How to link Australian iron with Marine le Pen

After last week’s tumultuous markets one of my clients sent me an email saying “I am so relieved your constant talk about worsening imbalances kept us from getting too complacent. Things really are as bad as you keep saying.”

I am not sure that what happened last week is proof of anything I’ve been saying, but I do think that the framework I have used over the past decade has been useful, at least to me, in understanding both the rebalancing process in China and the events that led up to the global crisis of 2007-08. And I think it continues to be useful in judging the adjustment process – or, more likely, the lack of adjustment – that explains why we still have a rough ride ahead of us. This framework has made it relatively easy to make predictions, sometimes “surprising” ones, because by working through the imbalances and assuming – safely, I think – that deep imbalances always eventually reverse one way or the other, we can work out logically the various ways in which this rebalancing must take place.

I have argued that since the 2007-08 crisis we have seen some adjustment in the US, very limited adjustment in China or Japan (except to the extent that Beijing under Xi Jinping has stopped imbalances from getting worse), and worsening imbalances in Europe, and it is for this reason that I have never been impressed by the strong market recoveries we saw around the world. If I had to summarize the key points about the framework I use, I would make four main points:

  1. The adjustment process. All growth creates imbalances, and in every case these imbalances will eventually reverse. What really determines a developing country’s long-term success, I believe, is not how well it does during the growth years, but rather how well it manages the subsequent adjustment. Growth miracles are very common, but real success stories are rare. The reason, I would argue, is that developing countries too easily reversed the great gains they made during the good years because the adjustment turned out to be far more costly than anyone had anticipated. It is far more important, consequently, for economists and policymakers to understand how to manage adjustment and minimize adjustment costs than to figure out how to generate rapid growth.
  2. Debt and balance sheets. Probably the single biggest sources of adjustment costs are the amount and structure of debt, or, more generally, the structure of balance sheets. Economists must understand (but almost never do) national balance sheets and sovereign financial distress as well as corporate finance specialists understand business balance sheets and corporate financial distress.
  3. Savings imbalances. The purpose of savings is to fund productive investment, and while the amount of productive investment opportunities is probably infinite, institutional constraints in every country significantly can reduce the ability of productive investment fully to absorb the total amount of savings created within an economy. These constraints vary from country to country, and until we understand how to remove these constraints, rising income inequality and mechanisms that repress the growth of median household income (relative to GDP growth) often result in what I would call excess savings. The consequences of excess savings include speculative asset booms, trade imbalances, unemployment, and unsustainable increases in debt.
  4. Globalization. In a “globalized” world, no country, not even the US, can protect itself from the consequences of imbalances elsewhere. The global economy is a system in which certain types of imbalances are impossible. I especially focus on the requirement that global savings and global investment always balance, but there are others. Because an imbalance at the global level is impossible. if there are imbalances in one country or region, there necessarily must be the opposite imbalances in another, and the more open an economy, the more likely it is to respond to imbalances elsewhere. It is impossible, in other words, to understand any non-autarchic economy in the world except in the context of global imbalances.

It is on the fourth point that I want to focus in this blog entry. I have never been even remotely an expert either on iron and steel production or on the Australian economy, but recent action in the iron ore markets and a vibrant debate within Australia has, in the past three weeks, set me up for several planned and unplanned meetings with Australians – some old friends, some fund managers and bankers, some government officials – who remembered some of the comments I made a few years ago about Australia and iron ore and who wanted to discuss future prospects.

Three-and-a-half years ago, I gave a dinner speech in Sydney to a group of Australian mining industry investors. In the speech I argued, as I always have, that the historical precedents, the extent of China’s imbalances, and the growth in Chinese debt made it very clear that China urgently needed to adjust its growth model in a way that would inevitably cause a sharp fall in demand for hard commodities. I stressed that the adjustment was going to be far more difficult than what they were hearing from sell-side analysts, most of who had only just woken up to the realization that there been a great deal of investment misallocation in China.

Australian iron ore and Chinese interest rates

But because these analysts still did not understand that over-investment was a structural problem embedded deeply into the growth model – and not simply the accidental byproduct of occasional outbursts of enthusiasm – they had failed to explain to their clients that an unsustainable growth in debt and a seemingly insatiable demand for iron were simply expressions of the same system. As soon as an analyst understood that debt was growing at an unsustainable pace, I told the conference guests, he should know that Chinese demand for iron ore was also unsustainable.

Once China began the rebalancing process, I added, demand for iron ore had to collapse, and I could say this with full confidence not because I had disc drives filled with data and sophisticated correlation models that proved my case, but simply because this was the logic of the investment-driven growth model, and we had seen this same logic work its way many times before. The powerful opposition rebalancing would necessarily unleash – from groups the Chinese press had dubbed “vested interests” as early as 2007 – always made it unlikely that Beijing would implement significant reforms before 2012. It was only then that the various factions and groups would have agreed among themselves the distribution of responsibilities and privileges of China’s new leadership, including the president and premier, Xi Jinping and Li Keqiang, respectively.

It may have taken a surprisingly long time for analysts to understand why the credit process made rebalancing both urgent and inevitable, but it was clear to many economists, especially among Chinese academics, that severe distortions had been building at least since the beginning of the last decade. As early as 2007 Premier Wen openly acknowledged the distortions and imbalances that Chinese growth generated (it is probably not a coincidence that this is around the time we began hearing of “vested interests” in the Chinese press).

As an aside, it seems generally to be the case that the longer an adjustment is constrained, the more likely that the adjustment takes place in the form of what traders call “gapping” – which is a big, discontinuous change instead of a smooth adjustment – so when the change finally took place, the fall in demand (and iron ore prices) would almost certainly occur very quickly, in a matter of two or three years, perhaps. As Rudiger Dornbush said of financial crises, they often take much longer to come than you expected, but then things fall apart much more quickly than you thought they would. This means, to return to iron, if you understood China as a growth “system”, with its own logic, its liquidity channels, its institutional distortions, its balance sheets that embedded pro-cyclical or counter-cyclical tendencies, etc. you would have known that once the process started, rebalancing was going to cause iron ore prices (and prices of other hard commodities) to collapse, and I stressed, as I often do, that I did not think the word “collapse” was overly dramatic.

This is because any shift in Chinese demand for iron ore will necessarily be a big shift in total demand. China consumes about 60% of global iron ore production, an extraordinarily high share probably unmatched in history except perhaps (I am not sure) by England in the mid 18th century, when it was pretty much the only country in the world building machines, railroads, and iron bridges. This would be an astonishing consumption share even for the United States at its peak share of global GDP (around 33% in the late 1940s?), and so was all the more so for a country that represented only 12% of global GDP.

China’s disproportionate demand for iron was clearly the result of its intensely investment-driven growth model. This would change dramatically, I told the guests. I expected that the shift in demand for iron ore generated by rebalancing would cause iron ore prices within 3-4 years to drop by over 50% from their then-current levels of around $180-90 a ton.

The audience was clearly shocked by this forecast. The question and answer session at the end of the speech was brisk and suggested quite a lot of resistance to my predictions. But I really was convinced of my math, which connected iron ore prices inexorably with the extraordinarily large gap between China’s Nominal GDP growth and interest rates set by the PBoC, and it was clearly impossible to maintain this gap. In fact as I started writing more about the outlook for hard commodity prices over the next year, I adjusted my outlook downwards and proposed that iron ore prices would fall below $50 a ton before the end of the decade. A few months after this particular conference I was back in Sydney to speak at another conference, and after I spoke, Gerard Minack, former chief strategist at Morgan Stanley Australia, gave his own presentation on the world economy and, more specifically, on the slow-turning battleship of expansion in the production of hard commodities.

He is obviously an extremely smart guy and his presentation was an eye-opener for me. For anyone interested, I summarized some of his arguments in a September 16, 2012, blog entry, in which among other things I quoted the CEO of Fortescue as saying:

Iron ore prices have slumped to $US104 a tonne in recent days, yet Mr Power said it could soon rebound as high as $US150. ”As soon as restocking and production returns to normal we expect to see prices back in the $US120 to $US150 per tonne range,” he said.

In my blog entry I followed his quote with “He will almost certainly be wrong”. Even though I know nothing about the iron ore market, and certainly not as much as the CEO of Fortescue, I know arithmetic, and even before I heard Minack’s discussion of the global increase in production, I simply could not get the arithmetic that connected Chinese interest rates with Australian iron ore exports to work otherwise. Minack’s in-depth analysis of the supply side just made the arithmetic all the more convincing.

Rebalancing demand for metal

Needless to say my metal price projections, especially for iron ore, were not  popular in countries like Australia, Brazil, and Peru, where I have many friends and clients and visit often. I think however that most of my clients understood my reasons for expecting Chinese demand to drop. It simply wasn’t possible that any growth rate could keep China consuming 60% of total iron ore. That even a small adjustment in Chinese demand, let alone the large one I expected, would cause a big drop in global demand seemed brutally logical to me and, I hope, to the clients to whom I tried to explain it.

Early this week I was with an Australian government representative in Beijing whom I have known for many years and he told me that iron ore prices were currently around $83 (I think they dropped another $2 last week), and that while some people in Canberra were reluctant to say it too loudly, he and others were increasingly in agreement with my lower forecast of less than $50 well before the end of the decade, in part because supply has come off much more slowly than predicted, but mainly because they now recognize that China’s rebalancing was indeed going to be a far bigger deal for Chinese demand than sell-side research had predicted.

The fact that China’s demand remained so high for so long had created complacency among iron ore producers about China’s ability to continue buying so much iron, but we have to remember that when an adjustment takes longer than expected, the correct interpretation, I would argue, is not that it is less likely to happen, but rather than when it happens, it will take the form of larger-than-expected gapping. China has only completed the first part of the rebalancing – interest rates, wages and the currency have all moved sharply closer to healthy levels, levels at which the imbalances are no longer getting worse, in other words, but Beijing has still not got its arms around credit growth because to do so would cause GDP growth to drop much more sharply than Beijing is willing to tolerate.

This is the next great challenge for Beijing, and when the regulators finally do start to repair overextended balance sheet, with a much higher debt-to-GDP ratio than any other country at China’s stage of economic development, according to a presentation Monday night by my very smart former student, Chen Long, I expect annual GDP growth rates will continue dropping steadily, by 1-2 percentage points a year through the rest of this decade (and there has been increasing talk in the past month or two that GDP growth rates are already 1-2 points below the printed rates). As I have argued before, except under implausible scenarios (at least 2-4% of GDP transferred every year from the state to households) I cannot work out arithmetically any meaningful rebalancing process that is consistent with average GDP growth much above 3-4% during President Xi’s 2013-23 term in office. This used to be considered a shocking prediction not so long ago, but not anymore. In fact I notice that in a recent paper, Larry Summers and Lant Pritchett have suggested that the arithmetic of previous growth miracles implies that China will grow by 3.9% on average over the next two decades.

Like with my prediction, a number of people have responded to the 3.9% projection with incredulity, but Summers and Pritchett point out, like I have many times, that the same historical precedents that form the basis for expecting much slower growth during the adjustment period also predict that it will be nearly impossible for anyone to believe these lower projections. I have studied most of the major growth miracles of the past 100 years (and directly experienced some), and in every case there have been pessimists that predicted a difficult adjustment process with much slower growth. In every such case, however, these pessimistic predictions were met with general incredulity (and for some odd reason almost always written off as “wishful thinking”) but while I have indeed found that the pessimists have always been wrong, it always turned out that they were wrong because actual growth turned out to be much worse than they predicted.

Even among the greatest “Japan skeptics”, for example, I cannot find anyone who came anywhere close to predicting in the late 1980s or early 1990s that Japanese growth over the two decades after 1990 would average well below 1%. For all the economists, especially Brazilian economists, who began in the late 1970s and early 1980s seriously to doubt the Brazilian miracle, to take a second example, I am unable to find anyone who expected growth in the 1980s to be negative. For a third example, not everyone in the early 1960s believed that the USSR would inevitably overtake the US economically before the end of the century, but excluding fierce anti-Communists predicting fire and brimstone, I don’t know anyone who expected that by the 1980s the USSR would essentially be insolvent (technically it wasn’t, but LDC debt traders nonetheless included the country in their universe of defaulted or restructuring sovereign borrowers). The 1997 Asian crisis, in yet another example, exceeded in virulence any prediction that I can find. This history proves nothing about China’s future, of course, but it does suggest how little informational content there is in the incredulity with which such pessimistic forecasts are treated. This is exactly what is supposed to happen.

Adjustments are always the most difficult part, and have nearly always been harder than anyone expected, but it is important to remember that they represent the rebalancing process, so that the adjustment in growth is not symmetrical. In the case of China, for example, whatever GDP growth turns out to be, and again this is just arithmetic, Chinese household income growth will be higher and investment growth lower – after nearly thirty years of the reverse relationship – so that the impact of slower growth will be disproportionately smaller on consumption growth and larger on investment growth. This means both that lower Chinese growth will not be nearly as painful for Chinese households as we might expect, and that demand for metals will get especially hard hit.

What matters to the Chinese adjustment process, and therefore to iron ore prices, will be how Beijing resolves balance sheets distortions. But when we think about how the Chinese adjustment will affect Australia, we must also consider the impact of savings imbalances globally. The most difficult question to answer for a country like Australia, I think, is whether slower Chinese growth leads to greater Chinese flight-capital outflows, especially when Australia is a favored destination for worried Chinese business owners.

Will the US ride to the rescue?

Normally the contraction impact of much weaker iron ore export prices should be partially mitigated by the expansion impact of a weaker Australian dollar, as iron-related inflows drop sharply. If these inflows however are counterbalanced by rising private inflows from Chinese businesses and wealthy individuals taking money out of China, either because of weaker domestic growth prospects of because of rising nervousness and uncertainty, asset prices might not fall as much as we would have expected, but Australia will be caught in a vice a little like that of, for example, Spain, in which export weakness cannot be partially counterbalanced by a weaker currency.

How China, Australia, Brazil, Europe and all the rest will adjust will be determined in part by their debt structures. Thanks to Hyman Minsky’s growing group of followers, we are beginning to remember some of the things we knew about the nasty interplay between debt, overvalued currencies, and unemployment back when John Maynard Keynes, Mariner Eccles and most of all Irving Fischer explained these things to us. I am not completely sure about what Australian balance sheets look like, but I am often told that debt levels in certain sectors (the household sector, for example) are quite high. Higher debt implies a tougher adjustment because as worries about default rise, the debt itself changes the behavior of economic agents in ways that nearly always reduce growth and increase balance sheet fragility. The good news, however, is that Australia tends to have the kinds of institutions (legal, financial, etc.) that reduce the frictional costs of adjustment, so if it is any consolation, they would be worse off if they were a member of the EU.

By the way everything I have said about Australia is likely to be even truer about Brazil, although I don’t think Brazilians need to be much worried about a sharp pickup in Chinese flight capital into Brazil. On the contrary, they are likely to see their own flight capital outflows, especially as depreciation pressures increase. Either way all of this creates ugly and self-reinforcing disinflationary dynamics in Australia and ugly and self-reinforcing depreciation dynamics in Brazil (depending on the extent and structure of external debt, about which I no longer remember much) both of which cases may be hard to shake off without a major US recovery.

But will there be a US recovery? I have always been optimistic about the creativity of the US economy and the speed of its adjustment processes historically – socially painful, let us not forget, but economically efficient – but recent reports about what some are calling the “euroglut” will make a US recovery all the more difficult, perhaps even derailing it, not to mention having a potentially awful impact on China’s adjustment. The “euroglut”, for those who have not followed, is a process described and named by Deutsche Bank strategist George Saravelos, whose note last week caused a frisson of well-justified fear throughout the markets.

This euroglut is not new in the making. A year ago I wrote about a graph prepared by EU economists and presented by them at my Peking University central bank seminar. This graph showed how Europe planned to resolve its domestic imbalances. By running large and growing current account surpluses, or, to put it differently, by forcing their excess savings onto an unwilling world, Europe hoped that it would reduce unemployment at home by taking a bigger share of demand from abroad.

Because we have spent a lot of time working through the global implications of changes in trade and capital flows in any one part of the world, my students were quick to get the implications, and they pounced on the visiting economists (always politely, of course). They quickly pointed out that Europe is too large simply to assume that the world can absorb large changes in its capital and trade accounts, and as they debated about the ways global constraints would affect the assumptions about European surpluses most of them quickly decided that either the markets would not permit surpluses of this size, perhaps by bidding up the euro, or the impact of these surpluses would be very negative for the world.

It would probably be so negative that I referred to this graph as “the scariest graph in the world” in one of my subsequent newsletters. In the newsletter I said I hoped that European attempts to export its demand deficiency would be undermined by a rising euro (Martin Wolf had made this same argument in one of his columns) that would reverse the contractionary impact on the global economy of European attempts to absorb a larger share of foreign demand. The world simply would not be able to accommodate this kind of surplus. It is surprising how many policymakers in so many places simply assume that the world will absorb whatever surplus they need to assume in order to make their policies work.

But it turns out that I may have been wrong to think that an appreciating currency would make the scariest graph in the world nothing more than an opportunity for my students to debate global imbalances. Last week’s report by Deutsche Bank may have changed our views. Speaking of what he called a $400 billion “euroglut” of excess European savings over already-paltry European investment, Saravelos argued that the European export of savings was structural, driven by a (rational) refusal by European investors to invest in a stagnant Europe with rising debt and rising unemployment, and so the euroglut could not be undermined by a rising euro. He further wrote:

The clearest evidence of Euroglut is Europe’s high unemployment rate combined with a record current account surplus. Both are a reflection of the same problem: an excess of savings over investment opportunities. Euroglut is special for one and only reason: it is very, very big. At around $400 billion each year, Europe’s current account surplus is bigger than China’s in the 2000s. If sustained, it would be the largest surplus ever generated in the history of global financial markets. This matters.

I need to think a little more before I believe that a euroglut really can be sustained, but its size certainly does matter, and the fact that some Europeans think this is a legitimate policy to allow Europe, and especially Germany, to avoid repairing its weak domestic demand and to continue ignoring workers incomes suggests that Europe is willing to in a way that only recently they found unacceptable and irresponsible in China. We will see how serious Germany is about recent suggestions that it plans policies aimed at increasing domestic demand.

Savings as an expression of international love

Only an increase in German demand will work. Saravelos says that Europe must export savings not because of rising domestic thrift but because of a structural fall in investment as slow growth and worries of an unsustainable debt load cause wealthy individuals and businesses to take money out of the country as fast as they can. This is important. I don’t think many of the sell-side analysts writing about China have yet understood the connection between European capital exports and China’s adjustment process. In a year or two I suspect we will all get it, but for now I would keep a very wary eye on the incompatible needs of the European and the Chinese adjustments. I need to learn more about this euroglut, but if it exists, I should make two points about its impact on global growth:

  1. If excess European savings flow primarily into developing countries with huge investment needs that have remained unfunded largely because of a lack of reasonably-priced domestic savings, and here India and parts of Africa immediately jump to mind, European savings exports will cause global GDP to grow and global unemployment to fall.
  1. If excess European savings flow primarily into developed countries – the US being the most obvious candidate – or into developing countries with excess investment and savings – China, most obviously, not so much by flowing in as by preventing outflows – it will cause European unemployment to shift abroad to those countries. The net global impact – if there is no immediate response in the form of aggressive trade intervention and a sharp increase in beggar-thy-neighbor policies, of course – will be a potential shutting down of a US recovery, a virtual guarantee that Abenomics will fail (not that there was much hope for success anyway), and a brutal increase in the difficulty of a Chinese economic adjustment.

If the prospect of a sustained euroglut, on the other hand, causes enough trade intervention and beggar-thy-neighbor retaliation that prevents Europe from running the proposed surpluses, a wave of European defaults, including sovereign defaults, is almost certain (and I am certainly not the first person to have noticed that a massive wave of defaults has historically been one of the most efficient, if brutal, ways of resolving huge savings excesses). The only alternative would be even higher unemployment, which would certainly bring the savings rate down, but at a cost that is probably politically unacceptable.

Europe must resolve its demand deficiency by increasing domestic demand. Attempts to export its excess savings can only lead to one of three outcomes: A) global growth rises because Europe’s savings are all directed at developing countries with significant infrastructure investment needs and insufficient capital, B) global growth drops sharply, global unemployment rises, and China’s adjustment becomes all but impossible, C) international trade and capital flows collapse in a repeat of the 1930s, so that Europe is forced to resolve its savings imbalance either by a massive increase in unemployment or a wave of sovereign defaults.

Option A would be a wonderful outcome but is very unlikely, especially as the euroglut is being driven by private capital exports, and to the extent these are seeking safety, India and Africa are unlikely to be major destinations. Option B is likely to be the most likely outcome at first, but it could quickly cause global trade relationships to become bitterly acrimonious, in which case we will quickly switch to option C. Last night while I was taking a break from writing this blog entry I decided to flip through Keynes’ Economic Consequences of the Peace and I came across this ominous line: “There is no European country in which repudiation may not soon become an important political issue.” No European country indeed. I am glad I don’t believe in omens.

We should hope that Saravelos is mistaken in his euroglut hypothesis. It would mean that German industrialists and their government allies, who have attempted to grow not by investing in productivity but by forcing German workers and their European partners to subsidize their unit labor costs, after having caused huge damage to peripheral Europe’s balance sheets and European workers everywhere, including in Germany, will now pass the cost onto the rest of the world. Probably the only winner out of all of this is Marine le Pen. The longer Europe refuses to debate honestly about debt and the euro, and the the longer it suffers from stagnation and unemployment, the more credible the Front National becomes in denouncing centrist parties for sacrificing workers and the middle class to protect the interest of bankers.

This blog entry started out on iron ore and Australia, but is finishing with Marine le Pen. As I say in my book, in a globalized world anything that affects the relationship between savings and investment in one country – and nearly everything affects that relationship – must have the opposite effect on the rest of the world. There is no way of escaping the fact that imbalances generated in one country become a problem for everyone.

The possible, if implausible, silver lining in the euroglut story is that if the euroglut ends up financing an infrastructure investment boom in India and Africa, I will have turned out to be totally wrong about iron ore prices (and Marine le Pen won’t become President of France).


 Add your comment
  1. – Australian town of Moranbah suffers under low coal prices (think China):

    – But the US also wants to have a lower currency.

  2. Didn’t know that Europe was running such a big Current Account Surplus, thought it was much smaller. But demand dropping demand from Southern Europe certainly helped to increase that Surplus.

    • I need to rewrite a part of this reply.

      I think there’s (way) too much of a thing called “Germany bashing” going on. Mr. Pettis puts (way) too much blame on Germany’s behaviour. I acknowledge that Germany has a large CA Surplus and the impact of that Surplus. But one should include developments in Southern Europe as well, to understand the full picture. As a result of the financial problems in the PIIGS consumption over there decreased significantly. But as a result of decreased consumption, imports & associated Current Account Deficits in the PIIGS also decreased at the same pace (turned into a net Surplus ???). I therefore would argue that the total eurozone’s Current Account Surplus went much higher because the shrinking CA Deficits in Southern Europe didn’t keep the overall eurozone’s CA Surplus subdued.

      • Perhaps not surprisingly, Willy2, I disagree and think the problems is less “German bashing” and much more the need for so many people to treat this tragedy as a morality play, in which we get to decide which country we should bash.

        One of the leaders of one of German’s top four political parties, with his European counterparts, came to my office in Beijing six or seven months ago to tell me that he agrees completely with my analysis. I am pretty sure he doesn’t believe I was German-bashing so much as, if anything, bank-bashing. My point has always been that German workers around the turn of the century made concessions which, given the enormous traction those concessions got from the creation of the euro, ended up hurting German workers (to the benefit of business owners) and forcing a consumption boom onto the rest of Europe (to the benefit of bankers) — and please, I hope no one retorts with the inevitable and inevitably stupid: “Forced them? No one put a gun the the head of the Spanish consumer and forced him to buy another flat screen TV!”.

        When the consumption boom ended, as it always must, the solution has been not to unwind and reverse the process by which European banks and rich Germans benefitted and German workers didn’t, but rather to screw European workers and terrify middle class savers in order to save the banks and maintain the currency. In my opinion, the rigid insistence on “defending Europe”, whihc means protecting the value of bank assets, will end up being the main reason Europe will fall apart, because it gives the anti-Europe right such a wonderful opportunity to take control.

        I have characterized the European crisis as the latest in the long battle in which every debt crisis inevitably pits bankers against workers. Each side does what is in its best interest and probably seriously believes what is in the country’s best interest, but their interest are opposed. As I have written before, sometimes the bankers seemed to have been right, some times the workers, and sometimes both, but every debt crisis is resolved by assigning the losses to some group within society, and to ignore the dynamics of this wealth transfer in favor of deciding whether it is the stealing Spaniards, the lazy French, or the greedy Germans who should be blamed is — to me, at least — profoundly silly and pretty useless as analysis, although clearly very satisfying and lots of fun.

        • – Interesting to learn that a number of high ranking germans are aware of the problems of the current financial situation.
          – However, there’s a relatively simple solution. Germany (with the US) has had one of the lowest rates of investments in infrastructure. Put more money into repairing/modernizing roads, bridges, railroads and presto, there’s more investment, more work & income for the workers.
          – In one regard I admire Germany. Interest payments on mortgages are (unlike here in the US) not tax deductable, a home buyer Always has to put down 20% of the mortgage sum and can only borrow 80% max. And that results in german workers having (comparatively) more purchasing power than US workers/households. They spend (comparatively) less on “fixed costs”.
          – But more & more people are starting to realize that the workers/households were left “holding the bag”. That the banksters were bailed out at the expense of the taxpayer (=workers/government). But the banksters still have A LOT OF sway. Did you read the work/book(s) of one Mr. Michael Hudson ? E.g. “Super Imperialism” ??

        • Everyone is talking about a Eurozone break up, but I wouldn’t be surprised to see a USD-zone (a.k.a. USA) break up as well, perhaps even before a Euro zone break-up. I consider US taxrevenues & tax outlays to be the glue that’s holding the US states together. When/If those revenues drop significantly (10%, 20%, 30% or more) then I would be hard for me to believe that a US “break-up” is not one of the possible outcomes.

        • Mr. Pettis,

          To be more precise: I continue to agree with A LOT OF your thoughts/(thoughtful) writings. But my regard/admiration for Germany is still higher than for my admiration for e.g. the US and for multiple reasons. That’s why I got riled up (perhaps a bit too much) and used the words “Germany bashing” in a previous reply. And in that previous reply, I explained why.

          I regularly read the english (web-)version of the german quality magazine called “Der Spiegel”.

      • Willy2 WROTE: “I think there’s (way) too much of a thing called “Germany bashing” going on. Mr. Pettis puts (way) too much blame on Germany’s behaviour.”

        The problem is not Germans ‘bad’, Spaniards ‘good’ or Spaniards ‘good’ and Germans ‘bad’. The problem was that one rich, old country was lending to another rich, old country. The problem was not that Germany was running surpluses; the problem was that those German surpluses were eventually winding up in the wrong places. Rich old countries should lend to poor young countries. That way when the rich old countries retire, the countries that are poor and young now would have grown-up while becoming richer and would hence be able to pay them back for their retirement expenses.

        This is not something that Adam Smith’s invisible hand seems to have been able to accomplish in Europe. German private banks did not want to take the risk of lending to poor, young countries and so they just took the safe (or what they mistakenly thought to be safe) option of making short-terms loans in the common Euro to Spanish banks.

        Since the ‘invisible hand’ does not seem to be doing the job, perhaps the German government could take the risk in order to correctly direct its surplus towards young & poor countries. Here are some points along this line of thought:

        1) Germany creates a pan-Germanic sovereign wealth fund called the Gross Deutschland International Finance Corporation (GDIFC).
        2) All the surplus Germanic countries (Germany, Netherlands, Austria, Switzerland et cetera) can own shares in this corporation in proportion to their GDPs.
        3) This corporation then borrows the excess savings (i.e. surplus) of the Germanic countries by issuing long-term bonds (10, 15, 20, 30 years).
        4) By government diktat, this corporation then turns around and makes long-term Euro-loans to banks in poor & young countries (or purchases long-term government or corporate or financial bonds in those countries).
        5) These local banks in capital-poor young countries then reduce their interest rates and widen capital availability to businesses and households in those poor & young countries.
        6) As a result, the Germanic trade surpluses will eventually (even if not directly) wind up as trade deficits in the poor, young and capital-deficient countries. As long as the bonds are long-term and government-guided, the problem of capital instability and panic-runs in those poor young countries is automatically mitigated and IMF won’t need to be called in every few years amidst riots.
        7) What if it all goes bad and these poor young countries can’t pay back? Well, then it would be no different from what we have now. In fact, when one rich old country lends to another rich old country, as Germany did to Spain in recent years, the loans are almost certain to go bad either due to unneeded investment or gluttonous consumption. But if the same rich old country had made the loans to a variety of poor young countries, some of the loans may indeed have gone bad, but others might have turned out to be good. As for the ones that go bad, the rich governments of the Germanic countries could just write them off as “foreign aid”, which is something they like to do (and boast loudly about) anyway.
        8) In fact, it is not necessary to make ONLY loans (i.e. debt channel) to those poor young countries. The GDIFC could as well borrow Germanic savings on long-term basis and use that money to buy and hold equity (private or listed) in the reputable local companies in the poor young countries.
        9) Alternatively, the GDIFC could provide incentivized long-term loans for companies from the Germanic countries themselves, for the specific purpose of making FDI investments in the selected poor, young countries.
        10) Regardless of the actual instrument, the key point is that the savings of the rapidly aging and capital-rich Germanic countries would be made to flow into young capital-poor countries that MIGHT (not necessarily) be able to find some productive uses for those savings. Worse comes to worst, the Germanic countries would still be no worse than they are today after having lent to fellow rich old countries like Greece, Spain, Italy and so on.

        I could be wrong. Something to think about……

        • – One major reason german surplusses were recycled into Southern european bonds was that as a result of the Euro exchange rate risks disappeared.

          – Southern Europe has Always persued inflationary monetary policies to resolve financial problems. That meant that Southern european currencies were “weak” and Southern europe was forced to pay higher interest rates than in northern Europe.
          – France switched from a “weak” to a “Strong” currency policy in the 1980s and the reward was a stronger French franc.
          – In 1990 (??) Greece paid 25% interest whereas Germany paid “only” 10%. But already in the early 1990s the impact of the upcoming Euro was felt. It meant that in the 1990s the spread between e.g. greek & german yields narrowed (bit by bit). Investors were reaching for yield and found that (without exchange rate risk) in Greece & Southern Europe. In early 2008 Greece paid only slightly more than Germany. So, Southern Europe benefited massively of being in the Eurozone with Germany for over 20 years.

          And that’s why those german CA surplusses ended up in Southern Europe as CA Deficits.

          • Correction: I meant to write:

            “– France switched from a “weak” to a “Strong” currency policy in the 1980s and the reward was lower French interest rates”.

            But as a result of a stronger French franc French farmers suffered under cheap italian & spanish Agricultural imports.

        • Willi2,
          you are for sure wrong about 20% down payment. (relatives bought a house in Germany in 2010 and put less than 5% down and no paying principle, just the interes,t for some years, I think 5. Good income and permanent job though are a must ).
          Not much realization that the workers got screwed by bankers either.
          Spain and Greece are blamed as lazy. USA is blamed as greedy and as a cause of financial crisis.
          No, purchasing power is definitely lower than in the US for workers, but safety net is great: education, healthcare, etc. are guaranteed.

        • Vinezi,

          German economists Daniel Gros and Thomas Mayer wrote an interesting paper for the Centre for European Policy Studies in 2012 on a possible German SWF. I forget the detail, but you may find it of interest.

          • Yes, it does seem very similar to what I was suggesting.


            Although I would like to see a common SWF for all the Germanic countries that are running surpluses. So instead of the Deutschland SWF (DESWF) that the authors suggest in their article, I was pointing to the benefit of a coordinated Gross-Deutschland SWF.


            Another point of interest in the above-linked policy paper is the concluding paragraph in which the authors write: “One might of course object to our proposal that it presents a typical Germanic mercantilist view which transfers the burden of adjustment to the rest of the world.”

            This is why I was suggesting that the surpluses be specifically directed towards the young and capital-poor countries.

            If the surpluses are directed towards the US then it WILL be mercantilism which ‘ transfers the burden of adjustment’ to the US. On the other hand, if the surpluses are directed towards young & capital poor countries, then it will NOT be mercantilism and there will be no ‘burden of adjustment’ to transfer at all.

            A ‘natural’ flow of capital from rich old countries to poor young countries will create jobs on both sides and be a true win-win. For example, the workers in the rich old Germanic countries will be busy producing machinery for export and the workers in the poor young countries will be busy using that imported machinery to produce more goods that they can consume or invest in their own economies. In fact, this was the relationship between the US and England for the first 150 years of the American Republic.

        • But all this doesn’t solve the fundamental problem of too little demand in Germany (think modest wage growth, falling interest rates).

        • You’re missing something else. In economics, having “Savings” means that production is larger than consumption. So, both in Germany & China production is larger than german & chinese consumption. And german & chinese consumption of the consumer is so low because of low interest rates & modest wage growth.

          Germany has a CA Surplus (or “Savings”) of ~ $ 280 bln. but those “Savings” don’t end up in the wallets of the german consumer. They end up in the pockets of the corporations. And that depresses german consumption. That’s why the word “Savings” is so misleading.

          • Correction: I should have written: In economics, having “Savings” means that investment is larger than consumption. So, both in Germany & China investment is larger than german & chinese consumption.

          • Willy2 WROTE: “Germany has a CA Surplus (or “Savings”) of ~ $ 280 bln. but those “Savings” don’t end up in the wallets of the german consumer. They end up in the pockets of the corporations. And that depresses german consumption. ”

            Just stating something as fact does not make it so. You have have to provide DATA (EVIDENCE) to back up your claim.

            I have checked the data. There is NO EVIDENCE whatsoever that German HOUSEHOLD consumption has been ‘depressed’ or ‘suppressed’. Here are the data for you to examine yourself:

            A) German Household Consumption

            B) German Household Savings

            C) Therefore, by adding (A) & (B), we can conclude that German Household INCOME was around 70% of GDP. This is a respectable figure and does not indicate any “repression”, “suppression” or “depression”.

            Do you disagree? Do you still insist that wages or household income or household consumption have been ‘suppressed’ in Germany? If so, please provide reference-DATA to support your view.

  3. As usual brilliant, and you are frighteningly alone showing your academic courage. I have some thoughts which I hope are additive as this is the most important topic of the times.

    It should be understood that it is not just that there is a curious Dornbush “suddenness” that resolves imbalances, but if those imbalances were built as policy, especially policy that at its heart is meant to provide societal control, increase government power or repair a perceived deficiency in power or alleviate a risk to power (Tienanmen) , or to counter a foreign security risk, the imbalances created by policy can only be resolved by “un-policy”. In other words via catastrophe and jumps which will be weeks in the process versus the decades that the policy required to build those imbalances. Since imbalances created are the results of policy, it means by definition they have the current group in power committed “all in” on those imbalances. China may actually be able to remedy the imbalances by a change in policy based on Confucius ideals of the greater good -but that has never been accomplished in history be it the Athenian mercantilism to Roman wheat trade with Egypt to American housing market. So the odds as defined by history is that China will experience a very severe cataclysm ,right up there with a Yihetuan or Taiping event. I hope not. As that would result in war.

    That is what is unsaid – maybe it has to be unsaid – is that such imbalances are not just severe economic conundrums lacking sensible policy – but are always the cause of all war. These imbalances, therefore, are the most important foreign policy and security issue for the USA and all world governments. If they are successfully deflected from the international lines of transmission – for example the USA “ate” the first phase of the China imbalance resolution via the solvency event of 2008 – they will always cause at best intense internal insurrection or a civil war and at worst global war. Very serious stuff indeed.

    These imbalances are intolerable for this globalized world.

    Your ideas on Saravelos “Euroglut” are thoughtful. And Saravelos is thoughtful to approach Europe on an international identity perspective like the good Minskian I am sure he must be. But that glut does not exist in truth. The real imbalance is not that that Germany and a few Nord fellow travelers have excess savings and low demand, but that all of those savings are matched and then some by the deficit in the PIIGS. The T2 accounting has become ubiquitous such that it no longer terrifies or even really acknowledged . And the Nord EZ feel they have successfully forced the PIIGS into a long term acquiescence of the policy that built the T2 imbalances, and they will remedy those imbalances via labor. Thus the 50% youth unemployment in Greece today, near matched in Spain and Portugal. And with Italy starting to follow. This remedy though is a fiction, a Potemkin policy which is providing the illusion that the Nord have the ability to consider exporting their excess savings and deflation to the USA. What will happen is all those savings will be marked down so the entire EZ will net to levels the T2 net would now indicate (and then of course the “shadow” netting added as well) so that all that Euroglut goes “poof”. Of course the last time Europe had this process WW II occurred, and it is telling that you went to Keynes “Consequences of the Peace”. The only constructive answer that can work for Europe is that the T2 and other shadow imbalances are netted across Europe via transfer payments both spot and forward via trans-Europe unemployment insurance like payments and social security and health coverage. There is the small issue of a constitutional apparatus being built to administer this. So I do not think the “Euroglut” is of any risk to the USA.

    What I do know is that the highest levels foreign policy formulation in the USA from the beginning of the Euro crisis were well aware of all I say above and anticipated the current status. I heard such discussion first hand. The USA policy formulated for the EZ crisis from 2011 on was to give Germany a “green light” to force PIIGS to use labor to maintain and work to remedy the EZ imbalances. That very capable US analysis calculated thresh hold levels of unemployment in the PIIGS that they feel could be maintained before insurrection and the return of fascism. That Fed Reserve support of the regional central banks along with one off ad hoc measures like the IMF “troika” would also assist in maintaining German hegemony of Europe. france would be bought off by calling this a Gaullist European solution. This is because of the obvious logic that the only possible competitor to the United States hard power would be a Monnet Plan “United States of Europe”. So the USA is supporting the German hegemony at the terrible cost of strapping the PIIGS, thereby keeping Europe in one vast chronic “frozen” economic crisis. The USA has no interest in seeing a land and naval force develop that would equal the US military. And a United States of Europe would have a land and sea force the complete equal to the United States.

    Lastly you are wrong, There is one economist who clearly anticipated both the USSR demise as well as the Japanese crash. Whats more she correctly predicted the “lost decade(s)” of Japan that followed the 89 crash. I do not think she was aware of this but I would imagine this autodidact economist must have read Minsky, but she able to do this with a very clean application of Minskian like identities to imbalances. Whats more she freed herself from the national account data and considered the world as populated by large city-state economic regions. That was of course the great Jane Jacobs. That means just as you went to “Consequences”, a read of “City and the Wealth of Nations” is a good use of time now.

  4. On Marine Le Pen.

    For at least 40 years, since Giscard d’Estaing in 1974 and may be even since the events of May 1968, French politicians have promised their people that it was possible at the same time to:

    1. Increase the purchasing power of wage, and in particular of the minimum wage,

    2. Work less, both by decreasing the working week and by lowering the legal retirement age,

    3. Increase the scope of social benefits and public spending, thereby pushing taxation to high level,

    4. Commit France to the Euro, thereby giving up any possibility of adjustment via exchange rate,

    5. Commit France to free trade with countries that have 10x lower wages, 2x lower social charges, 30% longer working week and year, older retirement age, 2x lower taxes, while not making sure that exchanges rate will be set at level that make trade flows balance,

    6. Create jobs and reduce unemployment.

    For 40 years and counting, French politicians – both left and right wing – have failed.

    Absolutely every French citizen has understood by now, if only intuitively, that all these objectives are mutually incompatible and that one has to choose.

    Everybody, that is except the political establishment. And that’s by far the main tailwind behind Marine Le Pen despite the very serious reservations that the vast majority of French people have about the true nature of the beliefs she represents.

    By the same token, your suggestion that Europe simply increase its domestic demand by raising workers wage will be incompatible with reducing unemployment as long as the leakage due to labor arbitrage allowed by the world trade and monetary system is not resolved.

    So, we’re going around in circle.

    • Unfortunately in a globalized world it is indeed hard not to participate in beggar-thy-neighbor policies.

      • I’m not sure how to understand your response.

        Do you mean that the “euroglut” about which you are concerned is in fact a predictable response under the system of Europe following a beggar-thy-neighbor policy vis a vis the rest of the world?

        Or do you agree that boosting domestic internal demand will fail to reduce unemployment in Europe as it will predictably leak abroad due to foreign countries following beggar-thy-neighbor policy vis a vis Europe under the system?

        In both cases, we are indeed going around in circles.

        The inevitability of beggar-thy-neighbor policies in a globalized system does sound contradictory with the mutually beneficial international trade based on comparative advantage.

        This apparent contradiction suggests more work needs to be done to clarify the costs / benefits of globalization and the related ways to best organize it.

        • I mean the latter. Europe’s BoP problem is that private investment is so low that the only likely ways to address the excess of savings over investment is either to export savings and run a large CAS, to force down savings drop (probably in the form of rising unemployment but also possible by raising household income in Germany), or (best of all) to have governments initiate large infrastructure projects, although this means mostly Germany as other large European countries might have trouble raising the debt. Germany has discussed both increasing household income (mainly by cutting taxes, I think) and investing, so they are making the right noises.

  5. Thanks once again Michael. As an Aussie I find your thoughts on our economy spot many here talk of the Iron Ore price rebounding over$100 again soon and of endless prosperity thanks to China and its urbanisation.Here in Sydney it is common for Chinese investors?,to pay a million dollars for a very average house,even bidding against each other for the same property.

  6. Excellent piece, a joy to read. Thank you for taking the time to write this blog.

  7. ^^Michael Pettis WROTE: “…In my blog entry I followed his quote with “He will almost certainly be wrong”. Even though I know nothing about the iron ore market, and certainly not as much as the CEO of Fortescue….”

    Good article on the whole, Michael. However, I do think you are being unfair on that CEO fellow. His job is not to ‘speak the truth’ and disseminate the results of his analysis; that is the job of university professors. His job is to rally share-prices and create ‘value’ for shareholders. In light of this, what did you expect him to say? That iron-ore prices were going to collapse and that everybody should dump the shares of his company? Did you expect him to commit professional suicide by indulging in blunt talk? He was, as they say, ‘talking his book’. He said what he had to say. It is no reflection on his knowledge or lack thereof. The public statements of CEOs cannot be used as yardsticks to measure their awareness of market or macroeconomic conditions.

    • I guess we can see whether he has increased or reduced Fortescue’s exposure to iron to determine his true views on iron ore prices.

      • Hi Michael, Your prediction on Iron Ore Prices, leaves me with a sobering thought that most of the Australian Wealth created in the last decade would be wiped out if this happens. More importantly, why would banks keep increasing exposure given the correlation that these prices have with debt repayment ability?

        • Told an Australian friend in 2008 to hold his USD (paid in USD), China would stimulate, wait for bottom and swing back up, buy, ride it up, sell his AUD when stable at previous or above, then buy back his USD, an the same over, never thought China would extend its bubble this long. But this noise is extended by many, GOLD, commodity super-cycle, de-link between Gold and Oil and other commodity prices. It’s like Healthcare in US it can grow faster than GDP, but not forever, same with investment in commodities, or investment in construction of GDP. Wonderfully simply model, with great power, theoretically accuracy should be weak, but it seems you might be on to the unified theory, or a more precise component, additional definitional component, of mere Supply and Demand.

          Just like QE2, many emerging countries ill complain of dollar wars, where Fukuyama would say Clientalism is strong, speaking to a bought off, long supported political patronage network and base, but any CEO worth his salt should have used the low rate environment to lessen his companies ongoing financial load. Yet, national policy makers will try to suggest, for the purposes of influencing the masses that the external other, do this or that (often maniacally, as they always do, right George). Of course in coal or oil, for MNC’s in free and open markets, there is the issue of market share, Audi investing another billion in China, even though auto sector will weaken (local gov’t, SOE’s fleet cars, and lessening consumption) as Saudi Arabia will ride a lower environment (not specifically to weaken Russia, Iran or US production as is described by different parties) but to maintain share. Even Nigeria is having to discount into Asia, with even higher transport costs. So, only the most obtuse in Australia would have not seen it coming,all of my Aus (and SA) friends were informed. Michael, it will take a new condominium to see these gluts work out, or even India get the money (whatever happened to Roussef’s 800 billion over the next 5 years, 5 years ago, didn’t happen). It seems we will ride this out, maybe hit a deep rut and infrastructure will become the end of the decade buzz. It amazes how zero-sum people still remain (GR).

        • I prefer to think of wealth as the ability to produce goods and services, and although Australia will have a tough adjustment, its real wealth will continue. In fact more than one Australian has pointed out that the metals bonanza has actually distorted the Aussie economy.

      • ^Michael Pettis WROTE: “I guess we can see whether he has increased or reduced Fortescue’s exposure to iron to determine his true views on iron ore prices.”

        Yes, it looks like they are (1) reducing their capital expenditure and (2) using the money saved to pay down debt (3 billion$ repayment so far). This delevering tells us clearly that they expect demand (volume) & prices to fall. They seem to be preparing for a fall in share-prices and probably don’t want to get caught in a high debt/equity ratio trap when that does happen.

  8. ” A) global growth rises because Europe’s savings are all directed at developing countries with significant infrastructure investment needs and insufficient capital,”

    Prof. Pettis, what do you think about this simple attempt: as China tries and adjust household consumption to higher percentage of GDP it would require a “second China” to provide its rising middle class with products at low costs. India is the only one who has the potential and scale to do it. Thus, China will invest in infrastructure in India and build up its production capacity, this in turn will increase investing from Europe.

    Of course, I’m trying to be forcefully optimistic here because after reading your articles I regret I do not drink alcohol.

    Oh, yeah, Fortescue has been a great short in part thanks to your teaching and it’s interesting to see it go on its way to the bottom.

    • We are all linked, unfortunately zero-sumthinking obtains, the world has far too much capacity. I am afraid that their intelligentsia and perhaps anture of poltical system revolved around the noise of Said to late. It is fashionable, currently to re-date their movement toward taking a more global orientation to their development (1970’s 2 rupee to dollar, late 1980’s 18, today 62, and not so long ago, long around 40). Their re-orientation, mostly long after China, 2 decades or more, enabled China to break the ADM on the back of its excess. A new global agreement is needed, people will eventually see that.

    • An India infrastructure boom (and an American one too, by the way) would be great for India (the US) and the world. The real question is whether the leadership is capable of pulling it off. That is where my Indian friends tend to be very pessimistic.

      • The thing about American infrastructure is that almost all of the country’s infrastructure is done by the states. If we want an infrastructure boom here in the US, we need to fix private, state, and local government balance sheets.

        The wrong way to help state, local, and private sector balance sheets is the way the socialists wanna do this: by transferring the debt to the federal government out of some naive idea of “democracy”. Let’s take something that people are responsible for and transfer it to the nation whereby the decision makers aren’t responsible for their actions while future generations get stuck with the costs. That’ll work well. Of course, expecting socialists to make sensible decisions is, in and of itself, not sensible.

  9. Infortunatly euroglut is REAL. We talk a lot about this in France and in Europe. A french left libertarian Jean Marc Daniel stated that french asked china to rise its currency when China run a large current account surplus, but now Europe run a current account surplus France still ask for euro devaluation. More they get it thanks to Janet Yellen. This is a VERY BIG problem. Because to me the most unreliable market is currency. But there is no real price of money and stocks either. Only way people think of getting out of the crisis in Europe is by lowering the wage the same than german did.

    On commodities i would like to know how you people think China consumption will shift to other South East Asia countries, with factories moving from Shenzhen to Vietnam. Because their is clearly a FAKE demand for commodities in China due to shadow banking stockpilling. Market overvalue chineese demand for sure. But what the fondamental will look like?

    On Africa, I honnestly absolutly don’t think carry trade can drive investement in Africa like it did in South East Asia. Because the type of investment are too differents in north and in south. And they can bear the risk. Plus you can’t expect that a market lead by pention fund to take any disrupting risk like nationalisation.

    • ^^Cedric WROTE: “..You can’t proove that african [boom] is due to commodities. It clearly started with debt relief. Please look at Russia South Africa Brazil, who realy surf on commodities boom. …”

      A) Here you can clearly see how the change in terms of trade for SSA is OUT OF PHASE with the net commodity-importing countries.

      B) Here you can clearly see how the change in terms of trade for SSA is IN PHASE with the net commodity-exporting countries.

      C) As the AMPLITUDE of the swing in 2009 (when commodity prices crashed in response to the global economic crash) indicates, SSA is MORE dependent than Latin America, but less dependent than oil-exporting MENA & CIS.

      • Of course South Africa is a net exporter if it <

        • SSA stands for Sub-Saharan Africa. Since you seem to prefer IMF, the data presented in the graphs are from the IMF itself. Here are the raw data:

          If you want to go country by country to make sure that it is not just South Africa that is skewing the results, here is the same information from the World Bank shown in cumulative-index form for each country, rather than the annual-growth form for the whole region that the IMF prefers:

          Any way we look at it, the issue remains the same: Favorable terms of trade caused by rising commodity prices have boosted Sub-Saharan African economic growth-rates significantly. When commodity prices decline, the reverse will take place. What was a ‘tailwind’ over the last decade will convert into a ‘headwind’ over the next decade, and the ‘African growth-story’ that the media have been gushing about will come to an end.

          This has all happened before. It’s the same old movie being played again. There is too much dependency on commodities, aid and external debt in SSA.

          • While there is too much global capacity (commodities and productive) it seems part of any new agreement must be around small business and entrepreneurship (while working to reverse income inequality dynamics over time, making large industrial investments as necessary, more regional trade, infrastructure to facilitate, and certainly political and social evolution’s).

      • Of course South Saharian Africa is a net exporter. But what you didn’t get in your data is this, Why Argentina Venesuela, Bresil, in such shape now and not Nigeria, Ivory Coast, Tchad… One reason could be your data overvalue South Africa who clearly benefit from the boom. The other could be that most of these countries are poorly connected to global market and factories are old and less productive than foreigns. So when you invest in it it still make sense to continue your activity because you probably buy it cheap, work force wage isn’t killing you like in South Africa, and productivity is low. The guy who invest in a fency new complex in South Africa, before the crisis and now face an ultra bear market is clearly screwed.
        A lot of farmer are just on their own, most of cities food are produce IN the city. So that’s why you don’t have in your data a surge in export of soy bean or wheat, and so you won’t have a crash. But yes SSA is poor and as most poor people do they sell very cheap product like commodities.
        Your graph on net exporter and SSA is interesting but did you heard about closing factories in Tchad or Nigeria or Congo? But your surely heard about mega project in Tanzania and others. In China factories are already closing their door, in South Africa too, why not in other countries? The guy who stop producing wheat in China is not stupid enougth to start it in Africa if he have no good reason.

        • Cedric WROTE: “Why Argentina Venesuela, Bresil, in such shape now and not Nigeria, Ivory Coast, Tchad…”

          Argentina, Brazil and Venezuela have internal political problems affecting their growth. Argentina just had a bad experience with hedge-fund forced default. Venezuela has just lost papa Chavez. Brazil is going through its worst drought in 80 years in the middle of a crucial election.

          But Nigeria, Ivory Coast & Chad will SOON be joining them when the commodity boom ends. Give a little bit more time.


          Cedric WROTE: “Your graph on net exporter and SSA is interesting but did you heard about closing factories in Tchad or Nigeria or Congo?”

          The reason we are not hearing about ‘factories closing’ in (say) the Congo, is because there are almost no factories to close. When you see countries like Congo, with very HIGH industry-share of GDP accompanied by very LOW manufacturing-share of GDP, you can be sure that they are commodity-centric economies. Countries like this will be very badly hurt when the commodities boom ends.

          • The weather excuse like GDP is not growing in US because it’s cold, are really funny. Maybe the weather is going up and down all around the world. Look at this
            I think there is a clear trend in services all around Africa. People can wonder if it’s directly connected to investment in commodities. But look most of african factories are outdated with low prodctivity and small size. So if price collapse it s still possible to sell because you size is small and your targeted price was lower. These people will be hurt by total demand collapse but not the price in first place. And it’s different because with financiarisation of market total demand, price and production are disconnected. But remeber most of these guy aren’t goldman sachs traders. So you can expect their contract to be more ground based and also their financial target. Do you heard the story of Eike Batista? This kind of story doesn’t exist in SSA because markets are far less sophitsicated.

          • ^^Cedric wrote: “Look at this ….[LINK]….I think there is a clear trend in services all around Africa.”

            In the linked graph you provided, look at the MASSIVE DIFFERENCE between the ‘industry (% of GDP)’ curve and the ‘manufacturing (% of GDP)’ curve. That is a tell-tale sign of how commodity-dependent the economy really is.

            A) This is what a commodity-export dependent developing country looks like:

            B) This is what a commodity-import developing country looks like:

            C) Here is the terms of trade comparison between the country in (A) and the country in (B):

            When the commodities boom finally ends, the terms of trade curves of the two countries will tend to converge. When that happens, the country in (A) will see a ‘headwind’, while country in (B) will see a ‘tailwind’. In other words, growth will slow in the former and speed up in the latter.

          • you don’t get me. I agree your statments individualy. Africa is commodities dependent, price will collapse ect… But you can’t take it as a theory because, when price will collapse you don’t KNOW if minging will have the same impact in Angola. You don’t know if before they will pass market friendly reforms. You do the same errors as Matlhus, you think everything will be the same BUT price will collapse. But thing move together you cannot just single out one parameter. In the chineese story prof has two scenario i think i would be stupid to just think that after a commodities cycle their is only one end.

  10. Michael, This would be a really depressing denouement if the Iron Ore price heads for an eventual $50/T as it would wipe out a third of Australia’s all wealth accumulated over the last decade and there could be other spill-over effects. The world out there is difficult to predict and I am not going to make it even more difficult by posing the following challenge: To what degree thus the commodity prices influence the ability to pay back debts by most Chinese companies and if it is high, how then could the banks keep increasing exposures, based on what incredible arguments?

    • China is a net buyer of most commodities, so lower commodity prices actually make China’s debt burden on average easier. The problem is that a lot of Chinese companies speculated heavily on metals as a way of obtaining financing that would have otherwise violated banking regulations. On top of it, many companies fraudulently borrowed multiple times against the same inventory. There was recently a big scandal in Tsingtao (or perhaps another city — my memory is fuzzy) about the collateral fraud.

      Of course companies with no use for these commodities who inventoried them just for borrowing purposes may be smacked pretty badly, especially if they used he borrowing in real estate, as many seemed to have done.

  11. I’m a big fan of your work, but I’m also a shipping analyst so I follow the iron ore markets very closely.

    Only comment I’d like to add is that while I believe your expectation of a rebalancing is correct, you may want to look closer at steel demand and not iron ore demand. Steel production is only up about 5% this year, while iron ore imports are up 12%. Why is that? The higher quality, lower cost ore from Australia and Brazil is displacing domestic Chinese production. Steel production is what will rebalance, and the 5% number suggests that is already occurring. Iron ore may still have time to grow as the substitution effect plays out. And of course iron ore prices will fall down to the marginal cost, which is much lower for the Australians and Brazilians. The prices are falling because so much lower cost supply has come online this year.

    • Thnaks, FNP. I am sure you would have no problem disputing my claim in the blog piece that I know nothing about the steel or iron ore industries, so its a great help when guys like you jump in.

  12. The info provided above provides answers on some developments in the US:
    – I kept wondering why, in spite of falling US Household income since say 2007, the US Current Account Deficit & US Trade Deficit remained – more or less – flat since 2010.
    US Trade Deficit:
    But it looks like, the Eurozone running increasing Current Account Surplusses actually kept the US Current Account Deficit flat.
    – Currently we see that the US is experiencing some sort of a corporate investment boom. I Always was wondering why those companies did that because median US Household income started to fall in 2007 and kept falling (=weakening demand). Based on Mr. Pettis’ info (current account deficit) one would expect that US consumption would go through the roof (like in Spain). But that failed to materialize. Instead we saw that US home prices rose after 2010 and now the money is flowing into building more factories in the US. In that regard I would argue that we see a new financial bubble in the US like we saw in Japan in the 1980s. In both cases we saw a massive investment in production capacity. So, the US in 2010-2014 equals Japan in the 1980s !!!! And we all know how the Japanese investment bubble ended, right ?

    Another reason why we won’t see increased Household demand is that interest rates are so low. High(-er) interest rates are beneficial for households but low(-er) interest rates are detrimental for households and beneficial for the corporate sector. It perfectly fits the “US corporate Investment bubble” thesis.

  13. Great post, as always!
    I long have been surprised at the absence of any real opposition to austerity in the Eurozone, given that there is a fairly strong argument that the current Great Recession is worse than the 1930s. Hence one would expect the rise of extreme political parties as in early 1930s Germany (to take the most extreme case). My take (derived from Hamilton’s Who Voted For Hitler) is that the decisive shift to the NSDAP was occasioned by the rise of the KPD with its threat of expropriation of property, leading the propertied to choose Hitler as a least bad option. I don’t see a credible left wing expropriation threat in Europe today. So far, Hollande and Rajoy are doing a good job of protecting property so who needs Le Pen? Only if the workers embrace a radical expropriationist is it likely that the propertied interests will find Le Pen acceptable .
    On this same line , I wonder if the aging population structure of the Eurozone doesn’t act as a break against even a temporary withdrawal from the Euro. Pensioners and near pensioners would likely be terrified of a dramatic surge in inflation such as would accompany a withdrawal from the euro and this group is much more important in Europe than say Argentina. Rajoy was careful to avoid cutting pensions, and Valls has merely frozen them (which isn’t very painful in a disinflationary environment). A move to slash pensions in France(in either real or nominal terms) might be the tipping point for a surge to LePen I think as her fundamental base of support would be from the elderly, and the non working population in general (although a significant portion of the youth unemployed population would be immigrants and of non European origin, unlikely to swing to Le Pen).

    • The French need to get out of the Euro, stimulate the economy and all the while restructure/reform pension schemes. I understand the interrelated issues with lack of consumer demand and income inequality. I think in France and elsewhere including the U.S. they are suffering from too much income be routed to older generations in the form of pensions and other govt. programs at the expense of younger generations. Younger people undoubtedly have a higher propensity to spend their income than well-heeled pensioners. Of course, pensioners will scream bloody murder that they earned it (even if evidence suggests otherwise) and they are more likely to vote.

    • On Hollande “doing a good job of protecting property so who needs Le Pen?”

      According to France statistics institute (insee), public sector spending was €1.21Tr in 2013 and private sector value added was €1.33Tr, so an effective taxation of the taxable base of 91%. In 2014, it will be around 93%. In 2007, pre-crisis, it was 81%, where it had been since 1993 which was the previous severe crisis. It means private property is being “confiscated” in France through near 100% taxation of value added even though legal title to private property is formally maintained (since recently, a not immaterial number of people are in a situation where they are forced to sells assets, ie. property, to meet their tax obligations, which triggers capital gains which are themselves highly taxed, etc … but “fortunately” this problem will eventually disappear with falling prices).

      Of course, such tax proceeds are being redistributed but this is proving unable to stop unemployment and poverty to spread. In fact, France is caught in a vicious circle whereby confiscatory taxation is causing the taxable base (private sector value added) to shrink, hence deficit to widen, hence debt to grow, hence taxes to increase, and so on so forth.

      Ultimately, the fact that this €1.33Tr of private annual value added is almost entirely taken away through taxation and redistributed at negative marginal return (fiscal multiplier < 1) means that it is no longer possible for France total debt of €7.32Tr (public + private including financial) to be realistically repaid by the cashflows generated by future production, whatever the time horizon considered. David Einhorn has just noticed ( Said differently, what Cyprus, Greece, Ireland, Italy, Portugal, Spain (together ~ 1/3 of Eurozone GDP) came close to but ultimately couldn't do, ie. break the Euro, France (~ 20% of Eurozone GDP) will almost certainly do it by crossing to the other side. The only questions are whether it will do it voluntarily or involuntarily and, more importantly, what will be the consequences on political relations within Europe as well as within France.

      France impossible fiscal and social situation – and the vicious negative loop between the two – is clearly fueling support for the extreme right (Le Pen) as both jobless and "poor" people and also highly taxed "rich" people are increasingly resentful and lose patience with traditional political parties, either left or right. Under these circumstances, the rise of the extreme right is unfortunately not very surprising. The current French situation is indeed somewhat similar to the German situation of 1929-1930.

      It is rather telling that the best selling book of the year in France is titled "The French suicide".

      If his main priority is to help the growing army of unemployed French people and avoid the election of Le Pen at the next election in 2017 with all the potential unintended consequences that may follow, President Hollande has a rather short 2 year window to arrange a negotiated break up of the Euro. It is of course pretty unlikely that the initiative comes from him as this will be perceived as bad for the economic and diplomatic prestige of France, one of the six founding members of the European Union, as well as bad for his own personal prestige. But, this is precisely where there could be a very slim hope. Hollande presidency is already so hopelessly lost at this mid-term point that he has hardly any short term personal prestige left to lose. And that gives him just a tiny extra chance of seeing that he can in fact – and in extremis – be helpful to his country.

      What ultimately matters is not to preserve at all costs the Euro, which was just a mean to an end, but to preserve peace in Europe, which is an end in itself. Europe has already paid a horrific cost to nationalism twice in the past 100 years. The last time, it was in large part due to France insistence that "Germany should pay". Now Germany, and Europe together, should be acutely aware that France should be allowed a sort of soft default by leaving the Euro in order to facilitate its economic recovery. In other words, France should pay, but not in Euros.

      • You say ” public sector spending was €1.21Tr in 2013 and private sector value added was €1.33Tr, so an effective taxation of the taxable base of 91%. “. Subtracting public expenditure from private sector activity is not the normal way to calculate economic activity-at least not since the 1940s, as you I’m sure know. High as French taxes are, they’re not quite that bad. If a genuine radical left wing party looked like it would say raise death duties to 100%, then the propertied classes in France would get scared enough to vote for Le Pen. Otherwise Valls or some Sarkozy type will do the job of protecting the enarques and other well off types, while giving the sans culottes some xenophobic bones to chew on.
        I ‘ve always accepted Michael’s arguments that the Eurozone as presently operated is a disaster for most of its inhabitants. Demand needs to be pumped up and no doubt there is lots of low hanging fruit for supply side reform (although I always worry that these reforms benefit the bankers more than the workers). Otherwise, a Frexit/Spexit/Grexit is the only hope.
        I’ve just been trying to figure out why there has been no Eurozone break up yet . I do think that the French desire to cut a bigger figure in the world explains some of their stubbornness in staying in the Euro (after all it was they who really stressed the exorbitant privilege that the US allegedly enjoyed in having the world’s reserve currency and were about the last to abandon hard money in the 1930s), but I still think the inflationary fears of pensioners might be a bigger factor.

        • It is true that public sector expenditure is usually presented as % of nominal GDP, not only in France but everywhere. With 2013 GDP of €2.11Tr in 2013 in France, that would be 57% taxation. But it is always presented as % of GDP because the optics are much better for politicians, not because GDP is a good approximation of the taxable base. GDP includes depreciation of fixed assets which is a tax deductible expense for the business sector (not for the household sector but neither it is a taxable income). Total value added is a better approximation of the taxable base. It was €1.89Tr in France in 2013, so an effective taxation of 64% on that basis. The reason i have shown it versus private sector value added of €1.33Tr corresponding to 91% effective taxation is because French value added and debt data suggest that public sector is not able to self-finance itself and is in fact dependent on taxing the private sector and on raising debt to finance itself, hence the ultimate source of value added funding the rest of the system seems to be the private sector. Perhaps, the best approximation of reality is somewhere in the middle of the 64%-91% range of effective taxation of the taxable base. It doesn’t change the conclusion that it is already excessive and past the point of negative marginal return as demonstrated by the worsening budget deficit this year despite rising taxes.

          I believe you are right that if taxes increase further, Le Pen is likely to get more votes. You are also right that immigration is no longer the sole theme defining Le Pen and that economic themes such as the Euro and globalization are now part of her positioning as moderate political parties have made the big mistake (in my view) of leaving this space for her to occupy.

  14. According to eurostat data the trade surplus of the eurozone is occuring through higher consumption repression in the eurozone compared with the rest of the world. For instance, in august imports to the eurozone decreased by more than 3% while exports decreased (year over year) by 0,9%. This is reported as “positive” news for the eurozone that is “gaining competitivity” as commentators like to say. I think that a significant part of the surplusincrease is going to non-eurozone european countries (Poland, Czeck Rep., Baltic countries etc.) whose surplus is beign reduced, but it is too early to tell. If they can invest wisely this would be good news.

    In any case, latest data on eurozone imports and exports isn’t good news.

  15. If we take all the large (>10 billion$) surplus countries of 2012 and put them to one side, we get this:

    Surplus Country__________ 2012 Billion$
    Germany ……………………..252.3
    China…………………………. 215.4
    Saudi Arabia………………….164.8
    TOTAL_________________ 1,545 Billion$

    Next, if we separate the oil & gas exporters we get:

    Surplus Country__________ 2012 Billion$
    Saudi Arabia…………………164.8
    TOTAL_________________ 611 Billion$

    So 40% of the global surpluses of 2012 are directly related to oil prices, implying that 40% of the global deficits must also be related to oil prices. If oil prices cool along with China’s energy intensive boom, then these surpluses may considerably reduce, and in some cases perhaps even vanish.

    Would that help the global trade situation? I don’t know. Something to think about.

    Could it set-off a consumption boom in the US as consumers use the reduction in their gas expenses to perhaps eat out more often? Could it set-off an investment-boom in India by lowering the oil/gas subsidy-burden and containing inflation?

    • I tend to think that the US consumer, of old has vanished, as the costs of products, in an environment of grave global over-capacity, and increasingly more efficient use of resources (technology meets material science) ensures, along with the previous couple decades of volatility has shaken up most. Were they to believe they can reignite something for the American consumer they are mistaken. Look at the Millenials versus Generation X and Baby Boomers, they are far less endeared of over-consumption, interested in creation, craft, DIY, doing well while doing good. It seems nationaly and internationally more serious thought need be given to moving parties in better direction. These days, when I hear a new rap song, I smile somewhat, I don’t think they have gotten with the picture (bling as upward mobility, that so 1990’s, now we have Lorde, and post-post-modern Creative hipsters, without Oprah moralizing, and Jerry Springer drama). Maybe a little too Libertarian.

    • I think oil related surplus are not of the same kind the prof talk about. Oil doesn’t create so much job in the country and the wealth create by it is shared by few people. To make it spread to the all society redistribution is a key. But I don’t think redistribution can create sustainable job. Because subvention do act like the market should change with the market himself. Like when it’s time to invest in biotech, you put money on it, then you put it in farming ect… But subvention just stay the way they are for a long. So when biotech hype is over you still have subvention.
      What countries do if they cannot create much job with oil? They create sovereign fund and invest in other countries like Norway do. At the end of the day the money go to net importers of oil. So consumption could be hurt by less money put in USA. If indian government were reducing oil subsidies to lower the tax rate it would be great but they probably won’t.

      • Cedric WROTE: “..What countries do if they cannot create much job with oil? They create sovereign fund and invest in other countries like Norway do. At the end of the day the money go to net importers of oil. So consumption could be hurt by less money put in USA. If indian government were reducing oil subsidies to lower the tax rate it would be great but they probably won’t….”

        1) Is it your claim that HIGH oil prices HELP the US economy? Could you please elaborate on this point a little further?

        2) India does not need to lower the tax rate at all. A reduction in petroleum subsidies leads to a reduction in the government’s revenue deficit, implying that government savings will rise (or at least dis-savings will fall). The resulting fall in government borrowing automatically makes more domestic capital available (reverse of ‘crowding out’) to the private sector and leads to lower interest rates. Historically, this has been sufficient to set off an investment boom in India. In other words, rising oil-prices act as a ‘headwind’ to the Indian economy, while falling oil-prices act as a ‘tailwind’.

        The 1970s, for example, were a hard time for the Indian economy but a great time for the petro economies. Conversely, the 1980s were a good time for the Indian economy, but a hard time for the petro economies. You can see for yourself in the following graph:

        • For USA, i said that the money from oil flow to USA if form of consumption led by debt. Less money mean less debt.
          On India your are wrong. Because Indian government faking local oil market is a loosing game. Of course government win if oil price rise. But maybe somewhere in India some entreprenors wish their could be real price and less black market. More, all industries impact by oil price need the real price to INVEST the right way. I think China is a good exemple of that. This subsidies come from the pocket of people who use less oil to those who use more oil, so it come from poor to rich as global. I don’t see what kind of good can bring this kind of subsidies. And in all around the world their are disepearing like in Indonesia or Africa.

          • Cedric WROTE: “On India your are wrong. Because Indian government faking local oil market is a loosing game. Of course government win if oil price rise. ”

            I think something may be getting lost in the translation here. Why would the Indian government WIN if oil prices rise?

          • Taxes, you know cigaret, alchohol, oil… It rules the world!

  16. I don’t understand the statement “…the amount of productive investment opportunities is probably infinite, institutional constraints in every country significantly can reduce the ability of productive investment fully to absorb the total amount of savings created within an economy”.

    Perhaps the potential for productive investment is infinite over an infinite time horizon, but during any given period, how can it be thought of as infinite? There are physical supply constraints in the short term. Also, an attempt to exploit too many investment opportunities would require so much savings as to create a demand deficit, which would lead to recession.

    • I am exaggerating Tew. Sorry. All the productive and nonproductive investment opportunities in the universe cannot be infinite. I really just mean that it is hard to imagine that we ever run out of investment opportunities,

  17. Dear Prof. Pettis

    I do not think you should be surprised by the note of Deutsche Bank’s George Saravelos.

    When core countries cannot force peripheral countries to reduce enough current account deficit to rebalance, and especially when the north does not want to reduce its own current account surplus to cooperate with the south, the only easy way to survive this crisis is to push the problem to some other country. This is a fact clean and clear.

    Draghi did a marvelous job by pushing up German Euro value and press down PIIGS Euro value through internal devaluation, in which LTROs and verbal interference function well. ( German Euro appreciates when inflation is up. But Spain Euro depreciates when inflation is down, due to liquidity trap effect.) Unfortunately Germany refuses to invest more, Draghi has to QE to push up severely Euro Zone current account surplus in total. At the same time, he does push problems onto other country.

    The script maybe is unfolding like your framework. But, there is one thing deserves attention. The speed-up of RMB internationalization looks like that China is going to partly take the exorbitant “burden” and absorb some part of European savings, which could slow down the fast pace towards the dangerous finis.

    • Maybe, Scandk, but I have always been skeptical about RMB internationalization. I have been in China 13 years now and it has always been less than five years away.

  18. Really great post, thank you. I am from Australia and have been reading your blog posts for years. You have mentioned the Australian economy briefly in previous posts but it was a real treat to read a post with Australia as one of the focal points.

    I think this is a really interesting time to be observing the Australian economy. We are undoubtedly about to undergo massive period of change, primarily due to China’s re-balancing.

    • A strange site indeed. The previous low rate of AUD to USD at the beginning of millenium, and the relative cost of things then; consumer goods, assets, the alteration to government pension systems, buyout of public employees, institution of a fairly high minimum wage, the few decade long ride of wealthy growing asian economies (tourism, education, wealth emigres), the impact on asset prices, on housing (am i right you only have variable interest rate mortgages, or they predominate), the continued, long-term spike, even if 2000’s saw prices rise further, the growth of commodity prices since 2008, 2008 (prices were below what they are today, I believe), the general unaffordability, and then the movement of the economy toward more and more commodity exports, the rise of the AUD, even before the great spike in ore prices, the very high wages as AUD rose, and the grave impact on domestic industry, where Australia, doesn’t even have a domestic brand food manufacturing anymore. A lot need be done to normalize. The AUD will fall, but how low,can it fall? If housing is mostly adjustable, will the government have to force rates to stay low. Then the mass of missing revenues from royalties to fees to income taxes.

  19. The more I read your descriptions of excesses at the global level being impossible to sustain, the more it reminds me of the mechanics of controlling large AC electricity networks.

    In a large AC network generation and demand must match, excess generation results instantly in a higher than allowable network frequency, excess demand results in a lower than allowable network frequency. The advantage that electrical networks have is that excesses of any kind are visible to everyone instantaneously. With global economic networks it appears from your description that the latency between excessive inputs and subsequent instability are long enough for the system participants to fool themselves.

  20. Thanks for doing a piece on Australia Michael! After Iron Ore hitting a low of $77 recently is has popped back up into the 80s and it wouldn’t surprise me for it to rebound over the next couple of months as it takes a breather. What worries me is 2015. In a typical down market there are rebounds and if this one in Iron Ore goes for a few months and gets around $100 the next leg down would see it beat $77 and then head down to the 60s or 50s like Michael says. Once China struggles for 7.5% gdp growth this year I think next year they will realise that 7.5% is just to great a target and will have to issue a target of 6.5 or 6%. Once they do this, the global economy and especially export countries like Australia, Brazil, Canada will realise that their worst fears are coming true and hope will dissipate.

    I think although National income has been declining in Australia and unemployment has edged up into the 6s from the 5s things will get dramatically worse in 2015. Combine the lower iron prices with household debt to gdp being around 100%, iron ore falling further and the decline in mining profits, government tax receipts and royalties, mining construction and the stock market (where a 3rd of stocks are mining) and I believe we are going to see some major fireworks in Aus. Phillip Soos (independent economist from Deakin Uni) has come out with some interesting figures saying that a few months before the Lehman collapse, Lehman had around 5% of gdp under assets.Sounds big right? Well, the big 4 banks in Australia (Anz, Cba, Westpac, Nab) have 40-45% of gdp under assets each. Each! They call Aussie banks the safest because our economy barely got touched during the GFC and our banks were lauded as being safe. We only export about 5% of total exports to the USA but around 75% into the Asian region. The GFC was not our big test, it wasn’t even a small test. As Michael says, the big test is a declining China and it’s at our doorstep.

  21. I disagree. The US can do a number of things to mitigate the impact of inbalances in other countries around the world. It’s far from powerless but the question remains whether or not the US WANTS to do the following things:
    – A MAJOR overhaul of the tax system (less tax deductions).
    – Impose a LARGE taxincrease.
    – Impose capital controls.
    – Completely withdraw all military troops from around the world. Don’t spend one USD on military spending outside the US.

    • Not that i agree or disagree but with the over-assumptive univeralizing tone and language, which generally makes the perspectives of any discussant who moves from/on such useless.

      As an exercise, rather than merely feeling the moment, or being excited in the energy of the emotion, again for a Spinozan as me, generally a useless habituation, perhaps you should do a series of thought exercises where you take a step back and consider the result of what you propose. Not sure that your assertions, other than reiterating tired old ideological rhetoric, would lead to the benefit that you propose.

      Again, not that I disagree with some of your propositions, but merely the tone and spirit in which they are written. Don’t you grow weary of such? Aren’t we moving past that? I did decades ago. Tired old dis-empowerment noise on the premise of faulty economics inter-fused with political imperative; economics subsumed to political perspective (and rather than arrived at, seemingly preferred, strange).

      • “Faulty economics inter-fused with political imperative; economics subsumed to political perspective” ??

        – But economics are/is Always “interfused with/subsumed to” political views. In spite of that, I didn’t comment on the political dimensions of military spending or taxation. That’s quite a different “kettle of fish”.
        – I reread my reply and I don’t see where my logic can be categorized as “faulty economics”.
        – US military spending outside the US is so large that it has an very significant impact on the in- & out-flows of money of the entitiy called USA. (think “Current Account Deficit”). If one wants to understand the in- & out-flows of money then one must include military spending as well.

        • ^^Willy2 wrote: “US military spending outside the US is so large that it has an very significant impact on the in- & out-flows of money of the entitiy called USA. (think “Current Account Deficit”).”

          One option here is for the US (as deficit country) to come to an arrangement with surplus-countries like Japan & Germany. Japan (as surplus country) can pay for the cost of stationing US troops in Japan/Korea, as Japan is the primary beneficiary of having the US as an ally against a growing China. Similarly, Germany (as surplus country) can pay for the cost of stationing US troops in Central Europe, as Germany is the primary beneficiary of having the US as an ally against a growing Russia. The defense budgets of Germany & Japan have been very low since the end of WW-II because they have been under the US ‘umbrella’. Given the surplus/deficit situation today, it is not unreasonable for them to now start sharing the cost of that ‘umbrella’.

          As for the adventures in Afghanistan, Iraq and so on, the cost could be spread between the Western Nations. Countries like Japan & Germany that don’t like to commit troops to foreign operations could provide larger shares of cash support for such operations.

          If such arrangements can be reached, much of the overseas military budget will be self-funding and hence not affect the CAD.

          • – The combination of 300 million US consumers & the USD being the world’s reserve currency already makes those foreign US military “adventures” “self funded” by those same …….. foreigners. In other words, those foreigners already pay for US foreign “adventures”.
            – All that military equipment is (predominantly) made in the US and it increases US imports (e.g. iron ore from Brazil). It’s simply increased consumption and pushes the US Current Account Deficit (CAD) deeper into the red. So, when the US increases its military spending then it also increases the CAD.
            – Combining the lines above means that, for the US, the larger the CAD the better for the US and its military spending and the larger the “Exorbitant Privilege”. But as Mr. Pettis has pointed out, it also means that the US incurs a larger “Exorbitant Burden” when things “turn sour” for the US, as happened in 2007 through 2009.
            – The implication of the info in Mr. Pettis’ article (above) clearly suggests that by running an increased CAD, Europe is already funding (among others) those US foreign military “adventures”.

          • Willy2 wrote: ” In other words, those foreigners already pay for US foreign “adventures”.”

            No, they do not. ‘Funding’ something is not the same as ‘paying for it’. Incurring debt is not the same as being ‘paid’. Here are the two cases clearly separated:

            CASE I) US borrows from foreigners (Japan/Germany) to fund its military adventures abroad. This implies a capital account surplus (external debt) to match the current account deficit (foreign costs of military). This is what is happening today.

            CASE II) Foreigners (Japan/Germany) GIVE the money (‘pay’) to the US to fund its military adventures abroad. This implies that there is no capital account surplus (no external debt), but that’s okay, because there will be no current-account deficit either. This is because these ‘payments’ are net current transfers and are a part of the current account. Therefore, the current account deficit of CASE(I) is merely being cancelled by these incoming ‘official transfer payments’ on the current account. Therefore, there will no military-triggered current account deficit if Germany & Japan ‘pay’ for the cost of US military involvement in their neighborhoods.

            I hope this does not sound too confusing.

          • @Vinezi:

            – Increasing the US military budget means more consumption and hence pushing the US CA Deficit deeper into the red.
            – Paying for all the costs (e.g. bread, butter, eggs, water, etc. bought locally) of e.g. US military bases in e.g. Japan, Germany or South Korea doesn’t increase the CA Deficit but it does lower the Capital Account. It’s a transfer of money from the US to e.g. Germany.
            – So, the gap between the CA balance and the Capital Account balance grows. The CAD and Capital Account don’t have to be the obverse of each other. That gap between the two shows up in the form of e.g. growing debt in the US. And that growing debt is precisely at the heart of what Mr. Pettis has coined “Exorbitant Burden”.

          • Willy2 Wrote: “Paying for all the costs (e.g. bread, butter, eggs, water, etc. bought locally) of e.g. US military bases in e.g. Japan, Germany or South Korea doesn’t increase the CA Deficit but it does lower the Capital Account. It’s a transfer of money from the US to e.g. Germany.”

            It does increase the CAD.

            (1) US military bases abroad are treated as sovereign US territory. Any bread, butter, eggs and water bought from the local economy and transferred into the US base IS ACCOUNTED for as an IMPORT. It is identical to any other things the US might physically import from that country and is reflected in the US CAD statistics.

            (2) If US servicemen go OUTSIDE the military base and visit a restaurant in the foreign country, then the money they spend is accounted for as a ‘tourism import’ in US accounting. It has the SAME effect on the CAD as an ordinary American visiting that country with a tourist visa and spending money there.

            (3) The money spent on (1) & (2) is just a payment on current account and has nothing to do with the capital account.

            (4) If the host country uses these military-consumption dollars to buy something from the US then the current account cancels (or balances) and no reference to the capital account is necessary. On the other hand, if the host country ‘holds on’ to these dollars (i.e. increase its reserves), then it is accounted for as a capital account surplus in the US accounting system. This capital account surplus then exactly matches the current account deficit incurred in (1) & (2). Remember that these dollars that the host country is ‘holding on’ to ARE just as much debt instruments as US government bonds.

            I hope I have not been unhelpful.

          • I don’t know how to reply to #1 through #3.

            About #4: It does make a difference whether the host country simply holds the USDs or buy T-bonds. Holding USDs means that money isn’t recycled back to the US and lowers the US Capital Account. Buying e.g. T-bonds means recycling those USDs back to the US and increases the Capital Account.

            Buying T-bonds or holding cash (USD) also each have an impact on the currency exchange rate between e.g. the Euro and the USD. Holding USDs mean the Eur/USD goes up but buying T-bonds means the Eur/USD goes down. Each choice has its pros & cons.

          • Regarding #1 & #2:
            It could be but you’re (implicitely) confirming something else. So, the CA Deficit increases as a result of US military spending but the Capital Account Surplus remains flat. The difference of the balances of the two shows up in the FX reserves. But since the US is paying with USD there’re no changes in the US FX reserves and therefore shows up in increased US debt to the rest of the world.

            There’s certainly a difference between the holding of USDs or e.g. T-bonds. When I hold USDs then I have a (small) claim on the US goldreserves (and the gold reserves aren’t debt instruments but (REAL) money). When I buy T-bonds then I switch those claims on the US gold for claims on the US government (a.k.a. debt).

            Using the words “growing Russia” & “Growing China” assumes you see those countries as a threat. Events occurring in the Ukraine (I won’t go into all the details, fine print) have made (more) europeans aware that the US actually a bigger threat to European “security” than Russia is. That US interests are less aligned with European interests than European interests are aligned with russian interests.

            More over, Japan wanted to make up with China (in 2009 – 2011) but that effort was thwarted by the US (from 2011 onwards). (Again, I won’t provide the details. I isn’t suitable for this blog).

          • Willy2 WROTE: “Using the words “growing Russia” & “Growing China” assumes you see those countries as a threat. Events occurring in the Ukraine ..X.. have made ..X.. europeans aware that the US actually a bigger threat to European “security” than Russia is….. ”

            If this is indeed the case, then Germany should first pay the US to go away and then pay annual sums for the US stay away. That would also be helpful for the US because it would increase US income on the current account because of German payments, while reducing expenses on the current account because of the reduced cost of keeping the military in Germany.

            It does not matter whether Germany believes Russia to be the threat or whether it believe the US to be the threat. What matters is whether Germany (as the surplus country) PAYS the US or not. I think 1% of German GDP should be enough as payment to the US, either to stay on (if Russia is the threat) or to stay away (if US is the threat). That would automatically reduce Germany’s surplus by 1% of GDP and help reduce the US deficit to a certain extent.

            Pay up, Germany. Pay up, Japan. Surplus countries of the world, pay up! Uncle Sam needs the money. Don’t make Uncle Sam hurt you. Just pay up!

          • Willy2 WROTE: “…When I hold USDs then I have a ..x.. claim on the US gold reserves ..x.. When I buy T-bonds then I switch those claims on the US gold for claims on the US government (a.k.a. debt)..x..

            What you say WAS true for foreign-holders of the USD before Nixon closed the Gold Window on August 15, 1971:

            Holding the USD today is not a claim on any gold held by anyone anywhere. The USD is now just as much US government-debt as any other USG bill, note or bond. There is no “real” money any more; they are all debt instruments now.

          • “That would automatically reduce Germany’s surplus by 1% of GDP and help reduce the US deficit to a certain extent.”

            All the surplus-countries at the bottom of this graph should be asked to pay 1% of their respective GDPs to the US as ‘pro-rated share of costs’ for the US ‘defense umbrella’.

            This would reduce their current account surpluses by 1% of GDP each and so knock about 150 billion$ off the US CAD.

            After WW-II, these countries were broke and so it was okay for the US to waive cost-sharing at that time. But if they now have EXCESS-savings and are merrily running surpluses, then there is no reason why they should be allowed to ‘free ride’ on US coat-tails any more.

            If they eliminate their surpluses in the future, then the US can once again waive these charges. So these charges would apply only to those countries that use the US umbrella to keep defense expenditure low *AND* then run current account surpluses.

            Something to think about.

        • How do you factor in your calculation the advantages ( or loses if implemented incorrectly) the country gets for using its military?
          I mean it is complicated calculations and much information is not even publicly available.

          • ^^Jon WROTE: “How do you factor in your calculation the advantages ( or loses if implemented incorrectly) the country gets for using its military?”

            What advantage does the US get by ‘using’ its military? I mean what advantage accrues to the US that does NOT accrue, for example, to Germany & Japan, by the size of the US military? Could you describe some?

            IF you argue that the US ‘uses’ it military to drive down global oil prices by invading oil-rich countries and pumping out their oil, then you must ALSO admit that any such benefit also accrues to Japan & Germany. So what UNIQUE advantage is their that accrues ONLY to the US and not to others under the US umbrella.

            Please let me know your thoughts.

      • I must add one or two things. As a result of “Exorbitant Privilege” the rest of the world subsidizes the US and the US is very well aware of that. But with the upcoming “Rebalancing” the US must its part as well. I would argue, that the US (like the rest of the world) has a choice to either to rebalance voluntarily or it can resist the rebalancing now but then the rebalancing will be forced upon the US involuntarily. But an involuntary rebalancing will be much more painful.

        The “Exorbitant Privilege” means that the US consumes too much and produces too little, resulting in the CA Deficit. To adress, to reduce that CA Deficit US consumption must be reduced. And increasing taxation, capital controls and withdrawing US troops from around the world are a number of very powerful tools to reduce US consumption and the US’ part of the rebalancing.

    • “Completely withdraw all military troops from around the world. Don’t spend one USD on military spending outside the US.”????
      It will be a miracle if they stop expanding.

      • Agree. And that’s why, at some point in the future, financial circumstances will force a much more painful involuntary (!!!) withdrawal.

  22. Very logical and brilliant analysis, in my humble view, Mr. Pettis.
    There is also, I believe an elephant in the room, which is economical enslavement of many countries by the US policies.
    I understand the issue is politically charged and why Mr. Pettis is reluctant to talk about it, but as he points out, in global economy there is a mutual dependence between countries and their policies.
    The fact of the matter that the US government is not interested in other countries to stop soaking up a glut of existing US dollars, in spite of what they say publicly.
    Many countries are forced into relationship where for hard commodities they export, they receive foreign currency ( mostly US dollars) which they are forced to keep in reserve in order to be able to print they own currency. You want an example?
    Just read a document RUSSIAN FEDERATION FEDERAL LAW written with a help of American “advisers”.
    Article 1: The Bank of Russia shall fulfill the functions and exercise the powers … independently from other federal bodies of state power.
    (RCB and Russian federal government are separate entities.)
    Article 22. The Bank of Russia shall not be entitled to extend loans to the Russian Federation Government to finance the federal budget deficit and buy securities at their primary placement, to finance deficits in the budgets of the government extra-budgetary funds, budgets of the constituent entities of the Russian Federation and local budgets.
    Article 23. Federal budget funds and assets of the government extra budgetary funds shall be kept in the Bank of Russia.
    So RCB is completely independent from Russian government and is not allowed to buy Russian government obligations and, to add insult to an injury, the government has no access to all of its budgetary funds, since it is stored in RCB.
    In practice, “economically dominated” county is shipping oil and hard commodities out and in return receives a permission from other countries to print their own currency. When (and not if) that arrangement ends, the unwind could be potentially catastrophic for the US dollar.

    • I know very little about the Russian financial system, but taking your post at face value, Article 22 you describe reads to me as merely prohibiting the CB purchasing primary offerings: in other words, directly financing the government. This is standard fare in most economies. It wouldn’t stop secondary market financing.

      I see nothing special in the Russian situation that prevents them either requesting payment in another currency or selling dollars for roubles. And the idea that this Russian government believes that Russian law even applies to them is fanciful to day the least.

      • James,
        I lived the US for 15 years and since 2007 live in Germany and it is amazing to me, how successful western media was in creating the image of “dictator” Putin doing anything he wants and Russian government rubber stamping his decisions. In contrast, Boris Yeltsin was very “democratic”, according to US Media, even when he directly ordered russian tanks to shoot at the government main building in 1993.

        But more to the point, In 2000 Putin tried to nationalize Russian CB. But Russian government Duma opposed to it, so it never happened.
        Wait, are you saying that the bank bailout and QE in USA and Europe is not against the law? Or Roosevelt stealing US citizen gold and later Nixon defaulting on the gold payments altogether? Look at the US constitution Article 1 Clause 1:
        “No State … make any Thing but gold and silver Coin a Tender in Payment of Debts”
        Of course there is plenty of corruption also in Russian government, but when it comes to global aspects of economy, Russian laws definitely apply to them. Otherwise, they would not default in 1998 when the country dollar reserve was exhausted.
        The main job of RCB is to keep ruble stable with respect to the US dollar. That is exactly what it is doing right now and that is what prevents the RCB from requesting payment in another currency or selling dollars for rubles any time it wishes.

        • I’m sorry, I don’t see what any of your post has to do with either the topic at hand or the one you introduced. You lived in the US and Germany? Good for you, so what?

          Ditto the relevance of Yeltsin, unless you’re offering him as a straw man to contrast Putin, or the latter’s power in 2000 when first President.

          I have not made comment on QE or a government’s right to recapitalise banks. Again, I fail to see the relevance, but to answer your question, yes I believe these actions to be lawful.

          If you’re going to quote the Constitution shall we do it right? What you’re referring to is actually Article 1, SECTION 10, Clause 1. Your omission of “Section 10” gives away it’s purpose: the limits on the states, i.e. in this case it is within the sole power of the Federal Government to create money – States can only settle debts by offering gold or silver.

          Finally, if the Russian CB or State decides to hold dollars as part of Rouble stabilisation then fine, but that is their choice and they are certainly not forced into it.

          • JamesPF,
            the reason I mentioned my whereabouts, is to say that I see that in both in Europe and the USA, the media drew a picture of Russia presenting a clear and present danger today, both for the Europe and for the world, and even smart people completely believe it.
            Never mind the fact NATO forces have been drastically expanding East since 1991 and now aiming at advancing right to the Russian border.
            More to the point, you are right that individual States in the USA are not allowed to create money, but it does not mean that the the Federal Government may create the legal tender that is not backed up by gold and silver, at least not according to USA Constitution it can not. That is where the cheaters of Federal Reserve Bank are coming in:
            According to Federal Reserve Bank Services web site
            Q: Is U.S. currency still backed by gold?
            A: Federal Reserve notes are not redeemable in gold, silver, or any other commodity. Federal Reserve notes have not been redeemable in gold since January 30, 1934, when the Congress amended Section 16 of the Federal Reserve Act.
            Since when Federal Reserve Act or its amendment trumps the Constitution?

            As far as Russian CB being forced in to something that or not, I do not have any proof other than the time line: in 1993 as the Russian the government was trying to change the economic policy, including the role of RCB, they were shot at from the tanks, called on by Mr. Yeltsin. Right before that the officials who tried to get rid of american economical “advisers” were fired by Mr. Yeltsin.
            Could be a coincidence, though.

    • What unwind? Historically, one of the most dangerous economic circumstances for a country to be in is a heavy commodity exporter. Russia is on the verge of breaking, much like the Soviet Union was in the 80s. The only advantage of the US being the reserve currency for the US is in war where it allows the country to use capital inflows to fund wars.

      • *the only current advantage

      • Historically, one of the most dangerous economic circumstances for a country is to default on its debt or hyper inflate its currency.
        Oh, wait. The US already did default in 1971, just never admitted it. Neither did other countries, which pretended nothing has happened and still support irredeemable US dollar.
        When reality sets in, hold on to your hat. Unwind will begin.

        • I am not sure that I agree that “Historically, one of the most dangerous economic circumstances for a country is to default on its debt.” more than two-thirds of US states defaulted in 1837-41, and in those days American states were virtually sovereign nations, and not the states that we know them as today. Lots of countries have defaulted, including in modern times very successful advanced ones like Germany and Japan (China too). In fact I would argue that if certain European countries were to default today, they would be much better off. Default is an economic decision. It can be a bad one, but isn’t necessarily so.

          Separately, lots of people like to say that the US defaulted in 1971, but I think that gets a little hyperbolic. Going off gold is really a very different thing than not repaying debt obligations. It is nothing more then devaluing a fixed rate currency, and is exactly what the UK did, for example, when it dropped EMU in 1991.

          No one says the UK defaulted then, or that China defaulted in 1994 when it devalued its currency. Every country went off gold in the 1920s and 1930s, including the US, because after WW1 there had been significant mismatch between their money bases and their gold supplies. Some people argue, a little tautologically, that the mismatch wouldn’t happen if the commitment to gold were permanent, but no country has every given up its sovereign right to get on or off gold or silver when it thought necessary.

          Defaulting on your debt means something quite specific. Devaluing your currency, whether against gold or against the dollar, means something else. I don’t think it helps to clarify things to insist that they are the same.

          • “Every country went off gold in the 1920s and 1930s, including the US, because after WW1 there had been significant mismatch between their money bases and their gold supplies.”
            I thought US went off gold in 1971.
            Soviet Union was on gold up to 1991, even though there were severe restriction on converting ruble to gold and maintained stability by a monopoly of foreign exchange transactions.

          • The US did go off gold in 1971, but this was not the first time. Like many countries the US has gone off gold more than once, Jon. It is pretty common during times of great price distortions, especially times of war, that countries withdraw their promise to exchange currency for gold or silver. Until the 1930s these withdrawals have almost always been temporary.

            As for Russia, I am not a Russia finance history expert but I would bet that the ruble was not gold-backed until 1991, and certainly not in a meaningful way. Perhaps they did so nominally because it would have been politically embarrassing to peg their currencies to the dollar, but remember that after 1971 gold went officially from $32 an ounce (if I remember right, although I may be off by a couple of dollars) to, I think $1000 in less than a decade, and it has been extremely volatile ever since. Had the ruble or any other currency been pegged to gold, the 1970s would have crippled them and the subsequent 3-4 decades would have been tough to manage. Except indirectly by pegging to the dollar, few countries after WW2 had gold-backed currencies. It would be easy to check.

          • If we agree that gold is not necessary as a base to stable monetary systems, can’t we expand the scope of the discussion and say that fractional reserve credit systems are also no longer necessary (as their justification was precisely to deal with insufficient quantities of precious metals) and explore whether full reserve credit systems (what Fischer called 100% money) can be useful in the present situation of excess debt where credit systems stability can quickly become problematic and whether this is possible to articulate internationally in a way that brings neither exorbitant privilege nor exorbitant burden to any party?

            Thank you

      • “I have argued that since the 2007-08 crisis we have seen some adjustment in the US…”
        I am sure i have missed it professor Pettis explaining it in other posts, but by what measure the US is recovering?g
        Certainly not by debt to GDP ratio. if anything, it got worse.×785.png

        • Don’t confuse debt with government debt. Total debt has declined in the US.

          • Thanks you for clarifying it. No matter where I looked, however, I could not find any specific information on total debt in the US.
            Any help?

          • Financial Accounts of the United States on the web site of the Federal Reserve.

            Two caveats:

            1) If i remember correctly, part of the decrease in relative debt in the US since the post crisis peak is due to accounting changes, both in the denominator (nominal GDP has been increased by ~ $500bn to include intangibles such as R&D) and in the numerator (the Fed simply erased ~ $2.4Tr of debt at the latest release)

            – Then, there is the question of whether one should include central bank liabilities in total debt. Normally, it is not necessary as this amounts to a rounding error and total debt is simply public sector + households + non-financial businesses + financial sector debt. Post-crisis, however, most of the deleveraging of the financial sector has been done by selling assets to the Fed via QE so that financial sector has decreased leverage in proportion to an increase in central bank liabilities.

    • Read this

      see if you can understand this….. do you see how it alters from your preferred interpretation, and of course has no relation whatsoever to the use or not use of the USD.

      You realize the document that you cite is a Russian Federal law enacted in 2002 and changed dozens of times since then.

      • yes Csteven, I know hot to read.
        So what exactly in this fancy description contradicts to Articles 22 and 23 of the law?
        So what if the document was updated? Did its substance change? Did RCB main task of maintaining stability of Russian ruble with respect to US dollar change? Can RCB now fund Russian government?
        More to the point, now that Russian government and the whole country under US sanctions, what does RCB do? Is he trying to help Russian economy in any way? Any bailouts of the companies like Obama and Bush did with General Motors and the US Banks?
        Of course not. The only task RCB is doing is now to make sure Russian rubble stays within “allowed” range with respect to dollar, just like it did in 1998 when the whole country defaulted.
        Just think about it for a moment, the whole country is in default because it did not have enough of printed paper which is an obligation of ANOTHER COUNTRY and is not even supported by anything tangible. The country which itself defaulted in 1971 when it refused to honor its gold obligations to the foreigners and is in default ever since.
        If that is not a definition of a country economic dependence from another country, then you are right, I am just not as smart as you and ” I am just not getting it”.

        • You realize when you cited article 22 above, you didn’t cite the last sentence of the first paragraph, which refuted your claim entirely, all anyone has to do is read the entire paragraph, to see what you want others to believe. Why did you copy and paste chosen sections of first and second paragraphs and splice them together.

          Same old tired noise, and nothing to do with the topic, as usual.

          • I copy and pasted the parts of the sentences to show you as an example that no normal politician or lawyer would want to have voluntarily this language in the document IN THE FIRST PLACE. Can you find anything remotely like that in Europe or China? I did not think so either, smart guy.
            But more to the point, if you think there is nothing abnormal going on here, answer this
            “Russia’s largest state owned oil driller is currently banned from obtaining loans from Western lenders greater than 90 days due to sanctions. So the oil giant (Russian Rosneft in this case) asked for $49 billion from the national wealth fund instead.”

            So why Rosneft can not get the loan directly from Russian banks? Rosneft has steady revenue and the local banks can handle $49 billion. Try to explain that, since you are so smart and reading all the “correct” books.

          • ^^JON wrote: “Russia’s largest state owned oil driller is currently banned from obtaining loans from Western lenders greater than 90 days due to sanctions. So the oil giant (Russian Rosneft in this case) asked for $49 billion from the national wealth fund instead.
            So why Rosneft can not get the loan directly from Russian banks? Rosneft has steady revenue and the local banks can handle $49 billion. Try to explain that…..”

            It is very simple and easy to explain.

            1) Rosneft has long-term (> 6 months) external commercial debt in USD of 50 billion$, incurred probably for acquisitions & equipment purchases from the West.
            2) These loans were effectively being rolled-over by Western lenders before the sanctions and Rosneft had no problem.
            3) Once the sanctions were applied to Rosneft, the external lenders (western banks) refused to roll over these loans, except on a very short term basis at high interest rates.
            4) Rosneft cannot go to Russian banks, because it needs US dollars. If it goes to a Russian bank, then that bank will have to go somewhere to get the dollars. So Rosneft has only two choices:
            (a) Borrow from Russian foreign-exchange reserves (‘wealth fund’), or,
            (b) Borrow from some other (non-western allied) country’s reserves (such as a loan from Chinese or Venezuelan Banks in USD).
            5) So Rosneft, as a state-owned company, just chose to go with option (a) as the cheapest option, because the Chinese or Venezuelans would have extracted a huge price for helping them during sanctions.

            Where is the surprise?

      • Is RCB now desperately trying to keep ruble stable with respect to US dollar? Yes or NO?
        In 1998 it did the same, until RCB ran out of US dollars and Russia defaulted.
        In practical terms ( and that is what matters in the end ) how does your sentence “no relation whatsoever to the use or not use of the USD.” make any sense??????
        The whole country of Russia had to file for default because it did not have enough of worthless paper of another country liability which, itself defaulted in 1971, but never admitted it ever since.

        • I am not checking the dates of posts, but I think Prof Pettis already effectively (And politely) nonsensed your claim about the US “defaulting” in 1971.

    • ^^Jon WROTE: “Article 1….xx Article 22….xx Article 23……xx”

      I’m not sure why there is a sense of shock or surprise here. These three articles are true of most central banks in the world. Most central banks are:

      (1) Independent of the Government (central banks in India, Brazil, South-Africa are independent, Chinese central bank is not). Remember that even though the Bank of England is owned by the government, it still acts independently and professionally. This is a common and recommended feature of central banks.

      (2) Most central banks do not extend loans directly to the government. Monetary operations are carried out by buying government bonds from the general market under open-market conditions. This is generally how it is done in most places as a recommended practice.

      (3) All central governments keep their budgetary and extra-budgetary funds at their central banks. Where else would they keep their funds? At their own version of WaMu?

      (4) As for this notion that the Russian Central Bank must hold USD assets in order to ‘print’ Ruble-currency as liabilities, implying that the primary Ruble is effectively backed by the US Dollar, is a COMMON practice in countries transitioning through gravely unstable periods of change. It has been done many times in Latin America and was done for a brief period in India after the end of the Cold War. It is simply a method of creating a perception of stability in international markets and preventing currency-run panics in the domestic market.

      Dollar (65% of reserves) & Euro (25% of reserves) are at the top of the following graph and all non-reserve currencies are at the bottom:

      Does this surprise anyone?

      (5) As for why the Russian Central Bank did not bail out banks/companies like the US Federal Reserve did, the answer is very simple: the effect of the crisis on Russia was relatively small and troubled banks/companies in Russia could be handled using standard methods. The US, on the other hand, was the epicenter (Lehman collapse) of the whole affair and the crisis was the worst since the Great Depression. It could not be handled using standard methods, therefore, the Federal Reserve had to step in to prevent another Great Depression.

      • Vinezi Karim.
        1) it just goes to show that India, Brazil, South-Africa are restricted in its economic policies. I have to admit, I do not know what the reasons are.
        As far as “Bank of England is owned by the government, it still acts independently and professionally”, you made me laugh. You do have a great sense of humor.
        3) Russian government can KEEP their budget with RCB, that is not a problem.
        The problem is that it can not access when it needs it without jumping through some hoops. It would be strange that the related language is implemented.
        5) For your information, 1998 Russian default had nothing to do with just “some”banks or companies. 95 % of the banks became insolvent because the country ran out of US dollar reserves.
        OK, I understand now. So when 140 millions of Russians suffered in 1998 during the default and lost their live savings, to you it is “relatively small” event and is not a problem, but when Lehman collapsed, God forbid the rest of the USA banks will be in jeopardy, we must save them no matter what.
        No wonder that the bankers in the USA are so powerful when even average US Joe Schmo thinks the banks are of the most importance.

        • ^^Jon Wrote: “5) For your information, 1998 Russian default had nothing to do with just “some”banks or companies. 95 % of the banks became insolvent because the country ran out of US dollar reserves.
          OK, I understand now. So when 140 millions of Russians suffered in 1998 during the default and lost their live savings, to you it is “relatively small” event…. ”

          A) When I said the problem in Russia was ‘small’, I was referring to the 2008 global financial crisis.

          B) As for the 1998 crisis, now that you mention it, I would point to the fact that the Russians were suffering LONG BEFORE the 1998 crisis. The WHOLE PERIOD from the Soviet collapse in 1991 through to the 1998 crisis was marked by rising unemployment and shrinking output (i.e. negative GDP growth):

          In fact, it was only after the 1998 devaluation (and the oil price recovery) that Russia started adding jobs and increasing output.

          The ‘Great Depression’ in Russia BEGAN in 1991 and ENDED in 1998. Therefore, 1998 was a GOOD YEAR for Russia as it represents the turning point when the climb out of the Great Depression happened in Russia.

          The Russian Central Bank may or may not have bailed banks/companies/government in 1998, but the IMF was CONSTANTLY bailing Russia out through the WHOLE 1991-98 period with a steady stream of USD.

          All this has happened in many other countries as well. I fail to see any ‘hegemonistic’ conspiracy against Russia.

          • Vinezi Karim,
            it does look from the graphs the unemployment started to improve after 1998, but I am not sure it happened BECAUSE of the default. Correlation does not mean causation. What definitely helped that the price of oil at some point went up and also change in economic policy from year 2000 where oil companies started to pay at least SOME taxes after Putin came to power.
            What your graph do not tell you is how many people’s lives were destroyed because of the default and how many natural resources were stolen meanwhile from Russian people and sent abroad. More to the point, the country had no choice but default, while others could always QE. And I do not mean just USA, Europe is doing it too.
            As far as IMF, those are the loans that had to be paid back while austerity packages and privatization of resources by foreign companies were forced on the country. it is much more of an attempt to force the country in economic dependence than financial help.

          • ^^Jon WROTE: “…it does look from the graphs the unemployment started to improve after 1998, but I am not sure it happened BECAUSE of the default. Correlation does not mean causation. …”

            It was not the default that led to job creation, it was the DEVALUATION of the Ruble from 10 RUB/USD to 25 RUB/USD that ended the depression, created jobs and finally stopped the downward spiral of output.

            The reason Russians kept suffering from 1991 to 1998 is that the Russian leadership refused to devalue the currency. Once they overcame their hang-ups and devalued, the Great Depression of 1991-98 immediately came to an end.

            This is something that had been seen in many, many countries before. Trying to hold your currency too high leads to draining of reserves and eventually leads to default (and IMF bailouts). Devaluing your currency solves that problem and economy recovery & reserve accumulation begins again. Here are some examples:

            Thailand in 1984 &1997 crises. Indonesia in 1975 & 1997 crises. India in 1991 crisis. Numerous others like this. They all ran out of reserves, just like Russia in 1998, by trying to hold their currencies too high.

            All of them went to the IMF for bailouts. They then devalued their currencies, regained economic growth and began to rebuild their reserves– just like Russia did after 1998.

            So what is so special about Russia that we should see ‘conspiracies’ in all this? Yes, Russia is like Indonesia, Thailand, India, Argentina, Mexico, because all these countries have to issue external debt in someone else’s hard-currency (like USD or EURO). The US & Germany are different because they can borrow from foreigners in their OWN currency. Yes, they are far more empowered than Russia, Thailand, Argentina et cetera. But this power is something they have earned by being transparent, stable and respectful of the market system. Russia, with its history of communist revolution, coups, counter-coups, dictatorships and so on, has not earned the respect and trust of the markets. This is not a conspiracy, it is just a simple fact of history.

        • Jon WROTE: “As far as “Bank of England is owned by the government, it still acts independently and professionally”, you made me laugh. You do have a great sense of humor.”

          Setting aside all personal mirth, the ultimate test of the independence of a Central Bank is in the broad market reaction. Would you say that the Bank of England is a laughing stock in the global market place?

          Judging from market reactions, I would put the Bank of England as the #3 most respected central bank, trailing the Federal Reserve (#1) and the Bundesbank (#2), but way ahead of the Nippon Ginko.

          • I do not know how you define “respect” when it comes to a central bank, but when Fed started to add junky mortgage back securities to its portfolio, it was shock for a lot of people and it lost a lot of respect in many people eyes.

          • Bank of England reputation?
            Soros September 16, 1992.

          • ^^Jon WROTE: “I do not know how you define “respect” when it comes to a central bank…..”

            Here is one way to define ‘respect’……

            We can calculate the share of reserves globally-held in a particular country’s currency held as a proportion of the issuing country’s GDP-share of the global economy:

            In 1998 (pre Euro):
            1) USD 70% of Global Reserves, 21% of Global GDP.
            This implies as ratio of 3.3.
            2) German Mark 15% of Global Reserves, 5% of Global GDP.
            This implies a ratio of 3.0
            3) Pound Sterling 3% of Global Reserves, 3% of Global GDP.
            This implies a ratio of 1.0
            4) Japanese Yen 6% of Global Reserves, 7% of Global GDP.
            This implies a ratio of 0.8

            As of now (with Euro):
            1) USD 60% of Global Reserves, 17% of Global GDP.
            This implies as ratio of 3.5.
            2) Euro 24% of Global Reserves, 17% of Global GDP.
            This implies a ratio of 1.4
            3) Pound Sterling 4% of Global Reserves, 2.4% of Global GDP.
            This implies a ratio of 1.6
            4) Japanese Yen 4% of Global Reserves, 4.7% of Global GDP.
            This implies a ratio of 0.8

            CLEARLY, the respect-ranking was and is as follows:
            1) US Federal Reserve
            2) Bundesbank (close second)
            3) Bank of England
            4) Euro Central Bank (close third)
            5) Nippon Ginco

            The numbers have now confirmed exactly what I had originally said from general observation about the rankings.

        • ^^Jon Wrote: “95 % of the banks became insolvent because the country ran out of US dollar reserves.”

          Many countries have run out of reserves without having any banks becoming insolvent.

          For example, India in 1991 ran out of reserves during the Soviet collapse (the USSR at the time was India’s largest trading partner) and oil-price rise triggered by Saddam’s 1990 invasion of Kuwait:

          However, not one single bank in India became insolvent because of this.

          Please explain the connection between a country running out of reserves and its banks becoming insolvent.

          • My understanding is, and I could be wrong here, the reason Russian Banks were insolvent because just as RCB they heavily depended on US dollar for their solvency. I have to admit though, the details are not clear to me.

          • by what measure you judge Federal US bank to be transparent?
            “The Federal Reserve might be the most secretive institution in our nation’s history. For decades, Fed officials, politicians and various “experts” have insisted that such secrecy was integral to its independence and, therefore, its effectiveness.”
            So to you, the size of government debt and its ability to borrow is indication of trust? Then you are right, the US government has A LOT OF TRUST. I just do not think consumption is something to be proud of.
            More to the point, general Russian government debt is about 291,653 million US dollars, but there is no reason why it can not be brought to zero. Why should the government debt exist at all, especially to foreigners?

      • Vinezi Karim,
        regarding you explanation about why Rosneft can not get the loans from Russian banks:
        would not the Chinese Banks have THE SAME problem as Russian banks as far as obtaining US dollars to the loan to Rosneft?
        Or asked differently, how come that Chinese banks have no problem obtaining US dollars to lend to Rosneft while it is a problem for Russian banks. What makes Chinese banks so special?

        • ^^Jon WROTE: “would not the Chinese Banks have THE SAME problem as Russian banks as far as obtaining US dollars to the loan to Rosneft?
          Or asked differently, how come that Chinese banks have no problem obtaining US dollars to lend to Rosneft while it is a problem for Russian banks. What makes Chinese banks so special?”

          If Rosneft went to Russian Banks, the Russian Banks would have to get the USD from the Russian Reserves (‘wealth fund’). So Rosneft is just bypassing the middle-man and going straight to the Russian Reserves (‘wealth fund’) itself. It comes to the same thing in the end.

          Similarly, if Rosneft went to Chinese Banks, the Chinese Banks would have to get the USD from the Chinese Reserves. There is nothing special about Chinese banks.

          The only reason they did not go to Chinese Banks is that the Chinese government would have bargained hard to extract huge concessions from Rosneft in exchange for allowing them to use Chinese forex reserves during Western sanctions.

          Russia Forex Reserves: 520 Billion$
          Russia External Debt: 720 Billion$
          Russia NET External Debt: 200 Billion$ (=720-520)

          China Forex Reserves: 3,480 Billion$
          China External Debt: 980 Billion$
          China NET External Debt: -2,500 Billion$ (i.e. China is a Net Lender)

          • Vinezi Karim,
            I am not sure I agree that the amount of currency other countries hold in their reserve defines respect for its CB.
            By this definition, the bigger the US Foreign exchange debt, the more respect we should have for Fed. You think it makes sense? I do not.
            To me it is a sign of problem, not its strength.

    • Thanks, Jon, but there may be some confusion here. Many countries use the dollar to back their currencies, but this is a choice they make because they believe their currency policies are not perceived as credible, and by backing their currency with another, say the US dollar, they are effectively signaling to the world that they have given up monetary control and accepted US monetary polices as a way of gaining credibility. The UK could decide to back sterling with rubles if they wanted to, but because sterling is highly credible and rubles are not, it would be strange if they did. Still, that is wholly their choice.

      Occasionally countries are “forced” to adopt this policy — I think the US forced Haiti in the 1930s to back the gourde with dollars, for example (but please check before you quote this) — but what is more typical is that the country’s policymakers choose to do so because no one, especially in their own country, will otherwise believe them. When Argentina experienced hyperinflation in the late 1980s, for example, and no sane Argentine would every hold Argentine currency for more than an hour, Domingo Cavallo created a currency board in which the amount of pesos was supposedly exactly equal to the amount of dollars held by the board, and every peso was instantly convertible to one dollar on demand.

      Argentina was not forced by the US to do this. It did so because they could think of no other way to make the currency credible, so they essentially locked themselves into the dollar (it could have been German marks, Swiss francs, Japanese yen, gold, oil, or anything else, by the way, but they preferred dollars for obvious reasons). It turned out that there as enough wiggle room in the rules that a decade later they had the same old problems of fiscal indiscipline and an overvalued peso, and so in 2001 they choose to abandon the currency board.

      I am no Russian expert but I think Russia used the dollar peg to gain monetary credibility, and once they ran out of dollars, their peg lost all credibility and the currency collapsed. In 1997 several Asian countries, most astonishingly South Korea, whose currencies were also pegged to the dollar ran out of reserves and were forced to devalue. They did not peg because the US forced them to — in fact the US constantly complained about the unfairness of the peg — but because they thought it might benefit them.

      There is a large literature on whether it is better to peg, to float, to dirty float, or to back with gold, silver, or something else. The only thing on which we all agree is that nothing “works” if there is no fiscal and monetary discipline, and everything works when there is. Politicians don’t seem especially fond of this theory, however.

      • So why not peg to gold, indeed? If it is a question of gaining respect for your currency, gold trumps US dollar.
        Better question, why would you want to make your country economical policy dependent on your strategic competitor?

        • Jon:

          You should write the boards of Central Banks of the world, outside of that, many of us are really tired of how the Gold people confound discussions. The noise, the untested, over-assumptive, ideological, extremist, politically infused, morally-contradictory, philosophy upon which it is based is useful for disruption, and quickly people move passed that. The beauty of what we find here, is that many of these points of economics, macro-economics, are discussed through systemic frames, not philosophical belief constructs, where a father of modern rationalism told us 3.5 centuries ago that nothing is good or bad except insofar as HOW it effected each individual mind. While I might see something as good, another the same as bad, we can run around in circles of that, here we discuss systemic relations.

          • Csteven,
            if anything is untested, it is ability of the world economy to function for the extended time since introduction of an irredeemable currencies. They have not been around even for a 100 years and in itself is a huge financial experiment;

            I am trying to understand why would foreigners exchange their hard earned wealth for a promise to pay by a country which has no means or desire to ever pay it back. Also, so what that the unemployment in the country is high and many industries left for good. The government debt still sells just fine, so where is the problem for the financial elite? How would it ever come to an end?
            There is no “philosophical belief constructs” on my part. To me it is as “systemic relation” as it gets.
            So I am sorry, Csteven, I am not as smart as you, who apparently figured it already out.

        • It’s a tough question, but the answer is easier when you consider alternatives, of which there are very few. If you back your currency with another currency, your best choice is the currency of a country that has certain characteristics, including the following:

          1. It should be large enough that your own use of the currency doesn’t cause huge distortions in that country’s monetary policy. If Russia pegged to Swiss francs, for example, the SNB would probably lose all control of their currency as Russian use dominated.

          2. It should be very easy for foreigners to acquire the country’s government bonds, so you need large, liquid markets and a long history of no capital controls.

          3. Your business cycles should match theirs so that they are running loose policies when your economy needs tight policies and vice versa. This is very hard to find. The amount of trade you do with them might matter in this regard, because presumably the more trade, the more aligned the economies. The more countries that base their own currency directly of indirectly on the currency you choose, especially among your neighbors or the countries with which you trade most, also matters,

          4. Their currency should be credible, their central bank respected, and probably very transparent. If you are going to subject your economy to their monetary policy, you presumably want to have a pretty good idea off what their monetary policy is.

          5. It is better if that country is not ferociously opposed to your pegging.

          Backing your currency with gold or some other commodity also creates problems, among which is simply the problems of supply (is there enough of the stuff) along with two, I think, especially important monetary ones:

          1. Volatility. If you peg to gold (or silver, oil, wheat, or anything else), your currency rises and falls in line with the price of gold, and if you look at gold charts you can see that this volatility is considerable. It is possible, for example, for the price of gold to rise tenfold or to drop by 90% in a decade, which means that your currency would too. If most countries peg to gold, as happened in the late 19th Century, this isn’t a big problem, but if you are the only one, it could be huge. China historically has been a silver-based country and I have often thought that you could actually write a very interesting history of China since the mid- or late Ming Dynasty based just on the change in the silver price of gold.

          2. Discipline. The strongest argument in favor of gold-backed currencies is also the strongest argument against. When you peg your currency to gold (or anything else) your ability to manage domestic monetary policy is severely constrained and determined largely by gold flows (this, by the way, is why gold-backed countries typically went off gold during times of war).

          • As far as volatility of the currency:
            Oil today at 2 grams, is about the same as it was in the early 1950s; but if you measure the price in US dollars, you would get the impression that it is about 30 times more expensive today.
            So may be it is not the gold that is volatile, but the US dollar?

          • Of course you are right that volatility can be expressed in many ways, Jon, but I would argue that you might want to consider three points:

            1. I haven’t done the exercise, but if you take any two volatile commodities, such as gold and oil, and compare their exchange ratios over any long period, you will find a huge range of exchange ratios, in which case by choosing your period correctly you can make any argument about volatility you like. Over the past 100 years you will find many times during which the exchange ratio was the same as it is today, or was at whichever other date you choose, and many times when it wasn’t.

            2. Volatility is not measured by the change in value from one point in time to another. It is measured by the variance around the mean change. If the price of a widget rises by exactly 4% a year forever, and the price of a gadget forever doubles one year and halves the next, after some period of time you will see a huge change in the price of the widget and much less change, or even no change at all, in the price of the gadget. The gadget, however, is more volatile than the widget.

            3. The price of gold was repressed in the 1950s, so the price you are using is not its “fundamental” price. In 1933 when gold was still at its official price of $20.67 (ain’t Google great?) FDR formally took the dollar off gold and then tried to inflate the economy (or perhaps I should say to “dis-deflate” the economy) by forcing up the price of gold. By 1934 the government was buying gold at $35 an ounce after which, I believe, it stopped devaluing the dollar against gold. That was the price ultimately embedded in Bretton Woods in 1944, but by the 1950s a number of countries had to organize the Gold Pool to sell into any buying so as to prevent prices from ever rising above that level.

            During that period and in spite of inflationary policies (although these did not get out of hand until the 1960s), the US maintained that price as the “official” price of gold until, of course, once it no longer was able to do so and so the Nixon Shock. So excluding the WWI period gold was officially $20.67 an ounce until 1993, from 1934 to 1971 it was officially $35 an ounce, but again only because it was defined that way. Once this definition was suspended, in 1971, the price of gold rose I think 24-fold within a decade (oil rose too, of course, I think 10-fold).

            I know this part of the story quite well for very good reasons. The only time I ever visited the US before college was for a 2-week stint in NY to see my grandparents when I was 11. Like any good NY kid my brothers and I played an awful lot of stickball (its a NY thing) and one day I managed to hit the ball into the windscreen of a neighbor’s car and break it. When I told the neighbor and my father paid up ($100), he told me that I owed him three ounces of gold.

            A decade later, when gold was over $800, if I remember, my father loved reminding me that I still owed him three ounces. That was when my dad’s friend, a famous financier, told me that my father was playing clever with me, and he explained Bretton Woods and the subsequent gold price repression. Of course my father insisted that a contract was a contract but I insisted that if Nixon could break a contract I could too. My father hated Nixon so rather than allow me to claim Nixon as a role model we closed out our deal with a bottle of wine, most of which I drank anyway. But I do remember $35 an ounce.

          • That was quite a story about gold price, Michael. Hope you enjoyed the wine.
            I found a chart showing historically oil priced in gold. It is interesting to compare timing before and after 1970. Begs the question, what would happen, if gold window was not closed.

        • But that is essentially the exact same thing. Tying your currency to a more stable item to lower its volatility. Why Gold? Why not cows? Cows at least offer a stream of cash flows. Its like gold and a bond all in one package.

          The problem comes when a currency locks into the dollar and then offers a GDP to interest differential to the currency it is tying itself to. It is just offering the impossible..

          • Gold has the highest marginal utility known to mankind so it is perfectly suited for store of value. Cows do not.
            love their milk, though.

          • “Gold has the highest marginal utility known to mankind”. Why do you say that, Jon? Gold has some utility- — jewelry and some industrial uses — but historical its main value has come about because it is a kind of fiat currency.

            The oldest and longest-used form of fiat currency was, as I mentioned in another blog entry, cowrie shells, but once they stopped being widely used, in the mid 19th century, their value collapsed to become merely decorative. If we ever stopped using gold as a monetary asset, I suppose its value would probably also collapse to its decorative and industrial uses. Jade has widely been used in China as a currency but no longer is, although currently the purest forms of jade are actually more expensive than gold, so depending on how you define marginal utility you might argue that pure jade has a much higher marginal utility.

          • Michael Pettis wrote: “gold….x….cowrie shells….x…jade”

            Cowrie shells and jade are brittle. One earthquake and all your cowrie-shells and jade may become worthless if crushed. Gold is malleable. Even if it is bludgeoned into foil, it will still retain its value and can easily be converted back into any desired form (coin, bar, brick, ornament) at will.

            Gold, cowrie shells or jade may be equivalents as forms of a general circulating-currency, where only rarity is the criterion and accumulation (hoarding) is not an issue. But once accumulation & storage becomes an issue, Gold is clearly better suited than jade or cowrie shells.

            For example, if a ship sinks in the ocean with a treasure of cowrie shells, jade and gold on board, only the gold will still remain intact after 200 years. The cowrie shells (exoskeleton) & jade (calcium/sodium content) will be worn away.

          • VK is right. No one is ever going to use the more destructible stuff as money. I heard some wackos are even thinking of using paper as money, but it’ll never fly. Paper is even easier to lose, destroy or rot than cowries, so I guess we are stuck forever with metallic coins.
            Hey, VK, if cowrie can’t be used as money, why does Pettis think it was used as money even longer than gold? Did it used to be malleable and beatable into foil?

          • Michael Pettis WROTE: “….if cowrie can’t be used as money, why does Pettis think it was used as money even longer than gold? ”

            Please read my original comment carefully. Cowrie shells CAN certainly be used as money. Special paper CAN also be used as money. Anything that is rare (whether naturally rare or artificially made rare, whether universally rare or only locally rare) CAN be used as money by mutual agreement of the concerned market participants. Even canned fish can be used as money:

            But where accumulation & storage (HOARDING) is concerned, gold has a HUGE advantage over cowrie shells, paper, canned fish and other things.

            There is a difference between immediate circulating-currency, for which an arbitrarily large number of things could be suitable, and the means of hoarding of excess inventory as a store of wealth, for which gold is especially and almost uniquely well-suited.

            I hope this clarifies the matter sufficiently.

          • If we went back to gold, the US would find terrorists in Australia, South Africa, Canada and Peru. All 4 are countries I very much enjoy traveling to and would like it to remain that way. I would prefer we stay with dollars.

          • Our money today isn’t paper. It’s just a number stored in a computer somewhere. What’s it backed by? What effectively amounts to the US military.

            With regards to gold and a gold standard, we will never go back to it. Why? I don’t think there’s enough gold in the world for trade to take place. Another problem with a gold standard is that if a few countries go off gold, then your country experiences inflation. If there’s a banking panic or something crazy where people hoard gold halfway across the world, your country experiences deflation.

            My main worry about fixed exchange rate regimes is volatility suppression in the rate of exchange. Why am I worried about this? Because some bureaucrat or politician is better off by maintaining the status quo than taking short term pain for a longer term structural reward. I’m worried you’d see countries getting locked into policy options of maintaining the rate of exchange until it blows to smithereens.

            I do think the Bancor is a good idea, but the most important thing we need to focus on is to decentralize monetary policy all across the world everywhere for everyone. We cannot be in the position of trusting bureaucrats to make intelligent, thoughtful decisions–particularly some academic economist with no skin in the game. Obviously, the current situation isn’t robust.

          • Marginal utility – subsequent units of a commodity are valued less by the economizing individual than units acquired by him earlier.
            This is known as the Principle of Declining Marginal Utility.

          • Definition of fiat money:
            “nonconvertible paper money made legal tender by a government decree.”
            Gold does not need a government decree to be a store of value or work as money. So I am not sure I understand Mr. Pettis statement ” but historical its main value has come about because it is a kind of fiat currency.”
            In any kind of tough economical hardship ( war, revolution, fiat currency destruction through hyperinflation) people naturally gravitate to gold, at least for the last 1000 years in Europe and than later in America. Any example when fiat currency lasted anywhere near that long? I did not think so either.

      • Is it a correct statement: if country A has a structural trade deficit against country B, the currency of country A is overvalued against country B?

        • ^^Jon WROTE: “Is it a correct statement: if country A has a structural trade deficit against country B, the currency of country A is overvalued against country B?”

          It depends:

          CASE I) If both countries are at similar levels of development, then YES.

          CASE II) If country A is a poor, developing country and country B is a rich, developed country, then NO, it is not NECESSARILY true that country A’s currency is overvalued. Although, it could be so.

          CASE III) If country A is a rich, developed country and country B is a poor, developing country, then YES, it is true that country A’s currency is overvalued (or country B’s currency is undervalued).

          The trick is to ascertain whether the direction of flow of capital is ‘natural’ or ‘unnatural’, which determines whether the structural trade deficit could be sustained for a long time or not. In case (I) & case (III), where long-term unidirectional net capital-flows are usually unnatural, the trade deficits will need to be soon reversed. The only exception to this reversal-principal is when the trade deficit country in CASE (III) has a RESERVE currency with no alternative.

          Do you disagree? Please let me know your thoughts.

          • Vinezi Karim,
            it is not as straightforward in today world, the US obviously can not directly threaten European countries with its military. But any time you see Europe adapting policies which hurt EU economy while US directly encourages it, its strong military presence is a factor.
            Latest example, sanctions. The trade between EU and Russian was big, so the damage to their economy is enormous. So you have to ask yourself why the EU agreed to something that makes zero sense for THEM.
            i agree with your thinking on “CASE III) If country A is a rich, developed country and country B is a poor, developing country, then YES, it is true that country A’s currency is overvalued (or country B’s currency is undervalued).”
            That implies China could and probably should let yuan float to correct for imbalances.
            I would like to know if you can support or reject a statement from professor Fekete saying about Asian countries were being actively discouraged during the Aisan crisis to sell their US Treasuries. If true, it goes against idea of US complaining about their exuberant privilege.

          • ^^JON Wrote: “I would like to know if you can support or reject a statement from professor Fekete saying about Asian countries were being actively discouraged during the Aisan crisis to sell their US Treasuries. If true, it goes against idea of US complaining about their exuberant privilege.”

            The USD is the same as US Treasuries — they are all debt claims on the US government. The difference is only that USD nominal interest rate is zero, while the other debt-instruments pay a few percent for the additional risk of potential for capital loss if bond prices fall w.r.t. currency. So most countries hold dollar-reserves in a mix of USD and USG treasuries.

            If (I don’t know the details) the IMF advised the Asian countries not to sell their US treasuries, the IMF was implying that they should not defend their over-valued currencies during the 1997 crisis.

            And that would have been sound advice. After all, as you have yourself pointed out, the Bank of England was humiliated by George Soros when it tried to defend the ERM-peg of their over-valued pound in 1992.

            As for the notion that the US somehow benefited from their NOT selling their treasuries, it is easy to dispel:

            The total reserves (all currencies) involved in the 1997 crisis was 120 Billion$. Assuming 75% were held in dollar-assets, we get 90 Billion$ as dollar-reserves. Of this, assuming 80% were held in treasuries, we 72 billion$ in treasuries. Even if ALL these treasuries had been sold-off to defend the local Asian currencies in 1997, it would have made NO material DIFFERENCE to the US, as the sums involved were too small to trigger any large increases in USG bond yields.

            I am afraid that you may be seeing conspiracies and hidden ulterior motives in what are perfectly reasonable actions.

          • Thank you Vinezi Karim,
            I am trying to have an open mind. But let us say China for one reason or another decides to sell their US Treasuries /US dollars on the open market. Let us also say there is a wiling buyer(s) for US dollars who then decides to convert them to real goods. Do you not see how it could create a problem for US government? The sheer amount of US dollars / Treasuries which are not in circulation is staggering.

          • Jon WROTE: “But let us say China for one reason or another decides to sell their US Treasuries /US dollars on the open market. Let us also say there is a wiling buyer(s) for US dollars who then decides to convert them to real goods…”

            You say:
            1) X sells US Treasuries /US dollars in the open market.
            2) Someone buys them.
            3) That someone then converts them into real goods & services.

            This happens every day. People are constantly trading in their currencies for USD in order to purchase real goods & services from economies that operate in other currencies. Its called international trade.

            However, the KEY point to note is that the buyers want those USD for purchasing real goods & services from all over the world, not just the US. For example, if they want South African gold, they pay in USD. If they want Brazilian soy-beans, they pay in USD. If they want Russian oil, they pay in USD. If they want Ukrainian wheat, they pay in USD. If they want Australian iron-ore, they pay in USD. And so on…..

  23. What does this piece really say? It really says that the nationalist movements in Europe (particularly the National Front) actually have some solutions to the structural problems in Europe.

    On another note, I’m really worried about the rise of nationalism. Many of these countries have declining populations with minorities having the highest fertility rates. In the case of countries like France and the UK, the country’s Muslim populations have had very high fertility rates. These populations also tend to be from different regions with a completely different view of society. This will not end well.

    Attached below is a list of fertility rates of Muslim vs non-Muslim populations across differing countries in Europe. France is actually, from a relative standpoint, in much better shape.

    For the record, I have no problems with Muslims in particular and some of my best friends are Muslim. Muslims, on the whole, tend to be very kind and hospitable people. However, people with differing views of society that are discriminated against in their own society can create major problems. This is what you’re seeing in Europe ranging from France to Norway to Sweden to lots of other countries. All I’m saying is that the current sitaution is inherently unssutainalbe.

    • Suvy
      what you see on TV is what makes a sensation, that is why they show it.
      Who wants to watch news about Muslims integrating in the society and being productive. That is just plain boring, right? Even though its is by far the majority.
      I live now in Nürnberg and there is absolutely no problem that I can see on the regular basis.

      • It’s not just TV. Half my hometown is Muslim and, even in a city with a tradition of tolerance, there are still tensions that occasionally flare up. As economic circumstances get worse, you’ll see an intensification of these conflicts–particularly in these European nation-states. In a hundred years, don’t be surprised if these Muslim minorities start to become majorities. Why could this be an issue? Because many of these Muslim populations have a fundamentally different view of society. You’re seeing different laws in Muslim districts in the UK and in other places.

        With regards to US immigration policies, I don’t give a shit who you are or what your religion is as long as you believe in a free society. I don’t want people in my society who don’t believe in having a free society and I think we should prevent people from coming into here if they don’t have a similar view of society. In other words, this immigration policy would affect <5% of immigrants (if that).

    • Prof did you read this article from Xiao Geng and Andrew Sheng? very interesting because it is clearly coded ambitious. They want a kind common currency agreement between RMB and USD. But what is funny that they also said that US should reduce by himself his current account deficit…
      I think they wrote this piece because as you they think RMB is not going to be normaly trade soon so this waycould be a good way to do reform without saying it.

      • which article?

        • Sorry! I didn’t want to post there and the article is from prject syndicate
          “American-Made Financial Repression”. It’s realy connected with your lasts posts.

          • For some reason, I find almost everything on Project-Syndicate to be insane, ridiculous, and (usually) modern liberal/progressive which coincides with authoritarianism for the most part–especially the parts that preach bullshit ideas like equality.

            Unfortunately, this piece is just as insane as most of the other pieces on the site. For example, take this part:
            “If the Fed’s benchmark interest rate can be restored to historical trend levels, China would have more policy space to adjust interest rates in alignment with its growth pattern and pursue an orderly opening of its capital account.”

            The Fed raising the short term money market rate of interest to previous levels? Are the guys that wrote this insane?! Long end rates are falling from collapsing global demand and they want us to raise short end rates?! That’d cause the entire US banking system to collapse. On top of this, they’re talking about needing to cut the US fiscal deficit (I absolutely agree here), but raising short end rates would cause the fiscal deficit to explode!

            “Instead, he recommended that Asian countries develop a regional currency that would provide macroeconomic stability in the face of dollar volatility.”

            Earlier in the piece (see quote above), they’re suggesting a currency union among Asian countries. That’s the dumbest thing I’ve ever heard. Let’s create the same problems in Europe and turn them to Asia. On top of this, let’s take countries that absolutely hate each other and create a centralized authority so that the powerful can tell the weak what to do. What could possibly go wrong?!

            What the US really needs is radical decentralization and an elimination of the Federal Reserve. If the Fed was eliminated, the dollar would fall in the FX market and allow the US production being stolen by these retarded Asian countries to come back here.

          • I agree but i think the article is coded. Because authors can be so stupid to prentend that all problems come from US but China should do reform. I really think they just want China to make reform but they don’t want to say it.
            They talk about common currency not about union. And i think they want it because of what the prof said, asian currency imbalances. This could help because with a common currency they can start to stop the peg with USD. A common currency is generaly agood thing but I don’t think there is a political agenda for that in asia.

          • I don’t think a common currency for Asia is a good thing. It increases centralization and would make the place less robust.

            One of the reasons Beijing has the peg is, IMO, because they have such a tightly controlled economy. What they need to do is to loosen the reins and the centralized control. I think it needs to happen. It’ll either happen willingly or unwillingly. The question is not whether Beijing will loosen the economic grip; the question is how the loosening will occur and at what cost.

            Personally, I don’t see a way that China doesn’t blow up or something crazy happen. The entire economic system is based on tight control over everything whereby the incentives of the rulers and the elite basically force the Chinese government to lock into certain policies. Basically, China’s current political setup is to hop on a 300 mile highway with no exits. If something goes wrong, bad shit will happen. I don’t see how anything going on in that country is halfway sustainable.

          • Yes, I read the piece but disagree with much of it. The surprising thing is Sheng’s claim the Japanese bubble was caused by the US’s forcing it to revalue the yen after the Plaza Accords. People used to say this 15-20 years ago, especially in Japan, but this idea has been so discredited, not least by the Japanese, that I am surprised people still say it.

            I think now most monetary economists say that had Japan revalued earlier, and eased up on its domestic financial repression, it would not have suffered anywhere near as much as it subsequently did. In fact had Tokyo been able to postpone revaluation another couple of years, the crisis would have probably ultimately been much worse. Funnily enough the so-called “Japan bashers” turned out to have done Japan a great favor.

            One of my PKU students did a great presentation a couple of years ago on this topic. He showed, among other things, something that people like Sheng have never explained, perhaps because they are unaware. The Plaza Accords were not just about the yen but also about DM. After the agreement both currencies shot up, but only Tokyo responded with a sharp expansion of credit and lower real interest rates, much like the Beijing did after the RMB began appreciating.

            Berlin did not. Needless to say, Japan, but not Germany, suffered from the great bubble, which is consistent with Kindleberger’s (and Minsky’s) insistence that bubbles are the results primarily of liquidity shocks. On that note it is worth quoting the September 16 2010 speech on Japan’s post-bubble experience, by Bank of Japan’s Masaaki Shirakawa, who argued among other things that “protracted low interest rates play an important role in preventing an economic downturn, but, at the same time, they tend to delay adjustment in excesses accumulated during the period of bubble expansion.” He was talking about why Japan had the bubble and indirectly why China would too.

            It will soon become consensus (“soon” means in a decade, I guess) that if China had revalued earlier and much more sharply, and raised interest rates, its 2003-10 GDP growth would not have been quite so spectacular but it would be facing a much, much easier adjustment. Of course what with all the frantic cheerleading during those years it would have taken real policy courage to have done so.

            Unfortunately some people in China, and not just Sheng, do seem to be repeating the misguided version of the Japanese story: the US forced currency appreciation, which led to the bubble, which led to decades of stagnation, and all this will happen to China too. Most economists I speak to seem to know better, but one way or the other it is hard to imagine that as the economy gets worse blame won’t be anyway placed on the US or Japan.

            And why not? Hasn’t Marine le Pen told us that France’s problems are caused mainly by Germans, Americans, Chinese and Muslims? Isn’t American unemployment caused by Mexicans? Isn’t Germany’s problems caused by lazy Spaniards? Could anything explain Venezuela’s soon-to-come default better than a Washington plot?

            Damed foreigners.

          • – I think the japanese yen going up marked the start of the “blow-off” phase of the japanese economy. Not only injected Tokyo extra credit into the system but it meant that foreigners poured in to benefit from a rising yen.
            We saw something similar in China from say mid 2005 up to mid 2008. The yuan went up against the USD and a lot of investors piled in to take advantage of the rising yuan. Hence the Sjanghai stock market bubble/bull market. It was eerily similar to what happened to the Nikkei in the late 1980s.

          • “I think now most monetary economists say that had Japan revalued earlier, and eased up on its domestic financial repression, it would not have suffered anywhere near as much as it subsequently did”

            Economists are so good at explaining events after the fact aren’t they? They’re understand how to prevent the problems after they happen.

            Most economists remind me of a superhero by the name of Captain Hindsight. If you don’t know who Captain Hindsight is, just watch this 1 minute video.

          • Michael Pettis WROTE: “On that note it is worth quoting the September 16 2010 speech on Japan’s post-bubble experience, by Bank of Japan’s Masaaki Shirakawa, who argued among other things that “protracted low interest rates play an important role in preventing an economic downturn, but, at the same time, they tend to delay adjustment in excesses accumulated during the period of bubble expansion.” He was talking about why Japan had the bubble and indirectly why China would too.”

            I could have sworn that he was talking about Greenspan-Bernanke, the dotcom & housing bubbles, rising debt/GDP ratios, falling efficiency and the rise of consumption-rates in the US in the past 15 years. In fact, now that I think about it, he could well have been speaking about any monetarist bubble anywhere.

          • The Japanese stock market and real estate bubbles of 1985-1989 is best explained, i think, by the combination of the BoJ aggressively easing monetary policy and massive speculative inflows attracted by the strengthening Yen following the Plaza Accord in 1985.

            BoJ loosening monetary policy to cushion the economy from the impact of the attempted trade rebalancing following the Plaza Accord triggered a chase for yield which displaced domestic investors towards real estate and equities while facilitating a strong credit expansion funding the real estate bubble.

            Speculative foreign inflows magnified the boom. With central banks committed to a stronger Yen and a weaker $ from 1985, it became very profitable to borrow in depreciating $ to buy risk assets denominated in appreciating Yen. This carry trade on a massive scale fueled the Nikkei bubble at least until end 1988 when the Yen started to weaken again. Its own momentum carried the market for another year to the end of 1989.

            Vinezi Karim is right to point out that this is the exact same thing happening today, most notably in the US.

            As QE ends in the US but real interest rates remain negative for “an extended period of time” and QE accelerates in Japan (still dealing with the legacy of the bubble of 25 years ago…), the $ is appreciating and the Yen is depreciating. Thus making it very profitable to borrow in depreciating Yen and invest in risk assets denominated in appreciating $ in another massive bout of carry trade.

            The current S&P500 bubble is indeed the exact mirror of the late 1980’s Nikkei225 bubble. The symmetry is almost perfect.

            It is very comforting to see that the mistigri of imbalances of 30 years ago is still going around today, augmented by the mistigri of all the additional imbalances that have accumulated since…

            The good thing is that there is generalised real estate bubble in the US. Not that monetary authority haven’t tried but it’s too fresh in the psychology of the people and there is too much to allow another real estate bubble for now. That should make the next economic crisis less violent.

            Consensus in a decade or so about what’s causing these destabilizing booms and busts? Really? It doesn’t look that way at all. On the contrary, it is rather clear that there has been a complete takeover of the credit easing / asset bubble blowing school of thought. It doesn’t matter how many times they are proven wrong, they keep applying ever larger dose of monetary amplification to the oscillator until it goes completely wild. In that, at least, they succeed. Unfortunately. No need to wait for Captain Hindsight after the fact, we already know the end of that particular movie for having seen it many times in the past 30 years.

  24. Africa is banking on the continued economic growth from China-fueled investment and commodities. Its not clear to me if the slowdown and re-balancing from China will diminish or increase the investments in African infrastructure and the appetite for raw materials, particularly energy and metals.

    What is clear is that Africa does not have the political legitimacy to absorb lower growth and higher unemployment without the potential for significant social upheaval. So far, investors in Nairobi have been willing to overlook problems with terrorism, corruption, political malfeasance, lack of opportunity for the youth. Ditto for Uganda and South Africa. However, it seems plausible that the slow down in China could lead to a contraction in East and Southern Africa, and the calm we are witnessing now may not survive the next 3-5 years. Any thoughts?

    • This is an interesting point……. commodity exports are certainly not a certain path to development.
      So we all know Africa trades too much with the outside world, and not enough with each other, so more infrastructure and more tightly bound together and operating economic trade unions, etc…

      So, China has been funding its companies to go out and do what other countries who have developed do, big infrastructure, real estate (MENA, AFRICA, LATAM Developed Countries; like Hyundai in Libya with the Water project). Then some talk that manufacturing, low-level manufacturing was being supported by some Chinese companies in Africa. Of course, many more traders were being supported excess inventories in China, to Africa, putting handcrafted small African manufacturers (Shoes, household wares) on the ropes.

      So, GDP slows, rise in NPL’s, great excess capacity, altering growth model, less commodity imports, large amount of reserves, grave amounts of inventories…..

      My guess, China will seek to dump inventories as much as possible (20 years of clothing inventories currently in warehouses and channels), so they will seek to use networks of Chinese traders in Africa to do this.

      China will continue to loan these countries for Infrastructure, as they will seek to use the resources of the companies who may be less needed domestically (Roads, Rail, Ports, Electrification).

      China will lessen investment in Infrastructure.

      I suspect talk of Chinese Manufacturing shifting to Africa to serve domestic markets in Africa is likely not the truth either.

      That being said, there is a lot of private money off-shore. It might be that Africa, is a large, largely undeveloped market, where increasing amounts of such might go (Chinese and otherwise). Problem is grave excess capacity and inventories in the short to medium terms.

      Africa has to work on the social and political transformations too. It seems it is becoming increasingly obvious that these alterations need to come as, not after, a certain level of GDP and income growth is being obtained.

    • lessen investment in commodities (not infrastructure)

  25. I agree with the post, which is very professional.

    Where I have a problem is mostly in the thrust of the comments from the piece, where the concept of comparative advantage seems to be left out of the picture. Currency manipulation may make economic signals fuzzy, but it will be cheaper to produce manufactured goods in China than in the US. Increased trade likely increases wealth through reallocation of resources to the more efficient producers. These gains have been accumulating year after year for decades. So while there are negative consequences from imbalances due to globalization, I find it difficult to believe that in the long run those negatives outweigh the positive aspects of global trade. And, after all, the volatility machine does provide trading opportunities!

    A few odd bits-
    In the global mining industry, it is now cheaper to hire a machinery operator in Arizona than it is to hire one in Chile.

    Cliffs in the US just wrote down $6 Billion of Canadian iron ore/coal mine assets, so perhaps the adjustment will fall in more places than OZ.

    The German surpluses have been going on for years. What I don’t get about the Eurozone is that the preferential capital treatment afforded domestic government bonds by banks ensures that a breakaway from the Euro by any member (save Germany) ensures that their banking system becomes insolvent. The German banks I analyze don’t have much PIIGS exposure. The only semi-elegant way I see to resolve the Eurozone imbalances is for Germany to resume using the DM, and for the rest to live with a depreciated Euro where trade terms can come into balance to benefit countries other than Germany.

    • There is widespread misunderstanding – in most cases involuntary – about Ricardo’s theory of comparative advantage.

      Ricardo’s theory of comparative advantage states that countries will mutually benefit if they exchange finished products for which they have a relative cost advantage, leading to a specialisation of said countries in the production of said finished products, leading to a rising standard of living in all participating countries. This conclusion is reached under the assumption that countries trade finished goods for finished goods, for instance Portugal sells wine to England in exchange for cloth. This goods for goods exchange means that, in Ricardo’s framework, trade balance remain balanced. Said differently, Ricardo’s theory is not supposed to be valid if a country exchange goods for IOUs issued by another country, like in the case in the current international trade and monetary system. In a monetary environment, the corresponding assumption to Ricardo’s would be that exchange rates are set at levels that, on average, makes the respective trade balance be at equilibrium. There is no doubt that this mutual benefit is the intention of the founding fathers of the GATT as it is explicitly and solemnly indicated in the preamble to the original 1947 agreement. However, to my knowledge, nowhere in the various GATT / WTO agreements that have been signed over recent decades to liberalise international trade is there any mention of the fact that exchange rates should be set at levels that make trade flows balanced across participating countries. The WTO has pushed free trade globalization without any consideration for exchange rates. As if international trade and exchange rates were two completely different things, while of course they are the two inseparable sides of the same coin.

      Instead, Milton Friedman theory of floating exchange rates has been added to Ricardo’s theory of comparative advantages as the second intellectual backbone of the push towards trade globalisation in the post Bretton Woods world unilaterally decided by the US in 1971.

      Milton Friedman’s theory states that market forces will ensure that exchange rates adjust at levels which, on average, make trade balances balance. This conclusion is reached under the assumption that there is no official intervention in FX markets. Of course, this assumption has never been valid in the real world. In practise, surplus countries recycle their accumulated monetary reserves back into the deficit countries, thereby bidding up the currency of the deficit country relative to their own, thus completely negating the adjustment envisaged by Friedman.

      There is more still. Ricardo’s theory also assumes that there is no relative technological change between countries engaged in trade. But, in the current system, US firms can set up in China via FDI with their own equipment, technology and range of intermediary products. Said differently, US firms can import US relative advantage (ie. its modern production technology) to China and combine it with China relative advantage (ie. its cheap labor). At the end, the technological transfer means that the initial relative advantage between countries is altered. China ends up with both efficient production methods imported from the US – which means that its initially lower productivity can quickly catch up – and cheap labor. The overall balance of relative advantages is firmly tilted into China’s favor. Under this condition, it is no surprise that trade becomes unbalanced and that China becomes net exporter to the US. To my knowledge, nowhere in the GATT / WTO agreements is there any restrictions on cross-border investments that alter the initial conditions of production, ie. the comparative advantages in Ricardo’s sense, between participating countries.

      So, we see that the intellectual foundation and justification for the current international trade and monetary system in place since the 1970’s are very weak and essentially non-existent.

      This of course should not necessarily prevent you to believe in the benefits of free trade as practised under the current international trade and monetary system. You may believe in it because you have demonstrated under real life conditions that this system effectively leads to the best possible outcomes. In that case, we are eager to learn about your demonstration. Or you may believe in it as a matter of faith, which seems to be your case and it is of course eminently respectable. But you appreciate that it would be totally futile to ask dozens of millions of displaced workers to share your faith in free trade and refrain from bringing their votes to extremist political parties that tell them – unlike mainstream political parties – that delocalization of their former plant to low cost countries is responsible for their misery.

      If we want to successfully contain the rise of extremist political parties, we need to go slightly beyond the mere repetition of unsubstantiated beliefs and confront the issues in a more rigorous and open mind.

      • I don’t believe that free trade, as espoused by Ricardo and Friedman, ever existed. There are all sorts of ways to cheat at this card game, including export/import restrictions and irrelevant government product requirements, in addition to FX pegging. So what! Also add in that financial flows dwarf product flows.

        Your points are academically correct, but it’s rather easy to set up a straw man argument that a classroom example does not reflect reality, and there’s no possible way to set up a counterfactual with numerical examples of something that has never existed.

        There is comparative advantage, where the US can produce wheat more competitively than Iceland-to set an extreme example- which I know is true. It IS cheaper to produce iron from high quality ore with a fully developed infrastructure than to use poorer grade ore without competitive infrastructure. Ask Cliffs! I am not an academic, but I am an analyst, and I work with what exists.

        If you look at the economic progress in China over the past 2 decades, it may have occurred due to the 1994 devaluation, but the results of pulling countless millions out of poverty isn’t the worst outcome. Look at the economic progress in Latin America, where market forces have brought some skilled worker’s wages to levels that exceed those in the US. That’s the demonstration.

        There are also losers in the process, which you allude to while ignoring that there are winners as well.
        But this is all last year’s argument. The upcoming problem for labor EVERYWHERE is that machines will replace human labor at an increasing pace. That’s what concerns me; because I see no solution to the pervasive dislocation of labor that will happen over the next decade, at least until the baby boomers fully retire.

        • Is machine replacing labor everywhere a problem everywhere?

          Does it ensure a post-industrial structure for poor countries who didn’t develop? (why all parochial ideologies, those in the post mid 20th century world, built on the foundations of other philsophies have been so detrimental, heightening ideals beyond reality and feelings, able to be witnessed across ideological stances today, as if all except moral imperatives above realism, while jousting as to a few points hear and there that are actually more moral; the Spinozan in me chuckles)

          Some more questions, advance of tehcnology, material science, evolution in energy, battery tech, the emerging ethos and zeitgeist of the people, altering relations to the external worlds we find in things, people, possessions, locales, regions, nations and globally, under the presmises of your point, machines are able to do more, this is the post-industrial society, discussed decades ago, does that mean they do everything, or that human enabled by machines can do more, that is, while much work has been done at the margins, will more work be done by those who have seemingly been marginalized (labor) during this period of time.

          Look at alterations in finance, for that matter. Some guy wanted 10$ to make potato salad, people for a laugh, and less money than a pack of cigarettes, gave him 60,000. So, more than the dystopian sci-fi, escape form New York scenario is at hand my friend, stodgy, ossified bureaucrats might not realize it, and protect the people technocrats might be less inclined to believe so, but it is upon us. Problem is, so many in the developing world, and others, are so lost in the dis-empowerment memes of previous ages of thought on these matters, I believe.

          Suvy’s decentralization is interesting,but still zero sum, and not appreciating a broader range of impact as it is still applied to more distinct large units, that while existing long into the future, misunderstand grass-root movements, I believe

          • “Suvy’s decentralization is interesting,but still zero sum”

            It’s not about being zero-sum or not (we have no way of determining that over any extended period of time). It’s about being more robust. You can think of decentralization eliminating the impact of a left tail by placing an absorbing barrier on the left end. What it does is drastically reduce the risk of ruin.

        • 1) I’m not ignoring the fact that there has been winners from globalization.

          In March 2014, in a comment to “Economic Consequences of Income Inequality” which you can refer to if you like, i clearly outlined both the winners and the losers. The winners have been ~550k new entrants into the global labor market from developing countries since 2000 and a ~+$13.5Tr income uplift for nearly 1.7bn developing countries people. In several other comments, i have also documented that profits from productive and financial activity and those indexed on them have also done well. The losers have been ~450m developed countries workers, 95% of whom have seen declining income in real terms and a not immaterial portion of whom have fallen into unemployment and out of the labor force, sometimes in poverty. More importantly perhaps if you only think in terms of world averages, the big loser has been global growth which has been eroded by the continued pressure on demand due to continuously falling share of production and the related continued rise in debt / income. The fact that globalization is now working against global growth and against global stability is precisely because, in a large part, international trade has not been based on true mutually beneficial comparative advantages but mainly on one-way labor cost and FX arbitrage. True comparative advantages are relatively few and essentially concern natural resources, which is by the way all the examples you spontaneously provide (US wheat and Australian iron ore). For virtually all manufactured products, there is no real international comparative advantage to speak of, simply labor cost and FX arbitrage. That’s why you shouldn’t be surprised that the concept of comparative advantage is left out of the picture, especially if you work with what exists, as it is largely a myth arising from a misunderstanding of Ricardo’s theory, a more respectable name for labor, FX and tax arbitrage. Even in the rare cases when true comparative advantages do exist, as in the case of natural resources, the benefits of over-specialization are highly dubious, something Michael Pettis and others sometimes refer to as “the curse of commodities dependent countries”. Let’s not even go there for the time being and let’s simply watch Australia in the coming years for an interesting real life experiment.

          2) What i’m saying is that the international trade and monetary system in its current set-up is reaching an unstable situation where it is dangerous to keep pressing for more globalization.

          During the 40 year course of globalization in its current set-up, total world debt has grown from ~100% to ~300% of world nominal GDP. This is getting dangerous. Total capital is about ~450% of world GDP, so it means there is precious little equity left in the system. The global debt pyramid is at risk of becoming unstable any time. A collapse of the precarious global debt pyramid would trigger extremely negative consequences, early 1930’s style, with the difference being that the number of participating countries to the world international trade and monetary system is now much more important. You might think that this has already happened in 2008-2009 and that the chances of a repeat are low. You would be wrong. Since 2009, the world has continued to releverage, using the extra room afforded by lower interest rates (see the recently published Geneva Reports on the World Econmoy titled “Deleveraging? What deleveraging?”). Labor share, hence final demand, has continued to fall. Over-investment has continued to pile up, if in different parts of the world. Social tensions have been rising in various countries, the rise of extremist political parties in Europe being just an exemple. You have noticed the rise in geopolitical tensions as well. Just think of it from a risk management perspective: if things are becoming unstable and volatile, do you rather increase or decrease exposure? You decrease exposure, of course. If you are a corporate manager, you see the company under increasing debt load from past expansion having generated poor and falling returns, you invest even more to push growth or you slow down and prioritize cashflow generation and a better use of existing resources? You slow down and deleverage, of course. This is also what we need to do with the world trade and monetary system: it is becoming dangerous to push the accumulated imbalances even further. On the contrary, it is wiser to let the system rebalance in an orderly fashion while it is still time and we are not presently in a crisis situation. To do that, we need to urgently close these labor and FX arbitrage opportunities that are eroding global demand and fueling the global debt snowball as well as seeding the seeds of wrath in an increasing number of countries. As an aside, doing that will bring the system much closer to the conditions described by Ricardo in his comparative advantage work so all “believers” should be over the moon with this idea (hint: no, they are not).

          In various articles about Europe, and at the end of this article as well, Michael Pettis has made an explicit link between the Euro and the rise of extremist political parties in Europe. For instance, in “Can Pedro Sanchez save the PSOE?”, he wrote: “The policymaking elite, both on the left and on the right, have been reluctant to make explicit the connection between the German policies, the Euro, and domestic unemployment, preferring instead to blame misguided domestic labor policies. […] This is why the extreme right has done so well throughout Europe and will continue to so”.

          I believe Michael Pettis is right but that it goes even further than what he says. If we consider Europe in isolation, he’s absolutely right about German wage policies, the Euro and the inacceptably high unemployment in Europe (12% in the Eurozone on average and closer to 20% if we consider under-employement ; 10% in EU27 ; Germany is ~30% of Eurozone GDP and ~20% of EU27 GDP). However, if we consider Europe within the global system, it is very clear that Germany has no other policy choice than the one followed since 2000 which consists of reducing unit labor costs in a system where international competition is based on [labor costs / productivity * FX]. It is precisely because Germany has adopted this labor policy that it today has 5% unemployment and total-debt-to-GDP 100pts below that of other developed countries (by the way, these two metrics are only good on a relative basis, they remain poor in absolute). The moment it relaxes this policy, unemployment and debt will increase again in Germany. For Germany to be able to increase domestic wage, it has first to be in a situation where domestic production is no longer at risk of being undercut by China or any other lower cost countries. Only then Germany can follow Michael Pettis advice. Before, there is no viable solution. So, I believe it is correct to rewrite Michael Pettis’s statement as follows: “The policymaking elite in developed countries, both on the left and on the right, has been reluctant to make explicit the connection between the international trade system based on labor and currency arbitrage, the international monetary system allowing duplication of credit on a worldwide basis, and domestic under-employment and excess debt situation, preferring instead to blame their political opponents, the weather, faulty bank regulation, rigid labor market institutions, other governments, red tape, etc […] This is why social, political and geopolitical tensions have risen and will continue to so”.

          PS – like you i’m not an academic. There is no need for that, any 12 year old immediately understands Ricardo’s comparative advantage with the Portuguese wine vs. English cloth example, it’s really not like trying to build a bridge, design a plane that can fly, discover the origin of the universe or analyze German banks – how many do you think will make it and how many tens of billions euros cash infusion do they still need for having work too much with what doesn’t really exists? Sometimes i wonder whether some banking assets are not even more inexistent than true comparative advantages? Or are they simply part of the same misconception about how real economic value is being generated? Anyway, what was the relevant point you were trying to make in this academic vs. analyst remark?

          • Last comment first- I saw an extensive exposition of a frictionless Ricardo/Friedman system which really doesn’t mean much to me because trade barriers have existed always and everywhere. That’s why I saw an academic approach to the issues of the day.

            The more recent comments are much more on point to the problems I see. FX manipulation, the rise of intelligent machines, and the intellectual collaboration that vastly improved communications all allow lower costs, and thus have a deflationary impact. That causes stranded investment that can happen quite quickly and is very disruptive to the lives of those affected. It’s also called progress. In poking around investments, I see software firms making no money that have solutions to technical problems that now require expensive machinery, so the machinery manufacturers can lose their markets and business before they can react. The creative destruction is the same as it ever was, but a whole lot faster.

            The offset is that there has been a reduction in costs of physical goods, so the lower incomes go further. Many products are no longer paid for, such as music, or the replacement of newspaper classified ads by Craigslist, which is a dead loss of GDP in the $ measured economy while the job is done more effectively. It’s just not measured because they are not paid for in money anymore.

            Yes the debt is scary. With respect to China-
            “Then you might have the event that tips the world into a recession. It is the second largest economy in the world. Since the top of the credit cycle in 2007, global nonfinancial debt has gone from roughly $70 trillion to $100 trillion, and China is half of that increase – it has gone from $9 trillion US to $25 trillion.
            China accounts for half of all new debt put on globally since the last peak, though it is only 12 percent of the global economy. If you are looking for the credit event or credit transmission, you have to look at China. You will see all of the excesses we saw in the West from 2005 to 2007 and then some.”
            from p.31- Jim Chanos interview- Chapter 2 available at –

            The shortage I see is secure income to service debt. A million dollar portfolio throws off far less income that it did 10 years ago, so people living on investments get cautious, and that lack of a cash flow can cause negative changes in valuations in a very short period of time. Also, by the math, a low discount rate causes much greater price volatility on a 100bp change in rates (a 100 bps shift causes a much larger price change on a 3% yielding asset than on a 10% one). An investor would have to be myopic to not notice this, so it is likely already in the price. In other words, the caution has already been expressed at the individual level (see the decreased default rates in US consumer debt), but not by governments.

            Even so, it doesn’t pay to extrapolate the 2008 shock- if confidence increases for whatever reason the increased business makes the debt service possible, and at current rates even easy. What I know is that it’s very easy to be seduced by negative economic and stock market arguments; they just sound more cogent, but they are often wrong. I know it sounds like magical thinking, but over my lifetime I’ve heard so many cogent “end of the world” arguments that don’t come to pass that I know the world is far too complex to get doctrinaire on a negative view.

            There are a lot of smart people going to work every day to improve life, which provides a very powerful uplift to the economy. It’s always there, but is not noticed. I see tons of progress in electronics, disease management, and the simple everyday improvements in logistics that have to be kept in mind when formulating a worldview.

            Because so much of the growth is not paid for, or actually destructive of $ based transactions, I see a huge mis-measurement of economic progress. I know for certain that my life is better simply by being able to converse with you, and to get Michael’s commentary for free, where I used to pay ISI and whoever else for economic analysis. It ain’t in the numbers!

            Also, the demographic profile of Europe assures that there will be a shortage of workers eventually, so the unemployment has to resolve. I see it as a time ballet, where there is maybe 5-10 years where a large fraction of the population becoming “Lilies of the field who toil not, nor do they spin” to borrow a phrase from Keynes and the Bible. Maybe that leads to inflation later on, but who really knows?

            To continue from Keynes (Economic Possibilities for our Grandchildren)-
            “From the sixteenth century, with a cumulative crescendo after the eighteenth, the great age of science and technical inventions began, which since the beginning of the nineteenth century has been in full flood – coal, steam, electricity, petrol, steel, rubber, cotton, the chemical industries, automatic machinery and the methods of mass production, wireless, printing, Newton, Darwin, and Einstein, and thousands of other things and men too famous and familiar to catalogue.
            What is the result? In spite of an enormous growth in the population of the world, which it has been necessary to equip with houses and machines, the average standard of life in Europe and the United States has been raised, I think, about fourfold. The growth of capital has been on a scale which is far beyond a hundredfold of what any previous age had known. And from now on we need not expect so great an increase of population.
            If capital increases, say, 2 per cent per annum, the capital equipment of the world will have increased by a half in twenty years, and seven and a half times in a hundred years. Think of this in terms of material things – houses, transport, and the like.”

            I acknowledge the chance of another accident, and have my toes out less on the economic surfboard, but who hasn’t done that? That’s why it’s less risky than it looks where blind belief has recently been rudely repaid. Maybe the blind belief is still in China? I don’t live there, so I don’t know.

            As to ephemeral bank assets, as before I’m most concerned by the concentration of sovereign debt in own country banks in Europe, which has real accident potential in the event of the unthinkable. The systemically most dangerous assets are those which are viewed as most safe where no allowance for loan loss is provided.

            As far as the political change risk goes, older people might vote for crazies and demonstrate in the streets in patriot costumes, but it’s always been males aged 15-30 that have the testosterone levels that overcome natural caution to commit mayhem –that’s why the Middle East is boiling over, while a disaffected fraction of Europe votes for LePen.

    • There is an enormous literature about comparative advantage. Ricardo proved elegantly and conclusively that specializing in comparative advantage always increases output. The math is impossible to refute. The two main criticisms of comparative advantage are

      1) While global output is raised, it isn’t at all obvious how the increase is shared, or even if both countries are at least as well off after specializing than before.

      2) Much more importantly, comparative isn’t static. If certain areas have better productivity growth than others, you always want to specialize in the former. In some cases there is nothing you can do about it — Greenland will never be great at producing sugar or bananas — but in other cases you can use protection to alter your comparative advantage. It cannot be a coincidence that every successful country used protection (or military means) to break their comparative advantage. The British protected seafaring and some manufacturing against the Netherlands until they were more productive, and only after then went for free trade. They did the same with India over textile production. The US protected themselves from British industry until they had the advantage in fact protection was one of the “three pillars” of the “American system”). Japan, Germany and Korea all did the same (directly or indirectly, through List, copying the American System).

      But protection by itself isn’t enough. Protection plus ferocious domestic competition seems to be a good strategy. Protection plus national champions seems to be a bad strategy. And as Friedrich Engels (of Communist Manifesto fame) warned, protection is a habit that is very hard to drop. It often ends up just subsidizing powerful local vested interests forever.

      So while Ricardo was right, and brilliantly so, he was not complete. He proved that comparative advantage in a static system is always output enhancing, but he did not prove that in a dynamic system free trade is always good for everyone.

      As for German exposure to Europe, remember that while Germany ran surpluses and the periphery ran deficits, this suggests capital flows from the former to the latter — not necessarily, of course, but in fact bank lending from German and French banks to the rest of Europe was quite substantial. I haven’t seen recent numbers, but if they are much lower, remember that since the crisis banks have offloaded their exposure onto official agencies — the ECB most obviously through Target 2 and QE — and in the end these agencies are implicitly backstopped by Berlin.

      I agree that the least disruptive euro exit is probably a German one, but this would imply a surge of the DM relative to the euro, so that German banks and investors, or perhaps mainly Berlin, would suffer from the currency mismatch moving against them.

      • I’d actually go a step further. The reality is that it’s very difficult for a country to know the exact policies that will succeed ahead of time. I’d argue that it’s impossible. Economists are very good at telling you what policies you should take up after the fact, which is completely useless and gets struck down by the narrative fallacy. The only real way to have success is to have a system whereby a bunch of things are tried and failures occur quickly and occur often. You also need a way to mitigate the risk of ruin.

  26. ^Michael Pettis wrote: “..Normally the contraction impact of much weaker iron ore export prices should be partially mitigated by the expansion impact of a weaker Australian dollar, as iron-related inflows drop sharply….”

    The problem with Australia is the same as the problem with the Sub-Saharan African countries, in that its goods exports are almost ALL commodities and priced in USD. Therefore, weakening of the AUD will not help it increase its goods exports, as it has almost no non-commodity goods exports in which it can become more competitive at any conceivable AUD/USD exchange rate. For all practical purposes, Australia has been completely de-industrialized.

    Australia does have some advantage in service exports, such as tourism and education, but these sectors are small compared to the goods exports in commodities. So there might well be a small tourism and education boom, with a surge in tourist and student arrivals in Australia in the event of a weaker AUD, but apart from that it is difficult to see any advantages that might accrue from a falling currency.

    Australia imports almost all household durable items and industrial machinery items (see imports in the linked goods trade list). The falling of the AUD will make essential imports (standard of living items) more expensive for Australians, without the option of manufacturing any of those products cheaper within Australia. In other words, terms of trade will go down sharply. Therefore, if the ‘fleeing’ Chinese money does comes in through the capital account, it would prevent the AUD from falling excessively (i.e. funds the Australian CAD), thereby possibly containing inflation and holding up living standards (perhaps for a bit longer).

    I could be wrong. Only time will tell how it actually plays out in Australia.

    • Another point to consider along this line of thought:

      1) We are speculating that as China’s boom cools, a lot of rich Chinese might see financial or political risks ahead and so move their money out of China (legally or illegally) and into Australia.
      2) However, risk is always relative. Even though these rich Chinese may see Australia as a safe haven compared to a post investment-boom China, it is possible that rich Australians may see the US/UK/Canada/Switzerland as safe havens compared to a post commodity-boom Australia.
      3) Therefore, any capital flight INTO Australia by rich Chinese might be accompanied by a capital flight OUT of Australia by rich locals.
      4) Rich Australians would be selling AUD assets while rich Chinese would be buying them, and asset prices may even remain relatively stable. This two-way capital flight phenomenon—IF it actually happens–would be interesting to watch.

      Something to think about…

    • I think you’re likely to see stagflation-like effects (or even straight up stagflation) in many commodity exporting countries. This includes Russia, Canada, Australia, South Africa, and other countries (including countries in Africa). They’ll see their currencies decline, which will push up the cost of imports while the collapse in worldwide demand will hammer their export industries. In other words, they’re likely to see falling production with consumption being stable or maybe even increase from rising input prices.

      • I think commodity producing countries will see their currencies fall, do not see Chinese money flows as materially able to alter that dynamic, and believe that, as I have been saying for multiple years on this blog, there will eventually be an infrastructure push in developed countries (my original points, several years ago, was that 2014 would see Us economy strengthening, and 2016 rise in talk of infrastructure (to which I now add Picketty), with 2018 lots of infrastructure. In the US this is whether Dem or Republican, no choice.

        The more interesting story is how technology is enabling the normal human to be able to produce more; has anyone seen the toys that now enable children to design their own circuit boards, that work, and can be used in all sorts of applications thereafter around DIY, Makers, Robotics….(Internet of everything), same with RFID, etc….this besides all the tech training, start-up (y combinator), lean weekends, mobile mondays, crowd-funding, challenges (X prize), and similar…..

  27. Really an interesting blog about the worlds most fascinating economy! My compliments for that

  28. Hi Michael, I quite agree with the analysis, of course. Just a note on iron ore: you would probably agree that Rio Tinto and BHP were quite aware of the possible decline in prices and in fact have been focusing more on things like their cost advantage, lower Australian exchange rate, lower brown- and greenfield production globally, and even some expansion in demand from so-called emerging economies. To that extent, it is not even a question of their being right or wrong – simply because they have the “might” of extremely low costs of production and sea-borne delivery!

    Just a note of caution of “balances and imbalances”: a careful reading of your analysis will point quite correctly to the fact that the “imbalances” have a very political origin, and they are not due to some kind of “accounting mis-match” or search for a “golden mean”. In other words, these are not “numerical” or accounting imbalances but rather imbalances in the political implications of the wage relations within separate capitalist nation-states concerning what you call their “bankers” and “workers”. (By the way, I wrote recently on Schumpeter’s distinction between “entrepreneurs” [dynamic, energetic, innovative and above all “self-denying”] and “capitalists” or “financiers” [static and hedonistic”].)
    Finally on Jane Jacobs: I think that, with all due respect to that great scholar of urbanistics – and a very urbane one at that! – whom I have fondly admired since my sophomore years, I fear that her predictions, though perhaps coinciding with those of Minsky, may have been based on very different economic and above all sociological assumptions. But then again, to me that just shows that it is possible to make accurate economic predictions by basing oneself on broader sociological analyses. Indeed, one could argue that your own work is one of the finest examples of such enlightening eclecticism (not meant disparagingly, God forbid!). Cheers and good work!

    • Thanks, Joseph, and yes, i agree. If two or three robust analytical frameworks lead to the same conclusions, that is probably strong reinforcement. In fact mystics and LSD notwithstanding, reality is reality, so the only justification for any framework is that it allows us to capture the same reality.

  29. In his article Prof. Pettis complained that often the predictions of pessimists are not pessimistic enough. Here I am going to make a pessimistic prediction: A total collapse of China, Russia and EU by the year 2020. I hope it is pessimistic enough. The one nation to emerge strongest from this entire mess: USA. Which will be the king of the hill, surveying the wreckage with smug satisfaction. I am not an economist (my PhD is in Physics) and I feel that one does not need any economic model or even simple arithmetic to make such predictions. My line of arguments is as follows:

    Modern human societies are extremely complex systems with billions of agents interacting with one another in myriad ways. It is getting even more complex as technological advances make division of labor ever finer and drives the process of change ever faster. Under these circumstances, only those societies will thrive which adopts more of a ‘bottom up’ method of social organization rather than a ‘top down’ mode. In other words, societies which empower individuals over the collective, decentralize power and are more welcoming of change will succeed whereas all those which practice heavy handed centralized management will fail. Free market capitalism will trump all other forms of “managed” capitalism. Following this line of reasoning it in not too difficult to predict the downfall of USSR or Japan. USA and few other English speaking societies which emphasize individualism, empiricism, freedom and openness will dominate this century. So the rise of English speaking peoples, the dominant theme of the past 300 yrs, will continue. The 21st century is going to be the 2nd American century.

    • I agree with your assessment of the core process that over time creates the wealth of nations.

      However, to predict that the US will be the winner from the application of this process, you are implicitly assuming that the US will be able to solve its excess debt problem, which now necessitates a permanent centralized management of its entire financial-markets-based asset base, which is blurring the entire price signal system at the core of the decentralized competitive organization as well as shifting the rewards from productive to speculative activities, thereby undermining the positive influences of the bottom up forces that you mention.

      It is also not possible to relate the rise of the police state in the US with the values that you mention are necessary for the wealth creation engine to perform adequately.

      Since these difficulties are not specific to the US but now concerns many countries in the world, it is still possible that the US be the winner on a relative basis while continuing to deliver poor economic outcomes in absolute. Perhaps that’s what you mean. It would be, in that case, a very small consolation.

      • “is still possible that the US be the winner on a relative basis”

        Well, all measures of success and failures are RELATIVE. There are no absolute ideals against which to measure performance. The fact is that the US keeps adjusting and innovating and outperforming others over VERY LONG time scales. That companies like Apple, Microsoft, Google, Facebook or SpaceX (many of which are founded by immigrants) which did not exist a generation ago are now powering the US economy forward and leading us into the information age, is a testament to the remarkable flexibility and adaptability of the system. On the other-hand, the more heavily managed systems, (e.g. USSR or Japan), can generate much faster growth over short periods of time while those societies are relatively simple, but as those systems become more complex, they inevitably stumble and fall apart. The miracle fast growth phases never seem to last more than 30-35 yrs.

        • Fully agree with you on the innovation strength of the US, the emergence of businesses that didn’t exist a generation ago, the adaptability of the system.

          Disagree with you that all measures of success and failures are relative in economics (is that true in physics?).

          For all the terrific Apple, Google, Microsoft, Facebook, SpaceX, the US economy has delivered poor absolute outcomes over the last generation (absolute in the sense of not by reference to other countries):

          Working age population (source Census Bureau)
          1989: 143.4m
          2014: 188.4m

          Full time jobs (source Bureau of Labor Statistics)
          1989: 97.5m
          2014: 119.3m

          Full time employed / working age population
          1989: 68%
          2014: 63%

          Total credit outstanding (source Federal Reserve)
          1989: $12.4 Tr
          2014: $57.5 Tr

          Total credit outstanding / working age people
          1989: $87k
          2014: $305k

          • “Disagree with you that all measures of success and failures are relative in economics (is that true in physics?)”

            Well, economics is not Physics and never will be. You can write an equation for an electron but not for a human being, much less for entire socities.
            I do not get how exactly terms like “rich” or “developing” can have any absolute meaning. They are always relative. True that US had a tough last decade. But it’s not the first time that it happened. US had tough decades in 1930s and 1970s as well (decades when commodity supercycles peaked, so there might be a relation). Just after WWII, US debt to GDP ratio was at 120% . But lean times were followed by two decades of economic boom. We maybe witnessing the strart of just another such period. Again the measure is realtive. With EU or Japan going nowhere, sustained US GDP growth of 3% will be considered boom times indeed.
            Plus I do net get in what sense US delivered poor absolute outcomes over the past generation? Has the standard of living gone down ? Were TVs, refrigerators, cars, air travel etc. more affordable in the 1970s ? Were the homes bigger ? Obviously not. Is there anything that the Americans could have easily afforded a generation ago but not now ? I can’t think of any.

          • ^^DAM WROTE: “Well, economics is not Physics and never will be. You can write an equation for an electron but not for a human being, much less for entire socities.”

            Surely, it is EASIER to write an equation for an entire society than it is to write an equation for a single human being. In the face of statistical uncertainty, aggregates are easier to describe than individual units.

            For example, can anyone really write an equation for an electron? What is an electron anyway? Does anybody really know?


            ^^DAM WROTE: “Just after WWII, US debt to GDP ratio was at 120% . But lean times were followed by two decades of economic boom. We maybe witnessing the strart of just another such period. Again the measure is realtive ….xx…. Plus I do net get in what sense US delivered poor absolute outcomes over the past generation? Has the standard of living gone down ? Were TVs, refrigerators, cars, air travel etc. more affordable in the 1970s ? Were the homes bigger ? Obviously not. Is there anything that the Americans could have easily afforded a generation ago but not now ? I can’t think of any.

            This graph answers all your questions:

            1) The US government-debt/GDP ratio did RISE rapidly during WW-II, but private-debt/GDP during that period FELL considerably (‘crowding out’), such that TOTAL debt/GDP ratio did not change much.

            2) During the ‘two decades of economic boom’ following the end of WW-II, US government-debt/GDP ratio did FALL considerably, but private-debt/GDP during that period ROSE (reverse of ‘crowding out’) just as fast, such that TOTAL debt/GDP ratio again did not change much.

            3) After 1980, however, the government-debt/GDP ratio and the private-debt/GDP BOTH ROSE SIMULTANEOUSLY (assisted by the mechanism of the debt-financed CAD), such that TOTAL debt/GDP ratio began to rise to levels not seen during the Great Depression.

            4) The Great Depression had a high TOTAL debt/GDP ratio not because government & private sectors borrowed heavily , but because the GDP itself collapsed during that time. In other words, as seen in the linked graph, it was the reduction in the denominator that drove the ratio up in the 1930 and not as much a rise in the numerator.

            5) The outcome of the past generation is not good because TOTAL debt/GDP ratio has been RISING, implying that debt is growing faster than nominal GDP. This means that the US has been borrowing more & more to get the same increment in standard of living over the past generation. This trajectory is ultimately unsustainable.

          • We continue to largely agree on the resilience of US economic organisation as a source of fundamental long term strength (i maintain my above caveat that centralised management of the balance sheet has long term corrosive effect if it becomes a permanent feature).

            As a scientific person, you will have no problem spotting poor absolute outcomes over the past generation in the US by simply looking dispassionately at the data:

            – “Has the standard of living gone down?” According to the US Census Bureau, median real household income was $51.9k in 2013 and $51.5k one generation ago in 1988 (in $ of 2011). So, to be precise, living standard has not come down but has stagnated over the past generation. You can only fit a flat line through these data points, not a +2% p.a. exponential anymore (sadly). But, you can still very much fit a +2% p.a. exponential line through real debt per household. Which bring us to your next question.

            – “Were TVs, refrigerators, cars, air travel etc. more affordable in the 1970’s? Were the homes bigger? Obviously not”. Well, these things were obviously more affordable in the 1970’s since they could be bought on current income then, while they have had to be bought on credit over the past generation and still today.

            You might call the above a good relative outcome (and some countries have indeed done worse) and i might call it a poor absolute outcome. It’s not the interesting part. It is what it is. The interesting part is how and why this divergence between income and debt? And that’s where Michael Pettis has an interesting way of looking at things.

          • “To, to be precise, living standard has not come down but has stagnated over the past generation.”

            @DvD: We have been hearing a lot about wage and middle class stagnation in the US in recent days, but if you look at data more closely, a totally different picture emerges. More and more of worker pay over the past few decades is going in the form of fringe benefits like healthcare, pensions, paid leave etc. if you look at the total “Compensation package” it won’t look so stagnant anymore. Moreover, what people are concerned about are not incomes per se, but what they can do with their incomes. The fact is, due to the amazing increase in productivity and innovation which are the hallmarks of free market capitalism, American households can do a LOT MORE these days with a certain amount of money compared to what they could have done a generation ago. They are paying ever lesser portions of their disposable incomes for things like food or utilities or life’s other necessities. There has been a dramatic fall of real prices of almost everything from TVs to air travel since the 1970s. So there has been a dramatic rise in living standards.

            As for debts, their rise was a temporary phenomena. American households have sharply reduced their debt loads over the past few years. Hopefully the government will do the same over next few years.


          • Speaking of looking more closely at the data, you seem to have missed the fact that i was referring not to real wage but to real household income, which includes wage and salaries, investment income, rental income, transfer payments, etc.

            As for household debt, yes it’s good that it came down (but remains far higher than one generation ago despite the supposedly dramatic increase in living standards…), but let’s not forget that households are ultimately responsible for their fair (and often more) share of government debt so at the end of the day nothing has really changed and liabilities have simply been redistributed in a different way as is typical when losses are socialized.

          • ^^DAM WROTE: “As for debts, their rise was a temporary phenomena. American households have sharply reduced their debt loads over the past few years. Hopefully the government will do the same over next few years.”

            Here is a MUCH BETTER graph that shows all the components of debt (household, business, financial & government) as % of GDP:

            The OVERALL debt is what we need to track. We cannot celebrate a reduction in household-debt/GDP without accounting for the increase in government-debt/GDP.

            Household-debt/GDP came down for a while mainly because of massive defaults on mortgages** (‘jingle mail’), all of which were transferred to government balance sheets (USG or Fed) via bailouts. So on an overall basis, there has been no deleveraging in the US. Here is the proof–

            The latest Federal Reserve Report on US Finances:

            A) Table D.3 on page 5 entitled “Credit Market Debt Outstanding by Sector” gives us the TOTAL (non-financial) debt as:

            YEAR—Debt in Billion$

            B) Table F.6 on page 12 entitled “Distribution of Gross Domestic Product” gives us the GDP as:

            YEAR—GDP in Billion$

            C) Therefore, we can calculate debt-load (i.e. debt/GDP) from (A) & (B) as:

            YEAR—Debt Load (% of GDP)

            It looks like the total debt-load has been more or less constant over the 5 years listed in the report. This implies that the idea that the US has been deleveraging since the crisis is a myth.

            Do you disagree? Do you still feel that the US has been deleveraging? If so, please provide your reference data as evidence.

            **NOTE: The households which have truly deleveraged (reduced their debt/income ratio) have done so by means of defaulting on their underwater mortgages (‘jingle mail’). These households have destroyed their credit ratings and will (a) have difficulty accessing credit and (b) have to pay higher interest rates in the future. In light of this, it is difficult to see how this default-assisted deleveraging could possibly help future household spending.

          • “The Federal Reserve reported today the net worth of American households – the difference between the value of total household assets and total household liabilities – rose to a new all-time record high of $80.66 trillion in Q4 last year.


            I just cannot reconcile the claims of the inexorably rising debt/GDP ratio of US with the data showing that the NET wealth of US households (assets minus debt) has reached a record high. Now that household net wealth is rising and Government debt/GDP ration has also started falling, how come the overall debt to gdp ratio still increasing. Can someone please explain ?

          • ^DAM WROTE: “I just cannot reconcile the claims of the inexorably rising debt/GDP ratio of US with the data showing that the NET wealth of US households (assets minus debt) has reached a record high. Now that household net wealth is rising and Government debt/GDP ration has also started falling, how come the overall debt to gdp ratio still increasing. Can someone please explain ?”

            This is the ESSENCE of the insight that Michael’s research has provided. It is, in fact, the foundational idea on which his blog, his books, his lectures and the last 10 years of his painstaking work stand.

            Michael core idea is that debt remains fixed on the RHS of the balance sheet, but asset prices on the LHS on balance sheet (“wealth”) are volatile and hence the source of the risk to ‘net worth’.

            So debt expansion (or credit expansion or monetary expansion or fiscal expansion) may inflate asset bubbles** and make everyone feel “wealthy” for a while, but when the cycle turns and the bubble bursts, asset-prices will collapse even as the debt that was incurred to inflate that bubble remains the same. This leads to a collapse in ‘net-worth’ and hence results in defaults, bankruptcies, bailouts (i.e. financial crisis).

            Recall that household ‘wealth’ rose SPECTACULARLY during the housing bubble (2003-2007) and during the dot-com bubble (1997-2000) as well. And each ‘bust’ (2001, 2008) has required lower and lower interest rates for ‘sustaining’ the subsequent recovery. Now with interest rates at ZIRP levels, there is no further lowering possible (i.e. liquidity trap).

            **NOTE: The US has already generated massive asset bubbles as of 2014–

          • “So debt expansion (or credit expansion or monetary expansion or fiscal expansion) may inflate asset bubbles** and make everyone feel “wealthy” for a while, but when the cycle turns and the bubble bursts, asset-prices will collapse even as the debt that was incurred to inflate that bubble remains the same”

            Well, bubble creation and their bursting have ALWAYS been INTRINSIC features of any capitalist system. But that does not mean that when bubbles burst we all go back to where we started from. The only real source of growth is productivity growth, and there is no doubt that technological advances, information revolution, shale revolution, etc is dramatically increasing productivity and wealth all around. So along with some illusory growth, some REAL wealth growth is also taking place. Only the balance between them changes from time to time.

          • DAM WROTE: “Well, bubble creation and their bursting have ALWAYS been INTRINSIC features of any capitalist system. But that does not mean that when bubbles burst we all go back to where we started from.”

            You are correct. This is true as long as we don’t see a SECULAR, LONG-TERM rise in the debt load (i.e. debt does not rise faster than nominal GDP in a secular fashion). With the temporary exception of the Great Depression (when the nominal GDP itself was mistakenly allowed to collapse), this was indeed the situation in the US before 1980. After 1980, however, something unprecedented happened– the debt/GDP began to rise in a secular fashion for over a generation. This is the problem today. Each bubble since 1980 has required lower interest rates to sustain and each following bust has required even lower interest rates for recovery.

            With ZIRP & QE, we have reached the end of this road. We are now at the edge of the cliff and face three choices:
            (1) We continue forward on the path. In this case, we will fall off the cliff and crash violently on to the rocks below.
            (2) We stay at the edge of the cliff. In this case, we will have slow-growth for a generation at least.
            (3) We turn back and head away from the edge of the cliff. In this case, we will get stagnation (and recessions) for a generation.

            There are no ‘good’ options left. The only choices are between bad and worse. This is the reality, whether we like it or not.

          • ^DAM WROTE: ” So along with some illusory growth, some REAL wealth growth is also taking place. ”

            This is true everywhere and at all times. Even in the USSR there was some REAL wealth growth along with some illusory growth. Even in China over the last 10 years, there has been some REAL wealth growth along with some illusory growth.

            Here is the key point w.r.t. the US today:
            1) Total growth = Illusory growth + Real growth
            2) Debt growth > Total growth for last 30 years
            3) Therefore, Debt growth > Real growth for last 30 years.

            Debt cannot grow faster than GDP in a mature, developed economy in a secular fashion because that would lead to a reductio ad absurdum. As Michael’s research has clearly shown, the concept of debt-ceiling is a very real one. Yes, cyclical up-down patterns in debt/GDP are certainly possible, but any long-term and sustained increase in the overall debt/GDP ratio necessarily indicates an unsustainable model of growth.

            Over the next 30 years, the “real wealth growth” component (creativity, innovation) may well continue at the same level as the last 30 years. However, the “illusory growth” component (debt-financed excess) will have to turn negative in order for the US to rebalance. Thus the total growth, which is what is measured as the sum of “illusory growth” and “REAL wealth growth”, must necessarily slow down.

            As Michael has repeatedly said, countries that develop imbalances ALWAYS rebalance; they can rebalance the good way or the bad way, but they always rebalance. By way of illustrative example:
            1) Over the last 30 years, let us say that total growth of 3% was composed of real growth of 2% and illusory growth of 1%
            2) Over the next 30 years, we could see total growth of 1%, which will compose of the same real growth of 2% and illusory growth of -1% (reversal or rebalance).
            3) In other words, just as the “illusory growth” component PULLED-UP the total growth rate over the last 30 years, the same component will PULL-DOWN the total growth rate over the next 30 years.

            If we compare this to Michael’s specific application of his generalized theory of debt-ceiling to China, we can see certain similarities. This is because China and the US have both been travelling down an unsustainable path of using rising debt-load to turbo-charge growth. This process is now coming to an end. Both China and the US will now have to pay the price for the unsustainable debt-binge and spend a long time with slow growth as they rebalance. Of course, as Michael has pointed out, the Chinese rebalancing slowdown may not be painful for ordinary households in China. But in the case of the US, it is ordinary households that will hurt the MOST during the US rebalancing and a lost generation of young Americans may well be the result.

          • Yes, it’s true that bubble creation and bursting have been features of capitalism, though you can debate whether it’s intrinsic to capitalism or whether it’s simply a function of how the credit system is designed and whether the benefits of the credit system thus designed (in terms of being “reckless” enough to finance many seemingly “crazy” undertakings) exceed or not the costs (in terms of panics and crisis) over time.

            But, it is not true that when bubble burst we remain above where we started from. From the chart attached to one of Dr Atanu Maulik comments below showing real US GDP per capita, you can see that real GDP per capita in 1933 was the same than in 1904 (meaning, more concretely, that living standards dropped by ~ 2/3) and that the 1929 level was not recovered before 1938. And that was with advances in automobile, radio, household appliances, electrical machinery, plastics, etc. driving productivity growth.

            The conclusion, which one should take the time to carefully meditate with regards to the current situation, is that very real wealth growth (by all accounts, the 1920’s were “roaring”) can quickly turn illusory if it rests on unstable balance sheet structures, both domestically and in relation to the global network of claims. It is not enough to simply say that the balance between illusory and real wealth changes from time to time. One should really try to comprehend the forces at play much more deeply, as you would do for a physical system i imagine.

            That’s why the collective priority of policymakers from the largest economies of the world should be to design and keep an international trade and monetary system which is balanced.

            For the past 40 years, the priority has been to develop an international trade and monetary system which is unbalanced and for the past 15 years (25 years in Japan) to prevent it from collapsing by adding to financial instability. Here lies the weakness of the current situation, not withstanding the fact that the current IT and shale energy revolutions are great, like the car or electricity revolutions were in the 1920’s.

        • Please do not use Facebook as example of powering USA economy.
          A company must make profit in order to do that.
          Even though it is a lot of fun to look at pictures of my relatives with their cats, I have to admit.

          • Actually facebook may be making more real profits than those phony Chinese banks with trillions of dollars of assets.

          • ^^DAM WROTE: “As for debts, their rise was a temporary phenomena. American households have sharply reduced their debt loads over the past few years. Hopefully the government will do the same over next few years.”

            I wish I could share your rosy optimism about the US, but I cannot, because the data do not support it. For example, although total US debt has been rising faster than US income over the last 30 years, US total interest-payment cost has NOT been rising faster than US income over the same period. Here is the reason for this divergence:

            Note that a secular-FALLING trend in interest rates:
            (a) Makes stock-markets rise due to rising P/E ratio,
            (b) Makes bond-prices rise due to falling yields,
            (c) Makes existing debt easier to service, and,
            (c) Makes more debt-load possible due to falling interest costs

            Interest rates in the US are as low as they can possibly be. Since interest-rates cannot go any lower on a secular basis, there are TWO scenarios to consider for the future:

            (1) US Interest-rates stay low for a generation. If this happens, the US will see slow-growth for a generation, since the ‘tailwind’ of falling interest-rates will no longer exist to boost domestic consumption and investment via inflating asset prices and room for further leverage.
            (2) US Interest-rates begin a secular climb UPWARDS for the next 30 years. If this happens, the US will see rising unemployment, since the secular rise in interest-rates will then act as a ‘headwind’ to domestic consumption and investment via deflating asset prices and forced-decreases in leverage.

            Much (but not all) of the growth of the last 30-years was built on rising leverage made possible by the secular decline in interest rates. With interest rates as low as can possibly be, the US has now reached its debt-load limit. In other words, the US has now painted itself into a corner. Under the circumstance, as you may well imagine, the future does not look rosy.

            Do you disagree? Do you still feel that the future looks rosy? If so, could you please elaborate, preferably with reference-data, on the sources from which your optimism springs.

          • @Vinezi Karim: A lot of reports have come out recently which shows that the debt position of US households is currently the best in many years, in fact decades. The household net worth (assets minus debt) is at the highest level ever and keeps improving.


            Yes, the government debt position has deteriorated significantly during the great recession, but the situation has started improving there also. US GDP growth is returning to its historic ~3% level, i.e. the Nominal GDP growth will be around 5%. At the same time the deficit this year is less that 3% of GDP. So the debt/GDP ratio have started going down.

            The reasons I have such a rosy view of US and believe that it will come roaring out of the corner that it has gotten into are as follows.

            1. US has persistently achieved sustained higher productivity growth compared to its developed country peers and I expect this trend to continue. Consider this, US employment has just returned to pre-recession levels, but the real output is 7% higher. So US is delivering 7% more output with same number of workers. The best performance among G7 by a wide margin.

            2. The shale revolution has been a game changer. This has DRAMATICALLY improved US competitiveness. US now has LOWEST energy prices in the developed world. This has made US the most attractive investment destination and leading to US manufacturing revival and export growth. It is already showing up is drastically reduced trade gap and surging dollar. In all this US has been greatly assisted by EU and Japan, both of which are destroying their industrial competitiveness by their pigheaded green-unicorn hunt. Things are only going to get better for the US from here on.
            3. US has taken the leadership position in all the technological fields that are likely to power growth in the coming decades, from cloud computing to self-driving cars to 3-D printing to New Space industries US is the undisputed champion and its lead is growing.
            4. The most crucial factor is demographics. US has the healthiest demographics in the developed world, in fact better than much of the developing world. So US workforce will continue to grow as far as the eye can see and US will have one of the lowest median ages and one of the most dynamic work forces. This gives US a chance to simply OUTGROW debt.


          • 1.Consider this, US employment has just returned to pre-recession levels, but the real output is 7% higher. So US is delivering 7% more output with same number of workers. The best performance among G7 by a wide margin…..

            Yes, US productivity has indeed grown by 7% since the crisis. But did you know that the productivity in Spain has grown by 11% since the crisis?

            Do you know WHY these productivity numbers are looking so good for Spain and the US? Something to think about.


            2. The shale revolution has been a game changer. This has DRAMATICALLY improved US competitiveness. US now has LOWEST energy prices in the developed world…..

            Yes, you are correct that the shale GAS revolution has led to US GAS prices being 1/3 that of GAS prices in Germany or Japan (the competitors). On a prima facie basis that does sound like inspirational news that is eminently suitable for media-spin and stock-price pumping. Upon closer examination, however, a variety of doubts arise:

            How much effect does cheap gas that have on…
            (a) Overall energy prices?
            (b) Regulated electricity rates?
            (c) Cost-proportions relative to labor & capital of average manufacturing?

            We note that DESPITE the COLLAPSE of gas prices in the US due to the Shale-fracking revolution, gas is STILL an EXPENSIVE way to generate the electricity that is needed for manufacturing:


            3. US has taken the leadership position in all the technological fields that are likely to power growth in the coming decades, from cloud computing to self-driving cars to 3-D printing to New Space industries US is the undisputed champion and its lead is growing….

            What is new in this? The US has ALWAYS HAD the leadership position in all the technological fields since 1945. So why have Germany & Japan been able to grab huge chunks of the massive global market-share that the US used to have in the 1950s?


            4. The most crucial factor is demographics. US has the healthiest demographics in the developed world, in fact better than much of the developing world. So US workforce will continue to grow as far as the eye can see and US will have one of the lowest median ages and one of the most dynamic work forces. This gives US a chance to simply OUTGROW debt.

            Again, what is new in this? The US has always had better demographics than Europe & Japan for three key reasons:
            1) It is a far more religious or conservative place with higher internal birth-rates than Europe & Japan.
            2) Unlike Europe & Japan, the US is a culturally-powerful ‘nation of immigrants’ that manages to Americanize and successfully assimilate large number of immigrants from all over the world.
            3) Unlike Europe & Japan, it has vast amounts of excess space, arable land & water to absorb this rising population.

            Still, despite having great demographics, we note carefully the following:
            1) US total debt (excluding financial) was about 150% of GDP in 1980
            2) It is about 250% of GDP today.
            3) The excellence of demographics and a growing labor force have NOT been able to stop the RISING of the debt-load
            4) Since debt/GDP cannot rise indefinitely, the US has been on an unsustainable course of growth for the last 30 years.

          • “Do you know WHY these productivity numbers are looking so good for Spain and the US? Something to think about.”

            I know the answer for Spain.

            You tell me the reason for US.


            We note that DESPITE the COLLAPSE of gas prices in the US due to the Shale-fracking revolution, gas is STILL an EXPENSIVE way to generate the electricity that is needed for manufacturing:




            What is new in this? The US has ALWAYS HAD the leadership position in all the technological fields since 1945. So why have Germany & Japan been able to grab huge chunks of the massive global market-share that the US used to have in the 1950s?

            What matters is not market share but PROFITS. Copiers will always trail innovators.



            Again, what is new in this? The US has always had better demographics than Europe & Japan for three key reasons:
            1) It is a far more religious or conservative place with higher internal birth-rates than Europe & Japan.
            2) Unlike Europe & Japan, the US is a culturally-powerful ‘nation of immigrants’ that manages to Americanize and successfully assimilate large number of immigrants from all over the world.
            3) Unlike Europe & Japan, it has vast amounts of excess space, arable land & water to absorb this rising population.

            Still, despite having great demographics, we note carefully the following:
            1) US total debt (excluding financial) was about 150% of GDP in 1980
            2) It is about 250% of GDP today.
            3) The excellence of demographics and a growing labor force have NOT been able to stop the RISING of the debt-load
            4) Since debt/GDP cannot rise indefinitely, the US has been on an unsustainable course of growth for the last 30 years.

            History has not ended yet. We shall know in the coming decades, who lives and who withers away.

          • Again, there is nothing wrong with US productivity. This is not where the issue lies. The key question is rather why, for the past 17 years, the US economy (and many others) only seems able to (re-)create jobs under asset bubble conditions that prove unsustainable and whether that’s temporary or whether it’s a deeper problem. Some clarity of view on this question could become handy if it so happens that we are in the mature stage of the third iteration of this centrally-managed asset reflation strategy which creates less economic gains during the boom than losses during the bust.

          • “Again, there is nothing wrong with US productivity. This is not where the issue lies.”

            I agree. During my research days in Medical School, I studied an ephedrine addict who spent numerous hours at the gym and was built like Arnold Schwarzenegger. His problem was not his physique but rather than he could not successfully body-build in the short-term without ingesting the very drug that was destroying his cardiac capacity in the long-term.

            This has been the problem with the US over the last 30 years. It has been ingesting the drug of rising debt-load in order to build-up its economic output. Now it has reached a stage of chronic addiction such it cannot grow its economy in the short-term without the drug, even as it inexorably heads for the economic equivalent of a heart-attack in the long-term if it does keep using the drug. In effect, the US has painted itself into the corner of severe drug-addiction.

            In fact, this is the ESSENCE of Michael’s INSIGHT: The US has been on a debt-fueled consumption & investment binge over the last generation. The data clearly indicate that the US has needed to incur more and more debt in order to generate the same increment in economic output. As a result, total debt in the US has been rising faster than GDP in a secular fashion (i.e. debt/GDP ratio has been going up steadily) over the last 30 years.

            Therefore, it is clear that the US has been moving in the direction of its debt-ceiling for a long time. The reason the US has been able to do this for so long without hitting its debt-ceiling is that the secular falling trend in interest rates has been moving the debt-ceiling upwards. However, interest rates have now fallen to levels that are as low as they can ever be. Therefore, it is not possible to keep moving that debt-ceiling further upwards any longer.

            In light of this, the US now has *ONLY TWO* choices–

            (A) Stop using the drug now and put up with the long withdrawal symptom of slow growth (STAGNATION):
            The US abandons the debt-driven growth-model it has been using for the last 30 years and voluntarily corrects the imbalances that have been causing debt to rise faster than GDP. If this happens, then US growth must necessarily slow down (to well below the 2.9% average that it managed to achieve over the last generation) as it makes the adjustment (or rebalances).

            (B) Continue to use the drug to get fast growth now and suffer a massive heat-attack later (COLLAPSE):
            The US refuses to correct the imbalances voluntarily and continues to rush forward using the same debt-driven fast-growth model. If this happens then the US will eventually make contact with its debt-ceiling at high speed and the adjustment (or correction of underlying imbalances) will be forced upon the US in a sudden, violent and catastrophic fashion.

            Do you disagree? Please let me know your views on the matter.

          • In the US like elsewhere, the apparent complete unwillingness from policymakers to understand the how and why of 2008 and their rush to repeat the same unsuccessful strategies they have tried before has been absolutely astonishing. In itself, such an apparent reaction raises troubling questions. Perhaps the comment below from George is on to something: the sorcerer’s apprentices are too thrilled playing their dangerous games that they want to raise the stakes further. I really don’t know whether that’s the case but it’s an hypothesis that can’t be dismissed for the time being because it is actually quite compatible with what we have observed so far.

      • What is now happening in the energy sector is a perfect illustration of what i meant by the “permanent centralized management of the entire financial-markets-based asset base which is blurring the entire price signal system at the core of the decentralized competitive organization as well as shifting the rewards from productive to speculative activities, thereby undermining the positive influence of the bottom-up forces [that have made the success of the US economy over recent centuries]”.

        In a decentralized free market system where money is neutral (ie. money supply grows at the same pace as economic activity), prices result from the confrontation of supply and demand in each market. Rising prices indicate tight supply, hence the need for investment in that particular market to increase supply, high prices providing a decent return on investment.

        But in a economic system where money supply grows faster than economic activity, and even more so in a system where this money creation no longer comes from commercial banks themselves operating in competitive banking markets but from the central banks, money is no longer neutral and the interpretation of the price signal becomes difficult. Do rising prices reflect a tight market where investment is needed or do rising prices simply reflect the fact that part of the excess money supply is placed speculatively in this particular market? The price mechanism becomes misleading. Those who misinterpret the price signal and borrow to invest in a market where rising price seems to indicate tight supply run a big risk.

        Take the tripling of oil price between early 2009 and spring 2011. Did it reflect a tight oil market in needs of heavy investment to debottleneck energy supply? Or did it reflect the fact that part of the money creation by central banks went into oil as an asset class? Those who misinterpreted the price signal from oil (they were many) and borrowed to acquire shale fields, order offshore drilling rigs, increase capacity to manufacture subsea equipment or special tubes and pipes are now in a very difficult situation. Several will go bust.

        The same happened in the residential market in the previous cycle. Did the rising price of US homes (and elsewhere as well) reflected tight supply – demand even though new construction was outpacing population growth due to the demographics evolution? Or did it reflect Greenspan engineered wealth effect to “help” the US economy recover from the 2001-2002 recession? Those who misinterpreted the price signal (they were many) and borrowed to invest in the residential market back then went bust in 2008-2009.

        And so on so forth.

        My point is that the price mechanism, which is the signaling system of the decentralised market economy guiding the allocation of capital, is distorted. Including in the US (mostly in the US?). So investment decisions are distorted as well. They become de facto speculative (by that i mean they don’t rely on robust economic calculus since it is no longer possible). Losses resulting from unsound investment decisions multiply in every corner of the economy (technology sector in the late 1990’s, real estate sector in the mid-2000’s, oil sector now, etc). The resulting capital destruction has the pervasive impact of leading to heigthened caution from people making investment decisions. Corporations learn it is wiser to ration their real investments because they can’t trust the price signal and see on closer inspection that demand is not strong. The cashflow is instead returned to shareholders where it remains in the capital markets which are more mobile and don’t need to commit long term to a real asset. The reward shifts from real productive investment to speculation. This reduced real investment activity plus the credit losses of previous capital misallocation means another round of money injection is necessary to “support economic growth” and keep financial assets from deflating. And so goes the vicious circle, on and on again from one cycle to the next, resulting in ever more misallocation and destruction of capital. It is in fact the same outcome than the other system known for its centralized management of the economy not based on an adequate market-determined price system: communism. According to Keynes, Lenin said “the best way to destroy the capitalist system is to debauch the currency”. Why do you think he said that? We don’t realize it first because the effects are so slow that they are hard to detect on a day to day basis. The same was true for communism : it took several generations to realize what utter failure it was economically. The religion of the omnipotence of central banks is fairly recent, really started from the mid or late 1990’s. We may not realize its failure to enhance or even maintain prosperity before 2045 and our children and grand children might not get rid of it before 2070. Who knows?

        Everybody can see for his or herself whether the evolution of the political organisation of society that is the corollary of this centralized economic organisation is already discernible.

        You don’t need an economics PhD to understand that (in fact, many economics PhDs don’t get it). You don’t need a physics PhD either. All you need is honest observation of the facts.

        So, Dr Atanu Maulik, i’m afraid your pessimistic prediction is not pessimistic enough. It should also include the US as it started 20 years ago to turn its back on what made it the world economic powerhouse and a +2% p.a. real GDP per capita compounder to join the club of centralized economic management resulting in capital misallocation and eventually destruction.

        • The fault behind everything you said is that for you to be correct you have to assume that correct price at t0 is determinable. It is not!
          See, that is why I personally think if you don’t understand Black-Scholes you can’t understand price. Most people see price in the market as a static number and not as a center point of a distribution. If you learn to see the distribution you realize that the market is speaking in uncertainty and it is telling you that right up front. Otherwise you are reading an instruction guide that is missing every other page. No fault but your own, the info is there.

          • Absolutely not. For me to be correct, it is sufficient to assume that the inherent uncertainty around future price is lower when prices are not distorted by excess money creation during the boom phase of the cycle followed by money destruction in the bust phase. For empirical confirmation that this assumption is indeed correct, you need to look no further than Myron Scholes going bust with LTCM in 1998. If only Scholes had realized that the distribution of future price was even wider than he expected due to the amplifying effects of excessive monetary swings, he may have avoided this embarrassment and you would have had the pleasure of seeing more people study his model. I wish you better luck than him with these capricious derivative creatures.

          • Oh, I never said he understood his own model, or that a model is only a tool, or knew how to put inputs in correctly. I am just saying advancing the logic behind seeing a Future as a static market price determination was off the charts brilliant. I actually agree with you, LTCM set their correlations too tight which inadvertently resulted in lowering their volatility and then to top it off they miscalculated the shape of the distribution, because Merton thought he was playing with a normal distribution.
            And since when did calculus become capricious? Until you told me that, I always thought calculus was so helpful in defining non-linear movements…
            As for wishing me luck.. thank you for the genuine concern.

          • Saying that “in a decentralized free market system where money is neutral, prices result from the confrontation of supply and demand in each market” is not at all the same as saying future prices are determinable with certainty or static. What we are talking about here is effectively a inter-related dynamic network of trillions of prices across billions of products across many local and regional markets. This is the signalling system of the market economy guiding capital allocation towards wealth creating uses. It is anything but static (your expression “static market price determination” is a contradiction in terms). I never said nor assumed that future price were determinable with certainty nor that they were static, ie. i never said investing was riskless. What i said is that when excessive swings in money supply disturbs this signalling system, either via prices of goods and services or via asset values reflecting capitalized values of these goods and services transactions, the chances of getting wrong signals increase, sometimes dramatically, and hence the chances of misallocating capital and destroying wealth increase with it. Investing become extremely risky – and frankly impossible – because you can’t trust the price signals. Fluctuations are greatly amplified as the continuous supply-demand adjustments are compounded by large swings of speculative money flows in and out of particular markets. This is what i said. You are most welcome to disagree with this argument, but please let me know without misrepresenting it.

          • DVD,
            My bad.. I shouldn’t have used the word ‘static’. It is not what I was implying, but I accepted long ago that I am a terrible writer.
            I was saying that if price of a future is $65, one should not take the price signal as $65. One should take the price signal as $55- $77 w/in 1 std dev, and $45 – $90 w/in 2 std dev… etc…
            I simply meant price needs to be looked at with an understanding that the Future market is telling you to be uncertain. And historically it underestimates it. So be even more uncertain than it tells you to be.
            If it wasn’t that way, it wouldn’t be any fun.

          • Fine. Understood and agreed. But i still don’t see anything incompatible between what you say and what i say. In fact, when you say that, ex-ante, the future market underestimates the actual distribution of prices as witnessed ex-post, perhaps you are implying that there is something more than just supply and demand affecting price dynamics. Perhaps this something more is swings in speculative money flows in and out of particular markets?

            As for oil producing and oil services companies mistaking the ~ $110 / b oil price for a fair market price reflecting supply and demand and engaging capital expenditures for dozens of billions $ on a multi-year basis on that assumption, disregarding any possibility that financial speculation may have pushed oil price far from its supply-demand determined price, it is something i’m absolutely certain of, for the simple reason that it’s a conversation i had with many of the companies concerned over recent years.

    • The book I am currently planning, DR AM, is about development, balance sheets and adjustment, and the characteristics of successfully adjusting systems, one of which is probably complexity and many moving parts. I may even co-write one chapter with one of my PKU students on how political systems can promote or retard adjustment, although needless to say we will have to tread very carefully on that topic.

      • I am happy to know that in his next book Dr. Pettis will be focusing on the nature of a nation’s political and economic institutions on their long running economic performance. In this context I would like to point out a remarkable phenomenon : the remarkable consistency of economic growth in US. The per capita GDP in US has been growing at the rate of ~ 2% per year over a period of 200+ yrs.

        So if one plots US per capita income vs time one can fit an exponential through the data points. The time constant of this system, which I think essentially captures all its complexities including the quality of its economic and political institutions, have remained remarkably stable over centuries. I would like to know from Prof. Pettis, whether any research has been done along these lines to reveal what information is captured by this time constant and why it has this particular value and why it has remained so stable over time in US ? I would also like to know whether similar data exists for other nations and what can be said about the time constant for those societies ?

        • DAM WROTE:” The miracle fast growth phases never seem to last more than 30-35 yrs.”
          “The per capita GDP in US has been growing at the rate of ~ 2% per year over a period of 200+ yrs.”

          The miracle of ‘fast growth’ is only possible during the ‘catch up’ phase when a country is far away from the productivity horizon.

          England & Benelux were the original industrial countries. The US & Germany did ‘catch up’. In the graph you have linked, for example, see the FAST GROWTH (above trend) for the US before WW-I. That was the catch-up phase during which the US was below the ‘industrialization horizon’ represented by England. After that, the US grew at the same pace as the horizon, which happens to be about 2% per annum.

          The reason ‘miracle growth’ cannot continue for too long is that growth MUST slow down as the country approaches the productivity horizon. How fast a country can grow and how long it can continue would depend on how far that country is from the productivity horizon.

          Korea’s miracle growth is OVER, because it has now reached the horizon. This was discussed in the comments section of one of Michael’s old articles. You can still see why the Korean miracle is over here:

          • “How fast a country can grow and how long it can continue would depend on how far that country is from the productivity horizon.”

            That is JUST ONE of the many factors determining growth rates. We should never stop reminding outselves that there is no law of nature which says that poorer countries will keep growing faster than richer nations untill they catch up. As people like Ruchir Sharma have pointed out (Breakout Nations) such a thing never happens. That’s why out of 190 odd countries in the world, only about 30 are considered developed. Now it is becoming clear to most that much of that hoopla about the “rise of the rest” over the past decade was just that, hoopla. Much of that growth was fueled by the commodities boom and cheap money flooding in from the west. Now that the commodity bubble has burst and the tide of easy money recedes, wheels are coming off the “rest” from Brazil to South Africa to Turkey. When the storm is over and the dust settles, we will find that most of them will be back to where they started from, back to the 20th century.

          • ^DAM wrote: “We should never stop reminding outselves that there is no law of nature which says that poorer countries will keep growing faster than richer nations untill they catch up.”

            I never said they would.

            When I said, “How fast a country can grow and how long it can continue would depend on how far that country is from the productivity horizon”, I was referring to the POTENTIAL of a country for long-duration fast-growth being proportional to that country’s distance from the productivity horizon set by the developed countries.

            In other words, a country that experiences the ‘miracle’ of fast growth over a long period of time, is NECESSARILY a country that is far from the existing productivity horizon (i.e. it is merely doing ‘catch-up’).

            However, the condition of being far from the productivity horizon is not SUFFICIENT to guarantee fast growth for a long period of time. In other words, just because a country is developing does not mean that it WILL grow faster than the developed countries.

            Developing countries that are unable to grow faster than developed countries are said to be caught in a middle-income or low-income ‘trap’. This was discussed in one of Michael’s old articles, and you can still see this issue of countries caught in these income ‘traps’ here:

            I hope this clarifies the point a little.

          • It is increasingly obvious that that development requires something more….
            Recent State Led development notions (autocratic and technocratic responses) were a hoped to be option/excuse because countreis are either unable or unwilling to advance along more measures than the economic. this might have been recognized where governments, civil society, Int NGO’s, Int Institutions, Corporations, Religious Groups, People, Pundits, Academics and Journalists all heightened notions of the MDG’s (were are on the cusp of the results at present. So along Political-Legal, Social-Economic, Technological-Environmental lines, along functions that obtain to these, and are inter-twined we find hope for development. Of course geo-political situations obtain to much development, not because countries got special treatment per se, but because there were fewer who were developing along the free market line/way/modality (many of these countries were successful, at a time of geopolitical ideological tensions between bipolar contestants; with a third way, generally half-heartedly adopting the perspective of either, has many sought to build national identities (before you respond, if you are want to write GREAT, GOOD, BAD WORST, or if your response can be received part and parcel in that way, please don’t).

            So we have dutch disease, we have the middle income curse, we have more participants, we have a very large country seeing what its impact on the world is, we have many smaller countries who have seen higher growth rates, we have youth bulges, in need of addressing, we have increasing education, we have more people, more countries doing development, and we have hit a quagmire. it is sticky, levels of growth require a concomitant commitment on some to enable that growth, systemically this is more understood.

            Many complain of Fukuyama’s End of History, but it seems that Political-Legal, Social and Economic movements/changes/alterations are required, and simultaneously. It seems that greater global cooperation and new mechanisms to enable development are required. I think that China needed to move in this direction over a decade ago, acutally in the mid to late 1990’s, but with consumption rising, and, possibly growth slowing, they hyper-charged, and I believe acceded to the WTO under this premise (with decision made before, George).

            So where from here, a new global bargain is needed, but with so much confusion, I tend to think Rodrik is correct (DvD), and that we will move back to L. of Dem’s.

          • Yes, I agree with Dr AM that “distance from the productivity horizon” , while sounding so reasonably sensible, is actually dangerously over-rated as a source of growth. Germany in the 1930s and Japan in the 1980s managed some pretty raid growth even though being among the most productive countries in the world. Lots of poor countries have managed to stay far from the horizon. Rapid growth seems to be mainly a consequence of rapid increase in inputs, and it is hard to find very strong evidence that rapidly growing countries that were far from the productivity horizon were able to increase productivity more sustainable than countries that were less far.

            I am stuck with the idea that rapid sustainable growth is a function largely of the creation of institutions that both encourage individuals to behave productively and that are flexible enough to minimize the inevitable adjustment costs associated with periods of rapid growth. So far my argument can be legitimately criticized as being little more than a kind of truism (“successful counties are countries that have the kinds of institutions that lead them to success”), but I think there is a lot more to it than that and I want to explore this more in my next book.

          • Michael Pettis WROTE: “I am stuck with the idea that rapid sustainable growth is a function largely of the creation of institutions that both encourage individuals to behave productively and that are flexible enough to minimize the inevitable adjustment costs associated with periods of rapid growth. ”

            This is one component of the distance from the productivity horizon. Productivity growth comes from capital deepening AND EFFICIENCY growth.

            Apart from shallow-capital, countries far from the productivity horizon also have poor institutions and hence hence low efficiency. Therefore, ‘catch-up’ INCLUDES building better quality institutions to minimize inefficiencies. This was a key conclusion that was reached from an earlier discussion as seen here:

            For example, the US was a lawless society when it was doing catch-up in the late 19th century. Judges were being bribed, congressmen were bought & sold, media were threatened, policemen were indulging in criminal activity– just like in Latin America today. The difference was that during its catch-up phase the US kept improving its institutions such that it could finally match the benchmark English-institutions by about the mid 20th-century.

          • Michael Pettis WROTE: “I am stuck with the idea that rapid sustainable growth is a function largely of the creation of institutions that both encourage individuals to behave productively and that are flexible enough to minimize the inevitable adjustment costs associated with periods of rapid growth.”

            You should be able to prove this, Michael.

            Malaysia and Korea started out on similar paths, with US-backed and strongman-led Listian-capitalist economies in the 1960s. However, Korea eventually went on to finish ‘catch-up’ and become a developed (OECD) country, while Malaysia got caught in the same middle-income trap as the Latin American countries. Why the difference?

            If you can show that Korea continuously built or improved on (quote) ” institutions that both encourage individuals to behave productively and that are flexible enough to minimize the inevitable adjustment costs associated with periods of rapid growth”, while Malaysia did not, you would have demonstrated the validity your theory quite vividly.

            Can you? Is that why Korea succeeded while Malaysia failed? Please let us know of your findings.

          • Michael Pettis WROTE: “Germany in the 1930s and Japan in the 1980s managed some pretty raid growth even though being among the most productive countries in the world.”

            Japan was still some distance from the productivity horizon set by its peers in Europe in the 1980s. In other words, Japan was still doing ‘catch-up’ in the 1980s when it experienced ‘miracle growth’. Since then, Japan has been tracking the productivity of its counterparts in Europe, with no more possibiliy of ‘miracle growth’.

            Does anybody have the productivity data for Nazi Germany? If so, perhaps we can look at the evidence for that case as well.

          • “Does anybody have the productivity data for Nazi Germany? If so, perhaps we can look at the evidence for that case as well.”

            I did some digging and here is what I found:

            The ‘miracle’ of 7% GDP-growth in Nazi Germany from 1933 to 1939 was almost entirely labor-driven and there was only a small increase in productivity during this period.

            The unemployment rate was 33% percent of the industrial-workforce in 1933 due to the Great Depression. This was reduced to only 2% by 1939 by massive government-debt financed re-armament and infrastructure programs that created lots of industrial jobs.

            The simple addition of these industrial workers to the economy was sufficient to boost economic output by 50% over six years from 1933 to 1939. So much of this miracle was not about “going-forward”, but really just about REGAINING lost-ground from the mass unemployment that began from the crash of 1929.

            Others could recheck the facts on this as well. Perhaps some of the German blog-participants here could shed some more light on this.

  30. When the long commodity-boom ends, and the terms of trade converge to their historical trend values, here is what may happen:

    A) Amongst the Countries that are running trade SURPLUSES:

    1) The following countries will see their USD surpluses DECREASE because of falling export prices
    Saudi Arabia
    United Arab Emirates

    2) The following countries will see their USD surpluses INCREASE because of falling import prices


    B) Amongst the Countries that are running trade DEFICITS:

    1) The following countries will see their USD deficits DECREASE because of falling import prices
    United States
    United Kingdom

    2) The following countries will see their USD deficits INCREASE because of falling export prices
    South Africa


    • Nigerian budget are under pressure now they say they can take it until oil hit 78 USD. It will be very interesting. It seems that even if it’s election time there they want to make spending cut.

      • Oil will soon be around 30 USD/barrel. Even at that price, Nigeria will still keep pumping. The reason for this is that the ‘lifting costs’ per barrel are about the same all over the world at approximately 15 USD/barrel.

        The reason Nigeria/Russia have higher ‘total costs’ per barrel is because of higher ‘sunk costs’ or higher fixed costs in their oil sector. But those fixed costs have been incurred anyway, regardless of whether pumping continues or not. Even if Nigeria and Russia stop production altogether, they would still be faced with the charges for the sunk costs. Therefore, STATE-OWNED oil companies in Nigeria & Russia will KEEP PUMPING as long as oil prices are reasonably above ‘lifting costs’, even if its means that they will not be able to recover their fixed costs. The difference will then be made-up by government waivers, grants and bail-outs. This will cause Russian and Nigerian forex reserves to reduce considerably as they pay-off international oil-development related debts, even as they sell their oil at 30 USD/barrel. In other words, the windfall profits that Nigeria/Russia saw during the oil rise of the past decade will turn into effective losses during the upcoming oil decline. There was never any ‘peak oil’ and there will never be any ‘peak oil’. Much before the world runs short of oil, oil itself would have been redundant by solar-electric applications.

        Do you disagree? Do you think it is impossible for oil to sell at 30 USD/barrel? Please let me know your thoughts on the matter.

        • To me oil price is going down because of the QE, not because of less demand. QE totaly destroy the price of the fear with and as market get used to low cost of bonds they project low growth for many years.
          I don’t know if the FED have enought power to win against oil price fear and growth in US. I think you agree with me that the fear is very high right now. With the end of the QE situation will change and market will forecast higher growth in US and so higher price for oil.
          Remeber that shale gaz in US don’t worth it if oil is at 30 USD.

          Nigerian goverment won’t back up state own companies for many reasons. The first one is that oil companes are not erally by the people, it could be very dangerous politicaly to give more to those people. Finance minister clearly said that the road was more about reducing subsidies than debt. PLus many big name fortunes in Nigeria are not related to oil and they proablby won’t agree with this. Also a root of Boko Haram is difference between north poor and South Nigeria oil rich. Taking the risk of puting more money to the south without expecting any gain for the north is more and more difficult.
          In Russia Putin as so much power that he probably can do what you say.

          • In a related matter, we have all seen Australian and Brazilian companies circulating colorful brochures that show that their companies have lower cost of production of commodities (iron ore, coal) than Chinese companies, which are mostly state-owned or party-connected.

            These brochures are effectively saying that as demand declines and prices fall, it will be Chinese miners who will shut down due to their higher costs, while Australian and Brazilian miners will still be in business because of their lower costs. Here is an example of this idea:

            This idea of cost-of-production advantage would have been true if China were a true ‘free-market’ country like the US or UK. But that is not how China operates. During the last decade, when China’s production of commodities could not keep up with rising demand triggered by its unprecedented investment binge, China was okay with importing those commodities. But China will never allow closure of its own mines in favor of cheaper imports– regardless of price/costs. They will tax imports such that their own miners remain in business. In order to keep Chinese commodity-using producers competitive, China will subsidize its own miners in addition to taxing imports. China will do whatever it takes to keep its own commodity production going. This implies that the reduction in Chinese demand will hurt the Australian and Brazilian companies the most, EVEN IF they do have the lowest cost of production as they are now claiming.

            Here is a recent example of China doing the above:

            As commodity prices fall, we should expect to see a lot of state-interference and agency-meddling in the markets. With the exception of the Anglo-Saxon countries, there are very few truly ‘free-market’ countries that will allow cheaper imports to displace domestic producers– even though protecting the higher-cost domestic producers comes at a heavy price for their economies as a whole.

          • Interesting article, I think that crack in China, people want to get rid of these poluting factories. I think this is one of the few consencus in Beijing. I don’t know if you were in Beijing but it’s worst that what they told you. There is a lot of China bashing for no reason but pollution is a real deal. They were a article from FT or Bloomberg stating that chineese factory were forced to buy MORE coal from australia because of briebery concerns with suppliers and the new Xi policy. And pollution realted regulation make chineese coal price higher than australian one. This is not same article but it still say that import are on the rise.
            I don’t think people in Beijing necesserly want the free market and an open society but they really want to change on pollution and corruption.
            To me the collapse in the commodities will it China hard in first because, when they were still in the investment spree, they implemented policy to boost productivity of mining. So they started to build big project with high productivity and lower pollution but they build it with price at the time that were very high. Now these projects probably don’t worth anything. To help them would be very impopular.

  31. The chart suggests that China actually has done a fairly decent job of reducing the Current Account surplus. I noticed something else.

    Take a look at the US Trade Deficit since 1998.
    From 1998 up to 2006 the US trade deficit continued to increase. But from 2006 up to mid 2008 that Trade Deficit remained – more or less – flat. And frankly, I am not surprised because in mid 2005 the chinese PBOC allowed the yuan to go up (gradually) against the USD.
    So, the rising Yuan/USD kept the USD trade deficit flat, instead of increasing.

    I also think that the yuan startting to go up against the USD in the 2nd half of 2005 was the final straw that broke the back of the camel called “US housing bubble”.

    I think China was surprised or even shocked to see the EUR/USD to go up after 2001. Pegging the Yuan to the USD meant that in that after 2001 china benefited (massively) because those very profitable exports to the Eurozone turbo charged chinese manufacturing and the build-up of Currency reserves. But it also created more and larger distortions in the chinese and US economy.

    • Willy2 WROTE: “And frankly, I am not surprised because in mid 2005 the chinese PBOC allowed the yuan to go up (gradually) against the USD …..x…… So, the rising Yuan/USD kept the USD trade deficit flat, instead of increasing…”

      Why should a rising Chinese RMB flatten the US trade deficit with the world?

      After all, China is competing with other Asian countries to export to the US. If the RMB rises, some other Asian country will become more competitive than China and will hence export the same thing to the US at the old dollar price.

      Yes, I can understand that a rising RMB might flatten CHINA’s trade SURPLUS; but it would merely increase the surplus of some other Asian country. So why should a rising RMB flatted the US trade deficit with the world?

      Would you please explain this point further?

      • – Because it made US exports more competitive relative to chinese exports. Think e.g. Europe. Remember that e.g. the EUR/USD continued to rise from 2001 up to mid 2008. See my previous reply.

        • Uhmmmm…Vinezi, of course is correct in his assertions, and you might be a little confused in yours, US vis a vis Chinese Exports (What Exports, more specific please, that would be interesting to hear)

          Euro/USD has more to do with a rise of the Euro used in baskets globally after unification, and then recent bank capitalization/income problems, and likely cross-regional borrowing lending and other issues than Chinese and American competition re: exports to Europe (or are you suggesting that this was done also to stymie European exports to elsewhere vis a vis American and Chinese, not sure but mostly just statement, no substantiation) .

          • – The US was actively jawboning the USD lower from say 2001 up to mid 2008. And it did go down against a number of currencies. Was the US hoping exports would increase ? Was the US hoping that then the rest of the world would be forced to pick up the tab for US military spending abroad ? Perhaps, I don’t know.
            – In Asia China is the “big boy on the economic block”. So, I could imagine that other asian countries manipulated their currencies as well (to follow the yuan).
            – I don’t have any examples of exports. It’s doesn’t matter too much. I simply look at the trade statictics, the Current Account, exchange rates and throw Mr. Pettis’ “Balancing Theory” into the mix and then a rather clear picture emerges. No need to go into specifics.

            – See these charts of Los Angelos’ container traffic
            It’s a relative good proxy for US exports to East Asia. See that outbound container traffic remained flat from 1998 up to 2006 and then container traffic rose gradually up to say mid/late 2008. I attribute that to the rise of the Yuan-USD. Sounds simple to me. These charts are a good example of how distorted asian trade (predominantly China) with the US was.

        • Willy2: “….Because it made US exports more competitive relative to chinese exports. ”

          Are you saying that the US is in export competition with China? I can understand that the US may be in competition with Japan, Germany/Europe, but the US as a competitor to China is hard to imagine.

          The US, Germany & Japan sell sell high-end, high-tech or heavily branded products. China sells low-end, low-tech and cheap generic products. US, German & Japanese brands are known world-wide. How many people can name a single Chinese brand?

          Can you name some specific products that both China and the US are trying to sell to the world?

          • Chinese companies don’t necessarily have to compete with US companies. A rising Yuan/USD could mean that e.g. the Mexican peso goes down against the yuan as well. It then simply means that profit margins for chinese exporting companies decline, comparatively to companies that produce e.g. in Mexico (think e.g. textiles).

            A rising yuan/USD also increases purchasing power for chinese consumers, then chinese consumers can afford (more) high end US products. Hence the falling US trade deficit.

      • – Keep in mind that from 2001 up to mid 2008 the Eur/USD rose from ~0,80 up to ~ 1.60. This rate doubled. Think of the implications for China when it pegged the Yuan to the USD. The main target of chinese exports was the US but as the Eur/USD rose it turbo charged chinese exports + profit margins to Europe, as well. Even when the peg was loosened the rising Eur/USD kept the chinese economy humming. Watch the Zerohedge chart regarding the Current Accounts. The chinese CA Surplus kept rising from 2006 up to mid 2008.
        – This rising Eur/USD also kept the Eurozone’s CA surplus in check. But then Germany’s CA surplus showed up in Southern Europe as CA Deficits and wreaked havoc over there.
        – A LOT OF people here in the US and around the world overlook the (economic) importance of Europe. Europe (depending on how one defines “Europe”) has a GDP of about 80 to 90% of US GDP.
        – We saw in the late 1990s three financial crises (Brazil-(1999), S.E. Asia (1997 & 1998) & Argentina (2001)). Personally, I am convinced that a rising DEM/USD (1984-1995) benefited these countries. But when the DEM/USD started to fall from 1995 up to 2001, these three regions/countries suffered heavily because their exports profit margins on exports to Europe melted away as a result of a falling DEM/USD.

        • Once again, the Euro was slated to come in between 1.06 and 1.16 to the dollar, which it did, then sank soon after, then was picked up globally. The .84 low to 1.65 high were market actions in the aftermath of what it was slated to come in at and are always used by those who try to argue, to win arguments, often n moral or ideological and political grounds, for purposes other than economics, where we have the wonderful ability here to discuss systemic relations.

          For example if I discuss infrastructure on Inequality, this is not for political purposes it is because infrastructure is a useful way to create jobs, reinforce consumption and asset valuations, and because inequality, which has swung in a direction for too long, as moved out of concert with that which it need support, asset valuations, structurally, not ideologically, morally or politically, structurally. Like replacing rusting bolts in a bridge and welding new cross supports.

  32. I would like to continue here the discussion above with Rich L as the wider format will make it easier to read than the more narrow column.


    All the positive forces that you mention – innovation and creativity, technological or otherwise, on-going scientific and technical progress and its ramifications in countless fields of application, development of knowledge, positive contribution of billions of dedicated people seeking to do well and good on a daily basis, thereby extracting all the minuscule granular improvements that together amount to productivity which is indeed the engine behind the spectacular rise in living standards since the mid-nineteenth century – all of that is indeed crucially important.

    Dr. Atanu Maulik is also referring above to these core factors. I couldn’t agree more.

    But, to avoid any possible confusion, if only implicit, it is important to clarify that these benefits are not at all brought about by globalization of trade and capital flows.

    These benefits are brought about by an organization of society and its economic activity based on competitive decentralized markets enabled by freedom of exercising the activity for which one has the more affinity and capability and where one is rewarded in accordance to the usefulness of goods and services he / she delivers to interested members of society, meaning that everyone has an on-going motivation to do better, cheaper, more efficient, more convenient, etc. It is of course understood that society can not do without a certain level of public goods that have either too low and / or too remote in time return profile that they are best provided for on a mutualized basis through a certain level of taxation of the wealth creation allowed by the competitive process discussed above.

    To be clear: i am not in any way suggesting that we curtail the positive influence of these factors. The opposite, in fact.

    To see how these beneficial factors can be made even more effective, we first need to understand how globalization influences and interacts with these factors.

    There could be a positive influence in that globalization, by increasing the size of available markets, spur competition and spread the benefits of innovation and improvements even further. For globalization to create further value in this way, on top and in addition to the inherent wealth creation emanating from the decentralized competitive markets organization at country level, international competition should be based on true competitive advantages arising from intrinsic local natural resources and know-how and not on mere labor cost and currency arbitrage with productive know-how being portable (that’s why it needs to be increasingly in machines form, to be portable) wherever the arbitrage gains are the greatest, in which case no extra value if being generated, instead existing value is simply shifted from one place to the other. This is where Ricardo’s ideas fit in.

    As discussed, Ricardo’s ideas do not apply in the chosen institutional framework in which globalization has taken place in the real world. So, the second situation prevails, whereby some local markets have been on the wrong side of the arbitrage and have lost jobs and incomes despite fundamentally performing capabilities and know-how (which is now being lost as time go by) or where in the best case productivity gains are no longer shared between labor and capital but accrues entirely to capital, while other markets have been on the positive side of the arbitrage and have gained jobs, incomes and productive knowledge. Value has been transferred but no incremental value has been generated. This is what Csteven refers to as “zero-sum”. The fact that no economic value has been created is confirmed by exponentially rising debt relative to production as lost income has forced up leverage to allow demand to keep up with supply on a global basis.

    Total debt has now reached the critical point of ~ 305% of world nominal GDP, ie. ~ $230Tr (the $100Tr you mention only refers to global non-financial debt in securities form, to which you need to add non-financial debt in loan form as well as financial debt which is effectively double leverage on the same underlying asset base ; see Geneva Reports on World Economy 16 for most recent estimates). At such elevated level, debt acts as a brake on the productive process and counteracts the beneficial effects of the factors you mentioned. Indeed, when there is widespread suspicion that the debt load is so big that it is not realistically repayable by future production cashflows whatever the time horizon considered (what you refer to as “shortage of secure income to service debt”), it has the pervasive impact of making everybody – people, companies, governments, banks – cautious. To varying degrees, everybody acts with some restraint, if not defensively. It precisely prevents “confidence to increase for whatever reasons” as you hope.

    This is the big negative influence of globalization in its current set-up on global prosperity: the accumulated debt due to too much labor income leakage has put a big break on the ability to spend. From here, it takes nothing for this pervasive cautiousness to become self-fulfilling and for the global economy to reach a standstill or even contracts due to now better understood debt deflation dynamics. This negative influence of globalization far exceeds its positive influence related to the broadening of markets. That’s why i’m suggesting that we curtail globalization in a coordinated manner while there is no stress. It will happen anyway, but likely less orderly, hence less beneficial.

    Broadly speaking, there are two alternative solutions to adjust the institutional framework of the global trade and monetary system to allow it to become wealth-enhancing instead of zero-sum wealth-transfering:

    – Either we find a way to keep global free trade while closing all arbitrage opportunities in terms of labor, currency and tax. This means revamping completely the exchange rate regime into a system of fixed but cooperatively adjustable exchange rates set – by reference to a unit of account that is not also the domestic currency of a participating country – at levels making cross-trade balances indeed balance at cruising speed economic growth (the “euroglut” means that a trade balance can be in surplus by virtue of the economy not growing so trade balance equilibrium must be understood in a state of economic growth alongside potential). It also means excluding from the scope of free trade all goods and services whose invoicing goes through a tax heaven at any point of the value chain, so as to relocate the tax base where economic activity is really taking place.

    – Alternatively, free trade is only allowed on a voluntary basis within regional groupings of countries that are large enough to ensure effective competition in all markets and have similar standards of living and political organizations so as to reduce dramatically arbitrage opportunities of all kind. No currency union but same fixed but cooperatively adjustable exchange rates. Same exclusion for goods and services virtually transiting through tax heavens. In that way, income and output, demand and supply, labor and capital will evolve in synch, without leakage, thereby switching off the debt accumulation engine. The observations of Dr. Atanu Maulik remain valid that the regions that will do well are the ones whose organization favors decentralized competitive markets. Trade is of course possible beyond these regional free trade alliances, subject to appropriate tariffs so as to not open arbitrage opportunities.

    This second idea of regional free trade areas among countries at a similar stage of development and with similar political organizations was the conclusion reached by Nobel laureate Maurice Allais in the early 1990’s. Like Triffin in the 1960’s, Allais was ignored in the 1990’s. Sadly, what has happened since then has fully justified his early warnings about the flawed current institutional design of globalization. The fact that his vision proved absolutely correct makes it all the more interesting to revisit his ideas to perhaps finally find the road to global prosperity and peace.

    As to whether financial markets investors are overall myopic and herding or whether they are farsighted and independent minded ; whether the risks are priced in or whether this is the Fed+BCE+BoE+BoJ put for an “extended period of time” that is priced in, i let you judge that, with perhaps only an amicable reminder that equity values are effectively subordinated to all debts for which service there is not enough cashflows and that, as should be clear from our discussion, credit easing policy can only be powerless at best (and more likely counter-productive) to resolve the problems of excess debt and excess under-employment accumulation which are logical by-products of the current world trade and monetary system.

    • ok; fast-foreward 10 years; President DvD calls a meeting of the G-20 which unanimously agree and implement the above rigamarol – and debt continues to increase; now what?

      • Dan,

        Unless you have a strong view that debt will continue to rise in my proposed rigamarole (in which case, i’m listening), there is no need yet to worry about debt hypothetically continuing to rise under an hypothetical different set-up in 10 years time for the simple reason that we are precisely having this question with the existing rigamarole for real here and now: the crisis started mid-2007 with the shutting down of the interbank money markets, there has been many G20 meetings since, debt has continued to increase, we are soon in 2015. And now what?

        I have tried, however imperfectly, to answer this question.

        Now your turn.

        • And now what? The Americans are proposing both trans-Pacific and trans-Atlantic trade partnerships (which will encompass something like 70% of world gdp) in an attempt to EXPAND international trade. The Chinese have not as yet joined – my guess is they will – no choice. Fred Bergstrom at Peterson Institute proposes going further and creating a free trade agreement with China. I would support both. Your solutions (kindly correct me if I am mistaken): a return to fixed exchange rates or local trade blocks remind me of “return to the gold standard” arguments. Ref. debt: I would INCREASE domestic debt at fixed interest rates; external imbalances are a problem caused by the Chinese (and German and oil) govts for which they will pay a price. But as they say, the Chinese govt never misses a chance to shoot itself in the foot.

          • Thank you.

            These proposed trade partnerships could be a good or a bad thing.

            It all depends whether they are designed in a way that prevents the development of imbalances due to labor / currency / tax arbitrage that cause leakage to final demand and make debt grow or whether they are – like the current WTO system – not designed in such a way.

            For instance, a North America – Western Europe trade zone could very well be conceived as a regional free trade zone (albeit a large one) between countries at a similar stage of economic development (similar wage level in particular) and sharing a somewhat similar political organization and culture. Something i said could be a good idea. But what about the currencies aspects to mention only these? From a US perspective, it could be very “unfair” under such trade partnership if the rest of the world would join Western Europe in unduly accumulating US$ reserves, thereby bidding up the US$ vs the € (the “exorbitant burden”) or even more so vs the Peseta, Lira, Franc, etc if we go back there. Vice versa, from a European perspective, it could be very “unfair” under such trade partnership if the Fed would manipulate the US$ lower by abusing the “exorbitant privilege” and expanding too liberally the global supply of US$.

            Regarding the proposed trans-Pacific trade partnership, given how destabilising has been China joining WTO in 2001 on US job and debt markets as well as on Chinese investment markets, there is little further need to insist on balancing mechanisms built into this other potential trade arrangement.

            So, it is not enough to simply say the solution is now that “the Americans are proposing both a trans-Pacific and trans-Atlantic trade partnership”. You need to know what – if anything – is built into these proposed schemes that will keep them in balance so that goods can effectively be exchanged for other goods based on real comparative advantages rather than for credit. In other words, what – if anything – is built into these proposed schemes that will make them effectively mutually beneficial and wealth enhancing. You say the imbalances are caused by China and Germany. Certainly. But may be tomorrow they are caused by India and the whole of Europe not only Germany (the “euroglut”). And after tomorrow may be by Brazil and Japan again. It is a certainty that if the system permits imbalances, someone will take advantage of it to “game the system”. That’s why the balancing mechanisms need to be built into the system by design.

            So, we are not necessarily far apart, you just need to go one step further and tell us more about these proposed trade partnerships in terms of how they propose to prevent the development of potential imbalances.

            Fixed exchange rates as in irrevocably fixed exchange rates (the Euro for instance) are not at all the same as fixed but adjustable exchange rates which is basically a system of cooperatively managed exchange rates whose sole purpose is to prevent and correct early the development of current account imbalances. From time to time, certain exchange rates are periodically realigned in a coordinated fashion to serve that purpose. Keynes’ Bancor proposal for instance was a system of fixed but adjustable exchange rates. Gold is absolutely not a necessary feature of such a system.

    • This may be talking past your point, in which case I apologize in advance, but as I’ll be getting shorter bandwidth I guess that’s an offset….

      When I’ve researched specific US tax and immigration law, the only thing I see are the fingerprints of interest groups putting their grubby paws on the law and twisting them to suit their own purposes. In the US lobbyists control policy, and they care about parochial goals, with very little concern for the commonweal. I suspect that it’s likely the same around the world. Grand policy initiatives are shaped by those who make political contributions to benefit their interests, so why will more of the same make for a better world?

      With respect to debt levels, debt and savings has to be affected by world demography.
      US Gross private Savings were 104.6 Billion in 1960, and in 2013 were 3401.9 Billion.
      (from – )

      I know that as a retired baby boomer, I have more savings than ever, and way more than my parents, thanks in part to inflation, but also because my population cohort is near the top of the savings mountain, preparing to spend down into retirement. My bank savings account is someone else’s debt, and that debt has to be bigger than ever, and pay less interest than ever, because there are so damn many of us, and it’s a worldwide phenomenon!

      As for government debt- in 1960, national defense constituted 52.2% of total outlays of the US budget, and nondefense payments to individuals were 26.2%. In 2014 national defense constituted 17 % of total outlays of the US budget, and nondefense payments to individuals were 70.4%. (stats are at – – look at Table 6.1)

      Social Security and Medicare eat up most of the budget, and discretionary expenditures are very low. The US government is now best understood as an insurance company with an army. That’s why politicians scream so much; they are essentially powerless with so many locked in expenses.

      Thinking forward for the next decade or two, the boomer generation that saved is at their max in savings now, and as they spend down, what will occur is that the folks emptying my bedpan as I enter senility will make relatively more than my eroding savings will earn, thus balancing out national accounts.

      Maybe I’m already senile, but I can’t imagine that trade policy that can’t realistically be beneficially altered is more important than the spending and saving preferences of the world’s population. I think the rise of world debt, and its subsequent decline, are already baked in the cake. I also think that personal service labor will be better paid as I start to need it, with mechanization of manufacturing and services being a material offset to that wage pressure.

      As to the euroglut, the reinstating of the DM will take care of that glut quite quickly. Don’t hold your breath waiting for that; the Germans aren’t that stupid.

      I’ve noticed a trend of comment that seems to believe that the US government actually knows what it’s doing. What I see are individually smart people, along with a fair measure of the doctrinally blinded. Maybe ¼ of Congress talks to the other side, and as a body they are incapable of intelligent policy choices. I don’t think that the US is a smart, all powerful hegemon- look at the record!

      • Thank you.

        Trade policy is not more important than the spending and savings preferences of the world population. It is inter-dependent.

        It is the great insight of Michael Pettis’ work to show that countries compete internationally (trade policy) by adopting domestic policies (pushing down labor share of production) that push up domestic savings beyond domestic investment, these excess savings having to find somewhere to invest themselves. The countries that have followed this strategy have tended to have better economic performance (more growth, more jobs, less debt). The countries that have followed the opposite policies of stimulating internal demand have tended to have worse economic performance (less growth, less jobs, more debt). Naturally, there is a tendency to emulate the policies that have worked best across more and more countries.

        When Draghi speaks about “structural reforms” in Europe, that’s exactly what he means. The euroglut is just a manifestation of that. When the recently elected BJP government in India writes in its election manifesto “We will encourage savings as an important driver of investment and growth.” (p. 27 of the English version) and “We should no longer remain a market for the global industry. Rather we should become a Global Manufacturing Hub.” (p. 29), that’s also what it means.

        It boils down to this: when the international trade and monetary system provides an overriding incentive for countries to compete internationally by repressing their internal demand, it can only lead to an on-going weakening of global demand. And it does indeed.

        In such a situation, deciding a priori that “trade policy can’t realistically be beneficially altered” is like artificially closing a potentially important door towards a possible solution. There is absolutely no a priori reason why this door should not be opened.

        And yes, of course, lobbies of all kind will interfere with whatever initiative. Is that a reason not to do anything? Not at all.

  33. I posted a comment above. The other comments and especially Pettis response is terrific.

    An additional point one should make is that large imbalances are always deliberate policy choices. Both the US “imbalance of last resort” and the large surplus of countries like China are also results of policy.

    They do not happen by any sort of organic development.

    So, all imbalances are the accounting of the country’s foreign policy.

    It strikes me as very strange how almost all economists – even Michael Pettis – refuse to consider imbalances in terms of their being deliberate policy choice.

    Perhaps because it is considered hysterical – or fantastical like a eminent scientist citing science fiction – economist avoid seemingly at all costs that imbalances are the accounting of foreign policy choice. But this ignores what Heraclitus called “the father, the king of us all”. War.

    But the imbalances make no sense and one loses any ability to have prescience in the analysis unless the starting and end point is “war”. Or in a more polite phrase “foreign policy”. It really has little to do with macro economics.

    So in that light German led so called “euroglut” has to be considered in terms of the peace of WWII onwards, which of course was Jean Monnet’s focus since the end of WWI and no serious consideration of “euroglut” can take place without facing hard power and the framing of hard power in terms of the country’s foreign policy.

    So while the identification of these imbalances and description of these imbalances by Pettis and only a handful of others is often genius, the answers are solely within the political policy area, in particular the foreign policy arena.

    The USA massive deficit should be seen as another aircraft carrier task force – that is how it is formed and that is its purpose – rather than some organic happenstance development from an absence of economic reasoning.

    • I agree that these distortions in savings and investment are “policy choices”, George, but I think it is a stretch to see them as war-based foreign policy choices, except to the extent that being richer and having a more developed economy tends to make you better at war. Like you, I have a lot of very senior contacts in the US government, some of them quite old and close friends, and they genuinely want the US deficit to drop and even become a surplus because they genuinely believe that is good for the US economy (as do I, by the way).

      I don’t see how these deficits can ever be described as the equivalent of offensive weapon systems (and if so, why would Germany’s opposite euroglut also be an offensive weapon?). There have been many times in US history when it has run surpluses and many times when it ran deficits. It is hard for me to find any consistent perception that the US perceived itself to be militarily more powerful when it ran large deficits. Wilson’s perception of the US role in the world didn’t seem to be much diminished by huge American surpluses, nor did these same surpluses prevent Harding from rejecting Wilson’s ambitions altogether.

      I might accept that Reagan’s deficits were part of a US decision to force the USSR into an unwinnable arms race, but the deficits were an unwanted consequence of those policies, and not part of the policy. Reagan after all seriously pressured Japan in order to reduce their surplus, and some of the lead trade negotiators of the 1980s and 1990s are good enough friends of mine that if large deficits were part of the US offensive position, I have to say that even though I am clearly not important enough to lie to with such astonishing and unnecessary skill,they nonetheless have.

      • Mike – “war” is two sided, defensive as well as offensive.
        Those at senior levels of the US govt who want deficits to shrink or disagree with current US imbalances are not in power – simple as that. When they do gain power we have a one weekend solution that swings it to what they desire – not to make light of the months of diplomacy prior – like the Plaza Accord.
        There is little doubt in my mind China’s gaining WTO membership was directly related to 9/11 as the USA had to secure that side of Afghanistan for war. So “war” defined the China imbalance which took place after 9/11. Now with the China Pivot, and if the USA has the hard power to make it effective, the yuan will richen and as far as USA is concerned the imbalance shrinks or are removed. Then exported inflation to China and something like what happened to Japan post 89 occurs. But if China is not aware that this is going on or if they do not think the USA has the hard power capability to impose this change, then serious error take place and war occurs. And this is what happened with Japan in 1941 as the US sanctions post Japanese adventures led to the break down of the Root-Takahira Agreement .
        I know deep analysis was applied to current European imbalances not to determine that they existed but to determine where cusp points were for Spanish unemployment and the other peripherals, not to provide remedy or fix the imbalances or out of concern for the tragedy that is Spain now, but to gauge the amount of leash to provide Germany. The USA goal was to maintain the Schroeder swing from the Monnet plan to the Franco-German Gaullist model. The Gaullist model eliminates the possibility of a United States of Europe and thereby the formation of an equal hard power peer to the USA. So the policy to remedy intra-EZ imbalances via labor was allowed or even somewhat supported by the USA. No glorious formation of the United States of Europe from the forge of crisis as Monnet Plan intended was to occur. This has worked. But the price, and it was a US foreign policy choice, are the resulting imbalances.
        It is undeniable that in a multi- polar world requiring Metternich-Kissinger “balance of power”, imbalances such that we are now having either caused civil or world war. (Ergo I noted your reference to “Consequences”.)
        In this age, the USA – and I am not saying it is not “good policy”, maybe it is right to never have the threat of a USE given track record – dispenses trade surpluses to other nations in lieu of building 3 or 4 more aircraft carrier task forces and other hard power that would be reuired if they did not allow those other countries to impose a trade deficit on the USA or to allies of the USA and under the USA hegemon. I am not saying that the USA uses their trade deficit as an offensive weapon but for the last 20 years as a defensive weapon, especially post 9/11. But there is little doubt that for the USA the trade deficit and other imbalances are a choice.
        Consider this – if the USA moved yuan to, say, 2 next week which would effectively cut the value of China’s dollar based reserve surplus by 2/3 and basically eliminate their export trade – and the USA could do that effectively if they so decide – would China see that as an act of war? The Japanese had to eat the yen from 260 down to 120, but of course they had no recourse in the 1990s – they had to accept that setting. In the 1930s with similar trade measures imposed by the USA the Japanese attacked Pearl Harbor.
        So I do not think I am being overly dramatic is stating that almost all the imbalances now are deliberately imposed by policy that is foreign policy and is “backed” by the nation imposing ability to wage war, or the nation with power accepts imbalances from others to gain security or to avoid war. Hope I making sense as this is the most important issue for China and the USA today. After brilliant minds identify to the public the levers and nature of these imbalances, then at least the discourse of democracy can prevail in the USA. I do think those in power in the USA and China know all this stuff well, it is after all their foreign policy or counter-foreign policy, and I think they are not keen or are best benign for you to table this problem with your brilliant work.

        • You actually think that within 6 days of 9-11, a decision to let China in was made for all of the extensive reasons you state, when Mexico was the last to conclude negotiations with China, and the US the last to sign, having already agreed and waiting to see what transpired with Mexico.

          You really believe that? all that was decided within 6 days……all the years of mulling over Yugoslavia and trying to get the French and Germans to agree (only a weapons embargo was easy to agree to).

          All the time while the Uk and France were trying the cajole the US into participation in Libya, all the time for Syria, and you believe that negotiations were concluded rapidly because the US was interested to have China on their side. My friend, they didn’t need China, they had the American people. And for all the 911 conspiratorial theorists out there they could have attacked the capital building in Topeka, Kansas to the same effect vis a vis Afghanistan.

          • Cstevens – yes I do believe that, the WTO entry by China was likely to be a long drawn out affair well past the November 2001 date. If you remember China was in near engagement with the USA with tail rudders of US planes getting chewed up and forced to land in China. The US is the hegemon, face it. And folks in DC are clever and fully awar of the nature of these imbalances. They are either allowed or they are induced or they are eliminated at will. It is a political calculus.

            My point is that it does little good to illuminate the balances and what is causing them without fitting it into the foreign policy of the USA and the “others” response to that policy. What is Pettis massive contribution is that few even acknowledge these imbalances exist.

            My point is that these foreign imblances have always been the root cause of war – they have fangs.

          • that there is political calculus, that there is a longer term tenor and underlying theme which underpins strategic thought as to free trade and global inclusion in that free trade system, that this is a longer term thought, belief and impetus,…..yes, yes, yes……that this is unerringly related to calculas as to war, or that the negotattions agreed to upon by Spetemeber 17th 2001, approved at ministerial meetings on Nov 10th 2001, that had been negotiated for years, where negotiations with the US had completed before Mexican, hwere upon Mexican signature, the Us followed up and signed, yes, yes, yes…..that this was some sort of pressure, with some support for war predicated upon some Chinese accession to Us demands, so far unseen, unless Michales untaxed war statement, I find this a notion of a long lineage of thoguht whose roots are found in notions of morality, and idealism that do not obtain to societies across the globe let alone in regard to global governance. further, i find these notions counter-productive to further participation, or consideration of governance at the global level, as exhibited in Geneva Report 14, and otherwise, prior, during and after its publication to be much less than you imagine, and that further, others need to move, far more than the US on these matters. Further, am happy were there to be movement, and do not suppose in any way whatsoever the repercussions that many, as who hold your thought, imagine. So, let’s have at it, really, don’t you think its time to test those waters.

        • George: you ask: “. . . if the US moved the yuan to, say, 2, next week. . . – and the US could do that effectively if they so decide. . .” How would they do that?

        • Robertson raises interesting issues regarding the continuum between economics and politics and specifically the use or abuse of foreign trade and exchange rates in terms of Realpolitik. I am sure, and this transpires from his response above, that Michael agrees with the broad thrust of this thesis which in any case has illustrious classical proponents from Friedrich List to Friedrich Knapp to Keynes himself – and more recently the work of a monetary theoretician with whom I spent most enjoyable moments in Cambridge, Princeton and even Florence: I am referring to the lovable Marcello De Cecco and his “Money and Empire” and other works.
          Where I would wish to refine Robertson’s position is on two salient points” the first is that the nexus “imbalances- foreign policy” should not be drawn too strictly, because it can’t. And one of the reasons why it can’t is that at some point economic policy conducted with the express purpose of “waging war” ends up causing “internal” (!) imbalances for the nation-state that wishes to abuse this strategy – not least for the simple fact that it upsets relations of power within the nation-state (!) in terms of class relations at the most obvious!
          I stress this because I do think, again, that Robertson makes very valid points in terms of interpreting “economic science” as a “concentrate of politics” – but that has to be enlarged to all so-called “economic” categories and not just to international economics. Cheers.

          • I have wanted to get Money and Empire for a while now, but it seems to be out of print, and living in Beijing of course makes it impossible to find in any library. Am I wrong? Is if available anywhere for purchase?

          • Joseph – I am not talking about the absence of banana trees in France and therefore imbalances imposed by the EU that favor French Guinea rather than the American Chiquita.

            And I am not talking about “waging war” but the ubiquitous reality of hard power which has only one purpose but to be deployed in war – either defensively or offensively.

            Rarely do nations pursue an offensive war now. Maybe those of empire building prior to WWI were offensive – the “scramble” for Africa and the dismembering of China with agreements like the Root-Takahira. But since the stalemate of WWI, pretty well all wars are defensive, even if a nation attacks first. Even Hitler had (delusions) that his invasions were defensive.

            I also do not see “war” as a continuum. The USN now has many assets in the W, Pacific that are now armed loaded ready to attack China, I am sure only for legitimate concerns. And of course China has the same. This is not hysterical or warmongering or being dramatic, it is just reality. The use of your market or your production capability in relationship to foreigners is always in context of foreign policy. Trade unions and pacts do much to move that to shared domestic policy, but foreign policy always is the senior partner if not the only partner. It is Kerry who leads, not Pritzker as soon as the USA leaves the USA.

            It is a terrific and rare academic feat, what Pettis does, but if one is talking China it does not have much use unless one also considers what the costs are to maintain what hard power if, say, USA moves the yuan towards 2.

            I do not think anyone doubts the USA, given the mandate from The People (and in the USA corporations are People as decided many times by SCOTUS), could move the yuan to 2 in a day or so. Would they? I do not think so but they have done as much to the yen in recent history. When it is considered to move the yuan to 2 – and it is always being seriously considered by analysis and policy folks in DC – they do not consider it without considering in context of hard power, whether one or two more aircraft carrier task forces are required or the 25,000 Marines in Australia become 50,000 or – and so on. That is of course “war”.

            This is not as a simplistic point as one might think.

          • George,

            If what you say is true, it reinforces the idea i highlighted above that free trade is only beneficial and in fact only desirable between politically allied nations at a similar stage of economic development. Otherwise, all these games played by “smart” people make it inevitable that sooner or later something “stupid” will happen.

          • George

            Just so we stay on fact, 2500 marines (omit the extra 0, on a rotational basis)
            Then are you saying that movements in Japan, related to the unwinding of the carry trade, Ms Wantabe, and everyone who could borrow in Yen, and movements up thereafter, and then the pain of Japanese export reliant industries, and the low consumption more generally in small apartments, then Chinese, and other purchase of Japanese bonds, didn’t effect the run up in the value of the Yen and then reversal, it is some people here orthere with political calculus. I choose systemic relations over machinations any day.

        • George

          WWII got the US out of the Great Depression…..Mercantilism was had under the tenants of war

          These are suspect and like the following…

          Trying to discuss the actions and principles of cooking flatbread on thick stones over open fires (from our past) and applying the same principles of necessity to the kitchens of molecular gastronomists. While history for understanding specific cases is useful, as to what can and might happen, or not, of what has come before, even for designing framework, the ideological stances of war and similar, neo-Darwinian, and based in mercantilist history and thought, and applied too liberally from the time of the 1960’s counter-culture movement is getting tired.

          • I don’t know if WWII got the US out of depression, but it did fix a temporary demand problem. If you looked at total debt/GDP ratios, the real debt burden was wiped out in two phases. The first phase was the reflation from 1933-37. The second phase was WW II when the private sector debts were transferred to the government sector.

        • “In the 1930s with similar trade measures imposed by the USA the Japanese attacked Pearl Harbor.”
          Could you please elaborate on that? I thought it was about oil embargo.

      • The thinking goes like this: a country sells oil for US dollars, buys US Treasuries with them which it keeps in its FX reserves.
        USA sees these dollars as “money out of circulation”, which gives the US ability to print fresh dollars and use them for spending as it sees fit. This system suits US and to keep it this way it needs to use its military to maintain it this way, so that the US Treasuries would not be converted back to dollars. By soaking up the US dollars other countries effectively subsidize the US spending.
        I am not saying I agree with this thinking. I am just saying a lot of respected economists are saying something along the lines and I could not find anyone who can refute it.
        For example, professor Fekete:
        The Asian
        crisis of the 1990’s was a perfect example of this. Throughout that crisis the
        message from the U.S., the lending banks and the IMF was the same: We’ll let
        you get away with almost anything. But don’t you ever contemplate helping
        yourselves by selling your U.S. Treasury debt.

      • “By stopping the progress of their conquests and reducing them to unmeaning and disgraceful defensive, we destroy the national expectation of success from which the ministry draws their resources.” – Alexander Hamilton

        A foreign “war” policy suggested by Hamilton to defeat the British via the bond-market.

    • I now understand the reason for all the patriot missile launchers lining the beaches of Copacabana and Ipanema. All those debt infused wars that the US had with Brasil.

      Choice A- Devalue currency
      Choice B- Global Thermonuclear War
      “Shall we play a game” -WOPR (1983)

  34. I am afraid you are right, Michael. Only Amazon seem to have availability at the absurd price of $199! None of the Italian publishers have available copies – I have just checked. A google search yields only pdf copies of some short papers and youtube interviews.
    If your Italian is tolerable, I can send the original Einaudi paperback copy to you from Australia (I will be in Taipei next month in any case!). If you can forward your postal address to my email address, I will be able to forward my copy as early as this week. Cheers again.

    • You are too kind, Joseph, but I can real only read something of this nature in English or Spanish. My French reading was built around stealing from my cousins and reading Tintin and Asterix as a kid, and my Italian reading is a lot more rudimentary, so unless you have a comic book version in Italian it wouldn’t do me much good. The good news is that a lot of these older texts are suddenly becoming perceived as more relevant then ever, so maybe someone will re-issue it at some point, but if you do ever run into an English translation…

  35. About Lepen : present inbalance in the world started when FEWD start bullish partner for the nsake of its currency. putin, Lepen are just by products of this. The fact is : we can live without your freemassonic new world order bullshit.

    • Glad to hear it, Alia. It would be hugely worrying for me if I thought you couldn’t live without my thoughts (I prefer calling them “thoughts” to “bullshit”, but I do recognize the resemblances).

      PS I am not allowed to confirm or deny any membership in Freemasonry. Sorry, but this whole running-the-world thing is sort of hush-hush.

      • No problem, Michael. Yes, the Italian is certainly not elementary. I will try emailing the good professor soon to see if he has a spare copy of the translation. Otherwise, I should soon be in Cambridge (next month) and I’ll certainly see if I can track down an English translation for you.
        By the way, your reply to Alia had me in fits of laughter. A presto!

    • Just FYI, not that I am into freemasonry, but you know the one point of requirement for joining is the belief in a God, monotheism, so that means Jews, Christians and Muslims (and others from South Asia and the near East also), Alia. You realize that there are Muslim free-masons, but much of the illucid noise that surrounds freemasonry is but a red herring, and boring, childish conspiratorial thought.

      Reminds me of the video I watched of Kagan, where a serious young man, stood and said, “Come on, what goes on at the CFR, tell us?” Kagan stated, “a bunch of old fat guys sit around and discuss things, write papers, etc”

      CFR: Non-partisan think tank, middle of the road, kinda white toast and bland, not terribly provocative (but for B.S.; FTM), and vilified by those on the far right, far left, extremists, Conspiratorial theorists, and film script writers. Kinda funny, none of these parties should actually have a problem with the CFR, it is in the center (but it isn’t a good apparatchik, doesn’t have fervor and enough zealousness for the cause). Or those who believe this idiocy, and not diligent enough to interrogate the matter by review of many on all sides of an issue, thus able to be driven by other paranoid delusional s, cultists, and the brainwashing team into buying that non-sense.

      • Almost every traditional religion has the concept of unity as the Sacred (or God in monotheism). For example, Hinduism has the Brahmin. The way I think about it is that in Hinduism, a god is divulged from the concept of the Sacred. In monotheistic religions, most people don’t think that way.

        I’m starting to think that monotheism is actually very unnatural. Monotheistic cultures can often be very religiously intolerant. One of the key aspects of Hinduism is that there is truth in all religions. I get very irritated by fundamentalist Christians (there are other fundamentalists, but I rarely interact with fundamentalists of other religions) when they say that there’s only one way of looking at the world. Quite frankly, it seems to me that they miss the point of everything. They praise some God while advocating destruction of the environment on a very large scale without realizing that the same God they worship is the God they recklessly try to destroy. These people think religion is about belief and are often very strict. This sort of extremism is what leads to complete atheism on the other side as the atheism comes out as a response to the extreme religion.

        Sorry for the digression, but almost all religions I can think of today are “monotheistic” in a sense. It’s just that fundamentalists don’t seem to understand the point of anything.

  36. In the past week or two some regular commenters will have noticed that some of their comments have either not been posted, or have been only partially posted, with sections deleted. I do want to approve comments quickly and I don’t always have the time to read comments fully before approving, so some times things slip through that I otherwise might not want, but to state a few of my unstated beliefs about my role as gatekeeper:

    1. Bad manners. A few readers are perplexed by what seems obvious to the rest of us: discussions are usually more interesting when courteous and when they follow charitable principles – the latter meaning that if Mr. X says something that can be interpreted either as a reasonable statement or, perhaps by taking it too literally, as an absurdly stupid statement, assuming the former almost always turns out to be correct and always leads to a more interesting debate. Another suggestion: really stupid statements are rarely taken seriously anyway, so pointing out how stupid someone’s comment is will not add much value to the debate, and does run you the risk of being tarnished with the same stupidity.

    2. Relevance. When we discuss international economics an awful lot of subjects are relevant, but not all. I understand for example that geopolitical issues are an inescapable and often extremely interesting topic, and in fact sometimes necessary to complete a discussion, but detailed and gory descriptions of which countries can kick the asses of which other countries will be considered of limited relevance. Muscle-flexing, arguments about who is and who isn’t a terrorist, insults, why Mr. X is a despicable leader or religious figure or academic, expressions of rage toward one country or another, etc. are also likely to be considered irrelevant. Sex will only be considered relevant if sufficiently titillating.

    3. More relevance. We have skated at the edge of racism and orientalism at times in our comments section, and although I am not at all squeamish and I do not think there is such a thing as a topic that cannot be discussed, it requires more than simply an assertion for me to agree than any objectification or disparagement of a country, race, religion, ethnic group, etc. usefully contributes to the discussion. I also don’t feel any obligation that my blog serve as a platform for beliefs others may have, no matter how deeply felt.

    4. My imbecility. From time to time a disgruntled reader will write a 4,000-word polemic angrily refuting every single sentence or paragraph I have written and pointing out that only stupidity could justify my beliefs. Last week in one such extremely long and dependably dumb missive I was even – although only as an aside to much weightier refutations – spanked and forced into intellectual submission for saying of Gerard Minack that he is “obviously an extremely smart guy”. For all the obvious hard work and intellectual wattage that goes into writing these polemics, however, I don’t always approve them. If I judge the writer, however incorrectly, to be poorly educated and of limited intelligence, I will not necessarily feel an obligation to respond because this could easily take up more time than I think it is worth. I also cannot simply approve the comment and ignore it because over time I have learned that doing so almost inevitably generates several long follow-up polemics, and many readers complain that these ruin the comments section.

    5. Missionaries. For those who are absolutely certain that their mission to expose my stupidity is an important one, my only suggestion is that you expose it more gradually, perhaps two or three points at a time, in which case I am more likely to respond. Please pick your strongest two or three points.

    6. Befuddlement. It would be helpful if at some point some kindly polemicist explain to me why he feels such urgent need to read my blog even when it is clear that I manage to get nearly everything wrong. I am not trying to be clever here – my blog pieces are quite long and I really am curious as to why such obviously intelligent, accomplished and no-doubt important or busy people would take the time to read me and to write really long responses.

    7. Anonymity. Although I understand that some readers prefer to comment anonymously, and others for professional reasons have no choice, as a rule I think people who are prepared to present their views openly and under their own names tend to be less than fully tolerant of people who misuse anonymity to engage in personal attacks. If someone hates Mr. X, for example, and is prepared to call him a liar and a pederast, my blog might not be the most appropriate forum, and if he wants to publish his views on my blog anonymously, there is always the chance that a tiny bit of contempt might affect my attitude towards his writings.

    Sorry for this long comment but I think it will save a lot of people a lot of time if they know beforehand why they might not want to put too much effort into their comments. I will repost it from time to time.

  37. Prof. Pettis –

    The tension between savers and debtors can be eased by changing the asset used to save from debt to floating rate physical gold (“freegold”).

    It appears China, Russia, Asia, Europe are all aware of this given gold purchases/actions/structures of currencies.

  38. I note your point that savings should fund productive investment, but I would also like to point out that savings flow from the production function. A lot of excess demand for assets (globally) has not come directly from the production function (output-revenue) but from endogenous MS growth. Much of this remains asset focussed, so technically it is not saving until asset focussed MS becomes consumption focussed and enters the production/consumptiion function and the net devolves into saving and investment. I agree that excess savings over and above investment can occur and has likely occured, but that this is not the only source of excess MS focussed asset demand. It complicates matters.

    Obviously in China we have had massive infrastructure spending, which is endog MS directly entering the production function, but as you say, once it enters it comes out and is unable to find a home and is an important driver behind shadow banking development. This is a function of forced investment i.e. the monetary flow flow dwarfing the core economic output function, itself a function of imbalances or immature non investment components.

  39. Ouch. Australia has become more and more dependent on exports to China in the previous years.

    A chart from the excellent australian financial website MACROBUSINESS. (Webpage only available for paying members)

    Mr. Pettis gave a truly excellent interview (audio) to the McAlvany Financial Group (from Denver, Colorado, USA). Posted: february 2013.

  40. Someone above mentioned that the US total debt has declined. That´s not true. It increased by $2 trillion in just one year(Q2/2013 to Q2/2014, last data available), rising three times faster than the nominal GDP in the same period(by around $700bn). US has the same unsustainable debt dynamics as either Europe or China. And that´s excluding unfunded liabilities, north of $100trillion. If one of these major economies crashes, rest will follow. No where to hide.

    Americans hoping that the dollar´s reserve status will save them. That´s a chimera. I keep reading how supposedly all the money rushed to US after 2008 crash. If that was true, FED wouldnt have to print $4 trillion. US borrowing costs are low, not because everyone is running to Treasuries, but because FED is the market now. Without FED printing, 10year yield would be at 4-5% making US insolvent. And that´s the whole point of money printing, keeping the yields down, prolonging the illusion of prosperity a bit longer. If yields rise, EU/US/China/UK/Japan … etc all will become insolvent. The global economy(all players included), is a house of cards, it will crash and the only question is when. My guess 5-10 years.

    • ^^PeterL WROTE: “US has the same unsustainable debt dynamics as either Europe or China….. x …..The global economy (all players included), is a house of cards, it will crash and the only question is when. My guess 5-10 years….”

      This was the debt-load situation in 2008:

      How much has it changed for the countries listed? For example:
      1) China’s main component of overall-debt in 2008 was corporate-debt. We know that corporate-debt/GDP has EXPLODED because of the investment binge since 2008. So clearly China’s debt-load situation has deteriorated.
      2) Japan, Brazil & India had government-debt as the main component of overall-debt in 2008. Here are the trends in government-debt load for Japan, Brazil & India since 2008:

      So which countries have seen their overall debt/GDP ratio IMPROVE since 2008? Which countries have stayed the same? Which countries have seen the ratio DETERIORATE since 2008? Do you know? A country-by-country differentiated analysis would be more helpful than a sweeping generalization of fire-and-brimstone for the whole world.

      • Im talking about countries(economies) that matter, obviously, so primarily the three biggest players US, EU, China. It´s very nice that debt levels in Brazil, India or some other countries are improving, but when the global economy crashes they will be all swept down along. And the debt dynamics in all of US, EU, China are clearly on unsustainable path.

        • PeterL WROTE: “Im talking about countries(economies) that matter, obviously, so primarily the three biggest players US, EU, China.”

          Size of Top-Ten economies in Billion USD in 2013 (World Bank Data)
          EU Bloc—17,350,853

          Since the 2008 crisis, which of these countries have seen their Total (i.e. Household, Corporate & Government) debt/GDP ratios:
          (a) Rise (or worsen)
          (b) Stay about the same
          (c) Fall (or improve)

          Can you tell us?

          Since the 2008 crisis, which of the listed top-ten countries have seen their banking-credit (or money supply or M2 or broad money) as % of nominal GDP:
          (a) Rise (and by how much)
          (b) Stay about the same
          (c) Fall (and by how much)

          Can you tell us?

      • Bravo Vinezi, and the 100 tr figure are 75 year estimates which you failed to alter, which have altered where, for example, FICA is now 6.2% for worker and 6.2% for employer, that change alone alters dramatically 75 year in the future dynamics, as will advancing ages for retirement, for me it is 67, and will likely be extended, before I am 67. So, baby boomers got a easy pass on this one, funny but they are often the ones yelling the loudest at this.

        One simple thing that can be done to address the issue at some point were it required is just cost of living adjustments, would people not have it, or would they rather it deflated in real terms a bit, so, again…..

        • Of course, unfunded liabilities have a lifespan 70+ years, but they are still rising by $2+ trillion per year. So if they are currently at around $110 trillion, 10 years from now it will be $130 trillion, then $150 trillion etc, well you get the picture.

          Moreover, I was more focusing on much closer threat to economic health, that is total debt. As is clear from the link I provided, total debt rose 3 times faster than the economy last year. In other words, for every dollar of growth, US had to borrow 3 dollars. And this is now going on for decades, since mid 80s, esentially. So do you consider this sustainable, when debt is permanently growing much faster than economy? OR will it just hit the wall at one point? I think, the answer is obvious. And that´s not some pessimism, or ill-wish on mine side, that´s a mathematical certainty. Unfortunately.

          • Debt and wealth is growing faster than income; why wouldn’t it in this interest rate regime? But if one sees the M1 or the M2, the growth has long stymied as most of the supply did not go into goods and services; so on one hand we have close to deflation and on the other high inflation in stocks and bonds, where the money got diverted.

          • No, not at all, that is not what the unfunded mandates are, they are acutally estiamtes, as i said for 75 years from now, other forms of debt, are in no way associated with what is called, by thoe who read a certain vein of the webosphere, and are within the frame of such a notion, with unfunded mandates. unfunded mandates are notions, of what would happen based upon certain scenario’s, these alter, dramatically, with changes in tax rates, like the FICA rise from 5.6 to 6.2 (employer and worker 1.2%; 120 million full-time workers, in 2090 who knows, 2050 400 million people in US, therefore some similar number of FT workers, and PT workers, etc…). So changing number of imputs (workers, taxes,new things and ways to tax, policies, structures of economies prevailing at the time) and how technology will alter the landscape, socially, politically, economically, governance-wise, even human potential (self-medical, self-learning, self-producing, etc) and altering demographic structures and profiles(living longer will require alterations as living healthier will be facilitated), all these,along with growing cognizance of the macro-economics,global system realtions, etc…. will alter the terrain of socio-politico philosophies, from what has occurred since Thatcher-Reagan (taht has run its course), leading,to new frames. So, yes 75 year unfunded mandates are merely a tool of dissension used to foster notions within the socio-political dialogues that people are fond of, and do not exist but within the model, of political actors, who hope to have something occur relevant to policy, but this dies as we learn more of these dynamics. Such a notion will wither in the discussion environment as the excess of previous era’s leads to altering structures (Picketty, Inequality and Infrastructure in 2016, building to 2016).

  41. It was Prof Pettis who said that total debt in the US had declined since the global financial crisis. Professor do you have a source for this? I find it completely implausible, particularly with the free money provided by central banks…


    • Anthony S WROTE: “It was Prof Pettis who said that total debt in the US had declined since the global financial crisis. Professor do you have a source for this?”

      Here is the latest Federal Reserve report entitled “Financial Accounts of the US” (PDF file):

      The information you requested is in Table D.3 on page 5 entitled “Credit Market Debt Outstanding by Sector”.

    • Anthony S WROTE: “…I find it completely implausible, particularly with the free money provided by central banks…”

      Are you referring to ABSOLUTE debt or to debt-load (i.e. relative debt or debt/GDP)?

      Here is the latest Federal Reserve Report on US Finances:

      A) Table D.3 on page 5 entitled “Credit Market Debt Outstanding by Sector” gives us the TOTAL (non-financial) debt as:

      YEAR—Debt in Billion$

      B) Table F.6 on page 12 entitled “Distribution of Gross Domestic Product” gives us the GDP as:

      YEAR—GDP in Billion$

      C) Therefore, we can calculate debt-load (i.e. debt/GDP) from (A) & (B) as:

      YEAR—Debt Load (% of GDP)

      Looks like debt-LOAD (i.e. relative debt) has been more or less *CONSTANT* over the 5 years listed in the report.

      • Mhmmm, and why do you exclude financial debt? Does that not matter? I think we saw during 2008 crisis that finacial debt does matter, and very much. Total debt, means total debt, it´s not that difficult to understand the meaning of the word. Hence, you need to look at table L.1, on page 9. And there you will learn that total debt rose by $2 trillion, on last counting. (vs previous year, Q2/2014 vs Q2/2013).

        Or just look at this chart:

        • PeterL WROTE: “Mhmmm, and why do you exclude financial debt? ”
          PeterL WROTE: “Total debt, means total debt, it´s not that difficult to understand the meaning of the word….”

          The point you make was discussed at some length in one of Michael’s earlier articles. You can see that old discussion right here on Michael’s blog:

        • ^^Peter L WROTE: “Hence, you need to look at table L.1, on page 9. And there you will learn that total debt rose by $2 trillion, on last counting. (vs previous year, Q2/2014 vs Q2/2013).”

          Okay, per the special request by Peter L, here are the ratios from TABLE L.1 9 for TOTAL debt (including financial-sector debt & foreign borrowing from the US)—

          A) Table L.1 on page 9 entitled “Credit Market Debt Outstanding” gives us the TOTAL debt (INCLUDING financial & foreign borrowing from the US) as:

          YEAR—Debt in Billion$

          B) Table F.6 on page 12 entitled “Distribution of Gross Domestic Product” gives us the GDP as:

          YEAR—GDP in Billion$

          C) Therefore, we can calculate total debt-load (i.e. debt/GDP) from (A) & (B) as:

          YEAR—Debt Load (% of GDP)

          If we include all financial-debt & foreign borrowing from the US, as Peter L wants, it looks like the total debt-LOAD has been FALLING over the 5 years.

          • Post 1:

            Your reasoning why financial debt should not be included is flawed, Im afraid. It may work in theory, but not in real world. You saying that banks are esentially only intermediators, borrowing from A, lending to B, and then returning money to A, hopefully with profit. There´s just one little problem. Bank will not always make profit when lending to B. Stocks, mortgages can decline in value, loans, investments can go sour etc. So i think you see now that the debt of financial sector is very real, indeed, and thus needs to be included.


            Year on year comparisons are meaningles, because they dont show a long-term trend, they are just fluctuations. For a long-term trend you need to look at longer period, decades for example. Let´s see:

            1980: 2.993
            1990: 6.023
            2000: 10.472
            2010: 15.230

            Total debt($trillions):
            1980: 4.729
            1990: 13.837
            2000: 27.150
            2010: 52.322

            Debt load(% of GDP)
            1980: 158%
            1990: 229%
            2000: 259%
            2010: 343%

            You see the trend, right?

  42. A real clarity of thinking here Michael. Many thanks.

  43. to csteven (no reply button on your post, so im putting it here)

    All what you said is true, of course, with certain changes situation with liabilities COULD get better, it could also get worse. And so far anytime politicians tinkered with them, they always made the situation worse, so looking at their past record it will only get worse. Of course, I dont expect all those liabilities to materialize, because when a country is broke and cant pay, it wont. Im just saying that americans(and of course europeans) are up for a rude awakening, because the paradise they expect to retire in is an illusion.

    BUT, most importantly, as I said above, my main worry currently is total debt, because it´s a more immediate threat. Do you also have something about this to say? The fact that last year for each dollar of growth, US had to borrow 3 dollars, the fact that this is now going on for decades. So do you think it is sustainable when the total debt is permanently rising faster than the NOMINAL growth of economy? I think this is the key question to answer to understand our near future. Forget liabilities, total debt is the real problem.

    to Procyon Mukherjee

    That´s correct, both debt and wealth are rising, the problem is that for different people. Debt rising mostly for ordinary people, wealth for the rich, and that´s why inequality is exploding. Some people believe that middle class will dissapear when baby boomers retire as young people currently earn less than the previous generation. First time in american history.

  44. – The combination of 300 million consumers and the USD being the world’s reserve currency means that the US is forced to run CA Deficits. A lot of people don’t include the impact of those 300 million US consumers.
    – When other countries are running CA Surplusses (Germany, Eurozone, China, …..) then the US is more or less forced to absorb those financial inbalances resulting in (large(r)) US CA Deficits.
    In that regard the US is incapable of influencing the impact of those events occuring outside the US. In that regard the US is left at the mercy of worldwide imbalances outside the US.

    But that doesn’t mean that the US is totally powerless and can’t do anything to reduce those same inbalances.
    – It can reduce or eliminate US military spending outside the US. (Reduces the CA Deficit)
    – It can increase US taxation (dramatically). This reduces US consumption and hence the Trade & CA Deficit.
    – Impose capital controls. Another very effective way to reduce consumption.

    I would like to point out that the Bush administration did two things that increased those inbalances: Increase military spending (~ 60 to 70%), increase the US military footprint outside the US and cuts taxes (buying support for those foreign wars ??). In that regard the US deliberately (& (un-)wittingly ??) helped to increase those already existing world wide inbalances.

    But one should also note that the last time the US CA balance were positive, was around 1990. From then on those US CA deficits became larger & larger. See this chart:

    I also can link events occurring in China, Australia to the US economy. The US still needs to import a range of commodities. When, as a result of China slowing down and commodity prices going down in price then (even with US demand remaining flat), the US CA deficit & Trade Deficit will shrink as well. It will decrease the subsidizing of the US economy.

    I also want to point out that the large investment boom in China (seem to have)/has spilled over into other countries, in the Far East & South East Asia as well. So, it was not limited to Australia. See these links:
    Ouch. This is going to be ugly.

    I also came across this article. It contains a chart that provides more details of the german & euro CA surplusses. The german CA surplus never went down significantly !!! Ouch.

    • The one and only reason for CA deficits is the dollar´s reserve status. Agree with reform of global finance, crucially allow oil to be traded in different currencies, and CA deficits will disappear. Is US ready for this? I dont think so. Dollar´s reserve status is a very powerful tool, not only economic, but also political. I wrote in the different thread, that in the long term, having the world´s reserve curency is, in my opinon, a liability. I dont think americans understand this. Yet. So dont complain. You have what you chose to have.

      BTW: US cant reduce the military expenditures abroad. Your bases are there to protect precisely what we´re talking about, the dollar´s reserve status. Stop protecting Saudis, and they will start pricing the oil in yuans, yens, euros or whatever currency. You want this? No. You see everything is interconnected in the world and you cant just cherrypicking.

      • No. The US CA Deficit is the product of many things, it’s NOT limited to US military spending. If e.g. the US consumer would reduce its spending (20%, 30%, 40% or more) then the CA deficit would vanish into thin air and turn into a Surplus. And a Surplus would hurt the US government even more. Because then the US consumer would be forced to pay the full 100% of all those US foreign military adventures.

        A military budget of ~ $ 700 bln are 700 bln reasons why it’s so extremely hard to cut that budgets. And with a CA deficit of ~ $ 400 bln, it means that foreigners foot the military bill to the tune of ~ $ 400 bln.

        But no matter how you want to slice it or dice it: Either that budget is cut voluntarily now or let upcoming financial events cut that budget involuntarily later. But when upcoming financial events force the US government’s hand then the adjustment process will be much more painful. So, for the health of the US financial system it’s better to reduce that budget ASAP.

        • I didnt say CA deficits were caused by military spending, i said the main cause was/is the dollar´s reserve status.

          Agree with your second and third thoughts, CA deficits will go down one way or another, and budget deficits should be cut.

  45. Everyone who wants to see another set of “Imbalances” should look at Eastern Europe & Turkey. Those countries are running also (significant) CA Deficit. I attribute that to the low interest rates in Western Europe & the US. (a.k.a. “Reach for Yield”).

    • Why is it that no one who discusses carry trades ever mentions forward currency pricing and present expected value?

      • – That could play a role as well. I don’t know. I simply apply the logic as outlined by Mr. Pettis. That, combined with higher turkish interest rates, provides a good enough explanation for me.
        – Turkey is running a CA Deficit of about 6.5% of GDP. It’s larger than the US CA deficit in 2005/2006 (at ~ $ 800 bln or ~ 5% of US GDP). Turkey has (along with Hungary) also a comparitively high amount of short term debt. That means that Turkey is very vulnerable when it loses confidence from the financial markets, like South Korea in the 2nd half of 1997. (Read Mr. Pettis’ “The Volatility Machine”).
        – We saw financial turmoil in Turkey in january & february of this year as well. The turkish central bank was forced to raise short term interest rates, in an attempt to defend the currency, back then. And that’s for me clear & resounding signal “something is wrong”.

        • “I simply apply the logic as outlined by Mr. Pettis”

          Would you please be so kind as to link to that outline. I would appreciate reading that.

          All things being equal, raising rates is going to put term pressure on your currency, not strengthen it.

          • – Mr. Pettis gave an excellent interview to the McAlvany financial group in february 2013. Although I don’t agree for the full 100%.
            – Read the articles Mr. Pettis posted on this blog.
            – Search on YouTube for videos with several videos featuring Mr. Pettis.

            Higher interest rates are always a driver for moneyflows. E.g. interest rates in Europe & the US were lower than in the EMs (including Eastern Europe & Turkey) after 2008. And that was reflected in the fact that those EM countries enjoyed an inflow of money (a.k.a. Reach for yield) and additional growth but now those flows seem to be reversing (rising USD & Euro against those EM currencies.
            See the turmoil in the EMs in mid 2013 & early this year. NOT a good sign.

          • “Higher interest rates are always a driver for moneyflows. ”

            Yes, it’s called dumb money. I have had to explain this no shortage of times. Which puzzles me because I thought this was Finance 101. I hear Central Bankers repeat it again and again as well.
            It is nonetheless WRONG. The change in rates will be offset by exactly that amount in the forward currency market resulting in the expected value not changing and remaining at zero. Your argument is wonderful as long as you refuse to look at the forward market. You are stuck in what i call t0. you need to look at the box of t0 vs unwind at t1.

            Today Dec 14 Br Real is 2.59 with a 1 yr rate diff of about 10%. Dec 15 Real is 2.84… See where the 10% went! Expected value of the unwind is 0.

            If Brazil raised rates to 20% the Dec ’15 Real would move to about 3.1. Again no need to chase yield because your expected value of the 4 transactions you would have to make to complete the trade remains at 0.

            All you are doing is taking a spec trade on the Dec Real which would save you a lot of headaches and commissions just selling the Dec Real. Which is nothing more than a 50/50 bet…

            I have moved staggering amounts of currencies, fighting like a dog for edge at the 4th decimal. Anyone who thinks 10% is just lying on the table, needs to take a better look at the table.

          • – No, I think (!!!!) you got it backwards. Being forced to raise short term rates is a sign of weakness, not one of strength. For me, it’s a sign a currency is already under (extreme) pressure. It’s the last one wants to do. That’s why I “don’t like” the change in language at the BoE & FED that amounts to hints that both central banks, at some point in the future, are going to raise short term rates. I personally attibute that to the fact that both the US & UK are running CA Deficits. Countries with a CA Deficit Always have – in general – higher rates.

          • @Derivs:
            – That stuff is too complicated for my simple braincells.
            – The “reach for yield” does exists. I see it daily in the financial markets here in the US. And that “reach for yield” here in the US seems to have ended. Look e.g. at spreads between T-bonds & corporate bonds. That ratio has turned for the worse this year.

          • ^Willy2 WROTE: “Higher interest rates are always a driver for money flows. ….. interest rates in Europe & the US were lower than in the EMs … after 2008. And that was reflected in the fact that those EM countries enjoyed an inflow of money …. and additional growth… but now those flows seem to be reversing …….”

            Why are those flows reversing now? Are the interest rates in Europe & US now HIGHER than in the EMs? Are those flows “chasing yields” in Europe now? Have the yields in Europe surpassed the yields in EMs?

            I’m confused. Please explain your point a bit further.

          • @Vinezi Karim:
            – the first sign of weakness is that EM markets were underperforming in late 2013 & 2014. It means that investors have become more cautious.
            – I looked at a number of exchange rates of EMs and they haven’t gone down (too much).
            – I also look at a number of commodity currencies and those have gone down against the USD in the last months. In spite of higher interest rates in those countries.
            – Watch this:

      • An oversight of how a number of EM have fared since 2013:
        (free regsitration required).

    • Willy2 WROTE: “Everyone who wants to see another set of “Imbalances” should look at ….xx… Turkey.”

      Turkey is a disaster waiting to happen. Here is why:

      1) The average national savings rate reduced from ~ 20% during the 1990s to ~ 15% of GDP during the 2000s.

      2) The investment rate, however, averaged the same at about 22% of GDP.

      3) The difference, by definition, came from increasing the CAD from 2% to 7% of GDP on average.

      4) This increasing CAD was financed mainly by SHORT-TERM External Debt. Turkey’s forex reserves are barely sufficient to cover short-term debt by origination and clearly insufficient to cover total short-term debt by maturity (i.e. short-term debt by origination PLUS long-term debt maturing over the next 1 year).

      5) For historical comparison, this is the same short-term debt v/s forex reserves TRAP that caused the ASEAN crisis in 1997 and the South-Asian crisis in 1991.

      Since investment rates remained the same and savings rates reduced, the Turkish boom was, by definition, a consumption-driven boom. This increased consumption in the face of constant investment rates was financed by gorging on foreign DEBT. Therefore, Turkey has been borrowing from the world in order to increase its internal consumption. This is not sustainable. Turkey is headed for a text-book BOP or currency crisis. The smallest perturbation may lead to a call on its debt and result in a run on the Lira. When that happens, all hell will break loose and the Turkey will wind up in the IMF Intensive Care Unit (ICU) once again.

      Given that this has happened to them many times before, Turkey should know better. But Turkey, it seems, never learns.

      • – Agree. Turkey is a basket case.
        – But Turkey is also the victum of CA Surplusses elsewhere. E.g., Europe, Middle Eastern oil exporters.

      • I agree. I’m need to open a short Lira position at some point, now that I think about it. I think the Yen, Lira, and Ruble are all one way bets.

  46. Very interesting read as usual.

  47. I believe that India has more than enough iron ore to supply infrastructure buildout, there isn’t much coal available though.

    • I think all countries should get off coal ASAP. It’s very environmentally damaging. Coal usage actually releases more radiation into the air than nuclear (it’s ironic, I know).

      In terms of importing economic inputs, China’s much worse than India. Shipping stuff from the Persian Gulf to Mumbai or Chennai takes only a few hours really and control over those lanes is relatively easy for India. That being said, India needs a lot more infrastructure–particularly pipeline infrastructure to transport natural gas across the country more effectively.

      For extracting natural resources effectively, human and financial capital is really important. You not only need cash, but you need the people who have the skillsets to do all this stuff. You need people specializing in engineering, geology, material science, and a whole host of other stuff. If not, we’d all still be chopping wood and using it for energy, which is very ineffective and extremely environmentally damaging.

  48. The obvious destination for this “euro glut” is the US Treasury market as was the prior “China glut”. This could be accommodated by an expanding US Govt balance sheet which is already a little to large or more safely, if it could be engineered, a shrinkage of the federal reserve balance sheet as the U.S. recovery takes hold. This would accommodate a euro zone participation in the recovery and head of the widely anticipated losses in U.S. Long bonds. The Fed Govt balance sheet is likely to slow its rate of growth as the recovery takes hold and the Fed Reserve is not mandated to accommodate euro area economic activity. It might do so however if this an obvious alternative to rising US short rates as capacity and labour market constraints in the US become more acute. The alternative of a more restrictive global trade environment potentially sets in motion difficult to manage tit for tat policies that would slow growth everywhere. Maybe we are looking at a global economy here with the global reserve currency issuer is forced to factor in its role in the big picture. A big part of this picture however is everyone displaying the appropriate discipline. The powers that be acting through their chosen instruments particularly the U.S. Fed Reserve may be hesitant in finding out whose without clothes when the tide goes out. After this long desperate and experimental expansion of liquidity the alternatives to actually systematically rising short term interest rates are likely to be explored with some energy.
    The chain of causality I lean towards, albeit with less research, less historical insight, and less in depth analysis among other potential shortcomings is that globalization is the key independent variable. This has forced countries like Spain and Germany (referring to the French indemnity blog) to adapt in their own specific ways to the market disruptions and labour market arbitraging. The Fed Reserve also from the first bite of these disruptive forces leaned towards being more accommodating. This rise in liquidity globally has encouraged over investment in fresh stories. Obviously the euro and the removal of currency risk from the club med countries encouraged high spirits which perhaps politicians who are less than perfect were quick to exploit and accommodate through less than well thought out plans, to encompassing state sectors and less than air tight regulatory environments. The Germans acting rigorously and decisively to these globalization and excess liquidity developments and seeing clear and present threats to their export markets, threatening speculative activity in the currency markets and reacting to labour market arbitraging were quick to lock in a currency deal creating the Euro. They obviously in this uncertain world are not going to let labour costs get out of hand.

    The decisive exogenous event in this picture is globalization. The German CAS is therefore an outcome of these forces which is locked in by the institutional framework established to deal with them. The likely hood of significant orderly debt relief in club med (euro zone countries bordering the Mediterranean) increases in proportion to the evolution of these entities in the direction of “not repeating the mistakes of the past.” Otherwise the argument could be presented that the internal adjustments arising from being unable to devalue and unable to borrow are necessary to address the impact of globalization anyway. In the meantime low euro area interest rates and QE are going to make this debt burden more sustainable.

  49. They quickly pointed out that Europe is too large simply to assume that the world can absorb large changes in its capital and trade accounts, and as they debated about the ways global constraints would affect the assumptions about European surpluses most of them quickly decided that either the markets would not permit surpluses of this size, perhaps by bidding up the euro, or the impact of these surpluses would be very negative for the world.

    Could somebody please explain how to estimate how much of a change in capital and trade accounts the world can/would absorb? I assume it’s obvious because MP states this as obvious enoughto not warrant explanatoin and nobody else followed up on it, but I’m still on the steep part of the learning curve when it comes to international finance and economics.

  50. Okay … it’s been a year. the $50 mark was hit a few months ago. there’s all sorts of stuff happening again in europe, china, usa and australia … can we have an update on the commodities adjustment drama …

    (I guess a year is a pushing it, but i’m so impatient to wait for history to happen, I have been following this since 1997 …)

    But seriously if anyone has any links to other recent articles that are following this issue in a similar way to Prof Pettis, I would really appreciate the linkup, thanks.

Leave a Comment

Your email address will not be published.

33 Trackbacks

  1. China’s Rapid Growth Model Is About To Slam Into A Wall | Allmin.ed (Pingback)
  2. China’s Rapid Growth Model Is About To Slam Into A Wall – Investor News (Pingback)
  3. China’s Rapid Growth Model Is About To Slam Into A Wall - Set Squared Centres (Pingback)
  4. Jordan Meyerowitz | China’s Rapid Growth Model Is About To Slam Into A Wall (Pingback)
  5. Kerry Stokes: “Worst I’ve Seen Since ’91″ | Trade the Tape (Pingback)
  6. Orwell festival | Consort3's Blog (Pingback)
  7. How to link Australian iron with Marine le Pen | Michael Pettis’ CHINA FINANCIAL MARKETS | Redding Holdings, LLC (Pingback)
  8. The Flat Debt Society « Föhrenbergkreis Finanzwirtschaft (Pingback)
  9. Chinese Property Slide & More Fed Speak | Trade the Tape (Pingback)
  10. High savings levels can mask underling complex debt spirals: brief addendum to differences between debt and saving.. | Depth Dynamics (Pingback)
  11. Globalization = Permanent Instability | ZombieMarkets (Pingback)
  12. 전세계의 최신 영어뉴스 듣기 - 보이스뉴스 잉글리쉬 (Pingback)
  13. Today’s News October 30, 2014 | The One Hundredth Monkey (Pingback)
  14. Globalization = Permanent Instability - Techhic (Pingback)
  15. Charles Hugh Smith ~ Globalization = Permanent Instability | Shift Frequency (Pingback)
  16. Globalization = Permanent Instability Washington’s Blog « The Progressive Mind (Pingback)
  17. Globalization = Permanent Instability | News-Press-Liberty With Responsibility! (Pingback)
  18. Un lucru e usor previzibil: globalizarea va aduce lumii o stare de instabilitate permanenta, osciland intre cresteri si depresii economice! Asta intrucat libera circulatie a capitalului va fi favorabila celor care il detin, dar vor fi afectate zonele in c (Pingback)
  19. Peligrosas transiciones monetarias | Situation Room (Pingback)
  20. Three Nightmare Economic Scenarios That Could Trigger Recessions In 2015 | Technology, Social Media, Digital | Digital News Hub (Pingback)
  21. Three Nightmare Economic Scenarios That Could Trigger Recessions In 2015 | Business Insider (Pingback)
  22. People think China is lying about its economic growth and the truth could be far worse » GeoFront Capital Group (Pingback)
  23. People don't believe China's growth figures and the truth about the economy could be far worse | News (Pingback)
  24. People don't believe China's growth figures and the truth about the economy could be far worse - Set Squared Centres (Pingback)
  25. People don't believe China's growth figures and the truth about the economy could be far worse | Send Emails (Pingback)
  26. China's rapid economic slowdown is probably even worse than the government will admit | Appsoko (Pingback)
  27. China’s rapid economic slowdown is probably even worse than the government will admit | Allmin.ed (Pingback)
  28. China's rapid economic slowdown is probably even worse than the government will admit » GeoFront Capital Group (Pingback)
  29. The Chinese economy is going through puberty - and the rest of the world will feel the impact - [email protected] (Pingback)
  30. The Chinese economy is going through puberty — and the rest of the world will feel the impact | UKexpress Breaking News, Latest News and Current News from UKexpress Breaking news and video. Latest Current News: UK,U.S., World, Entertainment, Health, (Pingback)
  31. The Financial Engineering 500 | Mercenary Trader (Pingback)
  32. Some bankers aren't worried about China — they're excited about the 'new economy' | CAPITOL ZERO (Pingback)
  33. Press Today » Some bankers aren’t worried about China — they’re excited about the ‘new economy’ (Pingback)