One of the most frustrating aspects of any discussion about China’s economic prospects is in the confused way with which economists and analysts, who often seem to suffer from what Giuseppe Gabusi calls “GDPism,” employ the concept of GDP. We all think we know what the term is supposed to mean. It is generally assumed that GDP is the total value of all goods and services produced by an economy, so we think of it as a measure of wealth, or as a measure of debt-servicing capacity, and we assume that it is a measure that can be compared across countries.
But it isn’t a measure of wealth or of debt-servicing capacity, and GDP comparisons across countries are often meaningless. GDP measures certain types of economic activity that we agree to define as GDP, but these measures are conditioned by the institutions that mediate economic transactions. Among those institutions, for example, are the accounting conventions used to recognize the value of inventory, or to write down investment, in such a way that reported GDP is artificially changed by these conventions.
GDP Requires a Mark-to-Market Mechanism
To explain why we need to tease out the full consequences of this insight to understand the Chinese economy, I will go through a simple exercise to arrive at conclusions which are, or should be, obvious but which are nonetheless ignored in many discussions about the Chinese economy.
Point 1: GDP does not directly distinguish between activity that increases a country’s wealth and activity that doesn’t.
Consider the case of a country in which there is a corporate entity, which we will call China Corp., that decides to invest $100 in each of two separate projects. One project, Value Bridge, is economically justified—it could be, for example, a bridge that relieves traffic congestion significantly and so sharply lowers manufacturing costs for a neighboring industrial park. The other project, Nowhere Bridge, turns out to have no economic value—a bridge to nowhere, for example, that receives no traffic.
In either case, China Corp. ends up with two $100 investments on the asset side of its balance sheet. The counterbalancing credit shows up either as a $200 reduction in cash or a $200 increase in debt (in this case, let us assume the latter). Net assets are unchanged, and there is no impact on the company’s income statement, although in the future there will be, as interest is paid on the debt and the bridges begin to generate revenues. If the revenues are greater than the debt-servicing costs, these remaining revenues will continue to be added to GDP in the future.
In the current period, Value Bridge and Nowhere Bridge contribute to an increase in economic activity in exactly the same way. They both cause GDP to rise by some amount equal to the $100 value of the investment times some multiplier, which, to make our lives easier, we will assume is one. The amount by which the productive investment boosts the GDP calculation, in other words, is exactly the same as the amount by which the nonproductive investment boosts the GDP calculation.
The point is that when the investment is made, the GDP calculation has no way to distinguish between the productive investment project and the nonproductive investment project, even though the former makes the economy richer by contributing to its productive capacity while the latter does not. Both productive and nonproductive investments boost reported GDP in the same way.
Point 2: The mechanism by which GDP is forced to record real changes in productive capacity is some form of marking-to-market mechanism.
Let us now assume that China Corp. recognizes that Nowhere Bridge is a bridge to nowhere and creates no economic value at all, so it must take a full write-down on the asset. The Nowhere Bridge investment project, which appears on its balance sheet as an asset, is then written down to zero in the form of a $100 credit to the balance sheet. The counterbalancing debit is made in the form of an expense that reduces the net profits of China Corp. by $100.
When we use the income approach to calculating GDP, the writing down of the asset associated with Nowhere Bridge causes a $100 loss to China Corp., and so reduces its retained earnings by $100. This reduces GDP by lowering the value-added component by that amount.
This is how the GDP calculations adjust in a market economy to recognize bad investment decisions. They are written down and the loss is recognized in the income statement. This is the mechanism by which the GDP calculation is forced to reconcile the accounting records with real value creation in the economy.
Notice how this happens: at the time the investment is made, GDP is boosted by the $100 investment in Value Bridge and is also boosted by the same amount by the $100 investment in Nowhere Bridge. When the investment in Nowhere Bridge is recognized to have created no value, the Nowhere Bridge asset is written down on the balance sheet by $100, the amount of the investment, and there is a counterbalancing $100 debit to the income statement that causes a reduction in the net profits of the business sector.
This reduction in business profits reduces the value-added component of the GDP calculation, and the economy’s reported GDP conforms to the underlying economic reality. In a market economy, the value of the investment in Value Bridge increases GDP whereas the value of the investment in Nowhere Bridge does not.
Point 3: In an economy in which there is no mark-to-market mechanism, reported GDP will be higher by the amount of wasted investment.
Let us now assume there are two countries, China A and China B. The two resemble each other in every respect except that in China B, there is no formal mark-to-market mechanism because all loans are guaranteed by the government sector. In each country, there is a company, China Corp., that makes the two investments described above.
In both countries, in other words, there is a $100 investment in Value Bridge and a $100 investment in Nowhere Bridge, and in both cases GDP is increased by the investment amount. The difference is in the accounting treatment of the write-down. In China A, as described above, the investment in Nowhere Bridge is written down to zero, and the accompanying loss reduces China Corp.’s retained earnings, which removes the impact of the investment on China A’s GDP. In China B, however, the write-down does not occur, so the investment in Nowhere Bridge remains on the books at $100, and there is no $100 loss on the income statement that reduces retained earnings by $100.
Remember that in terms of underlying economic reality, including the value of all goods and services produced by the economy, China A and China B are identical, but when it comes to reporting economic activity, there is a difference between the two. China A’s GDP will be lower than China B’s GDP by the amount of the write-down. What’s more, China Corp. in China B will have $100 more in assets than its counterpart in China A, and this will be matched on the other side of the balance sheet by $100 more in retained earnings.
Although the two economies are identical, in other words, China B will have a higher GDP than China A. More generally, in economies that do not recognize investment misallocation, and that do not write down overvalued assets, reported GDP will be higher than it otherwise would be, as will the reported value of total assets.
Point 4: Even if wasted investment is not formally recognized and written down, it will not create a permanent increase in GDP.
This difference, however, is not permanent. Over time, the difference in the recorded value of the two countries’ assets will be amortized to zero, typically because China B will record a higher depreciation expense than China A, so in the future China A’s businesses will record higher net earnings than China B’s, and its assets will depreciate more slowly, until eventually the financial statements of both entities will once again be identical and their GDP levels will be the same. I should quickly note that to make it easier to understand, I am assuming away the impact of financial distress and other balance sheet effects, but in fact these effects will reduce China B’s real and reported earnings even further.
The net result is that during the period in which China A and China B are investing nonproductively on a sufficiently large scale, China B will always show a higher level of GDP than China A, and total assets held by China B’s residents will always have a higher reported value than total assets held by the residents of China A. At some point in the future, however, their relative positions will be reversed, and China A will begin to report higher GDP growth than China B, until eventually the two countries have identical balance sheets and income statements.
How to Read China’s GDP Data
But remember that the two countries are identical. They produce identical amounts of wealth and value. It is only the failure to write down assets that causes an economy to record higher GDP than otherwise. This means that if one believes that China has misallocated investment and has failed to write much of it down, then one has no choice but also to believe that:
- Chinese GDP is overstated every year by the net amount of wasted investment made during the year that has not been correctly written down. If, for example, a government entity borrows $100 to invest in a project that over the rest of its life causes only $60 worth of additional goods and services to be produced, China’s reported GDP will be overstated by $40.
- At some point in the future, when China begins explicitly or implicitly to recognize and write down bad debt, this overstatement will be reversed and the country’s reported GDP will be understated by the amount of implicit amortization.
- Chinese wealth is also overstated by the amount of wasted investment made during the year that has not been correctly written down. In the example above, not only is China’s reported GDP overstated by $40, but Chinese entities collectively claim to have $40 more wealth than they actually do.
- When China begins explicitly or implicitly to recognize and write down bad debt, this is simply the obverse of assigning the losses to one economic sector or another, and it will happen one way or another. Put differently, as the bad debt is eventually written down, households, businesses, and/or government entities will discover that they are poorer than they thought by $40. This is why, as I have written many times, the process of deleveraging, which includes writing down bad debt, consists of nothing more than assigning debt-servicing costs to one economic sector or another.
- Notice the impact on savings. GDP is equal to consumption plus savings, and if reported GDP overstates the value of economic activity, the reported savings rate also overstates the value of savings by the amount of wasted investment in each period. This also means that the value of the stock of Chinese savings is overstated by the amount of investment and bad debt that must be written down.
Perhaps Growth Has Already “Collapsed”
Think about the following three countries. All of them have had a decade of 10 percent annual GDP growth driven by high investment growth rates and boosted by highly inverted balance sheets, with debt growing from nearly zero to 60 percent of GDP. But now, in all three countries, we have reached the point at which the return on additional investment is negligible. Here is what follows in each country:
- In Country A, investment growth drops to zero, driving annual GDP growth down to 2 percent, where it remains for the next five years. Debt also grows by 2 percent to remain steady at 60 percent of GDP.
- In Country B, the authorities have a growth target of 6 percent and encourage government entities to keep investment levels high enough to reach the target, even if this means an explosion of debt. For the next five years, GDP grows by 6 percent, while debt soars from 60 percent of GDP to 260 percent of GDP.
- Finally, in Country C, the authorities have implemented significant institutional reforms aimed at making the economy more market-driven and these reforms have caused a massive redistribution of wealth in such a way that consumption growth surges. The growth in consumption encourages additional growth in investment so that GDP growth drops to 6 percent and remains there for the next five years, with debt growing at the same pace to remain steady at 60 percent of GDP.
Clearly, China most closely resembles Country B, but which of the other two countries more closely resembles Country B? Many economists are so impressed by GDP figures as the most fundamental description of the underlying economy that they don’t really distinguish between Country B and Country C, and because Country C enjoys healthy growth, they assume that Country B does too. One of the more consistently confused figures has been Stephen Grenville, a former Australian central banker, who recently said:
The China bears have been around for years, continuously predicting the end of China’s stellar growth story . . . So far, so good. China’s unsustainable double-digit growth came to an end in 2008, coinciding with the global financial crisis. Growth was artificially stimulated for a couple of years but only by huge fiscal and financial stimulus. Since then growth has settled to a still-outstanding 6.5%.
If you assume, as Grenville clearly seems to believe, that there is no relationship between the growth in economic activity and the growth in GDP, then he is right to describe China’s current GDP growth as “still-outstanding.” But that seems a pretty astonishing assumption. If GDP growth had not been artificially boosted by credit expansion, then it is hard to understand why Beijing has been trying urgently to get credit growth under control for over five years but has not even been able to prevent it from accelerating.
In fact, I would argue that “the end of China’s stellar growth story” has already occurred, and occurred quite a long time ago. Growth in the Chinese economy has collapsed, but growth in economic activity has not collapsed (let us assume, with Grenville, that somehow the reduction in GDP growth from over 10 percent to 6.5 percent does not represent a slowdown in economic activity). The growth in economic activity has instead been propped up by the acceleration in credit growth and by the failure to write down investments that have created economic activity without having created economic value. In that case, high GDP growth levels simply disguise the seeming collapse of underlying economic growth in a way that has happened many times before—always in the late stages of similar apparent investment-driven growth miracles.
But there is no way to get around the logic of debt: either the debt proceeds went to fund a productive investment, in which case debt-servicing costs are fully covered by the additional productivity generated by that investment, or they were not. If they were not, the debt was created either to fund an expense or to fund an unproductive investment, and in either case the associated debt-servicing cost must be assigned to some other economic entity.
Most of the remaining so-called bull scenarios for China implicitly assume that existing losses on investments that have not been correctly written down will never be recognized. At first, these bull scenarios had the virtue of consistency—the bulls believed that there was no need to recognize the existence of unrecorded losses because these losses in fact did not exist.
Later on, as it became obvious to everyone that there certainly were unreported losses on Chinese balance sheets that emerged from the failure to write down unproductive investment, and that these losses were significant, the bull scenarios began to incorporate implicit assumptions—implicit but never acknowledged by the bulls—that some mechanism or the other would permit the economy never to have to recognize these losses. The most popular form of these mechanisms typically involved some kind of debt monetization or a return to financial repression, but as I have shown many times before, all these do is pass on the losses in hidden ways to the household sector. In that case, the losses are eventually recognized, and in fact recognized in the most damaging way possible to the economy in the long run.
A Digression Into Accounting
I don’t pretend to have any great knowledge of GDP accounting—what I describe above is really quite basic stuff—but for those who are interested, what is seen as the correct way to record a debt transaction in which the proceeds are used to fund an unproductive investment is to record the expenditure as an expense. In that case, net earnings are reduced by the amount of the wasted spending, and net assets are reduced by the amount of the debt. Typically, this is done in two stages:
- The economic entity borrows some amount, say $100, and uses the proceeds to make an investment. This will have no impact on its income statement, but both its assets (in the form of investment) and its liabilities will rise by $100, with no impact on its net wealth.
- When the $100 investment is recognized to have no value, the economic entity will write down the value of the asset by $100, with no change in debt, of course, and its expenses will rise by $100. In that case, both net earnings and net assets are reduced by $100.
The two steps together are the equivalent of recording an unproductive investment as an expense. But, as I show above, if the economic entity fails to write the unproductive investment down to its true economic value, the second stage is avoided. This changes the way the unproductive investment was recorded without changing in any way the underlying economic entity.
China’s GDP: Different Than Assumed
The reason I have initiated this discussion of GDP is to explain why we systematically misinterpret the information provided by Beijing’s regular GDP data releases. On July 17, 2017, China’s National Bureau of Statistics reported that, at 38.1 trillion renminbi (or $5.7 trillion), China’s GDP for the first half of 2017 at comparable prices was 6.9 percent higher than it had been in the first half of 2016. This came in slightly above consensus expectations of 6.8 percent.
Analysts and investors treated the news of higher-than-expected GDP growth in much the same way they would if it had been about Brazil, a European country, India, Japan, or the United States. The Shanghai-Shenzhen CSI Index, for example, reacted positively, rising 2.3 percent over the next three days. Several economists also saw July’s data release as good news.
But I have long argued that when reported growth comes in above consensus expectations, the implications for China’s economic prospects are not the same as they would be for most other large economies. In the latter cases, higher-than-expected growth might suggest that we should revise upward our longer-term growth expectations because the underlying economy is performing better than expected. In China, however, when reported growth comes in above consensus expectations, it does not imply a stronger economy. The higher demand that drove growth is unlikely to have been a consequence of underlying health—rather, it is far more likely to have been created by a temporary increase in economic activity in response to government decisions to maintain high levels of GDP growth.
This means debt will have grown faster than it otherwise would have. Higher-than-expected GDP growth should therefore suggest that we revise downward our longer-term growth expectations. It simply means that a higher level of unrecorded losses must be written down in the future and, because it implies more debt than otherwise, financial distress costs in the future will also be higher.
We typically use GDP as if it were an expression of the total value of goods and services produced by the economy, but it clearly is no such thing. For those who are interested, Diane Coyle has written a gem of a book about the development of GDP (GDP: A Brief But Affectionate History), which goes a long way toward explaining how GDP can be useful as a measure for the size of an economy and when it isn’t useful.
GDP can be a fairly good proxy for the total value of goods and services produced by the economy, one that allows us to compare two economic entities or to calculate the growth rate of an economic entity. But this is only true under fairly easily defined conditions. One of the key conditions is that the entities being compared must have consistent mark-to-market mechanisms. The reported GDP of the two economic entities cannot be meaningfully compared if in at least one of them there is a significant amount of misallocated investment that does not generate enough productive capacity to justify the cost of the investment. I discussed this further in a May 2014 essay explaining why the PPP adjustment for China—which begins with an assumption that China’s GDP is calculated in a way that is consistent with the U.S. calculation of GDP—is a thoroughly meaningless exercise.
Comments(117)
Hi Michael, glad to see a new article from you. Aside from credit growth and TSF, is there any other metrics by which to infer the extent to which wasteful investments are being made?
Hi Michael, I'm a fan of your work and agree that China's GDP data have major flaws. However, I think you might be mistaken about the way that GDP calculations are supposed to recognize bad investments. The income approach to GDP uses firms' gross operating surplus which is not the same as their retained earnings in that it isn't affected by the speed at which firms depreciate or write down their assets. Yes, faster write downs/depreciation (consumption of fixed capital in the national accounts) reduce firms' net operating surplus but the output of the equation given in the UNstats paper you linked to "gross operating surplus = net operating surplus + consumption of fixed capital" won't change since a lower net operating surplus will be offset by higher consumption of fixed capital. Basically, whether or not Chinese firms mark-to-market the value of their investments should make no difference to GDP. That aside, I believe your broader point on GDP not being a good measure of wealth creation and ability to service debt still holds, along with the argument that GDP would be lower if it weren't for the government encouraging overinvestment.
Put it simple,in the case of China,if the banks write down the bad loans,the banks would report lower profits,so lower GDP.
Put it simple,in the case of China,if the banks write down the bad loans,the banks would report lower profits,so lower GDP.
Interesting. I have question, though: isn't it that the point is that the depreciation and amortisation policies are rigged to meet the 7% GDP growth objective? Is the consumption of fixed capital figure reliable? If it is underestimated, to improve the economic outlook, the net operating surplus would be just as inflated if writedown were not taken into account?
As soon as a GDP number of a large economy is reported, there is always a deluge of commentary about the supposed health (or lack thereof) of the economy concerned. This is non-sense. First, GDP numbers are subject to revisions up to 3yrs after their initial reporting. In that process, it is not infrequent that an initial say +2.6% real annual growth finally becomes +1.8% a couple of years later (I'm referring here to developed markets). Of course, what has been initially qualified as "satisfying" or "robust" is never later requalified as "modest" or "mediocre". In that sense, initial commentary is of little value, if any. As a timely indicator of economic momentum, GDP is completely useless. Second, and more importantly, it is strictly impossible to conclude anything about the health of a given economy from Gross Domestic Product alone. To do so, you also need Gross Domestic Balance Sheet, or at least Total Domestic Debt from all sectors (households, companies, government). Even in the relatively rare cases when this number is reported, it is typically reported later than GDP and receives much less publicity and commentary. For most countries, however, this number is simply not reported or not even compiled by statistics offices. It is immediately visible to anyone that a similar and "healthy" +6% GDP growth doesn't have the same quality if Total Debt has grown +6% or +15% during the same period. The second case is of course "unhealthy", especially if relative debt is already high. Any significant and sustained divergence between total debt growth and total production growth is in itself the sign of an imbalance and any self-respecting economist would want to understand the origin and cause of such imbalance. But there is of course little interest in that. It was this same obsession about GDP growth that caused most "observers" to not see the great financial crisis coming, even as the large and prolonged increase in Total Debt / GDP was plainly observable. For most economists from the official, financial or even academic sectors, career risk is simply too great. As John Kenneth Galbraith wrote, most people "deem it unwise to be sane when sanity exposes one to ridicule, condemnation for spoiling the game or the threat of severe political retribution". Or, in more practical terms, most people prefer to dance till the music stop. The main advantage of this activity being of course that we don't need to pay no economist for that.
DvD, Good Commentary, Good Reading.
A good article and the principles are fairly clear to me now; however, couching the discussion in terms of GDP initially confused me a bit. I think the big impacts are really to net domestic product (NDP) and some discussion of NDP could be useful. For example, the article states: “At some point in the future, when China begins explicitly or implicitly to recognize and write down bad debt, this overstatement will be reversed, and the country's reported GDP will be understated by the amount of implicit amortization.” “This is how the GDP calculations adjust in a market economy to recognize bad investment decisions. They are written down, and the loss is recognized in the income statement. This is the mechanism by which the GDP calculation is forced to reconcile the accounting records with real value creation in the economy.” In the income method depreciation is added to income in calculating GDP. The information I have does not specifically define how impairments/write downs to fixed investments are to be handled. Impairments could be included in depreciation (or consumption of fixed capital using BEA terminology). If so, the increased depreciation then exactly equals the reduced profits, so that there no net effect on calculated GDP. If alternatively impairments are subtracted from profits but not added to depreciation then there is a reduction in GDP calculated by the income method; however, in this case it appears GDP by the expenditure method does not match GDP by the income method. Therefore, I assume the correct method is to include impairments/write downs in depreciation (consumption of fixed capital) resulting in no change to calculated GDP. However, impairments/write downs result in a decrease in NDP. Based on this approach one could say that malinvestments result in an eventual reduction in NDP when they are eventually written off; and NDP is a much better measure of useful production and wealth creation than GDP. There seems to be a tendency of economists to focus on GDP when NDP is much more meaningful. Not sure where this comes from.
NGDP does not stand for net GDP. It stands for nominal GDP, which's supposed to be a good proxy for the nominal income. Then, inflation measures are used as a way to turn NGDP into RGDP (real GDP). NGDP is easy and generally pretty accurate. If there's any flaws, those flaws are far more likely to be in RGDP. Inflation is tricky to measure cuz it's highly sensitive to how the consumer basket is set up among other things.
Ignore my comment above. You said NDP, not NGDP. That being said, if increase depreciation is higher than reduced profits, wouldn't that difference shown in wages? If it doesn't affect corporate margins, it must affect wages. If it affects wages, it will affect GDP by either lower consumption or lower household savings (hence affecting NX).
I'm currently reading through the NIPA primer from the BEA. It does not seem to agree with you. I'd post a link, but my comment will be deleted if I do since I'm not allowed by the rules of the blog, so you can Google it and read the paper for yourself.
Part of it is that NDP is a bugger to work with. Ideally, you want a measure of economic activity that is not particularly sensitive to arbitrary decisions or standards, and any measure of consumption of capital is highly susceptible to arbitrary decisions and standards.
Suvy I believe my interpretation is correct. BEA Guide to the NIPAs page 9 states: “Consumption of fixed capital (CFC) (1–11) is the charge for the using up of private and government fixed capital located in the United States. It is defined as the decline in the value of the stock of fixed assets due to wear and tear, obsolescence, accidental damage, and aging.” This text does not directly call out writing down assets because they are later determined to be worth less than they cost; however, for accounting purposes this kind of write down is not really much different than obsolescence. See also the comment from Julien, which agrees with this interpretation. Net domestic product (NDP) is GDP minus CFC. It is better than GDP as measure of wealth generation within an economy. NDP is also more closely tied to the balance sheet, since asset write down adjustments for NDP would be exactly the same adjustments as applied to the balance sheet.
If CFC is taken out of corporate profits by a writedown, that shows up as a drop in GDP and in a reduction of GVA. All increases/decreases to growth have to show up in wages or in corporate profits/margins. If we see declining margins from firms writing down infrastructure assets, it must show up as lower GDP than what'd otherwise be the case.
Funny story: I was at a shareholder meeting for a company I'm heavily invested in a couple of years ago. It's an infrastructure company that had to take a writedown for some unexpected flooding that happened in an area, which's why their earnings were down in the previous quarter. When they took the writedown, their profits fell. That means GDP was lower than if they didn't write down those assets cuz the amount that wasn't written down would show up a higher corporate profits or higher wages (in this case, corporate profits).
G Stegen good analysis. I totally agree. Then how do we reconcile your point with Michael Pettis one, which is also quite illuminating?
No one believes GDP numbers in the US. They may have been valid at one time but the Heath Insurance tax is being added into the numbers as an addition not a subtraction. The proper way would be to add Health Insurance Company profits to GDP but there are no profits and health insurance is actually being subsidized. Probably the best read for the US economy would be the number of people on SNAP. My guess for China would be the number of people who don't go back to the cities after the New Year Celebration.
Huggy, we can go just about anywhere for the long-term existential angst that has besieged the minds of the belabored of those given to be beleaguered. Don't you tire, it is conspicuously common.
I think that population mostly consists of you and not really anyone else. Japan's numbers (mostly due to sketchy inflation data that doesn't line up) are far more shady than US numbers. Same thing with Chinese numbers. Some areas in the US where ~60% of the population lives are growing rapidly (mainly densely populated regions, growing cities, areas on the coasts, etc). The rest of the areas are depopulating and not growing at all. This is how healthy empires and countries should work. Certainly for inflation data in the US, private estimates match government estimates. Growth data seems relatively accurate considering that we have rapidly growing areas. In the region where I live, I've seen traffic get much worse over 15 years. US numbers certainly seem pretty accurate. Also, government subsidies to insurance markets do show up as government spending (which's a part of GDP calculations). The SNAP budget is tiny. The welfare programs that're truly costly are Medicare, Social Security, and Medicare. Most of the stuff you said is wrong.
Also, health insurance taxes are a subtraction cuz they're taxes. G-T is part of NIPA. T reduces GCPE. It's all in the accounts. I don't think you understand GDP accounting very well.
Hi Mike. Enjoying the new article.
looking at Japanese GDP over time, in Yen terms is instructive. Especially if you also overlay debt dynamics, recent Abenomics and similar to get a handle. The thing that interests me, as much if not more, are the following: farm to ferrari mentality and social discourse, belabored to long, inhibiting efforts to switch to consumption, on any level that can see a timeframe that can reverse Questions as to whether or not China does have the financial to make the investments necessary to see proper switching to consumption (as globally there is insufficient sustainable demand), as {asset valuations will be imperilled, gov revenue streams will be stressed, and these assets need be written down, or serviced,as the assets themselves need be maintained [roadways, ports, airports, empty buildings, factories, electric power stations, mines, sewer systmes, buses, fleets of vehicles, military assets, and so forth and so on], while the first real test, in an era of directed social discourse and media distortion, sees difficulties that will see capital rushing for any exit. At least, will reveal, to speculative wealth, now is time to secure whatever you can. But as to Michales piece here, whatver your intutions as to complicity of factors, an be viewed graphically through charts, via Japan (in Yen terms for GDP).
The argument made by the person (who knows far more about Asia than I do) was that Japanese inflation numbers are off cuz their basket doesn't match other countries in the OECD. Japanese inflation went down first and up later, which was after the commodity price crash even though Japan is a heavy commodity importer. If we look at the Yen, it's been stuck in the range of 100-120 vs USD for ~4 years now. Also, TFP in Japan has been stagnant since the 70s even though their GDP/worker numbers keep going up. Something is clearly not right and the BOJ is now explicitly pegging the yield curve.
Do you think the Chinese leadership is aware of these arguments and are simply buying time; or really clueless?
Of course they are aware, but they are caught between a rock (the people) and a hard place (vested interests). As Mike has written many times: a re-distributuon of income/wealth is needed but powerful forces are against this.
Michael’s post seems to have three suppositions: Chinese companies price capital incorrectly; Chinese companies invest in value destroying projects; There is no correcting accounting mechanism in China for these projects as exist in other countries, thusly Chinese GDP inflates ‘real’ growth and debt servicing ability. Please help me understand. I know for a fact that Chinese companies of all types, to include SOEs, publish WACC numbers. SOEs don't need to make much of a decision between equity and debt finance, but are they not using their published numbers to make investment decisions? I’m having issue matching the big picture to actions of individual firms or financial managers. If a financial manager doesn’t know or ignores capital prices, what do they do all day? Seems like a pretty sweet gig. Sign me up for that job.
Chinese companies don't price capital. The Chinese government prices capital. There is no market mechanism for capital allocation in China. And most all Chinese data is a scam for their companies. I was looking at a company called Evergrande a few weeks ago. I almost died laughing. It's a scam.
1.) Of course Chinese companies assign a cost capital to their investment decisions. Certainly China has more artificial input- value control, but firms know a number (WACC) that needs to be achieved to break even. I agree that this number is easily distorted and future cash flow projections are easily distorted. 2.) SOEs account for about half of bank loans. So about 50% of Chinese bank lending is a ‘market mechanism for capital allocation,’ no? 3.) I agree a large part of the data is a fundamentally flawed. However, Data is certainly not perfect anywhere. The debate on exactly when the US started to enter the recession comes to mind. I don’t buy that non-local SOEs are so incompetent that their numbers are completely fabricated (that seems to be your idea). 4.) This discussion will be muddled as long as we don’t distinguish between the types of companies, particularly SOEs. I agree that any real estate developer in China is ridiculous. My contention with your post in general is that local SOEs, as opposed to China as a whole, are the most egregious ‘scams.’ Large SOEs like CRRC or ChemChina pursue a national narrative, but I can’t believe they aren’t a.) calculating lending costs (WACC) and b.) purposefully approving projects under that value to the order of magnitude we see with debt rising. In short, it is easy for me to see how local SOEs, accounting for about 2/3 SOEs in China, need an infinite rise in debt, but I can’t see how the larger companies face the same trap without willfully ignoring finance managers. I really don’t get it. I sincerely apologize if I’m missing something obvious.
I was referring to larger RE developers. I have no clue about local SOEs. My mistake.
My point is being missed. I'm thinking that the SNAP numbers give a real indication on where the economy is going in the US. SS tax collections also give a real indication. At one time electricity production in China was used as a GDP indicator. The world is awash with funny-money that disappears when attempts are made to turn it into spending money. My GDP number is bigger than your GDP number. (joke)
Social Sec numbers follow demographics. It's a pay as you go system. I'd like to eliminate FICA taxes in the next recession as a stimulus, but I doubt that happens cuz Dems will come in and say "morally wrong" cuz "equality" even though FICA hits the middle class the hardest, but okay.
"There is no correcting accounting mechanism in China for these projects as exist in other countries..." I think the correcting mechanism is the same in every country. When morale is high amazing things can be accomplished. When morale is low the simplest things take forever. When food, clothing, and shelter production fall to low levels than a system changes. Leadership makes the difference. Identify the issues and make effective changes. Easy to say, tough to do.
Social Security taxes shift money from producers to consumers. Progressive income taxes shift future decisions from producers to politicians. Because producers are forced by circumstance to be pragmatic they continually have issues with politicians and consumers. Politicians and consumers are always looking for who killed the goose-that-lays-the-golden-eggs. The goose that they cooked and ate for lunch. (joke)
"Most of the stuff you said is wrong." The test of my wrongness will be if the US tax cuts are a failure. I can't find the reference now but I remember President Putin having a meeting with President Bush just after the Bush tax cuts. President Putin said the key to a robust economy was a stable currency (eg low inflation) and low taxes. I hope my accuracy is better than Jonathan Gruber and President Obama. I mean Jonathan Gruber's remarks before he started calling himself a liar. (joke)
Putin's economy is incredibly weak. The guy is a moron on economic matters. His currency has fallen ~50-60% in the last 5 years. Russia's economic output has collapsed and the entire country is in a massive public health crisis. The average life expectancy for men in Russia is ~62, alcoholism/drug addiction is rampant, and everything in his control is in freefall. Obama said Russia is a regional power and Putin's weak due to the Russian economy's reliance on oil. That's 100% correct. I suggest you read The Volatility Machine by Prof Pettis.
"The SNAP budget is tiny" Who cares? I said SNAP not WIC for a reason. No one wants to be on SNAP. No one likes dealing with a bureaucracy and the amounts are small even to recipients. If SNAP enrollment is growing then times are hard. Doesn't matter what GDP numbers indicate. Tell hungry people that GDP numbers prove that they aren't really hungry.
WIC is reserved for pregnant women who are poor. SNAP rises can merely be the result of the application of technology coupled to information and referral modalities that need not indicate a direction to "things getting hard", but merely indicative of how our trade openness, and financial globalization has led to wage stagnation, where a bulk of those on SNAP are working poor. Rather than WIC being opposed to SNAP as you imagine, increases in WIC utilization likely portend future rises in SNAP coverage. So, technology and the greater ease with which people can find themselves eligible is likely responsible for a large share of the uptrend. Always were eligible just didn't access.
SNAP enrollment is down yoy BTW.
"leadership" Leaders know what the problems are and know what they can do easily. I can't imagine an easily solved problem being discussed here. In the movies the hero tells the King, the King believes him because he is obviously right, then the King kills the villain in one-on-one combat. Lights come up. (joke)
SNAP is down YoY. So GDP is going up if my observation is correct. Replacements for hurricane damage, tariffs, restrictions on immigration and tax cuts will make the US economy boom. Something will probably happen in NK that will give China a new outlet for goods and services. Exports to the US have probably peaked for China. De-dollarization is in fashion and that means world trade will drop till some other mechanism is accepted world-wide. My understanding is that currency conversion acts as a trade barrier.
WIC is women and children. Not just pregnant women. In some ways it is an agricultural subsidy. They can buy milk but not buttermilk. Items are marked on the grocery shelves as being WIC approved. It is more long term than most SNAP enrollment. In the past WIC type help would have been provided by the extended family. One could make the case that WIC helps the grandparents more than their daughters and grandchildren that are enrolled in the program. I would make the case that it helps the grocery stores and the agricultural industries the most. It also helps the US as a whole by stabilizing the food industry. Does China have anything similar?
The categorical requirement simply means that each participant must fall into one of three major categories: Women: Pregnant (during their pregnancy and up to six weeks after birth or at the end of the pregnancy) Postpartum (up to six months after giving birth or end of pregnancy) Breastfeeding (while they are breastfeeding up to their infant's first birthday) Infants up to their first birthday Children up to their fifth birthday WIC-Wikipedia......preganant women, and children, income dependent, and welfare can not support anyone, the money given, so, pregnant women, and their children, under 5. Also, then poor owkring mothers. Your point is this is a problem, and not the world, with the acquiescence of the American establishment, using the US as a demand provider, to service their excess capacity, and industrial policies. As to more help, whom, what? Where? Why? Of course, there would then be issues, in application, that would determine access, like, household income, there would have to be, poor women, with children, living with grandparents, and paying rent, leaving very small income, to get the minimal support of largely dairy products, and other bare necessities as you imagine. So even of the set of poor women, neither all of those who could access, do, for one reason or another, nor is there support of assertion, that grandparents would benefit more, as there is not even, outside of mere statement, that the benefits provided to the class, imply, a level of consumption of such products, above that which would be desired for the identified primary beneficiaries, let alone support that such is occuring, but for statement, in the causual existential angst assertions, of those who prefer such a direction to belief, regardless of supporting facts or data. Thus, merely the direction of the "ideologist.
"technology and the greater ease with which people can find themselves eligible is likely responsible for a large share of the uptrend" Depends on where you are in the US. In some places EBT cards could be used in casinos till it became public knowledge. No one in an area where most people have a job want to be seen using an EBT card. Because beer, cigarettes and other things can't be bought with EBT cards in those states it is usually easy to spot an EBT card user. Fraud in US Federal programs is rampant and technology makes the scamming easier. I know this because I read Wikipedia. They have a page for corruption just involving Illinois.
Point was, asserted rises need not be indicative of growth in difficulty for families, merely that there are many reasons that access may increase including better information and referral service programs run by more effective social service agencies and technology, enabling more of those always able to access these benefits, who had previously not known, or had the ability to access. But rather than addressing the issue, seems as if response was to express your emotional displeasure, and to appeal to families providing such, along the normal chain of the social cultural conservative critique. I agree with you as to what families "should" do, and as my philosophy professor stated, should ought to be (irony) taken out of the english language as it expresses hypotheticals, of what I prefer, not necessary, and mere statements of fact. We need more fact, and less emotional reasoning if we are to get anywhere. If not, we remain the creature of some interest groups criticism. I prefer not to be the object, of any groups target marketing campaign. Why I turned off the TV, plus I do not need any medicine created for geriatrics.
WIC is a fraction of SNAP, likely many on WIC, can also receive support under SNAP, as well. Don't believe mutually exclusive, with WIC being criteria dependent supplement to SNAP. www.fns.usda.gov/wic/wic-funding-and-program-data www.fns.usda.gov/pd/supplemental-nutrition-assistance-program-snap
"Russian economy" I've read that most of the provinces of Russia are subsidize by the economy centered on Moscow and a few other provinces. The US subsidizes Alaska, Hawaii, Arizona and probably a few more. Climate and inland waterways make a big difference. I think Russia is doing a great job economically given the amount of land it encompasses. Change in NK may benefit Russia quite a bit now that US consumption of outside oil is dropping. Russia could team with China to build refineries and shipping ports in NK. India, China, South Korea, Vietnam and maybe Turkey could be the refineries biggest customers.
The five most dependent states on federal funds (measured by spending-taxes per capita and source is WalletHub) are Kentucky, Mississippi, New Mexico, Alabama, and West Virginia. The states that're the least federally dependent financially are Delaware, Minnesota, New Jersey, Illinois, and California. Hawaii and Alaska are middling. Arizona is in the top 15, but not in the top 10. I'll bet that most of it comes down to Medicare and Social Security recipients.
Russia, like most others, mistook what occured during the late 1990's, and late 2000's. Rather than diversify and strengthen it's fundamentals, to integrate within the greater European system, it reinforced it's reliance on the economic structures, that enabled it to buttress oligarchs friendly to the regime. It reverted to previous geopolitical thought strategies, that highlighted any number of {Marxian, Anti-Imperial, Conspiratorial, Social-Cultural}, to validate this movement as it reverted to a theoretical posturing that linked itself to a longer term Russian Historical presence (overlooking, but pandering to elder's on the greatness of the WWII victory). Essentially, in line with Michaels piece, it saw GDP growth figures, it understood what was required of it (natural resources), it closed ranks on the permissable Oligarchs and used State power to re-organize the centralized control of wealth and assets in its society, and delivered adequately on raising standards of living of the Russian people, unsustainably over a longer term, during the period. It's focus was to antagonize it's population over the perceived wrongs committed against it's people. While consolidating power, on the grounds of National resurgence, paid for by enhanced resource prices. Nationalized some assets, reneged on some agreements, then was back at the brokering table after the tide turned. This was short-sighted, counter-productive to a broader swathe of Russian interests, and inevitably destructive from the perspective of the interests of the Russian people, as history will illustrate.
"Japan" I think mathematically you can't have a shrinking population, a trade surplus, and inflation. I think the trade surplus exports inflation unless you have a growing population. Anyone know of any books or articles on this subject?
You can definitely have a shrinking population with trade deficits and inflation. Japan exports its capital to invest in plants across the world and gets returns off that. That automatically means it's a capital exporter (by definition), hence it runs a trade surplus. Their biggest edge is in exporting technology to build plants elsewhere. That's why basically every Japanese car sold in the US is actually made in the US while cars made by American companies are made mostly in Mexico.
Surely you mean, "exports deflation". Not inflation, but this is interesting, because of how your expression, gels, with those whose thoguhts are concerned for inflation, when the world is still roughly at ZIRP, and essentially, is in a state of suspended depression, where assets blow-up, due to savings glut, and a great excess of money printing globally (on the back of false rises in asset pricing). When you say inflation, are you speaking of asset prices? Ironically enough, inflation on the grounds of competition for scarce goods, is typically what is discussed when considering inflation. But I suspect, rather than competition for goods, that the longer term time horizon, will yield in retrospect, how asset bloat, and moeny printing globally, inevitably did lead to inflation, if the world economy doesn't see deflation when the next shoe drops, as it yielded a tendency to need to support asset value increases, rather than of competition for good, in a world of grave excess capacity and savings.
All this talk about WIC, Snap, SS, Medicare, Medicaid, Food Stamps. It's a sure sign of Republicans. Whenever there's problems of distortion, inefficiency, they look down - down at the people who have less than them. I look up. The underlying message is " Hey, we wouldn't have a problem if we didn't have to take care of the poor and less fortunate." The republican party isn't really a christian party. Finding people to scapegoat for the negative effects of their greed and selfishness is an old, time proven method of the w & p. The old, sick, weak - they never got anyone into a war that I know of. No, it's the lust for w & p that does that.... Distortion in our GDP. Well let me think. The dot-com bubble, the housing bubble, there's a bubble in commercial retail space and a slow bubble in the stock market right now. But Hey. We're lucky - we don't have vested interests here that distort economic forces with power forces, compromising the general population for their personal gain. We have a perfectly adjusted scale called the "marketplace" that functions flawlessly. Our biggest problem is our charitable impulses that undermine natural and healthy self-interest. Right? I see problems when the billionaires who don't pay taxes.
Yok: True as to Reps, but needs to be interrogated. For example, long have Democrats, and Social Justice Christians, rather than Cultural Conservative Christians been open to Immigration. From Dems and Social justice Christians, thought being, we respect individual effort, and should respect the hard-working immigrants, then, we are all immigrants notion bandied about. Cultural Conservatives, Pat Buchannon, and Conservative Christians, usually, Protestant, and many varieties of Born-again religions would worry of Cultural dilution, as would Authoritarian Nationalists (globally) and any number of Critical Theoretical Social Marxian groups in the present era, oft hypocritically (as theirs is often to rail against White Men). The Alt-Left and Alt-Right, globally make wonderful bedmates to oligarchs and kleptocrats globally (why the Right and Left call each other Fascists and Fascists often call themselves Nationalists or Communists). Look a little further, you note Dot.com, Housing, Commercial Real Estate, Stock Market bubbles, and distortion to GDP. I would add allowing Non-Market Economies into the WTO, by Baby Boomer Idealists. These all after the deregulation of the US Financial System. Early, Alt-Right and Alt-Left critics, used Marxian power and exploitation memes to note how the developed world, through Financial Globalization were exploiting the Developing world. What should be seen is how such distorted the Developed World. The inherent contradictions, the resultant malinvestment, the false growth, the money printing, the beggar thy neighbor development strategies, the blow-up of productive capacity, the savings glut, the asset bloat, the wage stagnation, the growth in nominal income and wealth inequality, and an extended shallow depression (as to last, remember in US GFC, high net worth lost 5 of 7 trillion, so when next shoe drops, might be a reversal of wealth inequality dynamics in nominal terms). So, populist backlash, due to the contradictions between desired belief maintenance, and real and material interests of individuals and societies. The confusion of the clatter, will lead to lines along Zeihans more logically structured, less emotionally complicit, trajectories. Reversal of recent modalities of global integration as required by both ends of spectrum, as the pendulum swings in the opposite direction.
Charitable Inclinations.....Healthy Self-Interest, are they contradictory......certainly, insofar as 84% of Americans volunteer each year to some cause or another, would one infer that this not be a Healthy Self-Interest....as to billionaires, and common memes toward taxes, these are certainly not related merely to notions of self-interest, but to geopolitical strategy, political artifice and for most that hold them, short-term, parrochial considerations, that are certainly not self-interested, were, and when, the impacts, are more directly seen. Actually, that is pretty much why there is aglobal backlash in the developed world, and how even the most directed of paid commentators globally, have lost a lot of the old incendiary logics used 10 or 20 years ago, if these are somewhat inculcated by the Critical Theoretical Alt-Left and Alt Right in the developed world these days.
Most of the US budget is to the elderly. It's the young that're getting crushed. And I'm sorry, but the ones who got us into dumb wars are not the young; they're the old. BTW, the bubbles the US had are relatively small compared to the bubbles on the Eurasian landmass. In the US, our housing bust of 2008 is a smaller bubble than the current housing bubble in Sweden. We have a federal budget of ~22-23% of GDP. ~60%+ goes to the elderly. But somehow writing down 5% of GDP in student debt or reducing that is unaffordable even though we spend more than that on taking care of the elderly annually? How can societies last when they suck resources from the young to give to the old? They will not continue expanding in the same way they were before. BTW, is the elderly makes up the largest plurality of the GOP.
I don't mean to hate on the elderly, but I'm tired of seeing my friends get screwed again and again and again. We're not talking about expensive things here. It is not expensive to provide a basic level of health insurance for the young or to make sure they aren't paying exorbitant amounts to go to school. In fact, they're both quite cheap. I'm not talking about big government programs or massive expansions of state power (I'm against those things). I'm talking about small, sensible reforms that should be easy to pass and are very affordable.
What I'm hearing is that everyone should believe US GDP numbers because they are better than most countries. People should make significant financial and policy decisions based on those GDP numbers except those numbers aren't really good till they have aged three years. Also that most US federal nutrition payments only help the recipient and not their extended family or the food industry because only a really small number of people receive them. Is that a good summary?
I don't think anyone here is saying the things you claim they are. Your comments really aren't coherent TBH. And you're focusing so much on insignificant transfer payments. You're focusing on noise, not signal. I suggest you read your hysterical comments on the last post of your predictions for what would pass in Congress and then compare that to reality. The comments you're making now are even more ludicrous. To be perfectly honest, I don't think you're making an honest attempt to listen and understand the arguments others were making. Really no point in engaging anymore.
"Really no point in engaging anymore." True. As far as predictions go, there will be a US tax cut. If congress doesn't have it done before the election the new 33 senators will be anxious to get it done after the election. The last two bills in US congress on Obamacare would have saved most of Obamacare. Not that I am a fan of Obamacare. If the tax cut doesn't pass before the election the new senators will decide Obamacare. Since new senators will be supply-side believers, Obamacare will probably be mostly gone if the tax cut isn't passed this congress. China will prosper as it opens up NK to development. Russia will prosper as it finds a new market in NK. Hope I have cleared everything up. (joke) Make your predictions based on your metrics and see what comes true. (joke) One long term prediction. US senators will be changed back to being appointed by state legislatures. Because the US media is tired of internet populism. (joke)
"How can societies last when they suck resources from the young to give to the old?" Everyone of those old people were young once. US Social Security is means tested now in a quite devious way. See Hall v. Sebelius SCOTUS decision. From when I was 24 years old to when I was 36 years old I worked at a company that had yearly meetings touting their retirement program. The first thing they showed was Social Security payments. I guess now they are telling them (24 to 36) that outer space aliens are going to take care of them in their old age. Might be one reason that Russian men are said to drink so heavily. (joke) If you work at a company that is promising you a glorious retirement remember that they might not know what they are talking about. I've read that glorious retirements only happen in societies that have increasing worker productivity numbers. I've read that the US worker productivity numbers have been very good in the past but are falling. I read the worker productivity numbers in the IPhone factories in China are excellent.
Just a note on labor productivity: creating labor productivity growth isn't hard. If you build useless garbage by excess capital inputs, you'll drive up labor productivity. That's what the USSR did (which drove up labor productivity until its collapse) and it's what China's doing now. Labor productivity went up in the 2000s cuz excess investment into housing created growth that showed up as labor productivity. Of course, total factor productivity (TFP) was flat starting from ~2003-2009 and only picked up after 2010 (in the US). That's cuz building random stuff to drive growth is not productive long-term and actually adds a cost. TFP growth has been rising steadily since 2010, which makes sense cuz that's when the housing bubble had fully crashed and the US economy had fully adjusted from the bubble. In most of the OECD, TFP is stagnant and the US is one of the highest in seeing TFP growth since 2010. In places like Germany or the UK, there hasn't been any TFP growth at all.
Suvy. I hadn't known about this. Thanks
Suvy, please send me an email at chinfinpettis@yahoo.com
Sent.
Thanks for the info on TFP.
A very good observation on GDP and it's limitations in describing the Chinese economy. The main issue here is still how to value real estate and fixed assets. I had a friend who took out a 7 year lease on a small property in Beijing. He opened a small shop and ran a loss on operations for 3 years. In that period the area his shop was in had developed so fast that he flipped the shop's lease for 4 times its value and made back his loss and created a good profit. I think a lot of people still believe that the value of your assets will outgrow any loss you may have on operations. Now the guy who took over the shop didn't do it based on a bank loan because you can't get a loan for a shop in China, but when we talked to him he had borrowed the money from someone who had gotten money out based on a real estate project in their home town. No one cares about operations if you get it all back on assets
Anders, sounds like a bubble to me. Sooner or later asset prices come back down to earth, where economic utility determines valuation.
Hi Mike. Just saw a clip by Luke Spajic on Bloomberg. Chinese debt 260% of GDP - not a problem - 320% of GDP - not a problem. It's not a problem as long as rate of servicing the debt is lower than growth rate of economy - this can go on for years according to him because the room for growth is incredible. And besides it's all funded internally from their own savings. Hey, so what if a lot of human effort is wasted, so long as people are happy while they are wasting their effort.
The pattern I'm seeing is that China will need to adapt to being frozen out of the US market. Looks like inflation will greatly increase and dollar debts will be inflated away. China's 1-R-1-B initiative will be just-in-time and may more than soften the collapse in trade with the US..
Yea, we've been hearing inflation coming for the past decade. It's no more likely now than it was 15 years ago. I think it's less likely. In the middle of a demographic bust with excess capacity and strong USD, inflation won't rise. I think there's a real potential of higher growth with low-to-negative inflation.
Well, I think "needing to adapt" is the rebalancing to increase household share of consumption that Michael's been talking about. That can't come about until households retain a greater share of GDP, which may now start to become possible (maybe...) now that Xi has consolidated his power (as Michael and his students concluded a couple of years ago as inevitable). I'm not sure about dollars getting inflated away, although maybe an economist can help me on this one. So long as there is a surplus of goods and a lack of demand for those goods, it would seem that deflation is the more likely outcome.
I think you are absolutely right if the future holds USD at the current relative exchange level or gets stronger. We hold difference of opinion as to where USD is going. I think the Federal Reserve can weaken USD if other political actions are taken in the US. If citizens wages triple and prices double there will be no unrest in the US as long as employment participation rate increases strongly. China will want to dump USD sooner rather than later if USD is weakened significantly. Getting out of USD could become a rush.
OK, but Michael has argued (pretty persuasively, I think) from his various posts and books that the only way that the US can balance unilaterally is by imposing capital controls, that China buys so many USDs because it needs to export capital as a fundamental in its growth model, and that historically, in periods of excess supply/insufficient demand, it’s the creditor nations, not the debtor nations, that suffer in trade wars (or capital wars, which I guess is the same thing). Why would this time be any different? Also, what would all these countries rush into buying once they sell US dollars? I don’t understand your scenario of US wages rising faster than prices—please begin with the basics: (1) GDP = Savings + Investment + Consumption and (2) Current Account Balance = Domestic Savings – Domestic Investment. In your scenario, which variables increase and which ones decrease? As an aside, your conjectures could be correct—I’m just trying to work out the steps. And FWIW, if you haven't read The Great Rebalancing yet, it might change the way you view things at the moment--I know it did wonders for my understanding, althoguh I keep forgetting important parts of it and have to relearn them by reading Michael's (unfortunately infrequently) blog posts.
Claire, I agree with you. US can unilaterally shift its trade balance if we were willing to impose capital controls. Granted, it's also a terrible idea that'd create a lot of pushback domestically as well as internationally. I'm also not really sure wages rising faster than prices in the US would necessitate higher inflation either. If we see rising wages for working and middle class folk, it could push more people up the income distribution which means higher savings rates. More importantly, overconsumption economies aren't really at much of a risk of inflation. Total capacity utilization in the US is pretty low relative to historical norms. So you gotta think that higher wage growth, and potentially higher consumption, just means either higher savings rates for households or TCU goes up. I don't really see how that creates inflation. It could actually create deflation by creating rising USD (so lower input costs), rising American output/growth, and rising productivity, which'd all place downward pressure on inflation. I'm very bullish on the US Dollar, especially medium-to-long term. I think the US economy could potentially be at risk of overheating and I think growth rates could take off.
Suvy, I don't have the economic models to say whether such policies are inherently "good" or "bad"--I just see something like this as inevitable, essentially because European and Asian export-led countries are not going to change their policies until they are forced into it, and the US, as the country bearing the brunt of these policies, is basically going to (eventually) force them. As for the rising savings rate in the US--I assume that this too is inevitable, but I haven't looked at economic data for a long time--this is sort of a really cool intellectual game for me, but it's not my career, and I don't really spend too much time reading about these evens outside of Michael's blogs and books. So whereas once I looked at lots of data and had no model, I now feel that I have a great model, but no longer plugging data into it...
My understanding of the relevant issue discussed in the book is that the US trade deficit requires some other country to use their dollars to buy bonds or other financial instruments denominated in US dollars. My belief is that the Federal Reserve can flood the world with dollars to effectively reduce the percentage of bonds et al by nominal value that China can buy. Also all bonds are computer entries in US Treasury data base. All US financial instruments are heavily regulated. US government agencies can control these items in anyway they deem appropriate. Why different? Because President Trump was elected. Things can change in a controlled way with President Trump's guidance or things could get chaotic. President Trump is unpopular with the media but very popular, at least right now, with US citizens. Stripped of the media bias President Trump has been very reasonable and has indicated he will sign anything the US Congress is willing to vote on-the-record and pass. That is why so many in US Congress are retiring. (joke) Trump's way or the highway.
So you clearly haven't read the book. You need to stop spinning BS. If you read the book, you'd know that the US doesn't need foreigners to buy US bonds. If foreigners became net sellers of bonds, you'd know (from reading the book) that US bond prices would likely rise, not fall (or equivalently, yields falling instead of rising). If you don't know, you should really just say you don't know rather than pretending as if you do know.
"US wages rising faster than prices". My belief is that investment in US automated factories is going to be the next bubble. That and trade schools. Looking like close-the-borders and build automated factories to lower manufacturing cost below what China and the rest of Asia can accomplish with workers. Germany has proven that this can work. To build a factory skilled labor is required. Stop H1B visa. Sudden shortage of welders, pipe fitters, electricians, plumbers, application programmers, etc. Trade schools open up and start training for 100K+ jobs. Everyone who already has these skills is offered 250K jobs. Apprenticeships take off. Financed by the newly created money from the Federal reserve.
Germany and China repress wages. Germany doesn't let workers work >35 hours/week. Also, I'm deeply skeptical on Germany's educational system and think it's been unable to adapt. Productivity for American workers is higher. American wages are much higher than German wages overall. It's across the board really. If you're a skilled worker, you're way better off in the US. In Germany, a tech developer who's been working for 20 years might make what my friends who studied computer science made annually walking out while being taxed less than half what the German gets taxed. If you're skilled labor, you're better off in the US and it's not even close.
Germans are complicated. I agree it is easy to get any number of Germans to immigrate. That said at least one German business has found a way to stay competitive through automation. (joke) It is the Germans with the biggest sense of humor that immigrate.
"you'd know that the US doesn't need foreigners to buy US bonds." Has to happen if the US Dollar is going to be the world reserve currency. (see book) Also I said dollar denominated financial assets which includes other things. Name the things a nation must buy (or do) if it wants to run a trade deficit. That is in the book also. See SNB for a good example. They buy AAPL stock and others (eg USD financial assets) so that they can run a trade deficit with Euro area. That was explained in the book also.
No, it doesn't. Maintaining an open capital does not mean others must buy your bonds. It could mean the opposite.
"pretending as if you do know" I predicted President Trump's victory. I bought his 2016 coins from Amazon at $11 each because they are a good investment. (I have some with the mis-printed back. Don't bother with the 2017 at a $1 each. They are near worthless.) I now think that the tax bill will get done in 2019. I didn't realize the Republican Senators and the Republican Leadership in the HoR were so tone deaf. It will be a much bigger tax cut in 2019 and will include a repeal of the Obamacare Individual Mandate. I feel sorry for the politicians who will lose their seats. They don't see it coming.
I told you they were clueless in the last post. They can't pass anything, but this tax bill has a shot. It's not really a very big tax cut (~$1.5 trillion in debt over 10 years implies a deficit of ~$120 billion/yr, or ~.6% of GDP). It's not a bad start, but a lot of stuff will need to be rolled back for the bill to pass. I currently have the chance of the tax bill passing as a tossup. It's not a bad start, but many things will need to be changed for it to pass. It cannot pass the Senate in its current form and will likely take months to secure all of the votes.
"is by imposing capital controls" If I remember right the book said there were indirect ways to impose controls and that Japan? and German? were using some of the indirect ways. I'm not sure because I read the book one or two years ago. I think it was a Christmas present.
Why would we wanna impose any kind of capital controls? The US isn't Japan or Germany. If we imposed capital controls, such policy would function as a de facto tax on the American consumer. Why turn a flexible, dynamic economy into something less flexible and more rigid. It's not just bad policy. It's absolutely awful policy.
Yes, Japan counterracted the effects of the rising Yen after the (1985?) Plaza Accord by increasing investment and lowering interest rates (expanding credit). The key is that this just reinforced Japan's already large structural imbalances and drove asset prices and productive capacity even higher, which made the eventual adjustment even worse (reinforced by Japan's absolute instringence against writing off bad debts to keep their Zombie companies going). Sound familiar? One of the key differences between then and now, though, is that Japan was on a smaller scale and was pulling these tricks in isolation and at a time of growing world economic growth--in other words, the rest of the world could absorb the ramifications of their policy decisions. I don't think the world today is in an analagous situation, so China is in a tougher spot.
"...became net sellers of bonds...US bond prices would likely rise, not fall..." A countries bond prices rise if holders start selling them in mass? I'm thinking you meant to say something different from what you typed. Maybe that interest rates paid by such bonds rise? (eg Venezuela, Argentina, and lots of others) The Federal Reserve can do anything the domestic politicians will allow. The fact that US Bonds are allowed to be rehypothecated may make your statement true since worldwide debt is so high and the dropping of the dollar as reserve currency (which will happen later rather than sooner) would require a lot of refinancing.
No, I meant exactly what I said. If foreigners stopped buying bonds, dealer inventories would adjust as the current account deficit falls. If dealer inventories take the hit, risk assets get crushed and people move into Treasuries. So Treasuries likely rise as yields fall. The way you're thinking about asset prices is wrong.
US gets a congress that is closer to President Trump politically if the people who voted for President Trump don't get a significant tax cut.
LOL! Try betting on it and see what happens.
The US needs to inflate debt away. To stop unrest this requires wages and the social-safety-net to increase. To increase wages and social-safety-net means the rest of the world must be walled off from the US increases. Otherwise it is impossible to inflate away debt. President Trump seems to be the only US politician who can make this happen.
The US doesn't have a debt problem. Net debt (not gross debt) is historically on par w/70s and 80s.
I lived through the seventies and eighties. President Nixon got rid of the last part of the Gold standard so that more debt could be created. In the eighties the Democratic Congress tried to impeach and remove President Reagan at every turn and the US economy didn't really get rolling till 1986. Next the economy was hobbled by President H W Bush balancing the budget by signing a tax increase and going to war in Kuwait. Smoke and mirrors for the next twenty four years. So here we are and we have debt and IPhones to show for it. Kicking the can down the road. Just ahead is a brick wall too tall for the can to be kicked over. Structural changes are in order.
Public debt is an asset for the private sector. Also, there's a lot of cash (~$3 trillion) held overseas by American corporations that's tax deferred cuz companies like Apple and GE take most of their income abroad to minimize their tax bill. If you account for all of those private sector assets (among others), net private sector debt is actually quite low and on par with the 70s. Also, there were capital controls in the late 60s and 70s. Today, there aren't. In a world of global supply-chains, we won't see high inflation unless supply-chains get disrupted.
"take most of their income abroad to minimize their tax bill." -- They did but are now being chased by EU tax men. Under President Trump the IRS will likely join the hunt. "net private sector debt is actually quite low and on par with the 70s" -- Stock buy-backs have pushed up debt. GE is more representative than AAPL. Pay-day Lenders are on every corner. Sub-prime and student loans are not well. "Also, there were capital controls in the late 60s and 70s. Today, there aren't. " -- The guy who mows my lawn has trouble depositing the check if it doesn't list his birth name instead of his advertising name. T's must be crossed and i's dotted. "In a world of global supply-chains, we won't see high inflation unless supply-chains get disrupted." President Trump's policies and other items are disrupting supply chains. Every international company is looking at moving part of its manufacturing back to the US. The Federal Reserve is raising interest rates. Regardless of the Federal Reserve Board member speeches raising rates is an action done to slow inflation.
Net corporate debt (corporate debt minus offshore cash and government bonds held by corporations) is actually pretty low. Corporate cash held overseas is ~$3 trillion. Corporate debt is ~$13-14 trillion. Corporate debt in 2008 was ~50% of GDP. Today, it's ~70% of GDP with $3 trillion in assets abroad. That's ~50% of GDP net and doesn't include Treasury holdings of corporations. Trump's policies aren't disrupting supply-chains either. That's a lie. The idea that Fed is hiking rates to slow down inflation is trash. None of the claims you just made have any basis in reality. Trump hasn't done anything to impose capital controls.
How do you come up with this nonsense? How have supply-chains been disrupted? If you did that, the cost of the computer I just bought a few months back would be at least double what I got it for. We're not going back to the 50s and 60s. Those days are dead. Hell, the only reason I know about it is cuz I've read about it in books. In 15 years, no one will remember the world where the US had capital controls and tons of local banks with banking restrictions between states. The people who do remember this stuff will be dead in 10-15 years. If Trump actually tries to take us back there, there's gonna be a political backlash that'll put Democrats in office for decades. More importantly, too many Republicans from states like Texas and Florida are not gonna stand for it anyways. Bannonism is politically suicidal medium-to-long-term.
If I'm wrong then: NY, NJ, Illinois, and California bonds could be great investments. Those States would be leaders in any Europe and Asia trade rebounds. GE would be an investment opportunity of a lifetime if international trade is about to rebound strongly. FNMA (Fannie Mae) is under 3 dollars a share. Open boarders would make a housing price surge as close to a sure thing as anyone could hope. So FMNA could be a winning investment. The Democrat party theme song is "Happy Days are Here Again". Since 1933. I don't recommend investing in any of the above and would advise anyone to not follow my investment advise. Happy Days.
"The people who do remember this stuff will be dead in 10-15 years." Statements like this may make you feel better but they don't add to the discussion. My statements are how I think debt will be reconciled. Have you read and comprehended "The Great Rebalancing"? How do you think the World is going to be re-balanced? More taxes on the hordes of idle rich people? rich wealth = FUNNY MONEY. Real wealth creates food, clothing, shelter, and after those are met entertainment. Hierarchy-of-needs. Use to be taught in College.
Easy way for debt to be reconciled: higher income taxes on very high earners, taxing capital gains/dividends as income, and getting rid of the mortgage interest rate deduction. Deficit immediately goes into surplus for decades. Debt will be wiped out. It's not gonna happen through inflation in a world of global supply-chains when there's no capital controls. For an overconsuming economy, that's nearly impossible.
The US doesn't have a debt problem either. US federal debt not held by the public is <30% of GDP and we have immigration. These risks aren't risks we actually face.
"For an overconsuming economy," -- The US isn't consuming as much as was expected. 1B 1R is a plan to address this fact.
70% of the economy is consumption and runs a ~$700 billion current account deficit. By definition, that is an overconsuming economy.
That's wrong by definition. If you disagree, that makes you wrong. You can't run large current account deficits and say you don't overconsume.
"Easy way for debt to be reconciled...The US doesn't have a debt problem" -- See if you still think so in 2032. I think US GDP will be 106 trillion and the deficit will be 5 trillion. 21 trillion collected in taxes. A 2032 FRN will be worth about the same as $5 today. The US national debt will be about 54 trillion. Inflation.
So tell me how your political predictions of the bills you said would pass turned out? Your prediction record is poor and it won't be $106 trillion. This is not gonna happen.
Sorry. I left out a 20. I meant a 20 FRN in 15 years will buy what a 5 FRN would buy today all-things-else-being-equal.
Ten months and counting. A lot of things are happening that aren't being widely reported. How many have heard of the Cloverhill Bakery deportations? The results were higher wages in Chicago and the deportations of 800+ lawbreakers. And possibly the retirement of a US Congressman after 24 years.
Huggy, I haven't heard anything about it. Tell me more.
Deporting a few hundred illegal immigrants in a country of 330 million is a drop in the bucket. Run the numbers on that. We're basically adding 1 million people to this country every year.
I have adjusted my timetable till after the 2018 elections. I still believe a large number of Senators will lose their seats if they don't pass something that feels like a tax cut to people who voted for President Trump. Senators are elected by regions (State boundaries). President Trump was elected overwhelmingly on a regional basis. A projection of former President Obama's policies 15 years would be 33 trillion GDP and a national debt of 33 trillion. 106 trillion GDP is more believable than that. Over consumption or surplus nations buying US debt? Re-read The Great Rebalancing before you decide.
"adding 1 million people to this country every year" -- Probably a time local maximum. 800+ people losing their jobs and being deported is the most likely reason Congressman Gutierrez decided not to run for reelection. No one affected believed it was possible till it happened. Companies will not want to see their profits cut by over a third and will start replacing illegals. I've read that H1B visas are starting to be more difficult to get. My understanding is that President Trump is appointing judges that are as strict or stricter than Justice Scalia was. President Trump is forcing Senators and Congressmen to vote on record. Most members of Congress including Republicans approved of almost everything that President Obama implemented by executive order. The rate of US consumption growth is falling. That is why Russia, Saudi Arabia, and others are being forced to make other arrangements. The US was the marginal consumer that bid up prices. Oil is half the price it was at its last peak price. Possibly China will take over the role of marginal consumer. An environmental cleanup like what was done around the Great Lakes in the US and additions of discharge sequestering devices could increase China consumption since the US is a leader in these areas. Also China could import more pork or other meats from US, Australia and others if it is really true that pork farms are causing pollution of rivers. Most of the US international influence is due to the fact that countries feel they must sell into the US market. China could do the same thing if China developed an international banking system. I've read that new rules that were recently announced in China are leaning this way.
Mike...Just watched your interview with David Li. He seemed insecure. He's a professor and on an advisory committee to China's Central Bank. His two early rebuttals were nonsensical. That type of thinking shouldn't come from a Phd Economics. I have to think that he is among the 99.95 % of economist who serve wealth and power or their own private interests. Wealth and Power doesn't confide, make privy. It's not democratic. Except for a small group, it doesn't want the population to know truth. Wealth and Power subjugates and employs to its own interests. He was being honest as far as keeping people busy to keep them from making trouble. He knows he has to praise and erode away the doubts. Debt comes from savings. Right... Wrong - Debt comes from trust.
Michael Pettis: Thank you for a highly relevant and well-articulated introduction to the more complex areas of national accounts. While the many flaws to national accounting are well known it is good to be reminded whenever they present the more extreme examples. That was probably the case with Chinese statistics last year when it was paramount for the leaders to present an unblemished picture of the economy. It was always believed that anything would be done to fence off potential critics well ahead of the most important party conference in decades. So the government maintained growth at what may have proven an unsustainable high level with fiscal and quasi fiscal/monetary policy stimuli. It may be commendable though that they have done this without rather cooking the numbers, but for the country the latter might have still been preferable in terms of less wasted resources! That said, one could also note that China is not alone in implementing potentially wasteful policies to sustain growth. I believe Japan coined the term “building bridges to nowhere” some decades ago. Present ultra-loose monetary policies of BoJ and ECB could also leave their respective economies with many investments that could prove dubious in the future when the imbalances they ultimately create will have to be undone.
I don't understand this interpretation of GDP at all - one that values only 'worthwhile' investments. Using this logic for the consumption portion of GDP, consumption of education, which provides future benefits for the economy, should also be treated differently from consumption of leisure activities. Agree that there might be an issue of bad investments in China (and other economies), but changing the GDP measure is probably not the best way to address it. Fundamentally, to me anyway, nominal GDP is a measure of overall economic activity closer to how much money changes hands in a given year.
Investment appears in expenditure/consumption GDP, not in income/output GDP. The two have to sum to the same total. GDP is not a measure of viable or sustainable wealth creation, but measures the country's net current income and spending for the year. Wealth creation or asset inflation as also per marking to market is not part of GDP! Michael Pettis is confused. It has been a valid criticism of China's GDP sums in the past, and given that they are rarely if ever revised in hindsight, has been that market value of construction investment (between start and completion of construction projects) has been included in GDP - plainly wrong. This could have led to between 10 and 20% exaggerated GDP numbers. But, calculating wages, profits, and net trade balance should produce a check (when adding up income GDP) on DP measured by consumption.
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