Later today I am leaving to New York and DC for a week, so this may be my last post for several days since my schedule will be pretty hectic. Of course most of my trip will involve meetings with bankers, investors and some government officials, but the timing of my visit was based on the three-week tour of a group of my favorite Beijing musicians. For those who live in the northeast and are interested, check out the tour schedule and by all means come and see the shows. The work of these artists is, in my opinion, among the most interesting in the music world and will give a very different idea of what Beijing’s hippest youth are thinking about than most people assume. I will be attending most of the performances until November 11, when I return to Beijing.
But on to grayer topics. When the US economic data for the third quarter of 2009 came out last Thursday judging by the market reaction it seemed much more mixed to me than it apparently did to others, especially as far as it relates to China. It is true that after four quarters of negative growth, with GDP contracting 3.8% in the year to July, we finally got positive GDP growth of an annualized 3.5%. This was above expectations, and given China’s reliance on US overconsumption, the increase certainly seemed to be good news.
Even better, much of that growth was powered by a 3.4% increase in personal consumption, which was itself powered by the rather astonishing 22% increase in durable goods consumption – or perhaps not so astonishing if we chalk it up, as most experts do, to the “cash for clunkers” program. Americans, it seems, bought a lot of cars in the third quarter of 2009.
As I (and many others) see it, however, this surge in auto sales in the US isn’t likely to represent new and sustainable purchases, and so undermines any optimism generated by the growth in consumption. The surge in car sales may simply be Americans taking advantage of temporary government subsidies, and to that extent represent not new purchases but rather an anticipation of future purchases. If that is the case, whatever we get this year in new car sales will result in a reduction next year.
Why am I so negative about the good consumption numbers coming out of the US? Because the rise in personal consumption was accompanied by a 3.4% decline in household disposable income. If US household income declines, and this is likely to continue as unemployment rises even further, it is hard to imagine that US households are really going to splurge on new consumption. Consumption and household income must move in the same direction over any reasonable time period to be sustainable.
As if on cue, this was at least partly confirmed by the subsequent release of September numbers. As Friday’s Financial Times put it:
US consumer spending stalled in September after climbing in each of the prior four months, dampening spirits, as the effects of government stimulus programmes started to wane. Personal consumption expenditures fell by 0.5 per cent, or $47.2bn, last month, commerce department figures showed on Friday. The data were in line with the predictions of Wall Street economists, who expected that the expiration of the popular “cash for clunkers” car rebate scheme would hit spending.
In September, spending on durable goods, which includes cars, fell by 7.2 per cent after jumping by 6.7 per cent the previous month. Incomes were flat in September, slipping by just 0.1 per cent, after ticking up by 0.1 per cent in August. Companies are continuing to freeze pay or cut salaries as they wait to see the shape of the economic recovery.
So in spite of temporarily good consumption numbers, there probably has been no sustainable increase in US consumption, just in government financed spending. Both China and the US are dealing with their imbalances either by slowing down the rebalancing or by exacerbating the very things that caused the imbalances in the first place. Slowing down the adjustment makes good political and social sense, of course, but it shouldn’t blind us to the fact that US households cannot continue leveraging up to absorb the excess production that Chinese companies are leveraging up to produce. We will rebalance, one way or the other.
By the way, and speaking of not rebalancing, net new lending in October might be up. According to an article in Bloomberg:
China’s four biggest banks granted 136 billion yuan in new loans in October, higher than the previous month, Caijing magazine reported, citing industry data. Bank of China Ltd.’s new loans in October were 44 billion yuan, the most among all the banks, Caijing said. China Construction Bank Corp. lent 36 billion yuan, Industrial & Commercial Bank of China Ltd. granted loans of 33 billion yuan and Agricultural Bank of China lent 23 billion yuan, the magazine said on its Web site.
Resolving the imbalances
The same day the economic numbers were released Tom Holland had an interesting piece in the South China Morning Post on two “new” proposals for solving the Asian side of the destabilizing imbalances at the heart of the global economy – one from the International Monetary Fund and one from Barclays Capital. The first:
As the IMF points out in its regional economic outlook published yesterday, household savings have actually declined across much of Asia over the past 10 years. Even in China, the personal savings rate has remained more or less constant, which means it cannot be ordinary individuals who are responsible for the explosion in the region’s excess savings.
What’s actually happened…is that saving by Asian companies has ballooned since the crisis of the 1990s. Thanks to energy and land subsidies, cheap credit, low wage costs and lax environmental standards, Asian companies have made bumper profits in recent years. And because of weak corporate governance, they have been able to retain a large portion of those earnings rather than paying them out to shareholders as dividends, feeding the savings glut.
The answer, according to the IMF, is to strengthen corporate financing options, so companies no longer need to hang on to earnings, while beefing up corporate governance standards to ensure a better dividend payout. The IMF estimates that raising emerging Asia’s financial market development and corporate governance standards to rich-world levels would lower the region’s corporate savings by 7 per cent of gross domestic product, wiping out the savings glut and going a long way towards rebalancing the world economy.
I think it is widely agreed that there should be a more robust mechanism for forcing SOEs and other large corporations to disgorge their profits and return them to shareholders, including the government, but I wonder if it isn’t a little more complicated than that. As I see it, SOE profits are not the result of their value creation but are rather more than 100% explained by various subsidies delivered from the household sector. Without subsidized and controlled interest rates, even ignoring the other subsidies, the most important of which may be the currency undervaluation, SOE profits in the aggregate would be negative.
In that sense SOE profits are simply part of the transfer from household income to the state sector, and the most efficient way to return the money to households is likely to be to raise deposit and lending rates rather than dividend them back to shareholders. If the shareholders gain access to those profits via increased dividend payments, as I see it we are still seeing a transfer of income from Chinese households to the state sector.
The state may spend it more wisely than the SOEs (something that I would have to see to believe), but unless that money directly or indirectly was sent back to the household sector, perhaps by paying for health care or lower taxes, it doesn’t really address the fundamental problem. If it goes into state-favored investment projects, there will have been no rebalancing. I am convinced that Chinese households need to receive a larger share of national income, or their consumption growth will always lag growth in production and high savings rates will persist.
The second new proposal described by Holland:
The emerging-Asia economics team at Barclays Capital have come up with a different solution to the problem. In a report also published yesterday, they argue that the way to get rid of the region’s excess savings is not for Asian countries to save less but for them to invest more. Barclays’ analysts argue that Asia’s problem is not low consumption. Across much of the region, with the exception of China, household consumption ratios are similar to those in the European Union. Instead, the source of the glut is the low level of investment, which has declined since the Asian crisis.
Given Asia’s heavy need for infrastructure, Barclays recommends that governments should use the region’s excess savings to ramp up investment in order to promote future economic development. That certainly appears to be China’s preferred solution. The problem, however, is ensuring that investment is channelled into productive projects rather than misallocated to building excess capacity. Barclays’ answer is to finance more projects with private, rather than government, capital. That, however, would need financial reform and stronger governance in order to work.
I can’t speak for the rest of Asia, but I doubt that what China needs is a lot more investment. We seem to have forgotten all the lessons of the overinvestment crises of the 19th and early 20th centuries (and perhaps Japan in the 1980s) in favor of the mantra that increasing investment is always a good solution to whatever the current problem is. Although there is no question that much of the world probably invests too little (e.g. the US), the idea that there is infinite scope for additional investment is simply not true, and I worry that so much of China’s investment is already non-viable that increasing it significantly can only make matters worse. Building yet more stuff, if it does not repay the cost of the investment, means reducing future consumption, and it is consumption growth that powers economies over the long term.
Perhaps I am sounding like a skipping CD, but for rebalancing to occur in China we need households to grab a larger share of income. Any other solution, I think, misses the point. China entered the crisis with the highest investment rate in history, and probably also one of the highest rates of misallocation of investment in recent times, and then grew it sharply and quickly. This probably isn’t the solution to low Chinese consumption.
What the 1930s tell us about the coming protection
Finally, Barry Eichengreen and Douglas Irwin have a July 2009 NBER paper out with the title “The Roots of Protectionism in the Great Depression” which examines the relationship between protectionism and monetary conditions. According to the very helpful abstract:
Previous research has shown that countries that remained on the gold standard tended to endure sharper and longer downturns than those that allowed their currencies to depreciate. Eichengreen and Irwin offer an important trade-policy corollary: without the flexibility to depreciate their currencies, many gold-standard nations turned to trade restrictions in hopes that these would boost their domestic industries and curb unemployment. Thus, the 1930s’ rush to protectionism was not so much a triumph of special-interest politics as it was a result of second-best macroeconomic policies, the authors write. Their study “suggests that had more countries been willing to abandon the gold standard and use monetary policy to counter the slump, fewer would have been driven to impose trade restrictions.”
This was a fascinating paper that covers a lot of the ground in Eichengreen’s magisterial Golden Fetters. I think the paper (like the book, incidentally) has a lot to say about the current crisis, and the political implications are, I think, a little worrying. When they argue that countries that were tied to, or late to abandon, the gold standard were the ones most likely to employ protectionist measures, they could also be arguing that countries whose exchange rates are forced untenably high are also more likely to use protectionist measures to achieve adjustment by other means.
In that sense the refusal of Asian central banks to permit the needed appreciation of their currencies against the dollar may end up having the same impact on the adjustment process of the overvalued currencies. The 1930s seemed to show, according to the authors, that when their currencies could not adjust, countries became protectionist. So if the overvalued dollar cannot adjust except against the euro, and if the already overvalued euro has to bear the brunt of any further adjustment, will American and European politicians be forced into the “second-best” option of trade protection? No prizes for guessing what I think. By the way the chorus of complaints over the currency regime seems to be getting louder. After Paul Krugman’s piece in the New York Times last week I saw the Financial Times had a pretty strong piecetoday by Alan Beattie called “Renminbi at heart of trade imbalances.”
By the way, Douglas Paal, Taiya Smith, Michael Swaine and I will be speaking at a Carnegie Endowment event, on President Obama’s trip, to China on Thursday, November 5 from 12:15 to 2 p.m. I have been told that it will be live-streamed and there will be opportunities for questions. If anyone is interested he can find it here.
But what about the other alternative ? I.e. Asian countries (especially China) pursuing a deliberate inflationary policy to rebalance exchange rates in real terms but not in nominal terms. That is consistent with “households to grab a larger share of income” : if households get more pay and prices increase because of already tight margins for corporates (I.e. the latter have to pass the cost), inflation becomes a consequence of the policy.
Considering the recent monetary history of China, it may be that it is the Chinese that are the most prone to self-fulfilling high inflation expectation. After all, the farmers that are storing copper in their backyard are in China, not in the US.
Not to be offensive to anyone, this is sounding much like a brad setser post. At the risk of sounding like a broken gramophone (think hmv looks much cuter than virgin) , let’s just say no one can force the consumers to leverage up and “consume”. If the consumer decides to stop or reduce consumption of certain goods, stock levels will rise, leading to reduced orders and therefore eventually reduced production. This will lead Asian nations to rethink the consumption /investment (which might result in excess capacity) matrix . Don’t “surrender” the power (to consume or not consume) or the responsibility that comes with that power.
As for the currency issue, just guessing but the response might well be similar to the american response to the chinese request to protect chinese investments in american assets?
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This post was mentioned on Twitter by darnoc: Pettis: What rebalancing of Chinese and American consumption? http://bit.ly/14AaZE...
A slightly different perspective on GDP growth as it relates to PCE. It was entirely funded out of savings which is unsustainable for a consumer whose debt levels are too high and for whom lending standards are being tightened. Per Dave Rosenberg (late of Merrill, now Glushkin Sheff):
“Because of the housing and auto subsidies, the personal savings rate plunged to 3.3% in Q3 from 4.9% in Q2 — in the past quarter-century, there have been only four other times that the savings rate went down so much in one quarter. If not for that plunge in savings, real GDP actually would have contracted fractionally last quarter. The entire GDP growth was funded by a rundown in the savings rate that occurs less than 5% of the time.”
As for your ending comments on currency, this could be modeled in a game theory context. Absent constraints, seeking advantage should inevitably lead to a race to the bottom and debased fiat currencies.
The one point that always sticks with me is the fact that it is the Chinese government that is intentionally devaluing the work done by its own citizens. The world values their work more than does their own government.
I also am expecting that there will be protectionist actions from other countries. As Thomas I. Palley points out……..
“Furthermore, the problem is not only America’s. China’s currency policy gives it a competitive advantage relative to other countries, allowing it to displace their exports to the US.
Worse still, other countries whose currencies have appreciated against the renminbi can look forward to a Chinese import invasion. China’s currency policy means that dollar depreciation, rather than improving America’s trade balance and stanching its leakage of jobs and investment, may inadvertently spread these problems to the rest of the world. In effect, China is fostering new imbalances at a time when countries are struggling with the demand shortfall caused by the financial crisis. ”
http://www.project-syndicate.org/commentary/palley10
In the end, the removal of one mechanism of homeostasis (currency values) will, be necessity, be replaced by another (protectionism).
Michael, thanks for another fantastic piece. I thought you might be interested in a comment I sent to my clients today re the upcoming G20. Having spent a number of years as a Policy/Central Bank watcher at a firm called Medley Advisors I still watch this space very closely. I’m not sure that the market is give the Pittsburg G20 “Framework” sufficient weight and how FX adjustment is part of the solution:
As you know I believe the Pittsburg G20 was a huge event and marked a massive turn in markets not least EUR/$. So with Geithner on the tapes saying he would “not be surprised if issues on currencies arise at G20” its time to refocus on this weekends meeting. Central bankers and finance ministers will gather in Scotland to start putting flesh on the “Framework for Strong, Sustainable and Balanced Growth” agreed in Pittsburgh G20. The Framework has three areas of focus; macro strategy, reform and strengthening of capital markets and structural policy change. For markets the macro side is the most interesting and despite the scepticism of markets to my mind this is epoch making stuff. Effectively, it commits the G20 to nothing less than reshaping the pattern of global aggregate demand, reducing the macro cycle and more importantly holds the members accountable. This weekend is the next stage in the process and indeed, in Pittsburgh G20 set the objectives for their minions:
· “Continue developing cooperative exit strategies” that while dependent on individual circumstances should be coordinated, clearly communicated, anchor expectations and reinforce confidence.
· Launch the new Framework, which entails fleshing out how the mechanics of the process will proceed. I also believe that each member country will have to deliver a draft individual economic forecast within the “Framework for strong, sustainable and balanced growth”.
· These individual plans will be assessed in an environment of “candid, even handed, and balanced analysis”. The IMF will ensure plans are “collectively consistent” via “analysis of patterns of demand and supply, credit, debt and reserves growth”. The results of the first mutual assessment will be presented to G20 premiers at the June 2010 summit in Canada and they will agree on any common action
It’s this commitment to “collective consistency” that is the most interesting and conveys enormous power to the US as G20’s biggest single economy. So if Geithner stands up and says in 2010 , we forecast a current account deficit of 3% of GDP as consumers continue to save and we export more’ its essentially impossible for the big exporting countries to grow except via higher domestic demand. Continued export reliance just won’t pass the “consistency” test unless the EU takes more of the strain, which they won’t.
So that clearly puts the pressure on China who will talk about structural plans to boost its domestic demand and lower savings rates. Unfortunately, while reforming social safety nets are a vital part of that process so is RMB appreciation. Indeed, the chief economist of the IMF said after Pittsburgh that “if rebalancing is to come soon”, an “appreciation of Asian currencies vis-à-vis the dollar” is necessary. It should also be noted that the US Treasury in 15th October FX report not only spelt out what they expected from the RMB but linked it clearly to the G20 Framework:
“Although China’s overall policies played (note past tense) an important role in anchoring the global economy in 2009 and promoting a reduction in its current account surplus, the recent lack of flexibility of the RMB exchange rate and China’s renewed accumulation of foreign exchange reserves risk unwinding some of the progress made in reducing imbalances…Both the rigidity of the RMB and the reacceleration of reserve accumulation are serious concerns which should be corrected to help ensure a stronger, more balanced global economy consistent with the G-20 Framework. Treasury remains of the view that the RMB is undervalued”
In theory the Asian could reject this pressure but that is a path towards a rough 2010 with protectionism and unilateral beggar-thy neighbour FX intervention. That’s a game that the current account deficit countries win on a relative basis as exporters fight each other to death over the crumbs of aggregate demand. It would also be a death blow to the newborn G20, a body where they have finally achieved global recognition. This is also a path that would throw all the adjustment back onto EU and the Euro. Indeed, should G20 fail to make progress on FX I believe that when Trichet and Almunia visit Beijing later this month they will make it clear that FX intervention in EUR/$ is the next step for the EU. So unless they want their Euros delivered hot off the press, Beijing and the rest of Asia need to step back from their intervention.
Therefore, I believe the odds are good that within their Framework plans the Asians pencil in FX appreciation vs. the $, which for the RMB would almost certainly mean an initial move back to at least the gradual 5-6% RMB appreciation that occurred prior to July 2008. This should take the pressure off the Euro and suggests a lower EUR/ASIA trade. This is one of the primary reason I turned bearish on EUR/$ a month or so ago and remain so.
This might be interesting also…….
“He Maochun, a professor of economics and diplomacy at Tsinghua University, said China had no choice but to combat American protectionist measures with its own.
“We have learned our bad behavior from other countries,” he said. “China’s actions in this area will serve as a deterrence and warning to other nations.”
http://www.nytimes.com/2009/10/20/business/global/20yuan.html
Please keep beating this drum, Michael. Not only do we seek to lapse back into the status quo in domestic power structures and financial arrangements, but we’ve been doing our damndest to lapse back into the same borrowing, consumption, and investment relationships.
This isn’t just dangerous from the perspective of wasting more time. It’s much more dangerous from the perspective of creating stronger deflationary forces. China is continuing to invest at an incredible pace in production, meeting a phantom demand that either doesn’t exist or has been artificially goosed upwards by enormously lax monetary policy. Meanwhile, even more bad debts are accruing in the system, both in America and China and elsewhere.
I find it pretty awesome that we managed to come out of the last crisis having basically only scalped a few unliked people and organizations in the banking system. It speaks wonders to the inertia of this entire setup. I don’t think we’ll be able to break it in time.
Perhaps I am sounding like a skipping CD, but for rebalancing to occur in China we need households to grab a larger share of income.
That, and further investment actually compounds our problems, while looking pretty in annualized GDP figures. I personally think it would also be helpful to examine the distribution of income in America. If more of the income were not flowing to the top few percent, we would see more goods & services inflation and less asset inflation, which I think would be beneficial overall.
And yes, protectionism is America’s only defense against the undervalued RMB. I don’t think there’s any risk that America will invoke it, given the current political caste’s desires and incentives, not to mention pressure from other major players and the WTO.
And I really don’t see China revaluing the RMB. The dropping USD is doing the hard lifting for China, boosting their exports even further, and allowing China to “diversify” holdings into the rest of the world as well. Revaluation would also bankrupt the PBOC immediately. It’s pretty clear to me at this point that China is playing out a “winning” strategy of welching on its accomplices in the Prisoner’s Dilemma.
But on the off chance that we can stop welching and move towards a more positive equilibrium, keep skipping your CD, Michael. Yours is the sanest voice I read anywhere these days, and I’m very glad to have you around.
I think the USA is overly influenced by the financial industry, with the result that we have already politically largely abandoned even viable manufacturing. We won’t confront China because Wall Street would screech. That’s where the power is.
I always find your blogposts interesting and I think I learn a lot from them, the sames goes for this one. Thank you.
On another note, I recently moved to Japan to do postgraduate studies and I am very interested, as well as frightened, by the similarities with the current situation in China and Japan during the bubble economy. Have you any books or papers that you recommend that discusses the bubble economy in Japan and the subsequent crash. Sorry if this has been discussed in previously in the comments section.
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It does appear the US could have some kind of recovery, but I highly doubt we get near the peaks of prior years. Credit on the margin has been damaged and the source of most new credit, home equity, has been significantly wiped out. The solution has been more debt and I believe more bad debt in the case of housing.
In China, I have proposed for some time that foreign money has been impounded for years and I have read, maybe on your site that Galbraith and a group had some evidence that the trade balance in China was actually lower and much of the surplus was smuggled investment. I would have to venture that the sum of foreign investment in China is in the multi-trillions.
I am not sure I understand Eichengreen’s contention, but I suspect the real problem has to do with debt. I believe China has actually devalued their money more than the Fed has the dollar. The problem is the lack of free financial systems in the exchange department. Widespread crony lending and speculation in a normal economy would lead to a fleeing of capital most likely.
This isn’t going to end well because most countries have debt problems and the relative level of China and India are only significant in the amounts of their populations. There isn’t energy to continue to rapidly elevate these economies without disrupting the rest of the world. There isn’t demand to put these economies on solid footing. The employment picture in the US indicates to me the real recession/recovery looks more like an L than a V. What is going in in China is clearly a statistical fiction that has very little to do with current real demand or much to do with the near and maybe even distant future.
BTW, I couldn’t figure out what that Galbraith report said, as it was nothing but a bunch of math formulas. It was posted with a message that it deduced that much of China’s trade was disguised smuggled investment. It stands to reason an economy that is coming out of the distant past to modernization isn’t generating near the capital that would be necessary to do what has been done. If this is the case, it means two things. One is that if capital had to flee, China would be in a mess and second, if China prevented the capital from leaving, there would be a potential problem for those highly invested there. This ballgame is in the early innings and the recovery is about to set up man time.
Lark, the US manufacturing sector is still the largest in the world.
Julian, I too have been watching the G20 signals ahead of the finance ministers’ meeting in Scotland this weekend. The G20 was China’s chance to become a leader in a more global forum (the SCO being a bit limited), but it seems they are going to be the bogeyman more and more.
I noticed CITI and Nomura issuing reports about RMB reform over the last few days. CITI even came down saying they believe a deal has been agreed between the US and China over RMB appreciation early next year.
Meanwhile measures targeting China via trade increase across the world…
I know Prof Pettis was reading up a lot about the situation before the Plaza Hotel Accords back in the 1980s. I wonder if any of the signs now are similar to what was going on before then…?
[...] More here. [...]
It is a total fallacy that the Great Depression was caused or lasted longer than otherwise because of trade restraints. Total trade between Europe and the USA was too small to even matter. It was much less than even 1/2 of 1% of GDP.
Well said Mannfm
http://www.ftchinese.com/story/001029585
For anyone who can / is willing to read chinese. This is not content translated from FT English, it is original Chinese content.
Michael, have you seen Jonathan Anderson’s “The Myth of Chinese Savings” on the website “All Roads Lead to China”:http://www.allroadsleadtochina.com/reports/Anderson_November.pdf
What do you think of his argument? I find it very compelling.
I think that we are getting closer and closer to a currency crisis based on the U.S. govt’s misguided policies of ever increasing deficits. And the action in the dollar index is particularly worrisome. While I do not think now is a great time to be buying gold, I am still very bullish on the gold price and gold mining stocks in the long term. In my view it is one of the few sectors where investors can protect themselves from the Keynesian policies of the govt. And in terms of specific gold mining companies, one I like a lot is San Gold, which recently announced the discovery of a new high grade gold zone at its Rice Lake Mine in Canada. I read a few very interesting articles on the company at http://www.goldalert.com/goldmining/sangold including one that discusses how it is increasing production and reducing costs. There are many unintended consequences of the huge deficits the govt is running up, and I think the gold price reaching new highs is a strong indication of the currency debasement and money printing that are going on.
Hi Michael,
I just saw the Carnegie Endowment video of the event you refer to. Thanks for the indication. Each speaker gives a very well supported view on an important subject: economy, climate change and defense. You all seem to share the same opinion that a breakthrough won´t come out of the president´s trip and that trade dispute is increasing strongly. The site is very interesting so I decided to sign its e-news. Internet is amazing for the possibilities it opens.
By the way, I notice on your presentation that, although you have written that before, you are now more emphatic that a contraction on the US GDP is a more probable outcome until, 4 or 5 years from now, China is forced to face the impact of the measures it´s taking (or not taking) now.
Regards,
Christopher.
Why then is Stephen Green such a China bull?
Green is a long-term China bull: “The best assumption about China is that it will grow reasonably rapidly for the next generation.”
But he is obviously aware of imbalances in the Chinese economy:
Green says that countries like the US that borrowed heavily to consume would need to cut back their consumption while countries like China, Japan and Germany which grew via exports would need to promote domestic demand
China is a mercantilist nation, full stop. Go back to Hume and others to understand the proper meaning of the term. With this as a starting point, the policy consequences that flow are no mystery. This means that we can’t talk about China in the same lexicon as major western trading partners because the logic behind decision making is so different. China’s rivals in Asia get this, because they are much the same, only much smaller. Scale and absolute power and influence talks in command and control regions. The ASEAN statement on the RMB is thus much more important than anything from the US Fed or ECB. China just announced that it wants to take a 10% global market share in auto exports, and anyone who has been around the regions recently in China knows that every city mayor with a hint of ambition has created an industrial zone waiting for auto parts producers to invest. The incentives being offered are ridiculous, not to mention the export supports that will come from the central government, explicit or otherwise. Let’s take this as an example and go back to the original point – China wants to accumulate external surplusses and prevent (or substantially slow) the pace at which they are spent, except to buy resources. Despite China’s tantrums about protectionism abroad, domestic markets are still effectively protected against imports. And in those instances, such as cell phones, where foreign companies have dominated, the intentional lack of legal protections and active programs to rip-off and then legitimize foreign technologies as home-grown follows the same logic. Do we really think that China will buy many Boeing and Airbus airplanes when it can make its own? Does China really need to import foreign cars? Even in agriculture, China will not import higher value added goods in a wide range of categories – reference tiny imports of pork despite massive shortages a few years ago. All in all, China is waiting for the balance of power to swing in its favor so that no country dares to respond to its tantrums in a way that is consistent with their own commercial values, choosing rather to bow in fear of retribution. This is a bluff that no one will call, and one that will be even harder to call once China has a military that can back up its commercial bluster. So we can continue to have debates about rebalancing according to orthodox economic policy, but the world is in fact rebalancing according to a political logic backed on China’s side by mercantilist economic policies. Don’t expect much from the Party, because despite its success in the past 30 years there are still far to many people that are too poor to play by any other rules for the indefinite future.
Green works for Stan Chartered. Most people doing analysis for banks are operating with an attempt to sell investment products to their clients. As the majority of products are long ones, most of these “sell-side” analysts tend to be quite bullish.
Stephen GReen has done some great work during the crisis however. I always enjoy reading the StanChart Research / notes he contributes to.
report on ghost cities in china
http://www.zerohedge.com/article/other-side-chinas-8-gdp-growth-ghost-cities
sparrow,
Wow. Who knew that bubbles could have bubbles.
Yes the American politicians are wimps when confronted by the united forces of Chinese mercantilism and ‘American’ outsourcing corporations.
On the other hand, unemployment keeps rising, and the latest news is an unexpected & substantial drop in consumer confidence (70% => 66%).
This puts the wimps between a rock and a hard place.
If the Dems don’t face this, they will lose big in the midterms.
The truth is, we’ve lost so much manufacturing to outsourcing, that getting rid of the peg OR imposing tariffs would have a substantial positive effect on employment.
China Lambastes Dollar “Carry Trade,” Diverting Attention from Its Currency Manipulation
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Yves Smith | Nov 16, 2009
What a difference seven years makes. No one had a problem with Japan having super low interest rates and stoking a global carry trade, nor with the US running overly loose monetary policy that led to a real estate bubble that spread its impact beyond our borders via the creation of toxic mortgage product sold far and wide.
But one difference this time is now the dollar, rather than the yen, looks like the best funding currency, and the dollar is a deeper market, so the scale of potential damage is much greater. Second is that a lot of countries are running loose money policies, but they are at least making some credible noises re tightening (whether they follow through is another matter, of course). The US, by contrast, has made clear that it is keeping things easy-peasey for the foreseeable future. And the US (starting with the Greenspan era) has signaled any hawkish moves well in advance, so the odds that the Fed will have a sudden change of heart are just about zero.
Now, to play devil’s advocate, one could argue that the loose money policy is warranted. There is tons of slack in the economy, unemployment is high and rising, capacity utilization stinks. Surely raising rates now would be the worst move possible, right?
The authorities are completely responsible for the messes on two different fronts that intersect to create monetary policy dilemma. Going below 2% for Fed funds was a huge error (well maybe you could justify 1% as a very short term expedient), but the Fed is now painted in a corner. But second, and the much bigger issue, is that (as everyone can see) all this cheap money is not going into the real economy. A few very high quality borrowers are getting good rates; everyone else finds credit scarce and costly. So spreads are higher than before, and even absolute rates are often higher expect in markets like mortgages where the Fed has intervened.
Now some readers will correctly say that overly loose lending is what created the problem, and we need to undo that, but they are conflating two issues. Tightening up on WHO gets credit and HOW MUCH they get is separate from pricing. If this was mere improved standards, you’d expect to see more discrimination within various types of borrowers. But instead, across entire swathes of borrowers, particularly consumers and small businesses, banks have simply turned off the spigot. This has little to do with a return to prudent practices. In fact, it illustrates a real cancer: that across consumers and many small business owners, old-fashioned multi-variable decision-making (which included some verification of income) has been replaced by heavily or entirely FICO based systems. Those systems failed utterly. But they were cheap to operate, banks have no intention of reverting to earlier, more costly approaches. So we have a credit assessment process that is broken, but no one wants to admit it.
So if all this loose money isn’t getting to the real economy, there should be no reason not to raise rates, right? Wrong. This little procedure is again, entirely about the banks, screw the real economy and everyone in it. First, low rates (and now a steep yield curve) are an ideal setting for banks to make money. Greenspan pulled the same trick in the wake of the S&L crisis, and it enabled banks to rebuild their very wobbly balance sheets comparatively quickly (I’m amazed at the revisionist history about the early 1990s banking woes, which also involved pretty serious damage from dud LBO loans, and left the US banking system seriously undercapitalized). This plus high spreads makes ofr a very attractive environment for any new business.
But the second reason for keeping rates low is explicitly to keep asset prices aloft. The bubble is an explicit goal of policy. Remember, early in the crisis, they was talk of the markets being irrationally depressed. Funny how it is only prices that are seen as inconveniently low, and not ones that are insanely high, that are criticized.
But to cite Richard Nixon parodists: Let us make one thing perfectly clear. These monetary shenanigans are in no small measure the result of the utter failure of nerve late last year and early this year, to take sick institutions and resolve them. In many cases might not have entailed the bogeyman of nationalization (as in protracted government ownership), but throwing out the old top management and board, and forced debt to equity conversions. Cleaning up the banks was never treated seriously as an option, when the track record clearly shows that that is the fastest, least-cost way to deal with a financial crisis.
Of course, the powers that be really only want bubble restoration in those asset classes to which banks and capital markets firms are heavily exposed. A bubble in gold goes them no good, and a bubble in other commodities is downright counterproductive. And that was the logic behind the Fed’s proliferating programs: to drive liquidity to the markets it deemed worthwhile. We can see how well that worked.
Now even though China is correct in accusing the US of stoking a global carry trade, they are not exactly free of blame either. China’s past and continued currency pegs helped enable US reckless borrowing.
And despite the many complaints of readers yesterday on a post on government deficits, let me point out one ugly fact. The main argument was “we need to cut our debt levels.” Guess what, sports fans. That will not, cannot happen across the economy unless we run trade (more accurately, current account) surpluses. Do you think this has a snowball’s chance in hell of happening if China keeps its currency pegged at favorable rates to the dollar? So China’s fulminating, even if narrowly correct, serves to distract attention from its own culpability in this mess.
And low dollar interest rates pose a particular problem for China. Its dollar purchases had been, and may still be, running at levels so high as to make it impossible to sterilize the purchases. The net effect is that they wind up importing our loose money policy to the degree that they cannot fully sterilize the dollar purchases they make to suppress the value of their currency. Some recent reports (admittedly anecdotal) suggest inflation in China is running at 15%, which is the upper limits of what the population will tolerate. So the Fed’s policy is of even more immediate interest to China.
Some snippets from the news. First the Financial Times, which highlights that there is more than a bit of the pot calling the kettle black here:
The US Federal Reserve is fuelling “speculative investments” and endangering global recovery through loose monetary policy, a senior Chinese official warned…
Liu Mingkang, China’s chief banking regulator, said that the combination of a weak dollar and low interest rates had encouraged a “huge carry trade” that was having a “massive impact on global asset prices”….
Before these latest comments, however, Beijing had generally been most critical of US fiscal policy, urging Washington to spend less.
But speaking at a conference in Beijing, Mr Liu said the Fed’s policy of maintaining low interest rates together with the weak dollar posed a threat to the global economic recovery.
“[It] is boosting speculative investment in stock and property markets and will pose new, real and insurmountable risks to the global recovery and particularly to the recovery in emerging markets,” said Mr Liu…
However, Mr Liu’s criticism of the Fed comes as China’s own monetary policy is attracting growing scrutiny at home and abroad. Critics say the massive expansion in bank loans this year could cause asset price bubbles and inflation.
Qin Xiao, chairman of China Merchants Bank, last month said China “urgently” needed to tighten monetary policy to avoid stock and property market bubbles.
On Monday, Dominique Strauss-Kahn, the head of the International Monetary Fund, said a stronger Chinese renminbi was part of the reforms that Beijing needed to implement in order to increase domestic consumption and help ease global imbalances.
The Wall Street Journal argues that higher rates in China may not curb speculation:
China hasn’t raised its benchmark interest rates since late 2007, although policy debate has been shifting in Beijing as the recovery in the domestic economy consolidates and as the People’s Bank of China tries to manage the flood of liquidity and credit underpinning the recovery.
A key concern about any Chinese rate hike is that it may prompt more speculative inflows into the recovering domestic economy. And because of the way the yuan pretty much tracks the U.S. dollar despite the local unit being referenced to a basket of currencies, increased capital flows into China adds further to the liquidity in the domestic money markets.
China continues to state that its own exchange rate policy reform will be done for its own needs and done in its own time.
And a separate Journal story:
Chinese leaders previously expressed nervousness that the U.S. may be ready to sacrifice China’s economic interests to haul itself out of the worst recession since World War II. China is the largest creditor to the U.S. It frets that huge U.S. budget deficits will weaken the dollar and slash the value of China’s massive foreign-currency holdings, which hit $2.273 trillion at the end of September, the latest figure available.
Beijing’s suspicions of U.S. intentions have been exacerbated by trade quarrels under the Obama administration.
These intensified in September, when U.S. decided to hit Chinese tire exporters with tariffs. The U.S. has since targeted Chinese steel pipes with tariffs, a decision that China denounced as “abusive protectionism.”
The U.S. is now moving ahead with investigations into the alleged “dumping,” or selling at below-market prices, of coated paper from China and Indonesia, and of certain phosphate salts from China. China has started its own investigation into imports of some U.S. cars.
Yves here. I have zero sympathy for the Chinese officialdom on this issue. The government bought Treasuries as a result of an explicit, concerted strategy to pursue mercantilist aims to help their manufacturers at the expense of ours. This was not an “investment”; this was a by-product of currency manipulation. Now the US bears a lot of blame for not taking that practice on a long time ago. But we need to quit indulging this crap. Buying foreign assets at a time when you are keeping your currency low by design is almost certain to produce foreign exchange losses. So the US is to blame for the inevitable result of Chinese currency manipulation? I don’t think so.
Update 4:00 AM: Paul Krugman has taken up the currency peg theme tonight:
Despite huge trade surpluses and the desire of many investors to buy into this fast-growing economy — forces that should have strengthened the renminbi, China’s currency — Chinese authorities have kept that currency persistently weak. They’ve done this mainly by trading renminbi for dollars, which they have accumulated in vast quantities.
And in recent months China has carried out what amounts to a beggar-thy-neighbor devaluation, keeping the yuan-dollar exchange rate fixed even as the dollar has fallen sharply against other major currencies. This has given Chinese exporters a growing competitive advantage over their rivals, especially producers in other developing countries.
What makes China’s currency policy especially problematic is the depressed state of the world economy. Cheap money and fiscal stimulus seem to have averted a second Great Depression. But policy makers haven’t been able to generate enough spending, public or private, to make progress against mass unemployment. And China’s weak-currency policy exacerbates the problem, in effect siphoning much-needed demand away from the rest of the world into the pockets of artificially competitive Chinese exporters.
But why do I say that this problem is about to get much worse? Because for the past year the true scale of the China problem has been masked by temporary factors. Looking forward, we can expect to see both China’s trade surplus and America’s trade deficit surge.
Yves here. “trade deficit surge” = “bigger US debts”. These two issues are inextricably linked. Back to Krugman:
That, at any rate, is the argument made in a new paper by Richard Baldwin and Daria Taglioni of the Graduate Institute, Geneva. As they note, trade imbalances, both China’s surplus and America’s deficit, have recently been much smaller than they were a few years ago. But, they argue, “these global imbalance improvements are mostly illusory — the transitory side effect of the greatest trade collapse the world has ever seen.”
Indeed, the 2008-9 plunge in world trade was one for the record books. What it mainly reflected was the fact that modern trade is dominated by sales of durable manufactured goods — and in the face of severe financial crisis and its attendant uncertainty, both consumers and corporations postponed purchases of anything that wasn’t needed immediately. How did this reduce the U.S. trade deficit? Imports of goods like automobiles collapsed; so did some U.S. exports; but because we came into the crisis importing much more than we exported, the net effect was a smaller trade gap.
But with the financial crisis abating, this process is going into reverse. Last week’s U.S. trade report showed a sharp increase in the trade deficit between August and September. And there will be many more reports along those lines.
So picture this: month after month of headlines juxtaposing soaring U.S. trade deficits and Chinese trade surpluses with the suffering of unemployed American workers. If I were the Chinese government, I’d be really worried about that prospect.
Unfortunately, the Chinese don’t seem to get it: rather than face up to the need to change their currency policy, they’ve taken to lecturing the United States, telling us to raise interest rates and curb fiscal deficits — that is, to make our unemployment problem even worse.
And I’m not sure the Obama administration gets it, either. The administration’s statements on Chinese currency policy seem pro forma, lacking any sense of urgency.
That needs to change. I don’t begrudge Mr. Obama the banquets and the photo ops; they’re part of his job. But behind the scenes he better be warning the Chinese that they’re playing a dangerous game.
Update 4:30 AM: Sheesh, Ambrose Evans-Pritchard is on the same page as Paul Krugman, namely that China’s policies are global economic menace number one:
By holding the yuan to 6.83 to the dollar to boost exports, Beijing is dumping its unemployment abroad – “stealing American jobs”, says Nobel laureate Paul Krugman. As long as China does it, other tigers must do it too.
Western capitalists are complicit, of course. They rent cheap workers and cheap plant in Guangdong, then lobby Capitol Hill to prevent Congress doing anything about it. This is labour arbitrage.
At some point, American workers will rebel. US unemployment is already 17.5pc under the broad “U6? gauge followed by Barack Obama. Realty Track said that 332,000 properties were foreclosed in October alone. More Americans have lost their homes this year than during the entire decade of the Great Depression. A backlog of 7m homes is awaiting likely seizure by lenders. If you are not paying attention to this political time-bomb, perhaps you should….
It is fashionable to talk of America as the supplicant. That misreads the strategic balance. Washington can bring China to its knees at any time by shutting markets. There is no symmetry here. Any move by Beijing to liquidate its holdings of US Treasuries could be neutralized – in extremis – by capital controls. Well-armed sovereign states can do whatever they want.
If provoked, the US has the economic depth to retreat into near autarky (with NAFTA) and retool its industries behind tariff walls – as Britain did in the 1930s under Imperial Preference. In such circumstances, China would collapse. Mao statues would be toppled by street riots.
I was going to write that I anticipate capital controls before this is over, but neglected to make that my coda, and now I see Evans-Pritchard has come to the same conclusion. It doesn’t have to be as draconian as what he suggests, but it is the inevitable end game if China refuses to relent.
Getting rid of the peg is not America’s decision. It’s China’s decision, and China will make it in her own sovereign interests. To be blunt, I see no reason to be an accomplice to a wealthy America that is desperately trying to weasel out of debts accrued over thirty years of profligacy at China’s own expense.
I think Obama’s visit to the country was handled very well, including the several simultaneous strong statements that China does not intend to yield to foreign pressures to revalue or float their currency.
Let inflation differentials bring any misvaluation into alignment. And to the extent that over-investment and deflation are happening in China, deflation will have to happen to a greater extent in America.
@ndk, you think American is “desperately trying to weasel out of debts accrued over thirty years of profligacy at China’s own expense?”
How could this have been “at China’s expense” when China has climbed to the top of the heap as a manufacturing power primarily by BOTH selling to the American consumer AND being the outsourcing destination of choice for transnationals who dump their American employees for Chinese?
Your spin is a foul smelling perversion of the truth.
The US households are facing triple whammy of increasing debt (thanks to the interest rate on credit card debt), reducing income and desire to spend.
Even if all of them have high-paying jobs, as long as the desire to spend is not curb, the situation will never get better. The people will still be as poor.
On the other hand, the Asian households and companies save too much money. It is a cultural issue, a stricter corporate governance will not solve the problem.
Speaking from the standpoint of investors, I personally rather the companies keep the money and look for investment opportunities. Hardly anyone in Asia wants to invest in a company that pays high dividend.
The only concern is the corruption of the management team, especially in China companies.
Michael,
The link to the tour schedule is broken, and I’m very curious about your favourite Chinese band, the details and name of which I cannot access. I am a student involved in avant-garde art production in China, the USA, and Britain, and I love keeping track of the New among Chinese youth, especially in Beijing. I deeply respect your posts about the Chinese economy, but this little mention of music is the first thing spurring me to comment. Pleeeease let me know your favourite band(s)–and anything else about your tastes in Chinese music. You teach in Beijing, is that right? Oh God, this is hilarious, I was just going to look up the owner of D-22, whom I’ve met, because I remembered it was owned by a professor, and I was going to ask if you knew him. Now I see it’s you. Hilarious. Anyway, this means we must have met, I think at the Stanford conference last November. Funny thing. Anyway I’d LOVE to hear about your music tastes, and what you’re following these days, who’s played (well) at D-22 recently, etc. Use my email if you like. Thanks so much, Cao Xue Qin