If we don’t understand both sides of China’s balance sheet, we understand neither

With so much happening in China in the past month it seems that there are a number of very specific topics that any essay on China should focus. I worry, however, that we get so caught up staring at strange clumps of trees that we risk losing sight of the forest. What happened in July this year, and again in August, or in June 2013, or a number of other times, were not unexpected shocks and game changers. China is a dynamic and unbalanced economic system entering into something that we might grandly call a “phase shift”, or less grandly the rebalancing process, and that it is doing so with a great deal of debt structured in a highly inverted way. Anyone who sees China this way would have been able to predict not so much the specific shocks, panics, and credit crunches that we have experienced, but rather that we would of necessity experience a series of very similar shocks.

These debt-related shocks will occur regularly for many more years, and each shock will advance or retard the rebalancing process so that it affects the way future shocks occur. There are only a few broad paths along which the Chinese economy can rebalance, and if we can get some sense of the China’s institutional constraints and balance sheet structures, we can figure what these paths are and how likely we are to slip from one to another.

In order to get Chinas right I would argue that above all we must understand the dynamics of debt, and of balance sheet structures more generally. Four years ago one of my clients sent me a research report by Standard Chartered in which their China analyst warned that while Chinese debt levels were still negligible, there was a chance, small but no longer insignificant, that credit growth could speed up sharply and debt eventually become a significant constraint for policymakers. Things were fine for now, the analyst seemed to suggest, but it was possible that Beijing could mismanage its way into a debt problem.

The overwhelming consensus at the time was that China’s growth model was healthy and sustainable, and would generate GDP growth rates for the rest of the decade that were not much lower than the roughly 10% we had seen during the previous three decades. My client sent me the report along with the comment that the sell-side was finally recognizing that the Chinese economy was at risk. A leading analyst who had long been part of the overwhelming bull consensus was, he said, finally beginning to understand the Chinese economy and the problems it faced.

I wasn’t so sure. It seemed to me that those who understood the Chinese growth model would have also understood that its overreliance on investment to fuel growth, combined with the structure of its credit markets, extremely low interest rates, and wide-spread moral hazard, made soaring debt almost inevitable, and that debt was already constraining policymaking.

To suggest that this might happen only if the new administration – that of Xi Jinping – mismanaged the process suggested to me that the analyst did not really understand the self-reinforcing relationship between rising debt and slowing growth, and was underestimating how difficult it would be for the new administration to break out of this process. It was going to happen almost no matter what Xi’s administration did, and his administration would be very unfairly blamed for incompetence. At the time the research report was written there was an aura of invincibility about policymaking in China, so that warning about possible future policy mismanagement seemed like perfunctory prudence. But every “growth miracle” ends up follow the same credibility path, with what once seemed an unending stream of sophisticated and dedicated leaders at every level of policymaking suddenly and unexpectedly becoming an administration of clunky, incompetent bureaucrats, as foolish as the rest of us. When the miracle country outperforms expectations year after year during the expansion phase, we assume that brilliant policymaking is the cause, rather than– more appropriately, as I will explain– inverted balance sheets. When this same balance sheet inversion subsequently causes the economy sharply to underperform expectations during the contraction period, our admiration for policymakers quickly turns into contempt for their incompetence, usually tinged with bitterness that our forecasts turned out so magnificently wrong.

There is a very big difference between acknowledging that China has a lot of debt and understanding how debt and debt creation are embedded within the financial system, but the Standard Chartered economist, like most, assumed that the former implied the latter. In June the NBR’s journal for Asian economic research, Asia Policy, put together a roundtable to review Nicholas Lardy’s book, Markets over Mao. I was one of the five analysts who were asked to participate. Lardy is one of the best informed and most knowledgeable of the economists covering China. In my review I praised his book for the quality of its analysis, and it well deserves that praise.

But there was a fundamental disagreement in how he and I interpreted the data, and this disagreement extends to the majority of analysts covering China. Lardy believes China is in reasonably good shape economically and concludes with optimistic growth forecasts. Based on the same data and absorbing much of his analysis and interpretation of that data (I have been reading Lardy for many years) I expect growth to slow sharply. The current consensus for China’s long-term growth, I think, is around 6-7%. Lardy has said “China could grow at roughly 8% a year for another 5 or 10 years.” I believe, however, that without a massive and fairly unlikely transfer of wealth from the state sector to the household sector, the average Chinese GDP growth rate under Xi Jinping cannot exceed 3-4%.

So why do we disagree? I suspect that we disagree for the same reason I disagreed with the Standard Chartered analyst, who saw an unsustainable debt burden simply as an unlikely but possible result of policy mismanagement. We disagree, in other words, not on the fundamental data but rather in our understanding of debt dynamics and the constraints the balance sheet can place on an economy’s “fundamental” operations.

As I see it there are at least two important disagreements here. The first is about the impact of balance sheet structures on exacerbating volatility. Neither Lardy nor the Standard Chartered analyst spent much time discussing how the balance sheet might affect growth. For me, however, this has been and continues to be a key component of the Chinese economic “miracle”, and indeed also of every previous growth miracle. As I said in my review:

Rebalancing is often harder than expected, in other words, not just because of opposition by vested interests, but more importantly because highly inverted balance sheets cause policymakers to overestimate potential growth during the miracle years. But when growth during the rebalancing phase contracts more than expected, the same balance sheet inversion that exacerbated the expansion phase will also exacerbate the slowdown, especially as declining credit quality reinforces, and is reinforced by, slower growth.

I made a similar argument two weeks ago in a Wall Street Journal OpEd about why it is so important that Beijing maintain its credibility, which is the only way of ensuring that China’s substantial balance sheet mismatches can be managed and rolled over:

History suggests that developing countries that have experienced growth “miracles” tend to develop risky financial systems and unstable national balance sheets. The longer the miracle, the greater the tendency. That’s because in periods of rapid growth, riskier institutions do well. Soon balance sheets across the economy incorporate similar types of risk.

…Over time, this means the entire financial system is built around the same set of optimistic expectations. But when growth slows, balance sheets that did well during expansionary phases will now systematically fall short of expectations, and their disappointing performance will further reinforce the economic deceleration. This is when it suddenly becomes costlier to refinance the gap, and the practice of mismatching assets and liabilities causes debt, not profits, to rise.

Financial distress can be worse than a crisis

The second misunderstanding is about why “too much” debt matters. For most economists, the main and even only problem with too much debt is that it might lead to a financial crisis, and that the fear of crisis undermines confidence and so can cause spending to drop. But while these are important problems, these analysts are mistaken in limiting their concerns to these two issues. While a financial crisis is certainly a risk, the damage debt does to an economy occurs long before any crisis, and for debt to be terribly damaging to an economy’s long-term growth doesn’t even require a crisis.

In fact one can easily make a case that while a financial crisis may be spectacular, it nonetheless limits the damage caused by excessive debt by forcing a recognition of the losses, only after which does the system begin to allocate capital efficiently. Until this happens, the adverse impact of debt on growth can persist for decades. A case in point is Japan. Japan never had a financial crisis or a banking sector collapse, but from 1990 to 2010 the amount by which its share of global GDP has declined, substantially more than 50%, far exceeds the damage caused to any other country by a financial crisis. Or consider the heavily indebted countries of Europe, like Spain, Italy and Portugal, who have avoided crises, but only in a way that makes it hard to believe that they are better off economically today than they might have been had they suffered a financial crisis in 2009 or 2010.

In my review of Lardy’s book I try to explain why debt constrains growth, whether or not it leads to a crisis:

The second way liability structures can constrain growth, while often poorly understood by economists, is actually well understood in finance theory. An economic entity will suffer from “financial distress” if debt has risen so much faster than expected, or growth is so much lower than expected, that economic agents become uncertain about how higher debt-servicing costs will be assigned to different sectors of the economy. This uncertainty forces these agents to react in ways that unintentionally but automatically intensify balance sheet fragility and reduce growth. This uncertainty is intensified if the debt burden rises and falls inversely with debt-servicing capacity, which almost always happens when economic growth is highly credit-intensive, and which seems to be happening in China.

Because this seems so counter-intuitive for many people, it bears repeating. The problem with too much debt is not just that it might cause a crisis. The problem is, first, that debt may be “inverted”, i.e. structured in a way that systematically enhances volatility, which means good times become better and bad times worse. This automatic leveraging-up of volatility has seriously adverse impacts on long-term growth. Second, when debt levels are higher than expected and growth lower (one of the nearly inevitable consequences of highly inverted balance sheets), if this divergence causes uncertainty about how the debt servicing will be resolved, the uncertainty itself forces agents to behave in ways that automatically reduce growth and increase balance sheet fragility further.

Lardy’s response to my discussion of debt indicates, I think, just how much disagreement there is here and how easy it is for most economists to misunderstand what I think are the relevant issues – although in fairness it should be noted that he is responding to five separate reviews, and so this is unlikely to be his full response:

Contrary to Michael Pettis’s assertion, the book does give some attention to the liability side of the Chinese economy. I note the huge buildup of debt starting in the fourth quarter of 2008 and analyze the challenges this debt poses for financial stability. But in Markets over Mao I point out that China differs in several critical respects from other countries where rapid debt buildups have precipitated financial crises.

To begin with, China’s national saving rate, reflecting the combined savings of households, corporations, and the government, approaches 50% of GDP, significantly higher than any other economy in recorded history. Like households, countries that save more can sustain higher debt burdens. Second, the vast majority of this debt is in domestic rather than in foreign currency…Thus, its debt does not involve any significant currency mismatch, a major contributor to many financial crises. Third, the majority of this debt has been extended by banks, and China’s systemically important banks are financed entirely by deposits rather than through the wholesale market…Finally, the government has enormous scope to further increase bank liquidity should that become necessary. Other factors, too numerous to list here, also suggest that a banking crisis is far from certain in China.

Lardy is not actually disagreeing with anything I said. In fact I fully agree with him that a banking crisis is unlikely, and have written many times that while it is possible, and the risk of its happening should not be dismissed out of hand, I do not think China is likely to have a banking collapse, any more than Japan in the late 1980s and early 1990s was ever likely to have a banking collapse. This doesn’t mean however that China’s debt burden is irrelevant.

A system of interlocking balance sheets

Japanese GDP growth, after all, did indeed collapse as it was forced to rebalance its debt-laden economy, and this collapse in growth has lasted an astonishing 25 years, with, as I see it, still no end in sight. I would argue that Japan’s debt structure explains the 25 years of low growth and will ensure many more years of low growth. During the first wave of excitement over “Abenomics”, for example, I wrote on this blog and elsewhere that just trying arithmetically to work through the consequences on the country’s debt burden of the success of Abenomics made it hard for me to see how Abenomics could possibly succeed in generating inflation and real growth without an explosion in its current account surplus that the world would not be able to absorb.

It was precisely because of China’s debt dynamics that I began arguing in 2006-07, and contrary to consensus, that China’s growth model was unsustainable, that its debt was rising too quickly and could not be reined in without a significant drop in growth, and that China had urgently to rebalance. The same logic made me argue in 2008-09 that China’s adjustment was going to be brutally difficult and would entail at least a decade of GDP growth that could not exceed 3-4% on average. And yet I have always also argued that China’s banking system, because of an implicit guarantee by Beijing, is very unlikely to collapse, and if one excludes things like the credit crunch in June 2013 or this month’s stock market panic, we are unlikely to see a financial crisis unless GDP growth – and with it credit growth – remains at current levels for another 3-4 years at most.

This, for some reason, has been very hard for most economists to grasp – for example the most common “refutation” of my argument and that of other skeptics by so-called “China bulls” is nearly always something along the lines of “He has been predicting a crisis for six years and it still hasn’t happened”. At first I assumed that these bulls were being – perhaps understandably given how poorly their forecasts had performed – defensively dishonest, but I quickly realized that the same argument was being made by people I respected a great deal who were incapable of  such a defence.

It wasn’t dishonesty, I realized, but a failure to understand the economy as a dynamic system in which a)imbalances could persist and grow for many years before eventually rebalancing, b)the more rigid the institutional structure of the economy, the deeper imbalances were likely to get, c)the longer they persisted, the more disruptive the rebalancing was likely to be, and the less significant the “trigger” that set it off, and d)there are many ways rebalancing can occur, and the way it actually occurs depends on institutional constraints and rigidities. These economists seem to find it difficult to understand that an economy can have a very unbalanced debt structure, with debt growing at an unsustainable rate, so that there will be a significant reduction in future growth, but a crisis is only one of the ways, and not the only way and certainly not imminent, that this reduction in future growth can happen. It is only when debt is subject to a “sudden stop” that a crisis can be inevitable, but in many if not most cases there is no crisis.

Lardy of course is far more sophisticated than most economists covering China, but while he says that he “does give some attention to the liability side of the Chinese economy”, he mostly notes that there is a significant amount of debt, before going on to explain why he thinks a banking crisis is unlikely. He misses what I think are the most important aspects of China’s liability side, however, for example: the extent and nature of the balance sheet inversion and how it will exacerbate the economic contraction and convert refinancing risk into unexpected increases in debt, rather than unexpected increases in profits, as occurred during the expansion phase; or whether the reinforcing relationship between unexpectedly high debt and unexpectedly low growth will create enough uncertainty about how debt servicing costs will be allocated that it forces financial distress costs onto the economy.

These are the reasons debt matters, not just whether or not debt must lead to crisis, and the failure to address these reasons is, I think, typical of the kind of attention most economists give to debt, in China and elsewhere. It perhaps explains why economists have such a poor track record in predicting economic reversals – the models they implicitly use make it hard to understand and quantify a dynamic rebalancing process.

It is neither enough to note the amount of debt a country has or to speculate on the probability of a debt crisis. What matters is the systemic role of debt in generating economic activity, the feedback processes that are embedded in debt structures, and the uncertainty that may arise about the resolution of debt-servicing costs. To summarize, there are at least four important issues to consider:

  1. It is possible to structure an economy in such a way that excessive debt creation is not a “choice”, not even a bad choice, but is instead the automatic consequence of institutional constraints within the economy, and in fact it is very rare that a country experiencing many years of “miracle” growth hasn’t created such constraints. This is why it should have been possible to see well over a decade ago that China’s excessive indebtedness was inevitable. Economists who warned of the possibility of a deterioration in the balance sheet, but who thought nonetheless that China could avoid this outcome without a major restructuring of its growth model and a significant reduction of its growth rate, were always fundamentally mistaken. Excessive debt levels were never a “possibility”. They were a necessity as long as the growth model had not been fundamentally transformed.
  1. The structure of the balance sheet, by which I mean the types of mismatches between assets and liabilities when debt levels are high enough, can systematically enhance volatility, so that periods of expansion, real productivity growth, or benign global conditions can result in many years of growth that exceed expectations. This comes however at a cost. First, the same balance sheet structures that enhance growth during the expansion phases will cause growth to slow much faster than expected during the contraction phases, and second, enhanced volatility always reduces value, although not always perceptibly at first, because it increases gapping risk. This process is perhaps counterintuitive to those who think all economic activity is driven by fundamentals, but is well understood by traders and investors, who know how it works in margin buying, leveraged positions, and derivatives that directly quantify leverage and gapping risk.
  1. Apart from enhancing volatility, high debt levels can adversely affect growth any time there is uncertainty about how debt servicing costs will be resolved, i.e. to which sectors or groups they will be explicitly or implicitly allocated. This uncertainty will affect the behavior of any sector of the economy to whom the costs might be allocated, in the form of either direct taxes, indirect taxes (e.g. inflation or depreciation), appropriation or expropriation, or wage and consumption suppression. These sectors, all of whom will alter their behavior in order to protect themselves from bearing the costs of debt, comprise most of the economy, including foreign creditors, small business owners, savers within the banking system or in other forms of monetary assets, workers, wealthy owners of financial and non-financial assets, the agricultural sector, importers and exporters, the mining sector, and many others. The wealthy might take their money out of the country, for example, and creditors might shorten maturities and raise interest rates, business owners might disinvest, the middle class might dis-intermediate savings, workers might organize, local policymakers may engage in protectionist activity, borrowers might invest in riskier projects, banks might reduce the scope of their lending to the most protected sectors, etc. The point is that it is a mistake to assume that the only or main cost of excess indebtedness is a financial crisis.
  1. The balance sheet can embed strong feedback mechanisms within the economy that make it almost impossible to predict the growth of debt. The balance sheet mismatches that during the expansion phase could be refinanced in ways that created unexpected profit, can easily lead to rising debt instead as the mismatches become harder to refinance or require government guarantees.

This is why I would argue that once a country’s balance sheet reaches a certain critical point, any analysis is fundamentally mistaken if it simply acknowledges the existence of a great deal of debt, or sees a debt buildup as unlikely, or as the consequence of bad policy, when already institutional constraints make it a necessary corollary of growth.

Debt was already a problem in the Chinese growth model more than ten years ago (and is a problem in several advanced economies too, who are going to find it nearly impossible to grow out of their debt burdens without implicit or explicit debt forgiveness). Those analysts who do not understand why this is the case probably do not understand why the balance sheet will continue to be a heavy constraint on Chinese growth and will underestimate the difficulty of the challenge facing Xi Jinping and his administration, which means among other things that they will be too quick to criticize Beijing for failed policies when growth drops below their projections.

But to understand this requires probably a fundamentally different way of understanding economics. The economy is a dynamic system made up, as Minsky said, of interlocking balance sheets, and the way economic growth, exogenous shocks, debt dynamics, income distribution, and ever other dynamic process is intermediated from balance sheet to balance sheet depends both on the structures of the balance sheets and on other institutional constraints that characterize each economy. For those doing “empirical” economics, multiple regression and various kinds of multivariate analysis will no longer march down the royal road of mathematics but will rather be relegated to one of the side-streets, for occasions in which the economy is expected to be heavenly, and in which, as David Byrnes sang, nothing ever happens.

Instead when we do math we will prefer to think in terms of options, probability theory, and lots of simple algebra, all of which are well suited to understanding both how debt can disrupt an economy in a predictable way and how the threat of that disruption can itself also disrupt the economy in a predictable way. Unfortunately this will make forecasting very difficult – at least the current variety of forecasting, as in: China’s GDP will grow by 6.84% in 2016, 5.93% in 2017, 5.77% in 2018, and 5.02% thereafter.

But losing these types of forecasts is not much of a loss. When nothing happens, these forecasts are often quite accurate. When something happens, however, they are always wholly useless, an obvious such case being growth forecasts for China both during the unexpectedly large fiscal stimulus in 2009 and 2010, and later, just as it reached the end of its period of growing imbalances and began the reversal process, around 2011-12.

 

 

This is an abbreviated and much edited version of the newsletter that went out two months 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.

 

532 Comments

 Add your comment
  1. «The problem is, first, that debt may be “inverted”, i.e. structured in a way that systematically enhances volatility, which means good times become better and bad times worse. This automatic leveraging-up of volatility has seriously adverse impacts on long-term growth.»

    But usually these structures are very intentional, very deliberate, because they maximize the profits of those economic agents whose income is proportional to volatility, that is those agents that push for good times to be as good as possible in particular, but also who having stored a lot of wealth gained by the resulting upward overshoot in safer locales, then profit also from making bad times as bad as possible too, which give insiders the opportunity to buy assets cheaply in the consequent downward overshoot.

    That applies to Argentina and Greece but also to the USA and UK and China. In all these countries there is a large and influential “ever bigger leverage” constituency of insiders, which happens to include a large number of politicians and their sponsors, and many “sell side” economists they sponsor.

    The problem of “inverted” structures is thus exquisitely distributional and political, not economic.

    At times from echoes and hints I suspect that the Bejing elites are still fearful of the “mandate of heaven” tradition and will find the radical courage to push back the “ever bigger leverage” constituency among them. I suspect that won’t happen in the USA or the UK or the other countries where the “ever bigger leverage” constituency seemingly coincides with the political and business elites in almost their entirety, plus the vast majority of the upper middle class.

    • biggestbrotherofthem All

      Yes . In a nutshell “exquisitely distributional and political, not economic”

      And yet we are faced with a rhetoric of small government aimed at destroying those checks and balances on the risk happy cowboys, and a philosophy of big government without any institutions which check and balance!

      in toto its risk on.

    • biggestbrotherofthem All

      I just looked up the mandate of heaven and it seems to be almost identical to the “divine right of kings” aided by tons of fine art juxtaposing religious icons next to recognizable faces of monarchs. The Hapsburgs nailed this. Check out the old masters. 50c for a false equivalency? Not in this case I believe.

      • «the mandate of heaven and it seems to be almost identical to the “divine right of kings”»

        It is quite the opposite: it is the idea that the government is legitimate only if it works in the interest of the masses. That is, the masses can legitimately get rid of any government that does not work in their interest, and usually quite violently.

        • biggestbrotherofthem All

          Fascinating. They do however share the idea of divinity or mandate coming from a supernatural power as does, in the case of the mandated, and I may be wrong here too, the forces which overthrow. May take a little longer to overthrow if you are waiting for a mandate from heaven? Give me a sign. Are we all ready yet? How about now? Not ready. Are we?

        • The Mandate of Heaven is not centered around a moral compass, working for the masses. It was a Daoist philosophy that linked natural disasters as a sign to the quality of leadership. Therefore, by nature of being Daoist, there was no massive work in the interest of the masses.

          Instead leaders were concerned with transcending themseleves, becoming immortal. For many dynasties this was done by making elixirs, Waidan. Huge amounts of state funds were used to eat cinnabar and mercury. After later learning eating mercury involves a health risk, Daoism moved to inner cultivation practices, inner alchemy. One could bastardize this and make in moral, but you would be mistaken.

          It is entirely possible (likely, perhaps) that I missed your point, but the Mandate of Heaven was not a tool that ensured what westerners commonly know as good deeds. It was a way to understand natural disasters as a sign of personal cultivation.

          • Please ignore this comment. I come to this blog only to read, not to defend religous understanding of political realities. I am sorry to take away from the topic at hand.

          • The “Mandate of Heaven” was more symbolic than real. In most traditional monarchies (particularly in the East), the monarch was often not entrusted with much power. Monarchy is useful for the administration, not for a monarch.

            In the sense of monarchy being about the administration and executive, the American political system can be considered a Constitutional Monarchy with the monarch being a President elected by an electoral college.

          • Suvy

            You are way out on a limb always trying to prove the president monarch, America push west empire, socialist Europe built for was thesis. It is a novel way to review aspects of these economies. Have you read Fukuyama’s Political Order (vol 1) and Political Decay (Vol 2).

            This is a much better review of the political development of areas of the world and institutional decay than the superficial, if I might, review and likening of political development, subsumed to an economic frame of dubious, ideological, origin, although not sure where you are proceeding from on this.

            In the West, Kings were weak, before the rise of cities, before serfs escaped from the land, mixed with merchants and formed guilds, and started creating wealth, which gave Kings a powerbase separate from reliance on a competing set, of often wealthier, knights and nobles, who held vast estates, where the kings were chosen from among them. It is this process, which eventually begat the industrial revolution as these cities also became the sites of universities, etc….

          • I’m not saying the US was empire and Europe was socialist exclusively or anything like that. What I’m saying is that pre-World War I, empire was the primary mode of operation for semi-large states. “The West” didn’t develop sophisticated political institutions until ~1200 or so, after the Fall of Rome, that is. What is an emperor, but a king of kings? Similarly, what is a President, but a governor of governors.

            The process you described is how it developed in some areas, but different in others. In the case of Spain, Portugal, and the like which were fought from the rule of the Moors, the monarchy was definitely absolutist. It varied, but as soon as the feudal structure broke down in the West, in large part due to the advancement in artillery, it gave rise to what ended up being labeled as absolutist monarchy.

            To show the Presidency and the Executive is akin to a monarchy, I’ll cite no one other than Alexander Hamilton.

          • From Federalist #70:
            “I PROCEED now to trace the real characters of the proposed Executive, as they are marked out in the plan of the convention. This will serve to place in a strong light the unfairness of the representations which have been made in regard to it.

            The first thing which strikes our attention is, that the executive authority, with few exceptions, is to be vested in a single magistrate. This will scarcely, however, be considered as a point upon which any comparison can be grounded; for if, in this particular, there be a resemblance to the king of Great Britain, there is not less a resemblance to the Grand Seignior, to the khan of Tartary, to the Man of the Seven Mountains, or to the governor of New York.

            That magistrate is to be elected for four years; and is to be re-eligible as often as the people of the United States shall think him worthy of their confidence. In these circumstances there is a total dissimilitude between him and a king of Great Britain, who is an hereditary monarch, possessing the crown as a patrimony descendible to his heirs forever; but there is a close analogy between him and a governor of New York, who is elected for three years, and is re-eligible without limitation or intermission. If we consider how much less time would be requisite for establishing a dangerous influence in a single State, than for establishing a like influence throughout the United States, we must conclude that a duration of four years for the Chief Magistrate of the Union is a degree of permanency far less to be dreaded in that office, than a duration of three years for a corresponding office in a single State.”

            Emperors are king of kings just like the President is the governor of governors. It’s clearly imperial (and all contained in Hamilton’s brilliant thought).

          • One more point of note: I’m sure that Turks and some people from other peoples have integrated well into German society and culture, but the current immigration into Europe isn’t Turk nor are they even Turkic peoples. This is low-skilled labor with, largely, a different view of society wherein the peoples in question are primarily tribal.

            I’m not saying that the refugees are bad, evil people because I don’t think that. However, I do think it’s foolish to say that this immigration won’t be without consequences (some positive and some negative). Assimilation of some small groups of people from various different regions that’ve had lots of interaction with the aforementioned nation for hundreds of years where the Germans and other peoples have fought alongside critical wars is fundamentally different from low-skilled labor with, by and large, a different view of society whose people are completely different from Turkic peoples (the only real similarity I can think of is that both are Muslim, but that doesn’t say much at all). Simply put, I’m saying that what you said about Germany doesn’t contradict anything I’ve said.

    • The Mandate of Heaven is there for symbolic reasons. It’s supposed to represent the descent of the leader from the spiritual world (regardless of the blood lineage of the guys who get thrown on and off the stage).

  2. biggestbrotherofthem All

    As a reader of your blog none of the recent events surprised me! Jim Cramer on mad money the other week announces “what if growth in China is only 4%.”

    The only thing I know is that the mental inertia to change an inground economic measure perpetuates long after the facts change! I mean in 2006 we were getting a new credit card offer a day. We knew it was unsustainable, yet the economists and Fed were saying this time it was different and it kept on going for another 18 months before things seized up. So be patient Prof. Just keep saying the same thing over and over.
    You have been shown to be right so far.

    • biggestbrotherofthem All

      Not that each blog entry doesnt add. Just that the overall point still doesnt seem to have widespread comprehension. I mean I could spend all day on the Wall St Journal, FT.com, NYTimes saying JUST READ MICHAEL PETTIS FOR PETES SAKE!

    • Thanks, BBOTA. You say “I mean in 2006 we were getting a new credit card offer a day. We knew it was unsustainable.” This is one of those things that gets a little frustrating. There were so many signposts written in very clear language. How was it possible not to have known? Somehow we are using a model that severely distorts the way we see and interpret otherwise obvious things.

  3. Mr. Pettis,

    I think you are right about economists having a poor understanding of debt dynamics and how they can steer the trajectory of economic growth in a country, even without the occurrence of a crisis.

    As someone who was recently at school taking classes in macroeconomics, I unfortunately have a rudimentary understanding of some of these balance sheet mechanisms you refer to. Are there any more comprehensive texts you can recommend, from yourself or others, that would help to get a more solid grasp of these debt dynamic concepts you use to assess the state of the Chinese economy?

    Best,
    Phil

    • Read Hyman Minsky on debt and balance sheets, Phil, and get a decent understanding of basic options. My book, Volatility Machine, covers some of this.

    • biggestbrotherofthem All

      From Wikipedia:

      xxxxxxxxDebit Credit
      Asset Increase Decrease
      Liability Decrease Increase
      Income (revenue) Decrease Increase
      Expense Increase Decrease
      Capital Decrease Increase

    • Reed Steve Keen. His Debunking Economics should be mandatory for every highschool economics course. More importantly his basic debt model based on Minsky, nails the first order dynamics of debt in the economy. He as well has been predicting the China economic problems, based on credit growth. As he did with the subprime crisis.

      • I know his work and earlier this year I brought him in to speak to my central bank seminar.

        • Steve Keen has a fantastic Youtube channel with many of his lectures.

          Only can only dream of the day Prof. Pettis will share his wisdom via audio/visual with the rest of the world 🙂

        • I’ve got too many fundamental disagreements with Keen and other Post-Keynesians. For example, they seem to argue about how labor unions are good in general without looking at the institutional rigidity big labor places on an economic systems. Labor unions favor large corporations by increasing costs on labor-intensive firms, which indirectly favors capital-intensive firms that’re almost always larger. Labor unions are inherently anti-entrepreneurial and labor unions DO NOT protect the middle class. Labor unions help the WORKING CLASS, NOT the middle class. That’s not even including the fact that labor unions have historically been one of the most racist institutions in American (and world) history.

          Then, that crowd (I’m generalizing, but my generalizations are largely correct) claims to say how there’s demand inefficiencies if you don’t have labor restrictions like labor unions. However, they completely ignore structural rigidities. They just assume that the goal of government in economic policy is to stabilize short-term demand, but that’s wholly erroneous. The goal is to maintain institutional flexibility so that the system can adapt as necessary.

          Secondly, they simply assume that “democracy” is good. Free elections, as a way to get rid of retards/crooks, is VERY important. Democracy, as in giving the people what they want, is fundamentally stupid. If you view democracy as “power to the people”, then democracy is best achieved by monarchy because the people are united and have a head. Otherwise, a successful “democracy” (in the classical liberal sense) involves pitting the people against each other in internal affairs means that there’s really one primary mechanism of rule: divide et impera.

          My problem with Steve Keen is the same with most economists, whether heterodox or “mainstream”: they don’t bother to fully question their assumptions and they seem to ignore how their models and views of the world shift if their assumptions are shifted.

          Another issue I have is how they paint FDR as the primary leader that led to the “success” of the US in the 20th century. It wasn’t FDR that was the critical factor in determining the role of the US in the 20th century. That was already done by John Pierpont Morgan in the late 19th century. The way that he would come in and restructure everything to make things run effectively. The capitalist structures in the US during the “Gilded Age” were so incredibly effective. The leftists primarily pin this on protectionism, which may certainly have been a part, but it wasn’t the only factor and I don’t even think it was the #1 factor. The #1 factor was the incentive structure that favored radical decentralization and capitalist empire. The key factor of the success of the US in the 20th century was the Hamiltonian vision for the liberal capitalist empire.

          Again, the left ignores this because they find it morally wrong. Instead, they take up Marxist type of thinking while citing some sucker like Howard Zinn on how “equality” didn’t exist while favoring big labor. I’m sorry, but when you have a bunch of racist bigots who have living standards that’re comparable to aristocrats in other countries getting angry at people who don’t look like them that’re willing to work longer for less pay while taking less prestige and providing better skillsets and you take their side over the other guy that wants to give the poorer people a shot in hell in the name of “equality”, you need a reality check. Even Michael Hudson and many other Post-Keynsians (I’d argue most, if not close to all) are sympathetic to these Marxist arguments. That’s fucking despicable in my opinion. It’s hypocritical, not logical, and ends up with emotional pandering.

          I run into these kids (by kids, I mean people even in their 30’s) who read these arguments and take them seriously and I find it straight-up dangerous. These people who read this stuff don’t ever bother to question their assumptions and most have a shitty understanding of history. These kids are seriously naive and I think much of it comes from guys like Keen, who I’ve read a good bit of. These people admire people like Joan Robinson who said that Mao Zedong was gonna do good things for China. I’m sorry, but that’s straight up sucker thinking.

          The worst part is the way these people want to expand the welfare state by “single-payer” or some other nonsense while talking shit about empire. Do they not see what’s happening in Europe right now? They have migrants who’re being treated like second-class citizens simply because of institutional inflexibility coming from strong unions and a strong welfare state. Now, this could be balanced off if those same external powers imposed peace and collected taxes in places the refugees were coming from, but that’d be imperial and thus it’s “morally wrong” in the eyes of leftists.

          I’ve got libertarian/conservative friends and they’re certainly not right about everything, but there’s more sensibility and far less hypocrisy than the leftists. The other side is emotionally-loaded garbage that can’t work. The conservatives will win if they can win the Asian, black and Latino vote. With that being said, guys like Donald Trump and Rand Paul are looking out for African-American and Asians (maybe even Latinos as well) interests far more than people like Bernie Sanders. Yet, the conservatives are the ones that’re racist. I’m sorry, but the other side is filled with utter hypocrisy and stupidity. You don’t make the world a better place by pretending its something it’s not.

          • Howdy! Please take a breath … Ok, your arguments would be easier to read and think about if they were not presented in a ‘us’ and ‘them’ form, ‘good’ and ‘bad’. Calling people a ‘leftist’ or whatever does not help much in a quite scientific discussion. I could not care less if Newton or Einstein or Schroedinger were ‘leftists’ or ‘libertarians’ when studying their contributions on physics. You might do yourself and others a favor trying to distinguish between economic scientific ideas presented by people and their political opinions.

            The main contribution of Steve Keen is his ‘debunking’ some standard economics textbook theory and replacing it with a highly interesting and very simple dynamic model with appropriate non-linear behavior: it creates moderations, crashes, or even quite benign circumstances. This has zero to do with his political position in life, he could be ultra-left, square-in-the-middle, or ultra-conservative, it does not make one iota difference to the behavior of his simple model.

            It is up to you to see how you could integrate this fundamental truth of the behavior of our economy (non-linear, prone to booms/busts) in your political views. As is the free right of Steve Keen. It is not very fruitful to ignore the interesting scientific work he has done.

          • As one who made mathematical models of the physical world for over 40 years, I can tell you that you can make all the models you want and see how they perform in a simulator, but that tells you nothing about whether or not the model predicts what happens in the real world. I am holding no brief for or against Steve Keen, but the proof of the model is how it matches real life (if that were the goal of your model making). I am just saying the the existence of a model and its ability to show complex behavior is not proof in and of itself that the model bears any relation to reality. The only test of the relation to reality is measurement, if you can figure out how to make it.

          • Agreed. With one difficulty in economics: predictions influence what you measure (to some degree). But your main point is very valid: you can have a complex model showing behavior that fits real economic behavior with the underlying model being very wrong. That is actually what i have against the quite well-known experimental studies of Hommes. His assumptions on how ‘investors’ trade in a market are not based on what can easily be known to be relevant investor types. As a value investor i know i do not switch from being value oriented to momentum trader, i stick to my method, as do all Graham & Buffett style investors. Still th emodelled behavior is good, even the experiments with real humans work.

          • I’ve got Steve Keen’s Debunking Economics book, much of which I’ve read. I’m extremely familiar with his work and all of my criticisms of him are valid.
            FACT: He speaks approvingly of labor unions as a way to provide workers with “fairer wages”.

            How do I integrate non-linear impacts in my “political views” as you put it? I integrate non-linear dose-response curves better than Keen, I’ve done more work in dealing with complex systems and understand the impacts of error propagation in such systems much better than Keen.

            I’m a math guy that’s been studying this stuff since I was 14 (I taught myself Calculus I over a summer at 14) and am currently working on research to use payoff based approaches to limit impacts, thus deal with risk, in systems where thin-tailed dosage turns into fat tailed responses with various payoff curves. My research focuses on how shifts in payoff curves affect our risk exposure. Last semester, I worked on research to study how convex dose-response curves can affect small errors and how increases in convexity create fat-tailed responses. I’ve also worked on other research studying how boundary conditions across non-uniform substances can shift wave structures using non-linear PDEs (the waves are necessarily cyclical due to boundary conditions). There’s A LOT of things you can criticize about me, but my mathematical ability IS NOT one of them. My first graduate level sequence in chaos theory was at the age of 19 where most of the people in my class were 27 years or older. At the age of 18, I was in my first complex systems class was a graduate level class in control theory. My first class on PDEs was when I was 17. My understanding of these kinds of concepts, particularly non-linearity (my favorite thing to study, ironically enough), is one of the best in the world and it’s 20 times better than Keen, or any economist for that matter.

            Oh yea, so let’s talk about what’s most important in systems that exhibit chaotic behavior then, shall we. The most important thing is adaptability, which means that geopolitical financial systems MUST have institutional flexibility because you don’t know what the hell is gonna happen. Unless you assume that you know what’s gonna happen and exactly the way it’s gonna happen, flexibility of institutions IS THE most important thing.

            Secondly, there’s a basic concept in chaos theory called self-organization, which is called “free markets”. The idea of self-organization among systems is one of the most basic concepts in any chaos theory or complex systems analysis. Such systems are wholly decentralized and most economists (either left or right) think that these systems are robust because of “symbiosis”, but that’s wrong. Self-organizing systems are robust because they rely on exploration and exploitation. In other words, they work by eliminating what’s fragile. Of course, if you point this out to Keen’s students (I have done this BTW), they get angry and find it morally wrong. I can keep going for days, but this is enough for now. I’ve interacted with Keen’s students and they’re naive fools. If these people are the leaders of tomorrow, we’re all more screwed than we can imagine.

            Also, the idea that this stuff can be “scientific” is a complete and utter joke. Science (as we know it) is a procedure by doing replicable tests repeatedly under fixed circumstances and publicly displaying such a procedure. In the domains we’re talking about, such methods cannot be used. So the use of the term “scientific” is inherently flawed.

          • You can’t use use all of physical science in social science because human subjects of social science read what is written about them, and change their behavior to suit them (to beat the system).

            We also need to remember that money doesn’t measure everything of human value.

          • Oh, and by leftist, I mean anything relating to or consisting of some basis in Marxist based thought. I include many aspects of Minsky in that category. While Minsky is good, he’s also quite naive about many different factors and his understanding of history along with his sympathies really need to be checked. Anyone who says that Marx is good or that he understood the real issues of the time needs a reality check. Anyone who says that Marx had even somewhat of a positive impact in the direction of society again needs a reality check. Sympathies to this kind of thinking are inherently evil, contradictory, and retarded.

            Marx is just a hyper-emotional dumbass bigot who never bothers to question his assumptions. This was a guy who’d never committed a violent act in his life, but then advocates the worst kinds of violence against honorable people who would rather die and fight than give in to cowardice. Of course, when we hail Marx as a better person than Andrew Carnegie, JP Morgan, or even Rockefeller, we need a reality check.
            http://suvysthoughts.blogspot.com/2015/07/on-absurdity-of-leftist-marx-based.html

            The classic example of the idiocy, retardedness, and injustice of Marx was his view of the trans-continental railroad. In building the trans-continental railroad, Marx said that it was wrong and evil because Chinese workers (“Chinese rabble” as he called them) were working for lower wages, and actually doing better work because they knew how to use gunpowder, and doing more work which was “expropriating” wages it from the “workers”. Then, he attacked “democracy” in the US because the US isn’t a democracy as much as it is a liberal empire. I consider any sympathies to that kind of thinking to be PURE EVIL. How is that kind of thinking good?

            It increases bigotry and basically says that racist bigots should be entitled to things because they view themselves as inherently better. It’s awful. The funniest thing is that the only countries who would tolerate Marx were countries that were liberal (the UK and the US), even though Marx hated liberalism (in the classical sense, not in the American sense).

            People like Howard Zinn and even Michael Hudson or Steve Keen have sympathies to that kind of thinking. How is that good? It’s the worst and most horrible kind of thinking. Then, Hudson in particular claims empire is bad and uses “imperialism” without even properly defining it. Empire isn’t fun or nice or dandy, but it’s necessary. Saying “imperialism” to everything empire does is retarded. Many societies in the world are tribal, which means that nation-states cannot be imposed upon them.

            I know many consider the US as a nation-state, but the US is fundamentally imperial. The easiest way is to go from bumfuck South Carolina to Miami and it’s easy to see that the population or ethnic structures are fundamentally different. It’s not a homogenized structure enforced from the top where becoming a citizen means accepting a “culture”. Miami and bumfuck South Carolina (or Eastern North Carolina) have completely different cultures that aren’t remotely similar. I spent a large part of my summer travelling up and down the East Coast of the US and it’s obvious that the US is an empire, not a nation-state. Even a half-baked understanding of American history is enough to make my point, but of course, any logic that attacks leftism or progressivist, leftist narratives is “morally wrong” because it makes someone feel bad somewhere. It’s also not “politically correct” and “political correctness” is censorship even though “political correctness” is used as a positive indicator of free speech on all the leftist indices for free speech. Anyways, I’m tired of such blatant hypocrisy.

            Of course, any sort of sensible understanding of such concepts is “morally wrong” because it makes someone somewhere feel bad about something that happened to someone else. So of course, the only “correct” response is to arbitrarily take down people’s reputations that disagree with this collectivist view because large groups of people in crowds all strongly imbued with emotional “logic” must be correct. Of course, this is what I’ve personally experienced when dealing with many of Steve Keen’s own students or even academic friends in various online forums.

            The funniest part is when these same people cite Kindleberger or many other financial historians as supporting their arguments for things like support of big labor and “financial crises” when they do no such thing. Anyways, I find this kind of thinking and the viewpoints they express extremely dangerous so I will absolutely ruin the logical basis of their arguments with no remorse what so ever. I have no problem ruining their understanding of how they think the world works.

          • Oh yea, such examples of utter naivety would be Varoufakis in representing the Greek government recently. He came out and said, “I’m here to speak the truth to power” and he actually expected it to work! LOLOLOLOL!

            All of the people on the left praised him so much when I was standing here and pointing out how, yea, he gets economic ideas, but his fundamental world view is retarded. How do you actually think that “speaking the truth to power” is gonna work? How is such thinking good? How is it good to pretend the world is something it’s not?

            Yet I see the same kind of thinking in the academics like Michael Hudson or Steve Keen when they support these absurd world views and ideas that have no chance of working. I’m sorry, but that is certainly sucker thinking.

          • “labor unions are good in general without looking at the institutional rigidity”
            Beware universals my friend, we can only falsify.
            “ favor large corporations by increasing costs on labor-intensive firms”
            It wouldn’t seem to favor. It costs less to start a 10-30 union electrician shops than it does to buy one McDonalds franchise (dependent upon the location of the franchise). We can not continue to drive down wages that drive consumption, and the rationalization of all actuarial relations in our society because some economic pundits, and philosophers believe in a global free market, to optimize and enable wealth creation on a global basis, when such does not exist, those who think asset valuations can sit near the moon as they try to drive down wages to third world levels assuming that a technological or economic utopia is about to envelope the world.
            “WORKING CLASS, NOT the middle class”
            And you do not like Marxist thinkers?
            “most racist institutions in American (and world) history”
            World history……have you ever lived for an extended period of time in any other country
            Have you ever spent any significant amount of time among people from another culture, and I don’t mean if you are an ethnic minority, among your own ethnic group, in the country of your birth, or in the country of your parents/grandparents birth.
            How exactly can you determine this racism, degree of racism, or comparison of the proposed racism to other manifestations of racism. You are very smart, you weaken your argument each time you resort to this over-emotional, over-opinionated bias. Frankly, having lived in about a dozen countries, visited multiples more, I find the US to be among the least racist, as I have learned to de-tune myself from a predilection to see racism under very many similar appearing garbs. In other words, one learns to view through a non-Hollywood hyped, social-marketing of views and morality based lens. Many things that those who are sensitized to see as Racism, when one alters their frame. As I grow older, I also am amused at how so many issues are hyped after the experience of them has withered (racism, sexism, Yuan currency values, the success of the Chinese model, the role of oil in the global economy, etc, and so on).

            “demand inefficiencies… structural rigidities
            the goal ….stabilize short-term demand
            the goal ….. institutional flexibility”
            The goal, might better, a goal, or goals that in points in time need compete for policy-makers attention
            “democracy…..one primary mechanism of rule: divide et impera”
            This is a jaded view, and while your view is not racist, I am not sure what problem there should be with racism, as such an ethos is admired, especially as you also criticize naïve Darwinism, and much such bland assertions, especially to skill sets, when of course you are using straw men, to support a set of perspectives,

            “question their assumptions”
            I hope you have not arrived at a position, at some tender age, that prevents you from challenging your own assumptions. Once again, while I somewhat relate to your notion on this matter, I am not always sure that it is not that others do not challenge their assumptions, how can we know either way, but very might elevate their values cum beliefs, to positions that drive their views. Inevitably we all might be guilty of such a position, even the more reasonable, among us.

            FDR vs John Pierpont Morgan
            Hamiltonian vision for the liberal capitalist empire.

            Again, some here some there, but can you not see the relevance of your own criticism upon yourself, invested in this matter.
            “bunch of racist bigots who have living standards that’re comparable to aristocrats”
            What a leap you have made here. And why should they not live as aristocrats.
            “getting angry at people who don’t look like them that’re willing to work longer for less pay while taking less prestige and providing better skillsets”

            Can you prove this. And how would you be able to say this SIEU, must be a full 85% comprised of minority groups as members, even though these groups would likely comprise a small percentage of the population as per ethnic origin.
            “give the poorer people a shot in hell”
            Can they give this other guy this shot in hell. It sounds as if you have constructed the minority ethnic super-hero who should be living the life of an aristocrat in another country, or should they themselves not, even though they have the genetic make-up to fit the bill. Do you realize how narrow-minded and racist you sound, or are you going to give me the racism requires power Howard Zinn-Noam Chomsky-Blank Panther mantra. Not merely racist, but fantastical. You need to experience more of the world.

            “read these arguments and take them seriously and I find it straight-up dangerous”
            I sympathize, and feel that many people are being led by the nose by propagandists who want to market ideas and beliefs. Many people around the world make an excellent living doing just that.
            “welfare state by “single-payer” “

            Had we got a single payer system in the 1990’s we could have gotten cost containment and wouldn’t see the ridiculous costs associated with Health insurance that we find now, which can only rise.
            Such would have led to less industry leaving, and more business locating to the US as this is a consideration of companies in choosing where to site their locations, and we wouldn’t needlessly be subsiding the rest of the world’s pharmaceutical bills, by being the profit center of large European pharmaceutical companies who charge ridiculous amounts in the US market while selling at a fraction of the cost back home and in emerging markets.

            “They have migrants who’re being treated like second-class citizens simply because of institutional inflexibility coming from strong unions and a strong welfare state”
            Have you ever been on the factory floor of a European manufacturer in Europe (I have), how can you even make these assertions. Then, have you ever been to say, a Turkish ghetto in Germany, again. You read something and then believe it. Experience. Time for some empiricism.

            Are you saying that the melting pot has been better than the cultural menagerie, or than true multi-culturalism, which can lead to lead to ethnic ghettos and alienation. And you believe that this is an institutionalized problem, of some racism, rather than of concern for it, the incorrect implementation of some theory based policy, that likely was wrong. Ie….countries of EU so concerned for their countries native culturals, that policies in support of culture internally, created ghettos of ethnic groups that haven’t assimilated. The next question is, that could be a common discussion, bu then have you ever drank a beer with a Turkish-German, in Germany, probably not. Did you notice a big difference, if had, likely not. Anyway. Hell, I even attended the German Miss Phillipines contest, you actually believe what you state. Do you know how many German men are married to Black women? A strange set of contradictions.

            “same external powers imposed peace and collected taxes” …..” imperial”
            Do we have an obligation to do this?

            “I’ve got libertarian/conservative friends and they’re certainly not right about everything, but there’s more sensibility and far less hypocrisy than the leftists”
            Does this mean that libertarians and conservatives are then better than other thinkers.
            “The conservatives will win if they can win the Asian, black and Latino vote”
            These people have a vote. How is that possible with the racism. Or isn’t that bad, shouldn’t we just make Bernie Sanders King. Shouldn’t they have more than a vote; perhaps as many votes as those who are registered to vote.

            Are you sure that Blacks and Asians, or Asians and Latino’s, or Latino’s and Blacks, let alone Asians, Blacks and Latino’s have the same interests. That they don’t conflict. Along your line of thinking, isn’t that racist, and at least as emotionally pandering as the Leftists, Marxists and Socialists that you would hope to criticize.

            Finally, I may agree, disagree be reviled or shouting exactly to what you write. But I write, because you have much more to offer than this garbage.

            Aura Medicritas: The Golden Mean….all truth is found in the middle.

            I am not sure has been making you hyperventilate, but take a bath, smoke a doobie, have a scotch neat, do some yoga and relax. Especially as to these matters, because, America is in much better shape than you imagine.

            I should mention, I do not watch the news in TV, if you are doing that, stop immediately, they were late to every party, even twenty years ago when I stopped.

          • @Suvy:
            Now I know why you call Steve Keen a socialist. A “Socialist” because he’s “Pro Union” ?? German companies actually embrace the unions because they help to bring stability in a company. On top of that german unions are absolutely uncomaprable to the military style unions here in the US. US unions are – more or less – considered to the arch enemy of US corporations. German unions never insisted on a thing called “Closed shop”. On average germans have a very favourable view for the german unions. Never been to Germany ?

            Unions have become less important because the structure of the economy has changed. there was a shift from large companies with LOTS of blue collar workers to smaller companies with more white collar workers. and that has hollowed out the power of the unions.

            Unions are “Racists” ?? I take issue with those words !!!!

            Besides that I sense that you let your political view in the way of the discussion. And I do think that we here in the US put too much emphasis on the importance of the “Capitalist class” and we put too little emphasis on the “Consumer/Worker class” in the economy.

          • Willy2,

            The consumer and worker classes are, by and large, not the same. The primary consuming class is the middle class. The working class IS NOT the middle class and it’s a basic error to assume so.

            I also agree that the structure of the economic system has changed to the point where we no longer need unions, but places with strong, entrenched unions disagree (for obvious reasons). This is one of my primary qualms about unions.

            “German companies actually embrace the unions because they help to bring stability in a company.”

            Why is company stability good? You’re kinda making my point. Unions increase barriers to entry, place more restrictions on small scale firms, and purposefully try to limit entrepreneurial behavior. Germany is the perfect example. In Germany, 50% of GDP is accounted for by the top 1% of firms and 30% of employment. Many of the smaller firms are tied into the supply chains of the larger firms. If a large firm goes bust, the entire economic system is in jeopardy. We need to be careful of our assumptions.

            Note: My response to Csteven is detailed at the very bottom of this page.
            http://blog.mpettis.com/2015/09/if-we-dont-understand-both-sides-of-chinas-balance-sheet-we-understand-neither/#comment-140903

          • Oh yea, do you wanna know how repressive the German empire was on the states they had? Wilhelm II was a nutcase. The Germans were allied with the Turks and the Turks were just as repressive. These were places doing horrible things purely for a few people trying to keep a grasp on power they didn’t deserve. Even in that video, Tooze talks about how German people were starving.

            The way the Germans were behaving in Africa? Whoa, that was one of the most cruel ever (and this is saying something, even for Africa).

          • I agree with you suvy:”You don’t make the world a better place by pretending its something it’s not.”

          • It was unequivocally FDR who put the US into its position of power in the 20th century. Not JP Morgan, who barely got the US out of the Panic of 1907 and had no idea how to deal with the next one. You have to study your history again. I’d suggest starting with the capital flows between the Allies in World War II.

            You also don’t seem to know shit about single-payer healthcare. Basically every developed country in the world has it, and most of the third-world countries do too. It’s just plain better. What we have here (insurance companies and medical conglomerates) has *even more* institutional inflexibility than a simple streamlined system like Canada’s. There are actually more “solo practice” doctors in countries with single-payer like Canada than there are in the US. In the US a doctor needs a full-time staff of five to handle insurance paperwork and so it’s forcing large institutional medical practices.

          • Nathanael,

            I’m sorry, but if you really think FDR was the person that gave the US its financial and economic power in the 20th century, you’re fooling yourself. The US had the world’s highest living standards AND per capita income by the late 19th century. When the US actually did acquire hegemony after World War I, the US had been the largest economy for 5 decades. There’s no way FDR could’ve developed all that.

            BTW, if you actually compare the financial and economic structures of the US to other countries, the American corporate and financial structures were the most robust and fundamentally sound. Constant banking panics DO NOT EQUATE with a poorly functioning economy or unproductive investment. What regular banking panics do is they eliminate malinvestment and asset bloats regularly. When you eliminate regular banking panics, that’s when malinvestment takes place on a large scale.

            “You also don’t seem to know shit about single-payer healthcare. Basically every developed country in the world has it, and most of the third-world countries do too.”

            This is straight up wrong. Japan, Germany, Singapore, and even many other countries DO NOT have single-payer.

            Of course, single-payer is cheaper. Why? Because the government mandates a cap on how much can be spent. In order to meet the cap, care is rationed. People always bring up how government bargaining power drives down costs for prescription drugs, but that drives pharmaceutical innovation out of your country. The US has the largest pharmaceutical industry that’s $340 BILLION. The next are Japan and Germany with $95 billion and $86 billion respectively and the fourth is France with $46 billion. Note how the US, Japan, and Germany DO NOT have single-payer. That is not a coincidence and has to do with incentive structures.

      • Yes. Steve Keen is indeed excellent.

        • I’m not so sure. There’s a lot of flaws in his work. For example, there’s one case where for a “proof” of his view of aggregate demand (which I actually do tend to kinda agree with) wherein pulls up the movement of aggregate demand and debt across time, takes a correlation, and says the correlation proves his view of aggregate demand. Correlations are useless without residual plots.

          His students have made similar errors. When I’ve pointed out the mathematical flaws in the works of Keen’s students to them, they’ve either responded by ignoring me, going in a fit of rage, or blocking me, but none have been able to discuss the mathematical assumptions behind the models they’re using.

          Keen thinks he understands the complex dynamics of economic systems, but he only kinda does. Then, he cites MMTers and makes historical claims about “capitalism” and why people like Hitler got to power in the 30’s, but he’s mostly wrong on his historical assertions. Keen talks about how the strength of capitalism is in its dynamism to innovate, but then goes on to say how labor unions are good. There’s a lot of flaws in his works, although there’s some good stuff too.

          Keen says that “deregulation” was what caused the financial crisis when regulation has never been able to prevent financial systems from having issues. We didn’t have this

          Basically, all of the narratives used by the left are complete garbage. I’ve been reading through American history and everything used by the left of why the US reached economic primacy are wrong. The Great Depression and World War II happened because Woodrow Wilson was an ideological idiot and FDR didn’t make the US in the 20th century with his New Deal nonsense. FDR’s New Deal wasn’t large enough from a demand side and created a lot of institutional rigidities as well, like its agricultural policy. What led to the Great Depression was excess capacity of the US, which was driven in large part by financial imbalances caused by a gold standard and war finance in World War I.

          Actually, after World War I, the Republicans in Congress wanted to write down the debts, but it was Woodrow Wilson and the Democrats who were against this because the Republicans were supported by the money. There were Republican Congressmen who were literally citing Keynes’ Economic Consequences of the Peace in Congress in the face of the stupidity led by Wilson and the Democrats.

          I remember Keen, in one of his videos, cites Kindleberger as saying that he understood financial crises and structural economic issues while claiming Kindleberger supports his viewpoints, but Kindleberger does no such thing. For example, I just finished World Economic Primacy by Kindleberger not too long ago and there’s very few points in there where Kindleberger agrees with even a bit of Keen’s assertions on how economic primacy is attained. Kindleberger’s basic view is that institutional flexibility is what leads to economic primacy, but Keen explicitly stands against institutional flexibility in issues like “regulation”, in finance, and especially in the case of unions (where Kindleberger is clear).

          • Suvy, why should Keen be correct on everything? That is a rather high standard to hold people to. It certainly did not hold for most of the brilliant minds in history. Einstein was not right on all things, Keynes was not, Adam Smith was not, Schumpeter was not, and most certainly Steve Keen will not be. I would be much more interested to see you discuss his non-linear debt model, given the knowledge of modelling such systems you apparantly have. I fully agree with your hesitation to see correlation as causation, it is the same point where i am not fully convinced. For instance Keen points to steep rises in private Chinese margin debt to ‘explain’ the recent stock market bubble, but that raises the hairy question of where the prior (and much larger) bubble in China came from, since there was practically no margin debt at that point in time. Combined these two bubbles would in fact suggest that margin debt may as much be a result of a euforic state of mind among speculators, that is people take anything they can get to invest when euforic. That also fits the Tulip Bulb mania much better: people pledging/selling their house to acquire rare tulip bulbs.

          • Keen’s models represent a pretty simple phenomenon. When he talks about an attack on “The Great Moderation”, it’s a concept called volatility suppression. You see volatility suppression in lots of other areas including forest fires (and their size) and political systems (autocracies tend to suppress volatility)–just see the article below.
            https://www.foreignaffairs.com/articles/egypt/2011-04-15/black-swan-cairo

            From a probability perspective:
            Basically, complex systems lead to nonlinear response functions because complexity is rarely linear. Now let’s suppose that we have a certain dose variable that’s uncertain. The results of the response variable rely not only on the shifts in the dose variable, but in the shifts of the degree of uncertainty and the shifts in the variation of the degrees of uncertainty as well. So even if we have a thin-tailed dosage, the total response or impact of an event/shift on the system could end up being extremely fat-tailed event.

            Remember that fat-tailed distributions usually do not lead to more events in the tail. Fat-tailed distributions lead to more of the total variation in the tail!!
            Fat-tails IMPACT: Increases winner-take-all effects

          • *becoming a fat-tailed distribution, not a fat-tailed event.

            Simply put, fat-tails almost always end up with outliers dominating the total events.

          • Mandelbrot (1983), “Even though economics is a very old subject, it has not truly come to grips with the main difficulty, which is the inordinate practical importance of a few extreme events.”

          • Yep. the usual right wing talking points. Unions bad. Wilson, Carter & FDR bad. Reagan good. Right ?

            Frankly, you may have read A LOT OF books but I remain un-impressed.
            – “Wilson, an ideological idiot” ?? Wilson caused the Depression ?? More ideological nonsense. The US (with Japan) benefited from the war in Europe (think: loans & production of helmets, uniforms, shells etc.) and that helped – combined with FALLING interest rates- to ignite the US housing bubble of the 1920s.
            http://www.library.hbs.edu/hc/crises/forgotten.html
            That housing bubble collapsed and was the trigger for the crash of 1929 and the ensueing Great Depression. Seems you didn’t read enough of Steve Keen’s work. He also pointed to the US debt/credit bubble of the 1920s. And what happened from say 1995 up to now is simply a rerun of the 1910s, 1920s & 1930s.
            – The MMT-ers DO have a number of valid points but they’re missing other important points. FDR actually seems to have read one or more pages from the MMT text book.
            – Because FDR’s spending helped to lift the US out of the depression (from 1932 up to 1937).Then FDR pulled back spending and the economy tanked. But the US economy actually recovered during WW II, thanks to the GIANT government spending program called “World War II”. Government spending during WW II allowed the US consumer to deleverage. Source ? Steve Keen !!!
            http://www.debunkingeconomics.com/the-fiscal-cliff-presentation-in-congress/
            – US’ “World Economic Supremacy” is declining because US institutional flexibility is on the wane. To see that one should look beyond the “bad” unions. Sectors like Healthcare, the military, agriculture, also (heavily) depend on government spending. The attitude there is “DO NOT touch my budget. INCREASE my budget”. Talking about “institutional flexibility” !!!!
            I see a similar situation in China (think: SOEs) !!!
            – Deregulation is not responsible for the financial excesses, but it does help to INCREASE the excesses.
            – If one wants to decrease the consumer’s debtload then one should add MORE regulation & change the (tax-)laws. E.g. Here in the US mortgage interest payments are tax deductable but not in Germany. And that’s one reason why german consumer debtload is smaller than in the US.

          • – Wilson wanted to write off the “Liberty bonds” but Congress blocked that because Wall Street bought TONNES of those bonds with leverage !!! writing off those bonds would have meant that Wall Street would have to take a giant hit.
            Source: Adam Tooze.

          • – Correction: I wrote “Wilson” but I should have written “Harding”.
            – The “Surpression of Volatility” was exercised by …… Corporate America and NOT the government of the FED. Becuase from 1981 onwards there was a corporate policy called “Moderate wage growth”.

          • Willy2,
            “The US (with Japan) benefited from the war in Europe (think: loans & production of helmets, uniforms, shells etc.) and that helped – combined with FALLING interest rates- to ignite the US housing bubble of the 1920s.”

            The problem in the 20’s wasn’t a “housing bubble” (which is really just conspicous consumption). The problem in the 20’s was overcapacity, which was really started in World War I when the US was mass producing arms.

            World War II was good for the US if you simply assume linearity in determining the impacts of the aspects of events. It only seems good because of the strength of the Great Depression in the 30’s. You’re making the assumption that what’s good for the US is more geopolitical power, which I’d strongly disagree with. World War II accelerated the increase in geopolitical power in the US, but that’s fundamentally different from economic primacy which the US had established by the late 19th century.

            I’ll cite the same figures Prof. Pettis always does in this regard. In 1929, ~40-50% of the economy was investment, much like China today. The US resolved it by having investment drop 90% and consumption drop 10% from 1929-1933.

            I’d like you to find a single sentence where I said Reagan was good.

            “Deregulation is not responsible for the financial excesses, but it does help to INCREASE the excesses.”

            This is straight up wrong. Countries with highly regulated financial systems (like China now or Japan in the late 80’s) tend to be the ones with higher excesses because regulation allows the people in power to control what’s going on, so anything that hurts their power is automatically off the table in terms of policy. There’s a lot of implicit assumptions you’re making when you say deregulation exacerbates excesses, many of which I’d disagree with and most of which are historically false.

            If you don’t know that Woodrow Wilson is an ideological idiot, I don’t know what to tell you. He was an explicit Social Darwinist. He attacked Andrew Carnegie for wanting to donate money to black colleges. He was against writing down debts at the Treaty of Versailles, which Keynes talks about in The Economic Consequences of the Peace. Wilson really was an ideological idiot.

            Look, you can actually believe the stuff preached by the left or you can realize the truth. None of the narratives are actually true whether it involves the Civil War, Mexican-American War, the Frontier Wars, the Gilded Age (which was one of the best times in US history IMO), World War I, the Great Depression, World War II, the post-war period, or today.

            I’m sorry, but the MMT guys are straight up naive. They’re saying that “faith”, “trust”, and “democracy” are all that’s necessary to give some guy control of the system and say don’t run it for nefarious ends while placing the incentive structures in such a manner. I’m sorry, but that’s foolish. To say government debt doesn’t matter? That running current account deficits, running up government debts, and then using those to fund consumption is good for the economy? You’re kidding me, right? How is any of this good? It’s just gonna end up increasing conspicuous consumption via obvious means. That’s what the incentive structures are being aligned to do.

          • ” The “Surpression of Volatility” was exercised by …… Corporate America and NOT the government of the FED.”

            I’m sure this is accurate, just like the Greenspan and Bernanke puts over the past few decades. What about the “Great Moderation” being hailed by Bernanke when citing Greenspan’s monetary policy of expanding liquidity to escape recessions while creating asset bubbles. Wait…… that would mean your comment is wrong.

            I’d also like to add that Fannie Mae and Freddie Mac where institutions set up by the New Deal. So the costs of many of the “progressive” policies where long-term whilst being unforseen in both event and scale while the benefits were immediate and obvious. In fat-tailed environments, those aren’t good decisions to be made.

            “If one wants to decrease the consumer’s debtload then one should add MORE regulation & change the (tax-)laws. E.g. Here in the US mortgage interest payments are tax deductable but not in Germany. And that’s one reason why german consumer debtload is smaller than in the US.”

            Germany’s total debt load is higher than the US. The total assets of the German banking system are ~250-300% of GDP (compared to ~80% in US) with half the capital ratios of the US. Germany’s government debt is ~90% of GDP in a time when ~50% of it’s economy is exports with half of those exports going to southern Europe, the German banking system is also the largest holder of Southern European debt, and Germany is exporting unemployment to all of Southern Europe. Please keep telling me about how the US should be like Germany.

            If you wanna talk health care, let’s talk about health care then. Health care systems don’t scale linearly, like anything else in the world. So a health care system that works for a nation-state with 80 million people across a landmass of <200,000 square miles needs to be different than an empire of ~320 million people and a landmass of ~3.6 million square miles.

            The problem with the typical narratives from the left, which are taught in most of all of the humanities and social science classrooms, are based on many implicit assumptions that make lots of people "feel good". Most of the narratives are built on exploiting emotional sentiment, but aren't backed up with logic nor are the backed up by the facts.

          • Willy2,

            Cite me one time where labor unions became strong before the country achieved primacy. I can cites many examples of countries with entrenched labor unions destroying the economic primacy of countries.

            With a labor union, you’re literally creating a group of people with a united interest that gain nothing from any structural change in the status quo unless it’s holding a gun to a business and extorting more from them. Then, you’re saying this adds institutional flexibility. Think about that statement for a second. You can cite someone using a superficial understanding of history, but when you actually look at the history, there’s no doubt about the clarity of the consequences of central government support of labor unions.

            Even today, the biggest problems facing the poor are entrenched police and teachers unions, which do a lot of harm. Keep in mind that stuff like teachers unions don’t help teachers, they just help teachers in the unions.

          • biggestbrotherofthem All

            Suvy.

            Being good at math does not make you worldly wise. But reading, as you do, might!

            Unions, child labor restrictions, garden cities, building regulations, habeas Corpus, anti slavery…..all these things emerge in Europe after decades of exploitation of factory workers and miners.

            The unions gave good pay and good working conditions, which reduce the profit of their employers somewhat, but by putting the money in the pockets of the workers created a boom to the economy, a growing service sector and a growing middle class!

            Its the next step in Industrialization – should China choose to take it

            Its not that complex really.

            As for Steve Keen. He just plugs all the dependencies and relationships normally shown in 2D graphs into linked dynamic models and so extrapolates more than you can in 2D. He hasnt broken any major economic variables. He has just linked them and extrapolated. Logical thing to do in the computer age – and so far he has been shown to be right.
            So we all need Steve Keen.
            and
            I think China needs unions, and a democracy not a fuhrer.
            ( their “dissimilitude” which means that they are not similar!)

          • Willy2,
            The liberty bonds should have been written off. Before the US government entered the financing of the war, it was JP Morgan Jr. personally financing the war and he wasn’t even profiting from it. JP Morgan Jr. did it because he thought it was just, not because he wanted a bunch of money from it. The Feds can’t come in and just wipe out everything he did on that without giving him some recourse. That’s not right.

            Wilson didn’t want to enter the war, but was forced to enter when the German navy resumed U-boat warfare against Allied shipping. Basically, JP Morgan Jr. was proven to be right, Wilson was proven to be wrong, but somehow Morgan Jr. is the bad guy? That argument makes no sense.

            BTW, I’ve read The Deluge. I’m citing it heavily in my facts here. You’re taking one fact from The Deluge and saying it proves your point, but if you put that one fact in context, it disproves every single one of your points.

            As for “moderate wage growth”, why not have that wage growth show up as deflation from falling input costs and falling production. What we need is REAL wage growth, not just “wage growth”. One way to achieve REAL wage growth is with wages stagnating and deflation coming from rising productivity growth and falling costs.

            Also, don’t cite the leftist nonsense about how “deflation is bad” because that depends on the circumstances. Deflation is good if it stems from rising productivity and falling consumer costs because it INCREASES real consumer demand and purchasing power. Deflation, stemming from liquidating assets, can be catastrophic because of debt deflation effects. It’s a mistake to assume all forms of deflation are debt deflation effects (like those on the left almost always tend to assume).

          • @Suvy:
            – First of all: DO NOT reply to something I DIDN’T write.
            – “Liberty Bonds”: If you replace “shouldn’t write off” with “should write off” then we agree. But “Wall Street” was larger than J.P. Morgan alone and that’s why those write offs didn’t happen.
            _ When I was talking about the “Great Moderation” & “Volatility Surpression” I was only referring to the low inflation (see Steve Keen’s work) in the timeframe 1981 up to 2007. That was caused by “moderate wage growth” that started in 1980/1981. For that policy was corporate America responsible and not the FED or the government. (In Europe the same thing happened as well). But “moderate wage growth” also helps to undermine demand from corporations. In that regard “moderate wage growth” is undermining/deflationary.
            – No, increased productivity on its own isn’t necessarily good for consumers & workers. Other circumstances have to be favourable as well.
            – Overcapacity after WW I: The US economy experienced a sharp & deep deflation in 1920 & 1921. But demand from Europe then picked up nicely after WW I. And then the US had a credit bubble that popped in 1929. See this chart.
            https://www.dropbox.com/s/oag5fs07mbk7yuj/1350-NetUSDebtasAPercofGDP.jpg?dl=0
            – Regulation is useless when people don’t want to enforce it. Japan was highly regulated but yet all those excesses occurred.
            BTW: the AIG debacle of underwriting mortgages and Credit Default Swaps happened from an office in London. And the financial sector in England is (much) less regulated than in the US.
            – Both “the left” & “the right” have their own set of ideological blinders. I don’t trust neither any more.
            – Agree. The MMT folks don’t get “the full picture”. They e.g. wrongly think that a government can increase its debts indefinitely. FDR could do it in WW II because back then the US federal debt to GDP ratio was much lower than now.
            – I didn’t say anything about US increasing its geopolitical power. You brought it up.
            – Wilson’s presidency ended in 1921, then came Harding (1921-1923) & Coolidge (1923 – 1929). So, putting all the blame on Wilson for the Great Depression is utter nonsense.
            Hint: GOOGLE it.

          • “Regulation is useless when people don’t want to enforce it. Japan was highly regulated but yet all those excesses occurred.”

            Exactly why relying on regulation is retarded. Why do people who argue for more “regulation” never discuss regulatory capture? Usually, the most regulated banking systems tend to be the most fragile (like Germany, China, and Japan today). Regulation provides stability in the banking system, which is the problem. Corporate stability isn’t a good thing.

            “Wilson’s presidency ended in 1921, then came Harding (1921-1923) & Coolidge (1923 – 1929). So, putting all the blame on Wilson for the Great Depression is utter nonsense.”

            I don’t know if that’s fair. The Great Depression was caused by lots of factors, but there’re a few large factors that account for most of the variation. These factors would be:
            1. Return to the gold standard at pre-war parity
            2. The accumulation of foreign assets by the US (related to the gold standard)
            3. The collapse of the American banking system
            4. Terrible monetary policy (related to point 3)

            As Tooze discusses in The Deluge, a large part of the financial agreements were agreements about global security, which all became tied together into a very fragile network where one collapse caused everything to fall apart. The biggest issue was the inability to write down the war debts immediately after the war. If you don’t think Wilson had the primary input on much of this, you’re kidding yourself.

            Wilson was clearly an ideological idiot. Of course, you don’t have to believe me, all you have to do is read The Economic Consequences of the Peace.
            “When President Wilson left Washington he enjoyed a prestige and a moral influence throughout the world unequalled in history. His bold and measured words carried to the peoples of Europe above and beyond the voices of their own politicians. The enemy peoples trusted him to carry out the compact he had made with them; and the Allied peoples acknowledged him not as a victor only but almost as a prophet. In addition to this moral influence the realities of power were in his hands. The American armies were at the height of their numbers, discipline, and equipment. Europe was in complete dependence on the food supplies of the United States; and financially she was even more absolutely at their mercy. Europe not only already owed the United States more than she could pay; but only a large measure of further assistance could save her from starvation and bankruptcy. Never had a philosopher held such weapons wherewith to bind the princes of this world. How the crowds of the European capitals pressed about the carriage of the President! With what curiosity, anxiety, and hope we sought a glimpse of the features and bearing of the man of destiny who, coming from the West, was to bring healing to the wounds of the ancient parent of his civilisation and lay for us the foundations of the future.”–John Maynard Keynes

            “No, increased productivity on its own isn’t necessarily good for consumers & workers. Other circumstances have to be favourable as well.”

            Why do you simply assume consumers and workers have the same interests? The primary consuming class is the middle class which consists of engineers, computer programmers, doctors, lawyers, teachers, administrators, civil servants, and the like. The working classes consist of factory workers, construction workers, landscapers, and so forth. The primary input of the middle class is human capital, which is difficult to substitute. There’s a huge difference between a good engineer, teacher, or doctor vs a bad one. If some guy is moving a box, it’s much easier to substitute with someone else provided they’re capable of moving the box.

            Unionization can actually reduce wages for the middle class by preventing competition. For something like teachers unions, they have arbitrary licensing with adds barriers to entry from people like engineers. In the case of math teachers, the wages of math teachers would go higher if unions got weaker (and if we added school choice, but those problems are VERY related) because many schools would pay to get the best teachers. In order to get the best teachers and encourage work in teaching instead of engineering or computer science or law or whatever, wages would go higher for teachers. I think there’d be a similar effect on police unions where wages for police officers actually go higher.

          • ” On 5 October 1918 the German government addressed a brief Note to the President accepting the Fourteen Points and asking for peace negotiations. The President’s reply of 8 October asked if he was to understand definitely that the German government accepted ‘the terms laid down’ in the Fourteen Points and in his subsequent addresses and ‘that its object in entering into discussion would be only to agree upon the practical details of their application.’ He added that the evacuation of invaded territory must be a prior condition of an armistice. On 12 October the German government returned an unconditional affirmative to these questions; ‘its object in entering into discussions would be only to agree upon practical details of the application of these terms’. … The nature of the contract between Germany and the Allies resulting from this exchange of documents is plain and unequivocal. The terms of the peace are to be in accordance with the addresses of the President, and the purpose of the peace conference is ‘to discuss the details of their application.’ The circumstances of the contract were of an unusually solemn and binding character; for one of the conditions of it was that Germany should agree to armistice terms which were to be such as would leave her helpless. Germany having rendered herself helpless in reliance on the contract, the honour of the Allies was peculiarly involved in fulfilling their part and, if there were ambiguities, in not using their position to take advantage of them.”–John Maynard Keynes

          • ^^Suvy WROTE: “Also, don’t cite the leftist nonsense about how “deflation is bad” because that depends on the circumstances. Deflation is good if it stems from rising productivity and falling consumer costs because it INCREASES real consumer demand and purchasing power. Deflation, stemming from liquidating assets, can be catastrophic because of debt deflation effects. It’s a mistake to assume all forms of deflation are debt deflation effects (like those on the left almost always tend to assume)….”
            ———————————————————–

            There are THREE types of deflation. The relevant equation is:
            Price-level growth-rate = (Money-supply growth-rate – Real GDP growth-rate) + Velocity of Money —(I) [NHOE]

            TYPE I) Deflation can be caused by a fall in the ABSOLUTE level of the money-supply. This is the main factor in the Great Depression. This is when everyone goes bankrupt, banks fail and the money-supply contracts in an absolute sense. Note that this refers to a negative value for the first term on the RHS of equation (I).

            TYPE II) Deflation can be also caused by a fall in the RELATIVE level of the money-supply. In this case, the money-supply does not shrink. It merely grows more slowly than the real production of goods & services. Note that this refers to a negative value for the term in brackets (i.e. first term minus second term) on the RHS of equation (I).

            TYPE III) Deflation can be also caused by a fall in the VELOCITY of circulation the money-supply. In this case, the money-supply may even rise much faster than production, but the falling speed of recirculation (i.e. people are hoarding money and refusing to spend) could lead to deflation. Note that this refers to a negative value for the third and last term on the RHS of equation (I).

            I presume what you are calling “bad” deflation is of Type I and what you are calling “good” deflation is of Type II.

            However, please note very carefully, that the deflation the world is facing TODAY is of TYPE III. For example, even though the money-supply in Japan has been growing fast, they have still been struggling with deflation for the last 20 years. This is because the persistent deflation in Japan is of Type III:
            http://goo.gl/NBm0QO

            Type I & Type II deflation are relatively easy to remedy, because all we would have to do is “print” more money. It is Type III deflation that is the real tough nut to crack. This is because Type III deflation is not related to the easily-manageable physical money-supply, but is rather dependent on the more ephemeral concept of future-expectations (or confidence).

            It is pointless to get into Left v/s Right debates about Type-I v/s Type-II deflation when the world is facing a completely different type of deflation altogether.

          • Vinezi,

            If we’re talking about consumer prices, the primary factors won’t directly be shifts in the money supply. The primary factors will be shifts in production and consumption. Now, shifts in the money supply obviously affect production and consumption, but the way in which they do so is more important than the actual amount of money supply growth.

            Secondly, there’s a question about what we define as the money supply. For banks, the money supply is the amount of reserves. For the economy as a whole, money can range from being M2 to M2+other very liquid assets that can be used as collateral to get cash (ex. ABCP, T-bills, etc.).

          • Um, no, Suvy, you *REALLY* don’t know your history for this period. You’re casually omitting the policies of Harding, Coolidge, and Hoover, which are the *direct* cause of the Great Depression (particularly Coolidge).

            Wilson was also supporting the Keynesian position, but promptly got very sick and died before the peace negotiations were completed; his incompetent replacements/substitutes were unable to push through his peace settlement policies. The post-Wilsonians in the Wilson administration did not do a good job.

          • Nathanael,

            For someone who claims to know so much about Harding and the Great Depression, why do you ignore the fact that it was Harding who tried very hard to get authorization from Congress to write down war debts in 1922. I was the Democrats who didn’t allow him to do so. The Republicans wanted to write down war debts and if they had gotten their way, I don’t think World War II would’ve happened and Hitler wouldn’t have risen to power.

  4. Great read as usual Michael.

    Since so much of modern growth sentiment is based on the perception of the central bank “put”, the optionality in the process you speak of, then it helps to think of the negative gamma associated with being short the option, either for the central banks who wrote the put, or perhaps “the market players” who did not understand they were in a risk-reversal and short the 25-delta call.

    Anyway I thought you might be interested in reading this with regard to your post on Chinese FX reserve sales and implications for the US current account. Reserves are not always what they seem.

    I’d be interested o hear your thoughts.

    http://www.alhambrapartners.com/2015/09/01/the-nightmare-scenario/

  5. You are absolutely right to take this holistic, cyclical…. above all, sui generis approach. ….But still $3.7T and growing. And no-one in human history can economize on a dime like the Chinese. (check out their corn market in a land of the hungry.)

  6. This is such a good analysis of the macro look at both sides of the balance sheet.

    What always confounds me, is that China has one of the traditional market forces pegged; i.e. the currency. Normally the balance sheet and the currency move and absorb some of the ebbs and flows of money creation. With China, the pegs make it more difficult to analyze.

    All I know is that when Argentina and Mexico devalued off their peg, they didn’t do a 1 or 2% “devaluation.”

    Is there any possibility of a full on RMB plummet?

  7. The paragraph where you explain why the uncertainty on how debt servicing costs will be resolved and its multiple potential effects on the economy is key. I have been thinking on it and trying to figure out what is happening in Europe and Spain rigth now and how debt problems will affect the economy and my particular economy. I have no clues but your reasoning makes me read the news very differently and, many times, skeptically.

    In any case I have reached the following conclusions. First, as a general pattern, financial crises in Europe are beign avoided by transferring debt from the private to the public sector. Financial instability is supressed by institutions like the ECB providing liquidity when required with certain restrictions (applied mainly to Greece). The debt problem is being resolved mainly by wage supression and increasing taxes and this is causing and will cause sluggish growth, if any, low consumptiom and overreliance in current account surpluses that the rest of the world seems unable to absorb. Particularly, my income is wholly at risk, and I don’t know what to do with my savings that I have happily secured below my matress. I don’t foresee any significant improvement in the next 10 years when my children will incorporate to the workforce or the jobless masses. My wife is a fund manager and tells me that just triying to keep the value of our savings will require close attention and active management from our side, without relying on professional managers whose fees will just eat meagre yields or increase losses. We are seriously thinking on moving to the US in the near future were I have more professional alternatives or, start our own business here in Spain if we find an opportunity. I already have my own bussiness but its future is shady. With the risk of loosing both income and savings we have already reduced expenses and do not plan to spend or invest in anything that we do not consider essential.

    As you say there is much uncertainty about how the path of debt resolution that is beign followed will unfold in unexpected outcomes: the future of the Euro, the EU itself, political turnouts here and elsewere, capital fligth, social unrest, pensions, medical care, education, etc. In fact there are not expectations at all and people just try to survive and focus on a day-by-day basis or flee to other countries.

    Uncertainty is the word.

    • And just as it forces you to alter your behavior, Ignacio, the same uncertainty forces all economic agents to alter their behaviors.

  8. Am I the only person who finds it funny that people still look at extremely high GDP growth for an extended period of time as a good sign? When I see something like that, a red flag alarm goes off in my head.

    We could easily create growth by printing money for people to wipe out mountain ranges build high rise condos in the middle of nowhere, but how can that possibly be good?

    • Future generations will laugh at us for using GDP in any economic discussion. The measure is an abomination.

      • I don’t think it is useful to choose only between ideal information and no information. There are significant problems with the GDP calculation, but the biggest problem is that people who use it usually have not tried to understand what it means and how to use it. See my May 17 entry for some of the ways GDP is unnecessarily misused and some ways in which it can be very useful.

    • You are overdoing it a little. I visited China in 1988, my father in 1978. I worked their for a while and consulted joint ventures in the period 1991-1998. The compound growth that China generated is nothing short of spectacular and lifted hundreds of millions of of people out of poverty. Similarly beneficial was long high growth streaks in Japan, Hong Kong, Singapore, Taiwan, South-Korea.

      When i visited in 1988, people were pointing to the ‘failed’ Special Economic Zones, with rows upon rows of empty buildings waiting for industries and workers to arrive. Today Shenzhen is an undisputed economic powerhouse, and so are the other three. There are of course always failed projects at such massive economic speed and investment determination, but what stands out above all is many of these economic experiments and bets turned out spectacularly well.

      We can all point to the youtube video’s of empty space in China to ridicule their investment focus. But we may then forget to offset this with the spectacular way in which China rose in the new industry of solar, outcompeting Germany and Japan and South-Korea.

      The slowdown is inevitable, Michael Pettis nails it completely. But no need to belittle what has been achieved as well.

      • I never belittled what China achieved, but there are some serious red flags for which there will be consequences for. China did a great job of reducing poverty rapidly over the past few decades, but at what cost? To that question, I do not know the answer.

        A really good long-term sign for China is that Chinese fertility rates have plunged, but that’s also a bad sign too. There’s adjustments China needs to make and those adjustments will be difficult. If China pulls through, it’ll be all the better for China.

  9. I fail to understand exactly what is the nature of the Chinese Imbalance. It is hinted that there is excessive government debt, but I have also always read that China is a huge holder of US bonds, so also has great savings. How can these be met simultaneously? Are these bonds in private hands?

    After reading your post on 2011 forecast, the question is then, which planet do you recommend to colonize? Is Mars free of global imbalances? and would it be save from trading with earth?

    • You seem to be suggesting, Luis, that countries that have a lot of US government bonds, or reserves more generally, cannot have excessive debt, but I am not sure why one would follow from the other, and in fact think it is far easier to explain why the opposite is more likely to be true. But whatever argument you might prefer at first, and assuming you can logically explain your reason for linking these two, long before going to Mars if I were you I would have wanted to remain on earth and consider testing my argument against some of the more obvious and visible examples in recent history. For example, I wonder why Brazil, with its huge recent FX reserves, or Japan’s huge accumulation of USG bonds in 1990, wouldn’t have made you reject the idea that lots of reserves are incompatible with lots of direct of contingent government debt. I have also several times mentioned that of the three greatest hoards of central bank reserves in history, two of them were very famously followed by terribly brutal economic adjustments powered by soaring debt (one of which is always referred to as the greatest depression in history). The third of those three, of course, is China today. Given the precedents, why would China’s having too much debt today surprise you?

      • My silly joke might have made my question ironic and meant for a sophisticated answer, when it was in fact very naive and demanding a simple answer. I would expect that if you have a debt but lots of reserves you can pay back your debt with your reserves. Is the problem that the debts are much larger than the reserves?

        • Sorry, Luis, but it was very late at night and I have addressed this misconception so many times that I guess I get annoyed if I think a reader of my blog is asking me the question not because he genuinely wants to know the answer but rather because he thinks it makes him look cleverer than he is. FX reserves can only be used to pay for the purchase of goods and services produced abroad, including tourism, royalties, etc., and to service foreign debt and otherwise pay for foreign investment. But remember that foreign currency reserves do not imply wealth at all. They are simply the typical form in which the central bank’s balance sheet is mismatched.

          The US is by far the wealthiest country in the world, but its foreign currency reserves are minimal. The same is true of Canada, Australia, most European countries, and indeed all advanced economies with the exception of a few in Asia who have followed specific growth polices in which domestic demand has been suppressed. If reserves, however, made a country wealthier, or debt repayment easier, then it would be extremely easy for a credible economy to wipe out its debts at no cost. The Fed, for example, could simply issue $10 trillion of bonds, under the sovereign guarantee, and use the proceeds to buy euros, and overnight its reserves would rise by $10 trillion. To make this transaction especially easy, the Fed could simply ask the ECB to to the opposite transaction, which they would be delighted to do because then both countries would see their FX reserves rise by $10 trillion on the back of a transaction that could be negotiated, signed and executed in just a few minutes.

          The reason the ECB and the Fed have not done this is because each country would be worse off. Each country would assume the risk of the other’s default without benefitting from the other’s not defaulting. There is downside risk, in other words, however small, and no upside risk at all unless the currency of one or the other suddenly were to lose credibility. Notice one other important thing. The Fed would have to incur domestic currency liabilities to acquire the euro-denominated reserves (as would the ECB to acquire dollar-denominated reserves). This is how all central banks acquire FX reserves — they borrow domestically to pay for foreign currency assets, and consequently give up control of domestic monetary policy in order to intervene in the currency (look up the “impossible trinity”, either on my blog, where this is much discussed, or anywhere else, if you want to understand this more fully).

          This process of acquiring reserves explains the two main reasons why having all the FX reserves in the world does not prevent you from having a debt problem. First, if the debt is domestic debt, you cannot convert your reserves into the domestic currency needed to service the debt without reversing your currency regime and almost certainly demolishing your tradable goods sector (and because it is very rare, perhaps unprecedented except in the case of countries whose economies are overwhelmingly dominated by commodity production, for a country to have substantial reserves without a currency regime aimed at growing the tradable goods sector, this would probably also demolish that country’s economy). Second, and far more fundamental, is that FX reserves are simply mismatched domestic liabilities, and every dollar that was somehow used to service debt in one part of the economy would automatically cause the net indebtedness of the central bank to rise by exactly one dollar. To put it more specifically, if Beijing, for whom the net indebtedness of the Chinese banking sector is a contingent liability, were somehow able to take $2 trillion from the PBoC and use it to reduce the net indebtedness of its domestic banking system, the net indebtedness of the PBoC, which is already technically insolvent and has probably been so for at least three or four years (the necessary information is never made public) would rise by exactly $2 trillion. Beijing, in other words, would have reduced one set of contingent liabilities by $2 trillion while increasing contingent liabilities elsewhere by the same amount. The use of reserves can only shift debt, not pay it.

          Finally, in case you wondered, the three largest accumulations in history of central bank reserves as a share of global GDP are probably, in order, those of the US in the late 1920s and early 1930s, of China today, and of Japan in the late 1980s and early 1990s (I say “probably” because reserves can be held in different ways, and much of Japan’s FX purchases occurred through institutions that shared reserve-accumulation with the BoJ). Needless to say, the two predecessors subsequently experienced terrible adjustments set off by soaring debt, just as China seems to have started doing, and massive reserves proved to be no help at all. In fact, as i suggested in my first response, it is easy to make a plausible argument that high reserves tend to cause, not resolve, debt problems for an economy. The very process of accumulating reserves also causes monetary expansion, and if high reserve levels are the consequence of rapid reserve accumulation, so must rapid monetary expansion.

          • >> The Fed, for example, could simply issue $10 trillion of bonds, under the sovereign guarantee, and use the proceeds to buy euros, and overnight its reserves would rise by $10 trillion.

            this made a light bulb go off for me. I’ve never understood what the liability side of the balance sheet of a country’s reserve bank looks like — a reserve bank looks like a big piggy bank with gold and a bunch of exotic currencies piled up in vaults haha — but of course the reserve bank has to redeem all the promissory notes it has issued (d’oh). and sometimes it exchanges its (high-quality) promissory notes for someone else’s lower-quality ones (like, say, a state or regional government). so in doing so it can dramatically change the status of its own balance sheet (or the value of its currency in circulation) rather quickly. I don’t know why it is that it’s so much harder to visualize the balance sheet of a reserve bank than it is to visualize the balance sheet of, say, a typical corporation; but for me there’s no comparison. I think it’s because the value of currency is so abstract.

            anyway: that was a great hypothetical example, thanks for the insight.

          • Thanks very much for this detailed answer. It really impresses me your willingness to clarify your point of view to non-experts. Many thanks again.

          • Is that the case just for China or any other country with FX reserves?Because, there are reports that Saudi Arabia used its foreign reserves for fiscal purposes. Now, maybe there is a confusion due to the fact that Saudi central bank, SAMA, also controls SWF so journalists mixed those two up?

            .

          • Definition: Forex Reserve Accumulation = Current-account surplus + Capital-account Deficit.

            In other words, all the net money that came in through the current-account PLUS the net money that came in through the capital-account has to be pushed out through the forex reserve-account in order for China to maintain its currency-peg.

            Therefore, there are two components to the Forex Reserves (F), which may be written as:
            F = X + Y, where X = Cumulative current-account surplus and Y = Cumulative capital-account deficit

            The X part represent real domestic savings (wealth) that has been stored abroad. The Y part does not represent any additional wealth, as it is merely a swap between exported domestic savings and imported foreign savings (i.e. net zero).

            The argument that Michael is making about the 10 Trillion USD-EUR/EUR-USD swap is of the type Y. He is correct that type Y forex reserves do not

            represent any wealth for the reserve-holding country, as they merely offset a foreign claim.

            However, in China’s case, we can ROUGHLY split their forex reserves into its X & Y parts as follows:
            1) China total reserves (F) according to the World Bank are about 3.8 Trillion$ as of 2014.
            http://goo.gl/h0RlMc
            2) China cumulative current-account surpluses (X) as of 2014 are about 2.6 Trillion$. In other words, China has cumulatively produced 2.6 Trillion$ MORE than it has either consumed or invested domestically.
            http://goo.gl/LLrcln
            3) Therefore, China’s cumulative capital account deficits (Y) would be about 1.2 Trillion$ (Y=F-X). In other words, on a net-basis foreign-savers have cumulatively invested 1.2 Trillion$ in China and so China had to push out 1.2 Trillion$ of its domestic savings via the reserve-account in order to maintain its currency peg.

            Therefore, of China’s 3.8 Trillion$ total reserves, X = 2.6 Trillion$ represents real Chinese wealth stored abroad, whereas the other Y = 1.2 Trillion$ does not represent any additional wealth for China.

          • ^Vedran WROTE: “Is that the case just for China or any other country with FX reserves? Because, there are reports that Saudi Arabia used its foreign reserves for fiscal purposes. Now, maybe there is a confusion due to the fact that Saudi central bank, SAMA, also controls SWF so journalists mixed those two up?”
            —————————————-

            A) During a resource boom, a resource-country with a unfree capital-account maintains its currency-peg by using a two-tiered approach:
            (TIER 1) The fiscal surplus (or budgetary surplus) resulting from the rise in royalties is pushed our via Sovereign-Wealth Fund accumulation.
            (TIER 2) The EXCESS of the current-account surplus OVER the fiscal-surplus is pushed out via Forex-Reserve accumulation to hold the peg.

            B) When the resource boom becomes a resource bust, then the process in (A) is REVERSED in order to maintain the currency-peg:
            (TIER 1) The fiscal deficit (or budgetary deficit) resulting from the fall in royalties is financed by drawing down on the Sovereign-Wealth Fund.
            (TIER 2) The EXCESS of current-account deficit OVER the fiscal-deficit is financed by drawing down on the Forex-Reserves to hold the peg.

            Note that only TIER 2 is a monetary operation and TIER 1 does not affect local liquidity.

            If the boom has been prudently handled, then a short bust can easily be smoothed out. However, if the boom was not prudently handled, or if the bust turns out to be long, then budget-cuts (or tax-increases) and a devaluation of the currency may become inevitable. After all, if a squirrel puts away a fixed stock of nuts during the summer, then he has to hope that the winter will be over by the time he finishes that stock.

          • ^^ERRATA: In the comment above, the term “Capital-account Deficit” should be replaced by “Capital-account Surplus” in all the THREE instances in which it has been used.

            “Capital-account Surplus” implies more money coming in via capital-account than going out.
            “Capital-account Deficit” implies more money going out via capital-account than coming in.

          • Vinezi Karim, tnx for the answer.
            So what you are saying( real wealth of 2.6 trillion) is different than what Michael Pettis is saying. It would be great if Michael could comment on what you wrote about FX reserves. It seems there is no agreement on this subject. To add fuel to the fire this is what famous hedge fund manager Kyle Bass said today: “Such losses would force China to use much of its foreign exchange reserves (which stand at about $3.6 trillion) and sell bonds to recapitalize the banking system”. On the other hand other hedge fund manager Jim Chanos is in line with Michael Pettis: “The Chinese banking system is built on quicksand, and that’s the one thing a lot of people don’t realize. When they talk about the foreign reserves of $3 trillion, what everybody forgets is there’s liabilities against that.”

            So there are two camps and someone is wrong. And it’s not a minor mistake. It’s a couple of trillion dollars mistake. So get together and debate it until you come up with something.

          • Vedran WROTE: “…It seems there is no agreement on this subject….So there are two camps and someone is wrong. And it’s not a minor mistake. It’s a couple of trillion dollars mistake……”
            ——————————————-

            This business of cumulative current-account surpluses (Type X), cumulative capital-account surpluses (Type Y) and the liquidity swaps that Michael describes in his comment (Type Y Corollary) was discussed in one of Michael’s previous blog articles. Please read that FIRST. AFTER you have read that, if you still have any doubts, then you can come back and raise them here.
            http://goo.gl/AhxlUH

            ——————————————-
            ^^James Kaianos SAID: “The Chinese banking system is built on quicksand, and that’s the one thing a lot of people don’t realize. When they talk about the foreign reserves of $3 trillion, what everybody forgets is there’s liabilities against that.”
            ——————————————-

            Yes, it is true that the foreign exchange reserves have liabilities against them. But on whose balance sheet are these reserve assets? On whose balance sheet are the liabilities? Who owes what to whom? This is unclear from the statement from Mr. Kaianos.

            1) TYPE X Reserves (genuine Chinese wealth stored abroad):
            The Chinese central bank is on the RHS (creditor) of the consolidated balance sheet of the entire US banking system and Americans are on the LHS (debtor). Mirroring this, in the consolidated balance sheet of the entire banking system of China, the Chinese central bank is on the LHS (debtor) and **CHINESE** people are on the RHS (creditor).

            In this case, once we CANCEL OUT the Chinese central bank as merely an intermediary between the two balance sheets, we get the net result that Americans owe the Chinese people.

            2) TYPE Y Reserves (no net Chinese wealth stored abroad):
            The Chinese central bank is on the RHS (creditor) of the consolidated balance sheet of the entire US banking system and Americans are on the LHS (debtor). Mirroring this, in the consolidated balance sheet of the entire banking system of China, the Chinese central bank is on the LHS (debtor) and **AMERICANS** are on the RHS (creditor).

            In this case, once we cancel out the Chinese central bank as merely an intermediary between the two balance sheets, we get the net result that nobody owes anybody anything.

            QUESTION: Can Type X Reserves be used to re-capitalize the Chinese Banking System?

            The answer is no. The ONLY way to recapitalize the Chinese Banking System is for the Chinese government to REDUCE its OWN net-worth, either by going deeper into debt or by selling its OWN assets. Reserves are of no use in this process because the Chinese government (via the Central Bank) is already sitting on the LHS (debtor) of the consolidated balance sheet of the entire banking system of China. This is because Americans do not owe the Chinese government (or central bank) anything; their real debt is to individual Chinese people who deferred their personal consumption. Therefore, Type-X reserves are assets belonging to Chinese individuals; they are not the assets of the Chinese government (or central bank).

            So, in this sense, Jim Kaianos is correct. As to the other ‘famous’ fellow you mention, I have never heard of him and I have no idea what he is trying to say from your quote.

    • Savings are on the RHS of balance sheet of the consolidated balance sheet of the entire banking system, while debt is on the LHS of that balance sheet. Savings are an asset to the people who save, but a liability to the banking system, whereas debt is an asset to the banking system, but liability to the people who borrow. In other words, the banking system, as the intermediary, represent merely the overlap between the RHS & LHS of the balance sheets borrower and savers, respectively.

      Therefore, if there are a lot of savings in the banking system, then it follows that there must also be a lot of debt. Therefore, there is no incongruity between saying that a country has high-savings and saying that it has high-debt.

      When a country has local savings that are lower than its local debt (e.g. US, UK), then it means that the country is a net-debtor to the world and has high net external-debt. This, in turn, means that foreign savers (or foreign central banks if the country is a reserve issuer) are occupying the RHS of the local balance sheet to the extent of the deficit of the local savings below the local debt, while local borrowers are taking the corresponding place on the LHS. Such countries typically tend to runs current account deficits.

      When a country has local savings that are higher than its local debt (e.g. China, Japan), then it usually means that the country is a net-creditor to the world and has negative net external-debt. This, in turn, means that foreigners (or the local central bank if the country is a reserve accumulator) are occupying the LHS of the local balance sheet to the extent of the surplus of the local savings over the local debt, while local savers are taking the corresponding place on the RHS. Such countries typically tend to runs current account surpluses.

  10. Always instructive to see your views Michael. Would love to know your opinions on India’s macros, BS, prospects, if they ever come up in any of your future works.

    • I have wanted to learn a lot more about India since three or four years ago, but China began its adjustment roughly around 2012, and since then it has been hard to go three or four months without some disruption, “unexpected” change, or financial or debt-related shock, that prevents me from escaping this fascinating economy. I will get around to it, however, and of that I am sure.

  11. Michael – Spot on. Nothing explains this better than the excerpt below.

    A turkey is fed for a thousand days by a butcher; every day confirms to its staff of analysts that butchers love turkeys “with increased statistical confidence.” The butcher will keep feeding the turkey until a few days before Thanksgiving. Then comes that day when it is really not a very good idea to be a turkey. So with the butcher surprising it, the turkey will have a revision of belief—right when its confidence in the statement that the butcher loves turkeys is maximal and “it is very quiet” and soothingly predictable in the life of the turkey.…The key here is that such a surprise will be a Black Swan event; but just for the turkey, not for the butcher….” Anti-Fragile (Nassim Taleb).

  12. “These debt-related shocks will occur regularly for many more years, “.
    What on earth is the author talking about?
    I’m unaware of any ‘shocks’ to China’s economy, let alone debt-related.
    The Chinese economy is growing at a staggering rate and its net debt is extremely modest by Western standards.
    Can someone fill me in?

    • It is late at night so I can’t fill you in except briefly, but since you ask the question about what I have written in a way that suggests incredulity, let me also be as admirably frank as you are. If you are not aware of debt-related shocks that have occurred in China in the past few years, and if you think Chinese debt is extremely modest by any relevant standards, then clearly you have not been following China at all in recent years, either directly, or indirectly in the form of comments and analyses by others, and you cannot be so confused as not to know that you have not read much, if anything, in several years, in which case why on earth would you want to disagree with anything someone might say about China?

      • Perhaps some of the comments are trying to say the same thing I am. I suspect that there are some golden nuggets in your post, but I am having a devil of a time figuring out exactly what they might be. We write comments in the hopes that the discussion will reveal these nuggets. When the discussion talks about debt, but does not distinguish between public debt and private debt, then it is only meaningful to the author who knows shich debt he is talking about.

        If the author who fails to distinguish really thinks that public debt as just another facet of the lump of debt that includes both kinds, then I think some readin on Modern Money Theory would be appropriate.

        I mentioned that China is somewhat sovereign in its own currency. The roadblock to be totally sovereign is the attempt to peg their currency to the dollar. That may have been a beneficial policy in the past, but now it is a hindrance to full currency sovereignty. Of course, if the Chinese government does know about or won’t use the freedom that this currency sovereignty gives them, then they will be following in the mistaken footsteps of the USA government.

        The world id not going to solve its economic problems with a currency devaluation race to the bottom. It is impossible for all the countries in the world to be net exporters, unless the extra terrestrials start buying earthly made goods.

        • Gantal claims to be “unaware of any ‘shocks’ to China’s economy, let alone debt-related”. Let’s ignore how blind or thick (or maybe he just woke up from a four-year coma) someone must be not to be aware of these shocks. Hell, every single day the FT or the WSJ has at least 4-8 articles about them, and they have been front page news everywhere for months. Can you explain how Gantal’s comment supports yours? Gantal is, in my opinion, so out of it that he isn’t embarrassed by saying what he says. I know that every time Pettis writes one of his brilliant essays (or maybe many people just like to pretend they think they are brilliant essays even though we are as confused by them as you are), there are often two or three people who read the blog, find it completely over their heads, and rather than try to figure it out, complain that they’ve been had. I assumed you were just doing the same, until you said Gantal reinforces your complaint. I am not to proud to admit that I don’t understand what you have said, and rather than just dismiss you, I prefer to seek enlightenment from you. I really don’t know how Gantal’s confusion proves that your confusion proves that Pettis is confused. Can you explain?

          • “Let’s ignore how blind or thick (or maybe he just woke up from a four-year coma) someone must be not to be aware of these shocks. Hell, every single day the FT or the WSJ has at least 4-8 articles about them, and they have been front page news everywhere for months”.

            The FT, The Economist, the WSJ and all Western media have been completely wrong about China’s economy in the 40 years I’ve been reading them. Completely. Wrong.

            They’ve been recycling their alarums and excursions for almost two generations and neither they (nor you, apparently) have noticed that they are always wrong.

            Does this not alarm you? At least make you curious?

      • Gantal:

        Search Michael. I have been participating on blogs since the late 1990’s. With Michael, at least since FTM of CFR since 2003-4 (how I found Michael, and I might say, that FTM was somewhat special, in that most of the most highly rated economic bloggers of the world today, participated in BS’s attempt to tackle forensics of capital). With that said, Michael handed it to you.

        Most of us here can and do read on finance, economics, history, philosophy, and current events. Some of Michael’s commentators would be better judges of the global system than 95% of the economic and financial journalists out there (including those who purport to be advisers to hedge funds and the like; scarily enough).

        If you have not understood this piece, a simple frame that is accurate, then do yourself, and your pocketbook a favor by taking the time to buy his books, and delve deeply into his columns. You have stumbled upon the future of an economics, finance, and development reconfigured.

        For example, having been privy to a level of dialogue far above anything available at the time, I returned from a year in Asia in 2008 to the tunes of my friends going, “you were so right, everything you said is happening. Who was surprised by the GFC”, not me. My friends were only surpised that I was correct. At that time, such led me to describe to my Australian and South Arican friends, exactly what would happen tot heir currencies and that China would stimuus, well before both of these currencies reached their bottom before overshooting. An easy safe and cool 150% in ayear. Or led me to Ford, 1500% in a year. Too oil today and while it would stay low. Or to the futility of China, shortening the timeframe of its development, and essentially forcing up the cost of commodities, the cost of its overdevelopment, and the debt that you seem to not be aware of. Likely yu not aware of capital to output ratio’s, p/e’s of exchanges, the relationship of debt to development in this model, how China has exacerbated the dynamics, how they were integral to the GFC, how the ADM has been broken, adn so many other issues. You should spend a hundred bucks and buy michaels books, or go to the library. Then delve deeply into his columns.

        I laugh at how obtuse most commentators are otherwise. I only read articles, even of the revered FT, for their data. But see, I even recognized in 2006 when the Economist changed its editor, most people just listen to the highly ideological, and usually misunderstood perspectives of overly assumptive, lessor journalists, frankly.

        • “But see, I even recognized in 2006 when the Economist changed its editor, most people just listen to the highly ideological, and usually misunderstood perspectives of overly assumptive, lessor journalists, frankly.”

          Taleb calls them journos and then proceeds to attack them for not having any skin the game. I don’t really disagree.

          • YEs, read Taleb’s opinion, part of reason why I reconsidered my opinon on him.
            But they do have skin in the game, and I mean, they are humans on this Earth.
            The global community accelerated globalization, that impacted me, any I might love, any children I might have or support and similar. So more than just having no skin in the game, these journalists are problematic, because the provide a superficial exposition of the issues. But hey, people are even taking pictures rather than texting at the moment for communication, maybe they get what they deserve.

          • I don’t get how you don’t like him, at least in many respects. He’s the man. Personally, I think he’s one of the most brilliant people in the world. His work and his understanding of the world is definitely one of the most fundamentally sound I’ve seen. He’s extremely rigorous and he’s cool as shit.

            I comment on his Facebook page all the time and he actually bothers to read that stuff. He’s liked a lot of my comments, including my views on empire, democracy, and “equality”. He genuinely understands the real issues whilst providing real fixes to serious problems we have. On top of this, he goes after frauds with no remorse. He takes down crooks at will.

            Taleb is a BAD DUDE!

          • I reconsidered my opinion on him, being that I am more fond of him now, have re-read a couple of his books.

            On his topic he is profound. More broadly he is merely opinionated.

          • I think a lot of people get pissed off at Taleb for the way he carries himself. Have you seen this book he wrote?
            http://www.fooledbyrandomness.com/FatTails.html

          • “Fooled…” is an absolutely brilliant book, although about one third of it, the parts that seem to be driven by resentment, can be edited out. I have all my students who want to be traders read it. I am less impressed by the books on black swans and on anti-fragility, the latter being more easily explained, I think, by optionality.

          • Taleb talks about optionality a lot in Antifragile. He used to be an options trader for 21 years and he has a derivatives textbook (Dynamic Hedging). Honestly, I thought the best part of Antifragile were the appendices, but most people don’t really understand them (Prof. Pettis, I think you’d find the appendices quite enticing for Antifragile).

            Maybe sections of his book are driven by resentment, but Taleb isn’t the kinda guy that pulls punches. I usually get irritated when I have to read books written like stories (I prefer extremely dry material that uses obscure facts with different models or views), but Taleb writes his stories well.

      • Gantal, otherwise known as Godfree, frequents most major China-related sites and posts blindly pro-CCP drivel.

        • Thanks Paul, but it seems weird to me that they exult when people encourage China to follow a path that has caused so much damage to so many countries, even when that same damage begins to occur to China, but they are enraged when people try to understand why this damage has occurred, and how China might be able to avoid or minimize the damage.

        • biggestbrotherofthem All

          How do you know Gantal and Godfree are the same? I am just curious thats all.

      • Here are some snapshots, using World Bank figures, indicating that China’s debt is lower than the US’, the UK’s, or France’s.

        Carnegie: http://carnegieendowment.org/experts/?fa=533 (click the ‘Latest Analyses’ tab).

        Am-Cham Presentation: http://insight.amcham-shanghai.org/wp-content/uploads/Shanghai-AmCham-Why-do-views-differ-so-much-on-Chinas-economy-revised.pdf

        Debt to GDP Chart https://docs.google.com/document/d/1MMNHiH-PxNhM1PMUzvk9STEQptGHzIGRWEMcDWdF1w8/edit

    • China’s net debt is modest? Are you just counting the MOF? Net debt suggests you need to look at all corporates, local governments, central governments, ministries that can raise debt aside from the MOF, PBOC insolvency liabilities maybe etc etc.

      Gantal, maybe again you haven’t received the notice, but even Zhou Xiaochuan was admitting that there had been an adjustment (which caused shocks) as recently as this weekend.

      As with other specialised news or columns, it is a bit self-defeating when the “nothing negative can be said” paid/just fanatical trolls try and engage in the comment sections of this blog. Aside from looking incredibly ignorant and out of their depth, they stick out like sore thumbs, and generally make intelligent people feel quite exasperated.

  13. Mr. Pettis,

    As a long-time China watcher (as a matter of business interests), I have appreciated the insights that your essays have brought to the discussion.

    This essay in particular is by far the best analysis that I have seen of the situation in China over the past 5 years.

    The only thing I want to add: As someone that worked in Japan in the 1990s, it amazed me how long it took international analysts and international expectations to adjust to the reality of much slower growth.

    My base case for China is not that different from what happened to Japan. Japan’s total factor productivity effectively stalled for a full decade before resuming growth a few years before the global financial crisis.

    I expect a long-term slowdown to around 2-3% real GDP growth in China as well as no financial crisis. I also would like to point out that the most important factor in all of this is that China will likely shift the burden onto the Chinese public as Chinese savers will effectively pay the cost of re-capitalizing China’s financial system through internal rate policy (as you have pointed out on several occasions).

  14. I think there may be a relation between this article and a conundrum for the Chinese economy that I always wondered about. If the Chinese economy depends on massive exports, how is this going to succeed when all the buyers of Chinese products run out of the money to buy these products? The answer seemed to me to be having domestic demand in China sop up the products for which China could no longer find foreign buyers. Is this article saying that the state is keeping too much of the wealth, and not transferring enough of it to the private sector to spur private domestic demand? If the author would only say this, and talk about specifics on solving this problem, perhaps his disagreements with other experts could be resolved. I have a feeling that his disagreements arise because the other experts can’t figure out what he is getting at either.

    • If my supposition of my point is correct, then wouldn’t Keynes and our own experience with QE show that transferring the wealth would not be enough to spur domestic demand for anything but stocks as has happened in the USA and China? Some how the government has to replace the missing private demand. That seems to be what China’s stimulus policy was all about. What is the analysis of why that failed to create a sustained growth situation?

      • Michael has addressed this in depth, at least half a dozen times over the last several years.
        Frankly, I tend to believe Michael is over-optimistic, when is considered a bear, and overly pessimistic.

        But to make a long story short, Michael thinks rebalancing toward consumption can be done in a decade or 15 years, I don’t think that it can be done, if they make all the right decisions for two decades. By that period they will have waves of retirement, and the rest of the world has neither a decade nor two decades to accommodate China, especially while the EU is hoping to be accommodated along with Japan; coupled to a weakened US and EM.

        So Michaels solutions involve ways to make Chinese wealthy by switching assets, perhaps shares of SOE’s to the Chinese people rather than continuing to be held by government, raising interest rates because higher interest rates help Chinese consumers to reach their savings targets for retirement and rainy days more easily thus can lead to discretionary spending, etc…

        This is art of rebalancing, of course China is lowering the Cash Reserve ratio’s of banks, and interest rates, and loosening the currency to make debt more sustainable, easily able to be regreened, and they are not rebalancing, even as wages in China have risen, because they still rise more slowly then stated GDP growth, and are lowering than the growth in Investment, even the growth of money supply.

        One more thing, China, as a percentage of GDP has lessened its reliance on exports. This is necessarily so, as their GDP has gotten (supposedly) so large that of course, they couldn’t rely on exports to drive their growth, for the intuition you state. Alternatively, if China’s GDP is 30-60% overstated, as many believe, their reliance on exports would be higher. the previous dynamics that stem from difficulty in serving debt, (Cash Reserve Ratio of Banks, P/E’s, Interest rate lessening, and devaluation would all be supportive of problems servicing the debt of the export (and other) sectors, in this case if GDP is significantly overstated I should imagine.

      • Because of the high proportion of investment in the composition of GDP, and because of the low wage share, ow proportion of worker income in wage share, ensuring that the wealthy and business would reap the benefit of any productivity gains in society, any wealth generated, while they could only invest, rather than consume any meaningful percentage of their profits, thus investment need to continue to grow at a high pace, so constructed. How could such a continued level of growth lead to a sustained growth situation, whatever that is. Consumption, driven by a market filled with economic agents, rather than a relatively small percentage of such relative to the size of the population, would be more sustainable, as there are many moving pieces. Were people to learn how to consume and drive the economy, by that being the preponderant force in the economy, rather than continuing the increase of a relatively small share of the population of economic agents, China would be able to drive more sustainable growth. Of course invest, begs the question for what.

        If China’s goal was continuity of political leadership or the growing integration of their soveriegn territory for an extended period of time, at the extent of their current borders, even pressing for those to be extended, perhaps they have been extended, but by no means has their high growth been beneficial, because it is on the back of increasing investment as a share of GDP. So, of course, that is less extendable over a great deal of time, outside the bounds of the miracle industrialization process, than have the people drive the economy, through consumption, and small investment, in an open market, with transparency, accountability and accountable governance.

        Have you been wedded to the Chinese growth story?
        Why? For what reasons do you see the likelihood of growth, today, or a year ago, necessary in the Chinese case? Perhaps an exposition fo your assumptions is useful. Or your previous assumptions?

      • In reply to Steven Greenberg: Do you know what this article is about? The purpose of this article is very clearly not to explain “that the state is keeping too much of the wealth, and not transferring enough of it to the private sector to spur private domestic demand.” He refers to this, and discusses it so fully in so many other places that now even economists who at first disagreed with him have been forced to agree, or at least to pretend they didn’t used to disagree.
        But if you really want an answers your questions, why not read the many other blogs where he answers the questions? If you only plan to read this blog, why not accept that he is discussing something else, which is the two reasons the balance sheet has such an important and ignored impact on growth?

  15. Dear Dr. Pettis,

    Clearly one can afford to take on higher debt if the growth rate is high in a productive fashion. The problem happens only when there is mis-allocation of capital with this debt. This seems to have happened quite a lot in China. Can a developing country do better than China by allocating debt capital in a better fashion? Instead of focusing on investments like empty buildings or non-competitive factories.

    My second question: For China, the debt capacity should be higher than say France where the long-term growth potential is lower? When French debt (public / private) is equivalent to China as a % of GDP, why is debt not such a problem for France that has a longer-term lower growth potential?

    Thanks

    • NR, when there are easily identified productive investment projects that the private sector won’t or cannot make, perhaps because of political uncertainty, weak property rights, significant externalities that cannot be captured easily, etc. there is a role for the government to centralize the capital allocation process. There is however always the sam problem. After many years of directing investment successfully, almost by definition it becomes harder to identify similar projects, in which case it is better to reform the financial system so that rather than top down, the decision-making process is bottom up — allocated by the market, for example. The problem, as Albert Hirschman noted forty years ago, is that a highly centralized decision-making process tends to create a powerful group of vested interests that oppose reform. In the end there isn’t likely to be a “solution” in the sense of a program that applies to all developing countries. I suspect each country will have its own solution depending on its political system, institutions, etc.

      As for your second question, I am not sure how much higher China’s growth potential is relative to France. It is probably a little higher, but not as much as recent years might imply. Remember that China is going through a rebalancing, and the historical precedents suggest that growth will slow far more sharply than most people believe possible today. History also suggests that although there are periods in which it seems that developing countries will almost certainly converge with developed countries, these periods are separated by much gloomier periods in which convergence is substantially reversed. In the end developed countries have always been able to bear much higher levels of debt relative to GDP in part, I suspect, because their economies are much less volatile and more highly diversified, and in part because their financial systems and institutions overall, especially if they are democracies, are much less rigid. There is a lot more to say about this, and I hope to in my next book, but I am pretty sure that other things being equal, France can carry more debt relative to GDP than any developing country, including China.

      • Now we are getting to some concrete things that help clarify what this discussion is all about.

        Still, I find the topic of “debt” to be too abstract. There is “private debt” – debt owed by private citizens, and there is “public debt” owed by the government, which in this case is also somewhat sovereign in its own currency. The prescription very much depends on which debt you are talking about. One sector’s debt is another sector’s surplus.

        With France tied to the Euro, the situation is much different, and not directly comparable to China.

        • Is there a difference between debt. After all during recent bouts of crisis, globally, and in the past, sovereigns have nationalized debt, insofar as taking debt onto their balance sheets, or look at QE, it led to shortfalls in revenues, it led to need for paying for the legislated automatic stabilizers, and led to deleveraging of the private sectors, where those proportions of debt migrated to the Federal debt.

        • Sorry, SG, but I guess I am as confused with what you are trying to say as you are with my essay. Yes, there is a difference between public debt and private debt, but I don’t imagine you would think that this isn’t obvious to quite a lot of people who write about debt. I get the feeling that you have recently read some non-academic write-up of MMT, find it exciting, and are trying to fit lots of different things into some kind of MMT framework, even if they don’t always apply. Can you explain exactly where you think this essay, which is on the impact of balance sheet distortions, has made a mistake because of my failure to distinguish between public and private debt? Also in the Chinese context do you have a useful way of distinguishing between public and private debt? There is a huge argument about this and it is not necessarily because no one has read that MMT essay. And which prescription “very much depends on which debt you are talking about”?

          I am also puzzled about this sentence: “With France tied to the Euro, the situation is much different, and not directly comparable to China.” I thought someone else was comparing France to China, and I was explaining why they are not comparable. I was born and grew up mainly in Europe, and I have spent the last 13 years in China, so I am aware of many of the differences, but I don’t understand what you think is the mistaken comparison between them.

          • I came to this article from Naked Capitalism’s cross post. I have never read your blog, nor your books, hence my confusion. I felt that there was something important you had to say, but i couldn’t figure out what it was. As I read some of the comments that did not address my own comments, I saw a comparison to France. In the welter of back and forth, I must have missed your explanation that they were not comparable.

            Since I don’t know about all that is behind your balance sheet talk, I have no background to understand the point you are making that negates the possible Chinese sovereignty in their own currency. I fully agree, that there are plenty of ways to use this sovereignty badly, so I have no brief for exactly how the Chinese have used it.

            As I read the article originally, I kept hoping for some concrete knowledge about how China and the rest of the world could turn the situation around. All I found was continuing reference to balance sheets and debt that I could not turn into concrete actions. I suspected that you all, who are familiar with this, might know what you were talking to each other about. I was hoping to get a clue. I can see that I need to back out of this conversation, and seek answers elsewhere. Maybe one of these days, I’ll have time to read your book, and two years worth of blog posts here. Until then, I will await someone to write a Primer about what you are talking about, unless you can point me to one that has already been written.

            I have become aware through some of the Q & A here, that you know fully well the difference between debt of entities that don’t make their own money, and entities that do. I don’t know what you think of the different policies and actions that the difference makes available to the two different types of entities.

          • Stuff like MMT (and other theories of that nature) can be very pernicious. I don’t get how people become so fascinated with theories to the point where they completely ignore the assumptions. There’s A LOT of implicit assumptions in MMT (primarily about political factors) that make me cringe. The worst part is that we should rely on “faith” and “trust” because “socialism”, “democracy”, and “equality” are good.

            MMTers automatically make this assumption that because the people want it, that means its good. Another part I get outraged about is this idea that if the government runs a deficit, the private sector is automatically running a lower deficit without realizing that a shift in the government balance could just cause a shift in the current account without the private balance decreasing, or worse, that increasing government deficits would increase private and current account deficits by expanding liquidity. It’s ideas like MMT that make me vehemently against “democracy” and “equality”. I’m sorry, but not everyone should have even close to an equal say.

            There’s a fundamental difference between free elections and “power to the people” or “equality”. Equality is, at its most fundamental level, always a push for power. No one actually wants equality; the people who say they want “equality” really want power. It’s just hyperemotional pandering to accomplish the worst goals possible.

          • Don’t assume I have no criticisms of MMT. I just used that as a concrete example of something. As a newcomer to this blog, and not aware of Michael Pettis before this, I was just trying to get the discussion to something concrete. All the posts that have equations that compare Pettis to MMT are very concrete. Just what I was looking for. Thanks.

          • ^Michael Pettis WROTE: “Sorry, SG, but I guess I am as confused with what you are trying to say …..xx….. but I don’t understand what you think is the mistaken comparison between them.”
            ————————————————–

            A) I think that Greenberg thinks that you are an idiot, Michael, because:

            1) His pet MMT states that G − T = S − I − NX, where G is government spending and T is government taxation, whereas you have repeatedly written the equation as S – I = NX (i.e. excess of savings over investment MUST equal net-exports) in your blog, thereby apparently suggesting to Mr. Greenberg that you either are ignorant of the meaning of (G-T) or are assuming incorrectly that government deficit must always be zero (i.e. balanced budget or G = T).

            2) To close this dialectic, I suggest that Mr. Greenberg follow the derivation of the MMT equation given below, with the suffix ‘g’ referring to government-share and the suffix ‘p’ referring to the private (or non-government) share:

            GDP = C + S = C + I + NX (Note that this is the equation that Michael and everybody else here uses)
            Therefore, GDP = Cp + Sp + Cg + Sg = Cp + Ip + Cg + Ig + NX
            Therefore, Sp + Sg = Ip + Ig + NX
            Therefore, (Sp – Ip) – NX = (Ig – Sg)
            Therefore, (Sp – Ip) – NX = (Ig – (T – Cg))
            Therefore, (Sp – Ip) – NX = (Ig + Cg – T)
            Therefore, (Sp – Ip) – NX = (Ig + Cg) – T
            Therefore, Sp – Ip – NX = G – T (Note that this is the form in which the MMT expresses the relationship)

            In other words, the terms S & I as written in the MMT should have a suffix p to indicate that they refer to PRIVATE savings and PRIVATE investment. Once this is done, the confusion between the MMT equation (preferred by Mr. Greenberg) and the GENERAL equation (used by Michael and others here) will be removed. In turn, once the confusion is gone, nobody will need to be think anybody else to be an idiot.

            ———————-

            B) I think that Greenberg feels that comparing China to France would be a mistake because:

            1) Chinese government debt is in Yuan and China can print as much Yuan as it wants (sovereign currency)
            2) French government debt is in Euro and France cannot print Euro (non-sovereign currency)

            I think Greenberg is saying that China cannot be forced to default on its government debt under any circumstances, while France (like Greece) may be forced to default on its government debt under certain circumstances.

            Why don’t we let Mr. Greenberg confirm this? Is this what he meant when he wrote that France is “not directly comparable to China”? Once he confirms it, then the other blog participants here can engage him in further discussion.

          • Not knowing who Michael Pettis was, I started with the assumption that he had something important to say, based on this post. I was looking for something concrete that I could use to judge, because I was losing the point among all the abstract talk. All lI needed was someone to point me to some background. Just as I explained how I misunderstood what people here were saying, people here seem to have misunderstood what I was saying. Fair enough.

            Your assumptions about why I said you couldn’t compare China and France seem to match the words that I used. So I guess my only failure to communicate was a failure to make it clear to you that your guess at my meaning was exactly correct.

          • ^Suvy WROTE: “Stuff like MMT ..xx.. can be very pernicious.”
            —————————————————

            This isn’t anything pernicious about MMT; rather, MMT is just mundane and banal. It does not say anything new. It does not provide any additional insight. It just says the same things that everybody already knew in a slightly different way.

            For example, in my previous comment on this page, I showed a simple derivation of the “novel” MMT equation (G-T = S-I-NX) from the standard, universally-known and commonly-acknowledged equation, GDP = C+S (supply-side) = C+I+NX (demand-side).

            As to the supposedly-novel realization of MMT that government deficits increase private savings (whether domestically or internationally), while government surpluses decrease private savings (whether domestically or internationally) — this is just a another way of saying that government deficits increase liquidity (or increase effective money supply), while government surpluses decrease liquidity (or decrease effective money supply). If the demand for liquidity is rising slower than the speed with which government deficits are adding liquidity, then there will be a rise in the price-level (i.e. inflation). Conversely, if demand for liquidity is rising faster than the speed with which government deficits are adding liquidity, there will be a fall in the price-level (i.e. deflation). All of this is standard knowledge. There is nothing new here.

            If you disagree, please let me know exactly what the MMT says that you believe to be NEW or DIFFERENT from the standard view.

            —————————————————
            ^Suvy WROTE: “Another part I get outraged about is this idea that if the government runs a deficit, the private sector is automatically running a lower deficit without realizing that a shift in the government balance could just cause a shift in the current account without the private balance decreasing, or worse, that increasing government deficits would increase private and current account deficits by expanding liquidity.”
            —————————————————

            This was discussed last year in the comments section of one of Michael older articles entitled, “China, Europe, and optimal currency zones”. Here is that comment:
            http://goo.gl/LckF4X

            As you see can, the problem is not with MM theory; the problem lies in its incorrect or careless application. After all, the standard MMT equation G-T = S-I-NX does include ‘NX’. This means that government deficits can also either decrease the net-export surplus (or decrease the current account surplus) or increase the net-export deficit (or increase the current account deficit). Therefore, if careless people overlook all this and unthinkingly say that US government deficits NECESSARILY add to the savings of the US private sector, then the fault lies with the people saying such things and not with MMT.

            MMT is simply old Keynesianism in a new bottle, perhaps adorned with some bells & whistles. Nothing new here, as far as I can see. Let me know if you disagree.

          • When I read the discussion here about debt without any differentiation between public debt and private debt, it was not clear to me that what was being discussed. I knew that MMT talks about sector balances, so I used that as a way to explain what I found missing in the discussion.

            I first read about sector balances in reading the MMT Primer. I am not arguing that nobody else said similar things.

            Sorry if I made people so defensive by my apparent lack of tact.

            Sorry that this is the first article I have read on this blog, and that I didn’t know about the books you read, nor the years of prior posts.

            I might have at least provided you with some value in bringing to your attention that there are people who might stumble onto this blog and are not aware of all the past history. If this blog is meant to be a private conversation only among the cognoscenti, I apologize for intruding. I’ll leave you to discussing this amongt yourselves.

          • @Steven Greenberg

            There wasn’t a problem with your original statement, but typically when people talk about “private debt” vs. “public debt” in the manner that you started; there’s a typical implication that it’s in a politically loaded manner (i.e. public debt is intrinsically bad or whatever other personal bias they bring to the discussion).

            The reality is that in China, much of the “private corporate debt” is effectively the government’s debt held in off-balance sheet entities as a result of the massive investment boom that China has experienced over the past 30 years.

            In your original statement about whether the problem is that too much of China’s wealth is effectively held by the state, the problem is that … that’s not the problem in China.

            The problem in China is that it has experienced a historically unprecedented investment boom with the result that around 45-50% of the economy is investment (or related to investment). In advance economies those numbers are below 25% (sometimes well below that), but no economy can experience an extended investment boom without there being dangerous misalignment of economic incentives.

            Basically, China’s economy needs to be sharply re-balanced towards domestic consumption, but the debt overhang will likely end up being paid for by depressed interest rates (effectively private Chinese savings will end up “refinancing” all of the massive debts that have built up as a result of the investment boom in China). The “smart money” in China realizes this and is trying to move out of China towards assets in Western countries.

            Simply shuffling wealth in China to the private sector isn’t a solution to China’s problems; China’s problems will only really be solved by a sharp and forced adjustment downwards in investment and a clearing of the debt overhang that is sitting in their economy.

            China basically needs to experience a 10 year period where the aggregate economy grows by say 3% (investment declines 2-4% per year while consumption rises 8-10%).

            The real problem is that it’s never as simple as “just increase consumption and decrease investment”…; usually these things end messily in crashes of some sort when any type of investment boom ends (US in 1930s, Japan in 1990s, etc.).

            Most likely we will likely see a much harsher short-term realignment with investment collapsing at a much faster rate, while consumption also contracts or doesn’t grow for a short period of time before the short-term pressures ease and domestic consumption can drive the economy.

            The main issue is just that China’s economy is so misaligned (with so much recent investment going into effectively unprofitable activity) that the longer it stays misaligned… the worse the inevitable “collapse” will be, whether it’s a Japanese-style drawn out deflationary period or something akin to the US in 2007.

          • Now that is an explanation I can understand. It actually closely matches my original understanding, and is what I thought this article was implying. The discussion on this board gave me the impression that my original interpretation was wrong. The reason why I brought up Keynes (I think I did on this board, but maybe it was somewhere else), is that one of the lessons his theory taught me is that you cannot increase demand for products and services that employ people by putting more money into the hands of people who are too afraid to use that money to buy things (other than stock investments that they foolishly think will boom forever).

            Where I differ from your analysis, is just assuming that nothing can be done other than what has already been done, or a severe economic contraction where there is massive unemployment in order to rebalance things. I am suggesting, that PERHAPS, there may be other, creative, and untried methods that could be examined.

            If there is large amount of unmet needs in the Chinese society, large amounts of unemployed people, and available resources to make things (or people to perform needed services), then there is a correctable failure of the economic system to do what it seems it ought to be capable of doing.

            So let’s spend some time imagining how this economic failure could be fixed without the need for great suffering, and even less use of the resources to create what people need.

            For instance, give some thought to why there is real-estate inflation because of too many yuan chasing to few available real-estate properties at the same time that the Chinese government has invested massive amounts of money building housing and cities that remain unoccupied.

            Sure the Chinese government may have made such a huge blunder, that there is no solution. However, if the problem is that people cannot afford to move to the new cities and new housing, or cannot afford even the new housing, or whatever other reasons there may be, is there anyone with enough creativity to figure out how to fix these problems? Does China need to subsidize transportation back and forth from these empty cities? Does it need to subsidize peoples’ moving costs. Does it need to subsidize the public’s buying of these empty properties? If any of there isfues or anything like them is the cause, then a Government that is sovereign in its own currency can surely come up with the wherewithal to make these fixes happen.

            The apply this to our own country where peoples’ mortgages are being foreclosed, they are forced to vacate their houses, they become homeless, while their vacated homes remain empty and cannot find a buyer. The banks are holding property that is not generating returns while there is massive homelessness. The FED created $29 trillion dollars to bail out the bank, but cannot think of a way to get the people who need housing connected to the massive supply o empty housing.

          • Vinezi,

            I believe MMT goes beyond that obvious accounting identity. There’s many more aspects to it, including assumptions about the banking system, as well. For example, MMT states that government spending creates money, taxes destroy it, that the history of money begins with governments, money comes from governments/doesn’t include bank deposits, that government “net financial assets” play THE central role in a private economy, and other erroneous assumptions.

            MMT is this idea that if someone somewhere else holds a gun to your head and tells you how to do things based on some theory of people “smarter” than me and apply these ideas forcefully because of “democracy”/”equality” and the “trust”/”faith” coming from “democracy” and “equality”, it’ll all work out great. Yea, I’m not buying it.

          • I am not sure where you get that MMT is advocating the figurative holding a gun to your head. MMT is trying to explain how the monetary system works. I agree that if you want to propose a theory of how something works, it ought to match up with experience of seeing what an actual system has worked historically.

            I have proposed on the New Economics Perspective blog what I think is an aspect that their theory misses, and one that does change people’s behavior.

            That missing factor is the idea of valuing almost everything based on the principle of mark-to-market. An example is me holding 1,000 share of a stock. If the closing price today is $1 higher than it was yesterday, I value my stock as having gained $1,000. If I base any purchase decisions based on my increased net worth, then it is as if somehow $1,000 was created. However, there was no act of creation of any actual, or physical, or accountable money. No bank, no FED, no government, no shadow banking system created $1,000, but I will very likely act as if someone did.

            If that behavior is not accounted for in a model like MMT, then it will very likely not be able to predict behavior based on this theory and be correct in predicting what will happen. Other than not accounting for trillions and trillions of dollars of “value”, it may only be a minor flaw.

            I have never had anyone on the New Economic Perspectives blog respond to my question. Or explain how my concern is not relevant to the behavior of the economy. Mark-to-market applies to almost everything that we put a dollar “value” on, not just stocks.

          • ^Steven Greenberg WROTE: “When I read the discussion here about debt without any differentiation between public debt and private debt, it was not clear to me that what was being discussed.”
            —————————————–

            Why don’t you tell us in concrete terms about what you think is difference between public sector debt and private sector debt? You write in somewhat abstract fashion that “one sector’s debt is another sector’s surplus.” Now this might be obvious to the cognoscenti, but you are probably going to bypass a lot of readers here with such abstract concepts. If you would only put your views in more definite terms, I am sure a lot more people here would be able to better understand exactly what you are trying to say. For example, here are 5 concrete questions:

            1) What is the difference between public sector debt and private sector debt? Is one better than the other in some way? If so, which one is better and why? On the other hand, if each has its own set of advantages & disadvantages, what might these be?

            2) Is it not correct that when the public sector borrows & spends to permit an increase in private sector saving today, then future tax payment obligations for the private sector must rise by a larger amount than the private sector savings have increased today? So is the net effect for the private sector merely more ‘money in hand’ today, in exchange for a promise to pay higher taxes tomorrow? If this is true, then how is this any different from an increase in private-sector debt?

            3) Is there a difference between the debt of the central government (i.e. the government that owns the ‘currency printing press’) and the debt of local governments (i.e. provincial, state or city governments that cannot ‘print currency’)? In other words, is all public-sector debt the same, regardless of by which level of government it has been issued? Or would you treat the debt issued by local, state & provincial governments the same as private-sector debt, while referring to the debt issued by the central government ALONE as public-sector debt? And what about State-owned Enterprises? Are their debts public-sector debts or private-sector debts?

            4) Which level of government in China do you think is responsible for the rapid rise in debt in China? Is it the debt of the sovereign central government that has risen rapidly over the last 8 years? Or is it the local, state or provincial governments than have been on a borrowing binge?

            5) What difference would it make to Michael’s prognosis of China’s economic-trajectory whether the debt in China is entirely public, entirely private or a 50/50 mix of the two? For example, if all of the debt in China today has been public-sector debt, then would China then be able to continue growing at 8-10% for the next 20 years? Conversely, if all of the debt in China today had been private-sector debt, then would China then be in danger of an imminent banking system collapse?

            Please let us know your views in terms that all of us can understand.

          • Since China is sovereign in its own currency, it can create as much money as it needs to to retire Chinese government debt.

            People in the private sector are not given the right to create Chinese currency to pay off their debts.

            That is the difference between public debt and private debt.

          • ^SG WROTE: “Since China is sovereign in its own currency, it can create as much money as it needs to to retire Chinese government debt.
            —————————————

            But ‘money’ *IS* government debt. So how can any government ‘retire’ its debt by creating more government debt?

            For example, if the government prints currency to buy-up its outstanding bonds (as Japan is doing), then it is just exchanging one form of sovereign debt for another. After all, currency is nothing else but a sovereign bond that (i) matures instantly, (ii) automatically & constantly rolls over, and (ii) has a zero-coupon.

            —————————————
            ^SG ALSO WROTE: “People in the private sector are not given the right to create Chinese currency to pay off their debts.”
            —————————————

            Thank god for that. We have enough problems already.

            —————————————
            ^SG ALSO WROTE: That is the difference between public debt and private debt.
            —————————————

            So we conclude that the difference between public debt and private debt is this:
            (1) The private sector cannot always exchange one form of debt for another; therefore, there is a non-zero probability of hard default.
            (2) The public sector can always exchange one form of debt for another (implying a guaranteed roll-over); therefore it cannot hard default.

            Is this what you wanted to say?

          • I have never understood the argument that currency is government debt. If you want to redeem that debt, what does the government owe you? They will just give you back what you brought in to redeem. That may be debt, but it sure is a funny kind of debt. The only time that you really can “redeem” it and not get back the very same thing, is when you pay the taxes you owe to that government. You bring in, the money, they will take it, and then they will cancel out the tax debt that you owe.

            Saying that people in the private sector aren’t given the right to create currency is just a statement of fact. It is not a wish that they had that right.

            If you want to redeem your currency for something else than the currency itself, then it is up to you to find a private buyer to give you something else in return for the currency. The government does not owe you the right to redeem it from the government for anything but the currency itself.

          • ^SG WROTE: “I have never understood the argument that currency is government debt….”
            ——————————————–

            It is not an argument; it is a fact. It is also the First Principle of Modern Monetary Theory (MMT).

            In one of your previous comments, you advised Michael as follows: “If the author who fails to distinguish really thinks that public debt as just another facet of the lump of debt that includes both kinds, then I think some reading on Modern Money Theory would be appropriate.”

            I suggest you do as you advise.

          • I have read what MMT says about the currency as debt, and I still don’t buy it. MMT says that the obligation to redeem money as payment of taxes is what gives money its value, and I wonder why China is willing to hold trillions in US Govt binds, when it owes not taxes to the US Govt. I also wonder why MMT ignores the impact of mark-to-market valuation.

            I suggest reading about MMT. I don’t suggest swallowing it, hook, line, and sinker.

          • ^SG WROTE: “If you want to redeem your currency for something else than the currency itself, then it is up to you to find a private buyer to give you something else in return for the currency. The government does not owe you the right to redeem it from the government for anything but the currency itself.”
            ————————————————————-

            That is merely an administrative convenience. US government could easily have given you the right to redeem the currency-debt for anything your heart desires. The reason it does not is because it wants to avoid the associated administrative headache.

            For example, if I were to go to the US government with US Dollar bills (i.e. government debt instruments) and ask for repayment of the debt, the USG could ask me in what form I would like to be repaid. If I answer that I would prefer repayment in gold, then the USG could easily buy the gold (at the current market price) using those dollar bills and hand that gold over to me. I would then feel satisfied that the USG has repaid its debt to me in gold.

            The only difference between this (fiat currency) and gold-backed currency is that in the latter the government guarantees a FIXED amount of gold per unit of currency (i.e. pegged), while in the former the amount of gold would be variable (i.e. float).

            From the above two paragraphs, you could take away the word ‘gold’ and replace it with, for example, the word ‘coconuts’– nothing would change.

          • What the government could give you when you want to redeem your dollars is a far different thing from what the government is obligated to give you. How you can call something a debt, when there is no legal or even imaginary obligation to redeem it, is what I cannot understand. Accepting dollars as payment of taxes, is the only promise and obligation the government has.

          • Hmmmmm…..you can do my favorite thing and buy old cars, tractors, pavers and desalination trailers, chemical wash trailers at government auctions.

            A bit tongue in cheek. But….

            While not a fan of state led capitalism, there is an economic role that any stable government of every advanced society (and otherwise) can and does play in any economy. It is true that there is not, and never has been an advanced society, without a government who played such a role.

            It is a hard fact that Laissez Faire Liberals of the current era seem confused by, mostly because they themselves are Liberals descendant of the Enlightenment, as opposed to Traditional Monarchists, the opposite option, either a Liberal, Adam Smith or a Monarchist, but free marketeers cum libertarians, of the common era are philosphically confused on these matters; primarily because what they think there beliefs are economic “facts”, rather than merely preferences, when in reality most are merely of recent primacy in the financial narrative made popular by the common media over these last few decades (only)l whereas they are led to believe there is ancient provenance.

          • SG WROTE: “What the government could give you when you want to redeem your dollars is a far different thing from what the government is obligated to give you….”
            ——————————————————–

            Before 1971, the US government was obligated to redeem a US Dollar by repaying the bearer with 1/35th of an ounce of gold.
            After 1971, the US government has been obligated to redeem a US Dollar by repaying the bearer with 1 USD worth of gold.

            You could say that US Dollar is still gold-backed, except that it is not backed by a fixed quantity of gold.

          • https://en.wikipedia.org/wiki/Nixon_Shock#Later_ramifications

            “The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate. ”

            What’s your source for the claim “After 1971, the US government has been obligated to redeem a US Dollar by repaying the bearer with 1 USD worth of gold.”

          • ^SG WROTE: “I have read what MMT says about the currency as debt, and I still don’t buy it…..”
            ————————————

            MMT Quote: “Whenever a tax is imposed, each taxpayer becomes responsible for the redemption of a small part of the DEBT WHICH THE GOVERNMENT HAS CONTRACTED BY ITS ISSUE OF MONEY. Each taxpayer has to acquire his portion of the debt from some other holder of government money and then present it to the Treasury in liquidation of his portion of that GOVERNMENT DEBT. The redemption of GOVERNMENT DEBT by taxation is the basic law of coinage and of any issue of government ‘money’ in whatever form.”

            What part of the term “Government Debt” is unclear in this statement? The very act of issuing money incurs an obligation. Money IS debt.

          • The only part of the money that is issued by the government that is debt, is the amount of taxes that it will wipe off your record if you give it some of its own money. For all the other money it creates above and beyond the taxes that are owed, there is no implied redemption of the money it creates. Is there some part of what I just said that is controversial or hard to understand?

            On the other hand, the government does not have to levy any taxes in order to buy what it wants. It just needs to create some money, and go out and buy whatever it wants that is available for purchase with its money. Of course there are plenty of other good reasons for levying taxes, and some are related to making the money get accepted by the public, but that is not the whole story. We shouldn’t pretend that what explains part of the value of money or its use, exaplains all the value of money or its use.

          • I should have mentioned that one of the reasons for levying taxes is so that the government has a means of pulling money out of circulation that it has put into circulation by creating some money in the first place. What is the proper amount of money to grease the wheels of commerce varies over time. The government sometimes has to put money into the economy, and sometimes it has to take it out.

          • SG, you said:
            “I am not sure where you get that MMT is advocating the figurative holding a gun to your head.”

            This is the intellectual assumption built into the theory. It starts by saying that governments impose money upon everyone else, which is not only false, but that also means they MUST NECESSARILY be doing so by holding a gun to someone else’s head. The end authority of all governments is in force.

            Of course, leftists claim that they deserve authority of use of force because they know better (by left, I mean Marxist or Marx-based thought), but that’s a different issue altogether. Not surprisingly, MMT is a nonsense theory pushed by leftists who claim to know justice better than everyone else and then use “democracy” and “equality” to claim their superiority. Of course, it’s all just hyper-emotional pandering to suckers, but yet again, I’m getting off topic by a rant.

          • “This is the intellectual assumption built into the theory. It starts by saying that governments impose money upon everyone else”

            Actually what MMT says is that having to pay taxes is what gives value to money when the official money is the only thing the government will accept as payment. You are free to use anything else to pay other debts. You can use credit cards, paypal, bitcoin, iou’s, or barter. Some of these things use a dollar value as a unit of measure, but they don;t use government created money.

            I can see that part of the value (maybe the initial part, and some of the continuing part) is created by the government insisting you use it to pay taxes. I just don’t buy the argument that taxes are the only thing driving the value of money.

          • ^^SG WROTE: “The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate. ”

            What’s your source for the claim “After 1971, the US government has been obligated to redeem a US Dollar by repaying the bearer with 1 USD worth of gold.”
            ———————————————

            Here is my source (from the link you have yourself provided): “I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, *EXCEPT* in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.”

            This means that instead of paying 1 oz of gold for every 35 USD (pegged price), Nixon authorized Connally to pay 35 USD worth of gold (at market price) for every 35 USD.

            So what happened in 1971 was nothing but a devaluation of the USD and not a default. Instead of devaluing it down to a smaller fixed amount of gold (i.e. lowered peg), however, it was devalued to a smaller amount of gold that varied according to market conditions (i.e. floated down).

            My claim that “after 1971, the US government has been obligated to redeem a US Dollar by repaying the bearer with 1 USD worth of gold” refers to an automatically-fulfilled obligation as it imposes no real obligation on the USG at all. After all, the holder of that US Dollar can easily get the same 1-USD worth of gold from the marketplace and has no need to go and bother the government. Therefore to make the claim that I made is the SAME as saying the USG has no net obligation, because the private marketplace itself can provide the redeeming value to that US Dollar.

            You can think of the USD today as gold-backed, coconut-backed, cotton-backed, wheat-backed et cetera, with the proviso that the amounts of these things are not fixed, but vary according to market conditions.

            To say “the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate” is misleading. The Federal Reserve creates/prints currency (base money) and puts it into the market place by PURCHASING USG debt instruments. The currency on the RHS of its balance sheet (liability) is offset by USG debt instruments on the LHS of its balance sheet (asset). Therefore, the Federal reserve has already tied the dollar to USG debt. This is because the US dollar is nothing but a specific form of USG debt that happens to be guaranteed by the USG by way of its other debt-instruments. When the price of USG debt goes down (i.e. yield rises), the value of the USD goes down with it (i.e. weak dollar), thereby implying inflationary conditions. Therefore, the “weak-dollar policy” you were recommending in your other comment automatically implies a policy that results in higher interest payments (or higher yields) on USG debt.

          • “Actually what MMT says is that having to pay taxes is what gives value to money when the official money is the only thing the government will accept as payment. ”

            This is equivalent to what I said. Taxes necessarily involve some form of coercion. Secondly, the value of money doesn’t come form the authority to tax; it comes from trust. As I said, the initial assumptions of MMT are flawed.

          • ^SG WROTE: “The only part of the money that is issued by the government that is debt, is the amount of taxes that it will wipe off your record if you give it some of its own money. For all the other money it creates above and beyond the taxes that are owed, there is no implied redemption of the money it creates. Is there some part of what I just said that is controversial or hard to understand?”
            ———————————————-

            It is easy to understand, but it is outright false. From 1950 to 2008, the amount of money created by the government (i.e. the monetary base) was only about 50% (ranging from 40% to 60%) of the total tax collection of the US government. As to how the USG was collecting taxes MORE than the money it had created– I will let you figure it out.

            After 2008, the government has created so much money that the monetary base has now exceeded tax collection for the first time since the beginning of the fiat money system in 1933. We are in a Brave New World of QE, and it is scary….
            https://research.stlouisfed.org/fred2/graph/?g=1On5
            https://research.stlouisfed.org/fred2/graph/?g=1Onb

            ———————————————
            ^^SG Also WROTE: ‘On the other hand, the government does not have to levy any taxes in order to buy what it wants. It just needs to create some money, and go out and buy whatever it wants that is available for purchase with its money.”
            ———————————————

            Yes, you are correct. This process is called “the government going deeper into debt”.

  16. I see a stream of comments here that are so abstract and disconnected from concrete examples non-experts could understand, that I am still left in the dark. Balance sheets, assets, and liabilities, inversion, …

    You all seem to be talking to each other as if you understand. I am still left out. I tried explaining what I don’t understand. I tried putting it into concrete terms that I do understand as an example of what would work to communicate to people like me.

    I haven’t yet seen any indication that anybody on this thread has even heard what I am asking.

    • Steven,

      Not to be rude, but your comment comes off as a bit entitled. I think there are a number of readers/lurkers in your boat (that is, not having a finance/econ background). I count myself in this group. I started reading this site in 2013/2014 – the first thing that I found helpful was reading through the year or two of essays that preceded the first one I read. I’ve read every post since then and the professor’s books in reverse order (finishing Volatility Machine now). The material above seems to dovetail more closely with the Volatility Machine, as compared to the other books. I find it more challenging as well. In any event, if you are really interested in all of this, it would probably do you well to read the Volatility Machine.

      Outside of these seemingly abstract discussions, the professor’s general framework for understanding major financial/economic issues is, fortunately for us, relatively simple and elegant. If you’ve read his books and previous essays, you would probably state that China depends on investment far more than it depends on exports. The exports being a residual of the incredibly high savings in China, which itself is higher than the incredibly high level of investment (Savings – Investment = Exports). That isn’t to say that China hasn’t taken measures to goose exports. I think a bigger point (with respect to exports) is that it will be more difficult to do that and realize the employment benefits in the current environment (where countries are particularly loathe to export demand and import unemployment).

      Regarding investment, Professor Pettis has pointed out that this has been driven by repressed interest rates, which I think he would state supports the investment model in a procyclical manner (repressed interest rates support excessive investment, which leads to exaggerated GDP growth, which itself encourages more investment). He has also stated that repressed interest rates are associated with repressed consumption in China, where apparently households rely on interest gained on savings for their consumption and spend more when interest rates are higher (opposite to the U.S., where households tend to feel wealthier in a low interest rate environment – home value/stocks increasing – and spend more).

      In any event, the solution to an over-reliance on both investment and exports is increasing consumption. If you search enough (I don’t have time to find a link), you can find posts where Professor enumerates a number of ways to do so. This information is also in his book, Avoiding the Fall.

      Regarding stimulus, I think what China did was go on an investment binge, and that’s not what Professor Pettis talks about when he discusses rebalancing and increasing consumption.

      • Thanks Deek. Sometimes it is worth stating what might seem obvious.

      • I don’t feel entitled. I was just explaining why I was having a hard time understanding, just in case people here actually wanted to reach people who weren’t already steeped in the knowledge. If you are happy to just talk among yourselves, I can appreciate that. Except for my response to Michael Petti” recent response to my comments, I’ll quietly go away, and let you have your private conversation.

        Sorry to intrude where i wasn’t wanted.

      • ^Deek WROTE: ” He has also stated that repressed interest rates are associated with repressed consumption in China, where apparently households rely on interest gained on savings for their consumption and spend more when interest rates are higher (opposite to the U.S., where households tend to feel wealthier in a low interest rate environment – home value/stocks increasing – and spend more).”
        —————————————-

        In this regard, the following two points are of some interest:

        (1) US households USED to spend more in a low interest-rate environment until 2008 due to the pernicious concept of the Wealth Effect. After the GFC, however, this relationship has been broken. Households are now to scared to borrow to consume against rising asset prices, and banks are too scared to lend to households against rising asset prices. Please see the following comment from one of Michael’s previous article for more details on this breakdown:
        http://goo.gl/F1YTk5

        (2) You/Michael are correct that Chinese households do spend less in a low interest-rate environment and spend more in a high interest-rate environment. However, we should note that this behavior is not limited to Chinese households, as it is also seen in many US households that are composed of retirees. Here is why:

        The average American retiree has a fixed volume of savings and a fixed period over which those savings must be made to last. Many such retirees prefer to put their volume of savings in safe annuities rather than take risks in volatile assets. The return on such annuities is linked to the prevailing interest rate; therefore, when interest rates rise, the retirees get a higher income, and, conversely, when interest rates fall, their income gets cut. Therefore, the spending of such retirees in the US generally tracks the interest rate. In this sense, the behavior of the average US retiree-household strongly resembles the behavior of the average Chinese household.

      • « (where countries are particularly loathe to export demand and import unemployment)»

        Which countries? Perhaps among the large ones mostly Japan and Germany.

        Conversely some of the biggest anglo-american culture economies have had a policy for 30-40 years of exporting demand and importing unemployment, and they have hugely succeeded at that.

        They call that with euphemisms like “controlling wage inflation” or “reducing the power of unionized industries”.

        Importing capital and exporting jobs also helps drive down interest rates and up asset prices, and helps to cut taxes while at the same time financing multiple wars.

        They have had monetary and fiscal policies driven by the desire to fund cheap imports and to make it cheaper for corporations to offshore entire industries.

        To a large extent the imbalances in China have been made possible by the flood of cheap money and the other policies that the largest anglo-american countries have adopted.

        Indeed one of the themes of M Pettis work is that when “core” countries choose to flood the world with credit, including expanding adoption of ZIRP, “peripheral” countries suffer (if that’s the right word) with extreme investment booms. It has been to some extent a good choice for China that the chinese government have decided to “sterilize” some of the flood by creating a “saving glut” parked in USA securities.

    • In the good times, everything is flying high, they think the ground has changed, the fundamentals of physics no longer apply, there is a cycle up, it keeps cycling higher and higher, just as everyone thinks it will, perhaps because of the expectations that it will. It is a pro-cyclical phenomena, everyone shouting hoorah in unison, and it keeps shooting higher and higher until everyone knows that hte laws of physics don’t apply to this phenomena, at least not the laws that we believed. But eventually the air gets too thin, one can not breathe, things seem to be not working as we expected just a short time before, we need to descend and just as we knew, were certain that we would keep shooting higher, we turn, and are being flung further and further lower, lower than we can ever imagine, adn more quickly than we thought possible. We go lower, and lower, than we could have thought possible, maybe the law as of physics do hold, what the hell were we thinker, we are being flung faster and faster, lower and lower. Pro cyclical, for, positive force to the cycle, further in direction of the cycle.

      Supply and demand and growth and procyclicality.

      Assume over a 30 year period there is a certain amount of investment in houses, a certain number of cars purchased, that the economy has a fairly obvious range of teh number of summer homes, second cars, second houses, numbers of pair of jeans, or gold watches. Now assume that in one segment of that thirty year period, let us say 10 years, that 20 years of houses, 20 years of gold watches, of second homes were purchased, what would you expect, that the following ten years would see less second homes and less gold watches purchased than in a normal 10 year period. One could say that the demand for houses or watches for the next 20 years, was brought forward into the first ten years of that 20 year period. Over the long term everything reverts to the mean. Bringing forward demand ensures that demand in the following period would be slower, and necessarily. Just ask American construction workers who lost their jobs after the GFC, and for which it took time to work through the surplus of houses, for houses to get back to the long-term average.

      A couple of concepts explained, does that help.
      You will have to purchase Michael’s books and/or slog through his old columns

    • Caramba Mr. Greenberg, but you are right to feel a little left out. Some of us have “heard” what you are asking, but we were unaware of your importance and just dismissed your questions as being from someone out of your depth because your disagreements don’t make much sense, especially in this particular blog post. Can you try reading it again? I think maybe you are used to other websites where in any discussion of China it is possible to say “China depends on exports” and feel you have contributed instead of being laughed at. This blog entry is not about the sources of China’s growth, and if it was, you would learn that there are much more important things for China than exports, no matter what your favorite websites say. It is about balance sheets. Look at the title — it might help.

    • biggestbrotherofthem All

      Well you may need to try harder.

  17. I very much appreciate your discussion about how debt affects growth. Indeed, it is sorely misunderstood by most economists and market participants (excluding Minsky). However, it seems to me that you’ve excluded the most important channel by which debt hinders growth: through the aggregate profit sources. (The profit sources are defined by the Levy-Kalecki profits model, which was the framework utilized by Minsky in his work on financial instability.) Each of the private profit sources–take fixed investment, for instance–is typically debt financed. Moreover, the financial liabilities created in the financing of investment will end up on someone’s balance sheet, as will the physical assets that were built or purchased. Each of these liabilities/assets must be serviced/justified by the income flows in the economy. So when balance sheets (liabilities and assets) are too large relative to income, firms are loath to issue new liabilities (whose servicing is dubious) in order to accumulate new assets (whose value will not be justified by current income streams). The result is that aggregate investment remains weak or falls; according to the profits model, this implies weak or falling aggregate profits.

    This is the very phenomenon that we have witnessed in Europe over the past few years. Outside of the fracking boom–which was driven by a technological breakthrough–it’s also the phenomenon we’ve witnessed in the United States. Indeed, it’s the same thing that happened in Japan over the past two decades. And more important at this point, it’s the phenomenon that is unfolding in China. Sky-high leverage and excess capacity are now stymieing investment, not only in China but all across the EM space.

    (Some folks like to point at weak industrial commodity prices and exclaim “that’s why EM investment is deteriorating.” To which I ask: Then what caused weak commodity prices in the first place? Overextended balance sheets caused investment deterioration, which began dragging on growth and ultimately on commodity prices, which has no doubt exacerbated the weak investment. But key word is exacerbated, not caused.)

    • I don’t think I have excluded it, Douglas. I consider it one of the many “financial distress” costs that arise with the uncertainty with which debt servicing costs are allocated as it alters the behavior of economic agents. It is one of the topics I hope to explore more formally in my next book, and if you have readings that you think I should not omit, please let me know.

      • Giancarlo Bergamini

        Does it have anything to do with the concept of balance-sheet recession ? Then Richard C. Koo’s “The Escape from Balance Sheet Recession and the QE Trap” would be apposite. It would indeed be magnanimous on the part of prof. Pettis to cite Richard Koo when the latter (reprehensibly in my opinion) did not include the works of prof. Pettis in the reference list of the above book.

    • “this implies weak or falling aggregate profits”. Problem is, profit levels are historically far above trend. See the point Jeremy Grantham of GMO.com is making for some years now. So somewhere in your causal chain of reasoning there must be a flaw.

      Anyway the causal chain of reasoning is highly suspect in a dynamical model. Since it seems the majority on this blog sees the dynamical nature of the political-economic system (which is quite a relief), these long causal chains should be avoided. In a dynamical system you typicaly find multiple feedback loops and in a real political-economy the trouble is there is a huge amount of such loops. This makes the weather system look easy. In general it then becomes quite uninteresting to state ‘which caused which’ in a sort of linear way. A system behaves in a certain way, easily perturbed from its track by relatively minor adjustments. That is why any true ‘prediction’ is impossible. The major exceptions are what Didier Sornett calls ‘pockets of predictability’ near phase transitions. Michael Pettis correctly calls this period in Chinese economic development a ‘phase shift’, and that is the reason this behavior of the Chinese economy is to a higher degree predictable at this point in time. And has been predicted by Michael, by Didier Sornette, by Steve Keen. As have been the Subprime crisis by all three.

      The key is the set of specific parameters that the Chinese economy (politics) is showing, not just one signal item: total debt level, investment saturation in the current development phase, declining growth of working population, multiple simultaneous and large bubbles (stock market, real estate market, construction industry capacity, etc), change to a different core strategy for further economic development (consumer, social security, legal system, etc).

      Debt plays a very significant role, as Minsky correctly pointed out, but only by itself leads to more predictable behavior in limited situations such as very high debt relative to GDP or very low debt just after a major debt crisis.

      • I think this is a very important point, Erikwim. It is probably impossible to make predictions in an “Adam Smith” world in which no agent is big enough to affect the overall system (in which case of course “asset-side” analyses and “balance-sheet” analyses end up with the same forecasts) because although every transaction creates an imbalance, the imbalance resolves itself very quickly although often unexpectedly because of positive and negative feedback loops, which exacerbate or dissipate volatility, respectively. To make good predictions you would have to be able to predict unexpected shocks and figure out all the loops, neither of which is possible. But once you introduce major rigidities, institutional constraints, and economic agents large enough to prevent automatic adjustments (governments being among the largest), the imbalances can persist and grow over time until they are powerful enough to overcome institutional constraints. Certainly in recent times deep imbalances and deeply unbalanced growth seem to be the rule, not the exception, and the greater the imbalance, the smaller the shock required to force the reversal. I have had good luck in making quite a few predictions that were against the consensus and yet turned out to be correct mainly because I’ve been lucky enough (I guess), to work in a time during which very deep imbalances are constantly being created and reversed. I am trying to figure out whether or not to discuss this topic more generally in my next book or rather to focus more narrowly on debt and balance sheets.

        • Do discuss that point, it seems another rich vein of discussion that is useful for challenging the assumptions of readers, thus having potential for disrupting their frames, and (perhaps) enabling some to begin to interrogate these matters more carefully. These issues do have great global importance.

        • please make it a very big book and discuss absolutely everything you haven’t said already in one of your other books 🙂

          • Yes, as large as they will allow, with a beautiful outline in the back for those of us who love tables of contents, indices and appendices; especially when they have beautiful outlines which facilitate our reflection, please.

        • A brilliant example of a ‘long causal chain’ is the Bank of England video explanation of QE. http://www.bankofengland.co.uk/monetarypolicy/pages/qe/default.aspx To finally get to the point where it actually helps consumers and businesses spend more money on goods and services (not asset prices) they need many steps of causation, of which most are very shaky and some are quite obviously mistaken. For instance the idea that the BoE buys govt bonds ‘from pensions funds .. and not so much directly from banks’ is a joke. They are buying in the most liquid markets on earth, and supposedly they can target specifically from whom they buy, and these people are then not going to go into that liquid market and trade. Obviously this is not the case, and their buying does end up indirectly buying govt bonds from banks (a simplistic linear causal link, in reality is a complex web of feedback relations).

          The main supposed link between QE and spending is through ‘lowering borrowing costs for businesses and households’ which ‘in turn leads to consumer spending and more investment’. Both are highly shaky statements in precisely the environment in which QE is applied. First of all spending is far less dependent on ‘borrowing costs’, it in the first order depends on ‘borrowing’, that is ‘can you get the lone + do you want another loan’. In a recession fro many businesses the asnwer to both questions is ‘no’, they would just like to revolve existing loans if needed, and can often not do so at all, or at increased costs. Secondly as Richard Koo has been saying tirelessly: in a balance sheet recession people want to pay down debt, not increase borrowing to do spending and investment. So the supposedly main channel is blocked mostly.

          The BoE fails to explain how it does work, it misses the most important channel. The real reason QE works at the heighth of a crisis is it prevents asset prices from crushing through long term valuetrend. That especially stops more households from going (deeper) underwater. That in turn (i know also a pretty long causal chain) truely after a ‘wait and see’ period stops people from aggressive over-saving out of disposable income to repair the ‘hole’ they are in.

          The BoE also fails to explain the negative effects of QE on spending, which are very direct! Lower govt bond yields directly lead to lower ratios for pension funds and insurance companies, which then after some lag have to increase premiums and decrease pension payments (see the Dutch case). This direcly negatively affects spending of all working households and all retired households. On top it leads to a loss of confidence in retired households of their future spending power, and an increase of uncertainty of adequate pension savings of working households, both of which might start to save more in response.

          They probably know all of this? but to stimulate the ‘confidence fairy’ they don’t want to say it? In truth, i am afraid they do not fully understand what they are doing, being guided by oversimplified models and stuck to their idea that spending responds to interest rates, even in a balance sheet recession.

          • ^Erikwim WROTE: “…..Secondly as Richard Koo has been saying tirelessly: in a balance sheet recession people want to pay down debt, not increase borrowing to do spending and investment. So the supposedly main channel is blocked mostly……”
            ————————————————————–

            A) See pages 3 (Table D1), 4 (Table D2) & 5 (Table D3) of the latest Federal Reserve Report here:
            http://www.federalreserve.gov/releases/z1/current/z1.pdf

            With reference to the data above, can you tell us exactly WHO has been ‘paying down debt’?

            B) From the data in that report, I extracted the percentage growth in TOTAL non-financial debt (Table D1, column 1) and plotted it against nominal GDP growth. Here are the results:
            http://goo.gl/BG5iPG

            From this graph, it looks like debt is still growing. There is no evidence of any systemic paying-down of debt. Perhaps this ‘Richard Koo’ fellow should look more closely at the data?

            C) From the data in that report, I also extracted the percentage growth in the debt of each sector (Table D1) and plotted them over time. Here are the results:
            http://goo.gl/MW9Uet

          • Good points.
            – I remember looking through one of Koo’s presentations http://csis.org/files/media/csis/events/081029_japan_koo.pdf. In the Japanese case he shows corporations were delevering substantially.
            – as for US data, I saw this one: https://research.stlouisfed.org/fred2/series/HDTGPDUSQ163N. Not sure how that matches your data.
            – Dutch data: http://www.cbs.nl/en-GB/menu/themas/macro-economie/publicaties/artikelen/archief/2015/schulden-huishoudens-nemen-weer-iets-toe.htm. Here I have to mostly agree with you, it is not a lot of delevering.
            – since the 2008 bubble was mostly about housing, the delevering should especially have been visible in household debt, especially those households with underwater mortgages. The historical data set on US mortgage debt does show a decline in one-to-four family residence mortgages http://www.federalreserve.gov/econresdata/releases/mortoutstand/current.htm.
            – still what does remain is that households ‘want to’ reduce debt (or perhaps more correctly do not want to take on new debt, as long as current debt remains affordable), especially underwater households (those being especially the young households, that normally could be expected to do big ticket spending partly with debt).
            – households did indeed start saving more after the 2008 bubble: https://research.stlouisfed.org/fred2/series/PSAVERT.
            – household debt to income ratio’s came down in US, but not in Canada http://www.ritholtz.com/blog/2013/10/household-debt-to-income-ratio-usa-vs-canada/. Household debt ti income in UK shows a bit of delevering, but still remains elevated: http://www.voxeu.org/article/household-debt-and-spending-uk
            – probably the complete picture of saving and debt is highly related to QE policy to repress long-term mortgage rates, financial engineering in corporations (non-financial), re-flating of asset prices especially housing (preventing further house price collapse, which would have triggered massive long-term delevering in the household sector)
            – as a result household debt in several countries is still very high, dangerously high as many economists have been saying (o.a. OECD, Steve Keen, Adair Turner).

            Thx for pushing me to dig a bit deeper again.

          • What matters to the economy is the total debt and not household debt alone. Additional aggregate demand can be provided either by the government going deeper into debt or by households going deeper into debt. Which one does it is largely immaterial. As for the total debt, it is clearly growing. It has always been growing. It has not been reduced for even one instant. See the *FIRST* column in each of Tables D1, D2 & D3 on pages 3, 4 & 5:
            http://www.federalreserve.gov/releases/z1/current/z1.pdf

            Statement A: The US economy has been stuck in low-gear since the 2008 crisis.
            This statement is TRUE. Nominal growth has fallen from 6-7% pre-crisis to 3-4% post-crisis and there is a ‘potential gap’.

            Statement B: The reason for (A) is that the economy is deleveraging (i.e. debt is actually being repaid).
            This statement is FALSE. There is no evidence of deleveraging in the economy. Total debt has been constantly rising.

            Statement C: The reason for (A) is that debt is not growing faster than GDP (i.e. debt-load is not rising).
            This statement is TRUE. The US economy today cannot close the ‘potential gap’ without a rise in the debt-load. This is why Krugman is screaming that there is not enough debt in the economy or that debt-levels are too low.
            http://www.nytimes.com/2015/08/21/opinion/paul-krugman-debt-is-good-for-the-economy.html

            We had discussed this point extensively last year in some of Michael’s old articles on this very blog. Here are the links to some of those discussions:
            http://goo.gl/Dolu1T
            http://goo.gl/9IgJlp
            http://goo.gl/C1OEi1

          • Hi Vinezi. Ok, let’s look a bit deeper into how this debt dynamic works, as i see it. (by the way did you read Richard Koo? he is not just some chap. i ask since i do not see you referring to Koo anymore). And sorry I do not have the time to read through all the comments on all the blogs, us commenters are way to productive. (Would love te read the main points if you know where to find them)

            Let me speak from my experience in NL. When the crisis hits, the effect in the real economy is companies cut back on labour (increasing unemployment, decreasing aggregate wage income), creating massive tax deductable losses asap. This sets off the automatic stabilizers of social security and substantially decreases govt revenues from income tax + profit tax (govt may actually need to repay profit taxes). The automatic stabilizers keep private aggregate income (wages + social benefits) almost constant, which allows households to start cutting back on spending and increase saving. Now is this decrease in demand compensated by increased government spending? Nope, not one cent. The increased govt spending is almost exclusively on automatic stabilizers, which fully go to private wages, not to building new roads or high-speed railways. The increase in govt deficit, which drives increased govt debt, is driven by: rapidly increased spending on automatic stabilizers + loss of tax income (increase of tax refunds).

            What is the net effect:
            – aggregate demand drops: households consume less, businesses cut back on investment, govt initially spends the exact same amount on govt. consumption + govt. investment (increased spending on automatic stabilizers does not directly add to aggregate demand), local govts are usually forced to balance budget and thus also (with a small time lag) cut back on spending.
            – debt remains almost flat? govt deficits increase govt debt (additional spend on automatic stabilizers, tax cashflow reduction), business debt depends on leverage situation in business sector and cash-flow dynamics in the business sector (in the Japanese case they drove delevering since they were highly levered, especially on real estate), household debt depends on leverage situation in households, in the 2008 case that meant a desire to save especially among families with ‘underwater’ homes.

            Main point: the increase in govt debt in the first years (perhaps many years) after a ‘balance sheet recession’, does not create additional aggregate demand, it simply replaces the demand that was lost by firms cutting back on wages.

            So, if households increase their savings(rate), this directly reduces aggregate demand. I think an added effect is that the ‘underwater’-problem mainly hit families in their prime spending age, and deterred families about to enter this phase to do the big ticket purchases (with new debt). The boom made sure that most families that bought a home had already redone their kitchen + bathroom + extensions. Young families saw the financial distress (and were repeleld by new regulation) and postponed buying a house. The combined effect of these two big (debt-based) spending groups increasing their savingsrate and stop taking on new debt, in NL severely hit the economy, with all sorts of knock-on effects. Suddenly there were no more vans in my 1930s street, while in 2007/2008 one in two was getting a major renovation done.

          • ^ErikWim WROTE: “MAIN POINT: the increase in govt debt in the first years (perhaps many years) after a ‘balance sheet recession’, does not create additional aggregate demand, it simply replaces the demand that was lost by firms cutting back on wages.”
            ————————————————————

            Look-up the difference between a Keynesian ESTOPPEL and a Keynesian STIMULUS. This was discussed extensively on this forum last year.

            The argument that government deficits “do not create additional aggregate demand, as they simply replace the demand that was lost by firms cutting back on wages” is true of ALL recessions, not just ‘balance-sheet recessions’.

            In addition, and as a matter of definition, ALL government deficits create additional aggregate demand. All government deficits, whether estoppels or stimuli, are INTENDED to REPLACE the aggregate demand lost due to the wage-gap caused by employment being below potential. This is the very basis of Keynesianism itself.

          • I am not sure, not all demand is created equal. Again what i observe is a bit different. In a balance sheet recession of say mortgages, people with mortgages all along the value chains (or webs if you will) have a high desire to save. That translates in private people taking profits at many steps along the economic transaction chain, and using the profits to pay down debt. If in such a situation a government spends some additional money, the multiplier is pretty low, the effect does not ripple very far through the economy. If on the other hand there is a regular recession, with little balance sheet issues, people will not have such a high desire to save. An additional amount of spending by the government can now be hypothesized to ripple much further through the economy, creating a higher multiplier effect.

            Perhaps then the difference is that in a balance sheet recession you have to keep deficit spending for a long time, whereas in a regular recession the shorter period of deficit spending is sufficient to get the economy running on its own again. Very long deficit spending however creates its own dynamics. In the 70’s it contribted/sparked quite uncontrollable inflation, whihc led to abandoning Keynesian ideas. Today (and in Japan) it contributes/forces very low interest rates blowing serious bubbles and financial engineering all over. Again non-linear effects, context specific and dependent on the historical path.

  18. “History suggests that developing countries that have experienced growth “miracles” tend to develop risky financial systems and unstable national balance sheets”

    Do you think that it was worth it for China to grow in the manner that it did? In other words, given the slower growth that they will experience in the near future, was it a good idea to structure their economy in the manner you described to achieve 10% growth for three decades?

    I am genuinely curious about this, because I am not sure why you put “miracle” in scare quotes. Regardless of what happens now, an incredible number of people have been pulled out of poverty. Or is there some other growth model that would have allowed them to achieve a better outcome?

    • I hope that not everyone assumes that these are scare quotes intending to mean that I am using the word sarcastically, especially as sarcasm was one of those affectations I hope I had mostly left behind in my high-school years and now use only as short-cut in deflecting a discussion with someone that I don’t find very intelligent. Quotation marks around a word or phrase simply mean that the word or phrase is being used in a nonstandard way, and I think that referring to a period of rapid economic growth as a “miracle” is a fairly non-standard use of the word “miracle”, and certainly there is no widely accepted definition of “miracle” in economics. I also think that the alternative to “miracle” growth is not stagnation — there are many kinds of healthy growth, and it is noteworthy that every period of rapid growth that has been referred to as “miracle” growth has been followed by a terribly difficult adjustment after which the preceding growth period typically lost its “miracle” modifier. So had a less leveraged China grown at “only” 7% or 8% (intended to suggest that these are actually extraordinarily good growth rates) during this entire period, for example, instead of 10-11%, not only would might growth have been much more sustainable, and China unlikely to face the extremely difficult adjustment that I expect it to face, and which it is now only beginning, but if the growth had not been as highly unbalanced as it was, due in large part to financial repression, ordinary Chinese would have been just as well off as they are today, except that there would be much less concern that the losses embedded but not recognized in the banking system might be allocated to them in the future. While of course many people were pulled put of poverty in China since the mid-1970s, I wouldn’t argue that this was because of the highly inverted balance sheet that China put into place in the early and mid 1990s. I would argue that an important reason is that Beijing decided some time in the late 1970s and early 1980s to end, and even reverse, economic policies put into place in the 1950s, 1960s and 1970s, during which period China slipped form being among the wealthier countries in Asia — far wealthier for example, than South Korea — to becoming among the poorest. That was an important decision, and having made that decision In think the alternatives for China were not “miracle” and continued economic backsliding.

      • «many people were pulled put of poverty in China since the mid-1970s, I wouldn’t argue that this was because of the highly inverted balance sheet that China put into place in the early and mid 1990s»

        A cynical point here is that the pro-cyclical “inverted” balance sheet did indeed help pull many chinese out of poverty by providing the extra incentives needed to motivate many “insider” constituencies to stick their necks out and run big political and business risks associated with a big change in policy.

      • MIchael, thanks for discussing these things at length on your blog and being present in the comments. I find the question presented by MC highly valid. Your answer comes accross as a bit “utopian” to me, in the sense that it assumes it is reasonably possible to have created a smooth 7-8% growth path form 1978 until somewhere in the future (continuing for some two more decades to move China on a broad base to developed status?). The assumption it is humanly possible to do so from the 1978 starting point in China, given its then political system and background, given human nature, given world history, seems a very bold one.

        The question MC poses is so relevant precisely because China (and before Japan) pulls off quite a political-economic stunt of moving its huge population out of poverty, its industry through the stages of initial copy-cat (textile, toys) to world-class innovation (solar, alibaba), through multiple hiccups (the first set of Special Economic Zones were also ghost cities, as was Shanghai Pudong area).

        To come to a conclusion it seems odd to compare the Chinese case to a ‘utopian’ ideal path of political-economic development, where it would make far more sense to compare it to similar cases such as India, Brazil, Argentina, Russia, Indonesia, Mexico, Nigeria, etc.

        Also it is obvious China is very consciously following the development examples of Japan, Singapore, Taiwan, South-Korea. All of these have made the fast and successful transition to developed nation status. The evidence then points in the direction that Yes, it is worth the risk of hitting a brick wall at some point, rather then doing it slowly and risking getting stuck or creating failed trajectories such as in Russia or Argentina or Brazil a couple of times.

        The interesting question going forward is how China could get out of their predicament without too much damage, so it can pull another few hundred million out of poverty. For correctly many observers have stated that China is not in the position of Japan when Japan got stuck, China is more likely in the position the European economies were in after their ’60’s boom.

        What can be predicted based on dynamic economic models is this debt binge and investment binge has to end, and will cause strong drag on growth and will require major shifts of activity. But that is only up to a point just past the phase transition. After that all models can do is show possible paths, but predicting again becomes impossible.

        • Erikwim

          Solar – previous generations of technology, massive build out of capacity, state subsidies, export subsidies, and mass bankruptcy across the space is your model of innovation.

          Alibaba- Ecommerce – stuffing channels – paying companies to hire people to buy products, and return them the next day, with a percentage of sales volume going to such, while creating revenues to run up shares prices in a stock market that Chinese leaders at G-20 are trying to say popped, as if such is the problem of the Chinese economy, rather than the overly dependent upon false asset valuations, printing money, and cycling through asset classes, one to another, tying risk, and volatility from one to another, until there is no safe class left, due to how they are so treacherously inter-linked is your Bloomberg brained idea of innovation.

          “very consciously following the development examples of Japan, Singapore, Taiwan, South-Korea”

          very consciously, thus likely also quite adroitly, no…..

          but, Chinese population is 5 times the combined size of these other economies, and China is at a very different place economically and demographically than these were at similar levels of development on a very broad range of indicators (started with per capita)

          “Russia or Argentina or Brazil”

          Likely these were more a problem of the “Washington Consensus”, no…
          Would you equate the problems of these three to be those China faces? (problems at each point of their multiple failures) (Or are you prescribing sugar when more insulin is needed)

          Aftr debt binge, alterations and drags on growth…..

          too much wasted investment, too much time cultivating a sense of pride over an economy that is supportive of wasted investment, shock at a disruption, fear, distrust, disbelief, shock, great amounts of time, China will already be in the past 2035 demographic deficit, its too late scenario. Bold alteration will take 10 years. The Chinese are anything but bold, put on acceleration, breaks, shift, known as taking decisive action, but highly conservative, or they would have made the right changes to an obviously flawed model years ago, but rather than do such, they followed the easy path of investment sugar from 2003, where consumption had started to rise as a percentage of GDP, and they started to heighten investment again. Funnily at this point, their industry was in such a state of unprofitably, even before the last decade of over-investment in capacity, that companies were borrowing from banks, to invest in stock market (2003-06) so they could heighten profits, like now. And similarly, right after a property boom, no.

          • Hi Csteven, The question MC asked was historic, not about where China stands now. i think we actually mostly agree on where China stands now, and it ain’t pretty. So i am not comparing China today to Brazil or Russia or Argentina or India today, but to these same countries in say 1978. There can be little doubt that China moved much further ahead since then then any of these countries. I am therefore highly curious as well to see how India performs with a very different historic track and a different political society. Still even if China completely stagnates for a decade, their track record from 1978-2014 is spectacular by any measure, and it is extremely hard to say if they could have gotten to the same position through another historic path. That includes my impression that Michael Pettis is correct that their choice of development path has basically set them up for this overinvestment boom coupled to real estate speculation, corruption and local govt finance mess. They probably underestimated the dangers of creating a private debt boom, perhaps since this is not part of mainstream eonomics.

            But their #1 priority is becoming the Land of The Middle again. Such a political target of course means they wil try to run the economy for that purpose, including the financial system, including a fair share of accidents along the way. The roadmap to the future however is not difficult at all to see and no rocket science. They simply follow the steps that fully developed economies took, with a little twist of their own. They can do it now, or after some political turmoil, but Chinese leadership has a track record of being highly practical when it comes to moving forward, even if some of tehm have to move to the sidelines for a while.

          • Erikwim, Hi….

            I am afraid I agree and disagree. The China story has posited that they are pragmatic, perhaps highly practical.

            Underestimated dangers or retrenched on reform
            Model set-up for Over-investment boom, or they retrenched on reform
            Track record spectacular, or they retrenched on reform.
            Mainstream economics…..underestimate, no, mainstream economics is not at play in the Chinese economy. From soon after entry into WTO China has been retrenching on its commitments to privatize, open up, and became more market based (mainstream). Almost the entire last decade (and a portion) has been one of the party, after admittance into WTO of turning toward more centralized party administration, the timidity and weakness of Hu and Wen, after aggressive opening, around banking crisis, and calls that they might have gone too far, leading to rises in investment, reinforcement of support for SOE’s, etc…

            Of course this, but for noting State Led Capitalism, is exactly contradicted by most common commentary of the past decade, because, well, the commentary was wrong. This practice, and ignorance more generally, is almost “Assassin MAce-esque”

            “They simply follow the steps that…..”

            Not even close……on any and every level the Chinese model has been super-charged, their timeframes constrained, this is why some started writing around 2003-2005, most hearing in the post-2008 world, China Old before rich, rich before old.

            There is nothing typical of the China model; it is everyone else’s on steroids, extreme, highly exacerbated.
            Michael is optimistic.

            The lethargy and weakness of Hu and Wen, is replaced by an attempt of Xi to consolidate power and push for……..who knows?

            As per India, who else can develop when so much of the worlds time and investment has gone into China, when perhaps half (or more) of their manufacturing plant is going idle, and so much of their infrastructure neither profitable nor able to be maintained.

            So, we get One Belt and AIIB, SCO Bank, BRIC Banks, any DB’s to support the vast overcapacity in the industry of industrialization (cement steel coal, energy, machinery) to build anything that can rationalize any part of Chinese excess capacity. Why should India build another steel plant when 4 times American production, and twice European, likely much more, sits idle in China at present.

            #1 priority….I have long argued, insofar as they survive intact, that the current Chinese government has been more successful then previous manifestations (KMT,Dynasties) in drawing together the current territory into tighter linkages; roads, rail, airports, etc….they have strengthened their territorial integrity.

          • “#1 priority….I have long argued, insofar as they survive intact, that the current Chinese government has been more successful then previous manifestations (KMT,Dynasties) in drawing together the current territory into tighter linkages; roads, rail, airports, etc….they have strengthened their territorial integrity.”

            *Sigh*. Do you see what I mean when I split up countries and the like into different geopolitical financial structures and why I categorize China as old, crony imperial? The financial system is basically a way for elites or whomever to transfer power within, and across, the system to accomplish geopolitical goals whether that be to turbocharge industrial production or to pay someone off or whatever.

          • With regards to India, India has some issues. The real problem, in my opinion, is this idea of an Indian national identity. Why is it a problem? Because trying to configure something that’s never existed makes no sense. I’m sorry, but Bengalis, Tamils, Gujuratis, and Kashmiris will never see themselves as one and the same. It’s just not gonna happen.

            So what’s likely to happen in India is that you’re likely to see development gaps between states widen. Across South India and West India, development is occurring at a rapid rate. In most states in India, fertility rates are below the US. Only in a few inland states (like Bihar and Uttar Pradesh) do you see massive fertility rates. However, the inland states have such high fertility rates that the total fertility rate of India is 2.5. That tells me the current situation is not sustainable, either in terms of economic connectivity or political unity.

            This is also the reason why India has no business being a Parliamentary Democracy because the poorer states with all the people are gonna impose themselves on every other part by their sheer population mass and loot the other stage. “Equality”, “democracy”, and eventually “socialism” will simply trump common sense. Of course, I’m merely describing the first 45 years after Indian independence. Why did the guys in power change course? Because the markets said if you don’t, the state won’t exist.

            Anyways, I don’t see how India as a state in its current form can exist for much longer. If things keep going this way, we’ll see South and West India simply split off or shit will hit the fan and everyone will become poor again.

          • The comparison of China with Taiwan and South Korea is imperfect, but probably the closest parallel out there. It is certainly closer than China compared to Japan in the 1990s, because they were at fundamentally different levels of development (Japan was close to 100% of U.S. GDP, China is at 20%). Japan in the 19th century is a closer parallel to China today than Japan in the 1990s.

            As you point out, the big difference is size. China can’t rely as heavily on an export-led strategy as Taiwan, South Korea and Japan did, because the world simply cannot absorb the scale required. However, size also gives China an advantage, which is that is domestic market can be the engine for innovation and growth. In this sense, it is very much like the U.S. Whether it can capitalize on it is the question that it is currently tackling with. All the words spent on economic theory, accounting identities (500 comments and counting!) etc. they are a sideshow compared to China’s real-world ability or inability in leveraging its domestic market to break out of the middle income trap.

          • Size does not give China the advantage of the US. In China, the Western 60-70% of the country is a total wasteland (it’s Central Asia for God’s sake). In the US, the Western strip of the country lies on the Pacific Rim trade network. The massive area in the Midwest is some of the most fertile turf in the world that’s literally located on the Greater Mississippi Basin, which means it’s automatically integrated into a trade network.

            China’s “size” is comparable to Russia’s “size”, not the size of the United States.

            Keep in mind that the entire region of Cantonia (I’m using this term to describe the region that’s Cantonese) don’t really view themselves as being a part of the population that speaks Mandarin. The largest city in China is Guangzhou, which is the old city of Canton–if I’m wrong, please correct me. There’s lots of internal divides in China that could cause problems, especially when we’re talking about the allegiances of local elites and how that interplays with China’s imperial structure. Of course, this has always been China’s major problem throughout its history and things really aren’t a whole lot different today.

            I always get attacked for using “economic theory”, but I don’t really think I use a whole lot of theory. Actually, I had some European attack my approach (geopolitical finance)–when attacking the nation-state structure as being the primary problem in Europe–for being too heavily reliant on “socioeconomic theory”, when the first assumption I begin with is by saying lets throw out social factors and people’s “feelings” about these issues. Let’s instead impose geopolitical constraints on financial systems. I may be, and probably am, using some “economic theory”, but to say I use “socioeconomic theory” is just blatantly false. I’m not subscribing to any of those theories because I don’t think that such assumptions are valid. Then, these leftists accuse me of being an “anarcho-capitalist”, which makes no sense to me because I detest anarchy and I’m fundamentally an imperialist.

        • Then the correct answer should be, YES so far, but It could turn into NO depending on how the imbalances are resolved.

  19. Always enjoy reading your arguments reference the dynamic behaviour of a system. From what I have been reading, explaining economics in algebra and stochastic have seem to be the normal convention in economics theory. Any idea why dynamic processing & understanding feedback are rarely used to help explaining?

  20. Professor Pettis,
    It is not often that I see you write something that is blatantly false so I can’t help but take this rare opportunity to set you straight. You stated that “enhanced volatility always reduces value”. Shame on you. For a detailed explanation of option pricing theory that proves your statement false, I suggest you read a brilliant book called The Volatility Machine (I think you could learn a lot from it). But I will just give you an example of when “enhanced” volatility actually increases value, which invalidates your statement.
    A company with very low intrinsic value and significant bankruptcy risk can actually increase their equity value by increasing earnings volatility rather than reducing it. The same is true for a sovereign whose debt is highly discounted, whereby increasing volatility can actually increase the chance that they are able to service their debt…thus the volatility increases the value of their debt.
    But I’ll cut you some slack and assume you meant to say enhanced volatility “almost always” reduces value.

    • Hopefully, it is apparent that I was just giving you a hard time about a topic you obviously know. But there is a reason that I bring up this unique circumstance where it is actually rational for an economic agent to increase volatility according to option theory. I wonder if this can at least partially explain why the balance sheets of highly indebted economies typically become even more inverted as economic growth slows.
      I mean, doesn’t it make sense for a brokerage house or WMP manager in China, who will be insolvent unless the market recovers, to double down on that bet?
      P.S. Maybe National Bank of Greece should lever up even more and just go out and sell a bunch of CDS on Greek debt? How amazing would it be if that enhanced volatility increased their equity value to the point that it set off a self-reinforcing process between the value of Greek Debt and the bank’s equity value.

    • Your point is completely correct. There are other ways in which volatility creates value, as Soros explains very well with his concept of reflexivity.
      I have another problem with the statement from a valuation perspective, the importance of short term volatility is quite irrelevant to longer term investing. Since ‘value’ is usually meant to be future discounted cashflows it is not volatility that is important, its is predictability of future cashflows. This is something Buffett has been explaining for years. It does not matter if one year earnings are high and the next low, such as for instance in catastrophe insurance, as long as the longer term level of earnings is predictable and wipe-out risk can be controlled (no zero in your compounding).

      Volatility is important in the case you have regulators on your back, or in case you have shorter term commitments. For instance life insurance companies are now ‘forced’ by new Solvency II regulations to sell there ‘risky’ investments, that is stocks and low rated bonds. With risky here in fact meaning ‘volatile assets’, completely ignoring the historic returns on asset classes which would imply that to a life insurance company a 30-year German Govt Bond today is orders of magnitude more truely dangerous to hold then say some S&P 500 index fund, or a selection of even a basket of some 20 single common stckk positions.

  21. (apologies; a bit off topic) Yi Wen, research dept. of St. Louis Fed, ; presents a very different “New Stage Theory” of China’s rise;

    The Making of an Economic Superpower―Unlocking China’s Secret of Rapid Industrialization
    by Wen, Yi
    in Working Paper Series, No. 2015-006,
    research.stlouisfed.org/wp/more/2015-006

    • Read the conclusion, a piece written by a Chinese academic who is trying to reinvigorate the success of State Led Capitalism meme, as he must. The conclusion seems an attempt at consistenly and constantly rationalizing the success o the Chinese model, as validation or the heavy hand o the State. Further for garnering support for Chinese eorts at going global with its model, with its industrial support, and how over the long-term, although compressed as has been their industrialization drive, despite a changing global system. It seems to ignore both altering demographic (China and global) structures, inter-relations, and while positing Western imperialism for a necessary portion of previous Western development, totally ignores Chinese reliance on the global markets, and posits previous Chinese “success” as merely the result of a rm guiding hand by the State. Marx’s seizing o the heights of the economy; and a Socialist transformation thereafter, upon a necessary, mechanistic, set of alterations, by those who admire of an engineering mindset (the financial press of previous years and those who revolve around a shallow set of economic presumptions).

      I wander what the author would actually write if he wasn’t required to write this piece.

      This one is said to challenge Michael’s Savings and Investment focus

      http://www.voxeu.org/article/six-questions-about-china-s-rise-1953

      Very prescriptive.

      • Sorry Lenins heights

      • The worst thing that’s happened to the world over the past 500 years (and probably world history) has been the rise of this Marxist/nationalist type of thinking that’s led to decolonization. Decolonization has been a disastrous failure with the exception of the US, India, Korea, Indonesia, Malaysia, Australia, and Canada. The problem is the ideas of radical change and revolution that came from this Marxist/nationalist type of thinking.

        I’m not saying empires are this blessing and God-send, but empires do operate within existing power structures and don’t like radical change. So rapid and sudden changes don’t blow the system up. Once this nationalist sentiment started to seep in, the world got irreparably fucked up.

        Secondly, there’s a fundamental difference between imperialism and empire. In the emotionally baked (and mostly retarded) definition of imperialism used by Marxists, they just make a bunch of assumptions they don’t understand and claim they can’t be wrong because they feel a certain way. Imperialism, the way I define it, is the exploitation of a social, political, or economic development gap by one state over another. Empires don’t have to resort to imperialism all the time–although it may be necessary at certain points.

      • Sad truth is he’s a Chinese-American; read his bio; taught at Cornell etc. What struck me is the fact that he does research at the St. Louis fed – which I always thought was one of the better research facilities; but you are correct; reads like something out of China Daily.

  22. I think I slightly disagree with the thrust/merits of the purpose of the article.

    I perceive that Lardy’s *general* direction is that the Chinese leadership has the tools to handle a manageable Chinese debt problem, not quite so much that he doesn’t understand that debt can be dynamic as well as static.

    So I think that a developed story about Chinese institutional rigidity should be told here, and with some details about how few tools there are available to Chinese leaders in managing that institutional structure.

    Know I’m being somewhat unclear, I only have a slim grasp of things myself.

    • They have the party.
      The party doubled several years ago, after, or around the GFC/Lehmans.
      Successful business, the educated young and others were brought into the system.
      This was likely 30 years after Deng started reforms (approximately).
      Advancement in party leadership is based upon success in constructing GDP at local level.
      Local government has gone as far as its going to go in infrastructure and property development on the back of taking land, selling to high bidder and creating profits and revenues at the local level.
      Local government has a strong influence over local banks within their village, town, province/city.
      Local government has debt which has, I believed, started to be turned into bonds.
      The local governments have no ability to generate rents without it being on the back of real estate (high tech parks, roads, bridges, extra capacity in the industries of the moment (solar, ecommerce), or those of industrialization (cement, steel, mining, electricity generation, etc).
      The government centralized revenues at the center, Beijing, a hallmark of any advanced society, is the centralization of taxation, and the distribution of proceeds (just ask the USSR, one of the reasons its collapse was so shocking, desperate).

      So, I guess the story goes, it took alot of convincing to move toward more open markets, and a society, as communist, with private property. Along the way the descendents of the party officials have benefited accordingly. The typical, role in party, role in government, role in mass organization (Scientists, Womens, Farmers Union….this is how they state they have a civil society) and the officials families are in business, or assets are held by others (see Tianjn explosion, and who really owns this building, owes its a fairly advanced memebr of the local internal security establishment), where party officials have influence of finance, are tasked with creating GDP, and have ability to influence the direction of funding.

      The case for institutions in China is one of Institutional Weakness, which is development bank speak for graft, which is what the Chinese in their publications refer to as anti-corruption, as they are focused on the task and continuous problem of tackling it, ineffectively, so the positive term, rather than negative.

      So, institutions, they have rule by law, rather than of law, because the party is above law, above constitution.
      In fact, in such systems it has long been OK, for people to criticize a government office, or department, just not a party official who holds that office, or in the capacity as a party official, because government bad, party saving people from bad governments.

      But then overall, there would be some confusion and difficulty, party size has increased, many long term members and their families have benefited, but that was during the inevitable rise. The system has to change to secure the advances, but there is disagreement. Xi has tred to consolidate power like no recent leader, to effect change, but there are many factions political, and ideological, that pull the country in different directions.

      Early on stress red aristocracy and take on role on PLA, usually held by predecessor. Stress support for PLA, perhaps even push external East/South China Sea for PLAN, to stress firm nationalist criteria enjoyed by a largely peasant based military. Consolidate power, and attempt to make some changes.

      It has been stated by some reviewers ( 😉 ), that signs of Xi’s consolidation of power will be steps toward rebalancing toward a consumption driven economy and away from a state led model (movements on interest rates, lessening reliance on investment, slower GDP growth, etc) In this process we would see a lessening of the rigidity you might speak to, as necessary and politically difficult alterations are made to China’s economy, financial system, that would imply evolutions in the institutional landscape.

  23. Thank you for the read Michael. It indeed is insightful.

    Pierce

  24. I think one critical issue are China’s accumulation of foreign assets. China’s had many “investments” to countries like Nicaragua or Venezuela or Russia. These countries in Africa or Latin America or even Asia have, at best, questionable credibility, and at worst, zero credibility. Many of these “investments” are for “infrastructure” projects that either haven’t been done or have been completed as low-quality that can’t be sustained and can barely be used. There will be consequences for these actions.

    • Remeber that these loans are committed not spent, in most cases. So, flow and stock is what you want to consider insofar as FDI, or Chinese FDI (or loans).

      It would be an interesting exercise to see how much has been announced and how much provided. Reminds of the old discussion of how much reserves are there actually, with, multiple groups having some say over dedicated sovereign wealth money, that always seemed as if some were double dipping, as people added sums, that didn’t jive, because different government agencies cited the same resources. This must be 7 years back or so.

  25. I have enjoyed reading Lardy over the years and so much of his analysis is very thoughtful. But my biggest issue with his analysis is that he seems to dismiss the issue of capital misallocation in the Chinese economy. Or at least he seriously downplays its importance in assessing the economy and its future.
    I am completely bewildered by the fact that someone with his knowledge of the Chinese economy can fail to ascertain the enormity of the problem posed by capital misallocation. It is endemic to every single part of the economy. But because of the sheer magnitude of the misallocation in China I can’t believe the issue with Lardy and others is that they just fail to see it. I think I would actually be offended if someone thought they could convince me otherwise.
    So the only way I can explain his dismissal of the gross misallocation of capital in China is that in his mental model of the economy the allocation of capital plays a small or even no role. I would highly disagree with this argument but at least it’s not as intellectually insulting as trying to tell me that the amount of misallocated capital in China is small.

    • I realize that a lot of people missed the housing bubble despite the obvious signs. But China’s investment bubble is so much more obvious. I mean we are talking empty neighborhoods vs empty CITIES! Maybe I am being naive but I like to think that if we built entire empty cities the size of Manhattan here in the US, EVERYONE would be aware that we have a little overinvestment problem. But somehow in an economy with household income 1/5 the size of the US there are actually people out there that don’t see it as a problem. I feel like I am living in Bananaland.

      • Yes, it is obvious that if the Chinese government has invested in creating housing and cities that remain empty long after the time when they should have been filled, then there is an obvious problem. As I understand it, there is tremendous housing inflation in China. So, it seems obvious that someone made a mistake if the cannot match up the demand for housing with the supply of housing. It is just as obvious that there needs to be an analysis of what went wrong in getting the right product, in the right place, at the right price, so the product would be used.

        I haven’t looked, but do you have access to such an analysis?

      • Yes, this is the real problem with China’s economy. Essentially, it is completely “misaligned” in terms of its structure.

        Think of it like this: China’s $11 trillion in GDP is being produced by far more “unprofitable” entities than the $17 trillion GDP of the US.

        In the US (or any more developed country), far more economic activity is being produced by activities that must be profitable, otherwise those entities will go bankrupt and be dissolved.

        In China… that simple does not happen. China essentially has created a giant “zombie economy” composed of overinvestment in factories that are producing enormous quantities of steel/iron/copper/etc. goods/products that are unprofitably being produced…

        When you look at China’s 45-50% of GDP that is from investment, it’s absolutely imperative to think about how much of that is unprofitable and represents economically misallocated capital.

        The result is basically that China’s economy needs to go through a dramatic restructuring because much of the economy is otherwise just going to be a “zombie economy” without a dramatic clearing out of unprofitable investment…

        This is probably why 5% GDP growth in China is extremely unrealistic when you think about how swiftly that 45-50% investment needs to turn into 25%…

        For that to effectively happen over a 10 year period, China would need to either triple its consumption if investment doesn’t shrink.

        • «China’s $11 trillion in GDP is being produced by far more “unprofitable” entities than the $17 trillion GDP of the US.»

          That is a difficult argument to make! Very difficult when considering that 40% of total business profits were being made in the USA by financial conglomerates, that generally destroy value.

      • If the US injected $20 trillion into the American banking system over the next 3 years, we’d probably easily hit 10% GDP growth. That $20 trillion is much less than a lower bound to what China’s doing as a proportion of its economic system. How can any of this possibly be considered good? I’m wondering the same thing as you.

      • Mjm123 WROTE: “….I like to think that if we built entire empty cities the size of Manhattan here in the US, EVERYONE would be aware that we have a little over-investment problem….”
        ————————————————————

        That is true, but how many people here in the US do you think are aware of the following….
        http://goo.gl/k9P5Bo

      • … tho a couple of hundred million people are expected to move into urban areas in the short to medium future (whether that’s where the empty apartments are, and whether they can afford to buy those apartments, is another question). still given the scale of the ongoing migration the presence of huge numbers of currently empty apartments is not as obviously disastrous as it might at first seem

    • I don’t think Lardy is blind to misallocation. The more relevant question is the relative amount of misallocation.

      I have seen a lot of anecdotes about the “ghost cities” (although they seem to always be about the same two to three examples). China is a big place, you can always find examples. And some of them, like the 60 Minutes’ example Zhengzhou, are now fairly well populated.

      I remember seeing the sensationalist headline about “64 million empty apartments” or something like that. But I tried to trace the figure to the source, and ended up at a quote from some analyst that was based on some back-of-the-envelope calculation he had done – yet it became front page news and is still being cited.

      The over-capacity label was thrown around with high-speed rail a few years ago, notably by Patrick Chovanec. Yet only 4-5 years later, high-speed rail usage is flourishing.

      So I guess I am like Steve looking for some real data on the source. I am open to the fact that there is massive capital misallocation and I am also open to the fact that there is a manageable amount.

      • Its quite easy to see the overcapacity, Mak, without even coming to China. Just check out steel, shipbuilding, etc. In fact it was easy to predict overcapacity long before it happened. With negative real lending rates, equal to one third of nominal GDP growth, widespread moral hazard, corruption, second rate bankers with very little credit training, ferocious credit growth, and a big business culture that valued employment and revenues more than profitability, there isn’t a banking system in the world that wouldn’t have finished in an orgy of bad lending.

        But a quick correction. You say: “The over-capacity label was thrown around with high-speed rail a few years ago, notably by Patrick Chovanec. Yet only 4-5 years later, high-speed rail usage is flourishing.”

        What do you mean by flourishing? I hear differently, and some of the senior managers and former senior managers have been under a lot of unwelcome pressure. Perhaps you mean, like a lot of people often do, that the trains are quite full, but of course this has absolutely nothing to do with whether the HST is a productive investment or not. How many people ride it is purely a function of price. I remember several years ago I had occasion to fly the Concorde three or four times, and it was always pretty full, and yet it was a huge money loser, to the extent that one of the two partners who joined forces to build the SST, the UK, dropped out early. Certainly if the Concorde had not been full, they could have dropped ticket prices enough to fill it two times over on every trip, without making it any less of a money loser.

        • Comparing with the Concorde is not very useful. If i remember well the concorde had a problem of being uncompetitive even at variable costs (other airplanes were just flying cheaper regardless of sunk development & construction costs), was super-loud (not allowed to land at many main airports) and environmentally unfriendly. In short: a lemon.

          High-speed railway is far more competitive on a variable cost basis, on a convenience basis and on an environmental basis. The big question with high-speed rail is mostly if the sunk costs make the investment a financially wise one. As with a lot of infrastructure investments this is indeed very much open to debate.

          The biggest difference is that stopping to fly the Concorde kills all investment, it puts a big 0 in the compound returns. High speed trains will keep riding for a long time to come, and even if high-speed trains are replaced by regular trains, the returns on investment will keep compounding for perhaps hundreds of years.

          Finally the investing thesis for high-speed rail networks should not be viewed from the narrow return on investment on the train-business, but from the total development effect. What is at times ignored is the very high impact on a very long term basis on the value of the land surrounding the nodes of high-speed rail networks. Including lots of spin-off and indirect valuation effects.

        • Damnnnnn……

          I don’t think most people realize that the most valuable thing about trans-national transportation infrastructure is not to support the movement of regular citizens, but to support the movement of goods and to link basic things like power lines, lines of communication, and other things of that nature. I think Bernie Sanders and many leftists (I mean socialist/Marxist/nationalist as leftist) have the same issues.

  26. This is a ‘naming’ contest.
    http://goo.gl/KjzWC9

    1) The first hill on the left has been named “The Internet Bubble”
    2) The second hill (in the middle) has been named “The Housing Bubble”
    3) What should we call the MASSIVE MOUNTAIN that lies to the right?

    Blog participants can use their creativity to come up with a suitable name and perhaps Michael can judge the winner.

    Here is my person entry into the contest: I would like to name it “The B2B Bubble”, where B2B stands for Bubble-to-Bubble. Alternatively, I would like to name it “The B2C Bubble”, where B2C stands for Bubble-to-Collapse.
    —————————————–

    Next, we can examine the underlying GDP growth that is supposed to drive, as well as be driven by, the stock-market:
    https://research.stlouisfed.org/fred2/graph/?g=1Lmw

    1) The Internet Bubble was driven up the first hill by an economy growing at an average 6.0% nominal rate.
    2) The Housing Bubble was driven up the second hill by an economy growing at an average 6.5% nominal rate.
    3) The ‘yet un-named bubble’ has been driven up a MASSIVE MOUNTAIN by an economy growing at an average 3.5% nominal rate.

    If it takes an economy growing at 6% nominal to drive the stock-market up a hill, how can the same economy growing at half that rate drive the stock-market up a mountain that is twice the size of the hill? Does this make any sense to anyone here?

    • It does in one respect: look at the underlying profitability of the corporations creating that…

      The S&P 500 in 2015 is fundamentally different from the S&P 500 in 2007 and 1999…

      The main difference is that the debt to earning ratio of the current S&P 500 is far lower than it was at the peak of the previous booms.

      Large tech corporates show this example pretty obviously: Apple, Google, Microsoft, etc. are sitting on enormous piles of cash and near-cash equivalents. Compared to 2007 or 2000, large tech. companies look completely different in terms of their cash flow and balance sheet structure.

      The balance sheets of the large banks/financials (JPM/WFC/etc.) also looks much healthier than it did in 2007 in particular.

      Yes, a part of this is being driven my “cheap money” as in the S&P’s P/E multiples are probably slightly higher than where it should be…, but in general, large corporate stock doesn’t look heavily overvalued in terms of the debt structures of the companies and the cash flow.

    • The International Cosmopolitanist (bleeding heart modern liberal) meets the true Laissez Faire Liberalist (neo-liberal); and they have a global growth can go to mach 5 love child, affectionately called the “This Time is Different” baby Huey bubble.

    • Oh, the S&P, this is the, as well as debt, the Murray Feldstein a la 1998, Bill Clinton create surplus pay down debt, but where will GLOBAL capital run to, if we do away with debt, further, the Feldstein advise EM to insulate against financial disruption and use the USD gift of three month trade cover, now advocated as 6 month by IMF, and applauded by some Liberal Laissaz Faire Cosmopolitans, as more is better, up to a couple of years coverage, known by our Marxian and post Modern critics, as America needs foreign financing of its consumption, or rather, excess printing and asset bloat in EM, where dollar assets on the global market led to, was a primary cause of GFC, which is followed by QE and the 2000’s EM BLOAT seeing a bloat in asset valuations, as can be expected under such conditions bubble.

    • What are your thoughts, Vinezi? Should stocks mirror GDP growth? To what extent should they correlate? I think this is a fascinating question, though one that I am far from qualified to answer.

      I came to this blog around the same time I became aware of the Random Walk/Vanguard/passive (index fund) investing approach. In the U.S., over an 80 (or 100) year period, common stocks provided a 10 percent return. There may be massive swings from year to year, but looking at the S&P500 or Dow Jones as far as it goes back, it seems like it would be much more difficult to find a 30 year period where a family wouldn’t win if it contributed some of each paycheck to a broad-based index fund with a low expense ratio. With $10,000 invested today, and by investing $1,000 per month (perhaps in VTSAX) over a 30 year career, one would expect to have nearly $1.25 million waiting in retirement.

      Reading the comments of some of the far more knowledgeable blog participants, who are perhaps more skeptical than Professor Pettis with respect to the U.S. (yourself, DVD, etc.), I get the feeling that you believe this paradigm is in question. And though you would have likely made astute observations and been skeptical if you were around to point out our financial follies over the past ten or so decades, the market continued its march forward.

      Speaking of a “massive mountain,” this term comes to mind as I look at a historical chart of the Dow Jones. I believe this is what Warren Buffet was looking at when he asked how anyone could have lost money in the stock market over I believe an approximately 100 year period.

      Is the issue that the indices today are climbing absurdly higher than in past periods of prosperity? This gets back to the first questions…historically, have stock market returns followed changes in GDP, and should we expect them to?

      Sometimes it seems as though, in the end, even if we are constantly making monetary and fiscal errors, you are better off calmly putting your money in the market, sitting tight while we inflate and then deflate, and then cashing out at the end where, if it is many years from the beginning, history (which I imagine includes decades of bad ideas and poorly conceived initiatives) says you will have much more than you started with. With the caveat that “past returns don’t guarantee…yadda yadda yadda.” However, I suppose you won’t have achieved CStevens’ 1,500 percent return.

      I blame Michael Pettis for putting strange new thoughts in my head, like “how does one go about shorting iron ore?”

      • ^^Deek WROTE: “What are your thoughts, Vinezi? Should stocks mirror GDP growth? To what extent should they correlate? I think this is a fascinating question ……xx…. Speaking of a “massive mountain,” this term comes to mind as I look at a historical chart of the Dow Jones. I believe this is what Warren Buffet was looking at when he asked how anyone could have lost money in the stock market over I believe an approximately 100 year period …..xx…. Is the issue that the indices today are climbing absurdly higher than in past periods of prosperity? This gets back to the first questions … historically, have stock market returns followed changes in GDP, and should we expect them to?”
        ——————————————

        The “Warren Buffet Indicator” is Market Capitalization/GDP. Therefore, the same Warren Buffet you quote is pointing out that market capitalization tracks the nominal GDP in the long run. This implies that average growth in stock market valuations equals the average nominal GDP growth over long periods of time. The Warren Buffet Mountain is on the RHS of the following graph:
        https://research.stlouisfed.org/fred2/graph/?g=1LFB

        • You can also apply the Buffet Indicator to the entire economy , i.e. national wealth ( net worth ) vs gdp. Over the past 65 years , national wealth has grown at the same rate as gdp , and maintained very nearly the same ratio to gdp ( ~3.4x ) , outside of transient departures during bubble periods :

          https://research.stlouisfed.org/fred2/graph/?g=1LMK

          I used potential gdp in the graph , but you can plug in regular nominal gdp by using variable (a) in the series 2 formula instead of (b). If you use a sufficiently high-powered magnifying glass , you might even be able to see the “wealth effect” – i.e. the upward deflection of gdp during the bubbles. ( No ? Me neither. )

          • ^^Marko WROTE: “You can also apply the Buffet Indicator to the entire economy , i.e. national wealth ( net worth ) vs gdp. Over the past 65 years ,national wealth has grown at the same rate as gdp , and maintained very nearly the same ratio to gdp ( ~3.4x ) , outside of transient departures during bubble periods….”
            —————————————

            Did you mean to say that National-Wealth has been more or less constant at around 340% of GDP, *EXCEPT* for *TRANSIENT* departures during *BUBBLE* periods? If so, I have an astonishing graph for everyone to see:
            https://research.stlouisfed.org/fred2/graph/?g=1LTQ

            In that graph, we can see that from 1950 to 1996 the National Wealth/GDP ratio was more or less a constant at around 375%. After 1997, however, we have been on a space odyssey, rushing past supernovae as we zip through wormholes at warp speed.

            This does not look good.

            PS: For those who want to use POTENTIAL GDP instead of actually realized GDP, here is that corresponding graph..
            https://research.stlouisfed.org/fred2/graph/?g=1LTZ

          • Vinezi ,

            Yes , my multiplier of 3.4x gdp is conservative. I used it to try to illustrate a baseline of national wealth as a multiple of gdp that seems to be fairly secure ( book value , perhaps ? ).

            The deviations above that are not necessarily abnormal , of course – it’s a market , with all sorts of variables impacting valuations. And , as Piketty has shown , national wealth / gdp ratios can shift over time.

            Here’s the same graph I posted before , but with national wealth bracketed between 3.4-4.4 x gdp :

            https://research.stlouisfed.org/fred2/graph/?g=1MQf

            People will have to decide for themselves whether the recent bubble era is simply a transition to a “new normal” wealth/gdp ratio , or a deviation that will eventually revert to historical norms. I lean towards the latter , but without any compelling justification. Just a hunch.

          • ^Marko WROTE: “The deviations above that are not necessarily abnormal , of course – it’s a market , with all sorts of variables impacting valuations. And , as Piketty has shown , national wealth / gdp ratios can shift over time …. xx …. People will have to decide for themselves whether the recent bubble era is simply a transition to a “new normal” wealth/gdp ratio , or a deviation that will eventually revert to historical norms….”
            ———————————————————

            Here is a revelation of interest….

            A) From the discussion above, we already have the US Total National-Wealth/GDP expressed as a percentage:
            https://research.stlouisfed.org/fred2/graph/?g=1LTQ

            B) Now, let us look at the US Total Capital-Stock/GDP expressed as a percentage:
            https://research.stlouisfed.org/fred2/graph/?g=1OVr

            C) Next, let us compare (A) & (B) to examine their relative trends side-by-side:
            https://research.stlouisfed.org/fred2/graph/?g=1OV6

            D) Still further, let us subtract (B) from (A) to examine the trend in their difference (i.e. spread) expressed in percentage-points:
            https://research.stlouisfed.org/fred2/graph/?g=1OVu

            E) Lastly, let us compare (D) to (A) on one hand & (D) to (B) on the other hand:
            https://research.stlouisfed.org/fred2/graph/?g=1OVz
            https://research.stlouisfed.org/fred2/graph/?g=1OVE

            Would someone like to take a shot at explaining this? DvD or Marko, perhaps? What is the difference in MEANING between the terms ‘National-Wealth/GDP’ and ‘Capital-Stock/GDP’? Do they actually represent different things or are they just measured differently? Anyone?

          • Vinezi,

            I think what we see in your graphs is mainly the difference between market values and “book” values. The net worth of households , which supposedly ( when combined with gov’t net worth ) represents the “national wealth” is predominantly based on market values – specifically so for equities and real estate. My understanding is that the capital stock measures are derived from “perpetual inventory” accounting methodologies , where new assets are valued at cost and then depreciated according to asset-specific schedules. There are other differences , I’m sure. For one , I don’t think land is included in the capital stock measures , while it is included in the value of real estate for net worth purposes. Capital stock is related more to the classical production function concept , while net worth or national wealth is more in line with Piketty’s definition of “capital”.

            The two measures paint different pictures over the last few decades , that’s for sure.

          • ^^Marko WROTE: “I think what we see in your graphs is mainly the difference between market values and “book” values….”
            ——————————————-

            Assume that I have some ASSETS, the return on which provide me with an INCOME. Let us look at three different modes in which I can become “richer”….

            A) I consume less that my INCOME and use the resulting SAVINGS to purchase more ASSETS at the same price-valuation. This not only makes me richer because I now have more assets at the same price-valuation, but also increases my future income at the same the rate of return. In this case:
            (i) My capital-stock/income ratio stays the SAME, because capital-stock & income rise by the same proportion.
            (ii) My wealth-stock/income ratio stays the SAME, because the capital-stock level tracks the wealth-stock level.

            B) I consume all my INCOME (i.e. no savings), but I go into my ASSETS and use innovation to increase their EFFICIENCY such that their rate of RETURN increases. This not only increases my future income by increasing the rate of return on my unchanged number of assets, but also makes me richer by increasing the market-valuation of my assets since people are willing to pay more for that higher rate of return. In this case:
            (i) My capital-stock/income ratio FALLS, because capital-stock stays the same (i.e. no added savings) but income rises because of rising efficiency.
            (ii) My wealth-stock/income ratio stays the SAME, because wealth-stock rises (i.e. people are willing to pay more for the assets) by the same proportion as as the efficiency-generated rise of income.

            C) I consume all my INCOME (i.e. no savings) and make no change whatsoever to my ASSETS; but for some EXTERNAL REASON people are willing to pay more for the assets. Even though this does not change my future income because the rate of return and the number of assets remain the same, it still makes me richer by increasing the market-valuation of my assets since people are willing to pay more for them. In this case:
            (i) My capital-stock/income ratio stays the SAME, because capital-stock stays the same (i.e. no added savings) and income also stays the same.
            (ii) My wealth-stock/income ratio RISES, because wealth-stock rises (i.e. people are willing to pay more for the same assets) even though income stays the same.

            ******************************

            Now let us look at what has been happening in the US since 1950:
            https://research.stlouisfed.org/fred2/graph/?g=1OV6
            (I) From 1950 to 1980, on an approximate trend basis, it appears that (A) was the prevailing mode.
            (II) From 1980 to 1996, on an approximate trend basis, the dominant mode seems to have been (B).
            (III) From 1996 onward, on an approximate trend basis, it is mode (C) that seems to have taken over.

            CONCLUSION: The 1996-2001 Internet Bubble was a true bubble. The 2003-2007 housing bubble was a true bubble. And what we have now is just as bad a bubble as the previous two.

            Does anyone disagree? Let me know of any counter-thoughts.

          • Agree with a lot. The onsumer example though is a good illustration of where your analysis is too linear. When i use the trick tought te me by one of my early prof’s (take an argument to the extreme and see what happens), we could do A in the extreme: nobody consumes nothing anymore, ‘saving’ everything. This is obviously not possible for several reasons: there is lots of things one cannot ‘save’, like apples or waking hours. Second: nobody would invest a thing, since there would be nobody going to consume anything. But that said, the shifts in main focus you describe are visible. Though in the ‘internet bubble’ i again cannot agree. I lived inside the bubble and in its aftermath, but it was a time of lots of real investment in real stuff and real innovation. It was not just blowing bubbles.

          • In the case of corporations, for example, we can write as follows:

            (1) MODE (A) is the equivalent of the corporation using its profits (i.e. savings) to incur capital expenditure in order to expand its production capacity. This results in greater income from the increase in assets that is generated by the re-investment of profits.
            (2) Mode (B) is the equivalent of the corporation engaging in restructuring, by cutting waste, increasing training, encouraging innovation and so on, in order to raise the efficiency with which its assets are deployed. This results in greater income from the same assets due to greater efficiency.
            (3) MODE (C) is the the equivalent of the corporation doing nothing useful in particular, while mainly sitting around and looking pretty. In this case, there is no increase either in income or in book-value (or capital stock), but its market value (or wealth) still rises just because people are willing to pay more for it due to an external factor, such as the availability of ‘cheap money’ for example.

            Now COMPARE the above explanation to DvD’s essay on the same subject in which he said (quote): “…how to explain this apparent paradox that the equity market is doing very well …xx….even when the economy is not doing so well…? The answer to this apparent paradox is that….”.

            Here is the full version of DvD’s original comment on this very page:
            http://goo.gl/VBQT3Z

            What do the blog-participants here think? Are these two explanations the same? Or is there at least considerable over-laps between these two explanations?

            ************************************

            On the other hand, in the case of households, we can write as follows:

            (1) MODE (A) is the equivalent of households consuming less than they earn and using the resulting savings to purchase rental property. This results in greater income from the increase in assets that is generated by the investment of savings.
            (2) Mode (B) is the equivalent of the households engaging in ‘home-improvement’ to increase the efficiency of the rental property they own. This results in greater income from the same rental property, because renters are willing to pay more for that increased efficiency.
            (3) MODE (C) is the the equivalent of household doing nothing worthwhile in particular, while mainly sitting on the couch & watching TV. In this case, there is no increase either in income or in book-value (or capital stock) of their rental property, but its market value (or wealth) still rises just because people are willing to pay more for it due to an external factor, such as the availability of ‘cheap money’ for example.

            Does this sound logical? Any objections or doubts? Please let me know if anyone sees any flaws.

          • Note carefully the EFFORT v/s REWARD trade-offs in the three modes described in the comments above:

            1) In mode (A), an EFFORT must be made to generate savings that can then be invested. This implies that we must make a SACRIFICE today by forgoing consumption in order to become richer tomorrow. The EFFORT of saving today is REWARDED by an increase in living standard (or income) tomorrow. This is one way nations prosper.
            2) In mode (B), an EFFORT must be made to apply intelligence, creativity & diligence to bring about innovative CHANGE. This implies that we must fully-utilize our freedom to re-arrange our affairs in such so as way as to keep reducing waste. The EFFORT made to raise efficiency today is REWARDED by an increase in living standard (or income) tomorrow. This is another way nations prosper.
            3) In mode (C), NO EFFORT is required. We can sit on our fat arses the whole day drinking bud. All this mode needs is the EFFORT-FREE creation of more and more money/debt/credit/liquidity at the push of a button. This total LACK OF EFFORT today will be PUNISHED by a fall in living standard/income tomorrow. This is the way nations perish.

            Bubble, anyone? Is anyone still in any doubt that what we have had for the last 20 years in the US is nothing but a gigantic bubble that has been pulsing up (1996-2000), down (2001-03), up (2004-07), down (2008-10), up (2010-present)? Does anyone disagree that the only possible future outcome now is the final, complete and utter annihilation of this unprecedented 20-year super-bubble?

            I hope I don’t sound too pessimistic. If I do, perhaps someone of a more optimistic nature can tell me of a way in which the “wealth expansion” of the past 20-years can continue in a sustainable fashion? I am keeping an open-mind. What are the counter-views?

          • ^Erikwim WROTE: “Agree with a lot. The consumer example though is a good illustration of where your analysis is too linear. When i use the trick tought te me by one of my early prof’s (take an argument to the extreme and see what happens), we could do A in the extreme: nobody consumes nothing anymore, ‘saving’ everything. This is obviously not possible for several reasons: there is lots of things one cannot ‘save’, like apples or waking hours. Second: nobody would invest a thing, since there would be nobody going to consume anything….”
            ———————————————————–

            Yes, this is the standard Keynesian (demand-side) analysis of inadequate aggregate demand due to an excess desire to save and insufficient consumption. You should not need professorial mind-tricks to arrive at this conclusion, given that it is one of the most well-known principles of demand-side economics today.

            Note the following:
            1) Mode (A) is raw Capital Accumulation. This is how early-stage growth is generated in savings-constrained developing countries (e.g. India). This is the key factor that allows a Classical Economy to escape what is known as the ‘vicious cycle’ of poverty.
            2) Mode (B) is rising Total Factor Productivity (TFP or efficiency). This is how late-stage growth is generated in demand-constrained developed countries (e.g. US). This is the key factor that allows a Keynesian Economy to escape what is known as the ‘capital ceiling’ problem of ever-slowing growth caused by diminishing return on capital.
            3) Regardless of whether an economy is Keynesian or Classical, the sum of mode (A) & mode (B) is the total supply-side determinant of labor-productivity (or output per worker) in all economies.
            4) Mode (C) is Bovine Excreta. This is how economies are destroyed. Mode (C) has no effect on the supply-side. Any possible psychological effect it may have on the demand-side (‘wealth effect’) is but a temporary delusion. When the delusion has departed so far from reality that it cannot be further sustained, the bubble bursts. We are getting close to this point now. This is The End….

          • ^Erikwim WROTE: “This is obviously not possible for several reasons: there is lots of things one cannot ‘save’, like apples or waking hours.”
            ——————————————-

            Forgive me for nitpicking, but this statement has some minor flaws.
            (1) The term saving refers to that fraction of OUTPUT of the economy that is not consumed within the accounting period. Labor (‘Waking hours’) is not an output of the economy. All ‘unemployed’ people are actually fully at work; it is just that their labor-productivity is zero. Since wages track labor-productivity, they get zero wages. When they switch to some other form of work such that their labor-productivity rises above zero, they get non-zero wages and are said to be ’employed’.
            (2) Apples can certainly be saved. It is called inventory-savings. “Eat what you can; can what you can’t, and praise the lord between”.
            http://goo.gl/cSCth6
            (3) Even if I cannot ‘save’ those apples myself, I can always swap them for wheat with someone who would like to eat those apples (consumption) and has excess wheat (saving) to trade. I can then put that wheat in inventory-savings.
            https://goo.gl/QocRDb

          • Nitpicking is a nice thing to do, i do it myself at times. But in this case it perhaps made you miss the point. Most economists and people studying economics seem to have a tendency to forget the real physical world. Waking hours is an output of nature, of biology and physics. Not using this free energy for anything useful means this free energy has gone to waste (to heat to be precise). This also applies to saving all apples, as anyone that has ever lived on a farm knows: many apples are just left to rot, they go to waste and are forever lost. Economists talk about an ‘output gap’, which is just the same as stating we could have used the free energy in the accounting period to do something useful but failed to do so, letting free energy go to waste.

          • ^Erikwin WROTE: “…..This also applies to saving all apples, as anyone that has ever lived on a farm knows: many apples are just left to rot, they go to waste and are forever lost…..”
            ——————————————–

            I agree with you. Apples can certainly be “left to rot, go waste and be lost forever”. However, in your original statement you claimed that apples were thing that could NOT be saved. In my response, I was merely pointing out that apples can indeed be saved, if that is what you want to do. I certainly did not mean to say that apples can never be wasted.
            https://goo.gl/7M7p6j

      • Ford was a no-brainer, Senate Finance Committee, GM and Chrysler, will you lose the corporate Jet and Take a Dollar Salary, Yup.

        Ford will you, nope. We started slashing jobs, and paying down, reorg’ing debt a few years back, I’ll keep my few million dollar salary.

        All the tough talking, say it as I see it, market actors, straight from Catholic High school to the trading floor, and old people, would be like, exactly.

        With that said this is more Taleb Nassim’s philosophy, lotsa small losses on a daily, weekly, annual basis, and some really big ones, at low risk. Nassim would imagine you to blow-up from his Fooled by Randomness before getting to the end of the time you imagine where you cash out. But perhaps not if you are value trading.

        With that said I love Buffet’s value perspective.

        Evaluating his choices, gives you a wonderful insight into fundamental trends.

        His 47 billion in on the Train company, foretold the coming Fracking boom.

        Should immediately start reading associated trade, union and supplier journals and mags.

        Shorting iron ore, short the composite indexes of associated large exporters, honing in on those of higher percentages of exports that go to China, as that is what the largest body of observers will review. Of course focusing on financials.

        Have you seen the Stern (SoB) Volatility site….may find leverage of companies there.

        Bulk shipping companies.
        Ship Builders.

        Read Baltic, and read around the topic (shipping journals, seamans mags/unions, ….)

        But then these have never recovered during the heights prior to 2008.

      • Deek,

        You are asking an important question that many are puzzled by: how to explain this apparent paradox that the equity market is doing very well – generating a total return of about +10% p.a. on average over the long term – even when the economy is not doing so well judging by the excess debt and the excess under-employment it keeps generating?

        The answer to this apparent paradox is that total returns on equity (price appreciation + dividends) can be broken down in 3 different factors: (a) the real operating returns of the business assets that equity represents at constant level of systemic debt relative to output / income ; (b) the extra profits accruing to these business assets thanks to the leveraging up of the real economy which allows these assets to sell more products at higher prices than would otherwise be possible ; (c) the multiple expansion on the total profits (a + b) of these business assets due to money creation flowing into equity as an asset class (leveraging up in the financial sphere) so that an increasing proportion of investors / speculators hold equity securities on leverage precisely for the reason that equity returns are superior to debt costs on average over the long term.

        We might call (a) the real operating returns on equity whereas (b) and (c) are factors related to the credit cycle, ie. they reflect the creation of new purchasing power via the credit system during expansion phases of the cycle followed by their destruction during the bust phases when it becomes clear that this new purchasing power is not backed by real income. Over time, the respective weights of these factors has varied. In the recent period since the 1980’s, the weight of (b) and (c) has increased and has become the dominant influence since 1995. It is no surprise for instance that, of the three tech companies that VP mentions, two (Microsoft, Apple) have in recent years launched enormous debt issues to finance equity buy-backs.

        Look at the S&P500 chart provided by Vinezi Karim: the 3 credit cycles since 1995, each with their respective boom (credit expansion) and bust (credit contraction) phases, are clearly visible. The entire MSCI All-Country World representative of the world market cap shows this exact same pattern.

        This is well understood by the best investors who apply different strategies to deal with this situation:
        – Warren Buffet is the best buy and hold investor of the past 50 years. To be successful, such strategy has two requirements: first, only invest in quality business franchises because they will need to survive economic downturns ; second, yourself as an investor, always keep substantial amount of cash (and no debt of course) so that you are not only not wiped out during panics but you can actually buy at attractive prices “when others are fearful”.
        – George Soros is the best long / short investor of the past 50 years. His “boom – bust theory of reflexivity” is similar to Michael Pettis “inverted balance sheet”. It recognizes and capitalizes on the self-reinforcing effects of debt on the price of financial assets, by being long and leveraged on the way up and being short and leveraged on the way down.
        – While this “amplified oscillator” pattern of the equity market can be extremely profitable for those who can stay on top of it, it is of course the cemetery of those who don’t understand the dynamic, as many Chinese investors are finding out at the moment.

        To summarize: the equity market is a part of the economic system (actually not a big part, most of output and employment is with unlisted companies), it can move up and down for fundamental reasons (with the fluctuations of the real operating performance of the underlying businesses within the context of a self-financed economic system) or it can move up and down for more speculative reasons related to the overall credit cycle. When the equity market moves for fundamental reasons, there is no reason to be skeptical. When it moves primarily as a reflexion of an “inverted, highly leveraged, balance sheet”, there is every reason to be skeptical. In this latter case, the correct market indicator is obviously the one provided by Marko (Total Capital / Nominal GDP) and not the one dubbed “Warren Buffett indicator” provided by Vinezi Karim (Equity Marketcap / Nominal GDP) because the stock market can no longer be viewed in isolation since it is under the dominant influence of overall balance sheet dynamics, hence becomes a by-product of the Total Debt / Nominal GDP trend.

        • DvD

          This is my favorite posting of yours, well, clear and statement of dynamics (without all the adjectives). Great stuff. thx.

        • ^DVD WROTE: “In this latter case, the correct market indicator is obviously the one provided by Marko (Total Capital / Nominal GDP) and not the one dubbed “Warren Buffett indicator” provided by Vinezi Karim (Equity Marketcap / Nominal GDP) because the stock market can no longer be viewed in isolation since…….”
          ——————————————————–

          A distinction, my good sir, without a difference:
          https://research.stlouisfed.org/fred2/graph/?g=1M6X

          Note carefully that the graphs linked above include (quote):
          (1) The one provided by Marko (Total Capital / Nominal GDP) on the left-axis, and,
          (2) The one dubbed “Warren Buffett indicator” provided by Vinezi Karim (Equity Marketcap / Nominal GDP) on the right-axis

          What is the real difference?

          • They are surprisingly similar , which suggests that asset prices as a whole are pretty well represented by stock prices alone.

            I see one major difference that could have had an impact for anyone using such charts for market timing. In 2006 or 2007 , the corporate equity multiple peak would not have been too alarming , since it was well below the level of the dotcom bubble. The net worth multiple peak , however , was at the highest levels ever ( for the period shown ) , suggesting it might be time to cut and run.

          • The real difference is the level, my good sir.

            By itself, you cannot conclude anything from an equity marketcap of say 140% of GDP. Debt has first priority over cashflows, equity only claims what’s left after debt service. So the interpretation of a 140% equity value relative to GDP is quite different whether there is 100% or 300% of total debt to GDP underneath. In the first case, equities are very cheap while in the second case they are very expensive. It is a world of difference for an indicator of the stock market.

            Please note i only refer here to equity value of business assets, ie. to the stock market. To be complete, the equity value (net worth) of residential assets must also be included, which is the case in the Net Worth series from the Fed shown in your graphs. In fact, it is even clearer with residential real estate. You couldn’t possibly conclude that residential assets are cheap or expensive by simply knowing that residential equity is 80% of GDP without also knowing how much is Mortgage Debt relative to GDP. If mortgage debt is 25% or 70% of GDP, it makes a big difference to the “indicator” of the real estate market.

          • DvD ,

            You make a good point. A high net worth/gdp ratio that’s accompanied by a very high debt/gdp ratio is much less desirable than if it’s accompanied by a low debt/gdp ratio. With very high debt , when a credit crunch hits much of that net worth may go “Poof !”.

            I think Vinezi’s point here was that the curves are so similar that they convey very much the same information. To me it seems to indicate that stock prices are a pretty good indicator for the entirety of household asset values , probably reflecting trends in some kind of generalized economic “mood” or “animal spirits ” .

        • Thank you, DvD and Csteven, for your thoughtful replies.

          Re: Buffet and buy and hold, it seems to me the easier/safer way to approximate this approach (for those less talented or inclined to make judgements on the quality of individual businesses) is simply to buy and hold index funds – the most simple version being having something like 90 percent in a total stock market fund and 10 percent in a total bond market fund.

          I have the 10th Edition of “A Random Walk Down Wall Street.” On pages 178-181, there are comparisons between actively managed funds and the indices. In the 1980s and 1990s, the annualized returns from the top 20 equity funds were only three or four percentage points higher than the SP500. I’m not sure if this takes into account the higher fees of the actively managed funds (and possibly higher trading costs/taxes from more frequent trading). Further, the top 20 equity funds in the 1980s provided lower returns than the SP500 in the 1990s. The top equity funds in the 1990s provided lower returns than the SP500 in the 2000s. The point being that you are no better off paying “experts” to choose quality companies than you would be buying and holding index funds.

          DvD, you mentioned it being important to choose companies that survive economic downturns. But it isn’t that another advantage of using a total stock market index fund? Assuming you eliminated harmful debt, have an adequate emergency fund, etc., you should be fine unless the market itself ceases to exist. It has come back every time from 1929 through 2008.

          Regarding sitting on cash, I find this to be tempting. However, it seems particularly risky and perhaps not necessary for those calmly and relentlessly buying index funds in their 401k/403b/TSP and IRA every year (along with the taxable brokerage account). In a Random Walk, Malkiel cites the following statistic: 95 percent of significant market gains over a 30-year period came on 90 of roughly 7,500 trading days (p161, he cites H. Negat Seybun, U of Michigan). In other words, Malkiel suggests that we would miss 95 percent of significant market gains by not being in the market for those 1 percent of trading days.

          Csteven, I have not seen the SoB site, at least until I googled it after your comment. I’ve signed up for the Baltic Journal’s newsletter. I’m halfway through the Volatility Machine. There is much reading to do.

          • Deek,

            Yes, it makes sense to invest in regular installments in a broad equity index for a prolonged period of time. You save high fees and you run with the surviving blue chips since the others will regularly be dropped from the index.

            Of course, to invest on a regular basis, you need to have a regular income, which might not necessarily be the case anymore in a severe downturn, precisely when valuations are most attractive. The opportunity cost of keeping dry powder pales against this major benefit of being there when entry prices are depressed.

            As for the fact that gains are concentrated in a relatively small number of days, it might very well be the case (i have never looked into that). It is my impression that the same is true for losses. I find it much more difficult to capture these “out of range” days than to broadly capture these big cycles that we mentioned before (that, in itself, is not easy). Easier to be approximatively correct than precisely correct. And definitely better than to be precisely wrong.

          • ^^DvD WROTE: “Of course, to invest on a regular basis, you need to have a regular income, which might not necessarily be the case anymore in a severe downturn, precisely when valuations are most attractive. The opportunity cost of keeping dry powder pales against this major benefit of being there when entry prices are depressed.”
            ————————————————————-

            The Eternal Axiom: Stock-prices may rise and fall over short periods of time, but they always go up over the long run. Therefore, if people put their hard-earned savings into stocks on a regular basis over their 30-year working lifetimes, then they are assured of both good returns as well as protection of their principal.

            A) Here is the proof over a TYPICAL 30-year period:
            https://research.stlouisfed.org/fred2/graph/?g=1OzX

            B) But here are the results over the most RECENT 30-year period ending TODAY:
            https://research.stlouisfed.org/fred2/graph/?g=1Ozx

            So far the US has seen only Type (A) over any 30 year period:
            https://research.stlouisfed.org/fred2/graph/?g=1OAh
            https://research.stlouisfed.org/fred2/graph/?g=1OAm

            Could Type (B) possibly happen in America? If not, then why not?

      • Watch James Bullard, Chief of the St Louis Federal Reserve, glaringly CONTRADICT himself:
        http://goo.gl/qA0oRl

        Note the contradictory statements that Andrew Bullard makes:
        A) On one hand, the article says (quote), “Even though he DOESN’T EXPECT an asset bubble in the near term, Bullard said he’s worried that if near-zero interest rates continue in the next few years, they would combine with the expanding economy, to create bubbles.”
        B) On the other hand, the article also says (quote), “In particular, he said the ratio of household wealth to household income should be flat in normal times, but it rose during the Internet bubble in the late 1990’s and the housing bubble in late 2000’s. Bullard said the value of the ratio today was close to the previous peaks, which worries him.”

        1) Here is the HOUSEHOLD Wealth to Total Income (GDP) ratio
        https://research.stlouisfed.org/fred2/graph/?g=28US
        2) Here is Andrew Bullard’s specific HOUSEHOLD Wealth to HOUSEHOLD Income ratio
        https://research.stlouisfed.org/fred2/graph/?g=28Vp

        Now which is it? Does Bullard “NOT EXPECT an asset bubble in the near term”? Or is Bullard saying that a bubble has ALREADY FORMED because “the household wealth to household income ratio today is close to previous bubble peaks”?

        If high-ranking officials of the federal reserve are contradicting themselves in such glaring fashion, then this is going to end very, very badly.

        PS: Note that Bullard correctly points out that the household wealth to income ratio should stay more or less flat. If we look at the curve in (2), we can see that the average flat-value should be about ~540% of Household Income. However, it now at a bubbly 660% of Household Income. This means that for the market to correct, household-wealth must COLLAPSE by at least 100 percentage-points of household-income. This means that 14 Trillion$ of market value needs to be WIPED OUT from household-wealth in order to restore normalcy. This is exactly what will happen when the current bubble in stocks & real estate bursts. It is now only a matter of time. Tick, tick, tick…..

  27. “Then there’s also domestic demand – something that China is trying to transition its economy towards and which now accounts for 45% of China’s gross domestic product (GDP).”

    This from http://www.bbc.com/news/world-asia-34148936

    Is this accurate or relative to previous attempts to classify investment as consumption.
    This as consumption share of the economy seems too large.

    • ^Karishma Vaswani of the BBC wrote: “Then there’s also domestic demand – something that China is trying to transition its economy towards and which now accounts for 45% of China’s gross domestic product (GDP).”
      —————————————————————

      This is incorrect. Demand refers to both consumption & investment.

      GDP = C + I + NX, where (C + I) =Domestic Demand and NX = Foreign Demand

      Therefore, domestic demand as a share of the economy can be written as (C+I)/GDP = 1 – NX/GDP

      This tells us that domestic demand is now about 98% of GDP in China. How much of that is consumption and how much investment is a different question.

  28. To understand this right. The only way out of it’s rising debt problem is for China to restructure its economy, so that it will be able to service its debt in better way. The fundamental idea behind your argument is, please correct me if I am wrong, that the balance sheets in the Chinese economy have been pushed in to an unbalanced situation over the last 15 years, because the economy has supressed consumption, wages etc first through export subsidies and then through state controlled investment in fixed assets. Or to be really simple about it, there is not enough private demand for consumption in China (or the rest of the world) to support the return on the investments in fixed assets made over the last 7 years. A return which is the only legitimate reason to create debt now as opposed to creating it in the future.

    I tried to put holes in this theory, but it seem fairly solid.

    Still there is a good argument for claiming that technical improvement combined with the fairly good redistribution of wealth exists in China could solve a lot of the issues.

    I will agree that the standard arguments we heard over the last few years ago like “Go West”, “relaxing one-child policy will lead to population increase” lack empirical evidence. But I am not sure if you have taken into account that China has a political system and a popular mentality in place where redistribution of wealth is possible. Its is possible, but easy, to include more individuals in the social security system. It is possible, but not easy, to go against the SOEs expansion into all parts of the economy.

    There is also an enormous amount of inefficiency and waste that can be addressed at every level. The small revolution in the private transport industry we are seeing that the moment where both state owned taxi-companies and private individuals are getting a bigger share of the wealth.

    I think that technical innovation within the private sector is still only in its infancy in China and there is a will within the current political system (as opposed to the former) to reform.

    Not to be demanding but could you within the rules of mass communication in China give a list of concrete examples of what could really help reverse the balance sheets?

    I know that the system has to raise interest rates, start an inclusion of a larger part of the population into the social security system, start a larger privatization and then release the restrictions on the agricultural sector.

    Anyway thank you for a great blog

    • Anders; ” Its is possible, but easy, to include more individuals in the social security system.” Of course; the same for health care, education, the environment, etc. Ask yourself: what are they waiting for?

    • Anders

      Go back to Michaels thread on 2011 predictions (several down), I think he outlined, there, and many times over elsewhere, what he thinks need occur for China to rebalance toward consumption.

      • Cateven, I have been reading this blog since 08, so I know many of the suggestions.

        My issue is that a consensus has formed around what prof Pettis has been saying for years. I think many reasonable people agree that this is now a problem of political choices.

        I would like the discussion to move forward in the sense that what are the consequences of these political choices.

        Will raising the interest rate (I guess that is the best and simplest way to rebalance) result in a massive rise in unemployment? I fear that many of the employees in SOEs would not be rehired after their SOE will have been put out of business. Now a raise in unemployment, especially in the cities, will not strengthen consumption. I would like to discuss the consequences of the choice put forward to rebalance the sheets so to speak. In order to do that I was hoping for a post only on choices based on the concept of imbalances within the balance sheets. Or to put it in another way “you are right what next?”

        • Oh, I know you have been here for many years.

          I think you have answered your own question however.

          Frankly, your intuition/answer by way of question is the exact reason why I suspect Michael to be optimistic. Lack of alteration, is not merely due to fear on the part of leadership of losing power, I suspect it to be cognizance of what (can, will, is more likely) to occur.

          The large stimulus, before EU started to show weakness, the pushing of Rise of Rest notions, all these, hopefully to progress notion that this is a contained American problem, but of course it isn’t and wasn’t (it is a global system issue). So the Chinese would have liked the world get back on trajectory even if US had domestic problem, that the world could decouple, but it couldn’t. Now, after giving that little bit of extra insulin, it hardwired itself to an IV of speed. Alteration, now, the intuitions you hold, wall ahead, maybe focus on cushioning our fall. And still keep pushing ahead. There must be a Sun Tzu on Project Strength at time of grave weakness while gird your expectations at time of moderate so as too not attract too much attention. But when fundamentally weak, progress; maybe not all the East and South china Sea, but large portions of it, yesterdays trade, their tactics in negotiating land boundaries ask for more than has ever been discussed, and then seem like be magnanimous in giving in to some demands of other side, the current Hollywood, and Industry of 1990’s tactic of get deal signed and renegotiate, etc….

          With all that said, you are entirely right…..such a posting would be most interesting.
          Even replies to this thread from the expectations of others as I am sure they can be useful for such a purpose.

        • “Now a raise in unemployment, especially in the cities, will not strengthen consumption.”

          More or less my point. So what are the other choices? I posited government directly subsidizing private consumption. I don’t claim that I know how this will work out. I only claim it is a possible action to be examined and analyzed. Oh, along with this, the government might want to raise taxes on the upper end of the income scale, to take liquidity out of the hands of people who are sitting on wads of cash that could compete for goods with the newly increased demand for consumer goods on the lower end of the income scale.

          • ^SG WROTE: “I posited government directly subsidizing private consumption …xx… along with this, the government might want to raise taxes on the upper end of the income scale, to take liquidity out of the hands of people who are sitting on wads of cash…”
            ————————————–

            You are saying that in order to reduce underemployment and bring the economy to its full potential, we must punish savings (“take from the Rich”) and reward consumption (“give to the Poor”) through State intervention.

            This is a standard Keynesian prescription and makes a lot of sense SUBJECT to two conditions:
            1) There is inadequate aggregate demand in the economy
            2) There is excess productive capacity in the economy

            Therefore, this would be an excellent prescription for China, which obviously suffers from both (1) & (2).

            However, is there inadequate aggregate demand in the US? I don’t think so. I would argue that the US has *EXCESS* aggregate demand. This point was discussed in some detail in the comments section of one of Michael’s previous articles. Here is that comment:
            http://goo.gl/LckF4X

            Therefore, UNTIL the US closes its current account deficit (i.e. either balances the current account or runs a current account surplus), any Keynesian solution would be either ineffective or inefficient. In light of this, if underemployment continues to be a problem in the US, then the first order of business must be to wipe out that trade deficit BEFORE we go about playing Robin Hood.

          • Yes, the provisos 1 and 2 in your comment must always be kept in mind, and i always do. When I am not careful to explain that this part of Keynes only applies under his stated conditions, I sometimes leave out the description of what ailment this cures.

            Your raising of the current account deficit is a good point. MMT does account for this in saying that the government deficit needed to spur full employment is increased by the size of the current account deficit. Or the government deficit would be less if the current account deficit would be less. I have long felt that ultimately we will have to let our currency float down to where it belongs to be. The mantra that we need to have a strong dollar in the face of huge trade deficits is another thing that makes no sense to me. As the price of imports increases with the declining dollar, more of our spending will return to the USA. So in a way that you have highlighted, and I have not been thinking of in those terms, the excess demand for foreign goods would be turned into the appropriate level of demand for domestic good.

          • Steven:

            Which country are you referring to?

            Gov to take liquidity out of hands of those sitting on cash.?.?

          • This applies to any country. Right now, I would think it applies to the USA and possibly to China.

          • ^Csteven WROTE: “Which country are you referring to? Gov to take liquidity out of hands of those sitting on cash?”
            ——————————————————————

            This already happens in all countries. All countries impose a SPECIAL TAX as a PUNITIVE MEASURE on those who hoard liquidity or sit on cash. This special tax is called the TARGET INFLATION RATE and is generally 2-3% in most developed countries.

            This is why Krugman is practically screaming that the target inflation rate should be raised from 2-3% to 4-5%. He wants to increase the tax rate on those who are sitting on cash or hoarding liquidity.

            Note that when the actual inflation rate slips significantly below the target inflation rate (as it has now in most countries), then this represents a ‘TAX CUT’ that benefits liquidity hoarders. In other words, ‘inadequate inflation’ reduces the tax-cost of hoarding liquidity or sitting on cash. This tax-cut (or falling cost of holding inventory of liquidity) encourages even more people to hoard liquidity and makes the deflation situation worse. This is one reason why deflation, once it sets in, is so hard to reverse.

  29. the primary balance sheet imbalance is when demand does not equal supply. savings can be used to make “purchases without sales” and reserves are savings. My view is that the global balance sheet of repressed demand outside China has hit the supply economy of China. This lowers cash flow and now the liabilities in country move in the Minsky direction. What steps can the leadership take to avoid a hard landing?

  30. Your article reminds me of this quote from Maurice Allais: “The analysis shows how cautiously one should consider the prosperity of an economy in real terms as long as potential imbalances are developing, at first sight small in relative terms, but capable of triggering, when they materialize and compound, deep changes in collective psychology” – La crise mondiale d’aujourd’hui, 1999 (my translation).

    • DvD, I have always been intrigued by the bits and pieces I can find of Allais, but most of his stuff is written only in French, and is pretty heavy-going, so that the much lighter French I grew up reading makes it tough for me to plough through. If you don’t mind and if it isn’t too much, could you pass on the larger section from which you draw the quote? I am curious to know what he means and whether I should follow up.

    • DvD and Vinezi (others)

      How would you respond to this, DvD….

      “Deflation and inflation are macroeconomic phenomena. However, we cannot fully understand them by only exploring macro data because the behavior of aggregate prices such as the Consumer Price Index depends crucially on the interactions of micro prices. On the other hand, all in all, the results we obtained have confirmed that aggregate prices significantly change, either upward or downward, as the level of real output changes. The correlation between aggregate prices and money, on the other hand, is not significant. The major factors affecting aggregate prices other than the level of real economic activity are the exchange rate and the prices of raw materials represented by the price of oil. Japan suffered from deflation for more than a decade beginning at the end of the last century. More recently, Europe faces a threat of deflation. Our analysis suggests that it is difficult to combat deflation only by expanding the money supply.”

      http://www.voxeu.org/article/deflation-and-money

      What does this portend for non-commodity EM?
      For the prospects of EU?

      • ^Csteven QUOTED: “Deflation and inflation are macroeconomic phenomena. However, we cannot fully understand them by …..xx…..”
        ——————————————————–

        This is incorrect.

        (1) Nominal GDP growth-rate = Real GDP growth-rate + Price-level growth-rate (NEGLECTING HIGHER ORDER EFFECTS or NHOE)
        (2) Nominal GDP growth-rate = Money Supply growth-rate + Velocity growth-rate (NHOE)
        From (1) & (2), we can write:
        (3) Price-level growth-rate = (Money Supply growth-rate – Real GDP growth-rate) + Velocity growth-rate (NHOE)
        However, from the supply side, we already know that:
        Real GDP growth-rate = Labor-Productivity growth-rate + Employment growth-rate (NHOE)
        Real GDP growth-rate = Labor-Productivity growth-rate + (1 – Unemployment-rate) X Labor-force growth-rate (NHOE)
        Real GDP growth-rate = Labor-Productivity growth-rate + ((1 – Unemployment-rate) X Participation-rate) X Population growth-rate (NHOE)
        Therefore, we can re-write (3) as:
        (4) Price-level growth-rate = (Money Supply growth-rate – Labor-Productivity growth-rate – ((1 – Unemployment-rate) X Participation-rate) X Population growth-rate) + Velocity growth-rate (NHOE)

        Therefore, inflation (i.e. Price-level growth-rate) is ONLY dependent upon the following six (6) factors:
        (i) The growth-rate of the Money Supply
        (ii) The growth-rate of Labor Productivity (i.e. output per worker, including capital & TFP)
        (iii) The rate of Unemployment
        (iv) The rate of Labor-Force Participation
        (v) The growth-rate of the Population
        (vi) The growth-rate of the Velocity of Circulation of money.

        All other things, like the price of tea in China, the price of oil in Arabia or the exchange-rate, can only affect inflation if they act through one of the above six (6) variables.

        QUESTIONNAIRE FOR JAPAN–
        (a) Does Japan have a deflation problem? YES
        (b) Is the money-supply growing fast? YES
        (c) Is there rising unemployment? NO
        (d) Is there falling participation? YES
        (e) Is the population shrinking? YES
        (f) Is the velocity of circulation slowing? YES

        So what is causing the deflation problem in Japan? For any GIVEN rate of money-supply growth (b), we know that (d) & (e) are inflationary, while (c) is neutral and (f) is deflationary.

        Therefore, we can conclude that the reason that Japan faces deflation DESPITE fast growth in money-supply is that the velocity of circulation is falling even faster in Japan. Given that the velocity of circulation is an expectations-based behavioral phenomenon, we can conclude that what Japan is facing is a crisis of confidence.

        Let me know if you disagree.

  31. “While of course many people were pulled put of poverty in China since the mid-1970s, I wouldn’t argue that this was because of the highly inverted balance sheet that China put into place in the early and mid 1990s. I would argue that an important reason is that Beijing decided some time in the late 1970s and early 1980s to end, and even reverse, economic policies put into place in the 1950s, 1960s and 1970s, during which period China slipped form being among the wealthier countries in Asia — far wealthier for example, than South Korea — to becoming among the poorest. ”

    Would be greatly appreciated if someone can point to some chart showing the above (asian countries wealth in the past two centuries, not as percentage of world GDP). Thanks!

  32. Concentrating on rate of growth is concentrating on the wrong measure. Employment levels and living standards are the right measures. All else is derivative of the right measures. If China had full employment and rising standards of living, who in the ordinary populace of China would care what the growth rate was.

    Still in this thread there is a lof of talking about how bad debt is without differentiating private debt with public debt. When the Chinese government creates money, they make no promise to redeem that money for anything but more money. So the issued money is not debt to the Chinese government. If the Chinese Government wants to run a bank for the people by issuing bonds that they sell to the public for money in return for interest payments and eventual return or money upon redemption, then that is a separate issue. I don’t believe that China is saddled with financial rules set up centuries ago when they weren’t sovereign in their own money, that require them to issue debt instruments for each dollar that they use for non-central bank government uses.

    • Here is a photo of government-debt issued in the form of a BEARER BOND. This is a bearer-bond that instantly matures, constantly & automatically rolls-over, and carries a zero-percent coupon….
      http://goo.gl/0LYlhs

      Note that on the face of the bond it says in Plain English, “I PROMISE TO PAY the bearer the sum of…..”. If this is not debt, then what is?

      • And what does Indian bearer bonds have to do with Federl Reserve notes or the much more significant accounts at Federal Reserve Banks where therre is no physical money at all?

        I never said that there isn’t any country that makes its own currency and doesn’t promise to redeem it. Although, if you look at the Indian note, it just says the government guarantees it. What does the government guarantee to do?

        • I just noticed what the Government promises to do when you turn in this note.

          “I promise to pay the bearer the sum of five hundred rupees.” So they give you one piece of paper claiming to be worth 500 rupees with the promise to give you another piece of paper worth 500 rupees is you try to redeem the first one. I wish I could buy stuff with pieces of paper that made no promise other than giving you back another piece of paper.

          • ^SG Wrote: “So they give you one piece of paper claiming to be worth 500 rupees with the promise to give you another piece of paper worth 500 rupees is you try to redeem the first one. I wish I could buy stuff with pieces of paper that made no promise other than giving you back another piece of paper.”
            —————————————————–

            This is true of ALL government debt-instruments. For example, if I have a 10-Year USG bond and I go to the government on its maturation day and ask for repayment, the USG will just given me USD. All that would have happened is that the USG would have exchanged one IOU on one piece of paper with another IOU on another piece of paper. They are all IOUs; the only difference between them is in their liquidity-ratings and, hence, their coupon rates.

            This is why the government cannot “retire or redeem” its debt by creating currency. If the government wants to “retire or redeem” its debt then there are ONLY TWO WAYS for the government to do this:
            1) Sell some of its assets, like land, off-shore mineral rights et cetera and use the proceeds to buy-back its bonds from the marketplace and then tear them up, OR,
            2) Run a fiscal surplus, with government spending less than government taxes, and use that tax-surplus to buy-back its bonds from the marketplace and then tear them up.

            Think about it in terms of own personal situation. If you are in debt, then how would you go about “retiring or redeeming” your debt. You would have two choices:
            1) Sell some of your possessions (e.g. car, TV, jewelry) and use the proceeds to pay down your debt (i.e. shrink RHS of your balance sheet to shrink the LHS of your balance sheet), OR,
            2) Reduce your spending to below your income level and use that surplus to pay down your debt (i.e. keep the RHS of your balance sheet constant, but shrink the debt portion of the LHS of your balance sheet while increasing the equity portion of the LHS of your balance sheet by the same amount).

            Let me know if this is still insufficiently lucid.

          • In my own personal situation I don’t get the option of creating my own money which is readily accepted anywhere in this country, and in most places around the world. Many of the things I say about US government debt and money only work internationally if the US dollar is accepted as payment. If we manage to muck up our currency, that assumption goes away. Under the present conditions, the the truth of what I am saying holds. I am sorry I forgot to mention the assumptions on which sovereign currency like that of the USA works.

            There is nothing worse than not being able to see the difference in budgets for people who can’t create accepted money, and the budgets of entities that can. If that difference is too much to get your mind around, there is no argument I can think of to make, to get you to see what you are missing.

            Can you at least accept that the ability to create money that is universally accepted must make some kind of difference? We may not agree on what that difference is, but surely there must be some difference.

          • ^Comment above: “Reduce your spending to below your income level and use that surplus to pay down your debt (i.e. keep the RHS of your balance sheet constant, but shrink the debt portion of the LHS of your balance sheet while increasing the equity portion of the LHS of your balance sheet by the same amount).”
            ——————————————

            ERRATUM—– Typographical error. LHS and RHS should be the other way around in the above statement.

          • ^SG WROTE: “There is nothing worse than not being able to see the difference in budgets for people who can’t create accepted money, and the budgets of entities that can. ”
            ——————————————————————————

            Everybody is able to see this difference. This is not where the disagreement lies. The disagreement in this discussion is that you are saying that money is not debt, and I am saying that it is debt.

            Here is the difference between you & the USG:
            1) If you want to expand your balance sheet by going deeper into debt, you must have someone willing to lend you the money. If no-one is willing to lend you money, you cannot borrow and you cannot go deeper into debt.
            2) On the other hand, if the USG wants to expand its balance sheet by going into debt, it does not need a lender, because it can always create its own money.

            The disagreement in this discussion arises when you say that the money “created” in (2) does not results in a rise in USG debt. It does. It has to because money (Currency/Base) is created as USG debt.

            A) Before 1971 (or before 1933), the USD was on the right side of the Federal Reserve’s balance sheet and gold was on the left side. This implies that the USD was redeemable in gold before that date.
            B) After 1971 (or after 1933), the USD is still on the right side of the Federal Reserve’s balance sheet, but USG debt has now replaced gold on the left side. This implies that the USD is now redeemable in USG debt– which is the just the inverse of the traditional transaction in which USG debt is redeemable in USD.

            Let me know if you disagree with (A) or (B) or both.

        • ^SG WROTE: “And what does Indian bearer bonds have to do with Federl Reserve notes or the much more significant accounts at Federal Reserve Banks where therre is no physical money at all?”
          ———————————————————————-

          A) That Indian “bearer bond” you saw IS a currency note. All modern currency systems run the same way. All currency notes are government bearer bonds, although they are zero-coupon, instantly-maturing and automatic-constant-rollover instruments.

          B) As for currency or cash reserves that banks hold at the Fed, lets see if we can understand the issue in another way:

          1) The currency in bank vaults or reserves (electronic or physical) held by them at the central bank is an asset to the commercial banking system (LHS of balance sheet).
          2) The currency in circulation (physical) is an asset to the people holding it (LHS of balance sheet).
          3) But the same currency of (1) & (2) is a liability to the central bank that issued it (RHS of its balance sheet).
          4) This currency-liability of the central bank in (4) is offset by the matching assets it holds (LHS of its balance sheet)
          5) The matching assets that the central bank holds are government debt-instruments (short-term bills, medium-term notes or long-term bonds)
          6) Therefore, currency is backed by government debt. Therefore, currency is redeemable in terms of government debt, just as government debt is redeemable in terms of currency.
          7) Therefore, currency is just another form of government debt.

          In light of this, when the central bank creates money to “retire or redeem” government debt (as in Japan’s current “debt-monetizing” experiment), it is merely removing less-liquid forms of government debt from the marketplace and replacing them with the most-liquid form of government debt, which happens to be called ‘currency’. As far as the marketplace is concerned, the central bank is merely ‘swapping’ one form of government debt for another– the total outstanding amount of government debt does not change.

          The word ‘currency’, from its Latin root, means “that which runs or flows”, implying the characteristics of something fluid or liquid. This is why the most-liquid form of government debt is called ‘currency’.

          ANOTHER POINT TO PONDER: Here is the typical yield curve for government debt instruments of varying maturity–
          http://goo.gl/OLgHWh

          In that graph, imagine that yield curve going to time=0 on x-axis. Where would it make contact with the y-axis? Obviously, it would be at 0% yield as it would end up at the point of intersection of the x-axis & the y-axis at (0 Time, 0 Yield). That meeting point IS CURRENCY. Therefore, we can write the range of government debt instruments over that normal yield-curve as follows:
          (MOST LIQUID, Zero Coupon) Currency > 1-month bill > 6-month bill > 2Y note > 5Y note > 10Y bond > 30Y bond (LEAST LIQUID, Max coupon)

          Given that Currency fits snugly in with the others above, can you now see the error in saying that Currency is not a form of government debt?

    • Steven,

      Ultimately, the fact that Government can use their power to issue legal tender money to satisfy their debt obligations is a mere technicality / legal nicety that changes nothing fundamental to the fact that losses from excess debt always have to be borne no matter what.

      Total capital is a finite multiple of production. For a given output, you only need so many plants, pieces of equipment, patents, roads, ports, bridges, vessels, airports, residential units, schools, universities, etc.

      In the extreme case where there is no equity left in the system and all capital is debt, it is still a finite amount.

      In the extreme case where all debt is public debt because the Government has backstopped the entire credit system, it is still a finite amount. That this finite amount can be diluted into an infinite amount of monetary units is true. So what? Technically and legally, it is different from default. Economically, it is identical, the loss has been taken.

      • You may be missing a point about MMT that I have not mentioned here. The only limit to what we (meaning this country or the world) can produce is the actual resources to produce it. The limit is not money. We can make as much money as we want up to the constraint imposed by real resources. MMT says this explicitly, but sometimes I forget to include that in the discussion. There are so many factors in our complex world, it is hard to remember to mention them all. Of course, there isn’t room in a discussion to include all the factors.

        • ^SG WROTE: “The only limit to what we (meaning this country or the world) can produce is the actual resources to produce it. The limit is not money. We can make as much money as we want up to the constraint imposed by real resources.”
          —————————————————–

          What you are really saying that is we should NOT look at (Debt/Actual_GDP) but instead we should look at (Debt/Potential_GDP), because it is the potential GDP that is defined by the “resource constraints” and not the actually-realized GDP (which could be lowered by unnecessary unemployment et cetera).

          Okay, let us do that. Here are the curves that compare the commonly-reported Federal Government’s (Debt/Actual_GDP) to its maximum-utilization of resources level of (Debt/Potential_GDP):
          https://research.stlouisfed.org/fred2/graph/?g=1N3F

          Where is the revelation? What has changed by raising this issue of “resources are the limit, money is not the limit”?

        • Yes, the constraint is how much can be produced and how much of that can be devoted to debt service. That’s why total debt matters. The distinction public – private debt is only of secondary importance.

          • ^^DvD WROTE: “Yes, the constraint is how much can be produced and how much of that can be devoted to debt service. That’s why total debt matters.”
            —————————————————–

            When SG speaks of “resource constraints”, he is speaking of the supply-side determination of POTENTIAL GDP.
            When you speak of “debt service constraints”, you are speaking of the demand-side determination of ACTUAL GDP.
            The difference between the two is called the ‘Potential Gap’.

            It looks like there are two opinions in this discussion:

            A) Stephen Greenberg’s view (same as Dan Berg’s view) may be succinctly summarized as follows–
            (1) Actual GDP today is below potential GDP (i.e. inadequate aggregate demand with high underemployment)
            https://research.stlouisfed.org/fred2/graph/?g=1O8E
            (2) Therefore, USG must borrow & spend more in order to raise aggregate demand and reduce underemployment
            https://research.stlouisfed.org/fred2/graph/?g=1O8P

            After keeping the current-account deficit issue in mind, this view seems to be generally correct and is borne out by the data. So what is the problem that DvD has with this?

            B) DvD’s alternative view may expressed as follows–
            (1) At any given interest rate, when debt rises faster than GDP, the debt-service load also rises faster than GDP.
            https://research.stlouisfed.org/fred2/graph/?g=1O9z
            (2) The rising debt-service load implies a rising transfer from those with a higher marginal-propensity to consume (i.e. the Poor) to those with a lower marginal-propensity to consume (i.e. the Rich). This leads to a rise in inequality and hence contributes to downward pressure on future growth-rate of consumption.
            https://research.stlouisfed.org/fred2/graph/?g=1Oa8
            (3) Since sustainable investment tracks consumption, (2) leads to downward pressure on future growth-rate of investment as well. This implies downward pressure on future growth-rate of aggregate demand (i.e. consumption plus investment).
            (4) Therefore, increasing USG debt-load now will only lead to relatively lower levels of aggregate demand and cause higher underemployment in the future.

            Now which of these two views is correct? Is Greenberg correct that USG must borrow & spend more NOW in order to close the Potential-Gap and reduce current underemployment? Or is DvD correct that if the USG borrows & spends now, then it will only increase the Potential-Gap and cause higher underemployment in the FUTURE?

            Or can both views be conditionally right? Is there a way to converge this dialectic? Anyone?

          • Vinezi;

            Or: one of these views is incorrect. Possibly DvD believes piling debt upon debt is inherently a bad idea; but if I buy a house my debt rises enormously; if I am capable of paying down the debt over time, no problem to solve. If i then borrow even more to make energy saving improvements to the house – piling debt upon debt – again, no problem. Obviously, I am assuming intelligent investments; the analogy would be intelligent fiscal policy, impossible today in the US given the political environment – but the IDEA seems to me to be fairly obvious.
            By the way, NOT the case in China where massive investment was wasted, debts unsustainable and DvDs worst fears may very well occur.

          • Vinezi,

            The idea that governments should borrow and spend the difference between potential and actual GDP is implemented in real life to varying degrees during each slowdown / recession phases of the economic cycle.

            In the US, the last time it was possible to think that this idea worked was in the 1990’s when, after the rise in government deficit and debt arising from the early 1990’s recession, growth picked up, the US government went into budget surplus and a debate started on how fast Federal debt would be retired. As it turned out, this situation was only very brief.

            Since then, the trend of real economic growth has eroded further, the gap between potential and actual GDP has widened further, the trend of across-cycle government deficit has deteriorated so that deficits are now permanent including during the high phase of the cycle, public debt has gone super-exponential relative to the taxable base and under-employment has soared.

            The same observation can be made in many other countries.

            So, whether or not the explanation you give for it is the most correct or complete, it is already a well established fact that B has materialized and A has failed. This is not a question anymorey. Or, as Dan says, one of this view is incorrect, namely A. The only relevant question still open at this point is “why”?

          • DvD WROTE: ‘In the US, the last time it was possible to think that this idea worked was in the 1990’s when, after the rise in government deficit and debt arising from the early 1990’s recession, growth picked up, the US government went into budget surplus and a debate started on how fast Federal debt would be retired. As it turned out, this situation was only very brief.”
            ———————————–

            Why? What was so special about the 1990s that the US government bucked the historical trend and went into budget surplus? And why was this new trend not able to last? In addition, do you think that the USG can ever go back to balancing its budget as it did during the 1990s? Or is that impossible from now on? Let me know your thoughts.

            Working data to assist you:
            A) Deficits & Surpluses during the 1990s.
            https://research.stlouisfed.org/fred2/graph/?g=1Pe9
            https://research.stlouisfed.org/fred2/graph/?g=1PdI
            B) Spending side fall during 1990s (and then rise after 9/11/01).
            http://goo.gl/b4CGhV
            http://goo.gl/TPVHVp
            C) Revenue side rise during the 1990s
            https://research.stlouisfed.org/fred2/graph/?g=1PdW
            https://research.stlouisfed.org/fred2/graph/?g=1Pe0

          • One of the most interesting analysis i remember on this question was this one: http://mindinstruments.blogspot.fr/2014/10/america-estopped.html

            Not sure whether the extra 2 years of data we now have since you wrote this piece would reveal something new. The main question to my mind is still forward-looking. It is the economic impact of the sharply stronger USD, whether another giant like India will take China place in “the game”, whether the current stretched valuation of US financial assets (see your and Marko Net Worth / GDP chart) doped by the large capital inflows of recent years hold or crash, etc.

          • Here are some graphs that may be of considerable interest to everyone on this forum..

            (1) Total Wealth as a percentage of GDP
            https://research.stlouisfed.org/fred2/graph/?g=1Qpr
            (2) Total Debt as a percentage of GDP
            https://research.stlouisfed.org/fred2/graph/?g=1Qpj
            (3) Dividing (2) by (1), we get the Debt to Wealth ratio or the Leverage ratio
            https://research.stlouisfed.org/fred2/graph/?g=1QpC

            Perhaps DvD would like to comment to provide some insight on the leverage situation?

    • ^^SG WROTE: “When the Chinese government creates money, they make no promise to redeem that money for anything but more money. So the issued money is not debt to the Chinese government …x…. I don’t believe that China is saddled with financial rules set up centuries ago when they weren’t sovereign in their own money, that require them to issue debt instruments for each dollar that they use for non-central bank government uses.”
      ———————————————————–

      This poem is entitled ‘WHEN THE GOVERNMENT TAXES’:

      1) WHEN THE GOVERNMENT TAXES, it removes money from the marketplace. When the government spends, it puts money into the marketplace. Therefore, if the government spends more than it taxes (i.e. runs a deficit), then it puts additional money into the marketplace on a net basis.

      2) WHEN THE GOVERNMENT TAXES, it redeems government debt from the marketplace. When the government spends, it issues government debt into the marketplace. Therefore, if the government spends more than it taxes (i.e. runs a deficit), then it issues additional government debt into the marketplace on a net basis.

      3) WHEN THE GOVERNMENT TAXES, it reduces aggregate demand in the marketplace. When the government spends, it increases aggregate demand in the marketplace. Therefore, if the government spends more than it taxes (i.e. runs a deficit), then it generates additional aggregate demand in the marketplace on a net basis.

      (1), (2) & (3) are all saying the SAME thing. Money = Debt = Governmental-generation of additional aggregate-demand via deficits.

      (1) & (3) are what Stefan Greenberg accepts, even as he vehemently rejects (2).
      (1) & (2) are from Modern Monetary Theory, which does not discuss (3) explicitly.
      (1), (2) & (3) are from standard Keynesianism, with (3) explicitly-stated, and (1) & (2) treated as given.

    • QUESTION: Is modern fiat currency (e.g. USD) actually just a form of government debt (e.g. USG bond)? Or is there something magical about currency that its creation is free of all debt encumbrances, reminiscent perhaps of the Immaculate Conception?
      ————————————————————————

      A) Here is a photo of a 100$ federal reserve note:
      https://goo.gl/OVNOVX

      Since this is a liability (i.e. debt-claim issued) of the federal reserve, let us say I take it to the federal reserve and ask them to repay me. They will merely look at their balance sheet to examine the nature of the corresponding asset (i.e. matching debt-claim held). Since the corresponding asset is either a federal government note, bill or bond, they will just hand me that debt-instrument to redeem their liability to me. They will then use the federal reserve note that I handed over to them to *BUY* from the marketplace another federal government debt-instrument, just like one I brought to them, but with a forward maturity date. Therefore, there will be no net-change to the balance sheet of the federal reserve because of my meddlesome activity, except for a forwarding of the maturity date (i.e ‘rolling over’) of its *ASSETS*.

      B) Here is a photo of a 100$ federal government bond:
      http://goo.gl/VTUFPs

      Next, let us say that I take the federal government debt-instrument that I got from the federal reserve, which happened to be at maturity, and approach the federal government itself to ask them to repay me. They will merely print another debt-instrument, just like the one I brought to them, but with a forward maturity date, and then *SELL* it in the marketplace to get the equivalent federal reserve note. They will then hand me that federal reserve note to redeem their liability to me. Therefore, there will be no net-change to the balance sheet of federal government because of my meddlesome activity, except for a forwarding of the maturity date (i.e ‘rolling over’) of its *LIABILITIES*.

      C) Now that I am once again in possession of the same federal reserve note as I originally had in (A), let us say I once again take it to the federal reserve and ask them to repay me……okay, this is an infinite loop. The federal government and the federal reserve are merely giving me the run-around. Each one gives me the IOU of the other when I ask to get repaid and I keep running from one to the other. ONLY TWO things actually do happen in this infinite process:
      (i) I keep getting older with the passing of time.
      (ii) The federal government’s debt-instruments keep getting ‘rolled over’, thereby staying forever young.

      CONCLUSION: USG debt is redeemable in USD and USD is redeemable in USG debt. They are one and the same. If we don’t understand this, we will keep going around in circles indefinitely.

      • Michael’s article is entitled, “If we don’t understand both sides of China’s balance sheet, we understand neither”.

        It occurred to me that this discussion with Stephen Greenberg on the nature of fiat currency and the role of the federal reserve could similarly be entitled, “if we we don’t understand both sides of the Fed’s balance sheet, we understand neither”.

        The Fed has USD on the RHS of its balance sheet (liability) and has USG-debt on the LHS of its balance sheet (asset). As Michael put it, if we don’t understand the nature of both, USD & USG-debt, then we understand the nature of neither.

        I suspect this is why Stephen Greenberg is confused about both.

        Here is a comparison of the Monetary Base (i.e. total amount of government-money USD that has been created by the fed as a liability) and the total amount of USG-debt held by the federal reserve as the corresponding asset. As expected, they are more or less the same under normal conditions:
        https://research.stlouisfed.org/fred2/graph/?g=1PC9

        PS: Note that after 2008, there is a sudden 1.2 Trillion$ difference between them. This 1.2 Trillion$ is the amount of USD created/printed by the fed to purchase government-agency mortgage bonds. These government-agency bonds are non-traditional forms of USG-debt (or implied USG-debt) held by the federal reserve as an unusual measure in response to the Great Financial Crisis.
        https://research.stlouisfed.org/fred2/graph/?g=1PCj
        http://www.federalreserve.gov/releases/h41/current/h41.htm

      • Here is a recent article from Forbes, in which the author makes the SAME MISTAKE as Stefan Greenberg:
        http://www.forbes.com/sites/michaellingenheld/2015/09/11/its-time-to-confront-deflation/

        EXCERPT from Forbes article: “What would “trying hard enough” entail? It certainly wouldn’t be popular with a large percentage of the population. The classic example is helicopter money, which wouldn’t necessarily involve flying currency but rather capital injections into personal savings accounts. A broad-based cancellation of debt obligations would be another option….”

        Note the key flaws:
        1) The author implies that the fed can put freshly-printed money into personal savings accounts. It cannot.
        2) The author implies that the fed can use freshly-printed money to cancel existing debt obligations. It cannot.

        The ONLY thing the Federal Reserve can do is adjust liquidity. It can ONLY use the dollars it prints/creates to purchase USG debt-instruments. It can do nothing else with them. Neither can it pay-back anybody’s debts with that money nor can it put that money into anybody’s personal savings account. For every liability it issues, it must acquire a corresponding asset– there is no such thing as ‘free money’.

        The reason the author makes this fundamental mistake is because he thinks, like Stefan Greenberg, that freshly printed money is unencumbered by debt. This is what I call the myth of the Immaculate Conception of Fiat Money.

        So is there a way to do the things the author would like to see happen? Yes, there is. The ONLY way to it is as follows:
        1) The USG goes deeper into debt to borrow money (either freshly-printed directly from the fed or from the market) and puts that money into the personal savings accounts of ordinary people– with the HOPE that they will go SPEND it and not just hoard that money.
        2) The USG goes deeper into debt to borrow money (either freshly-printed directly from the fed or from the market) to give to banks to write-down the debt-obligations of people– with the HOPE that they will then go SPEND the resulting reduction in their debt-servicing costs and not just hoard that difference.

        In other words, the ONLY way in which the author’s dreams can come true is if the US Government goes deeper and deeper into debt. There is no way the Federal Reserve– their famous & fashionable ‘nuclear option’ not withstanding– can do anything about the author’s fantasies.

  33. Krugman says “Debt is good.” You disagree for China, but also presumably for the United States. Is that so?

    • —————————————————–
      ^Dax WROTE: “Krugman says “Debt is good.””
      —————————————————–

      Fire is a good servant, but a bad master.
      Krugman says, “fire is good”.
      Krugman correctly points out that fire keeps us warm, cooks our food and lights-up our cigarettes.
      But can Krugman not see that the same fire, if it spins out of control, can also burn down our house and turn us into crisps?
      Caveat Debitoris; Caveat Creditoris.
      Caveat Populi; Caveat Rex.

  34. The self-reinforcing relationship between rising debt loads, slowing economic growth and heightened financial volatility is visible in many different countries. Each political system is of course pressed to provide a response. This vicious circle is in itself very hard to break out of, and your analysis of the pro-cyclical effects of credit leading to fast profit growth on the way up and to financial distress on the way down is implacable. Yes, perhaps policymakers underestimate these effects. But it is also true, I believe, that the policy response is not so much dictated by the nature of the problem at hand. The way in which the political system is organized dictates to a large extent the formulation of the policy response, typically along the path of least resistance from the point of view of the vested interests.

    For instance, in 2008-2009, China responded to slowing economic growth caused by debt saturation at its main trading “partners” after a period during which China fueled its economic growth by accumulation of external surplus at the expense of said “partners” by dramatically stepping up its own credit creation. It was of course a terribly bad idea, as several precedents (Japan, in particular) strongly suggested back then and as is now plainly obvious even for the most fervent believers in the “miracle”. The main reason why this policy response was pursued despite being obviously a headlong flight towards perpetuating the problem at hand was that it was the response easiest to articulate for the policymaking circle. This “credit-financed stimulus” response quickly became an “institutional imperative”.

    A few lucid minds observed in 2008-2009 that, to reduce global balances feeding the global debt snowball, a joint movement was necessary, involving the countries with excess domestic supply over domestic demand (China) increasing domestic consumption and the countries with excess domestic demand over domestic supply (the US) increasing domestic supply. In fact a few lucid minds have suggested that for many decades, for instance Keynes at Bretton Woods in the 1940’s, Triffin and Rueff in the 1960’s when Bretton Woods was becoming unbalanced, which eventually led Nixon to suspend $ convertibility to gold in 1971, more recently you wrote “The Great Rebalancing”. As far as the policy response to the 2008-2009 situation, it is remarkable that the respective political process in the countries concerned led to the exact opposite to what was necessary: China added to capacity (supply) via its debt-financed investment program while the US stimulated demand via the wealth effect. Not surprisingly, the imbalances have been perpetuated and debt has continued to grow faster than income in both countries. Which means the situation is still has precarious today, if not more, than 7 years ago. Which means that another round of policy responses is necessary. China has now started this second round of policy response. The monetary easing and currency devaluation measures recently announced continue to follow exactly in the footsteps of Japan. Which, again, is very strange because Japan has been going nowhere but deeper and deeper into debt with these exact same measures for 25 years. Again, the solution is not dictated by the problem at hand, but by whatever seems the least detrimental to the vested interests. The US has not so far started another round of policy response but the Fed dilemma is obvious which would like to normalize policy despite having failed to lift both inflation (now at 0%) and employment (adjusted for the drop in labor force participation not related to demographics, unemployment is still around 12%).

    I use China and US as convenient metaphors for surplus and deficit countries respectively for the issue is global. Indeed, global debt has continued to increase faster than global income since 2009 according to recent McKinsey and Geneva Report on World Economy studies and global employment has continued to lag according to recent report from the International Labor Organization. Not exactly the desired outcome. The vicious circle has not been broken. It has been perpetuated.

    It seems therefore an integral part of the self-reinforcing process that wrong policy responses dictated by institutional constraints and the related dominant economic doctrines rather than by the actual problem at hand exacerbate the problem. They perpetuate the imbalances, hence the debt loads. Perhaps the reason is that policymaking circles benefit from these imbalances. This raises the question of whether the various political systems as currently set-up are best suited for an orderly resolution of these imbalances driving debt to unsustainable levels quasi everywhere. Or, in other words, could it be the case that the interests of the political elite have diverged from the interests of their population in so many places? Is the apparent inability of policymakers to resolve this excess debt crisis a sign that this is also a crisis of domestic political representation within a globalized economic and financial system? If that’s the case, the resolution of untenable balance sheets might not only lead to financial volatility but perhaps also to political volatility. The rise of extremist parties in Europe and the rise of non-establishment candidates in the US suggest that political volatility is indeed on the rise. Things might happen.

    • Now this is an explanation I can follow and believe. One big factor you left out, and only brushed by in the end was:

      “Or, in other words, could it be the case that the interests of the political elite have diverged from the interests of their population in so many places?”

      You didn’t say it, but in my view the rise of billionaires in almost all countries id the problem. If these billionaires didn’t get all the benefits of rising productivity, freer trade, etc., but left some of the money for other people in society to earn, then those other people wouldn’t be forced to go into debt. It is the Wall Street types who have been pushing on the debt bubble, repackaging, and selling debt, and reaping huge profits for putting people into debt.

      You didn’t mention in your list of possible things to do to get out of the debt crisis is forcing a more even distribution of wealth. You nay have been thinking of this outcome in your last sentence when you said “Things might happen.”

      I’d like to see an orderly and controlled things happening, than to see it end in violence. However, one way or another, this imbalance will be rectified.

      • ^SG WROTE: “….in my view the rise of billionaires in almost all countries is the problem. If these billionaires didn’t get all the benefits of rising productivity, freer trade, etc., but left some of the money for other people in society to earn, then those other people wouldn’t be forced to go into debt……”
        —————————————

        A) Sergei Brin, Steve Jobs, Mark Zuckerberg, Larry Page, Jeff Bezos. All billionaires. All bastards. They have done nothing to enrich society; they merely “take all the money” and “leave nothing for other people in society to earn”. They are the reason why average American households are forced to go deeper & deeper into debt.

        Is this what you wanted to say? If not, please clarify.

        B) After the collapse of the USSR and the end of India’s experiment with Fabian Socialism, India has seen the rise the rise of Billionaire oligarchs like never before. Yet, household-debt in India is still super-low at less than 10% of GDP. So why do you think that the rise of American Billionaires has “forced” American households to go into further into debt (US Household Debt has risen to 80-100% of GDP), when the rise of their Indian counterparts hasn’t “forced” Indian households to go into further debt at all (Indian Household Debt is still at 8-10% of GDP)?

        Can you explain this dichotomy? Is it possible that there may be a difference between the effects of a rise in inequality in a savings-constrained country (e.g India) and the effects of a rise in inequality in a demand-constrained country (e.g US)?

        C) Even if American households have been “forced” to go deeper & deeper into debt since 1980, how much of that “force” would you distribute over the following factors:
        (i) The rise of billionaires in America (which is the single point you mention as an increase in inequality).
        (ii) The rise of the Wealth-Effect ideology at the Federal Reserve (which encourages households to borrow & spend).
        (iii) The rise of the current account deficit financed by reserve-flows from foreign Central Banks (which implies rise in total US external debt).

        Let us know (preferably with data) as to how much of the increase in US household debt has come from each of the above-mentioned factors.

        • India has also had very high inflation over the past 30 years and inflation in India has only started to come down very recently–largely related to the collapse of commodity prices worldwide. So the one time deflationary pressures are being forced on India, real growth is shooting up because India is a net commodity importer. Anyways, that’s why household debt in India is so low: inflation and supply-side dynamics.

          • Disagree. You describe exactly the situation of here in the US in the 1960s & 1970s. That high inflation in combination with low Household debt are caused by high wage increases or an inflexible labour market (see e.g. Brazil). I also would assume that interest rates are very high (say 7, 8 or say 10%). And how much USD denominated has the corporate sector ?

            Once US wage increases started to remain under the level of inflation, US CPI inflation collapsed from ~ 14% in 1980 down to ~ 4% in 1984 and Household debts started to balloon.

          • India has had an inflexible labor market from 1947-1991 or so. Keep in mind, I’m NOT talking about the US, I’m talking about India (which is a developing country).

            Anyways, the retards that ran the country post-independence really fucked it up. These were people who allied with the USSR and thought Stalin was a good guy. They thought they knew everything and that social science theories were correct based on their feelings. Their ideology was “democracy”, “equality”, and “socialism”. Of course, it was a disastrous failure where population in the ENTIRE Indian subcontinent was 1 billion in <50 years IN ONLY India. Central planning permanently fucked India up.

          • ^SUVY WROTE: “India has also had very high inflation over the past 30 years ..xx. Anyways, that’s why household debt in India is so low…..”
            ———————————————————-

            Then why is government debt in India so high?
            http://goo.gl/RTBGnd

          • The Indian government has been corrupt and crony since the country’s founding. The guys who took over after independence in 1947 thought that the world operated by socialist economic theory, so they took up Soviet style central planning. The result? A rent-seeking bureaucracy that never showed up to work. The bureaucracy is being drawn down, but it’ll be difficult.

            I can’t explain how much the people who took over after independence (the Gandhi dynasty and the Indian National Congress) fucked India up. In the entire Indian subcontinent, the population in 1945 was 1 billion.

            How did they get a diverse country with different interests to take up central planning? Simple: use the poorest part of India with the largest populations and highest fertility rates, most of whom spoke Hindi, to ally together and overpower every single area that desired local autonomy (my home state, Andhra Pradesh, was actually one of the strongest in fighting this, but without much luck). How were they able to overpower local autonomy? By “democracy” and the “will of the people”. It’s such nonsense.

            The environmental damage done by these idiots is what really scares me. Water reservoir levels near the place my parents grew up would mean you’d have to dig a well about 4-8 feet to reach water. Now, that number is ~50 feet. Socialism really fucked India up. Liberalization reforms were taken up in 1991 and India’s done great since then, but I’m worried that most of the damage has already been done.

            The saddest part is that India has been the most successful country in decolonization (excluding South Korea, Australia, and Canada) over the past 100 years or so.

          • I don’t know why my comment keeps getting cut off, but the population in 1945 was approximately 300 million people and by 2000 it was bigger than 1 billion.

      • ————————————————–

        ^SG WROTE: “You didn’t say it, but in my view the rise of billionaires in almost all countries id the problem. If these billionaires didn’t get all the benefits of rising productivity, freer trade, etc., but left some of the money for other people in society to earn, then those other people wouldn’t be forced to go into debt.”
        —————————————————————————–

        Your Honor, the billionaires are innocent and I can prove it.

        Defense Exhibit A) “My clients did not do it”

        The billionaires are only ‘billionaires’ in a notional sense. Their net-worth is overwhelmingly concentrated in equity. Their debt-claim holdings are very small. Their billions come from a notional market-valuation of the shares they hold in companies they started. The billionaires do not have a significant presence on the RHS (creditor, depositor, bond-holder et cetera) of the consolidated balance sheet of the entire US banking system. After all, Bill Gates does not have billions of dollars of “money” (i.e. debt-claims)– the large numbers associated with him merely represent the market-valuation of the shares that he owns in Microsoft.

        Therefore, the billionaires COULD NOT have been responsible for the fact that American households, who sit on the LHS (debtor) of the consolidated balance sheet of the entire US banking system, have been “forced to go deeper into debt”. In fact, given that the billionaires are company-founders/entrepreneurs who have generated renewed economic activity, thereby creating jobs, they also COULD NOT have been responsible for the fact that some American households are “unable to earn” (i.e. unemployed).

        Defense Exhibit B) “Somebody else did it”

        So who is “forcing” American households deeper into debt? Who is “creating unemployment” for American households? The answer to the first question is that American households are being driven deeper into debt by the people sitting on the on the RHS (creditor, deposutor, bond-holder et cetera) of the consolidated balance sheet of the entire US banking system (i.e. expanding length of balance sheet or rising liquidity). The answer to the second question is that some American households are being thrown into unemployment by the fact that the people sitting on the RHS of that balance sheet are doing absolutely nothing besides just sitting there (i.e. falling velocity of money).

        So who is doing this? As we have seen in Defense Exhibit (A), the answer does not lie in ‘the billionaires’; they are merely being used as a scapegoat by political activists. The real people sitting on the RHS of that balance sheet and doing nothing are primarily the CENTRAL BANKS OF THE REST OF THE WORLD. Therefore, we can conclude that it is the reserve-debt financed current account deficit that is primarily responsible for (a) pushing American households deeper into debt and (b) thrusting greater unemployment on them.

        Defense Exhibit C) “The victim is to blame”

        However, Defense Exhibit B) is only part of the story. Assume that a household has 100$ in income and goes and spends 80$; it then puts the other 20$ in pension funds to benefit from incentives like tax-concessions & matching-offers. This would give us a consumption-rate of 80% of disposable income and a savings-rate of 20% of disposable income. Further assume that the same household now goes and borrow 15$ and spends it. This would result in the accounts recording a consumption of 95% of disposable income and a savings-rate of 5% of disposable income– very much like we have recently seen in America.

        But FROM WHOM did this household borrow that 15$? After accounting for Defense Exhibit B), the answer, shockingly, is that they are indirectly borrowing from their OWN pension funds. Pension funds, unlike the much-maligned billionaires and very much like the foreign central banks, have a significant sit-still presence on the RHS (bond-holder) of the consolidated balance sheet of the entire US banking system. This leads us to conclude that, at least in part, American households have been forcing themselves to go deeper into debt by occupying the RHS of the expanding balance sheet via their own pension funds. In the future, when time comes for these households to draw-down their pensions, it is they themselves who will have to repay their indirect debt to the pension-fund as individuals in order to claim the direct pension that is owed to them by the pension-fund as part of a pool– if that makes any sense.

        This is somewhat like a man who saves 20$ in a desk-drawer for his old-age. Immediately, he then takes 15$ out of that sum, writes an IOU for that sum and puts in the drawer, and finally goes and spends that 15$. In one part of his brain, he thinks he still has 20$ of savings for his old-age, but that is only true if he is able to repay that 15$ before he gets old. If he does indeed repay that sum before he gets old, then his consumption-rate must decline in the near future by that ammount. So why does this man go down that IOU route? Why is he not afraid of doing things like this? The answer is that his fearlessness comes from his belief in an all-powerful federal reserve, which has been promoting the ‘WEALTH EFFECT’.
        ———-

        JUDGE: How does the Jury find?
        JURY: Not guilty, your Honor.
        BILLIONAIRES: Thank god. The supply-siders are right: we really are job-creators. The job-destroyers and debt-imposers are the foreign central banks and other debt-claim holders like household pension funds. As equity-holders, we are completely innocent. The truth has been revealed at last. From now on, demand-siders (such as Mr. Greenberg) need to leave us alone and go pick on somebody else.

        PS: Note that the three points raised in the previous comment (above), i.e. (I) billionaires, (II) wealth-effect, and (III) foreigners, have all been covered in this dramatic trial.

    • dani Rodrik’s

      Globalization Paradox

  35. @csteven,

    This comment is directed at you. It was supposed to be a reply to a different comment, but it just wasn’t meant to be so (I guess).

  36. @Erikwim and @Csteven,

    When I refer to “they” or the general group in my statement, I’m referring to the school of Post-Keynesian economics. It’s something that’s gotten more sway, but many of the “leading economists” (for lack of a better term) and their students in particular, don’t seem to understand that much of what they advocate will take us further away from economic primacy. The only real place where they’re somewhat correct is on inequality (for the completely wrong reasons) and some amount of finance, even though they still think “deregulation” is the problem–including Steve Keen.

    What we need are ruthless structures focused on breaking the fragile. What that means is we need to remove ineffective structures. In large part, this would be public sector labor unions like police unions or teachers unions. Also destroying large corporations siphoning public funds like the Export-Import Bank that helps firms like Boeing, even though it may appear to be economically efficient in the short-run.

    If what I’m saying means we have to take up some form of protectionism or the taxation of US assets being held abroad, then so be it. However, we must not institutionalize structures that speed up the decline, like labor restrictions do. The key to economic primacy is innovation, enterpreneurialism, and risk-taking that appears as borderline gambling. Safety doesn’t lead to economic primacy and the desire for safety will simply accelerate the decline. If that means we have demand inefficiencies stemming from lower periods for a while with long bouts of deflation (in demand leakages from international trade, we can offset these impacts by taxation of American assets or protection), then it’s well worth it. However, economic primacy is the key to everything else and it’s very important for the US and American interest to maintain economic vitality, even if there are short term demand inefficiencies.

  37. Professor Pettis, thank you for the post. Enjoyable recap of the costs of financial distress.

    If you have time, just have some quick questions.

    1. Was trying to piece together / guess at the major ways in which Chinese debt has become inverted. Collateral borrowing based on real estate / infrastructure projects vs. collateral borrowing based on hoarding inventories such as copper vs. others not listed here, which are the ones that are most essential?
    And one point that I can’t seem to grasp is how China’s large FX reserves mismatches its balance sheet? (Unlike LatAm, where it seems much easier to understand how FX/interest rates and export earnings etc interact with foreign currency debt in contributing to balance sheet inversion).

    2. In relation to the first question, because households have indirectly subsidized investments, does that mean any associated costs have already been incurred? Or because of embedded leverage if real estate drops substantially the costs will be much higher? Then it’ll just be whether households get assigned the majority of the cost or the gov’t, depending on whether they decide/manage to rebalance?

    3. On the policy side, do you think the gov’t understands the situation well but just have their hands tied in many cases?

    Thank you!

  38. @Csteven,

    Let me make a few points. First off, the US is, by far, the least racist country. But my point is that I see certain minority groups using “equality” and “democracy” as a tool for them to rally support to attack minority groups all the time. It USED TO BE that the people who said this in the late 19th and early 20th century were usually Democrats who supported Woodrow Wilson (who ran one of the most racist campaigns in American history). However, I see the same thing being used by certain minority groups to just arbitrarily take down people’s reputations for saying something they find “politically correct”. Regardless of what the actual skin color or race or gender or religion of people is, if they find an excuse to seize power, they’ll use “equality” or “democracy” as a way to do so. What I’m saying is really bad in many American colleges. Even I’ve had situations where I’ve been in my college library talking with someone about something like the “democratization of capital” being foolish or that socialist financial structures run through banking systems, which makes them very debt-based and they’re very debt-based in order to control the people who hold assets in their economic system, I get nasty looks even though it’s obviously true (Zeihan discusses the same phenomenon, but he discusses it in the framework of “capital being viewed as a national asset” in nation-states). Other things I’ve gotten nasty looks for saying include:
    1. The people are the biggest threat to any republic
    2. Democracy as a way to get rid of bad leaders, is fundamentally sound, but “democracy” as a way to give the people what they want is fundamentally retarded
    3. Ideas like Social Democracy and Democratic Socialism are dumb as hell because they distort incentive structures
    4. Saying class mobility is necessary, but that straight equality or favoring equality over mobility is flat-out stupid

    If it was someone less intelligent than me saying the same stuff in ways that aren’t as intelligent, you have the political correctness police come in to attack and ruin these people. Fundamentally, it’s the same shit as before and the people who’re getting attacked the most are conservatives and libertarians for pointing out obvious shit that goes against the leftist creed taught in social science classrooms. For me personally, it created a bunch of people who try to avoid me because I can ruin everything they’ve been told or annihilate their entire world views in seconds, but if it wasn’t someone like me, they get attacked by the “political correctness police” because the other guy is “morally wrong”. If I was an undergrad who said this stuff in a social science classroom, I’d be fucked.

    In many colleges, this kind of discussion isn’t tolerated outside of technical fields and this is the dominant view that’s taken hold in society. And the primary problem is coming from the left, not the right. The reason why I talk about them all the time is because these are real issues that aren’t even given the light of day in many college campuses, and if someone does express these in such a way where you can’t attack them for being dumb/ignorant, many simply run in fear. Yet these people call themselves “liberals”, but I fail to see the liberality. They say they want “toleration”, but I fail to see the “tolerance”. However, these are the same people who usually have “Ready for Hillary” or “Equality” bumper stickers on their laptops and notebooks.

    In terms of me personally, it’s not an issue because it creates a polarization of people who are either scared of me or attracted to me due to the ways I express myself. However, I’m being worried about the limited debate in colleges. Why do I bring all of this up? To point out that regardless of who the masses actually are, they’re all the same. For example, there’s racism in India against Africans, but how is that different from a group of whites or Chinese being racist against blacks? It’s the exact same.

    • Oh yea, when I discuss class issues and you said “and you don’t like Marxist thinkers”, it’s important to note I’m not getting my views of class from anything close to Marxist indoctrination. Any functioning society must have a class structure. In Hindu society, most people think that the caste system has always been by birth and must always be so, but that’s not even close to the truth.

      In Hindu scripture (if you actually read the Vedanta, which no one seems to do but everyone always wants to talk about it like they do), there’s no discussion of the caste system as being done via birth. Instead, the caste system is a necessary organizational structure for any healthy, well-functioning society. The logic is as follows:
      1. The most important thing for a society to protect is its learning and knowledge, so the highest level are its philosophers, holy men, and scholars.
      2. In order to protect that tier of society, you need ruling elites. Historically, the ruling elites would be warlord aristocrats. In the Hamiltonian vision of capitalist empire, he replaced the warlord aristocrats with liberal capitalist tycoons. Either way, the rulers MUST have skin in the game, which is something Hamilton understood.
      3. Below the ruling elites, you need a taxation and development base which is where you have the middle classes. Roughly speaking, the middle classes include small merchants, traders, shopkeepers, teachers, engineers, administrators, civil servants, and the like.
      4. For the middle class to operate, you then need a working or laboring class.

      Again, any functional society must have this kind of a structure. Everyone needs to play their part and must fulfill their duty. Everyone is not equal and it doesn’t make sense to treat everyone equally. If a ruler fucks up, he needs to be ruined. If the common man fucks up, it’s not fair or just to ruin him because the common people have spouses, families, and children. So you need different rules for different tiers of society. Hence, the idea of “equality” is retarded.

      • I believe all major traditions have some form of a similar structure for society with similar symbolic structures. There can be class mobility within these structures (and Islamic societies were historically the most notable in this idea of class mobility).

        People represent Hamilton as the first person of this new nationalist order, but I don’t think that’s true at all. Hamilton was one of the last people of the old imperial order. He wasn’t looking to create this new radical system for things to operate by. He was looking to preserve the most important and necessary parts of the old system. The older I get, the more and more I wonder in the amazement of the sheer brilliance of Alexander Hamilton.

  39. @Csteven,

    In regards to empire and the westward expansion of the US, the US expanded with the private sector leading the way. The real key method of expansion was via capital exports used to develop the Western frontier with the infrastructure coming afterwards. The expansion was capitalist empire.

    In my view, the Civil War wasn’t caused by slavery either, although slavery was certainly a factor. The Civil War was caused because of differences within the empire that created rebellion. I think control of the Mississippi was as big an issue as slavery, as were the issues of tariffs. Anyways, most of the Union population didn’t want a Civil War with the South; it was the capitalist elites in the Union that wanted the Civil War. It was the capitalist elites and holy men (by whom I mean philosophers or religious leaders) that were really pushing for the Civil War. What happened during and after the Civil War was that the Union colonized the South and conquered it. Similarly, the Spanish-American War was another example of the US showing fundamentally imperial behavior as was the Mexican-American War.

    We can argue about the level of justice behind all of the wars and frontier expansions, but it doesn’t change the fact that they happened nor does it change the fact about the imperial nature of the US. I tend to think all of those wars weren’t only inevitable, but they were just (including the Mexican-American War). Others may disagree with me, and that’s fine, but I don’t think you can argue about the truths of the American Empire.

    Whether you talk about China expanding west, Russia expanding east, or the American expansion in any direction–all of those expansions were fundamentally imperial behaviors taken up by empires. Empires like peace and to keep internal peace, empires keep the wars at their frontiers. The US is no different. The purpose of empire is to impose peace and collect taxes.

    From a balance sheet perspective, the purpose of empire is to unite a bunch of differing states onto one balance sheet representing a common geopolitical interest. The US is organized as a liberal, capitalist empire where you have liberal institutions to check and rotate elites while you take a bunch of different autonomous communities, pit them against each other, and divide et impera. When the elites become crony or they take up too much power, the people become united for a split moment until they weaken the elites. Then, you go back to where you were. I think any decent understanding of American history basically leads to this explanation.

  40. interesting take by Daiwa…
    Of all the possible risk scenarios the meltdown scenario is, realistically speaking, the most likely to occur. It is actually a more realistic outcome than the capital stock adjustment scenario….

    http://www.dir.co.jp/english/research/report/jquarterly/20150910_010110.html

  41. DvD:
    It is possible to think this idea works when interest rates are zero.

  42. Mr. Pettis,

    Perhaps you can post, here on your website, an older (say 2 years old) example of your newsletter that went out to subscribers. I am interested in what you write in your un-abbreviated version of your newsletter. But I don’t know whether it would contain useful information for me and other commenters here on this blog.

  43. From Barry Eichengreen, Aug 26: http://www.chicagobooth.edu/capideas/magazine/fall-2015/chinas-challenge-how-to-strengthen-the-financial-system?cat=policy&src=Magazine

    (parentheses my comment) “Given that much (90%) corporate-bond issuance is by state-owned companies, whose bonds are subsequently purchased by state-owned banks, one wonders how many of these transactions are policy directed as opposed to arm’s length (all?). This raises the possibility of a diabolic loop if, say, (when) local governments get into trouble, infecting bank balance sheets, or banks get into trouble and engage in fire sales of assets that demoralize the bond market (as with equities).”

  44. The Bank Of International Settlements has issued a report on sunday that emphasizes the fact that a number of countries (Brazil, China, Russia, Indonesia, Turkey, India (????)) have borrowed in USD. And that’s NOT a sound situation now the USD is rising.

    http://www.economist.com/news/finance-and-economics/21646803-debt-ridden-emerging-markets-are-heading-nasty-dollar-hangover-feeling-green
    http://www.ft.com/intl/cms/s/0/d1702e12-7df6-11e4-b7c3-00144feabdc0.html#axzz3lpXj0ejh
    http://www.dailyfx.com/forex/market_alert/2015/09/15/BIS-Says-Two-Main-Challenges-Confront-Emerging-Market-Economies.html
    http://wolfstreet.com/2015/09/15/world-more-exposed-than-ever-to-us-dollar-emerging-market-dollar-denominated-debt/

    Now China has devalued its currency (FeliX Zulauf expects more devaluations of the yuan), a number of currencies & countries will suffer.
    https://www.dropbox.com/s/i1bwr42o2lrca5r/China.png?dl=0

    • In India, most of that debt is held by non-resident Indians (NRIs). I’m willing to bet most of those NRIs are American citizens with American assets, so I wouldn’t be too worried about India.

  45. Michael… I would’ve thought the below quote from your post would imply China didn’t have much of an inverted balance sheet (thus a more hedged one)?

    QUOTE:

    To begin with, China’s national saving rate, reflecting the combined savings of households, corporations, and the government, approaches 50% of GDP, significantly higher than any other economy in recorded history. Like households, countries that save more can sustain higher debt burdens. Second, the vast majority of this debt is in domestic rather than in foreign currency…Thus, its debt does not involve any significant currency mismatch, a major contributor to many financial crises. Third, the majority of this debt has been extended by banks, and China’s systemically important banks are financed entirely by deposits rather than through the wholesale market…Finally, the government has enormous scope to further increase bank liquidity should that become necessary. Other factors, too numerous to list here, also suggest that a banking crisis is far from certain in China.

    • Good question, DC. China’s balance should would be highly inverted except for one factor, which is the ability of the government to guarantee the refinancing of all mismatches. As long as Beijing has full credibility and borrowing capacity, this means that the balance sheet exacerbates losses but these losses are simply converted into debt and the debt rolled over an absorbed by the government. The problem is that as debt rises, both Beijing’s credibility and its borrowing capacity are undermined, with the risk being that at some point the balance sheet can collapse.

      • Michael – Could I extend this further to say that Beijing/PBOC in control of its own printing press could utilize it to “print” liquidity into the system? (allowing the known non-performing loan problem to continue extending & pretending?)

  46. On the federal reserve’s rate-rise issue, here is a graph that may be interest to everyone:
    https://research.stlouisfed.org/fred2/graph/?g=1RZW

    Here is the same graph with marking lines that I have added as pointers:
    http://goo.gl/TYFkQy

    As seen in that marked graph, there are clearly TWO DIFFERENT types of rate-increases:
    (1) Type A rate-increases (shown in RED, 1994, 2004) indicate that the recovery has established itself and that inflationary pressures are starting to build. If we look at the MZM velocity curve, which tracks inflationary pressure, we can see that the fed raises interest-rates just as soon as they detect either a sustained flattening (indicating that the deflationary pressure of the recession are over) or an increase in the velocity of money (indicating that inflationary pressure are starting to build). Once the fed starting hiking the interest-rate, they keep increasing it as long as the velocity of money keeps rising. As marked by the BLUE arrows in the graph, once the velocity of money has reached its peak and starts to flatten, the fed then stops the rate-increases and holds the interest-rate constant at that high level.
    (2) On the other hand, Type B rate-increases (shown in BLACK, 1999) are an indicator that the fed thinks there is a dangerous bubble in the economy. As seen in the graph, the fed began to raise interest-rates in 1999 EVEN THOUGH the velocity of money was still FALLING (i.e. there was no inflationary pressure). Therefore, we can conclude that the sustained rate-increases from the summer of 1999 through to the summer of 2000 were a deliberate attempt by Greenspan to BURST the internet-bubble and had nothing to do with concern about future inflation.

    Now we can look at what is happening with Janet Yellen (far right of graph): Is the velocity of money rising or at least flattening sustainably? No, the velocity of money is still falling. In fact, there does not appear to be any obvious end in sight, thereby indicating continuing deflationary pressure. Therefore, we can conclude that Yellen was not thinking of raising rates because the recovery had established itself. Therefore, this was not a Type A rate-increase decision that Yellen was facing. Therefore, by a process of elimination, we know that this was a Type B rate-increase decision that Yellen had to make.

    From all this, we can conclude that the fed is convinced that there is a DANGEROUS BUBBLE in the US economy. What Janet Yellen is facing today is a merely a repeat of what Greenspan faced in 1999-2000.

    Does anyone see any flaws? Can anyone draw any alternative conclusions? Does anyone think that we don’t have a dangerous bubble?

    • A) Here is a graph of the famous “Greenspan Squeeze”, in which Greenspan used a Type-B Rate-Increase to squeeze and pop the Internet-Bubble:
      http://goo.gl/J4ictJ

      B) Here is a PROJECTION of what it might look like if the fed once again uses a Type-B Rate-Increase, called the “Yellen Squeeze”, to pop the current bubble:
      http://goo.gl/SDpByb

      Note that the market initially responds to rising rates with a rise in stock-prices. This is because traders at first believe that rising rates indicate a growing economy with inflationary pressure and so bid up prices. This belief comes from the statistical fact that Type-A rate increases, which do indicate a growing economy with inflationary pressure, are much more frequent than Type-B rate increases, which are deliberate attempts to burst bubbles. It is because traders confuse the latter for the former that the market mistakenly continues to rise for a while even when the fed is trying to squeeze the bubble. Eventually, however, the realization does set sets-in and the market begins its rapid descent, as indicated in the “Greenspan-Squeeze” box in the linked graphs.

      • For those who are interested in East-Asia and/or Japan, here is an equivalent graph that shows the Type-B rate-increase that was used by the Bank of Japan (Nippon Ginco) to burst the Stock-cum-Real-estate bubble in 1989:
        http://goo.gl/rrHhfT

        As seen in that graph, the consequences of using a Type-A rate-increase to squeeze a JOINT stock-cum-real-estate bubble can be DEVASTATING. In the US, the 2000 bubble was largely a stock bubble with real-estate making only a minor part of it. Conversely, the 2007 bubble was largely a real estate bubble with the stock-market making only a minor part of it. The current bubble, however, is a JOINT bubble– just like Japan of the 1980s. Real estate prices are back at their previous bubble peak and stock prices have crossed their previous bubble-peak by a large margin.
        http://goo.gl/YK0XDD

        Given the slow growth that makes the unusual backdrop for this bubble, I strongly suspect that this will be the final bubble. Once this one bursts, there will be no more bubbles in America, just as there have been no more bubbles in Japan since the last one. Secular Stagnation, here we come….
        http://goo.gl/uQ14Xe

    • Some people don’t care about the stock-market. They care about the real economy which affects the lives of real people. They care about EMPLOYMENT. So here are the employment responses….

      A) Here is a graph of how the famous “Greenspan Squeeze”, in which Greenspan used a Type-B Rate-Increase to squeeze and pop the Internet-Bubble, affected real employment:
      http://goo.gl/k62SwU

      B) Here is a PROJECTION of what the real employment situation might look like if the fed once again uses a Type-B Rate-Increase, called the “Yellen Squeeze”, to pop the current bubble:
      http://goo.gl/7tnjmT

      Note that the employment curve initially responds to rising rates with a small rise (or at least no fall) in employment. This is because businesses at first believe that rising rates indicate a growing economy with inflationary pressure and so continue hiring. This belief comes from the statistical fact that Type-A rate increases, which do indicate a growing economy with inflationary pressure, are much more frequent than Type-B rate increases, which are deliberate attempts to burst bubbles. It is because businesses confuse the latter for the former that the employment-situation mistakenly continues to improve (or at least stay steady) for a while even when the fed is trying to squeeze the bubble. Eventually, however, the realization does set-in and businesses begin layoffs, which lead to a rapid descent in the employment rate– as indicated in the “Greenspan-Squeeze” box in the linked graphs.

  47. Some here may be interested in a recent addition to the flow-of-funds report , Q2 version of which was released today. They’ve added a new table ” B1 : Derivation of U.S. Net Wealth”. Some details at this post on Angry Bear :

    http://angrybearblog.com/2015/09/open-thread-sept-18-2015.html#comment-2676609

  48. Speaking of not understanding the conflictual dynamic between nations within the interconnected global balance sheet, it seems the Fed hare has finally realized that the race it is running against the ECB tortoise, the BoJ marathon man, the PBoC newcomer and many others has in fact no finish line. It is a “print or die” race … into an impasse.

    After eight years of being constantly invalidated by the facts, the Fed is finally starting to realize that the theory (“deflation, how to make sure it doesn’t happen here”) that has underpinned its actions has actually exacerbated the problem by facilitating another global credit expansion that has pushed global debt even further away from production flows supposed to service it.

    And now the global credit cycle is starting to contract with interest rates at 0% in all developed economies. How to make sure it happens here.

    No wonder policymakers are held in such discredit.

  49. QUESTION: Does the Keynesian-stimulus method of going deeper into debt to generate additional aggregate demand in order to bring the economy up to its full potential (i.e. eliminate the potential gap and reduce underemployment) work under ALL circumstances? If not, then when does it work and when does it not work?
    ————————————————–

    The Keynesian-stimulus prescription has two parts to it: the discharge and the re-charge. The first part of prescription entails accepting a rising debt-load (discharging) when the economy is below potential (slow growth) in order to stimulate growth. The second part of prescription entails forcing the debt-load back down (re-charging) to normal levels once the economy is back to running at full potential (fast growth).

    For the Keynesian-stimulus method to keep working, it is essential that each re-charge put back what the previous application took out during discharge. This implies that the debt-load that moved up during the stimulus period (discharging) MUST then move down during the following normal or boom period (recharging). If we apply only the first part of the prescription (“hey, big spender”) and ignore the second part (“deficits don’t matter”), then the Keynesian method will eventually stop working (‘dead battery’). The idea that we can keep using Keynesian discharge to speed-up growth during the slow period and then not recharge the system during the fast period is akin to the idea of a perpetual motion machine.

    In this regard, here are the individual Debt/GDP ratios for the federal government, state/local governments & households:
    https://research.stlouisfed.org/fred2/graph/?g=1SOt

    Here is the COMBINED Debt/GDP ratio for ALL THESE THREE PROVIDERS of debt-based additional aggregate-demand (i.e. Keynesian stimulus):
    https://research.stlouisfed.org/fred2/graph/?g=1SOy

    Note the following points in the combined graph–
    (i) The first Keynesian Estoppel of the bust of 1989-92 was CORRECTLY ‘recharged’ during the subsequent investment boom of 1994-2000 and the debt-load returned to its pre-recession level.
    (ii) The second Keynesian Estoppel of the bust of 2000-03, however, was NOT ‘recharged’ during the subsequent housing-bubble investment-boom of 2003-07. This caused the debt-load to stay at an elevated level when the next recession hit in 2008.
    (iii) The third Keynesian Estoppel of the bust of 2008-10 simply ADDED to the uncorrected imbalance left over by the second Keynesian Estoppel and sent the debt-load to even higher levels.
    (iv) As of today, almost NO PROGRESS has been made in ‘recharging’ the Keynesian ‘batteries’. The debt-load continues to stay at the same uncompensated elevated level. In light of this, if we encounter another recession now, there is a good chance that the Keynesian approach will fail and send the economy into permanent decline.

    CONCLUSION: This is why Stefen Greenberg’s (and Dan Berg’s) suggestion of using Keynesian spending to bring the GDP up to full potential, while sound under more normal circumstances, is so DIFFICULT to implement today. I think this is the point that DvD (and Marko) were trying to make.

    Has this closed the dialectic? Or does anyone see any flaws? Opposing arguments are welcome.

    • W.r.t the comment above, note carefully the SPECTACULAR ERROR that Paul Krugman makes in his conceptual approach to the issue of Keynesian stimulus. Probably due to the limited way Keynesian deficits are explained in text-books, Krugman always speaks of the manageability of the debt-load of ONLY the federal government when he advocates higher USG deficits. When he says that USG debt was >120% in 1945, he forgets to account for the fact that households & state/local governments had very little debt back then. Given that household deficits & state/local government deficits ALSO contribute to the Keynesian generation of additional aggregate demand, Krugman makes a mistake by not including them in his calculations. To demonstrate the scale of the error that Krugman makes, the following graph compares the Krugman-curve (in red) to the more relevant TOTAL Keynesian debt-load curve to show how much the two have diverged over time:
      https://research.stlouisfed.org/fred2/graph/?g=1SRV

      So now we have the real explanation of why Krugman is so unafraid of the debt-load. It just so happens that he is looking at a different curve– a curve that he correctly claims is not in uncharted territory. After all, Krugman asks, what is so scary about the following curve?
      https://research.stlouisfed.org/fred2/graph/?g=1SS2

      • Here is the TEXT-book Keynesian equation that was derived in a different era; an era in which almost all households were net-savers and businesses borrowed to invest (i.e. a textbook classical economy of the type the Austrian love to exalt).

        GDP = C + S = C + I + NX, where C is consumption, S is saving, I is investment and NX is the trade-surplus.

        Keynes broke this down into governmental and private sectors, using the suffix g for government and the suffix p for private as follows:
        Cg + Sg + Cp + Sp = Cg + Ig + Cp + Ip + NX
        Government Revenue (T) = Cg + Sg
        Government Expenditure (G) = Cg + Ig
        T + Sp = G + Ip + NX
        (G-T) = Sp- Ip – NX —-(I)
        Where (G-T) is the excess of governmental expenditure over governmental revenue and is called the fiscal or budgetary deficit.

        In other words, Keynes pointed out that in a demand-constrained economy, the government must run a fiscal deficit in order clear any excess private savings above and beyond that which are either needed for private investment or can be pushed out as net-exports.

        In other words, if the desire of the private sector to save EXCEEDS the desire of the private sector to invest and the desire of foreigners to borrow, then there are only two possible outcomes:
        (i) The government must run a deficit (i.e. borrow and spend by going deeper into debt) to CLEAR that desired excess of private saving, OR,
        (ii) Unemployment will RISE and the economy will go BELOW full-potential such that that desired excess is killed.

        That was THEN. This is NOW–

        Let us FURTHER break-down the private sector (suffix p) into three parts: Let b be the suffix for business, hp be the suffix for lower-income households & hr be the suffix for higher-income households.

        Cg + Sg + Cp + Sp = Cg + Ig + Cp + Ip + NX
        (Cg + Sg) + (Chp + Chr) + (Shp + Shr + Sb) = (Cg + Ig) + (Chp + Chr) + (Ihp + Ihr + Ib) + NX
        Note that businesses have no concept of consumption and that the savings of business (Sb) is what is called “retained profit”.
        T + (Chp + Shp) + (Chr + Shr) + Sb = G + (Chp + Ihp) + (Chr + Ihr) + Ib + NX
        T + (Chp + Shp) + Shr + Sb = G + (Chp + Ihp) + Ihr + Ib + NX
        Now let (Chp + Shp) = Wp = Income of lower-income households, and let (Chp + Ihp) = Hp = Total expenditure of lower-income households. Therefore, we can write,
        T + Wp + Shr + Sb = G + Hp + Ihr + Ib + NX
        (G-T) + (Hp-Wp) = (Shr + Sb) – (Ihr + Ib) – NX —-(II)
        Where (G-T) is the excess of governmental expenditure over governmental revenue and is called the fiscal or budgetary deficit and (Hp-Wp) is the excess of lower-income household expenditure over lower-income household income and is called the lower-income household deficit.

        Now compare the original Keynesian equation from the 1930s in (I) to what we have been seeing in more recent decades in the America as indicated in (II).

        Equation (II) is telling us that EITHER the government, OR lower-income households, OR both, must run a budgetary deficit to clear any excess savings that upper-income households and businesses generate above and beyond that which are either needed for investment by these two groups or can be pushed out as net-exports.

        In other words, if the desire of the higher-income households & businesses to save EXCEEDS the desire of the same two groups to invest and the desire of foreigners to borrow, then there are only two possible outcomes:
        (i) EITHER the government OR lower-income households OR both must run deficits (i.e. borrow and spend by going deeper into debt) to CLEAR that desired excess of saving, OR,
        (ii) Unemployment will RISE, especially for lower-income households, and the economy will go BELOW full-potential such that that desired excess is killed.

        This is the problem of inequality today. Inequality in a demand-constrained (Keynesian) economy is not a moral, emotional, religious or social “cause”. It is instead an amoral, cold and rational issue of the formation of unsustainable economic-imbalances in terms of rising perpetually rising debt-loads or persistent unemployment.

        I hope Krugman and Summers UNDERSTAND this point and STOP talking about ONLY the federal government’s deficit & debt as “Keynesianism”. That was indeed a good approximation to make in the 1930s, but it is a horribly bad approximation to make today. If someone reading Michael’s blog here happens to be a student of either Krugman or Summers, PLEASE convey this point to them and try to make them STOP repeating the assumptions made in the 1930s.

        Note two points of interest:
        1) I used the terms lower-income households and upper-income households because it is assumed that the former have a higher marginal tendency to spend, while the latter have a higher marginal tendency to save. The equation could be alternatively reformulated by just splitting households into type I (net borrowers who run deficits) and type II (net savers who run surpluses), without any reference to specific income-levels. This approach might be a good idea is there is a fear of escalating class-conflict.
        2) The NX is used to symbolize a presume trade SURPLUS. Given that America has been running a persistent trade DEFICIT, this means that either the government (G-T) or lower-income households (Hp-Wp) must run EVEN LARGER deficits (i.e. go even deeper into debt) to accommodate the deficit in order to prevent unemployment from rising. Thanks a lot, China. We owe you.

    • Vinezi: what you ignore is ceteris paribus; in this case; interest rates, which are now (approximately) ZERO; any reasonable fiscal stimulus with a modest rate of return should be undertaken. But building the proverbial new bridge requires a political decision – the Fed doesnt build bridges; Lincoln, FDR, LBJ managed the political process successfully and got “bridges” built – this president (blame who you will), cannot accomplish that. One hopes a new administration will.

      • ^Dan Berg WROTE: “…what you ignore is ceteris paribus; in this case; interest rates, which are now (approximately) ZERO; any reasonable fiscal stimulus with a modest rate of return should be undertaken….”
        ———————————————————

        Here is an article from Forbes magazine that discusses a related point of some interest:
        http://goo.gl/ByZJEA

        The article asks as to which of the following is a more relevant indicator of government debt-load:
        (a) Government-Debt/GDP
        https://research.stlouisfed.org/fred2/graph/?g=1TCp
        (b) Government-Debt/Government-Revenue
        https://research.stlouisfed.org/fred2/graph/?g=1TCv
        COMPARE (a) & (b): https://research.stlouisfed.org/fred2/graph/?g=1TCH

        We can take this article one-step further and introduce a THIRD possible indicator of actual government debt-load:
        (c)(1) (Government-Debt X Interest-rate)/GDP, OR,
        (c)(2) (Government-Debt X Interest-rate)/Government-Revenue

        Here are the corresponding data for you to examine:
        (c)(1) Government interest-payments as share of GDP
        https://research.stlouisfed.org/fred2/graph/?g=1TC2
        (c)(2) Government interest-payments as share of Revenue
        https://research.stlouisfed.org/fred2/graph/?g=1TCe
        COMPARE (c)(1) & (c)(2): https://research.stlouisfed.org/fred2/graph/?g=1TCY

        Is this the point you were trying to make? If you can confirm this, then we can proceed with this line of thought.

        • Yes; this is the point I was trying to make. In the FRED graph debt/receipts (blue line), debt/gdp (green line) between 1980-93 both rose steadily ( not good); trends then changed – markets were stable. The spike in debt/receipts in 2008 (not good) is now correcting – markets are stable. No one is arguing that high and rising debt is either desirable or risk free. It depends.
          The Forbes article adds more confusion. He states that economists dont like family-govt debt comparisons, fails to explain WHY, then proceeds to equate the two. But a family has a time constraint, govt does not. “Burdening the grandkids with debt” is always irresponsible for a family; not necessarily for a govt. What about the burden of a decrepit infrastructure which slows economic growth? (Obviously, debt can also be irresponsible for a govt.) But what if circumstances are such that a small increase in debt leads to a future large decrease in debt. Should that investment be made even if initial debt levels are high?

          • Yes, the point you are making is the same as the point Summers makes when he says that since monetary expansion has reached its limit with low interest rates, we should take advantage of the low interest-rates and use fiscal (budgetary) deficits to stimulate the economy:
            http://goo.gl/uQ14Xe

            Key EXCERPT from Larry Summers: “Imagine a secular stagnation world with a zero real interest rate. Then, government debt service is very cheap. As long as a public investment project yields any positive return it will generate enough revenue to service the associated debt. This effect will be magnified if there are any Keynesian fiscal stimulus effects of the project or if there are any hysteresis effects. Notice that with sufficiently low real interest rates, even fiscal stimulus, which does not have supply effects, can pay for itself through multiplier effects”.

            PARI I) What Summers is saying is that the US does not have a Keynesian debt-problem, because the load of interest payments on the US Federal government today are at the same level as they were in 1960, when nobody was saying that the US was in trouble. This is similar to the Krugman argument that there is no Keynesian debt-problem because the debt-load of the USG was higher in 1950 than it is now:
            https://research.stlouisfed.org/fred2/graph/?g=1TC2
            https://research.stlouisfed.org/fred2/graph/?g=1SS2

            On this point, we note that Summers is making the same error as Krugman; both of them mistakenly assume that the Keynesian load refers to the debt-load or interest-load of the Federal government ALONE. This is not correct. State governments & households are also providers of debt-based additional aggregate demand and so their debt-loads or interest-loads must be included in the calculation of the total Keynesian load of the US. Let us do that as follows:
            (A) Total Keynesian Debt-loads
            https://research.stlouisfed.org/fred2/graph/?g=1SRV
            (B) Total Keynesian Interest-loads corresponding to (A), after accounting for changes in the interest-rates
            http://goo.gl/8GwHPe

            As seen in the graph in (B), even though the interest-load of the federal government ALONE may be at the same level as it was in 1960, the TOTAL Keynesian interest-load for the US is much higher than it was back then. Yes, it is true that the total Keynesian interest-load for the US right now is still at the same level as it was in 1978, but this is only because the Fed funds rate is temporarily at ZERO now when it was at an unusual high of 10% back then. Given that the US cannot continue at zero interest-rate forever, any future rise will take the current Keynesian interest-load back up again. In fact, we can roughly estimate that at the current Keynesian debt-load level, a mere 2% rise of interest rate (from ZIRP) level will take the Keynesian interest-load level to highs never seen before in US history. In other words, even the existing level of the Keynesian debt-load will not be sustainable in terms of interest-load, if interest rates were to rise by even a small 2-3% from the current ZIRP level. This is the point that both Summers & Krugman miss.

            PART II) Summers is correct that fiscal deficits may stimulate the economy (i.e. close the potential gap) on a temporary basis. It may well be theoretically profitable for the USG to “level the Rocky mountains” if interest rates are low enough. But here is an example of a country that has been doing just that– It has been taking advantages of falling (or perpetually low) interest rates to stimulate its economy by running large fiscal deficits to “level mountains”:
            https://research.stlouisfed.org/fred2/graph/?g=1TMj
            https://research.stlouisfed.org/fred2/graph/?g=1U3U
            https://goo.gl/H0ADUC

            Far from the debt-load falling, as Summers/Krugman suggest will happen, this country’s debt-load has now grown so high that the very concept of Keynesian stimulus no longer works. The ‘batteries’ of the Keynesian system have died and the economy is now in irreversible stagnation; the idea of a Keynesian stimulator has replaced by the concept of a Keynesian ventilator. This country is now in a coma on permanent life-support. Let us compare this country’s benchmarks to the US—

            A) Compare Debt/GDP Loads:
            https://research.stlouisfed.org/fred2/graph/?g=1TM4
            B) Compare Benchmark Interest Rates:
            https://research.stlouisfed.org/fred2/graph/?g=1TM8
            C) Compare Interest-payment/GDP Loads:
            https://research.stlouisfed.org/fred2/graph/?g=1TM2

            Are you certain that the US will not down this path? Let me know your thoughts.

          • ^^Dan Berg WROTE: “…In the FRED graph debt/receipts (blue line), debt/gdp (green line) between 1980-93 both rose steadily ( not good); trends then changed …..”
            ———————————————-

            Yes, the trend reversed direction from 1992 up until 09/11 of 2001, but the 1990s represent an unusual trend that is nearly impossible to repeat. This point was specifically discussed a few days ago on this very page:
            http://goo.gl/ctnw3k

      • ^Dan Berg WROTE: “But building the proverbial new bridge requires a political decision – the Fed doesnt build bridges; Lincoln, FDR, LBJ managed the political process successfully and got “bridges” built….”
        ———————————————————–

        Related to the points you have made is this left-tilted (demand-side) article from the Washington Post that attempts to debunk conservative (supply-side) arguments:
        http://www.washingtonpost.com/news/wonkblog/wp/2013/04/08/why-do-people-hate-deficits/

        POINT 1: “You can’t just run deficits forever. Surely the money has to come from somewhere.”

        The general formula is as follows:
        If Budget-deficit > Debt/GDP X Nominal Growth-rate, then Debt/GDP (i.e. Debt-load) will rise.
        If Budget-deficit = Debt/GDP X Nominal Growth-rate, then Debt/GDP will stay unchanged.
        If Budget-deficit < Debt/GDP X Nominal Growth-rate, then Debt/GDP will fall.

        Therefore, as long as the Budget-deficit is LESS than Debt/GDP X Nominal Growth-rate, then such a budget-deficit can be run forever without any increase in the debt-load.

        POINT 2: "It's unconscionable to load so much debt on to our grand-kids."

        The problem with debt-load is not that the whole of the US loses future income. Even if all debt in the US were American-owned, it still represents a point of concern. The problem with debt-load is that it implies an transfer of income in the form of interest payments from the bottom to the top. This automatically leads to upward pressure on savings and downward pressure on consumption. For a demand-constrained (Keynesian) economy like the US, this is harmful because it puts downward pressure on aggregate demand and leads to rising unemployment in the future.

        Therefore, the problem is not "leaving a whole lot of debt to our grand-kids to repay". The problem is that our grand-kids may end up unemployed because of insufficient aggregate demand caused by the rising inequality that results from large interest-payment transfers from the bottom income-earners to the top income-earners.

        POINT 3: "We'll be in debt to the Chinese! Think of the national security risks!"

        The issue neither about the Chinese specifically nor about political security risks. The issue is that foreign borrowing causes the US current account to run into deficit. This implies that the US is exporting aggregate demand to the rest of the world. In a situation where the US has high underemployment (and is running fiscal deficit to remedy it), it is ridiculous for the US to be running a current account deficit. Therefore, the loss of aggregate demand and high underemployment is the REAL RISK of foreign borrowing, and not the silly antics of the Zhong Guo Gong Chan Dang.

        POINT 4: "We're broke! America is going to be bankrupt!"

        Just because the US Federal government cannot default on its debt because "it owns the currency printer" does not preclude the rest of America going bankrupt. If asset prices crash and mass unemployment results, households and corporations can certainly go into to mass bankruptcy.

        POINT 5: "Deficits will give us inflation!"

        Budget deficits are ALWAYS inflationary. Whether they actually cause inflation or not depends largely on what type of economy it is. In a demand-constrained Keynesian economy (like US today), the inflationary effect of budget deficits cancel out the natural deflationary effects of such an economy and do not result in actual inflation. In a supply-constrained Classical economy (like India today), the inflationary effect of budget deficits add to the natural inflationary effects of such an economy and result in high inflation.

        POINT 6: "Every dollar lent to the U.S. government is a dollar not lent to private companies."

        The "crowding out" of private investment by government borrowing is a very real concern in a saving-constrained Classical economy (e.g. India today). In a demand-constrained Keynesian economy like the US today, however, it follows that private investment is LOWER than potentially available savings. It fact, this is why the economy is called "demand-constrained". In such an economy, there is no concept of "crowding out". Government deficits in a demand-constrained economy tend to increase employment by generating additional aggregate demand and, in doing so, actually help private investors by increasing the demand for their output.

        POINT 7: "Countries with debt over 90 percent of GDP enter a danger zone."

        It is NOT the debt of the federal government ALONE that is relevant. This is a point that Michael's research has clearly demonstrated repeatedly. What matters is the TOTAL debt-load (or debt/GDP) of the whole economy.

        While an exact figure is difficult to argue, reason dictates that there must be a debt-ceiling beyond which debt-loads cannot rise without destroying future prospects for growth. The idea that there is no limit to debt-load is absurd.

        POINT 8: "Deficit-spending in good times makes it harder to do so in bad ones."

        This is ALWAYS true. Regardless of whether the economy is a Classical one or a Keynesian one.

        POINT 9: "Not balancing the budget means borrowing more, which adds to the national debt."

        It is not the ABSOLUTE level of the debt that matters. What matters is the RELATIVE level of debt (debt-LOAD or debt/GDP ratio). See Point 1.

  50. Mr. Pettis,

    If you want to read a theory on how demographics and the economy interacts then you should read the work of Harry S. Dent.
    https://en.wikipedia.org/wiki/Harry_Dent

    Dent is not an academic but he runs a consulting firm HSDent. Already in the 1980s, Dent discovered the socalled “Family Spending Cycle”. The heart of that thesis is that a family spends more and more money after a man and a woman have married because they have children. Those children cost over time more & more money. But that rise of family spending peaks as soon as those children start to find jobs. Then those children can pay for their own expenses and don’t have to rely on their parents any more. From then on the family’s spending continues to go down. And since spending drives an economy (See also Steve Keen: GDP = Income + change in debt) one should follow the spending habits of families.

    Typically familiy spending (e.g. here in the US) peaks at the (average) age of 47 years. Combine that with that the Baby boom peaked in 1961 and then one can conclude that the peak of the US economy was in 2008 (= 1961 + 47).

    Japan’s baby boom peaked in the 2nd half of the 1940s and therefore the japanese economy peaked in the early 1990s. But Japan has only a population of about 110 million.

    But the baby boom in Europe, North America & Australia peaked around 1961 and that means that in those 3 regions the economy would peak in 2008/2009. Keep in mind, N.-America, Europe & Australia combined have a population of some 730 million people. And then those 3 regions will put a more dramatic pressure on “familiy spending” and on the economy.

    Steve Keen is familiar with the work of Harry Dent.
    http://www.debtdeflation.com/blogs/2011/09/06/harry-dent-in-australia-september-october/

    • Thanks, Willy2. I will check him out.

      • Dent’s books are a typical american “How to” books and not literature/text books for students. I read the “The Great Crash Ahead”. about say 60% to say 80% is simply useless but the remaining stuff is good. What applies for the US applies also for Europe & Australia

        Although I don’t agree with his opinion on inflation:
        – In the 1960s & 1970s workers received wage increases at or above inflation and that pushed inflation higher & higher.
        – From say 1981 onwards, workers received wage increases below inflation. It effectively have put consumers on a wage diet. Let assume inflation is 5% but workers receive only a 3% raise then the workers/consumers lose purching power to the tune of 2%. But that 2% loss in purchasing WILL undermine demand. So, by maintaining this “moderate wage growth” (from the early 1980s) the coporate sector actually has undermined its own demand.

        • What applies for the US doesn’t apply to Europe and Australia. Australia has been a commodity exporter and Europe has a massive banking system with a fixed exchange rate between the countries in he Euro. It’s like comparing apples to beef to onions and saying they’re all the same. The real problem that’s being made is the sheer ignorance of supply-side economic factors and financial factors on those supply-side economic factors.

          “From say 1981 onwards, workers received wage increases below inflation. It effectively have put consumers on a wage diet. Let assume inflation is 5% but workers receive only a 3% raise then the workers/consumers lose purching power to the tune of 2%. But that 2% loss in purchasing WILL undermine demand. So, by maintaining this “moderate wage growth” (from the early 1980s) the coporate sector actually has undermined its own demand.”

          You do realize this problem could be fixed by reducing inflation, don’t you? Deflation increases real wages by falling costs.

          • – No. In Europe, Australia (+New Zealand) & North America are the same (demographic) forces in play. In all 3 regions the Baby boom peaked in/around 1961 and therefore the “Family Spending Cycle” peaked in all 3 regions in/around 2008 (= 1961 + 47).
            – Agree. Falling/reduced inflation is good for the consumer/worker.
            But it’s bad for the producer (shrinking profit margins). The problem is that the consumer/worker is employed by producers. So, when the employer goes belly up then it will put workers/consumers out of work as well and lose their income all together. 2 good examples are iron ore mining in Austrlalia and shale oil production here in the US. Keep in mind: Every job in the “oil patch” supports 3 jobs in the rest of the US economy.
            – From 1981 up to 2008 the consumer was willing to plug the gap between wages and inflation by going deeper into debt. After 2008 the US consumer was less willing to increase its debts & increase spending. Hence the weak economy.
            We saw that in early 2015. Falling oil prices meant that US workers saw their purchasing power increase but those workers didn’t spend too much on stuff. Consumers/workers chose to reduce their debts instead.

          • “No. In Europe, Australia (+New Zealand) & North America are the same (demographic) forces in play. In all 3 regions the Baby boom peaked in/around 1961 and therefore the “Family Spending Cycle” peaked in all 3 regions in/around 2008 (= 1961 + 47).”

            They’re not the same demographics. In the US, fertility rates have largely maintained ~2 and immigration is still creating population growth. In Europe (minus Scandinavia, France, and UK), fertility rates are <1.4 in most cases. The similarities are scant.

            "Agree. Falling/reduced inflation is good for the consumer/worker.
            But it’s bad for the producer (shrinking profit margins). "

            Why do you assume deflation has to lead to less employment? Supply-side deflation leads to higher real wages for workers, greater purchasing power for consumers, reduced costs for firms, and can lead to higher profits for firms. You're using natural resource firms as an example, which are gonna do terrible from deflation, but other firms do well. There's far more firms in a sound economic structure than just natural resource extraction companies. Why do you simply assume that some firms going out of business is bad? This is an assertion that you keep making in your comments that I just don't understand. What you take as fact is something I look at as a faulty assumption. Some firms must go bust.

            "Falling oil prices meant that US workers saw their purchasing power increase but those workers didn’t spend too much on stuff. Consumers/workers chose to reduce their debts instead."

            What does this do to demand over a longer time frame? It frees up real purchasing power.

          • @Suvy:
            Agree. Lower prices also lowers input prices for corporations and increases their profits but ONLY for a short while. Because corporations didn’t abandon their “moderate wage growth” policy. So, demand will remain “subdued”.

            No, it can’t be solved by reducing inflation. Because falling inflation (since 1981) is the RESULT of “moderate wage growth” since 1981. So, if one wants to reduce inflation then one needs to reduce wage growth even more.

          • “No, it can’t be solved by reducing inflation. Because falling inflation (since 1981) is the RESULT of “moderate wage growth” since 1981. So, if one wants to reduce inflation then one needs to reduce wage growth even more.”

            This is straight up wrong. How can you reduce an organic complex system to simple cause and effect dynamics (like saying falling wage growth is the result of falling inflation)?

            Secondly, rising inflation, historically speaking, has always led to lower real wages. Inflation is a highly regressive tax on those who don’t hold real assets. The working classes are the ones who hold virtually no real assets.

          • A couple other points of note: there’s a difference between NOMINAL demand and REAL DEMAND. I don’t know why you’re simply assuming away the difference.

            Secondly, there’s more to business than corporations. Almost all of the American economic system is driven by smaller scale firms, not large corporations. Small scale firms tend to be strongly middle class. So I don’t know why the first thing that comes to your mind are profits of large scale corporations.

            Remember: Real wage growth=nominal wage growth-rate of inflation

            Also, why are you assuming all kinds of deflations are the same. There’s different kinds of deflation that can occur for different reasons with different structural causes. This is a major issue with Keen: he just assumes away structural factors or talks about them in ways that’re incoherent and contradictory while claiming “history” supports him.

          • O.M.G.

            – Even with a fertility rate of 2 the US can’t mitigate the negative impact of the “Familiy Spending cycle”. Then the fertility rate has to be (much) higher. (Saudi Arabia has a rate of 5). But the amount of US births dropped by 12% since 2008, as well.
            – Wages & inflation:

            “like saying falling wage growth is the result of falling inflation”. This is NOT what I wrote !!!! Falling inflation is the result of “moderate wage growth”.

            Look at China: in 2009 worker’s/household’s share of GDP had fallen to a record low of ~ 35%. (source; Michael Pettis, september 2009).

            An “organic & complex system” can – if one removes a lot noise – actually be very simple.
            – Yep. We here in the US all hate Karl Marx, right ?

          • “Yep. We here in the US all hate Karl Marx, right ?”

            Marx had no complexity in his head. He was the kind of person who thought that if he didn’t understand it, it shouldn’t exist. Please don’t point out Marx as the kind of guy who understood complex systems (look at his views on religion, Asiatic mode of production, stateless society as a mark of progress, and much more idiocy). Marx was a retard, plain and simple. To say that he had any sort of complexity in his thought is just a joke. He’d probably never looked at a balance sheet in his life to be perfectly honest.

            ““like saying falling wage growth is the result of falling inflation”. This is NOT what I wrote !!!! Falling inflation is the result of “moderate wage growth”.

            Look at China: in 2009 worker’s/household’s share of GDP had fallen to a record low of ~ 35%. (source; Michael Pettis, september 2009).”

            You do realize that you haven’t proven anything, right? These are complex systems, so to reduce the entire system to one factor and say it’s the problem is fundamentally wrong. How is falling inflation stemming from “moderate wage growth” even bad? The biggest increases in standard of living and purchasing power in US history, particularly for middle class households, came during periods of deflation. The Great Depression was an exceptional case, not the norm.

            This is why I always harp on the point between the middle class and the working class. The middle class does very well in periods of deflation, provided debts aren’t being liquidated en masse. Unionization pushes up inflationary pressure and puts a huge pressure on the middle class by increasing inflationary pressure, which are offset for the working classes by indexed wages via unions. To say this is the path to prosperity is a joke.

          • Suvy WROTE: “Marx had no complexity in his head. He was the kind of person who thought that if he didn’t understand it, it shouldn’t exist. Please don’t point out Marx as the kind of guy who understood complex systems (look at his views on religion, Asiatic mode of production, stateless society as a mark of progress, and much more idiocy). Marx was a retard, plain and simple. To say that he had any sort of complexity in his thought is just a joke. He’d probably never looked at a balance sheet in his life to be perfectly honest.”
            ————————————————————-

            1) If Marx was a “retard, plain and simple” because he got some things wrong, then Einstein was also a “retard, plain and simple” because he too got some things wrong. In fact, all people, great or insignificant, are “retards, plain and simple” because everybody, at some time or another, will get things wrong. Note that Michael, to whom this blog belongs, may be SOLE exception to this otherwise-universal principle, because Michael is ALWAYS right.

            2) Marx, even though he was wrong on many things, was the amongst the most far-sighted geniuses of the past 200 years. The extreme Marxists, however, are indeed ‘idiots’. They are ‘idiots’ because they are unthinking followers who treat Marx as some kind of prophet and refuse to believe that anything that was said by Marx could be wrong. This is the deadly mistake that brings ruin upon them and other around them.

            3) Marx predicted that Capitalism was unstable and would be replaced by Socialism. He also predicted that Socialism itself was unsustainable and would be replaced by Communism. He prophesied that in the final Communist stage, there would be no need for government itself. This is striking prescience that shows genius.

            Comparing the system of the 1850s (when Marx wrote all of this) to the present system in the West (i.e. developed countries Europe, Japan, US), can anybody doubt that Socialism has replaced Capitalism? If we look closely, we can see that 70% of the planks of the Communist Manifesto has already been implemented in the US itself. What was Ronald Reagan doing? Why didn’t he dismantle all this and take the US back to what it was in the 1850s? Was Reagan himself a closet Marxist?
            http://laissez-fairerepublic.com/tenplanks.html

            Still further, if we look carefully, we can see that the Keynesian demand-side insight (1930s) is simply a derivation of Marxist ideas of the 1850s. In addition, once we realize that Friedman’s monetarist ideas are merely a privatization (or householdization) of Keynesianism itself, we can see that that Socialism has already arrived in all developed countries. The libertarian idea that Government is bad, is actually in perfect agreement with Marx, in that Marx claimed that government itself was a temporary phenomenon needed only until the Socialist period ended. In the communist stage, Marx predicted, there will be no government at all. Marx, in turn, was agreeing with what Percy Shelley wrote in support of the American Revolution (~1775): “That government is best which governs the least. Government is but a necessary evil; when all men are good and wise, government will of itself decay.”

            4) Japan is the pilot-probe of the final stage predicted by Marxist. Japan will be the first country to break the barrier of unsustainable Socialism and make the breakthrough into the early stages of Communism. This will happen when the return on capital in Japan goes to zero and capital becomes the same as [inventory – holding costs]. This is what makes Japan so interesting to watch. Germany & Italy will then follow Japan. The rest of the West will follow them slowly, accompanied by Korea. The US will probably be one of the last of the developed countries to cross the barrier into Communism. Note that all of this will happen peacefully, within the context of liberal democracy; Marx was wrong when he predicted violent revolutions.

            5) As for balance-sheets, Marx had tremendous insight into them. He insisted that people were the real assets on the LHS of any company. Can you find any top manager in the US today who disagrees with Marx? All of them say, “our people are out biggest asset”. This is exactly what Marx said. Marx, however, made a spectacular error when he claimed that people were the ONLY asset of any company. This is not true in the Capitalist and Socialist stages, because a return on Capital is justified in these two phases. So not all value is created by labor alone in these two stages– Marx got this wrong in his flawed “labor theory of value”. However, in the final stage, which Japan is now slowly entering, the “labor theory of value” will be correct, as the domestic return on capital will go to zero in this final stage.

          • “Marx, even though he was wrong on many things, was the amongst the most far-sighted geniuses of the past 200 years. ”

            This is nonsense. The first person who should get the credit for “Marx’s insights” is actually Alexander Hamilton.

            “Still further, if we look carefully, we can see that the Keynesian demand-side insight (1930s) is simply a derivation of Marxist ideas of the 1850s.”

            Wrong again. This is followed from Hamilton’s thinking. The idea of high wages to sustain strong internal demand. The idea that people are an asset that need to be invested in didn’t first come from Marx; it came from Hamilton.

            “The libertarian idea that Government is bad, is actually in perfect agreement with Marx, in that Marx claimed that government itself was a temporary phenomenon needed only until the Socialist period ended.”

            This is exactly why I’m not a libertarian. I actually like the American libertarian work on financial history, particularly on American financial history, and I’m quite familiar with it, but their philosophical approach would lead to geopolitical disaster. Both the libertarians and Marxists come from the approach of political economy, but political economy isn’t really what matters. It’s geopolitical finance that matters!

            So yet again, I’ll refer to Hamilton on these matters to supersede Marx.

            I’d actually disagree with the claim that most of the developed world is socialist. I don’t think Japan is socialist. I think Japan nationalizes their financial system, not for distributing things to its people, but to broker power transfers within elites whilst using the financial system for geopolitical clout. I’d agree with you on parts of mainland Europe, but this is a different topic for a different day. I’d also dispute the claim that the US is socialist; the US is federalist, not socialist. There’s a huge difference there. The US is a geopolitical financial system that’s basically the classic example of a liberal empire. The US is not Marxist in any sense.

            Again, using a political economy starting point leads to real errors because political economy doesn’t operate the world. It’s geopolitical finance that operates the world.

            I’d actually argue that socialism developed as a mechanism for warfare and, in particular, for states that were specifically built for warfare (like Germany). In Europe, capital is viewed as a national asset which is why everything in Europe runs through their banking system. The banking system is highly regulated and tightly controlled where foreigners are prevented from even having a say. In the US, it’s an equity/capital-asset based financial system (always has been since the days of Hamilton), which means you get a lot of recycling with virtually anyone being able to hold assets. This allows foreigners to have a very strong say in the financial system. Socialism, as we now know it, particularly in Europe came about because of the rise of nationalism in the 19th century.

            I’d also argue that, historically speaking, the American political system gives more power to the elites than virtually any system ever designed. The Marxist views are inherently populist with the power being vested in the people. For all the talk about “democracy” or “power to the people” in the US, the US is less democratic than Russia in terms of the “will of the people” or “power to the people”.

          • Oh yea, I’d also like to add that the US is probably the definition of Marx’s nightmare, not close to his dream. Even look at the social safety net in the US like unemployment benefits as the classic example. The creation of the social safety net was to basically create free labor, which helps the middle class and hurts the working class. The design of the social safety net in the US is to help the elites, not the people. It gives them better access to skilled workers whilst keeping the costs to the elite at a minimum. Hell, labor mobility within the entire US is even larger than any country of Europe even though the US is far larger.

            Another issue with Marx is the incorrect excess capacity arguments they use. Again, the primary consuming class IS NOT the working class, it’s the middle class! Marx hated the middle class and wanted to ruin them. Take a look at the way the crisis unfolded in the US in 2008. It was an overconsumption boom wherein the boom coincided with current account deficits, has led to deflationary pressures/deflation, and the large scale securitization of assets into shiftable capital assets. That’s not Marxist or socialist, that’s federalist.

            Of course, most people would talk about how much of an anomaly or how unusual it is for the US to be in that situation and how historically the US has never been here before, but that’s just garbage. This is just another story of a classic American crisis. We’ve seen this before, with regularity. This is usually how it plays out.

            Even look at how the crisis was “solved”:
            1. You take a bunch of bankers/government officials into a room
            2. Fill the room up with cigar smoke
            3. All of the people in the room become furious and angry with one another
            4. A bunch of laws get broken, but somehow confidence is inserted into the system
            5. The liquidity crunch is over and the masses complain about “unfairness” (this is completely justified)
            6. The bankers then proceed to blame the government for a crisis that they basically created
            7. The government gets a slap on the wrist and things continue as normal

            Is this new or out of character for the US? Not really, it’s basically how the US handled every single banking crisis throughout its history with the exception of the Great Depression. Is this the last time the Americans will do this? I’d laugh at anyone who legitimately thinks so.

            My point being, the current state of the US isn’t Marxist or socialist. It’s fundamentally federalist. We can talk about elites buying out Congress or how elites are subjugating democratically elected leaders to their will, but again, this is what usually happens in the US. Slowly, but surely, the elites are getting replaced with new elites. Especially at a grassroots level (I’m personally involved and can testify to this), there’s a lot of change occurring that’s forcing the old elites out. It’s slow, but in 10-15 years, the old elites will be completely purged.

          • The Ten-Planks of the Communist Manifesto at work in the United States today:

            1) Abolition of private property in land and application of all rents of land to public purpose.
            Private property in land has been abolished in the US. Even though people hold title to land on paper and can trade that title, in reality all land in the US is now property of the State. The rent payable to the State for use of this land is called property-tax. All such property-taxes (i.e. rents paid for use of land by private parties) are put to use for public purposes. Massive extension of Eminent Domain flows from this concept.

            2) A heavy progressive or graduated income tax.
            This is almost universal today. The rare exceptions, interestingly, are in the former communist states of eastern Europe and in certain petro-rich gulf countries.

            3) Abolition of all rights of inheritance.
            Estate-taxes (or ‘death-taxes’) were introduced to whittle down inherited property passed on from one generation to the next. In the asymptote, this was designed to wipe-out all inherited wealth by means of State-confiscation.

            4) Confiscation of the property of all emigrants and rebels.
            Numerous laws specify confiscation of all properties of those who either break the law (RICO) or flee the US to escape prosecution (Evaders).

            5) Centralization of credit in the hands of the state, by means of a national bank with state capital and an exclusive monopoly.
            The Maestro was a commie who presided over a State-monopoly. The Greenspan Put was nothing but State-backing of all risk-taking “investment”. The ‘lender of last-resort’ is a statist concept that did not even exist until 1913. This is why we hear, every now and then, cries of “abolish the fed!” accompany a call for freedom.

            6) Centralization of the means of communication and transportation in the hands of the state.
            We can imagine what would happen without State-monopoly air-traffic control. Risk-taking entrepreneurs would be flying planes willy-nilly into each other, with mass casualties reported daily. We can also imagine what would happen if risk-taking entrepreneurs arbitrarily introduced hundreds of standards for communication, each incompatible with the other. This is why the US has the FCC, FAA, FHA, USPS.

            7) Extension of factories and instruments of production owned by the state; the bringing into cultivation of waste lands, and the improvement of the soil generally in accordance with a common plan.
            This is called upstream production in the US and it is a 100% State-activity. The State pours billions into the upstream development and production of ideas in a process called research. These products then flow downstream into the guided commercialization arena and finally reach the marketplace to become available for the average individual. Without massive upstream State production, sometimes called basic research, there would be little technological change and the waste-lands of the mind would remain fallow. This is represented by NIH, NSF, DoD, DoE, DARPA and an alphabet soup of agencies that direct billions of dollars of upstream State-production, without the profit-motive.

            8) Equal obligation of all to work. Establishment of Industrial armies, especially for agriculture.
            The US introduced this at the time of independence itself, when it abolished all the titles that were common in the mother-country (UK). This is why, even today, a person who feels that the world owes him a living is said to be feeling “entitled”.

            9) Combination of agriculture with manufacturing industries; gradual abolition of the distinction between town and country by a more equable distribution of the population over the country.
            Numerous laws passed in the US making it compulsory for companies to deliver electricity & telephone to reach everyone in the country, regardless of the profitability of such a connection. The idea behind this was to “gradually abolish the distinction between town and country” and to prevent mass migration into the crowded cities.

            10) Free education for all children in government schools. Abolition of children’s factory labor in its present form. Combination of education with industrial production, etc. etc.
            There can be some debate about the quality of the public education system in the US; however, they can be no debate that that public education is free for all children. Laws to prevent under-age employment passed; children have vanished from the production process.

            PS: It is certainly possible, as Suvy says, that Alexander Hamilton was the one who wrote the Communist Manifesto and that Marx merely found it in a drawer of an antique desk and just put his name on the document.

          • ^^Suvy WROTE: “For all the talk about “democracy” or “power to the people” in the US, the US is less democratic than Russia in terms of the “will of the people” or “power to the people”.”
            ————————————————————-

            Did you also get this particular insight from Steve Keen’s non-linear, dynamically heuristic and endogenously accelerating stochastic model of peripatetic debt-disequilibrium?

          • Vinezi,

            Taxation isn’t ownership. If governments don’t have a right to tax, they don’t have anything. I’d also like to add that property taxes are run by local and municipal governments which vary from state to state. Some states don’t have property taxes (or income taxes, for that matter). Property taxes are not administered by the federal government.

            Secondly, credit issuance isn’t centralized. A central bank does not centralize credit or money issuance. A central bank centralizes the issuance of CURRENCY, not money or credit. Money issuance in the US is done by banks, not by the Federal Reserve.

            Also, central banks were built for warfare. They were explicitly designed to give a large region a united interest in the geopolitical sphere. This is the problem when we use things like social issues to determine the role of the state, we get errors in the way we think about things.

            The fundamental authority of all government is force and geopolitics, not people’s feelings, is the ultimate test of survival. Finance is used to mobilize those resources in times of warfare.

            There’s also no abolition of the rights of inheritance. It’s graduated, but inheritance isn’t abolished. Just ask the Walton family.

            You also said:
            ” Combination of agriculture with manufacturing industries; gradual abolition of the distinction between town and country by a more equable distribution of the population over the country.”

            Have you traveled the US? A more “equable distribution of the population over the country”?! Forget about the US, this is straight up wrong for the East Coast. You’re talking about how telephones were being given out as a right, but if you go to some random place in South Carolina, the distribution isn’t even close to how it is in, say, Charlotte or Raleigh-Durham. There’s huge gaps, not just in the wealth or income distributions, but also in the ability to access WiFi, the basic infrastructure needs for technology, and a whole host of other stuff.

            Does this look like an equable distribution of population? Almost all populations in the US cluster and most of the regions have very few people who live there.
            http://modernsurvivalblog.com/wp-content/uploads/2010/06/usa-population-density-map-flat.jpg

            I’d also argue that the laws about power and electricity have more to do with national security goals than anything else. There’s good reasons why you’d want a lot of those things from a national security standpoint.

            Oh yea, Marx wasn’t the first to ask for a public school system or state-sponsored education. Again, that was people like John Adams and Alexander Hamilton–including aid for people who want to go to college or get advanced degrees.

            “10) Free education for all children in government schools. Abolition of children’s factory labor in its present form. Combination of education with industrial production, etc. etc.”

            Yes, because apparently the only thing the US produces are industrially produced manufactured goods. Wait a minute…. The US is a service based economic system, not one that cranks out industrial goods.

            “Laws to prevent under-age employment passed; children have vanished from the production process.”

            Even in the industrial age, the idea that every single family had their kids working in factories in the US isn’t correct. Even in the late 19th century, the amount of education level among US workers was much higher than virtually anywhere else in the world. In terms of American skilled labor, the idea that all kids were just slaves in factories isn’t quite right.

            You’re talking about agriculture, but it was actually the capitalists that wanted communal agricultural settings. They simply thought it’d be more profitable and make more sense. This was true, in particular, for the Southwest US starting in the mid to late 19th century.

            Another point of note: private holding of land and the inability of governments to come in and take away private lands when there’s natural resources on the land is why the shale boom is in the US and not anywhere else. It has a lot to do with the way incentive structures lined up.

          • I’d also like to add that my problems with Marx aren’t even the stuff you’re pointing too. It’s all the other stuff he stood for. Most people would say Capital is his best work, but Capital is worse than The Communist Manifesto IMO. If you actually go through Capital (the first chapter is enough to suffice).

            One of the biggest issues I have with Marx is that he assumes only two classes, but in reality there are a total of 4 classes. He tries to split everything into a struggle between two groups, but he completely ignores class mobility. Marx talks bad about a class structure, but class structures are necessary. People always talk about the caste system as a birthright thing, but if you read the Vedanta, the caste system is merely a necessary organizational structure for any functioning society. Caste is not something that has to be mandated by birth, but there must be some organizational structure. Some parts of society are more expendable than others.

            In The Communist Manifesto, Marx talks about it as a good idea to give the power to the masses. That’s a horrible idea! If some guy is lifting a box from point A to point B, it’s easy to substitute. If some person has spent his entire life studying and observing sacred rights whilst trying to preserve the wisdom of our ancestors or if a philosopher has spent decades of their life meditating in random places where they go close to months at a time without food, that’s not easily substitutable. The latter deserves a far higher status in society than the former. The latter should be at the top of the social hierarchy while the former should be at the bottom. Why? Simply because knowledge, especially absolute Truth, precedes everything else. To say otherwise is just the triumph of blind ignorance over all knowledge and wisdom.

            What the Marxists will never understand is that in a capitalist system, hard work actually isn’t rewarded because hard work, in and of itself, isn’t virtuous. In a capitalist system, knowledge commands a higher premium than money. Capitalism, for the most part, creates huge incentives and benefits for the most clever, the most daring, the most intelligent, and the ones most capable of taking advantage of luck.

            Marx makes statements like, oh most people don’t have enough wealth. Well no shit they don’t! Most people, if given wealth, would destroy it by blowing it on stupid shit. This is actually more pronounced in Capital, where he says it’s the working class who create all the wealth because of their hard work, but this is just nonsense. Wealth doesn’t come from hard work; it comes from knowledge, daring, a high tolerance for risk, and the ability to take advantage of what we don’t understand.

            Of course, when we talk about what we don’t understand, Marx has no conception of such garbage. He simply assumes he understands everything, knows everything, and never bothers to question his underlying assumptions. There’s far more to The Communist Manifesto than those 10 points you made. There’s an entire social view that’s just complete garbage.

            From The Communist Manifesto:
            “Question 22. Do Communists reject existing religions?
            Answer: All religions which have existed hitherto were expressions of historical stages of development of individual peoples or groups of peoples. But communism is that stage of historical development which makes all existing religions superfluous and supersedes them. ”

            Is the purpose of religion really just a historical stage? Everything in The Communist Manifesto, except for the small section of those 10 points, assumes a linear progressivist model. The real world is complex, adaptive, and necessarily nonlinear.

          • Hi Suvy. Have you read Popper ‘the open society and it’s enemies’? The first part mainly deals with Plato, and why Platonic ideas are so persistent and so dangerous. Your view on philosophers in society comes very close to Platonic ideas, which easily leads to (somewhat) totalitarian states. I much prefer Friedman and Popper on this issue, even though in the public mind the term Open Society is now a bit too much claimed by George Soros.

          • *it should be sacred rites, not sacred rights.

          • Erikwim,

            I haven’t read a lick of Plato and what I’m saying does not lead to totalitarian states. The most brutal and totalitarian states in the past 500 years have been nation-states IMO. Nassim Taleb said about nation-states: apartheid with political correctness. That’s exactly what nation-states are. The most barbaric and disgusting idea of all time was this rise of nationalist sentiment in the late 19th century.

            Actually, much of what I’m saying is extremely close to Edmund Burke and even the Transcendentalists and others.

          • Yep Suvy, that is exactly what i meant, and agree with barbaric nationalism which is again on the rise in Europe. Even though you have not read Plato, i would urge you to read Popper, especially that first volume. In it he argues why the ‘philosopher’-state solution always leads to the fundamental problem: who decides what is good for all? That indeed is the Burke position you are referring to? Such a philosopher-state can be ‘enlightened’ (Burke), but need not be and can easily becomes totalitarian (Singapore seems a good case of both enlightenment and totalitarian characteristics).

            ‘Burke was a leading sceptic with respect to democracy. While admitting that theoretically, in some cases it might be desirable, he insisted a democratic government in Britain in his day would not only be inept, but also oppressive. He opposed democracy for three basic reasons. First, government required a degree of intelligence and breadth of knowledge of the sort that occurred rarely among the common people. Second, he thought that if they had the vote, common people had dangerous and angry passions that could be aroused easily by demagogues; he feared that the authoritarian impulses that could be empowered by these passions would undermine cherished traditions and established religion, leading to violence and confiscation of property. Third, Burke warned that democracy would create a tyranny over unpopular minorities, who needed the protection of the upper classes.’ (wikipedia)

          • Erikwim,

            I’d agree with Burke and Wikipedia’s assessment on Burke. I don’t trust the common people and I don’t trust “democracy”. With that being said, the US isn’t really a “democracy”.

            Religions and traditions are systems that’ve been developed over thousands of years via negativa (eliminating negatives). Due to the sheer fact that traditions have existed for so long, it automatically makes them robust (Lindy Effect). I strongly agree with Burke on all of those three things.

          • Hi Suvy, interesting. I find your thinking highly stimulating, since it comes from a different angle then my own, while we have the same basic instincts on the world of humanity (and biology) being of a complex nature. I’ll let it sink in for a while.

          • I find the same thing on here as well. It’s nice being in a place where I get put down for speaking garbage. The discussions on this blog are quite enlightening IMO.

            With regards to religion, you may wanna check out this paper by Nassim Taleb and Rupert Read on religion. Now, there’s a whole metaphysical and philosophical underlying to why traditional religion is robust as well, but that’s wholly different (and which I think should be completely separate) from the practical impacts of religion.
            http://econjwatch.org/articles/religion-heuristics-and-intergenerational-risk-management

            Speaking of which, I don’t think most atheists understand the concept of religion or God. Most, if not all, think of God as some man in the sky who popped things up, which no religion actually says unless you take some things too literally. In the Eastern religions especially, the concept of God is just a higher state (it’s basically like Transcendentalism, which was really just a response to modernism). Even Marx wasn’t atheist.

            And the idea that “evolution” disproves the existence of God is just ridiculous. The idea of “evolution” wasn’t first pushed forth by Darwin or anyone in the 19th century. The idea of “evolution” has a clear presence in both ancient Eastern and Western philosophy ranging from the Mahabharata in Hindu script to Marcus Aurelius in ancient Western philosophy. The idea that “evolution” is this brand new idea as opposed to some man in the sky popping people down on earth is really coming from people who probably haven’t read either ancient Western or Eastern philosophy. If I’m correct, both Lutheranism and Islam forbid the physical depiction of God because they consider it sacrilegious and wrong, which it absolutely is.

            Secondly, there’s this idea that the laws of physics contradict God. I wonder how many people understand both physics and metaphysics in such detail to talk about both things that way, but I’m guessing quite few of the people who do talk in such a way. Both Einstein and Newton clearly disagree with that assertion.

            Anyways, the current state of physics tells us that most of the world compromises of dark energy followed by dark matter, both of which don’t contradict any sort of metaphysics. If you look at the perspective of the quantum atom, most of the atom is really just energy, which discredits no metaphysical roots of tradition.

          • Hi Suvy. Interestingly what you say Keen is doing is the exact same thing you are doing talking about religion and evolution: setting up a sort of strawman. I personally am a ‘don’t-know-er’, not an atheist, but most certainly one who regards religion as both highly frequently erroneous (factually) and highly dangerous (as in brainwashing people to accept certain ‘truths’ and worst case act upon these). Also i studied physics (did not stay in the field) so know my basics, and there is nothing in physics or evolutionary theory that has anything to do with a God, even not a creating God (it just alters the ways things are created with progressing knowledge of how things work).

            your poistion on evolution is simply plain wrong. Evolution is not a theory that stated that things evolve, it is a theory on HOW things evolve. Darwin was a superb scientist and a superb observer as many of his other writings and collections show. That is why it is a scientific theory, and the old scripturs are not, even when speaking of evolution and continuous change. Some of the old writing grasped the fundamental facts of life, while many other writing were plain wrong. A lot of religious writing is of the latter, lots of factual and scientifically disproven nonsense.

            You probably also know the historic context. At the time of Darwin there was still a sizeable group of scientists seriously discussing the theory of creationism, the fact that all species were essentially created as they walked the earth at the time of writing. Even today there are lots of people not accepting the core evolutionary theory that human beings have evolved from a set of mere matter (or a combination of bacteria, virusses etc).

          • “Evolution is not a theory that stated that things evolve, it is a theory on HOW things evolve.”

            On this issue, the standard theory of evolution is wrong because it assumes the rate of continuous change is constant, which is something I would strongly dispute. I’d argue the rate of continuous change is fat-tailed (winner-take-all effects). We’ve also never observed a shift between species, although not for a lack of trying (I’m not saying this has never happened).

            Standard theory would say I’m wrong, but standard theory misses that the world is fat-tailed. They say that all the changes are perfectly random with no sort of memory. I say that the changes are, in fact, not even close to completely random. I’m saying the changes are fractals and there’s scaling effects.

            Secondly, the change is obvious. Do you really need rocket science to tell you things changed? You’re talking about how some people thought things as literally being popped by God in Europe? Well yea they did, they were corrupt. The Catholic Church was extremely corrupt by 1500.

            And this is the most important thing, why do you think of God as physical? Or anything that has to do with our physicality? GOD IS NOT A BEING! GOD IS THE CONCEPT OF BEING ITSELF!

            You and I obviously have consciousness. We have the ability to conceptualize the fact that we exist. That is a yes or no ability. You either have the ability to question your existence, or you don’t. So that switch was a sudden swing. What it means is that the world is fat-tailed. God didn’t create the first “human”. God created the first soul.

            Science is a procedure and evolution is the physical manifestation of a biological process. There’s a fundamental difference between the physical manifestation of a biological process and the birth of our spiritual consciousness. Two completely different things that must be kept separate.

          • Also, don’t mix up the difference between “a god” and “God”. They’re two completely different things. The latter is about the discussion in the roots of our existence and is the principle of unity. The former is about is usually about ritual practice.

            Oh yea, take a more careful look at Eastern religious rituals or temples. You see certain demarcations or certain figures accorded to certain patterns. That’s not coincidence. There’s valuable information hidden in those things, even though we might not be fully able to understand the information or even recognize it. It’s foolish to think we can express everything in words, isn’t it?

        • ^^Willy2 WROTE OR QUOTED: “In the 1960s & 1970s workers received wage increases at or above inflation and that pushed inflation higher & higher. From say 1981 onwards, workers received wage increases below inflation. It effectively have put consumers on a wage diet….”
          ————————————————

          No, no. Somebody is confusing between two very different things:

          1) Before 1980, wages grew faster than nominal GDP (i.e. Wages/GDP ratio rose)
          2) After 1980, wages grew slower than nominal GDP (i.e. Wages/GDP ratio fell)
          https://research.stlouisfed.org/fred2/graph/?g=1W7t
          https://research.stlouisfed.org/fred2/graph/?g=1W7q
          https://research.stlouisfed.org/fred2/graph/?g=1W7E

          3) Before 1980, wages grew faster than inflation (i.e. living standard was rising)
          4) After 1980, wages STILL grew faster than inflation (i.e. living standard was still rising)
          https://research.stlouisfed.org/fred2/graph/?g=1W7I
          https://research.stlouisfed.org/fred2/graph/?g=1W7J
          https://research.stlouisfed.org/fred2/graph/?g=1W7S
          https://research.stlouisfed.org/fred2/graph/?g=1W7X

      • Two charts from Dent’s book “The Great Crash Ahead”:
        – Family spending cycle:
        https://www.dropbox.com/s/bd5dl1px6te7z6b/2350-Uitgaven%20index.jpg?dl=0

        – US Birth index adjusted for immigration. See the black line in the background. Turns out that the US baby boom already started in say 1935 and not in 1945. The green trendline depicts the growing group of people becoming 47. That group started to increase already in/around 1982 and peaked in/around 2008. I assume this trend mitigated the impact of “moderate wage growth”.
        The dark blue trend line depicts the amount of people reaching the age of 65. That trendline already started to rise in/around the year 2000 (= 1935 + 65) and is bound to rise until 2026 (= 1961 + 65), assuming nothing bad happens.
        https://www.dropbox.com/s/kbf0e9b8909n04m/2450-Geboorte%20grafiek.jpg?dl=0

    • Am I the only one who gets a tinfoil hat/salesman feel from Dent? The front page of his site hits you with a video, while he gives his pitch, sort of sounding like a WWE manager (totally unfair criticism, I know), with the “Send me this book!” in a bright red box below the video. Then there is the red font and caps…more unfair criticism, I suppose.

      Perhaps Willy2 or someone else can explain how Dent factors immigration into his analysis. I would think this would mitigate, at least to some extent, any demographic troubles in the U.S. (which given ability of the U.S. to attract immigrants seemingly at all levels of the skill spectrum, I would think it is in a better demographic position than most).

      The demographic argument seems more pertinent in the case of Japan (lower fertility rate, longer living, lower immigration). However, did demographics really drive the lost decades…or did it merely occur alongside the real driving factor (perhaps while exacerbating the problem)?

      If Japan suffered the lost decades for many of the same reasons that China will eventually slowdown (e.g., repressed consumption allowing for wasted investment, challenging debtload, etc.), then these factors would seem to be the driving force of Japan’s troubles (rather than its aging population). Even if China (or Japan) had a higher percentage of 47 year-olds (or whatever ideal consumption age), they cannot consume in a balanced way while subject to financial repression, an undervalued currency, and repressed wages (and a poor social safety net in the case of China).

      Similarly, the United States cannot function in a balanced (healthy) manner in the presence of an unbalanced economic world order (characterized by unbalanced capital and trade flows). Should the DOW drop to 6000 or 3000 or whatever Dent predicts, I would think it would relate first to such imbalances which may be exacerbated or mitigated by demographic factors.

      • – Agree. Dent IS behaving like a saleman. But his work on the “Family Spending Cycle” is TRULY excellent & surprisingly SIMPLE. And he wrote a number of books about his predictions. Yes, he has his flaws. E.g. he didn’t see the 2001/2002 recession coming.
        – Dent bases his conclusion on the amount of babies born in a country (US, Germany, Canada, etc.) but he also adjusts that number for immigration & emigration. So, if a 30 year old canadian moved to the US in the year 2000 then one needs to move one birth from the cell “Canada, 1970” and move that to the cell “US, 1970”.
        – This development only occurs when circumstances are ideal (no wars, no famine, etc.) and that was the case for Europe, North America, Japan & Australia (with the exception of Yugoslavia, there was a civil war in the early 1990s causing LOTS of economic & demographic disruptions). But those “disruptions” show up in the birth statistics as well.
        – Japan has only 110 million inhabitants but peaked in the early 1990s. Japan with its strong export sector benefitted from a strong economy in N.-America, Europe & Australia, with some 730 million inhabitants. But Japan also benefitted from its proximity to China.

      • ^Deek WROTE: “Perhaps Willy2 or someone else can explain how Dent factors immigration into his analysis…..xx…..The demographic argument seems more pertinent in the case of Japan (lower fertility rate, longer living, lower immigration)….
        ————————————————-

        A) Japan 1995
        http://populationpyramid.net/japan/1995/
        B) United States 2010
        http://populationpyramid.net/united-states-of-america/
        C) Korea 2015
        http://populationpyramid.net/republic-of-korea/2015/
        D) China 2020
        http://populationpyramid.net/china/2020/

        All these issues of the relative demographics of JAPAN, KOREA & CHINA were covered in discussions last year on Michael’s blog. You can still see the essence of those discussions here:
        http://goo.gl/GYnv8q

        The United States is demographically NOTHING like Japan, Korea & China. They have inverting population pyramids, the US does not. I think people are confusing what the CBO (congressional budget office) calls the “baby-boomer retirement problem” with the problem of bad demographics of countries like Japan, Korea & China. The US does have a “baby-boomer retirement problem”, but it does not have the problem of bad demographics. Here is the DIFFERENCE between the two problems:

        A) In the case of bad demographics, the labor force itself shrinks. In other words, the number of people retiring (or leaving the workforce) is greater than the number of people coming into the workforce. This is caused by an inverted population pyramid. This is an issue that is being faced by Japan and will soon be faced by Korea and China as well. This is NOT a problem the US will ever face for the rest of this century, because its population pyramid is columnar and is expected to stay that way:
        http://populationpyramid.net/united-states-of-america/2050/
        http://populationpyramid.net/japan/2050/

        B) The baby-boomer retirement problem, on the other hand, refers to the fact that the total population of retirees grows FASTER than the labor force. This is due to the fact that rising life expectancy causes more people to come into retirement-status than are leaving it due to death. This process implies that the number of retirees per worker will rise, which happens to be the main concern of the SBO. This phenomenon is true in the US as well as in Japan, Korea & China.

        Once again, note carefully that the US faces problem (B), but NOT problem (A). Japan, China & Korea, on the other hand, face both problems. To put this in mathematical form for clarity:
        I) US Retirees/Workers Ratio: The number of workers does not fall BUT number of retirees rises due to rising life expectancy. This is a one-dimensional problem of a rising numerator WITHOUT a falling denominator.
        II) Jap-Kor-Chn Retirees/Workers Ratio: The number of workers actually falls AND the number of retirees rises due to rising life expectancy. This is a two-dimensional problem of a rising numerator AND a falling denominator, which is why it is often called a ‘double whammy’.

        • – Interesting. Indeed, but that’s a theme Dent also “pounds on”. Demographics in Japan & Korea are “horrible”. US demographics are better but that doesn’t mean the US is “Out of the (economic) Woods” by any stretch of the imagination.
          – Dent is actually the most bullish on India & South East Asia when it comes to the demographic side of the economic equation.

        • Does anyone know when the korean baby boom peaked ?

          • A) Determine the age at which the population pyramid for a country is at its WIDEST.
            B) Subtract that age from the date of the pyramid.

            For example, the 2010 population-pyramid for Korea is at its widest at about 40 years of age. Therefore, the baby-boom peaked in 2010 – 40 = 1970.
            http://populationpyramid.net/republic-of-korea/

            You can do the same for all other countries. For the US, the earliest widest point in its 2010 population pyramid is at 45 years of age. This implies that the post-war baby-boom in the US ended in 1965.

            Hope this helps.

    • ^Willy2 WROTE: “……..GDP = Income + change in debt….”
      ——————————————————-

      A) For any given country:
      GDP (Gross Domestic Production) = GDI (Gross Domestic Income). It can be no other way.
      GNP (Gross National Production) = GNI (Gross National Income). It can be no other way.

      B) For the world as a whole (i.e. for a closed economy):
      GDP = GNP = GDI = GNI. It can be no other way.

      Do you disagree? If so, could you elaborate on how production can exceed income by the ‘change in debt’?

      • Quite simple.

        “Income + change in debt = GDP”. That’s a MAJOR component of Steve Keen’s work which other economists overlook.

        If I take on more debt (say $ 100) then I can spend more ($100) on say milk, candy bars, cigarettes etc. And that leads to an increase of demand for those products and those products need to be produced (Gross Domestic PRODUCTION).

        Never heard of people who need a new (second hand) car (to get to work) but they don’t have enough money in their bank account ? Then those people borrow money to buy that new car. Then their debt changes by say $ 40,000. It also increases GDP by $ 40,000.

        One can say that by going deeper into debt one’s income goes up (temporarily).

        Steve Keen has a nice chart in which is shown the relatioship between change in debt & employment. If the change in debt decreases, unemployment rises. When the change in debt increases then employment will rise. See figure #4 in the link below.
        http://www.businessspectator.com.au/article/2013/8/16/economy/urgent-debt-lessons-forgotten-framework

        • OH yea, that chart, by itself, says absolutely nothing. Correlation DOES NOT mean causation, like Keen assumes. I can virtually guarantee that we can find plenty more variables with charts like that.

          Secondly, he just makes the assumption that falling prices are always bad and must come from expectations of falling prices, as he says here:
          “When businessmen’s expectations become gloomy the same twofold influences comes into play to push prices down.”

          Over time, prices should fall and this doesn’t have to be depressionary. I don’t know why people on the left always assume deflation=depression when it’s just not true. It depends on the type of deflation. There’s other errors, like saying the culprit for ignoring banks/money is Keynes, which is completely wrong. If you actually go through, dig, and read Keynes essays (I’ve read most of them, usually several times each), Keynes does nothing to ignore banks/debt.

          • “Correlation DOES NOT mean causation” Yep, the ususal rebuttal of the nay-sayers.

            More borrowing => more spending => more demand => more production => less unemployment. How is that so hard to understand ? Sounds like you found some (minor) flaws in Keen’s logic and then throw away everything. No, I remain un-impressed.

            Agree. Falling prices don’t have to be deflationary because it was offset, from 1981 up to 2007, by rising debt levels (= more spending) and favourable demographics. But after 2008 US Household debt levels started to contract & US demographics became unfavourable.

            Now look at the formula “GDP = Income + change in debt”. When prices fall then income (for producers) drops as well. Even when “change in debt” remains flat then GDP drops as well.

          • Willy2,

            You’re not distinguishing from higher nominal demand and higher REAL demand. Falling prices, in the case where they come from a fall in the cost of production, increase real demand. Why does it have to start with higher borrowing? Why are you making these assumptions?

            “Falling prices don’t have to be deflationary because it was offset, from 1981 up to 2007, by rising debt levels (= more spending) and favourable demographics.”

            This comment is contradictory. Falling prices are deflationary by definition. Thus, falling prices are NECESSARILY deflationary.

          • ^Willy2 WROTE: “……“Correlation DOES NOT mean causation” Yep, the ususal rebuttal of the nay-sayers…..”
            ————————————————————-

            1) First take a look at this graph:
            https://goo.gl/7ckWVy
            2) Next, compare it to this graph:
            https://research.stlouisfed.org/fred2/graph/?g=26VD

            From (1) & (2), we can see that rapid-increases in the usage of the word “ganja” in America after 1965 caused huge increases in the inflation-rate. Conversely, once the usage of the word declined after 1981, it pulled the inflation-rate down with it.

            From this, we can come up with a powerful prescription for the Japanese government, which has been trying to generate inflation in their economy, without much success, for the last 20 years. We could advise the Japanese government to encourage the usage of the word ‘ganja’ in everyday Japanese conversations, such as, for example, “ohayo gozaimasu” (good morning) could be replaced by “ohayo gozaimasu, anata wa ikutsu ka no GANJA o motte imasu?” (good morning, do you have any GANJA?). Once millions of Japanese people start using the word ‘ganja’ with increasing frequency in their everyday language, it would automatically cause inflation to rise and this would solve Japan’s deadly deflation problem.

            After all, we do have the empirical data to prove the effectiveness of this approach from (1) & (2), don’t we?

          • 🙂 🙂 :-)))

          • Vinezi,

            Well done sir, very well done (again).

        • ^Willy 2 WROTE: “Steve Keen has a nice chart in which is shown the relatioship between change in debt & employment. If the change in debt decreases, unemployment rises. When the change in debt increases then employment will rise. See figure #4 in the link below….”
          —————————————–

          (1) The graph you indicate is showing that debt growth went negative in 2010. This implies that total debt went down (or total money supply went down or total banking balance-sheet shrank) in 2010. This is false. Total debt in the US has been consistently rising. See pages 3 (Table D1), 4 (Table D2) & 5 (Table D3) of the latest Federal Reserve Report here:
          http://www.federalreserve.gov/releases/z1/current/z1.pdf

          Compare the following graph (plotted using data from the linked Fed Report) to the graph you indicated in “figure#4” of your linked article:
          http://goo.gl/GjOhbA

          (2) So if debt-growth has never been negative, why is underemployment high today? The cause of high underemployment despite a rise in the debt (or rise in money supply) is because the VELOCITY of money is FALLING. The employment problem today is not being caused by a decrease in the money-supply (or falling debt), but by a decrease in the velocity of money.

          (A) GDP (Nominal) = Money-Supply X Velocity = Debt-Level X Velocity
          Therefore, neglecting higher-order effects (NHOE), we can write:
          GDP-growth (Nominal) = Growth in Money Supply + Growth in Velocity
          GDP-growth (Nominal) = Growth in Debt + Growth in Velocity—(I)

          (B) GDP (Nominal) = GDP (Real) X Inflation-index
          GDP (Nominal) = Employment X Productivity X Inflation-index
          GDP-growth (Nominal) = Growth in Employment + Growth in Productivity + Growth in Inflation-index –(II)

          Therefore, combining (I) & (II), we can write:
          Growth in Employment = Growth in Debt + Growth in Velocity – Growth in Productivity – Growth in Inflation-index

          Now can you see why we are not getting good growth in employment (i.e. persistent underemployment) despite a growth in debt? Can you also see that the relationship between growth in employment and growth in debt (‘change in debt’) is not as simple as you seem to think? For example, has this Steve Keen fellow given any thought to the issue of the VELOCITY of debt/money? Has he accounted for changes in labor-productivity? What about the inflation/deflation changes? Has he kept that issue in mind?

          (3) Unemployment actually caused by diminishing money-supply (i.e. negative debt growth or decreasing debt or shrinking bank balance-sheets) was last seen during the Great Depression, when the banking system was allowed to collapse. The USG/Fed swore never to let that happen again and it has never happened since.

          • Hmm, i see things a bit differently (realy fundamental issues, so trying to keep an open mind and not go with standard economics, so i know i could be wrong at times, but as Watson said [IBM] ‘if you want to succeed double your failure rate’)
            i. velocity of money is not a cause, it is a result, it does not explain anything. The type of velocity of money decrease you refer to is the result of slowing down of goods/services transactions in the economy.
            ii. in your velocity of money discussion you ignore asset transactions, which cannot be ignored. Money is not just used for GDP transactions, but also (even mostly) for financial transactions. There is most certainly no slowdown in the volicity of money in high-frequency trading, to the contrary. The argument against QE (and a good one in my view) is it has mostly succeeded in stimulating financial transactions but has done little to stimulate real transactions.
            iii. the collapse in the Great Depression was not ’caused’ by decrease in money supply, the problem was the same as with the Lehman cardiac arrest: everything comes to a halt. Nobody knows who is going under next, no trade can be financed (initially for lack of trust, not lack of money, though the latter then becomes part of the self-fulfilling feedbacks), and as a result bancrupcies rise, more banks collapse etc.
            iv. It follows the success of fighting the 2008 crisis has nothing to do with creating more money. The success is fully due to doing everything needed to: a. not let banks fail to prevent further cardiac arrest / loss of trust (lender of last resort solves that), b. massive automatic stabilizers to stabilize aggregate demand which prevents massive deflation (temporarily increased/extended), c. preventing the worst hit assets from massively undershooting long-term trend value and plugging valuation errors (directly bailing-out insurers, homeowners, mortgage lenders, buying mortgage debt, lowering mortgage rates). The success of these policies is all due to the same systemic reason: stopping vicious feedback loops.
            v. Misunderstanding why crisis fighting worked, and wrongly attributing it to for instance QE as a method to support inflation, also does not help in solving the problem today.
            vi. QE has a second major effect: it starts all sorts of non-linear currency/valuation effects both at home and abroad, leading to reactions of other central banks (some call it currency wars) and carry trades and asset speculations setting of all sorts of non-linear asset behavior (see complaints of emerging markets) and non-linear valuation/regulation issues in the big pension/insurance sectors.
            vii. In general i see overconfidence in these formula’s in capturing what realy happens on the ground. Both GDP and inflation calculations are not as solid as these formula suggest, and the formula’s are mostly far too linear, and causal chains used to reason about issues far too long and simplistic. Which means it is crucially important to actually look what happens on the ground, and check if the aggregate macro formulas actually are a good description of what is happening and why things are happening. A case in point is the fact several famous Hedge Fund investors have been saying QE enriches them unnecessarily, but it takes ages before official policy realizes this effect and then does nothing about it. The obvious response should be to either cancel QE in time, or to treat these wealth transfers as windfall profits and design a counter-measure to correct unintended/unwanted increases in inequality. Instead what it in part fosters is the current discussion on Peoples QE.

          • ^Erikwim WROTE: “…as Watson said [IBM] ‘if you want to succeed double your failure rate’….”

            ^^Erikwim ALSO WROTE: “…. [A] is a good illustration of where your analysis is too linear. When i use the trick tought te me by one of my early prof’s (take an argument to the extreme and see what happens), we could do A in the extreme…”
            http://goo.gl/XIaOnw
            ————————————

            Let us apply the professorial mind-trick:
            1) If I want to achieve success, I must double my failure rate.
            2) If I want to achieve greater success, I must triple my failure rate.
            3) If I want to achieve spectacular success, I must quintuple my failure rate.
            4) If I want to achieve success in everything, then I must always fail.

          • Nice applition: you failed in step 4! Hope you learned from it.

          • ^Erikwim WROTE: “i. …..velocity of money is not a cause, it is a result, it does not explain anything….
            iii. …….though the latter then becomes part of the self-fulfilling feedbacks……
            iv…….The success of these policies is all due to the same systemic reason: stopping vicious feedback loops….”
            ——————————————————–

            When the result (i.e. output) is connected to the cause (i.e. input), then we have a feedback loop.
            (I) A negative-feedback loop decreases the input when the output rises and increases the input when the output falls.
            https://en.wikipedia.org/wiki/Negative_feedback
            (II) A positive-feedback loop increases input when the output rises and decreases the input when the output falls.
            https://en.wikipedia.org/wiki/Positive_feedback

            What is a “self-fulfilling prophecy”? What is a “self-fulfilling feedback”? What is a “vicious feedback loop”?
            Answer: Positive-feedback loops.

            Therefore, falling velocity of money is BOTH a cause and a result of deflation (inflation). This is precisely why a future expectation of deflation is called a “self-fulfilling prophecy” and this is why it is so hard to counter-act, as we have seen in Japan over the past 20 years. Similarly, rising velocity of money is BOTH a cause and a result of inflation. This is precisely why a future expectation of inflation is called a “self-fulfilling prophecy” and this is why it was so hard to counter-act in the US from 1965 to 1980.
            http://goo.gl/CetVxa

          • ^^Erikwim: “In general i see overconfidence in these formula’s in capturing what realy happens on the ground. Both GDP and inflation calculations are not as solid as these formula suggest, and the formula’s are mostly far too linear, and causal chains used to reason about issues far too long and simplistic.”
            ————————————–

            Which “formulas” are you talking about? The only equations in the previous comment are:
            (1) Nominal GDP = Money-Supply X Velocity of Money
            (2) Real GDP = Nominal GDP X Price-level (or Inflation-index)

            These equations are IDENTITIES, not formulae. Here is the proof:
            (1) Nominal GDP = Money-Supply X Velocity of Money
            https://research.stlouisfed.org/fred2/graph/?g=1WxA
            https://research.stlouisfed.org/fred2/graph/?g=1WxH
            (2) Real GDP = Nominal GDP X Price-level (or ‘Inflation-index’)
            https://research.stlouisfed.org/fred2/graph/?g=1WxK
            https://research.stlouisfed.org/fred2/graph/?g=1WxQ

            Formulae and Identities are both written in equation form. The difference between the two is that the former is valid under only a certain set of circumstances, whilst the latter is always valid as a matter of definition. While is it certainly possible for a formula to represent unjustifiable linearization, there is no such thing as an identity that is “too linear”. I strongly suspect that you are unable to distinguish between the two. Let me know if you disagree.

          • Hi Vinezi. Yep i totally disagree. You cannot define observable variables. You can of course write a formula and call it a definition, but then in your measurements you have to stick to measuring what you defined. If you combine three variables in a definition, and all three are observable, then you can no longer ‘define’ the relationship, you have to observe the relationship. Your ‘definition’ then becomes an hypothesis or a model of the world.

            nominal GDP = money-supply * velocity of money is such a formula. It is supposed to be a definition but it is not. It stipulates three observable phenomena. When observed it also is obvious the formula is wrong. We can simply observe the velocity of money in high-frequency trading for instance and observe the number of trades need not be related to nominal GDP even with a fixed money-supply. So the ‘definition is not a proper one, but an hypothesis which is easily disproved. People who properly observe have already suggested we should add asset transactions to the formula, which is obviously correct.
            The same for Real GDP = Nominal GDP * inflation factor. This seems a definition again, or a simple identity, but it is no such thing. It hides highly complex issues of how to determine real GDP in year N+1, compared to GDP in year N, how to compare this to nominal GDPs and how to construct inflation. It hides a tremendous lot of valuation issues, technological change issues, and in general leads to a chaotic set of inflation constructions. With the seperately constructed definitions of Real GDP, Nominal GDP and inflation, it is no longer certain the identity holds, the identity has then become a formula or model. Or one could strictly apply the identity, but then one has to choose: if definitions for GDP are given, then inflation can only strictly be calculated as defined, not seperately defined or computed. Anyway the ‘simple’ identity hides an enormous problem of defining what exactly is real GDP, and nominal GDP, and how both develop over time when comparing a horse & cart world to an i-phone & Tesla world.

          • – Well, this chart says total debt decreased (for a short while) after 2008.
            https://www.dropbox.com/s/jkcfw2lus37k8hb/1200-fredgraph.jpg?dl=0

        • ^Willy 2 WROTE: “Never heard of people who need a new car but they don’t have enough money in their bank account? Then those people borrow money to buy that new car. Then their debt changes by say $ 40,000. It also increases GDP by $ 40,000.”
          —————————————–

          What you have described is the basic process of money creation. *IF* the velocity of the money stays constant, then nominal GDP is proportional to the money-supply. If the money-supply grows (i.e. more debt is incurred), then nominal GDP also rises proportionally. There is nothing new here that “other economists have overlooked”– this is just standard knowledge.

          In your example, their debt rises by 40k$. As a consequence, the GDP increases by 40k$. But note that the 40k$ they spent also increases the income of the car-producers by 40k$ instantaneously. This may be written as:
          (A) Before the 40k$ debt is incurred (i.e. before the 40k$ money is created)
          GDP1 = Income1
          (B) After the 40k$ debt is incurred (i.e. after the 40k$ money is created)
          GDP1 + 40k$ = Income1 + 40k$
          GDP2 = Income2

          As seen in (A) & (B), GDP is ALWAYS (i.e. everywhere and at all times) EQUAL to Income.

      • Precisely that is the thing that A LOT OF “neo-classical” economist overlook. They overlook the part called “change in debt”.

        And that’s why Steve Keen puts a strong emphasis on “change in debt”.

        • ^Willy2 WROTE: “Precisely that is the thing that A LOT OF “neo-classical” economist overlook. They overlook the part called “change in debt”. And that’s why Steve Keen puts a strong emphasis on “change in debt”..”
          —————————————–

          Nobody has overlooked anything. The mechanism behind the examples you have described is already baked into the equation (GDP = Income) and does not need any “insightful” extra term to account for it.

          If someone is claiming that the identity (GDP = Income) is incomplete because it does not account for the ‘change in debt’, then such a person is a Quack.

          • – Good point. But when “change in debt” is already “baked into the equation” then it still can be overlooked. Precisely it’s already hidden/”baked into the cake” and not in plain sight.

      • ““Income + change in debt = GDP”. That’s a MAJOR component of Steve Keen’s work which other economists overlook.”

        I don’t think this is what he says and this statement, by itself, is wrong. Finance is a revolving fund. So AD=Income+NET CHANGE in debt=GDP+NAT.

    • – Based on Dent’s 47 year “family spending cycle” and chinese demographics I would argue that the chinese economy should peak in/around 2026 (= 1979 + 47). In 1979 China implemented the socalled “One Child” Policy. So, one could call 1979 the peak of the chinese baby boom.
      – Recently I came across the fact that the amount of births in the US dropped by 12% since 2008. Ouch. No “demographic recovery” in sight.
      – Interesting article:
      http://nypost.com/2014/02/08/thanks-to-aging-population-its-all-downhill-from-here-for-usa/

  51. “. . . rebalancing necessitates that service and consumption outpace other sectors of the economy. Right now all evidence, excluding topline official data, indicates that the consumption and services are growing at best slow to moderately and definitely not enough to shift the structure of the Chinese economy.”

    http://www.baldingsworld.com/2015/09/21/more-on-the-fed-china-and-chinese-data/#comments

    • And importantly, as Michael has related, because investment continues to grow faster than the economy, and growth in non-service sectors advance faster than growth in services; while loans continue to be focused upon servicing the rolling over debt of SOE’s and where support for SME’s, despite announcemnt of support for these is marginal. Even if growth in loans is slowing, it grows more quickly than the officially stated growth of the economy, and significantly faster than what most analysts now believe.

      Couple these to lowering reserve ratio’s in the banking system, lessening interest rates, and the recent devaluation and it seem obvious the economy hasn’t been rebalancing these last few years but is entering a phase where, of the previous steep rise in debt, loans are becoming more burdensome to service. With local debt being turned into bonds, difficulty in the markets, supposed lessened demand for loans, slowing completions in real estate and lessening starts, despite likely government manipulation of asset prices in support of first tier cities, as a measure to shore up asset valuations, as with interference in the stock market, with CHina (essentially), EU and Japan and recent FED response, along with EM weakness, that the world economy is nearing an important point in the movement on the path toward deglobalization, as the aforementioned countries and regions face challenges of parochial and contradictory responses to the GFC in 2009-2013.

      Grave difficulties ahead