I got back three days ago from my trip to the US and am still sludging through my jet-lag, but there are two quick takeaways from the trip I should mention. First, my Washington meetings convinced me (no big surprise here) that, just as it is doing in Europe, the issue of trade is getting more political attention than ever, and the adverse employment impact of the US trade deficit is an issue that will not easily subside. I did not leave Washington feeling that my worries about a rise in trade tensions were in any way exaggerated.
Second, I met with at least 30 different institutional investors, and perhaps the fact that my trip coincided with the twelve labors of Greece, or however many they have, worry over China and the state of the world economy was deeper than on my previous trips. For reasons I have often discussed on this blog, I have never been a believer in the survivability of the euro, and many of the people I met on this trip had heard me over the past decade express my doubts, so meetings that were ostensibly on China often became meetings on whether Greece, Italy, Portugal, Ireland or Spain will be forced to exit. Everyone wanted to know if turbulence in Europe would hurt China (I think it definitely would, especially if it came when there were worries about the Chinese financial system).
In the meetings where we discussed the euro I nearly always made reference to a thesis argued in Barry Eichengreen’s magisterial Golden Fetters (one of my favorite books) that the political enfranchisement after WW1 of very large segments of the population in Western democracies – most crucially the working classes, who historically bore most of the pain of adjustment – meant that the traditional adjustment mechanisms under the gold standard, which were deflation and rising unemployment, would prevent democracies ever from returning to the gold standard. Politics would make it impossible (and probably a good thing, too).
The pain of adjusting
This has an important implication for the discussion on the euro. Unfortunately the euro today imposes a kind of gold standard on European countries – it forces them to adjust to excessively high domestic prices, large trade deficits, and/or large fiscal deficits in the same way they would have had to adjust under the gold standard, and I don’t think that is politically likely to be acceptable. The countries that need depreciation to regain competitiveness or monetization of the debt to regain control of the deficit will have to choose between adjusting via deflation and high unemployment or exiting the euro. Politics makes the latter more likely.
There is one other way out, perhaps. Martin Wolf discussed it last week in an important Financial Times article called “Europe needs German consumers”. Wolf argued that trade imbalance within Europe helped to create the subsequent and damning financial imbalances, and that without resolving the trade imbalance it is pretty pointless to talk about fiscal belt-tightening and lower wages as the means by which the problems of outer Europe will be resolved.
So long as the European Central Bank tolerates weak demand in the eurozone as a whole and core countries, above all Germany, continue to run vast trade surpluses, it will be nigh on impossible for weaker members to escape from their insolvency traps. Theirs is not a problem that can be resolved by fiscal austerity alone. They need a huge improvement in external demand for their output.
This, of course, is the intra-European version of the global imbalance debate. It is simply another way of saying that policies in major trading nations that constrain consumption and subsidize production – in effect trading off lower household income for higher domestic employment – must have the reverse impact on trading partners who implicitly made the opposite trade-off, giving up employment in exchange for higher consumption. As long as those trading partners were able to use the recycling of surpluses to leverage up domestic demand, and so boost domestic employment through debt-fueled growth, the adverse employment effect was hidden.
Once the leverage process started to unwind, however, the deficit countries would inevitably see a surge in domestic unemployment. The best way to deal with the problem is to have both sides unwind the mechanisms that created the mirror trade-offs. Germany must put into place policies that trade higher consumption for lower employment, and use debt to force employment up, so that deficit Europe can gain employment, albeit at the expense of a lower share of consumption.
Germany might not like reversing this trade-off, which was the source of much of its recent growth (almost 70% of its growth since 1997), but in the longer term it will be much cheaper than bailing out the European countries, or allowing them to exit the euro messily and anyway force the reversal of the trade-off on Germany. You can’t run large trade surpluses if your trade partners are no longer able or willing to run the corresponding trade deficits.
Global rebalancing
This, by the way, seems to me to be the classic Keynes argument (although not, perhaps, the “Keynesian” argument): In a world characterized by contracting global demand and large trade imbalances, it is the obligation of the large surplus nations (and in the 1930s of course he meant the US) to stimulate domestic demand. Asking the trade deficit countries to leverage up to stimulate demand is counterproductive and would ultimately just postpone the necessary adjustment. Asking them to adjust via unemployment, on the other hand, makes everyone worse off. In other words it is far better for Germany to move aggressively to boost domestic demand than to ask Spain to cut workers’ wages.
In that context I have to say I am very heartened by all this talk in China of pressures to raise the minimum wages in a number of Chinese provinces. This is exactly the kind of thing China (and Germany) should have been doing all along. The South China Morning Post, for example, had an article claiming that factory bosses in the Pearl River Delta now fear a shortage of employees. This month Jiangsu, the third largest exporting province, imposed its first increase in minimum wages (minimum wages are set by local governments in consultation with the central government, and were frozen in late 2008). Shanghai, the second biggest exporter, has also announced increases. More is expected, with Beijing, Zhejiang and Guangdong all in line to announce something soon.
Many analysts expressed some worry that rising wages can set off an inflationary spiral in China. Although I think there is certainly a risk of rising inflation (the relative low CPI number for January, 1.5%, down from December’s 1.9%, was offset by the 4.3% PPI) I am not sure an increase in wages will have such a big impact on inflation because Chinese manufacturing tends to be heavily capital intensive and worker productivity has anyway risen faster than wages in the past ten years (in fact this “suppression” of wage growth relative to worker-productivity growth is part of the mechanism that forces high savings rates and low consumption in China).
In spite of nagging worries about inflation, most observers, as far as I can see, welcomed the possibility of higher wages. I think they are right. The whole concept of rebalancing the economy is completely meaningless unless it means raising household income as a share of GDP. Chinese wage earners have struggled with a number of factors that have made it difficult to raise their wages in line with the increase in national income (GDP), and since the level of household consumption is a function of the level of household income, this has forced a rising gap between the two and has forcibly resulted in a higher savings rate.
Transferring income
But in that sense I think many observers, who argued that raising wages was the best way to rebalance the economy because it is the most direct way to get income into the hands of workers, are missing the point. As I see it there are four main ways to raise household income, and while each of these can have the same aggregate impact, they differ on how the costs and benefits of that impact are distributed.
¨ Raising wages in the coastal areas will shift income from coastal manufacturers and SOEs to coastal workers. It may partially undermine the competitiveness of coastal exporters and will probably increase migration to the coastal areas.
¨ Raising interest rates will shift income from bank loan recipients – mainly real estate developers, large manufacturers, and above all the SOEs – to depositors around the country. By raising the cost of capital it will penalize speculators and the most capital-intensive industries – almost certainly a good thing economically but politically tough to do.
¨ Appreciating the RMB will shift income away from exporters, by reducing their subsidy, in favor of all other companies and households by reducing the cost of imports. I am not sure how the cost of imports is distributed across income classes, but I suspect that the urban poor will benefit the most and the rural poor second, since a rising RMB may put downward pressure on agricultural prices. Of course it will reduce China’s export competitiveness.
¨ Improving the health, education and social safety net – probably the weakest of the four mechanisms but the one that seems to get the most attention – transfers income from whoever is forced to fund it (not households through taxes, I hope) to whoever the recipients are. I suspect that the main beneficiaries are likely to be the urban middle classes and the poor.
The key to which policy is “best” depends on how policymakers want to distribute the costs and benefits. Of course the relative political strengths of the various sectors who may be forced to bear the cost will have an important impact on which policy is chosen, but there is no getting around the fact that any policy that increases the income of the household sector will have an adverse impact in the short term on unemployment. Over the long term, however, as it rebalances Chinese growth towards domestic consumption, its impact on employment should be better.
But this trade-off is inevitable, and there is no point in trying to deny it. Like Germany, China has chosen policies over the past decade that traded off lower household income for higher domestic employment. Because this necessarily resulted in trade surpluses that the deficit countries are no longer willing or able to tolerate now that their unemployment levels are so high, China, like Germany, must either work towards a reasonably smooth rebalancing or it will be forced into a messy and disruptive rebalancing. If it is to work towards a global recovery and a domestic rebalancing, like Germany today China must put into place policies that trade higher consumption for lower employment, while using debt to keep unemployment from rising too quickly.
The pace of adjustment
How messy and disruptive could the forced rebalancing be? That depends on the adjustment taking place in the US. On the one hand consumption numbers in the US were better than expected for January, but consumer sentiment was not. Here is the Financial Times article:
US retail sales rose unexpectedly fast in January, the government said on Friday, but hopes that consumers will emerge as a driving force in the economic recovery remained muted after a separate survey showed an unexpected drop in consumer sentiment.
…With unemployment at 9.7 per cent and the housing market still in the doldrums, American consumers have not returned to spending as aggressively as they had in the wake of previous recessions. The rebound in growth in the last quarter of 2009 was instead led by higher business spending and a sharp drawdown in inventories.
But Americans are shopping again: modestly but at a growing rate. In January, retail sales rose by 0.5 per cent, which was an improvement over the 0.1 per cent drop recorded in December and the 0.3 per cent gain expected by most economists.
However other indicators were not so good:
Meanwhile, consumer sentiment unexpectedly dipped from a two-year high of 74.4 in January to 73.7 in February, following big gains over the previous two months, according to the Reuters/University of Michigan monthly survey.
Although the recent drop in equity prices was judged to have contributed to the drop in the public mood, consumer sentiment related to current conditions actually increased, while it was expectations for the future that accounted for most of the unexpected decline. At the same time, long-term inflation expectations edged downwards, from 2.9 per cent in January to 2.8 per cent this month.
The big question facing the US economy is whether consumers will use any cash they accumulate as growth returns to boost personal savings. Alternatively, they could spend it on new goods and services, but with consumer credit still extremely tight, many economists believe that Americans will choose the first option and keep hold of their cash.
Meanwhile the key measure of the pacing of the global adjustment, the US trade balance, has shown some pretty rapid change. According to an articlein the New York Times:
After years of being told by Asians and Europeans that it had to find a way to reduce its trade deficit, the United States did find a way in 2009. A global recession did the trick, producing the largest decline ever in the deficit.
The recession caused American imports to fall by 26 percent, by far the largest annual drop in imports of goods since the government began keeping trade statistics in 1948. There have been only a few years with any declines at all, with the largest before 2009 being a fall of nearly 7 percent in 1982, another recession year.
Exports also fell, but not by as much, as can be seen in the accompanying charts. The result was a trade deficit in goods of $501 billion, or 3.5 percent of the country’s gross domestic product. That was down from $816 billion, or 5.7 percent of gross domestic product.
Any way you slice that, it was the largest improvement in the trade deficit on record. In terms of G.D.P., the biggest improvement before 2009 was in 1988, when the deficit declined by almost 1 percent. …Even so, the deficit, as a percentage of G.D.P., is larger than it ever was before 1999.
What happens to the US trade deficit, whether caused by changes in consumer confidence or by rising trade tensions, is key.
The fireworks are going off like crazy all through Beijing. Happy Spring Festival and enjoy the year of the Tiger.
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Michael:
It would be very interesting to hear more of your thoughts regarding the Euro, or if you could link to some old essays or paper you have written about it. The whole eurozone really has a terrible situation, I cannot really see how this possible can end well.
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There is a 5th way to transfer income: government directed infrastructure spending.
The massive rail road project is an excellent example. The government heavily subsidized the building of the rail road system and the ticket prices. Wealth is transferred to all the travelers in terms of cost savings. As a visitor, I am amazed by the fact that I could travel from one corner of Beijing to another for just 2 yuan (25 cents)! Conceptually, this is really similar to improving health, education and social safety net. Like transportation, these can all be thought of as just different kinds of infrastructure in a society.
Infrastructure spending is also hugely beneficial for China. Today, China still have couple of hundred million poor farmers living in rural area with little to no infrastructure such as roads. Building out the infrastructure will enable a higher rate of economic development of rural China than otherwise possible.
Michael, I thought you had said elsewhere that the lack of a social safety net was not the cause for China’s high savings rate. Here you seem to be saying the opposite. Am I mistaken?
Viktor, I have only discussed the euro on some of my blog postings, but I may write about it more extensively later. My basic points are, I think, not especially original, and all I add to the general debate is a little historical knowledge. For the former, I don’t think Europe has the necessary capital and labor mobility for an optimal currency zone, and the various economies, preferred monetary and fiscal policies, political cultures and demographics are too different for them to be yoked together in a monetary union that is as harsh as the gold standard (and this, by the way, is why I dismiss all talk of an Asian monetary union as overexcited political discourse with no underlying economic basis). I would add Eichengreen’s point that the adjustment mechanism, for a country that is forced to make a major adjustment but has no independent monetary policy, is incompatible with a robust democracy. Workers will simply not meekly accept the necessary deflation and unemployment.
For the latter, there is a history of currency unions, and it suggests that “successful” unions are only successful during the globalization periods of rapidly expanding liquidity and rising asset prices, but none of them survive the liquidity contraction. I don’t see any reason to assume that this time will be different, especially since this has been the most ambitious of currency unions and, as such, it has forced even more incompatibility into the union.
Silly things, I think that it is actually the opposite – much of the infrastructure spending in China does not transfer income from SOEs and manufacturers to households and in fact does the reverse. The funding for infrastructure projects is borne by households in the form of low interest rates and government borrowing (which is ultimately paid out of taxes), and much of the benefit goes to SOEs and manufacturers who are paid to build the infrastructure. If the infrastructure is not economically viable, as is too often the case, it represents a net loss to the country more than 100% of which is borne by households.
It is not enough to note the subsidies. The key is to work out who pays for the subsidies, and this is almost always households. It is a hidden tax that is too easy to ignore but whose impact is real.
Lee, my point is that it is not the lack of a social safety net per se that explains high savings in China. There is no evidence from other countries that weak social safety nets are associated with high savings or strong social safety nets with low savings. But the deterioration in the social safety net is important because it represents one of the many ways in which income is transferred from households to SOEs and manufacturers.
While I agree fully with the macroeconomic issues you have presented, I think the major culprit of weak german demand is not a lack of stimulus but an inadequate tax system, that favors the rich in many respects. Stimulating domestic demand in Germany could be achieved by returning to an old system of 80% top income tax rate and taking away the so called “cold progression” that turns more and more middle income families into top ratee tax payers. There has been an incredible amount of monetary wealth accumulated by relatively few individuals and this has been encouraged by legislation under the argument of liberalisation. Demand in Germany can only be stimulated by raising the income of the poor. This should be done through public work programs as long as private sector activity remains subdued and financed by taxing not only income but wealth itself. The recent massive inequalities in wealth distribution can no longer be attributed to different abilities but to a political system that has left the trails of “soziale Marktwirtschaft”.
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Michael:
A couple of questions:
Germany has chosen policies over the past decade that traded off lower household income for higher domestic employment. Was this in any way a result of the reunification ?
Will raising wages in the coastal areas of China result in the relocation of labor intensive manufactures to the interior ? If so wouldn’t the wage coastal increases be counter productive ?
I am afraid that the political and practical ramifications of a Euro break up are too big for a break up to be contemplated without a great deal more pain than we’ve seen so far. I’d suggest at least three likely attempted policy remedies before that happens. Bail outs of deficit countries, likely to be insufficient and stopgap. A general Euro devaluation, which might make it easier for Germany to accept an up word internal re-valuation. And third, of course, trade barriers, which are not likely to address the core issue but may become a political necessity to keep the currency, not unlike the gold bloc.
If I remember correctly, the Gold bloc held out until 1936, seven years into the crisis? That doesn’t bode too well.
On China, what does the first moves on the PBOC to fiddle with reserve requirements indicate to you about future policy? To me the fact that they chose that instrument instead of directly targeting interest rates or the exchange rate looks worrying. Or am I reading too much into it?
A few observations on Europe and the US which lead to an observation on China.
Your post is wide ranging. So are my observations. You suggest Wolf’s proposal to increase German consumption might be a way out of the EU’s problems. It would appear to fail on two counts: it does not attack the primary problem and assumes a closed system. Last point first. Should the Germans pursue policies generating more German consumption, there is no guarantee the products purchased will originate in the peripherals EU countries. They may well be from the US, China, or many other places. The EU is not a closed system and this approach potentially creates other problems without solving the main problem. If what I read is reasonably correct, the imbalance results from a combination of Greek productivity being low relative to compensation being too high. Unless the institutional and cultural conditions which create this nexus are addressed, you do not solve the EU’s problem with Greece and the other peripherals. That is, some of this is internal to Greece regardless of German policies because the imbalances are not merely with Germany. Wolf seeks a middle ground which seems nonexistent. Thus, your earlier position of the EMU being flawed from the start seems to dominate.
As for the US, you correctly show the economic signals are currently mixed. In a normal post WWII recession that might well signify a turning point as the second derivative leads the first. This, however, is the largest deleveraging event of our lives, not a normal recession. The mixed signals arise from the efforts of government fiscal and monetary policies to offset the contraction in private sector debt, at least in the US. Monetary policy appears to have hit the ‘pushing on a string’ limit and the force of potential continued fiscal policy is dissipating in face of voter opposition. There is nothing beyond hopeful thinking to suggest green shoots becomes a self-sustaining private sector recovery. Contrary to the reports, residential housing has not bottomed. The government’s mortgage modification programs are abysmal failures which merely delayed the deluge of foreclosures and short sales that will occur this year. In the commercial real estate sector and leveraged lending, policy is reminiscent of Japan circa the last decade of the 20th century: extend and pretend. If you watch the visible, the best this can do is delay the inevitable. Morgan Stanley has walked away from two major CRE projects and Tishman/Blackrock from the largest residential properties in NYC recently by handing the keys to lenders. In all three cases the implied value of the properties is less than 40% of their purchase prices of just a few years ago.
This was a prelude to a comment about your DC visit. Neither Europe nor the US is positioned to continue the policies that allowed China’s magnificent growth story to evolve in the post WTO ascension years. The economic and political conditions seem more aligned with reversing those policies. Witness Obama’s SOTU address announcing a goal of doubled exports in five years. Because neither party has sufficient credibility to pursue a mix of policies to redress imbalances domestically and abroad, they will focus on the latter, however falsely. The same appears true in Europe. And I sense Asia ex China continues to grow less enamored of China’s trade and currency policies. It seems China is running out of time to use modest adjustments of hiking minimum wages and it is not a bilateral set of pressures it faces. Perhaps that is why Jim O’Neill speculated Monday morning that China would revalue by 5% very soon? It won’t be enough.
Mr Pettis, did you see Robert Samuelson’s editorial in the Washington Post, and what did you make of it?
http://www.washingtonpost.com/wp-dyn/content/article/2010/02/14/AR2010021402892.html
Thanks
On EURO subject, here is a post from FT.com. Quite interesting!
(Quote below)
“GGBs: Our debt, your problem.
If Greece defaults, it will be the biggest sovereign default in history. If Greece is bailed out, it will be the biggest sovereign bailout in history. That’s what you get when there’s EUR 250 billion at stake. The Russian and Argentinean defaults, both south of EUR 60 billion, were not even a quarter as big. Thing is, as a Greek I’m as worried about the whole thing as a resident of the fictitious “South Sea” would have been when the South Sea bubble went bust. Here’s why: Debt is not dealt with very well by economic theory. Debts net out. For every lender there is necessarily a borrower.
Total wealth is the dollar amount it takes to control every home, every corporation every consumer durable and every privately owned resource. No mention of debt here (though if you want to get difficult, you will point out that to control a corporate you need to own both its stock and its debt, but bear with me) Thing is, if you add a bit of debt, you untie a lot of agents’ hands. If a 35 year old heart surgeon has access to the mortgage market he can move into a beautiful house before he collects his first ever paycheck, and he’s definitely good for the money.
That pushes up home prices. So a bit of debt definitely pushes up total wealth. On the other hand, recent experience indicates that a whole lot of debt leads to breakdowns. If we’ve all borrowed money to buy assets and for some reason they take a break from going up, marginal borrowers who count on selling appreciating assets to service interest on their debt will miss their payments. Their liquidator will sell their assets. This will drive down asset prices, which in turn will trigger margin calls to more people and the vicious cycle can start that Irving Fischer dubbed debt deflation. 2008 looked a lot like that and most people believe it had a lot to do with overindebtedness.
We also need to look at savings. If a country has a lot of savings, it can support a lot of debt. Japan has massive government debt, but equally massive private savings. Some countries, like China have massive savings and have to look abroad for investments. And some, like the US are the other way round. When it comes to debt, Greece is in a uniquely privileged situation. No, seriously! For starters, we Greeks are some of the world’s richest people.
On the official statistics alone, we are comfortably in the world’s top 40 for per capita GDP. But that’s peanuts. Lest we forget, that’s our declared income. Don’t quote me on this apocryphal statistic, but I’m reliably informed that exactly six Greeks declared more than a million EUR in income last time anybody counted. And exactly 85 declared more than half a million. So we’re probably a bit better than top 40.
Either that, or this trading floor alone has more rich people than Greece. Hell, our new recruits for this season alone could probably do it. If you have any doubts about Greek wealth, check out on Bloomberg the balance sheet of the National Bank of Greece, Eurobank, Alphabank and Piraeus bank, the top four. The four of them alone command EUR 164 billion in deposits! Slightly misleading, since they all have operations in the Balkans, but that’s almost one GDP, lying in deposits!!! More to the point, how many Greeks do you know who keep their money in Greece? That’s merely our spending money, it’s a small fraction of our savings and assets. Don’t even mention that a square meter costs less in Belgravia than in Psychico, Philothei or Kifissia.
Bottom line, as long as Switzerland and Citibank are going concerns (for that is where we keep the bulk of our savings), we’re loaded. Second, Greece scores well across all measures of debt but one:
We have extremely low household debt / GDP ratio.
We have extremely low corporate debt/ GDP ratio.
We have extremely low bank debt/ GDP ratio.
We have a manageable total debt / GDP ratio. Half that of the UK or the US!
We only score poorly on sovereign debt / GDP ratio.
That’s it!
Greece is a country with rich, underlevereaged savers, underleveraged corporates and a healthy banking system whose government happens to have borrowed a hell of a lot of money. But the world has grounds to be scared: with rates at 5% and government debt comfortably above 100% of GDP, servicing that debt costs 6% of GDP at the moment. GDP growth, in the meantime has not touched 6% nominal in a long, long time.
So here’s the deal: No matter what happens, the debt is now at a level where its growth has reached escape velocity. Even if Greece were to run zero deficit, ultimately we are heading to default. We can default now or we can default later. Is that a big deal? Frankly, no. 75% of the debt, probably more, is held externally. If JGBs fail to pay coupon, that’s a disaster for Japan, since 95% are held domestically. If GGBs fail to pay coupon, it’s far less catastrophic. For the debt-deflation spiral to start, you need the debt to be internal.
With an alleged 216 billion held by foreigners (plus the recent
the contagion risks mainly lie outside the border! Even the banks who are in the news for holding all those ECB-funded GGB’s aren’t as long as US banks are long Treasuries, for example, though they would probably have to be restructured. Basically, the economy is paying 5% or even 6% of GDP to service a debt whose failure will hurt three or four times more abroad than it will in Greece. Do I look worried?
Supposing we default, what will be left is a AAA credit here. Give it five years and a line will form to our door to lend us more. It would not be fantastic for us to default, granted, because at the moment we are in a virtual reality where a bunch of greedy foreigners lend us a fresh 5% of GDP every year on top of what they were lending us the year before. If we default they won’t lend us again for a short while. During that period we will have to live within our means. That will be a haircut. But it won’t be a catastrophe for Greece. Germany took a bigger GDP hit than that last year, for example, and so did the UK!
Indeed, I’m willing to bet Greeks continue to have good access to the international financial markets, and here’s why: as I’m writing this, Greek shipowners owe some EUR 100 billion to the international banking system.
Even with the Baltic Dry somewhere in the dungeon, this debt is being honored and serviced. Greek companies will be just fine, basically. It’s the government that is the joke here, not the country! Nevertheless, a sovereign default by Greece will set off a cascade. Italy has tons more debt than Greece and a much bigger proportion of it is held in Italy.
That won’t be a picnic. It gets worse than that, of course. People like to talk about PIGS, but the real oink oinks of the past decade have resided in the protestant part of the world. The United Kingdom and the US have total debt of more than 400% of GDP. You can never grow your way out of 400%, it’s as simple as that. And this concludes my first point: be careful what you wish for here, because Greece is a rich country that will mainly hurt others if it defaults. Directly (through the default) and indirectly, via contagion.
A default will have both negatives for Greeks (less money to spend) and positives, which don’t concern anybody here, so I will discuss them separately at the end of this piece.
This brings me to my second big idea here. When the Paulson / Bernanke / Geithner triumvirate decided to save the banks in September of 2008, who exactly was saved? Was it the American economy, as we are led to believe? What was the alternative? The establishment would have us believe that there was no alternative.
It was “hold your nose and save Wall Street” or a return to the dark ages. As Joseph Stiglitz, Willem Buiter and Paul Krugman were at pains to point out back then, an alternative existed: we could have done a GM/Chrysler on the banks. Expropriate the equity holders, pay 15 cents on the dollar to the bondholders and nationalize. Had we gone down that route, there would have been different winners and losers. Small business would have been a massive winner.
Rather than create zombie banks that are too busy pretending Ford is a great company (Ford owes banks 24 billion) and commercial real estate is about to turn a corner, they would carry on extending credit to small business. Sticking money into the zombies has had 100% the opposite effect of what was advertised. It has caused “extend and pretend” to the borrowers who are too big to fail and has throttled the little guy. Business was a loser.
The newspapers have us think that bankers were the winners. We did not do too poorly, but we are not the big winners. The big winners here are the baby boomers. That’s because they have their name against some 80% of the value in all pension funds and insurance policies.
And if the banks had gone down, that’s who holds their debt and much of their equity. Bottom line, had the banks gone down, no insurance product would be worth a penny more than the paper it’s printed on. So basically, the 2008 bailout sacrificed business, i.e. our generation, but saved our parents. The US bailout was intergenerational transfer, pure and simple. Now, our parents did not have enough kids.
The past 10 years has been the story of their struggle to sell us their homes and their equities at the price that will allow them to retire conveniently as they turn 65. They’ve thrown low interest rates at us to induce us to borrow against the homes they are selling us, but that backfired because low rates have pushed down their bond returns and their dividends. And their stocks have not gone up in ten years. The final straw was going to be the decimation of their insurance contracts and pension plans, but Paulson, Bernanke and Geithner jumped in and saved them.
Talk about the bankers is fashionable, but in the bigger scheme of things it was a side-show. It’s pretty much the same with the Greek situation. Yes, we Greeks have been naughty. Yes, we are overindebted. Yes, we live above our means. But, much like the evil bankers, this has nothing whatsoever to do with Greece. That is my main thesis here. The Greek saga (for I refuse to see it as a tragedy) is all about saving the French and German baby boomers’ retirement.
Sleepy fund managers and insurers in the north of Europe decided that they did not want currency risk and they did not much fancy credit risk. Sovereign risk denominated in EUR was just the ticket for them to deliver on their promises. So the decision was made to lend money to the Greek government. Tons of money. Leaving out wars, more than any country has ever paid back that escaped default. Greece had no need for this money and indeed put it to horrible use. But Greece is not the protagonist here.
This is a domestic issue for France and Germany! The governments of France and Germany have a choice here. They can side with the baby boomer generation, tax its progeny and funnel the money to Greece. Or they can refuse and have the baby boomers reap what they’ve sown. But the bottom line here is that if the money had not come to Greece it would have gone to Italy, Spain or Portugal. It wouldn’t have gone to Bunds and OATs, because they did not yield enough for these wide fund managers’ taste.
The goings on in America, where nobody is thankful for having been “saved” and where the economy is suffering the result of a misguided, short-term decision may push the French and German government to say “the Greeks don’t deserve a bailout” and allow their insurance behemoths to take the hit. But I would not bet on it. My money is that the baby boomers prevail again! Make sure you’ve covered GGB shorts by the end of the week!!! I, for one, hope we’re allowed to default, and here’s why: Once upon a time, Greece was a model small democracy. An extremely frugal government ran tight budgets and provided an extremely basic safety net, and truly threadbare services for a very low cost: Tax collected was minimal.
While tax rates may have been high, collection was virtually nil. A small oligarchy was the only source of capital and had the acumen, education and experience to deploy it as the country developed. Old families controlled the steel, cement, foodstuffs and construction companies that rebuilt Greece after the war. As recently as 1980, debt/GDP was at 30% and it would have been much lower were it not for the high costs of defense. When Greece joined the EU in 1980, all that changed. It was party time. Money that was sent to build the Greek infrastructure was funneled pretty much directly into the pockets of the oligarchy as well as the new Socialist oligarchy that emerged.
This was not chump change. It was 6% of GDP for 30 years. With the exception of farmers, who did extremely well off of the Common Agricultural Policy, the rest of the money went pretty much straight to Swiss bank accounts. As an example, Greece has paid 250% over list for F16’s and Mirage fighters and has spent EUR 750 million for an airport that was built by the same company that originally bid EUR 220 million for the project. No prizes for guessing what happened there. Once the addiction to easy money set in, the government of Greece was transformed from a lean provider of defense, basic health, basic education, a basic road network and extremely basic pensions to an auctioneer of projects to the oligarchy.
The families who control business in Greece used a system of bribes the government was happy to accept and set up a newspaper each to deliver threats its members would rather not. Sticks and carrots, and lots of Euros. And once the system was established, there was no need to stick to the money that was coming from the EU. ERM entry cost our politicians the printing press, but thanks to low EUR rates, the government could now service previously unthinkable amounts of debt with impunity. A residual part of that money may have ended up in useful projects, but the bulk ended up in the pockets of the twenty families who run Greek business.
A big chunk of that money, in turn, has been invested by these families in bringing to Greece every foreign franchise from Starbucks and Pizza Hut to IKEA and Stanley Kaplan, driving existing companies out of business in the process. In summary, EU funds have done to Greece what oil did to Nigeria, while low EUR rates have allowed the government of Greece to be able to service a debt of 100% of GDP, most of which has gone straight to the pockets of the oligarchy. Man on the street, with the exception of the farmers, has not benefited one jot. This does not make all Greeks poor. Shipowners do very well, and a natural resource called the sun is very helpful to our 165,000 hoteliers. Man on the street never saw the benefit of the 250 billion the government has borrowed. Ergo, support for austerity now that the bill has come is zero. You won’t see anybody accept an Irish solution in Greece.
The notion that Brussels will dictate to Greece terms on public sector wages and impose a May deadline are, frankly, comical. The government may like the idea, but the entire population will probably go on strike. Needless to say, Greece can pay. If the government chooses to freeze savings accounts it can pay the whole kahuna in one go. But the Greek people will refuse to take any hardship. This is a matter between some French and German baby-boomers, their government, and twenty Greek families who will happily take more. I hope we default and the country is freed from the curse of free money that befell it in 1980. Once our politicians have no more money to disburse to the oligarchs, we can start to be proud Europeans.
“
Rising wages in coastal provinces would be a good thing if the mix of production in those provinces stayed the same. But more likely, the mix of industries will change from more labor intensive products, mostly for export, to more capital intensive products, partially for export and partially to substitute for imported capital goods.
If the labor intensive production moved inland, then there would be a net loss of jobs locally but not at a national level. If labor intensive production moves to other low wages countries, Vietnam for example, then this would result in lower net employment despite rising GDP.
All the while total debt is rising.
I see that higher wages will initially cause higher unemployment but won’t the higher wages lead to more consumption and a larger services sector soaking up the lost export jobs?
Michael,
You cover a lot of ground here. First, your list of reallocative measures for the PRC is OK. This exactly what someone with a European tolerance for intervention and respect for the welfare of the population would do if made China’s benevolent planner. Unfortunately, that may not be the direction the PRC elites want to follow. They are satisfiers, not maximizers of non-elite welfare and they believe that their class (I guess some of the party school marxist ideology garbage has had a more than ritual effect: a lack of belief in non-zero sum class games) can defend its privileges and accomodate an important enough cooptative flow to make aspiring talent stay interested. Lenin meets Confucius.
As to the Euro: the EUR would be quite viable if only the countries bordering on Germany (and not even all of them) would use it. For the rest there are three problems: underdevelopment, political culture and trade patterns related to location. Ireland is more integrated with the UK than with the rest of the EU. Greece is similarly insulated and faces the competitive effects of new EU entrants. Italy and Spain have enormous informal sectors. But Italy has not much private debt, while Spain has little public debt. Both have intra EU trade imbalances (but so do Texas and Michigan). Portugal would be more of a problem if it were not so well-behaved.
There are very good reasons why a slow , messy and disciplining bail out of Greece may actually have beneficial effects for the EUR: (1) thanks to speculators, the EUR has become a lot more competitive, without having to relax monetary policy and (2) Greece is the right case to scare the monkey with. May fewer Greek sociology professors will be able to afford Philipina amahs in the future…
Unfortunately the New York Times article is out of date on the development of the US trade deficit – which has started to rise again.
The deficit, having peaked in April 2008 at $62.1 billion, shrank rapidly to $26.6 billion in February 2009. It then reached its low point in May 2009 at $25.8 billion, and subsequently began to expand – reaching $40.1 billion in December 2009.
Taking a three monthly moving average the US monthly trade deficit reached a low point of $27.1 billion in June 2009 and then began to expand again – reaching $36.6 billion by December 2009.
Taking average data for the whole year 2009 is therefore misleading as it fails to capture the real trend which saw a new expansion of the deficit from mid-2009 onwards.
Michael, have you seen the piece in nakedcapitalism.com that discusses the euro problem in the context of Dani Rodrik’s concept of a policy trilemma? Rodrik argues that we can choose only two out of the following three: democracy, sovereignty, and global economic integration. That sounds similar to your claim that enfranchisement of the working class (democracy) prevents the adjustment required as part of the gold standard (global economic integration) as long as each country in Europe maintains its sovereignty.
John Ross, I don’t think we should expect that the contraction of the US trade deficit must occur in a staight line. It is probably much more reasonable to expect it to bounce around in the short term as it contracts over the long term, right? The same should be true about unemployment, consumption and savings.
[...] “Rising wages in China are a good [...]
Pigeon, I don’t know much about the distribution of wealth in Germany, but I would agree that redistributing wealth downwards generally results in an increase in total consumption, since the poor consume a greater share of their income than do the rich. Interestingly enough in the US a greater concentration of wealth over the past decades seems to have come with the opposite – an increase in the consumption share of GDP – which probably means nothing more surprising than that a lot of things affect consumption patterns.
Nada, I do not know enough of Germany’s economic history to be able to answer the first question. As for the second, I am not sure why it would be counterproductive. It seems to me that it would limit the ability of wages to increase in the coastal areas, but spreading the benefits further inland is probably good socially and in its impact on consumption.
OGT, I am not sure that devaluation is an option for the euro. The euro can certainly depreciate, and seems to be doing so as a consequence of uncertainty, but I don’t think that the ECB can actually intervene enough to force a devaluation of the euro (against what? The dollar? That might not go over well in the US).
Dean, I agree that an expansion in German demand might simply lead to larger European trade deficits – which suggests that either it must be part of a globally coordinated policy (and that means other surplus countries would also have to expand) or it would lead to a significant rise in trade barriers. As for your second point on the European imbalance, Greek labor compensation is probably low relative to productivity, which is why there is so much pressure to devalue, but the very measures that cause growth in German net demand (assuming it does not all leak out) will cause a partial domestic adjustment. After all, if Germany (and the other surplus countries within Europe) forces an increase in net imports from the rest of Europe, those imports will come from somewhere.
Avid, yes I saw it. These are the kinds of statements in China, the US, Europe and elsewhere that worry me and leave me pessimistic about trade. It is a dialogue in which every participant clearly sees his own legitimate grievances and is unable to see anyone else’s.
Zjin, thanks. I suspect we are going to see a lot more like that. Some of his points are probably correct, but one important point that I think he misses is that debt has significant balance sheet impacts that affect the real economy.
Simon, probably yes, but the latter effect will occur slowly and the former quickly.
Rein, I agree with much of what you say except for the comparison of Italy and Spain with Texas and Michigan. Capital and labor mobility, along with the lack of sovereignty, reduce the impact of these kinds of imbalances, and it is pretty clear that there is far more of those in the latter than in the former.
John Ross, I agree with Lee’s point.
Lee, yes I saw it and liked it very much. And you are right, the argument put forward by the always intelligent Dani Rodrik is very similar to Barry Eichengreen’s implicit point that in a world of sovereign nations we have to choose between democracy and adjustment to the gold standard, and cannot have both.
The Chinese are clearly wary of another Plaza Accord type of restructuring that has most of humanity paying for Wall Street’s blunders. They also surely know that we will ‘lose the most’ in a trade war because global consumers will side with China and vote via expenditures. China has already won partly, because we have not been taking responsibility for our reserve currency role, and we have been abusing our privileges for too long. Once the actual benefits of a weak yuan are specifically assigned to what specifically benefits only the Chinese, and then if that is seen as separate from what benefits the MNCs, a rising yuan is of so little consequence that if the rising costs to US consumers is also considered, this all seems to add up to this: The US is trying to provide an excuse for a falling dollar. Or at the very least this is what the Chinese are worried that the the US is trying to do. Naturally, the average global citizen will eventually know that the fall of the dollar came at their expense and the US must cast as much blame as possible on the Chinese. But it seems the Chinese are well ahead of the game. Americans though only hear the “yuan up” side of the story, but the “dollar better not go down” side of the story is getting plenty of play in Asia. Interesting stuff.
[...] the rest here: Rising wages in China are a good thing Share and [...]
Interestingly, Eichengreen on the Euro, he seems to advocate a reduction in national sovereignty:
“My answer is no, creating the euro was not a mistake, but it could still be a mistake in the making. The Greek crisis shows that Europe is still only halfway toward creating a viable monetary union. If it stays put, the next crisis will make this one look like a walk in the park.
Completing its monetary union requires Europe to create a proper emergency financing mechanism. Currently, other member states can provide assistance to Greece only … in response to natural disasters or circumstances beyond a country’s control. This heightens uncertainty. …
Well, if Europe is serious about its monetary union, it will have to get over its past. It needs not just closer economic ties, but also closer political ties. Those running a strong emergency financing mechanism will have to be strongly accountable. They will have to answer to a strong European Parliament.”
http://www.project-syndicate.org/commentary/eichengreen14/English
zjin
The piece entitled “GGBs: Our debt, your problem” was somewhat interesting but it was not in the Financial Times.
It was an anonymous post on the Paul Kedrosky Infectious Greed site.
http://paul.kedrosky.com/archives/2010/02/greece_our_debt.html
Lee
The issue on the US trade deficit is not that it has not been shrinking in a ‘straight line’. There is a clear curve of development whereby the US trade deficit contracted until mid-2009 – May if you take the monthly figures and June if you take a three month moving average to smooth out purely short term fluctuations – and since then it has begun to widen again. This is very evident if you look at a chart, which unfortunately cannot be shown in the comments section but can be found here.
This is directly related to US consumption. Again it is not an issue that US consumption has not been falling in a ‘straight line’. The point is that under the impact of the financial crisis consumption has actually risen as a proportion of US GDP. US personal consumption was 70.3% of GDP in the 2nd quarter of 2008, immediately before the collapse of Lehman and the recession started, and it had risen to 70.9% of GDP by the 4th quarter of 2009. The rise in total consumption, that is including government consumption, was even higher.
This is why an analysis that a factor in the correction of global imbalances (a fall in the US balance of payments deficit and the fall in China’s trade surplus) has been through an increase in US savings and a fall in US consumption is wrong. It is simply not in line with the facts. US consumption as a proportion of GDP has risen and not fallen under the impact of the financial crisis.
Prof Pettis
Was wondering if there is anything you conclude from the announcement on China’s holding of T-bills etc having decreased in December.
Do you read it as a simple financial matter – perhaps selling off the increased holdings of short term debt accumulated over peak crisis time 12 months ago or so, or is there any other explanation? (Political vis a vis the US, etc?)
Lee and Michael,
The ‘trilemma’ concept is well established in economic theory. It essentially says you can only control 2 of the following 3: monetary policy, currency value, or capital markets. Choose any two and you lose control of the other three. Generally it refers to relatively open economies, but probably has applicability for China as well. I think it was first proven by Robert Mundell, but I could be wrong on that. It has been a hot topic recently.
Professor Pettis,
On the issue of infrasture investments, as you’ve mentioned the bulk of the cost is paid for by tax payers. Tax are used to make loan payments over a number of years. The tax source are from corporate tax and personal income tax. My impression, could be wrong, is most low and middle income Chineses pay no income tax or very little income tax. Farmers in rural China are likely to pay no income tax. As such, the wealth transfer is from the upper class of wealthy Chinese and from Chinese corporations. The wealth is also transfered from the wealthy costal regions to the poorer inner regions.
Another consideration: is the interest on savings really too low? The RMB is peg to the US dollar. While the Chinese financial system is close and therefore has some flexibility to adjust interest rate, it is still limited. As such, it is not clear the interest rate in China is really that low given where the interest rate is in the US (well, China could unpeg). By the way, correct me if I am wrong, China doesn’t try to control credit demand by adjusting interest rates like the US Fed. Instead, China directly control credit supply by setting bank lending quota and reserve requirements.
I think the bulk of the cost of infrastructure investments come from tax. Only a small portion of infrastructure investements come from households in the form of lower interest rate.
Professor Pettis,
I have the following questions.
1. How should over capacity in an economy be measured?
I point out in the comment of your last blog entry that maybe it is not China but the rest of the world that has an over capacity issue.
http://mpettis.com/2010/02/never-short-a-country-with-2-trillion-in-reserves/#comment-4712
I trid to define over capacity base on market price and rather productions are profitable. What are your thoughts?
2. What is the right _rate_ of increase of consumption in China?
Let me elaborate. Today, if we look at the per capita GDP of China, it is still very low and it still have a lot of room to grow. On the other hand, China’s overall GDP grew at 10.7% last quarter. No one is pushing China to grow it’s GDP even faster when clearly there is still a lot of room to grow. The reason for this is there are a lot of downside to growing too fast even if there is still a lot of room to grow.
Today, if we look at the Chinese savings rate, it is clear that Chinese should consumpt more. There is a lot of room for consumption to grow. However, the rate of consumption growth is already very high! So the question is how much higher can the consumption growth rate go? At what point is it too high? Clearly there is also a danger to growing consumption too fast in a society that is still in the midst of developing its social foundation.
Again, I do agree Chinese consumption should increase more. I just suspect the already high growth rate of consumption can at most only go up marginally higher.
By the way, anecdotally, when I visited malls in major Chinese cities, everyday (even normal weekdays) it is like visiting a US mall around the Christmas holiday! The mass of people is simply overwhelming.
Michael:
What is your take on the following ?
“Beijing’s ‘Buy China’ tech policy alarms trade partners”
BEIJING — Beijing says it wants to spur Chinese inventions with a “Buy China” policy that gives preference to domestic technology companies. But the tactic has provoked an outcry from Washington and business groups that say it will choke off access to the massive market for goods from software to clean power equipment.
Foreign companies have been alarmed by the government’s announcement it will favor technology developed in China when buying computers and other goods on which it spends billions on each year. The plan, part of a decade-old effort to promote “indigenous innovation,” would channel money to Chinese companies and add to pressure on foreign technology creators to shift research work to China and know-how to local partners.
The move reflects Beijing’s growing assertiveness as it tries to make Chinese industry more autonomous after depending on foreign money, markets and technology for three decades to drive its economic boom.
Trade groups say it violates the spirit of China’s World Trade Organization free-trade commitments and its pledges to avoid protectionism that might harm the global recovery. Washington and the European Union have complained, but Beijing retorts that it has yet to sign a treaty that would apply WTO rules to government purchasing.
The impact on companies is unclear because no details of how it will work have been released. But the government is China’s biggest software buyer and a key customer for other technology. Losing that market might hurt companies including Microsoft Corp., Intel Corp. and Motorola Inc. Suppliers worry the rules could be extended to purchasing by major state-owned companies in power, telecoms and other fields.
Some companies would consider pulling out of China if they conclude the loss in sales will be too great, U.S. and European trade groups say.
http://www.mercurynews.com/business/
If you are wondering why the US political argument for a revaluation of the Chinese yuan isn’t going anywhere, try to remember that policy makers in China have some basic common sense and aren’t ideologues like their US Neo-liberal Economist counterparts. The Chinese leadership should always place China’s interests first, just as American policy makers always place Wall Street narrow banking interests first.
MIchael,
Of course the comparison between US states and current EU components is very wrong, but that is the way it should go or otherwise it will not work.
A more important point is your last reference to Eichengreen. There is indeed clear friction between radical versions of sovereignty, democracy and inflexible FX. The misguided median voter of a truly sovereign state will always prefer the indirect adjustment to lagging relative productivity (the core problem in Europe) via inflation (brought on by competitive devaluation) to adjustments in nominal wages combined with shrinking the public sector. The public sector tends to become a dump for surplus graduates (see Greece’s abundance of teachers) who are very good at organizing temselves.
However, the EUR is not quite a gold standard, it is a treaty currency backed by an imperfect mechanism for fiscal and monetary policy coordination. In the 1990s that was the best that could be done especially looking at a Germany with severe digestive trouble. No one expected the thing to operate maintenance-free. Next, most EU countries are blessed with reasonable politicians who understand win-win situations and allow each other to score harmless points to keep the populists at bay and only the small countries have strongly proportional representation systems, but they tend to have well informed publics. Not much of dynamic democratic activity there. Finally, one of the EU’s problems is that country sovereignty (or rather the apparent disappearance of) is becoming a PR problem, as was visible during the botched constitutional upgrade. But that should not be confused with far worse pathologies. Europeans are used to foreigners closing their factories. Only the civil servants live in a fantasy world. I expect the Greece thing to be very opaque, messy, unsatisfactory and effective. But not symptomatic of an impossibility as suggested by Eichengreen, because the “gold standard”, democracy and sovereignty involved here leave plenty of room for compromise.
Ten minute interview w/ Prof. Pettis on the Carnegie Endowment website
http://www.carnegieendowment.org/publications/index.cfm?fa=view&id=30974
Ray and Dave Chiang you are obviously the same guy since you have the same writing style and the same total incomprehension over what is happening in China and what Chinese think. First, the US ins’t trying to provide an excuse for the falling dollar since what they want is for the dollar to fall against the RMB. Second, what do you mean by “the US political argument for a revaluation of the Chinese yuan isn’t going anywhere”? Do you read any newspapers in the US or China, or anywhere else for that matter? Third, “try to remember that policy makers in China have some basic common sense and aren’t ideologues like their US Neo-liberal Economist counterparts”? Do you know anything at all about Chinese policymakers? How does someone so ignorant of China become a spokesman for the China lunatic fringe?
Nada Townie:
As for as I know, that note about Greece appeared first in the “long room” at FT. Not that it really matters but…
Ray, I am not sure your assertions make much sense.
Dave Chiang, ditto.
Houhui, it was China’s recorded holdings of USG bonds that recorded a drop, but the holdings in street names went up, so we don’t really know what happened to real Chinese holdings. The main thing to remember is that the US ran a large current account deficit, so foreigners increased their net holding of US assets, which ultimately is part of the pool that funds USG borrowings, while China had a large current account surplus, which means their net investment abroad increased. Under those conditions I would be surprised if Chinese holdings of USG bonds really declined except to the extent that they swapped out of direct obligations and into close substitutes.
Dean, you are talking about a different trilemma, and yes, that is pretty well established. What Rodrik did was to use the original trilemma “framework” to posit a different kind of trilemma, one involving a more political slant.
Silly things, there are many forms of taxes, many of which are hidden or indirect. Basically economists think of any transfer of purchasing power from households or businesses to governments as kinds of tax, including such things as forced savings, inflation, etc. I would argue that the interest rate “tax” of long-term borrowings at suppressed rates are a very significant form of payment which, when added to the deposit/lending rate spread used to recapitalize banks who have made non-collectable policy loans, accounts for much or most of the cost of infrastructure investment. For example, if we assume that the cost of recapitalizing the banks is 2% (based on the actual spread less the more common spread) and the cost of suppressing interest rates is anywhere from 3% to 7% (which falls within most estimates of the appropriate interest rate for China), for a project funded with 10 year money, anywhere from 32% to 49% consists of the hidden interest rate tax. If we extend the funding of the project to 20 years, the hidden tax accounts for 46% to 64% of the cost of the project. Much of the rest of the project may be paid for with direct taxes or other forms of hidden taxes, but ultimately it is households who must pay.
As for your second question, there is a serious debate on what the “right’ interest rate should be in China, but the fact that the RMB is pegged to the US dollar shouldn’t imply that Chinese rates should be the same as US rates. There are many other factors that matter and in fact most developing countries, even ones who peg their currencies to the dollar, have substantially higher interest rates. And yes you are right that “China directly control credit supply by setting bank lending quota and reserve requirements.” It has to control lending through quotas since too-low interest rates means that demand for credit is likely to be too high.
To move on to your second comment, there is no real definition of overcapacity because it can mean different things in different contexts, but in conversations about trade and balance of payments it usually means the excess over what is produced and what is consumed domestically. In that context it would be strange if the country with the highest trade surplus as a share of global GDP in recorded history were suffering from too-little capacity and the rest of the world from too much. You are right that consumption is growing quickly, but the key here is that it must grow as a share of GDP. That means it must grow faster than GDP. A quick back-of-the-envelope suggests that if China grows by 8% a year over the next five years, consumption must grow by nearly 11% a year just to get us back to the very low consumption levels of 2003-04.
Nada, Chinese policymakers correctly pointed out that the “Buy America” provisions discussed last year were protectionist. I am not sure how anyone can suggest that the “Buy China” provisions are not.
Rien, I suspect you are more optimistic that I am about the willingness of European voters to shelve sovereignty issues (and perhaps also about the “reasonableness” of most European politicians). I go back to my home in Spain fairly often and I get the sense there that unwillingness to accept the required adjustment is likely to rise. I guess my main point is that whatever happened before 2007-08 is not relevant to predicting the next few years because currency unions are always much easier to absorb during periods of rising liquidity and asset price growth. It is in the contractionary periods that they all, I think without exception, have foundered.
[...] Rising wages in China are a good thing Share and [...]
[...] to India, is China. China has seen the emergence of clear inflationary capacity constraints. Some commentators have been calling for China simply to increase domestic demand by increasing domestic consumption [...]
Michael,
The “Buy China” regulations refer to Chinese government procurement and fully conform to WTO regulations. China never signed the WTO treaty to open state procurement to foreign corporations. Likewise, US government procurement also prohibits the purchase from Chinese corporations. Shenzhen based Huawei and Beijing based Lenovo are officially banned from supplying US government agencies with computers and network routers respectively.
Thank you Professor. I think I am missing Brad Setser!!!
Ross,
I realise we are looking at slightly different stats sets, but today Martin Wolf in the FT (i won’t link to it as i think you need a membership) wrote a piece “How to walk the fiscal tightrope that lies before us” in which:
Jumps in fiscal deficits are the mirror image of retrenchment by battered private sectors. In the US, the financial balance of the private sector (the gap between income and expenditure) shifted from minus 2.1 per cent of GDP in the fourth quarter of 2007 to plus 6.7 per cent in the third quarter of 2009, a swing of 8.8 per cent of GDP (see chart). This massive swing occurred despite the Federal Reserve’s efforts to sustain lending and spending. Similar shifts occurred in other crisis-hit countries.
Isn’t this a better method than looking at consumption share of GDP, given that other variables have undoubtedly also changed dramatically during the crisis? (not least GDP’s contraction, trade disruptions, and government stimulus measures.)
Raising wages vs. Currency revaluation
I can’t help but think that they are kissing cousins with one major difference. Raising wages allows the book value of reserves to remain intact, or at least hide it for another day. It does run the risk of magnifying the cost (in wage costs) of any future revaluation though, if not accounted for. It also does not address the issue of under-priced capital.
To me this option, raising wages, looks to have more political appeal than economic.
PS. If I recall correctly Michael, you once mentioned that a large portion of profitability of China’s SOE were a result of low interest rates. Have you given any consideration to the effects of rising rates will have?
Michael,
Even in Spain, there are whingers..But do they count, that is what I mean by reasonable politicians: those who lead, not follow, and understand what is best for the commonwealth they live in… Of course your concerns are valid.
Michael Pettis,
Complaining about China’s economic ascendancy is futile. We are merely returning back to the previous world order that existed in history. Around 800 AD, China’s GDP represented aproximately 50% of the entire world’s economy. I anticipate that per capita income in China will reach perhaps half of the US level in 20-30 years, then the Chinese economy will be several times larger than the US Economy. Short of a nuclear war, the tide of history cannot be stopped. The best way to participate is to invest in the Asian economic bloc.
Professor Pettis,
Many discussions of overcapacity are framed from the view of “excess over what is produced and what is consumed domestically”, as you’ve mentioned.
Unfortunately, this view really butchers the #1 sacred cow in economics: efficiency.
Consider what the consequence is if a country, any country not just China, holds back production even through it has the capacity to profitably produce more? The end result are:
- Foreign corporations, that otherwise would be uncompetitive, will continue production due to reduced competition.
- All consumers in the world will necessary pay a higher price for goods and services due to reduced competition. Consumers are forced to subsidize the uncompetitive businesses.
- Global economic growth (GDP growth) will necessary be lower.
- Resource will be severely mis-allocated. This is especially serious for the mis-allocation of human resource in the world.
Everyone looses in the long run.
In the short run, major changes do have a very real human cost dimension. Therefore it is understandable and correct for governments of developed nations to soften the shock. However, viewing overcapacity from “excess over what is produced and what is consumed domestically” misleads the analysis and will lead to significant inefficiencies.
A country is an economic actor like a business enterprise. I think the measure of overcapacity for a country should be the same as a business. Overcapacity should be measured by price and profitability of production.
Lastly, a good test of my argument is the prediction that we’ll see more over capacity issues as more and more poor nations unlocked their human capital and join the world economy. About half of the world’s 6 billion people are still living in poverty. There is still a very long road ahead!
Michael Pettis, The assistant Governor of the RBA said recently: “the Chinese economy was looking very good in the next two decades and infrastructure investment there could continue growing”
I wonder if you could share your thoughts on this. The prevailing view in Australia ATM is that Chine will grow forever and Australia will be a major beneficiary.
Professor Pettis,
I am not an economic or a financial guy but learnt many things after seeing US financial crisis. From the following link
http://www.financialsense.com/metals/greenspan1966.html
what I learnt is just to meet the economic growth FED has decided to follow fiat currency. They are printing money out of nothing and how long do you think this cycle will continue. The music has to be stopped one day right? Or do you have any insight in long run how they are going to take care of this? Is there any alternate currency system?
Thank you,
Paul
[...] reader has pointed me towards this nice post by Michael Pettis, which strays from his usual Chinese turf to take a look at Europe. It makes the [...]
houhui1979
If the issue being looked at is global imbalances, which are evidently strongly affected by what is happening to US consumption and saving during the financial crisis, then the appropriate measure is the share of consumption and saving in US GDP – as it the deficit of US savings compared to investment which is equivalent to the US balance of payments deficit.
A number of people have claimed that consumption has fallen as a proportion of the US economy and US overall saving has risen under the impact of the financial crisis. The figures I gave show that this is wrong. Exactly the opposite has occurred – US consumption has risen as a percentage of GDP and US savings have fallen as a percentage of its economy.
What has actually occurred during the US recession is a very sharp fall in US investment compared to US consumption. That is the ‘overconsumtion’ in the US economy has got worse.
Expressing the shift between the 2nd quarter of 2008 and the 4th quarter of 2009 in money terms shows that pattern very clearly. In this period US GDP fell by -$34 billion. However US personal consumption actually rose by $56 billion. In contrast US residential fixed investment fell by -$129 billion and US non-residential investment dropped by -$362 billion. The total decline in US fixed investment was -$490 billion. The breakdown of these figures is important as it shows that the downturn in investment was concentrated in non-residential, and not simply residential, sectors.
Over the same period US inventories rose by $9 billion. Net trade, that is the trade balance, improved by $298 billion. US government expenditure, consumption and investment combined, increased by $92 billion.
In current price terms, therefore, there has been no fall at all in US consumption, indeed it has increased. US fixed investment, in contrast, has fallen sharply. The same applies if the figures are looked at as percentages of GDP.
The mechanism by which the US trade deficit has begun expanding again since last summer is therefore clear. It is a product of the fact that US consumption has not has not been falling as a proportion of GDP, instead US total saving has fallen.
As the US balance of payments deficit, which is dominated by the trade deficit, expresses the excess of US investment compared to US savings then as soon as the precipitate fall in US investment slows up or reverses, as it did in the 4th quarter of 2009, then the falling US savings level means the trade surplus begins to expand again.
To summarise: US consumption has risen as a percentage of GDP while US investment and saving has fallen sharply. I know this is the opposite of the analysis put forward by Michael Pettis here and also by others. But the data show that this theory is wrong. It does not fit the facts. The US trade balance initially improved because US investment fell drastically as a percentage of GDP and not because US consumption fell as a proportion of the US economy. The US trade balance is widening again because US consumption has risen as a proportion of GDP and therefore as soon as the fall in US investment slows down the trade surplus begins to expand.
Everything fits into place when the reality of the expansion of consumption as a proportion of the US economy during the financial crisis is seen.
silly things,
i think your last point hints at the problem. Unleashing production whilst holding back consumption leads to the problems in the first place.
“Competitive” as a useful concept depends on a level playing field, not one distorted by trade policies favouring one side. The system will live with beggar-thy neighbour policies for a while, but not for ever (especially when an offending state grows to a certain level)
Complementing the excellent remarks made by “Silly Things” about capacity I would like to consider another related aspect that is the investment in infrastructure projects. There is no basis to predict that the return of these investments in China will be low or negative. I will point out two examples to show how difficult it is to predict the impact of such huge investments:
1) Brasilia. An entirely new city was built in the late 50´s to be the new Brazilian Capital. At the time, most “specialists” argued that it was a waste of money and effort. Today, it is believed to have been one of the most important steps towards the social and economic improvement of the country.
2) IT. This is the most surprising example. It is well known and documented that it took more than a decade before investments in IT started to show its contribution to productivity of businesses in general.
Professor Pettis
Another great post. Everything appears right on to me except for your apparent aversion to fiscal stimulus by the persistent surplus countries. A substantial increase in direct government spending by the surplus countries seems the best way to quickly reduce the excess net savings and associated trade imbalances without a big increase in unemployment while the longer term structural changes you suggest take effect.
John Ross comment:
“The point is that under the impact of the financial crisis consumption has actually risen as a proportion of US GDP. US personal consumption was 70.3% of GDP in the 2nd quarter of 2008, immediately before the collapse of Lehman and the recession started, and it had risen to 70.9% of GDP by the 4th quarter of 2009. The rise in total consumption, that is including government consumption, was even higher.”
This points to a major problem with US economy and the solution. The increased % of GDP is not a result of increased consumption but rather from reduced production. The US needs to increase the amount of production while reducing imbalance between consumption and production (i.e. increase net savings). The problem is figuring out how to accomplish this under the current “free trade” paradigm. In this post Professor Pettis suggests some policy changes that the persistent trade surplus countries should make to increase consumption thereby reduce their persistent surpluses. However, there is no suggestion as to how to get them to actually do it! The evidence suggests they will not do it unless forced. Professor Pettis suggests that this should be solved by diplomacy and statesmanship of enlightened leaders. This approach is simply not working. I believe that the only hope is a change in the “free trade” paradigm. The free trade rules should clearly state that it is not acceptable for countries to run continuing large trade surpluses. If they do not take action to reduce the imbalances then the trade deficit countries have the right (if not the obligation) to impose trade sanctions on any and all persistent surplus countries. The world has been on a “free trade” joy ride for the last several decades, which has yielded a lot of benefits along with some problems. However, because of the practices of the persistent surplus countries the joy ride is unsustainable and is headed for a train wreck. Changing to an enforceable balanced trade framework seems the only way to preserve the benefits of free trade while reducing the problems.
Silly Things is making one key assumption which, while it has been true the last decade or two, may not hold: That countries with production in excess of domestic consumption will be able to export the difference. This ability is not solely predicated on cost advantages; it implies the willingness (and ability) of deficit countries to absorb that exported excess capacity.
The willingness reflects political decisions (protectionism=bad) which can be reversed quickly. Smoot-Hawley, after all, was passed by the leading surplus country during the Depression (against the advice of the experts and the business-savvy President) — how much easier for protectionist measures to be taken up by deficit countries, who would be hurt less by them. The ability is dependent upon a capacity for running deficits, which capacity cannot last forever. As Herb Stein noted, “If something cannot go on forever, it will stop,” cite: http://en.wikipedia.org/wiki/Herbert_Stein
While I am an optimist by nature, I do not see this ending well.
Christopher Paterson, isn’t Brasilia exactly the problem? As a Brazilian I can say it was built at a huge cost in the 1950s and 1960s and resulted in an enormous increase in Brazil’s debt. Yes, perhaps fifty or sixty years later, Brasilia is being seen as useful, although that doesn’t necessarily mean that it was economically a good idea –its importance may be more political and geographic (by the way I don’t think anyone seriously argues that today, the building of Brasilia is believed to have been one of the most important steps towards the economic improvement of the country, as you suggest). However until then Brazil had a very tough time and even a debt crisis in the 1980s.
Perhaps China is building even more dubious projects than Brasilia, and even if in fifty years we decide that these novo-Brasilias weren’t such a bad idea, how does it address the problem that Professor Pettis identifies, that in the next few years if these ghost cities aren’t economically viable they will result in lower consumption as Chinese households are forced to pay to keep them afloat?
Also, when you say “There is no basis to predict that the return of these investments in China will be low or negative. I will point out two examples to show how difficult it is to predict the impact of such huge investments,” are you not conceding that it is also difficult also to make the argument that these investments are necessarily good? In that case we are left with the traditional Austrian argument that when there is too much capital available at artificially low prices, wasted investment is almost always the consequence.
Rodrigo,
It was not necessary to wait 40 or 50 year to realize the importance of Brasilia to the country´s development. I would say that immediately after its inauguration it became clear that it was a no return decision. It´s importance and results started then to be identified together with many of its problems that however do not offset the huge gains.
Well, about the Austrian argument, I don´t think it is proper to use a “semi” theory to justify facts. A scientific approach would go the other way around.
Christopher.
In my view, the concern expressed by Professor Pettis over China’s stimulus spending is necessary a long term concern.
1. First, the cost of the stimulus will ultimately be pay for by the Chinese tax payers (tax of various forms: personal tax, corporate tax, hidden tax, etc.) over many many years. Essentially the government collects tax and make periodic loan payments. Therefore the negative impact of paying for the stimulus on the Chinese spending power is gradual and long term.
2. The stimulus has not yet cause a raise in tax. For the last year or so I have not hear of any news that the Chinese government raised taxs. Understandably, no government should raise tax in the midst of a deep recession. There was no negative short term impact to Chinese consumption from government tax. Granted my observation doesn’t include hidden tax.
Here is an ironic side note on the heel of the US subprime mess. A great way to stimulate consumption is to have a real estate bubble! China may be at an early stage of one thanks to the government! At least, this is helping the global recovery!
3. Various data overwhelmingly indicated the Chinese government policies supported consumption in the near term. Here are just a few data to consider.
– At the beginning of 2009, tens of million of Chinese migrant worker were displaced. The total number of unemployed was many times that of the US; and these folks didn’t even have an unemployment insurance safety net! The stimulus significantly helped to put many to work.
– Over the last year, China’s export has recovered some, but China’s import has grew significantly more. China is helping to pull many countries up. For example, Japan’s export to China rose 43%. Also consider China’s role in the recovery of various material and oil exporting countries.
– China’s consumer spending – retail sales was up 17.5% year on year!
– Even US export to China grew rapidly! http://blogs.wsj.com/chinarealtime/2010/02/11/in-china-more-made-in-america/
In the short term, the data are overwhelming that the Chinese government policy stimulated the Chinese economy, Chinese consumption and contributed significantly to the global recovery process.
In the long term, it is reasonable to debate rather the Chinese stimulus is net positive in promoting Chinese consumption growth. No doubt there are many downsides to the stimulus. However, there is also plenty of upsides too. It is not obviously clear the net affect is negative.
Personally, I have a very high confidence that China’s infrastructure investment will have a net positive return in the _long run_. I’ll explain in a separate comment.
Here is why I think China’s infrastructure investment will have a net positive return in the _long run_. Note this analysis is not about Chinese consumption which I mentioned in my previous message. It is only about investment return.
1. The total write off of a particular bad infrastructure investment is an one time event. However, a good infrastructure investment will generate returns for many years. A good investment, over the long term, can often return multiple times the initial cost of investment. The Chinese government has made a large basket of infrastructure investments all over China. Undoubtedly some portion will result in a total lost (make a reasonable guess 5%? 10%? 20%?). The rest are good investments. Add to the recurring return from the good investments the very critical ingredient of a long investment time horizon, the total positive year in and year out return will overwhelm the lost! Basically, bad investments will merely move out the time horizon when the over all investment return becomes net positive.
A few clarification. First, my analysis above only apply to a large basket of investments. Any particular investment definitely can turn into a total lost. Second, the above analysis is greatly simplified. For example, I didn’t make any consideration for carrying cost (e.g. maintenance cost). Lastly, there are also pervert scenarios where the net return on the entire basket of investments become net negative. Throw in a good glob of corruptions, stupidity and wars would do it. Hey, I don’t have a functioning crystal ball either!
2. China made the infrastructure investment at the market bottom. Consider the example of China’s decision to move up the time table for the various railroad projects in the country. Last year, the market was at the bottom. Therefore cost and competition for resource and labor to build the railroads are considerably less. If China waits a few more years to invest, the railroad projects will most likely cost China much more (cost the Chinese tax payers more). Let’s also not forget the big side benefits of stimulating the economy and generating employment. The excellent timing will definitely have significant implication for the overall investment return. Indeed, the investment timing of last year is par excellence!
3. We often tend to forget China is a huge country. Visitors often only see the big cities. However there are still great many part of poor rural China that have very little infrastructure. As such, the odds of an infrastructure project being an useless “make work” project is very low. Note that I don’t know this for sure because I have not seen the actual project list of China’s stimulus investment. If other do please share. Lastly, infrastructure investments should significantly help the economic development of the poor rural regions.
I have very high expectation that China’s stimulus investments will be significantly net positive in the long term.
Doh! There was one hidden tax that everyone are angry about and I neglected it in my previous comment!
http://mpettis.com/2010/02/rising-wages-in-china-are-a-good-thing/comment-page-2/#comment-4985
China did re-peg the RMB to the dollar in mid 2008. This is a sort of a import tax that makes consumption of imports more expensive than otherwise. It also helped China’s export. However, China also had many policies that stimulated consumption and import. At any rate, the latest data clearly showed the stimulus policy overwhelmed the impact of the RMB peg on consumption. Also, China’s import growth was much stronger than export.
This is also bring up another point that I want to address. There are a lot of forces at work in the economy. There are also a lot of chatters that confuse things. The key lies in figuring out which forces are the main driving forces and which forces are minor side distractions.
Here is my view on the RMB peg issues. Please see the 3rd and 4th paragraph.
http://mpettis.com/2010/02/never-short-a-country-with-2-trillion-in-reserves/#comment-4797
Honestly, China should just revalue the RMB! The forces at work is much bigger than the minor affect from the exchange rate distortion. The distraction of the RMB peg is simply annoying.
G Stegen wrote
“A substantial increase in direct government spending by the surplus countries seems the best way to quickly reduce the excess net savings and associated trade imbalances without a big increase in unemployment while the longer term structural changes you suggest take effect”
I feel many would disagree. Money spent is still money spent. Money spent through stimulus is spent quickly and recklessly. “Stimulus” pushes demand forward. The money spent must eventually be paid back through interest or rebuilding savings. If anything it pushes structural reform further down the road
Very soon, the technology and physical infrastructure across China will be more advanced than in the United States. Every new housing complex in China is required to deploy fiber optics connectivity. The world’s fastest bullet train now connects Guangzhou to Wuhan. By 2014, an 8000 km high-speed bullet train network at 350 km/hr will connect all major Chinese cities. The high speed Tianjin-Beijing and the Guangzhou-Shenzhen railways lines have been running 2 and 5 years respectively without any problems.
New 350 km/hr Wuhan-Guangzhou railway
http://v.youku.com/v_show/id_XMTQxMjE5ODg4.html
The state-owned China Import-Export bank has agreed to finance a $7 billion Los Angeles to Las Vegas railway using the Chinese 350 km/hr “Harmony” express train. And Brazil is close to awarding a $17.5 billion bullet train contract to a Brazilian-Chinese consortium. The Chinese are bidding on the $45 billion California high-speed rail RFP, but the protectionist Obama Administration will likely veto that contract.
[...] quando se discute China, e seu blog traz nesta semana um artigo muito bom no qual ele se aventura a analisar a crise da União Européia, argumentando que a Grécia e outros países problemáticos não terão como continuar a manter-se [...]
Christopher Patterson, of course it became clear right after inauguration that Brasilia was a no return decision. After such an enormous cost we could never turn back, but it is strange to jump from this fact to the conclusion that therefore it must have been a good economic decision immediately (I say nothing of the controversial statement that even after 60 years we agree that it represented a good economic decision). I wonder if perhaps you have spent very little time in Brazil during this period? Brasilia is above all a triumph of what may be called political geography, and not perhaps economics.
I suppose I agree with you that it isn’t proper to use a “semi” theory to justify facts (although I confess I don’t know the difference between a theory and a “semi” theory), but aren’t you justifying the claim that Chinese infrastructure investment must have economic value greater than its cost by the dubious and certainly not widely accepted theory that Brasilia, after fifty years, has turned out to have positive economic value greater than its cost? This is merely a theory of yours, but even if it were true, how can it prove that Chinese infrastrucutre is not wasted? By that logic, it would be impossible ever to waste money on infrastructure spending, wouldn’t it?
DJC, I am not sure if your goal is to undermine China nationalists by making them seem loony, or whther you are simply getting all your info on Chinese infrastructure from CCTV9 and China Daily. Have you ever been here?
Tan,
All of the economic predictions from China policy experts in the past decade were flat wrong. Remember Gordon Chang who wrote the book, “The Coming Collapse of China”, have any of his predictions come true? Why does anyone take him seriously anymore. Perhaps Gordon Chang and Jim Chanos will be right someday, but not anytime soon.
Unlike the slow Amtrak trains in the United States usually tardy, the 350 km/hr bullet trains across China actually run on time. The taxpayer $180 billion wasted on the AIG / Goldman Sachs bailout could have been spent on rebuilding US railway infrastructure. And instead of wasting trillions on a global Neo-imperialist empire of invading sovereign countries for their energy resources, the Chinese are building a real industrial wealth economy.
Fan:
I agree. You have to be here to understand. It’s a joke to suggest, as DJC does, that technology and infrastructure of China will exceed the US any time soon. Building techniques here are still quite behind, construction is substandard by western standards. Things break. Buildings are put up quickly, some fall apart quickly. Fiber optic wires? I live in a modern place built in 2007 but the internet is so slow that there is no way you can use it for big data downloads.
China is, comparatively, advanced versus other developing countries, but there is a long way to go to catch up to the west.
As to the efficacy of investment decisions on infrastructure, I appreciate the discussion but here are a few observations:
You will always find examples of good infrastructure investments and bad ones. I think for China, there is still a compelling need for build out that by and large, most of the infrastructure development is beneficial.
Are those investment decisions the best economically, Pareto optimal? No, certainly not. Like all commercial investment decisions in China, they are, at the end of the day, made by bureaucrats who do not have any training in investment analysis decision making. Banks lend based on where they think there will be government support, not based on an economic analysis of the project. Sure, the banks will do such an analysis but there is no rigor to such analysis. An undergraduate business student could poke so many holes in the assumptions, it would make most projects look like Swiss cheese.
We think the analysis by the western ratings agencies on subprime was flawed, but you haven’t seen anything until you look at the pie in the sky assumptions of most projects here. But analysing the numbers in China is not that important. What’s important is knowing who is behind the project and whether the project will get the support it needs through subsidies, capital or other means.
Does anyone deny that the majority of commercial and public investment decisions in China are based substantially on government officials’ decisions? Does anyone think that government officials worry at all about optimizing ROI or maximizing shareholder value? We know in the west that government bureaucrats make suboptimal spending/investment decisions. Do we think Chinese bureaucrats are any better?
I think of it more like directional investment. We know we need to go north. If different projects take us northeast or northwest, that’s ok because the need is so great. We’ll figure out how to get back to due north after we take a few steps to the northeast. As long as we know we aren’t going south, let’s move. To me this sums up how China as a society currently invests.
By western standards, you get killed if you invest commercially this way because the margin for error is low in the west. In China, as a society, it has the ability to absorb suboptimal investment by moving the problem around within the economy (using all the techniques we have discussed) and ultimately dispersing the cost of those suboptimal investments across a 1.3 billion population.
The question is, can it be kept up? I wouldn’t bet the house on China crashing any time soon. More likely, there will be a slowdown in growth as the technocrats deal with the problem of overleveraged local government investment companies who owe the state owned banks a lot of money.
We could be looking at round 3 of the AMCs, asset management companies, like Great Wall and Huarong. 1999, 2004 and 2011?
DJC, you really are weird. When Nick Lardy said there would be a bank crisis was he wrong? When Pettis said China was overly reliant on exports was he wrong? If Chinese government is as smart as you claim, why do they act like Lardy and Pettis were right?
In China the government used to pay people like you 50 mau for each comment like yours. Now they only pay 10 mau. Do they even pay you?
[...] quando se discute China, e seu blog traz nesta semana um artigo muito bom no qual ele se aventura a analisar a crise da União Européia, argumentando que a Grécia e outros países problemáticos não terão como continuar a manter-se [...]
DJC, I don’t think most serious people would consider Gordon Chiang a “China expert” – outside of [sections of] the media/think-tank circus, that is.
Hua Qiao,
There is another reason China can absorb suboptimal investment at a higher rate. That reason is growth. At even the minimal 8% government target, it is still almost 3x the normal US growth rate. Such high growth rate can shrink a lot of debt problems very quickly.
I think the key question, I don’t know the answer, is who is over leveraged. In the end, when asset prices contraction, it is those that are over leveraged that will be forced out of the game. Everyone else can just ride out a contraction. The pain felt by the society as whole will ultimately depends on the degree of leverage.
Currently, the Chinese households do not seem over leveraged. For example, average down payment on home purchase is 50%! Let’s also remember the famous savings rate of Chinese households. Fall in housing price should not be a problem for Chinese banks or households.
The business sectors seemed very profitable. Much of China’s excess saving are actually profits from business. It is unlikely that Chinese business are over leveraged.
The debt held by China’s central government is only 20%. This too is very low and no over leverage here. Furthermore, there is plenty of fire power to provide stimulus spending like 2009 when the occasion arises.
Some has pointed out that the local Chinese government are the ones over leveraged. Victor Shih estimated the local Chinese governments may have a total debt amount of ~30% of GDP.
http://chinesepolitics.blogspot.com/2010/02/looming-problem-of-local-debt-in-china.html
What are the local government doing with so much debt? Unfortunately, Victor didn’t offer an answer.
One possible scenario is local bureaucrats are forming local business to share in on the central government’s largess for infrastructure building. In this case, the loans these local business take on are ultimately back by the central government’s commitment to build infrastructures. Perhaps there is a double counting of debt (e.g. debt appear on both local and central government to build a particular bridge for example)?
One thing should always be true. Even local bureaucrats are motivated by profit. I would not be surprise if economic utility of a particular infrastructure isn’t a high priority of the local bureaucrats. However, I would be very surprised if many of these bureaucrats will take out so much debt without knowing if someone else, the central government in particular, will ultimately pay.
[...] theme Michael Pettis writes a lot about, he recently made some very interesting comments about it (link) [...]
Thank you for your reply Professor. I think i understand your points totally. I guess my question was written a bit too quickly, I really about whether the Chinese government “changing the mix” so to speak, between direct, indirect, or non USG etc holdings, was meant to signal something, or whether they were market moves.
I presume if we are talking about indirect holdings rather than direct there is little to be read, but if China is moving into other dollar assets, could this be a sign of confidence in the recovery (more risky assets?)? Or perhaps a change of strategy in the PBOC. As always, the time delay in the TIC data is problematic, and the data is far from comprehensive.
Tom Holland at the SCMP recently wrote an article about some mainland Generals suggesting that reserves could be used as a weapon – which was quite amusing. I wasn’t suggesting anything like this.
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[...] quando se discute China, e seu blog traz nesta semana um artigo muito bom no qual ele se aventura a analisar a crise da União Européia, argumentando que a Grécia e outros países problemáticos não terão como continuar a manter-se [...]
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[...] of inflation on real interest rates – for me a much bigger problem. As I have said many times before, rebalancing in the Chinese context requires that household consumption rise as a share of GDP. [...]
[...] of inflation on real interest rates – for me a much bigger problem. As I have said many times before, rebalancing in the Chinese context requires that household consumption rise as a share of GDP. [...]
[...] on real interest rates – for me a much bigger problem. As I have said many times before, rebalancing in the Chinese context requires that household consumption rise as a share of [...]
[...] on real interest rates – for me a much bigger problem. As I have said many times before, rebalancing in the Chinese context requires that household consumption rise as a share of [...]