I recently “debated” twice with senior Chinese officials on the future prospects for China. In both cases they made the argument that Chinese growth rates were going to rise in the next few years and that the current deep pessimism is unwarranted. I argued, of course, that growth would slow even more.
Neither of the debates, I thought, was wholly satisfying. It seems to me that while a number of officials – at least among those with limited economic backgrounds – acknowledge that perceptions of China’s economic prospects have changed dramatically in the past few years, they don’t always understand why. There seems to be a worried resistance to the idea that we may have reached a major and difficult transition. The unwillingness to acknowledge the difficulty of the transition, however, can only make the transition all the more difficult.
In both of the “debates”, and in conversations I have had with others, my “opponents” (although that is too strong a word since there were many areas of agreement) largely constrained themselves to three arguments, which are the same three very unsatisfying arguments that we have heard many times before. First, they presented historical data showing rapid Chinese growth rates in the past three decades and proposed past growth rates as evidence of rapid Chinese growth rates in the next two decades. I probably don’t need to explain why this is a very weak argument.
Second, they asserted (many times) that since past predictions of failure have all turned out to be wrong, future predictions must also be wrong. If this were true it would, of course, be irrelevant, in the same way that people who predicted in 2002 that the Spanish real estate market was out of control might have been early but they most certainly weren’t wrong. Rudiger Dornbush once said: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought, and that’s sort of exactly the Mexican story. It took forever and then it took a night.”
But this argument, that past predictions have always been wrong, isn’t true. There have been predictions of failure in the past 20 years that were in fact correct – for example the claim in the late 1990s, made first, I believe by Nick Lardy, that China was going to have a banking crisis. The fact that China didn’t “fail”, however, doesn’t mean that Lardy was wrong. China did in fact have a banking crisis, but the growth impact was more than offset by a surge in lending which simply set the stage for the next banking mess.
It is as if you saw a middle-aged man in terrible physical shape running a marathon, and you predicted that after five or six miles he would be forced to quit. If however he took out a syringe and shot himself up with crystal meth, he would be able to continue running a few more miles, but this doesn’t mean that your analysis and prediction were wrong. It means that in a few more miles he will be worse off than ever (or will have to take an even bigger dose of crystal meth).
And third, they produced a number of what seem to me largely circular arguments – for example the claim that urbanization leads to growth and growth to urbanization, and so the process must continue, or the claim that since productivity has soared, past investments in the aggregate have been justified, even though the data “proving” the increase in productivity implicitly assumes that past investments have been economically justified. Except for reports of capital fleeing China, one could easily get the impression that even senior Chinese non-economists really don’t understand why the likes of Wen Jiabao, Li Keqiang, and now Xi Jinping seem so worried.
Can a prediction be based on a prediction?
For an example of this kind of argument, by another seemingly plugged-in person, see this article in Monday’s South China Morning Post arguing that brighter days are ahead for China’s economy:
I can’t predict when the economy will rebound, but perhaps it is time for analysts to look at the longer term. Where will China stand in 20 years?
First, let’s examine the prediction that its gross domestic product will become the largest in the world within a decade, and its economy will continue to improve over the next two decades. The Economist expects Chinese GDP to surpass America’s by 2018, and even if China’s growth rate were to drop to 5 per cent, this transition would only be delayed until 2021. Therefore, there is little need to worry about current GDP growth falling to 8 per cent. Other forecasts of when the transition will happen include 2016 (the International Monetary Fund) and 2020 (the Chinese Academy of Social Sciences).
…Second, the renminbi is forecast to become freely convertible within 10 years and possibly will be competing with the US dollar in two decades. In recent discussions, it was thought this first step could be realised in five years. I believe it will probably happen by 2020, or when Chinese GDP becomes the largest in the world.
..Third, it is said that Hong Kong is likely to exceed New York as a global financial centre within 20 years. As China’s economy continues to grow and develop, the realisation of the first two predictions will provide a great boost for Hong Kong, and it is expected to gradually become the dominant global financial centre.
…Fourth, some predict that Chinese enterprises will make up more than half of the Fortune Global 500 companies in two decades, and China will be a global manufacturing power. This year, there are 73 Chinese companies (79 if Taiwanese companies are included) on the list, a significant increase from only 11 a decade ago.
…Fifth, China is expected to make significant progress in the field of science, technology and education, and the University of Hong Kong is likely to be ranked among the top 10 in the world within two decades. According to a study by the science and technology think tank Battelle, China currently accounts for about 15 per cent of the total share of global research and development spending, and it will surpass the US spending within a decade.
…Thus, there is every reason to be optimistic about China’s economic prospects over the next two decades.
Notice that the reasons for saying that the Chinese economy will be much stronger than many people currently expect consist largely of citing a series of earlier predictions. This doesn’t seem like a very robust argument, and although I have only excerpted the article, I think anyone who reads the full article will agree that I did not leave out anything more substantial.
I don’t mean to pick on the author, a prominent former consultant and currently editor of China’s Economy & Policy, especially since it is a short OpEd piece, in which it is always hard to make substantial arguments, but in fact I hear this kind of reasoning a lot. The “proof”, the argument goes, that China will grow very rapidly in the next decade is that many experts have predicted that China will grow very rapidly in the next decade.
Unfortunately expert predictions of this sort are notoriously unreliable, and we seem to be especially bad at predicting turning points. This makes earlier predictions useless in a debate about whether or not we are at a turning point. I will discuss this more in the next entry on my blog, but for now there has to be a stronger argument for it to be credible.
I am not saying of course that there is no credible argument for the bull case. In order to argue that we will not see a sharp slowdown in Chinese growth, however, I would propose that it is not enough to claim that some expert or the other has predicted that Chinese growth will not slow down. Nor can we argue (which is much the same thing, I suspect) that China has grown rapidly in the past so it must grow rapidly in the future. And finally, and most foolishly, we cannot assert, as I have heard many times, that Beijing leaders cannot tolerate growth below 8%, so of course growth will not drop below 8%.
How to sustain the bull argument
To counter the current level of pessimism with the bull case it seems to me that we must answer specifically three questions. The first question, of course, has to do with debt. How much debt is there in China, in other words, whose debt servicing costs (adjusted upwards to eliminate interest rate and other subsidies) exceed the economic value creation of the projects funded by that debt.
Just as importantly, we need to show which sector of the economy will be forced to pay for the difference. Remember that excess debt doesn’t pay for itself, and if you cannot identify who is paying, then you haven’t resolved the problem. Many people, for example, argue that bad debt isn’t a problem for the same reason that China “grew out” of its debt crisis of the late 1990s. This is idiotic. China did not grow out of the debt. It merely forced the cost of the crisis onto the household sector through repressed interest rates and a wide spread between the deposit and lending rates.
This solved the banking crisis, but at the expense of the household sector and so directly caused China’s already very low household consumption rate to collapse. The important implication is that bad debt this time around cannot be resolved in the same way if we expect consumption to power economic growth, rather than lag it as it did during the period in which the banking crisis was resolved.
And remember that official government debt levels are not what matter. We must include contingent liabilities, we must estimate hidden and informal banking debt, and we must consider the further balance sheet consequences of an economic slowdown.
The first question, on debt, is of course closely related to the second important question, which has to with overinvestment. Are there significant areas in which Beijing can and will invest so that the real increase in economic value creation exceeds the unsubsidized cost of capital?
Even this question is a little more complicated than simply looking for good investment opportunities in China and then assuming that the bulk of future investments will go there. There are of course many areas in which the value of investment is likely to be positive in the very long term, such as primary education and social housing, but it is important to remember that these don’t pay off their investments for at least a generation or so, in which case they do not help address the current imbalances.
On the contrary, they make them worse for many years before they start reducing debt and rebalancing the household sector. The only kind of investment growth that can help China address its debt overhang is investment in projects in which the increase in productivity in the next five to ten years exceeds the unsubsidized cost of the investment.
This is a very simple but powerful condition. Any debt-funded investment that does not satisfy this condition must make the debt problem worse. The bull case must identify trillions of dollars of such potential investment and then show that in spite of constraints that led in the past to uneconomic investment, these “good” investments are likely to be made on a substantial scale.
The third question is about future sources of growth. Since it is now widely accepted that investment growth must slow sharply (unless we can find – and execute in spite of political constraints – many trillions of dollars of these new “good” investments) it is obvious that only a surge in consumption growth can replace investment.
So the question for the bulls is: how specifically will China cause consumption to surge? Since at least 2005 Beijing has tried to force up the growth rate of consumption and it has not been able to do so. More worryingly, there is some evidence that the growth rate of consumption may be dropping.
But – and this is just arithmetic unless we assume explosive growth in the external sector – if investment growth drops, consumption growth must rise by a much larger number (because consumption is much lower than investment) to maintain the same level of growth. If you cannot specify the mechanism that will cause consumption to grow (and please don’t propose an improvement in the social safety net), unless you deny that China must reduce investment growth you have no choice but to accept that GDP growth will slow sharply.
Any China bull that does address these three questions is missing the point. I am of course not suggesting that there is no answer to these questions. I’ve already written extensively on steps China can take – economically efficient but politically difficult – to address both debt and consumption growth. Any bullish forecast, however, that cannot come up with answers to these three questions is as useful as forecasts in 1989 and 1990 that Japan would get over its own domestic imbalances and continue growing by 7% annually for the next two decades – because it had always grown quickly in the past.
As an aside one of the predictions cited in the SCMP article above to “prove” future rapid Chinese growth is that “The Economist expects Chinese GDP to surpass America’s by 2018.” Regular readers know that I have a bet with The Economist on just this subject.
Reclassifying investment
The Economist has always tended to be very much in the bullish camp on Chinese economic prospects. In last week’s issue, for example, they have a new article on China – positing whether China is more Keynesian or more Hayeckian (I think it is neither). The magazine is, I think, increasingly recognizing how deep China’s adjustment problem is, but I think they are still a little too sympathetic to residual bullish arguments:
Moreover, investment that adds little to a society’s stock of productive assets is not necessarily malinvestment. Michael Buchanan and Yin Zhang of Goldman Sachs say that some Chinese investment is best seen as “quasi-consumption”. In this category they place things like earthquake-proof schools and more comfortable metro lines. Instead of adding to the economy’s productive capacity, these assets provide a flow of services (such as reassurance to parents and relaxed travel) directly to consumers. In this respect they are more akin to consumer durables, like washing machines or cars, than to iron-ore mines or steel plants.
As a rough gauge of the size of quasi-consumption, the Goldman economists add up China’s investment in house building and “social infrastructure”, such as utilities, transport, water conservation, education and health care. Reclassifying this spending as consumption would increase China’s household consumption to 53% of GDP last year, compared with only 35% in the official statistics (see right-hand chart).
Hayek thought that badly conceived investment would only result in a worse bust later. This belief is shared by many bearish commentators on China’s economy. But China’s high investment is backed by even higher saving. As a consequence, China does not need its investment to generate high returns in order to pay back external creditors. China has, in effect, already set aside the resources that will be lost if its investments turn sour.
To take the first two paragraphs, the debate about what should or should not be qualified as consumption gets a little wobbly at times and almost always misses the point. I haven’t read the Goldman Sachs piece, and I know Michael Buchanan to be a very smart guy (and a former colleague at Bear Stearns), but there are at least three problems with the argument as it is presented above.
First, it is a little hard to see the point of reclassifying investment outlays as consumption simply because they ultimately serve households, unless it is merely to try to make consumption number numbers look better than they are. Ultimately the point of all investment is to increase household consumption, and yet there is nonetheless a distinction between consumption and investment that is useful and valid in understanding the mechanics of growth.
Adjusting China’s numbers may make consumption seem higher, but in that case we should adjust every country’s in the same way and we would see the same result: China would still have the most unbalanced economy in the world, and it would still urgently need to raise household consumption. After all in the late 1980s we could have done the same thing in Japan to “prove” that the Japanese economy was not unbalanced (lots of comfortable trains, remember?), and yet it still would not have prevented Japan from undergoing the difficult rebalancing process.
Second, the impact on growth, which is the whole point of the exercise, will be unchanged by how we classify the spending. As China reduces investment, consumption must grow to replace it. Are we suggesting that it will be easier for China to increase the investment that it wants to reclassify as consumption? Fine, maybe it will be, but how we will pay for this increased investment? This is the key point, and it doesn’t matter whether you classify the spending as investment, consumption, or indeed anything else.
If this increased spending is paid by direct and hidden taxes on the household sector, as most spending and investment in China are, it simply makes it all the more difficult for household consumption to increase. Transfers from households to fund government spending are at the heart of the Chinese growth imbalances, and reclassifying those transfers does nothing to help the problem. Only reversing them will solve the problem. If it is paid for by liquidating assets in the state sector, then it also really doesn’t matter how this spending is classified. As long as it results in a transfer of wealth from the state sector to the household sector, China will rebalance.
And third, there can be a huge difference between the value of inputs – which is how all this is measured – and the actual economic value of what is created, and this gets us right back to the problem of overinvestment. If a local government spends $2 billion on the subway system, but creates only $1 billion of value (increased economic activity over the life of the subway), reported “reclassified” consumption might rise by the former number, but real “reclassified” consumption only goes up by the latter. In that case the value of the new consumption number is overstated in the same way that investment has been overstated.
The article does point out that not all past investment in infrastructure is wasted, but of course this is a trivial point and no one doubts it. The relevant point is very different. As long as debt in the aggregate rises faster than debt servicing capacity in the aggregate, it cannot be sustained, and one way or the other the difference must be covered by transfers from either the household sector, in which case the imbalances are getting worse, or by the state sector, in which case we are rebalancing but must go right back to the original political problem – which in China is referred to as the problem of “vested interests”.
Throwing away your savings
The biggest problem I have with The Economist article is actually not with the first two paragraphs in the section that I cite but rather in the last. To repeat:
But China’s high investment is backed by even higher saving. As a consequence, China does not need its investment to generate high returns in order to pay back external creditors. China has, in effect, already set aside the resources that will be lost if its investments turn sour.
This doesn’t make sense to me at all and illustrates, I think, some of the confusion about what savings mean. The passage seems to assume that the main economic problem facing a developing country is paying back external creditors.
But this isn’t the case. External debt is generally is a problem for smaller countries, but as the Reinhart and Rogoff book, This Time is Different, makes clear (and this is something that most financial historians already knew), most economic or financial crises are domestic, not external. It is true that many of the crises in the 1980s and 1990s were external debt crises, and this has colored our view of what a financial crisis must be, but this shouldn’t lead us to think that countries only have crises if their savings are insufficient to cover investment (I.e. they are running a current account deficit).
After all the US had no problem paying back external debt in the 1930s and Japan had no problem paying external debt in the 1990s. In both cases domestic savings far exceeded domestic investment – or, to put in the same terms as The Economist, their high investment was backed up by even higher savings – and yet both suffered tremendous slowdowns in economic growth and the US had a financial crisis.
Likewise China of course will also have no problem paying back its external debt, but losses do not occur when you borrow in foreign currency to fund investments. They occur when you invest in projects that are not economically viable, no matter how they are funded.
What is more important, it is not meaningful to say that China’s high investment is “backed” by higher savings. The Chinese growth model forces up savings, by constraining consumption growth, in order to fund investment (a higher savings rate is the same thing as a lower consumption rate) just as Alexander Gershenkron prescribed in the 1950s and 1960s. But once investment is misallocated (or “malinvested”, as The Economist prefers) higher savings is not a solution to the problem but rather a manifestation of the problem itself. If you do not believe this, then Japan’s Lost Decade(s) is very hard to explain.
Perhaps the easiest way to prove this is with a simple thought experiment. Let us assume that Beijing decides immediately to tax half of Chinese household income and to use the money to build a bunch of useless bridges. Would this be good for China? Certainly not, and the impact would be more debt and slower future growth as the cost of the excess debt was absorbed. What happens to the investment rate? It goes up, of course, along with GDP.
But what happens to the savings rate? It also goes up. Why? Because if you cut the disposable income of Chinese households in half, presumably you would cut consumption by nearly that amount. Since savings is simply GDP minus consumption, savings will soar.
Notice that the condition – that savings exceed investment – will still be met, and by definition as long as China runs a current account surplus savings must exceed investment. And yet it doesn’t help. Wasting money is always value destroying, and the fact that it is funded by domestic savings – as in Japan in the 1980s, the USSR in the 1950s and 1960s, and Brazil before 1975 – or foreign savings – as Latin America after 1975 and much of Asian in the 1990s – makes little difference except in the resolution.
Externally funded misallocated investment is subject to “sudden stops”. Domestically funded misallocated investment may or may not be, depending on the structure of the domestic financial system
The bull argument cannot ignore hidden bad debt
So to say that China has already set aside the resources to pay for the losses is, I think, meaningless, especially if it implies that somehow the impact of this wasted investment is in the past and not in the future. China has no more set aside the cost of the losses than Brazil had done so at the end of the 1970s, prior to its own lost decade. The losses are simply buried in the debt.
But an unrecognized past loss must be recognized at some point in the future, no matter how it is funded. On this point I think neither Hayek nor Keynes would disagree. In the end, the strongest indication about whether or not the current Chinese growth model is no longer providing sustainable growth is whether debt is rising faster than debt servicing capacity. This is where the debate must focus. Or to cite John Mills in his 1868 paper “On credit cycles and the origin of commercial panics”
Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.
If capital has been destroyed in the past, and that destruction is currently unrecognized, it must be recognized in the future, like it or not. This recognition can occur in the form of what Mills called a panic, and we would call a financial crisis, but given the stickiness of deposits in the Chinese banking system I don’t think this is likely to be the case in China. It can also occur in the form of many years of much slower growth in GDP, as those losses are ground away through excess debt repayment. But it will occur.
So if anyone wants to continue to be very bullish about Chinese growth prospects over the next decade, it seems to me that he must address and answer these three questions:
- How much debt is there whose real cost exceeds the economic value created by the debt, which sector of the economy will pay for the excess, and what is the mechanism that will ensure the necessary wealth transfer?
- What projects can we identify that will allow hundreds of billions of dollars, or even trillions of dollars, of investment whose wealth creation in the short and medium term will exceed the real cost of the debt, and what is the mechanism for ensuring that these investments will get made?
- What mechanism can be implemented to increase the growth rate of household consumption?
This is an abbreviated version of the newsletter that went out two weeks ago. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at chinfinpettis@yahoo.com, stating your affiliation, please. Investors who want to buy a subscription should write to me, also at that address.
Thank you, professor. Very educational.
It is a global ponzi scheme of massive debt. Europe and USA are complicit. There are some baby steps to reduce fiscal deficits in Europe and the fiscal cliff coming in USA, but debt loads continue to increase…
…this is because there is only one way to get out of this, and that is a massive global crash.
It must come eventually. The imbalances are far beyond what could be rectified with any slowburn rebalancing.
My guess is we will get a smallish crash within next several months, then hell or high water reflation by all, and then the final horrific crash sometime within next couple of years.
Yes, you are correct, there is an element of Ponzi about it, but you have to look outside the world of finance and examine the aggregate global psyche of humanity to fully understand what is going on. The sociopathic disease of Xtrevilism, that has its well spring in Evilism, was infected into the Chinese culture in 72 by Nixon. The Noble Lie, corporatism and control of global propaganda (think fascism gone underground here) are driving this very intentional, global herd thinning, deflationary spiral.
http://www.boxthefox.com/
We all need to be a lot more skeptical.
Deception is the strongest political force on the planet.
Professor,
I think your mean Hayekian rather than Hayeckian,
Very good post. You are on a streak with several interesting post.
Michael,
The data at the World Bank are indicating that China’s Household consumption has been rising as % of GDP over the last 2 years. It is no longer at the “surreal 34%” that you have been speaking about, and has since risen to 37% of GDP.
http://www.tradingeconomics.com/china/household-final-consumption-expenditure-etc-percent-of-gdp-wb-data.html
However, there does appear to be a small drop in Government Consumption as % of GDP.
http://www.tradingeconomics.com/china/general-government-final-consumption-expenditure-percent-of-gdp-wb-data.html
Adding Household and Government Consumption to get Total (or Final or Overall) consumption, the data are indicating that there has indeed been an increase in overall consumption as % of GDP over the last two years.
http://www.tradingeconomics.com/china/final-consumption-expenditure-etc-percent-of-gdp-wb-data.html
Does this conform to your expectations or predictions? Do the above-linked World-Bank data show the beginning of rebalancing?
If so, how is this happening? Are wages rising? Have interest rates paid to depositing households and interest rates charged to producers been raised? Have bank margins been squeezed? Has the Yuan been allowed to rise? Has a privatization drive been initiated?
Or is this just a sleight of hand “re-classification” that you mention in this article?
Thanks.
The WB seems to be using a slightly different measure than the NBS, Vinezi, and as far as I know the 2011 numbers have not yet been released by the NBS, so we should wait. My instinct is that there was probably little change in the household consumption ratio in 2011 but it might have risen in 2012. The problem is that GDP growth in 2012 seems to have been overstated which will make the consumption ratio look worse than it might otherwise be.
Michael,
You have often spoken about how an artificially low RMB acts to suppress consumption by making imports more expensive (and hence out of reach) of ordinary Chinese households.
I agree with this view, but I wonder whether “increased cost of imports” is the ONLY mechanism by which household consumption gets constrained by the artificially-low RMB.
In particular, I note that in order to keep the RMB down in the face of the Current Account Surplus, the Central Bank keeps piling on MASSIVE Forex reserves. In addition, the Central bank then forces banks to keep some of these reserves (or their printed RMB equivalent) on their books as “dead capital” that earns them no interest. Since the banks have to compensate for this loss, they can do two things:
(1) Pay depositors (household consumer in net) lower interest rates, or
(2) Charge borrowers (SOE/Corporate producers in net) higher interest rates.
Since Chinese policy places a ceiling on both lending and borrowing interest rates, it follows that the banking system recovers the cost of holding these massive reserves by paying even lower interest rates to the depositing households.
So this “artificially-low currency” factor may actually be a part of the “low interest to depositors” MAIN factor you also mention in order to explain the very low consumption (or high imbalance) levels that we see in China.
Does this sound logical? Or do you see a flaw in my chain of thought?
Thanks.
You are right. The low interest the PBoC pays feeds directly into transfers from the household sector, and should be included as part of any financial repression cost calculation.
Michael,
You have often commented that the economic “miracles” in Nazi Germany, USSR, Brazil, Japan & now China all followed this “debt-driven investment model” that eventually leads to an unsustainable rise in debt levels and so forces either a slow-down or collapse.
Now, the data for Nazi Germany & USSR are difficult to find. But the data for Brazil, Japan & China are available at the World Bank Website.
http://www.tradingeconomics.com/china/indicators-wb
http://www.tradingeconomics.com/japan/indicators-wb
http://www.tradingeconomics.com/brazil/indicators-wb
Could you tell us (perhaps in a future blog article) specifically which parameter(s) we should look at in order to extract evidence of this “debt-driven investment model” and how we can tell if a given country is “headed towards an unsustainable rise in debt levels”?
I can see the similarities between the data for Japan & China (super high savings, super high investment, constant trade surplus, low household consumption). However, the Brazil data for the late-sixties and seventies have NOTHING in common with China or Japan. Brazil seems to always have had high consumption, moderate savings and moderate investment— and yet you point to their debt debacle in the 80s.
So I am unsure as to what it is we are supposed to correlate with the idea of “debt-driven investment models that eventually lead to an unsustainable rise in debt levels”. In Brazil’s case, where does it show up in the World Bank Data?
In fact, in the 70s, Brazil seems to have had a domestic savings rate of ~20% and a Current Account Deficit of ~5%, leading to a total investment rate of around ~25% of GDP. And yet, Brazil seems to be doing a 10% GDP growth rate. How was that possible? I mean most industrializing nations need 35-40% investment rates to get to 10% GDP growth rates (ICOR 3-4%), but Brazil (at least according to WB data) was doing it at half that investment rate. How did Brazil manage to grow so fast at such low ICOR?
Could you please elaborate on why the Brazil data are so different from the data on China/Japan? Was the “Brazilian Model” of the 60s & 70s different from the “Japanese/Asian/Chinese Model”, and if so, how?
Thanks.
I have not studied Brazil deeply, but my guess is that in all cases an unsustainable expansion of debt is involved. My understanding is that due to its geography, it is very cost ineffective to develop Brazil’s interior, because it rises considerably in elevation from a very narrow band of lowland at the coast. It has been difficult to gain the economies-of-scale in the interior that could justify the transportation infrastructure. Yet most of the resources are in the interior.
So I think Brazil misallocates capital in a different way than China does– it is a fundamentally geographic problem that causes Brazil’s debt and economy to spike and then crash. But again I am not well studied, and await the professor’s comments.
http://www.financialsense.com/contributors/john-mauldin/2011/08/12/the-geopolitics-of-brazil
You may be right about the inland/mountains issue, but my question was more about why/how the Brazilian Model was different from the Japanese/Asian/Chinese Model.
Here is a night-time satellite image of Brazil showing the settled/developed areas:
http://alturl.com/beuih
And here is a physical map showing the Mountains (Serra), low-lying Coastal areas and the Amazon Basin of Brazil:
http://www.ezilon.com/maps/south-america/brazil-physical-maps.html
Brilliant question!
I had another conceptual idea, that I did not test against reality.
Maybe the common theme is the rate at which imbalances develop.
An exporter running a trade surplus, either has to recycle into assets in the foreign currency, as China does buying USTbonds and net importer of commodities, or it has to find another place to put the surplus.
Brazil is an net exporter of commodities, so it would either have to buy USTbonds or let its currency float and so let its consumers import a lot based on the strength of the Real. So perhaps the problem is that Brazil is driven into consumer bubbles, due to being primarily an exporter and importer, and not a value-added manufacturer.
In short, perhaps Brazil doesn’t have a sufficiently diversified economy, and is dominated by its massive ratio of exportable resources relative to industry. I think Brazil has tried to find ways to consume more of its own resources, i.e. 100% ethanol cars.
I didn’t go verify any of this against the reality in Brazil’s history.
If true, we can see that being a net exporter (or net importer in USA and Europe’s case) isn’t good for sustainable growth. Imbalances develop.
Yes, Brazil used a very different form of the investment-driven model and you can read more about it in Jeff Frieden’s book, Debt, Development and Democracy. I will address this more fully elsewhere, but the key to remember is that Brazil, especially after the period of the petrodollar recycling in the mid 1970s, financed its investment with foreign capital, which would have pushed down the savings rate. Before that the main mechanism Brazil used to subsidize investment was direct taxes, especially income taxes. By the late 1960s probably and certainly by the 1970s much of Brazilian investment was either being siphoned off in the form of fraud, put into huge investment projects that may have been profitable for the sponsors but not useful for the country, and went into its own “Go West” program, which included the development of Brasilia as the capital.
Micheal Pettis wrote with regard to Commodities in last month’s article: “…..When financing costs are low or even negative in any economy, there is a tendency to accumulate inventory since it is not only easy to finance but, thanks to low or negative financing costs, it can also be extremely profitable. If prices just keep up with inflation, inventory earns a profit, and the greater the pile, the greater the profit…………..”
—
Michael,
With regard to the unsold and/or unoccupied flats in China, would it be correct to regard them also as a sort of “inventory”.
Could we also argue, as you have for commodities in the quote above, that the low or negative financing costs means that this “inventory” of housing is not only easy to finance, but also profitable, since rising house prices increases valuation of the “inventory” and can be used as collateral to taken on even more cheap debt?
Is this a correct view of looking at unoccupied/unsold housing?
If so, would it be correct to say that a significant portion of China’s housing output (the unoccupied part) is not really Fixed-Investment (as it is normally considered), but rather a more wasteful excess-inventory component of savings?
I mean Savings = Fixed_Investment + Inventory + Net_Exports.
Obviously, occupied housing (normal) would come under Fixed_Investment, but shouldn’t unoccupied housing (abnormal) be separately booked under “Inventory” and not under fixed_investment. Is this a correct or logical view? Is this how China reports its GDP numbers? Or do the Chinese Accounting Authorities book unsold as well as sold & yet unoccupied housing also under “inventory” and not under “fixed_investment” ?
Thanks.
Yes, you can think of unsold and unoccupied apartments as inventory. I certainly think of it that way.
Michael,
You are probably used to “Pettis-Bashing”, but it is new to me and so I find it astonishing whenever I encounter it.
Some of the very people who are commenting on your blog are indulging in personal attacks. on you all over the place.
For example, the person who made the following comment on your blog–
http://www.mpettis.com/2012/04/09/the-ways-china-can-rebalance/#comment-7837
seems to have launched a campaign of personal attacks against you. As you can see here–
http://alturl.com/td8kz
Astonishingly enough, they call for you to “be shot” or “deported” and comment that “you look like a crook” and that “Patrick Chovanec just looks like a creepy weasel”. I also think they are accusing you of lying about your academic credentials and possibly misquoting you without providing links to your blog.
What do you think is causing this great and intense animosity towards you (and Chovanec)?
Is it just a puerile sense of misplaced nationalism? Or do you think it springs from a deeper problem of cognitive dissonance in which people know something is wrong but simultaneously insist on holding to a belief that everything is right? What is your take on this?
Thanks.
I fear that as things go insoluble in China, the rational leaders will be pushed aside by those who can promise such illogical nationalistic furor.
Perhaps it is comforting that he is only a low rank 1-star Major General and the higher-ranked 3-star Colonel seems to be a bit more level-headed, yet also can’t seem to grasp (after admitting that the economy is a net-zero-sum game), that subsidizing the social safety net or interior development, is a net cost to consumption, because much of the investment is unproductive.
The reason these guys don’t understand the economics, is because they fundamentally don’t understand the concept that giving away things for free, is the same as wasting other people’s money:
http://www.mpettis.com/2012/09/16/by-2015-hard-commodity-prices-will-have-collapsed/#comment-17051
Because only people who have their money at-risk in investments, will make decisions based on return on investment. When the central authority dictates that stolen capital (i.e. taxes) must be spent, it doesn’t have to be concerned with return on investment. Actually the bigger picture concept is degrees-of-freedom. When a centralized entity is taking capital from individual households, and reallocating it to households, this is not a net-zero-sum result, because the central authority can never fit the investments as well to the optimum opportunities, as could many individuals who are closer to the diverse individual opportunities. These chinese military officers view it just as a zero-sum moving capital around. But capital never moves without friction. The friction of a central authority is exponentially (the equation for entropy and thus degrees-of-freedom provides for this) greater than for many individuals moving capital. And what is capital anyway? Capital is the potential future human actions and other resources (money is only one tool to control and allocate capital).
So where ever Pettis says lower the fixed investment share of the GDP, what he really means fundamentally is to lower the centralized share of the GDP. When this share gets too high, is indicative of exponential waste (and thus there must be massive hidden debt in the economy).
It is not surprising to me that the citizens of China don’t understand these concepts, because otherwise why would they keep repeating the same “bigger is better” and “collectivism” disasters over and over in their history (note I am not well studied on China’s history just my impression)
On the math of how economy relates to the entropic force and the degrees-of-freedom in the microstates of a system, which now has a proven relationship to gravity and all other major theories of the universe as emergent, please see the video link at this post I made else where:
https://groups.google.com/d/msg/scala-debate/vysv97J0xok/l1boM1tvpZgJ
I am reminded of my prediction from 2011, of the reason why I thought the EU will not disintegrate:
http://www.coolpage.com/commentary/economic/shelby/Understand%20Everything%20Fundamentally.html
“organisms which are unable to comprehend the mechanism by which they are consuming resources faster than their ecosystem can replenish, thus are unable to stop the mechanism before they perish. So the implosion of the friction and thus the order only occurs when they perish, because they will continue to repeat the mechanism which they do not understand to be a cause of their suffering”
Clearly these Chinese military officers don’t comprehend the mechanism by which redistribution of capital from households to households, actually wastes capital and is not a zero-sum economic result.
Vinezi, yes this is a pretty regular problem here in China and many Chinese and foreign economists and commentators complain about it. I think this is a legacy of the Cultural Revolution, in which any skepticism is met not with counter-arguments but rather by claiming that the skeptic is part of an conspiracy to undermine China and demands that he be silenced. Obviously this should indicate pretty clearly how little intelligence and understanding informs the criticism. Fortunately among younger Chinese, unless put to it by their professors (and for some astonishing reason among many Chinese professors the preferred manner of debate is to demand that the authorities prevent the opponent from debating) this kind of thinking is much rarer. At schools like PKU, Tsinghua and many of the top universities in China there is room for lively debate. Fortunately several of the posters admit they don’t know much about economics because some of the things they say are pretty funny.
Very interesting. But is the culture amongst your intelligent students indicative of the culture and economic awareness of the citizens and thus politics at-large.
If the students rise up again (thinking of Tiananmen Square) to say “enough is enough” of this corrupt system, will the citizens-at-large be in support of further dismantling the centralized gridlock.
I like to draw on different scientific disciplines to analyze reality, e.g. economics, political science, pyschology, physics, etc..
I can understand that for obvious reasons (being a professor in China) you can’t probably speak to such political outcomes in public. It seems to me that the politics is very important for determining what outcome China will choose.
In the USA, the start of “QE-Infinity” before the election (with the M0 monetary base just in past 3 years malforming to a massive hockey stick two centuries in scope), is in my opinion a death call to the ubiquitous “do not tread on the free market” American culture endemic to Andrew Jackson’s era. That culture still lingers but has fragmented into for example a minority of millions “take my gun from my cold dead hand” (which is something different than “I will take my pitchfork to D.C.”)– individualistic nonetheless. Perhaps the people don’t realize that QE-Infinity is so the bankers can own all of the mortgaged real estate:
http://www.financialsense.com/contributors/catherine-austin-fitts/qe3-pay-attention-if-you-are-in-real-estate-market
Perhaps they don’t understand we are at step “Buy up as many remaining assets on the cheap as possible. Hide this action.” in the banker business model:
http://www.silverbearcafe.com/private/01.10/thinklikeabanker.html
http://www.silverbearcafe.com/private/06.11/owntheearth.html
All over the world it seems very few people want to fight the theft from prosperity caused by rampant centralizing of the management of global capital. In Europe, the citizenry of the periphery are rioting to have their debt cake extended without any defaults, thus without any return to free markets. And in the core, the citizenry support such, if it is coupled with ever more centralized control over the periphery.
I felt so ashamed/depressed to be living in this epoch, until it occurred to me that maybe this ubiquitous idiocy is reflective of some major shift between some old paradigm that can no longer compete, and that the majority of the people are still stuck in that old paradigm.
I have explained in past comments on your blog:
http://www.mpettis.com/2012/09/16/by-2015-hard-commodity-prices-will-have-collapsed/#comment-16753
that I think we are in the transformation at the cusp of the death of the industrial age and a new information technology age. Many of the youth seem to be totally immersed in the coming information technology age. A problem is that demographically the youth are much diminished in political power in the developed world, because the boomers were killing 40 million a year with abortion alone (not including contraceptives). Thus they can not overthrow the current Apocalypse in time to prevent the boomers from destroying themselves (to culminate within this decade).
I have found the 10 year research into the 4th Turning (Long Wave Cycle) to be very relevant in explaining what we can expect coming:
http://goldwetrust.up-with.com/t9p570-inflation-or-deflation#4735
P.S. I love your blog, but I won’t keep spamming it with my repetitious points.
Hi Michael,
I don’t follow your thought experiment. Where does the extra debt come from when the government tax the household to build useless bridges?
p.s. I think you missed a “not” in this sentence: “Any China bull that does address these three questions is missing the point.”
They don’t tax. they borrow.
I’m more curious how you can actually build “useless bridges” in areas where infrastructure is barely viable, and build “useless houses” in a country with 75% of the population inadequately housed.
Likewise I can’t fathom how one can dismiss the construction of hospitals, schools, waste treatment plants, etc as “bad investment”, and then point to Chinese educational expenditures as a financial drain. Yes, China still does need trillions in investment. They need more airports, roads, schools, hospitals, houses, more railways, better ports and power lines, more power plants and wastewater treatment centers. Spending on healthcare, education and research is also very low.
This is especially striking coming from someone who, by all accounts, seems to be a booster of the US economy. Do you really think the only way China can develop is by spending $45,000 a year on almost getting half of their 18 year-olds worthless degrees? Should they consume every new version of iWhatever that Apple releases each year? Should they increase their spending on pet boutiques and flashy cars?
You seem to think the only way for the Chinese economy to grow is to import more overpriced branded goods from the developed world, because surely Hummers and European wines are so much more critical than “worthless roads” in a nation that is laughably (or miserably) underpaved and underbuilt? Meanwhile piling on insane consumer debt.
As far as I can tell the lion’s share of the much vaunted private consumption in the US can be seen as horrible investments that yield negative returns as soon as the credit card is swiped. No, you really do not need 10 pairs of shoes and 100 different outfits.
As far as your constant swipes at the CCP for “consumer repression”, take a look at the savings/consumption patterns in Singapore, Taiwan, and even among Chinese Americans and see if that tells you anything.
I think you have misunderstood what is being said.
GDP = Consumption + Investment + Net_Exports
GDP_GrowthRate = Consumption_GrowthRate X (Consumption/GDP) + Investment_GrowthRate X (Investment/GDP)+ Net_Exports_GrowthRate X (Net_Exports/GDP)
A) The Consumption_GrowthRate in the last decade averaged 6-7%. –
http://www.tradingeconomics.com/china/final-consumption-expenditure-etc-annual-percent-growth-wb-data.html
Assume that this stays at this same average level of 6-7% over the next ten years.
B) The Net_Exports_GrowthRate in the last decade averaged 5-6% –
http://www.tradingeconomics.com/china/exports-of-goods-and-services-annual-percent-growth-wb-data.html
http://www.tradingeconomics.com/china/imports-of-goods-and-services-annual-percent-growth-wb-data.html
Given that the US/EUR cannot tolerate any further growth in China’s current account surpluses, it is not unreasonable to assume that this will go to an average close to zero or even slightly negative over the next ten years.
C) The Investment_GrowthRate in the last decade averaged 13-14% –
http://www.tradingeconomics.com/china/gross-capital-formation-annual-percent-growth-wb-data.html
In order to rebalance, assume that the Investment_GrowthRate averages to ZERO over the next ten years.
If you plug these values into the original equation, you will get an average GDP growth rate over the next 10 years of ~3-3.5%.
This is what Michael has been saying.
———-
Now your point is this: China still needs a lot of investments.
You are correct. China does. No doubt about that, as China is still a developing country.
China’s current annual investment is 3.5 Trillion US$.
http://www.tradingeconomics.com/china/gross-capital-formation-us-dollar-wb-data.html
So even if Investment_GrowthRate averages ZERO over the next 10 years, it means that China will keep investing 3.5 Trillion US$ per year over that period– giving us an total decadal investment of **35 Trillion** constant US$.
This is a MASSIVE amount of Investment.
And it will still continue to be made EVEN in the presence of 3-3.5% GDP growth.
35 Trillion US$ of investments should be more than enough to build the actually-needed low-income housing, water-treatment plants, schools, hospitals and so on that you mention.
Do you see the point? Zero Investment_GrowthRate does NOT imply Zero Investment.
China will continue to make massive investments. It is just that its investment growth rates will drop sharply. And this will automatically cause GDP growth rates to drop sharply. That is all Michael has been saying. Michael is NOT saying that China will stop investing altogether.
I hope my comment has been coherant and my point clear.
That seems to operate off the assumption that the consumption figures released by the CCP are reliable, and actually accounts for the vast untaxed service economy along with the services the CCP does not even count as GDP.
As for investments, I haven’t really done the math but I’m not convinced the model being presented is realistic. China’s aggregate net worth is something like $20t now. If China really has been investing $3.5t every year (give or take) it stands to reason that much of this money is simply recycled and not taken from some other sector and permanently locked into industries with overcapacity.
For one, rising incomes would account for quite a lot of “investment growth” as China’s current stage of development is highly labor-intensive. Second, roads and buildings require maintenance which likewise required increased wages – though admittedly I don’t know the accounting behind this. Third, much of the “low-hanging fruit” has already been picked. Building roads along the flatter plains of East China is relatively less cost-intensive than say paving through deserts, hills, tundra etc to link the interior to the coast. To maintain 0% investment growth would mean that China could sustain 0% wage growth for millions of workers, pay no maintenance and develop the interior at essentially the same cost as the East Cost, which does not stand to reason in my opinion. This is a generalization, but the vast majority of investment in China is into real estate if I’m not mistaken.
(A) The return of the good old informal-economy. I have nothing to say about that and I will stick to the data we have available. You may well be right. There could well be an underground consumption-based economy that more than balances China economy right now. China may have nothing to worry about. Premier Wen and all his economic advisors may just be panicking for no good reason at all. Perhaps we should inform them of the existence and extent of this consumption-based shadow economy so that they don’t fret so much.
(B) Please take another look at the graph that was provided. China’s investment was 3.5 Trillion$ for 2011. Given that we saw an average 14% investment_growthrate over the last 10 years, and allowing for dollar-inflation, it follows that China’s investment 10 years ago was only 0.5 Trillion $. This is the effect of compounding of growth rates. You can see for yourself here (focus window on 2001-2011):
http://www.tradingeconomics.com/china/gross-capital-formation-us-dollar-wb-data.html
Do you see what I mean? Similarly look at the same graphed data over the eigthies & the nineties to see the cumulative decadal investments levels in China. You can personally verify the following:
The cumulative investment from 2001-2011 was 16.8 Trillion current dollars.
The cumulative investment from 1991-2001 was only 3.5 Trillion current dollars.
The cumulative investment from 1981-1991 was a mere 1.1 Trillion current dollars.
Allowing for depreciation, does the sum of the above cumulative investments from 1981-2011 give you the “$20t” “aggregate net worth” for China that you mention.
Do you find this surprising? You should not, because this is typical for any poor-country that grows through 30 years of rapid growth as China has from 1981-2011.
As for the NEXT ten years, all I am saying is that, even with GDP_growthrate at 3-3.5% and with Investment_growthrate at 0%, we will see:
The cumulative investment from 2011-2021 will still be at least a MASSIVE 35 Trillion in today’s dollars.
I have no idea what “recycling” and “permanently locking” means. These are round-about financial terms, they have little meaning in macroeconomics. Either an investment was made or it was not. Either something was built or it was not. The data from the WB I provided indicate that the investment in 2011 was indeed 3.5 Trillion$. I will leave it to you to ponder the meaning of that data.
(C) As for rising wages, incomes, consumption and so on, you are correct:
(1) Wages must rise. And they will. That is needed for rebalancing.
(2) Rising incomes will require further investments in consumer industries. And these investments will be made.
(3) Physical structures do need to be maintained. And they will.
(4) It will prove a lot more expensive to build a road or a bridge in hilly or desert regions. Nevertheless, these roads & bridges will still be built in the Western regions.
(5) Zero Investment_growth rate does not imply stagnant wages. Please rethink this carefully. Wages will certainly rise.
The costs of items (2), (3) & (4) can very easily be included in the MASSIVE, UNPRECEDENTED 35 Trillion$ figure for the cumulative investments to come over the next 10 years.
I hope I have not been unhelpful.
Hello Hello,
(A little word play there).
But here are some things for us to reflect upon on a FUNDAMENTAL basis.
1) You are correct that China is still a relatively poor, developing country and clearly needs investments in a number of areas. So how do you account for the fact that China has been running consistent Current Accoung Surpluses?
In macroeconomics, a current account deficit implies that investment-needs are greater than available domestic savings and, conversely, a current account surplus implies that investment-needs are LESS than available domestic savings.
If China is in such need of investments as you say, why is it running a current account surplus? This does not make sense at all. What are your thoughts on this?
2) I agree with you that a large section of the population is “inadequately housed”. So how do you account for the large number of empty flats across China today? By some accounts the number could be as high as 65 million unoccupied flats. This is not a small overhang; this is MASSIVE, indeed, it is something without parallel in history.
http://alturl.com/5n4x6
http://alturl.com/q6nc7
3) There seems to be a trend of overcapacity in sectors “favored” by the Government, and severe under-development in sectors considered unimportant by the Government:
(a) Massive Steel Overcapacity worries Beijing.
(b) Massive Cement Overcapacity worries Beijing.
(c) Massive Automobile Overcapacity worries Beijing.
(d) Massive Solar-panel Overcapacity worries Beijing
(e) Massive Wind-turbine Overcapacity worries Beijing
If Beijing is worrying, so should we. That only seems reasonable. China’s Premier Wen Jiabao stated in 2007 that China’s present growth pattern is “unstable, unbalanced, uncoordinated and ultimately unsustainable.” Was he wrong? Is he wrong?
What do you think?
1) All of the East Asian tigers and Japan racked up surpluses over time as they were developing. In my opinion it has served a strategic advantage and is also a byproduct of the fact that they essentially needed enough USD to stabilize exchange rates.
2) 65 million unoccupied houses at the extreme end sounds like a lot, but this is China where not only the populations are huge but the houses are also small. People either cannot afford to move into cities because either a) there are no employment opportunities established yet or b) they cannot afford otherwise to move. China has traditionally had large swathes of unoccupied real estate that filled slowly to begin with, and then more rapidly as incomes and opportunities grew. Likewise, it makes no sense to leave millions of construction workers unemployed when there is work needed to be done, even if it incurs otherwise avoidable maintenance costs. This could be a problem in the future where the construction industry becomes too massive and gains too much bargaining power as in Japan, but the CCP (for now) has the power to break such vested interests.
3) I would say you have a general point but Beijing is always worried about everything.
1) China is not holding on to 3.25 Trillion$ reserves to “stabilize” anything. China and Japan both keep piling on the reserves to prevent currency appreciation in the face of their massive current account surpluses. This is mercantilism and not prudent monetary policy.
http://www.tradingeconomics.com/china/total-reserves-includes-gold-us-dollar-wb-data.html
The 2 most important thumb-rules for adequate Forex levels for the sake of “stability” are:
(a) 6-9 months of imports (Note that China has 22 months, implying massive excess)
http://www.tradingeconomics.com/china/total-reserves-in-months-of-imports-wb-data.html
(b) 100% of total external debt (Note that China has 530%, implying massive excess)
http://www.tradingeconomics.com/china/total-reserves-percent-of-total-external-debt-wb-data.html
So clearly, China is not holding such MASSIVE reserves for “stability”. It is holding these gigantic reserves in order to maintain its currency-peg (i.e. prevent RMB from rising) in the face of large and consistent current account surpluses. This is currency-manipulation that is typical of a mercantilist model.
2) I agree with you that 65 million unoccupied flats is a lot. Now you suggest that these unoccupied flats are just sitting empty because they are waiting for the migrants that you project will come to the cities in the next 10 years. You agree that there are maintenance costs, opportunity costs, interest costs and so forth, but you feel it is worth it because otherwise millions of workers would be unemployed.
I do not understand this at all.
Let us say millions of workers are right now building (quote) “ airports, roads, schools, hospitals, HOUSES, more railways, more ports, more power lines, more power plants and more wastewater treatment centers” for the migrants that you project will eventually come to the cities in the next 10 years when jobs become available for them.
So what will these millions of workers be doing next year? As the investment-level keeps accelerating, in order to keep these workers employed, what is now being built 10 years in advance, will soon need to be built 15 years in advance, and then 20 years in advance and so on. Eventually, logic dictates that such as system must eventually collapse under the weight of the “maintenance costs, opportunity costs, interest costs” of holding all that unused/underused/unoccupied infrastructure (i.e. overcapacity).
This is the very real danger that China faces today. And this is one of the key points that Michael has been trying to make. You cannot keep bringing future demand into the present indefinitely and still keep increasing investment levels.
3) I agree with you that Beijing is always worried about everything. In my view, they have every reason to be, as I explained in (2) above. Beijing is worried because Beijing should be worried. Very worried.
I hope my comment has been reasonably meaningful.
It is not a strategic advantage to have such a misallocation inertia. I explained the math at the following link.
http://www.mpettis.com/2012/10/27/when-the-growth-model-changes-abandon-the-correlations/#comment-19222
As usual well, a well written article Michael. But after some deep thinking recently, we need to take our thinking, logic and economic sense acquired in the west to a whole new different level if we were even to hope to understand the problems, as well as the opportunities in China correctly.
For example, a self-fulfilling prophecy, although vulnerable in other circumstances, can work for a long time in a very large, complex and growing economy, hence your opponent’s third argument about “growth brings urbanization, and urbanization brings growth” is not entirely without merit despite that it is a circuit logic; Similarly, the Economist’s comment on “investment does not need high rate of return because saving rate is lower”, albeit sounding nonsense to you and many other economists, is actually spot on for the circumstances; and your question about “who’s paying the debt”, an invaluable question otherwise, might be slightly beside the point in China. Empirically, we’ve seen how debts have been paid in China: by the people and saver, through depressed wages and artificially low interest rates; by the environment, through pollution; by the future life, by the underpayment to social security net; and ultimately by everyone of us on the planet, through capital inflows, consumption of Chinese goods, global warming, etc . You could argue this is making no sense, but it does; You could argue this is the cheating, it surely is. But you can’t argue this is not happening.
So I think both the China bears and China bulls are right: there are plenty of things to make you worry, and there are plenty of things to make you hopeful and happy. That where China’s going does need a long term view, so I think the South China Post OpEd is spot on but still short on timing: In order to succeed in China, ask yourself not about five years, or ten years, but a life time. Whether us individuals have that time horizon is another question, but even that, I feel unfortunately we don’t have much of a choice. China’s so big it can’t be ignored.
I am more than happy to share a more detailed visiting research report I wrote if you send me an email in private. These are interesting times and we should feel great to be part of the history.
reply was interesting will you share the possibility to read the report….post a link here?
Michael
Thanks for another great post. While it is fairly clear to me why Wall St sell side economists are willing to ignore the economic rationale that you present here and in your previous posts, I can’t see why publications such as The Economist are willing to unquestioningly follow their line. This business of reclassifying some investment as consumption makes little sense, however The Economist swallows it hook line and singer. Do you have a view why they are so keen to persue the “China will be the dominant economy and has no problems” line of thought?
I don’t think we need to explain disagreements by pursuing supposed motives.
John, I think Michael thinks the debt comes from the ‘useless’ in ‘useless bridges’
That means the savings are gone or wasted, not there anymore.
Remember that excess debt doesn’t pay for itself, and if you cannot identify who is paying, then you haven’t resolved the problem. Many people, for example, argue that bad debt isn’t a problem for the same reason that China “grew out” of its debt crisis of the late 1990s. This is idiotic. China did not grow out of the debt. It merely forced the cost of the crisis onto the household sector through repressed interest rates and a wide spread between the deposit and lending rates.
Dear Mr. Pettis, I shall say that the ratio of debt to GDP matters, not the nominal debt, and what matters is the real organic GDP level and given policy intervention, it is hard to know what would be the CHinese GDP if you close your eyes and imagine that the Chinese Government decides to mimick the level of intervention that exists in Hong-Kong (which is fairly small). How large would the economy be?
We have a bubble of government intervention and debt around the world. It is usually not good news for financial assets versus real assets, when the resolution is to avoid bankruptcies…. (first there is the classic deflation relief rally, but then the monied capital gets converted into circulation and watch for prices!!!)
Yes, and because there is so much debt around the world, it is all the more difficult for individual countries to resolve their domestic problems. The external sector provides little help.
Well, one way to help consumption, is for the current political structure to resign and move to less intervention in the economy and let the restructuring of debt happen, and let the bad investment clear without letting price structure crumble in deflation on the other side. And then as you pointed privatize and for the Gov to move out of the economy as much as possible.
Michael,
I generally agree with your thesis. I’m an Austrian with a hatred of malinvestment. But there’s a thought that’s been bothering me over the past few months, that may help explain why sometimes it takes a long time for bad investment to wreak havok. Even a semi-free economy is more robust than free-marketers like myself typically assume. Why is malinvestment of a limited extent more damaging to an economy than welfare-statist consumption? In the US we had hundreds of billions of dollars borrowed or taxed from productive people, and it was transferred to people who produced nothing, and instead consumed almost all of it on ephemeral goods and services. Basically this is investing in a project with an IRR of negative 100%. What if instead of that pur consumption spending, the government had invested in a rail project with a negative 10% IRR, with some of the welfare cases getting some of the employment? The net result to the economy would be somewhat better I think.
I’m not advocating either policy – in fact, I oppose both. But when I think about the high consumption US (and other developed countries), where perhaps 20% of the economy is welfare-state transfers of potential savings from productive people to consumers who produce no economic value, and are in effect, negative 100% IRR projects, the alternative of moderately negative IRR malinvestment looks like a better policy.
Consumption after all is a black hole for long run economic growth, contributing nothing to the provision of future goods and services.
I think it is a balance between consumption and fixed investment that implies there is not massive debt misallocation in the economy. When we see the huge imbalance to either side (e.g. services 70% of USA economy), then it is indicative of some force that is manipulating the free market. In the USA it is the central bank forcing interest rates too low coupled with a world reserve currency and high relative wages, and in China it is the currency peg to the reserve currency coupled with low relative wages.
That is why I wrote in my first comment on this blog page, that both the USA and China are complicit.
A. West, it is interesting that you raise these thoughts. When Mr. Pettis discusses Chinese malinvestment, I think of the terrible circumstances in the U.S. over the previous decade. You mention social transfers and I would also add defense expenditures. I am not anti-defense, but I think the only thing large U.S. defense expenditures contribute concretely to the future is subsidizing defense firm R&D to produce more sophisticated weaponry later. (Yes, defense spending contributes to security but it is not a concrete investment. Secondly, I would decline to have a debate at this time over whether U.S. defense spending increases U.S. global economic influence.)
More troubling for me was the malinvestment in real estate that I think caused the real destruction in U.S. GDP that is now being propped up by U.S. govt. spending and Fed monetary policy. This is the root of the slow recovery.
If I had to guess, social transfers and defense spending would be viewed as annual government priorities and claims established on the productive sectors. A highly-productive society with a financial system that can allocate resources quite efficiently can support these on-going expenditures, but certainly at a cost. However, excessive real estate construction and underused bridges are eventually a deadend. At some point, even a fool will not build another house next to an empty house nor erect another bridge next to an unused bridge.
I am sure we could look at every economy in the world and point to malinvestment. I think the questions are how is this malinvestment limited, how productice is the economy and how quickly does the economy adjust. Perhaps I am naive, but I think the U.S. economy is very dynamic and can deal with this better than most economies. In addition, the US Dollar’s role as the global reserve currency also lowers financing costs and improves the ability to raise capital which helps it overcome malinvestment.
How to be a china bull?
1) claim that china will surpass U.S. no matter what happens
2) Claim that a country geography does not matter
3) Claim that china government is omnipotent
4) claim that normal economics don’t apply to China, then come up with a wacky reason why (they are communist, they are hardworking, they don’t need food and water to live etc)
I have a contrarian speculation on recent events, that there may be a cash crunch developing in China, and/or the party insiders are cashing out.
We know that FDI (foreign direct investment) reversed recently, and is now in outflow.
Before the one week holiday last week, the largest injection of reverse repos ever. Most viewed this as sign that China was ready to ease as needed. I viewed it as a liquidity crunch. Reverse repos are short-term liquidity only.
Now I see the market is viewing SSE law mandated stock buybacks and the State investment company stock accumulation, as being votes of confidence:
http://www.bloomberg.com/news/2012-10-09/china-s-stocks-rise-to-3-week-high-on-economic-stimulus-optimism.html
My contrarian view is that this is the insiders misappropriating funds in order to help keep stock prices up while insiders cash out their stock options, and/or this is blind confidence similar to what we saw from the military officers in the prior comments.
I am also thinking that if the global consumer is imploding as much as I think, then any China massive stimulus program will actually cause the *real* GDP to implode. I speculate that China does not report the true price deflator (based on reports from within China that no one believes the CPI number), and thus their true GDP number is much lower than reported.
Note that much of data coming from all governments is probably lies now, e.g. even the BLS doesn’t release survey data, rather they release a blackbox generated dataset:
http://www.financialsensenewshour.com/broadcast/fsn2012-1006-3.mp3
Everyone is accustomed to thinking that China could stimulate a real GDP boost. I think it is false. They were able to hide it in 2008 (even professor Pettis had questioned their reported inflation rate back during the reflation), because the global consumer was also being reflated in the West to some extent. But now with exports cratering, I think they are unable to hide for much longer the real data.
Thus I see the recent events above as crunch time and denial extension. Again this is speculation, because none of us have the actual data.
Here are the thoughts from Gao Xiqing, the vice chairman and president of China Investment Corp., the Chinese investment fund that is increasing the fund’s stake in the China’s bank stock to which I referred to in my prior comment:
http://seekingalpha.com/article/912211-china-investment-s-gao-xiqing-economy-still-on-right-track?source=yahoo
His reasoning for why China is still in a bull market are flawed for the reasons the professor has pointed out in his blogs.
Gao Xiqing fundamentally misunderstands that (ultimately) demand meets supply at the price that is most economic. Building more infrastructure that China’s population can not afford, is just a subsidy, which is just waste (losses) as I explained in a prior comment about redistributing from housesold to households by centralized decision process.
China has a very low value-added, with many companies operating at thin profit margins and some SSEs operating with a (minus!) -800% profit margin via subsidies from the household sector (as estimated by the professor in a prior blog).
Thus China doesn’t generate enough value to afford this level of infrastructure. They’ve been able to build it anyway, because they stole it from the household sector.
But it is a massive delusion (that only a non-economist could make) to think that they can raise the theft of the household sector to an even significantly higher share of the GDP.
They are apparently able to convince themselves to buy the “crunch” or “dip” based on economic falsehoods. So I think that portends that they will deplete themselves and then the floor will fall out from under them. Massive chaos ahead in China if this represents the true economic reasoning process for the leaders of China.
Note that Gao Xiqing said he thinks they need to slowdown. So I assume that he wants to more slowly accumulate the dip and gain more information. But I doubt he is looking in the right place to gain economic understanding. Rather I bet he is thinking of managing a steady turn back up. Instead he is going to find that the downturn just keeps dipping and the crunches keep coming.
Alcoa seems to indicate that rebalancing is underway in China:
http://www.bloomberg.com/news/2012-10-09/alcoa-earnings-exceed-estimates-after-productivity-improves.html
“It now sees Chinese truck and trailer output slumping as much as 21 percent, compared with a decline of as much as 8 percent projected three months ago. Chinese can and packaging growth may be 8 percent, down from Alcoa’s July forecast of as much as 20 percent.”
So fixed investment must be cratering, while consumer demand is growing yet more slowly.
Also Yum Brands (KFC, Pizza Hut, Taco Bell) reported strong growth in China. Perhaps the news today that Taiwan exports suddenly grew 10.4% and South Korea’s export slump decelerated, could be consistent with China’s consumer imports are growing. I assume Taiwan exports mostly consumer electronics. Taiwan perhaps also got a Christmas and iPhone boost.
If construction and fixed investment are declining at 21% in China, and given fixed investment drive roughly 2/3 of the economy, then China’s nominal GDP may be declining at (-21 x 2 + 8) / 3 = -17%. Inflation is not below 0% in China, thus the real GDP may be imploding.
What am I missing?
Are trucks not even close to a one-to-one proxy to construction? Is construction not a proxy for fixed investment? Is aluminum in trucks not a proxy for truck sales? Is Alcoa at the marginal price for aluminum, thus sees its share of China’s aluminum decline sales faster than the total sales of aluminum in China?
I realize there are many possible holes in that proxy relationship, but still -21% sounds omnimous.
Coupled this with the past 2 weeks have seen two rounds of massive $40+ billion in reverse repo short-term liquidity injections by China’s central bank.
Await more data.
I think Yum would fare very well in a slowdown situation anyway. They can always open more KFCs in the countryside, and those lunchtime meal deals they have now for 15 RMB are competitive with almost any Chinese lunch you can buy. Plus the KFC is usually cleaner. So I think KFC could still grow rapidly even in a huge slowdown. Chinese people still have to eat, and it’s not that expensive.
I think Starbucks, Samsung, and Apple might be better proxies for collapsing consumer purchases. I can definitely see those two losing out big if China slows down drastically. Anyone have any data on theater ticket sales? I can see a lot of people cutting back on those also, when they can pick up a pirated DVD on the street for next to nothing.
For Taiwanese exports, are those components or finished products? China could have a huge jump in imports but if it’s all components to be shipped out again, that doesn’t say much about the consumption situation.
Gold, M0, and China
Very thought provoking article linked below. It is fundamental for our understanding of gold.
http://www.zerohedge.com/news/2012-10-10/guggenheim-gold-and-unsustainable-return-bretton-woods
Gold priced in US dollars relative to M0 (US monetary base)
http://guggenheimpartners.com/GP2011/media/images/MarketPerspectives/Chart-5-Back-Down-the-Yellow-Brick-Road.jpg
Somebody has to dump US Treasuries in order for gold price to rise significantly relative to M0. It is most likely to those exporters who when inflation gets high enough will benefit from lower import prices, more than sustaining exports (stronger local currency decreases exports):
http://guggenheimpartners.com/GP2011/media/images/MarketPerspectives/China-A-Case-Study.jpg
China and Japan hold the most US Treasuries:
http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt
M0 is skyrocketing:
http://upload.wikimedia.org/wikipedia/commons/thumb/e/ef/U.S._Monetary_base.png/220px-U.S._Monetary_base.png
China imports inflation from the USA, because its economy runs a huge trade surplus, meaning that the yuan is not allowed to appreciate in order to balance the economy within China between exports and price of imports. So noting that gross exports is only 30% of GDP, is not as relevant as noting that household consumption share is only 34% of GDP, while fixed investment is over 50%. This means that to fill in the gap in desired GDP growth that unbalanced trade could not create, China resorted to increasing debt in infrastructure.
Thus China’s model will ultimately be stopped by inflation, when the fixed investment and export share of the economy (both being unproductive for consumers and household share of GDP as indicated by the trade surplus) will reach feed mostly into inflation, because of the fixed exchange rate.
SPECULATION FOLLOWS:
None of us have the true data, or at least we can’t be sure if we have or not. The odds are we don’t have the true data, and the likelihood is the truth is worse.
I think China is actually at this point now. I believe if they reported their true inflation (and did not inflate their nominal GDP too), then real GDP has slowed much more than they admit. And I think any significant stimulus can only be in the fixed investment sector for as long as China maintains the weak Yuan, and thus this will feed into inflation and negate the nominal boost in GDP (real GDP is inflation-adjust version of nominal).
It is has become incredibly more difficult for China too, because its major export markets are now declining. Especially true when exports as priced in Yuan are adjusted for true inflation in China, thus without a increase in the value of the Yuan, the consumer share of the economy can not increase fast enough to offset the losses from the export share. And again as I said, increasing fixed investment, will just worsen the ratio to household share, thus exacerbating inflation. Yet increasing the value of the Yuan will necessarily decrease exports, which probably can not be offset by growth in household share, due to its very small size (especially after the multipliers from exports and fixed investment are factored out of the household share of GDP).
I think this is why we don’t see a major stimulus from China now and we won’t see one, unless the GDP goes into free fall. The best hope for China is a gradual rebalancing, and I think that is what they are trying to engineer now, while hiding the fact that real GDP is declining much faster (so as to prevent that panic that leads to the quick rebalancing implosion).
But there is only so long they can hold this lie together, because the perfect storm is brewing against them. They pushed the imbalance too far, and it is much too late (especially when global contagion is factored in) for them to engineer a slow rebalancing.
I don’t know how much longer China can hide their real GDP.
Shelby,
To your last point, the October monthly report from OPEC forecast for China’s 2012 growth in oil demand is 3.29%. The nice thing about oil demand is the tankers are pretty big, and easy to count. My brief look over previous years lead me to think the numbers make sense. A strong 2007, 6.28%. A crash in 2009, 1.47%. Did you see the ships moored in the strait between Singapore and Malaysia in 2009?
Shelby,
Assuming you are correct, or partially correct, what would the economic devastation be? A crash like in the USA?
Also, what would be a way to “short sell” china and prepare for the crash?
End of Finance?
—————————
First, this is not an investment blog.
I will offer my opinion. It is very risky to bet short over any near-term timeline that gives great leverage, because it appears to me (speculation from limited data) that China is increasing subsidies to the export sector (more loans so they can operate longer at thin or negative profit margins), allowing the real estate bubble to reignite to some perhaps limited extent, and injecting massive short-term liquidity via record setting $40+ billion reverse repos. And some (even a quote of the incoming Chinese Premier) think the data out of China is not accurate. So if the market participants are all fooled by this (and even China’s state investment arm and state companies are buying their own shares), then short bets on the market can expire before any crash is realized.
No matter what China and the market do over the next year or two, the Professor has reasoned that ultimately the difficult adjustment process will come. The only question is does it come by proactively beginning the adjustment process and a (hopefully more) muted level of suffering over a longer period of time, or will it be an implosion. Professor Pettis has warned and I agree history has shown that if imbalances exacerbate, eventually it can lead to an avalanche rebalancing.
Also I think China’s Yuan peg sustained the western debt bubble and vice versa, thus there is likely to be a global contagion implosion. The USA remains some what stronger *diversified* economy, because even with its huge real estate bubble, still has 70% consumer share of the GDP (which is the mirror imbalance to China and hints at the complicity), and thus the USA could rebalance by eliminating non-essential consumption and/or removing the friction of the welfare state. This would probably implode China, and thus Germany, etc.
Thus I think there is only one investment option to surely protect a store-of-value, that is not gambling. It is physical gold (and silver) held in your own possession. Whether the politics chooses to exacerbate the imbalances (and thus the negative real interest rates), or choose debt deleveraging crash, gold maintains its purchasing power in both scenarios , and it is the only asset that is not simultaneously someone else’s liability (i.e. there is no counter-party promise involved as with all other assets, even non-allodial titled real estate). Some incorrect logic out there argues that gold is something else, such as a protection against inflation. Gold is a protection against negative real interest rates, and a protection against debt deleveraging deflation (the crash of gold in 2008 was because gold is still price-fixed by futures markets until that bankrupt dollar financial system fails…this requires a very long explanation). See prior comments regarding the monetary nature of gold:
http://www.mpettis.com/2012/09/16/by-2015-hard-commodity-prices-will-have-collapsed/#comment-17029
http://www.mpettis.com/2012/10/07/how-to-be-a-china-bull/#comment-17681
Unfortunately, gold is also an enslavement mechanism, because its supply can only grow at 2-3% per annum. Thus it overly rewards “burying capital in a hole”, which is the antithesis of prosperity (since 2% is a natural population growth rate, unless we destroy future demographics…again antithesis of prosperity). It gives all the power to “he who holds the gold, makes the rules”. So society will always eventually debase any gold standard, and convert it to a fiat, e.g. the futures market in gold now. But during the period of gold discipline, the power will rest with those who control most of the 150,000 tonnes above ground. And certainly that is not the masses. Do I need to define slavery any other way?
I just want to make it clear that I don’t view a gold standard as a panacea, but in the short-term, unless you have an active growth investment, then the safest passive store-of-value is gold (until this global storm is over).
If this global contagion is real, imagine the potential chaos. In my opinion, all forms of financial investments will thus be vulnerable to failure. We’ve already twice had the $billions failure (theft!) of futures brokerage accounts, and in a worsening global crisis, capital controls are possible.
Gold is not the way to prosperity. It represents the old industrial and agricultural world economy where huge levels of capital were predominant over the value of the knowledge creation. This is changing now. Apple has (had) a larger mcap than Exxon-Mobile. A couple of guys in their garage with a couple of computers, can launch a $millions mcap startup software company. Knowledge capital is now outpacing hard resources capital in terms of value creation.
So my thesis is that the trap of the gold standard and the debt deleveraging new world order, will only catch those who don’t shift out of the old world economy. With this in mind, I have stopped all speculation in the financial markets, and have refocused myself back on creating another startup software company (as I had done in the past).
I would urge everyone to look for investments that are knowledge based. There are 7 billion people we need to employ. Manufacturing will move towards automation. The industrial revolution is over. The 3D printer is here:
http://goldwetrust.up-with.com/t182-technology-that-changes-everything#4485
This is probably my last post. I have stopped speculating about when China (and the world) will run out the rope of increasing debt. I have wasted far too much time on it, but it at least it has affirmed what I realized 25 years ago, that it was much more efficient and freedom-oriented for me to be able to create software with a computer, than become an (electrical or otherwise) engineer whose productive output has to be capitalized.
My dream is for this to be the end of finance, and for knowledge based production to exceed the paper value creation of wallstreet. I dream to see a world valued based on intelligence and art, not on gambling, passive investment (i.e. physical savings), theft, deception, leverage, and the “Law of Policitical Economics”. Of course, there is no way all 7 billion people can make that shift, thus its only a dream overall although I dream (very far-fetched) there could be two (mostly) orthogonal economies.
Correction: the second link on the monetary nature of gold should have been:
http://www.mpettis.com/2012/09/16/by-2015-hard-commodity-prices-will-have-collapsed/#comment-16460
The expectation, seemingly quite widely held, that the renminbi will inevitably and before too long replace the US$ as the major global reserve currency seems very fanciful, even perhaps lame-brained. China is not a stable democracy.
Michael,
Thanks once again for such a lucid article.
I had question on the triggering mechanism that would cause China to slowdown to the 3-5% level. During the 1997 Asian financial crisis, the investment bubble in many SE Asian countries was financed by short term capital flows and therefore the outflows of the same caused the bubble to burst and the subsequent poor economic performance. Given your description of the Chinese economy – it would seem that the country is subject to internal bureaucratic forces rather than “external” market forces. If so, what would trigger the crisis?
The parallel is Japan.
What events triggered the Japanese Lost Decade?
Falling collateral value held by the banking system (i.e. Land or Real Estate or House prices).
When Real Estate prices start falling, the “tide recedes and you find out who is swimming naked” (to paraphrase Buffet).
Indeed we don’t know how long the politics will continue to make the bubble worse.
Case in point, it appears that either speculators are misjudging the stimulus and subsidies coming/underway in China, or China is actually increasing subsidies for exports and fixed investment demand:
http://www.bloomberg.com/news/2012-10-13/china-iron-ore-imports-jump-to-20-month-high-in-september.html
http://www.bloomberg.com/news/2012-10-13/china-iron-ore-imports-jump-to-20-month-high-in-september.html
I have seen that the state investment arm and the state companies are buying their own shares. I have seen reports of liquidity subsidies to exporters. Etc.. So it appears rebalancing has been delayed again, and China is going to exacerbate their imbalances, while daring short-sellers to stay solvent for longer than China can remain irrational.
As I said in a prior comment, I think the catalyst that kills the politics, will be massive inflation. Looks to me from available data, that China is going to push it to that end, and then crash more horridly. But the data is also very noisy and we can’t trust any data any way. So we really won’t know until after the fact.
The polticians are accused of giving one of their own a death penalty to cover up the corruption at the top:
http://www.youtube.com/watch?v=oMM11YTw-vY
If they are willing to push it that far, then “let them eat cake” may be the outcome for a while yet.
Dear Michael,
You have argued more than once that the transition to a consumer-driven economy would reduce the price od commodities like copper. I wonder that other commodities as oil, rice etc. could rise. My question is if an hypothetical rise of such commodities is something that the chinese goverment fears as an undesired effect of the transition, and if this fear reduces their enthusiasm about promoting the transition.
I can nearly guarantee you that transition is delayed/avoided, because of the “Iron Law of Political Economics”:
http://esr.ibiblio.org/?p=984
How to explain to someone who believes China is our savior.
—————————————————————————-
Here is an email I wrote to a gold bug, who thinks China’s growth has been good and that China will make a gold standard, that China is fighting the dollar and the “SOB bankers” in the west, and this will be a good outcome. I had reminded him that the bankers are the ones who funded the formative events of the communist rise (as well bankrupting China first with opium and later by demonetizing silver in the west forcing China into depression and off the silver standard). He said he felt China was independent now, and he sees China as the savior for mankind, against those bankers who Hitler was trying to eradicate. Unfortunately far too many people think of China has superman powers.
==================
Please try to read this with an open mind. I am sincerely going to try to explain what I think I know. And I am not trying to be stubborn or to see things only one way. I am going to consider every possibility that I can possibly ask myself below. Please check my logic and see if you can find any place where I am not considering other perspectives that have a basis in known facts.
I want to put the time into this, because I am worried about you putting so much faith into something that might fail you in the end. And that might make you bitter. I don’t want you to be bitter at the end. I want you to win for yourself and for your kids and for a good feeling about humanity. Ditto myself.
Okay let us try to be as objective as we can.
China shares a strikingly low consumer share of GDP, with the worst African countries, e.g. the Congo:
[url]http://data.worldbank.org/indicator/NE.CON.PETC.ZS[/url]
NOTE: we can disregard Saudi Arabia and Luxembourg, because they have very tiny populations relative to the main resource they produce in their GDP (oil and global finance), thus the low share for them does not indicate unfairness for their citizens.
Following charts show that China’s consumer share of GDP has fallen from a normal level of 50% in 1980 to the abnormal 34% today:
http://www.chinaglobaltrade.com/fact/us-china-trade-data-household-consumption-share-of-GDP
http://www.rba.gov.au/publications/bulletin/2010/mar/3.html
While fixed investment (meaning infrastructure & high rises) have climbed from normal levels in 1980 to abnormal levels today:
http://goldnews.bullionvault.com/buy_gold_020820127
China’s per capita consumption of concrete and copper is 3 or 4 times higher than any other nation ever experienced at any stage of development.
So what could this possibly mean? Lets ask ourselves to consider all possible meanings and ramifications.
1. Lets consider if this means that China has been doing its citizens a favor, by accelerating development and modernization of infrastructure.
But the problem is that at least 63 million high rise apartments are unoccupied because the people don’t earn high enough wages to afford the quality that was built.
So lets see. The govt pegged the Yuan to the dollar (not allowing it to appreciate when so much foreign direct investment was flowing into China), which prevented the value of wages from being worth more on the international setting. Thus making imported copper and concrete more expensive, thus meaning the people could not afford to use the infrastructure.
And this peg of the Yuan thus increased exports (wages and costs of exports artificially lower) and decreased CONSUMER imports. Thus China had a huge unnatural trade surplus because of a price fixing action by a centralized authority. (strange to find a gold bug who thinks price fixing is good).
So where to spend this dollar surplus? Did they spend it all on gold to bankrupt the dollar? No that would kill their exports. So they recycled it into USTbonds, and bought copper, concrete, and other imported raw materials. So in order to make sure these raw materials would be utilized, they created massive debts at the LGUs (local govts) with a massive stimulus in 2008 that was 12% of GDP, much larger as a % of GDP than any other government bailout in the west in 2008. And increasing the debt of LGUs was something that had been going on for a decade or more. It was the way China recycled its trade surplus, without having to increase wages.
The LGUs did not pay market price to the peasants for the land they took for developers. In China, the govt owns all the land. They paid the peasants just enough for a bus ticket to work in sweat shops in the cities.
So #1 fails in terms of seeing China’s govt as being pro-people and not a tool of the SOBs.
At this point, I got tired and didn’t feel like writing down other possibilities, because afaics there are none that point to China’s government doing what was best for its citizens. There is no way to consider it anything but a transfer of wealth from the poor to the vested members of the Communist party (and friends). Even the middle class’s gains will prove to be ephemeral, because of the bubble that has been created and the middle class holds the bubbled assets that will fall in price.
Some reasons that explain the facts about the dollar peg, surpluses, low consumption, investments, … , above related: http://crisiscapitalista.blogspot.com.es/2012/01/china-y-las-multinacionales.html
Excuse me, but these are the very perspectives that lend to the all pervasive victim memes that pervade too many dialogues globally and bind the mind of memes to untenable and impractical universal notions of rights and wrongs that are narrowly useful for the exploitation of the masses, something perspectives such as these are supposed to be against, however, which feed much common delusion unto the very moment.
They reinforce perspectives that lend to victimization
denial of self-responsibility
offer solace in the conceptualization that others are responsible for your lives (and place limits upon the destinations)
confuse toward having others seek the external actors of nefarious intent rather than turning inward toward solving immediate problems and taking the steps necessary for advancing the lot of people, groups, and, ahem, even the nations they are built to protect under the memes created to influence the intelligentsia during the non-aligned movement, maligning the necessary steps toward development and supporting the machinations of populists
Simply, as to what you tried to explain, it seems obvious, and mostly internally due to vested interests, for countries to take the steps necessary, that is to do a speed-shift of sorts, from laying the foundations of industrialization, to shifting toward greater consumer consumption, which doesn’t have to be in the production of goods but also intangible services.
The fact is most of the globe will need to shift toward services, and greater distribution of wealth on a national basis. Some recentl;y industrialized powers might even want to consider the specialization argument (Shipbuilding = Japan, South Korea, China, Vietnam)….seemed toi have gotten stuck in Japan and China, with Vietnam trying to get into the game, not to mention ships still being built in US, EU, South Asia.
Fact is way too much supply globally. Few in developing countries should be upset that MNC’s give them jobs. We all need to move past the recently decolonized, build the nation-state, post-colonial dialogues that may have had relevance in the 1950′s and 1960′s, but are seriously disastrous for spreading in the current era. There are plenty of nations in desire of developing, and NIE’s and others have to be more understanding of their needs (ie not simply supplying raw materials and flooding countries with cheap manufactures) enabling further developing countries to advance in development.
Propaganda, that I had thought died out in the 1980′s should not be reincarnated.
You obviously have little experience, experiencing the developing world as it is rather than the one displayed on RT, Democracy Now, or similarly obtusely on MSNBC and Bloomberg.
Yet another anecdotal evidence that China refuses to rebalance.
China wants to duplicate 70% the ships in the world.
http://www.zerohedge.com/contributed/2012-10-18/shipping-news-and-bit-more#comment-2903193
Shelby wrote:
I put 24+ hours into researching and writing an article that I thought FinancialSense.com would publish, but the editor denied the final draft, because he felt only a small percentage of his readers could understand it. I tried to argue that he should publish it any way, so as to retain the intellectual readership.
It includes a section on China:
http://www.coolpage.com/commentary/economic/shelby/Demise%20of%20Finance,%20Rise%20of%20Knowledge.html#FutilityofFinancing
I induced comments about my article at ZeroHedge, and the level of arrogant ignorance about China amongst amateur Western speculators is pervasive:
http://www.zerohedge.com/contributed/2012-10-18/shipping-news-and-bit-more#comment-2903512
http://www.zerohedge.com/news/2012-10-21/chinese-gold-imports-through-august-surpass-total-ecb-holdings-imports-australia-sur#comment-2908306
Laymen seem to get quantity confused with value.
http://www.zerohedge.com/news/2012-10-21/chinese-gold-imports-through-august-surpass-total-ecb-holdings-imports-australia-sur?page=1#comment-2915221
“…It seems that you again did not grasp the mathematical point which I made before. It is erroneous to equate the value of manual labor to the quantity of manual labor. Mathematically manual labor could be quite large in relative quantity, but it could still be quite small in relative value, and thus small in relative share of the economy. This is because knowledge production is generating all the efficiency gains that lead to higher standard-of-living. For example, we can hire 100 people with spoons to do the work of one person with a backhoe. The increased quantity of manual labor does not mean value was added, it means capital was wasted.
For example, China has 1.2 billion people and significant percent of them employed doing manual labor. But the value is quite small and is being subsidized by printing Yuan, thus transferring from what would have been an external rise in purchasing power (appreciation of Yuan) in a market forex environment, i.e. there is almost no international value-added to that manual labor. When I say there is very low international value of that manual labor in China, my logic is that if there was they wouldn’t have needed to subsidize exporters with a Yuan peg to prevent consumers from having rising purchasing power for imports. You see the great volume of manual labor in China is due to charging nearly nothing for it in terms of international trade, i.e. a huge trade surplus with insufficient imports. This is non-intuitive and hard for most people to grasp mathematically….”
Dear Dr Pettis
I am a big fan of your insightful articles and have been faitfhfully reading them for a while now. This article strongly resonates with my views (which were strongly influenced by your earlier articles). The same logic also makes me lot more bearish than you are on the Chinese Growth story. From a pure economic sustainability perspective (keeping aside the politics part), the question that always bothered me was this.
If China is spending 50% of its GDP on Fixed Assets Investment and given that they have built up an unenviable stock of wasteful infrastructure, excess manufacturing capacity, over capacity in the housing and commercial stock, can they survive the next year by not spending even 1 penny in any sort of Capital stock? I suspect they can.
But I would like to believe they have still some genuine investment needs (including replacement capital stock in some sectors that actually have some real economic value). This last point is the key point you were making, that the bulls should show there are such projects. My point is, if there are, then the Chinese government should already have invested in them rather than wasting it in the first place. In any case, I think there will be a certain amount capex required irrespective of the amount of wasteful stuff around. And my gut feel is that it cannot be more than 25% of the current GDP level. If that is true, then in the ideal world Chinese economy needs to shrink immediately by 25% from this year’s GDP (actually more if you take into account the negative feedback effect), just to control the damage from now on (i.e. don’t create more useless stuff). Interestingly, the link below is the view of Hugh Hendry, one of the most successful HF managers and he is drawing the same conclusion (not sure about his basis though). Just showing the relevant paragraph here
“China is this big mouse trap that was formulated to grow at for 10%. In this pursuit of 10% GDP growth, China has taken negative marginal rates of return in its investment as long as the airport where no airplane lands were built and the city where no one lives was built. (He compares it to the short-focused mania of Wall Street wanting to beat quarterly numbers, a phenomenon that always leads to corruption). In March 2009 China made the wrong bet that it will save the world by their steady GDP growth. Now there is going to be a deep contraction. He tells the audience that he is not going publicly to say that the contraction will be more than 20%, but if he were to have a coffee later with someone he might say it.”
http://www.hedgefundletters.com/hugh-hendry-on-gold-china-treasuries-and-god/
I understand that is not politically palatable and Chinese authorities still have some more firepower to keep the machine chugging along for some more time. The question is will they really throw good money after bad growth or atleast use the less painful and smarter option of just fudging with statistics to please the Wallstreeters that seem to reward growth which ever way it comes.
Thank you for articulating your ideas so lucidly.