The following was written a month ago for my newsletter but because of the virus problem I had on my site I wasn’t able to post it until today.
China’s official GDP growth rate has fallen sharply – on Friday Beijing announced that GDP growth for the second quarter of 2012 was a lower-than-expected 7.6% year on year, the lowest level since 2009 and well below the 8.1% generated in the first quarter. This implies of course that quarterly growth is substantially below 7.6%. Industrial production was also much lower than expected, at 9.5% year on year. In fact China’s real GDP growth may have been even lower than the official numbers. This is certainly what electricity consumption numbers, which have been flat, imply, and there have been rumors all year of businesses being advised by local governments to exaggerate their revenue growth numbers in order to provide a better picture of the economy.
Some economists are arguing that flat electricity consumption is consistent with 7.6% GDP growth because of pressure on Chinese businesses to improve energy efficiency, but this is a little hard to believe. That “pressure” has been there almost as long as I have been in China (over ten years) and it would be startling if only now did it have an impact, especially with such a huge impact occurring so suddenly. Adding to the slow economic growth, the country may be tipping into deflation. Last Monday the National Bureau of Statistics releasedthe following inflation data:
In June, the consumer price index (CPI) went up by 2.2 percent year-on-year. The prices grew by 2.2 percent in cities areas and 2.0 percent in rural areas. The food prices went up by 3.8 percent, while the non-food prices increased by 1.4 percent. The prices of consumer goods went up by 2.3 percent and the prices of services grew by 1.9 percent. In the first half of this year, the overall consumer prices were up by 3.3 percent over the same period of previous year.
In June, the month-on-month change of consumer prices was down by 0.6 percent, prices in cities and rural went down by 0.6 and 0.5 percent respectively. The food prices dropped by 1.6 percent, the non-food prices kept at the same level (the amount of change was 0). The prices of consumer goods decreased by 0.9 percent, and the prices of services increased by 0.3 percent.
My very smart former PKU student Chen Long, who follows monetary conditions in China as closely as anyone else I know tells me:
The most interesting thing is that even if CPI remains stable month-on-month, it will turn negative year-on-year in January 2013. And if it continues to decline month-on-month at current rates, we could see negative year-on-year CPI as early as August/September.
June CPI increased 2.2% from a year ago, slightly lower than market consensus of 2.3%. June PPI dropped 2.1% on yearly basis, versus the median forecast of a 2.0% decline. On a monthly basis, CPI and PPI were down 0.6% and 0.7% respectively. The consumer price index has posted three consecutive months of negative monthly growth, and it was also the second consecutive month-on-month fall of PPI. Moreover, the year-on-year PPI growth has been negative for four months.
Inflation in China seems to have been licked. This is just what one would have expected in a financially repressed system, in which inflation creates its own correction by increasing the financial repression tax on household savers (thus reducing consumption) and lowering the cost of capital for manufacturing borrowers. Of course this same system means that deflation is unlikely to last very long because, as long as interest rates are not slashed, deflation will cause the real deposit rate and the real borrowing rate to rise. These increase consumption and reduce production, so putting upward pressure on prices.
Unlike some other analysts, in other words, I am not concerned about deflation persisting for long unless the PBoC cuts interest rates much more sharply than any of us expect. I know this may sound strange – most analysts believe that cutting interest rates will actually reignite CPI inflation – but remember that the relationship between inflation and interest rates in China is, as I have discussed many times before, not at all like the relationship between the two in the US. It works in the opposite way because of the very different structure of Chinese debt and consumption.
Hard landing?
Overall at any rate things seem to be going so badly in the economy that on Sunday Premier Wen Jiabao warned, yet again, that the economy is under serious pressure, and then did the same on Tuesday. According to an article in Xinhua, Wen on Tuesday reaffirmed Beijing’s commitment to growth:
Premier Wen Jiabao said Tuesday that stabilizing economic growth is the most pressing matter currently facing China. Policies and measures to stabilize economic growth currently include boosting consumption, diversifying exports and promoting investment, Wen said while meeting representatives from research institutes and companies on Monday and Tuesday.
The emphasis on investment to shore up growth comes as the world’s second-largest economy is being challenged with slumping external demand and low consumption at home. Wen said the structure, quality and cost-effectiveness of investment should be given greater importance, adding that investment should be used to improve livelihoods and help the country develop scientifically.
Given the very weak numbers, and Beijing’s reactions, China seems very clearly to be heading towards a hard landing, and many Chinese and foreign experts are urgently warning that Beijing must cut interest rates even more sharply, expand credit, and so save China and the world from disaster. We’ve already had two cuts this year in the lending rate. Here is what Xinhua said a week ago Friday:
The central bank cut interest rates for a second time in a month, fueling concerns that the slowdown in the world’s second-largest economy is worse than predicted. The People’s Bank of China lowered benchmark deposit rates on Thursday by 25 basis points and cut lending rates by 31 basis points, effective from Friday.
The central bank cut interest rates on June 8 for the first time since 2008 to bolster economic growth. “The limits for rates charged on individual property loans will not change and financial institutions must strictly implement differentiated policies on property loans to continue constraints on speculative purchases,” the central bank said.
A leading economist said that cutting rates twice in a month suggests weak growth. “The two cuts in interest rates within a month indicate that the GDP growth rate in the second quarter is indeed weaker than expectations,” said Lu Zhengwei, chief economist at the Industrial Bank, adding he expected that the figure would be 7.6 percent.
The cuts, or at least the first one, seem to have some impact. Although loan growth has been much slower than expected for most of this year, the June loan numbers finally surprised the market on the upside. According, again, to Xinhua:
China’s new yuan-denominated loans surged in June as the government moved to buoy the slowing economy. The June new yuan-denominated loans rose 285.9 billion yuan (about 45 billion U.S. dollars) year-on-year to 919.8 billion yuan, the People’s Bank of China (PBOC), or the central bank, announced Thursday. PBOC data showed that new yuan-denominated loans in June hit a three-month high after reaching 1.01 trillion yuan in March.
Mark Williams, at Capital Economics, added a lot more color:
China’s bank lending last month turned out not to be as weak as we had feared. Net new loans amounted to RMB920bn. This was only slightly above the median forecast of analysts surveyed by Bloomberg (RMB880bn) as well as our own (RMB900bn). But ever since the People’s Bank cut interest rates last week, we had thought that the risks to these forecasts were skewed heavily to the downside, on the belief that weak lending was the most likely trigger for the rate move.
In fact, new lending was significantly higher last month than in May when it reached RMB793bn. That suggests that government attempts to revive bank lending were starting to work, even before last week’s rate move.
The fact that the government has continued to loosen nonetheless is positive for GDP growth in the near-term. A continued pick-up in lending to fuel investment should quieten immediate doubts about the economy in the months before the leadership handover. But it is questionable how much stimulus China really needs at this point and, in particular, the degree to which more investment-led growth should be welcomed.
I think Williams is right, and I agree that those calling for additional interest rate cuts and more rapid investment and credit expansion are wrong. Why? Because what is happening in China may be just what China and the world need. After many failed attempts, over the past six months we may be seeing for the first time the beginning of China’s urgently needed economic rebalancing, in which China reduces its overreliance on investment in favor of consumption.
Regular readers of my newsletter may be surprised to see me say this. For the past four or five years analysts have been earnestly assuring us that the rebalancing process had finally begun, and I had always insisted that it couldn’t have begun yet. Why? Because as I understand it rebalancing is almost arithmetically impossible under conditions of high GDP growth rates and low real interest rates. Once the real numbers came in, it always turned out that in fact imbalances had gotten worse, not better. Typically many of those too-eager analysts have resorted to insisting that the consumption data are wrong, although even if they are right this does not confirm that rebalancing had taken place since errors in reporting consumption have always been there.
But this time seems different. Now for the first time I think maybe the long-awaited Chinese rebalancing may have finally started.
Of course the process will not be easy. Debt levels have risen so quickly that unless many years of overinvestment are quickly reversed China will face debt problems, and maybe even a debt crisis. The sooner China starts the rebalancing process, in other words, the less painful it will be, but one way or the other it is going to be painful and there are many in China who are going to argue that the rebalancing process must be postponed. With China’s consumption share of GDP at barely more than half the global average, and with the highest investment rate in the world, rebalancing will require determined effort.
How to rebalance
The key to raising the consumption share of growth, as I have discussed many times, is to get household income to rise from its unprecedentedly low share of GDP. This requires that among other things China increase wages, revalue the renminbi and, most importantly, reduce the enormous financial repression tax that households implicitly pay to borrowers in the form of artificially low interest rates. But these measures will necessarily slow growth.
The financial repression tax, especially, is both the major cause of China’s economic imbalance and the major source of China’s spectacular growth, even though in recent years much of this growth has been generated by unnecessary and wasted investment. Forcing up the real interest rate is the most important step Beijing can take to redress the domestic imbalances and to reduce wasteful spending.
And this seems to be happening. Beijing has reduced interest rates twice this year, and reluctant policymakers are under intense pressure to reduce them further. The students in my central bank seminar at PKU tell me that there are new rumors about the way the cuts were implemented. “Usually it is the PBoC that submits a proposal of rates cut to the State Council,” one of them wrote me recently, “but this time (July 5th) it was the State Council who handed down to the PBoC the decision to cut rates, so that the PBoC was not fully aware of the rates cut before July 5th.”
If my student is right (and this class has an impressive track record), this suggests that monetary easing is being driven by political considerations, not economic ones, which of course isn’t at all a surprise. But even with the rate cuts, perhaps demanded by the State Council, with inflation falling much more quickly than interest rates the real return for household depositors has soared in recent months, as has the real cost of borrowing. China, in other words, is finally repairing one of its worst distortions.
But this necessarily comes at a cost. Raising the real borrowing cost cannot help but reduce investment growth and increase cashflow pressure on local governments, and so with the rise in real rates China’s GDP growth rate must fall sharply. China bulls, late to understand the unhealthy implications of the distortions that generated so much growth in the past, have finally recognized how urgent the rebalancing is, but they still fail to understand that this cannot happen at high growth rates. The problem is mainly one of arithmetic. China’s investment growth rate must fall for many years before the household income share of GDP is high enough for consumption to replace investment as the engine of rapid growth.
As China rebalances, in other words, we would expect sharply slowing growth and rapidly rising real interest rates, which is exactly what we are seeing. Rather than panicking and demanding that Beijing reverse the process, we should be relieved that Beijing is finally resolving its problems. Andy Xie has a typically intelligent article on just this subject in last week’s South China Morning Post. In it he warns:
China has cut interest rates twice in a month, showing the government’s grave concern for the weakening economy. But it is the wrong medicine. Side effects will include worsening inflation, saddling credulous property speculators with debt and weakening the banking system’s ability to handle the looming bad-debt crisis. The renminbi may come under devaluation pressure, too.
Cutting interest rates is doubling down on a bad hand; the policy of printing money to fuel bubbles was wrong in the first place. To revive the economy, China must cut taxes, slim down the government, retrench state-owned enterprises, strengthen the rule of law, and give businesses incentives to focus on quality, technology and brands.
Except for the “worsening inflation” part, I agree. He goes on to conclude: “Trying to revive the bubble now will only crash the economy.”
The costs of slowing
Needless to say I think Xie is right, and we should not be trying to revive “growth” because that simply means reviving the credit bubble. But won’t slower growth create social dislocation in China and economic dislocation around the world? No, not if it is managed well. Remember that Chinese rebalancing requires that household income grow faster than GDP for many years, and if Chinese growth slows even to 3%, as I expect it will within the next few years, but household income continues growing at 5-6%, this is far from being socially disruptive. Households don’t care what GDP growth is, they care about the growth in their spending power.
The key to how painful this will be domestically is likely to be employment. So far this year rising unemployment doesn’t seem to have been a serious problem, but unemployment is a lagging indicator, and there is some evidence that we are starting to see strains in the job market. According, for example, to an article in last week’s Financial Times,
China’s job market has started to show signs of stress, putting pressure on the government to intensify fiscal spending to prevent the economy from weakening further. Like politicians the world over, Chinese leaders’ biggest single economic worry is whether unemployment is under control, and analysts say the job outlook will help determine whether they launch a big stimulus effort as they did nearly four years ago.
So far the labour market has held up much better than in late 2008 when 20m migrant workers lost their jobs. But cracks are appearing and that experience showed how the situation can change virtually overnight in China. “Depending on how deep the growth slowdown is, unemployment can deteriorate very suddenly,” said Ding Shuang, an economist with Citi.
We will need to watch unemployment numbers closely in the next few months. As for the rest of the world, Chinese rebalancing under conditions of much slower GDP growth shouldn’t elicit panic. What the global economy needs from China is not faster GDP growth, but rather more net demand, i.e. a contracting trade surplus. Chinese rebalancing will eventually provide exactly that, although the trade surplus will probably rise first before it begins to decline. We are already beginning to see that happen. Here is the Financial Timeson the subject:
Chinese export and import growth both slowed in June, showing that the world’s second-largest economy faces strong headwinds. Exports rose 11.3 per cent from a year earlier, down from May’s 15.3 per cent pace. Imports increased 6.3 per cent from a year earlier, half of May’s 12.7 per cent and well below expectations.
With imports so weak, China was able to pull in a trade surplus of $31.7bn, nearly double May’s total and the country’s biggest in more than three years.
Earlier this year there was a debate about whether China’s then-declining trade surplus was likely to rise or to continue falling. At the time I pointed out that as long as the global environment allowed it, we should see China’s trade surplus rise substantially before it began declining.
Why? Because it would prove much easier to reduce Chinese investment than to reduce Chinese savings, and the difference between the two, of course, is simply the trade account (or, more accurately, the current account, of which the trade account is by far the biggest component).
By the way, and as an aside, we need to make two adjustments to the trade surplus in order to understand what is really going on within the balance of payments. First, one of the causes of last month’s weak imports has been a sharp decline in commodity purchases. I have many times argued that commodity stockpiling artificially lowers China’s trade surplus by converting what should be classified as a capital account outflow into a current account inflow. If China is now destocking, then China’s real trade surplus is actually lower than the posted numbers.
Second, we know that wealthy Chinese businessmen have been disinvesting and taking money out of the country at a rising pace since the beginning of 2010. One of the ways they can do so, without running afoul of capital restrictions, is by illegally under- or over-invoicing exports and imports. This should cause exports to seem lower than they actually are and imports to seem higher. The net effect is to reduce the real trade surplus.
Since these two processes, commodity de-stocking and flight capital, work in opposite ways to affect the trade account, it is hard to tell whether China’s real trade surplus is lower or higher than the reported surplus. But once de-stocking stops, we should remember that the trade numbers probably conceal capital outflows.
How does all this affect the world? In the short term rebalancing may increase the amount of global demand absorbed by China, but over the longer term it should reduce it. Rebalancing will inevitably result in falling prices for hard commodities, and so will hurt countries like Australia and Brazil that have gotten fat on Chinese overinvestment. Rising Chinese consumption demand over the long term and lower commodity prices, however, are positive for global growth overall, and especially for net commodity importers. Slower growth in China, it turns out, is not necessarily bad for the world. The key is the evolution of the trade surplus.
This is an abbreviated version of the newsletter that went out last month. 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.
The export sector will collapse if RMB is to “revalue”, in fact, RMB is depreciating, rightfully. The Chinese economy is foremost export-led, unless you want to bankrupt the whole economy to start everything from scratch, it’s really hard to imagine to require RMB to appreciate in order to rebalance the economy.
Good article. And you left the best for last…”Slower growth in China, it turns out, is not necessarily bad for the world.”
… and not necessarily bad for China either…
Could interest rate cuts and a weak economy fuel renminbi devaluation, which leads to exchange rate inflation via currency crisis?
I believe that high asset prices, particularly housing and commercial/office buildings can be another drag that makes rebalancing difficult. Transition to a consumer driven economy will need some investment in these assets.
Excellent post as usual.
The Andy Xie article is available here http://www.facebook.com/permalink.php?id=172036692875757&story_fbid=341355559277202
The link in the post seems broken.
I am surprised to see you seem to be calling for yuan appreciation in your post but from what I can tell the yuan actually seems to be more likely to depreciate and that it has reached what appears to be a fair level.
Do you mean the yuan should no longer be managed in the manner it is and should instead be allowed float freely?
Michael,
Reading through your excellent article, i wonder if we won’t see a reversal of Victor Shih’s centrist versus generalist thesis. The rebalancing is such a complicated theoretical construct, will not local cadres pressure their local bank branches to lend to any stupid project that keeps local GDP numbers high? Victor’s centralization of control from the regional generalist factions into the hands of centrist technocrats works in a hyperinflation scenario. But it seems to me that the opposite could apply, that being that the rebalancing, which moves spending out of the control of bureaucrats and into the hands of households in a choppy and unbalanced way, would cause local officals to panic and prime the pump locally by jaw boning their Party underlings at the banks to lend on projects to keep sagging GDP from crashing. Shih’s thesis presupposes inflation is a problem well understood and everyone knows the cure since it has happened many times before. But in this much more complicated, confused and structural current problem, it may be that the centrists will not have the political backing to control the regional generalists. Might we not see a perverse acceleration of bridges to nowhere? There seems to be a struggle right now as banks are pulled and pushed over whether financing to local government platforms should increase or not. Until the banking system crashes, there might not be the national imperative for the technocrats to take over.
A sidenote:
I am able to access you blog directly from Shanghai, without help of VPN or other proxy device. A long waited surprise!
I’m a bit worried that China will start this rebalancing at a time when they have not advanced as far as Japan by the time the Japanese bubble burst, and are also facing demographic headwinds. Are there certain aspects of the Chinese situation that I’m not considering that would contradict this impression? It seems like they will have a very difficult time.
I think you look at inflation in too board a sense. The great fear is not general inflation but increased inflational pressure on food products.
Every increase in the money supply will marginalize a larger part of the urban population who´s access to food products will be constrained. China´s has massive structural problems with regards to food production. Investments in infrastructure, real estate and production for export put additional pressure on food production. I believe that the massive rise in food prices is the single largest problem coming from the imbalance of the Chinese economy. It also creates a extreme dependency on imports of foreign food products.
> massive structural problems with regards to food production
But if China moves up the value chain, its terms of trade of elaborately transformed manufactures will improve over commodities. One LED TV can be swapped for more tons of Australian wheat than a CRT tube. If the predictions I’ve seen are accurate, the greater intake of animal protein consumption can only be satisfied by countries such as Australia, NZ, Argentina, etc. ETMs are labor intensive and require short-intensive supply chains, exactly what Eastern China is evolving towards. On the other hand, modern agriculture requires micro-climate sensors, possible air-born fertilizer delivry and high quality control and long-distance transportation. For all this to happen, you need economies of scale to improve capital intensity. Exactly what is NOT happening with rural china.
If you think of prices as a market signalling mechanism, then the logical (if not necessarily politic) response is to create clearing mechanisms and try to eliminate distorting subsidies (and tell that to the EU and US farm lobbies). Japan is a classic example where the worry about food security led to overreach by their agricultural vested interests (hearsay about rice paddys between skyscrapers). I suspect that if you work out the relative purchasing parity in China, the increasing food prices more reflect the diversion of capital from inland West/Centre into Eastern excessive manufacturing capacity (too many TV factories) rather than any serious agricultural policy failure. Excessive dependence on foreigners is a problem if you don’t trust the rule of law in international contracts or keeping the arterial sealanes peaceful.
I think China already has moved significantly up the value chain with regards to swapping advanced goods for foods. The food capacity issues are related to over-fertilizing, distorting subsidies (as you mention) and a diminishing amount of arable land.
A reverse of diversion of capital from inland West/Centre to the Eastern parts would not increase the net production of food, because rural China does not lack capital it lacks soil. An increase of the rural workforce might increase food production, but is not likely to happen.
With regards to rule of law then I think many countries can suspend any deals on food products if there are supply issues at home.
Mr. Pettis
Thanks again for an excellent post. As you say the re-balancing may have started, I think this is in part managed from the top, and partly because the economy itself cannot hold up. So the transfer of wealth from government to private will start, how do you see that? Privatization of SOE’s? Financing schemes via bonds that really pays back? A revival of the stock market?
I for myself is also worried about house rents, those are laughable low. I suppose they have to appreciate too. How does this influence on CPI? Is house rent prices collected as part of CPI data? Also those without Fapiao?
Prof Pettis you have mentioned before that the levels of US debt do not matter. Is this because the US can simply devalue or default?
RS,
I do not think Prof Pettis said that debt does not matter but should not be priority.
The main priority for US should be to grow the GDP. In order to lower the debt you must cut
the budget and increase taxes. All of these would slow the GDP growth.
If you increase the GDP growth , you will collect more income tax , then by lowering the interest further increase GDP from exports. Thus devalue and increase in GDP would make the debt easier to pay.
The US has an internal debt (owned mostly by Americans) so its impact on economy is far less than if it was owned by foreigners who would demand or control higher interest and slow the GDP growth.
As you grow the economy, then you can pay debt and increase consumer wealth so you can re-balance easier to consumer economy. Remember Us lost about 40% average family wealth..
I too would like to get response from Prof Pettis on this issue.
Foreigners have no control over US interest rates. They are set by the US government. Do not make the mistake of confusing a currency-issuing government like the US with a country like Spain or Greece that does not issue its own currency.
Food Prices will continue to rise where global population, standards of living, and meat consumption rise and where GMO breakthroughs are either short in increasing varieties that (can vastly increase yields or) can be planted on marginal land or (where) there are ideological belief constructs that inhibit more universal acceptance of the use of GMO varieties. Further, will continue to rise, where there are lack of investments in large populous areas of the world, or where quickly growing populous countries fail to bring irrigation, fertilizers, and essential value chain components to global markets.
Even with all the former being supportive of increasing production, they will continue to rise.
And where the LED example above holds technically true, not necessarily nor in as such numbers as equates to the primary necessity of food. While some protection policies are extreme in the case of Food Security, although necessary in more balanced reasoned perspectives that seek efficiency (and security) rather than the sustenance of distorting influence, more assistance and support, and supportive investment that doesn’t enrage/displace/sideline the interests of local (subsistence) populations (globally), is necessary to alter the multi-stream development trajectories of the global peoples, as population and standards of living rise in a jumbled fashion globally.
More cooperation is needed. For example in the 2007-2008 period, rising global food prices were often blamed on the US use of corn for ethanol. No one advised the Brazilians to tear up their sugar cane for planting beats or surmised they should not use either for the creation of sugar rather than fuel. No one, said China or South East Asia should tear down their factories, and pull up newly paved roads and plant corn (even lessen their vast increased consumption of meat). Few who lamented rising food prices across large swathes of Africa, Asia, MENA ( or among interest groups globally) are cognizant of such in the light of great increases in global populations, great over-development of manufacturing capacity globally, great increases in some sort of paved land or structures. Consider it as such, with each % growth in population, there is a lessening of space in a single room, but not just by the percentage of growth in people in the room, but all the other things that people build, use and discard (and such will likely be for evermore, at least in the terms of our great-grand children’s lives).
Such will necessarily, bring rises in prices, in the ever increasing interplay between human need, and environmental reality. So, the (medium to long-term) future is carbon Fibre and Green; expect not simply rice paddies between skyscrapers (despite the inordinate influence of farmers in Japan), and gardens hanging from the sides of Skyscrapers, eventually more and more production, places wherever and whenever it can, especially where cultures cannot get their act together regarding sustainable population growth. (always makes me laugh that people of some cultures believe their cultures are more “family-oriented” which justifies unstable increases in populations that undermine the sustainable rise of national economies, and peoples standards of living therein, and other facets of national security where colonialism, imperialism, or foreigners are blamed for economic travails; it is high-time to end the beliefs in society that support “victimization” and build those that support personal responsibility).
Would appreciate it if someone could clarify this to me:
Higher wages -> companies closing -> less jobs -> some have more money some less.
Revaluation of the RMB -> export companies closing -> imports are encouraged due to revaluation -> tougher competition for local producers on addition of the higher wages -> not that many new local companies to consume from -> wages falling down (I did not understand why it is assumed there will be a real increase in wages in the first place in such an environment and if import taxes are increased than forget about higher consumption.)
Take 1 and 2 and you have unemployment for a lengthy period of time. Add on that a RE bubble of horrific proportions, SOEs going out of business (yeah, right) because of higher borrowing costs, possible poop in Europe zone, Australia resources boom following in the steps of China’s investment slow down etc. etc.
The way I read this article is: hurray! things are going to be less horrible than we previously thought, they are still going to be absolutely damn awful thought, just not as bad and it will take years and years and eventually it will be a happy ending if hell freezes over and everyone plays nicely by the rules. (I added the “hurray!” just for color, forgive me.)
Pardon, another question: wages have a real increase (deducting inflation) when demand is higher than supply or due to forced regulation (the latter ends with less jobs available and unemployment). What I do not understand is how in the described scenarios wages would have a real increase? Surely it’s the other way around and they would drop?
I see some comments asking Mr. Pettis to respond to the need for the U.S. Govt. to first focus on growth not on debt reduction. I have also been curious about Mr. Pettis’ thoughts on the many conservative politicians and economists who attack U.S. fiscal deficits and the Fed’s monetary expansion. I don’t agree. I do not see any risk of near-term inflation. I believe, as Mr. Pettis has discussed, you can let a depression and major deflation wreak havoc on the labor market leading to a push down of wages. Of course, many assets will lose more value and more defaults on debt will occur. Some argue that this is the fastest way to a recovery. My question is a recovery from what? How far is that bottom? Hey, even nuclear destruction will yield to renewed growth on the planet. I think the pain to the labor markets and the messy legal process of sorting out all the business and real estate debt defaults will cause permanent shocks to the confidence and the psyche of the country. Some conservative economists (Friedrich Hayek disciples) argue that the economy was shocked in 1920-1921 without policy intervention and bounced back quickly. They argue government intervention in the 1930s prolonged the recovery period from the Great Depression. I would love to hear Mr. Pettis’ thoughts on this approach versus fiscal and monetary stimulus. BTW, I don’t think Romney/Ryan will take this approach, but rather they will restrain govt. growth and incentivise investment and hiring. For me, I will continue to be a Salma Hayek disciple (silly joke).
Gloria,
You seem to be educated women so you know that any economic system is time limited.
For example the great European model was great but it reached its time. Any delay to
to form a closer monetary union or to go into individual countries monies will only result in longer pain. So we all be cheering if the decision is made to reverse the present model.
In US the housing boom was great when it lasted but now we have to cut our standard of living to pay for it.
Similarly, in China the export driven boom is ending, if you do not switch to consumer economy the economy will suddenly stop. No country in the world is rich enough to
have trade deficits for ever.
Revaluation of RMB will allow households in China to increase the purchasing power so will
increase in savings rates . All these will help during the transition period.
Prof Pettis is trying to educate us that during booming times no one pays attention to the end of economic cycle and they tend extend the economic cycle to extreme which cause travails for much longer periods during the transition cycle. Since the world economies are
interconnected we all suffer.
nah, the people in China who have the purchasing power do not need RMB to revalue to gain purchasing power, the people in China who need purchasing power depend on the exporting sector to give them the money to make ends meet. Only ivory tower folks will believe RMB appreciation will be a good thing. I think people need to understand that the lack of aggregate demand is because unfair distribution of wealth, you can’t solve that with RMB appreciation.
A very reasoned, fair and articulate article. Better then all those rubbish out there. Especially patrick Chovanec.
I have long wanted china to have a hard landing. And they finally are gearing towards thais view. China wasted too much money trying to save itself and the world during the last financial crisis. Externally they did it as they wanted the american and European to open up their (high tech) and resources market in Australia having not much successes.
The hard landing is good for china. They need this to weed out the weaks and inefficiency in their economy. And focus on China’s next transitional phrase which is the next 30 years, from lower cost based manufacturing to middle to higher end quality development.
Its leaders have already identified in its next five year plan.
Holding to lower interest rates will be detrimental. Lower rates cannot direct investments into ares as stipulated by its 5 yr plans. Lower rates will only pour money into ‘speculative’ engines. Property, stocks etc.
So slower growth, GDP is good for China. The crux to increasing consumption and increasing higher wages is that five year plan components (health, medicine, education, technology etc)
But i expect at least 1 more sweets till the transition of power. So i expect perhaps one more monetary injection into the market.
Matchy, I would disagree that a crash would or should lead to moving up the quality chain to high end manufacturing. I think to a certain extent, the high end manufacturing China does now is pretty wasteful, but largely done for enhancing national prestige. There is still a huge, huge, HUGE portion of the population engaged in farming or simple trades in the countryside. If a hard landing leads to large-scale automation in factories, where are these people going to work? On the farm, forever?
Automation leads to fewer low-skill workers and a small number high-skill workers, but the net employment effect is negative. Meanwhile, China still has an enormous poplulation of low-skill workers who are not going push the economy forward by remaining on the farm. These people have very little consumption capacity, and I don’t think a few machine engineers can use their purchasing power to compensate for the vast rural communities who would get pushed out of a high tech economy.
Anyway, China’s greatest advantage is still it’s vast, cheap labor pool. It simply doesn’t make sense to throw that advantage out the window by investing in automation at this stage. It’s hard to see how that route wouldn’t lead to large scale unemployment.
Bab, the idea that the Chinese economy is “foremost export-led”, is a myth. The Chinese economy is investment-led, and the trade surplus is simply the residual of a policy that, among other things, forces up the savings rate. I am also not sure why you say that “it’s really hard to imagine to require RMB to appreciate in order to rebalance the economy.” In fact it is hard to imagine the opposite. It is theoretically possible for China to rebalance while the RMB is depreciating, but this would only mean even higher wages and interest rates, and the impact on price of Chinese exports would be the same – they would have to rise.
Cjared, I would argue that not only is rebalancing not bad for China, but a failure to rebalance will almost certainly lead to a debt crisis.
Matthew, I will be discussing why a devaluing RMB ultimately won’t matter to China’s export competitiveness in a short article this week or next in the Wall Street Journal and a longer article on the Carnegie Endowment website.
Brian d Palma, see my response to Matthew.
Hua Qiao, your focus on the politics of rebalancing is absolutely correct. The economic constraints are in place so that the results are almost wholly an outcome of political bargaining. What is necessary for an orderly economic transition, a wealth transfer from the state to households, is politically very problematic.
JT, the fact that China is much poorer than Japan in principle doesn’t need to make the process more difficult since what matters are expectations, and remember that a well-managed rebalancing does not mean that the growth in household income will suffer much.
Shanghaier, I have written bfore about the five paths to rebalancing that China can follow and in fact this will be the subject of the second of the two upcoming books. I will write about that a lot on this blog in the next few months.
RS, I don’t think I have ever said that the level of US debts do not matter. I think they do and that they are still too high. He good news is that debt has come down since the crisis and will continue to do so. The bad news, of course, is that deleveraging tends to reduce growth, and the world urgently needs growth.
Stan, there are a lot of things the US needs to do, and I would begin with a serious increase in infrastructure investment, but debt concerns make that tough, which is a pity, since improved infrastructure would generate debt servicing capacity that exceeds the debt-servicing costs, and so would be good overall for the US economy.
Sorry I never meant to insinuate that you felt debt did not matter . Although private debt has come down US public debt has increased is there a difference in between private/public debt loads or do they carry the same consequences?
CSteven, I think I agree. I believe in general commodity prices will drop very sharply over the next two to three years but I suspect food prices may stay high.
Gloria, higher wages and a stronger RMB might mean fewer export jobs, but they don’t necessarily mean fewer jobs, since higher wages and a stronger MB will result in stronger domestic consumption. I depends on how the transition is managed.
Michael, enjoyed the thoughtful post and your points on inflation. I also think it is logical to predict that if it plays out this way that there could be a big divegence in commodities like iron ore from agriculture. As they transition to a more consumption led economy and per capita wealth rises there could continue to be a lot of pressure on ag while other commodities could drop substantially. There is a lot of good data out there from electricity consumption to the sale of high end watches so patching it all together is pretty interesting. I am curious your thoughts on how much the rebalancing effects the rest of the world. Thanks!
Phil, I don’t really focus in this blog on the monetary/fiscal debate in the US, but I would make two points. First, I agree with you and don’t think inflation should be our big worry. We are in a world of excess capacity and weak demand, and these are historically periods of deflation rather than inflation. Second, I too prefer Selma.
Thanks for your response. I have previously opined at Seeking Alpha that the U.S. and the entire globe (incl. China) need the Fed to stimulate (reinflate/print dollars) the global economy due to excess capacity. The weak demand and excess capacity is the reason businesses around the world are not investing surplus cash. As keeper of the world’s reserve currency, the Fed has to be at the vanguard of stimulating the global economy. I would also like to see the European Central Bank get more aggressive and get in front of their economic issues.
Hi Mike,
Nice to see a newly design website, except that the RMB currency on both sides looks ugly.
There are news that U.S Fed will announce a QEIII in September. Is this good news or bad news for China and the whole world at large? I hope your next article will be on this.
Throw the theory away, and think about the reality for a second, if RMB appreciate, lots of exporting sector companies will go bankrupt, and it happens to be that those exporting sector business owners (remember the Wenzhou folks?) are the major force behind the housing speculation bubble, so the housing bubble will pop, and then what? Mass unemployment, huge deflation pressure, …, we all know the story.
I don’t think there is an easy way out. I think the key is wealth redistribution through tax and political reform, other than that, I don’t think rebalancing is possible.
By the way, I’m not a trained economist.
Let me add that lack of consumption in China is not because China as a whole is lack of wealth, it’s really because that the people with the money to consume don’t have the desire or need to consume more (other than the luxury stuff and housing speculation), and people with the desire to consume don’t have the money, any policy that can’t address that problem is futile. I happen to believe it’s a political problem, not an economic problem, so there is no easy way out. We’ll see.
STAN,
What you wrote has nothing to do with my question which was very specific. Thank you for replying though.
Prof. Pettis,
Thank you for your reply. My previous question remains and that is how would [real] wages get higher in the first place in such an environment of re-balancing, as you wrote. Demand for employees will go down and so would wages. That’s a simple math.
(most likely I do not understand which is why I’m asking, I’m not saying you are wrong.) This is before we even look at the actual environment where wages and demand have been pushed up due to unrealistic low borrowing rates of certain companies and uneconomic investments. To me it looks very obvious wages can only go down.
I think that Prof. Pettis is saying that in such an environment, there would be negative inflation, and while wages growth would be negative, inflation would be more negative, leading
to positive real wage growth. I think I even read an article of his somewhere elaborating on this point.
Gloria, you are correct in pointing out that the rebalancing will be painful and fraught with risk. If you believe the export model has hit a wall (i.e. U.S. and some European countries cannot and/or will not allow their trade deficits increase), China will have no choice to steer policies towards stimulating internal demand and away from excessive savings/investment. For example, if China developed a small safety net, this could stimulate consumption. M. Pettis has discussed the policy of low interest rates has hurt households. Currency adjustments can be part of a natural rebalancing process. The other danger is the record of Government direction of the economy (anywhere not just China) is mixed. Many times Governments stifle and distort the healthy and natural adjustments in the economy due to domestic politics.
Sorry but I do not understand the connection between your comment and my question which was: why is the Prof. stating wages will increase in real terms while the re-balancing is still in process? I just cant see how that it is even remotely possible.
This is all such BS. When GDP growth slows from 10% for a decade to 0-3% there will obviously be huge imbalances and the country will suffer a lost decade, at the very least. To think that the consumer now will pick up this monstruous slack and malinvestment is delusional at the very least.
If consumer spending is still less than 35% of GDP that is because GDP does not reflect real economic output. I will venture to say that sustainable GDP moving forward is perhaps 30% lower than what is reported today. That would bring consumer spending to a 50% share of GDP.
If the central planners wish to fight this healthy deflation, they will only delay the correction.
It will be ugly, it will be brutal. Hold on to your gowns, ladies, we are going through hell.
Hi Michael
There seems to be a release of new local govt projects. Would they not amount to more of the same investment centric growth rather than the hoped for great rebalancing. I refer to recent articles such as the following on English.Caixin:
http://english.caixin.com/2012-08-23/100427785.html
Local Gov’ts in 7 Tln Yuan Investment Frenzy
A new round of intensive regional investment is planned across the country. Over 7 trillion yuan in new projects has been by announced in the past 50 days by various local governments…..
Are these sufficient to hold back the great rebalancing.
Thanks
Woza
Thank you for your reply
The 7 trillion (alleged) stimulus at the city level, plus the 1 trillion for new subways and highways just passed. I think the rebalancing party is already over.
I do trust all of the concepts you have offered for your post.
They are really convincing and will certainly work.
Nonetheless, the posts are too quick for beginners. May you please lengthen them a bit from subsequent time?
Thanks for the post.