Three weeks ago China Daily published a pretty funny article about a recent survey on credibility that had taken place in China. According to the article,
At a time when shamelessness is pervasive, we are often at loss as to who can be trusted. The five most trustworthy groups, according to a survey by the Research Center of the Xiaokang Magazine, are farmers, religious workers, sex workers, soldiers and students.
A list like this is at the same time surprising and embarrassing. The sex business is illegal and thus underground in this country. The sex workers’ unexpected prominence on this list of honor, based on an online poll of more than 3,000 people, is indeed unusual.
It took the pollsters aback that people like scientists and teachers were ranked way below, and government functionaries, too, scored hardly better. Yet given the constant feed of scandals involving the country’s elite, this is not bad at all. At least they have not slid into the least credible category, which consists of real estate developers, secretaries, agents, entertainers and directors.
I am not sure what secretaries have done to get themselves such poor rankings (could they mean party secretaries?), and I am not sure what kind of directors they mean (movie directors? managing directors?) but not everyone found this survey funny. Last week a columnist in the People’s Daily had this to say about the same survey:
In recent years, China has already paid a high price for the prevailing credibility crisis. The annual losses caused by bad debts have reportedly amounted to about 180 billion yuan, and the direct economic losses induced by contract fraud each year is also up to 5.5 billion yuan. Besides, shoddy and fake products contribute to another great loss involving at least 200 billion yuan. Generally, credibility crisis would cost China as much as 600 billion yuan every year.
The shortage of credibility is not only seen in the market transactions, but in the officialdom as well. Corruption in any form is about to erode the faith of the general populace in authorities and officials at different levels.
Although I fully accept that sex workers are more credible than government officials, I am outraged that teachers are so much lower on the list than prostitutes. Since bankers have become so out-of-fashion recently, I have been vociferously denying my banker roots and assuring everyone that I am and always have been a professor, but now it seems that in order to get any respect I am going to have to buy tight jeans and a leather jacket and try to convince friends that I actually make my living turning tricks. At my age it won’t be easy, but probably a lot easier than convincing people that I am a farmer (unless it’s on a plate I can’t tell a potato from a chicken) or a priest.
Speaking of low credibility, last week the South China Morning Post reprinted a New York Times article on continued losses in the US banking system:
Banks in the United States are now losing money and going broke the old-fashioned way: They made loans that will never be repaid. As the number of banks closed by the US Federal Deposit Insurance Corp has grown rapidly this year, it has become clear the vast majority of them had nothing to do with strange financial products that seemed to dominate the news when the big banks were nearing collapse and being rescued by the government.
…Staying away from strange securities has not made things better. Jim Wigand, FDIC’s deputy director of resolutions and receiverships, says lenders that are failing now are in worse shape – in terms of the amount of losses relative to the size of the banks – than the ones that collapsed during the last big wave of failures from the savings and loan crisis.
The severity of the current string of bank failures shows many of the proposed remedies batted about since the crisis began would have done nothing to stem the closures. These banks did not go beyond their depth with derivatives or hide their bad assets in off-balance sheet vehicles. Nor did their traders make bad bets; they generally had no traders. They did not make loans they expected to sell quickly, so they had plenty of reason to care that the loans would be repaid.
What they did do is see loans go bad, in some cases with stunning rapidity, in volumes that they never thought possible. That so many loans are souring is a testament to how bad the recession – and the collapse in property prices – has been. But looking at some of the banks in detail shows they were also victims of their own apparent success. Year after year, these banks grew and took more risks. Losses were minimal. Cautious bankers appeared to be missing opportunities.
Besides the fact that this suggests that it is not just in China that prostitutes may be more respected than bankers, I found this article very interesting for two reasons. The first is because it suggests pretty clearly that green shoots notwithstanding, we are far from an end to the banking crisis in the US (and, I assume, elsewhere), and it is going to take a while longer before bank balance sheets are robust enough to expand. All of this will adversely impact both consumer spending and business investment for the foreseeable future.
The second reason I found this article interesting is that I think it supports an argument I have been making for a while, that the current financial crisis was not “caused” by derivatives or complex securitizations. It was caused, as nearly all financial crises in history have been caused, by banks being forced to accommodate excess liquidity and taking on too much risk – something they must do when monetary conditions are too loose for too long. Making opaque investments in derivatives and complex securitizations is, of course, one way to take on too much risk, but it in no way caused the excessive risk-taking.
When observers insist that it was the deregulation and fragmentation of the “Anglo-Saxon” financial model, and the ease with which Wall Street was able to innovate financially that caused the big losses, I can sympathize only with the observation that we paid an awful lot of money to some very smart people whose great contribution to society – a newer kind of exotic swap, let’s say – was not terribly valuable. But it wasn’t the system itself that caused the crisis. After all one of the main reasons for the prestige of the “Anglo-Saxon” model was that its greatest competitor, the very highly regulated, rigid, highly integrated and almost innovation-devoid counterpart, the Japanese banking system, collapsed so frightfully – if less spectacularly – after 1990, and now the article cited above suggests that a lot of banks even in the US also managed to collapse in very old-fashioned ways – something Hyman Minsky would have predicted would happen even without the help of dastardly derivatives.
This is one of the reasons why I take it almost as an article of faith that the massive expansion in Chinese credit will lead inevitably to a massive expansion in bad lending, and that the “great” economic data is actually worryingly weak given the amount of resources, especially banking resources, expended to produce those numbers. Too many regulators here who should know better (and too many foreign observers, too) are convinced that Chinese banks are safe from losses because Chinese banks were too slow to understand complex financial instruments and so took on very limited (and often ill-advised) exposure to these instruments, and because they continue to be sharply constrained in their abilities to do so. In fact the biggest losses are always caused by exposure to real estate or lending against insufficient future cashflows, whether these comesin the form of old-fashioned loans or in the form of total-return swaps on sub-prime mortgage tranches.
Interestingly enough, it seems that recently there has been an increasing chorus of warnings within China about mounting risks in the banking system, and more generally about problems in the fiscal stimulus package. For much of the year the Chinese fiscal stimulus has been described – as I heard repeatedly during my testimony last February in Washington, to my surprise – as the “gold standard” of stimulus packages, but over the past two months the number of worriers seems to have expanded dramatically. The Financial Times in an article earlier this week put it this way:
Official readings of industrial production, fixed investment, power consumption and gross domestic product all show a strong revival, while equity and property prices have soared in recent months. There have even been signs of a recovery in exports, although these are still about one-quarter below the levels of a year ago.
But a growing number of economists and officials say the positive growth data hide worrying structural imbalances and the government’s response to the crisis may only have postponed an inevitable reckoning. With the world looking to China as a beacon to lead the way out of economic gloom, a second downturn would have a big impact on global confidence, not to mention commodity prices. “There is such a thing as good 5 per cent growth and bad 8 per cent growth,” according to one senior adviser to the government. “We worry that what we’re seeing falls more into the latter category.”
The concerns are the ones I have been discussing here for the past year – the fiscal stimulus is exacerbating the domestic imbalances, non-performing loans are certain to rise dramatically, and there is little evidence that consumption is going to grow organically quickly enough to absorb Chinese capacity. The article goes on to say:
“The main concern we have now is that a tremendous volume of loans was extended very rapidly to the corporate sector at a time when corporate profitability was declining,” says Charlene Chu at Fitch Ratings. “That would suggest there will be some significant asset quality problems down the road.”
While state-owned enterprises have been inundated with loans from the state banks, economists worry too that China’s vibrant private sector has been largely left to fend for itself. “The fiscal and monetary policy response to the crisis has mostly benefited the largest enterprises and biggest projects,” says Wang Yijiang, professor of economics and human resources management at the Cheung Kong Graduate School of Business in Beijing. “The small and medium-sized enterprise sector provides 75 per cent of the jobs to China’s urban workforce but now it is shrinking for the first time in 30 years of economic reforms.”
Not surprisingly, it was Chinese economists who were quicker to sense the problems than most foreign economists and observers, whose optimism has generally been more robust. For example the highly respected Yu Yonding, an economist with the Chinese Academy of Social Sciences and a former member of the PBoC’s monetary policy committee (who told me three months ago at a conference at Tsinghua University, during which I presented my now-standard argument that China’s development model was about to fail, that the problem with my analysis was that I am much too optimistic about China), had an OpEd piece in today’s Financial Times that repeats the familiar litany:
China has rebounded from the global slump with vigour. In the second quarter, its official figures showed year-on-year gross domestic product growth of 7.9 per cent. Those who doubt the quality of China’s macroeconomic statistics can check its physical statistics: in June, electricity production increased 5.2 per cent, reversing the falls of the previous eight months. It is almost certain that China’s GDP will grow more than 8 per cent this year.
But there are problems looming. More investment thanks to China’s rescue package threatens to worsen the already severe overcapacity, while the cash injection is already creating asset bubbles.
Dr. Yu warily suggests specific policy recommendations when he says that “China’s rebalancing is more the result of the global economic crisis than of policy initiative. China could do more to eliminate both internal and external price distortions to reduce its dependency on external markets.” Eliminating these price distortions involves, I suspect, revaluing the currency, liberalizing interest rates, and doing the other things that I and others have suggested would address the root imbalances between consumption and production, albeit at the expense of accelerating unemployment in the short term.
Premier Wen himself has been actively warning about trouble ahead. Earlier this week the South China Morning Post had this to say (although I wasn’t able to find any reference in the local press):
Premier Wen Jiabao warned the mainland faces new economic problems and said Beijing would stick to its stimulus plan because the recovery lacks a solid foundation, according to comments reported yesterday. Mr Wen cautioned against being “blindly optimistic” despite improvements in the economy, according to a statement on the State Council’s website.
“[The economy] still faces many new difficulties and problems,” Mr Wen was quoted as saying during a visit to southeastern China that ended yesterday. “There are still a lot of unstable and uncertain factors ahead and the economic situation ahead is still very grave, although both the world economy and the national economy are making positive changes now.” He cautioned that the effects of some government measures might fade while others would take time to show results, the cabinet statement said, without elaborating.
Meanwhile there is more and more talk about attempts by the PBoC and the CBRC to limit and control the banking expansion. The CBRC has apparently been tightening capital adequacy requirements and is reportedly going to disqualify subordinated debt from being counted as bank capital. Chinese banks have been encouraged to raise their capital ratios, and one of the ways they have done so is by selling subordinated debt – there was about $30 billion issued in the first half of 2009, versus about $10 billion in 2008. But much, if not all, of this subordinated debt was purchased by other banks, so it always made a lot of sense to eliminate bank subordinated debt from any notion of a capital cushion. In a banking crisis, just when banks need capital, this asset immediately becomes worthless.
Yesterday’s Financial Times had an interesting little piece on all this:
The banking regulator last month told lenders to raise reserves to 150 per cent of their non-performing loans by the end of this year, up from 134.8 per cent at the end of June. A communiqué last Friday canvassed views on deducting holdings of other lenders’ subordinated or hybrid debt from supplementary (non-core) capital. Then there are softer measures, such as reminding banks to ensure that loans for investment in fixed assets actually end up there. The central bank also has raised money-market rates to drain liquidity. The effects of all this can be seen in the M2 measure of money supply, which was up 28 per cent at the end of July, year on year, but which fell 3 basis points from the end of June.
This is how China tightens: imperceptibly, by degrees. As Goldman Sachs points out, China’s last tightening cycle began not when it raised rates in November 2004 but 18 months earlier when the central bank began to issue short-term bills to mop up excess cash. Listen to the rhetoric now, and you can almost hear the fluttering of doves. But look at the evidence, and it is obvious that hawks are gathering.
LOL!
On a lighter note, was wondering if you noted the irony
isn’t the study confirmed by this comment? 
“in order to get any respect I am going to have to buy tight jeans and a leather jacket and try to convince friends that I actually make my living turning tricks. At my age it won’t be easy, but probably a lot easier than convincing people that I am a farmer (unless it’s on a plate I can’t tell a potato from a chicken) or a priest.”
kidding of course, Prof. Pettis! Yours is the best blog on China!
Rahul
Mr Pettis
The credibility survey was rather funny – having been briefly in the education sector. let’s just say I don’t think the ranking of educators so far down the list can be entirely blamed on the pollsters or the respondents ;p
Frankly, it should come as no surprise that the stimulus package has resulted in even looser credit policies or even the asset bubbles. I’m of the opinion that it’s merely assuaging short term pain with medicine that’ll prove disastrous in the future. The asset bubbles will benefit no one except perhaps the middlemen (think agents, brokers etc) but as cynical as it sounds no one ever retains memory long enough for it to overcome greed. AThe loose credit policies put one in mind of the word “recapitalisation” some time down the road. Sigh, is it all beginning to have that sickening deja vu feel?
As for turning tricks, hmm, at the risk of offending people in the industry, those pimping certain distressed assets aren’t quite that much higher on the evolutionary scale don’t you think.
As for those who are still trying to pin the blame for the credit crisis on asian savers – not seeing clearly isn’t going to help moving forward? No one can force consumption or borrowing – no one can put a gun to the heads of consumers worldwide and force them to consume or to take out that loan. Even cash for clunkers depends on the willingness of consumers to comply.
“Listen to the rhetoric now, and you can almost hear the fluttering of doves. But look at the evidence, and it is obvious that hawks are gathering.”
Given the bank tightening, is it fair to say that the Chinese bank regulators and the Chinese banks are
1) aware of the risks ?
2) taking appropriate corrective measures at the right force/speed?
I really like the above quote because an economy can adopted to gradual change efficiently. However, sudden shocks is what really hurts.
The structural imbalances in China will take time to correct. I think the right approach for China is first soften the economic shock from the global crisis in the short term and continue to improve the structural imbalance in the long term.
Thank you for sharing your thoughts.
What happened to my comment from earlier?
Well, it is (sadly) not surprising to see distrust of teachers in China, as many are on the take at all levels of the educational system. Talk to anyone about getting into a good pre-school, or about getting into a doctoral program, and (sadly), money talks louder than accomplishments. Look at all the bogus doctorates being given to lazy officials, after their secretaries make appearances on their behalf in lectures and meetings. I am not surprised at all to see the relative credibility of sex workers, as they are the supply side for “animal spirits”. The government is about to reign in output and investment in the heavy industrial sector, and this will prompt howls from the provinces about their desperate straits after the recent credit binge. The central bureacracy will try to resist, but I think the demands of stability, especially during the next few weeks, will lead to a second round of rapid credit expansion. Who knows how much is being spent on the 60-yr celebrations and parades (and it is a worthy occassion to celebrate the fact that the People’s Republic has not come unglued during such rapid social and economic change), but my feeling is the lagged effect of the credit slowdown could hit at the wrong time, and the increasing use of “window guidance” and telephone calls in place of explicit policy will come back. All in all, facts on the ground are likely to call the grand bluff of the China’s growth model, and to regain it the Party is going to have to replace “whaterverism” with some consistent substance. There are plenty of highly qualified and dedicated educators in Beijing and elsewhere who can help with this, but I just don’t see how the present bureacratic disequilibrium in Beijing can produce a set of consistent and effective policy outcomes right now.
[...] The credibility of farmers, priests and prostitutes – and bankers? – Michael Pettis [...]
There are also rumours that Banks that fail to reach the 150% coverage could be punished by having their capital reduced.
I know that some people are complaining that comments are being approved much more slowly than in the past. Sorry, but it is not my fault. It is getting harder than ever to use proxies to access beyond-the-GFW internet sites, and it takes me hours before I can get onto this site and approve comments. I hope this gets resolved after the October events.
From a barebones Communist point of view, who are farmers, prostitutes, soldiers and students? They are the basic workers. The bottom of the heap.
Scientists, teachers, government functionaries, entertainers and directors are people who have risen above the bottom of the heap. A right thinking Communist would never trust such bourgeoisie people who see themselves as better than average.
Real estate developers, secretaries, agents, etc. are your classic middle-men. People who separate one person from another. I suspect the distrust of such people is much older than Communism and probably a universal human survival instinct.
Besides, with a prostitute, you know what you are buying, and you know whether you got it or not. That puts them ahead of a great number of traders out there.
Oh yeah, I know a bit about firewalls and proxies, I can recommend this: http://ideas.4brad.com/node/358
Feel free to edit this post for clarity or brevity
Judy Yeo | 26/08/09
“As for those who are still trying to pin the blame for the credit crisis on asian savers – not seeing clearly isn’t going to help moving forward? No one can force consumption or borrowing – no one can put a gun to the heads of consumers worldwide and force them to consume or to take out that loan. Even cash for clunkers depends on the willingness of consumers to comply.”
It was Bernanke who created the the Saving Glut theory to explain why the interest rate was so low that fueled the dot.com and housing bubble! It is a theory to excuse the Fed past action by blaming on the Asian for Western reckless consumption for example:
1-Zero Downpayment to buy a house
2-NINJA loan (Not Income, No Job & Asset)
3-Piggy loan to borrow for the down payment of your house
4-Use your house at ATM through Home Equity loan
5-Ingenious financial vehicles Option ARM, Alt-A, Jumbo loan etc…
6-Don’t save any money since the house will do the saving for you since housing price can only go up!
One wonder why there is such as problem in the financial system in the USA. I believe that many have not learned anything from it by looking at the American government action such as printing trillions of Dollar in order to give to the Wall Street crook! Yes, the same people who got the rest of the world in this mess!
In order to justify to receive that incredible amount of tax payer money, they have to blame on someone else such as the Asian saving gluts!
I believe that the “Saving Glut Theory” will go the same way as the “New Economy Theory” during the DOT.COM bubble era or that “Housing price never go down Theory”! All those theory simply does not past mustard at all. It would make those people defending it look silly when once we would start looking back at it like the way people started to look at theories behind that supported the the DOT.com bubble and the housing bubble.
Mr. Pettis,
I am wondering if China could use its foreign exchange reserves in order to deal with the NPL problem.
[...] The credibility of farmers, priests and prostitutes – and bankers? mpettis.com/2009/08/the-credibility-of-farmers-priests-and-prostitutes-%E2%80%93-and-bankers – view page – cached August 26th, 2009 by Michael Pettis | Filed under Banks, Financial crisis, — From the page [...]
Apart from the invaluable information about how the whole people think (it shows Chinese consumers are much more rational than elsewhere: the effect of superior culture), the banking part of your post is very timely. Raising capital (forced by (1) asset growth (2) redefinition of interbank subordinated capital and (3) raising the standard -in line with foreign regulators (no one would like to see NY office of BoC be subjected to a MoU) will become a virtual certainty and that will reveal a little more about the new structures at the top of the Chinese financial system. What CDRC mandates will have to be raised by the Big 4 from the market and CIC (the so-called sovereign wealth fund). Will CIC itself have to raise fresh capital or shift the balance of its investments even further to ( central huijin) its role as bank holding company. It will be interesting to see if the various firewalls constructed within China Inc work (at all) and how they work..
Judy,
Good to see your comment here!
Is there any talk aside from Yu Yongding about reforms of a financial kind, further SOE privatization? It seems like China has got itself into an awful catch-22 whereby further deregulation/privatization leads to job losses but the status quo is likely to just slowly take down the financial sector. Have there been any novel suggestions as to how to make the changes without the attendent welfare losses? This appears to be the crux of the problem since the longer this issue is ignored the more likely we are to have these trade tensions come to a head.
Prof Pettis,
The secretaries here means young beautiful ladies who sleep with their bosses and disrupt their families..The directors are movie directors who demand to sleep with those who want to get an actor’s or actress’s job.
These are just so common phoenomenon in China.Maybe you should know more about it..
Interesting as always, Prof. P.
To expand a little:
“we are far from an end to the banking crisis in the US (and, I assume, elsewhere), and it is going to take a while longer before bank balance sheets are robust enough to expand.”
The US built trillions in debt to the rest of the world in the last decade, and now is a net $4 trillion in the hole. That was masked through bad corporate accounting (loss assumptions, pension assumptions, inflated asset prices), a huge government debt that will be a tremendous drain on greater economy (as tax revenues contract), and inflated property values in the household sector. People and the economy did not feel the drain happening until it had reached an advanced stage.
We’ve only just begun to see the imagined wealth evaporate. There were massive bailouts for Wall Street initially, where the fraud was greatest, but the rest of the financial sector, and corporate, government and household sectors will not be protected.
Wealth will continue to evaporate in the US. As an investor I seek to position myself to avoid (or even short) the assets that will be losing value. Goldman Sachs and other well positioned firms are doing the same and recording huge profits.
“I believe that many have not learned anything from it by looking at the American government action such as printing trillions of Dollar in order to give to the Wall Street crook! ”
Agreed. This has postponed and worsened the problem, and it’s an indication of how American corruption works in contrast to Chinese corruption.
“Generally, credibility crisis would cost China as much as 600 billion yuan every year.”
The credibility issue points to a much deeper problem with corruption in China, that has historically been a huge economic drain. In my time in Mi Luo this Spring I saw first hand how it works both with the police abusing power and cronyism in the education sector. Much of the problem stems from a history of economic insecurity and a history of people protecting their own interests first and nurturing circles of friends to protect those interests. The corruption issue is well understood in China and being tackled most successfully in the advanced areas and most aggressively where public scandals are exposed.
And a key counterpoint if you don’t mind:
“one of the reasons why I take it almost as an article of faith that the massive expansion in Chinese credit will lead inevitably to a massive expansion in bad lending”
But the difference between China’s position and that of the US is huge one because the US economy was based on massive overconsumption and it must contract, while the Chinese economy has under-consumed and has great room for expansion. Also (again), China’s credit boom was largely a temporary phenomenon necessary to overcome outward foreign capital flows, and not nearly as much credit expansion will be needed as the flows reverse course. No doubt, the challenges are huge, but I see the government making the right strategic moves.
Given the many references in the past three days in comments, emails, conversations, Twitter, and even a TV interview today when I was asked if I wanted to wear my leather jacket for the interview, I am pretty sure – not that I ever doubted it – the discussions about sex are far more interesting than discussions about finance. I guess I should try to find more sexy references if I want to goose up my readership.
Judy, you say “No one can force consumption or borrowing – no one can put a gun to the heads of consumers worldwide and force them to consume or to take out that loan.” I tried to address that in my previous posting and explain why this kind of statement misses the point. If you assume that each country is a single person with the same preference, income and balance sheet, then your statement may well be true, but as soon as you accept the possibility of a large number of households and agents with different preferences, etc. then it is certainly not true. For example loose monetary policy nearly always results in consumption and borrowing going up. In that sense the central bank did exactly that which you say can’t be done – it “forced” an increase in consumption and borrowing, and didn’t even need to put a gun to anyone’s head to do it.
Silly things, I think some regulators are very aware of it, but their actions are constrained by the State Council, who was until now less worried. I am not sure I agree that gradual changes are less painful than shocks. It depends on many things, and on how you define pain – which includes social and political as well as economic. For example Japan’s gradual resolution f its own imbalances have left it with nearly two decades of no growth.
Armando, I think you are clearly one of those I mentioned for whom the discussion about global imbalances is wholly a discussion about whether it is all the fault of the US or all the fault of China. As I have said many times I don’t think that is a very useful way of thinking about it.
Tang Shuxia, not it cannot. The foreign reserves are simply assets against which the PBoC has liabilities, and even assuming that the PBoC could sell dollars for RMB (and it cannot do so without causing a collapse in Chinese exports), in order to use the foreign reserves either it would have to “donate” the money, in which case its assets would decline with no decline in debt, or the government would have to borrow money to “buy” the reserves from the PBoC. Either way government debt would rise by exactly the amount of reserves used to capitalize the banks. Since the government would do the same even without reserves, this means that banks can only be capitalized ultimately by direct or indirect taxes.
Nemo, there has been and continues to be a very vibrant debate within Chinese academic and government circles about the needed financial reforms. I will discuss this more I future postings.
RodgerRafter, I agree. There is an I-think-foolish sense that the worst is behinds us, but I still have not seen a full accounting and, more importantly, an assigning of all the losses. Simple financial distress theory suggests that until we have a clear reckoning of default probabilities we still have a long way to go.
The second part is, I think, a little US-centric. The assumption that it is always easy to expand consumption and that bad lending consists mostly of bad consumer loans, not bad producer loans, is based largely on recent US history. In fact Chinese banks have made producer loans which will become, I suspect, loans for overcapacity and against wasting inventory (as they have in past banking crises). It has been hard for policymakers to boost consumption, which they have been trying to do for years, and tit is this that has made their banking system so risky.
By the way except for Q1, for most of last year and this year China has had very large hot money inflows, not outflows. It has also run an FDI surplus. Even taking into consideration hot money outflows in Q1, credit expansion has been far greater than any reckoning of net outflows.
I think what keeps the savings glut vs. consumption binge debate so contentious is the terminology. There is something counter-intuitive about blaming what would seem the more prudent behavior. I realize, no one is blaming the family that saves to better their future, but that’s the way most people think of savings.
How about this: East Asia’s use of currency pegs allowed them to be drawn into financing a final act of a decades long, debt-fueled consumption binge in the U.S.
Most people here would agree that the imprudence was on our side, for the Asians it was more a technically miscalculation. If the East Asians had let their currencies float 5-6 years ago, the U.S. would probably be stuck in a continual deleveraging from the tech bubble bust. It wouldn’t be as bad, but we’d still be paying the piper. On the flip side, the East Asians would have had slower growth.
possibility of a large number of households and agents with different preferences, etc. then it is certainly not true. For example loose monetary policy nearly always results in consumption and borrowing going up. In that sense the central bank did exactly that which you say can’t be done – it “forced” an increase in consumption and borrowing, and didn’t even need to put a gun to anyone’s head to do it.
Mr Pettis
Not to be rude but what you’ve said is contradictory in itself. Large numbers of households and agents with different preferences are free to excercise choice. That is a key component of free will – which even central banks have to respect . After all, free will establishes the space for choice – what is preference without choice – the choice could be between not spending and spending , preferring to spend within your means or taking that cheap loan!
You are free to own a gas guzzler, no one can force you to give it up- if you run out of money for gas, well then you should take responsibility for your own choices. Unless you’re willing to push all blame for a kid overdosing on the pusher and absolving the kid of all blame (he was offered the drug by the pusher hence he is innocent?) ; you would not subscribe to the theory that just because the conditions are right for consuming recklessly therefore the consumer is merely forced into consuming – rationality still exists, hopefully?
Even economics offers us examples where consumption does not take place where there are policies aimed at stimulating it . For example, deflationary situations where consumption is delayed due to expectations of lower future prices? The Japanese have often been cited as examples where domestic consumption has been sluggish despite all that government prodding!
Huizer
hello! nice to see your comments here!when are you setting up your own blog?
Mr Pettis
apologies, forgot a point:
looser monetary policies do encourage borrowing and consumption – but force is a different matter altogether – just because your rival has taken that cheap loan and the gearing effect kicks in and your performance looks rather bad in comparison does not mean you are forced to take a similar loan. Similarly for consumers – keeping up with the joneses is a choice . Just because everyone else has taken to jumping into the ocean doesn’t mean you have to follow!
“RodgerRafter | 28/08/09
The credibility issue points to a much deeper problem with corruption in China, that has historically been a huge economic drain. In my time in Mi Luo this Spring I saw first hand how it works both with the police abusing power and cronyism in the education sector. Much of the problem stems from a history of economic insecurity and a history of people protecting their own interests first and nurturing circles of friends to protect those interests. The corruption issue is well understood in China and being tackled most successfully in the advanced areas and most aggressively where public scandals are exposed.”
You have a point about the level of corruption in China and it well known by all (public & government & foreigners) so there is actual effort from the government to fight it no matter what!
However, while the corruption in the USA banking system is not acknowledge at all.
Here is link in which explain why American banking system refuse to disclose which American Bank is receiving cheap loan from the Fed
http://www.zerohedge.com/article/racketeering-101-bailed-out-banks-threaten-systemic-collapse-if-fed-discloses-information
and here another link from Blooberg.
Talking about lack of transparency.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aatlky_cH.tY
Fed Defies Transparency Aim in Refusal to Disclose (Update2)
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By Mark Pittman, Bob Ivry and Alison Fitzgerald
Nov. 10 (Bloomberg) — The Federal Reserve is refusing to identify the recipients of almost $2 trillion of emergency loans from American taxpayers or the troubled assets the central bank is accepting as collateral.
Fed Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson said in September they would comply with congressional demands for transparency in a $700 billion bailout of the banking system. Two months later, as the Fed lends far more than that in separate rescue programs that didn’t require approval by Congress, Americans have no idea where their money is going or what securities the banks are pledging in return.
“The collateral is not being adequately disclosed, and that’s a big problem,” said Dan Fuss, vice chairman of Boston- based Loomis Sayles & Co., where he co-manages $17 billion in bonds. “In a liquid market, this wouldn’t matter, but we’re not. The market is very nervous and very thin.”
Bloomberg News has requested details of the Fed lending under the U.S. Freedom of Information Act and filed a federal lawsuit Nov. 7 seeking to force disclosure.
The Fed made the loans under terms of 11 programs, eight of them created in the past 15 months, in the midst of the biggest financial crisis since the Great Depression.
“It’s your money; it’s not the Fed’s money,” said billionaire Ted Forstmann, senior partner of Forstmann Little & Co. in New York. “Of course there should be transparency.”
“RodgerRafter | 28/08/09
But the difference between China’s position and that of the US is huge one because the US economy was based on massive overconsumption and it must contract, while the Chinese economy has under-consumed and has great room for expansion. Also (again), China’s credit boom was largely a temporary phenomenon necessary to overcome outward foreign capital flows, and not nearly as much credit expansion will be needed as the flows reverse course. No doubt, the challenges are huge, but I see the government making the right strategic moves.”
You got that right! China has a huge saving per capita so they have saved enough money in the past for future consumption while the USA has very little saving and big debt load so they have not present or future consumption. Many retail chain has gone bankrupt such as Circuit City, Mervin, Linen and Thing et al.
It is much easier to consume than to save money so that is why people in the USA has more debt than saving. Saving require discipline and commitment while reckless consumption is the opposite of it. China retail sales has also grown on a yearly basis from what I read in the past, followed by car sales..
“Michael Pettis | 28/08/09
Given the many references in the past three days in comments, emails, conversations, Twitter, and even a TV interview today when I was asked if I wanted to wear my leather jacket for the interview, I am pretty sure – not that I ever doubted it – the discussions about sex are far more interesting than discussions about finance. I guess I should try to find more sexy references if I want to goose up my readership.
Judy, you say “No one can force consumption or borrowing – no one can put a gun to the heads of consumers worldwide and force them to consume or to take out that loan.” I tried to address that in my previous posting and explain why this kind of statement misses the point. If you assume that each country is a single person with the same preference, income and balance sheet, then your statement may well be true, but as soon as you accept the possibility of a large number of households and agents with different preferences, etc. then it is certainly not true. For example loose monetary policy nearly always results in consumption and borrowing going up. In that sense the central bank did exactly that which you say can’t be done – it “forced” an increase in consumption and borrowing, and didn’t even need to put a gun to anyone’s head to do it.”
Mr. Pettis who force the head of the Fed to lower the interest rate so fast for such a long time? I don’t think that China or anyone else could order the Fed to lower the interest rate. The Fed is in control of the monetary supply to the USA by controlling through printing and interest rate.
Anytime that there is recession the Fed lower the interest rate and that lose monetary policy tend to fuel boom and bust such as the dot.com boom and bust and the housing bust! Right now, it fueling the Dollar bubble thorough massive printing of Dollar.
Also about the over-investment in capacity or production, China is investing in infrastructure(railroad, highway, bridges, power grid line, low cost housing) and most of them in the Western part of China and not over production. There is not point to invest in more factories for export if the customers are not buying since around 20 millions of people already lose their job in the China export industry and that affect mainly Guangzhou province.
“The assumption that it is always easy to expand consumption and that bad lending consists mostly of bad consumer loans, not bad producer loans, is based largely on recent US history.”
Expanding consumption will be both difficult and risky for policy makers.
Difficult because changing habits takes a long time. Risky because the biggest factor that got China rolling was cheap labor. That required modest living standards. Raising them means that Chinese labor will be less competitive and a growing middle class tends to push for more political reform than the government is comfortable with.
Still, I remain optimistic that China will continue to handle the transition gracefully. The Chinese sectors that I watch and invest in are booming: Telecom, Agriculture, Oil, Solar. They are making up for some of the slack created by falling exports, and in time other industries will continue the march forward.
Western governments and companies have been helping China’s long term situation by imploding in the global contraction. If they ever start thinking about long term competitiveness it’ll make things tougher for China. For the next few years, showing 8% growth is looking pretty easy.
Judy, wouldn’t your logic indicate then that no monetary policy can be blamed for anything as long as the central bankers don’t put guns to everyone’s head? From your argument it seems that you believe not only that Asian trade policies could not have led to the increase in US debt and consumption, but that excessively loose US money also could not have led to it. There were no policies that led to the increase because no one put a gun to the consumers’ heads. Consumption just suddenly rose for purely mystical reasons.
This is a very novel argument. Monetary policy can not be blamed for anything as long as central bankers don’t use guns.
armando: “You have a point about the level of corruption in China and it well known by all (public & government & foreigners) so there is actual effort from the government to fight it no matter what! However, while the corruption in the USA banking system is not acknowledge at all.”
there is an actual effort to fight corruption in china? that’s a joke. there has never been an effort to fight corruption and in fact it is getting worse all the time. the only people who go to jail for corruption in china are people who lose in the factional fights. the crime in china is not corruption, but rather belonging to the losing faction.
by the way, armando, why are all first and most detailed disclosures about corruption in the US from the US press, including all the ones you cite, but the chinese press never discusses chinese corruption except when it has become so well known that they can no longer hide it (or when the corrupt official is on the worng side of the fight)? it is much easier to learn about chinese corruption in the foreign press and in illegal and underground chinese sources than in the legal press.
this is the real distinction between systems that try to get rid of corruption and systems that don’t. if the government refuses to permit a free press, then the idea that they want to end corruption is a total joke.
Judy, I agree completely with Glenn. It seems that by your definition of responsibility very few government policies, except perhaps mass internment in concentration camps, can be said to “cause” anything. The way I see it, if the Fed, or any other entity, enacts policies that have always led to certain economic outcomes, like loose monetary policy leading to an expansion in lending, then whenever they enact those policies and the expected outcomes occur, they can be said to have caused the outcome. The argument that only deploying troops can properly be defined as causal gives the government a huge amount of leeway to do anything it wants without taking responsibility.
PMJ and Armando, it seems that both of your comments are beginning to get very close to silly tit-for-tat nationalism. I am happy to see vigorous debate in this blog, but let’s not turn this into a argument about which country is the most evil.
Armando, this is my response to RebelEconomist’s comment in the last blog. Point two is relevant to your discussion. It is true that the Fed could have countered the monetary consequences of Chinese policies, but this would have had a cost in employment, and for the Fed unemployment is also a problem that must be dealt with. If A’s actions force me to choose between either countering that action at a cost, or not countering that action, even if I choose the second and subsequently decide it was the wrong choice, I don’t think that absolves A altogether.
————-
As usual, thanks for your comments, RE. I see this is one of the issues that will take years to resolve. Two points: First, it seems to me that during most periods of very rapid monetary expansion, whatever the cause, risk appetites rise sharply and cause spreads to decline even as the risk-free rates decline (and as a emerging-markets bond trader for fifteen years I can say that I have seen that happen many times). That is why we would have seen the search for yield in the midst of the savings glut. As an aside I have argued before that the reason why “stages” of the industrial revolution seem always to occur during asset bubbles and globalization periods is that they are all driven by the same thing — increasing risk appetite that drives investment into developing countries, high techs, Florida swamp land and lots of other risky assets.
Second point: the fact that the Fed could have stopped the process by raising interest rates and didn’t, was probably a mistake, but there was anyway a cost to doing so. If the increase in liquidity was indeed caused by the savings glut mechanism, one consequence would have been a rise in US unemployment as the tradable goods sector in the US shrank to accommodate the expansion in the Asian trade surplus (this is Martin Wolf’s argument, by the way) and the Fed had to choose between higher unemployment and too-loose money. They may have made the wrong choice, but it is not obvious that they were fully responsible.
Thanks Michael. Sometimes it feels like being in HK is no different to being in NYC when it comes to getting good color on what is going on within policy circles in China, the lag between ideas being discussed and then appearing in CASS documents is non-trivial and the media seldom covers it all.
“Michael Pettis | 28/08/09
Judy, I agree completely with Glenn. It seems that by your definition of responsibility very few government policies, except perhaps mass internment in concentration camps, can be said to “cause” anything. The way I see it, if the Fed, or any other entity, enacts policies that have always led to certain economic outcomes, like loose monetary policy leading to an expansion in lending, then whenever they enact those policies and the expected outcomes occur, they can be said to have caused the outcome. ”
I agree with you that Government action can affect people behavior to some extent. However what Judy is trying to say is about people responsibility for their own actions. Just because a person has a credit line of 100K of Dollar, it does not mean that person need to spend it all in the casino. However, the lose monetary policy allow speculators and predatory lenders and unsophisticated investor that drove the price of the real state in the USA. Also, the lose monetary policy was used to fuel the commodity price such as grain and oil through the future contract market.
Nevertheless, not everyone fell to the allure of easy credit and save money for future use rather than to borrow it and spend it. However, now with the massive money printing even the all the people that save money will eventually lose everything through inflation!
Judy, let’s suppose you are in business and you have a competitor who is about equal to you in every way. Customers are equally happy to go to you or your competitor because there isn’t much difference in the service either way.
Now, your competitor buys some expensive machine (on borrowed money) that results in a slightly better product. The machine is really overpriced… it will never pay for itself in the long term, and there is no cost/benefit justification for buying it. The improvement that it makes in the end product is small, but still significant enough to draw your customers towards your competitor since, there is nothing much different about your products anyhow.
Normally, buying a machine of this nature would force your competitor to increase prices… at least they must push up prices enough to pay the interest on the loan, else they are going backwards. However, they got an amazingly good deal with this loan at very low interest, which will switch to “market rates” in five years time. So your competitor can afford to absorb the tiny interest payments and take most of your customers away with their slightly better product.
You calculate that at a reasonable guess of what “market rates” will be in five years time, and based on your knowledge of typical profit margin in this industry, if you close your doors tomorrow and all of your customers go across to your competitor then they will probably go bankrupt in approx ten years when it is impossible for them to pay the loan.
You also calculate that if you keep going as you are, your competitor will move from 50% market share to 80% market share and with only the remaining 20% you will go bankrupt in approx three years, unless you kick out a lot of staff and severely downsize the business, in which case you might hang onto a small piece of the market, with a barely viable business.
Someone comes and offers you a loan, at low interest with great terms, so you can buy one of these overpriced machines. Do you take it?
“Tel | 29/08/09
Judy, let’s suppose you are in business and you have a competitor who is about equal to you in every way. Customers are equally happy to go to you or your competitor because there isn’t much difference in the service either way.
Someone comes and offers you a loan, at low interest with great terms, so you can buy one of these overpriced machines. Do you take it?”
Your example is using low interest loan for investment purpose which a good example of using low interest to invest in any company. However, what Judy is talking about it people borrowing money for reckless consumption! Loan for investment and loan for consumption are two different thing! What happened in the USA was mostly loan for buying overpriced house and to fuel reckless consumption!
Armando, it is hard to argue a point when the conditions keep changing. Judy Yeo has said very clearly that monetary policies can’t force agents to change their behavior. Tel has given an example of just that. You say this example doesn’t count because it doesn’t involve consumers.
Ok, here is another example which involves consumers and is very appropriate since this is what happened in the US. Several low-income families in a neighborhood want to own their own houses in order to give their kids a stable home environment. Because they are risky borrowers, with the potential that as many as a quarter of them might default, banks in the past have never lent them money. But very easy money and new mortgage technology leads to a sharp decline in credit standards, and all of them are finally able to borrow.
Will they borrow? Of course they will, even without guns being put to their heads. Was their ability to borrow created by changes in the financial sysytem and monetary conditions? Of course it was. Will some eventually default? Of course they will, and did.
Meanwhile because they are able to borrow and buy, the price of houses rises, and all the other owners in the neighborhood feel richer. Will they increase their spending, thus reducing the share of savings out of current income? Of course they will — whether they are Americans, Chinese, or anyone else. Except under very unusual condition increases in wealth are always associated with increases in consumption.
Here are obvious cases in which easy monetary conditions caused savings to decline. And you keep insisting that US consumption was caused by bad Fed monetary policies. You are also now arguing that it could not have been caused by excess Asian savings because monetary policies cannot force consumption to rise.
That doesn’t make sense. Either monetary policy matters, in which case it makes sense to argue about whether the Fed or the PBoC was the main cause, or it doesn’t, in which case neither can be blamed.
Thanks to all who responded, whichever direction it may have taken.
Mr Pettis and Glenn ; the real question is in your causal link is a savings glut in asia, particularly China , the cause of what we see in the USA? Just because implementation of looser monetary policies is often followed by a rise in bad loans and increased consumption (not to mention speculation) is it a cause of both? What were the intentions behind the savings phenomenon or looser monetary policies? Do these policies mandate that consumers must increase consumption or that businesses must take that loan regardless of whether there is a need for that? Is assuming some iota of rationality on the part of the consumer or business entities too optimistic?
Just because motor vehicles do result in accidents and casualties, would you say that car manufacturers are mass murderers? What looks like a simple causal link (1. motor vehicles may cause death, 2. motor vehicle manufacturers make motor vehicles, 3. those who cause death are murderers therefore motor vehicle manufacturers are murderers would either of you gentlemen accept this?) may turn out to be highly suspect upon reexamination.
Tel : it will never pay for itself in the long term, and there is no cost/benefit justification for buying it.
Tel, there is a basic rule in business if it doesn’t work in the long term you should be relooking the strategic plan immediately when there is still time to redo your plan! With the tiny bit of accounting knowledge , I can tell you there is no point in following your competitor’s footsteps; at best there is a tit-for-tat struggle. The fact (derived from the conditions you set out ) is your competitor cannot afford that machine and it’s worse if you can see them going bankrupt even if all your customers were to go over. If the imperceptible difference can lead to your customers buying from your rival, think how much better it would be for you to concentrate on innovation – produce that big change and capture a bigger marketshare! If you think that in the meantime you’ll lose business or if the business is not viable, you really ought to rethink the direction of the business.
Glenn:Tel has given an example of just that.
please refer to the comment above for what I have said in relation to Tel.
As for your example , let’s just say everyone wants to better themselves (in fact this is reminiscent of what was said on brad setser’s blog over a year ago) but at what price? It’s all very well looking on the bright side- moving to a better neighbourhood but have the people you mentioned in your example thought of what would happen should their ability to pay those loans be affected – would they lose not just the chance at a better future but also what they already have? Loans have to be repaid, I learnt that lesson early on and this world is cruel when you least need cruelty. We all live and learn. Learning to take responsibility for our choices, be it consumption or investment, is part of maturing.
Generally speaking; there was an inordinate amount of emotion in the debate that went on and that could be due to social factors. I’ll be the last person to say monetary policies do not matter, they do, but unless policies are converted to law which mandate actions, for example, looser monetary policies lead to availability of easy loans and all businesses/consumers must take advantage of that, the ultimate decision lies in the hands of individuals – just because you can does not mean you must . The freedom to make choices is invaluable which is why it should be exercised with caution and taking responsibility for your choices and decisions is important for all rational beings who have been given the opportunity to choose.
Proving causal links and relations is vital to saying A causes B – if we were to further explore the motor vehicle example above -that motor vehicles have x% probability of causing fatalities are we comfortable with saying that since motor vehicle manufacturers are aware of that and continue their business their actions can foreseeably be blamed for causing fatalities therefore every motor fatality should result in a homicide charge against manufacturers? For example a drunk driver is involved in a car accident which results in fatalities. Would the car manufacturers be culpable of homicide since they are aware that their action of manufacturing the car would likely result in producing fatalities at a rate of x% ;a distinct possibility or pattern as seen in statistical studies? Would it not be more rational, for example , to say that a tipsy driver who chooses to drive his vehicle despite being in no state to drive should be responsible for the resulting fatalities in this particular example. No one presumably put a gun (how a matter of expression has turned so controversial is a mystery!)to the driver’s head to force him to drive that car in his inebriated state – that he decided to means he has to be responsible for the consequences.
Let’s not assume that policies of any kind dictate actions all the time(unless of course they are made into law – but even the public does not take kindly to dictatorship all the time ) that would be underestimating the rational capacity of fellow humans!
In the Chinese consumption debate there is a missing point:
The efficiency of the country,and the main power behind the politics and economy.
The Chinese system supporting the one with the many connection,not the avarage guy from the street.
For the Chinese business man,it is the issue with the US:in China,you can get anything for money,in the US you can’t.
At the end of the day,this is the issue to increase the consumption.
In China,the saving came from the “chosens”,but they will not use the money to consume (imposible for a man to eat 1000 tons of meal) but to invest,and to make capacity.Like in the US before the depression.Or russia,before the revolution.
So,the US can consume,and the natural barrier for the consumption was “eliminated” by the Chinese Komunist Party.
The Federal Reserve is the responsible party, not American over-consumers. They could have have chosen higher unemployment and lower consumption and we probably would have had a Japanese decade of stagnation as a result instead of a housing bubble. We should have removed the status of the dollar as a reserve currency and allowed it to devalue then and it should have prevented the crisis without high unemployment or indebtedness in the US. But, that would likely have been at the expense of slower Chinese growth. But then, the Chinese wouldn’t be facing serious over-capacity issues now would they? So “blaming” savers or consumers is like getting angry that pigeons show up and eat when you leave food setting outside.
“Glenn | 30/08/09
Here are obvious cases in which easy monetary conditions caused savings to decline. And you keep insisting that US consumption was caused by bad Fed monetary policies. You are also now arguing that it could not have been caused by excess Asian savings because monetary policies cannot force consumption to rise.
”
So the easy monetary cause to lower saving and you think it is a good thing? Many people in the USA are finding out the hard way about the importance of saving! Monetary policy that reduce people saving is not good policy!
Also, your example, pretty much shown that wealth effect is nothing more than an illusion that can easily come and go and where is that wealth effect right now? Where is it?
The lower interest rate lower the cost of borrowing. Imagine buying a 400K house on a 8% rate for 30 years vs buying the same house for 4% for 30 years! Lower interest seem to lower lending standard as well for speculation and that wealth effect encourage more people to borrow more and spend more since they feel richer now since their money supply seem to be limitless (Home equity to tap your house price increase without actually selling your house and your the interest pay in your home equity as tax deductible).
Great piece once again!
If a being does not have a solid background on China studies, he/she cannot fully understand this Op-Ed.
Lack of credibility leads to the bad status of debt finance in China. One of the barriers to “greent investment” for private sectors is a showcase.
Look forward to reading more, Michael!
Michael,
I am amazed by the persistence of the debate about who/what is to blame for the current downturn in the world’s economic cycle. What is the point? Politicians can use “blame” arguments for strategic and rhetorical purposes. But most people (even economists) would regard such arguments as either naive or hypocritical. I completely agree with your statement that in the absence of domestic credit growth in the US based on foreign savings things would have been different.
A fairly compelling argument can be made that experienced analysts should have realized that this growth in domestic credit (without a commensurate growth in productive capacity) would become problematic if not arrested at the right time. As many did, but not always in an alarmist fashion. The points of criticism that were raised in the US dealt with, i a international deficits (and their sustainability), public sector deficits and the degree to which policy relied on the international integration effects on US macroeconomic indicators (the savings glut phenomenon being part of that) and the weaknesses of the new bank capital adequacy regime. What no analyst appears to have envisaged is that a collapse (with a strong positive feedback loop with prices in the real sector, especially housing) in the value of the US private sector domestic financial assets (also held by directly by foreigners and often financed by short term funds raised in the US by those foreigners), would provide a variety of near-fatal shocks to highly leveraged (but initially complying with regulation) institutions in a recently (and necessarily imperfectly) re-regulated financial; services industry. These effects were i m o aggravated by increasing policy uncertainty as the “crisis” began (with regime uncertainty as well given the end of a second presidential term).
It appears that neither the policy makers in the US, nor the official financiers of the US CA deficit, did anything (except trying to resort to self-interested short term behavior) with the kinds of financial system “stress” assessments that any experienced bank risk manager, especially if in possession of the data resources available to the US authorities, could have made of a hypothetical extension of the trends that were in existence during the period from 2003. China and other large net exporters did not adjust their terms of trade via the FX market and US economic politicians (the Fed included) did not use anticipatory countercyclical policies which they should have known to be necessary on the basis on information they should have made available to themselves. If china’s currency had been allowed to appreciate a great deal (or other measures to divert the flow of tradeables to undersupplied domestic markets) as was recommended by many knowledgeable and , its exports might have suffered without much of its production capable of being shifted elsewhere in the short term. That might have pushed up US domestic inflation and hence short term interest rates while a much lower external demand for longer term financial assets would have pushed up interest rates, lowered the price of many mortgage-related securities, gradually put pressure in financial firms capital ratios and reined in the construction boom, all of that long before levels would be reached that would require a massive gvt bail out. China’s intervention might then (especially in combination with the early stages of the oil price rise) have had resp triggered similar cooling effects as endogenous US policy should have had.
Whether that would have kept voters happy remains to be seen of course.
Thanks for your comments Rien, but although I am as fed up as you are with the way the debate so quickly degenerates into a fruitless game of blame, I do think it is nonetheless important to try to understand whether or not industrial policies and their impact on Chinese savings were among the root causes of the imbalance, for reasons I tried to explain in the previous posting.
If Chinese policies had nothing to do with creating the initial payments imbalances, then the current adjustment in the US consumption imbalance will be relatively benign for China since it would have been American consumption that forced the rising savings rate onto China. As American consumers cut back on their consumption, the Chinese distortions will automatically correct and China will enjoy high consumption growth and high GDP growth with no need to transform its development model.
But if Chinese policies caused the high Chinese savings, which in turn caused or exacerbated high US consumption rates, then the adjustment in the US requires an equivalent policy adjustment in China. I have argued that in my opinion Beijing’s response to the crisis has been to reinforce the existing growth model, so in that case rather than aid the needed adjustment Chinese policies are simply reinforcing the imbalance. Since the US will adjust one way or the other, rising US savings combined with policies that prevent a meaningful and smooth decline in Chinese savings will mean that world, and especially China, will have to adjust via much slower GDP growth.
If the Asian savings glut hypothesis is even partially true, it seems to me that Beijing’s current policies to deal with the crisis will lead to a very unhappy ending.
For some strange reason, this analysis is interpreted by some not-terribly-bright people as being anti-China, although it escape me why trying to understand how a particular set of policies may be the wrong ones for China indicates a desire to undermine China. Certainly it is the same debate that an awful lot of policymakers and their advisors are having in Beijing right now – as the current rout in the stock market might suggest.
Armando: Not many people consume houses. If buying a house is not to be considered an investment for the average family then what would they invest in?
Judy: Good answer, you show great common sense. However, imagine the emotional difficulty of a business owner who has spent years building up their business and now faces the prospect of admitting that they must take a step sideways, throw away at least some of what they have, and start building up again into a new sector of the industry. They probably also have to stand facing the team they built over the years and tell some of them they are no longer needed, with the business requiring new skills. Not easy to see the big picture under these circumstances.
You suggest “concentrate on innovation” and that strategy offers potential, with the implication that the business will need to take on additional risk. If the business is getting tight due to lack of customers and lack of cashflow then taking on additional risk under these circumstances is, well, risky. The long run only exists after your survive the short run.
Michael Pettis
Your outline of a ‘benign’ reduction in China’s trade surplus versus what could be termed a ‘malign’ one is a reasonable juxtaposition.
But the key issue in judging it in relation to the stimulus package is what is China’s ‘development model’. If it is a high level of investment and a high level of trade (i.e. a high level of exports and imports but not necessarily a trade surplus) then indeed, as you say, it will be relatively easy for China to adjust to the narrowing of the US balance of payments surplus, which has contributed to the narrowing of China’s trade surplus, although not necessarily by the mechanism you suggest. The actual mechanism of adjustment is that the proportion of investment in China’s GDP has increased, thereby narrowing the gap between its investment and its savings, and creating a rather successful combination of rapid economic growth and shrinking the trade surplus – I have given the statistics of this high investment/shrinking trade surplus in detail elsewhere. This relatively easy (which I think is a more accurate word that ‘automatic’ because, of course, policy initiatives are required) transition is what is occurring precisely because the goals of Chinese policy are, rightly,a high level of investment and a high level of trade.
If, however, China’s ‘development model’ is a large trade surplus, as you argue, then evidently the shrinking of the trade surplus, which is what has occurred so far in 2009, would inaugurate a deep growth crisis and prolonged economic slowdown. The fact that no such crisis of growth has occurred, only what is in comparative international terms is a rather mild slowdown, is a confirmation that what is fundamental to China’s development model is a high level of investment and a high level of trade but not a large trade surplus.
In is indeed evident that the stimulus package has reinforced the existing model in my interpretation of it. It has raised investment and sustained trade (in the present international context the latter is by very much restricting the decline of imports compared to exports), which is why it has been successful. If, of course, the aim of the stimulus package was to reinforce a development model of the type you suggest, that is to maintain a large trade surplus, then it has been a failure – as China’s trade surplus has shrunk greatly.
The fact that the shrinking of China’s trade surplus has been accompanied by rapid growth indicates clearly that running a such a surplus is not a fundamental part of its economic strategy while a high level of investment and a high level of trade is.
When people talk about USA deficit seem to always point to China while ignoring the fact that the USA has an overall trade deficit with the rest of the world. Also, China export is not only to the USA but to the rest of the world! Also, people always mentioned how much China export but never how much China import from the rest of the world.
http://www.mint.com/blog/wp-content/uploads/2009/04/us-chinatradecomparison-2.jpg
http://www.mint.com/blog/finance-core/visualizing-uschina-trade-relations/
The chart above is base on 2008 number.
http://www.uschina.org/statistics/tradetable.html
From the graph on the link above of shows that the USA total import $2.19T while its total export is $1.38T so it give a deficit of -$0.81T!
While China only has trade surplus with EU and the USA while having a trade deficit with many of its trade partners from the graph above. China import $1.16T and export $1.47T so it it give a surplus of $0.31T. Most of that trade surplus is from EU and the USA so far.
EU export $132B to China while import $300B so EU has a trade deficit of -$168B.
While the USA export $71.4B to China and import $337.8B from China so the trade deficit of USA with China is -$267B
Another thing that I notice is that people assume that Asia only sell to EU and to the USA. Here is IMF report that over 50% of the Asian export is to another Asian countries!
https://www.imf.org/external/pubs/ft/survey/so/2008/CAR02608A.htm
You inform us China’s policy response is to reinforce the same problematic lending model. In the US, the policy response is to attempt to stimulate consumption, i.e., reinforce the failed consumption model. Both governments’ first thoughts are to keep doing what they have been doing, failure or not, in other words.
Michael, I think teachers don’t get much respect in China because they, like government officials, are often underpaid but have a lot of influence and power over their students. Thus, teachers can very easily fall prey to cronyism and bribery.
Michael,
Thanks for your response. Close reading of my awkwardly worded comments (it is not simple and space is precious) shows that China (and I assumed that everyone would expect a reasonable level of understanding of the US political economy among the Chinese policy specialists) could indeed have given in to US (probably insincere) requests for CNY appreciation, which then would have created an upwards bias in US consumer prices (at least that is what some US analuysts expected, myself I am not so sure) anyway, China could have caused an increase in inflationary expectations which should have prompted a taylorite (given high levels of employment and capacity utilization) response in the form of a rise in policy rates to somewhere between 4.5 and 6% (given also concurrenmt upward pressure on commodity prices, esp oil). That would have led to rising market interest rates (probably a parallel curve shift, if China made an effort to appear credible) and that would have stopped the housing boom plus all the related excesses (and buoyant USD GDP) in its tracks. My comments address also the follow on effects on financial intermediaries’ portfolios and capital. It was one of those fairly unique siruations where there would not be a lot of “eddies” in the system, hence the the market response to (1) Chinese policy and (2) the US policy response would have been highly predictable and hence fast.
China did not do that (the US gvt of the day would have been mightily displeased if they had) and by continuing to add to the CA imbalance (the CNY adjustment did not even match the rise in relevant Chinese productivity) put more fuel onto a fire that anyone with financial sector regulation expertise would understand as prone to runaway effects. And I do not believe that China lacks people with the relevant expertise. There are far more difficult subjects. As you see, I am not exonerating the Chinese at all. As said, no one is to blame in particular. The circumstances offered very few survival options with positive externalities for politicians on either side.
“Armando: Not many people consume houses. If buying a house is not to be considered an investment for the average family then what would they invest in?”
The point is that basic shelter (and in a location where employed people are searching) plus some enhancements are productive investments (they protect suppliers of labor from the weather), but most enhancements do not make those workers and their offspring more productive. If I buy a Van Gogh and nail it to the wall of my house, I add 25 mm to its value, but that is not an investment in economic terms, it is what investment bankers call an investment: something somewhere between a gamble on a horse and one on long term interest rates…
Michael,
Apart from clarifying my earlier comment, I completely agree with you that the interdependency between the two economies requires policy coordination (or at least constructive responsiveness) in order to achieve high welfare outcomes. But face it, in 2005 (for instance, 2004 would also do) the domestic situation in the US may still have had enough flexibility to undergo a CA shift (with weak or no household expenditure growth -consumption or housing) without structural damage to the financial system. China pushed forward and the US gvt was grateful.
The current situation is far less flexible economically and may me only marginally more flexible politically. I do not see anything in China or the US that says either side is prepared to accept the welfare consequences of more balanced (and less long term damaging to the US) trade relations. Hence I agree that we will continue to be on a risky course.