Comments on: I wasn’t impressed by China’s high reserve and GDP growth numbers

By: Twitted by e8keom0

Twitted by e8keom0 — Fri, 21 Aug 2009 04:13:30 +0000

[...] This post was Twitted by e8keom0 [...]

By: Tom

Tom — Wed, 29 Jul 2009 21:43:54 +0000

Prof Pettis,

I’m not sure how often you view comments on older postings, but I just discovered your blog and have been going through it over the past couple of days. I have a pretty simple question – why do you state:

“Furthermore I think the focus on investment in infrastructure and manufacturing will make much more difficult China’s ultimate transition towards an economy in which surging debt-fueled US household consumption plays a much smaller role. In addition much of this new investment is in projects with very low, or even negative, returns (and I suspect they would almost all be negative if interest rates weren’t kept so low by the PBoC). This is not a way to increase Chinese wealth.”

Why do you view their investment in infrastructure to have negative returns? I understand empty apartment buildings, but additional highways, etc… will be the basis for the growth of this economy for years to come. Haven’t we seen something like this in the US several decades ago?

By: steve from virginia

steve from virginia — Fri, 24 Jul 2009 05:01:18 +0000

Whoo boy, some interesting stuff and a lot of nonsense. Good grief!

This is from Mr. Ross:
“China is entirely right to prioritise large scale capital inputs because econometric studies show that capital inputs (i.e. the level of investment) are the main determinant of growth. Once it is admitted that China requires a high investment rate then the need for a high savings rate follows as an immediate consequences because investment can only be financed by saving.”

I agree with that, but the Chinese savings rate is an import; of the millions of high- paying US jobs relocated to China over the past decade. Without going into page- filling detail, that ‘wage/savings’ arb trade is coming to an end. With it goes the ‘real’ savings.

China’s savings are valuable to the Chinese and perhaps moreso to the US; they are a wasting asset. How will these savings be allocated?

This represents an unhedgeable risk for both China and the US that hasn’t been ’stress tested’. The easy/bad answer is inflation. The amounts of Chinese risk are enormous and growing. Sufficient risk and the reserves China possesses become inadequate. How do I know? Just reading the statements of the Chinese goverment financial hotshots convinces me that when push comes to shove there are enough bad loans @ PBOC dependencies to leave them insolvent @ the root. Just like their counter-parties in the US.

China yuan gambit:
http://economic-undertow.blogspot.com/2009/07/greshams-law-writ-large.html

Hey! The carry trade explains the foregoing:
http://market-ticker.denninger.net/archives/1252-Welcome-To-Hell.html

One can determine the size of the carry by counting the increase in China’s dollar reserves. That represents FX risk that has been hedged by being joined at the hip to Mr. Helicopter. Good Grief!!!

China subscribes to the ‘Key Man’ philosphy in that any institution that represents systemic risk is nationalized so it cannot ‘Fail’ but institutional risk swept under the rug emerges somewhere else! The race to the bottom has shifted from wages (unemployment =’s unemployment) to currencies. The crisis is likely to emerge from the broken dollar/yuan peg. Everyone and his/her mother thinks the yuan is undervalued, so everyone is wrong! The dollar is stronger because of what it can buy; Hollywood! What can the yuan buy? Salad shooters and toys covered with lead paint. Ugh!

The yuan is garbage and the Chinese themselves know it! This is why they only trade with international finance powerhouses like Belarus and Argentina. This is also behind all the ‘SDR’ nonsense. When the yuan trades the emperor will be seen naked, the last thing the Chinese managers want or need.

Ross sez:
“Econometric studies confirm capital inputs are the most important quantitative source of economic growth in China, the US and internationally. Any claim that economic growth is not correlated with the rate of investment therefore has no statistical legs to stand on.”

I hate to break it to you but conomies are made up of people with seemingly clever, stupid ideas, not statistics. Ross, meet Herman Daly.
http://www.publicpolicy.umd.edu/faculty/daly/sciam-Daly5%20copy%201.pdf

The people need resources to work with, the first order inputs such as water, soil, energy, minerals etc. The world is learning the hard way that credit is no substitute for resources, no matter how much is ginned up by finance and CB’s. First order capital isn’t even fixed, it’s depeleted and becoming moreso every minute, largely by the actions of leveraged Chinese ‘capital’, btw.

China’s manufacturing advantages are cheap labor and cheap coal.

http://www.energybulletin.net/node/29919
http://www.energywatchgroup.org/files/Coalreport.pdf

“The EWG report’s authors, taking these factors into account, state: “it is likely that China will experience peak production within the next 5-15 years, followed by a steep decline.” Only if China’s reported coal reserves are in reality much larger than reported will Chinese coal production rates not peak “very soon” and fall rapidly.”

Cheap labor and coal has given the Chinee people the ticket to a party that is ending very soon. Cheap coal will be gone in 5-15 years and then what? The world oil market has been driving economic policy since 1973. The Japanese embarked on building asset bubbles in the early 1980’s when oil prices were high. Inflating asset prices were to be a hedge against energy prices – sound familiar? Same asset bubble strategy tried in the USA beginning in 2000; same rationale, increasing energy costs rendering real production unprofitable. Send US jobs overseas and call it ‘trade’. Book the difference and invest in Wall Street and tract houses. Both the Japanese and the US are living the consequence with oil prices now past the point of energy- no return.

Peak oil took place in 1998: http://economic-undertow.blogspot.com/2009_06_01_archive.html

Here’s more: “Energy Secretary [Chu] was my boss,” David Fridley says. “He knows all about peak oil, but he can’t talk about it. If the government announced that peak oil was threatening our economy, Wall Street would crash. He just can’t say anything about it.”

http://www.bohemian.com/bohemian/06.17.09/feature-0924.html

One reason I can make relatively informed comments on China’s conditions is because that country and the US are joined at the hip, with the Chinese desiring to be more and more like America in all things. So, they repeat all of America’s mistakes and lie to themselves, calling the mistakes something else, like ‘development’ and ‘prosperity’. These are words that depend entirely on dirt cheap power and one other thing. What I read from Michael Pettis is the Chinese are too dependent on US customers. This is true. Now, the Chinese do not have them because the US customers have finally reached income parity with their Chinese counterparts. The Chinese themselves do not earn enough – recycled cash flows – to repay the enormous credit structure the government has grafted onto them, just like the dishwashers and landscapers lacked the means to support the subprime/securitization/structure finance credit regime erected upon them in the US. This is an insurmountable problem; it cannot be solved only coped with.

If ‘poverty’ cannot be ‘escaped’ by ‘growth’ in America, it certainly cannot happen in China.

The two countries for different reasons are attempting the same impossible task – to sustain the US consumption model – and are calling it an escape from poverty.

Escape from reality is more like it. A well- worn path leading to destitution, sprinkled along the way with momentary flashes of false hopes.

By: John Ross

John Ross — Thu, 23 Jul 2009 22:03:29 +0000

Michael Pettis:
There are two discussions, but which are highly interrelated, going on. Both are subject to factual testing. As you, reasonably, made a request for a paraphrase let me set them out.
The first is over the success or failure of China’s stimulus package. One school of analysis is that this package will fail, or even worsen the situation (either immediately or in the longer term). Those holding such views include Stephen Roach, Martin Roach, and yourself. As regards the fundamental reasons why the stimulus package will fail yourself and Martin Wolf have (overall, not necessarily in detail) a common thesis that China is overinvesting/oversaving. As the present stimulus package is, evidently, driven most powerfully by investment (in the first half of 2009 investment accounted for 6.2% of GDP growth, consumption for 3.8%, and exports for -2.8%) if China is ‘overinvesting/oversaving’ then such a stimulus package is likely to make the situation worse over any reasonable time frame.
A second analysis of China’s stimulus package is that overall it will be successful. I have set out my reasons for believing it will be below. Others who believe it will succeed, for somewhat different reasons, include Jim O’Neill of Goldman Sachs or Professor Danny Quah of the London School of Economics.
The assessment of the success, or failure, of China’s stimulus package is evidently a highly important issue for the world economy. People with serious knowledge of the subject support both opposed views. Quoting ‘authorities’ however does not settle any issue so let us consider the key facts. I will set out these out first as simply as possible, and linked to the underlying analytical points, in a positive fashion before dealing with the errors of the oversaving/overspending thesis you have outlined.
1. Put in technical terms the growth of factor inputs (labour and capital), in particular capital inputs, is the primary source of economic growth internationally, in advanced economies such as the US, and in developing economies including China – for a comprehensive survey of the factual data see Dale Jorgenson’s The Economics of Productivity. Therefore China is right to aim at a very high rate of growth of factor inputs – in particular, as this is the issue being discussed here, a very high rate of growth of capital inputs (investment). Once the goal of a high investment rate is considered correct then a high level of savings follows as a necessary corollary as investment can only be financed by savings.
2. A very high rate of growth of investment in China would not produce rapid growth if China used its investment inefficiently – then the alternative course, to maintain a high growth rate, would be not to invest at a high rate but increase the efficiency of investment. Theoretically an inefficient use of a high level of investment is entirely possible – indeed it is one of the main arguments against ‘import substitution’ models of growth which notoriously produce extremely inefficient use of capital whether they are based on market (e.g. Argentina) or non-market (e.g. the USSR) economies. However the most comprehensive studies, those based on Total Factor Productivity (TFP), find that China’s use of investment to increase productivity ranges from ‘respectable’ (the finding by a sceptic regarding Asian growth statistics such as Alwyn Young) to the view that China’s TFP is high. As even someone who shares your overall view, chan-lee james, concedes these are not a few but a large number of studies. Furthermore China’s TFP growth rate continues to be very high (1st or 2nd in the world in major economies according to the study by Jogenson and Vu noted above). Even if we take the worst case analysis that China’s TFP growth, based on a high level of investment, is ‘respectable’ then a high level of capital inputs plus ‘respectable’ TfP growth will produce rapid economic growth – the desirable outcome. If a high level of capital inputs is combined with high TFP growth, as found by other studies, growth results will of course be even better.
This deals with the ‘investment’ side of what chan-lee james refers to as the ‘Asian export-cum investment led model ‘. Now let us consider exports.
3. The problem with the accusation of ‘export’ led growth is that confuses two different issues. The first is the level of exports as a proportion of GDP. A high, indeed growing, proportion of exports in GDP is desirable – it is precisely the process of increasing international division of labour and securing the benefits of economies of scale that helps makes globalisation successful. As with high investment high exports are desirable.
A different issue is the relation of exports to imports i.e. not the issue of the level of exports but the question of a balance of payments surplus. Clarity would, however, be gained if people stopped attacking ‘export led growth’, which may be highly desirable, and simply dealt with the balance of payments surplus. A ‘high investment, high export’ strategy is intrinsic to China’s reforms and it is to be hoped it continues. In contrast there is nothing in either the facts of economic development or in economic theory that states that a high balance of payments surplus, as opposed to a high level of exports, and a high level of (efficient) investment, is desirable. Let us therefore consider the issue.
The appearance of a large balance of payments surplus is recent in China. From 1982-2003 its cumulative balance of payments surplus was $45.9 billion – an average of $2.2 billion a year or nothing to get excited about. Only after 2004 (by which time the cumulative surplus was still only $68.7 billion or an average of $3 billion a year) does China’s balance of payments surplus start to grow rapidly – i.e. the large balance of payments surplus is a phenomenon of the period 2005-2008 (2009 is discussed below). As China did not run a significant balance of payments surplus for 26 years out of the 30 year reform period (87% of the time) which constitutes its present development model and has run one for four years (13%) of that time it is, bluntly, difficult to sustain the thesis that what is crucial to China’s development model is that it have a large balance of payments surplus rather than that it has a high level of exports – the latter is certainly required.
However in 2005-08 China was in a position of a very large balance of payments surplus. As a country’s balance of payments surplus is necessarily equal to its surplus of domestic savings over domestic investment, China’s balance of payments surplus meant it was exporting part of its savings. This was not strategically desirable for reasons set out succinctly by Manmohan Singh, before he became prime minister, for India: ‘A poor country like India cannot afford to have a current account surplus. It means that the country is not able to absorb imports, and the Indian savings are not being converted into investment. That is why, Indian savings are being invested in US government securities for an interest rate of one-and-a-half per cent.’ Given that investment is the primary driver of growth, China would be better off investing a higher proportion of its savings domestically.
This is precisely what is beginning to happen during the first half of 2009 – and directly interrelates with the issue of the stimulus package. China’s investment level has risen further (as follows from the 6.2% of GDP growth in the first quarter coming from investment compared to 3.8% from consumption)in 2009 and therefore, given savings have not risen to the same extent, the balance of payments surplus has started to decline.
Once these key macro-economy facts are grasped it is evident why the stimulus package is successful. To summarise succinctly:
1. Capital inputs (i.e. the rate of investment) are the primary determinant of growth both in China and internationally – the stimulus package maintains (even increases by about 2% of GDP) China’s investment rate.
2. China’s TFP is respectable or high by international standards. Therefore the high level of investment will translate into a high level of growth.
3. The increase in the investment rate will move China’s investment level up towards its savings level therefore reducing the balance of payments surplus and utilising a higher proportion of China’s savings domestically.
In short, the stimulus package is a positively integrated package – evidently operating in a negative international economic environment. That is why it is successful.
The Pettis/Wolf ‘overinvesting/oversaving’ thesis wrongly believes the stimulus package won’t work, because it has a wrong picture of the macro-economy of China and of international determinants of growth. In particular it makes the following mistakes.
1. It fails to acknowledge that investment (capital inputs) is the decisive source of growth – not only in China but internationally. It therefore calls on China to cut its investment rate – which would have the inevitable effect, because capital inputs are the primary source of growth, of slowing China’s economy.
2. To attempt to claim that China could maintain the same growth rate it has to argue that China uses its investment inefficiently. This is straightforwardly contradicted by the major studies which show China has either a ‘respectable’ or a high rate of TFP growth.
3. Due to these two errors Pettis/Wolf even have the wrong proposal for how China should reduce its balance of payments surplus. Instead of arguing for China to raise its investment rate up to its savings rate (which would maintain or accelerate growth) they instead argue China should reduce its investment rate (and presumably, to reduce the balance of payments deficit, reduce its savings rate even more) – which will result in China’s growth rate falling, something which is neither desirable for China nor for the world economy.
Given this erroneous framework, which holds that China is ‘overinvesting/oversaving’ it is argued that the stimulus package, led by investment, will be a failure at best and more likely make the situation worse.
The connections between the different macro-economic frameworks and the assessment of the stimulus package should be evident from the above.
I hope that will suffice for the ‘paraphrase’ Michael Pettis requested.
I think it will be evident to readers that far from consisting of ‘non-sequiters’ this is a rather clear counter position of analyses and facts which is being tested around the practical issue of the success of failure of the stimulus package.
While there are different analyses within each overall view so far the facts support the position of those believe the stimulus package will work, and contradict the thesis of Pettis/Wolf (and for different reasons Roach) who believe it will not. This immediate issue of the stimulus package is, for the reasons outlined, linked to more fundamental questions of economic growth both in China and internationally.

By: Blogster3

Blogster3 — Thu, 23 Jul 2009 17:54:52 +0000

Oh dear…

I find it a bit startling that hyper-capitalist China has now become a torch for “socialists”. Surely “not Being America” is no longer enough to warrant support people? I remember a few years ago that Socialist Worker Newspaper was calling for the return to Maoism so as to put the Chinese revolution back on track – fringe groups will be fringe groups i suppose.

I hope also that no one from here gives Mr Ross what he wants and gives him the blog hits that i suspect were his intention from the start – why else all the links??? I also hope that Jiaotong university realise their folly before Boris Johnson or one of his advisors is hired by Fudan university in retaliation. I suspect it won’t be long.

For the record I have no problem with people disagreeing with others’ positions, but the manner in which one debates is very important, especially if one is accredited by a univeristy – supposedly a centre for educated and academic discussion. Many people have raised contrasting opinions on this blog before, and (aside from the 2/3 known nutters) have usually done so in a polite and academic fashion. It is a shame that someone affliated with a university should choose to proceed in a fashion that hardly does credit to the students / faculty members with whom he / she associates. Being a “maverick” can only carry one so far.

There are a lot of blogs out there nowadays, i could start one with a few clicks of my mouse. Worth reading blogs…considerably fewer in number.

I suspect Mr Ross would have faired better had he not announced himself in such a shameless fashion and entered the debate in such an oddly impolite manner.

By: simon webbe

simon webbe — Thu, 23 Jul 2009 16:26:28 +0000

ok Professor Pettis, thanks for your invitation,
let me recap some of the key elements i think i understand of professor ross’s arguments which i do not think you have responded to and which undermines the basic premise of your arguments:

the essence you have not responded to is spelt out in ‘Why Asia will continue to grow more rapidly than the US or Europe’. This showed that the US now lags far behind the key Asian economies in the proportion of its economy which is invested – with a consequent continuing decline in the international competitiveness of the US economy.
http://ablog.typepad.com/keytrendsinglobalisation/2008/09/data-on-long-term-trends-in-investment-and-economic-growth–this-post-deals-with-the-historic-trend-of-investment-and-econo.html

this mis a trend over literally hundreds of years of capitalist development now being led by a non-capitalist economy-
and the role of china is very significant
http://socialisteconomicbulletin.blogspot.com/2008/11/china-and-international-financial.html

the particular role of the state in China means that as well as showing historically high growth rates it can potentially weather the current 1929 scale crisis much better than capitalist economies
http://socialisteconomicbulletin.blogspot.com/2009/01/sunday-times-gets-it-on-how-china-is.html

how china responds is crucial
those not wanting to see China grow and US continue to fade due to its economic and poltical dead-end, will of course want China to pursue a different course- the different outcomes of China and Russina economies since 1989, show that western prescribed models had huge negative consequences for Russia (which China took a totally different and succesful direction to)-for n intro see book by peter Nolan.

One element neglected in this discussion is the deeper reasons for Japans’ economic crisis, and its relation to US economic and political interests-which has been mapped out very well in other blogs-those prescribing China to cut investment i fear have other interests- and i wold welcome Professor Ross to respond to your claim on 16/7 above that ‘To recap: just as Japan’s response to the 1987 US crash, which was a very small-scale dress rehearsal for the current crisis, was to use credit inflation and a massive increase in investment to work its way through what it thought would be a very short term reversal in the US ability to absorb Japanese excess capacity, so might China be doing the came thing.-my understanding is very different and it is part of a pattern of US global economic intervention that started in 1973-
China does not seem to be taking similar steps to japan-it is a very differnt type of economy

i would welcome your comments on these points which draw on trends of economies since the beginning of modern global capitalist development

By: Michael Pettis

Michael Pettis — Thu, 23 Jul 2009 06:11:43 +0000

Which Ross argument? As far as I can see he has simply announced that Wolf and I are wrong and that the facts prove it, but although some of his facts are simply wrong, even bizarrely so, and others I fully agree with, I am not sure how they indicate that Wolf and I are wrong. It seems that he completely misses the point of our arguments, so I am not sure how to reply.

For example he spends a long time insisting that China’s investment-led policy has led to growth, and that Chinese growth in the second quarter of 2009 proves once and for all that there is no problem in China with excess savings, but both claims are patently absurd. Of course it has led to growth. Investment surges always lead to growth, whether they are well or poorly allocated. It is only much later that we see why capital misallocation is a problem. So this year’s growth doesn’t prove there wasn’t misallocation or the systematic creation of excess capacity. In order to believe this you would have to be almost totally ignorant of economic history.

His argument reminds me of the triumphalist claims that Japanese growth in 1988 and 1989 “proved” that the worriers about the Japanese model were wrong. Not at all. I have said many times that China would surprise us with the amount of growth they generate this year and possibly next year, but that this would be because this huge surge in credit, both misallocated and unsustainable, would inevitably generate employment growth. It is as silly to say that because China is growing there cannot have been a problem with the fiscal stimulus than to say that because the US was growing rapidly in the early part of this decade there could not possibly have been excess consumption and poor real estate lending

In spite of a huge amount of his writing I still don’t understand which of our claims were wrong and why. Perhaps you could paraphrase his argument and help me?

By: simon webbe

simon webbe — Thu, 23 Jul 2009 06:03:55 +0000

lemiwinks said
However now, that demand in the rest of the world has collapsed in 2008, China can only rely on itself for both financing (savings) and demand creation. Can this work?

can anyone answer this?

By: simon webbe

simon webbe — Wed, 22 Jul 2009 20:24:39 +0000

Michael Pettis says 21/07/09 ‘Mr. Ross, there are so many non sequiters and so much muddled thinking here that it is really hard to know where to start. I think most of your substantial points have been pretty much blown up by others on this site,’
having read the blog and most of the comments in considerable detail including the linked articles i would like Mr Pettis to do us the service and not just defer to his blog fans but answer the convincing demolition of his essential line by John Ross-Please Mr Pettis i would like to see factual and reasoned responses to Ross’ arguments so i can take a more balanced view-as well as the clear evidence of non-sequiturs-none stood out to me and i do not like to believe i am being led astray unknowingly-otherwise your blog does you no service-which is a shame as i would hope to come back to it in the future and har the debate continued and expanded-

By: Houhui

Houhui — Wed, 22 Jul 2009 14:12:22 +0000

http://online.wsj.com/article/SB10001424052970203946904574301110723410346.html

Interesting (though blocked in China) piece with some relation to what is being discussed here.

Another little anecdote that may or may not be relevant to what has gone on following this blog entry:

2 Lesser known comedy BBC radio 6 DJs (Adam and Joe) earlier this year devised a strategy (mostly as a joke) to increase their own popularity / fame. They attempted to pick a fight (verbal) with members of a hugely popular BBC TV flagship series “Top Gear”, hoping that the resulting arguments / controversy would increase their own position and fame…