Contrary to some recent research reports cited in the press I do not think we have seen any substantial rebalancing of the economy towards consumption in 2011. This is largely an argument being made by economists who did not see why Chinese consumption repression was all along at the heart of the growth model. These economists are now too quick, I think, to hail evidence of a surge in consumption, but I find the evidence very weak and more importantly I am convinced that there cannot be a sustainable surge in consumption as long as the investment-driven growth model is maintained and as long as debt continues to rise unsustainably.
And as for debt, it is still rising quickly. As regular readers know I have always argued that the rise in Chinese debt, as bad as it is, was not going to lead to a banking collapse or any other sort of financial collapse because of the way local and specific debt problems would be “resolved”. Debt would simply be rolled onto the government balance sheet.
Last Monday I was in Hong Kong visiting few clients, and during my visit to Hong Kong the Financial Times gave me a nice gift – an opportunity to center my discussions – with this article:
China has instructed its banks to embark on a mammoth roll-over of loans to local governments, delaying the country’s reckoning with debts that have clouded its economic prospects. China’s stimulus response to the global financial crisis saddled its provinces and cities with Rmb10.7tn ($1.7tn) in debts – about a quarter of the country’s output – and more than half those loans are scheduled to come due over the next three years.
Since the principal on many of the loans is not repayable, banks have started extending maturities for local governments to avoid a wave of defaults, bankers and analysts familiar with the matter told the Financial Times. One person briefed on the plan said in some cases the maturities would be extended by as much as four years.
We are going to see a lot of stories like this. There is a growing amount of unrepayable debt in China and ultimately most if not all of it will end up on the government’s balance sheet. On that note I disagree with something Simon Rabinovich, in another article published in the FT on the same day, said on the topic:
China’s debt woes are very different from those of Europe or, for that matter, the US. In developed countries, the concern is the sheer amount of debt they have accumulated. The Chinese problem is less one of quantity and more one of structure: rather than issuing bonds, local governments have used opaque bank loans for funding.
“The problem is rooted in the national fiscal system,” said Huang Haizhou, chief strategist at China International Capital Corp, the country’s leading investment bank. “If a successful fiscal reform is implemented over the next three to five years by the new government, the problem will only be a temporary shock.”
Borrowing your way out of debt
This is almost certainly incorrect. The problem in China is as much the amount of debt as the structure – and by structure I don’t mean the distinction between bonds and loans (bonds end up mainly on the banks’ balance sheets anyway) but rather the unstable and self-reinforcing relationship between underlying conditions and debt servicing costs. The fact that much of the debt is being accumulated in an opaque fashion only explains why so many people did not see this coming, but it is not the fundamental problem.
As for the claim that successful fiscal reform can keep the impact limited, I am not sure what this means. Fiscal reform in China can only be successful, in this context, if it eliminates loss-making investment activities, and unfortunately I see it doing nothing of the sort. If the problem is that China is keeping growth high only or mainly by borrowing and misallocating the proceeds, then hidden losses are rising and one way or another the bad debt must be resolved. The only two ways to resolve the bad debt are by defaulting or by forcing someone else to make up the loss, and the former almost certainly won’t happen to any great extent.
That leaves the latter. The structure of the debt as this article defines it – transparent bonds versus opaque loan – is I think almost irrelevant. For example the article goes on to propose one solution:
“Five or ten years from now, local governments will borrow very, very little from banks. Their debt structure will be almost entirely bonds,” said Fan Jianping, chief economist of the State Information Centre.
There seems to be an almost touching faith in cosmetics here. If banks make foolish loans, stop calling them loans and start calling them bonds and the problem is immediately resolved – we’ll have no more bad loans.
True, we won’t, but we’ll have bad bonds, probably still on the bank balance sheets, and we’ll still be left with the problem of how to pay for them. Since household income is probably much too low to support another massive transfer to subsidize debt forgiveness, as happened after the last banking crisis of a decade of ago, the next debt crisis will have to be subsidized by government transfers.
But if households don’t clean up the next banking mess, how will it be resolved? My guess is that it will be resolved in the same way local government debt is being resolved – it will simply be directly or indirectly passed on to the government. And given the constraints that limit Beijing’s ability to push the household share of GDP down much further, Beijing, as I have argued before, basically has two ways to resolve another surge in bad debt.
Both involve transfers of assets from the government, but each has very, very different long-term implications. One way to resolve the bad debt is to privatize assets and use the proceeds to clean up the banks. The other way is to have the government absorb the debt. If debt rises faster than debt servicing capacity, there will have been a real transfer of assets from the government to the borrowers.
Japan’s debt
Which will Beijing choose? An article in Reuters this week reminds us of the consequence of the second way, which unfortunately way has the great advantage of being politically easier than the alternative. The article is about Japan and here is what it says:
Capital flight, soaring borrowing costs, tanking currency and stocks and a central bank forced to pump vast amounts of cash into local banks — that is what Japan may have to contend with if it fails to tackle its snowballing debt. Not long ago such doomsday scenarios would be dismissed in Tokyo as fantasies of ill-informed foreigners sitting on loss-making bets “shorting Japan.”
Today this is what is on bureaucrats’ minds in Japan’s centre of political and economic power. “It’s scary when you think what could happen if there’s triple-selling of bonds, stocks and the yen. The chance of this happening is bigger than markets think,” says a senior official. Leaning back in a leather sofa in his office, the official appears relaxed, but the way he wastes no time answering questions about a debt meltdown, suggests it is an all too familiar topic.
The official, like many others interviewed by Reuters, declined to be named because of the sensitivity of the subject and his alarm over Japan’s $10 trillion-plus debt overhang has yet to be reflected in public debate or action. But these officials would be the ones pulling the levers in the command center if Japan were to be hit by a debt crisis. The government borrows more than it raises in taxes, and its debt pile amounts to two years’ worth of Japan’s economic output, the highest debt-to-GDP ratio in the world.
This what I worry about most for China as it decides its adjustment process. Beijing could easily choose to absorb debt rather than pay it down through asset sales, and as debt rises it will be all the harder to raise interest rates. It will ultimately also create what is potentially a destabilizing debt overhang, although as Japan showed, it can take many years before the debt itself becomes unsustainable.
That is why although I don’t think it is a certainty, I am expecting that the most likely economic outcome for China for the rest of this decade is a combination of much slower growth and rapidly rising government debt. Privatizing assets and using the proceeds to shore up household wealth, directly or indirectly, is politically tough to do.
But that doesn’t mean it can’t happen. On Thursday the Wall Street Journal published a very interesting article on what is supposed to be an upcoming World Bank report – to be published this Monday. According to the article the report is already controversial but may gain traction within Beijing:
How much the report will help reshape the Chinese economy is unclear. Even ahead of its release, it has generated fierce resistance from bureaucrats who manage state enterprises, according to several individuals involved in the discussions. China’s political heir apparent, Xi Jinping, now vice president, has given few clues about his economic policies. Analysts expect the high-profile report will encourage Mr. Xi and his allies to discuss making changes to a state-led economic model that has alarmed Chinese private entrepreneurs while creating tension between China and its main trading partners, including the U.S.
The report’s authors argue that having the imprimatur of the World Bank and the Development Research Center, or DRC—a think tank that reports to China’s top executive body, the State Council—will add political heft to the proposals. The World Bank is widely admired in Chinese government circles, particularly for its advice in helping China design early market reforms.
They are also counting on the clout of the No. 2 official at the DRC, Liu He, who is also a senior adviser to the all-powerful Politburo Standing Committee, to help ensure that its findings are considered seriously by top leaders. Mr. Liu declined to comment.
Restructuring state involvement
The World Bank report will apparently warn that China is facing a very difficult economic transition:
An exclusive preview of an economic report on China, prepared by the World Bank and government insiders considered to have the ear of the nation’s leaders, offers a surprising prescription: China could face an economic crisis unless it implements deep reforms, including scaling back its vast state-owned enterprises and making them operate more like commercial firms.
“China 2030,” a report set to be released Monday by the bank and a Chinese government think tank, addresses some of China’s most politically sensitive economic issues, according to a half-dozen individuals involved in preparing and reviewing it.
It is unquestionably a good thing, in my opinion, that Beijing is made aware of how difficult, and urgent, the transition is likely to be, but it is also a little disheartening that it has taken so long to warn about what should have been deeply worrying us five or six years ago. China’s growth model was clearly unsustainable even back then, and was just as clearly heading to a debt crisis, and the longer it took to address the problems the more severe they were likely to get.
According to the WSJ:
The report warns that China’s growth is in danger of decelerating rapidly and without much warning. That is what has occurred with other highflying developing countries, such as Brazil and Mexico, once they reached a certain income level, a phenomenon that economists call the “middle-income trap.” A sharp slowdown could deepen problems in the Chinese banking sector and elsewhere, the report warns, and could prompt a crisis, according to those involved with the project.
It recommends that state-owned firms be overseen by asset-management firms, say those involved in the report. It also urges China to overhaul local government finances and promote competition and entrepreneurship.
…The World Bank and DRC argue that asset-management firms should oversee the state-owned companies, say those involved in the report. The asset managers would try to ensure that the firms are run along commercial lines, not for political purposes. They would sell off businesses that are judged extraneous, making it easier for privately owned firms to compete in areas that are spun off.
“China needs to restrict the roles of the state-owned enterprises, break up monopolies, diversify ownership and lower entry barriers to private firms,” said Mr. Zoellick in a talk to economists in Chicago last month.
Currently, many state-owned firms have real-estate subsidiaries, which tend to bid up prices for land, and have helped to create a housing bubble that the Chinese government is trying to deflate. The report also recommends a sharp increase in the dividends that state companies pay to their owner—the government. That would boost government revenue and pay for new social programs, said those involved with the report.
Growth slowdown
This is good as far as it goes, but it doesn’t go far enough. Of course increasing SOE dividends to the government for use in social programs will transfer wealth from the state sector to the household sector, but if the total profitability of the SOE sector is less than one-fifth to one-eighth of the direct and indirect subsidies transferred from the household sector, as I have argued many times, then even 100% dividends is not enough to slow the transfer significantly, and remember the transfers have to be reversed, not merely slowed. This proposal falls in the better-than-nothing category, but just.
What we really need are much more dramatic transfers, for example wholesale selling of assets, with the money used either to clean up bad loans or delivered directly to households. According to the article, however, “neither the World Bank nor the DRC proposed privatizing the state-owned firms, figuring that was politically unacceptable.”
This is the problem. The best solution for China, economically, seems to be off limits because it will be politically difficult. In that case the second best solution, a gradual build-up of government debt as growth slows for many years, is the most likely outcome.
And how much will growth slow? The World Bank report apparently doesn’t say, but the consensus has been slowly moving down towards 5-6% annual growth over the next few years. That’s better than the crazy numbers of 8-9% most analysts were predicting even two years ago (and some still are), but it is still too high. GDP growth rates will slow a lot more than that. I still maintain that average growth in this decade will barely break 3%. It will take, however, at least another two or three years before a number this low falls within the consensus range.
And by the way when it does, metal prices should fall sharply. Copper prices have done reasonably well in the past few months as Chinese buyers have restocked, as we suggested might happen to our clients last fall. With the recent easing we may see more strength in copper over the next month or so, but I have little doubt that within two or three years copper prices are going to be a whole lot lower than they are today. Chinese investment demand simply cannot hold up much longer.
Before ending I wanted to make one last, and totally unrelated, comment. There was a Financial Timespodcast last Thursday in which David Bloom, global head of FX strategy at HSBC, worried that if the euro keeps strengthening, it will end up “harming the region’s competitiveness.” He is right of course that if the euro strengthens, this can hurt the region’s competitiveness and so slow growth, but if this is a problem, why are European government’s still asking China and the other BRICs to contribute to their bailout? Don’t they realize yet that importing foreign capital means strengthening the euro and exporting domestic growth? The more money they take from abroad, the harder it will be to pay back any of the debt.
This is an abbreviated version of the newsletter that went out two weeks ago. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at chinfinpettis@yahoo.com, stating your affiliation, please. Investors who want to buy a subscription should write to me, also at that address.
Hi Michael,
The China banking system continues to be based on government directed capital and the moral hazard presumption that grandfather will come to the rescue. Bank loans in China are not based on debt service. Few bankers if any understand corporate finance and cash flow. Those that do, fudge their projections anyway to justify the loans. I have seen cash flow projections that would make your undergraduate economics students laugh.
When a lender evaluates a loan, the obvious question is how will the loan be repaid? A company can pay back the loan through 1) operational cash flow, 2) liquidation (sale) of assets or 3) by borrowing money from somebody else to pay the maturing loan.
In most commercial lending, financiers concentrate on the first item (operational cash flow) since that is, hopefully a recurring source of funds to service the loan payment. Typically, item 2 is the backup source of repayment and the loan often supported by a pledge of these assets as collateral. Item 3 is more difficult to predict and we often refer to it as the bigger fool theory-that is if the borrower is not cash flow positive, what fool would give it money?
In China, however, item 1 is not the focus (AND DON’T LET ANYONE TELL YOU IT IS). Chinese bankers may pay lip service to this but I doubt they can even spell or write the character for cash flow.
What this leads to is a system that bases its loan decisions on 2 and 3. The problem that I see with this is that #2 is based on asset values and therefore can be problematic in bubble markets. The western approach to real estate development finance has the same problem in that the loan repayment is dependent on the asset financed rather than access to a broader set of operational cash flows. In China, real estate loans, commercial loans and infrastructure loans all have a high degree of real estate collateral pledged and to the extent this collateral diminishes in value, there is great systemic risk… I would submit far more systemic risk than was present in the US when the residential real estate market melted down.
Therefore, in China, #1 is not evident; #2 is becoming impaired-not to mention the loans were most likely based on optimistic values even for a bubble market (have you ever seen a Chinese real estate appraisal? Laughable). The consequence is a huge and growing dependence on #3, which is obviously Grandfather, either directly or through a policy of ‘extend and pretend’ by the banks. Forget about Basel 2 and 3 capital. Risk capital is an accounting identity that, like all accounting, can be fudged. Therefore, as long as the banks are kept liquid enough to fund their balance sheets, then the game can continue. The consequence will be inflationary pressure and more financial repression at the household level. As you point out, growth will slow and I believe stagflation is a real possibility.
The question I would ask is even if China could sell state assets and fix the immediate problem, what will change banker behavior? As long as investment decisions are clearly in control of the Party, nothing will change. Did you ever notice that all state owned Chinese banks are organized in the same way? Regionally? Each regional branch is its own little bank. Even the CBRC is set up this way. It mirrors the way the Party is set up. Victor Shih’s great book is a good look at the historical struggle for China’s purse strings.
If China does not take measures to reduce its savings to the levels that can use fruitfully, it faces an even more serious problem: As long as China cannot utilize its own savings it is dependent on foreign trade surpluses to maintain growth.
China’s growth will slow if and when the global imbalances start to diminish. This can be triggered by two things. Either other countries restricting China’s access to their goods and capital markets or because their economies are too badly damaged by China’s imperial export of capital (the parasite killing its host).
“The other way is to have the government absorb the debt. If debt rises faster than debt servicing capacity, there will have been a real transfer of assets from the government to the borrowers.”
not following here. can’t the party raise taxes then? care to explain?
Hua Qiao,
That was a fascinating description of the financing processes in China. Could you elaborate on whether and how asset valuations are artificially propped up? If it was a relatively free economy one could expect changes in asset prices to trigger rebalancing, albeit painfully. Can this take place in China or not at all?
If the World Bank (or IMF) say it, you can be sure it is wrong. I don’t think they’ve been right about anything in human memory.
Japan’s future problem is not debt, it is demographics. The government debt is just private savings by Japan’s citizens. They are probably saving like mad, because so many of them are getting old. The government has just been spending to keep demand at a reasonable level.
The problem is in the real world, not the financial world. If their dwindling workforce is not VERY productive then there will be a diminished standard of living. All those saved-up Yen will just be chasing the few goods / services the workers can provide, and the price will go up (to reflect the reality of what’s available). Japan has been pushing robotics, etc. for years, I assume in the hope that this will make up for fewer and fewer workers. I hope they succeed.
Hua Qiao, much of what you say is right, of course, and my summary would be that from an economic point of view we know pretty much what has to be done, but since this requires transfers of resources from one group to another, ultimately this becomes a political question, not an economic one. This is why it is such a sticky problem.
Ken2, I would add a third trigger, which I think is a bigger problem. What is really driving Chinese growth is not the trade surplus but rather investment (the trade surplus is a residual consequence of policies that force up the savings rate). Because we have long since passed the point at which investment is economically viable, the only way to maintain growth is to continue the unsustainable increase in debt. However, as some economist once wryly pointed out, if it is unsustainable it will eventually stop.
Dave, if the government absorbs on private sector debt, it is the equivalent of giving away assets. If you owe money and I take on the obligation for you, it is the same as if I gave you money.
SteveK9, I am sure you intend the claim about the World Bank as sarcasm because of course it is not true. And although Japan certainly does have a demographic problem, to claim that because it has a demographic problem it cannot have other problems, including a debt problem, doesn’t make a lot of sense to me. Japan most certainly does have a debt problem, and this should be evident to anyone who has seen the numbers. To say that government debt is “just” private savings doesn’t mean anything in this context. All debt is funded by someone else’s savings.
hi michael,
is it possible for china to fund their investment by going through their own QE? What would be the side effects if they do so? And what are the other options available to them to fund their investment till the global economy recovers?
Hi Michael, I am a little confused as to what would be stopping China from using its foreign currency reserves to write off these bad bank loans? Is that possible but would be damaging because of inflation and the fact that it would further hold back domestic consumption?
I also wonder if viewing these bad bank loans as fiscal deficits is any less worrying, as suggested in article below? And again if the government running a large de-facto fiscal deficit is not concerning because of foreign currency reserves?
http://blogs.ft.com/the-a-list/2011/11/16/the-real-risks-to-china%E2%80%99s-financial-system/?s-financial-system/#axzz1fHJpdp52
peaksteel: what would be stopping China from using its foreign currency reserves to write off these bad bank loans?
me: since mr. pettis will probably break something if he has to answer that question again, let me try. first, foreign reserves can’t be spent in china. second, if the dollars were sold for yuan to spend in china the central bank would lose control of the currency and the yuan would soar, wiping out the export sector. third and main reason, reserves are just borrowed money, so asking why they can’t be used to clean the banks is like asking why the government can’t borrow money to clean up the banks. they can, but borrowing money to pay debt doesn’t solving the debt problem.
am i right, mr. pettis? oh yes, i forgot, the chinese central bank is already insolvent, isn’t it?
Johnnie, China’s foreign currency reserves is money borrowed from commercial banks right? Obviously I am not suggesting that the dollars can be sold for yuan to be spent in China but what is stopping the central bank from recapitalising banks by transferring this money back to them? Is it as you say the impact on the yuan? Ensuing inflation? Or have I totally misunderstood this?
I believed that I have been following your logic reasonably well, but reading Mancur Olson’s analysis of Stalinism in Power and Prosperity has left me confused about your proposed solution.
You argue that China has been investing in uneconomic production via the SOEs. These are made to appear profitable and are only allowed to continue to invest because interest rates are fixed at an unnaturally low level. The low level of interest acts as a transfer from households to SOEs and leads to the buildup of debt against assets that cannot support this debt (if it were to be priced correctly with higher interest rates) because they are uneconomic.
So far, so good. But now, as a way of resolving this debt problem and transferring wealth back to households, you propose privatizing those assets. But wait, these assets are lossmaking (with market rates of interest) and worthless by hypothesis! They don’t represent wealth at all but simply the congealed boondoggle of year of misallocated capital!
This turns out to be Mancur Olson’s point about the collapse of the Soviet system. People apparently spent a great dal of time worrying about which state owned assets to privatize and how fast to do it, which was beside the point when you consider that the assets were worthless. In the case of the Soviets, he argues that this was because corruption had already allowed people to suck the profits out of the state system, so that the only assets under consideration for privatization were the crappy ones (to paraphrase). The center was already hollowed out through years of uneconomic production based on political rather than economic principles.
It seems to me the same logic might apply to your suggested remedy in the case of China. If rates stay locked low, then the SOE assets are profitable, and privatizing them works fine as a transfer of wealth in the short term, but changes nothing about the low rates stealing form the household sector to fund uneconomic investment. In fact, it arguably makes this worse because now everyone has a direct share in the “profits” of this investment. But, on the other hand, if rates go up to a level that cuts off funding for production that will not be able to meet realistic debt service, then the assets are of questionable value. The higher rates paid to depositors should represent be a gradual transfer of wealth back to households, but the privatized shares would simply be so much shuffled paper.
I’m sure I’m missing something here, but I’m struggling to figure out what parts of Olson’s analysis apply to present day China.
HI BwO,
You said:
“If rates stay locked low, then the SOE assets are profitable, and privatizing them works fine as a transfer of wealth in the short term, but changes nothing about the low rates stealing form the household sector to fund uneconomic investment. In fact, it arguably makes this worse because now everyone has a direct share in the “profits” of this investment. But, on the other hand, if rates go up to a level that cuts off funding for production that will not be able to meet realistic debt service, then the assets are of questionable value. The higher rates paid to depositors should represent be a gradual transfer of wealth back to households, but the privatized shares would simply be so much shuffled paper.”
Thanks for this clarifying words. They supplement Michael post and Hua Qiao comments in a very useful way and certainly make the picture is clearer.
However I would be certainly not as negative as to say that Chinese assets have negative values. Since IMHO I have little doubt that a high degree of monetary destruction is of course in the making. And this not a China-centric event…
This is of course a very personal assumption but there is some back-up evidence to it in view of the sky-rocketing prices in numerous businesses and areas all around the globe.
@ Kivalur
This requires a long explanation to do justice but suffice it to say that the Chinese property market is a function of expectations. China’s property market is less than 20 years old and participants have never seen a downturn. There is a perception that property prices can only go up. Couple this with negative real interest rates on your deposits at China banks or investing in the Shanghai or Shenzhen equity markets (which are extremely volatile), the mainland investor has looked to real estate as a store of value.
If those expectations change, then obviously valuations will adjust. If this is done gradually, as the government is attempting, then perhaps the pain will be less. However, if there is a catalyst event for significant and sharp devaluation, then you could see systemic problems.
My point is that the China property market is based less on rental income and more on perceived speculative value and the potential impact of a sharp change in those expectations could have a large effect on the financial market because real estate is such an integral part of everyday part of commercial finance.
China does have 2 things going for it. First, it can monetize bad bank loans and keep the banking system liquid because it to date has a stanglehold over money flows. Secondly, there is still the overriding sentiment of “trust the Party” that pervades commercial investment decisionmaking.
Michael, I think what SteveK9 is getting at is that Japanese government debt and Japanese demographics are linked. An ageing population is going to save more and work less – reducing output and the tax take, while collect more government expenditures in the form of social security and health care. So by definition, the government must borrow more from domestic savers to cover its SS obligations. Japanese government debt thus is very high and yet interest rates very low as a result. It’s not really a problem of “malinvestment” as people think China suffers from, since the Japanese people have in the past few years enjoyed a relatively high share of national income, through high levels of social spending(welfare, pensions, healthcare) and also currency appreciation (an adjustment of sorts from the export driven development model of the past). There is an economist article that explains it.
http://www.economist.com/node/21538745
I am not sure what the final endgame for Japan would be, though, and I am curious what you and the other commentators here think.
@BwA
I think the issue is suppressed income. In order to transfer wealth from the private households to the stateowned sector, not only interests, but also wages are suppressed. That means that even if the SOE were worthless (which they are not), their dismantling would ease the systematic suppressing of wages.
@12 peaksteel
You might want to check this website’s archives. There are a lot of posts where the good professor details at length how you can’t spend the foreign reserves.
@16 huaqiao
I agree with your view completely, but why do you suppose Chinese aren’t as crazy about gold? I know works of art are spiking due to Chinese demand, but it would seem like gold would also spike. It’s a lot easier to hold onto some coins then worry about what could happen to your unoccupied property across the country. It would also be accessible to a wider swath of the population. Houses are crazy expensive.
@17 throatwarbler
I would add that Japan has enormous assets overseas (around $3 trillion I believe) Presumably some of these could be repatriated if the house of cards starts to fall. Japan is a huge exporter of high quality components, so as long as people are buying iPads, there should still be some work for Japanese people.
I think they really need to examine their immigration policy in order to prosper though. It’s simply too difficult for foreign labor to work in Japan. These young taxpayers would be a welcome boost to the economy.
Hi Michael,
Great review as always -we are almost so accustomed to reading good sense on your Blog that normally we would be de-sensitised to it, except for articles such as those you cite from the FT that emphatically remind us how much we need it! I remember reading those articles and having a hearty laugh – and even being tempted to comment on them, but for the fact that the FT have banned me permanently and so I had to start my own little blog! (I remember also an analogous comment on the FT Gavyn Davies Blog where Willem Buiter [none other!] opined that the ECB could “bring forward” seignorage on euro liquidity creation – a bit like adding another elephant at the bottom of the endless series on whose backs the earth rests according to the Indian sage!) I reserve the right to comment further once I have fully digested the rest of this engaging piece. But given that I agree with almost everything you have written so far…I can only offer encouragement for now! Ciao.
I believe that it is rising quickly for debt. This is largely an argument being made by economists who did not see why Chinese consumption repression was all along at the heart of the growth model.
Sorry, but I just don’t see a problem if the Chinese govt has to take on the bad loans, and loses money because they aren’t paid back. China is sovereign in it’s own currency, and these aren’t foreign currency loans.
But what would be the effect of this? Inflation?
Vinz Klortho
@ Adam,
They are buying gold. Especially as the mainland RE market has come within the gun sights of the government and starts to cool, it looks like money is moving into gold. The amount of gold purchased by China in 2011 is a multiple of gold purchases in 2010. Also find the same thing with jade as well. Did you see the article that the Europeans are getting ticked off about mainlanders dominating purchases of racing pigeons? Pigeons are not as liquid as gold except in a way that you and I would prefer not to think about!
Congrats – you are now a mainstream pundit. Will miss being part of the informed minority now that you’ve been fully discovered.
Again a very interesting pice. I have also enjoyed your article in the FT which is a kind of a summary of your writings here. Most commenters in the FT did not comprehend why you think that rising real interest rates would stimulate consumption in China and I think that it would be good if you could elaborate more on that subject.
I was thinking on what in my opinion is your most outstanding advice: Chinese should privatise SOEs (some, many or all) and use the proceeds to clean balance sheets or/and invest in public services like social security. I don’t know but if many of those SOEs are companies operating railroads/suburban transport and other basic services like I can understand it is tough to sell them. Are there in China investors with deep pockets able to buy those companies or would those companies be sold mainly to foreign investors? Is it really desirable to have basic services, some of them are natural monopolies, privatised.
@11,
Johnnie, peaksteel’s question is not that silly to deserve your answer like that. It is your faith in Michael’s analysis that is questionable. China’s foreign reserves can of course be used to capitalize their banks. this is what China has been doing since 2003! this is what the “Central Huijin” is all about. It was set up by the PBoC (and SAFE) and injected $45 bn from the foreign reserves into BOC and CBC in 2003. that was the first step to list these banks to meet the capital ratio requirement. In the following years it continued to put money into Chinese financial institutions. the money is kept outside of China – I agree with Michael and you that it will not be converted into the RMB, but who says banks’ capital has to be in RMB? PBoC’s holding of banks’ capital is the same as holding of U.S. treasurys. its holding of banks capital is illiquid, so there is technically a limit how much foreign reserves they can allocate for this purpose, but China has US$ 3 trillion! it is too early to worry about that!
The point is China can use its foreign reserves to help banks and has been doing it for years. you can argue whether this is the best use of their reserves, but it is wrong to say they cannot use it this way! I don’t disagree that China’s massive holding of reserves is probably not optimal. But the arguments that you (and Michael sometimes) made make it sound like China is in a worse situation than countries without any reserves, which is obviously not true.
@1 Hua Qiao
you said: “Few bankers if any understand corporate finance and cash flow. Those that do, fudge their projections anyway to justify the loans. I have seen cash flow projections that would make your undergraduate economics students laugh”
It is interesting that you have such strong confidence in Michael’s students, but have such strong doubt about Chinese bankers. mind you a lot of Chinese bankers have similar background as Michael’s students. There is no question that the level of sophistication of these analysts has increased significantly over the past 20 years.
My wife works for a bank (in China before and now in the US) as credit analyst and I always mock her cash flow projections. NO ONE can project cash flow precisely, and in your language, don’t let anyone tell you they can. It is always the combination of the three that you listed! In China the needle probably shifts a bit to the left, and in the west probably a bit to the right.
the Chinese economy has been doing phenomenally well over the past decades. IT MUST HAVE DONE SOMETHING RIGHT! Reading comments like yours feels illusional.
“foreign reserves can’t be spent in china. second, if the dollars were sold for yuan to spend in china the central bank would lose control of the currency and the yuan would …”
Stop right there!
China has had a problem (since its last set of problems) in that it ‘enjoys’ a current account surplus at the same time its currency does not appreciate. Howcum?
This lack of appreciation annoys foreign countries who wind up with big current account deficits (USA). Calls ring out for Beijing to let its currency appreciate (or else). China is frightened b/c a trade war puts them out of business.
What China did was very clever, it privatized its foreign exchange inside China.
Beijing looks the other way while manufacturers (exporters) with yen, euros and dollars sell these to loan sharks on the street corners/in pool halls for yuan at higher than official rates! With the ‘official’ exchange rate @ 6.5yuan/dollar the ‘Un-official’ rate would be 10 or 15 yuan per dollar, whatever the market will bear (and whatever was needed to keep the yuan rate low). This way the PBoC and the Chinese government can have their cake and eat it too! They can pretend to Schumer et al. that they were letting the yuan appreciate while the Triad Trade prevents this from taking place.
Dollars are used to buy fuel (at high prices) which is sold @ the depreciated yuan price to the Chinese household (oops). This is profitable for the manufacturers and ‘middlemen’ (which are also big companies). Everyone benefits including wannabe real-estate tycoons who borrow at the unofficial f/x rate expressed as interest: 120%- 180% per year.
Is this loan shark f/x for real? It has to be otherwise the yuan would appreciate: there is enough of a shadow f/x market to keep the yuan appreciation in check. The trade also means the real rate of inflation in China is a lot higher than the ‘official’ rate. After all: arbitrage between two currencies in one place is the definition of hyperinflation.
BTW: if the Brand X Chinese household is too broke to bear the burden of unraveling debts, who/which is going to buy state-owned ‘assets’? Broke is broke.
BTW II: The entire ‘China Consumption’ idea is a fairytale like abiotic oil. First of all, ‘consumption’ is a long word that means waste: the Chinese w/ half the GDP of the US waste as much energy as the same US. Ipso-facto, they already ‘consume’ (waste) twice as much per unit of GDP as does the US. What next? Three times as much?
Ignacio, increasing interest rates increases wealth of savers or in this case households .As households have more money they spend more . Thus increasing consumption and balancing the China economy from exports to consumption.
19# Adam
There has been some immigration from Brazil ( mostly japanese brazilian, who originate from japanese migration to Brazil in the thirties). But it hasn’t been a great success, and as far as I remember Japan has tried to repatriate some of them again.
@ Vinz
your point is Modern Monetary Theory,MMT. No inflation until spending approaches limits of resources. Probably why China buys up mines etc. worldwide –with dollars (?).
@JayB
I see deal after deal after deal in China (where I am) where the cash flow is versus debt service is under water. In the west, most commercial companies are considered leveraged if the ratio of their interest bearing debt (funded debt) to EBITDA is greater than 4 to one. In China, most state owned companies that I see have funded debt to EBITDA ratios of 8:1 and not uncommon to be double digits. Although EBITDA is not all there is to cash flow analysis, it is a common benchmark used to evaluate the operational leverage of companies.
I have talked to countless bankers who do not understand even intermediate level financial analysis and its impact on credit risk. These are not fork and knife relationship bankers. These are the guys doing the writeups and approving the credits. Maybe they have memorized what a current ratio is but they have no idea what it means in a credit context. I won’t say that all bankers are without these skills but I will say that the major SOE banks do not have analysts that will be in a position to use their skills to effect any change in decision making. If they do come up with a financially oriented concern on a deal, they will be told to smooth it over or change (fudge) the number by a more politically powerful senior officer.
Remember, this industry had to be recapitalized in 1999 and again in 2004 and the problems are baking again. It is the legacy of a politically driven investment culture, which much as there are some mainanders who would want to change, will be difficult to change overnight. Just have a gander at the government financing platform challenges, that to the relief of many bankers, Wen Jiao Bao just promised to back (bailout).
Prof Pettis
Nice one. Can’t help being the optimist and hoping, just hoping that Xi Jinping will bite the bullet and privatise SOEs. Better a controlled, voluntary sale than what is likely on the books for Greece. The only worry is that the situation may well come to resemble Russia post – Communism. As it is, the state has not found itself too comfortable with tactics of the nouveau riche, sorry, the new generation of entrepreneurs. What’s to say trepidation regarding that may not outweigh good sense.
Anyway, the quick, almost systematic removal of Xi’s closest rival, Bo just today may just reassure the politicos that biting the bullet is less dangerous… one can only hope.
@STAN 29,
I understand well what you say but I would like to see some quantitative data on household deposits, and how much would increase household incomes after a rise in real interest rates in relative terms with salaries and other rents. I also believe that depending on how those deposits are distributed amongst depositors, the effects of such a rise in real interest rates in consumption would vary significantly.
liaogz82, if you mean fund investment through monetary creation, it should cause additional asset bubbles and perhaps CPI inflation if investors become nervous and start withdrawing deposits.
BwO, even companies that make losses can still have significant positive asset value, and if the subsidies are taken away these companies can and will adapt to becoming profitable again.
Throatwarbler, the Japanese malinvestment occurred in the 1980s, and after 1990 we began to see a real rebalancing, albeit at nearly zero growth rates, take place. This is why, in my opinion, low growth in Japan has not been accompanied by popular anger.
Peaksteal, Johnnie and JayB, yes, Johnnie’s answer is pretty spot on. The question about recapitalizing banks requires a little more explanation, as JayB suggests, but not for the reasons he suggests. In principle the PBoC can indeed transfer dollars to the foreign account of Chinese banks to boost capital, but although this may reassure foreign investors (as it did before the big banks did offshore IPOs), it can’t reassure domestic investors because they cannot access this capital for the reasons Johnnie stated. Capital that you can’t get hold of when you need it is only capital by a trick of accounting. Otherwise it has little value.
The biggest point, however, is the one Johnnie makes. To say that the PBoC can use the reserves to recapitalize the banks is no more useful than to say that anyone who can borrow can borrow money to give to the banks. Of course it’s true, so why focus on the PBoC? Mainly because people get confused by the size of the reserves into thinking that somehow there is something extra there. And no, JayB, neither I nor anyone else has ever said it is better to have no reserves than to have reserves. You sound like those commentators who always insist that there can only be two opinions on China – that it will grow forever at 10%, or that it will collapse in six months – and if you deny the former you must be asserting the latter.
Vinz Klortho, not necessarily inflation, but one way or the other it would require hidden or direct taxation in which resources were transferred from one sector of the economy to the government to cover losses. Inflation is simply one of the ways this tax can take place.
Ignacio, that is always one of the problems with privatizing too late – it is not always clear that investors can buy, or are willing to pay anything near fair value. But remember that privatization doesn’t just mean selling companies for cash. Any transfer of state assets to households counts as privatization.
JayB, I am not sure why you think my having smart students is incompatible with Hua Qiao’s claim that Chinese bankers are fudging the numbers. Is it your contention that bad accounting can only occur in countries in which elite students aren’t very smart? Or do you think smart bankers can’t fudge the books? I can assure you that my students are indeed very smart and also that there are very few people knowledgeable about Chinese banking that doubt that Chinese banks have questionable data and systematically engage in transactions aimed at getting around transparency, to put it mildy. If you take a provincial loan officer for beer, he will even brag about how widespread questionable accounting and trick transactions are. This is really not a closely kept secret.
Steve from Virginia, you have lost me almost from the beginning, and certainly at the end. What does it mean to have “privatized foreign exchange inside China”? I hope you’re not suggesting that dollars are sold inside China and are used for financing purposes in the informal market, because there is absolutely no evidence at all that this is happening and it is not even clear why it would matter.
Ignacio, the IMF did a study on the positive correlation between real deposit rates and household consumption. It came out last year and I referred to it some time in the early fourth quarter.
@ Michael and JayB,
To clarify, I was not saying that Chinese banks cook their own books, but instead I was saying that the internal projections of cash flow that banker analysts do to justify financing a project are wildly optimisitic. JayB is correct to say that no projections are 100% accurate (duh!) But good analysts can see the fallacious assumptions used in optimistic projections. My point is that a combination of business volume pressure, state directed mandates and lack of critical analysis skill sets keep Chinese banks from evaluating operational merits of a financing project.
By contrast, I will be the first one to admit that after years of experience in the Chinese financial markets, I can say that I remain grossly incompetent at assessing the political connections, determining hidden party motivations and figuring out the impact of key project backers/sponsors, forces that have dominated the real credit decision making in the Chinese market over the last 10 years.
This is the point of my original post.
Source of repayment 1-cash flow skills not evident
Source of repayment 2- collateral values (primarily real estate) potentially volatile with current downward pressure
Source of repayment 3- additional capital from some other 3rd party, traditionally this source is relied on and mainland bankers are experts at figuring this out (if not, they won’t be bankers very long).
The issue of banks cooking their books is for another conversation. I would however, say that risk ratings and assessment of impaired assets are quite optimistic.
@Michael and Hua Qiao,
what I was trying to say is that more and more bankers graduated like your smart students have been working in Chinese banks in the past 20 years. there is no question banking practice is far from perfect, and banks data/books are questionable. don’t trust those 0% NPL ratios. but there has certainly been improvement on all fronts. you can certainly find corrupt officials and loan officers but at the same time it is simply a fact that more and more better qualified credit analysts joined banks, thanks in part to people like you. My wife graduated from a Chinese university many many years ago. she now works for a major global bank in the U.S. as a senior account manager for syndicated loans. Her classmates in the university and colleages back in China are now all senior bankers around the country. I doubt my wife knows more than all other people.
@ Hua Qiao,
The recapitalization of banks in late 1990s and 2004 was to a large extent due to legacy problems from the planned economy era and policy mistakes at the beginning of the reform (for example 拨改贷). Wen has to “bailout” bank again because banks participated government-initiated fiscal projects in the past few years during the crisis. These banks loans were not supposed to be loans to begin with. They should have been fiscal outlays. This is a big screw-up of Wen, instead of banks. Of course he needs to take the check.
The number of bank failures (or bailouts) in China is dramatically smaller than in the U.S. Those sophisticated bankers did not prevent Citibank from being routinely bailed out by the Fed over the years. I am not saying China has a better system (and please don’t say that I imply that), but the tone of your comments on Chinese bankers is unfair and offensive.
@ Michael,
on capitalizing banks with reserves. capital for banks IS and ONLY IS an accounting trick. whatever capital ratios required by Basel are not supposed to deal with bank runs. It is only a regulatory rule on how much leverage a bank can take. It is completely arbitrary. what really is the difference between a bank with a capital ratio of 11% and another one with 8.5% in a confidence crisis? both will be crushed in a similarly spectacular fashion. banks can never rely on their capital in this kind of situation. bank runs and liquidity problems are supposed to be dealt with by central banks. It is strange to expect that foreign investors in a Chinese bank feel more confident than the domestic ones because the bank has some capital in foreign assets instead of RMB.
I am not suggesting China only has two scenarios. But China does not have a worse problem than most other countries. The massive reserves it has is a boon rather than bane. It certainly gives the central bank a lot of resources and options to deal with all those issues. It is not something that one sneers about. BTW, I am not talking about you, Michael, but a lot of people do, and your argument is the most quoted reason by them.
” It is completely arbitrary. what really is the difference between a bank with a capital ratio of 11% and another one with 8.5% in a confidence crisis? both will be crushed in a similarly spectacular fashion. ”
There is no “confidence crisis” if the banks were actually restricted to 10x leverage – I suggest you break out a graph of the money supply and ask yourself what it means to a business when all their customers reach the point where they cannot take on more debt.
@JayB
No difference between now and the state directed and policy driven banking done 10 years ago. Are Chinese banks and bankers analytically better today than 10 years ago? Yes. But the impact is more superficial than you think. More form over substance and it will continue to be that way until bank organizations centralize their structures and move away from the regional provinicialism that dominates their credit decisioning. Read Victor Shih or Fraser Howie.
I compete and interact with Chinese bankers all the time and I stand by my claim. Just look at the U turn made by the CBRC on local government platforms. The CBRC was at first asleep. Victor Shih woke them up. They then took a hard line prohibiting further bank capital to be lent. Then on a local basis, they went one by one to examine each LGFP and reversed the classification, ruling all but the most brain dead deals as commercial, which means the LGFP has enough cash flow to service its debt without government intervention. Nonsense. The CBRC branches were either told by the CBRC HQ to do so or they were coerced by local cadres to do so. I think the latter with the tacit consent from HQ.
It is China that has sought to move away from the planned economy and create a more market driven financial sector. My point is that it is still far away from that model, that capital is still direct by command, that financial evaluative skills are either nonexistent or are given little voice to the decisioning system. Until the Organization department of the CCP gives up its control over the H-R function of naming the senior bank executives, I doubt much will change.
This is not about arrogance. If anything, it is to warn people not to buy into the facade that China’s banks have westernized their governance and credit decisionmaking, which seems to be their desire ostensibly. Many people might say following the western model is not a good thing (e.g. Citibank).
@JayB
Bank reserves are much more than an accounting trick. They are the cash out of which a bank can cover its obligations in light of non-performing loans. This has nothing to do with a run on the bank. If 5% of a bank’s loans are nonperforming, but it holds cash equal to 10% of its loans, then the 5% will not cause the bank to lose liquidity. Gov’t intervention in a crisis is something altogether different; reserves are supposed to provide a cushion so that a normal level of NPLs don’t trigger gov’t intervention.
I guess I don’t get it. Capital is a right side of the balance sheet concept. In theory Huijin (which is the entity that owns the majority of the state owned banks) could invest foreign reserves into the banks which would give them USD and euro denominated assets. The accounting offset would be an increase in shareholders equity, i.e. capital. But what would that accomplish? Why not just print RMB and inject the cash, thereby increasing capital that way? RMB are an obligation of the PBOC. Wouldn’t Chinese depositors feel better with an IOU from the PBOC as opposed to one from the US Fed or US Treasury or the ECB?
@ Hua Qiao,
Yours are interesting comments. Thanks a lot.
It is a pity that private banks in supposedly market-oriented economies, sometimes function worse than banks under central planning.
With confusion as to some of the distracting comments I refer everyone back to 2/22/2010, Michael’s quote below:
“Beijing is not Washington’s banker
If China runs a current account surplus, it must accumulate net foreign claims by exactly that amount, and the entity against which it accumulates those claims (adjusting for actions by other players within the balance of payments) ultimately must run the corresponding current account deficit. And as long as China ran the largest current account surplus ever recorded as a share of global GDP, and the US the largest current account deficit ever recorded, and especially since China also ran an additional capital account surplus (i.e. other non-PBoC agents ran a net capital inflow), it was almost impossible for the PBoC to do anything but buy US dollar assets. Given the sheer amounts, a substantial portion of these assets had inevitably to be USG bonds.
This was not a discretionary lending decision. It is the automatic consequence of China’s currency regime, in which it pegs the RMB to a foreign currency, in this case the dollar. Why? Because when the PBoC decides on the level of the RMB against the dollar, it does not do so by passing a law, and making it a capital crime for anyone to trade at a different price. What it does is far simpler. It offers to buy or sell unlimited amounts of RMB against the dollar at the desired price.
No one will sell dollars for less than what they can get from the PBoC, nor will anyone buy dollars for more than what they can pay the PBoC, so all transactions get done at that price. That is how the PBoC (or any other central bank that intervenes in the currency market) sets the foreign exchange value of its own currency.
This means that as long as it wants to set the exchange rate, then, it must take the opposite position of the market. Since the rest of the market is a net seller of dollars (China runs a current and capital account surplus), the PBoC has no choice but to be a net buyer of dollars, which of course it must then invest.
If it stops buying dollars, it must let the market decide by itself on the new equilibrium price of the dollar. In that case the value of the dollar has to plunge in RMB terms (or the RMB soar, which is the same thing) in order for buyers and sellers to match up and for the market to clear. The moment the PBoC stops buying, in other words, the RMB will rise in value – and so it cannot stop buying in anticipation of the RMB rising in value, as the FT article suggested.
Of course the PBoC must fund the purchase of these dollars. It does so primarily by borrowing in the domestic money markets, selling PBoC bills or entering into short term repos (although it also issues some longer-term bonds), or by “creating” money by crediting the accounts of the commercial banks who sell it the dollars.
This means, to simplify, that the PBoC has a balance sheet consisting on one side of dollar assets (and here “dollar” is short-hand for all foreign assets). Against this and on the other side it has a roughly equivalent amount of RMB liabilities (I say “roughly” because when you run a mismatched balance sheet, changes in the relative value of assets and liabilities will create losses or profits).
Here is where things get interesting. China’s reserves are often thought of as if they were a treasure trove available for spending. They are not. They are simply the asset side of the mismatched balance sheet. If the PBoC wanted to “spend” $100, say for example to recapitalize a bank, it could do so, but this would automatically create a $100 dollar hole in its balance sheet. – it would still owe the RMB that it borrowed originally to purchase the $100. To put it another way, the reserves are not a savings account, free for the PBoC to spend as it likes. Reserves are effectively borrowed money.”
@ Ignacio
You will get no argument from me about problems with western banks. I would, however, take issue with the notion that they function worse than banks in centrally owned economies. It depends on what “function” you want banks to do. If it is to act as an intermediary between society’s savers and society’s capital users in channeling society’s savings into the most productive investments at the least transaction costs, I would argue that market led banks are better for all the reasons Michael has been writing about on this blog.
The current monetary system will look funny when the growth engine of the world drops to 3%. I can´t imagine the size of US QE when that happens!, Gold/Yuan, soft commodities might be the best bet. I guess Europe and Japan would implode while US prints to oblivion.
wmt, if you mean mr. pettis is a mainstream pundit because of the financial times article or the tv interviews last week then i think you’re too late. in my bank and among my investor clients he has been famous for many years, with everyone always reading his posts and articles and sending them around. it was better when he was less well-known because then you could steal his ideas and seem very smart.
jayb i never said peaksteel’s question was silly. i just gave the explanation that is well-known to people who read mr. pettis regularly. when you insist that “The massive reserves it has is a boon rather than bane. It certainly gives the central bank a lot of resources and options to deal with all those issues,” I think you still don’t get it. it doesn’t give the central bank a lot of resources to deal with any of the issues mr. pettis is discussing.
it is almost the opposite. it runs a negative carry on its funding and losses on its revaluation, so it actually takes away resources to deal with the debt and banking issues that mr. pettis discusses since it is adding to the total internal government debt, and china’s problem is the internal debt, not the external debt. the resources the PBC have are helpful in fighting a currency run or to pay back foreign debt, but neither of these are a problem for china.
its like if a man trudging thirstily through a very hot desert is carrying a heavy bag full of warm clothes and you say that he is better off with all that warm clothing because it gives him options. maybe if he were in a cold place all the warm clothing would help, but when he’s trudging through a hot desert it doesn’t help at all and it actually makes things worse.
FrParlentAuxFr, china is not the engine of global growth. if it were it would be a net buyer not a net seller, and so if its growth slows down as much as mr. pettis thinks, which i think is too pessimistic but it could happen, it won’t hurt global growth unless china’s trade surplus shoots up. but i think if china slows because it is rebalancing, it will help global growth.
also i think if chinese growth slows that might actually strengthens the world’s monetary system and i wonder if mr. pettis would consider my argument and respond. i would say that since chinese currency intervention is one of the main causes of currency distortions, and that because it has prevented the US trade deficit from declining, it has increased the need for the US to have more agressive fiscal and monetary policy easing. if china reduces its savings and intervenes less, which i suppose mr. pettis would say is sort of the same thing, there will be less need for QE2 and 3 and 4 and so on. in my country we suffer a lot from the QEs and there is a debate if it is more the fault of the US or china. i think it is both but i think the US cannot stop until china stops.
Johnnie, judging from the way the debate over China has changed so radically in the last few years I would say that quite a lot of people have been stealing the good professor’s ideas and repackaging them. A few years ago no one talked about financial repression. Now everyone puts it at the center of the China discussion. I just wish he would spend more time talking about India because I am sure a lot of what is said about the Indian economy could benefit from some clear-headed and visionary analysis.
Johnie:
Which country do you live in?
Why does QE negatively impact your country?
How?
What impacts?
Etc
Would be an interesting addition to the discussion. Whether the QE’s are the cause or other, systemic factors, or there is a common dialogue that such is negative, and there are negative occurrences in our economy due to the ongoing “GLOBAL CRISIS”, and if the common dialogues are mis-allocating the actual causes. Would be interesting to hear your points.
The world consists of more than China and the US. While QE’s may have the effect of lowering the value of the USD that only serves the US. Other exporting economies want a higher RMB and USD.
Is the USD weak?
Against whom?
For example, Euro came in at 1.06 to 1.18 upon creation.
As grew in demand as an asset class, increase in value.
Have structural occurrences led to a bounded range, around where it sits.
Perhaps, EU banking, and growth in loans regionally further afield since Euro, increasing demand form those outside monetary union, etc…
Other issues related to Eu asset valuations.
Certainly, there are a variety of perspectives about the benefits and detriments of this dependent upon the perspective of the reviewer, and where they sit, the issues of importance to them. A major consumer of fossil fuels in the EU, may feel different then a manufacturer of cookware in Italy or Spain.
But is the USD really weak, against the Swissy, a rather small economy. The AUS the NZD, whose commodity and ag industries most likely benefiting from high commodity prices, perhaps prices beyond current reasonable demand.
If one looks at the issue, and evaluates the topic, although bandied about, I fail to see, the USD being weak. Against whom, the Korean Won, no. The Yen, perhaps, but unwinding of carry tade and economy not deflating in dollar terms with the rise in valuation of the Yen. The Indonesian, the VND, the Real, perhaps, but again, a recent focus on commodities, a strengthening of economy, the crying of their manufacturing industry, while followers of Lula said in previous election they would seek 800 billion USD in investment, nothing as such has occured, but certainly their currency would stengthen under such circumstances. Against the ZAR, no, the ZAR had vacillated between 6 and 12, and is where it normally sits in the 7 range. Against whom, look to Africa, during this period, many if not most countries have devalued, the Vietnamese dong is off 10% since the crisis. The Singapore dollar, yes, again, inflows, reorientation of global finance to arbitrage rules, to be instituted rules. Against the Ruble, perhaps a bit. Middle Eastern counties, mostly dollarized, pegged. South East Asia, have either held ground or weakened. The Taiwanese Dollar, increased marginally. Anyway, it would be a hard case to press that the US has used its currency in support of exports and the unholy grail of growing off others demand, or open market forces.
The real situation, beyond simply China is to engineer across Asia, especially those who have practiced Neo-Mercantilism or hoped to practice infant industry theory in mass is to coordinate a collective rise with China to shift toward models of greater domestic demand. Both must do it consecutively, it is unfortunate it didn’t occur as the Yen rose.
In my personal opinion, the current growth model for China is clearly not sustainable in the long-term. Further, the primary concern in that the growth post the financial crisis has been largely led by record growth in new loans. If this falters, growth will falter.
http://www.economicsfanatic.com/2012/03/is-chinas-current-growth-strategy.html
Ok, no banking crisis, because the banks are just a front; it really is fiscal spending.
However, if the world economy hits exports and capital inflows become outflows, will bank reserves be sufficient to roll over old loans and fund growth? Or will there be money creation and a devaluation of the yuan?
Where will the growth come from? Exports? Real estate? Capital spending? Consumption? How do you get positive growth if trade income diminishes? How is growth going to be funded? If it looks like the the Yuan is set to decline, expect capital flight to further it, and you’ve got major inflation.
The evidence that you’ve presented suggests more a debacle than a gradual wind down. When you’ve climbed all the way out on a fragile limb, sometimes there’s only one way down. Positive GDP seems very optimistic. When Japan hit the wall, the US and Europe were still growing credit; moreover Japan had world class companies. And as corrupt as Japan was, China is vastly more so.
Well the call for privatization is perfectly logical because there is probably a large net asset position in the SOEs for Beijing in the end which would help mop-up a large bank bail-out driven central gov debt increase. So in the end post privatization would the sovereign position of China which is free of entitlement obligation (hence the propensity to save) be as bad US, Japan or Europe? Probably not. Your call on Ren Min Bi as a preferred currency prof Pettis is perfectly logical but it also betrays a view that despite your concern about the debt levels in China, as long as they dot increase too much, and if China prefers privatization route, China would have a Swedish readjustment rather than a money printing/ debt monetization event which is always bad for a currency position and massively inflatiinary (unless a large debt instrument failure stop it in its track).
As for Copper price lower, very much agreed but in what unit? Since Prof Pettis you are very well versed in economic history, the unit of measurement should be specified (Jevons – a serious fall of Gold -today we call that inflation when currency goes down but not back then they would just say that the money (Gold – Silver goes down or the currency -coin- is debased, or they would say that there is a proliferation of circulation bank notes), that is Yuan probably? Given that printing’s consequences of USD will become apparent before China decides on the course of action to address its debt issues there is a good chance that de-leveraging through asset sales,which IS THE BEST OPTION will be followed and that your Ren Min Bi call will end up being absolutely brilliant.