Earlier this week I had a debate on TV with a local economist on the subject of trade relations. We had the same debate about six and twelve months ago and in each case while I argued that the trade problems were almost intractable and trade relations would inexorably deteriorate, he both times acknowledged that although things may have gotten bad recently, I was being overly pessimistic because the trade disputes had finally bottomed, and conditions would only get better.
Astonishingly enough this was still pretty much the debate we had this week. It is almost impossible to pick up a newspaper today without seeing several articles that directly or indirectly indicate how much worse things must get before we reach bottom, and yet there are still too many people who can’t understand the numbers. I would argue that a lot of people, especially in China, think that it is mainly US pre-election posturing that is driving all of this anger. If that is the case, why are we seeing article like this (“Fears of global currency war rise”) in the Financial Times?
Thailand is introducing a tax on foreign holdings of bonds, the latest in a string of attempts by emerging economies to curb destabilising capital inflows amid fears of a global currency war. The Thai cabinet on Tuesday imposed a 15 per cent withholding tax on capital gains and interest payments for government and state-owned company bonds, a clear signal that it would take tough measures to curb inflows of “hot money”.
Or how about this one?
Japan has called on South Korea and China to “act responsibly” on exchange rates in an unusually strong statement ahead of the G20 summit of leading nations in Seoul, expected to be overshadowed by rising tensions over currencies.
The statement by Naoto Kan, Japan’s prime minister, adds to pressure on Seoul as the host of the meeting in November to broker a discussion on currencies despite some countries, including China, pushing to keep the issue low on the agenda.
In fact it seems that every third article in the front section of the Financial Times indicates one way or another a country that is battening the hatches and preparing for a beggar-thy-neighbor world.
The problem is not pre-election posturing in the US. It is much worse than that. The problems is that the numbers actually do not work. China and Germany need to grow their surpluses to maintain growth. In fact China has to choose between an unhealthy overreliance on the trade surplus and an even unhealthier over-reliance on investment, as I mentioned in a comment in Bloomberg yesterday. Japan cannot allow its trade surplus to decline because with no demand growth this can only come about as a contraction in production.
On the other hand European deficits are collapsing as a consequence of the financial crisis. And the US cannot tolerate a rapid increase in its deficits. How does this math work? Surpluses and deficits, after all, must balance to zero.
Well I guess one way to get this balance (here comes my modest proposal) would be for China to engineer a New Deal in America, which we could call Xin Fa’an (“new deal” in Chinese). As I have discussed many times, most recently in my October 6 entry, my September 29 entry, and my September 11 entry, Beijing needs the US to continue running a rising trade deficit in order to absorb Chinese overcapacity while China slowly rebalances its economy towards domestic demand, which will take many years.
There are two ways that the US can run a rising trade deficit. Remember that a country’s current account deficit is equal to the excess of Investment over savings. If the US runs a rising current account deficit, this just means that the excess of investment over savings has risen.
One way, of course, is for savings to decline. There are two ways that can happen.
- US consumption can grow faster than US income. Since savings is simply income minus consumption, as long as consumption grows faster than income, savings will decline. Of course not only is it unlikely that US consumption will surge, but it would be terrible if it did. The US consumes too much, and needs to bring this number down.
- US unemployment can rise. As US companies fire workers, household income will decline. If consumption declines at the same rate as income, or at a slower rate, gross savings will decline. This, of course, is exactly what the US wants to avoid and why we are on the verge of a trade war.
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The other way the US can run a rising trade deficit is for a surge in investment. With a slowing world economy it is unlikely that private investment will rise, but as Joseph Stiglitz pointed out recently in a debate during the IMF/World bank meetings in October last week, the US is paradoxically in a very good position to increase investment because it has very poor infrastructure for its levels of development. The US has tons of room for a major expansion in infrastructure and, unlike in China, almost any infrastructure spending is likely to be value creating.
One way for this to happen is for the US government to fund and engineer the infrastructure spending directly. The resulting increase in the US trade deficit would of course be financed by Chinese lending to the US government as it is forced to accumulate USG bonds. But aside from the fact that there is too much pork-barrel politicking involved in US government spending, it will result in a rapid rise in the US fiscal deficit.
Would that matter? No, because this is exactly the kind of fiscal spending that is sustainable. US wealth creation would exceed the rise in debt and so the US is in the aggregate better off. But of course the politics of a rise in the US fiscal deficit are pretty sticky.
So why not have China do it directly? Let China engage in a massive rebuilding of US infrastructure – it can build airports, highways, damns, and railways – which would raise investment levels enough keep the US trade deficit high in a way that benefits the US and China.
Of course China would also have the right to charge for the use of these projects so that it can earn a positive return on its investment. The return doesn’t even need to be high – just better than the return it gets on its huge expansion in investment in China, which I suspect is negative for the country as a whole.
Even worse, China is lending money to foreign borrowers anyway to boost China’s trade surplus, and I am not sure they can count on a positive return there. Look at the $5 billion loan Premier Wen pledged to Greece to buy Chinese ships. That may look like a clever deal economically, but I think there is a very high probability that within five or six years Greece will be forced to default on its debt and will obtain significant debt forgiveness. In that case China will earn a negative return there too. You can’t get rich giving away ships.
As long as it earns more than it earns on its USG bond holdings, it will be better off economically even without considering the immense advantage of keeping the US trade deficit high for the eight to ten years China is going to need to rebalance its economy away from its toxic over-reliance for growth on the trade surplus and economically non-viable investment.
Talk about win-win. China will get the eight to ten years it desperately needs to engineer what will otherwise be a brutally difficult rebalancing. It will get a much higher return on its investment. And it can avoid the foolish pork-barrel domestic expenditures that have characterized the past several years.
The US can sharply improve its infrastructure in a rational way without a boatload of Congressmen arguing over who gets what. It can raise employment without raising the fiscal deficit. And as icing on the very large cake we can avert the trade war that is an almost inevitable outcome of the current imbalances.
So can we get China to fund the Xin Fa’an in America? Probably not. Muddled Chinese public opinion will be furious that desperately poor China is investing in rich America, even though the overall returns will be better and the cost of China’s adjustment will be much lower. Muddled American opinion will be furious that America is “selling out” to China. Bumptious politicians in both countries will completely fail to get the underlying economics of the trade, and they will never allow it to happen. But it is still a pretty good idea.
It’s not only a good idea, it’s already started to happen:
http://laist.com/2010/09/14/china_wants_to_build_californias_hi.php
It’s a good idea, but even if it was feasible, would it be sufficient?
But I guess that even if it is not sufficient, it could help lessen the pain of rebalancing.
Mr Pettis,
You’re skepticism is well founded but the idea itself lacks merit for other reasons you might not have mentioned. First, I am not so sure that increased infrastructure investment would affect US unemployment. Much of the work would be done by heavy machines operated by temporary workers. That is structural unemployment would not be affected. There is also a question as to whether the money would go to the areas of greatest need or would the money simply be squandered by the US Feds or state governments to pay high government salaries or building “bridges to nowhere”? China would have a worsening UE problem and the US would still have all the same problems with Medicare and Social Security while still paying interest on the old debt and new debt. This proposal sounds like the Japanese strategy of the 90′s. Japan today has wonderful infrastructure but it has not necessarily helped them attract new investment. Japanese spending simply saddled the population with more debt while not helping UE over the long run.
What do you mean by having “China do it directly”? Do you mean use Chinese companies and labour? If so you might want to look at how well that worked out for Canadian Natural Resources Limited, whom awarded a contract to a subsidiary of Sinopec, SSEC Canada Ltd for the construction of two tank farms. SSEC brought in labour from China. According Diane Francis…….
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SSEC Canada Ltd. brought in temporary foreign workers from China into Canada to do the work in 2006 and 2007. On April 24, 2007 an accident on site occurred. Two Chinese workers died and five more were injured, two seriously. They were immediately shipped out after the incident.
Canadian law ignored
An investigation by Alberta health and safety officials, along with employment standards personnel, ensued and in spring 2009 a total of 53 charges were laid against the three companies for allegedly unsafe working conditions which led to the fatalities and injuries — SSEC Canada Ltd., Sinopec Shanghai Engineering Company Ltd., and CNRL.
——–
Sinopec has removed all of their representatives from Canada, so as to not be served summons. On top of all the 132 workers were not fully paid.
http://opinion.financialpost.com/2010/07/03/2653/
Eventually there will be US investment in infrastructure (or we are completely mad). The idea that China would do this, rather than the US government, is as you say, VERY unlikely. I can just see the cartoons with a Chinese character sitting in a toll booth on a Chinese built highway in Illinois. At the same time I think you will see tariffs on Chinese goods. Politically the US can not tolerate unemployment at these levels for the 8-10 years you mention.
Sounds like a great idea to me. I can think of a few potential projects in Sommerville and Cambridge (and one big one in New Jersey!). If American workers were hired, perhaps U.S. public opinion would be more supportive. And the Chinese could produce a pretty nifty propaganda film that might then be broadcast around the world for all to see. Win-win indeed.
Michael,
This may be an intellectually sound idea, but as you say, the politics would be impossible, on both sides. I think your call for moderation on Yuan appreciation in the FT today might also be a lost cause.
Looking at things from a U.S. view, I see this playing out rather badly.
-Republicans will win the House and reduce the Democrats’ majority in the Senate to a point guaranteeing stalemate, and are also likely to win a lot of governorships.
-The winning Tea Party candidates will hold disproportionate sway, both because the split in power empowers small activist groups and because they’ve put the fear of God into mainstream Republicans.
-The 2009 stimulus is winding down and the word is anathema to the insurgents, state cutbacks will likely increase as more Republicans are elected to state houses. There may also be substantial cuts in Federal discretionary spending, or at least a budget crisis or two.
-We will either slip into recession, or very near it.
-The Fed’s QE2 will have as much a negative impact as a positive one as retirees, pensions, endowments and insurers all take a hit, and most of the investment it spurs will be in India, Brazil, Indonesia, Thailand, etc. If the Fed manages to seriously depreciate the dollar, oil hits $100/bbl and the and recession is a sure thing.
-The pressure on government do do something will be huge.
-What’s the one thing Chuck Schumer and Christine O’Donnell can agree on? Blame China!
It’s hard to imagine what China could do in the next six months to change that dynamic, outside of a very sizable appreciation.
Maybe if they did it through a sovereign wealth fund with a neutral CEO? Australian maybe? Nobody’s afraid of them.
This actually makes me slightly more depressed, since it is so unlikely to happen.
I assume you’ve seen the Martin Wolf and Tim Duy pieces on the end of Bretton Woods II. My feeling has been that the last ten years have been driven primarily by the unwinding of BWII, but events seem likely to accelerate now. If the US begins another round of QE, how does this affect the China? IE Currency peg/capital controls/inflation and so forth. Is there a breaking point or more start-stop adjustments?
Let them buy revenue bonds!
I don’t want this idea to be treated too seriously as a real proposal (the hint was in the title). It was partly presented as a joke that illustrates just how deep the problems are.
RS, I am pretty sure that building and maintaining infrastructure involves hiring real people, but even that is not the point. Better infrastructure, if not simply wasted, increases productivity and raises future production. Today’s’ trade deficit, in that case, would be paid for by tomorrow’s surplus in a way that increases wealth.
Glen M, no. I mean Chinese investors choose and invest in the project. They would hire local workers. It doesn’t matter if the work is done by American, Chinese, or even Ecuadorean companies. Better infrastructure increases US productivity no matter who builds it.
SteveK9, yes, it would cause huge uproar.
Gan Lu, I think we can all think of places in the US that could use some improvement.
Bob MA, yes, my pieces in today’s FT and Tuesday’s Bloomberg have caused a lot of consternation among my friends, but the point was not to argue that the world shouldn’t respond (and I have been saying for two years that we were going into full beggar-thy-neighbor mode anyway) but rather that it was going to be incredibly difficult for China.
OGT, I always read Martin’s Wolf pieces and yes I saw both his and Duy’s piece. All they are really doing, in essence, is pointing out how intractable the arithmetic is. That is why, I think, they get it right.
Why does the private sector in US stop to invest?
Competitiveness: Ultimately the US economy needs to be more competitive and efficient to be attractive for the capital investment. The problem is not outsourcing but investment outflow.
This means producing the same goods and service with lower cost, or producing better and more innovative goods and service at the same cost. In the short run, people have to accept lower wage and work more.
Uncertainty?This means reducing transaction cost via deregulation. Less political intervention. Stop porkbarrel that distort the incentives.
To correct the imbalance, Public spending cut and fiscal discipline is necessary. US people needs to work more and consume less.
The economical policy of Obama administration right now is counterproductive.
I really doubt that US has poor infrastructure compared to that in China. Building more roads, railways, airports won’t make US more competitve and productive against China in the long term. There are only so many US residents to drive, ride and take flights. Air pollution aside, more roads here do encourage car ownership (among all my friends) and other consumptions.
I would like to see the currency war coming soon. It is a much different situation when Japan, the population size is only 1/50th of the world at most, is the leading exporter. The reason is not over investment but also under-consumption because of PRC SOE monopolies. There are so many industries, such as Telecom, Energy, Financial Institutions, Healthcare (Hospitals), Military, etc, off limit to private enterprises. They are crowded in export industries, where SOE cannot compete on prices and favorable policies.
As you always say, as long as China, Germany and Japan are running trade surpluses, somebody have to run trade deficits. Without a war (currency or by other means), we cannot expect those big SOEs voluntarily relinquish their priviledges. Those smart efficient Chinese enterpreneurs still have to fight over paltry 2% gross profit from exporting.
Without the ability to plunder and sell opium to China like the West did in the 18th century and Japan did in the 20th century, it will be hard pressed for either to recover their deficit in any way. Thanks to the world wide web, the whole world can see how and when one nation had trespass the other instantly unlike months previously.
hi Micheal
I agree with the necessary macro-economic policy adjustment. But the point is micro policy reform is also important
Michael:
You are ahead of me. I was just thinking that the US is adamant about not increasing aggregate demand, which can only be done via a concerted, organized effort (hence, must be government-driven).
Since that is not happening, where is the demand to come from? QE has proven that it does not increase demand (although this is muddled since QE was executed in parallel with a weak stimulus).
At the very least, a Chinese proposal to jointly assist the US with “funding” their infrastructure needs would be a well-deserved humiliation to this US Administration.
But the Chinese investors should at least dress the toll takers in Chinese Army uniforms to remind US consumers who paid for the projects.
US infrastructure isn’t that bad and to think infrastructure build outs would have some far reaching positive impacts on the US economy is suspect at best.
The US is broken internally. Political leaders of both parties have hollowed out the economy as they ensure their wealthiest donors thrive as the US and global citizens suffer at their expense.
The US empire is dying. A new non-aligned is needed to seize this moment and slay the beast. The rapid fall of the US from greatness to being a canker sore on the world’s ass is breath taking. Slay the beast, sell dollars and US debt before it’s too late and you get zeroed out. That is Bernanke’s plan. How does China feel about the upcoming QE2, the blatant monetizing of US Treasury debt?
Panic first, my non-aligned friends. Slay the beast. US, UK are dying shells attempting to take the globe down with them to ease their fall. Slay the beasts once and for all.
Don’t tell me China can’t delever from the US. China can hold some holdings to maturity among other things. A decent paper on this: http://www.brookings.edu/testimony/2010/0225_us_china_debt_prasad.aspx
For imaginary solutions, here is another one for US.
Raise taxes on the rich and on consumptions. Cut military expenditure. Spend the revenues and savings to improve infrastructures and to help the poor and the unemployed. And sort out the financial mess in the meantime.
What’s the chance that such a solution would be adapted? Absolutely zero! Well, last time, it took the Pearl Harbour to get something similar done.
“I don’t want this idea to be treated too seriously…”
I caught the literary allusion in the title, though your argument is far, far more reasonable than Swift’s. (Swift’s essay was better satire, however.)
I just returned from a few days in Jiuzhaigou in Sichuan province. Many of the roads in the area, damaged by the 2008 earthquake, are now being repaired (at no expense to locals) by teams of road crews from different parts of China. As we drove along, we encountered sign after sign (i.e., of the ubiquitous red banner w/ large characters variety) thanking the various hard-working crews from Shanghai, Beijing, Anhui, etc. It’s fun to think of similar signs hanging near Chinese-financed projects in the U.S. I know this piece was tongue-in-cheek, but I still think it’s a great idea.
The breakneck integration of economies does not match the evolution of political systems (or leadership maturity). It would make me uneasy to open infrastructure investment to the Chinese, given how testy they have been lately. The troubles with rare earths in particular show that they are not handling their leverage wisely.
Considering the entanglement of Chinese investors, SOEs and the government, I think that it wold be to much to expect that they would accept looking at such a program from an RoI perspective.
Off topic alert. I caught George Soros’s suggestion to Martin Wolfe that China should allow its currency to appreciate by 10% per year. Any thoughts on this or today’s trade balance stats?
Hi Michael, you mentioned that “The US has tons of room for a major expansion in infrastructure and, unlike in China, almost any infrastructure spending is likely to be value creating.” Are you suggesting China’s infrastructure is more advanced than the US? How is it possible that a country with 1/10 of per capita income ( even smaller in terms of per capita capital stock) of the US has more advanced infrastructure? I agree the US has room to build, but your suspicision that return on China’s infrastructure construction is negative just does not make sense to me. A friend of mine who is really into photography told me that once he had to walk to a village in Tibet to take photos, and it took him a few days to walk there, because there was no road in any shape or form to the area. This is an extreme example, but I know how poor infrastructure is in remote provinces. Your assumption is that capital spending is terribly inefficeint and wasteful. What if this is not correct? In my view, China still needs a lot of infrastructure and fortunately enough China has enough savings to do it.
Besides, China is indeed building a lot of infrastructure abroad, but not in the U.S., but in Africa. that’s what is underping the massive boom in Sino-Africa trade.
Michael:
Interesting proposal, not sure the Chinese have the wealth to do such a thing, despite it being bandied about. But understand, this is an intriguing idea, hmmm, in so far as how opinions have been manipulated, are manipulated, it is probably unfortunate that it would be rejected out of hand by both parties.
Yet, might be a useful strategy to invest in more profitable ventures over the medium term at a moderate level over a period, as a part of the rebalancing, somewhat in deference to RS, not good to comprise too large of a percentage of the economy in one sector, not too support, in anyway, anything that RS considers, which seems, if believed, little more than the same old nonsense, packaged in similar bottles.
RS: Your writing shows a sincere lack of understanding related to how infrastructure would be built, building is not a federal or state activity, but one of private contractors, where in some cases maintainence is of state priority with Feds distributing tax dollars for such. Further, issues as to the solvency of Medicare and Social Security, although a concern, are often confusing as the CBO uses 75 year forecasts, although needing to be addressed, and the present might be an opportune time, surely less dire then the issues facing the Europeans, and arguably less severe than those facing China, where admittedly, China, lacking in such structures has the ability to be creative in their eventual institution; ie can consider multiple approaches, which of course doesn’t obviate the great costs which need be eventually borne as elsewhere. Again, to demography and dependency ratios.
As is noted by Michaels intriguing proposal, and RS’s tired old concerns, the debt which has been acquired has come with some cost, namely to the American taxpayer, and some benefit to global benefit, which is illustrated by the very discussion that we are considering in this proposal. That few seem to see this, the necessity of it, the value in it, while trivial issues are discussed, favored old positions defended, and a sincere lack of understanding and concern for how the system is being perverted illustrates either the complexity of the issue, or the sincere lack of responsibility that we inhabitants of the planet have for the very thing that provides for levels of existence. Yes, levels where there are great inequality, which should be of great concern, historically, yes, between countries, but more importantly, that which is developing within countries.
And where policies may have been mistaken at times, where they may have been detrimental at others, they have been beneficial at others, arguably more so for participants. Where the failure to see transparency, the strengthening of the states role in providing useful, accurate, correct data, and creating environments for the establishment of institutions, and stronger legal frameworks around entrepreneurship we severely misunderstand the variety of issues at play. Once and for all, there is a strong role for government in an economy, every economy, there is not a useful rationale for massive state intervention in an economy, during normal times, where the state creates mechanisms which clearly undermine the development opportunities of other players in the system.
Despite the fact that much global attention is on China, the US, the EU and new groupings of fashion, BRICs, CIVETS, etc…. what we really find is a lessening of global development potential by such mechanisms as what is, even, being applauded as a new model, intriguing as it is.
And finally, it is high time, we get serious about the value of ideas, and how before a product comes into existence, it first existed as an idea, an idea with value, that need be valued, and should not be sought for free, no matter how rapid development it sought, for what reason the rapidity is desired is a better question. I can postulate some reasons, even have compassion toward the goal. Insofar as their are so many more participants in this system, more maturity, and a return to the fundamental tenets upon which the system has rested is important. People can pander to non-interference, cultural concerns, and similar emotional based belief constructs which mostly work to deceive, or keep the populaces eyes firmly rooted in some point in the past while the benefits are less than optimally divided, which is, I argue, even detrimental to those who presently benefit from such structures over a longer term. Regardless, it seems things are coming closer to a head in these matters, were the level of discourse around them only evolve similarly.
China needs to come up with a solution that cuts its exports to the US, and probably Europe, significantly. China needs to do this for China. Otherwise China’s future is in other’s hands.
Prof. Pettis
I am a big fan of your blog and agree with 90% of what you write. However, this one is a big exception. It is strange, to say the least, that you propose fiscal stimulus by the US, while steadfastly rejecting the idea of increased fiscal stimulus by China. Are you really serious that there is a lack things that the Goverment of China can beneficially spend money on, while there are comparitively more things that the US Government can beneficially spend money on? I find this hard to accept. I think that if China looks hard it can find a lot of things with good benfits to the public compared to the costs. I have not been to China but can suggest a few places to look: pollution control projects; land restoration; energy efficiency improvements to buildings and industrial processes and facilities; public parks and recreational facilities; housing, infrastructure, hospital and school improvements in third tier cities, rural areas, and underdeveloped areas.
You have previously rejected increased central government (deficit) spending by China because the money will have to come from households, and hence from household consumption. Yes, part of it will have to come from households. But when? Likely 20, 30, 40, 50 years or more from now. And part of it will not have to be repaid, since a significant fraction will come back to the goverment in the form of increased tax revenue. What we are talking about here is getting past a large difficult transition from low consumption to higher consumption as a percentage of GDP. The structural changes you support are good, but will take many years or even decades to bear much fruit. IMO increased fiscal stimulus by the major surplus countries (China, Germany, etc.) is the only thing that can yield substantial results in the time frame needed to head off the impending trade war. The current situation might be actually be a prelude to the US elections, i.e. the 2012 presidential elections. Based on the reasonable assumption that high unemployment continues for an extended time, the worst case could be that the two parties start trying to compete for who is the most serious about doing something about the trade deficit, outsourcing of jobs, etc. Based on the lopsided vote in the House on the currency manipulation bill and the pick-up in press coverage it appears that the snowball is getting bigger and gaining speed. I think that China and Germany spending thier excess export earnings internally on things that benefit thier people would be a small price to pay to defuse this thing, even if it requires thier central goverments to borrow much of the money (from thier own people) in order to make it happen.
Can I take any credit for mentioning something similar in a comment?
Under “the politics of Chinese adjustment”
on 03 Oct 2010 at 2:57 pm
“((What if China decided to redirect a lot of it’s foreign reserves towards investment in weaker economies? If those investments were good would it not have a similar effect to increasing Chinese consumption? I guess if it resulted in a reduced deficit with China it would be. Is this an alternative way forward for China?))”
I guess it’s close but no cigar. Still I’m encouraged that my understanding got me near to making a valid observation. Isn’t this forum brilliant! Many thanks to Michael.
Professor Pettis,
Thank you for the excellent post. Your focus on the political aspects put me in mind of the various acquisitions of the various middle eastern sovereign wealth funds, I recall the uproar in the US and indeed the UK over the Dubai Ports World takeover.
I wonder though, would it be possible for a (Chinese) sovereign wealth fund to carry out your proposal without raising the same level of nationalist backlash? Something along the lines of a joint venture between a large American company and a Chinese controlled company (based out of Europe, the Middle East, wherever), with the capital provided along ‘commercial’ lines via a large European bank, perhaps. Essentially I’m wondering whether with sufficient obfuscation, the Chinese state could do this without having to deal with the crazy right wingers, or at least to a lesser extent. Of course it would be possible for politicians and pundits to play on this, but if the ownership structure is sufficiently ‘American/Western’ in character it might be difficult.
This also seems more likely to work now than in the past because in the west (or at least the UK) new investment by companies is treated as amazing news.
Mr Pettis,
Where has borrowing money to build infrastructure during a sever recession worked before? Did it help the US in the 30′s or Japan in the 90′s?
I wonder if increasing the productivity in the name of producing more goods cheaply would really benefit the United States. The US can produce all the good it wants but there would need to be buyers home and abroad to absorb those goods. All the While Europe and Japan and all of Asia and Latin America will be making competing goods with improved productivity as well as they invest in their own infrastructure. Doesn’t improving productivity eliminate the need for labor? It would seem that we need to slow productivity so that jobs can be preserved.
“The return doesn’t even need to be high – just better than the return it gets on its huge expansion in investment in China, which I suspect is negative for the country as a whole.”
Negative returns is not only a Chinese problem. It is a worldwide phenomenon due to extremely high real returns is the last three decades, conjugated with the creation of lot of money. There are just too many existing assets around. For your scheme to be sustainable financially , there must be acceptance of negative average return on the projects, and I am not sure the Chinese are ready to consider that. The time of win/win has passed long ago. We can now only aim for “loose less”/”loose less”; but it falls short so much of current expectations of all the parties in the economic game that I am as pessimistic as you regarding the occurrence of a collaborative outcome.
By the way, China is not going to “give away” ships. They will certainly be mortgaged, and it is an asset that it easy to seize (Of course the Greeks can keep them in their territorial waters, but it wouldn’t be a productive asset any more !). Beyond the return rate, I think that how assets are secured is going to be the big problem for your idea. Unmovable infrastructure is quite prone to “sovereign seizure”, even (in fact, especially) if it is a productive investment. The transsiberian and the Suez Canal, or, closer to us, Eurotunnel were undoubtedly positive for the world economy as a whole, but this was cold comfort to investors who lost their shirts.
Even an idiot farmboy from Flyover, USA can figure out that you are eventually going to run out of people that can buy your products, when all the decent jobs in the USA have been, or are going to be outsourced.
Take General Electric diesel locomotives (just one of hundreds of examples). No reason they need to be built in China, or Mexico. But they are, because the GE suits and stockholders makes more money than if they are built in Pennsylvania.
The idiots in Washington and Wall Street will never admit that they screwed up, and killed the golden egg laying goose.
And what happens if in 8 to 10 years China has not improved its toxic reliance on unhealthy growth and shifted significantly toward domestic demand? I give very low odds that the Chinese will have rebalanced much at all at the end of this decade.
But I disagree that too many Chinese would grumble about the investment. The party would tout this as China rebuilding and buying the superpower. Americans would view it as China buying their country, which would turn into increased coverage of the issue, which would cycle around and around, increasing American upset, and all the while this picture would please many Chinese, who would take their government’s propaganda in combination with American fears as confirmation of truth – that they literally were “owning” America. In a China where nationalism is in a whole other galaxy from what’s found in the United States, that could be exceedingly pleasing.
Thank you very much for your insightful discussion. I think I will have to re-think about the solutions for all these problems in global economy.
Zarathustra
Also sprach Analyst
Bizjetfixr,
Weak global AD is something not often mentioned, though M Wolf does on occasion. With the consumers of the US bankrupt then mercantilist Asia has to change strategies. But increasing domestic demand involves the redistribution of wealth and inevitably power; the U.S. fixed that issue with cheap credit but it didn’t work out to well.
Le Xing, you might want to look up what year it was that China banned opium, i am guessing you don’t know already….
…..1923! No Opium was sold by any foreign traders within China after that date. It did however, continue to be imported by Chinese traders.
Your dates are wrong too, the vast majority of the opium trade to China (which by the way was a solution to a China running a massive trade surplus) occured in the 19th Century. The failed Embassy in 1793 did not start the trade.
Also, when you say “The West”, what do you mean exactly? Britain? Belgium? Luxembourg? Spain? Andorre? France? Italy? Hungary? Greece? (which was part of the Ottoman Empire!?), The Netherlands? Germany? Canada? Argentina? Sorry to give such a random list but I am trying to draw attention to the absurdity of the term.
“The West” as a term used in modern day China usually indicates immense intellectual laziness on the part of the user – “Western Media” being a prime example. The idea that “The West” ever really acts in unison (in media or in other fields) is very convenient for nationalists / reactionaries in China, but unfortunately quite far from the reality. Normally “Western Media” actually only refers to the CNN website, the BBC website, and a few other newspapers. Convenient when trying to create the impression that the whole world is obsessed with China and hurting China’s people’s feelings, but there are thousands and thousands of TV Channels, Newspapers and Websites in “The West”.
Fiscal Stimulus: Yes able in the surplus countries, do to structures, poorly utilized in some of the countries, due to timeframes for the introduction of stimulus, poorly invested in all, where the goal is impacting expectations. In the advanced economies, it bleeds out into the surplus countries, of less impact toward restarting the domestic economy, in the timframes that stimulus are proposed for, longer terms useful for the economy, undermined by the expectations that are held regarding its (need for immediate) impact more maturity in these issues from lessening expectational needs, more utilitytoward benefit of the economy.
Frankly, people are using the same old tired frames to view these issues. When these issues are invested with an emotionalism, or reversion to historical themes that have been commonly held, even promulgated, where the history may have some utility, the “facts” are usually reminiscent of those to be had in some Oliver Stone film. Although they do (seemingly lead) us to one of those lightbulb moment, further to a, “I see” moment, but normally the expression that comes from our mouth, almost seeking in validation is, but a, “You see” moment. Where these things are excitedly spread, the connections of little validity are connected, and the incongruous/illogical/ but for suspension of disbelief techniques, are easily accepted.
Mostly, these historic, even conspiratorial, themes are holdovers from a conflict that existed a few decades ago, which shows you the stickiness in all these things, and, thus, an evolution in our perspectives, where values are often similar, these other constructs are often different, but for a longer term frame in these matters.
Again, the importance of mindsets, the influences of such, even where they are promulgated today, the tired stratagems, where seemingly nothing of greater value has been added implying, again, lack of maturity in addressing these important issues related to global stability and development. Anyway, if to have an opinion, which I believe all do have such a right, a subsequent responsibility to apply some balance within in it, rather than applying tired old slogans, whose value was undermined by the policy objectives they supported in previous eras. Hence, working to eliminate bias, prejudice, faulty and incongruous perspectives, to ensure less emotionality in evaluating these things as, surely, things will turn out very different if left less maturely addressed. Two concepts; bio-capacity and a plethora of development opportunities, should considerations be necessary.
Some of the basis of popular discussion globally on the world economy, again the stickiness from former strategams promulgated in another era, whose valiance even impacts the mindsets of people today, even those in the developed world, if their targets were members, especially the intelligentsia, and eventually decision-makers and populations, of the Non-Aligned Movement:
US corporations are evil, the US system is built upon aggression, the US meddles in the affairs of others, money is the only thing that matters to them
(holdovers from an ideological battle, historically based on the motives within opposing systems, especially as to ultimate goals, especially as to how benefits accrued, leading to an eventual perversion of both systems, where one had existed for thousands of years, a more natural state to man, and the other never existed, neither historically, but perhaps during the state of nature, even if then, and never thereafter, even its institution in recent memory were anti-thetical in theory and practice to the original philosophy of its founder, but romanticism, the investment of emotionality, can pervert its consideration, even possible desire for its resurgence, or validation of how previous structures, when utilized in the present system, might offer a new model of utility for consideration, yet, outcomes seem to be predictable, entrenched interests where some are more equal than others, not that income inequality doesn’t have to be addressed, perhaps again hangovers from the previous ideological battle)
The US has, and is intent upon keeping an empire, it acts unilaterally
(suggests that the world is multi-polar, hasn’t always been so, and the decision to not make a decision, or to take an action, is a decision, where even reluctance and similar, is often, not simply can be, a political stratagem. Perhaps, you very much support the goal or objective of a particular action, but couldn’t possibly openly acknowledge it, as it goes against many of the beliefs you have worked to cultivate within your society and similar. So oppose, then support as and when necessary, even quietly, if becomes unquiet, revert back to Evil Empire, and, yes they are bastards, aren’t they, but hey we are receiving such benefits, blah, blah, blah, the collective self-interest invades, can be rationalized, without jeopardizing the frames that have been cultivated).
So anyway, like an economy, despite our present day remote control mentality, these things evolve. Main issue today, system went from 1 to 5 participants. The system won’t be rebuilt, or fundamentally altered to rationalize a participant whose participation as presently defined is simply lessening the development opportunities of others in most need of development, even if the large developed players are mostly discussed, it will alter, as would anything that went from 1 to 5. This structure is not a viable model, it is a leach, in a system where all might be leaches, this one is simply sucking too much blood, and far too quickly.
This was a great read, thanks Michael!
The real problem with this idea is the U.S. political dynamic. Meaningful infrastructure spending will kill the scam that is the Republican Party: the conflation of the petroleum industry’s interests with national interests. Much of government policy in the U.S. is aimed at propping up at demand for petroleum products. Sensible infrastructure spending will kill much of that demand and so help trade balances, especially with the Middle East. Doing so will also kill the need for a bloated DoD, the Republican bureaucracy. Sensible infrastructure, that is infrastructure that improves productivity, makes Walmarts (largely in remote areas) and the accompanying isolated pro-Republican lifestyle much less competitive. Add to this the fact that Walmart is largely supplied by the Chinese Military and see how one party in the U.S. has to be dead set against your idea.
well, so simple:
China could use a large part of its huge financial capacity to buy any kind of equities all around the world instead of government bonds….
What Pettis’ “modest proposal” is really suggesting, once you strip it down to its core, is that reserve-rich export-man countries like China launch a kind of neo-colonial “mission civilisatrice” for the economically backwards import-man nations of the world such as the US.
And I think it could work! But we must modify his modest proposal to make it even more “modest”.
The original colonialism was based on the idea of advanced industrializing countries going into the back waters of the world and investing in infrastructure, and then trying to “civilize” the natives by imposing new cultural norms on them which allowed these natives to extract resources, and finally exporting the native’s raw materials back to the home country. This system only worked because the investment in infrastructure was socialized (for the glory of the Empire) while the profits where privatized into special chartered companies who were granted monopolies by autocratic powers.
Marx was actually quite supportive of colonialism (later qualified that only if led by a proletariat government) and since at least in theory the Chinese Politburo would seem to meet this criteria, it seems the China should have no ideological qualms about taking on the export-man’s burden.
But they would have to re-conceptualize colonialism a bit. Sure, the standard colonial model could still would work to some extent (forcing the natives to gather natural resources for shipment back to the home country) but the problem is that only a small percentage of the American population has much of a memory of, or is in any physical condition to do, any hard work. That would take a huge amount of cultural and physical reprogramming to get the import-man natives even half as productive as your average export-man. And in the end, just as European agricultural techniques often failed in tropic colonies, so to trying to impose the Chinese work ethic in modern America may also prove futile as well.
So a much more modern updated version of Colonialism would need to be conceptualized. Nowadays America’s best natural resource is plentiful aggregate demand, based the gluttonous consumption by many of its natives, but due to the incompetence of its banker class, the supply lines of consumables are being blocked from reaching import-man end-users by such silly notions as repaying debts! So the infrastructure the Chinese neo-imperialists could build would have to use the latest technology to bridge these debt swamps the natives have not been able to master in order to get these vital consumables into the hands of import-man. So it seems quite reasonable that the Chinese would want to come to America and build the train networks, the road systems, the airports, etc, to keep their products moving effectively to their end users in various import-man settlements.
As for political problems, that’s easy. The Chinese could do what the original colonizers always did, co-opt the local elite by promising to allow them to maintain their elevated status in return for their faithful execution of the colonizer’s policies. In other words the Chinese just have to go out and find a faithful roi nègre among the local native elite. And this local American elite would still be allowed to maintain many of their barbaric customs, including their various televised spectacles and diversions that keep the locals in such a calm and happy mood. And at the same time, who knows, maybe even some of the superior export-man ways would rub off by osmosis onto import-man?
But there are pitfalls in Colonialism that the Chinese would have to guard against. The most obvious is the danger of “going native”. Might not the Chinese viceroys and others imperial officers start to ape the no-work, all-play ways of the very natives they are charged with civilizing? Maybe the Chinese would even start tapping into some of the pacifying consumer goods stash in the pipeline before it got to the natives. Why shouldn’t they start “using” some of these goodies, they are a long way from home and they could stop any time they want, right?
And what if the natives start to get uppity and the radicals among them start to organize? Some natives might even try to claim that import-man is the equal of export-man. Other native factions may believe that they have made the transformation by learning the ways of export-man and so it is time for them to run the show. Maybe these groups would even get brave enough to start spray painting revolutionary slogans on the walls of the new infrastructure about throwing off the Chinese jackboot and whatnot?
And in the worst case the whole system could even collapse. Maybe in the end the import-man would manage to organize himself and when combined with the inevitable softening of the Chinese overlords, the Americans may actually manage to regain their independence again. But the question will be, are they really ready to stand on their own in an export-man’s world? What if they are not, what if all that infrastructure, all the new roads, airports, the high-speed train networks started to fall into disrepair after independence? What if in the end, import-man had been unable to imbibe enough of the export-man’s culture to understand why these assets are so important and after several years of import-man independence, the few trains still working would only manage to run at low speed, the roads were slowly reverting back to their natural state, and the airports were falling into disrepair? Would export-man, after organizing a few benefit concerts, in the end just stare down from afar and shake his head at the mess import-man had made of his former paradise?
Shuniata:
As the structure within the economy is so nebulous, and state controlled, as it sought, I suppose theoretically, to strengthen organizations, and then to spin them off, not sure if the logic is to prevent the resultant chaos from leading to a simultaneous mass unemployment, or to support the entrenchment of stakeholders from previous systems to garner their support as the system evolved, but surely the mechanisms, as could be suspected in the wrangling over transition by different stakeholder groups, has led to a structure that needs to be gently altered over time, with firm commitments to that end. Were it not other alternatives will avail themselves.
Chinese Military largest supplier, might be military owned corporations, or influenced, but not sure a case can be made as the largest, or even primary supplier, where the Walmart structure, is to provide designs, specifications, and then have a reverse auction of sorts, bidding the price lower, as can and would be done elsewhere. This leads to the China price, which but to vague illusions, as to resultant impacts from a rising RMB, is little discussed, perhaps as the mechanism that supplies such a price is illustrated. Again, point in case toward, the siphoning off of development opportunities elsewhere, and why the supposed model, has no viability as a model that can be created elsewhere do to the unique circumstances of the structure, and in dispelling Oliver Stone type perspectives, it should be understood why it has, and also why it cannot continue as such, nor is a model worth considering, if, it is a curious development within a system that is as natural as man, and has existed nearly as long as mans tenure upon the earth. Where too much conjecture is misplaced as to cause and effects in the present era, understanding that the system will evolve, mostly due to the number of participants who followed misguided policies during previous eras, philosophical vacillations during the Non-Aligned Movement experiments with different and quasi-systems of this or that. Ok government participates in every economy, for example what type of electric plug is to be used in a society, what standard voltage of electricity, but, should not be allowed, unless under very well defined terms of transition to control, operate, direct and support large facets of the economy.
As to investments, fine, under 10% or 4% in entirety of a companies shares, with no board membership or voting rights, limiting interests, and potential alterations of laws in support of this or that major holding. I see no problem, under well-defined terms for governments to hold such positions.
Mike,
Your blog gets more and more outrageous. My advice to you is to stop wasting the limited capital you have as a economics guru in trying deviously to influence others for the good of America. Be honest, truthful and ethical.
There are plenty of other places in the world for Chinese investment and definitely not in a poorly managed, militaristic bloated, xenophobic America. American problems are easy to solve. A good dose of socialism will restore the middle class and its economy to good health. It is all about a rich minority in power and control of the media maintaining their privileged positions after decades of distorting the system to suit their vested interests. You can even label it as blatant corruption.!
Kevin,
Thanks for the post. Haven’t had such a good laugh in a while. Reminds me of a line from a movie (I assume readers here are 18+):
“It’s SHITE being Scottish! We’re the lowest of the low. The scum of the fucking Earth! The most wretched, miserable, servile, pathetic trash that was ever shat into civilization. Some hate the English. I don’t. They’re just wankers. We, on the other hand, are COLONIZED by wankers. Can’t even find a decent culture to be colonized BY. We’re ruled by effete assholes. It’s a SHITE state of affairs to be in, Tommy, and ALL the fresh air in the world won’t make any fucking difference!”
Kevin
I assume this to be even more tongue in cheek than Michael’s piece.
Wu Jian Long, HI, and Kevin
Do you people even review the numbers, analyze such, review other issues, compare and contrast between groups offering different perspectives, often different numbers, review further, and evolve in perspective, or do you just have an ide-illogical bent to everything you say.
I’ll state mine, global development, while understanding material resource limitations as we move toward that goal hence the greater importance of valuing ideas, greater emphasis upon services and the great necessity of strengthening legal frameworks around Intellectual property (if understanding of other perspectives where they are based on issues other than greed), actions to alter growing income inequality, strengthening of institutions and policies which support entrepreneurship and private property rights, and a sharp sword against those who simply spout ignorance, and ideological preferences.
But when you read wide, across a wide range of issues, that which will occur, within ranges as if within the crawling peg of some overly export dependent nation or region, it is not difficult to understand the outcomes. This with respect for the great numbers of people involved, and the very difficult issues that need to be faced over the coming decades; water, land, resource, livelihood, demographics, human capital development, and expectational.
Wu Jian Long, you must be a very famous economist to give advice to Mr. Pettis. Can I ask you what is your real name and what you have written? Also do anyone read your work? As a Chinese I may say that people like you make Chinese look petulant and dishonest. Also I think in China may be xenophobia and racism is much greater than America, although of course we may not say this. You make us look foolish if you cannot recognize your own country. This is not the way to achieve progress.
WJL.
You say: “My advice to you is to stop wasting the limited capital you have as a economics guru.”
I guess even sillier than the idea that Pettis is wasting his time writing this stuff is that idea that you would waste your time taking it seriously, reading it and commenting on it. It would never occur to me to read something I thought was a waste of time, so I can only imagine you know Pettis is probably right but can’t get yourself to acknowledge your sense of national insecurity.
I hate to be too psychological about it, but if Pettis is wrong, and if you are nonetheless reading it and taking it so seriously, you must be able to explain why he is wrong. So far you haven’t explained anything even remotely intelligible. You are only pouting like an upset child. This isn’t even good nationalism.
csteven,
yes, I’m definitely trying to play on the irony of a former victim of colonialism now turing the tables of power.
HI,
That quote is a gem!
Agree with A Sam and others. I don’t see why there isn’t plenty of ‘productive’ infrastructure to build in China, certainly much more so than the US. Professor Pettis pointed out (in a response elsewhere) that the choice of investment was not driven by logic but other issues. But, coming back to my favorite example of nuclear power, China will invest hundreds of billions of dollars in this endeavor, which will not only benefit China enormously, but help the world control CO2 emissions. I’m sure there are many other worthwhile investments that China can and will make.
Kevin:
Interesting, yet, most likely a tired recycling of themes, whose adherents just seem not to fully understand the issues at play, despite the fact that previous bright-eyed predictions, should by now have led to teary-eyed withdrawal of such perspectives, even if the news stemming from current events belies what lay under the table.
So, anyway……we will see, no doubt you wait for the day of judgment, of atonement, even, retribution. Then, these things are so fungible, one mans colonized, has been another mans oppressor, but such points of antiquity, even if more recent than that term usually denotes, are of significantly less importance than what is likely to happen today and tomorrow.
Decoupling didn’t happen, unless a stimulus and lending boom equal to more than 40% of GDP, yielding an officially stated 10% growth rate are positive signals of a viable and sustainable model to you, absent demand. The signals globally of a stagnating economy from a demand perspective are abundant. Again investment for what, paid for by whom, and further for what reason…..not that it isn’t deserved or desirable, it is simply the timeframes that make it unworkable and undesirable. But then again, GDP and growth, regardless as to how constructed, and despite obvious antimony for the system, might seem to be the rallying point around which the blind shepherd the blind.
With that said, as I stated previously, I see nothing wrong with any government taking small, non-influential stakes, with no board membership, or such a great interest in the company, to affect policy at the national level, let alone models as have been recently applauded which only siphon off growth at similar levels, ie from other developing world economies, and this should certainly not be seen as an efficient allocation of capital for the greater good of the economy or the nations people. Not that that issue doesn’t need to be addressed elsewhere. Further, recent expectations globally need be tempered as the fire which was allowed to run a little too hot for too long gets rekindled, not that greater input from those who are warmed by it need not be considered in deciding what fuel to burn. I have a few ideas.
Michael,
Come to think of it, maybe a slight variant on your idea would be even better. China could fund (using perpetual zero coupon bonds) a JV with the US government that would employ in China redundant US workers (for instance from the construction industry) to do things for which the Chinese themselves (too busy exporting to the US) have no time. These workers would probably save as little while in China as they would at home, thus also giving a boost to Chinese consumption and lowering the domestic propensity to save. Especially if these workers were paid the US minimum wage plus a generous living allowance, maybe only a few million might be needed to rebalance the world economy..
Wu Jian Lung –
You lose a lot of credibility screaming about the United States being xenophobic. Yes, there is a great deal of racism and xenophobia in America, but somehow we manage to integrate large numbers of immigrants into America. Maybe we’re not #1 (I honestly don’t know whether we are or not), but we seem to do a pretty darn good job at it compared to many other countries, and we even *gasp* allow some of them and their children to rise to rather prestigious positions within our society (http://en.wikipedia.org/wiki/John_Yoo) and (http://en.wikipedia.org/wiki/Barack_obama). I don’t necessarily see this trait among many other countries in the world.
FYI — “A modest proposal” is in reference to Jonathan Swift’s satirical essay, where he suggested solving poverty in Ireland by using their babies as food.
The part I like about your blog the most is how you can dissect complex issues in such logical and lucid ways, which often makes great read even sometimes I disagree with you.
The part I dislike the most is that you are such a “big-picture” type, and desperate in need of a few research analysts.
Speaking of high-speed rail in China, building costs & enough ridership numbers of the Tianjin-Beijing line & the Wuhan-Guangzhou line are already available. How difficult is it to actually plug the numbers in a few models and figure things out? Mind you, we aren’t even talking about the additional economic activities brought in by the HSR lines, and the freed up freight capacities in the traditional lines worth to MoR — just the 2 lines alone, the Tianjin-Beijing line is already operationally breaking even, and according to my model, the Wuhan-Guangzhou line is already profitable at its current run-rate. Gosh, the network effect hasn’t started yet, and the Wuhan-Guangzhou line has been only operated for less than one year, yet in the busiest time, they are sending out a train every 8 minutes already!
No disrepect, but you probably don’t know much about infrastructure building in the US. Even somehow China’s involvement can miraculously cure NIMBY-ism, pork-ism, frivolous lawsuits, chronic delay and cost overrun, can you actually pick a couple of infrastructure projects, assuming the current planned cost (not the 200+% final cost in reality), remotely having the potential return as the existing HSR lines in China?
In the proposal, Michael Pettis argues the US infrastructure is the appropriate target for Chinese investments due to the fact that they are essentially the 2 dominant players in the current unbalance global economy. It’s a win/win outcome for both the world’s largest economies.
No one is arguing against the need for an adjustment; it’s all about the execution, where policies-makers aim at mitigating the collateral damage to the rest of the world’s economy in the near term, as well as maximizing collateral benefits in the longer term.
Americans and Chinese should not to be biased by ideologies; Tim Geithner has already called for China to take on a greater responsibility in world economy; I would easily interpret this as a concession of the economic power America has held over the past few decades.
In the end, so what if it’s Chinese money behind infrastructure spending? Why should Americans care?
Western foreign investments went into Asia in the last few decades, and these investments were a contributing factor to what everyone known as the Asian miracle.
Of course at the same time, Chinese leadership should focus on policies enriching the larger part of the population and ultimately creating the largest middle-class, which I suspect is already well underway.
Now surely that’s beneficial to everyone?
Kangwei: There is a measurable amount of water in the world, there is a measurable number of cows, there are a measurable number of trees, there are a measurable number of cars, there is not a measurable amount of power, if you were talking about the US economic power it was a much higher percentage of the global economy in 1945, somewhat less in 1960, somewhat less of of percentage in 1970, and an even smaller percentage today, a smaller percentage of a much larger thing. Before a much larger percentage of a considerably smaller thing. So, while these numbers are important, and while numbers will grow into the future, what is important is how this is done stably. Chinas growth in economic power doesn’t lessen US economic influence. And its not even important that it does or doesn’t. What is important is that the system enables global development, and that it eventually evolves in ways that enable more people to benefit, and that that is not derailed. Where there are so many in need of development, and a finite countable number of things in the world, the world will have to evolve in ways that value tangible goods less, and intangible services more, or it will alter to the detriment of those in most need of development. And many recent trends will have to be reversed and more sustainable economic relations maintained to work toward that goal.
Ok….lets get a couple of things straight…
per capita
Low Income Country in the World: Under 1,000 USD per year (not PPP)
Middle Income: 1,000 to 9999 USD per year per capita GDP
High Income: 10,000 and above
So currently China is a middle income country, although the benefits have been seriously skewed.
Middle class as has been designed elsewhere will require considerable more work, and under far more resource efficient standards than has been done in the past. But, efficiency and more from less, is one of the main themes from the time of the industrial revolution. This is why time frames are so important.
And fairies will dance at the bottom of the garden and the lion will lie down with the lamb… OK, it’s a tongue in cheek article but it’s the equivalent of adopting the foetal position and sucking your thumb. Let’s face it, tariffs will rise. It’s too late now for slow adjustment. Chinese policy making is just as much captive of special interest groups as in the US (or Europe or Japan) so the chances of policy coordination on the scale necessary are almost non existent. The US current account deficit is expanding as fast as the [weak] economic growth.
One thing you don’t mention is the US federal budget deficit because it reappears in the current account deficit by lowering the savings rate. If the US had no budget deficit then the current account might even balance. The tax base is far too narrow and too geared to the economic cycle via profit and capital gains taxes. There are high taxes for the rich and small businesses but no federal tax on consumption. Nearly half the population pay no federal taxes at all – social security payments they expect to get back. No surprise how they vote.
The US should bring in a VAT with a top rate of 20% – 25% on ‘luxury’ goods most of which just happen to be made in the big surplus countries – China, Japan and Germany. Things like computers and consumer electronics and BMWs. A VAT would be preferable to tariffs because it would lower the budget deficit and automatically lower the current account deficit. Will it happen? Ask the fairies. US bond yields have started to rise. The elites have lost control.
Pettis, does it bother you when you get derisive comments from people who clearly haven’t got a clue about what you are discussing? I would imagine it must be a little frustrating.
Litz, devaluing the dollar is one obvious way of lowering wages and increasing competitivity in the US. Look at China. Most large Chinese manufacturers are extremely inefficient and the SOE sector is clearly value destroying in the aggregate but because of subsidized interest costs and an undervalued currency are nonetheless able to price very competitively in the global market. This idea that countries run surpluses because their people work hard rather than because of domestic policies may be very common but makes little sense to me. For example American workers work longer hours, take fewer holidays, and are more productive than German workers, but Germany runs a surplus and the US a deficit.
Luc Zhang, yes, the US has much better infrastructure than China, but a nominal comparison misses the point. The optimal amount of infrastructure for each county depends primarily on wages and productivity levels. Because US productivity and wages are much higher than China, the US can have better nominal infrastructure than China but still worse infrastructure for its level of development.
Le Xing, the idea that the wealth of the West is based on opium, besides being totally anachronistic, is as silly as saying that China’s wealth before the 18th Century was based on plundering Vietnam, something that many Vietnamese may believe but which just doesn’t make sense.
Mark G, thanks for expressing your no-doubt deeply-held beliefs, but I am not sure any of them make much sense, at least to me. Sorry, but your last sentence has no meaning at all as far as I can make out.
AIMD, I am not sure the chances are absolutely zero, but yes, those policies would certainly reduce the US trade deficit. Raising taxes on the rich in China, cutting military expenditures and redistributing income downwards would, weirdly enough, have the opposite but equally welcome effect on China, that is to raise consumption. Unfortunately it is also very low probability.
Gan Lu, I agree it is economically a good idea, and frankly I was surprised by the number of economists, bankers and analysts around the world who have read and supported the idea, but I think the political impediments are very high.
Glen M, I think the PBoC would love to be able to raise the value of the currency 10% a year if there were a way of preventing massive hot money inflows, and quite a lot of people away from MofCom and Guangdong would like it too, but the hot money inflows could be overwhelming. I am working on a way of doing it in a different way that would not bring in hot money, but I haven’t fully worked it out yet. It would need a great deal of international cooperation and a temporary pass from the WTO.
A Sam, see my response to Luc Zhang. There is no question that, as in your example, infrastructure in parts of Tibet is abysmal, but Tibet (and most of the places in China with terrible infrastructure) is so poor and undeveloped that there is little economic value in significant upgrades in infrastructure.
CSteven, they don’t need wealth. They need only to recycle their current account surplus, which they are doing anyway when they buy USG bonds.
G. Stegen, I am sure there are many useful places in which to invest in China, but that is hardly the point. What matters is whether the spending actually is economically viable, and given the sheer size of the infrastructure spending needed to generate growth, the terrible capital allocation process, the factional squabbling, and the fact that local leaders have strong incentives to waste spending, it probably isn’t. Beijing policymakers make it clear almost on a weekly basis that they are terribly concerned that the spending is not useful, and the recent targeted RR hike by the PBoC is being interpreted here as part of the struggle between those who think the spending is out of control and those who don’t want it to stop.
Simon, I would be happy to give you full credit for the idea but only if you are willing to take on the task of clearing up some of the muddled thinking the idea seems to have generated. The idea may not be practical for many reasons, but some of the objections are just pretty weird and miss the point.
Garren, thanks, but I doubt xin fa’an will ever be put into effect, largely because of political difficulties in implementing.
RS, the economic history of the US makes pretty clear that in general government-sponsored infrastructure spending has been pretty dammed good idea. As a loyal New Yorker I just need to point out one of the greatest examples, the Erie Canal, was what made NY the great metropolis that it is and enriched the US no end. It may well have been one of the most value-creating projects of all time. As for Japan in the 1990s, I agree that much of the spending was wasted, and in fact have made the argument many times, but I am not sure why you consider the very smart infrastructure spending by Japan in the 1950s, 1960s and 1970s irrelevant. After all, Japan can hardly be considered a great failure over that period, can it?
Charles, I am not sure why you are so confident that the Greek ships are going to be “mortgaged” (I think you mean “lease-financed”). I saw no announcement to that effect, but even if they were, the historical precedents suggest that the debt is likely to be rolled into a general restructuring.
Brad, I don’t think China can wait 8 to 10 years. The adjustment will almost certainly begin much earlier than that.
KdeB, actually many import-men are more productive and work longer hours than export-men. Surpluses and deficits are not caused by virtue or its lack. They tend to be caused by structural or policy reasons. It is much more fun to moralize, but when you put these kinds of arguments in a historical context they generally don’t make any sense.
Wu Jian Lung, the “limited capital [I] have as a (sic) economics guru” largely comes from make obvious points that come across as outrageous to meatheads on either side of the debate. I am not sure stopping would preserve my capital.
HI, a famous monologue, and one widely known even within Beijing’s music scen.
Jxie, no disrespect either, but I am not sure you understand how to value the economic viability of infrastructure projects. The key benefit is likely to be economic externalities that are almost impossible to measure. On the other hand one of the largest costs, perhaps the largest, is likely to be the capital subsidy. Of course this doesn’t include other hidden subsidies and substitutions effects. I am afraid you are confusing operational revenues and expenses with the value of infrastructure, with which it is barely related. In your world, a well-functioning school system is probably considered a huge waste to the economy.
LandOfP, if it were a problem neither I nor anyone else would sustain a blog for more than a few days.
The logical absurdity of your “modest proposal” is an indictment of the unfortunate situation we’re in…This is what of a decade of cognitive dissonance, both public and private, gets us. I can see the headline now: “US Government Impotent, China Apologetic: China to Rebuild US.”
Michael, I am not sure that the restore of ” fair competition” should be a priority for the US economic policy. Distortion in chinese financial market is clearly doing harm to the Chinese economy. But that is more problematic for the Chinese. US profit from the chinese subsidy via consumer surplus.
Would devaluation create net jobs growth for US? I am not sure. We are experiencing a jobless recovery. The growth rate of US is not low. There are other micro factors behind jobless.
Prof Pettis,
Thanks for the response. I don’t think I meant to say that all infrastructure spending is wasteful. I question more the need for deficit spending on infrastructure in the name of increasing productivity of the manufacturing sector and creating jobs. Manufacturing Jobs will go to the countries with the lowest wages and labor environmental standards. Then infrastructure investment seems to follow the jobs. It has not been the other way around at least not recently. Exhibit A is Vietnam.
Thanks.
Michael,
Your ficticious proposal seems to get people busy. In one of your replies you wrote:
“Jxie, no disrespect either, but I am not sure you understand how to value the economic viability of infrastructure projects. The key benefit is likely to be economic externalities that are almost impossible to measure”
Also:
Le Xing:
“Without the ability to plunder and sell opium to China like the West did in the 18th century and Japan did in the 20th century, it will be hard pressed for either to recover their deficit in any way.”
A paranoid and zero-sum oriented China-basher would probably find that the US getting those externatilties (and China only a few bp over Treasuries in return ) is the exact opposite of what has been happening in the US-China relationship so far: by moving vast chunks of manufacturing to Greater China (and others), the US (and others) have also transferred many of the externalities associated with that. Some of these are bad (pollution, dead-end technologies, demeaning work etc) but some/ many/more are good (again for China): network effects, employment for people with limited personal development potential, scale for a range of suppliers and contractors, learning, etc ; textbook modern development economics. At last , the US is now realizing that the exodus of manufacturing has consequences for defence procurement (The Pentagon is the world’s largest single buyer of things ). A good example of those unwanted externalities, as well as a defence issue.
Now the question of the China basher (and his Chinese patriotic counterpart) would be : why would especially China (a country apparently still espousing the small-country zero sum view of international economics) give away positive externalities? Someone on this forum made a rather debatable remark about opium. But the opium imports may have taught Chinese policymakers something about externalities, maybe more than any other body of policymakers in the world: during the Qing dynastic period, China’s foreign trade went from very unbalanced (exports against precious metals, a bit like the current situation but without its modern monetary policy component of sterilization) to quite balanced, as China’s trading partners found a solution to the Qianlong emperor’s famous critique of foreign trade (and before he raised it): opium. An import with considerable externalities, as we have seen. Of course, if Qing China had had a political economy structure and process more amenable to integration (to its real advantage) in the emerging international economy of long range transportation and the industrial revolution, on the back of a switch in urban Europe away from alcoholic drinks to tea, those unproductive silver imports would not have gone on for so long and the transition to opium might not even have occurred, especially given the presence of a relatively hard state (at least initially).
The trouble with externalities is that they are hard to measure and difficult to demonstrate by policymakers requiring popular consent (ranging from the fragmented democracy of the US via the benevolent but domestically lazy early Qing to the anarchic and dysfunctional late Qing). But look at the reluctance of leading German and Japanese corporations to transfer manufacturing with embodied leading technologies far from their home base: they understand externalities, and they seem to have a more productive kind of China bashers among their politicians…
A more technical issue would be to better understand the link between TFP and the externalities of manufacturing transfer. In the sort term, the manufacturing transfer (in national accounting terms) seems to have not hurt TFP in the donor country, on the contrary, but that may be just it, a short term effect, almost a shock. The future consequences of having lost manufacturing for the benefit of services (leisure, healthcare , distribution of consumer products for instance, residential construction) are no doubt as yet underexplored. Better look at the discussions about the investment strategies of CDB and CIC: plenty of infrastructure and primary sector development, but not in the US. They have more important things to do.
AT, Petts’ tongue-in-cheek proposal may or may not be absurd, but it is definitely not a logical absurdity. On the contrary, it is eminently logical and in my opinion it makes a lot of sense, even though the reaction of many Chinese and Americans, as evidenced by comments on this site, would make it politically impossible.
“Mark G, thanks for expressing your no-doubt deeply-held beliefs, but I am not sure any of them make much sense, at least to me. Sorry, but your last sentence has no meaning at all as far as I can make out.”
Yes Profesor Pettis, being real and ahead of the curve has been of burden of mine for many years now. I should of phrased the last sentance better. You write that China must continue their relationship, maintain the staus quo with the US regarding the purchasing of US debt. The provided link takes a different approach. http://www.brookings.edu/testimony/2010/0225_us_china_debt_prasad.aspx
Rien Huizer, I think Pettis has already made the point, one which is consistent with the history as I have read it, that the claim China ran unbalanced trade (a trade surplus) before the opium trade is a myth. In fact during the end of the Ming and beginning of the Qing China went through a monetary collapse brought upon in large part by the depletion of Chinese silver mines and the closing of Japanese silver to export.
As part of what one historian rather inelegantly called the “Great Remonetization”, China desperately needed to increase the amount of silver in circulation, and as the Spanish began bringing back large amounts of silver from the Americas, China eagerly sought it. In fact nearly one-third of all the American silver ended up in China, something that couldn’t have happened if China was merely taking in silver to balance a trade imbalance. China was importing silver as eagerly as the Europeans were importing silk, tea, spice and pottery.
This may violate the guilt-ridden European narrative and the nationalist Chinese narrative, but some historians further argue that for the Chinese it wasn’t the import of opium that was the problem. It was that by importing opium the British virtually ended silver imports, and the imperial agencies desperately wanted those imports to continue. In that sense the Opium Wars may have been caused by silver, not opium. After all opium in China was quite plentiful, although not as cheap, before the British brought it in from India.
WdeThierry,
No guilt here! You may well be right about Chinese silver imports from Japan at the end of the Ming period, although the Japanese policy was to ensure that the volume of trade would not suffer, just the number of foreigners having contact with Japanese people. I really do not know if “China” needed all that silver badly, with fiat money in existence since the Song and virtual autarchy, it was probably not for industrial use, or to pay for other imports. Some form of domestic use, parallel to paper money (see also the last para). I know that the Dutch tried to maximize the value of the limited volume of cargo they could trade with Japan (and the Chinese, with similar privileges, did the same) and that silver and gold were important “exports” for the Dutch, while Japanese exports contained a lot of refined copper, silk and porcelain, even firearms. That the Japanese were exporting silver to China would be quite possible given the lack of complementarity between the two economies. I would tend to see silver as a form of cash (an internationally acceptable form of, hence comparable to treasury bills) and according to economic accounting convention, it would constitute a capital flow balancing a trade flow. If you would see silver as ordinary merchandise, there would of course never be a trade deficit in those days..And, more than likely those silver imports would have created monetary effects. More likely than not, silver was also the medium of choice for the regional smugglers/pirates/fishermen whose economic role is even less well documented that the official flows.
I suspect that the lack of a foreign exchange market prevented English paper money to be exchanged for the Chinese equivalent, even when English paper money had begun to circulate internationally in the late 1700s. There was little of high value and low volume Western traders could ship to China (or Japan) except bullion, and opium was a fine solution.
Anyway, my remarks were about externalities. Those of opium are clearly easier to identify than those of silver. There may have been a shortage (fast population growth, payments to supporters of Kangxi’s military campaigns, “payments” to Manchurian tribesmen, domestic lack of confidence in paper towards the end of a dynasty, etc.) of silver and the externalities of silver imports could have ranged from positive to quite negative, in the absence of a form of monetary policy and discipline. Maybe there is someone reading this blog who knows a lot about China’s monetary history, especially since the introduction of fiat money.
WdeThiery and Rein Huizer, a quick intervention on a fascinating topic before i run off to meet someone. I would agree with WdeThiery that we should not see China as having run a trade surplus that was then balanced by silver inflows. Silver was the object of Chinese trade, not a residual accounting entry, as in modern trade and central banking, and yes, to that extent, trade by definition balanced. I am not sure we should see pre-19th-Century China as practicing mercantilist policies.
Rien, although China had invented paper money long before, in fact the Chinese monetary system, as WdeThiery implies, was collapsing by the late Ming. I read a book two years ago (sorry, but i don’t have it in front of me) about counterfeit money in China during the Ming and Qing periods, and the need for money was so great during that period that in some areas of China merchants willingly and knowingly accepted counterfeit coins (with very low silver and copper content) as money simply because there was no alternative (interestingly enough in the late 18th Century Americans also knowingly accepted counterfeit bills because of the money shortage, so this is a recurring problem in history). The Chinese import of silver from Europe and the Americas was specifically to address that problem.
Michael,
I agree about your comments on import-men. I was trying to make an illusion to the absurdity underlying some of the moralizing on both sides and how this reminds me of similar attitudes about race during the colonial times. Since Americans are almost always on the side of power in any discussion I thought it would be interesting to make a little inversion and see how things felt to have Americans described as the weak and oppressed.
I really wasn’t trying to make a case for either side. But I do think Americans should take note about how far they are sinking and how it would be better for everyone if they were able to take care of things themselves before it really does become necessary for China to fix things for them.
Michael, WdeThierry,
I did not intend to picture Qing China as mercantilist! And meanwhile I found some research*) on silver flows in the 16th and 17th century (main sources Japan and Spanish America) that attribute part of these flows to a disequilibrium between the prices of gold and silver leading to exports of gold from China to Japan in exchange for silver. Japan reoriented its exports later to copper, which ended up largely in Europe. Incidentally, the reintroduction of “real” money (silver and copper) after a failed affair with fiat money and the resulting explosion in demand for suitable metal as you indicate might well be an interesting monetary phenomenon, especially against the background of a fast growing population (mostly living outside the money economy probably). Another interesting thing is of course the (convenient) explosion in world silver supply after the Spanish conquests in America and a very large increase in production in Japan (normally ascribed to civil war). Maybe Chinese demand for silver during the Ming pulled Japanese output but did it pull the Conquistadores? Fascinating discipline, economic history…
*) Dennis O. Flynn, Comparing the Tokugawa Shogunate with Hapsburg Spain: Two silver-based empires in a global setting. (in James de Tracy, The political economy of merchant empires: State power and world trade 1350-1750; Casmbridge UP 1991). Flynn also rejects the view that silver belonged in the “monetary” sector. He attributes much to a long period of active gold/silver arbitrage though. Still there is imo a fascinating monetary angle: monetary conditions in Europe were clearly expansive (the influx of Spanish silver, but apparently used also to ultimately finance trade with China) while in China the switch from Yuan paper to Ming silver/copper must have been very contractionary. Even barter (seeing silver as a normal commodity) requires monetary policy…
Seems to be alot of misconceptions
First and most importantly the quality of most every human relationship comes down to attitude. I enjoy Prof Pettis knowledge, insight and creativity in looking at complex problems and the discussions that result from his sharing these ideas on the blog. Some comments seem to be full of poor attitude which would surely result in destroying the motivation for him to continue.
Interestingly enough that point ties in well with what seems to be occuring in international relationships as well. Let’s take US China relations and I understand that the Chinese people are different than the government the same is true in the US. So strictly from a government to government point of view this is my opinion.
1) The US government was pushed and manipulated by US corporations into entering into a trade relationship that was unfair structurally to the people of the US with China. The supposed surprise of these currency issues could easily have been addressed then at the beginning. The history of mercantilism and trade relations between countries suggests that this was intentional as no policy maker could plausibly claim ignorance.
2) Obviously economic issues are tied into political issues, so what would be the economic push comes to shove. China is now playing a weak hand imo and of course will complain threaten kick and cry. Yet what can they do..
China has developed a growing list of economic enemies …many countries rightly or wrongly feel China has played unfairly.
Here is why I think China’s hand is weak
A) No defense for a China specific devaluation of treasuries ..and yes what could that really happen? Yes depending on how
B) Power elite in China have a vested interest in status quo to maybe moderate growth , killing off the customers seldom makes sense. It may not feel good but China must recognise they are only merchants to the worlds wealthy and have been invited into a club.
C) To think the US populace (not the govt) is to far corrupted and out of shape to BUILD WHAT IT NEEDS is foolish.
3) A Govt to Govt battle between US and China would be devastating and possibly lead to war(s). Public rhetoric designed for domestic political consumption on both sides may yield these bad results ..and big corporate money will use all its influence to avoid this.
In my opinion I hope the corporates win, the politicians are nuts ..and the populace worse.
Michael,
The Erie Canal is an interesting example, partly due to it’s own success, but also due to the surge of wasteful infrastructure spending it spurred as canals were built all over the eastern U.S. Some did prosper, but most were probably money-losing from the get-go.
There was one that terminated here in western Massachusetts that paralleled the Connecticut River, it lost money for a decade or two and then just disintegrated and was salvaged. The most ambitious was the Chesapeake and Ohio Canal, intended to link Washington, DC, with the Ohio River. The towpath makes a great bike trail today.
Of course, the same thing occurred with railroads when by the end of the 19th century tiny branch lines and parallel lines were built everywhere.
Of course, in these cases the cost of the waste was borne by investors.
Kevin de Bruxelles:
Still back to manufacturing, what of robotics, limited utility of technology (even when it is used in manufacturing rather than labor-intensive) due to 10 year time frames before the previously cutting edge technology becomes incomplete, and the very large development needs of the global people.
The key to the future is an increase in services, a more resource efficient approach to manufacturing, and the strengthening of rights related to intellectual property (the value of an idea, the only thing that has ever been valuable, as all tangible things come from this very intangible but necessary progenitor of any and all tangible goods), and similar.
I think it is interesting, I do believe the global bubble should have started to have been deflated in 2005, and I believe ultimate outcomes by your perspective are seriously mistaken. But I do hope we can get this thing back on track, I assume it will, yet, as always there are different possibilities. Most as posited by what has been written in the media regarding these issues will come to be very different then expected.
EU expectations that rises in value had validated their model, not factoring in all associated issues
Others emphasis on exports as the holy grail of economy
Others whose policies have increased inequality, although this has been a global occurence.
Many issues will have to be addressed to optimize the global economy for development, one in which their will be more money then ever imagined to be made, where it is necessary to maintain some inequality to maintain a capital base, the creation of a large global middle class will only occur under occurences of greater income inequality. Later rather than sooner it will get back to that point, there may be some pain to had prior to that point to make clear the necessity of feeling that pain, not feeling it for longer than is necessary, and a greater understanding of the interdependencies that currently exist, not that that couldn’t be altered, but would not be altered in the interest of global development, especially for those most in need of it, if investor portfolios are altered, and perhaps the solvency of banks who have lent widely across the globe.
Hi Michael,
Its interesting because it’s a move that no one is yet espousing. I’d like to see this developed a bit more …
I would ask the following : If the US is to support China’s transition period from exporting to consumption, during that 8-10 years when this may come about, US workers will be employed with vast infrastructure projects. Ok. However, what would the incentive really be for China to transition away from exports? Those infrastructure workers would take their paychecks to Walmart and continue to buy cheap Chinese goods, even if that production was supervised by American Mulitnationals. The infrastructure projects would have a higher ROE than similar Chinese projects so on that account it may make business sense for China. But it is my distinct impression that business sense is not really what the Chinese are after.
Americans would have employment and a more competitive infrastructure. But what is left out is the need to simultaneously develop the manufacturing base again in the US as well as lessening dependancies on consumption while saving more.
In essence, how do you tell / cajole / nudge / force Americans to consume less, unless the price of goods that they consume becomes too high? One way for this to happy is a currency adjustment. Or tariffs, or even capital controls. And how do you tell / cajole / nudge / force Chinese wealth creation to jump off of its gravy train in exports? In fact, it would probably expand under this scenario, IMHO …
Best regards,
Patrick
Pettis, comment #66:
“I am not sure you understand how to value the economic viability of infrastructure projects. The key benefit is likely to be economic externalities that are almost impossible to measure. On the other hand one of the largest costs, perhaps the largest, is likely to be the capital subsidy. Of course this doesn’t include other hidden subsidies and substitutions effects. I am afraid you are confusing operational revenues and expenses with the value of infrastructure, with which it is barely related. In your world, a well-functioning school system is probably considered a huge waste to the economy.”
Totally agree — other than what I am confusing about or what’s in my world. FWIW, in other places, I actually compared infrastructure spending with school system, i.e. both by itself can appeal to be losing money but in actuality benefit the society as a whole.
My problem is, once it comes to infrastructure spending in China, you chose your stand without ever looking at “economic externalities”. Initially you questioned if Chinese would be willing to spend money to save their less-productive time, which is obviously debunked by the ridership numbers; then you quoted Zhao Jian who raised the issue of increasing debt level — not for once you looked at “economic externalities”. BTW, given the ridership numbers, maybe just maybe, the real income & wealth in Chinese households are quite a bit understated by the official stats, which can bring up a slew of topics on how “imbalanced” China’s domestic economy really is.
You have a great blog, and personally I’ve learned a great deal by reading it. This infrastructure spending topic by itself, I just think you have a strong confirmation bias that you may want to re-examine again.
I wrote this in June, 2009:
A Chinese banker suggested the US issue Yuan- denominated credit instruments, the Chinese could print dollars to pay for them! One can laugh, but why not take this one step further: China can issue the US dollars they feel are required for liquidity and the US can print the Yuan denominated bonds that the US feels the Chinese need to buy to balance their current accounts. Both would be instructed to construe self- interests as narrowly as possible … Eventually, the understanding would arise that narrow national interests require both countries to act altruistically. America issuing Chinese debt and currency – and vice versa – would remove the gravitational effect of cronyism that is the driver for much of what passes for policy in both countries.
If things were to go wrong, the citizens could blame the others’ central banks and treasuries.
I also wrote that China should directly invest in the US 6 months earlier.
Conventional efforts to manage currency flows, savings rates and deleveraging tend to cancel each other out , at the same time ‘unintended consequence’ pitfalls multiply. Pegging the dollar/yuan makes one currency the proxy of the other. Inflation in China is held in check by deflation in the US. If the Chinese abandon the dollar peg currency inflation will manifest itself in China. Economic Undertow has long maintained the conventional wisdom that the yuan is underpriced is wrong. If the Chinese themselves felt the yuan was strong they would trade it and reap the benefits. It isn’t and they don’t.
Any upward revision of currency would be sort- lived; there are too many hazards to the government in out- and- out deflation: the Chinese are printing and they will print some more. There is little in the way of finance in China to ‘trap’ excess liquidity. With any increase in velocity, inflation leading to hyperinflation is not out of the question. Unlike America, there are few asset alternatives to the yuan in China. The Chinese’ savings are so much fiat scrap paper. Given enough Chinese stimulus savers’ hands will be forced; to spend now or lose everything. Once the savings emerge from tin cans buried in tens of millions of back yards, the race will be on.
Chinese hyper- inflation solves everyone’s problems. It removes Chinese savings ‘surplus’ and transfers it to the government, it inflates the value of dollar assets, inflating Chinese sovereign reserves at the same time. It balances current accounts. It takes pressure off the Euro and the Yen. The ‘people’ suffer, but who cares? The Chinese would rationalize that all wealth derives from the government rather than the people. They would execute a few malcontents, mop up excess yuan and pretend nothing at all had happened.
At the end the Chinese government would wind up much richer than when the crisis began. Is the Chinese government that cynical? You better believe it.
At bottom there are two interrelated issues; excess credit and declining energy availability. Creating credit then stashing away the excess does not solve anything; most of what the Fed has spewed as liquidity is in the Fed vaults, as bank reserves. Stashing away cannot substitute for an overall reduction of credit which is a necessary preclude to any kind of recovery. At the same time, the declining availability of energy – particularly oil and petroleum based energy goods – requires reduced demand.
The suggestion here on the blog that nobody reads is for both actions to be taken as vigorous policies from here forward. The consequence is for events to see to themselves and an acceleration of the crisis.
A year and a half later and crisis is what we got!
Fascinating discussion of silver and other metals, the only one point that seems missing is that colonial powers were able to keep their mercantilist policies and treasuries going in an unhealthy/unbalanced way partly because they had the colonies and their wealth of resources to exploit. Of course, things weren’t so pretty from the colonies’ point of view. Would not seek to draw modern parallels, that would be more political speak rather than anything else.
nice proposal by Prof Pettis but don’t really see “public sentiment” supporting this. Would be nice to see a pragmatic politician capable of rallying support fort his though.
WdeThiery, I totally agree with you and I apologize for being unclear…What I meant was pretty much exactly what you said. The result of logical reasoning was an absurd proposal that would be practical solution to the problem. Thus, the proposal was an absurdity that is very logical, i.e., a logical absurdity. Much like eating babies…
http://www.chinadaily.com.cn/opinion/2010-10/15/content_11413022.htm
Prof Pettis, as you noticed Xiao Gang’s article and commented last time, here is the latest one on local govt. debts
Jxie wrote:
“My problem is, once it comes to infrastructure spending in China, you chose your stand without ever looking at “economic externalities”.”
I’m sure Michael can defend his post but I’ll throw in my 2 cents. I understood Michael’s position to be precisely about externalities. Basically, if I’m a San Francisco professional making $200,000 a year, the value of quicker transportation is higher than if I’m a Chinese manufacturing manager making $20,000 a year.
The “joke” is that those massive dollar reserves do not truly exist.
Just as Japan found out when they tried to apply the “power” of their US dollar reserve position, if China strays from the abstract of the international reserve accounting by starting to replace US Treasurys with FDI – the true accounting of the value of the current liability in yuan now offsetting those dollars will show up in the mark on the FDI asset.
It takes a better mind than mine to figure the math – but basically the FDI asset China would acquire will decline in value on a pro rata basis of what the Chinese share of holding of that asset or subsector is equal to whatever amount in value the yuan generated in trade over true value. Or, if China buys 10% of the tollroads in America the value of those tollroads will decrease 10% times the amount that dollar FDI amount China gained from trade solely from the cheapness of the Yuan over intrinsic value.
China must always stay in an “abstract” asset or a day of reckoning will arrive.
Happened to Japan. For example, Japan lost about 30% of their Rockefellar Center asset which about equaled how much the yen was undervalued during the time the dollar reserve position was built to fund the pruchase.
Lastly that means Japan never really “crashed”, it merely returned to true intrinsic value.
China should be very very careful not to buy their own press. I figure China is about 40% to 50% smaller than most now proclaim.
Michael’s reasoning about the RoI of infrastructure improvements is correct. Though I don’t think that any improvement it can provide is enough overcome the ‘competitive gap’ that exists. At best it may allow for a lesser amount of people to produce the same amount of productivity. In a world hungry for employment growth, the opposite may be preferable.
The ridership of amtrak in the northeast corridor has gone up, so high speed rail in pockets of metro areas of the US is profitable for private investors(see link). In fact, a Chinese consortium led by China MOR and CIC, is bidding on all 3 high speed rails projects in the US which will provide jobs to Americans. No Chinese labor will be imported. However, the consortium faces tremendous political headwind by the local governments. The US needs to allow Foreign Direct Investment to help its deficit, buying Treasury is not enough.
Many thanks for the excellent and well argued thought experiment, it is by far the best suggestion I have heard to date but sadly I have to agree that the political barriers are just too high.
I would like to make one observation. Doesn’t the fact that America has such an infrastructure investment deficit point to how intractable the imbalances in the economy are likely to be. It is amazing that the country has squandered the invaluable benefit of being the world’s reserve currency on maintaining an unsustainable lifestyle rather than productive infrastructure. Even America cannot forever maintain a 100 dollar quality of life on 60 dollar earnings and getting that back in line will be painful indeed. I believe that we are approaching a global economic inflection point and as Duy says things can only get ugly from this point. I hope it isn’t significant that the only infrastructure investment the government has religiously maintained is the military.
Michael – I haven’t read all the comments, but I see one huge problem with your plan. If China funds the U.S. spending, then all of the employment gain goes to China – the capital inflow will equal the increase in the U.S. trade deficit, so AD in the U.S. is unchanged. True, China will avoid wrenching dislocation, but the U.S. will gain no employment and will merely be saddled with more debt to finance the new infrastucture. Increased AD from the infrastructure would be offset by the increase in the trade deficit (Y = C + I + G + (X – M). (X – M) declines by the capital inflow from China, offsetting the increase in G). We can fund the infrastructure very handily all by ourselves – we have an excess of desired savings. We don’t need China’s help for this, only the political desire to do it.
Prof Pettis
Just one thought, could the following sequence of events result in “Japanification” in the States and Europe?
Trade war–> cheap goods no longer available on the cheap i.e. prices rise sharply–> consumers forced to cut spending–> deflationary cycle starts Expectation of lower prices(on part of consumers) as retailers and manufacturers engage in price war to get marketshare, inventories buildup, as businesses face problems re survival, businesses engage in further jobcuts, number of businesses closing rise, downsizing increases, number of jobs lost increase, greater “stimulus” and rescue packages increase liquidity but businesses who secure funding are not expanding, they are sitting on cash and watching what happens next (usually big businesses and banks).
On the consumption front, things look ever more grim as jobs are harder to come by, income levels plummet (at least for the “large middle class”), consumption shrinks further. credit default rises. the housing market goes further into the red, even those who bought expecting a rebound find it harder to offload investments. Welcome to Japanification version 3.
How likely is that scenario?
sounds awfully like http://www.nytimes.com/2010/10/17/world/asia/17japan.html?_r=1&src=me&ref=world
This analysis is silly. Your analysis reminds me of the joke where the economist proposes opening the can by saying “assume a can opener”.
You are supposing a magic return on investment in public infrastructure, which means the rising debt levels don’t matter. But where is this return going to come from?
There are two sets of books to consider – first the US government. Large increases in debt risk a downward fiscal spiral – that is clear. Unless magically investment in infrastructure saves the day. This is not really credible – infrastructure investment is not sufficient for robust economic growth.
The silliness is even more obvious when looking at the external position. The US should get further in debt to its trading partners because investment in infrastructure will enable it to run large trade surpluses in the future? But if China is not willing to give up its trade surplus now, why would it do so in the future? Japan has been happily running surpluses for decades and is not thrilled about giving up their surplus.
I commented a few years ago that the most stable long-term arrangement was a commitment to balanced trade. You pooh-poohed me, saying some trade imbalances are reasonable. Fair enough: smaller reversing imbalances are fine. But the problem here is persistent imbalances which do not go away by themselves. I stand by my earlier recommendation.
Michael –
Isnt this what some Keynesian economists are proposing except with the US Treasury as the middle-man to make it politically more palatable? As in: China can keep buying Treasuries (with as we here believe, at a loss) while the US primes the fiscal pump by investing in infrastructure projects?
Its just a matter of who owns the bonds (the put) and who owns the equity (calls) on the investment.
Or alternatively, to replicate the current state of affairs, China (or essentially the Chinese savers) could just as well write unemployment cheques directly to US consumers to continue the status quo (for a short while).
Professor Pettis, I love your analysis, but I am pretty sure you have not learned much Chinese in China. Xin Fa’an does not mean “new deal”. There is a word fa’an, ???, but it means statute. ??? does indeed mean New Deal, but it is pronounced Xin Fang’an. I think your incorrect pronunciation of this word reflects the way that the -ng is often realised as a nasalisation of the preceding vowel, rather than a full -ng, so it might sound similar to xin fa’an with a nasalisation of the first a, but clearly you don’t really know the word and couldn’t recognise it in print. So why are you teaching in Beijing without learning Chinese? Are you an expert on the Chinese economy who can’t read the Chinese headlines? You see, there is a risk in showing off with these Chinese words, and falling flat on your face!
DW, actually I am more annoyed by people who speak Chinese and from there assume they understand the economy. It was my favorite student at Peking University who gave me the title for this piece. I will ask him if he has indeed fallen flat on his face, but I suspect his Chinese is pretty good.
Look, Professor Pettis, I don’t know what your favourite student at Peking university said to you about the Chinese for “new deal” – whether he mentioned it orally without spelling it for you, or whatever. But, what I saying is that the Chinese for New Deal is Xin Fang’an. I am not asking you whether that is so; I am telling you it is so. It is not a question. It is not something on which there are two views, both right. Quite simply, yes, I do speak Chinese, and I am just telling you that Xin Fa’an means “new law”, and not “new deal”. I would be surprised if your student were not aware of the word fang’an – this is such a basic Chinese word, I simply don’t believe your student, a native speaker of Chinese, does not know it. But, the Chinese for New Deal is Xin Fang’an.
Look, you could have just accepted what I said, instead of arguing back. The fact that you need to refer to your student shows that you do not have even basic Chinese. You personally don’t know the word fang’an and don’t know the word fa’an either – so you claimed an authenticity you can’t in all truth lay claim to.
But having said that, yes, I do totally accept your point that speaking Chinese is not the same thing as having a good insight into the Chinese economy. I can well believe your access to your Chinese students, being able to conduct high-level discussions with them in English, and your knowledge of economic theory means that you are one of the best-placed people to comment on the Chinese economy, and merely speaking Chinese is not the same thing at all. So, yes, your point is taken.
David Webb, thanks for telling me so emphatically that I am wrong, but I am telling you just as emphatically that my student disagrees with you, and frankly he has a lot more credibility with me than you do. According to him, the formal name for the New Deal in Chinese textbooks is Luo Si Fu Xin Zheng, although this name impies more than just economic policies. He also says: “Xin fa’an” means “new law” if you use it in a very formal way, but “xin fa’an” fits the New Deal scenario if it is not used in a very formal way, which you aren’t.
That is more than adequate for me, and suggests that i might not be the one showing off while falling falt on my face.
Dear Professor Pettis,
It would be wrong to argue, especially as you have such a fine blog. I like it a lot. But as you have raised it again, you are the one arguing: yes, luosifu xin zheng – do you know what this means? It means Roosevelt’s new policy/policies.
Look! There are many more websites, Chinese websites, using xin fang’an, than xin fa’an. If native Chinese people are the final say – by your own mouth – then xin fang’an it is.
Xin fa’an – new law. Xin fang’an – new scheme, plan or program. neither of these is exactly new deal – and neither is xin zheng exactly “new deal”.
You suffer from the flaw of thinking that an individual Chinese person has the final say on the Chinese language. As a former English language subeditor, I know very well that nearly all university graduates in England have poor English. We have reached the point in England where the average graduate cannot write grammatical English, and, worse, where you would struggle to find one who could.
So the opinion of an individual person means nothing – he could just as easily be one of the many, many Chinese who use the wrong characters in their Chinese. Ask him to write “penti” (sneeze) without looking it up. I have never met a Chinese person who could do that. I am afraid people who should know things very often don’t. It is fruitless to use this type of “proof”, as it doesn’t show anything. I once knew a man in England of Jamaican origin while I was at university. When we were passing a travel agents’ office, he saw an advert for Barbados and said, “that’s where my family are from”. I said, “but you said it was Jamaica”. He replied, “it’s all one country”. I tried to tell him it wasn’t, but it was no use. You see, you can only discuss the facts as they are, not discuss whether person X who should know the facts is right or not.
You could have argued that xin fa’an, “new bill/bills”, was close enough, and could be used without raising eyebrows. But you didn’t make that specific point.
Why don’t you google “xin fa’an new deal” and “xin fang’an new deal” replacing the Chinese words by the Chinese characters? I am afraid Chinese characters show up as question marks on your blog. If you google those, you will get your answer. Try http://www.google.com/search?hl=en&source=hp&q=%E6%96%B0%E6%96%B9%E6%A1%88+new+deal&aq=f&aqi=&aql=&oq=&gs_rfai=
I am not going to reply to any more posts that are simply reiterating that your student says xin fa’an. He may well do. I could list university graduates in England who could not write a grammatical sentence. It doesn’t show anything. I strongly suspect your student has told you a) the official form is xin zheng, but that means “new policy/policies”; b) xin fa’an does not mean “new deal”, but could be close enough in oral speech; and c) that xin fang’an means “new scheme” and is actually closer than xin fa’an. In fact, why don’t you reply SPECIFICALLY on a), b) and c) – I would lay money on it he has told you all three things, a) and b) and c). Seeing as you are choosing to be argumentative, don’t avoid any of those three things. Reply on a), b) and c), and state whether he could write penti. Thanks.
David Webb,
For someone so rude and full of yourself you are a little thin-skinned. Pettis’ reason for using Xin Fa’an seem’s pretty plausible to me, especially since the whole piece was written tongue in cheek. You are quick to point out how much smarter you are than others, but I haven’t seen much evidence for that, just bad mannered nit-picking, which is not even right.
On another issue, professor, it is interesting to me how widely this blog piece has been picked up and debated. There was even a Chinese policymaker yesterday (I forget who) who made the same points and even use some of your phrases (without citing you, of course). As impractical as it is, it is a pretty good idea, as you say.