I am still working on my piece on the global savings adjustment and will probably post it in the next week or so. The main point is to discuss what the implications are for China if we see simultaneously over the next few years an increase in US savings and a reduction in global investment. For today I wanted to discuss some of the economic data coming out of China as well as a couple of debt-related issues.
US debt and the dollar
But first, a quick digression. Today’s Financial Times has an article titled “Fears over US sovereign debts unfounded” which, as the title implies, argues that “Fears of a crisis of confidence in the US sovereign debt market – and a subsequent dollar collapse – are unfounded.” On a related note Bloomberg has an article today which notes that “Russian Finance Minister Alexei Kudrin said the dollar is in ‘good shape,’ further affirming that there’s no substitute for the world’s reserve currency.”
It’s great that commentators are coming back, however temporarily, to a sense of reality and common sense. There never was likely to be a crisis in the ability of the US government to fund its deficits, and all the pleading to foreign governments to continue purchasing dollar assets was based on very fundamental misunderstandings of both the form of the global adjustment and the functioning of the global balance of payments. For the former, the problem we are facing is that as Asian savings soared over the past decade, they were accompanied by a collapse in US savings. This is not a coincidence. An increase in savings in one part of the world requires a reduction in another, and causality can work either way, so please dear readers spare me the whose-fault-is-it outrage – it is not relevant here. The point is that without a marked increase in global investment, one requires the other.
The collapse in US savings was unsustainable, and it is now reversing. This creates a problem of excess global savings, which means financing deficits for creditworthy governments is not going to be a problem and will not result in soaring real interest rates. In fact Paul Krugman has a brief piece, based on numbers from Brad Setser, that shows the explosive rise in US government debt is more than matched by the contraction in household debt.
This is just another way of saying the same thing. Of course I will add my by-now-tiresome point that we do not have to worry about discretionary decisions by foreign governments as to whether or not they will continue financing the US fiscal deficit. Foreigners do not finance fiscal deficits. They finance current account deficits, and one (the current account deficit) cannot occur without the other (the financing). As long as the US runs trade deficits with China (or Russia or anyone else), those deficits will be financed, and the only thing that will stop that is a contraction in the US trade deficit, which is actually expansionary for the US economy and will reduce the need for fiscal expansion.
Remember, the US can force foreigners to invest $2 trillion a year in the US by the simple expedient of running a $2 trillion annual trade deficit. But this cannot possibly be a good thing. If we want the trade deficit to go down, we must also want foreign financing of the US to go down by exactly the same amount. This is not high-falutin’ economic theory, it is rather an arithmetical necessity. (By the way I tried to explain something related this Saturday when, on CCTV9’s Dialogue, two points were made – that the contraction in the US trade deficit was causing great pain in China, and that Chinese officials were warning the US government sharply to reduce its fiscal borrowing. China cannot ask both that the US slowdown its contraction in consumption and that the US government slowdown its fiscal expansion. It is precisely the growth of the US fiscal deficit that will cause a slowdown in the contraction of US net consumption.)
The second point, that the dollar is still in “good shape” as the world’s dominant reserve currency, should be obvious. I have not gotten around to writing why all these spectacular (or spectacularly reported) moves by China and others to “undermine” the reserve status of the dollar – announcements by Putin, currency swap arrangements between China and a host of countries desperate for cash, the announcement by a major Chinese banks that it will make the RMB available for international transactions, and so on – are all of almost no consequence except to the paranoid. At some point I will write more about it.
Debt and risky debt structures are rising
Let me turn to debt. Last week Andrew Batson had a very interesting, and very important, I think, article in The Wall Street Journal, discussing the impact of the stimulus on the government’s real debt position. “The cost of China’s stimulus program,” he writes, “is turning out to be much larger than official figures indicate, raising the stakes for the government’s attempt to restart high growth through massive borrowing.” He points out that a lot of the spending is being funded by provincial and municipal borrowings and by corporate borrowings, “virtually all of which are indirectly backed by local governments.”
He concludes: “As the central government is ultimately liable for those hidden debts, China’s total state debt is closer to 35% of GDP than the 18% shown by official figures.” In fact I have always argued that other not-yet-recognized liabilities, such as hidden municipal and government debt, the bankrupt AMCs, and other non-recognized debt, probably means that real government debt levels are higher than the official numbers by at least 15-25% of GDP, which suggests that, correctly counted, government debt levels may now be approaching 50-70% of GDP. If we throw in the possibility that the current bank-lending spree is also likely directly or indirectly to add to government debt burdens in the future (contingently, through a rise in NPLs), I would not be surprised if policy-makers are already starting to consider the possibility of a debt problem at the central government level. I am not saying that this must happen, but only that it is easy to construct some fairly plausible scenarios, involving the continuing global adjustment and the concomitant Chinese adjustment, that can easily suggest a debt problem.
My concerns of course were not made more palatable after I saw a very interesting article in last week’s Caijing (and what other magazine would have reported this?), with the unsettling subtitle “The property market bubble burst last year, but developers are still afloat thanks to governments, banks and a ‘subprime’ solution.”
The article notes how unlikely it is that the massive contraction and the difficulties in last year’s property market were not accompanied by high-profile failures among property developers. This is because, they explain, “local governments and banks have intervened to prop up Chinese property developers following last year’s sharp contraction in the real estate market,” and they show how this has happened.
Focusing on the case of Greentown China Holding Ltd, a large property developer that nearly went bust, they write:
Greentown faltered in the fourth quarter 2008 and stood on the brink of liquidation early this year. But it survived after a bank agreed to refinance foreign debt and a local government approved a grace period for land payments. Moreover, trust funds that use what at least one expert called a “subprime” scheme offered flexible financing for development projects.
Shou said his company has dodged the crisis. But he admitted that pulling through 2008 was extremely difficult. Indeed, Greentown saw a 10 billion yuan gap between its 2008 sales target and actual results. And debt payments loom for 2009.
The article’s authors, Zhang Yingguang and Gong Jing, go on to draw the unwelcome conclusions:
Industry executives think similar, short-term rescues for major property developers have occurred more frequently in recent months than generally acknowledged. For evidence, they point to the absence of high-profile failures in the industry.
This suggests that there are a lot of very dodgy debt deals out there that are based on nothing more than hopes and prayers. This doesn’t imply, of course, that all these deals will go bad. What I am worried about is something a little different – the highly pro-cyclical nature of these deals. If China recovers, these deals will probably do fine and will be repaid, and so will never show up as contingent debt, but if economic conditions deteriorate of course that is precisely when they will go bad.
And of course that is precisely when we most desperately don’t want them to go bad. Throughout history credit bubbles always end up, in their later stages, with these kinds of highly pro-cyclical structures (read about investment trusts in the 1920s for example, or the Japanese real estate and lending markets in the 1980s, or, in case you’ve already forgotten, the sub-prime market not so long ago). As long as economic conditions and liquidity-driven asset prices continue to improve, these highly unstable structures survive and prosper, but just when you most desperately want to avoid their breakdown, when conditions turn nasty, they come crashing down on you. These kinds of structures are what I call in my book (The Volatility Machine) highly “inverted” structures and they systematically increase volatility by reinforcing both good times and bad times.
Recent economic data
Finally, as everyone knows by now, a number of economic indicators were released last week, some good some bad. Some of the good news, according to an article in the South China Morning Post, was:
The National Bureau of Statistics said in Beijing that annual industrial output growth rebounded to 8.9 per cent in May from 7.3 per cent in April, outpacing a median forecast of 7.5 per cent. Annual growth in retail sales rose to 15.2 per cent in May from 14.8 per cent in April, slightly ahead of forecasts, partly due to a moderate pace of deflation.
For all of last year, retail sales were up 21.6 percent. Together, the two read-outs suggested a 4 trillion yuan (HK$4.5 trillion) government stimulus plan, allied with consumer spending, is starting to overcome weak global demand for the exports that powered the country’s breakneck growth in recent years.
Accompanied by the rise in US retail sales, this indicated to many that the Chinese stimulus package is working and that the global and Chinese economies may have bottomed out. In the author’s words, “A growing conviction that the global economy is starting to claw its way out of the deepest recession in six decades has seen stock markets rallying strongly from the depths plumbed in March, while hopes of burgeoning demand have driven prices of oil and industrial metals to multi-month highs.”
The next bit of good news was mainland investment levels. According to another article in the same paper:
Mainland investment surged in May on the back of government pump-priming and a recovery in the property sector, providing fresh evidence that the world’s third-largest economy is leading others on the path to recovery.
Investment in urban areas in fixed assets such as apartment buildings and roads rose 32.9 per cent in the first five months from a year earlier, compared with a 30.5 per cent rise in the first four months, t he National Bureau of Statistics said on Thursday.
Economists said that translated into a 40 per cent leap in May alone. Adjusted for inflation, the increase was even greater because mainland prices have been falling for several months.
Actually I think this is not good news at all. To me it indicates nothing more than that if you pump enough money into investment, investment will rise. A much more important question, and one of course not addressed by the data, is whether pumping money into investment is the best way to force the necessary adjustments in the Chinese economy, and whether this does not represent a ‘doubling up” of china’s bet on the global recovery. That is something only time will tell, and I have written about this enough times elsewhere to leave it at that.
The bad news is that, according to a release today by the Ministry of Commerce, foreign direct investment in the mainland dropped 17.8% year-on-year in May for the eighth straight monthly fall. Honestly I don’t think this is such a big deal except to the extent that it gives us a “businessman’s” view of economic prospects in China that is very different from the economic-recovery view so popular in the Chinese (and foreign) press, although of course it may simply reflect the desire abroad for cutting exposure and cutting capacity.
Much more interesting to me is the trade data. According to an article in Thursday’s People’s Daily:
China‘s exports and imports shrank for the seventh month in row in May, the General Administration of Customs said on Thursday. Exports fell 26.4 percent in May from the same period a year ago to 88.758 billion U.S. dollars. Imports were down 25.2 percent to 75.36 billion U.S. dollars. The trade surplus was 13.39 billion U.S. dollars.
The decline in exports and imports in May were worse than the 22.6% fall in April’s exports and the 23.0% drop in April’s imports, although Goldman claims that the decline is more or less flat if measured on a seasonally-adjusted basis.
April’s and May’s trade surpluses ($13.1 and $13.4 billion) were substantially below the equivalent numbers last year ($16.7 and $20.2 billion), so from that point of view we can argue that China is finally starting to reduce the negative net demand it provides to the world. Two caveats are in order, however. First, for the first five months of the year, China’s trade surplus is still up more than 13% compared to last year – $89.1 billion in 2009 versus $78.6 billion in 2008.
Second, imports would have fallen much faster except for the surge in commodity imports. Jamil Anderlini at the Financial Times gives one, benign, explanation for the surge:
Chinese import volumes of many commodities and natural resources surged in May, indicating a rebound in infrastructure building. That supported figures on Thursday showing fixed-asset investment was 32.9 per cent higher in the first five months of the year, compared with the same period in 2008, an implied rise of 38.7 per cent in May alone from a year earlier.
Keith Bradsher, in an article in Wednesday’s New York Times gives possibly a very different explanation:
Strong buying by China has helped lift commodity prices around the world this spring, but growing evidence suggests that a sizable portion of this buying has been to build stockpiles in China, and may not be sustainable.
At least 90 large freighters full of iron ore are idling off Chinese ports, where they face waits of up to two weeks to unload because port storage operations are overflowing, chief executives of shipping companies said in interviews this week. Yet actual steel production from that iron ore is recovering much more slowly in China, and Chinese steel exports remain weak.
Commodities and shipping executives describe Chinese stockpiling in recent months of a range of other commodities as well, including aluminum, copper, nickel, tin, zinc, canola and soybeans. Starting in April, China began stockpiling significant quantities of crude oil.
There have been rumors and some evidence of stockpiling for months, and if this is the case, and of course if the stockpiling is not sustainable, then the import numbers are likely to have been artificially boosted. Real demand by China for foreign goods will have actually been much lower.
Of course all of this has a trade impact. Regular readers don’t need me to rehash the arguments. Suffice it to say that the Chinese fiscal stimulus, rather than an adjustment to the new economic realities, in my opinion, is still based on boosting production and investment and constraining consumption, in spite of statements to the contrary (for example today’s People’s Daily has another front page article in which Premier Wen “stressed the importance of promoting domestic consumption”).
Unless the world recovers rapidly and sustainably and, more importantly, US consumers return to the heady days of financing their consumption by binge borrowing, we are going to need to see a greater trade adjustment in China. Trade tensions are not improving. Last week I had dinner with a very senior China manager at a large German company and he told me expected anti-dumping suits to surge in the first quarter of next year. As if to beat him to the punch yesterday’s Financial Times came up with this story (“China accused of predatory pricing practices”):
India’s small and medium enterprises have warned that they are suffering because of cheap imports from China. They are urging New Delhi to accelerate anti-dumping investigations and impose tougher safety and quality checks on Chinese products.
The appeal for greater government protection came amid rising tensions between New Delhi and Beijing over trade, after a high-profile dispute over an Indian ban on Chinese made toys. India’s Federation of Chambers of Commerce and Industry said on Sunday that a survey of 110 small and medium-sized manufacturers found that about two-thirds had suffered a serious erosion of their Indian market share over the past year, because of cheaper Chinese products.
In its statement, FICCI said the Chinese imports were between 10 and 70 per cent cheaper than comparable Indian products, a price differential that it said was “huge and difficult to explain”. Amit Mitra, the FICCI’s secretary-general, said Indian industries were being hurt by “typical Chinese predatory pricing” intended to drive rivals out of business so that Chinese companies could capture the market – and then raise prices to more normal levels. The bite was felt by companies in a range of sectors, including processed food, light engineering, building materials and heavy engineering, chemicals and textiles, FICCI said.
The fact that Indian wages are lower than Chinese wages is probably not enough to compensate for China’s much better infrastructure, but there are other reasons for the price differential. I discussed some of these reasons in an entry earlier this month.
It appears the much touted stimulus program has not done much to reduce the trade surplus. A significant additional increase in real net spending by the central government appears to be the only quickly effective counter-cyclical approach likely to reduce the current downturn without igniting a larger trade war. However, there seems to be an aversion to direct, on the books, borrowing by the central government. Instead they seem to want to resort to dysfunctional, back-door, off the books methods, like contingent liabilities, forcing banks to lend to borrowers who will not likely repay, forced lending to SOEs that do not have viable investment opportunities, etc.
Why the aversion to above board deficit spending by the central government? There is a large surplus of internal cash savings and a lack of other borrowers who can effectively use the funds and repay the loans. The government could use the excess savings to do things that need to be done for the benefit of the people. This is effectively the people borrowing from the people to accomplish things beneficial to the people. Longer term structural changes are needed to better balance personal spending with production. However, the other short term alternatives are to reduce production, resulting in more unemployment; or to try to increase exports and ignite a more severe trade war.
You are right that the U.S. does not “need” China to finance fiscal deficits. It does, however, “need” China to finance them at a low cost.
The important China-Treasury dynamic is one of price. China is a non-economic buyer of Treasuries — it is strongly price insensitive, and arguably its purchases have nothing to do with expected future returns.
By contrast, non-official Treasury buyers must be concerned with future real returns. In their view, the higher the deficit, the more probability the deficit will be monetized by the Fed, and the higher the term premium they require.
So we are moving from a regime where U.S. fiscal and monetary policies have LITTLE impact on sovereign yields, to one in which more stimulus results in a higher term premium. The free lunch is over. This could result in a “Latin” sovereign risk premium dynamic: one in which a weaker economy also weakens bond prices and the currency. This dynamic would have major consequences for the global economy.
Well articulated for such an entangled argument.
For the first 4 months of 2009 China’s trade surplus with the US is down 11% from 2008. Would you view this as a leading indicator where a decrease in US consumption is contagious to other Chinese foreign export markets. (IE: Germany’s trade surplus with the US fell 50% in the first 4 months)
http://www.census.gov/foreign-trade/balance/c5700.html#2009
Do you have data for China/US trade for May 2009?
Link to the CCTV9 Video mentioned in this post:
http://www.cctv.com/program/e_dialogue/20090613/104042.shtml
Just a few observations on some of the things I think we have to look forward to as things evolve: First is the rise in consumer (credit card) debt in the US as the effects of rising unemployment kick in. I am not sure how Setser figured this in to his numbers, but I think a second wave of badness might be on the way, especially if we take into account the maturity structure of outstanding US mortgages (mid 2010 could be ugly). Second, with unemployment rising in absolute terms by the largest numbers in emerging market economies the potential for trade frictions is greatest between China and other emerging markets and poor countries (see complaints from Indian auto makers, toys, etc. as above). Third, the only exit strategy for the G8 at this point is to essentially pull the stakes out of the tent and see what happens. We know what will happen, and why it is premature to think about the exits. Fourth, China and Russia keep playing this rhetorical/psychological game with the currency markets, and we have not seen the end of this. No conclusions here, but just some reasons to expect that the illusion of a return to normalcy is just that.
I just wrote a post regarding China’s longstanding ‘hidden’ debt. A CCB NPO auction failed in March , as none of AMC’s would bid on it. China is much closer to being cash-strapped then is commonly acknowledged.
US Dollar Set To Rise
http://www.oftwominds.com/blogjune09/dollarB06-09.html
G. Stegen, I cannot fully explain why the financing is all being done indirectly, and perhaps Victor Shih can chime in with his comments (although I think he reads this blog on RGE and not here). It may partly be because it is quicker and institutionally easier to put pressure on banks and local leaders to fund the stimulus, partly because it is considered useful to disguise the extent of the borrowings, and certainly there is talk that the Ministry of Finance is very reluctant to see direct debt obligations surge. It may also have to do with repayment. Direct MoF borrowings must be paid for through taxes, which are likely to fall mostly on the middle classes and the rich, and so may be politically difficult. Fiscal expansion through bank lending, on the other hand, can be “repaid” by boosting bank profitability via very low deposit rates, which spreads the repayment more generally and is a more disguised form of taxation. All of this is just speculation on my part, by the way.
David, yours is an interesting point and I need to think about it. My immediate reaction, however (and I will write about this soon) is that the world has an excess savings problem and so real interest rates are not likely to surge.
Stoenweapon, I would argue that the decline in China’s trade surplus with the US is far less than what one would have expected given the overall decline in the US trade deficit. I think we still have a ways to go. I certainly agree that it is through US imports that the contagion spreads from US consumers to the rest of the world.
I agree CNM. We still have several more shoes to drop.
Thanks Purple. I read your very interesting post.
It seems that CIC is being pushed to put a lot more money to work, witness their recent investment in an Aussie REIT, GPT and the desire to push a lot more cash into hedge funds and the like.
Stegan’s point is valid in that the flatness of the yield curve is probably done and dusted: Greenspan’s comment about the paradox of not being able to influence long term yields during the 2000′s can be explained by China’s trade surplus and need to sterilize and the fact that Fannie and Freddie were printing cash like there was no tomorrow by expanding their balance sheet. Both of these trends are likely to reverse on a longer running basis.
With regards to the savings glut, I’d have to agree but China is doing its very best to blow it all away as quickly as possible on fixed asset investment that may be weakly positive on an IRR basis and reflating a property bubble that probably should have burst before. Latinization is possible for the US but the quasi-Brazilian commanding heights model for China isn’t exactly ideal either.
Michael, its great to see you answer comments on your blog. What do you mean by ‘the world has an excess savings problem’? this is really confusing me. Thanks
If I were looking for a completely reliable and unbiased opinion of the strength of the US dollar, would I be well advised to ask those guys holding large volumes of US dollars? And this is from the same guys who have admitted that they themselves are looking around for alternative options. Hmmmm….
There once was a time when it was commonly believed that a strong economy required people working, not rapidly rising unemployment. The whole idea of trade is that something of value is exchanged for something else of value, can anyone explain which valuable goods the US is going to create in the near future (and how) ?
If China started buying General Motors vehicles for the amazingly reasonable price of USD 100k each, then they could buy a million cars a year for twenty years and cover the approx 2 teradollar Chinese holdings of US dollars, give or take some interest (I’m not going to try hunting for more exact figures). Maybe you don’t think this scenario sounds plausible, then by all means substitute your own.
Michael, another great post with plenty of food for thought. What do you think of the claimed 15.2% growth in retail sales yoy to May. While we are certainly seeing strong investment led growth, I’m a little more sceptical that Chinese consumers are boosting their personal spending by so much. All surveys of consumers I’ve seen indicate many are much more conservative with their own cash and many were intending to economize and spend less, quite inconsistent with this figure. In addition, growth in VAT and consumer tax receipts show nothing like this growth. Is this figure reliable?
Michael,
You are constantly reminding your readers that current account deficits get funded by definition. Therefore, there should be no worry about the US funding its deficit. I think this misses the point. At what price does the US fund this deficit? What combination of FX rate and yield on liabilities? Of course, the change in the price of funding the deficit will cause the size of the deficit to change itself. If it is all done via the exchange rate, the deficit may dissappear on the back of growing US exports and too expensive imports. If, on the other hand, it is all done via a rise in US interest rates the deficit might dissappear as a result of collapsing US demand and thus imports. (Pretty much what has shrunk the deficit so far) A complicating factor of course is that US oil imports are about $250 billion a year with crude prices at $70…with US consumption of oil pretty efficient already and demand already way down, it is hard to see how that import bill can be reduced. So the US needs to export that much, at least, to eliminate the need for more foreign funding. So when people fear the USD losing its reserve status, it is merely code for the USD is set to weaken alot. Why? Because the foreign debt will keep piling up to the sky until the US eliminates the deficit. If it can’t eliminate the deficit easily (oil) then the price to fund the deficit is likley to change. Given a choice by US policy makers of higher interest rates or weaker USD, I think everyone knows which one they like.
A further issue worrying foreign holders of US debt is that the Fed has begun QE. They are almost saying, “we have made our choice. We don’t want higher rates.” A signal that it is going to be the exchange rate? The Chinese are making noise to try and keep the US authorities “talking” the USD strong. While in the meantime thay are trying to spend USD as fast as they can. Stockpiling commodities and buying AUD, BRL, AND RUB strategic assets and as much of Africa as they can!
You make a lot of valid criticisms about the Chinesa economy and fiscal stimulus. What though would you do? I assume from your wriitngs that you support fiscal stimulus to counteract these powerful recessionary forces. But what would you do differently? So far the results in China look pretty good. IP up, trade down, domestic spending up. Looks like a rebalancing away from the export model and towards more doemtic consumption, no? I know you want savings and investment down but how to achieve that quickly? The Chinese have intiated more spending on the social safety net. That goes towards the end of lower savings. But that stuff takes much longer to execute, right? Investment spending is much quicker. You argue that they don’t need more capacity. Agreed. But is this investment really more capacity or higher connectivity to existing capacity or a redirection of capacity towards local demand? So far, it appears the Chinese have been getting it right. I admit big risks still remain, but it is hard to fault what they have done so far given the set of circumstances they found themselves in. Their own falut or not beside the point.
Professor Pettis: A great post as usual !
You are on the same wave lengths as Martin Wolf’s article in last week’s FT. He like you underscores the inconsistency of Chinese calls for the US to ease the pain of falling Chinese exports by propping up consumption — while cutting back on its reckless fiscal expansion to preserve the value of the US$.
It is bizarre that the countries running big current account surpluses (China, Germany and Japan) are doing so little to raise domestic demand relative to the deficit countries.
Like others I agree that the BRICs have no other option than to talk tough and keep on buying US Treasury paper. The alternatives are worse.
Unlike Tel who suggests that China could buy all of GM’s production for the next 100 years, I think they may be tempted to build a blue water navy and to upgrade their clapped out MIGs and tanks with Hummers.
I don’t understand why they just don’t go on a spending binge to upgrade their rural health and education systems and create a functionning pension regime? best regards James
Michael,
The excess savings may disappear as fiscal dis-saving is used in emerging economies to prop up demand.
Think of it this way: the reserve countries have a choice between accumulating dollars, other currencies, or goods and services. They are caught in a deflationary dynamic, and they cannot stimulate export demand — only import demand. So will they choose currency or goods?
I would argue they will increasingly choose goods as it becomes clear that export demand will not rebound soon.
So in a world in which 1) the U.S. Treasury faces a different (non-official) demand curve for its product; and 2) reserve accumulators choose to hold, on the margin, goods over currencies…
…in such a world, U.S. real interest rates would rise, especially under the threat of structural deficit monetization, which is what we are facing now.
Please keep in mind that years of excess stimulus have left us, the U.S., in a situation where every unit of export growth is more than offset by the resulting unit of real interest rate increase.
All of the above results in an increase in global money velocity.
Tel,
Take a look at this trade map for US export, if you click on the particular industries you will see who is leading the world export share in that category.
http://www.intracen.org/appli1/TradeCom/TP_EP_CI.aspx?RP=842&YR=2006
I don’t think there is a shortage of valuable goods in the US; however biotech, aviation and software in my opinion have a long way to go(just to name a few).
I think the bigger problems we face (maybe this is what your getting at, I don’t know) in the US is twofold – opening up domestic markets for our technologies in countries where the political and economic power is by large in the hands of corporations or mercantilists, and preventing a further erosion of the US job base caused by the relocation of US corporations taking advantage of lower production costs. Were not setting a good example here, and we are sacrificing our democratic values for profits by catering to the terms of communist governments. IE: Oracle, Cisco, Google, Yahoo provide China technology for their web and software censorship.
http://www.pbs.org/wgbh/pages/frontline/tankman/view/
The “corporation” is really the problem.
Prof Pettis-
If we play forward your interpretation of our economic trajectories a bit (US savings rate rising and China still under consuming), am I right to think we are at risk of a deflationary collapse in China? I would assume the central authorities would attempt to export at any price and this might in turn lead to a protectionist upswell in the US. Certainly it underscores the idea that treasury yields should stay low.
Thank you for provoking an interesting discussion.
Purple, like your blog.
Michael, I’m having difficulty with the suggestion that we should be increasing US fiscal deficits to slow down the contraction in consumption, although from China’s perspective it makes sense in the near term. I would prefer the savings glut of wealthier individuals and corporations are subject to harsh penalties for US withdrawal and lack of investment into the free market principles that promote new opportunity, research and development – rather than into politically influenced interests.
It is my opinion that the world’s share of GDP we enjoy in the US is far too dependent on credit, and a honest economic correction would have to be faced with the deflationary forces of accountability. I want to add that a more balanced trade deficit is not everything if the social and political way of life is sacrificed or reduced to poverty. Lastly, I would argue the artificial value of asset prices is eroding the true value of labor and “the last professor”
http://fish.blogs.nytimes.com/2009/01/18/the-last-professor/
Purple or Michael:
Can you please post a link to Purple’s writings on China’s “hidden” debt referenced in the comment above? Thanks
“Take a look at this trade map for US export…”
Good page, I’ll bookmark that one. Let me pull out the top 10 balance-of-trade earners for the USA:
#88 Aircraft, spacecraft, and parts thereof
#10 Cereals
#90 Optical, photo, technical, medical, etc apparatus
#12 Oil seed, oleagic fruits, grain, seed, fruit, etc
#38 Miscellaneous chemical products
#39 Plastics and articles thereof
#52 Cotton
#23 Residues, wastes of food industry, animal fodder
#47 Pulp of wood, fibrous cellulosic material, waste etc
#32 Tanning, dyeing extracts, tannins, derivs,pigments etc
I can see a few strong themes in that lot:
* Technology
* Agriculture
* Oil
And those themes mix with one another to some extent as well. Technology — yes, fully agree that the USA is currently the world leader, but by a shrinking gap every year, with more competitors. Agriculture — again, the USA is very productive, hugely efficient, lots of highly developed land, probably fairly stable (let’s ignore any global warming). Oil — big problem here (but also for other countries), it’s running out. Note that highly mechanised agriculture depends on oil, but plastics and chemical industries also depend on it. In a world without oil, the USA will be on a much closer to level footing.
Software I would throw into the “technology” category, same deal that USA has a strong lead now but steadily shrinking in an increasingly competitive industry. I’m not thinking that China is going to come on strong with software anytime soon, but Eastern Europe, India, Australia/NZ and maybe Japan all have a good chance in the software industry. Throw silicon chip design in with software, it’s mostly the same.
Biotech is a total black sheep, could go lots of directions. In rich Western countries, Biotech is a maze of ethics committees and rather arbitrary regulations, but probably the skills are stronger. Developing countries face complementary advantages/disadvantages so minor factors will make a big difference.
IMHO US pharmaceutical companies make most of their money by delivering tiny incremental improvements on established products into a highly regulated captive market. Not the sort of innovation likely to catapult them to world dominance, except perhaps for their great skill in manipulating government policy. The intracen chart seems to believe that the US is making a nett trade import of pharmaceuticals, I’m not sure how they handle IP licensing money flows.
Frankly, I believe that the USA lost focus on the things that made them great in the first place:
* Capitalism — the US model gradually moved to Corporatism, and is heading into Socialism. Too much power at the center leads to impractical decisions and the emphasis of those decision makers is mostly looking for ways to hang onto their power and milk it. Not enough people see the problem yet.
* Individual freedom — the “War on Terror”, the “War on Drugs”, rising Authoritarianism, intolerance and distrust, acceptance of torture, acceptance of corruption, (why go on?)
* Incentive and Hard Work — if there’s one single message that came through solidly from the recent financial crisis it’s this: reward for failure. Working stiffs now clearly understand that there is no ladder of opportunity unless you are willing to steal, sell drugs, and/or scam someone.
With a little bit of time doing it tough, they will take an interest in soul searching and reinventing themselves. I’m sure the USA will bounce back, but not quickly, and not by running yet another Hollywood remake.
Stu- I’ll take a crack at it. A savings glut is basically the flip side of a lack of effective demand. If people (or companies) earn/produce more than they consume it shows up as savings. In order to earn any return those savings need to be invested. However, if globally there is too much production relative to demand their will be a glut of savings chasing increasingly tiny returms. Other’s feel free to correct me if I am off.
Xueling- Hit Purple’s name to follow the link to his very interesting post.
Beijing orders ‘Buy China’ for stimulus projects
BEIJING (AP) — “China has imposed a requirement for its stimulus projects to use domestically made goods — a move that could strain ties with trading partners after Beijing criticized Washington’s “Buy American” stimulus provisions”.
“Projects must obtain official permission to use imported goods, said an order issued by China’s main planning agency and eight other government bodies”.
Just imagine if the US imposed a nation wide legal requirement to “Buy American” for all branches of government.
http://finance.yahoo.com/news/Beijing-orders-Buy-China-for-apf-15546146.html?sec=topStories&pos=8&asset=&ccode=
Is Beijing really in any position to criticize Washington? Has the US not bought enough goods from China already? How about reciprocating, is this word even in the Chinese Elite vocabulary? The Chinese government and their mercantilistic interests have failed the opportunity to open their markets during good times. Anyone thinking they will free up their markets during tough times without a major civil crisis is a pipe dream! The protectionism Michael fears could get much worse than we dare to forecast. I have no problem working harder to pay my share of debt to the Chinese, but how can I pay them if they do not want to buy anything I can do for them other than dig up soil!
US account deficit at the cost of economic flexibility?
Michael has acknowledged that the US will probably be first to recover the economic crises because the US economy tends to be the most “flexible”, yet the Professor encourages the US to increase its fiscal deficit as a means to slow down the rate of contraction in US consumption and credit.
The negative impact rising fiscal deficits have on economic flexibility need examination.
US economic flexibility will likely have to face a longer than expected crises as the debts and rising tax burdens on its population – threaten its ability to be elastic.
At what cost will the mountains of debt and rising taxes constrain the once envious US market flexibility?
Thank you Micheal for a very informative post.
@ David Pearson -Very interesting comment. Thank you.
Stu, excess savings means either that the desire for savings at current prices exceeds the desire for investment, or that production at current prices exceeds consumption, which is pretty much the same thing. The world must adjust by slowing growth. More specifically, while Asian savings surged in the past decade, US savings collapsed, thereby effectively keeping the necessary balance. Now because US households took on way too much debt they need to cut their consumption and raise their savings, which they are doing. This means that Asians must cut their savings and raise their consumption commensurately, but this is proving fiendishly hard. That is what I mean by an excess savings problem.
Tel, as a former trader my guess is that if you are looking for “a completely reliable and unbiased opinion of the strength of the US dollar,” the last place you would find it is with someone who has an incentive to talk his book. More importantly, we must distinguish between politics and economics. While it makes political sense for a host of reasons for different people to say different things about the status of the dollar, it is much more useful to see what they are actually doing and what they actually can do. Check Brad Setser’s blog for the best estimate of what China is really doing with dollars.
As for your second point, I am not sure I understand. Fevered punditry notwithstanding, the US is easily the largest manufacturing nation in the world and manufacturing output has increased steadily over the past years. Since productivity has increased even faster (and this is a good thing), the employment share of manufacturing has decline. By the way when the same debate was taking place in the late 1970s and early 1980s, the answer as to what valuable goods the UIS should sell in the future turns out to have been high tech and information processing goods and services, but no one knew it at the time. Then, as now, it is almost impossible by definition to predict what the most technologically advanced country will produce in the future.
Chris, I am not completely sure what to make of it. On the one hand we are told that domestic consumption is surging, yet on the other we are told that imports are collapsing. This is counter-intuitive at best. As we Americans proved to the world, when people go on a shopping spree they import a lot of stuff. At any rate everyone acknowledges that there are lots of problems with retail sales numbers.
Max, you misunderstand me. The point is not that we don’t need to worry about how the US fiscal deficit is funded. Rather it is that the surplus countries have little discretion in their financing decisions. It may be true that US obligations abroad pile up forever, but this will be because the US runs a trade deficit, not a fiscal deficit. I don’t want to get into the big debate about the relationship between the two, but for now the problem is not how difficult it will be to fund. As for weakness in the dollar, I think the dollar will and must weaken, but the reason it hasn’t is because many countries peg their currencies to the dollar at undervalued rates, so forcing excess strength in the dollar. Countries that do so cannot also complain about future potential weakness in the dollar versus, for example, the euro because their very policies only permit dollar weakness against un-pegged currencies. The dollar should weaken, but against Asian currencies.
As for your last point, I don’t consider myself as criticizing US or Chinese policies. I am trying to understand them and point out possible consequences. I don’t really discuss too often what I would do because it isn’t terribly relevant and anyway I have no big claims to knowing more than US and Chinese policymakers do. This is particularly true when policies are driven for political and not economic reasons. For example, I think current policies in China address short-term unemployment problems effectively but worsen the medium-term prospects for adjustment. Why choose one set of policies over the other? Politics. The choice may be perfectly reasonable, but I think it is nonetheless legitimate and necessary for guys like you and me to figure out the consequences.
Chan-lee, Martin and I have already discussed how we started from very different positions and yet ended up with nearly identical analyses. As for your final point, I don’t have much to say about military capabilities but I think China is very serious about upgrading its rural health and education systems. These things, however, are always much easier said than done, especially if you don’t want to run into massive misallocations and corruption.
David, you may be right, but for now I see rising global savings as a sticky problem that is not going to be easy to resolve and will only be made worse by declining global investment, especially as the massive fiscal stimulus programs around the world begin running into debt constraints.
Thistle, yes, I agree with your export-at-any-price claim and think we are already seeing it. The recent flap over the Buy-China provisions is just part of it. Just as interesting are the trade implications. Yesterday, just after the (rather forced, I think) love-in at Yekaterinburg, India has slapped restrictions on a whole slew of Chinese imports, and there will almost certainly be more.
Stoneweapon, I share your concern about the rising US fiscal deficit. However I am also convinced that the global institutional framework that governs the next several decades will arise from the wreckage of the current crisis, and I think it is ion the best interest of the US and the world that the US slow down its adjustment so as to make it easier for China. If the US adjusts too quickly, China will be screwed, and we will be stuck with a world filled with hostility and mistrust. This can’t be a good thing. As for the Buy-China article in your next comment, I am worried that in retrospect this will be seen as China’s Smoot-Hawley.
Michael,
Thanks for the reply. You say ‘excess savings means either that the desire for savings at current prices exceeds the desire for investment, or that production at current prices exceeds consumption, which is pretty much the same thing. The world must adjust by slowing growth.’
Cannot the adjustment take place through falling prices? If prices fall then won’t consumption and investment rise?
Michael,
You wrote a response to my comment but it was puzzling. I think it was meant for someone else? I never mentioned the US fiscal deficit. I was responding to your argument that
“It’s great that commentators are coming back, however temporarily, to a sense of reality and common sense. There never was likely to be a crisis in the ability of the US government to fund its deficits, and all the pleading to foreign governments to continue purchasing dollar assets was based on very fundamental misunderstandings of both the form of the global adjustment and the functioning of the global balance of payments”
Because the US government is the only one borrowing now, the current account deficit is funded by purchase of US treasuries (more or less) There IS a potential crisis in their ability to fund the deficit, the current account deficit that is. Of course, it WILL get funded, but the price might cause an economic crisis.
Just because China keeps the Yuan fixed to the USD doesn’t mean we can’t have a crisis in funding the USA. Suppose China says “every USD we buy from a Chinese exporter we sell to a European or a Brazilian or an Aussie for their local currency?” The Chinese would be forcing those markets to “price” the funding of US/China deficit, right? The Yuan would remain fixed and the USD would weaken substantially vs those currencies or maybe bond yields would rise or some combo? The Yuan would weaken too vs. those currencies and maybe produce even more exports for China? There is a lot of risk out there. I don’t think it is fair to say that people that think there is a possibility of a crisis in funding the US deficits fiscal or current, don’t understand the international balance of payments system. It will get funded but at what price. It may be a price that will cause a surplus to appear but it maybe a price that causes way too much pain way too fast?
Stu- You’re forgetting about debt, which is contractually fixed in nominal terms. The scenario of falling prices and wages means that more firms and consumers will not have enough money to meet financial obligations leading to a rise in bankruptcies, forced asset sales and a further depression of prices. Even those still able to meet their obligations are squeezed, if a firm’s income falls by 5% and half of it’s cost structure is contract debt, even if its adjustable costs fall in line with income the firm is worse off and less able to invest. The same goes for households.
Rinse and repeat, until, well, exactly when it peters out is a good question.
Interesting Max, so China just forces a current account deficit onto Europe, Ausie and Brazil? Providing vendor financing for the US in addition to themselves? One would assume there would be policy responses in said countries as China moved from manipulating their currency to manipulating everyone else’s. Somehow I doubt that would end any better for China than the current situation, but it would be interesting to see them try.