China’s debt problems have emerged so much more rapidly and severely this year than in the past that, combined with swirling rumors about the country’s leadership, a growing number of analysts believe that this may be the year that China’s economy breaks. As always, I am agnostic. There is no question that China will have a difficult adjustment, but it is likely to take the form of a long process rather than a sudden crisis. In this essay, I lay out, as methodically as I can, the dynamics that have driven the Chinese economy for over a decade.
When we consider the Chinese economy as a system, it turns out that the problems China faces are easier to understand than most analysts suggest. Like any deeply unbalanced economy or system, China’s imbalances must reverse, and one way or another, they will, but there are various paths by which this reversal can occur.
My July 2018 article in Barron’s sets out one case of how events force China to choose among these paths. If the global trade environment forces a contraction in China’s current account surplus, I argue, by definition it also forces a contraction in the gap between Chinese savings and Chinese investment. This means that either the country’s investment share of GDP must rise or the savings share must decline (or some combination of the two). There are literally only four ways that either of these outcomes can happen. Consequently, there are also only four ways that Beijing can respond, each of which would drive the economy to one of the four possible outcomes (or some combination of them):
- Raise investment. Beijing can engineer an increase in public-sector investment. In theory, private-sector investment can also be expanded, but in practice Chinese private-sector actors have been reluctant to increase investment, and it is hard to imagine that they would do so now in response to a forced contraction in China’s current account surplus.
- Reduce savings by letting unemployment rise. Given that the contraction in China’s current account surplus is likely to be driven by a drop in exports, Beijing can allow unemployment to rise, which would automatically reduce the country’s savings rate.
- Reduce savings by allowing debt to rise. Beijing can increase consumption by engineering a surge in consumer debt. A rising consumption share, of course, would mean a declining savings share.
- Reduce savings by boosting Chinese household consumption. Beijing can boost the consumption share by increasing the share of GDP retained by ordinary Chinese households, those most likely to consume a large share of their increased income. Obviously, this would mean reducing the share of some low-consuming group—the rich, private businesses, state-owned enterprises (SOEs), or central or local governments.
Notice that all four paths either raise investment or reduce savings, thereby reducing the country’s excess of savings over investment. This is what is meant by a contraction in the current account surplus.
More Investment Means a Greater Debt Burden
In terms of the first path, an increase in investment technically can occur in two forms. The additional investment can be productive. For that to be true, such an increase would have to result in a rise in debt-servicing capacity equal to or greater than the rise in associated debt-servicing costs. Or, to put it another way, the present value of the future increase in production generated by the investment must be equal to or greater than the cost of the investment. If that is the case, the increase in investment is sustainable and will not add to the country’s debt burden, even if it expands the country’s debt. By contrast, if the investment is not productive, it automatically increases the country’s debt burden. This means that either debt rises faster than debt-servicing capacity or that debt-servicing capacity is forced to decline, usually because productive resources were deployed nonproductively.
As an aside, if a nonproductive investment is not written down, it also results in what is effectively a capitalization of what should be an expense. In other words, an illusory increase in wealth is recorded. This is the main difference between money borrowed to fund consumption and money borrowed to fund nonproductive investment (aside from the fact that the former at least gives you temporary pleasure): neither increases wealth (that is, productive capacity) or income, but until it is correctly written down the latter allows you to report higher wealth and income that is wholly illusory. It would be as if you spent $100 on dinner and then rather than record an expense that is deducted from your total income, which would leave you $100 poorer after dinner, you instead record an asset, leaving your total wealth unaffected.
In China’s case, it is by now well agreed upon that a significant amount (and perhaps nearly all) of most public-sector investment in the past few years has been nonproductive; there has been no rise in the country’s debt-servicing capacity commensurate with the rise in debt. If Beijing were to engineer a further surge in investment, it is extremely unlikely that doing so would not result in an increase in the country’s debt burden.
Beijing’s Three Options
Consequently, if there is a forced contraction in China’s current account surplus, Beijing’s only possible response must involve one (or some combination) of three things: an increase in unemployment, an increase in the debt burden, or wealth transfers.
Beijing wants to avoid at all costs an increase in unemployment, which it has been able to do so far by maintaining high growth in economic activity. The Chinese national government also wants to rein in the growth in debt, but so far it has been unable to do so. Moreover, Beijing will not be able to rein in debt growth if it wants to avoid unemployment at least until it has managed a sufficient transfer of wealth to ordinary Chinese.
Unfortunately, rising debt is unsustainable and, at some point, Beijing will no longer be able to increase the debt fast enough to avoid a collapse in growth. It could take several more years before this happens, of course, but once it does the result will be an automatic surge in unemployment.
Put differently, over the longer run, Beijing can only avoid a sharp rise in unemployment or stagnant wage growth to the extent that it has managed to achieve significant wealth transfers. Beijing has engineered a small increase in the household share of GDP since 2012, but this has occurred far too slowly to have prevented a destabilizing surge in debt. Beijing must speed up the transfers, but it has had trouble doing so because of political opposition from so-called vested interests.
A Limited Set of Options
To recap, all of the plausible policy choices available to Beijing are limited to one or some combination of the following three options: more unemployment, more debt, or more wealth transfers. This is because China (and indeed most economies) is limited to six economic paths, of which only three are plausibly available if Beijing wants to avoid surging unemployment:
- A rise in unemployment or stagnant wages. This occurs when an economy is unable to generate sufficient growth to maintain demand for workers. (The remaining five options, by definition, do generate sufficient growth.)
- A sustainable increase in investment. This would entail additional investment such that the growth in debt-servicing capacity exceeds the growth in debt. Although this option is technically open to Beijing, achieving it has been much easier said than done over the past decade. We can reasonably assume that Beijing is no longer capable of engineering enough productive investment to keep the economy growing fast enough to prevent a rise in unemployment or wage stagnation.
- An unsustainable increase in investment. This would mean an increase in nonproductive investment (in projects whose value is less than the cost of the investment), a choice that would worsen the country’s overall debt burden. China has followed this path for the past few years but may soon reach its debt limits.
- A sustainable increase in consumption. In China’s case, this would signify an increase in the consumption share of GDP that is driven by a corresponding increase in the household income share. (And this would likely further lead to an increase in sustainable private-sector investment.) This is the goal of Chinese rebalancing— effectively transferring wealth from elites, businesses, or governments to ordinary Chinese households—but achieving it has proven very difficult politically.
- An unsustainable increase in consumption. This outcome occurs when consumption growth is driven by rising household debt, which (obviously) would worsen the overall debt burden. China has followed this path for the past three years but may soon reach its debt limits. Coincidently, this path also seems to have been the main driver of U.S. growth for the past decade or more.
- A rising current account surplus. This option is only plausibly achievable for very small economies whose rising surpluses can be easily absorbed by the global economy.
These six pathways logically cover every possible option open to Beijing. If we exclude the second and sixth options as unrealistic, and if we acknowledge that the third and fifth choices both would lead to a rising debt burden, Beijing is effectively left with the same three aforementioned options as described in the Barron’s article: an increase in unemployment (option 1), an increase in the debt burden (options 3 and 5), or greater wealth transfers (option 4).
This is no coincidence. No matter what economic event China is reacting to or what Beijing’s goal may be, once we exclude the second and sixth options above, every policy Beijing could implement must lead to one or some combination of higher unemployment, higher debt, or greater wealth transfers. This is why Beijing’s only possible response to a forced contraction in the current account surplus is also limited to these options.
Stein’s Law: What Cannot Go On Forever Will Stop
Eventually, however, one of these policies will no longer be available—the rising debt option. If Beijing does not rein in credit growth in time, it will be forced to do so once debt levels reach the point at which debt can no longer rise fast enough to maintain the country’s targeted economic growth rate. This adjustment can happen quickly, in the form of a debt crisis. Or (what I think is far more likely, at least for now) it can happen slowly, in the form of what is subsequently called a lost decade (or decades) of slow growth, similar to what Japan experienced after 1990.
There is little more to analyzing China’s economic options. Unless Beijing suddenly becomes able to do one of two things that it hasn’t been able to do in more than a decade, its options for preventing a fall in growth will be limited. That is to say, unless Beijing discovers and channels funding to huge new areas of productive investment (even as global conditions deteriorate), or unless China grows its trade surplus by several percentage points of GDP every year, this struggle will remain. And until Beijing manages substantial wealth transfers that shift income from low-consuming entities to high-consuming entities, the only way China can prevent growth from dropping sharply is temporary, by way of an unsustainable rise in debt. Once debt can no longer rise, unemployment will rise or wages will stagnate.
Some Illustrative Examples
It is worthwhile to consider how the following conditions or policy proposals would fit into this framework, the result of which is likely to be higher unemployment (via a slowing economy), more debt, or greater wealth transfers:
- China’s current account surplus contracts due to the trade war. If demand is reduced by a contraction in China’s trade surplus, either unemployment will rise or China must significantly increase the growth of its debt burden to make up for the contraction in net foreign demand (as it did between 2009 and 2011). Of course, the growth in the country’s debt burden will decline if the trade surplus expands. This is why the trade surplus is so important to China: it helps determine the growth rate of debt.
- Chinese SOEs increase dividend payments to the central government. Many economists have argued that an increase in the SOE dividend payout is key to China’s economic adjustment. But in fact, from a systemic point of view, it will have very little meaningful impact. SOE dividend payments represent a transfer of resources from SOEs to shareholders, mainly the government. As such, they mainly direct the focus of credit creation needed to generate economic activity. The greater the dividend payout, the more debt SOEs must create to generate any specific level of economic activity and the less the government must create.
- Beijing forces a reduction in credit growth. Because economic activity has become so heavily dependent on continued credit growth—whether that be household credit to boost consumption or corporate or local government credit to boost mainly nonproductive investment—a contraction in credit growth automatically causes a contraction in GDP growth. This is currently the problem Beijing faces today: in recent months, it has put substantial downward pressure on credit growth and, as a result, economic activity is slowing so rapidly that most analysts expect Beijing to panic, relent, and allow credit growth to pick up again before the end of the year.
- Beijing expands the Belt and Road Initiative (BRI). Foreign investment through the BRI can be seen mainly as a way of boosting the country’s trade surplus. To the extent that BRI financing causes an increase in net capital exports from China, it must also cause an increase in the Chinese trade and current account surpluses. As I explained in the first example above, the result will be that, for any given target level of GDP growth, China will be able to achieve it with a smaller increase in debt. The big problem, of course, is that to the extent Beijing has difficulty recovering the financing it has extended, the BRI represents a reduction in China’s net foreign asset position (that is to say that foreign assets decline relative to foreign debt). In that sense, Beijing is mainly exchanging domestic debt creation for foreign debt creation (or declining reserves).
- Beijing forces banks to increase lending to the private sector. This is proving to be much easier said than done, but to the extent that the private sector gains net new financing (that is to say, to the extent that the private sector does not merely use bank financing to pay down more expensive nonbank financing) and invests the proceeds, what matters is whether the new investment is productive or not. If it is, China will be able to maintain targeted growth levels with a smaller increase in the debt burden. If not, debt creation is simply transferred from the public sector to the private sector.
- CPI inflation rises. Rising consumer price index (CPI) inflation (which many in China believe exceeds the official numbers) undermines the real value of disposable income and so reduces the household income share of GDP. This means that rather than wealth transfers from businesses and local governments to households, we are seeing the opposite and, hence, a worsening of existing income imbalances. If that is indeed the case, because the sustainable consumption share of GDP will decline, it will take more credit growth than it otherwise would to meet the country’s GDP growth target.
- The RMB appreciates. Such appreciation has the opposite effect of rising CPI inflation. A stronger renminbi (RMB) effectively transfers wealth from the tradable goods sector and those who are long dollars (mainly the People’s Bank of China) to importers and those who are effectively short dollars (mainly households). By increasing the household share of GDP, and thus the sustainable consumption share, China can achieve its GDP growth targets with a smaller increase in debt.
- Chinese interest rates decline. Such declines have the same effect as rising CPI inflation and the opposite effect of RMB appreciation. Lower interest rates transfer wealth from net savers (mainly ordinary households) to net borrowers (mainly SOEs and local governments) and so worsen existing income imbalances. In this case, it takes more debt to achieve the GDP growth target.
- Chinese real estate prices plunge. A plunge in real estate prices would transfer wealth from those who are speculatively long real estate (mainly the rich) to those who are short (mainly the young and the poor). Apart from the potentially devastating impact on the banking system, this would cause a sustainable increase in consumption, although the adverse effect on consumer confidence could easily overwhelm this effect in the short term.
The point of these nine examples is to show that nearly any event or policy must fit into one of the six aforementioned economic options. In China’s case, this means (practically speaking) that Beijing must continuously choose between more unemployment, more debt, or more wealth transfers to the household sector. There seems to have been a serious attempt to rein in credit growth in recent quarters, but to the extent that it has been effective (and, in many cases, it has simply pushed credit growth from monitored areas to unmonitored areas), it seems to be showing up already in a weaker economy and rising unemployment. The official data do not record any slowdown in economic growth, but there is a spreading belief that the data this year seriously overstate economic activity (having long overstated real economic growth).
For the rest of 2018, I expect that we will see different groups in Beijing try to reconcile the need for slower credit growth with greater growth in economic activity. But because these two things cannot be reconciled, one group or the other must win. So far it isn’t clear whether we will see growth in economic activity continue to slow or credit growth pick up. The PMI data released on Friday suggested a stronger-than-expected pickup in manufacturing. One data point tells us nothing, but perhaps it’s a hint.
Appendix
The students in my PhD seminar have suggested that, from a policy point of view, it might be better to further subdivide some of the six economic options featured in this post. This doesn’t change the underlying framework, but it allows us to evaluate policy options more easily. Wang Xiaotong, for example, suggested that consumption should be divided into household consumption and government consumption. The students also suggested that it might make sense to divide unsustainable increases in investment into investment in rising inventory and investment in nonproductive projects. This would leave us with the following nine economic options, of which only six are plausibly available to China if it wants to avoid surging unemployment or stagnant wages:
- A rise in unemployment or stagnant wages.
- A sustainable increase in investment.
- An unsustainable increase in investment in rising inventory. This, of course, can only be sustained by rising borrowing.
- An unsustainable increase in investment in nonproductive projects.
- A sustainable increase in household consumption. In China’s case, this would mean an increase in the consumption share of GDP that is driven by a corresponding increase in the household income share.
- A sustainable increase in government consumption. For China, this would mean increased government spending on consumer goods and services funded by the sale of government assets or by higher taxes on the rich or on businesses.
- An unsustainable increase in household consumption. In China’s case, consumption growth is driven by rising household debt.
- An unsustainable increase in government consumption. For China, this would mean increased government spending on consumer goods and services funded either by debt or by higher taxes on ordinary Chinese.
- A rising current account surplus.
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Comments(92)
A looming risk is the rising amount of USD debt issued by Chinese banks & corporates. My concern is that in past USD debt wasnt a major problem, as it was funding businesses that has USD export receipts to repay the debt. This has evolved to USD issuance to fund more speculative domestic investments or other non USD related projects. China has around 3 Trillion of USD debt, rivaling its own USD reserves. There will be increased difficulty refinancing this debt in next year. I generally agree that any adjustment would be slow, akin to Japan, but I think there is a small probability that the imbalance from USD financing (which is out of control of PBOC) could cause a financial crisis. Falls in USD debt prices of Chinese issuers would also affect other USD debt prices, with the degree of inter-dependency of global markets, could mean that if China get the sniffles the rest of the world could catch the cold.
Very interesting and quite alarming comment. Can you please point to underlying data on USD denominated Chinese debt?
Very interesting. I confess I was not aware of this. Quite alarming, really - but obviously in line with what Pettis is expounding here.
And if the yuan is undervalued versus the dollar?
Dear Michael, What about massive investments in the high-technology sector? Thanks.
Finding money to invest isn't the problem, Econ researcher. Finding productive investments is. Every country seems to have targeted massive investments in high tech to turn them into technology leaders, including China, but beyond the hype, which is tarting to wear very thin in China, no one really has been able to pull it off. In China they've been talking about this for a decade, but the closer you get to Chinese high-tech entrepreneurs, it seems the greater the skepticism and even cynicism. At this point it is mostly giddy American venture capitalists who are still hyper-excited about the massive potential of Chinese high tech, but among investors and tech guys in China, they are considered pretty naive. This topic deserves a whole blog entry for itself, and maybe at some point I will make the attempt, although it is a pretty sensitive topic politically, so I am not sure ow much I want to discuss. But as a rule it is always a good idea to discount heavily most discussions about the promise of a technology bonanza.
China clearly needs to avoid a hard landing and has sufficient capacity to invest in productive investment wherever those opportunities exist. As noted in your blogs these opportunities within China have transitioned from almost unlimited two decades ago to very limited today. Poorly conceived infrastructure centric BRI investments are also undesirable for the reasons you have succinctly outlined. I wonder if a highly strategic investment drive into supporting the equally problematic transition Africa needs to undertake could provide an avenue for China much like the Marshal plan did for Europe and the US post WWII? Infrastructure and commodity extraction investment in Africa has been the strategy of choice to date but perhaps the real opportunity is something more long term and dramatic? Africa’s fundmental problem is rapid population growth and an increasing youth proportion within the demographic together with reducing employment opportunities ( and consumption demand) linked in turn to China’s reducing demand for commodities as it in turn transitions its economy away from investment. Africa’s growth has been linked directly to the recent commodity boom of course. China perhaps needs to see helping solving Africa’s fundamental problem ( by helping create sustainable employment opportunities that lead to a growing consumer class that in turn become a growing market for Chinese exports to offset US demand) offers a tangible strategic vision and opportunity that could avert a catastrophic outcome for both China and Africa in time? An innovative vision is needed for Africa that is realistic and takes cognizance of all constraints ( advances in technology and automation being clearly acknowledged constraints on employment growth along with the adverse effects of the trade wars and the unsustainable emerging market US debt burden). Africa has for example always had a large micro entrepeneur class that defaults to trading and services at a local level under all scenarios. If China could somehow channel some of its BRI capital into growing and maximizing this enormous informal sector of Africa ( everywhere one goes in Africa poor people are cheerfully trading whatever they can find to trade or providing services to whoever needs it at whatever price is affordable) it would surely be analogous to Marshal plan investment being channeled into re-building German manufacturing capacity post WWII? That became a sustainable win win for every stakeholder! What is required is creative thinking by those that can influence Chinese leadership who in turn already have a vested interest in Africa via BRICs and ongoing but limited and predominantly commodity extraction focused investment? Africa needs a plausible vision and strategy as much China needs to transition its economy. Out there sits a PhD student or two with the potential to solve this dual conundrum via a flash of brilliant/visionary insight?
This is a very important topic, Andrew. Presumably the great advantage of living in a world in which so many economies are awash in excess savings is that this should be great for those countries (most developing countries) that suffer from low investment and savings constraints. The problem, of course, is that investing in developing countries is very risky, and in the past 100 years nearly every developing country that received sufficiently large investment inflows subsequently suffered from debt crises or stagnation that reversed much of the original benefit. Part of the problem may be that these countries are simply unable to absorb large amounts of foreign capital quickly and productively, but in the 19th century developing economies absorbed quite a lot more foreign capital much more productively than they seem to do today. It is not that they didn’t have debt crises then – they certainly did – but on the whole investing in developing countries was productive for both the capital-exporting and the capital-importing countries. We need to figure out why things seemed to work better 100 years earlier than they do today and, more generally, how to channel large amounts of excess savings from advanced economies into productive investments in developing economies. Perhaps institutions were more appropriate back then, for example private sector flows may have done a better job than official flows or bank flows. Perhaps the forms in which capital flowed were less disruptive, for example investment flows in the 19th Century often took the form of FDI or equity, versus mainly debt in the 20th, and perhaps other forms of capital flows are even more efficient, such as workers’ remittances. Perhaps colonialism made the difference, in which case is there some way to replicate the investment advantages of colonialism without replicating its politics? Whatever the answer, this seems to me to be among the most important questions that economists should be trying to answer.
Hi Michael. Great work, as always - and most unsettling to boot for its geopolitical implications. With regard to the "productivity" (that is to say, profitability) of Western capitalist investments in the 19th Century, it seems to me that Professor De Cecco (of 'Money and Empire' fame, as you know) would argue that back then those profits could be absorbed back in the West - because of expanding populations there (US and Western Europe). In other words, investments in the periphery were profitable because they provided wage goods for expanding working populations in the West. That is no longer the case, of course. Cheers.
Michael, Colonialism certainly didn't do much to faciliate productive investment in those developing countries where the majority of the colonized had a different skin color/ethnicity than the colonizers. The only cases in which colonialism succeeded is when the colonized and the colonizers both shared some ethnic as well as cultural similarities.
Hi Michael. Great work, as always - and most unsettling to boot for its geopolitical implications. With regard to the "productivity" (that is to say, profitability) of Western capitalist investments in the 19th Century, it seems to me that Professor De Cecco (of 'Money and Empire' fame, as you know) would argue that back then those profits could be absorbed back in the West - because of expanding populations there (US and Western Europe). In other words, investments in the periphery were profitable because they provided wage goods for expanding working populations in the West. That is no longer the case, of course. Cheers.
Michael: I wonder if the pace of integration under terms of the decrease of size of world via technology and telecommunications is an additive problem. There seems in the developing world a faddishness to investment (types) and repetition of similar types of investment and then quick attrition and movement. With spread of these (ICT), the pace of atrrition is increasing. THen I suspect, additionallly, or more primarily, FDI and equity as opposed to debt. Also, likely higher wages implicated, and ongoing industrialization in high wage domiciles concurrently. Further, there might be some issue as to population, Considering the near vertical rise from around 100 years ago, and before. KhiKhi.... The current fad of critical theoretical non-sense may drive to knee jerk reactions and notions of Michael referencing, something positive of a commonly agreed horrid practice, in the interest of understanding the rather more important issue of development, more generally as we all are very well aware of a preoccupation with decolonization in recent years. As many of us were decades ago at far earlier stages of our study. But for us, here we are talking Global Economics, Finance and Development and how it can be achieved sustainably, which to us is rather more important than current popular themes in the modern media and lessor academia. Jut to be clear, and if you are cognizant, Michael was speaking to trade within colonial systems, and flows between, as perhaps implicated in previous success (as they were more successful). Many misunderstanding of this fact would only confound the issue, as many of these same, might believe, under premises of an equally specious globalization narrative, that the world was globalized 100 years ago, rather than consistent of closed imperial trading regimes. Which was the point of Michael's mentioning, something serious reviewers understand. Then, it is important for Michael to mention these, as we are concerned about the real potential of development of understanding, rather than assuring that those less-cognizant have their self-imposed belief-based constraints maintained.
Expanding populations can certainly help absorb overinvestment, Joseph, but it isn't enough. After all Brazil in the 1960s and 1970s had a rapidly expanding population, but in the end they too suffered from overinvestment and debt in the 1980s. You are the right that it helps, but it doesn't really address the fundamental problem. And while I think racism helped determine how the benefits of growth were distributed, Khichuri , I suspect that whether or not colonial investment was positive for long-term productivity growth might have had more to do with whether investment opportunities were in extractive industries or not. In countries in which the best investment opportunities were in mining or in producing a major cash crop, like sugar, cotton or coffee, foreign investment was profitable but does not seem to have led to long-term productivity growth. it tended to reinforce the extractive economy.
This is for Dr. Pettis on this subject. I would say that any economist study on this subject should include a political professor. It would be vastly informative as to why investments are not made in countries with political instability. Many African nations are land locked with no means of cheap transportation of goods produced plus they may be surrounded by nations that are unstable. This brings me to the "silk Road" in Africa. China is making a major investment there and it may not work because they are forcing nations to agreements that they may never repay. This would put another nail into the debt coffin.
China's highest levels of savings and investment followed (and were made possible by) rather than preceded its most rapid period of growth. Rural entreprenuership jumpstarted China's growth in the 1980s, while heavy infrastructure investment followed. Yet, the China model being promoted via the BRI puts infrastructure first. Also, China's funded the build-out of its infrastructure from domestic savings. As Michael suggests, China has stuck with this phase for too long. But the BRI encourages infrastructure construction funded with external debt, much as in Latin American during the 1980s. This again reverses China's experience. Also, China's infrastructure investment laid the basis for a diverse manufacturing base while the BRI is mostly strengthening rentier states. Whatever the BRI is, it is not a replicate of China's actual experience.
1."Chinese real estate prices plunge. A plunge in real estate prices would transfer wealth from those who are speculatively long real estate (mainly the rich) to those who are short (mainly the young and the poor). Apart from the potentially devastating impact on the banking system, this would cause a sustainable increase in consumption, although the adverse effect on consumer confidence could easily overwhelm this effect in the short term." I think there are far too many assumptions in this paragraph. 1. That only the rich are speculative. That is so, so not true. Everyone and their cousin have loans to purchase this golden asset that "will not be allowed to fall". We're talking here at the minimum lower middle class. So, apartment prices would fall and the banks then will give mortgage loans to the poor? Everyone and their sister (sorry) would try and find a way to move money out of the country and buy RE abroad. What would happen then? There is some basis bias here. People consume NOW because they see this precious asset increasing in price and assume it will continue to do so. They know they cannot rely on their pensions. They take on personal debt. What's going to happen when they realize it ain't so? The poor, BTW, still need their life savings to pay for health care and education. And what does "short term" mean? 3-5 years? And won't the bubble just repeat itself? So, it's clear it's difficult for me to exactly point out the issue here but the impact surely will be tremdous.
"I think there are far too many assumptions in this paragraph... That only the rich are speculative. " The only necessary assumptions here seem extremely plausible and even obvious: a)on average people who own more real estate are richer than people who don't, and b)on average they are more likely to own real estate as investment rather than as residence.
This is a reply to Prof. Pettis, for some reason it does not allow to reply to his posts directly. ": a)on average people who own more real estate are richer than people who don't, and b)on average they are more likely to own real estate as investment rather than as residence." This is a strawman argument. China home ownership is at about 90%. So you are saying that the 90% is richer than the 10%. OK. Lets get back to the main argument: You wrote: "A plunge in real estate prices would transfer wealth from those who are speculatively long real estate (mainly the rich) to those who are short (mainly the young and the poor). Apart from the potentially devastating impact on the banking system, this would cause a sustainable increase in consumption, " My point was, that China home ownership is so high and that even lower middle class and the poor find ways to speculate in RE with DEBT, via family or shadow banking that the impact of a plunge in real estate prices will be not as you describe it.
If you read Michaels other posts. Which you should, if even to review how useful or correct, prior to occurrence of what subsequently would happen, Michael's intuitions and models have been, you would see the great depth of discussion previously had on this issue. Certainly not of that which you imagine, as Micahel has shown rather easily. I suspect Michael, in this switching to consumption, is speaking partially to reality, and partially to desire, insofar as a way, conceivably that rebalancing can work. Of course re-balancing. of a redistribution will have some impact. As he notes, it is one of the only ways to avoid other calamities of extenuation of current trends. I suspect, this is part realization of a way, and a desire on Michael's part, as I wonder of the propensity to consume in declining environments of previous modes of growth, and the uncertainties introduced by this. But that some re-balancing of this trend should occur, or who has what, in what systemically important proportions, then of course Michael's models are highly relevant, and some of the least likely to be held of contradictions, due to their simplicity and how solid Michael's reasoning is. Such is why most of his long-term reviewers still read him, as we, mostly learned his models long-ago. His s**t is tight. Like an intoxicating baseline in a world of synth-pop.
John That is true, that those who aren't as wealthy, may speculate. They may even feel the pain of losses more. But due to access to capital constraints, and due to grave income inequality, and the recency of consumer debt, of course there are segments of population who are the drivers of the system, all know this. For example 7 trillion lost in US in GFC. 5 of 7 High Net Worth losses. Will be a simialr, if not more exacerbated situation in China. Now I suspect that transfers won't be as useful, while still necessary, because of the psychological impact of recent grwoth, and the uncertainties faced as rebalancing occurs. But who will see transfers,a re well discussed previously, merely review the extensive addressing of this topic in previous writings over the last, 7 years or so, I suspect. The theme has been discussed and developed at length. Felt pain depper likely for average, both those to see resources transferred small percentage, even with marginal speculation, relative to load of speculation, among middle and lower classes.
It isn't a straw man argument, John. Almost all the real estate price increases have occurred in urban real estate, and obviously this is what matters when we talk about a plunge in real estate prices. China's higher rate of home ownership is based mainly on rural home ownership (which, by the way, isn't 90%). The math is pretty obvious and quite simple. With over half of China now living in urban areas, the fact that many migrant workers own a small piece of farmland back home of very low value is largely irrelevant. Residents in a city without a hukou have a home ownership rate of close to zero. I figure that you must live in China -- on the assumption that someone who has no experience at all of the country would be embarrassed to make such assertive remarks – and I am frankly astonished that anyone who lives in China could possibly believe that real estate is distributed in such a way that a collapse in real estate prices would not result in a massive transfer of wealth from rich to poor. Where in China do you live?
1."There is no question that China will have a difficult adjustment, but it is likely to take the form of a long process rather than a sudden crisis." 2. "Beijing forces banks to increase lending to the private sector. This is proving to be much easier said than done" This is a contradiction. To my understanding "Argument 1" is mostly due to the claim that the four big banks are actually just the Government's bank and thus it is unlikely we shall see a financial crisis. This is negated by Argument 2. Are we to assume that for these institutions it's so difficult to increase lending to the private sector but somehow it will be easy enough for them to avoid a financial crisis? This does not make any sense to me.
I am not sure why it is so hard to understand, John. Please explain.
This is a reply to Prof. Pettis question: " I am not sure why it is so hard to understand, John. Please explain." I'll play along. You wrote: "Beijing forces banks to increase lending to the private sector. This is proving to be much easier said than done" YOU are saying that Beijing is unable to force the bank to land to the private sector. So, tomorrow if there will be a chance for a financial crisis, this is the SAME Beijing that will order the banks to act in a certain way. The SAME Beijing that is unable to force the bank to do what its want, according to what you wrote. By common sense, if they are unable to do it today they will be unable to do it tomorrow when it's much more difficult. Again, this is based on what you wrote. So, if on the other hand Beijing is not really trying at all it's a different story.
No need to play along, John, just to understand how banks work at a very basic level. My claim that regulators can probably prevent a crisis doesn’t at all contradict my other claim about their inability to force banks to lend to the private sector. Your confusion of these two things suggest to me that you don’t really understand banking enough to have a serious objection. Preventing a crisis means preventing a sudden collapse in liabilities. Why must this imply an ability to force growth in a particular type of asset? This is such a silly statement that it is even hard to figure how to answer it.
Guess what John? You don't understand cause you don't want to understand. You're angry. You're being perverse. You want to negate, frustrate, thwart.
1. You are right, it's not 90%, it's more at 80%. 2. Prices have sky rocketed at 3rd , 4th and 5th tiers as well. Tiny litte towns now have villas and condominiums these days. 3. You need to recall the wealth gap. The true poor which you describe, make perhaps several hundred RMB a month as you describe (such as growing tee), perhaps a thousand RMB. Lets say RE prices crash. How would that make them wealthier? They still would not be able to purchase any significant RE. More than that, their income would be reduced as well. I still do not think you appreciate the investment of middle and lower class in RE. 4. About 2-3 years ago you said the debt limit will be reached in about 3 years, any update? 5. "My claim that regulators can probably prevent a crisis doesn’t at all contradict my other claim about their inability to force banks to lend to the private sector. " 5.1 so now it's downgraded to "can probably", so basically like any other country? 5.2 there is another post by yourself where you link directly this ability to the fact that the 4 big banks are in fact the same as the gov, allowing better control in avoiding a crisis. I will try to look it up. 5.3 Since you posted this, new regulation came out regarding lawns to small/medium businesses. Bank stocks started to crash, due to fear of loans quality. Then, clarifyication came out that it's not mandatory.
Thank you Mr Pettis for another excellent and concise essay on Chinese economics. In this essay, you briefly mentioned the lost decade(s) of Japan since 1990. However, as suggested by some, it is only a myth that Japan ever experienced a stagnation since the high unemployment that usually accompanies such a scenario never occurred in Japan. I would be interested to know your view on this. Thank you again for your great works!
I think the "lost decade" refers to anemic GDP growth over that period. However, the average individual did fine, as assets shifted from the gov't/business sector over to the household sector (so the average person attained a larger portion of a similarly-sized pie).
Speaking of Japan, though, if China gets into a trade war with the US, presumably the price of Chinese exports would drop as they flood whatever other market is left to absorb those goods, thereby crowding out Japanese, Korean, and European exports to the degree possible (?)
The Japanese economy grew by an average of less than 0.5% annually during the two-decade period, Zhao, following decades of growth more than ten times that rate. But you are right that this didn't show up in the form of unemployment. Remember that Japan actually rebalanced during this period, which means that household income growth outpaced GDP growth, a point I have made many times before and which suggests that even if (when) Chinese GDP growth drops to below 2-3%, as long as the economy genuinely rebalances, household income can grow much faster (perhaps 4-5%?). The point is that in China rebalancing requires a transfer of wealth from local governments and elites to ordinary households, which is why I say that wealth transfers are the the only way to prevent the choice being limited to rising debt and rising unemployment. We always fall back to the same three choices.
That's exactly right, Claire.
To me the BRI initiative makes the most sense for 2 reasons: 1) it allows China to export its excess savings thus not increasing unemployment 2) it raises debt, but not at home 3) it will increase trade surplus but only down the road - since the payments for these projects (debt) will only occur in the future. I doubt that this debt will ever get paid back fully as it's doubtful that many of these projects are productive investments, but it does reduce overinvestment and debt buildup at home and kicks this off to recipient countries. The question now becomes how much of these investments are productive? Definitely many of these countries in Africa and Central Asia are starved for capital so perhaps this can work out. Maybe a sign of this will be to look out for increases in BRI projects over the next several years?
BRI was little more, last year, than Thailands FDI into South East Asia, at 14 billion USD. Where does China get the Capital for BRI? Especially with what is happening in Pakistan, Venezuela, to mention nothing of Sri Lanka or some African States? If fairly recent to watching China, one might imagine Chinese investments into Central Asia as BRI, but of course 15 years ago, one would have been merely talking of Chinese investments to diversify Energy Suppliers (and perhaps to dilute Russian power in the region).
Michael, You’ve repeated said in your writings that the only way to recover quickly from a financial or debt crisis is to quickly and decisively apportion the losses. But you have also said that if this happens in China, it won’t be as serious a crisis as it would be elsewhere because the Chinese state will essentially absorb (socialize) the losses If China continues on its present path of increasing debt until Stein’s law is triggered, the Chinese State will ultimately be forced to apportion the losses. The only entities capable of accepting those losses, by design or by default, will be “the rich, private businesses, state-owned enterprises (SOEs), or central or local governments:” the vested interests or are currently resisting redistribution. This will be a de facto redistribution of income. It will just be later, but less organized, on a larger scale, and probably accompanied by more social unrest. On the other hand, the Government is supposed to be run by card-carrying, income-redistributing, water-fluoridating commies. Do they still need the SOEs? (You need to explaining better why they can’t nationalized.) Let’s say that the SOE’s were milked by some combination of dividend extraction or subsidy reduction of 5% of annual GDP. How many millions of retirement home spaces could be built in China’s interior provinces for the parents of workers in the coastal provinces? If you are an elderly Chinese peasant who lived through the Great Leap Forward and the Cultural Revolution, any facility with hot-and-cold running water, central heat, and a clinic is a palace. That is a huge burden off their adult children and buys lots of social harmony. (Am I naive?) It’s also something at which the Chinese Government would probably be quite proficient and would support lots of jobs and absorb all the steel capacity that ticks off trading partners. By trying to finance housing and other consumption by lending, they are providing the rich with assets (claims on borrowers), but without much more income in the future, many borrowers will default (income redistribution). Transferring the purchasing power outright and up front is so much more organized.
It’s a good point, Kevin, but we are left with the same systemic problem. If SOEs (which BTW can’t really be nationalized because they are already government owned) were able to generate profits of 5% of GDP that were to be distributed to the household sector, that would only be a good thing if those profits were generated by massive amounts of productive investment. If they weren’t, they would be generated simply by implicit transfers from some other sector, ultimately the household sector, through subsidized interest rates, monopoly pricing, subsidized energy or other costs, etc. In fact much if not most SOE profitability in the past decade can be explained by these various transfers. SOEs are not considered by anyone has having been especially productive in the past decade. That leaves with two possibilities. In the latter case wealth is transferred from households to SOEs to allow them to generate the profits that are subsequently transferred back to households. Nothing has really happened on a net basis, in that case (except perhaps the creation of additional opportunities for corruption and rent seeking). In the former case we are implicitly assuming that there is a huge amount of productive investment into which SOEs can invest. Of course we cannot really make that assumption, and anyway of we did we’d have to ask why haven’t they already done so. This is why I find my framework useful. Once you think of the economy as an overall system in which all activity either creates wealth, destroys wealth, or transfers wealth, it becomes much easier to trace the various paths that China can follow.
It’s a good point, Kevin, but we are left with the same systemic problem. If SOEs (which BTW can’t really be nationalized because they are already government owned) were able to generate profits of 5% of GDP that were to be distributed to the household sector, that would only be a good thing if those profits were generated by massive amounts of productive investment. If they weren’t, they would be generated simply by implicit transfers from some other sector, ultimately the household sector, through subsidized interest rates, monopoly pricing, subsidized energy or other costs, etc. In fact much if not most SOE profitability in the past decade can be explained by these various transfers. SOEs are not considered by anyone has having been especially productive in the past decade. That leaves with two possibilities. In the latter case wealth is transferred from households to SOEs to allow them to generate the profits that are subsequently transferred back to households. Nothing has really happened on a net basis, in that case (except perhaps the creation of additional opportunities for corruption and rent seeking). In the former case we are implicitly assuming that there is a huge amount of productive investment into which SOEs can invest. Of course we cannot really make that assumption, and anyway of we did we’d have to ask why haven’t they already done so. This is why I find my framework useful. Once you think of the economy as an overall system in which all activity either creates wealth, destroys wealth, or transfers wealth, it becomes much easier to trace the various paths that China can follow.
Michael, You’ve repeated said in your writings that the only way to recover quickly from a financial or debt crisis is to quickly and decisively apportion the losses. But you have also said that if this happens in China, it won’t be as serious a crisis as it would be elsewhere because the Chinese state will essentially absorb (socialize) the losses If China continues on its present path of increasing debt until Stein’s law is triggered, the Chinese State will ultimately be forced to apportion the losses. The only entities capable of accepting those losses, by design or by default, will be “the rich, private businesses, state-owned enterprises (SOEs), or central or local governments:” the vested interests or are currently resisting redistribution. This will be a de facto redistribution of income. It will just be later, but less organized, on a larger scale, and probably accompanied by more social unrest. On the other hand, the Government is supposed to be run by card-carrying, income-redistributing, water-fluoridating commies. Do they still need the SOEs? (You need to explaining better why they can’t nationalized.) Let’s say that the SOE’s were milked by some combination of dividend extraction or subsidy reduction of 5% of annual GDP. How many millions of retirement home spaces could be built in China’s interior provinces for the parents of workers in the coastal provinces? If you are an elderly Chinese peasant who lived through the Great Leap Forward and the Cultural Revolution, any facility with hot-and-cold running water, central heat, and a clinic is a palace. That is a huge burden off their adult children and buys lots of social harmony. (Am I naive?) It’s also something at which the Chinese Government would probably be quite proficient and would support lots of jobs and absorb all the steel capacity that ticks off trading partners. By trying to finance housing and other consumption by lending, they are providing the rich with assets (claims on borrowers), but without much more income in the future, many borrowers will default (income redistribution). Transferring the purchasing power outright and up front is so much more organized.
The chinese people save so much because they have NO safety net. To "Reduce savings by boosting consumption" the chinese govt. must either a)provide a social and medical safety net as in most of Europe, or b)frighten people into spending by devaluation. Can they afford the first? That would be govt. 'of, by, & for the people', so, not happening. They surely can't afford the consequences of the second. Screwed.
No, Roland, this is a very common misperception. As I have pointed out many times before, China has among the highest savings rates in the world mainly because Chinese households retain among the lowest GDP shares in the world. High savings reflect a distortion in the distribution of income, not especially high savings preferences.
I find it increasingly appropriate that you write from an organization for international peace because the political battle for « the great rebalancing » of the distorted world economy has now started and already shows, still in its early phase, an inordinate amount of ferocity. From your logic - which seems robust - the economic interests of ordinary US households and ordinary Chinese households seem quite aligned. Their true political friends are not necessarily those presented as such in the ongoing judiciary and media war, perhaps an effect of the vested interests at work. It is to be expected that this battle will be ferocious since we are talking about the possible reallocation of about 4pts of global annual income or roughly $3000 billions dollars p.a. or a capitalized asset value of approximately $16Tr. It is telling that $16Tr is about the amount of monetary creation central banks have collectively conducted this past 10 years. It is as if central banks had collectively wanted - more or less consciously - to facilitate the reallocation of $16Tr worth of asset value by injecting this amount in the system. Depending on who benefited most from these monetary injections, central banks might have either helped or made the problem worse, we will find out soon enough. In any case, $16Tr is certainly worth a big fight from the beneficiaries of the current allocation, a rather unlikely coalition of communist and capitalist interests, and all indications point to a ferocious external and internal battle. It is truly impossible to say at this point who might win, nor at what price. In this context, we have to thank you for keeping a cool head and laying out a possible way towards a peaceful, orderly and expansive (ie. non-recessive) rebalancing. Let’s hope you are being heard in the right places
Thanks, DVD. My book, coming out next September, will make that point very strongly, I hope. This is not about China versus the US or Germany versus Spain. This is about certain sectors in each economy who are losing out to other sectors.
Excellent point made by DVD here, if I may. The feature of Michael’s work that I found to be most appealing (for me) and enlightened (for all humans of good will) was his emphasis on the analytical distinction between ‘firms’ (especially SOEs in China) and ‘households’ (meaning ‘workers’, of course). I think now is the time to give thanks to Michael for his outstanding work which anticipated the insuperable quandaries of the Chinese economy long before all sorts of other ‘economic pundits’ joined him - in a culpable belated manner, I suggest, the kind of contemptible me-tooism that Michael has always honourably eschewed. I do not mean to sanctify, but I think we ought to give deserved credit to Michael for his unstinting professional honesty. Regards to all readers.
Thanks, Joseph. The working title for the new book (although we will probably change it before it comes out) is "Trade Wars are Class Wars".
I'm thinking China might be able to re-balance by upping household share to 50% of GDP, getting the US to finance North Korean development (eg US loan NK $USD) with a large share of the $USD loaned going to Chinese businesses. That could help with the current developing-markets $USD shortage. If I understand correctly this would reduce Chinese savings and would be neutral to positive on employment. Also would be neutral toward US-China Trade balance.
Professor Pettis, One thing I'm trying to understand is how to think about the present value of investments rendering them "productive" or "nonproductive." I am very familiar with the concept in corporate finance terms, but it seems like under the conditions you describe, interest rates are either set artificially or otherwise manipulated (e.g., capital controls, limitations on access to alternative financial products). My sense is that non-productive investment could actually be accretive to GDP growth so long as the return is positive in real terms; however, the cost is borne by the households who receive a lower income share. In a purely market oriented economy, I guess they would allocate a larger share to consumption at that interest rate. If you have external financing, then I would think you can't play around with this forced saving and the debt capacity constraint is more rigid. The crux of my question: is the appropriate discount rate for this kind of decision based on the equilibrium rate in the absence of financial repression or other artificial constraints?
Yes, Steve. You have to discount all the returns on investment (including externalities, which are hard to value) at some equilibrium interest rate. If the interest rate is lower, or higher, it simply represents a transfer from net depositors to the borrower, or vice versa, without otherwise affecting the social value of the investment.
A bit off topic, but: Have you read Yanis Varoufakis' Adults in the room? Appalling insight into how Europe functions.
Yes. Great book. Terrible what was done to Greece.
Yes I have, Dan, and in fact met him a few months ago and am trying to bring him to China. He wrote a very nice review of my book and we find that although we come from different political traditions, we overlap a great deal in our understanding of global imbalances.
Yes I have, Dan, and in fact met him a few months ago and am trying to bring him to China. He wrote a very nice review of my book and we find that although we come from different political traditions, we overlap a great deal in our understanding of global imbalances.
Mike. Very much looking forward to your new book. Been busy, but wanted to weigh in. I'm pessimistic. Certainly more than you. You see people as basically good, but sometimes missing the mark, as having acted wholesomely in the past, but at this point just not there yet. To me, these things always move to the crisis point and a resolution for the temporary symptoms but not the underlying source - the underlying greed and selfishness of people, the lust for wealth and power - their refusal to acknowledge and accept that as part of their makeup. Will China rebalance? Yes, but it will be something that happens to them. Don't expect the "vested interest," the wealthy and the powerful, to share - it does nothing for them, they view it as a degradation, demotion, deprivation. All the past decades just wetted their appetite for triumph and power. They're capitalists, bent on accumulation of wealth and power to themselves, using their domestic population as a military force against their neighbors. Why share? You covet the wealth and power of others - that's why they always need markets - to use the subjugation and subordination of the domestic population as a means of acquiring the wealth and power possessed by others in foreign lands. Is there any wonder for war?
In many European countries, also in the US, there is such a growing gap between rich and poor, that I sometimes wonder how come there is not more social unrest. However, social welfare, specially in Europe, seems to keep the population relatively peaceful. Nevertheless, you can be a citizen in some of the PIGS, without job or other income, and still have a better life than your grandfathers - you have publich health insurance, a house, subsidies to help you pay the bills, and peace.
Prof. Pettis, I do not think the world can wait for a decade or more for the chinese economy to re-balance. It has been 10 years since the financial crisis and political extremism is taking over Europe and the USA, if we continue under the same situation (low growth) the world is going to explode way before 10 years are passed.
I don't think China can wait ten years either, Carlos. Most of us agree that China’s debt is at least 300% of its GDP, and if you believe, as I do, that growth in reported GDP has overstated growth in debt-servicing capacity for at least a decade, the debt-to-debt-servicing-capacity ratio is much greater than the debt-to-GDP ratio. After much squeezing and pushing Beijing has managed to get TSF to grow “only” 2-3 percentage points faster than nominal GDP, although real debt is almost certainly growing much faster than TSF. So if we assume that in the future debt will only grow faster than nominal GDP by 3 percentage points, and that there is no acceleration in credit growth to maintain a given unit of GDP growth (and historically, there always has been), after ten more years of this China’s debt-to-GDP ratio will hit 390%. If you assume, more realistically, that in the future debt will grow 5-7 percentage points faster than nominal GDP, it hits 460% to 540%. No rich country has sustained this level of debt without succumbing, and of course poor countries have historically been unable to sustain the same debt levels as rich countries. China must rebalance faster than that, and it will, but the question is whether or not it does so in a disruptive way.
Prof. Pettis, Thank you for your clarification.
Ambrose Evans-Pritchard in the Daily Telegraph (19/09/18) says "The state-controlled banking system can roll over bad debts for as long as it wants, albeit at a cost of lost dynamism." I am not sure what he means by "lost dynamism", but he states that there is no limit to China's capacity to increase debt. Michael Pettis said (blog, November 2016) that Chinese debt "can rise until credit growth can no longer be forced up to the point where it can be used to roll over existing debt with enough margin fully to fund as much new economic activity that Beijing targets". But how do we know that there exists such a point? What I cannot grasp is the nature of the limit to Chinese debt creation. Chinese debt is in its own currency - it can create enough of this to roll over existing debt and start new projects and can do so indefinitely. The only limit I can see is inflation. But then I think of Japan and am not so sure (and post GFC government debt has been rising steeply everywhere). I would love to see a blog post with an analysis of this - what is the limit of the "more debt" strategy, how might it unfold? (Or if there already is one I have missed, then the link :-))
The World is fine. Adjustments are being made. Large countries can take fifty years to address an issue with little consequence. The current situation is like a one-check-party in an expensive restaurant. All the rich dinners wait around till one of them gets tired of waiting and pays the check. China has lots of options and has just started. With better terms Russia and India could replace the US as China trading partners. That is what Ruble, Rupee, Yuan direct payments implies. China Banking would have to take on risk that they are now using the US Federal Reserve to side-step. Could happen. Especially if Hong Kong is turned loose in that direction.
DVD. Just read your post. I associate myself with your sentiments regarding Mike. Just read my post. Somebody has to be the pessimistic realist.
Hi Michael, very nice paper. I have two questions. 1. If Beijing try to force the wealth transfer, what economic measures should they take? 2. If Beijing try to maintain managed inflation accompanied with controlled contraction, how is it likely to grow out of debt for the long time?
I am not sure I understand your second question, Bin, but to address the first, there are many ways to effectuate wealth transfers from local governments and elites to ordinary households. Many of them -- greater government spending on education and health, healthier pension funds, eliminating the hukou -- were in fact proposed during the Third Plenum of October 2013. Others, like privatizing local government assets and using the proceeds to pay down debt, or employing a form of debt-equity swap unlike what is currently occurring, are being discussed but haven't been implemented. One way or the other I suspect all these different ways will be used to some extent because the problem is too big and the extent of the transfers too significant to be resolved in only a few forms.
Hi Michael, thanks for your explanation. It seems that the fiscal policy dramatically changed after this July. The bond issuance and fiscal deficit increased dramatically. It seems that Beijing wants to control debt growth rather than solve the debt issue. How much debt do you think is the limitation of the total capacity? And also, if debt accumulates too much, what will be more likely based on current political structure, deflationary depression or inflationary depression?
Actually, I am sort of curious how "vested interests" can block/have blocked any of the changes that would cause rebalancing. Without those vested interests having control over the exchange rate or tax rate or tax distribution mechanisms, what mechanisms do they have to force wealth in a particular direction (that would be sufficiently large to counter the actions of the central banks, etc)? I'm sure this is obvious to somebody--I just don't know China's system well enough to understand the details
...what is the limit of the "more debt" strategy... Collateral. Clear title. Accounting. Long term goals become improbable when debt become too large a percentage of GDP.
"growing gap between rich and poor" : The gap is account records in data-bases. If someone doesn't want fancy foods, exotic travel, and mind games exclusive to the rich then there is no gap in the US. Currently poverty in the US is caused by items that are termed mental-health-issues or drug-abuse-issues. Most homeless are not as powerless and oppressed as they are represented in the media. Why did Mr Marshall love Anna Nicole Smith? Much more complex than a gold digger story.
I sometimes watch vlogs posted by ADVChina on YouTube. Recently they posted "China is now more expensive than the USA." Watching that video I get the strong impression that taking into account average incomes n China and what apartments cost, what reasonable food costs, and what a car costs, then if we are talking about Tier 1 and Tier 2 cities China is more expensive than living in the rough equivalent of a Tier 3 city in the United States. If this is correct, well then this is a dramatic change, and it would also suggest, or at least ask the question, if instead of an increasing household share, the reverse is occurring. That is wealth is actually being drained from the households. I realize this is a difficult question to answer, because as with everywhere, not just China, it is difficult to get accurate and unbiased economic numbers. It also sounds like the younger generation are being forced to take on immense debts just to have a small apartment in Tier 1 and Tier 2 cities. If there should be a real estate collapse, is there any mechanism to allow individuals to go bankrupt? Or are they going to be expected to pay off a staggering debt the rest of their lives and regardless of their ability to pay?
Hugs, how long you been on food stamps?
Yok and Hugs: What exists in the US is of what we have done for the system. The system does not benefit evolution's in our Real Economy, and only drives short term, and layers longer term, distortions in the Financial economy that seem beneficial. We are reversing these trends. We have many excluded options, excluded merely of philosophical grounding. We are starting to gain a new center around altering our open-ness. For example, for me, as a statement, I do not buy anything beyond unmentionables and food products produced in US new. I buy everything thrift, not because I can't buy them new, but because I will deliver my revenues to the single mothers working in thrift stores, plain and simple. Many imagine, we can't do so many things, when clearly, we can and are. Our alteration might actually be what allows others to see what is at stake and what they might want to do than use rhetoric to norm entrap. With that said, .... Food stamps are income based against family size. Many people who are earning a decent living may require food stamps or health care assistance (CHIP) for kids. Of the financialization of the economy, and of the problems associated with the division of income of over-financialization and openness to trade, wages in the US have been held down. Of these influences Hugs, or you, Yok, might be on food stamps, and to most Americans, this is not a stigma. For those who haven't yet begun to understand the dynamics in play that distort the economy, run-up asset prices, run-up debt and lead to weakening real economy dynamics because of the supposed gains of mere numbers on spreadsheets in computers, more and more Americans, coupled to unfettered immigration and constant amnesties over three decades, have seen their wages depressed. This, as Michael has shown is as to how income is shared in the economy. Of course an unequal wealth and income dynamic is to be encouraged, as unequal as it has become is disastrous, the Financial cum Economic philosophy that has predominated in some circles, disastrous for themselves and others. It amazes me how asset prices and debt become unsurportable by revenues able to be driven by wages (globally) in the US and how some are expected to raise families on wages that seem less than those I earned as a 16 year old boy a couple decades ago (admittedly I had a well paying teenage job) . Farmers worried of not selling soybeans, no problem more fresh foods for Food Deserts, Dairies of Milk, more government cheese. The pendulum swings, as someone who likes to discuss on this board over the years, get with the future, and real economy and consumption driven by operations of the real rather than, merely, the financial economy. Get out front, rather than yesterdays dead memes; that emperor wore no clothes .
Hugs. I was responding to your post "there is no gap between rich and poor if you take out..... Most homeless are not as powerless and oppressed as they...." That's nonsense! The homeless aren't powerless? Then why can't they improve their lives? I asked "Hugs, how long you been on welfare?" cause if you ain't there, and never been there, well, you don't really know. And Hugs, you don't know what it's like to be on food stamps. I'll bet you don't know what it's like to need food stamps, to need food, to be chronically hungry.
Yok Chronically hungry. As a former social worker, there is not a possibility to be hungry in the United States if you are not a drug addict or mentally ill. There are literally dozens of organizations from Churches to Government Agencies to Food Banks and Neighbors and Friends. Another (2) population(s) that comes to mind might be single parents without time to get to the sites where plentiful resources are available. Others who do not want to take any assistance due to esteem concerns. Chronic hunger, if children, only of addicted or neglectful parents. Chronic hunger, if adult, only of mental illness, drug addiction or esteem issues. Food stamps and other automatic stabilizers highly useful, and perhaps moral. More focus on real economy rather than financial economy less need for automatic stabilizers except for occasional crisis.
Mr Stevens. I consider all the things you describe as good things. I don't consider going to the food bank, picking up my food stamps, riding a public bus to my job at McDonalds, going home to my low-income public housing or the low rent apartment I have on the same level as "Lifestyles of the Rich and Famous" minus the luxury.
Yok Have you ever lived in another country? Cstevens point was to describe the situation as is. There is a great difference between chronic hunger and Lifestyles of the Rich and Famous. Hugs, homeless. For some it is a choice. I gave a 2 hour ride, bought lunch and had my sunglasses stolen from me, after giving a 20 dollar bill to a young modern Hobo with a bible who train hops around the country. For others it is due to mental illness and alcoholism and drug abuse. Powerless, some. The main problem is the inability to provide an address, having a place to clean your clothese and a warm place to sleep in cold weather. Such is why there are so many homeless in warm places. They literally travel to them, and often move with the seasons. Some homeless have made extremely interesting life choices. Others of some illness (drugs, alcohol and mental) have few choices. Then there are youth fleeing broken homes. Powerlessness and limited choices usually come from inability to provide an address to get a job and to clean oneself easily. Often shelters have curfews and that limits work opportunities. By providing services for cleaning clothes and hygiene (showers), even if people sleep outside, those not suffering a debilitating illness could more easily find themselves in better conditions. If cities implement programs on an ad hoc basis, rather than a coordinated effort from the center, as a national program to enable movement to self-sufficiency, than you will see homeless populations migrate as with good climate. The cost of a bus ticket is often much cheaper than a hotel. This of course is a problem that should be addressed, but we need to discuss it adequately TO UNDERSTAND THE REAL ISSUES IN PLAY, rather than posturing around ideological premises.
I first started working for $1.63 an hour. The company was proud that it paid $0.03 above minimum wage. I've worked at the same company (in the same way an ax that has had it's head changed twice and handle three times is the same axe) now for 40 years. I started at $5.50 an hour and another worker complained that the company had started him at $5.00 an hour. Haven't been on food stamps but have friends, relatives and acquaintances who have. Have drawn unemployment insurance. Regularly discuss social security, medicare, and medicaid with people with first hand knowledge. Don't believe everything politicians and news media say. Law of unintended consequences make public policy decisions difficult.
"wealth is actually being drained from the households": Wealth is hard to define at the lower levels of society. Clear lines of growth are being muddled. See the tv show The Waltons based on a novel Spencer's Mountain for family based wealth parables. Lines of growth were clearer in the fifties and sixties than they are now.
A Society gets more of what it subsidizes. A Society gets less of what it taxes. Large companies are all subsidized to some degree. Almost everywhere poor people are subsidized. Study India, Brazil, Turkey, US, and others. Food and fuel are the most common subsidies for the poor and working poor. The largest numbers of rich people are widows whose wealth is managed by state regulated individuals and companies. Getting the right mix of incentives and punishments to feed, cloth, and house large numbers of people is difficult. Bureaucrats are people too and have conflicts-of-interests like all of us do. I make my living in automation so I push for broad based ownership of automated factories. eg Turn most people into a part owner of a production facility instead of working in a production facility.
Excellent. But, the choice to intervene to deregulate and reduce taxes is but another interventions. More policy to do what you advocate here. More sanity in not seeing every activity in the social arena as merely economic activity. We support open markets and policy choices because of how it is socially beneficial and welfare enhancing. We need to avoid premises that become unquestionable tenants of some (pseudo-religious scientifically true) Economic and Financial philsophy. Time for paradigm shifts in (belief/faith)-based perspectives of yesterday.
"...may require food stamps or health care assistance ..." These programs were created to stop prices from falling. The fact that they actually helped some people and didn't significantly harm people forced to pay an above market-clearing-price is serendipitous.
One of the criteria for siting an FDI or making a real economy investment in productive capacity, deciding where to site an investment, is the cost and quality of healthcare. There has been absolutely no utility in designing a healthcare system unable to deliver quality of life and wellness to the general population on a day in and day out basis, while being able to take care of highly specific and rare and costly procedures. There has been no utility in having a pharma system as we do, which essentially subsidizes global pharma R & D budgets and single payer systems elsewhere especially as the low hanging fruit in pharma has been surpassed. The world need merely thank us for all we paid yesterday. Providing durable and lasting Healthcare solutions is as structurally useful for the real economy as it is "moral" (actually I tend to believe that which benefits the Real Economy is maximizing utility and thus the greatest of moral impacts). Hugs, you are yesterday. We need more moving off of ideological pedestals for better today's and tomorrows. I have never received any welfare, myself, but am amazed we would continue to encourage such to be trended in our society, for more false asset valuations on the computer screens and quarterly statements of those whose philosophical posturing has delivered the distortions they imagine, still, to exist of the bogeymen of their common suppositions and stale premises.
"Then why can't they improve their lives?": depression, mental illness, drug abuse (also called self medication). I've been in a house with someone off their MELLARIL. He walked backwards out of rooms because he felt he must face north. Sadly he was facing south-south-east. Octagon was the soap orderlies put in socks to use as blackjacks to knock out mental patients before mental-health-drugs were developed. No sharp edges to crack-open-skulls. Thankfully I heard this third hand and have no personal experience. The charities that work with the homeless need all the support you can give them.
Very interesting!
Thank you for writing this blog. I was wondering if you had any opinion as the the vulnerability of the hong kong dollar to a depreciation if china were to have a crysis.
Thank you for writing this blog. I was wondering if you had any opinion as the the vulnerability of the hong kong dollar to a depreciation if china were to have a crysis.
Dear Prof Pettis, What reforms would be useful to facilitate the wealth transfer? I agree that wealth transfer in some form is needed for Chinese to have sustainable growth, but how to go about this? We have seen a reduction in the personal income tax rates this year. This was done to soften the effects of the strengthening of social security collection that came about when the tax authorities were aligned into the social security system. Could a wealth transfer to private households happen in the form of public funds focused on private consumption? The public health care system seems to be a good combination of the two. Education could be another area of interest for public funding that transfers wealth to private consumers. One issue I am not sure were to place in this discussion is the income side of the government (local or national). Real Estate has been the largest income driver for governmental funding over the last decades. Would a higher permanent taxation (as is already done in some cities) on house number 2< be a way forward? Any direct wealth transfer to private house is a loss of power for the government so realistically it would only be possible in some form of fusion with a state actor still be the middleman. My question is simply how to go about doing this wealth transfer in a fashion that would work in China?
Please be aware the link to the Chinese translation of this article is incorrect. It actually links to the translation of a different article Prof. Pettis wrote for Barron's titled "China's Best Option for Responding to a Trade War". If a Chinese translation of this article is available I would be grateful to anyone who could provide the correct link, as it would be very helpful to my studies. Thank you!
Marvelously comprehensive and acute as ever, Michael - many thanks. I am particularly struck by the commonality of China's current policy polylemma on the one hand, and those of the other advanced economies on the other hand. Much, if not most of my academic and practical work aims to show and respond to the fact that our principal problems all stem from our no longer being willing simply to face the fact that decentralized exchange economies, in which returns to capital appear consistently to outpace returns to labor, require either (a) equitable distributions of capital ownership or (b) regular redistributions, direct or indirect, from capital to labor if they're to grow stably. These are the only reliable means of maintaining balance in the long run. Other, temporarily less painful measures - notably export-led growth, private consumer debt, and much private and public investment debt - merely put off the inevitable, ensuring that 'correction' will be cataclysmic when at last it comes.
Dr. Hockett Exactly. Over-Financialization leading to too high a concentration of wealth, increasingly requiring more of the income in the economy, while, driving more savings, and reducing the inevitable incomes that can be sustainably delivered to service those asset values of the extending savings pools. Inevitably leading to a reckoning that sees depressed wages, bloated assets unable to hold, and a cataclysmic reckoning. We will see if next time they understand. Need to try to hold the asset values, while building the structures that can create the revenues to ensue that those values can hold. Of course they can't, and so much ideological confusion of long-term premising that few can see past their chosen blinders to sow greener pastures.
"In China’s case, it is by now well agreed upon that a significant amount (and perhaps nearly all) of most public-sector investment in the past few years has been nonproductive" Really? Who agreed upon this?
If a "significant amount" means "nearly all", than that's problematic. If it means ~50%, than less so. If a "significant amount" is 25%, than I'm not worried at all. Who are these people who well agree upon the productivity of China's investments? Because agreement on this topic is something I'm desperately trying to find.
I found a very sound China blog on insightful.co.in, check it out you may also like it.
Just looking at the recent path it seems clear that China has chosen the following; 1 Increase bank lending to the private sector 2 Increase middle class consumption 3 Increase Trade surplus through the BRI 3 Increase
Three demographics trends: 1. Declining workforce. 2. Several hundred million will migrate from rural areas to cities. 3. Growing number of retirees will draw down savings. Labor scarcity combined with the higher productivity of urban vs. rural employment should drive up wages while large elderly population should raise consumption-savings ratio. How will these factors impact the choices you discuss?
Urban to rural migration has reversed, and there wouldn't be hundreds of millions of more regardless. Then need to understand that even much of former was in reclassification of land in underproductive and poor interior provinces , villages near third tier cities. One of the weakest premises in the evolution of Globalization theory has been the tying of premises from theories of innovation to urbanization. Difference between slow agglomeration of cities and those by mandate. Sure the Chinese needed influx of cheap labor but industrial clusters developed of foreign FDI and overinvestment, mass redundancies in these of Chinese trade policy supports and money-print, the returning of so little productivity gains to workers and money-printing while being to access foreign demand o. MFN. China is aging and doesn't have adequate resources for old age dependency issues.
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