Deflation and debt
On Monday CPI and PPI numbers for February came out. CPI was down 1.6% year and year and PPI was down 4.5%, in line with or slightly below expectations and, according to Bloomberg, the highest rate of deflation among the 78 countries they follow. Some of this may be caused by one-off factors, especially declining food prices, and most of the press and analyst commentary suggested as much, but the figures are still too hazy to say with any certainty whether or not deflation is likely to become a problem. Qi Jingmi, an economist with the State Information Centre, a government think-tank, was quoted in an article in the South China Morning Post as saying “I worry about PPI. The sharp fall in PPI shows that the financial crisis is gradually spreading to the real economy.”
The PBoC’s Governor Zhou has already promised that China will do whatever it takes to prevent deflation, although at this point it is hard to find anyone who believes in the 4% target inflation for 2009. According to an article Friday in Bloomberg he said that “We would rather be faster and heavy-handed if it can prevent confidence slumping during the financial crisis.” The article goes on:
Chinese central bank Governor Zhou Xiaochuan pledged “fast and heavy-handed” policies to restore confidence and prevent the global financial crisis from deepening the nation’s economic slump. “If we act slowly and less decisively, we’re likely to see what happened in other countries: a slide in confidence,” Zhou said at briefing in Beijing. The central bank has “ample room” to fine-tune monetary policy after a record surge in lending in January, he said.
I continue to be very skeptical about the actual amount of control the PBoC has over monetary policy. Until last summer despite PBoC intentions to run “prudent” or “tight” monetary policies all the evidence suggested out-of-control money growth, and since then their promises to expand aggressively have been at least somewhat undermined by evidence of monetary contraction. I am convinced that given the currency regime, net foreign inflows or outflows more than other factors determine underlying money in the system, and since the PBoC has very little control over the net flows, and so little control over the rate at which it is forced to monetize those flows, monetary conditions are at least as likely to reflect external conditions as domestic policy.
That is why what interests me most about the inflation numbers is what they suggest about monetary conditions — a subject on which it is very hard to get complete data and for which we often need to draw inferences from other parts of the economy. In that light, it is worth noting that the money-versus-pork debate seems to have died down since last summer with the decline of inflation at year-end, but I suspect it is going to revive soon enough, as I discussed in one of my entries in December. For example, a Bloomberg article on Monday had this to say:
China isn’t yet facing “typical” deflation, where falling prices are accompanied by shrinking loans and money supply and an economic recession, central bank vice governor Yi Gang said, according to the state-run Xinhua News Agency. The central bank has “sufficient” policy tools to combat deflation, Yi said, without elaborating.
Maybe it is indeed true that falling prices are not accompanied by shrinking loans and money supply, but it seems to me that we can’t really say for sure. We think we know that loans aren’t shrinking because loan growth numbers in the official banking sector pretty clearly show rapid loan growth, but as I have written many times before, much of January’s loan growth represented either balance sheet rearrangements or other forms of loan growth that don’t represent real credit growth to the economy (and by now that is a pretty widely accepted interpretation of the January numbers, although many bank analysts continue to talk up the loan growth as effective).
In addition, there is still anecdotal evidence that the informal banking sector is having difficulty expanding and even that their balance sheets may actually be shrinking. Real credit in China, in other words, is expanding much more slowly than the headline numbers suggest and may even be contracting. We don’t really know. For those who care, the current issue of Forbes has a very interesting article by Gady Epstein on one part of the shadowy credit market in China.
By the way I assume that Vice Governor Yi is indirectly referring to Irving Fischer’s debt-deflation thesis. But in my opinion, and if I read Fischer correctly, the risk for China is not a financial collapse induced by excess and unstable leverage. In spite of the haziness of the debt accounts I really don’t think China has the amount and kind of leverage that is likely to lead to a collapse in asset prices (although my one caveat is that we don’t really know the relationship between asset collateral and debt in the informal banking sector). The risk instead — and a highly probable risk although the timing is a little hazy — is that China will see many years of sub-par growth as it works off its addiction to excess capacity and makes the tough and slow transition to a domestic-led economy. I think Nick Lardy’s warning of a “long landing” rather than a “hard landing” is what we should expect. I am only guessing here, and haven’t really worked it out, but perhaps monetary reflation, which I think would have been Fischer’s proposal for the US today, is not likely to be of much help to China.
Trade figures are out
Meanwhile, and back to the real world, February trade numbers were released today. As I guess pretty much anyone who reads my blog would know, the export numbers were terrible. Exports plunged 25.7% in February year on year, even though this year February did not include the Spring Festival holidays, and so was substantially longer than February 2008. The foreign press seems mostly to think that the sharp decline in exports came as a huge surprise to most experts, while the Chinese press seems to think it was largely expected (the SSE Composite declined on the news, but only by 0.9%). I have always believed that the fact exports were dropping much more rapidly in the rest of Asia than in China was clearly not sustainable, and that it was just a question of (very little) time before we began to see Chinese exports hit much more sharply. I do not believe the process is over.
According to an article in today’s Xinhua:
China’s exports plummeted 25.7 percent year-on-year in February, the fourth straight monthly decline, as global demand shrank, the General Administration of Customs said Wednesday. Exports contracted to 64.90 billion U.S. dollars, while imports slumped 24.1 percent to 60.05 billion U.S. dollars. The sharp declines reflected weakening external demand, which would persist throughout the year as the global recession deepened, said Zhang Junsheng, an economics professor at the University of International Business and Economics. “These huge falls were inevitable, given the global downturn,” he said.
…Exports of labor-intensive products contracted more moderately than total exports, reflecting the government’s moves to raise export rebates starting last July, the agency said. Garment and accessory exports fell 11 percent to 14.62 billion U.S. dollars, while those of toys sank 17.1 percent to 850 million U.S. dollars.
I have heard several times reference to the fact that the increase in export rebates has helped the textile sector, although I would have guessed that this wouldn’t be something policymakers would want to advertise to the outside world. Along that line I think we are going to see a lot more pressure on policymakers somehow to “deal” with the problems in the export sector. On Monday Commerce Minister Chen Deming announced a cut in export taxes. According to an article in Tuesday’s Financial Times:
China will reduce export taxes to zero and give more financial support to exporters as it tries to increase its share of global trade in the current crisis, the country’s commerce minister announced on Monday. China would “use all possible measures to ensure the stable growth of our exports and prevent a large drop in external demand”, Chen Deming said in an interview published by a Communist party newspaper. “We should increase our share of the global market… We must transform ourselves from a big export nation to a strong export nation,” he continued.
It’s probably not a good idea to announce a drive to increase China’s share of the global export market, especially since for the last several months, while the world has suffered a collapse in demand, China’s share of exports has risen dramatically, but this may have been said primarily for domestic consumption. Yesterday Chen spoke again about trade. According to an article in People’s Daily:
The pressure to fix the export sector is clearly rising. My friend Isaac Meng was quoted later on in the same People’s Daily article explaining why policymakers are taking a decision which is not likely to make already-difficult global trade relations much easier:
At a press conference on Friday Zhou Xiaochuan, the central bank governor, refused to rule out a devaluation in China’s currency, the renminbi. “If you can tell us clearly what is going to happen [in the countries where the financial crisis started], it would be easier for us to tell you what measures we will take,” Mr Zhou said when asked directly whether he would rule out a devaluation of the renminbi.
In a sign of how contentious the debate has gotten within China, the trade worriers put in a counterclaim. This from a Bloomberg article:
China should let the yuan rise 3 percent against the dollar in 2009 to deter capital outflows and help the country make overseas acquisitions, said Wang Jian, a researcher affiliated with the nation’s top planning agency. China’s foreign-exchange reserves grew by the least in more than four years in the fourth quarter as sliding exports prompted traders to step up bets on yuan depreciation. People’s Bank of China Governor Zhou Xiaochuan pledged last week to maintain yuan stability as investors pull money out of emerging- market assets because of slowing global economic growth.
“A weaker currency will prompt massive amounts of foreign capital to flee the country,” said Wang, secretary general of the China Society of Macroeconomics, a Beijing-based research institute under the National Development and Reform Commission that advises the government. “It won’t help exports. Foreign consumers still won’t have enough money to buy.” At least $1 trillion of “hot money” may have entered China, Wang estimated, as the yuan gained 21 percent against the dollar since the central bank ended a fixed exchange rate in July 2005. Depreciation would risk spurring a sudden exit of those funds, causing turmoil in the financial system, he said in an interview yesterday.
I think hot money flows are one of the potentially destabilizing factors we need most to worry about because the PBoC’s currency regime means that monetary conditions, as I discuss in the first half of this entry, are largely determined by net inflows or outflows. In that light it is worth noting that while imports in February were also very bad — they dropped 24.1% year on year — the February trade surplus was much, much lower than for any month in a long time. China’s trade surplus for February was $4.8 billion, lower than the $7 billion rumor I mentioned a few days ago and much lower than the roughly $34 billion average monthly surpluses of the past six months (and $39.1 billion for January).
This may be a very good thing for China as it goes into the G20 meeting, since it takes a little of the sting out of China’s growing export of overcapacity, but one month of “good” numbers after a long series of absolutely awful numbers won’t mean much, and we need to figure out more about the composition of imports. In particular I am interested in seeing whether imports include a lot of one-off rebuilding of commodity reserves. By the way with last month’s “low” trade surplus, some people are arguing that the era of massive monthly surpluses are over. This is from MarketWatch:
Trade and industrial policies
I hope Simpfendorfer is right. The Washington Post seems very worried about the trade-policy outlook. In an article titled “US to Toughen its Stance on Trade,” it warns that US policy seems increasingly dissatisfied with global trade and says that “the Obama administration is aggressively reworking U.S. trade policy to more strongly emphasize domestic and social issues.” Today’s New York Times also had a worried editorial on President Obama’s trade agenda, which included the following:
Trade will play an important role in the world’s eventual recovery, transmitting economic growth from one country to the next. Protectionism leads to further protectionism, and yielding to its temptation could unleash destructive trade wars that would crush any chance of recovery. Unfortunately, few politicians are willing to tell their constituents that unpopular truth. Instead, governments are succumbing to protectionism’s dangerous lure. In recent months, Russia has jacked up import barriers on cars, farm machinery and other products. The European Union has reintroduced subsidies on dairy products. Europe, India and Brazil raised tariffs on imported steel.
…If ever there was a need for collective action — on fiscal stimuli, monetary policy, aid to the developing world, fighting protectionism — it is now. A place to start the rethinking is China and how to encourage increased domestic consumption and investment in China and other cash-rich Asian countries so they can start pulling the world out of recession.
China’s leaders, in particular, need to understand that export-led growth no longer works for them or for the world. The United States will have more influence if it stops beating on Beijing for its foreign-exchange policy and engages China’s leaders as partners, not rivals. Vigorous trade will help the world recover. For that to happen, the United States will have to provide strong leadership and a clear commitment to fighting protectionism. Any sign of ambivalence from Washington will only make things worse.
The whole debate over trade is going to be framed within US and European discussions about fiscal stimuli since it is not at all clear that Chinese policymakers are contributing much more than some fairly smug, and perhaps hypocritical, statements about how everyone must embrace free trade. But the US and European discussions don’t seem particularly positive right now. According to today’s Financial Times:
Disagreements between the European Union and the US over how to combat the global recession widened on Tuesday as EU governments made clear they had little appetite for piling up more debt to fight the collapse in output and jobs. Finance ministers from the 27-nation bloc insisted in Brussels that it was doing enough to support world demand and did not need at present to adopt another fiscal stimulus plan, as Washington is urging.
I hesitate to enter these very deep waters, but I think the Europeans, at least as described in this article, might be right. There is a real need for an adjustment in consumption in the US, and I don’t think it makes sense for the US to attempt to replace excess household consumption with excess government consumption. One way or the other the US, along with China and most other countries that have contributed to one side or the other of the global imbalances, is going to have to accept a demand contraction.
Trade friction is an issue that will not easily go away. Not all the information released this week was bad, however. Some was good and some was neutral — by which I mean it could be read either as bad or good depending on your economic model. According to an article in today’s Bloomberg:
China’s investment spending surged as the nation poured money into roads, railways and power grids to counter a plunge in exports, which a separate report showed fell by a record in February. Urban fixed-asset investment climbed a more-than-estimated 26.5 percent in January and February combined to 1.03 trillion yuan ($150 billion) from a year earlier, the statistics bureau said today in Beijing.
The fact that fixed asset investment surged might suggest that the fiscal stimulus plan is having an effect and will counteract to some extent the slowdown in other parts of the economy. A worrier (me) would be very nervous however that the stimulus ended up worsening the overcapacity problem, in which case any benefit would be more than paid for next year. More unambiguously good news involved February car sales, which are up substantially and suggest that some government policies are getting consumers to go back to buying cars, although this was accompanied by bad numbers on car exports.
…However, despite the apparent rebound in China’s own car market, a slump in demand is crimping sales overseas: exports in January fell 33.5 per cent from a year earlier, to US$2.66 billion, the group said. The impact was most severe for domestic-brand cars, with January exports falling 64 per cent from a year earlier to 16,300 units, it said. Imports of vehicles also took a hit amid the deepening economic downturn, falling 20.3 per cent from a year earlier in January to US$1.73 billion, it said.
Finally before closing, and for an indication of rationality that sometimes seems to be missing from foreign expectations about China, few analysts in China seem to buy the idea so popular in the West that somehow Chinese policies may be enough to pull the world out of its economic crisis. Tuesday’s People’s Daily had a long article on the subject. Among other things it said:
To pin hope of the global recovery only on China is similar to charging a colt with an overwhelmingly big carriage and hoping it to drag the cart along, they said. Beijing-based economist Wang Xiaoguang warned that actually China’s influence is very “limited.” He said China’s stimulus package might help store up some investors’ confidence in world economy, but “China alone could not revive the world.”
Apart from export rebates, I suppose textile exports were also helped by the fact that even cash-strapped customers can still afford cheap clothes. After all, they need to wear something…
Regarding the way the government talks about export rebates:
I know some people in the PRC steel trade. I remember they always reacted very angrily whenever the government chose to reduce export rebates or did anything else to reduce export competitiveness. They seemed to have a sense of entitlement, as in: The government has to do everything it can to help them. It shouldn’t give in to those scheming foreign politicians trying to bring China down, but defend China’s interest. And “China’s interest” to them of course meant maximising steel exports.
In other words: I would assume that the government is saying these things to show the relevant Chinese business communities that it is doing all it can to help them.
Given the apparent collapse in demand can China really do much to stimulate exports with higher rebates or similar measures? The “China price” is already unmatched for many products so it is not clear how lowering the price for the lowest cost product will have any meaningful impact, other then perhaps for domestic political purposes?
Do you have any predictions for the outcome of the G20 meeting? Will they address the real issues effectively? =
Regarding, the China Government’s “scientific outlook on development.” If only this were true, all the world could sleep easier at night. There are plenty of capable and very respected scholars in China who are smart as one could find, anywhere around the world. But they have no power in China, just as often their counterparts in the United States are equally without power, and equally muzzled by the political machinery.
Add to this the apparent fact that the people with real power do not necessarily want to pay attention to either science or provable facts about the real world, should the data not be in line with their programs and keeping themselves in power.
Some thinkers opine that the power elite, such as those in China, or the United States, are just barely hanging on by their fingernails, to their positions of power. And that it is just a matter of time before the majority of the people put things right in some sort of enlightened way. But what are the odds that this might happen?
Most of the very severe problems that have struck the Chinese people during the past 60 years have something, in part or in whole, due to the lack of a democratic system. And so far, the system has not changed much. China has always been a wonderful place to live for people with supreme power. But also pretty much of a hell on earth for the powerless who need to learn how to bend like bamboo before the supreme force of the state. The powerlessness of the individual is a terrible thing for the family and for society.
This blog has always devoted itself to discussion of the interests of the powerful, the people with money, the ones who can read. But there is a far greater number of people who make up China’s economy who can not read, who have no power, but who have contributed more than their fair share to China’s great wealth today.
And it is amazing that these people’s economic concerns continually seem to get such short shrift on this blog. Science is good. Hopefully there will be more of it on this blog. And much more of it. Because, in the end, there is only one way that China can truly progress. And this is by instituting a much more democratic system, one in which every citizen has a real stake in his or her country. This is the only way to avoid continually making the mistakes of the past.
The Times editorial, in my opinion, sums up the problem;
“The United States will have more influence if it stops beating on Beijing for its foreign-exchange policy and engages China’s leaders as partners, not rivals”
The problem is that China, like Japan before, views the US as a rival, not a partner. The US has been the one labouring under the misconception that some of its trading partners were exactly that, partners. They were and are rivals, as demonstrated by the non reciprocated barriers.
Parroting the line trade is good for all parties ignores the distortions in place and the implications of such. Furthermore it also ignores the durability of economies to withstand the associated job losses. The ability is high and maybe beneficial when labour markets are constrained. The opposite is true when unemployment is high.
“The total lending this year will exceed 5 trillion yuan” said Su Ning, deputy governor of PBOC hours after the PPI and CPI numbers were released. The reaction of PBOC is very quick. This is the beauty of the system in China unlike in the US where they have to go through the sausage machine consisting of GOP and the Democrats.
Micheal, you also highlighted another interesting point about the favouring of labour intensive industries. Hiding the Micro in the Macro is still hiding.
Employment is job one for China, which I can’t blame them for. At the same time when it is generated by the income of trading partners and that income is reduced the relationship is bound to fail.
In neurology when you alter homeostasis it causes seizures. It seem the same applies in economics.
Should read export and import numbers and not PPI and CPI.
Most people on this blog have no good concept of what it might feel like to be rolled over and flattened by the Communist State, its state run bank, the BOC, or have any inkling what it feels like to be uprooted multiple times from one’s home due to a misconceived state project, such as a damned Chinese government dam. And most people here do not care, either, probably.
Anyone who has read Kafka in grade school, CAN get an inkling, however, of what it really means to be so powerless in China.
Due to the hype of China’s purported economic prowess in the media during the past 10 years, there is a total lack of balance in equally reporting the terrible state of sociological and environmental issues that almost totally negates the ever vaunted China yoy GDP progress reported by the press.
In fact, most of the reportage being contributed by the western press is done from afar. There are very few people of the west who have given up their citizenship, their foreign rights, to truly immerse themselves in the China milieu, and subject themselves to the same circumstances as the average Chinese in China, to gain a true perspective of what it means to live in this country. And, in fact, most of the reporting is being done by total newcomers who have not spent even 20 years in China, and therefore don’t know much.
On this blog, there are so many commentors who blithely state opinions which would never be made if the commentor were forced to spend 2 years in China, living the life, and walking the walk, of the hundreds of millions of migrant workers who suffer every day. Or even to trade places with the recent college grads whose lives, from when they were first born, were so very circumscribed by the state and the lack of democracy.
Even though, obviously, this blog is one of the best, maybe the very best about China, still, there is a lot lacking in terms of real meat. Maybe one would like to have much more Greenwich Village, rather than Greenwich CT, on this blog, for example.
But, one man can only do so much in terms of describing economics in China. And the blogger has just cut off a very small piece of the economic pie to blog about. This blog would be even much more interesting if the blogger could band together with some other really sharp minds to put together a new blog which could comprehensively discuss all economic issues, especially the science based economic issues. And, if this could be done, then the next time the blogger is called to Washington to testify, then how much more useful his testimony might be. And how much more interesting this blog might be, on a daily basis, for the likes of us
China may not be a main contributor to world recovery. But the flip side is that China was probably not a main contributor to the current crisis either. I have a question about deflation: is the shadow banking system in China so big that its contractionary effect can offset the expansionary effect of the formal banking system?
Regarding the auto industry, there are several independent EV companies in the pipeline in the U.S. The debate has already begun as whether to move the entire production lines, both for batteries and vehicles, to China.
“There is a real need for an adjustment in consumption in the US, and I don’t think it makes sense for the US to attempt to replace excess household consumption with excess government consumption.”
I think the best way to ensure strong protectionist sentiment in the US is for a collapse in living standards and soaring unemployment for ordinary Americans – this after decades of stagnant wages and declining benefits, due in large part to globalization and free trade.
So, sure, scrap the stimulus. Globalization hasn’t done much for ordinary Americans anyway.
For some strange reason, beyond the ken of most scientists, there seems to be some consensus among the idiots who rule the airwaves, that science is something to be denegrated. Just as it has always been since the days of being put on the rack during the dark ages.
We should not be surprised that some of our most respected scientists have, historically, been pilloried and have been forced to hide their science, for generations.
Just as this mistrust of science is happening in the United States from both a ground up and also from a political way, the lack of scientific savvy among the people in power in China is truly and totally very backward.
It is always easy to cast the first stone to make the case that China might be in some way, “backward”. But, in fact, during the past 8 years in the US, the government under Bush has proven itself to be much more backward from a scientific point of view than anything conceived in China. EVEN THOUGH both countries are extremely backward in terms of being enlightented about science and also about new ways in which each society can provide a better way of life for its people. There is always the fear that true facts and true science will somehow undermine each government’s power structure, and bring down the government.
Basically, we only need to know one thing. And this is the will of the people. For example, maybe it would be better to know and abide by the will of the people, rather than to put too much faith in the comments on this blog.
For example, as the majority of the people become ever more educated and also ever more aware of what is happening in the world today, then the opinions of the majority will become ever more important and valid.
There is some hope that a majority of the people, not of this blog, might be able to decide their destiny. Maybe someday be able to overthrow their extremely corrupt government, and live a democratic life. A much better life.
And then, the people on this blog, might be discussing the plusses and minusses of a much better world. Rather than the extreme hell that truly is China, now.
What do you make of the auto sales numbers? How do they square with the tens of thousands of factories that have shut down combined with tens of millions of laid off workers? I had heard apocryphally that government agencies were being urged to buy new cars (much like the US stimulus bill).
I heard of you from friends at Tsinghua long time ago but didn’t know existence of this blog until last week saw an article on telegraph.co.uk
I am surprised people are now worried about deflation in China. Even if we may get negative GDP deflator this year, this is not deflation – China only releases YoY CPI/PPI number, which distorts the real picture when the base was largely inflated in 08…and what is deflation? price coming down alone should not be called deflation? I am not economist and could confuse the concept here, but for me deflation happens only when money supply fails to catch up with GDP growth (MV<PY). Credit is definitely not tight in China. I am not sure how to measure velosity, but I assume it keeps steady most of the time. Output is still growing, though at a slower pace. I really don’t see what could push price down significantly from here.
It is also interesting to see how people’s view shift so quickly in the past few months. Earlier last year a popular view was BRIC is likely to immune to the financial crisis triggerd by credit crunch in developed world. In 4Q08, analysts began to refute the decoupling talk when emerging market including China went to the downward spiral fast. A consensus became trying to avoid Europe, emerging market, China, etc. In recent weeks, sentiment has changed again. ML’s recent fund manager survey shows that people are now incrementally more optimistic about China. As a Chinese, I am not particuarly excited about these news. I am not worried about near-term growth at all – government spending is definitely able to pick up the slack left by a weak export or private sector investment – but how is about next year or the year after when the stimulus spending lose steam? The best scenario is export sector recovers at that time and consumers in the states and Europe come back to their old consuming habits again.
Very good writing Michael. I have never believed the China pulls the world out of depression story for the very reason that they are geared to export. I don’t buy the 8% growth either, as it appears we are going to see a significant decline in foreign consumption of Chinese goods.
Another thing I agree with is the fact the US needs to tone down its consumption. It may be too much to ask as the US economy and banking system, along with much of the rest of the exporting world is linked to it. If this remains the goal, the world economies can only go off the end of the pier and out to sea. I don’t believe reflation will work for long in the US because the level of debt has reached unsustainable levels and the inevitible idea of settlement of debts through bankruptcy is looking us in the eye. The problem the US faces is all its money is now credit and linked directly to debt. The process could be catestrophic, which is probably why they are pursuing a process that is going to be catestrophic, only later.
Once again, its very easy for smart people in Beijing to agree that they need to solve the overcapacity problem but its another entirely to beat off interest groups at SOEs with a stick that have a vested interest in overcapacity to further their political careers and have unlimited bank credit lines. Two options are either a factional blowup between technocrats and leaders of SOEs or cutting their credit lines. Neither is politically easy.
PB, global demand is declining and with it the world’s trade surpluses, but within that decline countries can compete for market share. That already seems to be happening. As for my G20 prediction? It will be a waste of time. The disagreements between the US and Europe will make it difficult for the G20 to agree on much.
Nitwit, I see you are haunting my blog again. If your contributions are relevant they will be approved, but I am no more interested now than I was before in providing my blog as a forum to forward someone else’s agenda. Please keep to the topic at hand.
Glenn M, I think some factions in China certainly do look at the US as a rival, but others just as clearly hope for partnership on a variety of issues. In that sense Chinese attitudes to the US are not much different from US attitudes to China. Certainly non-Americans are less impressed than are Americans by US arguments that it is behaving altruistically. In my opinion both sides need to accept this as a given, and one unlikely ever to change, and deal with it rationally. We both get a lot more out of intelligent and self-interested cooperation.
Dr. Loo, perhaps. If all policies are deemed to be good ones, then a political process that permits very rapid execution of senior decision-making is clearly superior. But if we assume, like Alexander Hamilton (and, it seems to me, like Hang Feizi, the founder of China’s legalist tradition) that there is a very low probability that our leaders are actually benevolent and wise, the debate and fighting over the implementation of policies both reduces the probability that we are stuck with bad policies and, perhaps more importantly, allows us to reverse policies that have been shown to be detrimental – the latter being a particularly big problem for China. In the US although I am a very strong supporter of Obama and am very frustrated by his inability to move quickly, I have to say that I am also a little nervous about the long –term implications of the stimulus package and want there to be enough debate that we can prepare ourselves to minimize or one day reverse some of its potentially harmful effects.
Seatrus, about two years ago a Chinese academic estimated that the informal banking sector was equal in size to about one-third of the formal banking sector. Since then, and until last summer, it has probably grown much more rapidly.
Zhang Fei, it may have been partly a bounce from previous declines and it may partly be caused by what you point out. I too have heard that rumor.
Vivchy, deflation is a fall in average prices, and it can be caused for good reasons (rising productivity) or bad reasons (declining money supply). I am not sure I would be as confident as you that credit is not tight in China. Credit is certainly not tight for SOEs and state supported investment projects, but it may be extremely tight for SMEs.
As for last year’s popular view that BRICs would be immune from the crisis, rest assured that this view has never been popular either on my blog or in my writings. I have always considered this view to be based on a combination of muddled reasoning and wishful thinking on the part of foreign banks and investors and have said so often enough. At any rate I agree with your concerns over the longer term impact of the stimulus.
PPI -4% despite 2+ tr in new lending…those two metrics are diametrically opposed…not sure if that just means the 2tr hasn’t moved its way through.
I’m not an expert of monetary policy, but considering China’s still taking measures that actually boost production rather than consumption, I guess under overcapacity the downward trend of PPI will transfer to downward of CPI smoothly until real demand get boosted. In the long term I cannot see any significant rise in domestic demand, so although China is not likely to fall into Fisher’s debt-deflation, I thought China will witness a period of mild deflation, whose length depends on government’s effort to “prevent” it.
!offtopic!
you might have already heard about the concept of a basic income grant… and I would really like to read the ideas and oppinions (and problems seen) of people interested in the chinese economy regarding a basic income grant granted to every (registered)chinese living in china.
I especially like the idea of granting such a basic income grant as a type of newly created money NOT bound by any credits in the system.
Something that wouldnt be possible for a single country in a currency group like the Euro.
i BEG you to put ideological dislike for anything slightly resembling communism aside and give me good reason not to be so confident in the idea of a basic income grant.
ps: I previously mainly discussed the idea of a BIG in german blogs and forums, where a BIG would have to be paid by governement income or debt.
greetings and thanks in advance for…
Michael- Obama has a charming personality and he is kind of a super star in the eyes of many American like yourself. Let’s see what will be his score after his 100 days honeymoon. I very much hope you will not be duly disappointed. As far as I am concerned I believe he will be “down graded” by many American. Like most American presidents in the past he promises too much.
Michael,
I didn’t mean to imply that rival/partner dynamic was a calculated one. Merely that it is the inevitable result of the pressures the ruling party has. I hope that it did not come across as to suggest some sinister plot.
Politicians, regardless of country, are driven by the same natures that frequently see long term outcomes sacrificed for short term gains.
Hi Michael,
Excellent site, could you have a look at http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/ and possibly comment on what you make of it (btw it is a lengthy article.)
It explains very well why deflation is inevitable and actually we have been in deflation for quite some time. Some 45% of the world’s wealth has been wiped out in falling stock and asset prices. That’s nearly 60 trillion USD.
Thanks for your hard work in informing us. Cheers.
While the world is experiencing deflation, China’s monetary policy of the past 10 years uniquely positions it for possible monetary inflation.
As announced in Davos this year, China is loosening the reserve requirements on banks. As we all know, inflation is caused when money is borrowed into existence from banks and changing the reserve requirements is one of the single most inflationary measures that can be taken.
While I have no empirical data to support it, I can tell you that friends and colleagues working in China are finding it much easier to secure loans recently, both business and personal.
Dear Prof Pettis,
I hope that you will get to this msg and respond.
From reading your blog, I understand that Krugman is your man : ) but I do kindly ask you to think unbiasly about the following.
As external imbalances now rapidly unwinding, so too are global fx reserves. One of the most important (and overlooked) engines of global credit that drove EM growth and commodities, (and USD in my opinion) is now suffering massive contraction. Loose US monetary policy led to a domestic asset boom which caused a massive US trade deficit. Rather than allowing the dollar to depreciate, EM countries intervened in unlimited quantities. This led the EM nations to enjoy their own liquidity-driven domestic demand/asset booms as rapid FX reserve expansion resulted in rapid domestic EM money supply growth due to their inability to sterilize such large levels of FX intervention. With the prolonged and inexorable deterioration of the US trade deficit, EM money creation fueled their growth boom for so long that investors came to regard EM economic growth and the associated rise in commodity prices as secular rather than cyclical. This saw investors pouring investment flows into the EM world, which inflated the balance of payments surpluses even further, necessitating additional FX intervention, which only fuelled the boom further. This virtuous circle has now turned vicious.
I would like to rise the possibility that we might see the dollar crashing sooner and faster than anyone had expected, given if China’s trade surplus continues to nose dive which is very likely and decrease of FX reserves globally. When the massive amount of money parked in treasury realizes that China and other big treasury buying nations can not continue to buy even if they wanted to, the dollar could fall much quicker than most had anticipated. The sign to watch for is China’s trade surplus for the upcoming months.
What are you thoughts?
Thank you,
Leon
MXQ, yes. It is surprising that what seems like such a surge in credit creation would come with a sharp price contraction. Of course we need a few more months’ data before we an draw any conclusion.
Boomups, I am not sure why you would consider your income grant a communist policy since variations on these kinds of payments are common in social democracies and virtually non-existent, as far as I know, in communist countries, but the objections to them would be the standard objections about debt financing versus monetization and whether or not they would lead to increased spending or, more likely, increased savings. Without specific proposals it is hard to comment beyond saying that under the right conditions they might work and otherwise they won’t.
Dr. Loo, yes, I think expectations on Obama are unrealistically high, but he is probably as well-placed as anyone in recent memory to handle them.
VK, I read Steve Keen’s blog regularly. I think he is a very interesting economist and well worth reading.
Michael, it depends who you talk to. SMEs still seem to be complaining, but SOEs and state supported or sponsored projects are fighting off lenders.
Leon, I am not sure I understand your argument. If the US trade deficit declines it does mean, as you point out, that foreign central banks will no longer be large buyers of dollars, so that reduces demand for the dollar, but it also means that foreign exporters will no longer be big sellers, so it reduces supply of dollars by exactly the same amount. For a long time dollar bears argued that the dollar would crash because of the unsustainable trade deficit, and now I am hearing that the dollar will crash because of the collapsing trade deficit.
The truth, in my opinion, is likely to be a lot more complex. For several years I have been arguing that a global financial crisis will increase the value of liquidity and so currencies like the dollar and financial centers like London and New York will increase their relative share. I know that this is a highly contrarian position, but it seems to me that this is what the historical precedents suggest. This time may be different, of course, but I managed to win a some credibility over the years simply by assuming that things happen the same way over and over again, and I see no reason to change what has been a good strategy.
Michael,
I can follow your reasoning regarding the US$, but in what way would this apply to NY and London as “financial centres”?
Prof Pettis,
Let me rephrase my question.
Would the collapse of the Chinese trade surplus in addition to collapse of world’ FX reserve cause or speed up the bust in the US treasury bubble, which then leads to investors rushing out of the dollar?
Thanks,
Leon
Listening to Premier Wen’s press conference today I believe the situation in China will get cautiously worse before it can get better when he said the government has contingency plans in place if or when the situation is getting worse. By this he was implying the situation may get worse.I hope it is an “if” and not a “when”. He did however admitted that the GDP target of 8% is a task to achieve short of telling us that it is not achievable. Well, we have to keep our fingers crossed and hope for the best. On the other hand if China can’t achieve the magical 8 she is doing much better than the rest of the world in the midst of the global financial crisis.
Another point worth noting is when he requested the US government to honor their obligations regarding China’s treasurys holdings and to protect China assets in the US. As far as I am concerned this statement was well said and I hope the US government will take note of it seriously. As a Chinese I would like to add that this is our hard earned money over the past 30 years. Every dollar China lend to the US has blood and sweat. I can’t imagine the repercussion if US failed at the end of the day. A worst case scenario would be a Third World War and I pray it will not happen.
Reading Premier Wen’s statement I am wondering he is sending the message out that China will slow down in purchasing US Treasurys in the near future. If this is the case I am afraid the US money printing machine will have a serious problem.
I love his closing statement when he said I would love to visit Taiwan. “I have been thinking about Alisan and The Sun Moom Lake. I am 67 and if I had to crawl I will go and see them”. I very much hope Taiwan will respond to what he had said positively and intelligently as the days of Chen Sui Bien are over.
I hope he will soon be at The Sun Moon Lake and say “I came, I saw and I unified”.
Michael said, “yes, I think expectations on Obama are unrealistically high, but he is probably as well-placed as anyone in recent memory to handle them”.
You can’t blame Americans’ expectations on Obama as he kept on shouting “Change” during the election campaign. American were not given a chance during the last election. They were given 2 bad apples and between the 2 bad apples they had to choose one.
I will wait until his 100 days to see his score. I hope he will not screw up the American people again like Bush did. Bill Clinton did a better job as president as he only screwed Monica. Who cares maybe except Hilary.
Thomas, generally speaking as far as I can determine from the history, secondary financial centers tend to rise to prominence during the later stages of a liquidity-expansion cycle but rapidly lose market share during the contractionary period. My guess is that this is because the advantages proffered by the major financial centers – a diversified and sophisticated investor base and more trading liquidity – are undermined in a period in which financial transactions and trading volume surge around the world. As part of this surge, secondary financial centers, whose advantages include better time zones and more localized knowledge, see their own trading volumes rise sharply and experience their own huge expansion in investment activity, which increases the relative importance of their specialized advantages. After the financial collapse, however, liquidity and trading volume decline sharply everywhere, and especially in less developed and sophisticated markets, allowing the major financial centers to reassert their home advantages. As the old traders saw has it, liquidity draws liquidity. That, anyway, is my explanation for the seeming historical precedents.
Leon, I am not sure what you mean by the collapse in world FX reserves. There are many reasons why foreign reserves might decline sharply, including large shifts in trade accounts or massive capital flight from developing countries to the US. Some of these causes would be benign and some highly disruptive. For example, if US consumption dropped so sharply that Americans stopped consuming altogether, that would cause the large US trade deficit to become a large US trade surplus, and the world would be in serious trouble. If on the other hand a rise in risk perceptions caused massive flight capital from developing countries (something that I think will happen over the next few years), that would be very painful for developing countries but would have little to no impact on the treasury market. It is hard to predict the consequences without specifying the path.
Dr. Loo, I think the chance of the US defaulting on its debts are pretty close to zero and, if it ever got to that, it would be because the US and the world are in such dire straits that no one would pay much attention to Premier Wen’s concerns. But the fact is that China has already taken a huge loss on its reserves. When undervalued Chinese goods priced in RMB were exchanged for overvalued bonds priced in dollars and euros, the loss of Chinese blood and sweat automatically occurred. The rise of the RMB against the dollar does not create that loss. It only recognizes it.
As for whether China can slow down the purchase of dollar bonds, this is, I think, a huge misconception. It is impossible for a country to run a current account surplus with another country unless it recycles the flows back in the form of asset purchases. China can only stop buying US dollar bonds if it also stops running a trade surplus with the US, and if it did, the expansionary impact on the US economy would mitigate the need for the US government to run a fiscal deficit. By the way the idea that this money was “lent” to the US is not correct in the sense that you might lend money to your friend. Chinese purchases of US Treasurys are the automatic outcome of China’s running net exports to the US. I am quoted in a Globe and Mail article yesterday explaining why.
Finally I am not sure I think of Obama as being the least bad of two bad apples. Actually the 2008 election was, in my opinion, one of the best in recent history because both candidates were, in my opinion, very good and very qualified to lead. I think we elected the better of two very good apples. Reasonable men may differ ion this, of course, but I am pretty happy with the outcome. Still, no president, even Roosevelt, has an easy time during an economic crisis and Obama will definitely have to earn his salary.
Dr. Loo,
if I may add to what Michael has already responded:
China was not forced to sell all those goods to the US. It chose to do so, and one of the reasons for this decision was China’s goal to build up fx reserves.
Now China has all those coveted fx reserves, and so far, apart from a small devaluation of the US$ against the RMB (which was inevitable and certainly didn’t come as a surprise to Chinese policymakers), these reserves have kept their value.
(As a side note, and from an ex post perspective, China did a much better job of investing its surplusses than Singapore, which lost much of them by buying overvalued foreign equity stakes; buying treasuries was a much smarter move)
If China now believes there is a risk that those reserves will be devalued in the future (due to inflation and US$ devaluation; an outright sovereign default hardly ever happens if a country issues debt in its own currency), it has a choice:
It can choose to spend some of the reserves on buying goods from America.
Or if it doesn’t like the goods America has to offer, it can buy goods from some other country. Then this other country will have the fx, and will have to choose if it wants to buy American goods, or accept American assets (treasuries or direct investment or whatever).
In any case, if China chooses to spend the money, America will be happy, because it creates extra demand in the US. And it will reduce the American trade deficit, thus reducing downward pressure on the US$’s value. So in a way, spending parts of the surplus would help to safeguard the value of the remaining reserves. And China would get something in return for its sweat and tears, namely foreign made products in exchange for the China-made products it earlier exported to the world. Fair exchange, isn’t it?
If China does not want to do this, it can choose to keep its US treasury bonds, and buy even more of them. There are risks involved in doing so, but that’s life.
In any case, China has a choice. It is not a helpless victim in all this.
I am a techie not an economist but have a reasonable understanding of economics. What I don’t understand is how countries such as China, Japan, India, etc – have amassed massive $/US Treasury holdings. I understand that these are export led economies and so businesses in these countries have been exporting goods/services and amassing profits in $s. But these are private $s controlled by individual businesses, on their books as profits/retained earnings. How do these turn into state controlled funds? Is it when these foreign businesses repatriate the $s into their local currencies, the local govts gets $s and gives them local currency and so accumulates $s. The local currency in that transaction is just “created”?? From what I understand India, Japan (and perhaps China?) have been running budget deficits – isnt it strange that they have budget deficits as well as large surpluses of Forex?
Michael,
In your Globe/Mail article referenced above… you said:
As Prof. Pettis puts it, “You can’t suddenly turn around and start selling dollars, because if you start selling dollars, the value of the dollar will collapse against the renminbi, and the renminbi will shoot up.” The cost Americans pay for Chinese goods would shoot up, too, “which means you wipe out the export sector” in China.
… but exports to the US are less than 20% of China’s total. How does appreciation of the renminbi translate into a “wipe out” of the export sector in China?
I wonder what you think of Peter Morici’s proposals in the Asia Times (link http://www.atimes.com/atimes/Global_Economy/KC13Dj07.html):
“Regarding nonenergy trade, no solution is possible without addressing the trade deficit with China, and its manipulated exchange rate and other mercantilist practices. And given the role of the trade deficit in the nation’s macroeconomic problems and sovereignty problems foreign borrowing creates for the United States, no public policy problem is more urgent…
Americans need to recognize that China is hardly a market economy in a Western sense and is still highly state managed. Its financial system may not be able to sustain an unmanaged floating exchange rate; however, China can manage the value of its currency at 4 yuan to the US dollar as easily as it does 6.8 to the dollar. In fact, it would be a lot easier to manage a value closer to balance of payments equilibrium.
Simply, the United States should give China the opportunity, with a hard deadline, to manage down its trade surplus with the United States, either through meaningful and complete currency revaluation – complete means raising the dollar value for the yuan to a level that reduces China’s trade surplus with the United States by one third each year and to zero after three – or through other domestic means of Beijing’s choosing.
If China declines, the United States should simply tax dollar-yuan conversion in proportion to its official and surrogate currency market interventions. The United States should impose a tax equal to the quarterly value of China’s intervention divided by its exports of goods and services. China would then have a strong incentive to reduce and then stop intervening.
If China does not reduce and eliminate intervention and chooses for the United States to tax currency conversion, then the benefits from a revalued yuan of higher prices for Chinese imports that should go to Chinese businesses would instead go into the US Treasury. If China reduces and then eliminates one-way intervention and lets its currency rise to a value that balances trade, Chinese businesses would capture those benefits in the form of higher dollar prices for their goods.
…
Redressing the trade deficit with China in this manner would not be protectionist. China’s actions now are protectionist, and constitute a modern day Smoot-Hawley. China’s policies are about as protectionist and predatory as could ever be conceived by the most skilled 17th century mercantilist and are an absolute threat to US prosperity and sovereignty.
I am not advocating protectionism – let China stop rigging its currency and trade and the United States can and should compete. I am advocating the United States abandon a policy of appeasement in commerce and embrace self-defense and self preservation.”
Void, when countries intervene in the FX markets to manage the value of their currencies, they do so by having the central bank buy or sell the currencies involved. This alters the demand/supply dynamics so that the “equilibrium” price is that set by the central bank (this is almost always how central banks that set the exchange rate of their currencies do so). In so doing they necessarily build or lose reserves according to the net buying or selling of the rest of the market.
CCT, if the RMB value changes against the dollar, that affects not just pricing of goods sold to the US, but pricing of all goods priced in dollars. Of course it also affects the prices of all goods not priced in dollars too. If, for example, $1.00 = E 1.30 = Y 7.00 (where E is euro and Y is RMB), and then the RMB appreciates to $1.00 = Y 6.00, the RMB necessarily also appreciates immediately in Euro terms from E 1.00 = Y 9.10 to E 1.00 = Y 7.80. All Chinese exports to the world would see price rises and all Chinese imports from the world would see price declines.
Lark, I think Peter Morici may be unnecessarily combative. The US and China should work out a reasonable proposal that will occur over enough time to allow China to adjust without causing huge domestic damage – at least four or five years. It is in both countries’ interest that they do so in a cooperative and consultative way. Bashing foreigners is an awful lot of fun, and too many people in the US and China (and everywhere else) indulge freely in the pleasure, but it is almost always counterproductive. Unfortunately I think the nationalist idiots in China, the US, and the rest of the world will do well out of this crisis, to the detriment of the rest of us. I think it is hard for someone who has read a lot of history to be very optimistic. By the way by “nationalist idiots” I do not mean at all to imply anything about Morici, who strikes me as very smart and with a fairly sophisticated understanding of the global imbalances, if not always with a full understanding of the challenges China faces.
reply to thomas’s post on the 14/03
There are some points you either completely missed or didnt think that they matter regarding your upper post… which is it?
-The US dollars that china lends the US governement, by buying bonds from institutions with state warranty, mostly go into wages of US american living in the US (assumption). If china were to sell and stop buying those bonds in order to buy commoditys and assets, the value of the us dollar would fall dramaticly compared to those assets and commoditys. And if the seller of those assets and commoditys does not start buying the USD Bonds instead of china, then the US governement will have to find other means to pay their employees, and will probably just print that money–> lower usd value in general
and there will not be extra demand in the us, at most a shift of demand from labour to TRANSFERABLE assets.
though i am not saying all this would be bad for everybody. except the holders of big USD amounts in cash or bonds and unflexible usd wage earners.
Michael: A couple of questions.
RE: The Peter Morenci article cited by Lark.
I found this article to be a very clear and accurate discussion of factors that lead up to the current financial crisis. I could find nothing to argue with(Excepting some of his policy recommendations). Other than the policy recommendations, what comments do you and other readers have on this article?
RE: Your response to Void
The accumulation of FX reserves must necessarily be finanaced in some way. Logic tells me it must be some combination of taxes, government borrowing, net cash flow from SOEs, sale of government assets, and creation of money (e. g. printing currency). Are there other sources I have left out? Do you or other readers have an idea of the relative contributions of these various contributions to financing China’s large builup of FX reserves.
Boomups, I think it is more complex than that. Chinese purchases of USG bonds go to finance the net consumption by Americans of Chinese products. Although it is hard to disentangle all this, it is probaly more accurate to say that they finance Chinese wages rather than American wages.
G. Stephen, most of my comments on the Morici article are above — I think he gets the “plumbing” right but I am not sure he understands the constraints facing China. As for your second question, the PBoC finances its purchases of dollars wholly by creating RMB deposits at the commerical banks. Some of this money creation is then sterilized by the sale of central bank bills, although there is a dispute over how effective this is. It may be that central bank bills are too close a substitute for money to have much sterilization effect.
Mechael, how do you consider the comment of Rogoff on debt mount?
http://www.project-syndicate.org/commentary/rogoff54
Not the trade dificit, but the debt level is the key concern on dollar’s furture.
Obama do adress this problem by making promise to cut the debt level.But the recovery plan is indeed a government debt plan. Without Fed print machine, how could US manage to repay the debt?
Michael,
There were some articles a while ago suspecting that Chinese stimulus might actually go into Chinese stock markets, among them is this:
http://www.nakedcapitalism.com/2009/02/so-much-for-stimulus-chinese-loans.html
Now, this is today’s Bloomberg news:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aDtidHGVUJpg&refer=home
Would you view this recent Bloomberg article as a confirmation of the former suspicions?
Regards,
Roger Jarema