Will the reforms speed growth in China?

Although still vague on the specifics, China’s Third Plenum November partially clarified the nature of the reforms that Beijing is proposing for China over the coming year. Of course very little was said in any of the related releases about the difficulties, of which the most important are likely to be political, in implementing these reforms, nor did we hear – not unsurprisingly, I think – much about what specific steps Beijing will take to address these difficulties. What has been surprising to me is that many analysts – some of whom, but not all, recognize how difficult implementation is likely to be – expect that the reforms will unleash such a burst of productivity that growth rates in China will be maintained or even raised from the current GDP growth target of 7.5%.

This, I think, is extremely implausible. Much of what I have written in recent months concerns the difficulty Beijing will face in switching from one growth model, in which rapid growth disproportionately benefits the elite at the expense of ordinary households, to its alternative, in which much slower growth will disproportionately benefit ordinary households at the expense of the elite. This remains, in my opinion, a key consideration in evaluating prospects over the next few years, but however successfully the reforms are executed, I am convinced that analysts who predict that we are about to embark on a decade of 7-8 % growth both misunderstand the nature of China’s transformation and ignore the history of previous similar growth miracles.

It is almost impossible – in my opinion – that GDP growth rates over the rest of this decade remain at or close to current levels. I suspect that when growth rates drop, as they must, those who claimed that current growth rates would be maintained will argue that the reason their prediction was wrong was Beijing’s failure to implement the reforms correctly. While this may help save face, it is, in my opinion, profoundly incorrect. On the contrary, I would argue that if China’s GDP continues to grow annually at above 7% in 2014 and 2015, this will be precisely because Beijing did not implement the reforms. Successful execution of the reforms, in other words, is exactly why growth rates will fall sharply.

To explain why, I want to list three of the thoughts I came away with from the general reaction to the Plenum. First, while many analysts hailed the reforms proposed during the Plenum as extraordinarily “bold” and “innovative”, in fact Chinese economists have been debating these very reforms for a long time – even before March 2007, when then-Premier Wen Jiabao famously described China’s economy as “unsteady, unbalanced, uncoordinated and unsustainable.”

Most economists now recognize that in recent years too much of China’s massive investment spending has been wasted on projects with negative real returns – as happened in the late stages for every country that followed a similar growth model. Debt, consequently, is high and is growing much faster than China’s debt-servicing capacity. This is clearly unsustainable. Once China reaches debt capacity constraints, like nearly all of its predecessors did after many years of high growth, the country runs the risk of a sudden and disorderly disruption in growth.

To resolve this problem China must implement reforms that increase investment efficiency. This includes diverting resources from the state sector to small and medium businesses. Beijing must also increase the consumption share of demand, which requires above all an increase in the household share of GDP.

Boiled down to their essentials, the economic reforms proposed during the Third Plenum would do just that – by reforming the currency and interest rate regimes, changing the allocation of credit in the financial system, spurring innovation, reforming land ownership and residency requirements, imposing stronger rule of law, and perhaps even partially distributing state assets to households. There is nothing surprising or unexpected about any of these proposals.

The second thought I came away with from the consensus reaction to the Plenum is, as I have said many times before, that historical precedents suggest that the greatest challenge facing Beijing is not in identifying the right set of reforms but rather in implementing them. The reforms are relatively easy to prescribe, but political opposition to the reforms is likely to be very strong. To see why, we must understand how the alignment between the interests of the economic elite and the needs of the economy will change.

In the early 1980s, after many decades of war and economic mismanagement, China’s capital stock was far below its institutional and social ability to absorb investment productively. China urgently needed much higher levels of investment. Following the experiences of a number of “growth miracle” countries – and employing policies proposed by economist Alexander Gerschenkron fifty years ago – China put into place policies that did just that.

These policies, among the most important of which was the repression of interest rates, all worked in the same way. They diverted resources from the household sector, whose wealth nonetheless grew rapidly as rural migrants flocked to new jobs in the cities, into investment in infrastructure and manufacturing capacity, much of which was directed or controlled by the state and the economic elite.

While this resulted in at least two decades of solid and healthy growth, the state sector and the economic elite benefitted disproportionately from the combination of rapid growth and implicit transfers from the household sector. In fact the GDP share retained by ordinary Chinese households shrank dramatically over the past three decades, while the share retained by the state grew commensurately, of course, and income inequality widened. This has nearly always been the case in the early stages of the investment-led growth model – the state and the elite benefit disproportionately.

Now that soaring debt is forcing China to abandon the model, the relative distribution of economic benefits must be reversed. Ordinary Chinese households must retain a growing share of future economic growth, while the state and the economic elite must, almost by definition, retain a shrinking share. This is ultimately what it means to rebalance the economy and – as happened in other countries that followed this growth model – this is why the reforms are likely to be politically difficult. After thirty years in which the interests of the elite were positively aligned with the interests of the country, the reforms now imply a negative alignment of their interests.

How much growth can we expect?

My third thought, and this is the most important point, is about the pace of post-reform growth. Many economists believe that a successful implementation of reforms must guarantee growth of 7% or more during the rest of this decade, but this probably represents the greatest piece of confusion about China’s adjustment. Here is my Carnegie Endowment colleague, Yukon Huang, with one of the more optimistic predictions:

Despite the vagueness of the communique, the “decision” provided a comprehensive reform programme that, if acted upon, will absorb the energies of this generation of senior leaders and beyond. Ironically, rigorous implementation of these reforms will alter market incentives so that annual gross domestic product growth in the coming years could rise to 8-plus per cent even as the recent Central Economic Work Conference debated whether to lower the official target to 7 per cent to reinforce that quality now matters more than quantity.

Although not many other analysts are predicting growth rates above 8%, certainly there are widespread expectations that if the reforms are implemented growth will remain above 7%. Arthur Kroeber from Dragonomics in a Foreign Policy article expects that the reform program “is likely to be effective in sustaining the nation’s economic growth” while the Financial Times cites one analyst as suggesting that growth will stay in the 7-8% range:

However, data released on Tuesday confirmed that Chinese growth momentum remains robust, with investment slowing but retail sales picking up. The economy is believed to be growing roughly on par with the 7.8 per cent year-on-year pace it notched up in the third quarter.

This has put Lu Ting, an economist with Bank of America Merrill Lynch, in the camp that believes there need not be a trade-off between growth and reforms. “Reforms can also support growth, especially those reforms that make growth more efficient. So I don’t understand why people think reforms have to be negative for growth,” he said.

There are however at least three very strong reasons, I think, to argue that as the reforms are implemented, growth rates must drop sharply.

1.  Growth rates underpinned by tremendous credit expansion, which acts to increase demand, are unlikely to be maintained in a period of relative deleveraging, during which demand is reduced.

It is widely acknowledged that perhaps the most important reason to change the Chinese growth model is its excessive reliance on debt to generate growth. Debt has soared in recent years, to the point where many economists simply look at credit growth in the current quarter in order to determine what GDP growth over the next few quarters are likely to be.

But as China deleverages, growth in demand must drop sharply. After all if economic growth over the past several years has been goosed by rapid credit expansion, deleveraging must have the opposite effect. It is strange that economists who acknowledge that the current growth model is overly dependent on debt have failed to understand that its reversal will have the opposite impact. If it did not, it is hard to explain why anyone would consider debt to be a problem in the first place.

2.  The failure by Chinese banks to recognize misallocated investment must overstate past GDP growth, in the same way that this overstatement must be reversed in the future, either because the bad debt is explicitly recognized, or because it is implicitly written down over the debt repayment period.

If China currently has wasted significant amounts of investment spending, it is clear that much of the accompanying bad debt has not been written down correctly. Bad loans are almost non-existent in the banking system – that is they have not been recognized in the form of reserves or write-downs – and there have been no significant bankruptcies.

There may be good reasons for this. If a loan has been made to fund a project whose economic value is less than the economic cost of the investment, economists should treat it as a bad loan whose negative present value must be written down. However if the lending bank believes that the government implicitly or explicitly backs the loan, the bank does not need to write it down.

But while the bad loan might not represent a loss to the bank, it does represent a loss to the country, and the amount of that loss should be deducted before the country’s GDP is calculated. If Chinese banks have not correctly written down the bad debt, however, past GDP growth must be overstated by an amount equal to all the bad loans that have not been written down – a fairly large number that may amount to as much as 20-30% of GDP.

But the failure to recognize the loss does not mean that the loss does not exist. The losses implicit in the bad loans must (and will) be written down over the future, either explicitly, in which case they will result in a direct deduction to GDP growth, or implicitly, in which case they will require implicit and hidden transfers from one part of the economy or another (usually the household sector) to cover the gap between the “real” cost of capital and the nominal (subsidized) cost of capital. This transfer must reduce future growth.

The point here is that if credit is a problem in China – something no one doubts – it must be a problem because of wasted investment that has yet to be recognized, otherwise it would have resulted in negative GDP growth today. Failure to recognize the investment losses will, of course, artificially boost GDP growth today, but it must also artificially reduce GDP growth tomorrow as the recognition of those losses is simply postponed, not eliminated. The failure of many economists to recognize that wasted investment has a cost – even as they recognize that investment has been wasted – has caused them both to misunderstand the relationship between wealth creation and GDP and to understate the future impact of this overstated GDP.

Debt matters, and the only time it can be safely ignored is when debt levels are so low, and the borrower is so credible, that it creates no financial distress costs and has a negligible impact on demand. Neither condition applies in China, and so any prediction that ignores debt is likely to be hopelessly muddled. In fact I would like to propose a simple rule. Any model that predicts China’s future GDP growth must include, if it is to be valid, a variable that reflects estimates of the amount of hidden losses buried in the banks’ balance sheets. If it does not, it cannot possibly be a valid model to describe China’s economy, and its predictions are useless.

 3.  The same mechanisms that forced up China’s growth rates created China’s imbalances, and reversing the latter means also reversing the former.

China’s astonishing growth during the past three decades is partly the result of a system that subsidized growth with hidden transfers from the household sector. These transfers are at the root of the current imbalances, and once reversed, so that China can rebalance its economy towards healthier and more sustainable sources of demand, the very processes that turbocharged growth will no longer do so.

If growth has been healthy and sustainable, in other words, there would be no need for Beijing to change its growth model – in fact it would be foolish to do so. If growth has not been healthy and sustainable, this is almost certainly because it has been artificially propped up, and if the reforms are aimed at unwinding the mechanisms that artificially propped up growth, then subsequent growth rates must be substantially lower.

Low interest rates, low wages, an undervalued currency, nearly unlimited access to credit for state-owned enterprises, a relaxed attitude to environmental degradation, and other related conditions were both the source of China’s ferocious growth as well as of China’s unprecedented economic imbalances. Reversing these conditions will rebalance the economy, but will do so while lowering growth in the obverse way that these conditions had accelerated growth.

One of the most obvious places in which to see this is in excess capacity in a wide range of businesses. It is clear that Beijing recognizes the problem of excess capacity. Here is Xinhua on the subject:

Tackling excess capacity will be one of the top tasks on China’s economic agenda in 2014, as the issue becomes a major challenge to maintaining the pace and quality of economic growth. “The Chinese economy still faces downward pressure next year,” the Central Economic Work Conference pointed out on Friday, citing the capacity issue weighing down some sectors as one of the major challenges facing the world’s second-largest economy.

It should be obvious that building excess manufacturing capacity, like building up inventory, is a way of propping up growth numbers today at the expense of tomorrow’s growth numbers. Closing down excess manufacturing capacity must be negative for growth in the same way that building it was positive.

These three conditions, which are the automatic consequences of the reform process – deleveraging, writing down unrecognized investment losses, and reversing policies that goosed growth rates – must lead to much slower growth. In theory these conditions can be counterbalanced by an explosion in productivity unleashed by the reforms. When analysts claim that growth rates will not slow if the reforms are implemented, this must be implicitly what they mean.

But this is unlikely to be the case. For the net impact of the reforms on growth to leave China’s GDP growth unchanged, or even to accelerate, the amount of productivity that must be unleashed by the reforms is implausibly, even extraordinarily, high. What is more, the positive impact on productivity must emerge almost immediately. Longer-term productivity improvements – for example those generated by education, land, and hukou reforms, or reforms to the one-child policy, or a speedier and more efficient urbanization process – do not count.

I am so convinced that the implementing of these reforms must result in slower growth – if only because it is impossible to find a single relevant case in history in which the adjustment following a growth miracle did not include an unexpectedly sharp slowdown in growth – that I would propose that we can judge the forceful implementation of the reforms inversely with GDP growth. If China is able to impose an orderly adjustment quickly, its GDP growth rate will slow substantially for several years.

GDP growth rates of 7% or more, on the other hand, will suggest that credit is still rising too quickly and that China has otherwise been unable to implement the reforms, in which case China is likely to reach debt capacity constraints more quickly. Growth of 7% for the next few years, in other words, is almost prima facie evidence that China is not adjusting.

——-
I wish my readers a great 2014. This year promises to be an exciting and unsettling one. Stay tuned.
This is an abbreviated version of the newsletter that went out nearly four weeks ago.  Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at [email protected], stating your affiliation, please.  Investors who want to buy a subscription should write to me, also at that address.

55 Comments

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  1. Dear Prof. Pettis,
    Thank you for your recent article, it was very interesting and educational for me. I would like to ask about one point that you have made repeatedly in your articles. It is that the growth model China is currently following has been used many times in the past, and always results in a buildup of debt that, if not managed very skillfully, results in a “lost decade” of slow or no growth. I hope I have summarized your point of view correctly.

    My question is about the examples of South Korea and Taiwan. I believe that these countries also followed the Japanese model, i.e. the current Chinese growth model, and while I remember hearing about growth there slowing, I don’t remember anything about a lost decade in either country, and I understand these countries still to be quite healthy. Did they every suffer a lost decade? Or were they somehow so skillfully managed that they avoided it?

    David Eliezer

    • I have usually argued, David, that the adjustment can take the form either of a “lost decade” (Japan, the USSR in the 1970s and 1980s) or a short, sharper contraction that comes off as a financial crisis (Brazil in 1982-84, the Asian Tigers after 1997, the US in 1930-33). In fact South Korea and Taiwan have generally experienced that latter (including, of course, in 1997). It seems that usually when the investment boom is funded externally the risk of a “sudden stop” in external financing can force the latter, but when it is funded domestically we can see either. The key is when over-investment leads to losses that are not immediately recognized, at some point we are forced to recognize them either quickly in the form of a crisis or slowly in the form of a long period of stagnation.

  2. Remember Chinese corporate debt is the highest in the world as a percentage of GDP:

    https://web.archive.org/web/20130206035650/http://www.mpettis.com/2012/10/27/when-the-growth-model-changes-abandon-the-correlations/#comment-18916

    China’s ruling class is checkmated:

    https://web.archive.org/web/20130603115932/http://www.mpettis.com/2012/09/23/can-china-increase-export-competitiveness/#comment-16624
    https://web.archive.org/web/20130603115932/http://www.mpettis.com/2012/09/23/can-china-increase-export-competitiveness/#comment-16509
    https://web.archive.org/web/20130603115932/http://www.mpettis.com/2012/09/23/can-china-increase-export-competitiveness/#comment-16585
    https://web.archive.org/web/20130603115932/http://www.mpettis.com/2012/09/23/can-china-increase-export-competitiveness/#comment-17032
    https://web.archive.org/web/20130603115932/http://www.mpettis.com/2012/09/23/can-china-increase-export-competitiveness/#comment-16951

    The only way for China to readjust is for the elite to lose power. But this will mean chaos, because the economic system (e.g. see corporate debt) is not capable of functioning without the elite. There has never been a smooth transition from a centrally controlled (top-down) economy to a bottom-up economy. Even the reunification of East and West Germany required massive financing from West Germany, which won’t be available in this case due to the $150 trillion global debt (300% of global GDP), $1000 trillion of sovereign bond derivatives, and $1000 trillion of unfunded social liabilities.

    There is only one way, which is an overshoot into chaos.

    This is going to get very, very bad. War is very likely between Japan and China, because Japan is also losing hope. Even the youth have stopped having sex.

    http://armstrongeconomics.com/2013/12/27/chinese-press-urges-retribution-against-japan/

    http://armstrongeconomics.com/2014/01/03/cycles-in-demographics-sex-to-no-sex-free-love-to-no-love/

    The entire world is headed for a Madmax outcome:

    https://bitcointalk.org/index.php?topic=365141.msg4245914#msg4245914

    By 2016 or 17, we will know.

    • Rubbish. With about 30 trillion dollars sitting in offshore tax havens around the world there is plenty of money to help China adjust and for the investors in China to make a reasonable return.

      What there is not room for is for China to continue its existing investment led model. China needs to do what it said it would do at the third plenum and much more. Xi Jinping seems like a leader as good as any I have seen to undertake this enormous challenge, one in which I wish him luck. Not just for China but also for the world. The world needs a rebalanced China. But the world does not need and in fact cannot sustain a China that is unstable, unbalanced, uncoordinated and ultimately unsustainable. Let me repeat, the world needs a rebalanced China.

      • Global net wealth is apparently north of $200 trillion, so is $30 trillion that special given China’s proportion of global population.

        Let’s not conflate claims on future labor (aka. stored money) with social capital. Michael had an entire blog about social capital, which delves into some of the differences. He and I probably disagree on some specifics, interpretations, and political models.

        For example, it depends who controls that net wealth and what their incentives are. Since that wealth is (I assume) concentrated in top-down control, then we can’t expect them to willingly turn this over to the broad population. Even if we could convince those wealthy to give it back, redistributing concentrated wealth is wasteful, because no top-down controller can devise the optimum strategy for choosing who gets how much. For example, I was recently tasked with awarding donations to the typhoon victims in the Philippines and it is very difficult to predict how people can waste money when they received for free.

        My theoretical understanding of macro economic efficiency is that bottom-up systems anneal is microsteps of a multitude of independent actors, and this social capital is been destroyed over long periods of time with top-down control and debt, as evident if a large amount of stored money has been aggregated (then it is inherently dumb as I stated above), i.e. the Gini coefficients have risen and the middle class is threatened worldwide.

        The western political reaction to this as we enter what I expect to be the second wave of this global debt crisis after 2015 will be to erroneously blame the rich (when we should be blaming debt and top-down vested interests in governments) and increase regulation which further curtail the freedom of small businesses with a negative feedback loop on income that spirals us into the toilet boil of a potential Dark Age. Instead of allowing the FREEDOM from chaos of unmanaged defaults (i.e. no public backstops, no organized repressment) which could spawn a renewal, instead the top-down control will cling to power, raise taxes far above the Laffer limit, and witchhunt all private wealth.

        China appears to be trying to further some micro-managed delusion. I read for example how they are reviewing which solar panel manufacturers to kill. This is a sign that they apparently erroneously think they can have their cake (top-control control) and eat it too (expand market fitness and thus size).

        China’s model is built on being able to replicate the same activity, e.g. manufacturing, construction, etc.. The future markets are going to come from diverse bottom-up, accretive knowledge formation. I am not optimistic that China will be able to find a home for its $30 trillion on that bandwagon. East Germany was merged when the debt bubble was still young enough that dumb large capital could simply pour into the Euro (which along with LTCM and Russian default is apparently one of the factors for the exodus of capital during the late 1990s Asian crisis).

        But how is that capital going to find new demand to invest in?

        That global wealth is dying. The industrial age is dying. Oxford U. predicts 47% of all existing jobs will be replaced with computer automation within 20 years.

        We are headed into a chaotic transformation from the industrial age to the computer revolution. This is inherently bottom-up, not top-down. See my link above, and remember that the bazaar (open source) model the only known positive scaling paradigm for software development. Top-down, closed-source, cathedral models is limited by the Mythical Man Month negative scaling.

        I’ve overhead that China’s software game and internet developers know this. Purportedly they (e.g. Baidu) break their organizations down into numerous small shops competing autonomously. Maybe they will be the next leaders of China.

        As detailed in a past blog where Michael’s showed a chart of possible growth rates, the assumption in his choice for muddle through outcome, is that the demand collapse contagion in the global economy won’t be that excessive. Where will that $30 trillion go to seek demand, when the IMF is proposing an urgent confiscation and repression of savings throughout Europe?

        Don’t expect it to come from the developing world, because the top-down tail doesn’t wag the top-down dog. Outsourcing is peaking:

        https://web.archive.org/web/20130206035650/http://www.mpettis.com/2012/10/27/when-the-growth-model-changes-abandon-the-correlations/#comment-18898
        http://www.gartner.com/newsroom/id/2550615 (decline to 2% for 2013 reached as predicted by Morgan Stanley’s model)

        So China is going to need to enter a turbulent period where that $30 trillion is forced to take massive risks with winners and losers in a more free market economy.

        I suspect some of China (and the developing world in general) is ready for this opportunity. I just don’t expect turbulence to mild.

      • What about the USD 1200 bn currency reserves from China? If China goes under it will be selling first its currency reserves. So I would be concerned the most about the US treasury market and the US economy.

        Heinrich

  3. Prof. Pettis,
    This year will certainly be unsettling, even in the US. Economies are now reaching the limit of effective demand. The US will reach the natural level of real GDP this year. Most see growth taking off and it seems that Chinese economists are banking on strong growth in the US. Yet the US itself is closing in on a contraction in about one year. Obviously this would affect China too.
    It seems China is already sensing demand limits abroad and their renewed hope will ultimately be disappointed. The capacity utilization rates in China will not get better in time. There will be a reality check coming this year.
    I do not believe that China has the cultural capacity to raise labor share of GDP. As I think you might agree, low labor share will be the undoing of China. Labor share has fallen in the US. Effective demand is now lower there. This limits the potential of imports from China. A wake up call for the Chinese growth model is only a matter of time and the time is nearer than most think.
    Thank you for your guiding insights.

    • Rising inequality has always had a bad impact on demand, Edward, because the rich consume a smaller share, and save a higher share, of their income than the rest of us, and as you note this is a global problem, not just a Chinese one. If we cannot get investment to rise commensurately with the increase in savings, which is unlikely to happen if the market believes the relative decline in consumption is permanent, then something else must adjust to counterbalance the increase in savings caused by rising inequality.
      As fas as I can figure there are only two ways to counterbalance. Either the higher savings of the rich causes a surge in asset prices (stocks and real estate) which backstops a surge in credit-based consumption among the non-rich (the “wealth effect”), so that higher savings among the rich is counterbalanced by lower savings among the rest of us, or as manufacturers find themselves producing more than the world can absorb they cut back on production, which causes savings to decline via rising unemployment.
      That is the bad news. Rising income inequality requires either a consumption binge, which is ultimately unsustainable, or rising unemployment.

      • Professor Pettis, this seems to be the economic question of the 21st century. How in a world with incredible amounts of productive capacity (overcapacity) can the global economy grow and also meet the needs of more people?

        Is this truly all negative a choice between an unsustainable consumption binge or rising employment? Is there a way to make wealth more democratic while maintaining the benefits of free markets? It does seem odd that the problem is the modern world’s incredible ability to produce more goods. This could be an opportunity if managed properly.

        I still think that global QE will have a positive affect on global demand without all the inflation that has been feared by some. Inflation needs to be driven by demand exceeding supply. We know that the global capacity currently far exceeds global demand.

        I do think political policies in both the U.S. and China need to benefit income equality. They also need to be more creative than simply taxing the wealthy and giving to the poor. This approach just seems to institutionalize and entrench a larger, non-dynamic, non-productive and undereducated class of people on the bottom economic rung of developed countries. I do not believe government can make people productive if they do not have the will or motivation to help themselves. Incentives in all economic activities are necessary to make the free market work.

        However, I differ from many of my more conservative cohorts in the U.S. when I believe government policies need to be more pro-active in improving income equality. After thirty plus years of trickle-down, we need to re-evaluate where we are today. I think the danger and problem we have seen with trickle-down is that the powerful are able to push government policies that inherently benefit them and deter income equality. Whether it be the type of globalization that has been pursued, unfettered growth of large financial institutions supported and backstopped by government, unionization, regressive taxation, industry consolidation, I believe we have witnessed U.S. government policies favor the wealthy and powerful over the last thirty years. It’s impossible to explain to my Libertarian friends that the government is involved in shaping these policies, it is necessary and they always will be involved. To ignore this fact, is ceding the shaping of policy in these areas to the wealthy and powerful.

        We can argue all day about specific political initiatives, but I think a significant part of the U.S. electorate has swung to the left while a significant group has dug in deeper and become more recalcitrant toward government influence. I believe Mr. Pettis has warned of this political instability in Southern Europe. In the U.S. it has manifested itself in the political polarization we have seen today. My view is we need a moderate government that can initiate pragmatic policies that help income equality, the U.S. economy and therefore the global economy.

        • Michael recognizes the point I made in my prior post up the page, wherein I said all the problems are due to top-down control which of course concentrates wealth due to the Iron Law of Political Economics.

          Now we have confirmation in the recent China news.

          I explained in my prior post that the only way the problem is resolved is chaos which results from elimination the top-down control. The unemployment occurs because the system is misallocated due to this top-down control.

          The chaos restarts the system from the bottom-up wherein employment will grow again after the bottom in 2032 of this increasing global crisis.

          The growth in employment will be hitech and is ongoing now. For example much of this medical transcription (dictation) BPO outsourcing will be replaced by highly integrated speech recognition software.

          So the programmers get the jobs.

          We programmers realize we are going to envied and hated and the governments will try to tax us to death.

          So we are doing something about this too.

          Goodbye to this system we have now. I am sitting in the driver’s seat and you should brace for impact with chaos.

          There is absolutely nothing the governments can do to stop this. It is technological and structural.

  4. Official growth rate isnt something one should pay too much attention to.
    Changes in net financial position of China (global savings ), changes in supply and demand of raw materials and processed goods from China to the rest of the world, opening up of the capital account to the rest of the world(global investments market). These are the interesting predictions that could change our lives. No one really cares about the official GDP statistics that much. It does not affect our lives. It is stuff in a black box. We are interested in the interfaces of the black box.
    Micheal is really bright, the brightest of all, though he shouldnt allow himself to get drawn into academical mud wrestling about headline growth rate. It doesnt matter. Michael should use his superior model of economics to predict meaningful things to us.

    • Thanks for the compliment, Lemmiwinks, and you are right that a lot of the economic data is either wrong or irrelevant, but the GDP numbers do contain valuable information which we need to understand.

  5. Prof. Pettis,
    As you’ve noted, the excessive dependence on investment has led to wasteful investments not worth the resources expended on them, and hidden losses that are probably a significant fraction of GDP.
    As you’ve also noted in other posts and in “The Great Rebalancing”, down through history such losses when recognized have nearly always been taken out of the hides of the common people, not the elite (as we see here in the US, where people whose savings are in CDs receive essentially zero interest income, driving many to buy into junk bond funds and the stock bubble, where they’ll lose large fractions of their principal in the next bubble-burst).
    So I don’t see how rebalancing to a domestic-consumption led economy can occur, because the stealth confiscation of the common people’s wealth is going to accelerate, not slow, and with the population aging so rapidly that wealth confiscation is going to cause a large fraction of the populace to feel impelled to save more, not less.
    I agree with Shelby, that the only way for China to readjust is for the elite to lose power, but this will mean chaos.

    • jm,

      In the USA it is a general transfer of wealth from young people to older people — this would need a re-balancing indeed. Either a re-balancing or masses of people shouting for blood on the street in a few decades from now.

      Thing is, the USA has the system in place for this re-balancing. I’m optimistic it will happen.

      The question for Prof. Pettis, is this also happening in all other developing countries?

      Thanks,

      • What is that system in place in the US to rebalance wealth distribution, please?

      • John, it took me awhile to digest your comment on generational wealth transfer in relation to the subject of economic growth. Yes, you are absolutely correct the U.S. is subsidizing older generations (who have a higher propensity to vote) to the detriment of younger people. To the extent, upper class and some middle class Americans are subsidized with various programs this would have a negative impact on the consumption of younger Americans now and later (to the extent govt. debt limits future growth). Younger people have a higher propensity to consume.

        This is not the only thing limiting U.S. consumption and growth, but it’s a good start. The problem is you have older people who receive far more benefits than they paid in (Social Security, Medicare, etc.) actually believing they paid for them. They don’t just feel they are entitled to them. They have been told they have earned them. Not only that, most of American society thinks government benefits are one giant cesspool of a scheme. You should get yours because everyone is getting theirs. This is the general corruption of the idea of government assistance when there is so much abuse and fraud.

    • I think more generally what China (and the US, Germany, and many others) needs is a mechanism to redistribute wealth downwards. By definition this undermines the elite, and I am sure I am not shocking anyone when I say that there are many elites within the world that need to be undermined in this way.

  6. You are so smart. Tell me what is the Gold price for 2014.

  7. Prof Pettis,

    What happens if China just prints a lot of currency and debases its monetary base, let us say doubles its currency? Can this strategy depreciate RMB, make it export competitive and also wipe out all its debt from the balance sheet of banks (technically half the debt can be erased)? Maybe, consumption can also get started. Of course, its imports will have to be funded, but its exports might rise. Can you walk through with this maneuver?

    • Debasing the currency simply means transferring wealth from those who are long monetary assets to those who are short. In China this means transferring from the household sector to the net borrowing sector. It would cause a huge worsening of the Chinese imbalances.

  8. Thus, analysts predicting or asking for 7-8% growth rates are those representing the interests of the elites and will oppose significant reforms.

  9. While you mention all the relevant points in all your blog posts and your book on China, but you have never really talked about the veracity of numbers coming out of China.

    Is China really growing at 7-8% even now, isn’t it more like 4-5% as some China experts and even international banks have claimed? If so is the case then would not a rebalancing and slow down mean 2-3% growth really?

    Do you think that the issue of veracity of numbers is a non issue?

    • Actually I have mentioned m,any times that the data has problems with it, which is why it is more important to look at trends than at absolute levels. A bigger problem than the validity of the data is the validity of what it measures. Whether or not China grew last year by 7.7% or 5.5 %, much of this growth is in economic activity rather than in value creation.

  10. Professor Pettis,

    Good article. This answers my questions on increased productivities during this time of reform. Given how much is at stake, I think the CCP will muster the will to get this done. Otherwise, they face existential issues.

  11. Mr Pettis, when you say “Beijing will face [difficulty] in switching from one growth model, in which rapid growth disproportionately benefits the elite at the expense of ordinary households, to its alternative, in which much slower growth will disproportionately benefit ordinary households at the expense of the elite.”

    AND

    “After thirty years in which the interests of the elite were positively aligned with the interests of the country, the reforms now imply a negative alignment of their interests.”

    Would you disagree that we could easily say the same about Western economies over the last few years of QE etc.where the policies have mainly benefited financial institutions and mega rich investors? Or in other words, that more or less the whole world faces the exact same problem, just with different “characteristics”

    • Yes, as I suggest in my response above to Edward Lambert, the whole world has a serious problem with the distribution of the benefits of growth. Aside form the obvious social and political problems with this, it greats a real constraint on future economic growth.

      • To what factor(s) do you attribute this pb of distribution of income and wealth worldwide? Is it an imbalance deriving from globalization whereby free trade among countries / regions with salary differences of 1 to 10 results in transfer of jobs from developped to low cost countries, resulting in a downward pressure on world salary income (nb of people employed globally * avg global salary) with the difference being pocketed by business profit margin, hence the 1% of people indexed on the profits of the top 1000 world companies do very well?

        • That is the million-dollar question — why? One problem is that countries that try to raise wages find themselves undermined by countries that try to gain international competitiveness by lowering wages. This is what happened in Europe as Germany tried to increase domestic employment by lowering wages. They forced their resulting current account surpluses onto the rest of Europe, who are now paying in the form of higher unemployment.

          • Top-down control is the root problem.

            Sorry no one here will like to agree with that.

            If I am correct, then to fix the problem we have to destroy the government.

            Then the local actors can optimize the fitness of the economy, so that employment is maximized again with optimal value creation and distribution of wealth. I am discussing in great explanatory detail this root cause of the coming economic devastation.

            I got tired of talking about it, and decided to just go implement the solution.

          • Since we established last year on this blog, that I am probably the only (min-)anarchist regularly commenting here, I am passing along a fabulous theoretic epiphany that CoinCube and I synthesized mathematically, which posits that socialism was entirely necessary for the physical economy and thus is moving to higher economies-of-scale as the economy transitions to “knowledge+virtual”.

            I think this places the rebalancing of China and my prior comments within a greater context. Hope some find this interesting if they take the time to delve into the linked discussion.

  12. Why did you delete my comment?

  13. Excellence in it´s simplicity. Thank You Prof. Pettis for another great essay about the rules of economics. “Crash and burn!” or the “political way” leading to longer term stagnation(Japan and lost decades due to the refusement of writing down bad loans/investments). Still China is not Japan which of course implies good future prospects if reforms are choosen. Preferably today, not tomorrow! I also wish people(economists) study Schumpeter more than Keynes in the China-case.

    • I think and hope China can adjust successfully, but as long as policymakers (and the sell-side analysts who cheer them on) insist that reforms can take place without lowering growth, the likelihood of a successful Chinese adjustment will drop.

  14. What should be the ultimate per capita GDP level upper limit for China?
    Currently it is around Romania GDP level, and it could be interesting to understand what could be the difference (advantage) of of China above Romania (or Bulgaria or any other European/asian country with 7k/capita GDP)

    Taiwan GDP is around 30 k/capita, and they struggled in the 80s to change the way of the development to archive this level.

    What can be the ultimate efficiency of the Chinese economy, with the current model?

    7k . 10k,20k per capita?

    It is interesting, but the USSR reached the same level of per capita GDP before it had to change the way of development.

  15. Hi Professor Pettis,

    I previously tried to post this, but somehow it didn’t get through. What I said was that you are my economic rock star. I have read Great Rebalancing and Avoiding the Fall, and the logic backed up by data and historical examples is extremely convincing. You have cleared up so many things for me and many fallacies put forth by other economists/commentators. I think Japan’s lost decade analogy to China today is very instructive. It struck me during reading your books and articles that perhaps the Plaza Accord negotiated in the 80s, which depreciated the value of the Dollar and thus the Yen rose relative to the Dollar, may have accelerated and possibly exacerbated the inflation of the asset bubble in Japan and thus bring about the lost decade and rebalancing sooner than it might otherwise have occurred. I am not saying the Plaza Accord caused the rebalancing crisis, because we know bad debt had already built up in the system and it was just a matter of time until it could no longer be serviced, but perhaps it accelerated this trend and maybe even exacerbated the lost decade. What do you think?

    Also, once Japan was forced into this rebalancing beginning in the early 90s, the US economy began turning a corner and performing better, until from about 1995-2000, we were jamming. I don’t have any data to back this up, but I don’t think this was a coincidence, as our exports became more competitive and trade and capital flows were healthier for us, allowing us to become more productive and grow faster, etc., etc. in a virtuous cycle. Does this seem right to you? if so, it would seem China’s rebalancing, orderly or disorderly, can only bode well for the US economy, despite what most pundits claim. Do you agree? Thank you.

  16. Sulla, you make an interesting point regarding the post-Plaza Accord 90s bringing a relative improvement in the U.S. trade deficit. This surely helped U.S. economic performance during the decade.

    The 90s have also been noted for a confluence of events that unleashed what some, particularly Democrats, call the Clinton Economic Boom the longest expansion in U.S. history. During that decade, the U.S. experienced a tech/internet boom, a telecom boom enhanced by deregulation and the beginning of the real estate boom. Throw in an precipitous drop in oil prices to boot and you got yourself a hot economy. By 2001, the first two booms were popping and the real estate boom as we know pushed on to 2006-2007 with the support of low interest rates. The ensuing busts were notably large and the 2000s will pale forever in U.S. history as compared to the 90s. The similarities to the Roaring 20s and the Great Depression of the 30s cannot be exaggerated.

    • Hi Phil,

      Yes, I agree with your analysis. The healthier current account combined with all of those other factors led to unprecedented (except perhaps for the 1960s) economic growth, but some of those factors like the Internet tech boom turned out to be bubbles (irrational exuberance) that popped. I would add Clinton’s and Robert Rubin’s deficit reduction policies as adding to the growth factors. As Laura D’Andrea Tyson wrotein 2012:

      “By itself an increase in the deficit, either in the form of an increase in government spending or a reduction in taxes, causes an increase in demand. But how this affects output, employment and growth depends on what happens to interest rates. When the economy is operating near capacity, government borrowing to finance an increase in the deficit causes interest rates to rise. Higher interest rates reduce or “crowd out” private investment, and this reduces growth. The “crowding out” argument explains why large and sustained government deficits take a toll on growth; they reduce capital formation. But this argument rests on how government deficits affect interest rates, and the relationship between government deficits and interest rates varies. When there is considerable excess capacity, an increase in government borrowing to finance an increase in the deficit does not lead to higher interest rates and does not crowd out private investment. Instead, the higher demand resulting from the increase in the deficit bolsters employment and output directly, and the resulting increase in income and economic activity in turn encourages or ‘crowds in’ additional private spending. The crowding-in argument is the right one for current economic conditions.” http://economix.blogs.nytimes.com/2012/06/01/confusion-about-the-deficit/

      However, the crowding-out argument seemed to apply in the 1990s, and thus the elimination of the deficit enabled interest rates to fall and the private sector to put that money to use, adding to economic activity and growth. Of course, not all of this borrowing and investment may have been in the most value-producing enterprises (i.e., tech companies that never produced anything other than prospectuses or private placement memoranda) such that this too may have aided and abetted the tech bubble. I’d love to read more about this at some point, but have not found anything on point.

  17. The argument for encouraging more credit to smaller businesses (aka non-SOE) sounds encouraging but I suspect that china needs more “independent” institutions. Typical examples are an autonomous securities market overseer (hearsay one reason VCs are relocating to Beijing is closer access to MCOM officials regulating the IPO pipeline … paperwork becoming like FDA thought sorely needed, should be sped up). Another is something like ICCA (independent commission against corruption) which would try (if not succeed) in restricting govt favors to incumbant SOEs. And more public access to databases such as credit reports and official accurate stats to allow objective investment selection criteria.

    The problem is that china wants a dynamic economy without the social disruptions for bankrupcies (which in western world is essential for reallocating capital assets). In the US, people can go between east+west coast for jobs yet the regional parochism in China is strong (like conservative Texans despising if not discriminating against liberal Californians).

    Policy can only go so far as changing cultural values (eg entrepreurial founder rather than govt mandarin) is harder.

  18. Don’t know whether you read the book Breakout Nations, which made many valid points about China as well as many other emerging nations. What is lacking, still, for some, is that they have not placed much faith in the determination and ability of the Chinese leaders to correct the problems once they perceive them and think they are “major contradictions”. Xi obviously is trying very hard to reign in the powerful elite viz anti-corruption campaigns, and Li is doing his part in encouraging small and medium business participation. Recently more than twenty communities raised minimum wages. The top-down model has its advantages when the leaders know what to do and do it. Sometimes ahead of curve, sometimes behind the curve, e.g. corruption, however, they do not wait till the “natural”, or market force, to work its way through. Because, sometimes can be long. Just a thought. Thanks.

  19. As a avid follower, book buyer and read and re-reader I can’t get enough of what Micheal has to say. Not only that I want to spread the word that here is someone who absolutely makes sense in a morass of mumbo jumbo.

    Therefore, Michael, I want to be able to tweet your blog posts to the dozen or so (slowly growing) number of people unwise enough to follow my twitter account. To do this there needs to be a twitter button on this page. Alternatively you could get a twitter account and I could follow you and try to look smart by re-tweeting you. @mpettis-cfm is available.

  20. To the extent American QE stimulated Chinese exports, it means there is leakage on QE main objective which is to revive the domestic economy in the US.

    As far as China is concerned, susbsidizing demand for its goods might be beneficial but the triggering of excessive credit creation at home is clearly not. If credit grows faster than export income, as is the case, the net impact is detrimental.

    In the end, QE policies are really about trying to relieve the symptoms while exacerbating the causes. The race between economic growth and debt growth to try and achieve a “beautiful deleveraging” is always lost.

    Michael’s approach has the merits of focusing on the causes rather than on the symptoms.

    • QE policies were to stimulate domestic economy.

      This was to relieve a domestic and global liquidity crunch, to stabilize domestic asset valuations, prop up bank balance sheets, and enable a homeostasis that enabled the economy to recover, as it has.

      This of course, these of course, are only some of the factors which have enabled QE to the assist in the revitalization of “domestic (US) economy”. There are other factors. the structure of growth in Canada and Mexico, ongoing re-industrialization (US manufacturing employment numbers at multi-decade highs), moderating BoP dynamics, stabilization elsewhere, etc….

      While supposed advanced country economic experiences over the post 2007 period are accentuated, I believe that people forget what happened elsewhere, in the immediate aftermath of the crisis; go back and look to charts at the severe drop offs in systemically important Emerging markets, China (BRICS), SEA, SA, Korea, elsewhere.

      Now greater stability has reigned, if some retrenchment may occur as QE tapers.
      Vientam and China see higher wages, Myanmar is being integrated, East Africa is becoming more intertwined and a site for manufacturing, property values have recovered in Dubai, global energy landscapes strengthen, etc….etc….etc….

      The problem of CHina subsidizing demand for its goods, is that it is trade diversionary and siphons the potential of more balanced global growth into a pit of asset bloat, as longer term structural problems go un-addressed (Social Nets, Waste and Water Management, Pollution, Erosion, Degradation, Poverty, etc).

      • I fully agree that QE was a necessary condition to backstop the economy, the banking sytem and financial markets post Lehman.

        Whether QE is also a sufficient condition in itself to put US (or Japanese) economic growth on a sustainable, balanced, pace is far more debatable.

        As a matter of fact, of the several iterations, only QE1 had any visible impact on US economic growth. By contrast, QE2 was immediately followed by the soft patch in summer 2011 and on-going QE has had no noticeable on growth so far.

        It has had a noticeable impact on other imbalances thiugh, but in the sense of widening them further. For instance, the aggregate valuation of US financial assets (total non-financial debt + listed equity marketcap) relative to nominal GDP is now at 1928 level and above the 2000 and 2007 peaks, at 378%. Another way to say the same thing is that the wealth divide is also back at 1928 level. This is making the economy less – not more – robust by making it more dependent on a more narrow base of more volatile discretionary spending. This is also decreasing financial stability.

        Meanwhile, despite 4 years of decent economic growth (~ +2.2% real), there has been no aggregate deleveraging so far: total non-financial debt is stuck at 245% of nominal GDP despite continuous write-off of legacy mortgage debt. On a gross basis – before write-off – there is in fact a continuous releveraging as the domestic economy is still not producing enough free cashflow to self-finance even a +2% real growth. This suggests that the primary causes of the debt accumulation are still at play and that QE has simply moved the debt service constraint further by pushing interest rates lower. That’s purely addressing the symptoms.

        Under-employment (which is a better measure than unemployment given the drop in labor force participation far beyond the demographic effect) is not being resorbed.

        Let’s remember that the 2008 situation was not the result of a shortage of liquidity. Actually, money creation was quite strong (too strong?) in the 2003-2007 cycle. It is just that money creation was then generated by the commercial banks rather than by the central bank. Therefore, it is not highly likely that liquidity injections would fix a problem which doesn’t arise from a liquidity shortage in the first place. Better to directly address the real causes of the problem.

        In other countries / regions whose currency is linked to the USD, QE has facilitated excessive credit expansion, which means the excess debt problem that affected some developped economies 6 years ago has now spread globally. China for instance has materially deteriorated its balance sheet over that period with total debt to GDP reaching 200% in 2013. Globally speaking the debt problem has actually grown, not dimished. The implication is that a coordinated solution (rebalancing of trade flows) is now more difficult to achieve than 6 years ago. The generalization of QE policies and outright devaluations around the world is a clear indication.

        All-in-all, past the initial backstop phase of 2008 where it was indeed very beneficial, QE has been a high risk / mediocre reward propostion as far as the US and global economy are concerned. It distracted from working on trade flows as the prime causes of the imbalances by using monetary policy to simply make the burden of these imbalances temporarily lighter.

        Sorry, this is taking us a bit far from the topic if Chinese reforms. Thank you.

  21. Michael – another great article. Handicapped by my Samuelson goggles, not a lot of Chinese policies make economic sense to me. Your inside knowledge and ability to step somewhat outside conventional economics makes your articles very informative. Also appreciate that the economic lingo has been dumbed down for us laymen economists.

    I think you are 100% correct on the difficulty of China having the political will to transform from a Capex economy to a Consumer economy. It will require the Politicos to relinquish more power to the market, and as you noted, this will necessarily involve wealth redistribution from the political and business elite to the Chinese household sector. One can only look at so called Western democracies and see how well this has turned out over the last few decades.

    On a more psychological level, it seems that many Chinese investment decisions are not only driven by insider profit, but they often have a hubristic and grandiose flair. Even the most rudimentary ROI analysis appears to be absent in the decision making process. In the early days of infrastructure development, it was quite easy for the Politicos to avoid excessive mal-investments. Besides becoming very wealthy and making relatively good investment decisions for sustained Chinese economic growth, the Political Elite may have succumbed to the self delusion that they know all the economic answers and possess the “golden touch”. The same hubris afflicts Central Bankers and most Western politicians.

    I have often witnessed this hubris at Chinese manufacturing facilities. The owner/s are successful at one enterprise. They expand production or start up a secondary businesses that is totally unrelated to their primary area of expertise. No business or marketing plan, just build it and they will come. Idle and often expensive equipment taking up valuable floor space with little chance of ever finding enough demand to create a positive ROI. This pattern seems to have been repeated on a macro scale throughout China, particularly after the post 2008 slowdown.

  22. China’s growth cannot continue without a serious reckoning to clear out bad debt and malinvestment. The middle class savings committed to unsecured WMP will probably evaporate: http://alfidicapitalblog.blogspot.com/2014/01/bay-area-economic-ties-to-greater-china.html

  23. There is research that says that China has consumption that does not show in the official figures due to tax avoidance strategies and because the rich do not participate in the economic surveys.

    Michael – what is your opinion on the Zhu Tian and Zhang Jun’s paper ?
    Their work seems consistent with the Credit Suisse survey of hidden shadow economic activity.
    Zhu Tian and Zhang Jun tie their estimates more closely to the actual car sales and flow of funds metrics.

    http://nextbigfuture.com/2014/01/for-tax-avoidance-china-has-lot-of.html

    http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID2330698_code1081335.pdf?abstractid=2330698&mirid=1

    Zhu Tian, an economist at the China Europe International Business School in Shanghai, and other economists say government estimates routinely overlook trillions of yuan in hidden household spending, particularly among the mainland’s increasingly affluent middle class. To compensate for lower wages, companies in the mainland routinely lavish employees with gifts ranging from mobile phones and household appliances to luxury cars and vacations.

    By taking some pay in undeclared perks, employees lower their taxable income and companies reduce their taxable profits.

    While the items are for personal use, once a company pays for them the expense is classified as a business cost and left out of consumption and GDP.

    While housing consumption and company-paid private consumption have contributed to the underestimation of China’s household consumption, the most significant source of underestimation comes from the serious underrepresentation of high-income families in the household surveys, upon which household consumption expenditures in GDP are based. These surveys rely on randomly sampled households to record all monthly income and expenditure. These households receive only nominal compensation for participating. The aggregate household consumption expenditure is calculated by multiplying the average per capita consumption expenditure by the total population. High-income households are known to be under-represented because they have little incentive to participate in the surveys or to report their income and expenditure accurately. As a result, aggregate household consumption may be significantly underestimated.

    Add those numbers, and household spending amounts to about half of GDP, more than 60 per cent when combined with government spending, according to Zhu’s study, which was published in September with Zhang Jun from Fudan University’s China Centre for Economic Studies.

    In the paper, they have argued that official statistics underestimate China’s household consumption, and our re-estimation shows that the true consumption rate is more than 10 percentage points higher than the official figure. A consumption rate of 61.5% is still a lot lower than the world average, but for a fast growing developing country, it may be quite normal and also desirable. It is generally comparable to the level of consumption in Japan and the East Asian tiger economies during their fast growing years.

    Even today, according to data from the widely used Penn World Table (PWT), the tiger economies still maintain relatively low consumption and high saving rates. Korea’s consumption has been around 60% of GDP since the mid-1980s; Hong Kong’s consumption rate has also stayed around 60% since 1960; and Singapore’s consumption has not exceeded 60% of GDP since the mid-1970s, with an average of 45% over the past 20 years, lower even than China’s. Taiwan has had a slightly higher consumption rate, but it has been below 70% for most years since the mid-1970s.

    Indeed, partly because of this similarly low propensity to consume and high propensity to save, China may be on its way to becoming the next high-income East Asian economy.

    • Michael has said this before, but the high propensity to save thing is largely a myth. Chinese high savings rate is due to high corporate savings, not household savings.

      As for cars and appliances as hidden consumption, that’s possible but it’d have to be a huge number of appliances to make a dent. There could be hidden consumption wealth among the high earners, but that’s another problem in itself – high earners are going to save more than middle and lower classes by default (and there’s not that many of them).

      The Chinese gov has said many times they feel consumption is too low and investment too high. If consumption is really higher than expected as these two economists suggest, you would think the gov wouldn’t feel compelled to make those sorts of statements. Since the stated goal of the gov is higher consumption, you’d also expect them to doctor the numbers in favor of greater consumption. Yet the rates are still at historically record low levels

  24. ” It is strange that economists who acknowledge that the current growth model is overly dependent on debt have failed to understand that its reversal will have the opposite impact. If it did not, it is hard to explain why anyone would consider debt to be a problem in the first place.”

    Did Japan’s net debt ever fall? As I recall they have increased net debt 4% a year for the last 20 years. It looks to me like exchange rates are influenced more by political power and the larger the money supply the more political power.

    Remember the US net debt position increased by almost 5 trillion dollars this past year (Fed Z1). Take a look at how many countries have a smaller economy than the total amount of net new borrowing occurred in USD last year.

    http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)

    Because this is political I suspect the people you refer to know better, but simply have chosen a political side. I also suspect this new debt continues strong until the average salary of my Chinese friends reaches mine in another 5-10 years. I think the 2013 net new debt number the US and Europe posted was a surprise in that it returned to pre-crisis levels and I’m sure the Chinese will want to stay ahead of it.

  25. In short, load up with consumer shares where the valuation sometimes are in single digit earnings and dividend yields in 5% (yes there are some). The growth slows down say to 4-5% but so what?. If you find a “pawn shop” lending to SMEs at too high rates because they do not have access to central bank lines, and they have way too high capital ratios, if you bet that they will get a banking license, it should be great.

    And as usual Mr. Pettis, thanks for your clarity of view. Let us that this courageous “wrist cutting” that leadership is doing will be implemented. The good thing is that the top in China is well advised by people like you and they are bright people who have known hardship and are responsible and not delusional. One has to wonder what the generation of one child spoil kids will bring as a leadership in the next generations for China….

    The money market rates are rising and PBoC is letting them rise. The real cost of capital must manifest itself, in the West, all rates benchmark are completly distorted. Henry Thornton predicted that rates which were held to low in connection with commercial rate of profit would lead to an undesirable rise in credit. He wrote that in 1801. The West had made this mistake and it applying a medicine which is bad credit-friendly (again).
    The only way to prevent excess debt if to make the cost of capital dear and reward savers.

  26. To redistribute wealth; tax the land, and especially urban land where land values have inflated most.

    Land value taxation addresses land price inflation; a major source of wealth accumulation and concentration among the elite.

    Even a modest land value tax (ie; l% or less p.a.) would transform the economy, boost transparency and fairness and support sustainable investment and production.

  27. “The wariness about foreigners was to be a characteristic of the time. British intelligence had reports since 1909 about how German intelligence was being gathered in Britain and Ireland,” he says.

    When state of war stone-broke retired in August 1914, sleuth paranoia soared end-to-end the
    UK with a roseola of paper stories, books and films. High-profile movie theater releases,
    including the German language Descry Peril,
    Guarding Britain’s Secrets and The Kaiser’s Spies, added fuel to the flame.

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