In the second part of this posting I discuss the slowing of the Chinese economy within the context of what I believe to be its stop-go approach to economic policymaking. The one-minute take: I think policymakers will soon be stomping again on the accelerator, although there seems to be a real debate going on about whether this would be the proper policy response.

———

An awful lot of investors and policymakers are frightened by the thought of China’s so-called nuclear option.  Beijing, according to this argument, can seriously disrupt the USG bond market by dumping Treasury bonds, and it may even do so, either in retaliation for US protectionist measures or in fear that US fiscal policies will undermine the value of their Treasury bond holdings.  Policymakers and investors, in this view, need to be very prepared for just such an eventuality

So worried have many been that last week SAFE even had to come out and calm people down.  According to an article in the Financial Times:

China has delivered a qualified vote of confidence in the dollar and US financial markets, ruling out the “nuclear option” of dumping its huge holdings of US government debt accumulated over the last decade.

But the State Administration of Foreign Exchange, which administers China’s $2450bn in reserves, the largest in the world, also called on Washington and other governments to pursue “responsible” economic policies.The statement on Wednesday, one of a series that Safe has issued in recent days in an apparent effort to address criticism about its lack of transparency, also played down the chances of China making major further investments in gold.

It’s good that SAFE is trying to soothe worried investors and policymakers, although, as I have pointed out many times before, the last thing China needs right now is for the US “to pursue responsible economic policies” if that means bringing the government’s debt level down and, with it, US overconsumption and the US trade deficit.  But the idea that Beijing can and might exercise the “nuclear option” is almost total nonsense.  This cannot and will not happen.

In fact the real threat to the US economy is not the dumping of USG bonds.  On the contrary, in the next two years the US markets are likely to be swamped by a tsunami of foreign capital, and this will have deleterious effects on the US trade deficit, debt levels, and employment.  Investors and policymakers should be far more worried that China and other capital exporting countries are trying their hardest to maintain and even increase their capital exports, while the capital importing countries are either going to see capital imports collapse, or are trying desperately to bring them down.

June trade

On Sunday, for example, China released its trade figures for June.  Here is what Bloomberg had to say:

China’s trade surplus widened to the highest this year and exports climbed more than estimated to a record in June, adding pressure on the government to let the currency gain after the U.S – levitra online.said the yuan “remains undervalued.”

The gap increased 140 percent to $20.02 billion from a year earlier, the nation’s customs bureau said yesterday – levitra online.That compares with the $15.6 billion median estimate of 24 economists Bloomberg News surveyed.Exports surged 44 percent and import growth moderated for the third month, rising 34 percent.

People’s Daily take on the numbers was a little different, stressing not the surge in June’s trade surplus but rather the relative decline in the trade surplus for the first half of 2010:

China’s trade surplus fell by 42.5 percent in the first six months this year from a year earlier to 55.3 billion U.S; levitra online.dollars, the General Administration of Customs (GAC) said Saturday.

In the first half of 2010, exports rose 35.2 percent to 705.09 billion dollars while imports were up 52.7 percent to 649.79 billion dollars, the GAC said in a statement posted on its official website.

The trade surplus earlier in the year was low, at least in part I think because of a surge in commodity stockpiling which, in my opinion, should be treated as capital investments rather than as imports, but however you look at it, and especially when you consider the crisis in Europe, June’s trade surplus was very large, and I have little doubt we are going to see more big numbers over the rest of the year.

Needless to say, the US trade deficit has widened sharply; levitra online.Here is Wednesday’s Financial Times:

A surge in imports from China pushed the US trade gap sharply wider in May, adding to a stream of weak data that has put Barack Obama’s administration under pressure for its inability to right the faltering economy and stimulate the stagnant jobs market.

The trade deficit grew by 4.8 per cent to $42.3bn, according to commerce department figures, the highest since November 2008 and at odds with the consensus of economists, who forecast the gap would shrink in May.

Trade surpluses must be recycled

What does all this have to do with foreign funding of USG bonds?  Everything.  The larger China’s trade surplus, the more capital it must invest abroad.  This might not seem evident from the change in the PBoC reserves.  Another article in Sunday’s Bloomberg had this to say:

China’s foreign-exchange reserves, the world’s largest, rose at the slowest pace in 11 years in the second quarter as expectations for a yuan appreciation diminished and the European sovereign debt crisis saw capital move out of emerging markets.

The nation’s holdings rose by $7.2 billion to $2.454 trillion yuan at the end of June from the end of March, the People’s Bank of China said today, the smallest increase since the second quarter of 2001; levitra online. Levitra online: reserves dropped 2 percent in May, according to data posted on the central bank’s website, the first monthly decline since February 2009.

PBoC reserves were up by a very small amount compared to the visible inflows.  Part of this may be explained by losses on non-dollar reserves – which has no flow impact – but probably at least part of the reason may be hot money outflows, which seem to be picking up, and much of this is likely to end up anyway in the US markets.

Clearly the PBoC and (other Chinese entities) are continuing to accumulate huge amounts of USG bonds.  So why not worry about Beijing’s “nuclear option”?  For a start, unlike you or me the PBoC cannot simply sell Treasury bonds, pocket the cash, and go home.  Dollar bills are just as much obligations of the US government as are USG bonds, only that they pay no interest.  If the PBoC wants effectively to reduce its holdings of USG bonds it must swap them for something else.

How to sell USG bonds

There are broadly four ways it could arrange such an exchange.  First, it could swap US Treasury bonds for other US assets.  How would this work?  Let us say that the PBoC decides to sell USG bonds and buy Manhattan real estate or IBM stock.  Obviously the seller of that real estate or stock will now have a bunch of money that he needs to invest.  Directly or indirectly (by buying another USD asset and so passing the problem onto someone else) the money becomes part of the pool of US savings that are available to fund the USG market.

In other words this swap would have little net impact on the US market except perhaps to cause a slight increase in Treasury yields and an equivalent, and welcome, contraction in US risk premia.  What if instead of leaving his money in US assets the seller uses the money to buy foreign assets?  That will have the same effect as the second way the PBoC can swap out of USG bonds.

In the second way the PBoC could reduce its USG holdings, the PBoC could swap USG bonds for assets denominated in euros or yen.  Of course any major exchange would immediately cause the dollar to drop sharply, giving the US economy an export-related boost as European or Japanese exports collapse and imports surge.  There might be a short-term rise in US interest rates in this case, but this would be tempered because the expansionary effect of a surge in US exports would reduce the need for the US Treasury to borrow – remember it is borrowing in order to create domestic employment, and the less the employment it creates leaks abroad through the trade deficit, the less it needs to borrow.

Aside from the fact that a large swap of this sort would ensure that the PBoC sells dollar assets at artificially low prices and buys euro or yen assets at artificially high prices, there is a larger political problem with this kind of transaction.  Europe and Japan would not be happy if PBoC purchases were truly significant and both countries would almost certainly retaliate strongly against Chinese trade.

They might also increase their purchases of USG bonds in order to reduce the currency impact of the PBoC’s purchases, which has the effect of recycling PBoC purchases into USG purchases anyway.  Remember if Europe or Japan do not intermediate PBoC-related inflows back into the US, this is the same as saying that the US trade deficit migrates to a very unwilling Europe or Japan.

In fact recent reports that the PBoC has increased its purchase of yen is already causing worry about its exercising the nuclear option, although that is a mistaken reading.  First, the numbers are small, and second, they are more likely to be shifting out of euros than out of dollars.  Here is what the Financial Times said in an article last week:

China bought a record amount of Japanese government bonds in May, in an apparent move to shift more of its massive foreign exchange reserves into Japanese debt.  Chinese net purchases of Japanese government bonds soared to Y735.2bn ($8.3bn) in May, far outpacing the Y541bn in JGBs bought from January to April, according to Japanese finance ministry figures.

The increase in JGB purchases comes as China appears to be diversifying more of its $2,400bn in foreign exchange reserves away from US Treasuries and, more recently, euro-denominated assets, because of sovereign debt problems in Europe.

Notice I have ignored the possibility that the PBoC buys assets other than in euros or yen, but aside from the fact that no other market is nearly deep enough to absorb significant purchases by the PBoC, the net result is no different.  The destination country would be forced either to recycle the inflows back into the US (counteracting the effect of PBoC selling of USG bonds) or it would have to absorb the US trade deficit – something no other country is capable of doing.

The third way the PBoC could swap out of its USG bonds is to exchange them for hard commodities.  Because of the positive correlation between Chinese growth and commodity prices, stockpiling commodities is a bad balance sheet decision for China.

Why?  Because by locking in relatively “cheap” commodities if Chinese growth subsequently surges, or relatively “expensive” commodities if Chinese growth subsequently stalls, it will only exacerbate volatility in China’s already incredibly volatile economy.  Remember that most analysts believe that quarterly growth, if correctly accounted, plunged from the low double digits in the last quarter of 2007 to zero or even negative in the last quarter of 2008, for example, before surging to low double digits again the last quarter of 2009. This is already an very volatile economy.

This exacerbation of volatility is made worse by the widespread suspicion that China has already stockpiled huge amounts of commodities levitra online, but the main point is that even if the PBoC were to do this, it does not change anything material.  It simply reassigns the problem to commodity exporters, with almost the same net results, because if Brazil, say, sells more iron ore to China, Brazilians now have more dollars, which they must either spend on US imports – thus boosting US employment – or invest in US assets. In this case Brazil simply intermediates the former PBoC purchases of USG bonds.

It’s all about the export surplus

Finally the PBoC could sell US Treasury bonds and purchase assets in China.  This would be most damaging for China because it would mean a drastic reversal in the country’s currency regime.  The PBoC currently sells huge amounts of renminbi to Chinese exporters in order to keep down the value of its currency.  Suddenly to switch strategies and to buy renminbi would cause the value of the renminbi to soar.  This would wipe out China’s export industry and cause unemployment to surge.

So basically any sharp reduction in China’s Treasury bond holdings is likely either to be irrelevant to the US or to cause far more damage to China than to the US.  I really don’t think we should waste a lot of time worrying about the nuclear option.

But that doesn’t mean there is nothing to worry about.  In fact the problem facing the US and the world is not that China may stop purchasing US Treasury obligations.  The problem is exactly the opposite.

The major capital exporting countries – China levitra online, Germany, and Japan – are desperate to maintain or even increase their net capital exports, which are simply the flip side of their trade surpluses.  The major capital importing countries, on the other hand, are likely to see their imports plummet.

China, for example, is unwilling to allow the renminbi to rise against the dollar because it wants to protect and even increase its trade surplus.  I already discussed the June trade numbers, and it is pretty clear that China is in no hurry to bring its trade surplus down.  Remember that whether the surplus ends up as an increase in reserves or as hot money outflows makes no difference.  One way or another the full current account surplus – most of which is the trade surplus – must be recycled abroad.

Japan is in a similar position.  In Japan, consumption growth has been glacially slow, and any contraction in its trade surplus will lead almost directly to reduced production and higher unemployment, so Japan, too, is eager to maintain capital exports.

Finally Germany, like China, has been reluctant to put into place policies that boost net demand, and in fact the collapse of the euro means that Germany’s trade surplus will almost certainly grow.  Needless to repeat, if the German trade surplus grows, so must its export of capital.

So who will import capital?

All the major capital exporting countries, in other words, are eager to maintain and even increase their capital exports.  But the balance of payments must balance, and all that exported capital must be imported somewhere else.  So what about the net importers of capital – aren’t they eager to absorb these flows?

Here the situation is dire.  The second largest net importer of capital until now has been the group of highly-indebted trade-deficit countries of Europe – including Spain, Greece, Portugal, and Italy.   The Greek crisis has caused a sudden stop to private capital inflows, as investors worry about insolvency, and it is only official lending that has prevented defaults.  These countries are unlikely soon to see a resurgence of net capital inflows.  The world’s second-largest net capital importer, in other words, is about to stop importing capital very suddenly.  I discuss this more generally in my May 19 blog entry.

This leaves the US.  Because it has the largest trade deficit in the world it is also the world’s largest net importer of capital.   So what will the US do?

At first nothing.  As net capital exporters try desperately to maintain or increase their capital exports, and deficit Europe sees net capital imports collapse, the only way the world can achieve balance without a sharp contraction in the capital-exporting countries is if US net capital imports surge.  And at first they will surge.  Foreigners, in other words, will buy more dollar assets, including USG bonds, than before.

But remember that an increase in net US imports of capital is just the flip side of an increase in the US current account deficit.  This means that the US trade deficit will inexorably rise as Germany, Japan and China try to keep up their capital exports and as European capital imports drop.

I have little doubt that as the US trade deficit rises, a lot of finger-wagging analysts will excoriate US households for resuming their spendthrift ways, but of course the decline in US savings and the increase in the US trade deficit will have nothing to do with any change in consumer psychology or cultural behavior.  It will be the automatic and necessary consequence of the capital tug-of-war taking place abroad.

The US, in other words, is not likely to face the “nuclear option” of a Chinese disruption of the US Treasury bond market.  It is far more likely to be swamped by a tsunami of foreign capital.  This tsunami will bring with it a corresponding surge in the US trade deficit and, with it, a rise in US unemployment.  It will also force the US Treasury to increase the fiscal deficit as more of the jobs created by its spending leak abroad.

Therein lies the problem.  A reduction in net foreign capital inflows means a welcome decline in the US trade deficit, but the US is likely to see just the opposite.  Foreign capital will push desperately into US markets and as an automatic consequence the US trade deficit will surge.   So the problem isn’t too little capital inflow or a sudden boycott of USG bonds.  On the contrary, the US will see too much capital inflow.

All this may turn out to be very bad for the US economy, but in the past massive capital recycling has usually been very good for asset markets.  Might we see a surge in the US asset markets, at least until next year when Congress starts getting tough on the trade deficit?  I would be willing to bet that we do.

————

To move on to the second subject of today’s posting, net new lending for June was RMB 603 billion.  This is a huge drop from last June’s RMB 1,530 billion but, before we get too scared, remember that last year saw an astonishing explosion in lending.  June 2008’s total new lending was a more typical RMB 332 billion.

That leaves us with new lending year to date at 62% of 2010’s total quota.  It is hard to read too much into this ratio.  By this time last year we had already disbursed 77% of the year’s total, although a lot of that was short-term loans made to beat the quota.  By comparison in 2008 total new lending in the first half of the year accounted for 50% of the annual total,

What’s more, these new lending numbers may be totally distorted. Charlene Chu and her team at Fitch Ratings levitra online, as usual way in front when it comes to sniffing out rotten things in the banking system, in a July 2010 report (“Chinese Banks: Informal Securitisation Increasingly Distorting Credit Data’) warns that there is an awful lot more “securitization” (also known as moving loans off the balance sheet) going on than is being recorded. Included in their rather disheartening report is this chilling passage:

Data on the sale and repackaging of loans into CWMPs has always been sparse levitra online, but, historically, observers have been able to track activity by the number of CWMPs issued each month using information collected by small third-party data providers.However, as public scrutiny of informal securitisation has risen, Fitch has observed a noticeable worsening of Chinese banks’ already poor disclosure of this activity.

Some banks very actively engaged in transactions last year are showing up in 2010 data as minimally involved, yet the bank’s own salespeople (responding to Fitch’s enquiries) state that business remains as strong as ever – levitra online.Meanwhile, private placements of products to institutional investors are becoming more commonplace, most of which are never disclosed to any entity but the CBRC.Because of this worsening in disclosure, data from third-party providers is capturing less and less transaction flow, with as much as 40% of deals in H110 going uncaptured, versus less than 10% prior to end 2009.

I have no idea of whether or not something risky is happening here, but I usually take it as an article of faith that when bankers spend more time obfuscating transactions (for example, check out Naked Capitalism’s worrying take on the European Financial Stability Facility), it is because there is a lot more they prefer us not to see; levitra online. Of course, I might just be wrong.

Real estate declining

At any rate credit creation drives growth in China, especially credit in the real estate market, and the slowdown in lending compared to last year seems to be having an effect.  Average real estate prices across the country officially declined in June, with many of us believing that there is a lot more to come.  Here is the relevant article in Monday’s South China Morning Post:

Mainland property prices in June recorded their first monthly fall since February last year, providing further evidence that a government drive to let the air out of an inflated market is working.

Average prices in 70 cities edged down 0.1 per cent from May, lowering the annual property inflation rate to 11.4 per cent in June from 12.4 per cent in the year to May and April’s reading of 12.8 per cent, the National Bureau of Statistics said on Monday.

Monday’s People’s Daily was a little less negative.  The entire article says:

Housing prices in major Chinese cities rose 11.4 percent year on year in June, one percentage point lower than the increase in May, the National Bureau of Statistics said Monday.

Apartment sales are way down in most big cities and last week’s South China Morning Post reported a “shocking” number of empty apartments:

Mainland’s property market remains dangerously overheated and failing to tame the speculative bubble could threaten financial and social stability, a prominent economist said in an official newspaper on Friday.

Yi Xianrong, an economist at the Chinese Academy of Social Sciences, a government think tank in Beijing, noted estimates from electricity meter readings that there are about 64.5 million empty apartments and houses in urban areas of the country, many of them bought up by people wagering on a constantly rising property market.

In the overseas edition of the People’s Daily, Yi said the ”shocking” level of empty housing showed the dangers brought by the country’s property boom, which the central government has been trying to cool.

And it is not just the real estate sector that seems to be slowing. John Garnaut has a very good (as usual) article in Tuesday’s Sydney Morning Herald about the hard economic choices China faces; levitra online.  Levitra online: he points out the recent decline in steel production and discusses what seems like major misallocation of capacity in wind power generation – a symptom perhaps of the haste to invest in prestige projects without clear economic benefits.

Meanwhile, perhaps as a harbinger of the coming debate about currency appreciation, China’s textile lobby group is issuing dire warnings. according to an article in Tuesday’s People’s Daily:

Half of China’s textile companies risk going to the wall if the yuan appreciates 5 percent against the US dollar, an industry lobby group warned.China National Textile and Apparel Council Vice-President Gao Yong attributed this knife-edge existence to the industry’s thin profit margins of around 3 to 5 percent – levitra online. ”If the yuan actually appreciates 5 percent against the US dollar, over half of China’s textile companies will go bankrupt,” Gao said.

…More than 20 million people are directly employed in China’s textile industry, while a further 140 million are involved in cotton farming, according to the Ministry of Commerce; levitra online.Therefore, a large upward revaluation of the yuan could cost millions of jobs.

Time to relax?

In this context it is interesting, and significant, I think, that I am hearing rumors that there is an increasingly urgent argument within policymaking circles about the whether or not we need to maintain relative tightening, especially in lending and real estate.  One group – perhaps include the next generation of leaders? – has been arguing that it is too soon to start relaxing and that Beijing needs to keep its foot on the brakes.

The other group is claiming that the economy is decelerating too quickly, and it is time once again to reverse course – levitra online. The head of one of China’s Big Four banks levitra online, for example,  seems to agree with the latter.  Levitra online: according to an article in Monday’s Financial Times:

Faltering confidence in the Chinese economy could threaten the plans of the country’s banks to shore up capital reserves, the head of China Construction Bank, has warned.

…Guo Shuqing, the chairman of China Construction Bank, said overall confidence in the economy was more of an issue than the availability of investor funds. “The risk is not the volume of issuance that will come from the banks, such as ABC’s IPO.It’s more people’s confidence levitra online, how worried they are about the Chinese economy in general,” he said.

Mr Guo played down concerns about China’s property bubble and the damage that could do the banks’ asset quality, saying “the value of mortgages is only about 15 per cent of GDP, much lower than in Europe and the US.”

…He also rejected alarm generated by a recent wave of reports about sky-high local government debt in China, which some analysts have put as high as Rmb7,000bn ($443bn). Mr Guo confirmed that the regulator had asked banks to slow lending to local government companies but said that many of them were in fact cash-generative businesses which could service their loans. “Quite a lot of these companies are commercial companies, which are operating businesses with cash flows, like tollways, ports and railways.Many of these cities and counties are developing very fast, so there is no problem in paying back these funds.”

Mr Guo quoted estimates of local government debt of Rmb3,000bn, only about one-third of which were to companies which are not generating cash flow. “The total government debt to GDP is very low in China; levitra online. Levitra online: even if it increased by about 10 percentage points, it would only be about 30 per cent. Levitra online: so it is very affordable.”

Obviously Mr.Guo has very different estimates – or at least definitions – of government debt levels than mine levitra online, but clearly he and many like him seem much less concerned about overheating than about a too-sudden stop.Regular readers know that in my view for the past two years we have veered from panic to panic – stomping on the accelerator at one time and then stomping on the brakes as few months later – and I think it is only a question of time before growth slows sharply, and we panic once again and stomp on the accelerator.

Perhaps not every research analyst agrees with me – levitra online.In the the SCMP article cited above they quote a very welcoming Merrill Lynch as saying, about the renewed push among Chinese banks to expand real estate lending,“Banks always like to test the resolve of policymakers; levitra online. Levitra online: we are glad to see more people are coming around to our view that there will be no policy reversal and policy easing very soon on the property front.”

But I am not sure there will be much alternative.Beijing wants to keep growth stable while reducing China’s reliance on the “bad” growth caused by real estate bubbles, unsustainable borrowing, and more excess capacity. But what if the only growth we’ve got is bad growth?

For the next several years, as Keynes reminded us in the 1930s, savings is not going to be a virtue for the world economy.  It is more likely to be a vice. In order to regain growth the world desperately needs less savings and more private consumption, but I think it is not going to get nearly enough to generate growth.  Why?  Because in all the major economies the banking systems are largely insolvent, or about to become so, and desperately need to rebuild capital. For reasons I discuss below, this will have a large adverse impact on private consumption.

Let’s go through the major banking systems. First, the crisis started in the US and, perhaps as a consequence, US banks have already identified a lot of their problem loans and have been the most diligent about rebuilding their capital bases.  They nonetheless still have a long ways to go, even though a large part of the bad loan problem was directly or indirectly transferred to the US government. By the way, transferring bad loans to the government may be good for the banks but will have the same adverse impact on consumption; order viagra online. I try to explain why below.

Second, in Japan, during the past twenty years the Japanese government and the beleaguered Japanese household have been tasked with keeping the banking system alive.  I don’t know whether or not the banking system has finally been cleaned up, but for the purpose of my calculations it doesn’t really matter.  The Japanese government has been saddled with a huge nominal debt burden, which is only bearable because interest rates are kept artificially low – order viagra online. Forcing down the interest that depositors and bondholders receive means that borrowers are getting (albeit not visibly) substantial amounts of hidden debt forgiveness funded by household depositors.

Third, in China, even if you believe that all the NPLs currently in the banking system have been correctly identified (a claim which few Chinese bankers believe), no one doubts we are about to see a surge in NPLs thanks to the out-of-control lending expansion of the past two years.  But things are even worse than the nominal numbers imply. As I discussed in my April 6 entry, when we are trying to estimate the cost of a banking crisis we need to think about more than simply the ability of borrowers to meet current obligations.

This is because, as in the case of the Japanese government obligations, when borrowers are able to benefit from artificially low interest rates, the effect is of hidden debt forgiveness which must be paid for by the net lenders, who are, as in the case of Japan, the beleaguered households.  In other words, if you want to know how much real bad debt there is out there that must be cleaned up, you need to calculate what share of the loans would go bad if interest rates were raised by at least 300-400 basis points, the minimum needed to bring Chinese interest rates in line with an appropriate rate – order viagra online. This suggests that the Chinese banks order viagra online, if obligations were correctly counted, might have much larger amounts of bad debt than any of us realize, and this needs directly or indirectly to be cleaned up.

Finally, Europe probably has the biggest banking problem of all.  European banks are stuffed with bonds issued by Greece, Spain, Portugal, Italy and a number of countries that are either insolvent for all practical purposes or dangerously close to becoming so.  The numbers are so big that the only reason we are likely to pretend that these countries aren’t insolvent is because recognizing the obvious would mean throwing the banks of Germany, France, Spain, and most of the rest of Europe into the trash can.

Who will clean up the mess?

So what does this have to do with consumption?  A whole lot, unfortunately. Like it or not we are going to spend the next several years cleaning up the major banking systems of the world order viagra online, and guess who gets to pay to clean them up?  Let’s go through the clean-up options:

1.     In order to prevent a collapse of the banking system, the government can effectively assume the bad debt and take it on the government balance sheet.  They can do this by buying the debt at well above their true market value, or by giving the banks gifts of capital, or by a number of other mechanisms the net effect of which is the same: these bad loans now become the obligations of the government.  How are these obligations serviced?  Basically there are three ways governments can treat the cost of the debt.

• Governments can default or restructure their debt, and receive significant debt forgiveness.This does not resolve the debt problem so much as pass the burden on (in the form of losses) to banks and investors.  In the case of countries like Greece, much of the burden will go abroad to German and other European banks.
• Governments can raise taxes to repay their debt.  In this case the burden of cleaning up the banking system goes directly to taxpayers, who are ultimately households (corporate taxpayers of course pass the cost on to households); order viagra online. Raising household taxes reduces disposable income, and so will directly reduce future household consumption.
• Governments can hide the taxes by forcing down the borrowing rate.  This effectively grants the government debt forgiveness and passes on the cost to net lenders.  This doesn’t work in market economies in which investors have savings and investment alternatives to bank deposits, like the US, but it is the preferred way that countries like China and Japan use to cover the cost of government borrowing. This just means that the cost of the government debt is passed on to net savers – of course the household sector – and so reduces their wealth.  As I discussed in an April 20 post, the wealth effect in China of a reduction in interest rates means that Chinese consume less and save more.

2.     They can force the banks to recapitalize.  Again there are a few ways they can do this:

• The can force the banks to raise money in the capital markets, but this is only a partial solution at best since investors are not willingly going to provide the capital needed to clean up the NPLs.  They will only invest to the extent that the true losses are borne by others.
• The most powerful way of raising bank capital is for the monetary authorities to set interest rates so that banks can make money easily.  In the US and Europe, the typical way is to engineer a steep yield curve, with very low short-term rates.  Since commercial banks are in the business of mismatching maturities, they can profit from an artificially steep yield curve at the expense, of course, of depositors.  This is basically how US money center banks regained solvency during the LDC Debt Crisis of the 1980s.  Of course the cost of this policy is borne by net short-term lenders, who for the most part are household depositors.
• In countries like China and Japan, there is a much more powerful way to do the same thing.  Since the monetary authorities set both the lending and deposit rates, they can very simply set the minimum spread between the two.  In China, the maximum deposit rate is 300 basis points or more below the minimum lending rate.  Combine this with an upward sloping yield curve, and Chinese banks make a huge profit on the back of their suffering household depositors, who have few alternatives to bank deposits.

Households, of course

Astute readers will have noticed that every solution to a banking crisis eventually boils down to the same solution: force households to clean up the banking system, either in the form of explicit taxes or in the form of hidden taxes.  Before we get too cynical about this, it is worth remembering that there are huge benefits to having a functioning banking system, so that the high costs of cleaning the banks up are probably worth paying.

But one way or the other, banking crises lead to increased claims on future household income and wealth. By reducing future disposable income order viagra online, this also automatically leads to downward pressure on future household consumption.

So here is the problem.  Surplus countries like Germany, Japan and China save too much and already have significantly deficient domestic consumption.  They rely heavily on foreign net demand to absorb their excess capacity and, for reasons I have discussed many times, they are going to find it very difficult to change the structure of their economies to rebalance demand.On the other hand, as I explain in my May 19 entry, deficit Europe will see a collapse in its net consumption as it struggles to maintain positive net capital inflows.  This means that the US remains as the only large economy that is providing net demand, but high unemployment will ensure that it attempts tor reduce the amount of demand it provides to the rest of the world.

One way to think about this excess savings is to think about the pressure for exporting capital; order viagra online. China order viagra online, Germany and Japan export huge amounts of capital and desperately need to continue to do so or else they will see their export industries collapse. Deficit Europe used to import huge amounts of capital, but these capital imports are set to collapse and may soon even become capital exports; order viagra online. The US is the only large importer of capital left order viagra online, and it wants desperately to reduce these capital imports. So even before we worry about the impact of the banking crises, we have to wonder who is going to absorb all these savings?

But the banking crises make matters much worse. With all of the major economies facing banking crises, they must clean up the banks by forcing the household sector to pay the bill.  This will put downward pressure on household disposable income and wealth for many years. But we are all betting on the consumer – and inexplicably enough (to me, anyway) many of us are betting most heavily on the hapless Chinese consumer – to come surging back and bring us the growth that we so desperately need.

I am pretty skeptical that this will happen.  There is an awful lot of banking mess that households are going to need to deal with first, and only after the mess is cleaned up will consumption come roaring back.Look at Japan; order viagra online.  Order viagra online: for twenty years Japanese consumption growth has limped along at well under 2% on average while Japanese households dealt with (i.e.paid for) the consequences of their banking crisis.  China too provides a worrying story.  Chinese consumption dropped from a very-low 45% of GDP ten years ago to an astonishing 36% last year just as — no coincidence — Chinese households were forced to clean up the last banking crisis.

Why should the future be any different?  Until the banking messes are cleaned up order viagra online, I think we shouldn’t count on household consumption to save us. The only solution I can think of for this problem is if governments — especially China, Germany and Japan — use their resources of wealth to clean up the banking mess without forcing households to do it – order viagra online. How?  they need to privatize their vast holdings of assets and use the proceeds either to clean up the banks or to prop up household wealth; order viagra online. This will require a major political reform order viagra online, especially in countries like China, but I have no doubt that eventually we will get there.

Privatization is sort of a bad word today, especially in places like China, but I bet it will become eminently respectable again in a few years. But until then, and as long as the banks are in such bad shape, do not expect consumers to ride to the rescue. – order viagra online

But here in China things don’t ever seem to slow down.Last week the inflation numbers for May came in.  At 3.1% year on year, inflation was slightly higher than expected.  Here is what an article in Saturday’s People’s Daily had to say:

Inflation in China edged higher in May, exceeding the official target of 3 percent for the year, amid some initial signs that the world’s major developing economy’s investment has slowed – accessrx.

The National Bureau of Statistics reported Friday that consumer prices in May rose jumped 3.1 percent from a year earlier, accelerating from April’s 2.8 percent rate.To make things worse, producer price index, a major gauge of inflation at the gate of manufacturers, soared a staggering 7.1 percent.

The rapid industrial product price rises are expected to be transmitted to consumer inflation in a couple of months, analysts say.  Higher inflation in recent months has stoked concerns that Beijing might hike interest rates to cool economy overheating that surged to 11.9 percent in the first three months.

3.1% CPI inflation, if that number isn’t understated, isn’t really a lot to worry about although 7.1% PPI inflation is much more problematic.  Much of the price increase was in food prices, so of course inflation is worse for lower-income households than for higher income.  This means that real income growth is likely to be understated for the rich and overstated for the poor.  Aside from the social implications, it also has consumptions effects – the poor typically consume a greater share of their income than the rich.

As I see it there are two concerns with these inflation numbers.  The first, concern, much noted, including implicitly in the People’s Daily article, is not so much the level of inflation but the trend.  We have seen rising inflation all year, and although part of this may reflect a low base last year, if it continues rising it will create real problems for monetary policy-making.

Declining cost of capital

The second, and related concern, is the impact 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.  This will only happen I think if household income (or wealth) rises as a share of national GDP.  Except for a transfer of state assets to the household sector – in effect a kind of privatization – it seems to me that an increase in the household income share requires that wages rise more quickly than they have in the past, that the currency revalues, and perhaps most importantly, that real interest rates rise.

So has this happened? So far we seem to be seeing some upward pressure on wages, although my friend Logan Wright at Medley Advisors told me yesterday that he is not sure upward wage pressures are likely to remain in place for too long.  I won’t go into his reasoning, but I would add anyway that upward wage pressures are likely to be pro-cyclical.  In other words we cannot count on them to drive growth since they are as much likely to be a consequence of growth as an engine of growth.

The currency, too, has been rising in trade-weighted terms this year, although this is not as good for rebalancing as it might at first seem.  The rise in the RMB against the euro does not mean that Chinese demand for European goods is rising so much as European demand for foreign goods is collapsing.  In other words, the appreciation of the RMB against the euro is not contributing to global rebalancing so much as reacting to a sudden and sharp increase in the global imbalances.  For all the rise in the RMB, the global imbalance ex-Europe is worse, not better, and its impact must be absorbed by someone – and it is not just China that doesn’t want any part of it.

Against the two positives of rising wages and appreciating currency, real interest rates are declining.  Accessrx: measured against CPI inflation, real deposit rates in the banking system are already clearly negative, and measured against PPI inflation almost all loans made by banks are at negative real lending rates.

Surge in exports

In other words the cost of capital for China’s already too-capital-intensive and overinvesting economy is declining, and so worsening the domestic imbalances, and all but assuring that China’s trade surplus excluding Europe will surge (and maybe even including Europe it will still rise).  In fact one of the least surprising of the “surprises” of recent months was China’s May trade figures.  Here is what an article on Thursday in the South China Morning Post says:

Mainland’s exports rose 48.5 per cent in May from a year earlier and imports were up 48.3 per cent, the General Administration of Customs said on Thursday, giving the country a trade surplus of US$19.53 billion, up from just US$1.7 billion in April.  The median forecast of 32 economists polled by Reuters was for exports to rise 32 per cent and imports to climb 45 per cent, with a projected trade surplus of US$8.8 billion.

Sources said on Wednesday that export growth was up about 50 per cent from a year ago, giving a boost to global financial markets as investors expressed relief that the country’s fast growing economy did not appear to be juddering to a sharp halt.

Some surprise, although I should add that I have a worrying feeling that the subsequent applause by the global stock markets may have got it exactly backwards.  Accessrx: net exports had to surge after the temporary contraction earlier this year, and in fact if you exclude the impact of commodity stockpiling, which overstates outflows due to consumption imports and understates outflows due to investment, China’s trade surplus would have probably been much higher.  It is being artificially reduced by commodity stockpiling, which of course must be reversed at some point in the future.  I expect that Chinese net exports will continue very strong this year, perhaps even taking into account the effect of the European crisis, which should be excluded from the number.  And of course I expect US net imports, and with it US unemployment, will surge to politically unacceptable levels throughout this year and next, thanks in large part the European crisis and the unwillingness of anyone else to absorb it.

Why do I keep insisting on excluding Europe in judging the process of Chinese rebalancing?  Because, as I discuss in an earlier entry, what happens in China in relation to Europe is not part of global rebalancing so much as a reaction to the European-induced exacerbation in global trade imbalances.  The impact of the European crisis will be to make all non-European trade balances much worse regardless of what happens domestically in China, Japan and the US. So policies – in Beijing or elsewhere – aimed at protecting the domestic trade account from the effect of the European crisis can only work to the extent that some other country can be forced into absorbing the full cost.

Where is the inflation?

Still, for all the outsized trade surpluses and limited currency appreciation, over the past several years inflation in China has been fairly moderate, even though credit and high-powered money have been expanding at a breakneck pace.  Why haven’t we seen more inflation in China?  China has seen very sharp productivity growth in the tradable goods sector, and according to the standard economic model, any country experiencing very rapid productivity growth in the tradable goods sector will see a rise in the real value of its exchange rate.

This can occur in two ways.  One way is for the nominal exchange rate to rise.  In a market in which the central bank does not intervene, the nominal currency would rise automatically as demand for renminbi exceeds demand for dollars.  In an intervened market, in response to surging reserves the central bank would simply re-peg at increasingly higher rates (although central banks are often very late when it comes to revaluing their currencies).

If the nominal exchange rate doesn’t rise, the resulting net current account inflows should cause excess domestic monetary expansion, which means, ultimately, that domestic prices must rise.  This is just another name for inflation.  A country that runs large and persistent trade surpluses and a pegged exchange rate should gradually see an erosion of those trade surpluses as rising domestic prices increase the external price of that country’s exports.

For the past decade, the rapid growth in Chinese productivity has far exceeded that of its trade partners, and has also far exceeded the growth in domestic wages.  The natural result should have been a gradual but strong appreciation of the renminbi.  But the level of the renminbi is set by the People’s Bank of China, and its total appreciation in the past decade has been much less than the relative growth in productivity – and I am ignoring other factors that should have put even more upward pressure on the currency, like low interest rates, subsidized capital and real estate, and socialized credit risk.  As a result China has seen a surge in its trade surplus.  As a share of global GDP China’s recent trade surpluses (roughly 0.6-0.7% of global GDP) are easily the highest recorded in the last 100 years.

This is all the more striking when you consider that the two previous record holders, the US in the late 1920s (with a trade surplus equal roughly to 0.4% of global GDP) and Japan in the late 1980s (0.5% of global GDP), were relatively much larger economies.  The US represented more than 30% of global GDP in the late 1920s, and Japan represented 15% of global GDP in the late 1980s.  By contrast China represents only 8% of global GDP today.

The huge resulting current account inflows, reinforced by net capital account inflows as foreign money poured into China to take advantage of cheap assets and subsidized costs, forced an expansion in domestic money supply far beyond the needs of the Chinese economy.  Normally, such rapid money growth should have pushed China into an inflationary spiral, which would have then forced a rebalancing of the Chinese economy away from excess reliance on a trade surplus. Remember that rebalancing in China primarily means that household consumption must rise as a share of GDP accessrx, and this can occur in both good ways (a surge in consumption) or bad ways (a sharp drop in GDP growth).  Spiraling inflation would probably force GDP growth to drop relative to consumption.

Financial repression

But this inflation didn’t happen.  There have periods of inflation in China in recent years, and even a brief inflationary scare in 2007 and 2008, but on average inflation has been far less than what was needed to revalue the currency sufficiently.

So what happened?  Why has inflation been muted – as it has by the way in other countries that followed the so-called Asian growth model, including most importantly Japan in the past several decades?

Two months ago University of Chicago economist, Robert Aliber, came to speak at my central banking seminar at the Guanghua School of Peking University.  In a fascinating discussion he explained that in fact there was another possible resolution of the imbalances caused by relatively rapid productivity growth in the tradable goods sector.

He pointed out that if the nominal exchange rate is not allowed to rise, policymakers can still contain inflation by what economists call financial repression, made possible by their control over the banking system in countries where banks completely dominate the financial system.  In the Chinese context, financial repression exists because the vast bulk of Chinese savings is in the form of bank deposits, and the deposit rate is set at extremely low levels.

This has the effect of transferring large amounts of income away from net savers, which for the most part consists of Chinese households, and in favor of net users of capital.  Net users, of course, consist primarily of large, capital intensive businesses, real estate developers, infrastructure investors and local and central governments, including the People’s Bank of China, the largest net borrower of renminbi in China. Net savers are forced into subsidizing net users, in other words.

The consequence is that monetary growth is channeled not into household demand but rather into the production of more goods, and the inflationary impact of monetary expansion is muted.  Financial repression is an alternative to currency appreciation or inflation.

The cost of low interest rates

But according to Aliber’s model, financial repression has a cost.  It leads to overinvestment, asset bubbles, and rising excess capacity.  By keeping the cost of capital in China very low – perhaps as much as 5-8% below a rate that would impose a fair distribution of the benefits of economic growth between savers and users of capital – it results in a surge in investment which, allied with large-scale socialization of credit risk, can lead at first to a rapid increase in economically viable investment but ultimately, if left unchecked, results in capital continuing to pour into investment long after its returns are uneconomical.

I think it is pretty clear that during the last few years, and perhaps even longer, we have migrated into a state where the correctly valued costs of Chinese investment in infrastructure, real estate development, manufacturing capacity, and government spending, exceed the economic benefits.  In fact on Sunday Beijing announced measures aimed at what may be among the worst offenders.  According to an article in Market News:

China’s State Council, the cabinet, has ordered local governments to stop borrowing using financing vehicles that rely solely on government fiscal revenue for their income, and to shut down those financing vehicles as soon as possible.  The State Council said its policy announcement at the weekend is aimed at “effectively guarding against fiscal and financial risks.” Cumulative debt levels of local government financing vehicles have expanded too rapidly and local governments have in many cases illegally guaranteed the debt of those vehicles, resulting in ever-rising debt risks.

The economic impact of the government’s move to rein in local government borrowing is unclear – accessrx.Spurred on by the central government’s edict last year to expand lending to boost growth accessrx, banks lent lavishly to local governments to finance local development projects.

No official figures have been published on total Chinese government debt from the central, provincial and local governments.  However, Victor Shih, assistant professor of political science at Northwestern University in the United States, has estimated total debt at about CNY3.9 trillion by 2011, or approximately 96% of GDP.

…The State Council also forbid local governments from using their fiscal revenues to guarantee any more debt through financing vehicles.  The cabinet said banks are not allowed to provide loans to any local government vehicles that can’t generate stable cash flows to repay their debts.  The State Council ordered local governments to report their progress on cleaning up their debt vehicles by December 31, 2010.

Non-economic lending

Xinhua’s article on Monday was a little more circumspect:

China’s State Council, the Cabinet, ordered local governments on Sunday to better manage investment agencies amid concern that their borrowings, estimated at hundreds of billions of yuan, could cause problems for Chinese banks.  It also directed banks to control lending to these agencies by targeting loans at specific projects and monitoring how the credit is used.

Chinese banks have escaped the mortgage-related turmoil that hit Western financial institutions and triggered the global economic downturn, but analysts warn that a lending boom driven by government stimulus spending could leave lenders with a mountain of bad loans.

…The State Council statement said some banks and financial organs had poor risk awareness while investment agencies lacked adequate credit management.  Local governments, it said, had also broken rules.  They are not allowed to use state-owned assets or government revenue to offer guarantees, directly or indirectly, for the investment agencies.

These investment agencies or debt vehicles, which seem to account for a large portion of the recent fiscal and credit expansion, have become notorious for the quality of their investing, but since these debt vehicles were created precisely to generate the level, if not the type, of growth that Beijing required, it is not clear how easy it will be to enforce the new ban.It is going to be hard to generate rapid growth without leaving on the credit spigot.  This kind of thing is one of the expected consequences of financial repression.

More importantly accessrx, China’s financial repression is also at the heart of the imbalance in the Chinese economy.  By transferring large amounts of wealth from the household sector to net borrowers (perhaps as much as 5-10% of GDP annually, as I explain in an earlier entry), it creates the large growth differential between national GDP and household income that is at the root of China’s very high savings and very low consumption levels.

I should add that if much of this investment is non-economic, as I believe it is, this will exacerbate even further the differential.  Why?  Because the total economic cost of the investment (which must include the real debt forgiveness implied by excessively low interest rates), and which will be borne over the future as the cost are amortized in the form of debt repayment, exceeds the total economic value of the investment (which must include externalities), which will accrue upfront.  This means that we get more investment-driven growth today and less consumption-driven growth tomorrow.

China is faced with a difficult policy choice.  It can maintain an undervalued exchange rate, it can run the risk of inflation, or it can increase the domestic costs of financial repression.  How Beijing balances these separate forces will determine the pace and form of its necessary rebalancing.

The second school focuses on the impact of the Greek crisis on the real exchange value of the RMB and the threat of diminished demand in Europe’s deficits countries.  Thanks to the collapse of the euro, they point out, the RMB has already revalued in real terms and this, combined with expected weakness in the European market for imports, means that China should be more cautious than ever in adjusting the value of the currency – buy viagra.  Buy viagra: an article in Monday’s South China Morning Post makes this point:

The yuan has risen strongly against the euro and this appreciation will harm mainland exporters, a Commerce Ministry official said on Monday.  Pegged to a rising US dollar, the yuan has appreciated against a trade-weighted basket of currencies in recent months, which many analysts believe could constrain the scope for a possible revaluation of yuan.

Commerce Ministry spokesman Yao Jian did not say how US dollar strength might affect a long-awaited move to resume yuan appreciation, but he highlighted the impact of the weaker euro.  “The yuan has risen about 14.5 per cent against the euro during the past four months, which will increase cost pressure for Chinese exporters and also have a negative impact on China’s exports to European countries,” he told a news conference.

Yao Jian’s comments notwithstanding, I think both schools are wrong.  The first school makes the typical mistake of misunderstanding and misinterpreting bilateral trade numbers.  This is almost certainly the wrong way to understand international trade issues.

The second school is correct in evaluating the impact of the Greek crisis on the global balance of payments, but shunts aside the issue of how the adjustment burden is to be shared globally – basically the members of this school do not see this as China’s problem.  In doing so they propose a strategy that may be the exact opposite of what the world, and China, needs.  The Greek crisis, rather than reduce the urgency for China to revalue its currency and adjust its trade policy, may on the contrary require that China react much more aggressively than originally planned.

Why?  Because any sharp adjustment in trade or capital flows in one part of the world must automatically force a series of equally sharp adjustments elsewhere.  I explain why in an earlier post, and in a piece in today’s Financial Times Martin Wolf – as usual one of the few analysts who automatically thinks through balance-of-payments implications – makes the same argument.  This need to balance implies that the problems in Europe are going to make international trade relations, and especially those between China and its largest trading partners, much tenser.  In fact I worry that the sudden and unpredicted speed of the European adjustment will force a resolution of the global imbalances at a far faster pace than I, already pessimistic, was expecting.

Is pressure to revalue abating?

I say pessimistic because I believe China needs many years to adjust, and I had always assumed that the speed of China’s adjustment would be determined largely by political considerations in the US – after all if one side of the imbalance adjusts, the other side has no choice but to adjust just as quickly.  This was always likely to be faster that China wanted.

But now the Greek and European crisis may make the global adjustment even faster than that because of the speed with which European finances are unraveling.  To put this in context, it is worth noting that, according to an article in Friday’s Bloomberg, India’s Finance Minister, Pranab Mukherjee suggested that China might begin revaluing the RMB around the time of the G20 meeting in Canada this June.

Mukherjee’s comments indicate sustained pressure for a stronger yuan even as Europe’s debt crisis underscores Chinese policy makers’ concern about the durability of the global recovery.Yuan forwards are headed for the biggest weekly gain this year on bets China will soon relax its peg to the dollar; buy viagra.

China, the world’s fastest-growing major economy, halted the currency’s 21 percent, three-year advance against the dollar in July 2008 to help exporters weather recessions in the U.S., Europe and Japan; buy viagra. Buy viagra: authorities in Beijing have kept the currency at about 6.8 to a dollar, a policy that has blunted the competitiveness of Asia’s export-dependent nations, whose currencies have appreciated this year.

Buy viagra: mukherjee, who served as the foreign and defense minister in Prime Minister Manmohan Singh’s cabinet before being appointed as the finance minister, is under pressure from local exporters to use the Group of 20 platform to campaign against China’s currency policy.

As Mukherjee’s comments suggest, pressure continues growing from a number of countries, especially in Asia, for a Chinese revaluation, and for a while it seemed pretty obvious that China was going to begin revaluing very soon.

The events in Greece, however, have undermined expectations dramatically.  Among other consequences of the Greek crisis, the discussion about the currency seems to have become more polarized than ever within China, with proponents insisting that revaluation is still necessary for China’s rebalancing (in fact I would say that even without the Greek crisis the recent decline in real Chinese interest rates makes it more necessary than ever), and opponents arguing that the collapse of the euro against the dollar has already caused an effective (and large) RMB revaluation.

Xinhua today, in a front-page piece, makes this argument very explicitly, suggesting that the RMB devaluation will be put on the “back burner”.

The chances of an early revaluation of the renminbi look unlikely and could happen much later than expected, considering that the nation’s trade surplus may see steep erosions due to the European debt crisis and the growing trade protectionist measures against China’s exports, leading economists and experts said on Tuesday.

Earlier estimates were that the nation would allow the renminbi to rise during the second quarter, with overall gains of 3 to 5 percent for the whole year.  Economists now consider such a move unlikely and expect any currency moves to be deferred till the end of the year with a smaller range and overall gains of 2 to 3 percent.

Ministry of Commerce officials had on Monday indicated that the prospects for the nation’s exports were not that hopeful this year and the annual trade surplus may see a big drop.  “The improved trade balance will lay a good foundation for China to implement its macro-economic policy and the currency issue should not be too politicized,” said ministry spokesman Yao Jian.

Trade and finance must balance

The argument – very seductive on the surface but also, like many other seductions, a little dangerous – is that with a weak euro the RMB has effectively strengthened against China’s trade partners, so China has “done its bit” to help in the global rebalancing.  But I would argue that the problems in Europe, rather than partially resolve RMB undervaluaton, actually make the global rebalancing much more difficult and require more a aggressive, not a less aggressive, response from China.  Why?  Take a look the table below, which lists the top ten current account surplus countries based on CIA estimates for 2009:

Obviously China leads, with largest trade surplus by far of any country, accounting for just over a quarter of all trade surpluses.  This share has been rising steadily, especially since 2004, and also increased during the financial crisis.  Japan is a distant second, with a trade surplus less than half that of China’s, followed by Germany.

However if you add up all the European trade surpluses – the largest being, after that of Germany, Switzerland, Norway, the Netherlands, Sweden and Denmark – together they amount to nearly 28% of total trade surpluses, or a little more than China’s trade surplus (I know, I know, not all of these countries are part of “Europe”, but they are nonetheless going to be part of the same economic process).  Together these numbers are very large.

These large trade surpluses haven’t mattered much in the global context because within Europe there are also several trade-deficit countries with equally large trade imbalances.  The table below lists the eleven largest trade deficit countries in the world.

Obviously the US is the largest by far.  It accounts currently for just under one-third of all trade deficits.  Some research prepared for me by the Corporate Executive Board, and based on IMF numbers, breaks the data down a little differently, and shows that the US currently accounts for about 40% of total trade deficits, down from 70% in 2003.[1] I am not sure what the discrepancy is, but it doesn’t matter much to the rest of this argument.

Besides the US, there are a number of other countries with large trade deficits (and even larger than that of the US relative to national GDP).  Most of these are in Europe.  If you add up the trade deficits of all the trade-deficit countries in Europe, the sum amounts to just over 26% of total trade deficits.

So who will bear the brunt of the adjustment?

The numbers on both the surplus and deficit sides, in other words, are fairly large, but they net out to a small number.  So until now we could pretty much ignore the impact of Europe on the global trade imbalances because on a net basis Europe didn’t seem to matter too much (and it is aggregate numbers, not bilateral numbers, which really matter in this context).

But thanks to the crisis, we are almost certainly going to see a large and rapid adjustment on one side of the internal European imbalance.  This necessarily must have an equally large and equally rapid impact elsewhere.  Why do I expect a large and rapid adjustment?  Because a country cannot run trade deficits if these deficits are not automatically balanced by net capital inflows.  The balance of payments always balances.

One consequence of the Greek crisis is that over the next year or two Spain, Italy, Greece and Portugal may all find it much more difficult to attract net capital inflows.  Today’s Financial Times, for example, has a very worrying article on the recent Spanish auction:

Spain came close to its first debt auction failure on Tuesday, highlighting the funding problems for weaker eurozone economies.

The government’s difficulties in selling €6.44bn ($7.96bn) in one-year and 18-month bills sparked worries over its 10-year debt auction on Thursday.  Madrid had planned to issue €8bn, but only just attracted that amount of bids, with yields at record highs.This prompted debt managers to reduce the size of the sale by €1.56bn.Normally a government bill auction would be covered at least 1.5 times – buy viagra.

Will southern European countries have trouble attracting capital inflows?  Probably.  In fact, almost certainly.  In that case, they are all going to see sharp contractions in their current account deficits, exactly equal to the contraction in net capital inflows – and of course if any if these countries experience flight capital, this contraction can be very sharp.  Again, the reasoning behind this is explained in an earlier post

To get a sense of magnitude, those four countries are the equivalent in trade deficit terms of more than half the US.  If we assume that other European countries with large trade-deficits are also going to have to pay down debt, and may even find difficulty in attracting net capital inflows, then roughly 26% of all trade deficits in the world, an amount equal to more than two-thirds of the US trade deficit, are under pressure to contract rapidly.

Why does this matter to China?  Because, of course, the global balance of trade must balance.  Every dollar reduction in the trade balance of a European trade-deficit country must be matched, either by a dollar reduction in the trade surplus of Germany or some other European country, or by a dollar increase in Europe’s trade surplus.

Which will it be?  Probably a combination of both, but the sharp decline in the value of the euro against the dollar makes it likely that we will see much more of the latter than of the former.  In fact for many Europeans, the “silver lining” of the Greek crisis is that by pushing down the euro, it is making all of Europe, even countries like Germany that already have locked-in structural trade surpluses, more competitive in the international markets.  Europe’s trade surplus is likely to surge.

So where is the countervailing trade impact?  Beijing argues that the depreciation of the euro has automatically forced an appreciation of the RMB, and with deteriorating international markets, there is no need for China to accelerate the process; buy viagra. I would argue that with real interest rates declining in China, it is as if the RMB has been depreciating in real terms in order to protect China from the cost of the trade adjustment.  China (along with Japan) does not want to bear the brunt of the global adjustment.

A very reluctant US?

So that leaves the US.  Most policymakers around the world – while publicly excoriating the US for its spendthrift habits – are intentionally or unintentionally putting into place polices that require even greater US trade deficits.

This cannot be expected to happen without a great deal of anger and resistance in the US.  The idea that suffering countries should regain growth by exporting more to the world, and that rapidly growing surplus countries should not absorb much of this burden, will only force the US into even greater deficits as US unemployment rises to reduce unemployment pressure in Europe, China, Japan and elsewhere.

I would be surprised if the US accepted this with equanimity.  On the contrary, I expect it will only exacerbate trade tensions and ensure that next year the dispute will become nastier than ever.

To summarize, and to make the sequence clearer using nothing more than explicit assumptions and accounting identities, let me suggest schematically the list of factors that require either much greater flexibility on the part of surplus nations or much greater deficits on the part of the US:

1. I assume that for the foreseeable future the major trade deficit countries in Europe are going to find it very difficult to attract net new financing.  At best they will be able, through official help, to refinance part of their existing liabilities.
2. If these countries cannot attract net new capital inflows, their currency account deficits, currently equal to two-thirds that of the US, must automatically contract.
3. If European trade deficits contact, there must be one or both of two automatic consequences.  Either the trade surpluses of Germany and other European surplus countries – larger than that of China and just a little larger in sum than the European deficits – must contract by the same amount, or Europe’s overall surplus must expand by the same amount.
4. We will probably get a combination of the two, but a much weaker euro – combined with credit contraction, rising unemployment, and German reluctance to reverse policies that constrain domestic consumption – will mean that a very large share of the adjustment will be forced abroad via an expanding European current account surplus.
5. If Europe’s current account surplus grows, there must be one or both of two automatic consequences.  Either the current account surplus of surplus countries like China and Japan must contract by the same amount, or the current account deficits of deficit countries like the US must grow by that amount, or some combination of the two.
6. If the Chinas and Japans of the world lower interest rates, slow credit contraction, and otherwise try to maintain their exports – let alone try to grow them – most of the adjustment burden will be shifted onto countries that do not intervene in trade directly.  The most obvious are current account deficit countries like the US – buy viagra.
7. Buy viagra: the only way for this not to happen is for the deficit countries to intervene in trade themselves.  Since the US cannot use interest rate and wage policies, or currency intervention, to interfere in trade, it must use tariffs.

Tariffs in the US, Asia and probably in Latin America and Europe will rise.  These are big numbers and the risk is that the adjustments are likely to occur rapidly.  This means the rest of the world will also have to adjust just as rapidly.

I don’t really see how the numbers are going to work.  Europe, China and Japan are all implicitly demanding that the US trade deficit rise.  The US is determined to bring the trade deficit down.  Both sides cannot win.  There doesn’t seem to be the much serious attempt at global coordination.  In fact the easiest part of any global coordination – that between surplus Europe and deficit Europe – has already degenerated into a nasty round of accusations, counter-accusations and insults.

The hard part of the coordination is almost certain to fail.  It will take a few months for the impact of the euro weakness and the withdrawal of net financing to deficit Europe to be felt, but it will be felt.  Expect trade tensions to get nastier than ever by the end of this year or the beginning of the next.

By the way is there anything that China can do to head off conflict?  Yes.  It can buy euros.  The more the better – and just lift every offer out there.  By strengthening the euro, or at least limiting its weakness, this strategy will force the brunt of the adjustment back onto European surplus countries rather than onto the US and, via the US, back onto China.  Sarkozy and other European leaders might not be very happy, of course, but they will be at least partially mollified by the net capital inflows and the reduced humiliation of a collapsing euro.

But make no mistake – if southern European trade deficits decline, someone somewhere must bear the brunt of the corresponding adjustment.  The only question is who?

Any agreement must deal with more than the RMB. It must involve the whole range of issues which depress consumption in the surplus countries and force it up in the deficit countries.That means that not just the currency, but also interest rates and credit expansion (and workers wages, if anyone dares to address that) – buy cialis.  Buy cialis: i suspect an important part of the discussion will involve Chinese attempts to reduce savings by improving the social safety net, since this is widely believed to be a reason for China’s high savings, but as I have written many times, I think this issue is largely irrelevant.

My guess is that, unfortunately, along perhaps with promises on the social safety net, the currency will be the main topic. On that topic, Daniel Ikenson of the Cato Institute has an OpEd piece in today’s Wall Street Journal in which he worries that “forcing China to appreciate its currency through sanctions will impose higher prices on American consumers, thereby reducing Americans’ real incomes.”  Steve Roach made the same point in his Financial Times OpEd piece last week, and this is one of the most widely-cited reasons for opposing RMB appreciation or, what amounts to the same thing, dollar depreciation.  But while it may be true that a depreciation of the dollar reduces the real value of current household income, it only reduces household income overall if you assume it has no employment effect; buy cialis.

But why make that assumption?  I am pretty sure Paul Krugman, who recently had a spat with Roach on the subject of RMB revaluation, would agree 100% with both Roach and Ikenson that dollar depreciation, or RMB appreciation, would have no beneficial effects for the US if he also believed that it would have no impact on reducing US unemployment – buy cialis.

But of course he doesn’t believe that. Nor does Beijing, for that matter.  For Krugman, and most trade economists, including those in China, an undervalued currency shifts domestic demand away from imported goods to domestically-produced goods, and so increases domestic employment, although in the case of the RMB appreciation this will not occur as a simple substitution of Chinese-produced goods for US-produced goods, as I argued in last week’s posting.  The way to think of it, as Krugman points out, is simply to focus the relationship (an accounting identity, and so inviolable in both practice and theory) between net capital exports and the current account surplus.Forced capital exports are a way of forcing domestic absorption of foreign net demand, and of course it is through currency intervention that China forcibly exports capital to the US, which shifts demand from US producers to Chinese producers.

In the US, with its high unemployment rate, if this shift in demand causes unemployment to fall, it will cause nominal US household income to rise.  If the positive impact on overall household income of depreciation (the rise in employment) is greater than the negative impact (higher prices for imported goods), which is very likely, the net effect will be a real increase in household income, not a reduction.

But there is a second, perhaps more important, reason to wonder whether concern about the adverse effect on consumers of dollar depreciation is relevant.  Almost everyone agrees that the US saves too little and consumes too much and conversely almost everyone agrees that China consumes too little and saves too much; buy cialis. And how could they not agree?  These countries probably have the highest and lowest consumption rates buy cialis, respectively, ever recorded.

An important part of the reason for both problems is that Chinese consumers are effectively subsidizing American consumers. An undervalued exchange rate and repressed interest rates mean that Chinese households have transferred part of their income to Chinese producers to lower the cost of production.  This cheap cost is transferred via exports to American and other consumers.  This effect is magnified by the stupendous ease with which the American financial system can convert recycled capital inflows into incredibly foolish consumer lending.

Given the magnitude of the effective subsidy for American consumers, and the even greater magnitude of the penalty for Chinese consumers, it is perhaps not so surprising that US households are consuming too much and Chinese households too little; buy cialis.  Now here comes the politically tricky part; buy cialis.If you want US savings rates to rise buy cialis, it is a waste of time pleading for it. The only way the savings rate can rise is, by definition, if production growth exceeds consumption growth – after all savings is just production minus consumption; buy cialis.

So like it or not, if you want Americans to save more you must agree that either it must make production relatively easier, or consumption relatively more difficult, or both, and as it does this, as long as investment rises more slowly than the increase in savings, the aggregate impact will be a decline in the US trade deficit and, forcibly, a decline in the rest of the world’s trade surplus; buy cialis.  Buy cialis: a depreciation of the dollar does both.

Buy cialis: but of course it is not painless. When people argue that the US savings rate must rise buy cialis, and at the same time argue that it is unfair to penalize US consumers (which in this context mean removing foreign subsides for consumption), I am always seized with a sense of unreality. We are saying that we must correct the imbalances but it must be done at no cost to the consumer.

I am not sure that is going to be easy.  If we subsidize producers to make them produce more, it will be done at someone’s expense – either US taxpayers or foreigners.  Buy cialis: if we penalize consumers (by removing the existing implicit subsides), clearly they are bearing the cost directly. By eliminating sub-prime lending buy cialis, we penalized American consumers, and willingly or unwillingly we are going to continue doing so until consumption returns to a more reasonable level.  Buy cialis: one way or the other, rebalancing the US economy means tilting away from consumption and towards production, and although we can theorize about painless ways of doing it (Get Washington to stop wasting money! Improve education and infrastructure investment!) the fact is that in the short run it will be very hard to do so without penalizing consumption.

By the way China faces the obverse problem.  For years Beijing has insisted that it wants consumption to rise as a share of national income, and instead it has declined. Why?  Because Beijing wants to tilt the balance towards consumption without having producers pay the cost.  In other words it wants producers to continue benefiting from excessively low interest rates and an undervalued currency while exhorting consumers, who pay for the low interest rates and undervalued currency, to buck up and consume more.

That seems to me why this whole rebalancing process is going to be a lot more difficult for both countries than we currently expect. Both countries are eager to rebalance, and even more eager to avoid the price of rebalancing – or better yet, to shift it onto someone else – buy cialis.  Buy cialis: perhaps there is a realistic way to achieve both, but it isn’t obvious to me.

As many of my readers know (although I have not made any reference to it on my blog) hedge fund manager Jim Chanos recently made some headline-inducing claims about China. Chanos, a successful hedge fund manager who has made his reputation – and fortune – by identifying and shorting seriously overvalued assets, most famously Enron, seems to have read the PivotCapital piece that got a lot of attention last year, and partly as a consequence he claimed that China is undergoing a speculative bubble that makes it the equivalent of “Dubai times 1,000 – or worse”.

His claim was met with incredulity by New York Times columnist Thomas Friedman.  Freidman is best known for his writings on globalization, and although I have no doubt that he is a very smart man when it comes to getting politics right, especially in the Middle East, which I believe is his area of specialty, I also have no doubt that he does not understand China much and understands almost nothing about central bank reserves and the functioning of the global balance of payment.  I have read many of his articles, and so far I am pretty sure that these aren’t his strong points.

In response to Chanos’ claim Friedman made a number of very questionable statements about China.  These are matters of dispute and although I think they are completely wrong, they are at least defensible.  For example he says its true that there may have been risks of bubbles. ” Buy levitra online: in the last few days, though, China’s central bank has started edging up interest rates and raising the proportion of deposits that banks must set aside as reserves — precisely to head off inflation and take some air out of any asset bubbles.” 

Really?  I think you have to be a tad credulous to believe that the RMB 7.5 trillion lending target for 2010 and the slightly higher interest rates represents taking air out of the asset bubble.  I would argue that they simply mean that the astonishing rate at which they were pumping air into the bubble has moderated slightly, to merely excessive.

He also says:

Now take all this infrastructure and mix it together with 27 million students in technical colleges and universities — the most in the world.With just the normal distribution of brains, that’s going to bring a lot of brainpower to the market, or, as Bill Gates once said to me: “In China, when you’re one-in-a-million, there are 1,300 other people just like you.”

Aside from perhaps his overestimating the quality of the education system, this is very bad statistics, and perhaps shows how easily we can get intellectually overwhelmed by large numbers.  If China indeed has the same distribution of geniuses, or talent, as other countries, the fact that it has so many people won’t make it richer (and what about India?).  After all if you cut China into four countries, each country will have only one-fourth the number of geniuses.  Does that really mean that the four countries together are stupider?  If we combine the US, Canada and Mexico into one country, its a pretty safe bet that the total number of geniuses will be more than any of the three countries currently possess, but will average intelligence rise?  Can we really make the three countries richer that way (of course there may be good economic arguments for suggesting that unifying North American into a single country will make it richer, but the larger number of geniuses is not one of these arguments).

Ok, we can argue about these things, and we can agree to disagree, but where he completely blew it was, I suspect, on the one topic are where he was absolutely certain he could not be wrong.

Too bad, because he was.  Friedman proposed, yet again, a common misconception over the meaning of China’s huge accumulation of foreign reserves – buy levitra online.  Buy levitra online: he argued that thanks in part to the size of the reserves it would be impossible to make money by shorting China.”First buy levitra online,” he warned, “a simple rule of investing that has always served me well: Never short a country with US$2 trillion in foreign currency reserves.”

Really? Friedman proposed the rule sarcastically – as both untestable and too obvious to need testing.  It is so obvious that no country has ever had such high levels of reserves, so you can’t really test the hypothesis, but it’s also pretty obvious that a country with $2 trillion in reserves is in great shape.  Anyone who wanted to short it must be pretty stupid, right?

But it turns out that reality is not as obvious as he imagines. Buy levitra online: let us leave aside that the PBoC’s reported reserves are a lot more than $2 trillion, and that if correctly accounted they would be pretty close to $3 trillion.  China’s foreign reserves are certainly huge.They add up to an amount equal to about 5-6 % of global gross domestic product.

But they are not unprecedented.Twice before in history a country has buy levitra online, under similar circumstances, run up foreign reserves of the same magnitude.

The first time occurred in the late 1920s when, after a decade of record-beating trade and capital account surpluses, the United States had accumulated what John Maynard Keynes worriedly described as “all the bullion in the world”.At the time buy levitra online, total reserves accumulated by the US were more than 5-6% of global GDP.  My back-of-the-envelope calculations suggest that this was probably the greatest hoard of central bank reserves ever accumulated as a share of global GDP, but please check before you accept this claim.

The second time occurred in the late 1980s, when it was Japan’s turn to combine huge trade surpluses, along with more moderate surpluses on the capital account, to accumulate a stockpile of foreign reserves only a little less than the equivalent of 5-6% of global GDP.  By the late 1980s, Japan’s accumulation of reserves drew the sort of same breathless description – much of it incorrect, of course – that China’s does today.

Needless to say, and in sharp rebuttal to Friedman, both previous cases turned out badly for long investors and brilliantly for anyone dumb enough to have gone short.During the early years of the Great Depression of the 1930s, US stock markets lost more than 80 per cent of their value, real estate prices collapsed, and the US economy contracted in real terms by an astonishing 30-40 per cent before recovering in the 1940s.

Japan’s subsequent experience was economically less violent in the short term, but even costlier over the long term – buy levitra online.During the period following its astonishing accumulation of central bank reserves, its stock market also lost more than 80 per cent of its value, real estate prices collapsed, and economic growth was virtually non-existent for two decades.

The idea that massive levels of reserves are a guarantor of economic stability is, in other words, based on a profound misunderstanding both of history and of the nature of reserves. Reserves of course are not useless as an enhancer of financial stability, but their use is for very specific forms of instability.  Having large amounts of reserves relative to external claims protects countries from external debt crises and from currency crises.

Great, but neither Chanos, nor even the most pessimistic Sino-analyst, has ever said that these are the kinds of risks China faces today, any more than they were the risks faced by the US in the late 1920s or Japan in the late 1980s. The risks that China faces today (and the US in the late 1920s and Japan in the late 1980s) is of excessive domestic liquidity having fueled asset and capacity bubbles, the latter requiring the uninterrupted ability of foreign countries to absorb via large and growing trade deficits.  These risks include an explosion in domestic government debt directly and contingently through the banking system.

These are, very typically, the kinds of risks that threaten rapidly developing large economies, unlike the external debt and currency risks that typically threaten small economies.  And reserves are almost totally useless in protecting these economies from the risks they face (and, no, no, no, reserves cannot be used to recapitalize the banks – only domestic government borrowing or direct or hidden taxes on the household sector can be used to recapitalize the banks).

In fact, it was the very process of generating massive reserves that created the risks which subsequently devastated the US and Japan – buy levitra online.Both countries had accumulated reserves over a decade during which they experienced sharply undervalued currencies, rapid urbanization, and rapid growth in worker productivity (sound familiar?) – buy levitra online.These three factors led to large and rising trade surpluses which, when combined with capital inflows seeking advantage of the rapid economic growth, forced a too-quick expansion of domestic money and credit.

It was this money and credit expansion that created the excess capacity that ultimately led to the lost decades for the US and Japan; buy levitra online.High reserves in both cases were symptoms of terrible underlying imbalances, and they were consequently useless in protecting those countries from the risks those imbalances posed.

We must be careful how we read history.The fact that the US and Japan had terrible decades following periods during which they had amassed levels of reserves that China has subsequently matched, and under conditions similar to those of China, does not necessarily mean that China too must have a lost decade or two.  Chanos is not being crazy when he worries, but it is still an open question as to whether or not he will turn out to be right.

But the history does indicate that facile statements about central bank reserves should, at the very least, be measured against the obvious historical precedents; buy levitra online.Chanos might still lose this debate, but Friedman has already proven himself to be hopelessly wrong.

The US trade deficit unexpectedly narrowed in August, according to the Commerce Department in a report released yesterday; online viagra prescription. Online viagra prescription: exports were up slightly and imports down, mostly because of a reduction in oil imports, I think, but the trade deficit was still a hefty 3.6% of GDP.

So does this mean that the rebalancing is grinding forward? Today’s New York Times is appropriately cautious:

“Officials cannot just sit there and do nothing, and expect the rebalancing to continue,” said C.Fred Bergsten online viagra prescription, director of the Peterson Institute for International Economics. Indeed, American consumers are already showing hints of their old fondness for shopping rather than saving. Online viagra prescription: the household saving rate shot up from less than 1 percent before the crisis to more than 5 percent this spring, but it has since slipped back to less than 4 percent.In the early 1990s, American families were saving about 7 percent of their income — and even that was less than in much of Asia and Europe.

Simon Johnson, a professor of economics at the Massachusetts Institute of Technology, said it was normal for a country’s trade balance to improve during an economic downturn – online viagra prescription. “The adjustment we’re seeing right now could be the harbinger of a real adjustment in saving and spending, but we don’t know yet,” Mr – online viagra prescription.Johnson said – online viagra prescription. “People in emerging markets want to run big surpluses, because they want to build up reserves.”

There clearly still is a long way to go if the US is really going to raise its savings rate to some sustainable level, and I am afraid that part of the necessary policies that will lead there will cause a lot of disruption and conflict. Basically in order to raise the savings rate the US needs to enact policies that are similar in spirit to the policies that China has enacted especially during the past decade – and of course which China now needs to reverse. These involve putting into place conditions that spur output growth and constrain consumption growth. The difference between the two, of course, is the savings rate, and if output can grow faster than consumption, by definition the US savings rate will rise.

Given the huge differences in the two economies, and the even bigger differences in the accepted roles of the two governments in their economies, the US will have to accomplish this in a very different way than China does. The US of course cannot work to constrain wage growth and force households to subsidize producers out of interest income online viagra prescription, as China seems to have done, but there are other policies that will have the same effect.

For example, consumption taxes, or at least much higher taxes on oil, will have the effect of constraining consumption growth by reducing the real value of household incomes, and if these taxes are somehow matched by lower taxes on interest income the net effect will be to use consumption taxes to subsidize the cost of capital for producers. Online viagra prescription: these are the sorts of policies that can force a continued rebalancing in the US economy.

There is another obvious way of doing so, and this involves the currency. Last week Jean-Claude Trichet, president of the European Central Bank warned against the further strength of the euro against the dollar. At roughly the same time Asian central banks, worried that the failure of the renminbi to appreciate against the dollar would cause their economies to lose export competitiveness, intervened heavily in the markets to slow the appreciation of their currencies against the dollar.

Meanwhile China’s press is fulminating against claims that the renminbi must be revalued. An editorial in Xinhua last week had this to say:

The Group of Seven rich nations have again pushed developing China to appreciate its currency, the RMB yuan, so as to promote a so-called “more balanced growth”. On Saturday, G7 central bankers’ meeting held in Turkey’s Istanbul failed to produce any significant boost to the world economy – online viagra prescription.Instead, they turned fire on China’s currency, blaming it for the financial crisis; online viagra prescription.

In so doing, the rich nations have obviously intended to shirk their due responsibilities in the wide-spreading global financial turmoil; online viagra prescription.  Online viagra prescription: as it is known to all that the current crisis has been a result of developed countries’ lax financial regulation, excessive consumption and their lasting monopoly on the international financial system.

They are supposed to review loopholes in their micro-economic policies and financial regulation; online viagra prescription.However, some of them have tried to link the “under-evaluated” RMB exchange rate to the “global economic imbalance”, which they said had been the major factor behind the crisis; online viagra prescription.

According to their logic, China should appreciate the yuan considerably to cut exports and increase imports, so that Western nations’ trade deficit can be narrowed and “a trade balance” be achieved. They have turned a blind eye to China’s efforts to make the yuan more flexible.

All of this highlights the fact that a depreciation in the value of the US dollar is probably a necessary part of the adjustment process, but it is going to be extremely difficult. Overvalued exchange rates are part of the mechanism by which the US runs a trade deficit. An overvalued dollar increases the real value of US household income by lowering the costs of imports while effectively taxing manufacturers in the tradable goods sector.

This automatically forces consumption to grow faster than production and helps push the country into a trade deficit. Meanwhile countries with undervalued currencies have the opposite experience. As the cost of imports is forced artificially high and the producers of tradable goods are subsidized by the undervalued exchange rate, it is no surprise that growth in production exceeds growth consumption, leaving these countries with persistent trade surpluses.

So if we expect the US to reduce its consumption levels relative to its production (i.e.raise its savings rate and bring down the trade deficit, it is reasonable toe expect the dollar to decline. In today’s Financial Times an editorial makes just that point:

It would actually be rather helpful if the dollar were to weaken further – online viagra prescription.Politicians everywhere see strong currencies as national virility symbols online viagra prescription, but the effect of a cheaper dollar would be to help American exporters while making imports to the US dearer.

This is what America – and the world – needs.In the medium term, as Mr Summers put it earlier this year, “the rebuilt American economy must be more export-oriented and less consumption-oriented”.In short, the US must start living within its means, and the rest of the world must stop relying on its profligacy.

But against what can the dollar depreciate? Europe and Japan can make plausible arguments that their currencies are not undervalued relative to the dollar and so they should not be forced to bear the brunt of the dollar depreciation. Online viagra prescription: asian countries, and especially China, have relied on undervalued currencies as an important part of the package of policies aimed at spurring domestic growth and high domestic savings rates, and because the decline in US imports has already proved very painful, they are insisting that they should be forced to bear any more of the cost of dollar depreciation. The FT editorial continues:

This is the prospect that has worried monetary authorities in Asia. Online viagra prescription: the central banks of South Korea, Taiwan, the Philippines and Thailand have intervened in markets in the past week to bolster the dollar’s strength against their currencies.They are trying to slow the pace of any such rebalancing; online viagra prescription.

That is understandable: this type of reordering of the world economy would be enormously disruptive for these export-led countries, since their economic strategy is to sate the appetites of the consumption-led countries.

Everyone seems to agree that as part of the necessary global rebalancing the US will have to reduce its net imports online viagra prescription, and this will be achieved in part by a depreciation in the value of the dollar, but everyone also seems to agree just as fervently that any reduction of the US trade deficit should not come at their expense, but rather at the expense of the rest of the world. Europe says it is Asian that must appreciate, Asians implicitly insist that it is Europe that must appreciate. It doesn’t take a PhD to see the mathematical difficulty.

Like in the 1930s, every country wants to devalue its currency relative to the currencies of its trading partners in order to boost domestic employment and take a larger share of foreign demand. But as we learned in the 1930s, it is by definition impossible for everyone to improve export competitiveness by devaluing.

So how will the disagreements be resolved? Almost certainly by an increase in trade conflicts. What many of the global participants have probably forgotten is that in a world of contracting demand, it is countries who control net demand who are in the strongest position to determine the outcome of a fight over trade. If the dollar is not allowed to depreciate in an orderly way against the currencies of all of its trading partners, trade tensions have no way to go but up.

Evidence? How about this, in an article in Thursday’s Financial Times:

The US Department of Commerce announced on Wednesday it would launch an investigation into the import of seamless steel pipes from China, a move which could lead to new duties imposed and strain already sour trade relations between Washington and Beijing.

The US investigations, which could lead to a 98.7 per cent duty on Chinese steel pipes imports, came shortly after a European Union decision to impose anti-dumping tariffs on the same category of products.

Or this, in another Financial Times article published the same day:

Global trade tensions ratcheted up on Thursday as the US opened an investigation into Chinese steel imports and clashed with the European Union over chickens.

…The US has long complained that the EU has blocked chicken meat washed with chlorine and other chemicals from sale in Europe, despite both US and European scientific agencies concluding that such treatments were safe for consumers; online viagra prescription.But a panel of the chief veterinary officers of the EU member states rejected the treatments late last year.The outgoing Bush administration started legal proceedings against the EU in January, and negotiations since have failed to resolve the issue.

A European Commission spokesman said that litigation was not the appropriate way to deal with such complex issues.”However, since the US has chosen this path, we will defend our food safety legislation,” the spokesman said.

The fact is that these trade disputes are not going to go away, and because each side has legitimate complaints, or at least what seems like legitimate complaints to domestic audiences, without serious global coordination (don’t hold your breath) the only very likely outcome is even more trade disputes – online viagra prescription. And these are disputes which will be won by the country or countries that control the one resource everyone in the world wants: net demand – online viagra prescription. This means that if surplus countries don’t allow for a rapid and orderly adjustment of the imbalances online viagra prescription, which will require a rise in the value of their currencies among other things, the same thing will be achieved by trade conflict.

What are the prospects? I guess regular readers of my blog will be disappointed if I don’t show myself to be a pessimist, but in fact anyway I think the prospects for an orderly resolution are weak. I am not knowledgeable enough about other countries, but it seems to me that China certainly is not prepared for the cost of the adjustment and will continue trying to postpone it. Yesterday Liu Mingkang, chairman of the China Banking Regulatory Commission, told a conference in Hong Kong that “It’s far too early to talk about an exit strategy”, which I interpret to mean that the investment-driven stimulus package is going to continue. He said that Beijing did not need to rescue the banking system, and the measures it has taken to boost investment and to support the infrastructure sector were to help the economy. Of course he also said that he believes the banking sector is sound, so maybe he is just kidding.

For those of you who are able and willing to follow the complex world of chemicals, there is a related and very interesting article by John Richardson on ICIS news, a chemical industry publication (you can also find it here). He says:

Low density polyethylene imports into China were up by 85% in the first eight months of this year compared with the same period in 2008, according to International Trader Publications Inc, a provider of trade data and analysis on chemicals and polymers; online viagra prescription.

Online viagra prescription: benzene imports increased by 185%, polyvinyl chloride by 138% and methanol by 431%. Online viagra prescription: these latter two statistics are the result of weaker economics of coal-based production as well as re-stocking and stronger demand.

“Year-to-date totals were up for every commodity polymer, engineering polymer and major organic we follow except expandable and non-expandable polystyrene, polyacetals, polycarbonate and ethylene dichloride,” said Jean Sudol, president of ITP.

This implies high inventories in not just PE – the only polymer in which we gained clear evidence through a survey among 85 distributors and end-users carried out by a major Asian producer. It’s easy to overcomplicate things but to put it simply online viagra prescription, it seems impossible that this extraordinary surge in imports has gone into a sufficient increase in finished-goods sales to prevent some major dislocations.

All you have to do to reach this conclusion is look at real consumption growth (not the misleading retail sales figures) versus the decline in exports to work out that a lot of overstocking is likely to have occurred. This would be at the chemical and polymer levels and in warehouses full of unsold washing machines and refrigerators etc.

I am no expert on the chemical industry, and so perhaps I am misreading his piece, but this doesn’t sound like an industry that is readying itself for a world of contracting US demand.

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So what does all this have to do with the SED?  It means that the best hope for the two countries, I think, is a well coordinated set of policies acknowledging that the US savings rate must rise, and with it the Chinese must decline, but also recognizing that if this happens too quickly, or is accompanied by a collapse in trade, it will be bad for the US and terrible for China.  These coordinated policies must also acknowledge – and this becomes much more difficult – that the current Chinese stimulus may be making the adjustment more difficult, and much of it will have to reversed at the same time as the “appropriate” measures aimed at spurring consumption may cause a short-term rise in unemployment.

Finally, the while the US commits to keep fiscal spending high, to turn a blind eye to trade disputes, and to run large trade deficits for several years more, China must commit to the financial sector and currency liberalization that will effectively reduce subsidies to producers and constraints on consumption.  The SED might also discuss the ability of workers to demand and enforce wage increases, since there is a wide consensus in China and abroad that among the main reasons for low household consumption in China is that wages are rising too slowly relative to GDP, and household savings are “taxed’ too heavily via interest rate policies.  Of course discussing workers right in a bilateral context is politically difficult, even without the irony of this particular discussion, so it will probably not happen.

When I discuss these issues, I am often confronted by the “aha!” crowd who point out that my analysis must be wrong because if China does what I think they should do that would cause a rise in unemployment.  How can a policy be the right one if its implementation leads to a bad outcome?

That’s easy.  It can be the right policy if the alternative leads to a worse outcome.  That’s the problem.  There is no silver bullet here that can kill all the demons and leave us living happily ever after.  As I see it, the imbalances of the past decade were real and must be addressed, and we have broadly speaking three possible ranges of outcomes:

1. The US returns to its consumption orgy, the US trade deficit surges, and we’re back to the wonderful days of 2005 – cialis online order.China can continue pumping out production and funding US consumption.  The problem of course is that this cannot be a permanent solution.  It just postpones the resolution of the global imbalances while fueling another asset bubble and saddling the US with even more debt and China with even more excess capacity.

2. China begins a long – five or six years at least – process of forcing the necessary structural changes that will permit a shift from a production-led economy to a consumption-led economy.  The changes necessary involve liberalizing interest rates and the banking system cialis online order, allowing workers higher wages, and a number of other measures to boost SMEs, the service sector, and household consumption.  In the short term, however, nearly all of these measures will involve closing down unprofitable production facilities.  This must be done in conjunction with the US, so that the US adjustment is slowed down to a pace which China can absorb.  The US would do this by keeping fiscal expansion high enough to counteract the contraction in US household consumption.

3. Everyone does what they want to do anyway with no attempt at serious coordination.  US savings rise.  Chinese production rises too.  These two forces are globally incompatible and eventually lead to a sharp contraction in global GDP growth. The effects on China might include, but are not limited to, an explosion in Chinese inventory, a sharp and nasty contraction in international trade, or a brutal rise in Chinese NPLs and an unsustainable government debt burden.

High savings in China is not an accident.  Chinese trade and industrial policies that were aimed at generating employment growth by directly or indirectly subsidizing the cost of production, including currency and interest rate policies, nearly all effectively created forms of income and consumption taxes that constrain consumption even as they boost production (and a rising savings rates just means that production is growing faster than consumption), and to remove the latter you need to remove the former too.

It’s not so easy to increase consumption

So they have a dilemma: Remove the producer subsidies so as to allow consumption to grow, but cause subsidized producers to go out of business.  Or keep them in place, and perpetuate the production/consumption imbalance.

One way or the other Chinese policymakers are destined to be “successful” in raising the consumption share of GDP, because as the US reverses its earlier relationship between consumption growth and production growth, the rest of the world, which ran the opposite position, must also ultimately reverse.

Now for the next few years China’s savings rate will almost certainly decline and its consumption rate rise – it has no other choice except to inflate a major, debt-fueled overinvestment boom – but will that happen because of high growth in consumption or low production growth?  That is where policy matters very much, and the longer they wait to address the imbalance, the worse the outcome gets, I think.

Clearly Beijing wants to raise consumption quickly. Not too long ago a group government economists were reported to have reported on their website (sorry, but I lost the link):  “The new policy measures and initiatives will be the latest effort to shift growth from focusing on capital investment to a more sustainable model that gives domestic consumption a more important role in boosting economic growth.”

But they’ve been wanting to do this for a several years – as they explicitly acknowledge by calling this the “latest” effort – but the fact that it is harder to this now then it might have been three or four years ago doesn’t inspire me with much confidence.  It seems to me that most policies that will boost consumption in a stable and efficient way fall into one of two camps.  Measures like building the medical and social safety net, gradually getting banks to direct lending to service industries,  loosening the one child policy, and so on can be very successful, but will take years before they have much impact on real consumption.

In that camp I might add measures to force banks to increase consumer lending, because I think the last time they tried that (with car loans), nearly half the loans went NPL, suggesting that at first consumer lending will simply consist of free consumption financed indirectly by the government, when it bails out the NPLs.  This is a form of “consumption” I guess, but it is not really what the doctor had ordered.

Bad or worse

On the other hand reversing the policies that might have repressed consumption in the past will probably work more effectively within a shorter time horizon.  These would include liberalizing interest rates and allowing them to rise (which reverses the implicit transfer from households to producers), allowing workers to organize to demand higher wages, raising the value of the RMB, and so on.  Unfortunately nearly all of these measures would hurt manufacturers, especially in the export sector, and would cause an initial rise in unemployment.  I am not sure it is possible to manage the transition without a sharp, short-term rise in unemployment caused by the downsizing of the export sector as its implicit subsidies are removed, and it isn’t clear to me that any country that has managed a similar transition has been able to avoid this.My guess is China will have to do this, but will wait until they have no choice – building up in the mean time even more excess capacity and bad debt.And bad debt cialis online order, as I have argued before, must be resolved at some point in the future, and unfortunately usually in a way that constrains consumption growth.

One of the things that worries me is that the trajectory of rising US savings and increased investment in Chinese production is likely to squeeze the tradable goods sector in most countries around the world as China increase its market share.  Cialis online order: this will lead to accusations that China is behaving in a predatory way, and will almost certainly lead to increased trade tensions as policymakers around the world try to protect their tradable goods sectors form “unfair” Chinese competition.

But I don’t believe that China should be considered predatory.China desperately wants to raise its consumption rate cialis online order, because it is highly likely that for the next few years Chinese GDP growth will be limited to something below Chinese consumption growth.  Beijing would love to find the magic policy that transforms Chinese consumption overnight and turns China into a continental economy driven by internal demand.  It would love to see the trade surplus reduced not by a collapse in exports but rather by a shifting of exports to domestic consumption and a rise in imports (this last maybe).

The problem is that there is no such magic policy.  I cannot find any historical precedent of a country that was able to make the transition quickly and painlessly, and because of its own domestic problems – especially the employment effect of the contraction in the export sector – China is facing a difficult set of policy choices. The fact that the fiscal stimulus may be exacerbating China’s reliance on the export sector was not the plan. The fiscal stimulus is aimed at arresting a sharp and probably politically unacceptable rise in unemployment, and the fact that so much spending has gone into investment, rather than consumption, reflects rigidities in the economic and financial structure; cialis online order. China would love to see explosive growth in domestic consumption, but there is no way they can easily engineer such growth.

So we are stuck with policymakers, in China and elsewhere, making the best of a bad situation – cialis online order. They can be criticized for not beginning the adjustment process when conditions were much easier, but that is a criticism that can be spread around pretty thickly to policymakers in quite a few countries.  Anyway it is too late.

In these circumstances policy coordination matters a lot, and I see too little of it to have much optimism.  Beijing, Washington and Brussels must recognize that China and the world is still in a more vulnerable position than anyone seems to realize, and that rising US savings and rising Chinese investment create conditions for two seemingly irresistible forces to go head to head, and without coordination the consequences could be much worse than we expect.

So much for the good news.  The bad news is described in an alarming article in today’s Wall Street Journal which shows that trade tensions are continuing to rise.  

I have been hearing rumblings for a while about tougher stances being taken in Europe and the US in response to the perception that China is exacerbating the global contraction in demand by increasing subsidized resources available to manufacturers, most importantly by channeling a huge increase in lending at interest rates subsidized by Chinese household consumers and socializing the risk.  These new protectionist moves seems to be an expression of just this.  The article goes on to say:  

As I have been arguing for over a year, as unemployment around the world rises and as the necessary contraction in US net demand picks up pace, there was inevitably going to be a conflict with China as Chinese policymakers responded to the collapse in trade in the only way they could, by substantially stepping up investment.  The result is that China’s trade surplus has contracted very slowly – much more slowly than the contraction in the US trade deficit – and the result was a huge squeeze on the tradable goods sectors around the world. 

The fact that policymakers in Europe, China, Japan and the US seem to have no clue as to how difficult the transition for each of the other countries is likely to be, and so are doing not nearly enough to coordinate their response (in fact lecturing and finger waggling seem to the favorite forms of policy coordination), makes trade conflict almost a dead certainty – medication claritin. I don’t think there are necessarily any bad guys here – each country is desperately doing what it can to get itself out of this mess – but there is a lot of failed opportunity and I am pretty sure that the trade environment will continue to decline. 

The problem is illustrated in two interesting recent pieces. My friend Dan Rosen, of the Rhodium Group, has a very illuminating July 17 report that shows the composition of Chinese growth in the past decade.  He shows that for the past five years net exports accounted for about 10% to 15% of Chinese GDP growth, before collapsing to minus 41% in 2009 YTD. 

Until recently investment’s share of GDP growth peaked at around 65% in 2003 – a very high share by any standard – and going back the full thirty years of China’s reform period achieved an historical high astonishing of 81% in 1985.  From 2005 to 2008 the investment share of GDP growth averaged around 40% – still high – and then in the first half of this year accounted for a mind-boggling 88% of this years GDP growth. 

This year’s growth, in other words, is almost wholly a function of the massive increase in investment, and this increase in investment started out largely in the form of reopening production facilities and producing more “stuff”, without any significant rise in consumption.  As we know, when production increases faster than consumption, either the trade surplus or inventories must rise. 

On that note Xinhua published the following article on Monday: 

The per capita consumption spending volume of Chinese urban residents stood at 5,979 yuan (875 U.S – medication claritin.dollars) in the first half of this year, up 8.9 percent year on year, the National Bureau of Statistics (NBS) announced Monday – medication claritin. Deducting price factors, the growth reached 10.3 percent.   The per capita disposable income of Chinese city dwellers rose 9.8 percent year on year to 8,856 yuan in the first six months – medication claritin.Deducting price factors, the increase reached 11.2 percent, said the NBS. 

Consumption has been rising at around 9% a year for the past several years.  Notice that if GDP growth slows to under 9%, the savings rate in China will automatically decline. 

The second interesting piece is put out by the Economic Policy Institute, a group I believe not noted for its commitment to free trade; medication claritin. It shows China’s share of the US trade deficit excluding oil. According to their numbers: 

Perhaps as a consequence of a fiscal stimulus aimed at boosting investment and production, China’s share of the US trade deficit has grown significantly; medication claritin.  Medication claritin: since the US trade deficit is shrinking quickly, this means that other exporters are getting killed.  As I have argued for a while, this is not sustainable and will almost certainly cause trade tensions to erupt. 

Does this mean China is behaving in a predatory way?  I don’t thinks so.  I have warned for a long time that it would be very difficult for China to make the necessary transition to a consumption-led economy quickly enough to accommodate the global adjustment taking place. Unless it is willing to see its economy collapse, there is simply no way China can reduce its negative net demand quickly enough to match the contraction in US demand and so avoid squeezing the hell out of the global tradable goods sectors.  That is why policy coordination is so important, especially between China and the USD, and of course that is why I continue to be a pessimist – medication claritin. I do not think this policy coordination is taking place.  I will write about this more later this week. 

To continue the discussion of last week medication claritin, we are getting more conflicting signals about policy confidence.  Medication claritin: on the one hand Bank of China seems to love this party. According to an article in today’s Bloomberg: 

Bank of China Ltd., which doled out the most loans among Chinese banks in the first half, plans to keep expanding credit unless the government clamps down on the nation’s record lending boom.  The nation’s third-largest bank will maintain its original target of generating about 10 percent of China’s new loans in 2009, Beijing-based spokesman Wang Zhaowen said by telephone yesterday; medication claritin.Bank of China may “fine tune” its strategy in line with any government policy changes, he said.  

…Bank of China will continue to lend to 10 key industries with government policy support, including steel, shipbuilding and automobile, Wang said – medication claritin. Medication claritin: about 30 percent of its loans went to those industries in the first half.  

On the other hand two of the other members of the Big Four seem a lot more cautious.  Medication claritin: today’s South China Morning Post has this article: 

Mainland’s two biggest state-owned commercial banks have put a lid on their lending targets for the year, according to domestic media reports, in a move that will significantly slow overall credit growth in the second half.Industrial and Commercial Bank of China (ICBC) is aiming to issue full-year new loans of 1 trillion yuan (HK$1.3 trillion) medication claritin, while China Construction Bank (CCB) has set a goal of 900 billion yuan, Caijing magazine reported. 

The two banks, mainland’s largest by market value, granted new loans of 825.5 billion yuan and 709 billion yuan, respectively, in the first half. If they stick to their reported targets, this would imply that ICBC would have already issued 83 per cent of its full-year lending total, while CCB would have already issued 79 per cent. 

It is surprising to me that these members of the Big Four are responding so differently, at least in public; medication claritin. I wonder if the management of the different banks belong to different factions and so interpret the fiscal stimulus package differently. Perhaps my friend Victor Shih medication claritin, who understand these things better than I do and who sometimes reads my blog, might comment? 

Finally the Financial Times on Monday continued the thread discussed in my Saturday post with an article called “China warns banks over asset bubbles.” 

Chinese regulators on Monday ordered banks to ensure unprecedented volumes of new loans are channelled into the real economy and not diverted into equity or real estate markets where officials say fresh asset bubbles are forming.  The new policy requires banks to monitor how their loans are spent and comes amid warnings that banks ignored basic lending standards in the first half of this year as they rushed to extend Rmb7,370bn in new loans, more than twice the amount lent in the same period a year earlier. 

…Beijing’s concerns are echoed in other countries across the region, most notably South Korea, where the government says it is taking steps to cool a real estate bubble, and Vietnam, where the government has ordered state banks to cap new lending to head off inflation.  regulators are now concerned that too much money is being lent by the state-controlled banks and the country’s tentative economic rebound could come at the cost of a stable financial system. 

In statements published last week, Wu Xiaoling, who recently retired as deputy governor of the central bank, warned new lending this year would probably reach as high as Rmb12,000bn, a staggering increase of 40 per cent of the entire stock of outstanding loans in just one year.  

…Ms Wu hinted Beijing may soon raise the amount of money banks must hold on deposit with the central bank, marking a change of policy from last year when it aggressively slashed the reserve requirement ratio and interest rates.  The central bank has also ordered 10 banks, including Bank of China, to buy Rmb100bn worth of central bank notes with a maturity of one year and a return of just 1.5 per cent, according to Chinese media reports.  This move is interpreted as a warning to banks that have been the most active lenders that they should now start to rein in their excessive behaviour. 

For the sake of simplicity I am going to assume that there are only two countries, the US, which represents all the high-consuming trade deficit countries, and China, which represents all the high savings trade surplus countries – cheap cialis.Although of course there are other players, these two represent the lion’s share of their respective blocs, and for the most part the impact of other large countries (Europe, Japan, the UK) simply exacerbate the problems as I see them.

For the past decade until the onset of the 2007-08 crisis, the US has been growing quite rapidly. Powering this growth has been an even more rapid surge in consumption; cheap cialis.When US consumption grows faster than GDP, two things must happen.

1. The US savings rate by definition declines

2. If the country is running a trade deficit, and consumption is growing faster than production (assuming that investment isn’t falling, or is at least not falling by more than the difference), then the country must run a growing trade deficit – cheap cialis.Another way of thinking about this is that if investment exceeds savings (and with such low savings rates, US investment needs were much higher than US savings), the country must be a net importer of capital. To be a net importer of capital the US must run a trade deficit. These are just different ways of saying the same thing.

In that case the US has been running a growing trade deficit powered by the decline in US savings.But everything must balance. Cheap cialis: if US consumption growth exceeds US growth in production (I am ignoring changes in investment because they are a relatively small part of this), then in China production must exceed consumption. This is just another way of saying that as the US savings rate declines and powers a surge in the trade deficit, the Chinese savings rate must rise and power an increase in the trade surplus. In fact this is what happened.

Notice I am saying nothing about the direction of causality – cheap cialis. It could be US consumers who caused the change, and forced China into reacting – cheap cialis. Or it could be China whose polices have forced an increase in the domestic savings rate (actually an increase in production greater than the increase in consumption, which amounts to the same thing), thus forcing the US financial, system to accommodate by making consumer financing easier. Or of course it could be a combination of the two. The point is that the balance of payments must and will balance. Actions in one part of the system will cause equal reactions in another part, and the direction of causality is never obvious (See Note 1); cheap cialis.

As a consequence of the global crisis we are now seeing a sharp rise in US household savings rates.This has been partly mitigated by a sharp rise in government dis-saving (borrowing), but nonetheless aggregate US savings rates are rising, and with them US consumption must decline (See Note 2). If US GDP is also declining, the combination of a rising savings rate and a declining GDP must result in sharply declining consumption.

What does this mean for China? Obviously the US trade deficit is contracting quickly. This means that China’s trade surplus must also be contracting quickly.  In fact China’s trade surplus has been growing, and this is where my simplification (the world consists of the US and China) runs into a problem. Although all trade surpluses are contracting, the fact that China’s trade surplus is rising indicates that other surplus countries are bearing more than 100% of their share of the global contraction; cheap cialis. I don’t think this is sustainable and ultimately cheap cialis, perhaps even already, China’s trade surplus will decline. By the way the fact that China has been able to force at least part of its own adjustment onto trade competitors will likely lead to increasing anger with China, as it already seems to be doing especially on the part of Asian competitors, and will power a further rise in international trade tensions.

Here is the important point, I think: As long as the US was consuming more than it produced, Chinese GDP growth was constrained on the bottom by the growth in Chinese consumption. In other words, China’s GDP had to grow faster than Chinese consumption (which means of course that the Chinese savings rate was rising). In fact, while GDP was growing somewhere in the region of 11-13% annually, Chinese consumption was growing by around 9% annually; cheap cialis.Thanks in large part to US dis-saving, in other words, Chinese GDP growth exceeded Chinese consumption growth by around 2-3% annually.

So what next? Now that the US is raising its saving rate, this means among other things that the growth in US consumption will be lower than the growth in US GDP. If the US GDP grows slowly, consumption will be flat. If it contracts, consumption will contract sharply. In either case the US trade deficit should continue declining except in the very unlikely event that US investment grows by more than the increase in savings.

Since the balance of payments must balance, if US GDP growth exceeds US consumption growth, China’s consumption growth must exceed China’s GDP growth, and Chinese savings must decline. Chinese savings can decline because consumption rises cheap cialis, or they can decline because GDP declines, but they must decline.

That implies that Chinese GDP growth, rather than be constrained on the bottom by consumption growth (i.e.GDP must grow faster than consumption), will now be constrained on the top by consumption growth – cheap cialis. China’s growth in GDP, in other words, will be less than its growth in consumption unless there is a surge in investment. There has, of course, been a fiscally induced surge in investment, but with rising debt and collapsing corporate profitability, I think this can at best continue for a year or two, and probably much less.

So what does that mean for future Chinese growth? When China was growing at 11-13% a year, Chinese consumption was growing by 9% a year. The rapid reversal in the earlier decline in US savings might cause Chinese GDP growth to grow by at least 1-2% below consumption.  So if we assume that Chinese consumption continues growing at 9%, this initially suggests GDP growth rates of 7-8%.

But hold on. If GDP growth rates of 11-13% translate into 9% consumption growth rates, is it reasonable to assume that GDP growth rates of 7-8% will still result in 9% growth rates in consumption? I doubt it. My guess is that the growth in Chinese consumption will also slow.  This suggests that while the US is adjusting, China’s annual growth rate must be significantly below 7-8%, perhaps 5-6%, or even lower. The key is the rate of Chinese and US fiscal expansion, in the former case to permit the rise in Chinese savings rates not to constrain domestic growth, and in the latter case to slow down the contraction of the US trade deficit.

But this is just a guess, and the example of Japan after the 1987 crash and the subsequent reversal in US dis-savings suggests that while a credit bubble can keep the game going in China for a few years longer, ultimately the surprise may be on the downside. On that subject let me note something that an unnamed official confessed about the impact of the US crisis on his country’s economy:

We intended first to boost the stock and property markets. Supported by this safety net – rising markets – export-oriented industries were supposed to reshape themselves so they could adapt to a domestic-led economy. This step was supposed to bring about an enormous growth of assets over every economic sector. The wealth effect would in turn touch off personal consumption and residential investment, followed by an increase in investment in plant and equipment; cheap cialis.In the end cheap cialis, loosened monetary policy would boost real economic growth.

It sounds plausible and like it might work. Cheap cialis: except that it didn’t. The unnamed official was not an anonymous friend of mine at the PBoC – cheap cialis. According to Tomohiko Taniguchi, in Japan’s Banks and the “Bubble economy” of the Late 1980s, the speaker was an official at the Bank of Japan and he made the comments in 1988, during a period when Japan was routinely referred to as a “creditor superpower” (and a country, by the way, with enormous foreign currency reserves, and whose currency would within one or two decades, everyone knew, become the world’s reserve currency); cheap cialis.

After the 1987 Crash in the US, many expected the Japanese markets also to crash; cheap cialis. But they didn’t – cheap cialis. After faltering briefly, the Ministry of Finance ordered the Big Four brokerages to support the market, and support it they did – cheap cialis. Within a few months the Nikkei was testing new highs, leading a Ministry of Finance official to boast that manipulating the stock market was easier than controlling foreign exchange. Check Edward Chancellor’s Devil Take the Hindmost for an illuminating take on the Japanese bubble economy of the 1980s.

The comparisons with China are cheap cialis, and of course are meant to be, a little worrying. This is not to say that China must repeat Japan’s spectacular 1990 crash and subsequent lost decade (or two); cheap cialis. It is simply to point out that none of what we are seeing in China is particularly new and far from being a source of great strength cheap cialis, the intense manipulation of monetary and fiscal policies and the financial markets can actually make the necessary adjustment for China much more difficult. Cheap cialis: just as Japan failed to come to terms with the sudden collapse of the US trade deficit and tried to export and monetize its way out, China may be doing something very similar.

But one way or the other if the US is raising its savings rate and so forcing more rapid growth in US GDP than in consumption, China is likely to see its consumption growth constrain its GDP growth. This suggests to me that once the effects of the (I think) unsustainable credit bubble being inflated by policymakers here run their course, we are in for a longish period of much slower GDP growth.

Note 1. I know I will be assailed on both sides by people saying that only a fool is unable to see which way causality runs in this case, but let me suggest that if you know beyond any doubt the direction of causality here, then you probably do not understand the problem.

Note 2. Except, of course, in the case in which US GDP is rising much more quickly than the US savings rate, which is a complication I don’t think we need to worry too much about.