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Yet another discussion on the Asian savings glut hypothesis, and why it matters

August 20, 2009 in Asian development model, Consumption and production, Exports and imports, Policy, Savings glut, Stock market by Michael Pettis | 84 comments

The Shanghai stock market was up 4.5% in very nervous trading today but down 16.3% since its recent peak at 3478 on August 4, and still trading at more than 30 times earnings.\’a0 All this turmoil is triggering all sorts of worried comments about the sustainability of the fiscal stimulus package and whether it has already reached the end of its effectiveness (it hasn\’92t \’96 the government still has credit and fiscal firepower, and will use it if growth slows down significantly in the next few quarters).\’a0 It also makes it harder, but probably more useful than ever, to focus on the bigger picture, and this entry is definitely big picture.\’a0 It also turned out to be a very long piece, as these big-picture pieces tend to.\’a0

The topic is whether or not the global imbalances that have led to the current crisis were in any way \’93caused\’94 by the Asian savings glut, and besides arguing why I think this may be the case, I want also to argue that getting this argument right is far more important than many seem to realize. \’a0Mohamed Ariff, executive director of the Malaysian Institute of Economic Research, indirectly suggests why in a good OpEd article in today\’92s New Strait Times:\’a0

China\’a0is seen as the beacon of hope in these days of gloom and doom. This has led some observers to think China will lead East Asian economic recovery and thereby spearhead a global economic turn-around. But this faith in China as saviour may be misplaced.China’s imports from the rest of East Asia consist mostly of raw materials, intermediate products and components and parts, the bulk of it turned into manufactures for exports. China’s imports of consumer products from the region account for no more than a small proportion.

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China’s imports from its neighbours have plummeted in the wake of the slump in China’s own exports, although the Chinese economy is growing at seven to eight per cent, because China depends largely on domestic production for its own consumption, which does not spill over to the rest of the region through trade.

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Therefore, China will import more only if it can export more. For this to happen, the demand for China’s exports in the US and European markets must first recover.

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But our definition of a \’93recovery\’94 in the US, and whether it will indeed happen in the way that Ariff requires for Asian growth to return, depends in an important way on whether or not the current imbalances were caused primarily by an original distortion in US consumption or in Asian savings.\’a0

I started writing this because while googling around looking for something else, I stumbled early this week upon a blog by LSE\’92s Danny Quah with the intriguing title \’93Where in the world is Asian Thrift and the Global Savings Glut?\’94\’a0 I later found that like mine, his blog is carried by Nouriel Roubini\’92s RGE Monitor.\’a0 I also subsequently discovered by a weird coincidence that on Saturday I am sharing a panel with him in a conference at the Guanghua School at Peking University, where we will be discussing the \’93Reconstruction of Global Finance\’94.\’a0\’a0\’a0

The whole \’93savings glut\’94 debate is a controversial one because almost from the start it has degenerated into a fairly silly argument about who to blame for the global imbalances and the subsequent crisis \’96 or more specifically and more excitingly, whether the predator was wholly the foolish American consumer or the beetling Chinese saver.\’a0 Three months ago Brad Setser discussed all this in one of his blog entries that (inevitably) drew more comments than most, and as usual he provides a concise and enlightening discussion on the subject which you might want to read.\’a0 He is a proponent of the hypothesis, but nonetheless pretty fair-minded.\’a0

Professor Quah weighs in on the other side of the savings glut debate although, unlike most others in the debate, he seems not terribly concerned about assigning full blame to any of the major parties.\’a0 It is neither excess US consumption nor excess US savings that solely \’93caused\’94 the imbalance, in other words, because necessarily both sides are required for it to exist.\’a0

Except for the possibility of trade with outer space, the US deficit has to be matched dollar-for-dollar by trade surpluses in the rest of the world. Correspondingly, therefore, the rest of the world has been saving\’97consuming less than it has been producing\’97and accumulating dollar claims against the US as a result.\’a0

In this description, however large the global imbalance, a savings glut\’97wherever or however it might arise on Earth\’97has no independent existence. It makes as much sense to say the world\’92s excess savings caused enthusiastic US consumers to flood into Walmart to buy $12 DVD players, as to say US consumer profligacy made hungry Chinese peasants abstain even more and instead plow their incomes into holdings of US Treasury bills.\’a0\’a0

When two variables have always-identical magnitudes, obviously neither can usefully be said to cause the other.\’a0\’a0

Who are the predators?

This is correct, but as an aside, the discussion about enthusiastic American consumers forcing the Chinese to save, or hungry Chinese savers forcing Americans to consume, typically uses colorful but totally inappropriate images to describe the dynamics of the this process.\’a0 For example, I often hear opponents of the Asian savings glut hypothesis say, voices dripping with disbelief, that the savings glut hypothesis insists that the poor American consumer rushed out to buy another DVD player because terrible China forced him to borrow the money and buy the DVD player.\’a0 How could that possibly happen?\’a0

Well, that\’92s not how it would have happened.\’a0 In any large country, there are millions of households able and interested in increasing savings or in increasing borrowing.\’a0 Specific policies or financial conditions will determine at any given time changes in the behavior of some of these individual households, so that at the macro level, and only at the macro level, the country will have seen an increase in savings or an increase in consumption.\’a0\’a0\’a0

It is not every household that rushes out to consume when consumption rises, and this never happen because predatory savers force an otherwise unwilling consumer to buy. \’a0So if it had indeed been rising Asian savings that drove the US consumption binge, policies aimed at constraining Asian consumption and boosting Asian production (which cause savings to rise) will have initially led to a rising Asian trade surplus and US trade deficit, as the tradable goods sector in Asia expands and the tradable goods sector in the US contracts.\’a0

This surplus would be recycled into the US via purchases of highly liquid securities.\’a0 If the Fed failed to respond to this increase in liquidity by raising interest rates and contracting money (and contracting the tradable good sector), the financial system would have to accommodate the rising liquidity as it has always done throughout history \’96 by growing financial balance sheets and taking on more risk.\’a0 In that case the conditions for consumer borrowing will have been made increasingly easy, and those households who needed or were predisposed to borrow under easier lending conditions, and pressure on the parts of banks to extend credit, will do so.\’a0\’a0\’a0

As long as there are some households willing, however appropriately or foolishly, to increase consumption, the easier availability of consumer credit will cause them to increase consumption \’96 this has happened many times and in many countries, and has nothing to do with a predisposition to excess consumption.\’a0 Furthermore as recycled liquidity boosts household wealth by boosting the value of homes and investment portfolios, the rising wealth of each individual household will have an impact similar to rising income \’96 and with it consumption will rise.\’a0\’a0\’a0

So the point is the not very controversial suggestion that a surge in domestic liquidity in the US can easily cause US consumption to rise.\’a0 If that liquidity surge was \’93caused\’94 by the recycling of a large and growing trade deficit, then it is easy to see how at the macro level US consumption would rise in response to a surge in Asian savings.\’a0

Similarly, the proponents of the Asian savings glut hypothesis wonder in disbelief how an American consumer deciding to buy a DVD player could have possibly \’93forced\’94 poor Chinese peasants to cut their already minimal consumption and increase their savings. \’a0But there was no force.\’a0 A sudden explosion in binge consumption in the US would divert production from China, and as China increased the share of its output dedicated to exports, total production would not immediately be matched by total domestic consumption (Americans bought some of it) and the Chinese savings rate would necessarily increase \’96 whether at the household level or at the corporate or government level.\’a0

The interest rate argument\’a0

The point is that sarcastic comments about predatory American consumers forcing dim-witted Chinese households to save more and consume less, or predatory Chinese savers forcing helpless American households to borrow and consume, may be good debating tactics but they are misleading and explain nothing.\’a0 At the macro level either event \’96 higher Asian savings leading to higher American consumption, or higher American consumption leading to higher Asian savings, or even a combination of the two \’96 is perfectly possible.\’a0

So why should we accept the Asian savings glut hypothesis?\’a0 One argument that I first saw proposed by Brad Setser was that if the imbalances had been driven by US consumption, and therefore US borrowing needs, the consequence should have been an increase in US interest rates.\’a0 Had they been driven by excess savings, US borrowing rates would have probably declined.\’a0\’a0

In fact during most of the relevant period US interest rates did decline, even leading to the US Fed several times complaining about its inability to control domestic long-term rates.\’a0 So that pretty much settles it, right?\’a0 But Professor Quah dismisses this argument:\’a0

Many other factors could, of course, have driven down short rates: US monetary policy responded to national economic downturns in 1991 and 2001. Through the 1990s inflation rates worldwide converged and fell, together with short-term interest rates set by central banks everywhere. The burst of the dot-com bubble in March 2000 saw the NASDAQ index decline 77% in the following 18 months, prompting action by the US Federal Reserve. Japan\’92s monetary policy during its decade-long recession drove nominal interest rates there to zero.\’a0

Although he is right, this is not a completely satisfying dismissal.\’a0 The same savings glut that pushed down US interest rates could easily have pushed down global interest rates, especially in a world that was seeing rapidly rising capital flows that in many cases were aimed at \’93arbitraging\’94 (absolutely the wrong word, of course, but one widely used in the markets at the time) interest rate differentials.\’a0 After all it is often the case that, especially during periods of large international movements of capital, increases or reductions in US interest rates (or in British rates during the globalization period at the end of the 19th Century) are matched by changes in foreign interest rates.\’a0

Still, the fact is that his response does show that the interest rate argument is not final.\’a0 There might be other perfectly good reasons that explain the decline in US interest rates.\’a0

The bilateral trade argument\’a0

Quah\’92s main argument against the savings glut hypothesis, at least as far as his blog entry, seems to be that it could not have been a rise in Asian savings that drove the global imbalances because had it done so, much of the imbalance would have rested between Asia (or China, more specifically) and the US.\’a0 The strongest piece of evidence he presents is a chart that shows the US bilateral trade balances between the US on one side and China, developing Asia, the EU, and oil exporters on the other.\’a0 I have reproduced the graph below, but if you can\’92t see it well, just click on Quah\’92s blog (blocked in China, so China-based readers will need to use a proxy), and click on the graph itself for an enlargement (I wish I was clever enough to do things like that).

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As the chart shows, the US trade deficit rose nearly as quickly, or even more so, with those other regions as it did with China and/or developing Asia.\’a0 It wasn\’92t just a US-China phenomenon or a US-Asia phenomenon, it was a US-everybody phenomenon.\’a0

Quah\’92s argument seemed to be a powerful one at first, and I had to think about it for a while or else I would have to find myself deserting from the \’93savings glut\’94 camp.\’a0 In the end, however, I think his argument it turns out not to be very satisfying and I still think it runs against a timing story that better explains the imbalances.\’a0 I\’92ll say more on that later, but it seems to me that in a \’93globalized\’94 world, if the Asian savings glut hypothesis is true, not only would rising bilateral trade deficit between the US and other countries outside of developing Asia be possible, but they would even be almost necessary.\’a0

Why?\’a0 Because we have to be careful about misreading bilateral trade numbers.\’a0 It is the aggregates that usually matter.\’a0 I don\’92t have the data in front of me, but I believe that Europe did not run significant and rapidly growing aggregate trade surpluses during this period.\’a0 If that\’92s the case, then a growing bilateral surplus with the US is perfectly consistent with the savings glut hypothesis as long as you assume that trade is international and that any specific product can be produced and assembled in many countries \’96 which is of course a pretty unremarkable assumption.\’a0

So, for example, if rising Asian net savings \’93caused\’94 rising American net consumption (in the way described above \’96 no sarcasm, please), it would mean that money recycled from Asia into the US caused the US trade deficit to rise as it was intermediated by the financial system into consumer financing, even as it caused Asian trade surpluses to rise.\’a0

It\’92s the aggregate balance that matters\’a0

But, and this is the important point, the trade did not need to occur only at the bilateral level.\’a0 If rising Chinese savings was intermediated into rising US consumption and this bilateral relationship was resolved, to take a concrete example, by Chinese exporters producing shoes and American consumers buying shoes, the trade would not have had to occur directly between the two.\’a0 When Americans shop for shoes, they don\’92t care which country saw net savings rise, and when Chinese sell shoes they don\’92t care whose economy saw an increase in net consumption.\’a0 China could have produced shoes, sold them to a designer in Italy, where they would be packaged and branded, and then sold to American consumers.\’a0

In this simple case, Chinese excess savings would have \’93caused\’94 Americans to borrow money and buy the shoes, and so China would run a trade surplus, the US would run a trade deficit, and Italy would be balanced.\’a0 But Italy would nonetheless show a bilateral surplus with the US and a bilateral deficit with China.\’a0\’a0\’a0

Excess US consumption, in other words, would still have been \’93caused\’94 by excess Chinese savings in this case, but global trading and processing networks would have the bilateral trade imbalances, and their countervailing obverses, spread out though the world.\’a0 Many countries would run surpluses with the US and deficits with Asia, but at the aggregate level they would balance out at close to zero, and the US would be left with the sum of its bilateral deficits and Asia with the sum of its bilateral surpluses.\’a0

The point is that there is nothing in the Asian savings glut hypothesis that requires that all trade imbalances occur at a bilateral level and only between the participating countries \’96 that the deficit/surplus imbalances occur between the US and Asia.\’a0 It only requires that the US, as the equilibrator to rising Asian savings, have a large and growing trade deficit and Asia have a large and growing trade surplus.\’a0 If other regions also have large and growing aggregate trade surpluses that fed into the US deficit at the same time, that would perhaps be the problem Quah says it is, and either would need to be explained or would create problems for the hypothesis.\’a0 But they didn’t.\’a0

With one big exception, of course.\’a0 Oil exporters did see not only rising bilateral trade surpluses with the US, but they also saw rising aggregate surpluses.\’a0 Does this somehow weaken the savings glut hypothesis?\’a0 Again no, because those surpluses reflect one thing only, rising oil prices, and in an environment of rapid US and Asian growth, we would expect oil (and other commodity) prices to rise.\’a0 In fact the savings glut hypothesis would predict that as long as the recycling was occurring efficiently, both countries would grow quickly and high commodity prices would be not only possible, but in fact highly likely.\’a0

So as I see it, this is how the arguments and counterarguments stand:\’a0

1.\’a0\’a0\’a0\’a0\’a0\’a0\’a0 The argument that declining US interest rates proves the correctness of the savings glut hypothesis is wrong.\’a0 Declining US interest rates are suggestive but not final.\’a0 Other things could have explained declining US interest rates during this period, and of course there is easily a possibility of feedback loops in which any initial decline in US interest rates could, by increasing household wealth (via rising asset values) increase consumption and the US trade deficit, leading to Asian recycling, and so on to more lower interest rates.\’a0

2.\’a0\’a0\’a0\’a0\’a0\’a0\’a0 The argument that rising US bilateral deficits with many regions around the world disprove that the savings glut hypothesis is also wrong, and much less suggestive.\’a0 On the contrary, if the hypothesis is correct and if trading is truly globalized, we would expect US bilateral deficits to be high with nearly everybody.\’a0 At the aggregate level, however, we would not expect anyone except the high-saving Asian saving countries to run large trade surpluses.\’a0

3.\’a0\’a0\’a0\’a0\’a0\’a0\’a0 There was also an argument that I associate with Morgan Stanley\’92s Stephen Roach \’96 a very smart man who by the way disagrees strongly with the hypothesis \’96 since he was the one who first made this argument to me, over a lunch at Peking University two years ago.\’a0 According to Roach there has been no significant increase in global savings during the savings-glut-hypothesis period, which pretty much demolishes the idea of a saving glut.\’a0\’a0\’a0

I disagree because the hypothesis doesn\’92t imply in any way that global savings have increased.\’a0 In a closed economic system, unless investment has increased commensurately, an increase in savings in one part of the system must necessarily come with a reduction in savings elsewhere, and this was exactly the point of ascribing the current trade imbalances to a forced rise in Asian savings.\’a0 Rising Asian savings \’93forced\’94 declining US savings by causing the US financial system to accommodate growing domestic liquidity by taking on risk (again, no sarcasm please \’96 you might disagree but in itself this is not implausible).\’a0

Timing the flows\’a0

So where does that leave us?\’a0 Before answering, I think there is another thing to think about here, as I wrote earlier in this entry, and that is the timing issue.\’a0

In a June 4, 2008 entry, much of which is reproduced here, I mentioned a very interesting paper by German economist Jorg Bibow of the Levy Economics Institute of Bard College (The International Monetary (Non-)Order and the \’93Global Capital Flows Paradox\’94).\’a0 In it the author considers the \’93paradox\’94 of high and rising capital flows from developing to developed countries during the past decade.\’a0 This is a paradox because most economic theory (and history) suggests that developing countries are net recipients of investment, not net providers.\’a0

Bibow rejects the Asian savings glut hypothesis, but my understanding of his paper is that he agrees with much of what I understand the theory to be but rejects it on much narrower technical grounds \’96 he claims that the saving glut hypothesis is based on the \’93fatally flawed\’94 (his words) loanable funds theory.\’a0 However his narrative (to be horribly post-modern for a moment) of events seems very close to my own.\’a0

What interests me most is the data he provides in his paper (and you can see the accompanying graphs by following the link to his paper).\’a0 First off, Bibow discusses the evolution of the US current account deficit over the past fifty years.\’a0\’a0

Basically, according to the data quoted in Bibow\’92s paper, the US current account has been within a range of a surplus of 1% of GDP and a deficit of 1% of GDP for most of last fifty years with two exceptions.\’a0 The first exception occurred in the mid-1980s when the US current account deficit rose to nearly 3.5% of GDP in 1986-87 before declining sharply and running into a small surplus in 1990.\’a0 The second exception began technically in 1994, around the time of the Mexican crisis, when the US current account deficit climbed to around 1.6% of GDP, before it began to decline again, but it really took off in 1997-98, when it raced forward to peak at around 7% of GDP in 2007.\’a0\’a0

As an aside I should add that there was an acceleration of the growth rate of the deficit around 2004, if I remember, and I have a pretty strong suspicion that this had something to do with the financing of the Iraq war.\’a0 As I have pointed out before, US asset markets and consumption often boom during unpopular wars, like the Vietnam War, which tend to be financed not with taxes but with money creation and debt, and often these two things lead to great markets \’96 for a while.\’a0

If the US trade deficit was driven simply by an out-of-control US consumption binge, it is a little hard to see why it would have followed a pattern of general stability marked by two surges \’96 a small one from 1984-88 and a very large one after 1997.\’a0 If it was driven by Asian savings, this pattern becomes a little easier to understand \’96 or at least, what amounts to the same thing, we can posit a more plausible story to explain it.\’a0\’a0\’a0

The narrative\’a0\’a0

I will ignore the 1980s surge because this post is already too long, but again one can tell a very plausible story based on Japanese trade policies and domestic savings.\’a0 The post-1997 surge is much larger and more interesting.\’a0 1997 was, of course, the year in which several Asian countries, after years of tremendous growth and what seemed like invulnerable balance sheets, experienced terrifying financial crises and viciously sharp economic slowdowns, which profoundly impressed Asian policy-makers and has affected policy decisions to this day.\’a0\’a0

Since the main cause of the crisis seemed to be the sudden reversal in the early 1990s of current account surpluses into substantial deficits, along with highly unstable balance sheets in which large external obligations were mismatched with domestic assets and \’93hedged\’94 with extremely low levels of foreign reserves, one of the main (if mistaken) lessons policy-makers learned was the need to run current account surpluses and to amass large foreign currency reserves to protect countries from a repeat of the disastrous crisis of 1997.\’a0

These countries, consequently, but into place \’93mercantilist\’94 policies in order to achieve both goals \’96 persistent trade surpluses and large amounts of foreign currency reserves. \’a0This (I think plausible) story is reinforced by another graph Bibow reproduces.\’a0 The global capital flow \’93paradox\’94 to which he refers in his title is the fact that developing countries are exporting capital to rich countries.\’a0 According to his data, developing countries have almost always been net recipients of private capital flows \’96 which is what one would have expected from most economic theory and history.\’a0\’a0\’a0

They have generally been net providers of official capital as far as foreign currency reserve accumulation goes, but for most of the last fifty years reserve accumulation on average was significantly less than net private inflows, so developing countries were net recipients of capital.\’a0 (For much of the 1980s the balance on both was zero or close to zero, and I suspect that this reflects negative private flows to Latin American and others among the 32 defaulted or restructuring LDCs, as they were then called, netted against positive private flows to Asia.)\’a0

It is only in 1998 that reserve accumulation among developing countries begins to take off and by 1999 it exceeds net private capital flows to developing countries.\’a0 This is when the \’93paradox\’94 of net capital flows from developing to developed countries begins.\’a0 Except for a small decline in 2001 net flows from developing countries surge almost in a straight line to around $700 billion annually (combining $1.2 trillion of reserve accumulation versus $0.5 trillion of net private flows).\’a0

I am sure there can be other competing explanations for the timing of these flows, but I am very impressed by the fact that Asian savings, as expressed in reserve accumulation, surge after 1997, as does the US trade deficit, although exacerbated by the second surge around 2004.\’a0 Given the virulence of the 1997 crisis and the tremendous shock it provided to Asian policy-makers (and policy-makers in developing countries elsewhere), it seems to me that a very plausible argument can be made that it was the effect of 1997 that caused the shift in developing-country policies that led to the surge in savings and the corresponding increase both in trade surpluses and reserve accumulation.\’a0\’a0\’a0

The surge in the US trade deficit after 1997 is also more easily explained by a shift in Asian trade policies and currency regimes than by a shift in US consumer preferences.\’a0 Of course that doesn\’92t mean that nothing relevant happened in the US.\’a0 US monetary policy was clearly too accommodative, and especially in reaction to the Iraq war, so that it exacerbated the conditions created by the Asian savings glut.\’a0 If anyone is still looking for which country to blame, my understanding of the creation of the imbalances suggests that you can blame almost anyone you like and there is a good chance that you\’92ll be at least partly right.\’a0

Why does this matter?\’a0

The issue of what drove what is not simply of academic interest.\’a0 The consequences for the world of a system in which imbalances were driven by a sudden and self-perpetuating explosion in US consumption, which then forced higher savings onto Asian countries, are very different from a system in which imbalances were driven by a sudden and self-perpetuating increase in Asian savings, which then forced higher consumption onto non-Asian countries.\’a0\’a0\’a0

Deciding whether or not the savings glut hypothesis is correct is important not just because it allows us finally to decide which country really is the evil predator, the US or China.\’a0 It matters for a very different reason.\’a0

If it was an explosion in US consumption which drove the global imbalances, then we are likely to see a fairly benign resolution to the crisis for everyone, except maybe the US.\’a0 After all in that case the imbalances were driven by US consumption excesses, and since those excesses are, like it or not, going to be resolved by the need for US households to repair their badly-damaged balance sheets, the imbalances too will be resolved, and in a way that is mostly benign for everyone except recovering US households.\’a0 This process may be postponed by current US fiscal policy, and especially by recent policies that subsidize consumption, but it will only be postponed, not derailed.\’a0

And just as Americans can no longer binge consume, their binge consumption will no longer force Asians to save such a high and rising portion of their income.\’a0 Asian growth, and especially Chinese growth, will be much more balanced.\’a0

But if the global imbalances were driven by a surge in Asian savings, Asian and Chinese growth will still rebalance, but the rebalancing will be much more difficult.\’a0 Why?\’a0 Because too-high Asian savings, caused in large part by post 1997 policies that encouraged differential growth between consumption and production (as I discuss here, for example), have until now been matched by too-low US savings rates.\’a0 As long as the two imbalances balanced, the world economy could continue functioning without too much distortion.\’a0

But now if we can expect net savings in the US (and perhaps in many other parts off the world) to rise, we need to see a rapid change in those policies that encouraged too-high Asian, and especially Chinese savings. \’a0In that light there was an interesting and worrying OpEd article in today\’92s Financial Times by the Peterson Institute\’92s Fred Bergsten and Arvind Subramanian:\’a0

The Obama administration is increasingly signalling that the US will not continue to be the world\’92s consumer and importer of last resort. The clearest statements came last month from Larry Summers , White House economics director, in a speech at the Peterson Institute for International Economics and in an interview with the Financial Times. The US, he said, must become an export-oriented rather than a consumption-based economy and must rely on real engineering rather than financial wizardry. Tim Geithner, the US Treasury secretary, and other top officials have spoken similarly of rebalancing US growth.\’a0

If the US really is serious about this shift towards higher savings, and if the primary source of the imbalance was the Asian savings glut, and not an original US consumption \’93glut\’94, this means that in the future US policies will be in direct conflict with still-current Asian policies, and unless the US is unable to accomplish these goals, Asian countries will need to force through an adjustment in their development policies as quickly as possibly.\’a0 Asian and especially Chinese officials have acknowledged the need to increase consumption more quickly.\’a0

But for now this adjustment in policies that encouraged too-high Asian, and especially Chinese, savings does not seem to be happening.\’a0 “The optimal choice is to expand household consumption,” PBoC governor Zhou Xiaochuan said in a speech last month. \’a0″That is, however, easier said than done. While the current income structure cannot be dramatically changed in the short term, the second-best choice is to maintain and expand investments.”\’a0 He is almost certainly right, at least except for his last statement.\’a0

In fact as I have argued many times (for example here, and here), I suspect that most of the Chinese fiscal stimulus is exacerbating the imbalances \’96 both by boosting current and future production and by creating conditions that will constrain future consumption growth.\’a0\’a0\’a0

In that case there has been no significant rebalancing yet towards more rapid consumption growth taking a greater share of Chinese production \’96 just a frenzied attempt to keep current growth rates high by boosting investment, which will almost certainly lead to capital misallocation and rising non-performing loans, and clearly unsustainable attempts by the Chinese government artificially (and unsustainably) to boost short-term consumption by subsidizing it heavily with government debt (something the US seems to have been doing too) which has the effective consequence of reclassifying fiscal expenditures as household consumption.\’a0

The end result?\’a0 Planned increases in investment in China eventually become forced increases in investment \’96 rising inventory \’96 that ultimately must lead either to writing inventory off or closing down production facilities in the future.\’a0 This is, by the way, just another way of stating the excess capacity problem.\’a0\’a0

Perhaps what we need is a real return to Confucian roots. \’a0I recently read this quote from Lao-Tzu: \’93The sage does not hoard. Having bestowed all he has on others, he has yet more. Having given all he has to others, he is richer still.\’94\’a0

Tags: Bibow

Trade \’96 it\’92s not just the currency

June 3, 2009 in Asian development model, Consumption and production, Exports and imports, Policy by Michael Pettis | 53 comments

One of the reasons why trade-related discussions can seem so off-the-mark, I think, is because the conditions governing international trade are much more complex than we often realize. The determinants of the international balance of trade basically include anything that affects domestic consumption and domestic production, which pretty much means nearly everything in economics. Among other things this means that there is a very wide range of government policies that can affect trade \’96 sometimes explicitly and sometimes implicitly.

Unfortunately much of the analysis and debate doesn\’92t seem to get this. For example, many economists have pointed out that the bailout of GM is effectively a protectionist measure. I think it clearly has a trade impact, and this impact is \’93protectionist\’94, although not intended that way. What is missing from the discussion, I think, is a clear explanation of why it is effectively a protectionist measure. I would argue that the GM bailout has a trade impact because it affects in specific ways the balance between production and consumption in the US (and, of course, elsewhere), and since the US trade deficit is also the gap between US consumption and US production, to the extent that the bailout affects this gap it must affect the US trade balance.

In that case we can posit at least two obvious ways in which the bailout affects the gap. First, by effectively subsidizing the cost of producing GM cars, it increases automobile production in the US. Second, by allowing GM to retain the workers it would have otherwise fired, it increases consumption in the US by the amount which the retained GM workers spend on consumption, i.e. some large fraction (depending on their savings rate) of their wages. At first I was going to suggest that the relevant number was actually not their wages but the difference between their wages and their welfare payments, since most of the workers would presumably continue to earn some money after they were fired, but then it occurred to me that their welfare payments would have reduced other government spending, so perhaps it is not relevant (this is a subject of much disagreement between Keynesians and monetarists).

Since the GM bailout almost certainly increases production by more than it increases consumption, its direct impact is to reduce the US trade deficit (although to be complete we would also need to consider how the GM bailout affects GM\’92s competitors, many of whom produce cars in the US). However there are of course secondary impacts, the most important of which is the funding of the bailout. If funding the money used to bail out GM ended up crowding out investment in other production facilities, then the question becomes whether or not those other production facilities would have involved a more productive use of the money and, therefore, had a better impact, either in the short term or in the long-term on total US production. This is also part of the debate between Keynesians and monetarists.

So because we typically think of the currency and tariff policies as the main tools to affect trade \’96 which usually means to boost net exports \’96 much of the discussion surrounding trade policies tends to be limited to these two issues (although when the subject of \’93dumping\’94 comes up the discussion becomes a lot more sophisticated). This leads to strange arguments. For example when I talk about an increase in trade frictions leading to an increase in trade protection, I am often countered by the argument that the WTO makes tariffs very difficult so that protection becomes almost impossible. This is manifestly not true, but more on that later. These, at any rate, are the two best-known trade-related policies:

\’a8 Currency policies, whose first-order impact is to determine the relative pricing of imports and exports, but there are also a series of second-order impacts that can be very important.

\’a8 Tariffs, especially import tariffs, whose first-order impact also determines the relative pricing of traded goods, usually imports.

To repeat, any policy that affects the relationship between production and consumption must affect the trade balance because the excess of production over consumption is the trade surplus (or deficit, of course, if consumption exceeds production). So currency policies affect the trade balance primarily by their impacts on diverting production and consumption. A country, for example, that devalues its currency, raises the cost of imported goods and so reduces the real value of wages. This of course usually causes total consumption to decline. At the same time it allows local producers who compete with imports, who might not have been as cost effective as foreigners at the previous exchange rate, to begin producing more goods for sale to the domestic market. The combination of reducing domestic consumption somewhat and increasing domestic production means that the trade deficit will decline or the trade surplus increase.

One thing that economists always point out, and contrary to the mercantilist view, is that this increases domestic employment, but it doesn\’92t necessarily improve local welfare. Remember that by devaluing its currency, a country is worsening the terms of trade for its own products \’96 it must now produce more stuff locally for export to pay for the same amount of imports. It also results in a net reduction in total consumption. Currency policies often involve a tradeoff between employment and total welfare in the short term. Over the long term it is not always clear that this is true, however.

Trade tariffs work in very much the same way. Devaluing the currency by 10%, for example, has the same impact as putting a 10% subsidy, or negative tariff, on exports (the government pays exporters an amount equal to 10% of the value of their exports) and a 9.1% tariff on imports.

But, as I hope these examples show, it is not just tariff and currency policies that affect the trade balance. Anything that affects the gap between consumption and production also affects the balance of trade. These include:

\’a8 Corporate and personal income taxes. Personal income taxes reduce consumption by reducing disposable income. Corporate income taxes reduce production by raising costs for producers.

\’a8 Sales and other taxes. Depending on their impact they can also affect trade. The most obvious case is a sales tax which, by raising the cost of goods, reduces real wages and so reduces consumption.

The impact of taxes on trade are complicated by the fact that taxes represent a transfer of resources, so to understand fully their impact we also need to know what the government does with new tax revenues or how it finances reduced tax revenues. These can enhance or reduce either consumption or production.\’a0 So, for example, if the government put into a place a sales tax (which reduces consumption) and used the proceeds to reduce corporate taxes (which increases production), it could cause a large positive move in the trade balance (and by positive I mean an increase in net exports).
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There are a lot of other factors that impact trade, and I have randomly included the following, which I think are especially important, at least in China. Others can and will have others to add or may dispute some of my arguments.

\’a8 The level of worker\’92s wages. They impact trade in two ways \’96 by affecting consumption via affecting the purchasing power of households, and by affecting production via the cost to businesses of labor, and they tend to work in the same way as far as the trade balance is concerned. Lowering wages reduces consumption and increase production, so as to have a positive impact on the trade balance. Needless to say many economists have pointed out that low wages in China are one of the reasons for the high trade surplus.

\’a8 Unemployment benefits. Unemployment benefits tend to cause consumption to decline more slowly than production when factories close, for obvious reasons, although of course we need to take into account how these benefits are funded. I would guess that when a country\’92s workers do not receive unemployment benefits, it tends to be \’93positive\’94 for the trade balance.

\’a8 Subsidized costs to producers \’96 electricity, oil, commodities, etc. Subsidizing the cost of production is a very effective way to increase exports since it directly increases production by increasing the returns to producers. It also has an impact, albeit usually much smaller, on increasing consumption via its impact on employment. Since these subsidies are financed by taxes, subsidies may also constrain consumption somewhat, depending on the nature of the taxes used to fund subsidies.

\’a8 Subsidized costs to consumers. This boosts consumption, of course, although with the same caveat as above \’96 its net effect depends on how the subsidies are financed.

\’a8 Corporate lending rates. This should be included in \’93subsidized costs to producers\’94 but I put it in a separate category because it is a very important type of subsidy, especially in China. Low interest rates for manufacturers of course make it much easier to borrow money to fund otherwise unprofitable production facilities, thereby increasing production (and increasing consumption somewhat by its impact on employment). If the lending is directed at non-manufacturing activities, such as to the service sector, it will not spur manufacturing production but will still increase consumption. As an aside, in my May 20 entry I discuss an HKMA study that argues that in China 100% of SOE profitability can be explained by interest subsidies which, I argue, actually understate the true value of those subsidies, suggesting that many SOEs would actually be value destroyers if it were not for subsidized financing. This is a very important reason for the Chinese trade surplus, in my opinion.

\’a8 Deposit rates. In last week\’92s entry this claim generated a certain amount of controversy in the comments section, but it is widely believed that in some countries, like China, reducing deposit rates causes savings to increase and consumption to decline. I discuss some possible reasons in my November 27 entry, the most important of which is probably that in high savings countries in which most savings are in the form of bank deposits, the interest earned on banking deposits is a significant fraction of total disposable income, and lowering deposit rates has an effect similar to lowering wages. Of course if this is true, low deposit rates are likely to reduce consumption, just as low lending rates to producers are likely to increase production. They may also increase production by reducing the opportunity cost for corporations of investing retained earnings.

\’a8 Other credit intervention \’96 lending guarantees, directed lending, forbearance on addressing NPLs, etc. This is fairly complex since there are many ways to intervene in credit, but any policy which increases the provision of credit to manufacturers must increase production directly. It increases consumption somewhat too, as in the two previous cases, by creating employment and thus raising the total amount of wages paid. If the lending policy increases credit provision to consumers or the non-manufacturing sector, it increases consumption directly. Credit for infrastructure investment is a little more complex since it probably increases consumption today and production tomorrow.

\’a8 Special mention: cleaning up NPLs. This really belongs in the category above but in the case of China it deserves its own entry. There are two ways to recapitalize banks suffering from a surge in NPLs. One way is to recapitalize them directly. When the government does this is simply transfers money to the banks, as China did before the IPOs of the major banks. Depending on how these transfers are funded, they can have a variety of effects on production and consumption. The second way is to guarantee banking profitability by keeping a wide spread between lending and deposit rates. Policymakers may also keep lending rates very low in order to slow the accumulation of NPLs and make it easier for marginal borrowers to survive. As I discuss above, this can result in very low deposit rates, which constrains consumption, and very low lending rates, which increases production.

I focus a lot on various financial sector issues because it seems to me that it is through the banking system that policymakers can have their largest impact on the trade balance. By keeping rates excessively low (and remember that almost all interest rates in China are either fully controlled and set by the PBoC or very heavily affected by the controlled interest rates), policymakers can boost production and constrain consumption quite easily.

When production grows faster than consumption this necessarily forces an increase in the savings rates \’96 which ties this entry into my previous entry. And of course by controlling the direction of credit, either directly or indirectly by implicit or explicit government guarantees, the government has a major say in the total amount of production. It is probably not a coincidence that in the countries that followed export-oriented growth policies, the so called Asian development model, interest rates and credit tended to be highly controlled either directly or indirectly by the government and regulators. These countries have all had \’93surprisingly\’94 low interest rates and banking systems that channeled funding mostly into the manufacturing sector (when those countries had large informal banking sectors, as does China, the rates there tended to be much, much higher, suggesting that the controlled interest rates were far from an “equilibrium” level). I would argue that a controlled banking sector is a very important tool for trade policy.

Another one of the issues that this opens up is the distinction I have made many times between total consumption and net consumption. Notice that many policies increase both production and consumption. They usually do the latter by increasing employment. In many cases Chinese policies have been successful in boosting consumption in just this way. Since the world manifestly needs more consumption, as US household consumption declines precipitously, anything that boosts Chinese consumption should be a good thing, right?

Maybe not. What the world needs from China is not an increase in total consumption but rather an increase in net consumption \’96 i.e. the excess of new consumption over new production \’96 that is roughly in line with the decline in US net consumption. If consumption grows, but production grows just as fast, or even faster (and we can tell by looking at the trade balance corrected for various pricing effects and one-off purchases or sales), then the world imbalance is getting worse and the overcapacity problem will not have been addressed.

This means that many policies that may seem on the surface to be purely domestic policies are actually trade policies too, and legitimately subject to scrutiny and even criticism from abroad. This is clear from the GM bailout. I don\’92t believe that Congressmen agreed to the bailout because they wanted to engage in protectionist behavior. They did so because they wanted to protect American jobs, but they did so in a way that almost inevitably has a trade impact. The same thing is happening in China, but there is a real reluctance to consider that policies aimed, for example, at limiting unemployment among aluminum plant workers in Hunan (or is it Henan?) are not just internal matters but also international trade policies.

Trade, CPI and other numbers came in this week

March 11, 2009 in Currency regime, Exports and imports, Inflation, PBoC, Policy, Trade protection by Michael Pettis | 51 comments

Deflation and debt
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On Monday CPI and PPI numbers for February came out. CPI was down 1.6% year and year and PPI was down 4.5%, in line with or slightly below expectations and, according to Bloomberg, the highest rate of deflation among the 78 countries they follow. Some of this may be caused by one-off factors, especially declining food prices, and most of the press and analyst commentary suggested as much, but the figures are still too hazy to say with any certainty whether or not deflation is likely to become a problem. Qi Jingmi, an economist with the State Information Centre, a government think-tank, was quoted in an article in the South China Morning Post as saying “I worry about PPI. The sharp fall in PPI shows that the financial crisis is gradually spreading to the real economy.”
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The PBoC’s Governor Zhou has already promised that China will do whatever it takes to prevent deflation, although at this point it is hard to find anyone who believes in the 4% target inflation for 2009. According to an article Friday in Bloomberg he said that \’93We would rather be faster and heavy-handed if it can prevent confidence slumping during the financial crisis.\’94 The article goes on:
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Chinese central bank Governor Zhou Xiaochuan pledged \’93fast and heavy-handed\’94 policies to restore confidence and prevent the global financial crisis from deepening the nation\’92s economic slump. \’93If we act slowly and less decisively, we\’92re likely to see what happened in other countries: a slide in confidence,\’94 Zhou said at briefing in Beijing. The central bank has \’93ample room\’94 to fine-tune monetary policy after a record surge in lending in January, he said.

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I continue to be very skeptical about the actual amount of control the PBoC has over monetary policy. Until last summer despite PBoC intentions to run “prudent” or “tight” monetary policies all the evidence suggested out-of-control money growth, and since then their promises to expand aggressively have been at least somewhat undermined by evidence of monetary contraction. I am convinced that given the currency regime, net foreign inflows or outflows more than other factors determine underlying money in the system, and since the PBoC has very little control over the net flows, and so little control over the rate at which it is forced to monetize those flows, monetary conditions are at least as likely to reflect external conditions as domestic policy.
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That is why what interests me most about the inflation numbers is what they suggest about monetary conditions — a subject on which it is very hard to get complete data and for which we often need to draw inferences from other parts of the economy. In that light, it is worth noting that the money-versus-pork debate seems to have died down since last summer with the decline of inflation at year-end, but I suspect it is going to revive soon enough, as I discussed in one of my entries in December. For example, a Bloomberg article on Monday had this to say:
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China isn\’92t yet facing \’93typical\’94 deflation, where falling prices are accompanied by shrinking loans and money supply and an economic recession, central bank vice governor Yi Gang said, according to the state-run Xinhua News Agency. The central bank has \’93sufficient\’94 policy tools to combat deflation, Yi said, without elaborating.

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Maybe it is indeed true that falling prices are not accompanied by shrinking loans and money supply, but it seems to me that we can’t really say for sure. We think we know that loans aren’t shrinking because loan growth numbers in the official banking sector pretty clearly show rapid loan growth, but as I have written many times before, much of January’s loan growth represented either balance sheet rearrangements or other forms of loan growth that don’t represent real credit growth to the economy (and by now that is a pretty widely accepted interpretation of the January numbers, although many bank analysts continue to talk up the loan growth as effective).
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In addition, there is still anecdotal evidence that the informal banking sector is having difficulty expanding and even that their balance sheets may actually be shrinking. Real credit in China, in other words, is expanding much more slowly than the headline numbers suggest and may even be contracting. We don’t really know. For those who care, the current issue of Forbes has a very interesting article by Gady Epstein on one part of the shadowy credit market in China.
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By the way I assume that Vice Governor Yi is indirectly referring to Irving Fischer’s debt-deflation thesis. But in my opinion, and if I read Fischer correctly, the risk for China is not a financial collapse induced by excess and unstable leverage. In spite of the haziness of the debt accounts I really don’t think China has the amount and kind of leverage that is likely to lead to a collapse in asset prices (although my one caveat is that we don’t really know the relationship between asset collateral and debt in the informal banking sector). The risk instead — and a highly probable risk although the timing is a little hazy — is that China will see many years of sub-par growth as it works off its addiction to excess capacity and makes the tough and slow transition to a domestic-led economy. I think Nick Lardy’s warning of a “long landing” rather than a “hard landing” is what we should expect. I am only guessing here, and haven’t really worked it out, but perhaps monetary reflation, which I think would have been Fischer’s proposal for the US today, is not likely to be of much help to China.
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Trade figures are out
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Meanwhile, and back to the real world, February trade numbers were released today. As I guess pretty much anyone who reads my blog would know, the export numbers were terrible. Exports plunged 25.7% in February year on year, even though this year February did not include the Spring Festival holidays, and so was substantially longer than February 2008. The foreign press seems mostly to think that the sharp decline in exports came as a huge surprise to most experts, while the Chinese press seems to think it was largely expected (the SSE Composite declined on the news, but only by 0.9%). I have always believed that the fact exports were dropping much more rapidly in the rest of Asia than in China was clearly not sustainable, and that it was just a question of (very little) time before we began to see Chinese exports hit much more sharply. I do not believe the process is over.
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According to an article in today’s Xinhua:
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China’s exports plummeted 25.7 percent year-on-year in February, the fourth straight monthly decline, as global demand shrank, the General Administration of Customs said Wednesday. Exports contracted to 64.90 billion U.S. dollars, while imports slumped 24.1 percent to 60.05 billion U.S. dollars. The sharp declines reflected weakening external demand, which would persist throughout the year as the global recession deepened, said Zhang Junsheng, an economics professor at the University of International Business and Economics. “These huge falls were inevitable, given the global downturn,” he said.

…Exports of labor-intensive products contracted more moderately than total exports, reflecting the government’s moves to raise export rebates starting last July, the agency said. Garment and accessory exports fell 11 percent to 14.62 billion U.S. dollars, while those of toys sank 17.1 percent to 850 million U.S. dollars.

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I have heard several times reference to the fact that the increase in export rebates has helped the textile sector, although I would have guessed that this wouldn’t be something policymakers would want to advertise to the outside world. Along that line I think we are going to see a lot more pressure on policymakers somehow to “deal” with the problems in the export sector. On Monday Commerce Minister Chen Deming announced a cut in export taxes. According to an article in Tuesday’s Financial Times:
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China will reduce export taxes to zero and give more financial support to exporters as it tries to increase its share of global trade in the current crisis, the country’s commerce minister announced on Monday. China would “use all possible measures to ensure the stable growth of our exports and prevent a large drop in external demand”, Chen Deming said in an interview published by a Communist party newspaper. “We should increase our share of the global market… We must transform ourselves from a big export nation to a strong export nation,” he continued.

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It’s probably not a good idea to announce a drive to increase China’s share of the global export market, especially since for the last several months, while the world has suffered a collapse in demand, China’s share of exports has risen dramatically, but this may have been said primarily for domestic consumption. Yesterday Chen spoke again about trade. According to an article in People’s Daily:
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China’s foreign trade faces grim times in the coming months, Commerce Minister Chen Deming said yesterday even as the government tries to take steps to boost trade.

…Chen said the government would support exporters, in particular those of electronic goods and machines that account for 57 percent of the country’s exports. The government has raised export rebate rates and will expand the coverage of export credit insurance and encourage financial institutions to offer export credit services to boost exports, he said.

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The pressure to fix the export sector is clearly rising. My friend Isaac Meng was quoted later on in the same People’s Daily article explaining why policymakers are taking a decision which is not likely to make already-difficult global trade relations much easier:
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“Global trade and demand [are] collapsing and so are the currencies of many of China’s competitors and customers,” said Isaac Meng, an economist with BNP Paribas. “This is putting huge pressure on China’s export industries and the government to push all the buttons to boost the economy.”

At a press conference on Friday Zhou Xiaochuan, the central bank governor, refused to rule out a devaluation in China’s currency, the renminbi. “If you can tell us clearly what is going to happen [in the countries where the financial crisis started], it would be easier for us to tell you what measures we will take,” Mr Zhou said when asked directly whether he would rule out a devaluation of the renminbi.

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In a sign of how contentious the debate has gotten within China, the trade worriers put in a counterclaim. This from a Bloomberg article:
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China should let the yuan rise 3 percent against the dollar in 2009 to deter capital outflows and help the country make overseas acquisitions, said Wang Jian, a researcher affiliated with the nation\’92s top planning agency. China\’92s foreign-exchange reserves grew by the least in more than four years in the fourth quarter as sliding exports prompted traders to step up bets on yuan depreciation. People\’92s Bank of China Governor Zhou Xiaochuan pledged last week to maintain yuan stability as investors pull money out of emerging- market assets because of slowing global economic growth.

\’93A weaker currency will prompt massive amounts of foreign capital to flee the country,\’94 said Wang, secretary general of the China Society of Macroeconomics, a Beijing-based research institute under the National Development and Reform Commission that advises the government. \’93It won\’92t help exports. Foreign consumers still won\’92t have enough money to buy.\’94 At least $1 trillion of \’93hot money\’94 may have entered China, Wang estimated, as the yuan gained 21 percent against the dollar since the central bank ended a fixed exchange rate in July 2005. Depreciation would risk spurring a sudden exit of those funds, causing turmoil in the financial system, he said in an interview yesterday.

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I think hot money flows are one of the potentially destabilizing factors we need most to worry about because the PBoC’s currency regime means that monetary conditions, as I discuss in the first half of this entry, are largely determined by net inflows or outflows. In that light it is worth noting that while imports in February were also very bad — they dropped 24.1% year on year — the February trade surplus was much, much lower than for any month in a long time. China’s trade surplus for February was $4.8 billion, lower than the $7 billion rumor I mentioned a few days ago and much lower than the roughly $34 billion average monthly surpluses of the past six months (and $39.1 billion for January).
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This may be a very good thing for China as it goes into the G20 meeting, since it takes a little of the sting out of China’s growing export of overcapacity, but one month of “good” numbers after a long series of absolutely awful numbers won’t mean much, and we need to figure out more about the composition of imports. In particular I am interested in seeing whether imports include a lot of one-off rebuilding of commodity reserves. By the way with last month’s “low” trade surplus, some people are arguing that the era of massive monthly surpluses are over. This is from MarketWatch:
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“The bigger shock figure was the decline in the trade surplus to $4.8 billion as exports fell faster than imports,” said [Royal Bank of Scotland's chief China economist, Ben] Simpfendorfer. “February’s trade surplus typically falls because of seasonally strong commodity imports and seasonally weak consumer exports,” he said. “So, the decline in the trade surplus will likely be reversed next month. Nonetheless, the surplus will not bounce back above a $20 billion monthly rate this year.”

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Trade and industrial policies
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I hope Simpfendorfer is right. The Washington Post seems very worried about the trade-policy outlook. In an article titled “US to Toughen its Stance on Trade,” it warns that US policy seems increasingly dissatisfied with global trade and says that “the Obama administration is aggressively reworking U.S. trade policy to more strongly emphasize domestic and social issues.” Today’s New York Times also had a worried editorial on President Obama’s trade agenda, which included the following:
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Trade will play an important role in the world\’92s eventual recovery, transmitting economic growth from one country to the next. Protectionism leads to further protectionism, and yielding to its temptation could unleash destructive trade wars that would crush any chance of recovery. Unfortunately, few politicians are willing to tell their constituents that unpopular truth. Instead, governments are succumbing to protectionism\’92s dangerous lure. In recent months, Russia has jacked up import barriers on cars, farm machinery and other products. The European Union has reintroduced subsidies on dairy products. Europe, India and Brazil raised tariffs on imported steel.

Protectionism is also taking subtler forms, like Britain\’92s requirement that bailed-out banks favor domestic lending. The United States is not immune. The stimulus bill had a \’93Buy America\’94 provision, and it made it more difficult for companies receiving stimulus dollars to hire foreign workers under the H-1B visa program. President Obama\’92s choice for United States trade representative, Ron Kirk, appears ambivalent about the value of free trade. As part of his confirmation hearings this week, Mr. Kirk testified that he would work to expand trade but also argued \’93that not all Americans are winning from it and that our trading partners are not always playing by the rules.\’94

…If ever there was a need for collective action \’97 on fiscal stimuli, monetary policy, aid to the developing world, fighting protectionism \’97 it is now. A place to start the rethinking is China and how to encourage increased domestic consumption and investment in China and other cash-rich Asian countries so they can start pulling the world out of recession.

China\’92s leaders, in particular, need to understand that export-led growth no longer works for them or for the world. The United States will have more influence if it stops beating on Beijing for its foreign-exchange policy and engages China\’92s leaders as partners, not rivals. Vigorous trade will help the world recover. For that to happen, the United States will have to provide strong leadership and a clear commitment to fighting protectionism. Any sign of ambivalence from Washington will only make things worse.

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The whole debate over trade is going to be framed within US and European discussions about fiscal stimuli since it is not at all clear that Chinese policymakers are contributing much more than some fairly smug, and perhaps hypocritical, statements about how everyone must embrace free trade. But the US and European discussions don’t seem particularly positive right now. According to today’s Financial Times:
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Disagreements between the European Union and the US over how to combat the global recession widened on Tuesday as EU governments made clear they had little appetite for piling up more debt to fight the collapse in output and jobs. Finance ministers from the 27-nation bloc insisted in Brussels that it was doing enough to support world demand and did not need at present to adopt another fiscal stimulus plan, as Washington is urging.

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I hesitate to enter these very deep waters, but I think the Europeans, at least as described in this article, might be right. There is a real need for an adjustment in consumption in the US, and I don’t think it makes sense for the US to attempt to replace excess household consumption with excess government consumption. One way or the other the US, along with China and most other countries that have contributed to one side or the other of the global imbalances, is going to have to accept a demand contraction.
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Trade friction is an issue that will not easily go away. Not all the information released this week was bad, however. Some was good and some was neutral — by which I mean it could be read either as bad or good depending on your economic model. According to an article in today’s Bloomberg:
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China\’92s investment spending surged as the nation poured money into roads, railways and power grids to counter a plunge in exports, which a separate report showed fell by a record in February. Urban fixed-asset investment climbed a more-than-estimated 26.5 percent in January and February combined to 1.03 trillion yuan ($150 billion) from a year earlier, the statistics bureau said today in Beijing.

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The fact that fixed asset investment surged might suggest that the fiscal stimulus plan is having an effect and will counteract to some extent the slowdown in other parts of the economy. A worrier (me) would be very nervous however that the stimulus ended up worsening the overcapacity problem, in which case any benefit would be more than paid for next year. More unambiguously good news involved February car sales, which are up substantially and suggest that some government policies are getting consumers to go back to buying cars, although this was accompanied by bad numbers on car exports.
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The mainland\’92s sales of domestically made vehicles surged 25 per cent in February from a year earlier, as a tax cut for small cars and other measures helped revive the market, an industry group said on Wednesday. February\’92s sales totalled 827,600 units, up 12 per cent from the 735,000 sold in January, the China Association of Automobile Manufacturers said in a report posted on its website. Production in February totalled 807,900 units, up about 23 per cent from the year before, it said.

…However, despite the apparent rebound in China\’92s own car market, a slump in demand is crimping sales overseas: exports in January fell 33.5 per cent from a year earlier, to US$2.66 billion, the group said. The impact was most severe for domestic-brand cars, with January exports falling 64 per cent from a year earlier to 16,300 units, it said. Imports of vehicles also took a hit amid the deepening economic downturn, falling 20.3 per cent from a year earlier in January to US$1.73 billion, it said.

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Finally before closing, and for an indication of rationality that sometimes seems to be missing from foreign expectations about China, few analysts in China seem to buy the idea so popular in the West that somehow Chinese policies may be enough to pull the world out of its economic crisis. Tuesday’s People’s Daily had a long article on the subject. Among other things it said:
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A China-driven recovery of world economy is “unrealistic”, economists said amid hope, after the world’s attention was drawn to China’s annual parliament session, that the country’s stimulus plan would help the whole world out of the recession.

…Economists said they believe China would be able to keep its growth at about 8 percent this year, a growth rate long believed to be minimum to create enough jobs and maintain social stability. However, they said it is wild wish to count on the country alone to fuel the global recovery, as China’s economy accounted for only five percent of the world’s total.

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To pin hope of the global recovery only on China is similar to charging a colt with an overwhelmingly big carriage and hoping it to drag the cart along, they said. Beijing-based economist Wang Xiaoguang warned that actually China’s influence is very “limited.” He said China’s stimulus package might help store up some investors’ confidence in world economy, but “China alone could not revive the world.”

Tags: Art, Irving Fischer

Yes, trade policies do matter

March 9, 2009 in Balance of payments, Policy, Trade protection by Michael Pettis | 31 comments

One of my blog readers, Kalasend, responded to Thursday\’92s entry by asking about the composition of US-Chinese trade, and I think the question is interesting enough to be discussed in a separate entry, rather than in the comments section. In his response he pointed out that \’93China\’92s exports are mostly light manufacturing goods like toys, garments and other labor intensive goods which the modernized west simply lack the competitiveness and the will to do.\’94

I have heard this statement many times before, usually as part of a broader argument that since China is mainly exporting things that the US and Europe can\’92t or don\’92t want to make, macroeconomic policies aimed at adjusting the trade relationship are unlikely to make a difference on the actual trade balance. We are stuck, in other words, with the current trade relationship and probably for very good reasons.

Although I think there is a lot to be said for this argument, I nonetheless think it is fundamentally wrong for at least three reasons. The first reason is just the obvious point that macroeconomic policies that alter the factors that affect production and consumption necessarily affect the balance between the two, and the trade account is simply that balance. If the United States, for example, decided to provide large amounts of very low-cost credit to the US manufacturing industry, US production would automatically rise faster than US consumption, and so the US trade deficit would shrink. It may not be easy or possible to predict in advance the actual changes in the composition of the trade balance, and those changes might even be harmful in the longer term, but they would nonetheless occur.

By the way, any country that engages in any form of industrial policy must, at the very least, believe that my first objection to the argument above is correct, otherwise industrial policy aimed at altering the mix and structure of industrial activity would simply be a waste of time. I would also add that the none other than one of my great heroes, Alexander Hamilton, understood this very well when he designed the policies \’96 especially in his 1791 Report on the Manufacturers \’96 that virtually created the US as a manufacturing power and which were subsequently copied, very explicitly, by Germany after 1870 and Japan shortly thereafter. This is from the first paragraphs of his Report:

The expediency of encouraging manufactures in the United States, which was not long since deemed very questionable, appears at this time to be pretty generally admitted. The embarrassments, which have obstructed the progress of our external trade, have led to serious reflections on the necessity of enlarging the sphere of our domestic commerce: the restrictive regulations, which in foreign markets abridge the vent of the increasing surplus of our Agricultural produce, serve to beget an earnest desire, that a more extensive demand for that surplus may be created at home: And the complete success, which has rewarded manufacturing enterprise, in some valuable branches, conspiring with the promising symptoms, which attend some less mature essays, in others, justify a hope, that the obstacles to the growth of this species of industry are less formidable than they were apprehended to be, and that it is not difficult to find, in its further extension, a full indemnification for any external disadvantages, which are or may be experienced, as well as an accession of resources, favorable to national independence and safety.

My second reason for arguing against the claim \’96 that trade and macroeconomic policies can\’92t affect the trade balance because China produces things the US won\’92t \’96 is that both the US trade deficit and the Asian trade surplus have grown sharply in the past decade. Unless we make the argument that rising US asset prices caused US households significantly to increase their purchases only of things that Americans never made before, it is hard for me to see how this could have happened without some process in which US producers of those goods were replaced by foreign producers of those goods.

And if this only happened in the past ten years, I find it hard to be believe that this process of foreign producers replacing US producers is irreversible (I don\’92t even bring up the impact of Chinese textile producers in recent years on the southern European textile industry). Could it really be true that the decline of the US car industry or parts of the steel and chemical industries reflects refusal by Americans to continue their production, and so is irreversible? Can it be true that this process was not speeded up by specific policies affecting the car, steel or chemical industries in the exporting countries? On a related point, the Chinese government has recently announced that China plans to build a domestic competitor to Airbus and Boeing, but if the trade balance was simply a function of China making things that the US or Europe are no longer willing or able to make, wouldn\’92t this whole airplane-manufacturing strategy be a complete waste of time and likely to have zero impact on Chinese purchases of foreign airplanes?

Notice I am leaving aside the issue of whether or not it is in the US long-term interest to continue manufacturing things that can easily be manufactured in much less developed countries. I happen to believe that the future of the US, and indeed its great strength, is the fact that it is at the forefront of technological innovation and that it always skips forward to higher levels of productivity, and perhaps there is enough of a social Darwinist in me to wonder if the pressure placed on the US by industrial policies in less advanced countries might, while causing undeniable pain in the short term, actually speed up this brutally innovating process. That, however, is more of a normative judgment (I think I am using the word \’93normative\’94 very loosely) than a statement of fact.

My third reason for disagreeing against the argument that the US can\’92t make the stuff it imports from China, so trade policies are irrelevant, is that the hidden assumption in this argument is that trade balances can only change at the bilateral level. But of course this is not true. If US policies or conditions cause a contraction of net demand, and Chinese policies or conditions cause a contraction of net supply, that doesn\’92t mean that Americans will start producing domestically things that China used to produce and sell to the US.

What is more likely to happen is that the trade accounts of several countries at different stages of productivity and technology will all adjust, so that US producers of high-tech product A end up taking domestic market share away from producers in a slightly less advanced economy, whose producers of slightly-less-high-tech product B then take market share away from an even less technologically advanced economy, and so on down the chain to China. Given the complexity of international trade relations, any significant change in trade conditions or policies is likely to lead to a whole series of shifts among many different countries.

So far it may seem like I am making a case for trade protection, but I assuredly am not. I strongly believe that the US, and most other countries, generally benefit from open trade, and that it is in the best interests of the US, Europe, Japan and China to understand and work out those benefits within a stable institutional framework, but I also think the ease with which people who oppose trade protection make muddled or easily refutable arguments does no good to their position. In my opinion policies do matter to trade, and if we reject those policies it should not be on the specious grounds that they will have no impact.

But to turn from the airy world of abstractions to the real world, what is happening in the world of trade? Today\’92s Xinhua has an article urging Argentina to lift recently-imposed trade restrictions on Chinese goods.

Chinese business circles are deeply worried about the protectionist measures against Chinese products that the Argentine government has taken, a senior diplomat at the Chinese Embassy said in an interview published in La Nacion newspaper Sunday. “These import measures are discriminatory,” said Yang Shidi, economic and commercial counselor of the Chinese Embassy in Argentina.

The measures that Argentina has adopted since 2008 have affected many Chinese products and run contrary to the memorandum of understanding signed by China and Argentina in 2004, in which the Argentine side recognized China’s market economy status, Yang said. Argentina calculated the dumping margin for the Chinese products on the basis of the prices of a third country, he said.

“It is not fair,” because the costs of raw materials and manpower as well as productivity in China are different from those of other countries, Yang said. He stressed that a World Trade Organization member must respect related rules and regulations while introducing measures to protect its own trade. China stood firm against trade protectionism and urged to solve trade frictions through international consultation and cooperation, Yang said.

I checked out the original article in La Nacion and then wrote to an old Argentine banking friend of mine to ask what he thought about the article. He sent me the email equivalent of a grimace and said something unprintable about China\’92s standing firm against trade protection. I suspect that given the wide-spread perceptions, whether fair or not, of forceful Chinese intervention in trade matters, it probably doesn\’92t help China\’92s case to lecture too smugly against the evils of protection. From my friend\’92s reaction, and many, many conversations I have had and emails I have received, I am willing to bet that these lectures mostly just infuriate people.

There\’92s more, and bigger, on the trade front. Japan posted its first monthly current account deficit in 13 years (since January 1996) and its largest since the data first became available nearly 25 years ago. The deficit was $11.3 billion, with the merchandise deficit totaling $8.7 billion \’96 largely on the back of a whopping 46.3% drop in exports (imports were down a very scary 31.7%).

These extreme conditions, not just in Japan but throughout Asia, are not going uncontested. Bloomberg today had another very worrying article about the response of Asian central banks:

Asian central banks are abandoning a six-month campaign of defending their currencies, reversing course to cheapen exports that are falling the most in a decade. Policy makers from India to Malaysia to Taiwan are letting their currencies depreciate after South Korea gave companies an edge by allowing the won to weaken 19 percent against the dollar this year. Shipments from South Korea, Indonesia, Taiwan and Malaysia fell 17 percent in January to $79 billion, twice the drop of April 1998, when the Asian financial crisis was wiping out a third of the region\’92s economy, according to data compiled by Bloomberg.

It seems that we may be on the brink of a series of competitive devaluations, and it\’92s no good for all us rational people to agree that competitive devaluations are useless. They are only useless in the aggregate, but individually it will be very difficult for policymakers to continue withstanding the pressure for more depreciation.

If we see a lot more weakness in Asian currencies, and a partial reversal of the trend so far in which other Asian countries have had to absorb far more of the global contraction in demand than China, I wonder how significant the pressure will be on China to allow some depreciation. My guess is that policymakers will hold off on devaluation pressure as much as they can while using every other means to achieve a similar effect \’96 via subsidized labor, credit, and other costs to manufacturers \’96 but ultimately the howling of the export sector is likely only to increase.

But not everybody is as pessimistic about trade as I am. Daniel Ikenson, at the Cato Institute, had an Op-Ed piece in today\’92s South China Morning Post arguing that fears of trade protection are seriously overstated.

Yes, India did recently raise tariffs and place other restrictions on some imported steel products, and Ecuador raised tariffs by 5 per cent to 20 per cent on 940 different products. There have been similar actions in other countries and more are likely in the months ahead. But that kind of “backsliding” is permitted under World Trade Organisation rules. The WTO affords some flexibility to governments to occasionally indulge protectionist pressures, which allows the system to bend rather than break. The risk of such measures causing a perceptible drop in global trade flows is remote.

According to recent estimates from the International Food Policy Research Institute, if all WTO members raised all tariffs to their maximum allowable rates, the value of global trade would fall by 7.7 per cent over five years. That’s a substantial decline from the 5.5 per cent yearly rate of growth during this decade, and would be quite painful.

But, to put matters in perspective, global trade plummeted 66 per cent during the protectionist pandemic in the first half of the 1930s. The absence of rules in the 1930s meant that there were no proffered courses of action, no sources of adjudication or remediation, and no limits to the actions governments could take in response to external economic policies. Today, we have rules and respected institutions that have worked reasonably well to ensure the integrity of the trading system. Nearly 400 disputes have been resolved successfully during the 14-year history of the WTO, and there have been no trade wars.

In the 1930s, there were far fewer domestic constituencies advocating against protectionism. Today, there are burgeoning interests in a diversity of countries who favour lower tariffs because their livelihoods depend on access to imported raw materials, components and capital equipment. The fact that most WTO members’ tariffs are well below their maximum allowable rates suggests that something besides the rules compels openness to trade.

He may be right, of course, but I am not comfortable with comparisons between the relatively benign trade environment of the recent past and that of the 1930s. The recent past should be compared with the 1920s, when the trade environment was also relatively benign, but it changed sharply as unemployment rose and net demand contracted. We need to wait to see if this happens again.
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By the way, while on the subject of trade, there are big rumors that February\’92s trade surplus has collapsed to $7 billion. If this is true (and these sorts of rumors often are), it would broadly be a very good thing, I think, and would certainly relieve trade friction pressure, but the real trick will be to see why it declined. One suggestion making the rounds: China has significantly increased its import of commodities to rebuild commodity stockpiles. That would be a less-than-good reason for a drop in net exports. Let\’92s see what the number is.

Meanwhile whereas many people are happily celebrating the \’93recovery\’94 of the Chinese economy, I continue to be extremely skeptical and worry that whatever short term boost we have recently seen may be coming at the cost of a reduced ability to engineer expansion later (and to tell the truth I am not really sure what that boost was, since it seems to me that the best and most widely celebrated \’93indicator\’94 of economic recovery has been that the contraction implied by PMI was less in January than in November and December \’96 a weird indicator of recovery). I increasingly think Nick Lardy was remarkably prescient when he argued that the hard-landing/soft-landing debate (was it two years ago?) had it all wrong \’96 what we were going to see is a long landing.

For example the steel industry isn\’92t looking all that good. On Friday Bloomberg published an article which began:

Baosteel Group Corp., China\’92s largest steelmaker, said prices are close to its production costs, indicating that the country hasn\’92t had a \’93real\’94 demand recovery. Baosteel is \’93cautious\’94 about the demand outlook, Wang Jing, the company\’92s general manager for international trading, said in an interview in Beijing, while attending the National People\’92s Congress.

Benchmark steel prices in China jumped 46 percent between November and February on optimism that the government\’92s 4 trillion yuan ($585 billion) stimulus package would revive metals demand. The price recovery was because of traders replenishing inventories, Wang said today. \’93Demand hasn\’92t had a substantial recovery, but output rose faster because of higher prices,\’94 Wang said. \’93Our prices are on the verge of production costs.\’94

Also, in spite of all the eagerness to boost consumption, it seems that old habits die hard. Last weeks\’92s China Daily had an article celebrating the return of thrift to China\’92s feckless youth:

Many Chinese are tightening their belts during the country’s economic downturn despite government efforts to boost domestic consumption and replace evaporating export orders.

Wang Hao, 24, a Beijing office worker, made a public resolution in June last year to limit his weekly living expenses to 100 yuan ($14.6 dollars). That’s the cost of eight Big Macs in China. “The financial crisis has taught a spending lesson to young people in China, including me,” said Wang.

Bizarrely enough, the article concludes with:

The frugal lifestyle seems to be endorsed by authorities. In a commentary published last week in the People’s Daily, the writer said frugality did not conflict with the government’s demand-stimulating policies, as it called for reasonable rather than reckless spending. Frugality could also help people spend their limited money on the most needed things. “The neo-frugal way of living should become a fashion, especially in the financial crisis,” said the writer Wang Jinyou.

Before closing, as if I need to extend an already too-long post, I thought I might throw in something a little bit lighter. Today\’92s People\’92s Daily has an article on the recent development model, from which I quote:

As some Western media questions why China works, the world’s economic experts and scholars are also wondering the same thing: What tools China has to keep its economy resilient and why it is well-positioned to weather the financial crisis?

The answer lies in the nation’s unique growth mode featuring a “scientific outlook on development.” Over the three decades of reform and opening-up, China has evolved its own growth mode that aims to achieve development through scientific approaches based upon China’s national conditions and the international situation, analysts said.

The essence of such a growth mode is to seek a balance between development, stability, equity and clean environment, they said.

Tags: Alexander Hamilton, Argentina

The NPC meets, and Krugman refers to the savings glut

March 3, 2009 in Economic growth, Policy, Savings glut, Trade protection by Michael Pettis | 66 comments

With the tense start of China\’92s parliamentary season this afternoon \’96 and with the National People\’92s Congress meeting Thursday \’96 there isn\’92t much incentive to try to figure anything new out in China since we are likely to be given a lot more information and proposals over the next few days. What are the major topics likely to be covered in the meetings? I suspect that this article from yesterday\’92s South China Morning Post, on the topic of unemployment, gives a pretty strong hint:

If this is not addressed, it will be even more difficult for the government to maintain social stability down the road if unemployment remains high. China’s official urban unemployment rate is expected to be 4.6 per cent this year, which would make it the highest since 1980 when figures first began to be collected.

But, economists, including Zhou Tianyong from the Communist Party’s Central Party School, forecast that the real unemployment rate could reach 14 per cent, counting migrant labourers.

Senior officials estimate that up to 20 million migrant labourers have already lost their jobs because of the global economic crisis. They were mostly laid off by private firms and foreign-funded enterprises, the hardest-hit sectors.

I was told privately by a friend of mine two days ago that the number of migrant laborers who have already lost their jobs is actually closer to 30 million, but nonetheless Mr. Zhou\’92s comments reinforce some other claims to which I refer in a piece by me in the current Newsweek:

Although official estimates put urban unemployment in China at just over 4 percent of the workforce, most unofficial estimates are much higher\’97closer to 8 percent\’97and nearly everyone agrees that the figure is set to rise significantly in the next few months. Some credible estimates suggest that even if China were able to achieve the 7.5 percent growth projected in 2009 by the World Bank, unemployment would nonetheless double before the end of the year.

Clearly unemployment is going to weigh heavily on the minds of policymakers in China, like in the rest of the world, and we will have to wait and see what specific new measures are proposed over the next few days. Meanwhile I did nonetheless want to make a few comments about interesting stuff I\’92ve seen recently.

The first is a reference to an article in yesterday\’92s Financial Times, \’93Asean split on protectionism,\’94 which highlighted the difficulties of getting leaders to agree on free trade even during a conference whose primary goal was to defend free trade:

As south-east Asian leaders gathered on Friday for their annual summit, the region\’92s united front against protectionism was starting to crack under the pressure of the global economic crisis. The fight against protectionism is top of the agenda at this weekend\’92s meeting of the 10-country Association of South East Asian Nations, which on Friday signed an agreement cutting tariffs and other barriers with Australia and New Zealand.

However, the leaders appeared far apart in pre-conference comments on the balance to be struck between sustaining open markets and promoting economic activity at home. In the most forthright remarks, Abdullah Badawi, Malaysia\’92s prime minister, said every country had the right to encourage its citizens to buy local products.

\’93I think it is a normal reaction under this kind of situation. First of all we have to protect our people; we are doing the same thing. If we do not create projects by Malaysia, for Malaysians, then who will buy our products?\’94 Mr Badawi told the Bangkok Post newspaper.

For some of my readers I may be beating a dead horse, but as usual I will put up my warning that we need to be very aware of the deterioration in global trade relations that is likely to be a consequence of the rising unemployment everywhere in the world. The fact that even in a region heavily dependent on exports it is so easy (and so natural) to make the case for protectionism doesn\’92t bode well for trade discussions in North and South America, Europe and Australia. The article goes on to say:

Lee Hsien Loong, Singapore\’92s prime minister, said Asean might miss its target of establishing a regional economic community along the lines of the European Union by 2015 if member states failed to maintain open markets. \’93In this global environment, if we give the impression that Asean is not fully open for business I think we will be the losers when the new landscape emerges,\’94 Mr Lee told CNBC.

Most of the regional economies have built their prosperity on the back of export growth, and the slowdown in the US, Europe and Japan has hit them hard. \’93I think we all worry about protectionism, and not just from traditional channels,\’94 said Mari Pangestu, trade minister for Indonesia. In spite of Mrs Pangestu\’92s reservations, Indonesia is encouraging civil servants to buy Indonesian products, an echo of Barack Obama\’92s Buy American campaign that angered so many both within and outside Asia.

It may seem like a non sequiter to follow up with a second Financial Times article from yesterday, this one called \’93Emerging market finance: a gap to fill,\’94 but bear with me:

Two years ago, nearly a trillion dollars flowed into emerging markets as investors in rich countries toured the globe in the hunt for yield. Now there is a melancholy long, withdrawing roar as private capital flees to safer havens.

\’85Net capital flows to emerging markets will drop to just $165bn (\’a3115bn, \’80130bn) this year, down from $929bn as recently as 2007, according to estimates by the Institute of International Finance, which represents the world\’92s leading financial companies. Net lending from commercial banks, the IIF says, is likely to go into reverse. The reasons for this are not altogether straightforward. Some accuse rich governments, particularly the US, of \’93crowding out\’94 emerging markets, sucking up all the available capital to finance their stimulus packages. But Brad Setser, a former International Monetary Fund and US Treasury official, notes that as the private sector retrenches, the US current account deficit \’96 and hence its need for outside financing \’96 has actually been declining.

More likely, he says, is that emerging markets are being hit by a general decline in demand for riskier assets, as banks and investors haul money back home to shore up balance sheets and reduce borrowings. Similarly, the global shortage of the trade credit that finances cross-border commerce reflects a general desire of banks to reduce leverage, not the rich countries hogging all the available loans.

Why is this relevant to a blog on Chinese financial markets? Because if annual net capital flows to emerging markets drop by the projected $700-800 billion, an inevitable consequence is that foreign currency reserves plus net imports for those emerging market countries will also have to decline by exactly the same amount. In other words while some of this decline will be accommodated by a running down of central bank reserves, we should expect a very large decline in net imports among those developing countries, to add to the decline in net imports from North America, non-German-Europe and other trade-deficit-countries. Needless to say this decline in net imports must have as a necessary corollary an equal decline in net exports in the trade surplus countries.

My final comment \’96 hinted at in the title \’96 is on Paul Krugman\’92s Op-Ed piece in today\’92s New York Times. he starts off by discussing the viciousness of the global crisis and then goes on to ask (and answer):

How did this global debt crisis happen? Why is it so widespread? The answer, I\’92d suggest, can be found in a speech Ben Bernanke, the Federal Reserve chairman, gave four years ago. At the time, Mr. Bernanke was trying to be reassuring. But what he said then nonetheless foreshadowed the bust to come. The speech, titled \’93The Global Saving Glut and the U.S. Current Account Deficit,\’94 offered a novel explanation for the rapid rise of the U.S. trade deficit in the early 21st century. The causes, argued Mr. Bernanke, lay not in America but in Asia.

In the mid-1990s, he pointed out, the emerging economies of Asia had been major importers of capital, borrowing abroad to finance their development. But after the Asian financial crisis of 1997-98 (which seemed like a big deal at the time but looks trivial compared with what\’92s happening now), these countries began protecting themselves by amassing huge war chests of foreign assets, in effect exporting capital to the rest of the world. The result was a world awash in cheap money, looking for somewhere to go.

Most of that money went to the United States \’97 hence our giant trade deficit, because a trade deficit is the flip side of capital inflows. But as Mr. Bernanke correctly pointed out, money surged into other nations as well. In particular, a number of smaller European economies experienced capital inflows that, while much smaller in dollar terms than the flows into the United States, were much larger compared with the size of their economies.

I have written often about the savings glut hypothesis and my very strong belief that it lies at the heart of the fundamental global imbalance of the past decade, and I think it has extremely important consequences both for our understanding how the crisis will evolve and what are the likely consequences to the major players involved in the imbalance. I am a big admirer of Krugman\’92s and have been for fifteen years \’96 in the 1990s I used to read everything he wrote, and often within days of his publishing it \’96 so I am delighted that he seems to agree with Bernanke\’92s thesis, but I should add that I believe the evidence in support is so overwhelming that even if Krugman decided to deride the whole notion, I would remain convinced that the sudden and massive rise in Asian net savings following the 1997 Asian crisis was a prime cause of the corresponding and necessary decline in US savings.

I know I know, this is going to be considered a very controversial statement \’96 and inevitably someone will very stupidly demand to know why I am blaming China when obviously the full blame for the crisis should fall on the US \’96 but there it is. I just don\’92t see how recent events can be explained without the Asian Crisis of 1997 having played a major role. At least Krugman seems to agree. At any rate he finishes worryingly with:

And the saving glut is still out there. In fact, it\’92s bigger than ever, now that suddenly impoverished consumers have rediscovered the virtues of thrift and the worldwide property boom, which provided an outlet for all those excess savings, has turned into a worldwide bust. One way to look at the international situation right now is that we\’92re suffering from a global paradox of thrift: around the world, desired saving exceeds the amount businesses are willing to invest. And the result is a global slump that leaves everyone worse off.

Tags: Krugman, NPC

The US government frozen in the headlights

February 21, 2009 in Balance sheets, Policy by Michael Pettis | 44 comments

Often enough I find that when people want to \’93prove\’94 to me that China will continue growing well this year they simply quote government statements saying that China will grow by at least 8% in 2009. There is a touching faith, especially sometimes in China, in the strong connection between expert projections and the final reality, but as someone who actually keeps copies of \’93the year ahead\’94 January editions of The Economist by my bedside to ward of insomnia (I am currently re-reading the January 2006 edition, which is a lot of fun),\’a0 I think expert projections are little better than garbage. It is not just that experts get it wrong an awful lot (and they do), but rather that most economic projections ignore the highly pro-cyclical or counter-cyclical (usually pro) processes imbedded in balance sheets, and these usually force wide variations from expectations.

For two years I have been arguing that a US slowdown would cause a very rapid slowdown in China, but I hated projecting GDP growth because I think China\’92s financial system has hidden but highly pro-cyclical structures that make it likely to overshoot dramatically one way or the other (as it certainly did in the good years). All I was very confident about saying was that reality would be much worse than whatever the current expert projections were. In spite of my pessimism, nonetheless, had someone told me in late 2007 that 2008 fourth quarter GDP growth might approach zero, I would have rejected this projection as implausible.

Well, now we know that it may very well have been true. Year on year growth was 6.8%, and we aren\’92t given the numbers that allow us to back out the quarter on quarter growth, but most of the estimates I have seen range from negative 1% to positive 3%.

So what will happen in 2009? Of course I don\’92t know. The \’93everything but the kitchen sink\’94 strategy that I wrote about a few weeks ago, in which an increasingly worried government throws more and more fuel into the recovery program, suggests to me that there are two possible outcomes. On the one hand the government might fail to do much \’96 or better yet they may decide to use the crisis to force a transition that benefits China in the medium term \’96 in which case GDP growth will slow significantly, and fall well below the roughly 7% consensus that now seems to dominate.

On the other hand the government may throw so much fuel into the fire that they actually are able to get the 7% growth that many expect, but this is an extremely risky strategy. If the world recovers by the end of this year and the global economy races off again, it will look to have been a brilliant strategy, and Chinese policymakers will be feted around the world for saving China from the crisis. But if the world recovery takes a few more years to materialize, which I think it will, China will be worse off next year than this year. Government debt levels \’96 especially contingent debt such as non-performing loans in the banking system and hidden provincial and municipal debt \’96 will be much higher and provide much less room for expansion, and credibility levels will be much lower.

In my opinion, for what it is worth, it probably makes sense for the Chinese government just to assume the next several months are going to be disastrous, and rather than try to hold things off, which will only make it worse in the longer run because it will distort the adjustment process, they should try to accelerate the contraction of those industries that are destined to contract anyway with the collapse in global demand, and work on providing aid for workers who are going to pay the cost. I admit I may not be the brightest guy in the world in making political judgments, but it seems to me that a disastrous six months \’96 which can and anyway will be blamed fully on the US and other foreigners \’96 followed by two or three years of good news trickling in would be much better for political credibility than two or three years in which expectations are constantly disappointed.

So what has suddenly inspired me to start making pronouncements on political strategy? Partly the fact that I spent the past three days in Washington DC, and so breathed deeply of the rarified political air, but mostly because of recent hints that the Chinese government may \’93revise\’94 its growth target of 8% for 2009. According to an article in yesterday\’92s Bloomberg:

China may review its 8 percent economic-growth target for this year as the global financial crisis deepens, Deputy Commerce Minister Zhong Shan said. The legislature will discuss the goal at its annual meeting next month, Zhong said in Hong Kong today, adding that the government remains \’93confident that it can achieve that goal.\’94

I confess I am a little confused as to why they would want to review the goal if they are so confident that they will achieve it, but the article goes on:

The government\’92s 8 percent target is aimed at generating jobs and avoiding instability in the world\’92s most populous nation, China Banking Regulatory Commission Chairman Liu Mingkang said in Beijing on Dec. 13. \’93If China\’92s GDP growth slips to 6 percent or 7 percent any time, it will affect the employment rate and also social stability,\’94 Liu said then. Last month, he said meeting the 8 percent target would be \’93exceptionally arduous.\’94

It will be exceptionally arduous \’96 no question. On a separate but related note on Wednesday the Financial Times published a piece I wrote with the title \’93This is not the time to attack China,\’94 in which I argue that policymakers in the US and Europe, and even more so in China, do not understand how difficult the crisis will be for China and how little China can do in the short term to help the global adjustment.

But this does not mean that Chinese policymakers are knowingly engaging in predatory trading behaviour. On the contrary, although they seem unable \’96 some might say unwilling \’96 to understand China\’92s role in the global imbalance (much like the US failed to understand its role in 1930), they would nonetheless like nothing more than to see China increase consumption sharply. To that end they have unveiled a fiscal stimulus package and forced banks to expand lending at a pace so rapid \’96 January\’92s new loans equalled one-third of all new loans in 2008 \’96 it will almost certainly lead to a sharp rise in non-performing loans.

But in fact their efforts have only increased total consumption, not net consumption. China\’92s outdated development model, a banking system that seriously misallocates capital and its weak consumer base make it very difficult for China\’92s fiscal stimulus to cause a rapid net increase in consumption.

Rather than penalize China for assumed predatory trade practices, I argue in the piece that it would be much better to recognize Chinese constraints and to work out a long-term agreement in which China is guaranteed room to adjust, in exchange for commitments to adjust.

The world, with US president Barack Obama in the lead, has a tremendous opportunity to help China through a difficult transition and, in so doing, create a new sustainable global balance of payments and a favourable institutional framework that will govern trade and capital relations for decades to come. If not, the advantages trade deficit countries receive from pushing the full burden of adjustment on to trade surplus countries will be overwhelmed by a global environment of deep mistrust and hostility.

Will it happen? Perhaps, but I am not terribly optimistic. On the hopeful side my article got a huge amount of play in China and was widely reproduced (although I wonder if always with the permission of the Financial Times), so clearly a lot of people are beginning to recognize China’s place in the crisis. Two of the Beijing musicians I am close to even told me yesterday that they had seen the article several times, even though like musicians around the world they rarely spend much time on the financial pages of any newspaper.

Since one of my arguments in the piece is that policymakers here have been unable \’96 in fact unwilling may be a more apt word \’96 to recognize China\’92s role in the crisis or the cost of Chinese adjustment, I am a little surprised that my piece has gotten so much play here, but maybe they just love to read articles that suggest that China is being unfairly attacked. Still, maybe there really is a growing recognition that as a fundamental part of the global imbalance, China is going to have to adjust its economic model just as dramatically as the US. Both countries relied heavily on the same source of growth \’96 infinite leverage on the part of consuming US households \’96 and this was clearly unsustainable. But so far I am not sure that this message is likely to be believed in China.

Not only am I pessimistic, then, about Chinese policymakers\’92 willingness to confront reality, but my trip to Washington also left me very worried about US policymakers. I was lucky enough to meet a wide variety of very smart and influential people in the US-China Economic and Security Review Commission, the US Chamber of Commerce, the Treasury, Commerce and State departments, the Senate Foreign Relations Committee, Congress, and a very interesting breakfast with people at the Carnegie think tank. The impression I got was that there are a lot of smart people very worried about how quickly policymakers are going to react.

I have already suggested that I think it is pointless to hope that Europe \’96 or indeed other Asian countries \’96 refrain from protectionist behavior or provide needed leadership, and my great hope has been that the new US administration surges forward and begins to design not just a short term solution that addresses the current collapse (I know, I know, much easier said than done, but the crisis part will end soon enough nonetheless), but also a longer term plan about what the new institutional framework will look like. But I don\’92t think this is happening.

Many people I spoke to last week were really bewildered by China\’92s role, and although many of them were extremely sophisticated in their understanding, they gave me the impression that policymakers are going through an almost existential crisis and have lost all confidence. The world needs US leadership more than ever, and the US is in a very strong position to provide it for at least three reasons. For all the problems of the economic contraction, the US will probably suffer less than other countries, it will emerge more quickly than the rest of the world, and it commands by far the largest amount of the most valuable resource in the world: net demand.

Inevitably someone will misread this and think I am crazy \’96 the US has a great problem and, they will say, I am insane to suggest things are going so well. But note that I am not suggesting that the US is in great shape. I am suggesting that world is in worse shape, and the US has the flexibility and resources to reshape the global balance.

This seems to be something that not many people in Washington believe. The lack of confidence is so deep that several times I heard people refer knowingly to the Chinese fiscal stimulus (yes, that vague, risky, and hard-to-understand stimulus package) as the “gold standard” of economic stimulus packages. Gold standard? Really? The only way this can be true is if every other stimulus package in the world is total garbage. Perhaps it is.

One of my good friends in Washington, who is considering accepting a very senior position in the executive branch (surprisingly enough he might not accept it because of the bitterness of the confirmation process), asked me to point out a single bright spot for the US right now. I told him geopolitics \’96 the chance to engineer a new global framework that will allow the US to regain the centrality that was lost in the past eight years while including Europe, China, Japan and the rest of the world as firmly committed members. He smiled dubiously and asked me to write it up.

However, even if I am right, unless the mood changes dramatically I am not sure that US policy makers are in any position to seize the reins and steer us firmly into a new global institutional framework. Instead I suspect that things will continue drifting downward for the next year or so, until it is that much harder for anyone to work out a reasonable plan that doesn\’92t involve a great deal of hostility and mistrust. Maybe it is just because I am a little jetlagged, but I am not very optimistic.

This entry is all terribly abstract and doesn\’92t say much that is real about Chinese financial markets, the misleading title of this blog, does it? Sorry, dear readers, but I promise that my future pieces will be more concrete and not nearly so pontificatory, if that is a word.

On a less bombastic if more narcissistic note, however, I am delighted to mention a very nice article in this week\’92s BusinessWeek that discusses my musical activities in China. Sorry to toot my own horn like this, but that accompanying photo makes me look a whole lot better than I really do, and so I would like everyone to see it.

Gosh. Bombast and vanity. Who would have though three days in Washington could have had such a profound effect on me?

Tags: BusinessWeek, Washington

Will China have to choose between social stability and long-term growth?

February 9, 2009 in Financial crisis, NPLs, Policy by Michael Pettis | 25 comments

Wow! There are now rumors that Chinese net credit growth in January was substantially higher than the already-astonishing rumors of RMB 1.2 trillion I reported last week. I will get to that at the end of this entry, but I wanted first to discuss a possibly important issue related to credit intervention.

It is probably not at all controversial to suggest that the way governments in the US, China and elsewhere respond to the current crisis will determine economic growth prospects for the next decade and more, but it is probably also worth repeating this point as often as possible. In the panic to respond swiftly to some of the short-term problems facing policymakers, it would be easy for them sometimes to forget the longer-term impact of current policy responses, and so saddle us for many years with unwanted consequences.

Over the weekend I was reading a paper by Gonzalo Fern\’e1ndez de C\’f3rdoba (Universidad de Salamanca) and Timothy J. Kehoe (University of Minnesota), called \’93The Current Financial Crisis: What Should We Learn from the Great Depressions of the Twentieth Century?\’94 Basing their work on Great Depressions of the Twentieth Century, published in 2007 by the Federal Reserve Bank of Minneapolis, in which Timothy Kehoe and Edward Prescott, together with a team of 24 economists from around the world, analyze a number of \’93great depressions\’94 experienced by various countries in the 20th Century, they try to determine the impact of policy on the subsequent severity of the contraction.

Although I always worry about ideological predispositions in these kinds of analyses (one group of economists always seems to find that government intervention made things worse, while another always seems to find that in fact specific policies helped), some of the examples they use \’96 in Latin America primarily \’96 involve countries and histories with which I am pretty familiar, and at least this part of their analysis rings true to me.

Based on the data analyzed in the book, they conclude that massive public interventions in the economy to maintain employment and investment during a financial crisis will, if they distort incentives enough, make things much worse. I guess that probably wouldn\’92t come as a very controversial statement to anyone, but what interested me was that they seemed to focus especially on ways that governments have intervened in credit markets and in investment decisions. Two examples were especially illuminating, Mexico and Chile \’96 which both experienced massive crises beginning in 1982, the year which usually signals the beginning of the LDC Debt Crisis (or the \’93lost decade\’94, as Latin Americans call it). Their policy responses in the financial sector were radically different:
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In 1982 in Chile, banks that held half of the deposits were suffering severe liquidity crises. The government took control of these banks. Within three years, the Chilean government had liquidated the insolvent banks and reprivatized the solvent banks. The government set up a new regulatory scheme to avoid mismanagement. These new regulations allowed the market to determine interest rates and the allocation of credit to firms. The short-term costs of the crisis and the reform in Chile were severe, and real GDP fell sharply in 1982 and 1983. By 1984, however, the Chilean economy started to grow, and Chile has been the fastest-growing country in Latin America since then.

In 1982 in Mexico, the government nationalized the entire banking system, and banks were only reprivatized in the early 1990s. Throughout the 1980s, in an effort to maintain employment and investment, the government-controlled banks provided credit at below-market interest rates to some large firms and no credit to others. Even the privatization of banks in the early 1990s and the reforms following the 1995 crisis have not been effective in producing a banking system that provides substantial credit at market interest rates to firms in Mexico. The result has been an economic disaster for Mexico: Between 1982 and 1995, Mexico experienced no economic growth and has grown only modestly since then.

The differences in economic performance in Chile and Mexico since the early 1980s have not been in employment and investment, but in productivity. In Chile, unproductive firms have died and new firms have been born and grown. Workers and capital have been channeled from unproductive to productive firms. In Mexico, a poorly functioning financial system has impeded this process.

GDP per working age person in Mexico declined substantially in the 1980s and only began recovering by 1988, but a second banking crisis in 1995 eroded much of the recovery and as of today it has still not reached its 1982 peak. In Chile, the decline at first was much sharper. In two years GPP per worker in Chile dropped by around 20%, which it took six years to happen in Mexico. However productivity growth surged thereafter so that by 1988 it had fully recovered to 1982 levels and as of today it has doubled. Chile, as most of us know, has been for the past twenty years the fastest growing country in Latin America, even though it as among the worst hit by the debt crisis.

The main point the paper seems to want to make is that intervention in the allocation of credit had a huge impact on the way the country was able (or not) to recover from the crisis and regain productivity growth:

Japan suffered a financial crisis in the early 1990s and followed similar sorts of policies as Mexico, keeping otherwise insolvent banks running, providing credit to some firms and not others, and using massive fiscal stimulus programs to maintain employment and investment. Japan has stagnated since then. Finland also suffered a financial crisis in the early 1990s and followed similar sorts of policies as Chile, paying the costs of reform and letting the market dictate the allocation of credit to the private sector. The Finnish economy has grown spectacularly since then.

What implications this might have for Chinese policy-making in response to the current crisis? Again, we always need to protect ourselves from conclusions that owe more to ideology than evidence, but at the very least we should consider the possibility that massive intervention in the banking system, for all the short-term countercyclical benefits (i.e. banks are forced to expand, to satisfy policy interests, rather than contract, to satisfy commercial interests) can create serious enough distortions that Chinese growth for the next decade or so might be sharply constrained. In their words:

We need to avoid implementing policies that stifle productivity by providing bad incentives to the private sector. With banks and other financial institutions in crisis, the government needs to focus on providing liquidity so that banks can provide credit at market interest rates, and using the market mechanism, to productive firms. Unproductive firms need to die. This is as true for the automobile industry as it is for the banking system. Bailouts and other financial efforts to keep unproductive firms in operation depress productivity. These firms absorb labor and capital that are better used by productive firms. The market makes better decisions than does the government on which firms should survive and which should die.

Of course someone will inevitably argue that it actually makes commercial sense for Chinese banks to expand loans now, since there is likely to be an implicit, or even explicit, guarantee that makes most new lending essentially risk-free. Yes, of course, but that doesn\’92t change the underlying logic. Banks will be channeling capital to companies not based on their economic prospects but rather based on the guarantee, and so little commercial distinction will be made between healthy and unhealthy borrowers. My guess, and not a particularly controversial one I suppose, is that the provision of implicit or explicit government guarantees will have more to do with a company\’92s impact on employment than its economic prospects.

I don\’92t want to overstate the relevance of market versus government allocation of credit, but by the late mid-1980s, when I first started trading Latin American debt, it was pretty clear that Chilean banks were in much better shape than were Mexican banks, and were much more independent (Mexican banks were not privatized until the early 1990s). I specialized primarily in Mexican debt and bonds until I ended up running the Latin American trading desk, so losing my country focus, but it did always seem to me that the Mexican financial system was a lot less prudent than the Chilean, and government \’93guidance\’94 had a very big impact on credit allocation.

Before someone suggests that perhaps poor guidance leading to credit misallocation might be less of a problem in well-governed China than in poorly-governed Mexico, I would argue that much of China\’92s recent growth came about because of the massive expansion in credit, and while the sheer size of the expansion guaranteed that there would be many years of bubble-like growth, we will only now, over the next three to five years, discover whether or not the capital was indeed misallocated on a massive scale. I think it was.

The paper makes a point of saying that the difference in subsequent GDP growth between countries that intervened heavily in credit allocation versus countries that didn\’92t was not a function of different levels of employment, but rather different growth rates in worker productivity. There were no noticeable differences in employment levels between countries that followed one strategy versus the other.

In that case one can make the argument that if the goal of policy is to minimize social disruption, the \’93Mexican model\’94 may actually be better than the \’93Chilean model\’94 because while neither model created a noticeable difference in employment levels, in Mexico an economic contraction roughly similar in magnitude took six years, versus the two years it took in Chile. Mexico may have achieved this socially less disruptive adjustment at the expense of sharply lower levels of productivity growth over the long term, and perhaps this is the tradeoff that governments face in dealing with crises. Japan, it seems to me, also chose a socially less disruptive model, in exchange for a lost decade of growth.

In other words the best policy advice for the government to maximize China\’92s growth prospects, based on the Fernandez and Hehoe paper, is probably politically unpalatable. It would involve acknowledging that too much capital was allocated to production, and that a period of consolidation is necessary. Unfortunately this consolidation means that capital migrate in a major way from less productive users to more productive users, which is just a bloodless way of saying that a lot of companies are going to have to be allowed to fail, and banks and financial markets should be weaned away from political control and encouraged to make their own commercial decisions.

But should this happen in the midst of a global crisis? On the one hand, in China \’96 and probably most other countries \’96 real reform only seems to occur after a crisis, and so this is an important opportunity to get things right. On the other hand global conditions are too ugly for China to allow bankruptcies to take their swiftest course, and so undermining the social pact, so a strong case can be made for intervening heavily now and reforming later. Ultimately this is a political question that the Chinese must make: is there a tradeoff between long-term growth and short-term instability, and if so, which should China choose?

As I noted at the beginning of this entry, hot off the press is some related news about credit intervention. In an entry last week I mentioned the astonishing RMB1.2 trillion increase in loans that had been unofficially reported for January. This was a full 50% more than the previous monthly record, and nearly one-quarter of the total increase in 2008 (to be fair however January is traditionally always a big month for new lending).

Although this was seen widely as good news for the economy, since credit expansion will probably goose up the short-term GDP and employment numbers, I of course worried about exactly how much of this was real and, more importantly, how much of this will end up as future NPLs. It seemed to me that even the most prudent and commercial banking system in the world cannot expand at this rate without shoveling in an awful lot of garbage, and loan expansion of this base represented a gamble on the duration of the global contraction.

Well, it seems I was wrong. Reuters has just announced that net new lending may have actually been and even more surprising RMB 1.6 trillion \’96 twice the previous monthly record and an amazing one-third of credit growth in all of 2008. We will know by February 15 at the latest, when the PBoC publishes lending data, but if this is true (and the report was seen as highly credible by one of my friends at Reuters) it will probably goose the stock market up further while making people like me more worried then ever. Since for me much of the Chinese growth explosion of the past several years was caused by a badly allocated credit boom, the idea that the solution to a slowdown is to jack up the credit boom even further is very worrying. It is a little like the idea that the best way for the US to adjust to the decline in its debt-fueled household consumption binge is to replace it with a debt-fueled government consumption binge, although perhaps the US and China would choose very differently in the possible trade-off between long-term growth and short-term social stability.

At any rate if this number is true, and if these credit growth levels persist, at least it suggests China is very serious about contributing its share of global fiscal expansion. This should be part of China\’92s negotiations with the US on trade relationships.

Tags: Chile, Great depressions, Mexico

Is the US trade deficit sustainable? Is China\’92s trade surplus?

January 13, 2009 in Balance of payments, Policy, Trade protection by Michael Pettis | 25 comments

China\’92s December trade figures came out and, following November\’92s lead, everything is moving in the wrong direction. Exports were down 2.8% (versus up 21.7% in December 2007) which although bad at least is better than the average forecast of over 4%. Within overall trade exports to Europe were down 3.5% and to the US 4.1%. Given how quickly things are deteriorating in both countries, with rising unemployment likely to cut further into consumption, I suspect that this isn\’92t the last of the poor export numbers. As recently as three months ago most economists were forecasting export growth in 2009 of over 15%, but now most seem to be forecasting a contraction of over 10%.

Imports were way down, by 21.3%. I am still having trouble reconciling some of the other numbers for consumption, but generally speaking people who know more about this than I do say that of all the macro data produced in China, trade numbers are usually the most reliable. This suggests that Chinese consumption is dropping quickly, and it is probably no good blaming this on declining exports (about half of China\’92s exports are processed imports) or declining commodity prices since the decline in imports is much too large for either explanation to cover.

For the first time in six months China\’92s monthly trade surplus did not hit a new world record, but at $39.0 billion it is just a whisker below November\’92s $40.1 billion, and it is easily the second highest monthly trade surplus ever, beating out number three (China\’92s October trade surplus) by well over 10%. For those who are counting, the trade surplus in 2008 was $297.5 billion. The second half of 2008, at $197.6 billion, accounts for two-thirds of the total and the last quarter, at $114.3 billion, accounts for nearly two-fifths of the total. This is not a picture that the rest of the world, struggling with overcapacity and too little demand, is going to be happy to see.

Yesterday Peter Morici, former chief economist at the U.S. International Trade Commission and currently a professor at the University of Maryland, called on President-elect Barack Obama to press China to allow the yuan to appreciate because weakness in the currency is hurting U.S. jobs and manufacturing. According to an article in yesterday\’92s Bloomberg:

Ending Chinese currency market manipulation and other mercantilist practices are \’93critical\’94 to reducing the U.S. trade deficit and creating jobs in the U.S., Morici said. \’93Obama must address the huge cost of imported oil and the trade deficit with China,\’94 he said. \’93Otherwise, any effort to resurrect the economy is doomed to create massive foreign borrowing, another round of excessive consumer borrowing, and a second banking crisis that the Treasury and Federal Reserve will not be able to reverse.\’94

Morici is making the point that if demand leaks out the US trade account at anywhere near current levels, US government borrowing required to create the demand needed to boost employment in the US will be much greater than otherwise. Instead of requiring the US to initiate debt-funded policies to boost employment in the US, China, and everywhere else, it is politically much easier for Americans to demand that the US government borrow to fund employment in the US, and let China and other countries generate employment by their own fiscal borrowing. It is hard to dispute this logic. Others will make the same argument in the US, the UK, France, Italy, Spain, Australia and many other countries with large deficits.

I want to digress a little here. My fears about the hard-to-combat logic of trade friction in a world of collapsing demand and large trade imbalances seem to have thrown me into a group of analysts with whom on the issue of trade I do not always agree. For the record, I do not have a problem with secular trade deficits and I do not believe in \’93balanced trade\’94, whatever that means. This means I have never been a trade-deficit hawk.

In the days when everyone complained about the sustainability of the US trade deficit, they always argued that it was unsustainable either 1)because the continued foreign financing of the US trade deficit was unsustainable, or 2)because trade deficits represented the \’93giving away\’94 of the US to foreigners. I did not agree with either of those arguments. I am not worried at all about the \’93giving away\’94 argument for a bunch of reason that are probably obvious to most of my readers.

As for the other claim, given the huge size, efficiency and flexibility of the country\’92s financial system (and no, the current crisis does not change my view at all), I never doubted the ability of the US to receive net capital inflows for very long periods of time. Furthermore I believe that given the terrible demographics that Europe, China and Japan face (not to mention Russia) and the relatively benign US demographics, it makes sense for all of these countries to run up claims now against the US \’96 which they can only do by running trade surpluses with the US \’96 since they will need to liquidate those claims over many decades (and so run trade deficits against the US) to pay for their demographic adjustment. Surprisingly whenever I say this there is always some one who howls (for some reason this is a subject on which polite disagreement is difficult) that the US faces its own demographic crisis and if I don\’92t believe this why don\’92t I offer to guarantee the payments needed to resolve the upcoming pension crisis.

Aside from the fact that my guarantee would not be credible, the point is largely irrelevant. The fact that the actuarial assumptions underlying the US pension system turned out to be wrong does not indicate a demographic crisis like that facing Europe, Japan and China, who also have their own pension crises in addition to their aging problems. Unlike the US, these countries are facing a sharp drop in the size of the working population relative to the total population which, as I see it, creates a demographic bias to trade deficit (I think of total population as a proxy for consumption and working population as a proxy for production). This is not nearly as serious a problem in the US, and in the US would likely anyway simply lead to a relaxation of immigration restrictions. The US has a very different sort of demographic problem \’96 one that represents intergenerational transfers, and these have almost no bearing on the global balance of payments.

What was unsustainable about the current global balance, in my opinion, was not the fact of a US trade deficit (although by 2006 and 2007 it had gotten too high to last very long), but rather the level of household borrowing needed to sustain it. These are not unrelated things, of course, but I would argue that if the US trade deficit had been funded by equity inflows that resulted in an increase in domestic investment, there would not be a trade-sustainability problem. If it was funded by a household borrowing binge, then trade-deficit sustainability is necessarily constrained by the household balance sheets. This is why I have argued that a program of massive fiscal spending to replace household demand is not going to solve the current problem. It simply replaces one kind of unsustainable behavior with another, and still has to be resolved at some point with massive deleveraging.

To get back to China and current issues, the problem with the US trade deficit now is sort of a \’93Keynesian\’94 problem. US demand has the impact of generating both US production (and employment) as well as foreign production (and employment), and in a world of contracting demand, it is natural that countries that export demand \’96 i.e. trade deficit countries \’96 are going to be a lot less eager to do so. Anything that brings imports closer into balance with exports is likely to have a demand-enhancing impact similar to fiscal expansion, with the benefit that this isn\’92t achieved by running up fiscal debt. On the other hand it will have a demand-reducing impact for trade surplus countries. That is why trade disputes are likely to be very attractive to trade deficit countries who have \’96 I will continue to insist but it seems recently that this has become a much less \’93surprising\’94 claim \’96 the upper hand in any dispute with the \’93virtuous\’94 countries with high savings rates and trade surpluses.

There is a lot of other recent news that I wanted to discuss, especially about reserve accumulation and the banking system \’96 the recent closing of a bunch of informal banks, for example \’96 but this post is long enough and I will postpone the discussion for later this week.

Tags: Morici, Sustainable deficit

As deficit countries contract, can surplus countries be far behind?

January 10, 2009 in Fiscal debt and deficits, Hot money, Labor and unemployment, Policy by Michael Pettis | 10 comments

The US loses the most jobs since 1945, the Financial Times headline blared out yesterday. According to the article:

The US economy lost more than half a million jobs in December for the second month running, figures showed on Friday, making 2008 the worst year for job losses since 1945 and intensifying pressure on Congress to pass a fiscal stimulus. The number of jobs lost during the year reached 2.6m, while the unemployment rate \’96 4.4 per cent before the credit crisis \’96 jumped to 7.2 per cent in December, its highest level in 16 years.

Yesterday\’92s Telegraph was not a whole lot warmer on the subject of Europe. It had an article entitled \’93Europe’s economy contracts at rates not seen since 1930s,\’94 which started off with:

German exports and industrial orders have both plunged at the steepest rate since modern records began and Spain’s unemployment has surged above three million, capping one of the most disastrous days for Europe’s economy since the Second World War.

It is pretty obvious that consumption in trade deficits countries is adjusting at a breakneck pace \’96 \’93adjusting\’94 being a word often used by economist\’92s to mean \’93the party\’92s over\’94. The rising savings rate required by households to repair tattered balance sheets has not just meant an equivalent decline in consumption, since this rise is occurring so quickly that income is declining. The total drop in consumption is, and will continue to be, severe.

With consumption declining so quickly, and fiscal spending so far unable to keep pace, what does this do for countries exporting excess production? In some trade surplus countries \’96 i.e. Germany \’96 the predictions some of us had been making about the \’93second stage\’94 in the crisis, in which trade surplus countries get hit with deeper and longer-lasting adjustments, seem already to be coming true. Exports are collapsing, and with no increase in domestic demand to compensate, it is pretty hard to imagine how businesses are going to cope.

For all the attempts by the government to keep confidence up, Chinese businesses, not surprisingly, are worried. Yesterday\’92s South China Morning Post had the following article:

Business confidence in the mainland plunged in the final three months of this year to an eight-year low as the mounting effects of the financial crisis weighed on exports and industrial output, an official survey showed on Friday. The business confidence index fell 29.2 points in the fourth quarter to 94.6, the National Bureau of Statistics said. That is the lowest reading since the start of 2001, the earliest date for which official figures are available.

Hardest hit were manufacturers, hurt by shrivelling demand in the United States and Europe and a weakening domestic property sector. Their sub-index plummeted 32.1 points from the third quarter to 87.2. That reading is in line with two purchasing managers\’92 surveys published earlier this month, which showed a continued contraction in the sector, as well as economists\’92 expectations that exports shrank more quickly in December.

The debate locally about what caused the trouble and what to do about it (and not incidentally, who to blame) continues strong, and recently two things seem to have been added to the stew. One, the China-trade-imbalance argument has gotten enough traction within China that suddenly the debate seems to have erupted into the spotlight. A number of local analysts, especially critics of both the left and the right, have been arguing that Chinese monetary and fiscal policies may have been part of the root cause of the imbalances that led to the crisis.

Regular blog readers know that I won\’92t find this argument at all surprising, but local policymakers are inordinately sensitive to being blamed for anything, and the official position is that China is simply an innocent bystander in a problem wholly concocted and hatched elsewhere. However an increasing number of Chinese economists and academics seem to be challenging that position, so much so that the People\’92s Daily posted a rather angry editorial three days ago titled \’93U.S. blame game cannot change facts of financial crisis.\’94 The article blasts Paulson and Bernanke for saying that \’93a failure to address the rise of emerging markets and resulting imbalances was partly to blame for the global financial crisis,\’94 and concludes:

Imbalances in global trade and investment did have a role in the crisis but were not at the root of the problem. Loose supervision that helped pump excessive dollars into circulation was the root cause. When a morally upright person is mired in difficulties, he or she will engage in introspection rather than shift responsibility. China has moved to cope with the problem with a stream of measures and so have other large world economies.

It is not time to play a blame game. Regulators in the United States might not want to miss the chance that they failed to seize before the crisis, when property companies, investment banks and insurance companies juggled various financial products and Wall Street “elites” snatched tens of millions out of the bubble.

It is hard to argue with these conclusions, but a cynic might wonder if any of the participants in the crisis would be considered, by this argument, \’93morally upright.\’94

The second thing we seem to be hearing a lot of is concerning capital flows and whether or not China is experiencing hot money outflows. We are all still trying to figure out what is happening to capital flows and to the composition of reserve accumulation (or is it reserve dissipation?). In a recent note, Logan Wright of Stone & McCarthy tries to back out the things we know to get some sense of what is happening to capital flows.

He concluded in an email to me that was attached to his research report that \’93outflows of around $100-150 billion for the quarter seem within the realm of possibility, but we won’t know anything until we see the data,\’94 but was at pains to establish that he is only guessing. His guesses would be easier to dismiss if a SAFE official hadn\’92t made a rather surprising announcement four days ago. According to Bloomberg:

China faces a threat of “abnormal” cross-border capital flow because of global financial tumult, the country’s foreign exchange regulator said Tuesday.

I accidentally erased the article and can\’92t get it back, so I can\’92t quote much more from it, but I do remember finding the whole thing a little odd. There was no clear explanation of what was \’93abnormal\’94, but all the evidence suggests that money flows are not behaving as well as we would want them to. Other interesting official commentary last week included the following, from an article in Tuesday\’92s South China Morning Post:

The mainland’s financial position will be difficult in the year ahead as revenues fall and spending surges, Minister of Finance Xie Xuren warned yesterday. Painting the most sombre picture of the government’s finances in years, Mr Xie said that shrinking corporate profits caused by rapidly slowing economic growth, as well as tax cuts, would lead to a drop in revenue, while government measures to boost growth would add to spending.

\’93[It] will be a very difficult year,\’94 Mr Xie told an annual national meeting on fiscal affairs in Beijing. \’93The problem of unbalanced income and expenditure will be prominent in 2009.\’94 His warning came as an official revealed that the mainland’s giant state-owned enterprises had reported a rare decline in profits last year. \’93Profits of state-owned enterprises directly under the central government fell about 30 per cent year on year in 2008 to 700 billion yuan [HK$800 billion],\’94 said Huang Shuhe , vice-chairman of the State-owned Assets Supervision and Administration Commission

Some of my older readers will remember last year when I argued that something a lot of analysts saw as a real strength \’96 the huge surge in China\’92s fiscal revenues, which left the fiscal account more or less in balance \’96 was, in my debt-trader-influenced pessimist\’92s eyes actually a real problem. If the fiscal account stayed in rough balance with fiscal revenues soaring by 30% a year, it seemed to me that any discrepancy between the rate of revenue growth and expense growth could lead to a sudden unexpected rise in the fiscal deficit, especially since in a downturn the pressure for revenues to decline and for expenses to rise would be unbearable.

The probability geek in me instinctively worries about very rapidly changing numbers, even when they are good, because there is a lot more room for things to go very bad. From what Mr. Xie is saying, the worry was on the mark. The growth rate of fiscal revenues and fiscal expenses have already sharply diverged, and this is even before the big spending plans have been put into place. The article goes on to say:

Ha Jiming , chief economist at China International Capital Corp, said the weakening financial position would cast doubt on the government’s much-vaunted economic stimulus package. The measures, including the 4 trillion yuan stimulus package and tax cuts, are to stem a rapid slowdown in economic growth, by boosting public spending and private consumption.

It claims that economists \’93expect the mainland will have a budget shortfall this year, with the deficit between 500 billion and 800 billion yuan.\’94 I am nowhere near smart enough to predict what the deficit will be, but I am happy to bet anyone it will be a lot more than the current predictions.

Finally one last comment about recent interesting, and even surprising, government statements, is about a report last week in Laiowang, a Xinhua publication. According to an article on the topic in South China\’92s Morning Post:

The mainland faces surging protests and riots this year as rising unemployment stokes discontent among migrant workers and university graduates, a state-run magazine said in a blunt warning about unrest in this sensitive year. The unusually stark report was in this week\’92s Liaowang [Outlook] magazine, issued by Xinhua news agency, which laid out the hazards facing the mainland and ruling Communist Party as growth falters during the global economic crisis.

\’93Without doubt, now we\’92re entering a peak period for mass incidents,\’94 a senior Xinhua reporter, Huang Huo, told the magazine, using the official euphemism for riots and protests. \’93In this year, Chinese society may face even more conflicts and clashes that will test even more the governing abilities of all levels of the party and government.\’94

This report has been so widely discussed that I don\’92t have a whole lot to add to it.

My last comments are about two recently published pieces. On yesterday\’92s Economists Forum on the Financial Times website Martin Wolf published my short version of a longer article also published today in Far Eastern Economic Review on the global balance of payments and the US-Chinese adjustments.

Tags: Logan Wright, US jobs

The fun part \’96 assigning blame

January 7, 2009 in Balance sheets, Global liquidity, Policy by Michael Pettis | 25 comments

The piece I wrote for YaleGlobalOnline, which I mentioned in my last entry, was published today, and is called \’93US and China Must Tame Imbalances Together.\’94 In the article I try to argue that the roots of the current financial imbalance \’96 or, more accurately, of the latest and strongest stage of the current financial imbalance \’96 are buried in the trade and capital relationship between, primarily, China and the US. It is very important, I argue here and elsewhere, that the US and Europe do everything possible to help what could otherwise be a very difficult adjustment for China. The editor\’92s summary of the piece is:

With surging liquidity and massive trade imbalances, no one should have been surprised by the global economic crisis, because as finance professor of Peking University Michael Pettis explains, this has been the historical pattern. Pettis details the history of the crisis, starting in 1980s, when US policy encouraged securitization of mortgages, converting illiquid assets into highly liquid investments; US households shifted money into homes rather than savings accounts, and housing prices climbed; China, enjoying a trade surplus, collected US dollars and invested in US assets. A self-reinforcing cycle led US consumers to buy more, Chinese factories to produce more, banks in both countries to lend more, and the bubbles burst in late 2008. US adjustment is more rapid than China\’92s, which could lead to a new set of problems. Pettis warns that replacing US household consumption with US government consumption will only perpetuate the imbalances, and he urges the two nations to act responsibly, coordinating fiscal and monetary policies to ease US overconsumption and Chinese overproduction.

The argument I am making here is also part of a spirited discussion among a group of China scholars who communicate regularly on China-related themes. At the heart of the discussion is an argument over the monetary and policy mistakes made by the major players in permitting or even encouraging the credit bubble of the past decade. Although at its worst these kinds of discussions can quickly degenerate into a fruitless who-to-blame invective (“It is all the fault of Chinese polices” versus “It is all the fault of the US failures\’94), at its best \’96 and the discussion has generally been quite good \’96 it is a real attempt to understand the roots of the current crisis and the still-unclear ways in which it may continue to unfold.

I am not allowed to publish or publicize any of the comments among this group since the moderator wants to encourage completely open discussion, but I can say that one of the participants wondered about the sequence of events and questioned my claim that crises are always caused as a result of periods of excess liquidity, and that it is difficult for regulators to prevent excessive risk-taking when the financial system is forced to accommodate excess liquidity. I think that this is an interesting enough discussion, and very relevant to China, to repeat the argument and my response.

My friend argues that although he agrees excess liquidity is a necessary condition for credit bubbles, it is not at all clear to him that it is a sufficient condition. Besides excess liquidity, he argues, we need misguided regulatory policies to create a bubble and a subsequent financial collapse. In his view, the Fed was primarily responsible for the crisis because of its failure to regulate the financial system with sufficient rigor, and given the expansion of liquidity, it was only a question of time before that failure would lead to crisis.

In my response I argued that it is hard to say if excess liquidity growth is both necessary and sufficient condition for crisis since we would need an objective way to measure excess liquidity growth, and that is extremely difficult, at best. The late Frank Fernandez, while chief economist of the Securities Industry Association, spent years trying to do so, but always complained that the financial system was too good at developing new and unexpected ways to expand money.

I am convinced however \’96 perhaps a little monomaniacally \’96 that excess liquidity is sufficient and I doubt the ability of regulators to prevent bubbles. Part of my skepticism about whether or not a robust regulatory framework can truly prevent credit bubbles is theoretical, and part of it is empirical, with the latter resting on two personal experiences. First, in my reading on financial history and current events there has clearly been tremendous improvement over the past 300 years and more in our understanding of financial risks, the functioning of the financial system, the sophistication of our regulatory institutions, and monetary policy, but absolutely no concomitant reduction in the incidence of credit bubbles.

Quite the contrary, and if good regulation prevented crises, why wouldn\’92t we have seen evidence of gradual improvement in the number and viciousness of crises? Second, as a former smart-ass banker/trader I am too respectful of the enormous ability of the market to game any system that can be put into place. Regulators simply cannot outplay the market, and when too much liquidity leads to an increase in risk appetite, the financial system will find a way to take on more risk that might be healthy. As I argue in my piece, \’93When any part of the financial system is constrained from taking on risk, the market simply evades these constraints in one of three ways: It innovates around them, it generates or develops new and unregulated parts of the financial system, or it conceals regulatory violations.\’94

That leaves me a hard-core Minskyite on financial instability, and it is Minsky who creates the theoretical basis for my skepticism. According to Minsky it is not possible even in theory to eliminate financial instability because the very mechanisms used to control one form of instability will cause changes in the financial system (all those smart-ass bankers/traders) that will create new forms of instability. The whole purpose of a financial system is to intermediate risk, and when risk appetites change, the financial system will find a way to accommodate that change, whether or not regulators are comfortable with the change.

That doesn\’92t mean regulations are a waste of time. On the contrary, they are extremely important in the proper functioning of the financial system, but we need to be clear where they matter and where they don\’92t. As I see it, the purpose of the regulatory framework is:

1) To create a financial system that in “normal” times optimizes the ability of the system to allocate capital cheaply and efficiently. This is where issues of transparency, corporate governance, agency problems and information asymmetry matter.

2) To eliminate balance sheet feedback mechanisms that are automatically pro-cyclical and, to the extent possible, create fiscal and balance sheet stabilizers. These don’t eliminate bubbles and crises, but they do reduce the impact and weaken the transmission mechanism into the real economy.

To bring this back to China, it is for these reasons that I am more skeptical than most about the recent financial reforms in China. As I see it, the financial system here is replete with balance sheet pro-cyclicality, which the government has not directly addressed (in fact many of their interventions increase the risk) and so China runs the risk of a big, “unexpected” jump in volatility when things turn bad.

The strongest element of counter-cyclicality in China is probably government ownership and control of the banks, but even this is counter-cyclical only up to a point, beyond which it becomes massively pro-cyclical \’96for example if problems in the banking system ever threaten government credit, which is why I have always advised anyone who will listen that the government should be very sparing in its willingness implicitly or explicitly to guarantee credit risk. Government control of the banks can prevent banks from behaving in ways that exacerbate a downturn, and usually this is a good thing, but in a very severe downturn \’96 like that which Japan experienced after 1990 \’96 the attempt to control banking activity can actually backfire if it leads to a surge in government debt that threatens government credibility. This loss of government credibility hasn’t happened in Japan (yet) but it has happened in a number of other cases.

This is basically why I think the liquidity creation generated by the Chinese recycling of the US trade deficit would have led to crisis anyway, even if there had been stronger regulation within the US financial markets. And, by the way, although I share in the general horror about the huge breaches in our regulatory framework, I also remember that during the enormous petrodollar recycling in the 1970s, the US regulatory framework was much more robust, regulated, rigid and constrained then it is now, but that didn\’92t prevent excess risk-taking. The only impact of regulatory constraints was that extremely foolish behavior \’96 massive loans to countries that had no chance in hell ever to repay \’96 still occurred among American banks (to such an extent that by the time I joined the market in 1987 only one \’96 JP Morgan \’96 of the top ten US banks was not insolvent) but they occurred outside the regulatory constraint. For all the regulatory prudence the risky behavior simply migrated to London, where international banks were not as strictly regulated by their home countries.

The real fault of the Fed in the current crisis, in my opinion, was not to foresee that this unsustainable system would eventually come to a breathtaking close, and to prepare the stabilizers that would have prevented the decimation of the US financial system and its brutal transmission into the real economy. In fact every time they intervened to prevent the system from clearing, they increased the accumulation of balance sheet mismatches. The regulators did have a role, but it was not to prevent the crisis but rather to mitigate its impact. In my opinion the Fed could not have prevented the crisis except by engineering a recession in the US to counteract strong mercantilist policies in Asia, and that is perhaps a lot to ask.

One last thing about the joy of assigning blame, I have read and re-read several times Charles McKay\’92s Extraordinary Popular delusions and the Madness of Crowds and thought I should post the following selection from his chapter on the South Sea Bubble \’96 after the bubble collapsed bringing ruin in its wake:

The state of matters all over the country was so alarming, that George I shortened his intended stay in Hanover, and returned in all haste to England. He arrived on the 11th of November, and parliament was summoned to meet on the 8th of December. In the mean time, public meetings were held in every considerable town of the empire, at which petitions were adopted, praying the vengeance of the Legislature upon the South-Sea directors, who, by their fraudulent practices, had brought the nation to the brink of ruin. Nobody seemed to imagine that the nation itself was as culpable as the South-Sea company. Nobody blamed the credulity and avarice of the people,\’97the degrading lust of gain, which had swallowed up every nobler quality in the national character, or the infatuation which had made the multitude run their heads with such frantic eagerness into the net held out for them by scheming projectors. These things were never mentioned. The people were a simple, honest, hard-working people, ruined by a gang of robbers, who were to be hanged, drawn, and quartered without mercy.

This was the almost unanimous feeling of the country. The two Houses of Parliament were not more reasonable. Before the guilt of the South-Sea directors was known, punishment was the only cry. The king, in his speech from the throne, expressed his hope that they would remember that all their prudence, temper, and resolution were necessary to find out and apply the proper remedy for their misfortunes. In the debate on the answer to the address, several speakers indulged in the most violent invectives against the directors of the South-Sea project. The Lord Molesworth was particularly vehement. “It had been said by some, that there was no law to punish the directors of the South-Sea company, who were justly looked upon as the authors of the present misfortunes of the state. In his opinion they ought upon this occasion to follow the example of the ancient Romans, who, having no law against parricide, because their legislators supposed no son could be so unnaturally wicked as to embrue his hands in his father’s blood, made a law to punish this heinous crime as soon as it was committed. They adjudged the guilty wretch to be sown in a sack, and thrown alive into the Tiber. He looked upon the contrivers and executors of the villanous South-Sea scheme as the parricides of their country, and should be satisfied to see them tied in like manner in sacks, and thrown into the Thames.” Other members spoke with as much want of temper and discretion.

Mr. Walpole was more moderate. He recommended that their first care should be to restore public credit. “If the city of London were on fire, all wise men would aid in extinguishing the flames, and preventing the spread of the conflagration before they inquired after the incendiaries. Public credit had received a dangerous wound, and lay bleeding, and they ought to apply a speedy remedy to it. It was time enough to punish the assassin afterwards.” On the 9th of December an address, in answer to his majesty’s speech, was agreed upon, after an amendment, which was carried without a division, that words should be added expressive of the determination of the house not only to seek a remedy for the national distresses, but to punish the authors of them.

Robert Walpole, for those who don\’92t remember, was the brilliant (if not always scrupulous) statesman \’96 effectively Britain\’92s first Prime Minister, although the title hadn\’92t yet been invented \’96 who had been more or less pushed out of favor for speaking strongly and often against the South Sea scheme and warning of its consequences. After the collapse, he was called back to London to clean up the mess \’96 predictable, right? Perhaps because he had been so widely reviled for speaking against the South Sea scheme, he was not fully sympathetic to the claims that the whole thing had been a scam foisted on innocent people by evildoers. He was perfectly happy to avoid the whole orgy of blame and deal with the actual consequences, but needless to say blaming the schemers was always likely to be a lot more satisfying than acknowledging that an awful lot of people participated a little too willingly in the whole thing. Walpole was famously a realist \’96 when there were sufficient incentives for foolishness and fraud, he didn\’92t doubt that even the nicest people would act stupidly or dishonestly.

Tags: Walpole

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Policy

Yet another discussion on the Asian savings glut hypothesis, and why it matters

Trade \’96 it\’92s not just the currency

Trade, CPI and other numbers came in this week

Yes, trade policies do matter

The NPC meets, and Krugman refers to the savings glut

The US government frozen in the headlights

Will China have to choose between social stability and long-term growth?

Is the US trade deficit sustainable? Is China\’92s trade surplus?

As deficit countries contract, can surplus countries be far behind?

The fun part \’96 assigning blame

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