How might a China slowdown affect the world?

Two years ago it was hard to find analysts who expected average GDP growth over the rest of this decade to be less than 8%. The current consensus seems to have dropped to between 6% and 7% on average.

I don’t think Beijing disagrees. After assuring us Tuesday that China’s economy – which is growing a little slower than the 7.5% target and, is expected to slow further over the rest of the year – was nonetheless “operating within a reasonable range”, in his Tianjin speech on Wednesday Premier Li suggested again that the China’s 7.5% growth target is not a hard target, and that there may be “variations” in China’s growth relative to the target.

I think every one knows that variations will only come in one direction, and although his stated expectations are still pretty high, most analysts, correctly I think, interpreted his remarks as a warning that growth rates will drop even more. Here is how the People’s Daily described the speech:

Premier Li Keqiang on Wednesday said China can meet the major economic goals this year and policymakers will not be distracted by short-term fluctuations of individual indicators. Li downplayed the importance of some economic data from the past two months when delivering his keynote speech to the 2014 Summer Davos, which opened Wednesday in north China’s port city of Tianjin.

…China has targets of GDP growth around 7.5 percent and a consumer price index (CPI) increase of about 3.5 percent in 2014, with 10 million more urban jobs to keep the urban unemployment rate at a maximum of 4.6 percent.

Inflation is also below target. According to the National Bureau of Statistics Wednesday release, “In July, the consumer price index (CPI) went up by 2.3 percent year-on-year. Prices grew by 2.3 percent in cities and 2.1 percent in rural areas. Food prices went up by 3.6 percent, while non-food prices increased 1.6 percent. Prices of consumer goods went up by 2.2 percent and prices of services grew by 2.5 percent.”

Surprisingly, analysts continue to hail lower-than-expected CPI inflation as giving the PBoC room and encouragement to expand credit – largely I guess because this is what analysts say when US or European CPI inflation numbers are low, and although most of us haven’t thought through the differences between China and the US in the ways prices respond to monetary policy, we don’t want to seem like we don’t know what we are doing. The constraint on monetary and credit growth in China is not CPI inflation and never has been. Monetary and credit growth in China are constrained by the impact of GDP growth on balance sheets.

For me the main information coming out of CPI inflation data is that consumer demand relative to total production continues to be too weak to drive up prices, something confirmed earlier this week by the August trade numbers, which failed to suggest strong growth in domestic demand. According to Xinhua:

China’s exports in August rose 9.4 percent year-on-year to 208.5 billion U.S. dollars, with monthly trade surplus reaching an all-time high of 49.8 billion U.S. dollars, customs data showed on Monday. China’s imports continued to contract last month, with a year-on-year decrease of 2.4 percent, to 158.6 billion U.S. dollars, the General Administration of Customs said in a statement.

Trade surplus in August jumped 77.8 percent year-on-year and hit a record high again, after reaching an all-time high of 47.3 billion U.S. dollars in July, the data showed.

Although in my opinion the current 6-7% medium-term growth expectations are still far too optimistic, and will almost certainly be disappointed within one or two years, the good news is that most analysts at least recognize that the increasing risk of a “hard landing”, which they mostly seem to define as growth below 6%. The idea that during the rebalancing process Chinese growth can drop as sharply as it has for every other country that has gone through a similar rebalancing is still hard to accept, even though a little digging would make it clear that analysts underestimated the pace of slowdown during each of the previous cases too.

Still, the fact that we have been consistently surprised on the down side since 2010 has alerted most analysts to the possibility that we may continue to be surprised on the down side. A “hard landing” of growth below 6% is still considered unlikely, but no longer possible to ignore.

This worries a lot of people. A hard landing, we are told, would be devastating for the world economy because China is the world’s “growth engine”, and if it falters, growth around the world will also slow. There is also rising concern about a banking crisis within China. An economist at Oxford Economics recently told a Sydney audience that “Chinese authorities were understating the extent of bad loans on their banks’ books and faced tough choices in dealing with the potential bank failure.” In that he is certainly right, but he went on to say: “”We don’t know when there will be a China banking crisis and how it will play out but it is almost certain there will be one,”

I am not sure I agree. Insolvency doesn’t necessarily lead to crisis, as countries like Spain have made clear. It takes a collapse in liquidity to create a crisis, and if insolvent borrowers remain liquid, we are likely instead to see a long, difficult period of slow growth in which the losses are painfully ground out of the system (and always turn out to be greater than they would have been had they been recognized immediately). A banking crisis in China is always possible, and several people I respect are quite certain that there will be one, but I think that as long as Beijing implicitly or explicitly guarantees deposits, and as long as Beijing’s credibility with Chinese households is solid, and I believe it is, I think we are more likely to see many years of Japanese-style “zombie banks” than a banking crisis.

What does it mean if growth slows?

At any rate as far as I can understand, most analysts claim that if growth in China fell much below 6%, we would be likely to suffer the following:

  1. The rest of the world would slow, perhaps sharply, as a consequence of China’s lower growth.
  2. There would be a crisis in the Chinese financial system, which would spread to the global financial system.
  3. Political instability would emerge in China as unemployment surges.

I think most analysts may be overestimating the adverse consequences and underestimating the probability of much lower growth. I continue to expect growth rates to fall substantially, probably by 1 percentage point a year or more for the rest of the decade, so that in the best case, during the expected period of President Xi’s administration (2013-32), growth rates are unlikely to average above 3-4%.

Higher growth rates are not impossible, of course, but to get the arithmetic to work for me it would take some fairly implausible assumptions – mainly that Beijing engineers the transfer of 2-3% of GDP every year from the state sector to the household sector – for China to achieve growth rates anywhere near 6% for the next decade. I would make two further points about the consensus:

1. Even though most analysts who now think 6% is the likely lower end of China’s growth trajectory have already had one or more Damascene conversions, they still think of rebalancing largely as a linear process. It isn’t. The longer unbalanced high growth is maintained (and high growth is always unbalanced), the sharper the reversal must ultimately be.

In the best-case orderly adjustment, growth rates will drop every year, more or less smoothly, as credit growth is constrained and investment growth drops with it. As the reforms proposed during the Third Plenum are implemented, ordinary Chinese households will benefit from direct or indirect transfers from the state sector, so that total household wealth will continue to rise more or less in line with the growth in household income during the past decade. In that case, consumption growth will remain in the 5-8% range.

As this occurs, the consumption share of GDP growth will, of course, rise over the next few years so that much slower GDP growth does not imply much slower growth in the rate at which ordinary Chinese see an improvement in their standard of living. The two biggest risks to a smooth adjustment are, first, that the Chinese elite are successfully able to prevent the implicit transfers of wealth to the household second implied by the Third Plenum reforms, and second, that the wealth effect of a collapse in real estate prices, or a high correlation between consumption growth and investment growth, result in much slower than expected consumption growth. The second risk is the focus of a recent blog posting in which JCapital’s Anne Stevenson-Yang’s more pessimistic consumption expectations are contrasted with mine, with a follow up blog posting, and while we disagree, I don’t completely dismiss the JCapital position.

A disorderly adjustment will have a different dynamic. It is likely to occur after another 2-3 years or relatively high (7-8%) GDP growth rates followed by a very ugly contraction once debt capacity is exhausted, which will occur when new loans cannot grow fast enough both to roll over existing bad loans (by which I mean loans that funded projects whose returns were insufficient to liquidate the loans) and to generate economic activity. Average growth rates in the case of a disorderly adjustment will be well under 3-4% but the adjustment will be highly discontinuous.

  1. So if GDP growth rates are much lower than current consensus and even much lower than what most analysts would consider a “hard landing”, does this mean – especially if China’s economy is, as the New York Times called it, “the world’s main growth engine in recent years” – that the global economy is dire straits?

It depends on how China adjusts. China is not the world’s growth engine and never has been. It is simply the largest arithmetical component of growth, which is a very different thing. Whether China’s economy slows, and how quickly it does, matters to specific sectors of the global economy – positive to some and negative to others – and this will depend primarily on the evolution of China’s current account surplus. An orderly rebalancing will be good for the world on average and a disorderly one bad.

The same is true about the effect of a Chinese slowdown on social conditions. People do not generally care about GDP growth rates. They care about their own income growth relative to their expectations. Rebalancing in China means by definition that Chinese household income growth will outpace GDP growth, after many years of the opposite. A best-case orderly rebalancing should result in little change in the growth of household income, even as GDP growth drops sharply. This for example is what happened in Japan from 1990 to 2010, when GDP growth dropped close to zero but household income grew at nearly 2%.

A disorderly rebalancing, however, could result in negative growth in both GDP and household income, with the former dropping more than the latter. This, for example, is what happened in the US in the 1930-33 period – with GDP dropping by around 35% and household income dropping by around 19%. In the case of China, in other words, while elites will suffer in both scenarios, in the former case there is no reason for popular discontent.

Is China the world’s growth engine?

When analysts say that China is the world’s growth engine – something they said about Japan in the 1980s, by the way – they are implicitly assuming incorrectly the source of growth. If you multiply China’s GDP growth by its share of global GDP, you will find that Chinese growth over the last few years has comprised a larger share of global GDP growth than that of any other country. But this doesn’t mean it is the engine of growth.

An engine of growth drives growth around the rest of the world. If an economy is simply growing quickly, and especially if it is growing at the expense of other economies, it can hardly be called an engine of growth. In that case its growth actually constrains growth elsewhere.

Consider the colonial relationship between Britain and India 200 years ago. During the middle of the 18th Century and well into the beginning of the 19th Century India produced far more textiles – and usually much cheaper and of better quality – than did England, but a number of measures aimed at undermining Indian textile producers and protecting British textile producers (tariffs that almost always exceeded 50%, for example, and by 1813 were as high as 85%) meant that at some point in the first half of the 19th Century the British textile industry had become the most efficient in the world and was able largely to eliminate the Indian textile industry from global competition.

There is no question that Britain was the largest component of global GDP growth at the time (the US and Germany did not surpass Britain until the 1860s and 1870s), but it would be foolish to say, at least in the Indian context, that the UK was the “engine” of global growth. In the textile industry, its growth came at the expense mainly of India. I am not suggesting that China’s growth relative to the rest of the world is equivalent to Britain’s growth relative to India. My point is only that a country’s contribution to global growth cannot be calculated by measuring its share of global growth.

So what contributes to growth? One of the thornier debates in economics is the debate between supply-siders, who insist that increasing production is the only way to increase growth, and the demand-siders (often Keynesians) who insist that increasing demand is the only way to increase growth, at least it is when resources are underutilized. Each statement is one side of an accounting identity, but causality does not necessarily run only in one direction. Growth can be driven primarily either by supply or by demand, depending on circumstances. When savings are in short supply, it is the latter. When not, it is the former.

To put it more explicitly, when investment is constrained by a lack of savings, the best way to generate growth is to increase investment by forcing up the domestic savings rate, in which case the world’s growth engine is likely to be the country that exports capital to investment-hungry parts of the world. Of course a net exporter of capital is by definition a country that is running a current account surplus.

In the United States during much of the 19th Century, an erratic and unstable financial system combined with the huge infrastructure needs of a rapidly expanding continental economy meant that the US was almost always in short supply of money and capital*, and so to a large extent its growth rate was constrained mainly by British liquidity. When money poured into the US from Europe, and mainly from England, investments in the US grew apace and the US economy boomed, until some event caused the taps to be turned off (the collapse in silver mining in the 1820s during Latin America’s wars of independence, for example, which was followed by the US crisis of the 1830s and, as a matter of interest to those interested in Chinese history, with the replacement of silver exports with opium to the silver-starved Qing government in China). Whereas Britain may not have been an engine of growth for 18th Century India, or at least for the Indian textile industry, it was for much of the 19th Century the world’s engine of growth because it supplied much of the capital that a savings-starved world needed to fund investment.

But when savings rates are excessive, which is often a consequence of income inequality and a high state share of GDP, as I show in one of my earlier blog posts, the problem the economy faces is insufficient demand, not insufficient savings available for investment. In fact as consumption declines with the rising savings rate, it tends to reduce the need for productive investment, so that both productive investment and consumption tend to drop.

Technically you can never have “excess” savings over investment because savings must always balance investment globally. But as I show in another blog entry, the tendency of rising income inequality to force up the savings rate beyond the needs of productive investment must necessarily be balanced by one, or a combination, of three counterbalancing events:

  1. As the savings rate tends to rise (or, which is the same thing, as the consumption rate tends to decline) productive investment opportunities tend also to decline, so that excess savings flow into speculative and non-productive investment, including rising inventories, developing countries, risky technology ventures (which can generate huge positive externalities), real estate, stock markets, etc.
  1. Perhaps because rising prices in speculative assets causes a strong wealth effect, ordinary households borrow against their rising wealth to increase consumption faster than their income increases, driving down their savings rate in line with the rise in savings that accompanies rising inequality.
  1. Rising speculative investment, rising inventories, and rising debt eventually reach a limit, often followed by a crisis, after which unemployment must rise and, by reducing production faster than it reduces consumption, forces down the savings rate enough once again to maintain the balance between savings and investment.

When the world suffers from too low a level of savings to fund needed productive investment, policies that force up savings are positive for long-term growth. For similar reasons, economies with excess savings create growth abroad by exporting the excess to where it is needed. In that case the supply-side insistence on focusing policy on ways to generate additional savings does result both in more growth and in trickle-down wealth expansion.

However when savings are high enough and mobile enough that balance can only be achieved in the form of high unemployment, the world does not need more savings to fund more productive investment, as the supply-siders argue, but rather more demand, as the Keynesians insist. More sustainable demand (in the form of needed infrastructure or of higher consumption by wealthier workers) will lead to more productive investment by redeploying underutilized resources, including unemployed workers.

If there is such a thing as a global engine of growth, in the latter case, it is the country that is able (or is forced) to import the most amount of capital and export the most amount of demand (i.e. run the largest trade deficit). In that case countries with large trade surpluses that have to export excess savings do not cause growth abroad. As an aside Kenneth Austin recently published in The Journal of Post Keynesian Economics what I think is a very important paper on how capital exports affect the global economy. His paper is summarized in a recent New York Times article.

What will drive China’s contribution to global growth?

So what kind of world are we in – one with excess savings, or one with excess demand? I would be truly surprised if anyone suggested that we are in the latter world and not the former. A world of excess savings is prone to bubbles, and either debt-fueled consumption or high unemployment, and this pretty much describes the world we have been living for the past two decades. For this reason I would argue that countries that are absorbing excess savings – i.e. running current account deficits – are generating growth abroad while countries that are exporting excess savings – i.e. running current account surpluses – are weakening growth abroad.

China, in other words, is not the world’s growth engine. Behind Germany and ahead of some of the oil producers, it runs the largest current account surplus in the world, which means that it is exporting its excess savings in a world that has nowhere to put the money, and so the world must respond either with speculative asset bubbles, unproductive investment, debt-fueled consumption binges or unemployment.

This means that to assume slower growth in China will reduce growth abroad is wrong. As the growth rate of China’s economy drops, the fact that its share of global GDP growth will drop does not presage anything bad for the global economy. What matters is what happens to China’s current account surplus. As long as the world suffers from weak global demand, if China’s current account surplus declines relative to global GDP, China is adding net demand to a world that needs it. This is positive for global growth. If on the other hand China’s current account surplus rises, China will be adding more savings to a world already unable to absorb total savings productively, and the world will be worse off.

This tells us how China’s rebalancing will affect growth abroad. China’s contribution to global growth over the next decade depends on the relative pace at which savings and investment decline. If savings declines faster than investment, China’s excess savings will decline and with it its current account surplus. China in that case, will be adding net demand (or reducing negative net demand, to be more precise) to a world that needs it. If on the other hand China’s investment rate declines faster than its savings rate, its current account surplus will by definition grow, and the world economy will be worse off.

So which will it be? I think it depends on how orderly the rebalancing process will be.

1. In an orderly rebalancing, China will take steps to reduce investment growth. Instead of causing unemployment to surge, however, the reforms proposed during the Third plenum, most of which involve direct and indirect transfers from the state sector to the household sector, should keep consumption growth rates relatively high.

In order to keep the process as stable as possible and to prevent a surge in unemployment, my guess is that investment will decline more slowly than consumption will rise, so that in effect the gap between savings and investment narrows. This is just another way of saying that China’s current accounts surplus will narrow as a share of global GDP and the effect for the world will be positive (this is what occurred during Japan’s rebalancing between 1990 and 2010).

2. A disorderly rebalancing can occur in a number of different ways so it is hard to predict the impact on the current account, but the most likely outcome would be a surge in the current account surplus. Assume, for example, that a disorderly rebalancing occurs because Beijing waits so long to force through the reforms that it runs into debt capacity limits (i.e. the growth in debt cannot exceed the growth in the amount of bad debt that must continually be rolled over). In that case investment will drop quickly. At the same time unemployment will rise, which will partially reduce the savings rate, but worried Chinese households with jobs will cut back on consumption, which will increase the savings rate.

If the combination of the two causes the savings rate to rise, or to fall more slowly than the rapidly declining investment rate, the automatic corollary is a rise in the current account surplus. This would reduce demand in a world already suffering from low demand.

A slowing Chinese economy might be good or bad for the world, depending on how it affects the relationship between domestic savings and domestic investment, and this itself depends on whether Beijing drives the rebalancing process in an orderly way or is forced into a disorderly rebalancing by excess debt. My best guess is that Beijing will drive an orderly rebalancing of the Chinese economy, even as it drives growth rates down to levels that most analysts would find unexpectedly low, and this will be net positive for the global economy.


This is an abbreviated version of the newsletter that went out ten weeks ago.  Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at [email protected], stating your affiliation, please.  Investors who want to buy a subscription should write to me, also at that address.


* To the point, where counterfeit money was often accepted as real, even though it was known to be counterfeit (Stephn Mihm, A Nation of Counterfeiters: Capitalists, Con Men, and the Making of the United States, Harvard University Press, 2009). This, by the way and for those who find this kind of think interesting, was also true in China during the late Ming Dynasty, and explains China’s huge demand for silver, which was soon to be supplied by Spanish silver discoveries in the Americas.


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  1. – I think a chinese slowdown will lead to a drop in commodity prices and a drop in commodity prices will reduce the Current Account balances for a number of countries. Especially for those countries who are large importers (US, UK, ……… ) & exporters (Canada, Brazil, Australia, Chile, …… ) of commodities and it certainly will help to reduce worldwide inbalances.
    – In the last months we saw WTIC oil drop from ~ $ 110 down to ~ $ 70. That on its own will help to reduce those worldwide inbalances too. Although these lower prices are good for the US consumer, it’s bad for US oil production (think shale gas & oil) and actually could lead to MORE US oil imports and a larger US CA deficit. (US shale oil production becomes unprofitable when oil drops below ~ $ 75).
    – Chinese GDP growth dropping down to 6% is – IMO – a very optimistic view on economic developments in China.

    • Not just optimistic, Willy2, but nearly impossible. In my opinion it would take transfer from the state to households of roughly 2-3% of GDP for this to happen, and that would be politically too difficult to pull off. As for commodity prices, they still have a long ways to go. With Chinese credit officially growing at 14-15% (probably more if you include the growth in corporate receivables driven by cash constraints) and nominal GDP growth at around 9%, we have already started reining in investment growth but still have a long ways to go. When iron was at $190 I argued for a 50% price drop within 3 years. I am guessing we are now in the $70-80 range, but I think I was too timid in my projections, and now expect it to go blow $50.

      • – I think chinese growth is (far) below 6%. And even when at 6% today I think it will go (much) lower in the (near) future.
        – Commodity prices hinge on where the USD goes. And I think the USD will be going (much) higher, pushing commodity prices (much) lower. And I consider a USD going (much) higher to be the most bearish sign for the entire world economy.

        • Commodity prices depend on global supply factors, not on the USD. What role do commodity play in an economy? They’re only used as economic inputs.

          We’re seeing a worldwide collapse in the excess capacity the world has built up. What does that imply for the shift in demand for economic inputs?

          The USD is correlated to the movement in commodity prices, but it isn’t CAUSING the movement in commodity prices.

          • Suvy, Well said and generally correct.
            from the point of another whose currency is not the USD.
            If the dollar strengthened due to market conditions and/or Central Bank policies of another country, currently and previously, where commodities may lessen in USD terms, they can rise in different domiciles, but it is important to point out what you have, which is commonly incorrectly understood when discussed by US and foreign media sources; especially financial media outlets (to say nothing of those with social and political agendas).

            It is a shame that so much of what is stated, seems to be for short-term focused daily traders.

  2. Michael,

    Thanks again for sharing your insights.

    Your prediction that China can prevent a banking crisis makes a lot of sense, especially since all the big banks are state owned.

    But what about shadow banking? Was shadow banking in Japan analogous in size (or complexity) to what we see in China today?

    This is what seems most vulnerable to me, all the yield-chasing money tied up in funds of short duration and suspect collateral. Really what Lehman Brothers was all about.

    It seems like managing the banks might prevent the worst effects here of September 2008-2009, but not really those leading up to September 2008.

    One more question, re Japan 1990. Was consumption crushed there during the fall in real estate? I guess comparing them would mean looking at consumption, income and property prices all relative to each other.

    Thanks again,

    Bob Stewart

    • Much of shadow banking will end up in bank balance sheets, so there is unlikely to be a crisis. The problem with the shadow banking sector, especially trust and wealth management products, is that if you were to allow real defaults the subsequent “bank run” would be highly destabilizing and the authorities would probably have to find ways to insure it.

  3. my question is what is “excess savings” and “excess demand”? excessive relative to what? Is excessive saving causing overproduction and overcapacity? If too much saving is bad, isnt it more rational for workers to stop working and just get on welfare?

    • I use excess savings to mean the excess of savings over productive investment. Excess savings doesn’t “cause” overproduction. Overproduction results in excess savings, but you have to remember that excess savings is not something you can measure because by definition it cannot really exist overall. Globally savings is always equal by definition to investment, so that the concept of excess savings is really about institutions (income inequality, a rising state sector) that force up the savings rate in one part of the economy without there being a corresponding and realizable demand for savings to fund productive investment elsewhere. In that case by definition either this excess must flow into non-productive investment or it must cause savings elsewhere to drop, either by funding a speculative asset boom that funds a consumption boom, or by raising unemployment as workers in industries with excess capacity to lose their jobs. Unemployment, in other words, does work in maintaing the savings = investment balance, but its certainly not the preferred way to do so.

  4. Prof. Pettis and others,

    What should we make of the rate cut in China? Isn’t this the opposite direction of the way they need to rebalance?

    • Not necessery, because if growth rate are fake. It’s possible that they could also cut rate much lower.

    • HI everybody!

      Michael you lost me. Last time you you said that you did think that African economies will be hurt by lower China growth by the commodity market. I was sayung that if China rebalance (what i think) the current account surplus of China will move and some to Africa. I know and i agree with you that some will go to US. But where do you think the rest will go if it won’t go to Africa? Lot of countries in Africa are already in current account deficit and most of them have very low saving rate(so they export demand).
      Second i start to improve my knowledge on Africa, and one of the main main thing i learned that can interest you is that, african economies used to have a much higher saving rate before African economies crisis. But it was an over investment/mismanagment buble. And i think they just drop capital control/repression policy as consequence.
      in euro peg countries, banks are too liquid(which means that they do find customers). I wonder if you think it could be related to the central bank behavior? Because in this countries, they have to put half of the central bank asset in deposit in the french central bank in garanty. To me this kind of permanent outflow is the reverse of capital control. What do you think? (of course i’m interested in everybody thoughts)

      • African hard-commodity exporters with current account deficits (CAD) are certainly likely to see upward pressure on those deficits as commodity prices drop, Cedric, but remember that CAD must by definition be financed by net foreign capital inflows. If lower commodity prices reduce growth and increase risk, the CADs of these African countries are likely to drop as foreign investors pull back and local investors take money out of their countries.

        And here is exactly where the problem lies. Because the CAD is by definition the excess of investment over savings (which is why it must be equal, also by definition, to net foreign capital inflows), if the CAD declines, either domestic savings must rise or domestic investment must decline. Declining commodity prices means lower income, and so it is very unlikely that savings will rise, so the only alternative is that investment drops.

        Unfortunately as investment drops, workers will get fired, and so savings will drop too, meaning that investment has to drop even more. It is a very ugly circle, and it is not easy to get out of it.

        • Ok thanks, i think i disagree on two things.
          First i don’t think there is a connection between growth and commodities in Africa. I really think it’s a sevice story. New technology help a lot of people to do a better business and the biggest part of productivity come from there. Unfortunatly the service sector is very difficult to mesure and for most of it is still in the informal sector. you might have heard that some african countries made update of national accounting and service sector always explode in the new calculation. In Nigeria it came from 22 % to 52 % of the GDP, and oil sector from 33% to 14%.
          Second, the deflation deprsession cycle you talk is unlikely because of the quality of investment in Africa. Most of investment are low quality, and expect a low market price to make money. If you look at Mongolia, they are already hit by commodities fallling prices. Take now countries like Congo they are still growing even if they rely on commodities. because if you make cheap investments it is still make sense.
          They are many more fact that i would like to add but i don’t want to troll your blog.
          I don’t say that your argument are wrong but i don’t think they are relevant for most african economies.
          But they are still some countries where you can be right like Ghana, Botswana, Angola, Equatorial Guinea, South Africa.

          On current account my question was also:”who is going to make cheap goods that are actually made in China? India, bengladesh, Viet Nam?”

          I’m still interested in your opinion(and any opinion) on the behavior of euro peg central banks,.

          • it seems pretty obvious that domestically as China’s economy rebalances, with the BRICS and ASEAN infrastructure bank type talks, that this is essentially a tied aid type of situation for China in moving out, using its savings to subsidize the external operations of SOE’s that have been heavily involved in building out domestic Chinese infrastructure.

            There had been talk of small Chinese investors manufacturing in Africa.
            Early stage OBC investment has already cycled through domiciles in SEA, in some cases, onward into China, back out to SEA, from one site to another site in SEA, and toward SA.

            So, your question is a good one Cedric.

            It does seem that many developing nations who need to develop manufacturing to industrialize, and create a modern service economy, supported by a proportion of domestic manufactures, with a natural resource segment, are inhibited by ongoing focus in SEA, and then the rise of India, which I suspect will be inhibited as well, to speak nothing of Africa. If one considers the work of Kaplan, the entire Indian Ocean itself, might act as a break more widely in Africa itself, if development does occur even unto Tanzania, Kenya, Ethiopia, etc….bask to SEA, with SA between.

      • I am not sure that euro peg banks are too liquid other than the sense they have inexpensive loan opportunities from the central bank in Europe. They probably have impaired capital in that their balance sheets contain assets whose realizable value is significantly less than its notional value, for the most part sovereign debt that cannot be marked to market because the losses can’t be allocated. This combined with their massive leverage means they are crippled entities. Because the euro zone cannot deleverage in the same speedy fashion that the USA did after the the GFC this loss realization and recapitalization will take a long time and therefore effectively creates a zombie euro zone economy somewhat analogous to the Japanese situation subsequent to their late eighties real estate and stock market debacle with not dissimilar demographic profiles including aging populations and difficulties or refusal to absorb immigrants. Here the write downs were avoided for somewhat different reasons cultural for the most part. The Chinese recognition of losses subsequent to their credit creation spree is probably going to be treated gingerly as well. This leaves the global economy shy of demand drivers. Existing players do not wish to bite the bullet on the cost of the necessary write downs and they have the political clout to enforce their wishes. At least the USA has deleveraged more then the others and those parties that can export into this country can keep their people employed albeit at more competitive levels than they have been used to in the past. Germany has at least kept it self in the game by the artifact of a currency union with an extremely favourable exchange rate entry point for itself, very high costs for other parties who wish to exit the union and the prudent policy of keeping wage levels modest. This means as this drama unfolds their unemployment levels are likely to remain low. Canada may also escape the fate of the other commodity exporters by devaluing their currency and taking advantage of better access to the U.S. market. Mexico may also be better positioned than the other Latins by their better integration into the U.S. economy. The Qualcomm fines in China and other similar events lead one to suspect that consumer demand growth in China will be reserved by one mechanism or another for Chinese players. The similar events that tend to happen in India will likely make both these growing consumer markets less attractive destinations for capital infusions. Canada and USA appear better positioned to address their capital adequacies and demographic challenges going forward therefore genuine demand growth the rarest of all commodities in the current environment appears most accessible here.

    • Yes, Suvy, I think this makes the imbalances worse, and while Cedric’s skepticism about real growth is probably justified, I suspect that this is just part of the political back-and-forth we are going to see over the next year or two. Remember that rebalancing hurts the interests of the elites who benefitted disproportionately from unbalanced growth. Beijing has to juggle the need to implement the rebalancing reforms with the opposition these will generate, and so we will see them take steps forwards as well as backwards.

  5. Interesting view that a declining current account surplus in China would be good for the global economy but it makes sense. I guess it depends on where you are. I could see how this could be good for other large countries who are crying for growth. I’m in Australia and it seems that for the commodity countries it will still be a hard adjustment as their cash cow gets taken away. In Australia the decline is really starting to pick up with Real net national income declining for the 2nd quarter in a row as the terms of trade declines and unemployment slowly edging up.

    Perth, WA which was once the king of Australia shipping all of the ore out of the Pilbara to China is also declining heaps with rents falling, property vacancy rates rising and last weekends property auction clearance rate was around a woeful 25%. The Western Australia Premier recently came out in the media and said that Bhp and Rio tinto should watch their supply increases because it’s denting the iron ore price and causing state revenues/royalties to fall. You know it’s getting bad when the premier is blaming corporation operations for budget blowouts.

    • Yup. Australia is in major trouble. I suspect Australia ends up having stagflation or stagflation-like effects.

      • Actually, while the notion of lucky or blessed in these matters, has often been mentioned, and certainly moderated amounts of this, spread over a longer-time frame could have likely been experienced as such, the model of economic growth and wealth creation, and Australia’s proximity to a series of growth examples in East Asia, has long positioned it has a recipient of luck in “short” bursts. The excesses of this, and the rather grand example that China is in this, has entirely skewed the economic landscape and created challenges to balance for the typical Australian; costs structures in society, real estate (from Japan through NIE’s and Tigers to China), wages (minimum wage slightly more generous than the US when the USD commanded 2 AUD, now preposterously degrading of Aus industry at recent levels), etc….

        How this will work out is strange to consider. Again, Rodrik might be on to soemthing.

        But, with Hugh White bantering on the social and political space, and economic irrealists otherwise, it does seem a confusing set of forces might play on the Australian mind when trying to make sense of all this.

        An interesting point is notice the traditional spread between NZD and AUD has been broken. Might the NZD actually become stronger than the AUD do to differing structure in traded goods and services. If so, i should imagine many a wealthy Australians stand to make a pretty penny, then what, divestment. Interesting to consider.

      • No. Australia is headed for a US style DEFLATION. Australia has a debt to GDP ratio that’s about equal to that of the US. Australia has benefited in the last 20 years from chinese appetite, continued to invest LOTS of money in mining projects and now has to “face the music”.

        The Howard government (1996-2007) has squandered/waisted all that money/income and now Australia has face the consequences of the (giant) debt build-up. During the Howard government, Australian debt-to-GDP has more than doubled from ~ 60% to ~ 140%.
        The australian website MACROBUSINESS

      • No. Australia WILL have to face DEFLATION as well. Australian debt-to-GDP has risen during the Howard government (1996-2007) from ~ 60% up to ~ 140%. It more than doubled.

        The truly excellent australian website MACROBUSINESS has more details:

        Mr. Steve Keen has also provided more details:

        • Steve Keen is wrong. Australia is a heavy commodity exporter. A drop in commodity prices causes a rise in input costs, which is always bad for productive capacity while consumption costs rise. Note that as commodity prices fall, capital inflows into Australia will fall and the demand for the AUD will as well. The currency will fall, which is effectively like a consumption tax. So you’re gonna see falling productive capacity as inputs and consumption becomes more expensive–that’s stagflation. I wrote about it here.

          Steve Keen doesn’t grasp international economics (at all). Anything involving international trade is something Keen doesn’t understand very well. Keen is making a mistake to think that Australia is comparable to the US, but it’s not. The supply side of the economy is very different between the two countries.

          BTW, have you been paying attention to the AUD? I don’t think Steve Keen has either.

          • – Wrong. Falling commodity prices lowers input costs. It’s good for consumers but bad for producers. (think: production of US shale oil is profitable when oil >= ~$70 and at which price is oil today ?)
            – Oil priced in USD has dropped some 33% since july 2014 but even in AUD oil has dropped some 20% (AS WELL). Even the CRB index has dropped some 20% in AUD. What do you mean “Stagflation” ?
            – Australian iron ore exports (in tonnes) have actually increased in the last 12 months but it was the price per tonne that has dropped (alongside the rising USD). And that (price) drop means that already a number of smaller australian mining companies are on the verge of bankruptcy because they their calculations assumed a (much) higher iron ore price. Only with those higher prices iron ore production was profitable. Now we’ll see a flood of debt defaults of those same companies (=credit destruction = DEFLATION). What do you mean “Stagflation” ?
            – Even IF we would see Stagflation in Australia then that would be extremely DEFLATIONARY because it would make servicing debts much more difficult. In the stagflationary 1970s the australian debt-to-GDP ratio was at a mere ~ 20 to 30%, now it’s at over ~ 140%. Quite a difference, I would say.

          • Falling commodity prices provide lower input costs for countries that input commodities.

            If I export oil and oil prices are dropping, I obviously haven’t reduced import costs because oil isn’t something I have to import. An economy is just how you turn imports into exports. YOUR EXPORTS PAY FOR YOUR IMPORTS! In this scenario, all you’ve done is reduce export revenues, so your imports must come down. It’s not rocket science.

            PLEASE, PLEASE, PLEASE DO NOT compare the US with Australia.

            What do you think I mean by stagflation? If production is falling while consumption costs are increasing, that’s how you get stagflation. Outputs are what pay for inputs and if output revenue drops, inputs must drop as well.

          • Why do you think you can’t have bankruptcies while having inflation? You’re using a theoretical reason to back your claim when there are clearly MANY counterexamples that exist.

            BTW, ANYTHING your economy imports is necessarily an input. Since Australia is a heavy commodity exporter, a fall in the demand for commodities or a fall in commodity prices produces a drop in the value of the currency. You can export 10-15% more iron ore, but if you’re receiving 50% of what you were 5 years ago, good luck trying to keep your currency high.

            Remember that the currency functions like a consumption tax on imports. So it increases both input costs and consumption costs while placing downward pressure on real consumption. So revenue from outputs is falling along with the currency. Less output revenue must imply either:
            1. You reduce inputs
            2. The CAD goes higher, which will place further downward pressure on the currency and pushes up input costs and acts as a consumption tax.
            Also, Australian investment in mining that’s occurred over the past few decades will reverse, which also means falling production.

            The Australian economy is suffering from excess capacity due to the mining boom and a massive real estate bubble. If you have excess capacity falling while the falling excess capacity creates capital outflows, export revenues drop, and the currency is coming under selling pressure, you’re gonna see:
            1. Falling production
            2. Rising consumption costs

            What happens when production falls while consumption costs go up and a currency experiences falling pressure? That’s right, stagflation.

            Basically, there are feedback mechanisms embedded in the system and debt-deflation isn’t the only possible feedback mechanism.

            You brought up oil, but that’s one part of an economy and the Australian people buy a lot more stuff than just oil. I also don’t think we’ve seen the end of the fall in the AUD and I doubt oil prices can go <$50/barrel (in USD).

          • I’d like to point something out. Notice how I’m not really using any economic theory. I’m starting off by defining economics as how we use outputs to pay for inputs, then looking at the inputs and outputs while trying to find the feedback mechanisms in play.

            I’m not using theoretical BS from an economic textbook and saying that this happens when that happens or that this means deflation (ex. assuming credit destruction always means deflation). You really can’t do that when you’re looking at complex systems.

            You don’t know how something will impact something else without looking at how interconnected everything is. Steve Keen doesn’t really look at balance sheets (he kinda does, but not really) and doesn’t understand international finance, which is why his approach is completely wrong. He’s actually a very overrated economist.

            BTW, credit destruction can cause inflation if it causes capital outflows and a falling currency. Plenty of cases in history to support my example. That’s exactly why you don’t build your economy around commodity exports. Quite frankly, it’s quite a retarded idea.

          • Suvy, do explain what you mean by drop in commodity prices causes a rise in input prices, you mean because of lessening demand for AUD, by the mechanics you describe, if so, then state that, and loose the “always”, because if so, normally, and more generally, or in this case is better

            Because always assumes that only the forces you describe matter, and I suspect there would be many cases, where always wouldn’t be always.

          • “Suvy, do explain what you mean by drop in commodity prices causes a rise in input prices, you mean because of lessening demand for AUD, by the mechanics you describe, if so, then state that”

            I thought I did say that. I may not have been clear.

          • @Suvy:
            – Both Australia & US have remarkably comparable economies:
            – Debt-to-GDP ratios.
            – the % of people that work in mining, agriculture, manufacturing, Service sector, FIRE sector.
            – Only 5% of australian work is tied to mining.
            – Regarding the words Stagflation & inputs: Don’t start making up your own definitions. You’re only creating more confusion.
            – Of course, one can have more bankruptcies when there’s (price !!!) inflation (e.g. in stagflation). It much less likely when one has credit (!!!) inflation. If one has a (massive) credit inflation then price inflation doesn’t matter too much. (Think what happened in the US after 2001 with credit and e.g. oil.)
            – Australia’s problem is that the price of e.g. coal & iron ore (in USD) went down MORE than the AUD/USD went down in the last 1 to 2 years. So, in AUD the price of iron ore & coal went down as well. And australian wages have to be paid in AUD. The profit margin squeeze occurred as a result of production costs remaining flat & sales revenues going down. And that’s, combined with a debt/credit fueled investment boom toxic for an already heavily indebted country. But I see the same dynamics in China & the US as well.
            – Exporters (of e.g. electronics in S.E. Asia) to Australia don’t want to increase their (AUD) price and will be forced to take a lower profit margin on their exports to Australia. And that will reduce australian price inflation. We already noticed that manufacturers in Asia were forced to accept lower prices. So, I don’t see how there will be too much (price) inflation.
            – “International finance” doesn’t drive an economy. Consumption & spending does. “International finance” & trade is the result of inbalances in the world (e.g. some countries need to import oil and some countries export oil, etc. If every country had enough oil in the ground then why export that stuff in the first place ?). That’s why it’s important to understand the dynamics between debt, income & spending. And that’s why the work of Steve Keen is so important. Overrated ? Far from.
            – A cycle of economic expansion & contraction IS a cycle of credit expansion & contraction. Another good reason to listen to Steve Keen.
            – DO NOT think that falling commodity prices won’t have an impact on the US !!! Yes, the consumer benefits from those lower prices but domestic producers will see their profit margins being squeezed and evaporate (=leads to higher unemployment = lower demand). More over falling commodity prices shrink the US trade and Current Account Deficit. And that means the US “Exorbitant Privilege” shinks & turns into a US “Exorbitant Burden” (= leading to higher unemployment). And that’s in spite of “differences on the supply side”. Remember a previous blogpost on this website regarding that topic ?

          • How much of the American economy relies on commodity exports?

            Not very much. The comparison between the US and Australia ends there! It’s that simple.

            BTW, the price of iron ore IS STILL FALLING! It didn’t stop falling last year. It’s still dropping like a rock and will continue to do so because of Chinese overcapacity. All of this is stuff Keen doesn’t look at.

            The assumptions you’re beginning with are clearly falsifiable. In other words, you need to find a new place to start.

            There’s more going on in an economy than credit creation and credit destruction. An economy is how you pay for your inputs using your outputs. The US economy doesn’t rely on international trade at all (and most of the international trade in the American economy is tied to North America). How does that compare to Australia?

            You’re really overthinking this. It’s not that complicated!

          • Another point I forgot. It’s not about what exporters or countries want to do. It’s about what they HAVE to do or are FORCED to do.

            You can tell me all about what these exporters want to do, but that’s an irrelevant question. The problem with relying on exports is that when shit hits the fan, what you wanna do doesn’t matter any more.

          • @Suvy:
            – Agree. We (the US) are a net commodity importer and the % of the US economy relying on imports is (relatively) small (~ 13%). But that was not what I was saying. I said that falling commodity prices DO have a negative impact on the US because then the US Trade Deficit & Current Account Deficit shrinks. And a shrinking Current Account means that our “Exorbitant Privilege” turns into a “Exorbitant Burden” (See Michael Pettis). And I have noticed that A LOT OF my fellow americans find that very hard to swallow. They’re so US centric (including one “Suvy” ???).
            – Falling commodity prices (& a rising USD) also hurt US domestic producers and leads to higher unemployment (in spite of lower “input” costs for consumers).
            – The fact that Steve Keen doesn’t look at international money flows doesn’t mean he’s “overrated”. Keen is VERY WELL aware of how dependent Australia is on commodity exports and the “shaky” situation in China. But that’s not the (main) focus of his work/analysis.
            – “Falsifiable” ? I re-read my replies and don’t see why you use this word. All the facts I cited were found on the internet.
            – “There’s more going on in an economy than credit creation and credit destruction. An economy is how you pay for your inputs using your outputs.”

            Agree. But currently US total debt is at > $ 57 trillion and that’s why even a small (negative) change in debt has a MAJOR (negative) impact on the US economy (See Steve Keen). And we (the US) have paid for our “inputs”, partially by taking on more than $ 57 trillion of debt in the last say 30 years. So, credit creation & destruction DO play a major role in e.g. the US economy.
            – Australia & the US have something else in common. In spite of a very good export prices for commodities, Australia has been running Current Account Deficits for about 90% to 95% of the last say 15 years.
            – Yes, I know, iron ore prices kept falling this year.

            Unless there’s something meaningful left to be said I want to close this discussion.

          • The shrinking US trade deficit is a benefit for the US. I don’t know why you’re assuming that as a negative. The US is, by far, the world’s most capital rich country. So why is it a negative for the most capital rich country to be importing less capital? From a supply-side perspective, the dropping CAD is a wonderful thing.

            I’ve read all of Prof. Pettis’ books and a lot of his work. It’s not the shrinking CAD that makes the the “exorbitant privilege” into the exorbitant burden. That’s complete nonsense. It’s the geopolitical benefits derived from being the reserve currency vs. the economic losses that are the cost of being the reserve currency. The current economic system was used by the US to fight the cold war (and it worked great), but there’s no strategic fight that we’re waging AND the #1 reason the US has been involved in world affairs over the past few decades was for energy. Shale is changing that very quickly.

            Falling commodity prices do hurt domestic producers, but they also help out domestic consumers. They help out households a lot–particularly the lower and middle class households. I’d also like to add that the domestic production in the US has primarily come from shale, which is really experiencing breakout technologically. The US, for structural reasons, is the only country where shale has really taken hold. The kind of production in the US is changing. Almost all off-shore projects have been eliminated and will probably be eliminated in the next few years.

            I agree that we need to deleverage, but how do you experience a drop in debt levels if the current account balances don’t shift?
            Remember the accounting identity:
            private debt change+public debt change=current account balance

            BTW, if Steve Keen is an expert on Australia’s economy that we should take seriously, then how come he doesn’t focus on commodity exports or on the international effects. Those are THE most important aspects. How can we take someone seriously who doesn’t understand the most important part about what’s going on right now? Quite frankly, he seems to purposefully ignore these aspects because it doesn’t fit his political narratives (he’s basically a socialist).

            To add fuel to the fire, this was an actual post that he placed on his Facebook page by some idiot called Stephanie Kelton (MMTer). They posted the link below. The topic is about how a federal budget is not like a household budget and basically advocates the transfer of debt from individuals to the state. They talk about how this is a good thing without realizing that you’re increasing risk by suppressing volatility (preventing debt from being written down). The consequences of bad government spending IS NOT inflation! It’s risking a future drag in growth if the productivity generated by the asset is not enough to counterbalance the REAL debt servicing cost (the NGDP growth rate). There are a lot more problems with this piece that he linked to (like not discussing the issue of incentives for bureaucrats/politicians), but I’ll end it there.

            The reality is that Steve Keen isn’t nearly as well-versed of an economist as you make him out to be and the people who’s work he advocates actually does suck. For example, he actually uses the correlation coefficient as “empirical evidence” for his equations without even looking at whether the use of the correlation coefficient is even valid.

            Quite frankly, my analysis is 20x better than Steve Keen (and I don’t think very highly of my analysis). Steve Keen may be specialized in understanding debt deflation dynamics and he may be building very “sophisticated” mathematical models, but he completely ignores the most important parts time and time again. He’s got very little rigor and logic and much of the stuff he says/the work he puts out is flat out horrible.

            Note: The moron who Keen cited (Stephanie Kelton) also doesn’t seem to recognize that the real cost of transferring resources is the NGDP growth rate and naively thinks that the real cost of the government borrowing is only the 0% interest rates that they currently borrow. Kelton completely ignores the fact that holding short end yields at 0% and asking for the government to borrow effectively endlessly while claiming there’s no risk just capitalizes the debt servicing costs (Prof. Pettis talks about this BTW and Keen ignores it).

      • Agree.
        Let’s not forget the high debt the private sector hold. It amazes me how long this can continue. As Mr Twain once said: history may not exactly repeat, but it does rhyme.
        It is only now, when iron ore has plummeted that the Australian government and people take notice. A sad state when the expectations in Australia have increased and increased..and what would one expect when there has been 24 years of uninterrupted growth! Good article to heed.

      • Agree.
        With record levels of private debt, the expectations of this great country have moved beyond ‘normal’. With 24 years of growth, why would the nation of people want anything but!

        For the government and people to take note , it had to take iron ore to fall hard.
        Sad but true.

    • Laurent,

      I don’t have an issue with what you have said, just a comment that the auction clearance rates in Perth are really irrelevant as auctions have never been anywhere near as important there as they are in Syd/Mel. % of RE sales by auction is extremely small in Perth so not a reliable indicator. However the huge jump in commercial vacancy rates in West Perth and across residential RE in general is!

  6. I assume you see recent rate cuts as antithetic to rebalancing?
    Do you feel this is a retrenchment of the path toward rebalancing (perhaps even implying potential rises in NPL’s or merely lighting the load of the indebted)?

    • See my response to Suvy, Csteven. As nominal GDP growth slows and as real estate prices drop, I suspect many of the borrowers whose earlier attitudes towards borrowing and investing were a little cavalier may now be serious under cash-flow pressure, in which case one of the reasons to lower interest rates may have been to relieve the pressure. I would imagine that more than one PBoC manager gritted his teeth and muttered angrily under his breath as the decision was announced.

      • “I would imagine that more than one PBoC manager gritted his teeth and muttered angrily under his breath as the decision was announced.”

        Yet again, politics comes before intelligent decision making by bureaucrats. So what’s the solution? More power to bureaucrats (if you listen to the socialists/statists). Makes sense, doesn’t it? Wait…..

        • Suvy,

          It is a mistake to assume so much, if I might.
          While bureaucrats might be mediocre; something Karl Icahn attributes to bureaucrats of large businesses, as well, it is wrong to load on the term politics. This, like so many past-times, largely dilutes the impact and utility of our thoughts, and undermines the power that can be found in our considerations; come of them. For example, Michael s musings, where he still flies largely under the radar, are being adopted by some profoundly well known global policy-makers and discussants. This of course is useful, for there seems to be something profound in his simple frames, something that can speak to many issues.

          Politics is merely the art or science or practice of decision-making (in regard to risk mitigation or accessing opportunities).

          Politics is subsumed to structures and forces.

          So, the answer is no mere omission of bureaucrats, this is far to simplistic in the face of the sets of forces and structures that exist. And frankly, a decision, by you, on the terms of ideals and values you hold, in relation to the structures and forces that you perceive, as these relate to risks and opportunities.

          It is one thing to have a wonderful frame that explains so many things that can be seen and considered around us (Michael s simple model). But as he notes, there is no simple panacea, and the omission of art and science in decision-making, would not make our ideals and values achieved more easily, does not make certain that intelligence will be had, or could be had while leading to better decisions, this is a rather grave assumption, that might be existent of the beauty you find in probabilities..

          • I don’t find beauty in probabilities. I find beauty in uncertainty. Probability isn’t about probabilities; probability is about uncertainty.

            The primary problem I have with bureaucrats is the problem of incentives. They try to plan everything and most (not all) don’t know how to properly deal with uncertainty. They tend to favor centralization and most don’t have any skin the game.

  7. One aspect that you do not discuss is that China is the largest and marginal buyer of commodities, and has driven up the price of energy and metals to unprecedented levels- levels not seen for 2 centuries whereas productivity tends to drive down commodity prices in the long term. China is clearly the “Global Driver for Commodities” by any measure.
    A slowdown in China over the next decade will cause commodity prices to collapse below their marginal cost- typically more that 50% from current levels, because there is no other country that could purchase the quantities that China has consumed in the last 10 years. And historically commodities spend more time priced below their marginal cost (not capital cost) than above.
    The benefits of low commodity prices to Global GDP growth is largely unappreciated, and will benefit the poor and less well-off than the OECD.
    I support your thesis that a slowing Chinese economy will add to “Global Growth” not subtract. But I have my fingers crossed that it is a gradual adjustment like Japan, and not a discontiguous one.

    • Actually I have been discussing the expected drop in commodity prices (hard commodities, not soft, like food) as the automatic consequence of China’s rebalancing since at least 2008-09, Scott. Hard commodity prices were very low at the turn of the century and there was a widely-held belief that pretty much nothing could cause them rise. I suspect that we will get pretty close to those price levels, adjusting for inflation, by decade’s end. I think iron trade around $20-25 back then.

  8. Hi Michael,

    I haven’t been to China since 2012 when i was last in Tianjin. The baking crisis was getting better (there were a few reasonable bakeries opening up that actually had multi-grain bread.

    That’s me trying to be funny because you have a typo – banking/baking…

    Other than that, great post!

    • Thanks, but it still isn’t easy to get good bread. Having grown up in southern Spain, to which I return a lot to see my family, and where most places bake their bread five times a day, so that you can often buy it while it is still hot, we have a very long ways to go before I can say that the baking crisis is over.

  9. Michael, can you provide further reading/ref/insight into Japanese wage growth over last 20 years. You state: “This for example is what happened in Japan from 1990 to 2010, when GDP growth dropped close to zero but household income grew at nearly 2%.” thank you.

    • If NGDP growth is at 0% while household income is growing at 2%, the household share of the pie is increasing. If you have that process over 20 years, the household share increases by around 48% while NGDP stays flat.

      The same thing needs to happen in China. In China, NGDP has grown much faster than household income (although both have grown). A necessary implication of such growth means that the household share of income has fallen. One way to increase the household share of the pie is to have slower growth with relatively higher growth in household income.

    • I don’t have the data in front of me, Scott, but by lucky coincidence FT’s Aphaville has a piece today on the topic which you can find at

      They say “Real Japanese household consumption grew at an annual average rate of 1.2 per cent from the beginning of 1990 through the end of 2013”, which almost perfectly overlaps with my 1990-2010 period, and then add that “Japan’s population only grew by just 0.13 per cent per year during that period (on average)”.

      This brings real household consumption growth to 1.33%. If you assume that during this period of rising uncertainty and declining asset prices (for a negative wealth effect) there was an increase in the household savings rate — which should not be confused with the national savings rate, which of course would have to have declined over this period for Japan to have rebalanced — then real household income grew faster than the 1.33% growth in real household consumption. Throw in a little inflation to convert real to nominal, and we should get very close to 2% growth in household income.

      Whatever data it was that I originally saw that got me to the “household income grew at nearly 2%” statement is very consistent with the FT article. Sorry I can’t be more specific but I don’t have the time to look for the data. At any rate the claim that Japanese consumption growth outpaced Japanese GDP growth after 1990 is true by definition because the consumption share of GDP in Japan definitely rose after 1990.

      The reason this matters so much is because before 1990, Japanese growth, like China’s in the past two decades, had the same kind of imbalances in which implicit household transfers subsidized production and in so doing forced up the savings rate. After 1990 this process was reversed and Japan largely rebalanced. Some people find it hard to understand how household income growth can exceed GDP growth, but it happens all the time.

      Of course the way it did so in Japan was, I would argue, not by transferring assets from the state sector to the household sector but rather by transferring debt from the private sector to the state sector, and while the latter was politically likely to be much easier than the former, I think it left Japan with a nearly intractable problem, and which only a debt write-down can resolve. For this reason I hope China is not tempted to follow the Japanese model.

      I should mention that there are many other ways in which a similar rebalancing has occurred. I am quoting from memory, so please check the numbers before citing me, but from 1930 to 1933 US GDP dropped by 35% and US household income dropped by 19%, providing another case in which household income growth outpaced GDP growth. These kinds of rapid, brutal adjustments are probably the most efficient kinds economically, but needless to say they are socially very painful and I doubt China could absorb a rebalancing of this nature.

      But one way or another China will rebalance, and it is very useful for us to recognize all the different paths a rebalancing economy can follow, and to consider what are the necessary conditions for whatever we might consider the optimal path. I am not sure enough analysts and policymakers are going through this simple, and seemingly obvious, exercise.

  10. Michael, Its an interesting insight for me from your blogs regarding how the surplus account and deficit account affects the demand in the world. However, does china’s faster growth and export surplus always a bad news for the world as it is exporting its surplus not demand because as for commodity producing markets its still a big positive as long as china’s growth engine is moving with its high demand for surplus.

    Isn’t that deficit countries like India and Commodities exporting countries like Australia see China differently. For Australia it may be a big plus getting huge upward demand in commodities but for India (like other Countries competing china for producing Goods) its a big challenge to shore up our exports due to extremely low cost of products from china.

    • I am always reluctant to consider any economic condition as being “good” or “bad”, Vamsi, except under specified conditions. You are of course right to say that India and Australia are likely to be affected in very different ways by China’s rebalancing.

    • And then, the very high costs of commodities also created enhanced costs for infrastructure and the development of productive capacity. However, the high costs did also bring lots of investment in the sector, globally, and falling prices will be had for a fairly extensive period of time do to overcapacity in ability to supply commodities from recent investments. This process of falling demand will also likely see sites shuttered, that will reduce supply, should demand only slowly recover. Regardless, as to build out of capacity in export capacity from India, it suffers from overcapacity in export goods productive capacity in China, that will, as commodities, also attempt to see cash flows. Thus this era has seriously skewed a more balanced global economy. Further, the limiting factor on other developing world countries ability to develop export industries for industrialization, along with diminished demand conditions globally, will likely see tensions rise. We have a sort of stasis currently, while most are merely worried of the next site of financial crisis, as few focus on the structural dysfunctions that will require much greater cooperation, accommodation and comprise to see growth dynamics in the developing and developed world alike. Thus, tensions, and with a form of stasis, retrenchment.

  11. Thank you for making your insights public. I’m just a regular person, not in finance, in the San Gabriel Valley in Los Angeles, so your posts are helpful at explaining some of reason why real estate prices are pumped so high by Chinese investors and potential impacts as the Chinese economy his it’s rough patch.

  12. Seems to me that the optimistic scenario is counting on Chinese households to consume enough commodities to keep from crashing those prices, so that China still imports some (although less) commodities but they are made into products that are locally consumed or used in the economy like coal to generate electricity and oil for transport.

    Admittedly, I don’t know beans about China, but that looks like a pretty fine line to walk.

  13. Hi there professor,

    There’s been some talks of lowering both deposit and lending rates lately. Do you think China might be “forced” into going back to its financial repression ways if not only for a period of time?

  14. Prof Pettis,
    I guess a lot of people are wondering, what do these scenarios imply for Chinese property values? Presumably a disorderly rebalancing will certainly cause a major drop in prices since demand will collapse during any financial crisis and speculators will try to cash out. But what about an orderly rebalancing? Does it depend on how much property is currently held for speculative purposes? Presumably it will not be as easy for local governments to continue their land pyramid schemes when loans for property development become harder to obtain. Also, the elites will lower their speculative demand for property. But demand from regular people should continue or possibly even increase. During the orderly balancing scenario, everything will change, but the impact on property prices is more ambiguous.

    As a related side note, interest rates have declined recently. What does this imply for the governments commitment to orderly rebalancing?

    • In my book and at least one of my blog posts I discuss how speculative markets and fundamental markets respond differently to changes in information. At some point I might apply this analysis to attempts by Beijing to slow the drop in housing prices, but the short answer is that I don’t think they will work.

    • More than just financial crisis and destruction of wealth are the other impacts, and then to infrastructure more than housing (many people focus on housing because of its link to financial instability and excess, debt, globally), but in China, the numbers of those directly employed in construction, indirectly emplyed in supllying machinery and products for housing, and also those providing services to those employed, and selling goods, and transfers back to the provinces to care for families nad children. So, more than financial crisis and asset destruction, actually quite substantial drags on the economy which can no longer cycle investment up as the drvier of growth, but might have gone too far down this path, already, and thus is not quite sure how to manage a transition to other modes of growth. Collapsing asset values, even for those who do not hold these assets, might reverse the story that has been told, and create an environment in which people are reluctant to spend, and without, as Michael as noted, very contentious, and direct transfers from the state, perhaps even with it, people may be reluctant to spend. There seems to be evidence that investment and consumption are highly correlated, and where investment falls, consumption falls, as the economy has become so dependent upon growth in investment, consumption might not replace. This with or without a crisis, i suspect.

  15. In regards to a pending banking crisis, I agree with your point. However, I was wondering with the deposit insurance scheme likely to be implemented early 2015 and the recent boom in banking stocks, what makes you so sure that the banks will have lowered growth and act like japanese “zombie banks”?

    If deposit rates are liberalized at one point, it does mean that banks will see pressure through competition and lowered interest rate spread, but it should be a positive development in the long term.

    Also, how do you think the challenge from other financial institutions on banks’ distribution dominance in China will impact the banking industry in the long term?

    • There is a difference between competition and deflation. Liberalisation can rise price of goods if it was sold below its market value(like oil in many countries). So chinese rate could go up and probably will if they liberalized rate.

      • When countries do sell stuff like oil for below the market share, it can lead to trouble. The government is forced to subsidize the industry to pay for the cheaper energy costs for consumers.

        Often times, politicians/bureaucrats/dictators get locked into these types of policy options and choose to not shift gasoline costs. What ends up happening is usually what always happens with volatility suppression. You see no shifts in energy costs for a long time. Then BAM! Energy costs take off and the government budget (and usually the currency) come under major pressure.

  16. Hi thanks for this blog post it gave me a much better context of what is going on. I do have a question regarding the projection of a banking crisis. I agree with you that insolvency doesn’t necessarily lead to a crisis in China, as the “implicit guarantee” is in play and the fact that people still believe in the governments ability to provide liquidity.

    However, I feel like things are actually getting better for banks, as a deposit insurance scheme is set to be implemented early 2015. This will help move China towards a better credit rating system and a better debt market. Furthermore, if the deposit rates are liberalized, then it could help banks in the long run as well. The banking shares have also been very bullish as of late.

    So what is the reasoning to predict that Chinese banks will behave like Japanese “zombie banks” in the future? I do realize that Chinese banks’ distribution dominance has recently been challenged by online platforms and other financial institutions, but what other things are pointing towards a imminent decline? Thanks

    • The big banks would be insolvent if assets were correctly marked, Eqqus, and the small banks make the big banks look pristine. The survivability of many of the small is really in doubt, but Beijing probably won’t allow any of them to close, or very few if any do close, and so inevitably most or all of them will be absorbed by the big banks.

      This will leave the management of most of China’s banks dealing mainly with resolving “legacy” problems. It is hard to find any example of a country in which most of the banks were insolvent and struggling with legacy portfolios and yet were nonetheless dynamic, innovative and aggressively funding new growth opportunities. I see no reason to assume China will prove the exception. They have never had a banking system that knew how to do much more, even when conditions were optimal, than expand as rapidly as possible (after the 1900-1940 period, that is, when Chinese banks were quite good), so it hard to imagine their being an exception.

  17. Prof Pettis,
    I guess a lot of people are wondering, what do these scenarios imply for Chinese property values? Presumably a disorderly rebalancing will cause a major drop in prices since demand will collapse during any financial crisis and speculators will try to cash out. But what about an orderly rebalancing? Does it depend on how much property is currently held for speculative purposes? Presumably it will not be as easy for local governments to continue their land pyramid schemes when loans for property development become harder to obtain. Also, the elites will lower their speculative demand for property. But demand from regular people should continue or possibly even increase. During the orderly balancing scenario, everything will change, but the impact on property prices is more ambiguous.

    As a related side note, Chinese interest rates have declined recently. What does this imply for the governments commitment to orderly rebalancing?

  18. Great post as always Michael. I am reading more and more and seeing it in commodity prices how the world seems awash in production but not demand. Strange times indeed.

    I am intrigued by one point you made

    “The constraint on monetary and credit growth in China is not CPI inflation and never has been. Monetary and credit growth in China are constrained by the impact of GDP growth on balance sheets.”

    Would you care to elaborate on this. From my understanding conventional CB’s in the G7, the constraint does usually show up in PPI/CPI, though as many pundits pointed out in the last US tightening cycle, by the time it shows up at the CPI, bubbles were already well formed. In China, I guess you are saying that money and credit growth depends on the leverage ratios? This strikes me as odd, since Soro’s reflixivity shows that leverage ratios are dangerously pro-cyclical. Higher equity values justify higher debt, until they dont.

  19. “……..and second, that the wealth effect of a collapse in real estate prices, or a high correlation between consumption growth and investment growth, result in much slower than expected consumption growth. The second risk is the focus of a recent blog posting in which JCapital’s Anne Stevenson-Yang’s more pessimistic consumption expectations are contrasted with mine, with a follow up blog posting, and while we disagree, I don’t completely dismiss the JCapital position.”

    Hi Michael. I must admit I too am concerned about this aspect of adjustment in China’s economy. It is always inherently difficult to predict how wider society will react or adjust to sometimes rapid changes to the economy. When considering transfer of wealth from investment to households, I can’t help but look to Japan as an example of the high hopes that were held for household consumption as a replacement for the collapse in investment, but never really materialized. Much of the blame for Japan’s woes seems to fall on demographics, but I’m sure it’s somewhat more complicated than that.

    How China manages their transition, and whether the current expectations come to fruition, will be of great interest.,

  20. Michael, You said that President Xi is expected to be in office for 20 years, up to 2032? Really? Two 10-year terms?

    • i don’t think Michael would say that. Everybody knoes in China that president is elected for a 10 years. I really don’t see how this could change.

      • Cedric, some China experts say that the current model may not last long. Who knows when it might change? And Michael has not replied to my query — his silence speaks for itself.

  21. Michael, You say “during the expected period of President Xi’s administration (2013-32)” —

    Is that right? Is Xi Jinping likely to be President for 20 years?

  22. Unfortunately I think there is a third possibility for the Chinese economy that Dr. Pettis is probably ignoring for (very valid) personal reasons. It goes like this:

    1. Chinese leadership, for political reasons, decides that a destiny of declining GDP (soft or hard-landing scenario) does not match with their agenda (desire to become the dominant world superpower) .
    2. For political reasons, in order to keep the population in-line and maintain CCCP monopoly on power, decides to stoke nationalism via one or more conflicts on their borders. (See: Putin on Russia/Ukraine as an example)
    3. Leadership decides on a path of rapid industrial militarization as a way to stoke the economy and their political lives.
    4. China fully expects to lose an initial future conflict. If, for example, the new Chinese aircraft carrier were to be sunk in a conflict, leadership fully understands that the Chinese population will rally to their side and politically speaking it would be the best thing that ever happens to them. I.e. they ‘win’ whether they win or lose a conflict over some uninhibited islands. This will not be a major regional conflict, just a ‘bush war’ (at sea), but enough to wound/stoke nationalism.
    5. China & Russia may not be historical or cultural allies, but they would have strong reasons to form a tactical alliance.
    6. Western-allied countries finally stop supporting the mercantilist policies. Commodities exporters stop shipments to China, but China turns to Russia for it’s energy & raw materials.
    7. The global chess game continues, but now China is seen as leading an greater Asia axis.
    8. Result: China gets what it wants (global power, regional dominance, economic & political solutions)

    This is generally similar to the underlying causes of WW I. In this commenter’s opinion, this third scenario is the most probable.

    Unfortunately, living in a authoritarian system, Dr. Pettis can’t mention these things while living in China, but hopefully readers living in more free societies can.

    • Of course people living in China can mention these things. And of course the government will almost certainly continue to stoke nationalism (it does now, anyway) but it never likes these things (anti-Japanese protests) to get out of hand. Would the population really rally to the government’s side if a new aircraft carrier was sunk in a conflict gratuitously provoked by the Chinese government? Although few people have much good to say about the Japanese (and equally few have many bad things to say – most people just maintain a faintly embarrassed silence), after eight years living in China I have yet to meet a single person who has been in favour of a military confrontation with any other country. Of course the elite will fight hard to maintain their status, but being humiliated in a regional firefight is unlikely to be high on their list of viable strategies

    • Interesting, but not sure how this leads to regional hegemony, or that there is a quick linear movement from tactical alliance between Russia and China to a steady flow of natural resources, on the order of current usage, or heightened usage from abroad, in such a linear assumed fashion. Certainly there would be build out problems, complications with the greater influx of Chinese labor into Russia to see it happen, and so many other issues.

      This however, might be an underlying perspective of some.

      I have always thought that issues such as the 9 dotted line must be a sign, either of hubris or of weakness in the Chinese case (where statement of line, occurred to pander to some domestic interests, or to sight a rallying point in the case of economic turbulence, or merely, this is as good as it is going to get, so lets do this now, which will support the harder line Left, PLAN, and foment Nationalism, as a new venue for a more coordinated management of nationalistic feelings in society, as we enter a period of uncertainty)

  23. Michael,

    In a future blog could you please write about Chinese population trends, urbanization & changing demographics and how this effects the economic system? I.e. when will China not have to grow rapidly in order to employ migrants from the countryside? In my view this has a major bearing on the political economic decision making and is critical to understanding the odds of possible scenarios.

    • this is a bit of a misunderstood notion.

      There is quite a bit of artifically created urbanization in the interior.
      The logn story of urbanization, driven on the back of interior peasants moving to a coastal city is not really as it is understood.

      Urbanization has only been rising by 1% a year since the 1990’s, urbanization, on this story, was a pre-1990’s story. the ant tribes, of interior peasants, along coastal cities in recent decades has been a story of a mobile labor force, that hasn’t urbanized in a domicile but moves from city to city. One can imagine this process only being enhanced by recent infrastructure and housing build out.

      In North America, imagine the Canadian and US construction workers, that rebuild Katrina, moving onto a tornado in Kansas, and Sandy in the Mid-Atlantic.

      • I think it has to do with the way China accounts for the urban population. If I’m correct, there are a lot of people who live on the outer parts of the city that aren’t accounted for as a part of the Chinese population.

  24. Thank you for this article which shows once again that your analytical framework is very fruitful to assess the dynamics of the current Chinese and global economic situation.

    The debt situation is a complicating factor for China’s orderly rebalancing and therefore for its impact on the rest of the world.

    From 2009 to 2014, total debt to GDP in China grew from 150% to 250% ( Said differently, the last 5 years incremental debt to GDP ratio in China has been 370%. Similar to the US or Spain in the 2002-2007 cycle, similar to Japan in the late 1980’s (no surprise there as the same causes tend to produce the same consequences, which makes the incessant repetition of the same policy mistakes really hard to understand, but that’s a different topic). It means some of these loans are or will go bad. That the banking sector is owned by public rather than private shareholders may make the liquidity situation more stable but it does not change the fact that the cost of these bad debts will have to be absorbed (which is the point you made in “Bad debt cannot simply be socialized” if i remember correctly). The order of magnitude suggested by similar experiences is that ~ 10% of total debt is almost certainly bad, ie. 25% of GDP, which means a final loss of 17.5% of GDP assuming 30% recovery rate. Say the loss is absorbed over 10 years, we are talking about 1.75 point of GDP every year. Allowing for some GDP growth, the order of magnitude of the credit loss to absorb is about 1.5% point of GDP p.a. over the period.

    Broadly speaking, there are two choices as to who will absorb these bad debt losses of ~ 1.5% point of Chinese GDP p.a. for the next decade: either Chinese households and / or the rest of the world.

    – Either Chinese households will end up absorbing the losses through the suppression of interest rates. Of course, with debt of 250% of GDP, interest rates of 6% are no longer tolerable. Interest costs absorb 15% of GDP and total debt service around 40% of GDP, which is too burdensome. So interest rates are going down. Again, completely similar to the movement of US interest rates since late 2007 or Japan since late 1980’s / early 1990’s. Since banks need to keep generating pre-provisions profit for an extended period of time to be able to make provisions for bad debts, it is unlikely that lending margins can be compressed. So the entire drop in interest rates will be passed on to net depositors, ie. households. Again, similar to what we see in all countries that have preceded China in the debt hole. This negative transfer of wealth from the net depositor household sector to the net borrower business / State sectors will largely counteract the positive wealth transfer envisaged by the Third Plenum and the choice will therefore be to keep unbalanced growth or, more likely given the approaching debt constraint, to accept an even more pronounced slowdown as total household income growth also slows given lower deposit remuneration. Not very appealing.

    – Hence, the other possibility that China tries to shift the excess debt burden at least partly away from the shoulders of its households onto the rest of the world by joining the raging competitive devaluation party in which, like a good nightclub, everybody wants to get in. In this case, the Chinese rebalancing won’t really add incrementally to growth in the rest of the world.

    May be too pessimistic but the path for China to simultaneously achieve a successful internal rebalancing with sustained household income and consumption growth, a successful absorption of credit losses and a better (ie. less negative) contribution to growth in the rest of the world seems very narrow to me. Was still very much possible in 2009. But today, after 5 years of spectacular credit expansion that has weakened the national balance sheet, it seems to me difficult for China to square that circle. I hope i will be wrong.

    On Japan, while its rebalancing may have been successful in preventing a GDP collapse, it has not allowed a relative deleveraging (by definition extremely hard with 0% nominal GDP growth) but not even a stabilisation of relative debt. At the end, Japan situation has become even more desperate, notwithstanding its rebalancing. This is a reminder that, at current debt level, rebalancing (while difficult enough) is only a necessary but insufficient condition and that relative deleveraging is needed. This is one notch further in difficulty.

    • The debt/GDP figure is higher than 270%. I think it’s closer to 400-500%. If you use total bank assets/GDP, you end up getting a ratio that was around 300-350% in 2012-13. Loan growth was around 15-20% (roughly). So if you use those metrics and add in the growth of the shadow banking sector (which is still relatively small), you end up getting much larger numbers.

  25. Where China seems likely to get more growth.

    It seems that China can build out and invest in needed global infrastructure. Build roads, canals, high speed rail, power projects etc… for India, South Asia, Africa etc…. Many of these are high return projects. There are over ten trillion in projects needed over the next decade. Modi in India is inviting China to help India build needed infrastructure. Better Infrastructure would boost Indian GDP growth by 2% per year. The ASEAN countries have similar needs. China’s new global investment fund is a vehicle to fund those projects and also China companies and banks also fund directly. This seems likely to boost China’s sustainable GDP growth. If India and Asia economies get bigger then there is the potential for more trade with China.

    China is the low cost builder of nuclear power. Emerging countries seem willing to build a lot of that.

    What do you think Michael Pettis about a massive global infrastructure and investment buildout strategy and impact ?

    Over the longer term, China is going to further loosen then the child limitation. Going full two child probably in 2015. The previous loosening had one third of the effect. Adding 600,000 babies instead of 2 million. Full 2 child will add 2 million and not 5 million. this is added to 16 million per year. Going without child limitations will take the birth rate up to about 20 million per year. If they build out their social safety net and provide more solutions for child care for working mothers and families that will provide more of a boost to population. It will help the demographics from 2020 onwards.

    • This idea that governments can (and should) build infrastructure everywhere to do everything is absurd. Infrastructure has maintenance costs and those costs can be very high. Where is China gonna invest? Xinjiang? Tibet? Inner Mongolia? These are places that’re sparsely populated where the terrain is rough and harsh. These places can’t sustain large populations, which is why almost all of China’s population centers are relatively close to the coast. Many of those territories are also mostly occupied by minority populations, so I’m not even gonna get into the other risks. You just can’t build bridges and roads to nowhere and expect it to be useful. This is what Japan did while running massive deficits and calling it “stimulus”. Now, they’re saddled with a massive debt overhang and the middle class (households) are paying for the mistakes of retards that ran their country.
      Note: This isn’t just a Chinese issue. It seems like statists are using any logical reason to expand the power of the state and end up saying something like “let’s just build infrastructure” like there’s some kind of magical free lunch. I’m not against infrastructure spending, but this idea of why can’t everyone just build infrastructure all the time is dumb.

      Another problem is the capacity for a country to absorb the infrastructure. You can build infrastructure, but if your populace doesn’t know how to use it, you haven’t done any good. In order to be able to properly absorb infrastructure, a society needs social, political, and institutional capital. It does you no good if you build something and people start conflicting over its use.

      Another incorrect assumption you’re making about trying to push populations higher. Once you start to industrialize and go beyond an industrial society, children take a lot of time, energy, and money to raise properly. Again, the key issue is capital and human capital takes time to develop. This is the primary reason we’re seeing population declines in the developed world: to preserve family wealth. What does this mean? It means that, even in China, fertility rates will still stay low.

      Note that the only people who do have more children in the developed world also tend to be highly religious. Last time I checked, China’s atheist (this is a problem for a lot of reasons, but that’s a different topic for a different day).

      • China is doing infrastructure build deals in Pakistan ($45+ billion over 6 years), Africa, Silk Road- Central Asia, Africa, Russia and Southeast Asia. They are building high speed rail and ports and airports around the world. The high speed rail is boosting trade and linkage with southeast asia. The hundreds of billions per year that seems likely from these deals seem like things that will provide a boost to China’s company and economy.

        • china is trying to export its overcapacity to the rest of the world

        • Yea, and most of the infrastructure is a horrible waste of capital. Do you really think that building massive amounts of infrastructure in Russia is a good idea (the USSR did this BTW)? Look at a map dude. Most of the region is tundra and no one lives in Siberia, which is most of the region you’re talking about. Do you know how high the maintenance costs are in these areas? In the case of Russia, you can’t build roads and rail networks like you would anywhere else because of the terrain and geography

          Pakistan is politically unstable and is prepared to blow up any minute. Southeast Asia consists of countries hostile to China. There are so many things that can go wrong, but you’re automatically assuming they’re gonna produce value with these “investments”.

          By the way, do you know how much cheaper transport costs by water are vs transport costs by land? When you add in the costs of the road and rail networks, we’re talking about a 70 fold increase in costs when you’re talking about transport costs by land.

          Do you wanna know a bad example of infrastructure development? Take the Three Gorges Dam that was built in China, which was built in the middle of the river. By building that dam, they just caused transport costs to spike. It’s equivalent to the US placing a dam in St. Louis–it doesn’t make any sense.

          • Much ado is being made, but there is a significant amount of excess capacity of large well connected SOE’s which will see China attempt to export its savings and investment, supported by an army of workers, and Chinese sourced inputs, to build out whatever they can. They have a signifigant amoutn of recent experience in China, and the productive capacity to do this within China, to do this externally, and they would like to see this occur, while realizing cash flows.

            The real issue is future rounds of debt crisis in the places that borrow to see this done. How will these other countries afford it?

            Then, which other suckers get drawn into the inevitably posited as lucrative investment schemes.

            Might this see whole new eras of debt forgiveness being seeded.

            I sit, and wander, if this occurs, how exactly will DemiocracyNow, RT, Al Jazeera, PressTV, Prensa and so many others be covering it at the time.

            Will Wall Street Bankers, Fraudsters and Amerika be the most likely culprits as they have since Eastern Europe, under the Iron Curtain sought debt forgiveness in the 1970’s and 1980;s from western banks.

            Funny, both mainland netizen fanatics and libertarians picked up on the strategic tenants of soviet strategic thought and narrative manipulation and we are still reading the thoughts and effects today. Anyway, Gold is going to 2 million an ounce, did you year, debt, consumerism, ahhhh will they ever learn. Mr Kagan, please do tell us what the CFR does, because I am going to an animal mutilation at Roswell, just after I visit a Yeti and see the latest crop-circle. Nanu Nanu.

          • I’m an engineer and not an economist, but how do you go about measuring “waste of capital”?

            I always thought that all the infrastructure that got diverted to frivolities such as Facebook (or trading pieces of paper back and forth in a zero-sum game, for that matter) are an enormous waste of capital and talent because they don’t improve productivity or living standards. Maybe this is the wrong approach to take?

          • Don’t blame speculators or say that they don’t do anything useful. Just because you don’t understand something doesn’t mean it shouldn’t exist. Speculators provide trading volume and dissipate information by creating volatility. It’s a mistake to say speculators don’t do anything useful and call it just “trading paper back and forth”.

            Secondly, an economy isn’t something to be engineered. It’s self-organizing, not optimized.

            Thirdly, transport costs by water are cheaper, but do you know how much cheaper? When you factor in the cost of the rail and road networks, it’s about 50 times as expensive as trade by water. When you’re talking about harsh terrain, that number can go as high as 100 fold.

            You might think that all infrastructure is good, but that’s not the case. The classic example is building a dam in the middle of the largest navigable river in China (the other large river isn’t navigable and the rest of the navigable rivers are primarily in the south of the country and also relatively small). It may seem like it’ll pay for itself by creating power, but the predictions for the amount of money it brings in are always overstated while you get black swan effects on the other side. In this case, one of the black swan effects was an increase in transport costs by limiting transport via water.

            An economy isn’t something that can be engineered. It’s (much) closer to an ecosystem than it is to a car.

          • OK, I knew I shouldn’t have posted that last comment because it reduced the odds of my other questions being answered, and I view the other questions as more useful to learn about. But in any case:

            Just because you don’t understand something doesn’t mean it shouldn’t exist.

            I didn’t say or even imply that it shouldn’t exist. I said that I considered it wasteful. One view does not imply the other.

            You might think that all infrastructure is good, but that’s not the case.

            I didn’t say or imply this either. In fact, the only time I used the word “infrastructure” was in the context of the “waste of capital and talent” that you incorrectly just insinuated that I want banned.

            An economy isn’t something that can be engineered.

            I haven’t the slightest idea how you reached the conclusion that I think otherwise. But, if we’re discussing the wastefulness of a large, ~$30 billion project, let’s assume that this was not a government decision. Let’s instead assume that a few university students conceived the idea instead. Now, lacking money to do this on their own, they propose the idea to some Venture Capital firm instead. The VC decides that one billion people will each pay three bucks apiece to add a brick along the pathway of the Yangtze river. In exchange for doing this, they can take a bunch of pictures of themselves doing so and post it online for one of any many reasons, but let’s assume for the heck of it that they do so sheerly out of vanity and narcissistic tendencies (or, for that matter, because they are alll deeply religious and their priests tell them that this will guarantee their place in Heaven. It really doesn’t matter why they do it). They can come and do this whenever they want, and as little or as often as they want, so no coercion is involved and no real timeline is set. The project is, therefore, somewhat “self-organizing”.

            Let’s further assume that this actually works, and the “PhotoBrook” project, which cost $30 billion to build, is completed. So now you have the results of a VC-spearheaded project that is somewhat self-organized.

            Does this now make “PhotoBrook” a valuable project? Does the idea that you can’t understand the motivations of the people adding those bricks somehow negate your abillity to assign an overall economic value to the project? Will you now be in favor of such a project?

          • My comment got cut off.

            Berkshire Hathaway is a business with a total market cap of around $350 billion and that’s a private company unable to work and do projects that’re $30 billion. The only real institutions that can do projects even remotely close to $50 billion are large governments. To think a VC firm can do projects worth $30 billion? LOLOLOL!!!!!!!

            The purpose of central governments when building large infrastructure should primarily be for defense (this is why the interstate highway system was built). Otherwise, the structure should be decentralized. Even in the US, almost all of the infrastructure is done by the states. The federal government only accounts for around 30% of the transportation budget.

            Usually, statists respond by saying that if you can get bureaucrats with no skin in the game making decisions based on “trust” while keeping ideas like “equality” and “fairness” in mind, it does become possible to make something positive and is “an investment”. Such stupidity requires no sensible response and certainly doesn’t deserve one.

            Let me tell you the reality: building infrastructure projects in the middle of nowhere on places with harsh terrain rarely provide any value. There are plenty of such cases in history and those projects are almost always a complete waste of resources, talent, and capital. Now, take a look at a Chinese map and look at where most of their “infrastructure” is being built.

            I’m sorry, but building airports that no aircraft lands in or building gigantic malls with no stores is a gigantic waste of capital.

  26. Interesting discussion at Peterson Institute ref. reform in E. Europe, Russia and Ukraine which makes me even more pessimistic about reform in China.

  27. Great post as usual Professor.

    Does anyone have good references regarding re-balancing and consumption growth and real interest rates in the system, where does lowering interest rate switches from stimulatory to repression ?

    For example, in Australia, where interest rates is at 2.5%,
    a) does lowering it to 2% give a boost to the system overall because lower mortgage repayments etc mean households will have spare cash to spend ? or,
    b) it reduces economic activity simply because many pensioners (mostly, but also others who) depend on interests from their deposit accounts, and therefore will spend less, and the impact overall is negative, just like we see on Japan.

    • Australia total housing debt is $1.4 trillion. Making a rough calculation, .05% of that is $7 billion per year of extra national income. I’m probably wrong calculating it this way, feel free to provide better information. But I do believe that money in the hands of younger consumers with mortgages is more important to consumption than pensioner income.

  28. “There is also rising concern about a baking crisis within China.”

    Not enough dough? I know the feeling.

  29. Michael,

    Today on the FT there is an article where the BIS is alerting to the strength of the USD and I was caught by one comment: “…Mr Borio described the rise in lending to China by foreign banks as extraordinary, with outstanding loans to China doubling between the end of 2012 and June of this year to $1.1tn”

    This reminds me a lot of your comparison between China and Brazil period of high investment growth between 1967-1980, where after the oil crisis Brazil managed to finance its growth through foreign lending and thereby lengthened the “miracle” growth period. Could it be that today in China you already see a similar situation given the high probability of state guarantees for the Chinese banking sector?

    For an economy of ~9tri where ~50% is investment then 1.1tri is certainly not a negligible sum.

    • 3 trillion was taken off shore by Chinese SOE’s, their managers, the wealthy, leading up to the crisis, leading to round tripping, FDI, and similar, such that a fair portion of these loans, could be loans from these sources.

      Then the interesting question is why loans rather than FDI?
      Might these sources believe that loans are more easily, will be more easily recoverable, have mechanisms to ensure inflows and outflows in the case of economic distress.

      State seizure of FDI
      Growing thoughts that States have better ability to ring-fence the economy, and keep forex in, in the case of economic distress

      More profitable to do loans
      More forex required for foreign operations of Chinese organizations (money from BVI’s lent to China domiciled company for their operations in Kenya)

      So is this lending Standard Chartered in Singapore or Citibank in New York, or some small bank in the BVI’s, Guernsey or London.

  30. Michael,
    Have you seen Anne Stevenson-Yang recent interview in Barrons? I get an error when I try to post a link.

  31. Hi,

    I am from Portugal and Chinese investment in the Portuguese real estate market created speculation and drove prices up. It proves your paragraph but I do not quite understand. The Portuguese economy is in crisis and it is not the case that we do not have “nowhere to put the money”.

    “China, in other words, is not the world’s growth engine. Behind Germany and ahead of some of the oil producers, it runs the largest current account surplus in the world, which means that it is exporting its excess savings in a world that has nowhere to put the money, and so the world must respond either with speculative asset bubbles, unproductive investment, debt-fueled consumption binges or unemployment.”

  32. “… current consensus seems to have dropped to between 6% and 7% …” Ah yes and Lincoln never told a lie (Pete Seeger). Like with BLS figures in the US (funny acronym, ain’t it …) the Chinese statistics are largely phantasy. Like in Spain before the current crisis, what is “concrete” in them (in the very sense of the word) is overspending on construction that no one needs nor can afford. When this stops, the whole social fabric is rent asunder, e.g. all the migrant workers that now work on building sites will neither have a home nor a farm to go back to. Add to this that China owns worthless US paper and you see it is rather a poor country.

  33. Prof Pettis,

    It can confusing when you state that Japan rebalanced when they transferred their debt from private entities to the state. This can misinterpreted as Portugal can rebalance by placing its 245.4 billion eu debt in a “cloud”. If the debt is not reduced it will affect the economy moving forwards. And the annual 8.3 billion eu interest payment for Portugal diminishes the income Portugese households can receive to create demand for economic growth.

  34. An excellent post and discussion as usual. This blog has the most globalized audience I have seen. I agree with the points exposed in the post but I think I have detected a point od friction. It is quite possible that the government avoids a bank crisis by guaranteeing deposits but I wonder if they can do it without squeezing somehow the household sector which in turn would make the rebalancing process more difficult.

  35. Ignacio,

    In your opinion, which type of “rebalancing” will EU undergo?

    1. Will transfer all debts to ECB

    2. Will request all creditors to forgive substantial portion of all debts.

    3. Or as Prof. stated ” in the US in the 1930-33 period-with GDP dropping by around 35% and household income
    by around 19%. Thus income growth rate was larger than GDP growth rate which transferred income to the
    households and in combination with inflation created demand for economic growth.

    4. Combination of some

    • Stan,

      I don’t know. Unfortunately I am not skilled at reading nation-wide balance sheets so I don’t have a precise picture on how much have they changed since 2007. Regarding imbalances amongst countries very little has been done except for periphery households beign squeezed in order to roll on bad debt and reduce consumption. In my opinion some combination of those possibilities might occur but it seems we are committed to keep kicking the can for as long as we can.Don’t you feel that the future is more unpredictable these days?

  36. It’s great to have all the debate on here but I think we should all give thanks to Michael Pettis and the work he’s done. Especially with China over the last few years or more he’s been exactly right with regards to hard/soft landing, commodity prices and political battles. He should win an award for being about to apply economics so well to the China story. Michael Pettis is the best economist (Can’t forget Andy Xie- he’s been pretty good on china too) on China by miles and while thousands of other economists were flailing around saying this time might be different Michael had this view for years before main streamers even thought there were imbalances or even began discussing soft/hard landings in the investment driven growth model. Gold


    **Beijing’s largesse has come at a price. Chinese goods are flooding the Venezuelan market, as many Chinese credits are tied to the import of products and services. The low-priced imports are squeezing local companies.**

    **Not all Venezuelans welcome China’s growing influence. “I don’t know why they are bringing in Chinese construction workers to build apartments for us,” says Geraldo Lopez, a 27-year-old bricklayer in the central industrial city of La Victoria. “We don’t have enough work for ourselves, yet they’re giving these contracts to Chinese companies who don’t employ us.”**

    **PDVSA receives no money for the oil it sends to China, which has contributed to cash-flow problems. The company had been forced to increase its borrowing to cover costs: Its debt is up more than 10-fold in the past seven years, to more than $40 billion, and that excludes loans extended by the central bank. The situation has hamstrung PDVSA’s ability to invest in oil projects,**

    This illustrates Chinese strategy in relation to overcapacity and why China acts as a break on other countries development. This is also why tensions will rise and why this isn’t, and has never been, a China rise challenges the advanced countries story. This is a Chinese imbalances has impinged on global development and cooperation.

    How long until Maduro is overturned? Similar dynamics would necessarily obtain elsewhere.


    One reason I always discuss the philosophical assumptions, and strains of thought that underpin discussions because discussions of these issues are always interfered with on suspect, irreal, ideological cum moral and ethical basis. Of course, there can be political and social forces, as exhibited above, which hope to move more useful discussions int the realm of the useless, to push forward other goals.

    This is true whether actors are merely post-modern critics, political actors, sectoral actors (finance selling book) or merely those confused by a more general and pervasive confusion over what is actually occurring in the word, as to that which our frames typically hold.

  39. Does china really have a labour shortage? Millions of Chinese are working in unprofitable state enterprises, millions are employed in construction building infrastructure and houses that will never be used. if Chinese economy is allowed to rebalance, we may find that china has a labour surplus rather than shortage.

  40. Hi Michael,

    I just recently stumbled upon your site, and I love the way that you finally have got me thinking about things from a completely new perspective. I realize that this isn’t on topic with your article, so feel free to not post it, but your site had me wondering about two things in particular (I am not an economist, so maybe this is “obvious” or obviously incorrect):

    1. As I understand it, you believe that being the world’s reserve currency places an “exorbitant burden” on the US because it essentially forces the US to (among other things) import unemployment from other countries. I’m wondering if this, in turn, creates a further “blessing” to the US by forcing companies that operate in the US (as opposed to offshoring) to be very nimble and flexible in order to stay competitive? Going one step further, if the US eventually stops allowing other countries to “game” the current system, does that inevitably translate into an eventual lack of dynamism in the US, as local companies are no longer forced into being as competitive?

    2. I am still a little bit lost as to why a country such as Spain was “forced” into speculative investments due to Germany’s policies. Presumably, Spain could have chosen to follow the same policies as Germany (i.e., forcing productivity gains to outpace wage gains). I realize that this would just push the excess savings somewhere else, but Spain, presumably, would have preferred to have them somewhere else than in Spain. If, hypothetically, every EU country did this, then presumably you would end up in a “non-optimal” equilibrium with a set of so-called 1% (owners) everywhere in the world. This may or may not be desirable, but I think it would still be stable, would it not?

    Just to be clear, I am *not* trying to prescribe anything or to back up any political beliefs, because I don’t really have any. I’m just trying to wrap my head around the implications of your posts.

    Thanks in advance for any replies from anybody.

    (PS: Sorry if you get this post multiple times–I’m not trying to spam you, but I seem to get an error whenever I hit “Submit”

    • The error when submit happens to me, and is normal, hit it once.

      The argument that “gaming the system” forces “companies to nimble” is not different form the free trade argument more generally, and further to innovate, to track financials, etc…

      This has been the mantra, but without more people moving into the position, of say the privilege or burden holder, as you will, inevitably it can not work, because the process undermines the very thing it needs, consumers of the excess production. I think it is a hard case to prove that academics, research institutes on the sectors of the US economy, that have been hit hard by this gaming of the system, would be less innovative, this seems a red herring. In fact, with the march of technology, companies, are rather more simply able to be very much more innovative and nimble, that even individuals are becoming more nimble.

      Alcoa didn’t just create a new system that within 150 foot, replaces an aluminum smelter of a half mile, while dropping the production process from days to minutes, as they have create a new aluminum product that is 30% stronger than steel, and far lighter because the world requires a reserve currency to facilitate their trade, via lessening of uncertainty gained through having a reserve currency, and they didn’t need foreign financing to do it as the taxes, salaries, electric, water, and everything is paid in dollars. Dollars that the government could print. What do I care as long as my kids can go to school, I can pay the electric, buy bread and milk and meat and a few other things.

      The Spain was forced to accommodate German savings notion, could it just do the same.
      Spain could have done just as Germany, let’s say, but more than create a stable system, supposedly, of 1%’ers, it merely would have cycled the trajectory of the system lower, via deflationary impacts, inevitably on demand, and by create shorter term credit bubbles elsewhere. This is a broader problem of Southern Europe, the Med countries, who have faced increasing competition from elsewhere. We can’t forget that recent discussion was all cream and roses as to the countries like Spain before the GFC. These were brighter spots, with wealth and consumption rising. In fact, more than just cutting costs, and increasing production, the world actually needs consumers to rationalize investments. Of course, large capital flows running into a country to support investment, in narrow sectors of an economy, with resulting switching in the structures of GDP, to, too high levels in a sector is wasted investment. Such encourages some, China and Germany perhaps, or Australia and Chile, or resource rich poor economies, to focus too much of their GDP on a single horse in the race, and this makes them more susceptible to crisis, I believe. China and Germany, in investment for productive capacity, trade, savings, and surpluses, a process that necessarily need continue to rise, and siphons of demand from those who inevitably need demand their excess doemstic supply. Australia and Chile, becuase their economies may become too dependent upon the sale of commodities, neither enabling them to consider diversification, and even suffocating the development of industries, losing industries, resource rich poor countries, because of the similar, coupled to the weak institutions, and often corrupt groups that seek to maintain the raltions that occur, to keep benefiting monetarily.

      But as to Michael, Spain, simply, most German trade is European, and engineered surpluses will seek a domicile, balancing in the world somewhere, a natural place, is the formation, extension, and inevitable collapse of excess financial flows running into the Spanish housing market, as banks can lend across Europe, it is a natural occurrence that such would eventuate, and Surplus savers, savings would necessarily be imperiled, or the associated economy, would have to go through a painful deleveraging process.

      • The argument that “gaming the system” forces “companies to nimble” is not different form the free trade argument more generally, and further to innovate, to track financials, etc…

        Hmm…I didn’t think about it that way before, but I guess that sort of makes sense, except that it really means that the US gets the benefit of free trade (because its companies must constantly adjust), whereas the other country’s industry gets worse off because its companies will never have to adjust (providing that its government will buy and sell US Treasurys to accomodate the company).

        without more people moving into the position, of say the privilege or burden holder, as you will, inevitably it can not work, because the process undermines the very thing it needs, consumers of the excess production.

        I don’t understand why I am having such a difficult time with this part. Let’s go back to a simple two country system of China and the US. China uses financial repression to run large trade surpluses, which is identically equal to the US running large trade deficits. If we assume that the US companies can not resort to government subsidies, they inevitably suffer in the short run by laying people off, etc, and perhaps shutting down. Assuming China continues to subsidize exports by pegging its currency, one of two things now happens:

        a) Americans run down their savings until they can buy no more, and so China’s trade surplus dwindles until it eventually disappears. (I’m not sure if this also requires a default on American debt, but I’ll think that one through later)

        b) Americans now out of work find something else to produce that is either completely completely new, or else that is superior to what the Chinese are producing en masse and selling to the US. The Chinese companies, who were not forced to innovate, didn’t bother trying to find such things because they didn’t need to. But this new product (Widget 2.0) is superior to Widget 1.0, and so the Chinese start buying it from the US, thereby also (temporarily) reducing China’s trade surplus (Both the US and China will now either buy “cheap” Chinese products when they can, and “high quality” American products when they must, or Widget 2.0 is so overwhelmingly superior that it makes W1.0 obsolete and forces China to write off the inventory).

        Of course, in this model China can cop Widget 2.0, but there’s a lag in terms of reverse-engineering, producing, marketing, etc. Once Widget 2.0 is copied, this forces the US to come up with Widget 3.0, and etc. at nauseum.

        We can extend this to N countries, but so long as all countries are artificially reducing the value of their currencies (only) to the USD, it’s only the US that must innovate. The other countries are effectively reduced to merely copying the latest US creation. But if the US can no longer afford to pay for all of these country’s products (because it can not innovate quickly enough) and chooses to give up its reserve currency, it simply defaults, leaving these countries with a pile of useless paper and itself with presumably useful goods (and organiztional structures and cultures that are set up to continue innovating, because they were forced to do so in order to survive). Now the US is in a very competitive situation because it has real goods, no/less debt, a culture of innovation (or, perhaps, of labour flexibility–the US allows its companies to hire and fire more easily because it has no choice in order to survive, whereas other countries do not permit their companies flexibility because they can export unemployment elsewhere), and the ability to export its own problems to others. In this case, the US’s exorbitant privelege was its ability to decide when to end the game.

        Just to repeat myself, I’m not arguing in favor of this viewpoint (in fact, I realize that this view could very well be wrong) so much as I am trying to reason it out more fully for my own understanding.

        In fact, with the march of technology, companies, are rather more simply able to be very much more innovative and nimble, that even individuals are becoming more nimble.

        Well, in the example above, I guess that technology improves because of the necessity of the US employing technology to create the new generation of Widgets or to find a cheaper way to create the original version of Widgets.

        If there’s a gap in this logic, I hope that the post is at least comprehensible.

  41. China’s 2014 business census will be boosting the official GDP and GDP growth numbers for 2013 and 2014. China is also implementing accounting changes that will boost GDP by 8-10%. Combined the effect will be about a 15% increase in GDP in the 2014 and onwards numbers. The adjusted numbers plus including Hong Kong and Macua GDP means that China will be at about 75% of US GDP in 2015.

    There will be a 2019 business census. The census has boosted China’s GDP numbers in 2005, 2009, 2014 and will likely boost it for 2019.

    The nominal – exchange rate GDP of China-HK-Macua will very likely pass the USA for 2019.

    The US had statistical adjustments made to its GDP calcs (adding in entertainment and creative software that boosted GDP by 3%). Nigeria did a GDP rebasing that boosted GDP by a large amount.

    The new accounting and census will be the going forward official numbers. IMF and Worldbank use the official national numbers as reported.

  42. A world of excess savings is prone to bubbles, and either debt-fueled consumption or high unemployment, and this pretty much describes the world we have been living for the past two decades. For this reason I would argue that countries that are … exporting excess savings – i.e. running current account surpluses – are weakening growth abroad.

    This means that to assume slower growth in China will reduce growth abroad is wrong. … As long as the world suffers from weak global demand, if China’s current account surplus declines relative to global GDP, China is adding net demand to a world that needs it. This is positive for global growth.

    This logic is false in a global debt deflation contagion where global demand declines faster than China’s subsidized fixed-investment sector and exports do. Simple math says that when the global marginal-of-utility-of-debt has become negative, then there is no form of QE nor debt restructuring which can stop the decline in global GDP.

    I also doubt a successful redistribution to the consumer share of the economy from the subsidized investment sector, because it assumes there are assets of value to transfer between sectors. But if the assets were egregiously subsidized (i.e. examples of misallocated capital) then their net transfer value is small or even negative. For example, Michael’s alternative hypothesis to the reverse real estate wealth effect on consumption is that consumers will receive lower housing costs and that the consumption of the wealthy is not as sensitive to changes in wealth. But it seems reasonable to assume that supply meets overextended demand in a frenzied mass mania speculative debt bubble so everyone who was capable of buying a condo on credit did so which would include a perhaps 50% of the consumers given a $50,000 price for a 1 bedroom condo and an annual salary of $16,000. So the reverse wealth effect would diminish consumption. And if Jim Chanos was correct that the average investment condo size is 100 sq.m, then at $2500+ per sq.m, even if these drop -50% in price they will still be unaffordable to the majority of the consumers.

    • I think the economic possibilities for China are pretty clear. There’s really only 2-3 possible scenarios and time will tell which scenario actually happens

      I’m just waiting to see the political outcomes, which are far more uncertain and unpredictable. I wonder how the economic scenarios affect the political scenarios, but there’s so many possibilities. Currently, China is economically centralized and politically decentralized. If Prof. Pettis is correct, China will become more economically decentralized and more politically centralized.

      Most of China’s population lives in the middle/north of the country, but most of the navigable waterway lies in the south of the country. Southern China is also a very different climate with a very different geography. It’ll be interesting to see how all this plays out.

    • Another interesting thing about China is that the South doesn’t really get a say in what happens (the entire government is in the North). This is why, historically speaking, foreign powers have always been strong in the South (ex. Hong Kong, Macau). If the US stops patrolling the world’s oceans to protect everyone’s trade, the free trade order we’ve had since World War II will be gone. That has huge implications for China’s political situation.

      • @Suvy

        Currently, China is economically centralized and politically decentralized. If Prof. Pettis is correct, China will become more economically decentralized and more politically centralized.

        That is a thought provoking point. You are I assume pointing out that local governments are given a lot of autonomy (to borrow and build) which is one of the primary causes of that the fixed capital investment dominates the share of the GDP in Pettis’ model of China’s dilemma. You are also implicitly pointing out for example that the central government will need to assume all of the bad debt.

        …By the way, do you know how much cheaper transport costs by water are vs transport costs by land? When you add in the costs of the road and rail networks, we’re talking about a 70 fold increase in costs when you’re talking about transport costs by land…most of the navigable waterway lies in the south of the country … protect everyone’s [physical not virtual Knowledge] trade, the free trade order we’ve had since World War II will be gone.

        IMO irrelevant.

        Again I find my disagreement with your analysis hinges on my theory of a fledgling Knowledge Age which will render the physical economy irrelevant. You are egregiously overvaluing the importance of physical trade in the future economy. I believe your model is wrong.

        The top-down central government is entirely incapable of being in tune with this bottom-up global paradigm shift of economics. Even I assert Thomas Piketty got the facts wrong in his bestseller Capital in the Twenty-First Century.

        The currency wars and China’s subsidy of global manufacturing are a beggar-thy-neighbor competition into the deflationary abyss, because the Industrial Age is dying. Factories can produce more than humans can consume in a non-debt saturated economy and only require a small number of humans to do so. Even Oxford U. predicted that 47% of existing jobs would be replaced by automation before 2032. The world’s population has to move into the higher valued Knowledge Age, but the governments are subsidizing the old Industrial Age statism model to prevent the masses from being motivated to make the transition. Thus the governments are pushing us to the precipice of a discontinuous, waterfall collapse adjustment and overshoot with a bifurcation of the global economy into a (potentially megadeath) dying statism cancer and a fledgling autonomous Knowledge Age.

        I expect China to collapse into this deflationary abyss and fledgling Knowledge Age chaos along with the rest of the globe, but Asia will bottom first because it has much lower levels of constituent liabilities and taxes. It is as simple as that. Your model of the future of the USA is wrong. The future is about how much the State gets out of the way and allows the Knowledge Age to prosper. In the USA, Obama wants to use executive power to take totalitarian control of the internet regulating it as a public utility via the FCC and taxing it 16%. Ditto France. Spain taxes sunlight. The West is done, stick a fork in it. Asia is the future. Sorry Suvy your physical trade model is archaic.

        {satire}Prof. Pettis is wise to be moonlighting as an economist while (to fund) his serious career is in his Chinese music label, because creative knowledge production is where the future value is.{/satire}

        P.S. Also trade is a very small component of international capital flows, so trade has nearly no relevance on the imminent tectonic contagion of global finance.

        • Rendering geography irrelevant?! We don’t need farmland or natural resources. Economic inputs are no longer necessary as we’ve found ways to defy the laws of physics. We can produce as much as we want and increase our living standards to no end. We’ve entered the knowledge age. LOLOLOLOL!!!!!!!!

          Oh my God, we’re entering a new era where the past doesn’t matter anymore. LOL! Keep dreaming. This time is different.

        • I understand that we’re entering into the Post-Industrial world, but you still need economic inputs. We’ve been using natural resources for tens of thousands of years. To think we’ll live in a world where natural resources won’t matter is a joke. Hell, the longer we’ve used something, the longer the expected time frame of its use (Lindy Effect).

          The world is in a very precarious position where it’s more fragile than it ever has been before due to the flow of information, disease, etc.. Local problems become worldwide problems very quickly. The best thing for the world to become more robust is traditional religion, not knowledge.

          Correction: China doesn’t import most of its food (although it is a net food importer), but it does import most of its energy. Either way, control of shipping lanes is critical.

          • @Suvy, the relative weight of the physical resources is declining, e.g. commodity prices have been inexorably falling since the dawn of human civilization; Iron was a precious metal 300 B.C.. The $200 trillion global debt bubble has been sustaining the statist fixed capital relevance against the fledgling Knowledge Age. Physically advantageous paradigms are now a liability, no longer an asset. China and Asiawere historically constrained by the impossibly impractical (low ROI) cost of projecting trade and power across the Himalaya mountain range[1] — the mountanions geography that promote the farming of rice instead of wheat with its higher caloric content, irrigation, and labor instensity attributes making it concomitant with higher population density[2]. The Knowledge Age removes that geographical limitation and turns the high density population (which is crammed in along the non-mountainous coastline) into an asset.

   (historically China will revert from top-down to bottom-up)
            In the above linked comments, author ‘JustSaying’ is me.


          • The knowledge age does nothing to constrain geography. High density populations HAVE ALWAYS been the norm! It was ALWAYS an asset. Everything in the real world scales. What does that mean? It means you get small areas with large clusters of activity with most places where nothing happens. The only way wealth can be accumulated is in large population centers. Actually, it’s less true today than it used to be because of the speed at which people can communicate.

            Knowledge doesn’t remove uncertainty. On the contrary, the more information we have, the more the noise increases vs signal. In other words, we end up being under the illusion that we understand more. We end up being more prone to facades.

            Citing shitty biological studies based on “theory”? LOL!! Seriously? These are all narrative based disciplines where most of the people conducting them lack rigor. They don’t mean anything.

            Where the hell do you get this garbage? It seems like you’re overlooking some of the most basic factors. More knowledge doesn’t really fix anything. The problem isn’t a lack of knowledge in the first place–it never was. The problem is uncertainty.

          • You’re acting like most of the stuff you’re saying is this revolutionary new idea that’s never been known before. This is nonsense. Any system with fat tails ends up having dynamics you’re talking about. Again, the real problem is uncertainty and how you deal with it. It’s that simple.

            You’re overcomplicating EVERYTHING!

          • @Suvy

            Knowledge doesn’t remove uncertainty. On the contrary, the more information we have, the more the noise increases vs signal. In other words, we end up being under the illusion that we understand more. We end up being more prone to facades.

            Any system with fat tails ends up having dynamics you’re talking about.

            Mathematically incorrect. Study Nicholas Taleb’s Anti-fragility concept (whom which btw I exchanged emails and it seemed he basically approved of what I wrote in the linked section of my essay). Since you seem incapable of distilling to generative essence of concepts to conceive how that applies to your myopia, let me spell it out for you. The more numerous and distributed (decentralized) autonomous knowledge agents in a system, the less discontinuous the adjustments the system has to make, i.e. the less far out-of-balance the system becomes.

            Also you can’t seem to wrap your naive mind around the generative essence concept that what held the USA together economically (i.e. motivating immigrants to adopt a common language, as opposed to fracturing into factions of immigrant cultures) and propelled it to #1, was the fact that we were in an Industrial Age and during an Industrial Age, as you pointed out efficiency of distribution is a critical economic factor, thus the USA flatlands, navigable waterways, two coasts to two hemispheres of the world, etc.. gave it an unmatched economic advantage.

            Thus immigrants had an incentive to assimilate and the economy had an incentive to stay homogeneous for commerce. But watch what happens when the USA economy starts to implode after 2015, as the $200 trillion global debt bubble collapses into contagion. The incentives for assimilation will no longer exist in the Knowledge Age which survives the collapsing Industrial Age which is only be propped up with the $200 trillion of debt, but the fat lady has sung because the global marginal-utility-of-debt has gone negative and we just can’t continue borrowing for ourselves to prop up a dying paradigm of physical industry, fixed capital investment, and physical trade as an overvalued activity. Sorry you are wrong.

            But as I have explained in my theory of a fledgling Knowledge Age, that the individual knowledge workers didn’t have the economy-of-scale to produce and distribute their own knowledge works in a physical economy, and thus were enslaved by fixed capital in the Theory of the Firm and the Industrial Age. But the internet and virtual work and distribution has changed all that. Just like the Second Industrial Revolution was brought on by network effects from the First Industrial Revolution, we are now underway in the Second Computer Revolution where the network effects from the First Computer Revolution are starting to kick in and take effect. Anyone who fails to understand how this changes everything is going to have their myopic teeth kicked out by reality.

            Thus the geographical advantage the USA has is now not only muted, but becoming a liability for as I showed in one of the comments that was censored, the USA can’t keep up with internet speeds, because of its huge spread out landmass economics and the resultant fascist politics and oligarchies it creates. I don’t have time to spoon feed these concepts. You can either learn to read my writings and think deeply for some days, or you continue to remain ignorant. I don’t care! I am too busy actually writing software that will radically change the world in this Knowledge Age. I don’t have time to deal with Prima Donnas from the Millennials generation nor senile, selfish, entitled, statist, socialist, authoritarian boomers who don’t know when it is time to step aside and let our generation express ourselves.

            P.S. Appears Prof. Pettis has censored my prior two replies. Perhaps he is going to allow you to spout off with your 20-something, overconfident myopia (Dunning-Kruger effect) unchallenged. But I am posting all my replies at the bitcointalk forum which has 40,000+ reads, so the truth will not be censored and will be on the internet for posterity when everything I am writing comes true (as have all my other major predictions in the past). Because I understand deeply and you do not. Period.

          • So you sling code? Big deal. That makes you Mr. Expert and “right” on everything. Congrats. Want a cookie?

            Look, everything in the world has constraints. Regardless of how much knowledge you have, you can’t create something from nothing. All “progress” requires something. Even smartphones require rare earth metals. Think of all of the things we have and what they’re made of. You need energy to burn things like cars. It’s not a matter of knowledge; it’s a matter of constraints.

            People need to eat and people need energy to do something as simple as heat their home. I’m sure there are also parts of China where you’ve got a family of 10 living in a space with <1000 square feet. On top of this, you have population demography issues in China (which Prof. Pettis has mentioned several times).

            We may have technology and knowledge, but you can't violate the laws of physics. By the way, I don't see the point of you sending me the rice theory thing. Obviously, the North and South have different identities. You see the problems in Hong Kong.

            I'm looking at an economy like an ecosystem. You need inputs to have outputs. Now, that has to obey the Laws of Thermodynamics. You need things like natural resources.

            You might be good at writing code, but I seriously wonder if you'd say any of this to my face. I don't give a shit about who you've corresponded with. The stuff you're saying is nonsense.

            Look, debt is certainly a problem. That being said, I think China has one of the world's worst debt problem.

            By the way, how can you say commodity prices have been falling since the dawn of civilization? That makes no sense. What was the price of crude in 1000? What if you found crude in 1000 (I'm sure some people did)?

            One of the biggest ways we've developed capital is by learning how to extract natural resources better. Knowledge is not an economic input, it's just something we can use.

        • I make my point with 6 charts.

          Sorry don’t know how to post charts on this blog, so I provide a link instead.

          • Industrial commodities aren’t the only economic inputs and are the least significant ones that I was referring to.

            BTW, in the period for Rome you’re talking about, there was disease epidemics where almost 50% of the Roman population died. Of course the currency will collapse as production certainly did.

          • In 235, it started off with the assasination of an emperor. At around the same time period, smallpox broke out causing massive population declines. Trade became impossible and unsafe, largely from the stem of disease and political breakdown. Shifts in the climate caused massive population relocations, creating war. In the case of Rome, this was based extensively in its geographical location.


            You attempt to remove blame from the effects of top-down governance. Agriculture in Western Europe declined for numerous reasons all of which can be attributed to mismanagement due to top-down control and the funding of such misallocation. Socialized debt is a future tax. The agricultural sector was suffering under increasing taxes after the hyperinflation of the 3rd century had adversely impacted funding for the military while there were increasing military threats to the east. Pottery records indicate production increased through the 4th, as the rural sector was squeezed for every drop by Rome. As with all debt funding, growth was too rapid, and irrigation was polluted by clearing for too many new settlements. The resultant malnutrition, declining production, localized warlords, and thus disease coincided with the collapse of Western Europe due to the bankruptcy of its top-down militarized, servitude model.

            We will likely find the same top-down cause applies to of all Dark Ages– even the famines in Africa.

          • That’s what happens when you have a rampant increase in disease. Outlays shoot up, production falls, and people move to the countryside. Increasingly, land becomes the store of wealth and the middle class gets wiped out. Capital development becomes difficult, expensive, and impossible.

            These things are complex, which means there’s lots of different factors at play all working together. You get feedback loops that form on the way down. It’s not just one factor where everything’s simple.

          • @Suvy, you get to remain in bliss courtesy of Pettis’s unwillingness to allow my rebuttal to appear on his blog. I did post my lengthy rebuttal else where; Google is your friend. Goodbye.

          • I’m just looking at constraints. You still need water to drink and food to eat. You need to find robust ways to deal with economic change.

            Let’s take global warming as an example. Suppose the scientists are somewhat correct in terms of the shifting of global temperatures. Even shifting the possible arable land a few degrees north or south creates huge shifts in the way populations survive.

            What about water? This is a serious problem for a lot of countries. Not only do you need water to drink, but you need water to clean, irrigate, grow food, and all sorts of stuff.

            It’s not just if a country has enough water. It has to have enough water for its populations to use. That requires infrastructure and coordination. If you pollute or destroy your water sources, you have to spend resources to clean it up. Environmental degradation is China’s biggest problem (Prof. Pettis has spoken about this). Most of China’s water is polluted and many of the areas are under strict military control by the center of China (which is all in the North). These are serious downside tail risks.

  43. Bitcoin… check
    gold standard… check
    Martin Armstrong and his HAL 9000 machine… check

    Why am I not surprised…. my favorite gem was this.. “Armstrong has been predicting events precisely to the day. The below $57 closing price for oil on Dec. 31, he predicted long ago (I saw it)”

    I assume they are referring to this… Señor Armstrong on ‘July 9, 2014’ …”oil peaked intraday in 2009 but the highest yearly close came in 2011. It is poised to rally into 2017 and it appears this is lining up with our war models. ”

    Like Shakespeare said… “A fraudster by any other name is still a fraudster”… He also said something profound about “neither a borrower nor a lender be”… I think Mr. Pettis would like the second one.

    • Ah yes. The problem of cherry picking.

      I don’t get why most people don’t realize that it’s not about prediction. How often you’re “right” doesn’t mean jackshit. It’s how much you gain when you’re right vs how much you lose when you’re wrong that matters. In other words, it’s about the mathematical expectation, not the probability.

  44. “It’s how much you gain when you’re right vs how much you lose when you’re wrong that matters.”

    I agree. But therein lies the hard part. People are wired to do that backwards. Winning is a manic sensation, people seem to wish to capture it. Losing, is shameful, people tend to go into an ‘ostrich’ impression, and therefore let it run and run..

    • So all it tells us is that courage is more important than intelligence. I think, in order to have mental clarity, it’s more important to be ballsy than it is to be smart.

      • Ha! But we must remember that it is better to be lucky than ballsy, and for some reason luck seems to be related to doing smart things… so… I guess it’s important to be smart, great to be lucky, with the need for a set of balls. Then you just want to be right more often than wrong and right by more than you are wrong…… It’s that simple!
        Oh, let’s not lead out sociopathic tendencies so that one can handle the emotional tornado your long ruble trade can cause on the human psyche. Imagine, strong opinion, long in low 50’s up to near 80, back down below where you got long in low 50’s… Normal person now to be found rolled up under a desk somewhere, in pre-natal position, babbling about 4th century pottery.

      • China does pride itself for those…

  45. I’m very happy that China is slowing down its growth rate to a more sustainable level, and taking a turn back to fix some problems that they are in the rears on. Pollution has become such a huge problem in China, specifically on the eastern side, and without focusing on how to build companies sustainably, and finding better outlets for alternative energy, China would be the biggest most unhealthy environment for its newly rich. That, and by conservatively beginning to extend credit, will be the reason why China is reverting to a more slow but steady growth platform.

  46. “It’s the amount you pick up when you’re correct versus the amount you lose when you’re wrong that matters.”

    I concur. Be that as it may in that lies the crucial issue. Individuals are wired to do that rearward. Winning is a hyper sensation, individuals appear to wish to catch it. Losing, is dishonorable, individuals have a tendency to go into an “ostrich” impression, and accordingly give it a chance to run and run..

  47. Hi Michael,

    I was hoping to get your thoughts on the China slowdown affecting Australia and Australian property markets? You’ve written some great articles on China’s growth slow down, the decline of hard commodities and it having an effect on commodity countries and their terms of trade.

    My question is that, although we are feeling it economically, unemployment has risen from 5 to 6 % but hasn’t risen much further and the property market ( especially in a Sydney and Melbourne) is going through the roof and looks so strong at the moment with most sales going above reserve and people basically crawling over themselves to get a piece of the property pie. A lot of journalists and property salesman (and government) say that now is the time to have a go and that property will never (almost guaranteed) go down. I guess my question was just about what you thought of our property sector going bananas and how China’s slowdown might still have further effect on Australia over the next 1-3 years because there are some people now saying that yeah, $45 Iron Ore sucks but look, property in Sydney and Melbourne is still going gangbusters- it’s invincible?

    • A lot of the strength in the property sector may have been driven by foreign money, including mainland Chinese. I remember perhaps two years ago the Mayor of Sydney said that 80% of real estate sales in Sydney were to mainland Chinese investors. The problem is that Australia has two important relevant connections to China. First, the Australian boom was fueled in large part by strong commodity prices, especially iron ore, and commodity prices began to sure around 2002-03 mainly because of the investment intensity of the Chinese economic boom. As China slows, commodity prices have been hit especially hard, and this hasn’t been good for Australia. Normally one response would be a weakening dollar, which would partly offset the employment consequences of reduced Australian exports, but here is where the second connection comes in. In the past five years, perhaps because of the political fight against corruption and the economic slowdown, a large number of wealthy Chinese have emigrated or exported wealth, with Australia being a major destination. If the continued economic slowdown causes Chinese capital flows to Australia to remain steady, or even increase, the Australian dollar might not weaken as much as it otherwise would. In that case wealthy Australians might benefit from asset prices that are stronger than otherwise, but at the expense of higher unemployment than otherwise.

      • Giancarlo Bergamini

        For sure “…commodity prices began to surge around 2002-03” (6th line above).
        As regards the continued strength of the Aus$, it is an interesting case of capital flows offsetting the weakening effect of poor trade data. One should always be cautious in correlating exchange rate dynamics with current account balance.

      • Hi Michael,

        Yes definitely, we have had a lot of foreign capital coming into property. We do have a rule where foreigners can only buy new properties but in Sydney the Chinese are buying 1 in 4 and in Melbourne 1 in 5.

        Chinese and more broadly, foreign buying is definitely making a contribution but so are domestic buyers. Australia household debt has gone over 110% of gdp and we now have the 3rd highest households debt to gdp in the world. Housing has this invincible status that they even though bubbles popped around the country but it will never happen here..


        • I don’t know enough about Australian real estate to say much more, Laurent, but I know, as I am sure you do, that until 2007-08 everyone “knew” that while the US had suffered many housing bubbles in history in which housing prices declined, these were always local, and nationally, housing had never suffered a negative year, so it could not ever happen. The very fact that we knew this “couldn’t happen” caused us to change our investment strategy in a way that forced correlations to rise, so that knowing that it couldn’t happen probably ensured that it did.

          • Hi Michael,

            Yep, so your saying that “knowing that it can’t happen” ensures that it does happen- makes sense. I know the bubble will pop one day. It’s just until then, people on the street are just so confident that most believe we are on the verge of another property bull market. Friends of mine who don’t know very much about finance just say property won’t go down because a) Look at Canada, their property market is still going well, b) the government/central bank won’t let it happen, c) people will always want houses so the demand is never ending. These are actual reasons people give me, it’s just annoying that people on $50-$60k per year are in some cases buying 4-5 places and leveraging up to around $1.5-2 million in debt and believe that this is normal and the way to riches…

          • Yes, these secular cycles can be reflexive for many years. How long they last is always the difficult part to predict. With most of the participants in asset bubbles having never experienced severe asset deflation (as the case being for Australia, Canada, New Zealand etc), it only serves to accentuate the possibility severe asset deflation will eventually occur.

  48. Hi Michael,

    Just one more question (thanks for answering about Australian property). In regards to China, you’ve mentioned before that china will drop 1-2 percentage points of gdp per year for the next few years settling on a gdp growth rate of 3/4 or lower. I’m very curious as to why China’s slowdown will be more measured over a few years where as say other investment driven growth models like Japan seemed to slow much more abruptly resulting in a crash of their stock and property markets?
    Also, while I’m on the subject of China gdp, do you think that it is accurate or as some others like Xie says, is it off because figures come from the SOEs and work their way up and once they hit the federal government they are many times distorted?



    • I’ve argued that I expect growth to slow so that the upper limit on GDP growth is 3-4% during a rebalancing period of ten years (2012-22). It could be very volatile, depending on how long it takes to get credit under control, and growth could average less than 3-4%.

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