been imported directly from the UK-USA — which I agree may be a major source of worry.
PS: the World Bank did not put the costs of the banking crisis in China at 55% of GDP! The 55% number is the ratio of NPLs to GDP — the “COSTS” are the interest on the added public debt — and with rock bottom interest rates — big but not gargantuan.
Yours faithfully, James
We just need NET savings to increase. The real problem was the explosion in debt, so the simplest way to cure it it is to decrease debt.
But right now the Fed is trying to restart the asset-backed credit market. Is it really likely that adding to credit card lending and the return of 100% car loans is what we need?
It seems to me this is analogous to China trying to export its way out of trouble. The U.S. may show itself to be more able to readjust in the medium term, but right now most of the policies are geared toward increasing consumption.
What renders subsidizing savings ineffective is that, in the U.S. at least, you have a lot of ants (big savers, as a % of income) and a lot of grasshoppers (big borrowers, as a % of income.) The aggregate figures mask this, which is why Greenspan could argue that household balance sheets were in good shape while debt was rising very fast: asset prices were to, and in aggregate debt was only 20-25% of assets.
The problem is the majority of assets are owned by the top 10-20%. They don’t really need to save more, but they will be the ones nimble enough to exploit a tax advantage to it’s fullest. Some studies showed that creating tax deductible IRAs actually decreased savings because they were used by people who would have saved anyways, but now needed to save less to achieve a particular goal.
And what’s the point of people in the bottom 40% of income saving at 5% when they are paying 18% on credit card debt?
Prof Pettis-
How would you rate the possibility that the pressures you could describe might actually result in a nominal DE-valuation of the renminbi? It seems clear to me that there is currently very little foreign capital trying to get into China, and quite likely large amounts of both foreign capital and domestic savings trying to get out. As we saw in Russia, if trade surpluses fall, might the short term pressures of capital flight simply overwhelm your longer term adjustment hypothesis?
Michael – an excellent and insightful summary. One that I wholeheartedly concur with. If you listened to any of Barry’s speeches in Europe it was pretty tough love indeed, despite the headlines (CSpan carried them all btw). In particular his before and after G-20 news conferences took the alleged vaugness of the inaugural and made it pretty explicit. In any case the American consumer has already made up their minds. (An interesting interview on PBS’s Newshour is the last segment is online with Paco Underhill). One can’t listen to much of that and think US consumerism is coming back any time soon.
Yet the Chinese leadership is on the horns of a major dilemma – what you recommend is the right thing for the long-term but how to get there without sufferring so much short term pain that social disruption results. With 20 Million (!) jobs already gone back to the farms a dicey and delicate time.
[...] China Financial Markets which is written by Michael Pettis has an intriguing post on the death of the Asian development model. [...]
I agree with your analysis except that it seems to to assume extreme change is the strategy, or is needed, rather then gradual change. The priority of the stimulus package in place now is to reduce unemployment, which is, of course, an understandable priority. It is reasonably clear that the leaders understand the need to increase domestic consumption, but over time. The immediate priority in China, as in the UK, the US and elsewhere, is to keep people employed and ease the suffering. China is quite capable of making the transition if the US and EU economies simply stop shrinking and remain stable. International trade is not going to zero. China will continue to be very competitive and at least keep its market share, albeit at a reduced level, while it makes internal adjustments to encourage/support domestic consumption. The US, China and the EU particularly, need to give themselves time to adjust.
Elaine, I have too many disagreements with your interpretations of both US and Chinese history, and especially the accompanying conspiracy theories, to go into them in any reasonable detail, but I do want to dispute your characterization of the “Chinese” as having hired me to milk me for information while clearly seeing my weaknesses. First of all the “Chinese” didn’t hire me – it was the Vice Dean of the school who did, and he decided to do so after a single lunch meeting, presumably without having had time to contact Zhong Nan Hai. Perhaps they do know all my weaknesses, and of course you may know the people at the Guanghua School and their motivations much better than me, but I am pretty sure they hired me for very much the same reason that my former school, Columbia University, has hired a number of Chinese scholars to teach there – because they believe that having different professors with a variety of experiences, knowledge and viewpoints might enhance the learning process for the students and the prestige of the school. As long as they continue to be willing to have me teach here I hope to be able to continue teaching some of the extraordinary students here that I have met.
LetUsHavePeace, the claim that “the United States simply does not have the ability to repay at par all of its sovereign obligations”, although popular in some excitable circles, simply has no credibility at all. No developed country in modern times, as far as I can remember, has needed to default on its domestic liabilities as long as these are denominated in its own currency, and anyway the USG has less debt than many or even most other rich countries (and of course, more importantly, no external debt). The 1930s analogy is always taken too far, but Germany defaulted then in part because the bulk of its liabilities were denominated in foreign currency and gold and mostly because it had no intention of paying interest and principle to countries with which it was at war. I am not sure I understand or follow the reasoning of the second part of your comment.
Susan, they are not ignored. They are all fundamental to any discussion of policies that affect the gap between production and consumption.
G. Stegen, I think you are misunderstanding the process. First, I disagree with this statement: “Clearly the government has the money (e. g. the $2 trillion of accumulated reserves).” The PBoC reserves are not wealth, they are simply the asset side of the PBoC balance sheet. The PBoC created RMB liabilities in order to purchase the dollars it holds in reserves, and it is very possible that the value of the debt already exceeds the value of the assets. If they “spend” the dollars domestically it is no different than if the MoF borrows money to spend it. It is simply domestic-debt-financed spending. Secondly, even if they decided to put a bigger hole in the PBoC balance sheet, in order for them to spend the dollars in China they must convert those dollars into RMB. Since they are the dollar buyer of last resort, if they suddenly switch from buyer to seller the market needs to find a new clearing level. This would cause the RMB to soar.
Of course the government could borrow domestically and go on a spending spree to boost net consumption and investment to the point where China runs a trade deficit. In that case the reserves protect the currency credibility and allow them to run a trade deficit for a long time without creating fears of unsustainability. Nothing prevents them from doing this, but so far this hasn’t happened.
Chan-lee, you and I must be looking at very different demographic numbers and very different Chinese banks. For the first, the US demographic problem is very different and much smaller than that of most other countries. Of the six “majors” (China, Europe, India, Japan, Russia, and the US), only India has a better demographic mix than the US. Although the US baby boom is clearly aging, as you say, nonetheless last year more children were born in the US than at any time in history. The median age in the US is expected to rise only by around 3 or 4 years over the next few decades.
China, on the other hand, has what could be characterized as a serious demographic problem. The sweet spot of China’s demographic cycle does not have another 10-15 years. On the contrary, it is almost over, with at most three to five years left. This means that from growing at more than 1 to 1 1/2 % a year faster than overall population, China’s labor force will now shrink by more than 1% a year relative to overall population. China is becoming the most rapidly aging major country in history. Today, Chinese are younger than Americans, who are younger than Europeans. By 2030 Chinese will be older than the rapidly aging Europeans, with one of the highest, perhaps the highest, percentage of people over the age of 65 in the world.
As for your statement that “This implies that the recapitalisation of the banks (including foreign capital), cleaning up their bad assets in “bad banks”, floating the big ones on the stock market, appointing foreign directors, setting up better oversight, an independent, competent regulatory agencies, and better governance mechanisms over the past 5-7 years have been a total waste of time,” I wouldn’t characterize them as a “total waste of time”, but nor would I describe them much more favorably than that. Of all the things you mention, only the recapitalization of the banks and the transfer of bad assets (not their cleaning up, as most of them are still outstanding) has happened to any serious extent, and most bank analysts believe that the “clean up” significantly understated the extent of the bad loans. I am not sure what evidence you see of better governance mechanisms – I never saw them except in formal statements. All the most senior bank managers are selected by the government and rotated at will, and I have seen little evidence that bank leadership is much constrained by their foreign directors, to the extent that they have any. Certainly the loan surge of the past four months should make you very skeptical of any claims that Chinese banks are not still policy banks.
By the way, to answer your PS, I don’t have the document in front of it but if I remember correctly a World Bank study calculated the direct and indirect costs of the late 1990s banking crisis as costing China 55% of GDP. The 55% you are referring to is one of the many estimates of the total amount of NPLs in the system as a share of GDP.
Bob, we will decrease debt. I guess the question is how fast do we want the adjustment to take place, and that will be determined in large part by fiscal policy. I am worried that in their eagerness to slow down the contraction the USG may also be dragging out the recovery process.
Will, like with much of what is happening in China, I am reluctant to predict the path of the RMB because I see this is primarily a political decision more than an economic decision. It will depend on a variety of factors, including outflow pressures and the level of trade friction.
Pettis: ….We should never underestimate the immense flexibility of the US and its ability to restructure itself at a pace far faster than most other countries can manage (anyone who grew up in the dismal 1970s will remember the dramatic – and seemingly improbable – US economic transformation of the 1980s)….
Michael, could you please further elaborate what was the dramatic US economic transformation during the 1970 and 1980s? And what do you mean by “restructure faster”? The time it took to resume GDP growth, or there’s other indicators?
Quote Michael: “By 2030 Chinese will be older than the rapidly aging Europeans, with one of the highest, perhaps the highest, percentage of people over the age of 65 in the world.”
While I agree with you that China is facing a demographic challenge, I think this particular sentence is not quite right:
China still has a fertility rate of 1.6-1.7 per woman (unless recent data has changed very significantly), compared to 1.1-1.4 in Japan, Germany, Italy, Spain, Russia, Korea and Eastern Europe. A lower fertility rate implies a higher long-run percentage of over 65 year-olds (unless you are assuming that Chinese life expectancy will rise until it exceeds that of the various other countries).
P.S.:
Wikipedia puts China’s fertility rate at 1.77 as of 2008.
http://en.wikipedia.org/wiki/Demographics_of_the_People’s_Republic_of_China
If that is indeed correct, then China’s long-run demographic problem is far smaller than in all those various countries listed above.
It is, however, bigger than in the US, which has around 2.0 children per woman.
Thomas, I have no idea of where the Wikipedia number comes from and how credible it is, but the best demographic numbers come either from the UN or the US Census bureau. They strongly support my claims, which I don’t think are considered controversial. I would suggest you read Jiang Zhou’s “China’s Long March to Retirement Reform”, published by the CIS. (which you can find at http://www.csis.org/component/option,com_csis_pubs/task,view/id,5419/type,1/). Alternatively there is a wonderful site at China Profile (http://www.china-profile.com/data/overview_1.htm) that lists the numbers and has some great animation of the statistics. In particular you should look at slide 3 “Animation: China’s population by age and sex, 1950-2050 (moving age pyramid)”
Michael,
I am not disputing in any way that China has a big demographical challenge coming up.
All I’m saying is that based on its current fertility rate, China will never be “older” than the countries I listed above (nor will it even come close), simply because its fertility rate is still much higher than in all those countries.
Btw, the report you link to also confirms that China’s fertility rate is roughly 1.8, in line with the number quoted by Wikipedia.
For illustration, let’s take Germany’s demographic projections and compare them to China’s:
For 2050, the report you link to says there will be 1.6 “working-age people” for every “elderly Chinese”.
Incidentally, the same ratio of 1.6 is projected for Germany based on official data.
However, with a methodological difference:
For China, “working-age” is defined as “15-59″, and elderly as “60+”.
For Germany, “working-age” is 20-64″, and elderly as “65+”.
I don’t have German data based on the Chinese definition, but quite obviously, the German ratio would be much worse if you based it on the same parameters (i.e. 60+ instead of 65+), because the number of elderly would be much higher based on the 60+ definition.
And Germany doesn’t have the world’s lowest fertility rate. It’s very low, but some other countries are even lower.
[...] China Financial Markets which is written by Michael Pettis has an intriguing post on the death of the Asian development model. [...]
Sorrz,guys,but I think the fertility rate is based on the ratio between the childs and the ferile womens.
But in China the male-female rait 1.24 between age 1-4,so if we correct the fertility with the sex ratio,it will be somewhere between 1.3-1.5
The demographic problems Dr. Pettis discusses are widely accepted in demographic literature, and I think Thomas that you should check them first, especially since you are using incomplete information. To give an example, you say that Germany and China will have the same average age in 2050 based on a ratio of 1.6 elderly to every 1 working age person. This is only true if China and Germany have the same vertical distribution of age groups, including the same proportion of very young, which they clearly do not have thanks to one child policy.
The average cannot be inferred just from that ratio. China’s vertical distribution is skewed towards the older ages. That means the ratio you cite is distorted in favor of making China seem younger relative to Germany. In addition, Dr. Pettis is discussing Europe while you counter with Germany, but I am under the impression that Germany’s aging is far from the worst in Europe. Perhaps I am wrong, but I think other countries except France are all worse. Even if you are right that average or median ages in Germany is the same as China in 2050, since China is much younger than Europe today, Dr. Pettis is still right to say that China is aging much more rapidly than Europe.
I also think that the most important demographic problem is not average age but rather working population to total population. Here China has the most terrible statistics of any country, I think.
Professor Pettis: Chinese stats are pretty flaky. Hence there is ample room for disagreement on “lies, damn lies and statistics”.
I cite a 2008 study by Zheng Juwei Director of the Institue for Population and Labour Economics of CASS on “Rapid demographic transition, consequences and challenges for China”.
There is a consensus that China faces a huge demographic problem, the tricky question is when? Apparently, most analysts believe that the 2002 Census estimate of birth rates at 1.2% is a big under-estimate with 2008 estimate of 1.77% The Government’s view and Zheng’s working assumption is for a TFR of 1.8% into the future.
In 2005 the dependency ratio was 42.10% (of which 31.29% young (0 -14 years) and 10.81% old (65+). The comparable ratios for 2009 are 39.22%; 28.31% % and 11.21%. For 2020 these figures are 42.91%; 26.45 and 16.45%.
In sum, the Working Age population (15-64) will continue to rise over the next 10 -15 years, albeit with a larger proportion of dependent labour force growth coming from rapid urbanisation (as in post-war USA and Europe). This was the sweet spot I referred to in my comments and differs from the figures you cite that imply a much earlier and sharper ageing effect.
To be sure the proportion of elderly will rise from 11.21% in 2009 to 12.99% in 2015; and 16.45% in 2020 before topping out at 25% in 2050.
This will be a big challenge, but long-term projections should be taken with a grain of salt.
Thanks for your update on higher US birth rates — ordinarily this should be a positive in terms of a structurally lower savings rate — which is a plus for greater world demand.
As regards better financial performance of banks and the banking sector: I guess you see the glass as half empty rather than half full. By memory the “bad banks” (with the help of Korean consultants) have salvaged some 25-30% of book value. Moreover, recent NPL experience has improved with Regulators reporting current NPL ratios in the low single digits. Whether these are credible is another question given a sharp slowing in growth, but recent improvements are consistent with the Banks prospectuses circulated before their HK flotation.
The big question is what have we learned from past crises? You appear to think very little (perhaps based on US-UK experience?). But, if you compare Korean banks today with pre-1997 practises you would note a sea change in lending practises and risk management. Hence, you may be under-estimating the capacity of Asians and Chinese to “copy and adapt best practise techbique” to local needs. Indeed, imitation is far easier than invention and innovation. That is the basis of China’s world factory model and is now being applied to services and academia as well.
PS’ The costs of the financial crisis are indeed the interest burden of additional public debt. It is a line in the IMF spread sheet used in calculating the PSBR and the required primary budget surplus to attain debt sustainability.
Yours faithfully, James
My two cents? Not only is this one of the smartest economic blogs in the world, but the quality of the comments exceeds comments for most other serious blogs. From the economics department at UCLA, where this seems to be widely read, keep it up.
Quote Bomlat: “But in China the male-female rait 1.24 between age 1-4,so if we correct the fertility with the sex ratio,it will be somewhere between 1.3-1.5″
Your point is correct, we need to adjust for the unusual Chinese sex ratio.
Normally, 2.06 kids are considered necessary to keep population constant, because on average, 2.06 kids means one woman has one daughter (normally, there are 1.06 boys for every 1.0 girls).
If the Chinese sex ratio is 1.24:1, that means 2.24 kids are needed to have one daughter, i.e. 0.2 more than in other countries.
Based on this, 1.8 kids in China equals 1.6 kids in Germany/Italy/Spain/Japan/Hungary etc. However, all those countries have fertility far lower than 1.6.
Gustav,
we are discussing 2050. Today’s vertical age structure will have levelled out to a large extent by then, as long as we are assuming constant fertility rates from now on (which is what the demographers are doing, as far as I’m aware). And btw, I am not saying that China=Germany in 2050. I am saying that Germany will be in a considerably worse demographic position than China in 2050. And some other countries will be even worse off, if current fertility rates stay unchanged.
Again, I fully agree that China is ageing more rapidly than other countries have done. The point I disagree with is that China will ever be “older” than those various other countries mentioned above. This will not happen based on today’s fertility rates (unless the sex ratio becomes even more bizarre, as Bomlat correctly pointed out).
@Gustav
France, the UK and Scandinavia do have higher fertility ratios, which are roughly the same as in the US. So it is probably correct to assume that (ceteris paribus going forward) China will be “older” than these countries.
@Gustav
I re-checked the Chinese and German population pyramids:
In Germany, the absolute number of births has roughly halved from 1965 to 1975, and has fallen further since. In China, the drop from “strongest age bracket” to “weakest age bracket” is (so far) only about 1/3.
So if anything, the decline in absolute number of kids has been more pronounced in Germany than in China.
@Chan-Lee James
Quote: “In sum, the Working Age population (15-64) will continue to rise over the next 10 -15 years”
I believe this is not correct.
For example, the report linked to by Michael states that working-age population will stagnate in 2010-2020. Presumably, it will rise a bit until roughly 2015, and then slowly start dropping (with the drop intensifying after 2020). You can check p.7 in the report.
The numbers you quote in your post imply the same: You say that the dependency ratio goes up from 39 % in 2009 to 43 % in 2020. With overall population rising a bit (around 0.5 % p.a. right now, decelerating going forward), an increasing dependency ratio of 4 percentage points over 11 years implies that working-age population is increasing a tiny little bit (i.e. increasing during the first half of the 2009-20 time period, but starting to decrease shortly after 2015).
Michael is quite right: The “sweet spot” will last for a few more years, but definitely not beyond 2015.
Dear professor,
As per usual, you misunderstand me. Unlike in the US, the Chinese want all sorts of information as well as learning all our thinking processes. People in your classes go to various careers. The ones who join the Chinese government do NOT use your teachings, they simply explain what thinking you use and they all agree, ‘Yes, the Americans have figured out nothing concerning the truth about our plans. Good.’
Look, they have plans, you know. I watched them cook it up high in the political party itself. This is utterly different from the system you are in. You are NOT part of the communist party of China, you are an outsider.
You see, they are playing a very difficult game: they want to disarm the US the same was we disarmed Russia. Via economic collapse which will eventually prevent the US from funding our military expansion via international credit. Bankrupt, the US will have to surrender power in Asia to China. This is why Japan is suddenly talking openly about getting nuclear bombs.
The LDP always thinks about getting nukes but keeps this inside the upper tiers of their government and won’t tell outsiders.
If anyone graduates from your courses and enters the communist hierarchy, they will get special lessons taught by the Leadership itself and these will be about the 50 Year Plan they cooked up in the early 1980’s.
Scoff at me if you want! You don’t know my name but I will suggest, if you tell your students to read my information about how I watched, from very close quarters [ie, I was living with some of China's leaders!] the development of the 50 Year Plans.
I strongly suggest you go find some party officials and mention you know about these plans. Watch you get thrown out of China like lightning! Mention ‘Elaine MEINEL’ to them and they will probably flip out.
[...] The death of the Asian development model [...]
Michael: I wrote that the U.S. did not have the resources to redeem at par all of its sovereign obligations. Those include its guarantees of the money center banks’ debts and those of FNM, FRM, AIG and the other firms that have been “rescued”. That the U.S. does not have enough savings and the ability to borrow enough of other countries’ savings to redeem all these pledges at par seems to me a simple fact. Solvent financial institutions do have the ability to redeem all their pledges at par; that is what makes them solvent. What you seem to be arguing is that there is sufficient liquidity right now that the U.S. insolvency is not really a problem because it can be worked out over time. That presumes that the U.S. will have the ability to increase tax revenues and to raise world prices for goods and services sufficiently to restore solvency. It may. But there is an equal and even greater chance that there will be a “bank run” on U.S. obligations by the Chinese, that they will decide to dump dollar assets out of fear that the U.S. will default by converting debt to equity. Given a choice between a share in CITI and a pound of copper, I would do the same. When that happens, the U.S. will not default on its domestic bank deposits; but it will most certainly default on its guarantees of debt other than U.S. Treasury obligations themselves, by performing a “rescue”. It is this possibility that seems to me to have a real parallel with the events after 1930. n analogy
In regards to demographics, the U.S. has both a relatively high fertility rate and a very high immigration rate. According to the CIA Factbook, china has a very small out-migration:
https://www.cia.gov/library/publications/the-world-factbook/rankorder/2112rank.html
From that chart, it looks like old Europe too has net immigration.
There many questions hidden in the demographics.
The working age in China is by no means 60. Until last year it was close to 55 for men and 45-50 for women.
Another thing is that we don’t how many Chinese there are. The number of women without hukou could be huge as they were hidden away, because their parents would have to pay fines for having more then 1-2 children.
Pettis.
On the other hand a different group of policymakers and power brokers – who include, I think, the Ministry of Commerce, the important exporter constituencies, and above all the powerful provincial and municipal leaders – are much more concerned with enacting measures that immediately address the expected rise of unemployment in the short term.
I still think the 2 trillion dollar reserves is now seen as a curse more then a blessing by most people in Zhongnanhai, so both Victor Shih and you may be too keen on splitting the party, before anything is decided.
I would agree that the Ministry of Commerce could be seen as hawks on the boost employment or reduce trade imbalances issue, but with Xi Jinping and Li Keqiang most likely to take over in a few years, it might be more relevant to hear what they have to say, then the Ministry of Commerce.
On a recent visit to Guangxi Li Keqiang mention enlarging the internal demand/consumption and just stabilising the exports (http://www.wabei.com/news/200904/191053.html). The need for a stronger internal consumption base is a very good way for a new leader to position him self in opposition to the Ministry of Commerce, who most be getting some blame for this new mess and Hu Jintao/ Wen Jiabao that also have dirty hands. Li Keqiang is after all an economist and they are next in line for the power as the need for engineers subsides.
Wonder when the philosophers take over?
quick comments. will write more if have time later:
1. Whether the current surge of credits will turn into large NPLs needs closer look. What I heard is most of the new loans go to the infrastructure projects which were delayed or suspended as a result of the economic cool-down policy in 2007. I tend to believe these projects are not bridges to nowhere.
2. Export is a quick way for poor countries to catch up with their wealthy trade partners. Not only Asian countries, but also Germany grew this way post World War II.
3. The current global trade imbalance is a result of human capital arbitrage. If I were a capitalist, I would sure have moved my factory to the place with the cheapest labor. I can hardly imagine how Obama could bring the manufacturing jobs back to the states if he allows the Corporate America to continuously pursue profit maximum.
4. China only shares a very small part in the whole export value chain. Some people have calculated that for one dollar of export products, the foreign investors might get 60 cents, Hong Kong or Taiwan logistics middle man might get 30 cents, while China gets the rest 10 cents. So the major benefit gleaned by China from export is not export dollars but jobs created by the sector. The current infrastructure spending spree is intended to creat jobs for migrate workers who were laid off by the export sector.
5. The key challenge for China is to improve productivity. Right before Asian financial crisis Paul Krugman wrote a piece demising the so-called Asia economic miracle. I kinda agree with him. He argued that the Asian growth model is not sustainable because the high growth of most Asian countries had been achieved by inputs of capital and labor not by improvement of productivity.
[...] The death of the Asian development model (Pettis) [...]
Michael: I wrote that the U.S. did not have the resources to redeem at par all of its sovereign obligations. Those include its guarantees of the money center banks’ debts and those of FNM, FRM, AIG and the other firms that have been “rescued”. That the U.S. does not have enough savings and the ability to borrow enough of other countries’ savings to redeem all these pledges at par seems to me a simple fact. Solvent financial institutions do have the ability to redeem all their pledges at par; that is what makes them solvent. That presumes that It may.
Michael: I wrote that the U.S. did not have the resources to redeem at par all of its sovereign obligations. Those include its guarantees of the money center banks’ debts and those of FNM, FRM, AIG and the other firms that have been “rescued”. That the U.S. does not have enough savings and the ability to borrow enough of other countries’ savings to redeem all of its current pledges at par seems to me and most dispassionate observers a simple fact. Neither the U.S. private banks, insurance companies and other recipients of Federal guarantees nor the U.S. government has enough assets valued at market and enough ability to tax private assets to match the outstanding liabilities. In an orderly liquidation the creditors would come up short. That is not the case with a solvent financial institution; their ability to redeem all their pledges at par, provided they have access to a discount window to meet liquidity demands, is the very definition of solvency. What is also a fact is that, even with the assistance of its own central bank exchanging bank reserves for government paper, the United States remains dependent on the kindness of foreign savers and lenders. What you seem to be arguing is that, because the Federal Reserve is providing liquidity, the U.S. will have enough time (1) to raise world prices for goods and services so that the boost in the prices of the banks’ collateral will be enough to cure their non-performing loans and (2) increase tax revenues sufficiently to to raise whatever additional capital is needed. This may prove to be the case. But, if inflation does not return and buyers of U.S. residential and commercial real estate and bank lenders remain stubbornly cautious, there is an equal and even greater chance that there will be a “bank run” on U.S. obligations by the Chinese and others. You seem unwilling to even consider the possibility that, in the name of rescue, the U.S. authorities may see the auto company bailout as the model for the “final” financial system rescue. The U.S. would not even be in default as far as the swaps market was concerned, and both U.S. bank deposits and straight Treasury obligations would be unimpaired in value. The losses would be incurred only by the bondholders of the rescued institutions. It would certainly be the easy way out for U.S. politicians.
If this type of rescue were to become even a theoretical possibility, the Chinese would certainly have an incentive to swallow their losses in their existing U.S. dollar portfolio for the sake of not incurring further ones. Given a choice between a share in CITI and a pound or two of copper, I would do the same. It is this possibility that seems to me to have a real parallel with the events after 1930.
It may put me in what you consider “excitable circles”, but I think it worth the risk to suggest again that the potential insolvency of the United States rests with its having obligations that are not “domestic” at all even though they are denominated in U.S. currency. All the best.
Dear Prof Pettis,
I haven’t made much comments lately, but have been following your posts religiously. Hope all is going well for you.
I agree with your conclusion, death of the asian development model. but disagree that China is dependent on the US consumer.
1st, on US consumers. in addition to all the points you have stated above, state and local govts in the US are actual raising taxes for both individuals and small and private enterprises. US consumers are in for a long ride…. pple are bailing out on the long ended of the curve, the treasury curve is almost as steep as when lehman failed. it won’t be long til mortgage rates start to go up again.
second, on China’s development model. i believe there have been two basic models at work for the past decades. one is the export led model, the other is the private investment model. export led development largely provided massive job opportunities, but not wealth, it supplied social stability, but has really minimal impact on per capita income growth. the second model is the reform model which provided new sectors for private money to invest in, such as, real estate, mining, financials, internet, etc.
These twin engine of growth had supported China’s unbelievable growth, and social stability.
you have addressed the first issue which is deminishing external demand. however, the key to china’s future growth isn’t dependent on its export as stated above.
the real growth of china comes from healthy private investment opportunities which require the govt to continue its economic reform and open up industries, sectors for private money to invest in. however, such opportunties had been 1) capped by the govt, 2) deminished due to commodities prices.
hence, the future of China does not lie with the US consumers, but the private investment environment in China, which is not looking promising at the moment. I used to hear about pple making money from real estate, stocks, openning internet companies, buying small mines, etc. Now.. I hear nothing!
Leon,
You made a good point that China’s export strategy provided massive job opportunities but did little to increase wealth. In Fact if it was not for the the setting of prices by the government, man Chinese workers, feeling the full force of inflation, would have been worse off.
The methods needed to continue the development model were becoming increasingly expensive. Between that and the inevitable backlash from exported unemployment it was a model doom to fail.
Hello Thomas: To answer your query:
“In sum, the Working Age population (15-64) will continue to rise over the next 10 -15 years”. This says that the absolute number of WAP will rise over the next 10-15 years. But as indicated, the ratio of WAP to total pop will decline slightly. The 2 observations are not inconsistent, although I could have spelled it out more clearly.
But the killer issue is not the numbers per se,but how sensitive the projections are to recent changes in TFR that give a less pessimistic view of the future than Prof. Pettis — even though they are highly uncertain.
Returning to Prof. Pettis question “about what banks I am looking at to see evidence of better governance, efficiency and performance?” I cite public information including : 135 banks with BIS capital adequacy ratios of 8% compared with just 6 when the reforms were launched ; a steady fall in NPLs from 20+ to 6.16% in dec.07; 2.45% dec.08 and 2.04% in mar. 09; Current Bad loan provision coverage of 130%. Similarly the chief regulator expects NPLs to continue to decline in “value terms” through 2009. Ideally, I would like to have rate of return on equity as reported by the OECD, but China is not yet in the programme. Even so, if you look at the “best” Chinese banks (with foreign participation e.g. Communications Bank) — they have ROEs that are similar or better.
You can disagree with these stats — but they all show strong trend improvement based on providing better, more efficient “basic” plain vanilla banking services. By contrast, the G-10 banks show exactly the reverse.
If Letushave peace is worried about USA sovereign solvability — he should be losing much more sleep over the G-10 banking system and putting his money into basic commodities.
yours faithfully, JamesC
Michael:
I think I understand the process at a global scale. The government, via the PBoC collects up the net cash savings of the country and uses them to buy foreign assets (primarily US treasuries and other foreigh debt securities). They finance this primarily with various kinds of debt (e. g. bonds and obligations to depositors) and possibly by creation of money.
You state: “the government could borrow domestically and go on a spending spree to boost net consumption and investment to the point where China runs a trade deficit…. Nothing prevents them from doing this, but so far this hasn’t happened.”
This is exactly my point. I do not have the details of internal cash flows and balance sheets but the trade surplus is adequate proof that it hasn’t happened. If/when it does happen then the PBoC may need to switch to investing the collected savings in China goverment bonds which will then show up as the assets on thier balance sheet.
A key aspect is that the added public debt will be internal to China and denominated in RMB. If trade deficit coutries try to stimulate thier economies by deficit spending, the debt will be external and will often not be denominated in their currency, which is a completely different sitation.
If China attempts to hold the RMB constant while increasing goverment spending to the point the trade surplus disappears, the economy could begin to overheat (a desired outcome). If the economy hits capacity constraints/begins to overheat, then they could begin to let the RMB rise gradually and perhaps increase taxes a bit to take some heat out of the economy and reduce the budget deficit without causing massive unemployment.
Fertility rate:the real rate of fertility = nominal ferility – 0.2 , if the mal female ratio is 1,14:1
As Thomas calculation show it.
It is true roughtly between 1.6-1.8
What stops the Chinese government going on an unlimited spending spree is the threat of inflation and the limits of capital accumulation itself. China as a relatively undeveloped nation with still around half of its population remaining small farmers only tangentially connected to a market economy, has a finite limit to the amount of capital investment it can swallow domestically.
That’s why this year as the threat of inflation has receded as raw materials prices have collapsed its government is able to ramp up domestic investment to the point where it can completely offset the crisis of its export sector, but still has to export its surplus capital abroad.
That’s why I’m personally sceptical about the estimates of Goldman Sachs and the like that the US needs to return to an 8% domestic saving rate, the level which prevailed upto the mid 1990s, as for sure China will re-direct its economy towards domestic investment, but even then it will still not be able to absord its entire surplus. Where else will it be able to dump all this capital other than in US treasuries.
A very interesting take on China and the future from STRATFOR’s chief -
http://finance.yahoo.com/tech-ticker/article/237940/%22Split-Down-the-Middle%22-Why-China-Won‘t-Dominate-the-21st-Century?tickers=FXI,EPP,PAF,GCH,PGJ,EWJ,EEM
Anyone else see this?
Hi Michael,
I read with interest your articles and musings on the global banking crisis. I’m currently studying Mandarin at BLCU for a couple more months and have been frequenting cafes near WuDaoKou to study. I have been sitting near what i assume to be MBA students doing financial case studies, talking about gearing and the amount of debt companies should undertake. What really caught my ear was when one of the students talked about the IRRs they could achieve if they increased the sum borrowed. Fairly standard corporate finance model i believe and it was taught to me when i was studying finance.
Has this current crisis not altered what is being taught on these MBA courses at all? You talk about NPLs and this is the very basis why so many NPLs occur. Companies taking on too much leverage and subsequent cashflows are not sufficient enough to cover their debt obligations. How is the current crisis altering what is being taught to (potentially) the next financial officers, CEOs and directors of future companies?
Following the heated discussion on China’s demographics further up in the comments, I thought about the topic some more. If anybody is still reading this and interested in comparative demographics, here’s my blog post on this topic:
http://miscellaneous-economic-ramblings.blogspot.com/2009/04/demographics-china-vs-rest-of-world.html
chan-lee james, on the question about banks:
in my experience, Chinese banks are almost certainly piling up major NPLs. Bank loans from the Big 5 banks appear to be allocated to 3 sectors:
1) productive infrastructure investments, which are channeled through govt bureaus & SOEs (and suffer loss in the process)
2) non-productive government patronage, like setting up an SOE staffed with retired bureaucrats and armed with a goverment mandate or monopoly which it can borrow against
these first two are the recipients of a major portion of the recent bailout but it is the third which is most damaging
3) most bank loans – even to govt entities – are backed by real estate collateral. i would bet chinese banks have a proportion of assets backed by real estate collateral than US banks did by securitized mortgages. What happens to those NPLs if real estate values drop by 20%?
Mr. Robert Devine: in reply to your comments, I am not an expert on the Chinese banking system and have not absorped recent developments. Nonetheless, your impressions appear to be based on behaviour and trends circa 2003-04. Big changes have occurred since then.
The Watershed was the appointment of an independent Head to the CBRC in 2003 with political clout and cabinet level rank. His first act was to appoint a blue ribbon panel of experts (Volker, Eddy George, etc). Their first concrete actions were to ENFORCE better accounting and disclosure standards (including international NPL classifications).
Carrot and stick incentives were then introduced to restructure bank’s internal operations and to improve internal controls and management to qualify for “selective” debt write-downs and capital injections and early stockmarket listings.
The banks also made strenuous efforts to raise capital by issuing shares and subordinate debt.
The other pillar of the strategy was foreign entry in advance of China’s WTO commitments — to tap foreign management and technology (at the time that HSBC entered a joint venture with Comm BoC value added per employee was 1/8th of HSBC’s ! Their latest annual report shows the huge progress made in matching HSBC standards).
A string of high profile joint ventures have followed with improvements in productivity and profitability. I have already noted the sea change in meeting BIS capital requirements, the trend decline in NPLs and bad loan provisionning, etc.
But as you rightly mention a big remaining problem is potential new NPLs from loss-making SOEs and speculative bubbles in real estate, etc. But progress is being made even here.
Bankruptcy was virtually unknown a decade ago. But the new insolvency law in 1994 has seen a sea change. Since 1994, more than a half of the most inefficient SOEs have been closed or given to their workers (after writing off their debt). The number of small and medium size SOEs has dropped from 238 000 in 1993 to around 120 00 currently. (The biggest SOEs are of course mammoth National Champions that live off monopoly rents and hence have no financing problems. This was the policy of “grasp the large and free the rest”.)
That said, China is far from having a bankruptcy system that promotes efficient debt workouts, debtors in possession arrangements or recycling of damaged assets to new managers or that compensates creditors and stakeholders in an even handed way. It is work in progress.
Even so, a smaller more efficient SOE sector alleviates many of the NPL strains you mention. The flipside of this is also a dynamic “private” sector which may now be as large (in terms of share of GDP) as the USA’s (if you include the on-going bail outs of almost every thing). Recent OECD estimates by memory put the Chinese private sector at almost 2/3rds of GDP.
As regards the credit fueled 2001-05 boom in infrastructure and housing — the CBRC has not been completely asleep at the switch. From 2005, forward risk-based capital adequacy ratio requirement were implemented (unlike the pro-cyclical ones in place in the US/UK). Similarly, reserve requirements were raised steadily from 2006-07. Moreover, administrative guidelines targeted at overheating sectors (cars, steel, cement, basic materials and real estate) were put in place.
To be sure, these quantitative measures did not eliminate the boom bust cycle, but they probably damped it (c.f. the stockmarket) — which is more than the Bank of England and FED achieved !
The Chinese banking system has a long way to go to reach world standards –and to improve credit flows to the private sector. The CBRC and PBOC have big challenges to cope with slower growth and NPLs — but as “quantitative” measures are now the vogue — the Chinese are surely better placed at this then the US and UK.
Yours faithfully, James
PS: property prices in Shanghai are apparently on the mend along with industrial output.
PS’ If you are looking for lending data to the private sector check out Farrell and Lund “Putting Capital to Work” FEER 2006. They have probably made more recent estimates but my filing system is also work in progress.
Until we some action, Obama’s words are just rhetoric. Talk of increasing the consumer savings rate in the United States is noble, but the Federal Reserve continues to hold interest rates at 0%. U.S. consumers will not start to save until they can get better return on their investment.
What we are seeing right now in the United States are consumers who are tapped out. The reason that they are not borrowing is not because of a new-found saving religion, but rather an inability to borrow. Again, that’s not the fault of the banks, but the consumers themselves, many of whom are upside-down.
Regardless, everyone (including the PBoC) agree an increase in domestic consumption is the only long term answer. That’s why they are building the new social safety-net and pushing the message that spending is a patriotic duty. But this is not an easy transition for a country deeply rooted in a culture of thrift and caution.
Quote Chan-Lee James: “property prices in Shanghai are apparently on the mend along with industrial output”
Can you provide a link to recent data? Shanghai’s Q1 GDP release was quite dismal, much worse than China overall.
[...] teeth [or values it enough to buy a new one and maybe forego a meal.] Extreme, crass example – the more nuanced counterpoint, one that Pettis has been making for a long time now, goes something l… … if the explosion in new lending (loans are up 15% in the first quarter of this year) leads, [...]
[...] Death of the Asian Development Model: The wages (ahem) of frugality & underconsumption taken to the extreme. [...]
[...] private savings. One wonders if history could repeat itself. Certainly this appears to be Pettis’ [...]
[...] fact as I have argued many times (for example here, and here), I suspect that most of the Chinese fiscal stimulus is exacerbating the imbalances – both by [...]
[...] fact as I have argued many times (for example here, and here), I suspect that most of the Chinese fiscal stimulus is exacerbating the imbalances – both by [...]
[...] The death of the Asian development model mpettis.com/2009/04/the-death-of-the-asian-development-model – view page – cached April 25th, 2009 by Michael Pettis | Filed under Asian development model, Banks, Consumption and production, Fiscal stimulus, NPLs. — From the page [...]