Subscribe Feed (RSS)What should have been discussed during the SED meetings (Part 1)
August 7th, 2009 by Michael Pettis | Filed under Asian development model, Consumption and production, Economic growth.By coincidence I had two OpEd pieces that came out last week, one in the WSJ and the other in the Financial Times. The latter came about because about a month ago Martin Wolf asked me to write a piece based on my June 20 entry. The former came about on the previous Friday when I was thinking about last week’s SED meeting and why I wasn’t expecting much to come from it. Although they are very different pieces, both of them build on this idea that the inversion of the consumption/GDP growth relationship in the US has important implications for China’s future GDP growth.
For the WSJ piece I start by pointing out that when the Japanese and German currencies soared in value against the dollar after the Plaza Accords were signed in September 1985, many analysts thought that at long last their trade surpluses with the US would decline. They were partly right in the sense that the German trade surplus with the US did indeed decline. But in spite of the fact that the value of the yen doubled, Japan’s trade surplus nonetheless surged.
I don’t think this should have come as a surprise. There is a tendency to think that the value of the currency and the level of import and export tariffs are the main policy tools affecting the trade balance, and so absent a change in tariffs, any increase in the value of a country’s currency will automatically lead to a decline in its trade surplus.
Trade surplus
In fact the trade surplus reflects the gap between what a country produces and what it consumes, and so anything that affects that gap is implicitly a trade policy. I discussed this in some depth in my June 3rd entry.
In the case of Japan in the post-Plaza Accords environment, the Ministry of Finance and the Bank of Japan responded to the currency agreement by directing a flood of low-interest credit into the manufacturing sector while informally guaranteeing borrowers, so assuring lenders that profitability was irrelevant in determining the flow of credit. Sound familiar? As a consequence Japanese manufacturers increased their production even as the flow of funding into the manufacturing sector and traditional constraints on household consumption forced an increase in the gap between Japanese production and Japanese consumption. The result: a rising trade surplus.
By the way I have been reading Akio Mikuni and R. Taggart Murphy’s Japan’s Policy Trap: Dollars, Deflation, and the Crisis of Japanese Finance, an interesting book that covers a lot of this ground. I recommend it to China watchers, although I am no expert on Japan and I did have a big problem with the often-repeated assertion (and one that often pops up in discussions about China) that because Japanese trade was not denominated in yen the Bank of Japan was forced to accumulate dollars. In fact it doesn’t matter what currency your trade is denominated in – if you run a net current and capital account surplus, your central bank must accumulate foreign currency. Had trade been denominated in yen foreign buyers would still have had to convert dollars to yen with the Bank of Japan in order to make their purchases.
But that is a digression, and aside from a few irrelevant disagreements I think the book is quite illuminating. In China, like in Japan during the 1980s, there are a number of factors besides the value of the currency that affect the country’s trade account, and even if the value of the Chinese yuan rises, it will not automatically lead to a decline in China’s trade surplus commensurate with the contraction in global trade, especially if it is matched by a significant credit expansion to the manufacturing sector.
Several policies are aimed at boosting production besides the undervalued currency. As I have discussed before, these include very low lending rates enforced by the People’s Bank of China, energy and commodity subsidies, and probably most importantly, a flood of credit aimed at investment both in infrastructure and in the manufacturing sector. At the same time very low deposit rates, constraints on consumer financing, and low wages, among other factors, prevent consumption from growing at nearly the pace necessary to absorb everything that China produces.
As an aside MacQuarie’s Paul Cavey has a very interesting OpEd piece in last week’s Wall Street Journal, based on a longer research piece which I am not able to link. Among other things he argues that although China has run negative interest rates for much of recent history, until last year there was no credit bubble because credit was rationed – and credit rationing implicitly raises the cost of capital for the system, even if interest rates are nominally low. Recent conditions, however, are different, and all rationing has disappeared with the explosion in credit of the past eight months. Cavey concludes:
It’s not impossible for Beijing to take away the punch bowl of credit. There is plenty of room to defy the skeptics and in the next few months and push through structural reforms. For instance, some of the privileges state-owned enterprises continue to enjoy in terms of the ability to provide domestic services like banking and telecoms could be dismantled, allowing the country’s more productive private sector to thrive in local markets rather than just overseas. But without such changes China will be relying on growth financed by cheap domestic debt. This means China will be decoupling itself from the U.S. consumer, but at the cost of a credit bubble.
China’s consumption will rise
So to return to the main story, with the credit expansion and other measures aimed at boosting production, will China’s trade surplus soar? Probably not. Every trade surplus requires a trade deficit elsewhere, and as the leading trade deficit country, policies in the US that affect the gap between consumption and production will also determine the size of the US trade deficit. If the Obama administration is successful in forcing a rise in US savings levels, and even if it is not (since in the short term US households have no choice but to increase their savings rates), US consumption must grow more slowly than US production and the US trade deficit will narrow, except in the very unlikely case that US investment soars – investment would have to grow faster than savings to keep the trade deficit from contracting.
For China this almost certainly forces the country into either of these two outcomes
1. The government continues the current fiscal expansion forever, in which a huge expansion in government-led investment pushes growth forward.
2. The consumption rate in China must rise as a share of GDP.
There are at least three problems with the first option. First, a significant portion of the fiscal stimulus (and almost certainly a higher share than reported) is directed into manufacturing in the tradable goods sector, which needs anyway to be absorbed by rising consumption, either in China or globally. Second, given the inefficiency of the current fiscal and credit expansion, and the concomitant rapidly rising direct and contingent government debt, there is a real question as to whether this program can be sustained for more than one or two years.
And third, and this seems to be the most confusing point for some, the economic purpose of investment is to increase future production, and even if the fiscal stimulus turns out to be hugely efficient (it isn’t), without a surge in future domestic consumption to absorb the additional Chinese capacity we will still be stuck with the need for a massive return to US profligacy, and Chinese funding of that profligacy, to absorb the increased production.
The first option, in other words, is at best possible for a very short time, and ultimately we are forced into the second option: Chinese consumption must rise as a share of GDP, or to put it another way, Chinese GDP must grow more slowly than consumption.
So why should the US care what China does to rebalance its trade if changes in US consumption will force a rebalancing anyway? Isn’t discussion and coordination pretty much unnecessary if a rising savings rate in the US must ultimately force an adjustment on China?
No. US and Chinese policies matter because there are many ways that international trade can rebalance. In the US we will see consumption grow more slowly that production, just as in China we will see consumption growth outpace production growth.
Both will happen, but in both countries there is a good scenario and a bad scenario. The good scenario for the US would see some growth in consumption buttressing healthier GDP growth. But the bad scenario would involve a contraction in GDP driven by even faster contraction in consumption. For China a good scenario would involve surging consumption driving slightly slower GDP growth, and a bad scenario would consist of slow consumption growth dragging down GDP growth.
If China continues to pump out capacity and tries to export this excess abroad, and if US household savings rise much more quickly than US fiscal dis-saving (borrowing), we will almost certainly see the bad case scenario occur, at least in China, and especially if it leads to trade friction around the world. The nightmare scenario is that in the US a still-high trade deficit prevents a slowdown in consumption from nonetheless causing a sharp slowdown in economic growth, which leads to rising unemployment, which causes consumption to slow down even further. Meanwhile in China rising inventories eventually lead to cutbacks in production, which also lead to rising unemployment.
As fewer Chinese get jobs, the unemployed consume less, and the employed also try to increase their savings because of rising uncertainty. Since net Chinese savings must decline if net US savings rise (note I am assuming the rest of the world, including sustained investment levels, is constant, but I suspect the impact of the rest of the world will actually be adverse), the only way for this to happen if the Chinese savings rates rises is either for a burst of inefficient and unsustainable debt-fueled investment by the government, or for GDP growth actually to slow sharply.
I know all this sounds drastic, but the imbalances have to be worked out one way or the other. Rising savings in one part of the world, even assuming no changein global investment, requires declining savings somewhere else, and although it may be unrealistic to expect no change in global investment, the plausible prediction is that global investment will actually decline, which increases the pressure. This is just another way of saying that changes in trade deficits in one part of the world require equal changes in trade surpluses elsewhere. This is also just the obverse of saying that declining consumption in one part of the world requires rising consumption elsewhere (or sharply rising investment, which since it represents future production only postpones the need for consumption growth) or else global GDP must contract.
Uncoordinated policies
What will determine whether or not the two countries follow the good scenario or the bad scenario? Clearly fiscal and monetary policies in both countries will matter because they will set the speed of the adjustment and they may or may not speed up the adjustment process.
In the US, fiscal expansion is aimed primarily at slowing the pace of demand contraction. This may be necessary since I expect US consumption will grow slower than US GDP for many years, but it comes at the expense of a rising fiscal debt. I am not as worried as many others seem to be about US fiscal indebtedness and I am certainly not worried about the ability of the US to fund its debt, especially since the stock of debt in the US is declining (private debt is dropping faster than public is rising). As I have argued many times, I also think all the fear-mongering about whether or not China and other foreigners will continue to fund the US fiscal deficit is totally muddled thinking and among the least important things to worry about. Foreigners will and must fund the US current account deficit, and the bigger the deficit the more they will fund – so really we actually want foreigner to reduce their funding.
But there are reasonable limits to how much debt we want to see in the US, and we certainly don’t want to see a continuation of the global imbalances in which the debt-fueled consumption binge of US households is simply replaced by the a debt-fueled consumption binge by the US government, especially since as long as the trade deficit is high a large part of the job-creating aspect of US fiscal deficits will leak abroad, requiring even larger US fiscal deficits. In addition, the US fiscal program should be accompanied by specific measures aimed at increasing US household savings – I am not able here to go into much detail on how to do this (and I am no expert on the subject), but for example perhaps we can eliminate taxes on interest income, raise consumption or gasoline taxes, and so on.
Of course forcing an increase in US savings means improving the long-term US outlook while hurting short-term prospects for employment. Rising US savings means declining consumption growth, and remember that US GDP growth will be less than growth in US demand for the next few years as US debt levels decline.
I think China will face an even more drastic version of this trade-off, and this is because, as I have been arguing for two years, contractions in global demand force the most difficult adjustments not on the “sinful” low-savings trade-deficit countries but rather on the “virtuous” high-savings trade-surplus countries. China needs to cut capacity drastically and put into place the factors that will lead to a rise in net consumption, but most of these policies will actually hurt employment in the short term. I have already discussed what these policies are likely to be in my June 3rd entry, and almost all of them will almost by definition force a contraction in the tradable goods sector.
China’s problems will be made much worse if it is forced to cut capacity very quickly, which will happen if trade disputes get worse. Already disputes with Asian neighbors are pretty nasty, and they are likely to get worse with the US and Europe. There has been a lot of discussion recently about China turning to other developing countries as sources of net demand to replace the US, but this is unlikely. Aside from the fact that no one is large enough, none has the ability to run persistent trade deficits. China can fund these deficits for a while, but it will learn, as many have before it, that funding persistent current account deficits for developing countries eventually leads to defaults on the debt.
So after all the premable on what do I think the SED discussions should focus? Since this entry is long enough already I will postpone that part of my discussion for a couple of days.
[...] Read the rest of this great post here [...]
It is post like this that keep me coming back here. My interest in economics came about as a result of looking examples of homeostasis in complex networks and how they relate to the brain.
Michael, you are the Fred Gage of economics!
[...] Excerpt from: What should have been discussed during the SED meetings (Part 1) [...]
I am an avid reader of your Blog. I find your insights to be most useful in attempting to comprehend the “big picture”.
Well done, Sir!
This is my first ever post re. economic matters (and probably my last)
I have two obversations to make. I apologise in advance if my figures are not strictly accurate, although they should still be relevant.
Firstly, in the mid 80’s it was stated that the USA, with roughly 6% of the world’s population, consumed over 30% of the planets resources. Roughly 45% of this amount was spent on military spending.
Secondly, China is unlike any other country. It has a population of 1.3 billion. I would estimate that approximately 500 million Chinese are not sharing in this recent economic miracle. I spent 2 yrs in China, mainly in Guanxi and Kunming provinces. I saw the incredible construction boom taking place in Nanning. I saw the encouragement (from Beijing) of private car ownership and and generally the embracing of Western style, middle class/ professional consumer lifestyles. I also saw a few of the hundreds of million Chinese who can take no part in this bonanza.
I feel that the crux of the problem lies within these facts. America grossly over consumes. Military spending is totally disproportionate. In a nut shell the American Dream is unsustainable, USA needs to consume much, much less.
I was surprised that China embraced this market model with no thought of Peak Oil and the environmental effects of Global Warming et al. China’s achilles heel is the huge population that is been left in the cold, so to speak, by these reforms.
Inequality and imbalances, eventually, lead to conflict, not only in China and the USA but globally.
We are seeing an economic role reversal between the US and China. The US will soon no longer be able to compete at ANY level with China. China already built a strong foundation and base for establishing its domestic economy. Peoples attitudes have shifted. The only thing left for the Western institutions is to profit off of it, which they will be unable to do as a whole. Why? Because China does not play or adhere to their rules (intellectual property infringement, rule of international law, etc.)
Current fiscal expansion will last as long as the current system is supported by and garners the belief of the people. That system in the US is failing, and regressing towards a socialist economy, where people no longer believe in it (i.e. its “evil” to make money) while China is progressing towards a free market.
Your blog is interesting, but there is no sugar coating it. China can exist successfully without the need for Western markets.
Pei
You mean like the US was able to exit the game during the great depression?:-P
We will see how the Communist pary will able to stay in power during the “Chinese Great Depression”
And this could be interesting information for us:
http://www.chinalawblog.com/2009/08/when_the_chinese_government_ta.html
It would seem that a large part of both the US and Chinese stimulus program has been misdirected. In the US the inclusion of permanent tax cuts on the middle class was probably misguided, though it may have simply transferred public dissaving into private saving. Clearly more should have been put into public investments.
You’ve chronicled the misdirection of China’s stimulus ably enough. But beyond stimulus there other things policy makers can do. In China there is the oft discussed need for a social safety net and an opportunity to re-tilt the credit markets towards the consumer. While the US is already doing the opposite and should adjust tax incentives more toward saving by consumers.
None of those measures seem adequate, however, to avoid a long hard, and, politically, perilous slog for years to come. I wonder if you’ve read any of Steve Keen’s debt conversion ideas, they seem to me to be, and perhaps to Keen as well, to politically impractical. But some rethinking of traditional debt structures would seem to be in order after a crisis of this magnitude. Maybe China should be encouraged to convert its reserves to equity assets.
Excellent synopsis on China. This emerging market is one to watch out for. I’m afraid the treasuries we’re selling them will hurt us long term, however. See more at
http://joeshareholder.blogspot.com/2009/07/joe-shareholder-gets-kung-paud-by.html
Michael Pettis has the great merit of addressing the most important issues in the world economy. The problem is that he supports a theory which is wrong, and to try to defend it makes factual statements which are incorrect. As facts are always more important than theory we will start with these before considering the latter.
There are a number of factual errors in Michael Pettis’s post[1] so dealing with all would make a very long comment. Therefore only one, but in a very direct sense the most important, will be dealt with here. This is the relation between consumption and GDP in the US. Once the real situation on this has been established the implications for China can be
considered.
Michael Pettis has repeatedly stated that consumption is falling as a proportion of US GDP because US saving has been rising due to the impact of the financial crisis. Factually the exact opposite is the case. Consumption has risen as a proportion of US GDP and saving has been falling.
Thus for example on 20 June Michael Pettis stated: ‘we are now seeing a sharp rise in US household savings rates. This has been partly mitigated by a sharp rise in government dis-saving (borrowing), but nonetheless aggregate US savings rates are rising, and with them US consumption must decline.’ This correctly states that US savings are not equivalent to personal savings but also include government (and company) saving or dis-saving. But the factual claim that US household savings rates have risen sufficiently to offset the increase in the budget deficit, leading to a decline in consumption as a proportion of US GDP, is simply false. The deterioration in saving in the US government and company sector has been greater than the increase in saving in the personal sector – that is overall US savings have declined as a proportion of GDP.
He also wrote in the same post: ‘Now that the US is raising its saving rate, this means among other things that the growth in US consumption will be lower than the growth in US GDP.’ And also: ‘the US is raising its savings rate and so forcing more rapid growth in US GDP than in consumption.’ This is also incorrect – the US has not raised its savings rate, on the
contrary it has fallen during the financial crisis, and consumption has increased, not fallen, as a proportion of the US economy.
He wrote on 3 August discussing the US GDP figures that: ‘my main concern – no big surprise – was US consumption, which declined by more than GDP.’ This statement,for reasons outlined below, made the error of confusing personal consumption with total US consumption – which includes both personal and government consumption. This statement is therefore not correct. US GDP fell by more than the change in consumption between the first and second quarters of 2009 and consumption therefore rose as a percentage of GDP.
The simplest way to show without ambiguity the rising share of consumption in the US, and also the declining share of saving, under the impact of the financial crisis is simply to chart them. I attempted in another comment to post a chart which shows these trends. However it seems the comments section does not accept charts. I have therefore made a further attempt to post a chart here but on the assumption that it does not come out again the same trends can be shown slightly more laboriously in figures. Anyone who wants to see charts which show the rising proportion of consumption in US GDP during the financial crisis, and the declining share of savings, can find them here.
Taking figures, various dates could be taken as the beginning of the financial crisis – although all will show US consumption, as a percentage of GDP, rising sharply under the impact of the financial crisis. If the fourth quarter of 2007 is taken as the last before the full impact of the crisis then in that quarter US consumption was 85.8% of US GDP. If the second quarter of 2008, i.e. before the collapse of Lehman’s, is taken then consumption was 86.7% of US GDP – it may be seen that US consumption was rising rapidly as a proportion of GDP during the first half of 2008. For the last US GDP data available, that is for the second quarter of 2009, total consumption was 87.6% of GDP – a further sharp increase.
Taking the period from the last quarter of 2007 to the second quarter of 2009 US consumption therefore rose from 85.8% of GDP to 87.6% – a rise of 1.8% of GDP. Even if the narrow period between the first and second quarters of 2009 is taken US
consumption rose from 87.2% of GDP to 87.6%.
As there is no doubt as to the fact that consumption rose as a proportion of US GDP, anyone can download the relevant tables from the US Bureau of Economic Analysis and verify the calculations themselves, why does Professor Pettis make statements regarding fact which are the reverse of the actual situation? It is because he made two crucial errors.
First,most importantly, while in the first of the statements quoted above he correctly points out that total US saving is what must be considered,that is the rise in household consumption must be offset by deterioration in other (government plus company) sectors, in other statements, as shown below, he confuses personal consumption with total consumption, which is incorrect.
From the point of view of analysing the determinants of the US balance of payments it is total US consumption and total saving which is crucial – not personal consumption and personal saving. It so happens that both personal consumption and government consumption have been rising as a proportion of US GDP, but actually that is not essential. It would be sufficient for total consumption to be rising as a proportion of GDP even if one of its components were declining.
Second, a more minor point, within personal consumption he has not distinguished between movements in constant prices (which are important for statisticians but no one ever purchased anything with a constant price dollar) and movements in actual dollars – i.e. the ones people spend. It is actual dollars (current prices) that determine US consumption and its balance of payments. Therefore he does not point out that, due to price shifts, a small decline in US personal consumption measured in constant prices between the first and second quarters of 2009 actually translated into a rise in the proportion of personal consumption in US GDP between the first and second quarters of 2009.
Taking these errors in order, first consider the movement in components of US consumption. US personal consumption was 69.9% of GDP in the fourth quarter of 2007, rose to 70.3% of GDP in the second quarter of 2008, and rose further to 70.6% of GDP in the second quarter of 2009 – over the whole period the rise in US personal consumption was 0.7% of GDP. Between the first and second quarters of 2009 US personal consumption rose from 70.4% of GDP to 70.6%.
Turning to government consumption this was 15.9% of GDP in the last quarter of 2007, rose to 16.4% of GDP in the second quarter of 2008, and rose further to 17.0% of GDP in the second quarter of 2009. The rise in US government consumption between the first and second quarters of 2009 was from 16.8% of GDP to 17.0% of GDP.
Therefore as stated above US consumption, that is the sum of personal and government consumption, rose by 1.8% of GDP between the last quarter of 2007 and the second quarter of 2009, including by 0.4% of GDP between the first and second quarters of 2009.
Turning to the narrower area of personal consumption Michael Pettis rightly quotes the figure that US personal consumption measured in constant price dollars declined at an annualised rate of 1.0% in the second quarter of 2009 compared to a 1.2% annualised decline in GDP. But unfortunately he does not point out that due to sharp changes in relative prices in the US personal consumption actually rose as a percentage of GDP.
What actually happened in (current) dollar terms between the first and second quarters of 2009 was that US GDP fell by $28.2 billion while US personal consumption rose by $1.3 billion. The result was that US personal consumption rose from 70.4% of GDP to 70.6% of GDP.
Turning to US saving there is a statistical delay in that measured data for total savings for the second quarter was not published with the second quarter US GDP figures. But measured data is available up to the first quarter of 2009 and this shows that between the fourth quarter of 2007 and the first quarter of 2009, US total savings fell from 13.9% of GDP to 11.5% of GDP. It is relatively easy, if a little technical, to show that US savings during the financial crisis fell up the second quarter of 2009. I have dealt with the technical details of this calculation on my blog for those who want to check them and again the easiest way to see that US savings have been falling as a percentage of GDP is to look at a chart. If someone wants to challenge this calculation I will post the technical details here but unless someone does not accept these figures it takes us into a few details that are unnecessary to deal with otherwise.
There is therefore no doubt whatever as to the factual situation. During the course of the financial crisis consumption has risen as a proportion of US GDP. Saving has declined as a proportion of US GDP. The factual situation is therefore the opposite of the one that Michael Pettis claimed. Quite honestly the claim that US consumption has been falling as a proportion of GDP and saving has been rising does not have statistical legs to stand on.
In fairness to Michael Pettis it should be said that he is not the only economist to have wrongly claimed that US saving is rising and consumption falling. Robert Skidelsky, made the same claim in the New York Review of Books in July, for example. However the fact that more than one person holds a view which is not in line with facts does not make it more correct.
There are many very important issues that need to be discussed regarding the implications for China, and the world economy, of trends in the US economy. But this can only be done based on
the actual facts of the situation. Evidently Michael Pettis’s discussion of the implications of the trends which he claims have occurred in the US has to be revised if, as shown above, the facts are the opposite of those which he claims are the case. But that can be dealt with elsewhere. First the facts of the situation in the US economy should be established.
What would be best would be for Michael Pettis to accept the statistically clear, that consumption has been rising as a proportion of US GDP, and US savings have been falling as a proportion of GDP. It would then be possible to start to address the implications of, and reasons for, this.
As anyone can check the statistics I have outlined the sooner Michael Pettis admits the statistically evident, which he will be forced to do in the end, the sooner the discussion of the implications of the real situation for China can go forward on the basis of the actual facts of the situation. As Michael Pettis is rightly attempting to address extremely serious economic issues refusing to accept facts, indeed asserting the contrary of the facts, not only does not help others but means he is misleading himself as to the trends. Trying to claim that the economic facts are other than as they are also greatly slows down the necessary objective discussion.
I await Michael Pettis’ reply to the facts above. If he does not then others can take it that the facts are as I have described.
[1] For example Michael Pettis has also claimed China’s trade surplus is rising when it is actually falling.
I don’t know if you’ve spent time talking about this before, apologies if you have. But I presume part two of this post is going to talk about how to ease both the US and China into their new roles. One obstacle that’s often raised is China’s huge and unexhausted labour pool, which is often argued by Chinese economists and officials to necessarily depress the cost of labour, thereby hampering efforts to raise incomes and consumption. A few years ago there was a great article in The Economist which said that really much of the world’s current economic changes could be explained by just regarding China’s entry into the world systems as a huge supply-side shock in the labour markets.
So I wonder how true these claims are, and how problematic they are? Coming from law-abiding, fairly well-regulated Europe, I often think that measures like higher minimum wages and better social security systems would do a lot to spread the wealth and get China consuming. But would they really work? And does the US have anything to offer China in this sphere? Advice? Concrete assistance? Appropriately nuanced trade policy?
I look forward to your next entry.
Ross, since Pettis doesn’t seem to be commenting while he is traveling, let me once again make the obvious point that he is talking about consumption declining as a share of GDP over the next few years. Instead of trying to get attention by nitpicking, why don’t you present your scenario for China for the next five years?
Who is Ross? These comments are very long and always repeat the same thing.
Glen | 7/08/09
It is post like this that keep me coming back here. My interest in economics came about as a result of looking examples of homeostasis in complex networks and how they relate to the brain.
Michael, you are the Fred Gage of economics!
………………………………………….
Give me homeostasis, anytime
Fred “Rusty” Gage is a professor in the Laboratory of Genetics at the Salk Institute, and has concentrated on the adult central nervous system and the unexpected plasticity and adaptability that remains throughout the life of all mammals. His work may lead to methods of replacing brain tissue lost to stroke or Alzheimer’s disease and repairing spinal cords damaged by trauma.
Ross,
Hasn’t this issue of the trade surplus already been resolved? You are ignoring the substantive issue of what is happening to the import/export gap, and you are looking at the last one or two months while ignoring the impact of one-off stockpiling of commodities. I think you really are nitpicking rather than trying to engage in anything serious. Besides, isn’t one of Pettis’ main claims that a widening trade surplus cannot be sustained and must narrow? So what is your point?
And why aren’t you explaining why the fiscal stimulus is sustainable and either can go on for several years more without creating a debt problem or will soon become unnecessary for continued growth? Isn’t that the main issue? For us it certainly is the issue getting all the attention.
I hate to keep harping on this matter, but there is a flaw in the system of savings and debt along with the system of banking that makes all this other stuff meaningless. It revolves around this paragraph, which I finished my own ramblings. The effort of most people that publish is to keep the status quo intact, to keep the same people running things. To keep the same fools that made the mess in power. Every system government has employed in this area will only make the problem worse.
This is the gist of the situation
Savings, debt and collateral all serve to create each other. Only in this manner can the Japanese situation be explained. The Japanese answer to the problem was more debt, which in general would be inflationary, but in this case or in the case of maximum payable principal and interest is deflationary. This is what a depression really is, maximum payable principal and interest and the longer the effort to support the money supply goes on, the worse it gets. Irving Fisher was wrong, though his thesis of swelling dollars over the short term was correct. He forgot that the dollars spent a lot of years shrinking. When the result of several business cycles and government solutions to recessions piles up to debt in the amount of several times GDP, then too much has been borrowed out of the future to go on and continue to consider the debt legitimate and the money real in any sense. Like all psychological pain, it is created and made worse by the continued avoidance. No one wants to lose their status quo except the debtors.
The link is my website linked above
John Ross, I am going to look over your stuff, as I am likely to agree with you. I do want to correct something that is in my linked post. In one case, savings reduces debt, when it is used to pay bank credit. Of course, this is something that the bankers and government want to avoid at all costs. Also, I don’t believe in the idea that GDP is consumption, but that consumption is the result of GDP. If production isn’t needed or wanted, it is sold at a discount or wasted. The idea that something is produced that isn’t consumed in some fashion even capital goods is absurd. I believe much of this nonsense is used to cover up the fact that what is called GDP growth is nothing more than credit inflation.
Perhaps the most interesting conclusion in the Mikuni and Murphy book is that when a central bank carries such a large stock of foreign exchange on its balance sheet, that eventually it is inherently deflationary. Reference the mechanism described above. I agree that the SED did not produce much, and the reflationary policies that both sides have pursued have gotten us back(on both sides) to something like the status quo ante. Structural adjustments, as implied above, and by Mr. Ross I guess, are yet to come. For that US, that the consumption share of GDP rose a little bit is immaterial to savings rates, and more relevant to the fact that GDP has contracted more quickly overall than consumer spending. As for Pei’s comments, he/she is basically saying that China doesn’t need the US, or any other trading partners for that matter, because it has no respect for the legal institutions that form the basis for a functioning market economy. Maybe, and Chinese companies can continue to steal from their counterparts abroad and at home. It is not hard to imagine how much value this will destroy, and has destroyed already. The problem is that such things cannot be contained within China’s borders. Let’s hope that policy makers are a bit more enlightened than such nationalistic and animalistic capitalists.
Bomlat
The coming “Great Chinese Depression?”
Unless there is pandemic outbreak of a virus, how could things ever be any worse than the 20-30 Million that starved to death several decades ago? Things are still booming as the Chinese domestic economy is still very young and has many long legs to yet run with.
What it really boils down to is that the dream is still alive in China. A system is built on belief, followed by brains, and then labor/hard work. China has all three going for them, while the west is losing ground on 1 and 3.
Economists want to tie China into the West as if the West is needed for their existence. That seems rather arrogant to me (not directed at you).
how convenient, Ross’s entry allows him to
1 – YET again deliberately “misunderstand” what Pettis has said.
Allowing him to…
2 – YET again post a links to material which doesnt address the issue
Yet again I followed one of Ross’s links. To another blog…written by whom, i do not know…here is a quote criticizing Wolf, Pettis, Setser, etc
“A theory which is deficient in coherence, and which fails to foresee the possibility of reducing global imbalances by mechanisms which are actually occurring, is evidently a theory which is erroneous.”
Now i haven’t read Setser talking about imbalances before, but Pettis has said time and time again that the imbalances WILL CORRECT and ARE CORRECTING!!!
Is there a whole industry of people arguing against non-existant positions?
Yawn…
I think the problem is Ross, that even if you get people to look at your blogs / arguments once or twice, they will not return too often once they have actually read it. I guess it is like the tobacco industry having to find customers to make up for those that its products kill. (without the killing of course – just disappointing)
Your debating style is weak, you fail to acknowledge anything other than these weak little “misunderstandings” of yours which anyone who has actually read the posts in question will soon realise is just you misreading the arguments AGAIN and AGAIN.
In the last post you were going on about how this whole argument will be settled over the next few years…fine! So why are you still making your disingenuous arguments here?
btw – i know that the link i followed was written by Ross himself. (before he himself dismisses all my arguments because of this one unclear point)
Hi there Prof Pettis
I was wondering if you have any comments about money supply in China relative to GDP. I have been doing some calculations – admittedly with quite a lot of error margin, and the M2 seems to be very very high relative to the Nominal GDP. (The upper limit for my calculation was 190% of GDP by the end of June.)
With the July money supply and lending figures due out any day (tomorrow?), i was thinking about how high this can get. Do you have the Japanese equivalent from the 1980s lending flood which you describe in your entry?
Pei, i wouldn’t get too far ahead of things in your arguments.
Although China is standing up relatively healthily so far, don’t forget how much of its development (especially in terms of capital and technology) has relied on “The West” – I would prefer the term the outside world. There is really no such thing as the West in terms of the economics we are discussing – Unless you mean to include Japan, Australia (in fact any developed nation) as “The West”?
I look around here in Shanghai (substitute anywhere in modern CHina) and see a whole lot of outside influence. Be it construction ideas, transport systems, electricity grids, computers, communication technology etc etc.
Hard-work can be very important, but I think people in China were working very hard back during the famines and disasters that you mention too – it wasn’t that people were lying around sunbathing whilst the starvation was going on.
Belief in the future is important, but more from a political stability perspective i would argue – and it can change very rapidly during a sustained slump – just look at Japanese “confidence” over the last 30 years or so. (sorry to compare China and Japan AGAIN!)
As for Brains, i am very admiring of China’s ability here. But why are so many thousands (tens of thousands?) of students going abroad to study each year? – either China’s institutions are quantitively insufficient, or there is a perceived qualitative gap, or both?? Why are Chinese companies (in very general) not usually able to compete without government backing (ie Loans) in foreign markets very successfully yet? We are yet to see any “life changing” technological developments affecting global citizens which orginated in modern China. I know there are thousands of patents pending, but you take my point…
I don’t mean to suggest that they can’t, i just mean to say that i think you are being a bit premature with your argument that China doesn’t need the West (outside world) already. Think about energy supplies, the world energy markets are dominated by non-chinese firms and other countries. Wind farms and solar are receiving an admirable boost in China, but there is a long way to go. China relies on the US Navy to maintain open oceans etc etc.
Playing catch up in any field is a lot easier than leading the pack.
Pei,
In some ways, aren’t brains and belief mutually exclusive?
Prof Pettis,
At least,I think Ross has asked a good question here.The whole savings rate problem is really too abstractive,at least for me..Hey,there even hasn’t been a definition for it.
US consumption/GDP rate hasn’t been coming down this year.Steven Roach has mentioned this:
http://multimedia.caijing.com.cn/2009-06-25/110189317.html
TR,
I am not remotely nitpicking but dealing with an absolutely central part of Michael Pettis’s argument.
Michael Pettis claims that consumption in the US is falling and that this has a number of major consequences for the world economy and for China. He then constructs a theory of what will be the consequences of such a fall in US consumption for the world economy and for China. In other words he argues if A then it follows that B, C etc.
But I point out that such a fall in consumption as a proportion of US GDP has not factually taken place, therefore consequences can’t flow from it. In other words A is not true. That isn’t to ‘nitpick’ it is to show that one of the most central arguments is wrong.
Michael Pettis has the great virtue that he is looking at the key developments of the financial crisis affecting China not from the point of view of silly trivial explanations which cannot explain economic shocks of this magnitude (it is due to excessive bonuses to bankers etc) but from the point of view of the most important macro-economic trends in the world which are indeed powerful enough to explain what is occurring.
The problem is that the macro-economic trends he claims have happened haven’t actually happened. Michael Pettis has argued consumption has been rising as a proportion of GDP in the US and saving has fallen under the impact of the financial crisis. I point out that in fact the opposite has occurred. That is, as I said, the first premise of Michael Pettis’s argument doesn’t hold.
I note that neither TR nor others making similar points, or Michael Pettis, have attempted to refute the facts that I set out in my comment – they will not be able to because the trends I have outlined are the ones actually occurring. After a period of time when these points are not answered people should conclude that the facts as I have set them out are correct, and the statements made regarding the factual trends in the US economy made by Michael Pettis are wrong.
Michael Pettis has attempted to set out a coherent theory of what is happening in the US economy and how this is affecting China. He has done so in a logically interconnected fashion. That is well worth discussing. The problem is the theory doesn’t accord with the facts. The theory that the sun went round the earth was also logically coherent – it just wasn’t true. Once the real factual trends have been established then the reasons, and their consequences for China, can then be discussed.
Professor Pettis may wish to try to refute the facts I set out regarding the US economy – if not people are justified to conclude the facts are the ones I have set out not those he has claimed. Hopefully he will accept that the facts are as I have set out and then the discussion can deal with the trends that are actually taking place.
Prof. Pettis:
“US consumption must grow more slowly than US production and the US trade deficit will narrow, except in the very unlikely case that US investment soars – investment would have to grow faster than savings to keep the trade deficit from contracting.”
Why is a very unlikely case that investment soars in the United States? It seems to me that the U.S. government is trying very hard to subsidize residential investment, which is a large portion of investment in the United States. With the administration planning such large deficits, much of which will find itself in the “investment” category, I don’t think it is far-fetched to think that investment growth can outpace savings growth (at least in the intermediate term).
I don’t mean to join a debate that I wasn’t originally in here John Ross, but as far as i knew, Prof Pettis was talking about the future (5 years or more?) when talking about consumption in the US falling as a portion of GDP.
I personally don’t see how the US can continue importing / borrowing as much as had previously been occuring. The downward pressure on the dollar was already intense.
At the moment we are still in a transition phase (ie within 18 months of the shock). I would not expect new patterns to be emerging quite yet, at the moment everyone is still reacting.
From a banking perspective, i think certain truths need to be acknowledged.
1 – the lending in China this year has been extreme and at the very least strongly influenced by politics, rather than commercial viability. I am not one who thinks that the banks (despite all their Chinese board members senior figures being party members) are totally slaves to government will, and i also think government will has some contradictions, but truth is simple – no policy, no lending.
2 – It is not sustainable. I expect the July figures to be the lowest or perhaps around the levels of April and May this year, which I think reflects policy level ideas that agree that it is not sustainable. August will almost certainly be low too, whether or not Sept sees an end of Q spike is still a question…
3 – Keeping the RMB pegged to the dollar has had large costs in terms of sterilization over the last few years – especially with degrading dollar returns on the reserves. Had the crisis not removed the need to sterilize so much, and the corrections taken away the trend (for months at least) then around this year or next the burden of this would have become very hard. – In fact i personally believe that without this crisis and the reintroduction of the peg, the rate of appreciation of the RMB would have increased this year.
Aside from this, there seems to be a problem with the idea that China’s trade surplus and (connected or not) undervalued currency (and over-production etc – which you may not agree with) is a result of some sort of magic formula. We know what happens if everyone tries to devalue in a competitive way, we also know that not everyone can logically run a trade surplus. Trade tension is bound to arise, and i think we have proof that it already is doing so.
I would reiterate Greg’s point? If you dismiss all the imbalances / correction arguments, then what exactly do you see the world looking like in 5 years?
For what it’s worth, it seems to me the US GDP data from the BEA does say what Prof Ross says it does. I could not calculate the same ratio of government consumption/GDP (dividing line 21 of BEA Table 1.1.5 by line 1 of that table = 19.2% Q4 2007, 19.8% Q2 2008, 20.7% Q2 2009), but the direction (increasing as % of GDP) and magnitude (~1 percentage point) were the same according to my calculations.
I’m also not sure I agree with Michael’s statement above that “private debt is dropping faster than public is rising”. The latest (Q1 2009) Z.1 Flow of Funds, for example, shows a net decrease in private debt of $116.8 billion and a net increase in government debt (state/local govt, federal govt and GSEs) of $402.4 billion. Granted the data as of today may look different. (If I’m missing something, please correct me.) More importantly, though, I think the reason the government is borrowing is that it anticipates private debt dropping via repayment and default by a lot more, and for a long time.
And that’s the larger point, I think. As TR says, and as I’ve always understood Michael’s argument, we’re not talking about a process that was completed between the first two quarters of 2009, but one that has been triggered, has multiple paths and will play out over years. If Michael’s right about the consequences of the choices policymakers face, we’ll see it in the data inevitably; I’m not sure how much it matters that we don’t see it yet and think it kind of misses the point to use that a basis for accusations of mis-stating the facts. Also, Michael has always warned against (including in this post) a scenario in which government debt-fueled government consumption replaces consumer debt-fueled personal consumption in the US-China (im)balance – an argument that seems well-aware of the distinction between government and personal consumption rather than confusing them.
I’ll try to restate the problem with the Prof’s analysis of savings. its a simple error really, everyone makes it but the Prof should not ignore Ross’ very earnest comments.
Savings rate vs savings level
“If China continues to pump out capacity and tries to export this excess abroad, and if US household savings rise much more quickly than US fiscal dis-saving (borrowing), we will almost certainly see the bad case scenario occur, at least in China, and especially if it leads to trade friction around the world.”
Household savings rates have increased sharply – but this has little bearing on whether total levels of savings have risen or fallen. If total household income has fallen by X%, and household savings rates increase by less than X% (we all have to eat, even if we start eating Chinese takeout), then savings has fallen, not risen. The argument also overlooks public sector debt and spending, which has famously run into unprecedented deficit.
Pei.
China mixing the issues of Yugoslavia , the problems of the US during the great depression ,Germany before the 2nd world war and russia after the system change.
So,the outcome could be many thing,but there is more chance for nasty thing than for good things.
And I think that even this 30 million has same chance ,and each day that pass without a direction change the chance going up slightly.
Bcg81
Thank you for having independently done the calculations and verifying that the trends for US government spending are as I stated.
I can easily explain the small numerical difference between your results and mine – and the identical trend. The US BEA national accounts main aggregates table 1.1.5 line 21 which you refer to includes together government investment and government consumption under ‘Government consumption expenditures and gross investment’. Dividing this by GDP (line 1) gives exactly the figures and trend you indicate.
The change that needs to be made is that the US is highly unusual in putting together in its GDP main aggregates table government consumption and investment – almost all countries merely list government consumption under the equivalent line. To remove the government investment element it is necessary to use table 1.5.5 which lists investment in Federal Defence (line 53), Federal Non-Defence (line 56) and State and Local (line 59). If you subtract these from the figures in line 21 you will come up with my numbers.
The reason you find the same trend but slightly different numbers is that government expenditure is massively dominated by consumption and not investment – in the second quarter of 2009 government consumption was 17.0% of US GDP and government investment 3.6% of GDP. Therefore there was an identical trend.
For those who want to check the other calculations, personal consumption is in line 2 of BEA table 1.1.5 and can simply be divided by the GDP figure. This shows US personal consumption, as well as government consumption, also clearly rising as a percentage of US GDP – Q4 2007 69.9%, Q2 2008 70.3%, Q2 2009 70.6%.
It is slightly frustrating to have to state all this without charts as these show immediately that consumption has been rising as a proportion of US GDP but the comments sections here doesn’t accept charts. The relevant charts can however be found on my blog – which contrary to the suggestion of JohnT in a comment on Micheal Pettis’s next post very much exists.
As Bcg81 has independently corroborated the figures I produced I hope it should now be accepted that it is established that consumption has risen as a proportion of US GDP and not fallen as Professor Pettis stated.
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