Michael Pettis

China, bonds, macro
Michael Pettis
China, bonds, macro
Contributor since: 2008
Objective, by financial crisis I mean a very rapid adjustment in which balance sheets break down. I don't think that will happen in China because the liqudity of liabilities is much less than we might think. My guess is that China will experience what Nick Lardy called a "long landing", in which excess capacity will be ground out over several years of much slower growth.
Patrick, there is also the problem that the PBoC cannot transfer reserves to the AMCs without increasing their own net borrowings -- after all the reserves are not capital, they are assets funded by RMB borrowings by the PBoC. Convering the AMC losses out of reserves would require an increase in Beijing's net debt just as surely as paying the bonds off directly.
Glenn88, China’s net accumulation of foreign currency assets will be determined only by the size of its current account surplus. If Japan wants to sell dollars and buy euros, in principle China could take the opposite side, but China would probably not want to convert the few euros it has into dollars, making its reserve accumulation too dependent on just the dollar. If japans eels dollars for euros 9which I do not think they want to do) the net impact would be a rise in the euro versus the dollar and a transfer of the US deficit to Europe, something I think the Europeans would find unacceptable.
Djackson and HaavBline, of course one doesn’t automatically require the other. For example a rise in US savings could be offset by a rise in global investment, or by a decline in European and Japanese savings, but each is unlikely. Global investment is more likely to decline than to rise as a consequence of the crisis and especially once government fiscal expansions reach their limits. Japan’s savings rate has already declined tremendously and Japan and Europe are seeing sluggish growth and rising unemployment, which are unlikely to lead to the necessary rise in consumption to offset the rise in US savings. Other countries are much too small to make a difference, and anyway are mostly all suffering from the global slowdown so are likely to exacerbate, not absorb, the savings imbalance. The rest of the world is actually likely to make the problem worse, not better.
Chap08, I am impressed by your certainty that Jim Walker is wrong – especially since his prediction turned out to be right and everyone else’s wrong. What impresses me less is the logical sequence that assumes that a dollar bloc obviates the problem of rising savings within the member of that bloc. It seems to me that the opposite is true. The more tightly the economies are linked the more important are the mutually offsetting imbalances.
JamesLewis, the derivatives story is indeed a very interesting one and continues to cause a lot of concern. Strangely, in all the talk about internationalizing the RMB no one seems to have discussed the impact this might have on the process.
Michael Xia, thanks for your kind comments, but as for the latter, it is nearly two weeks later and there still is no evidence of any concerted attacks nor evidence of actual syringes. The two clear “syringe” cases involve two junkies holding up a cab, something that probably occurs in every big city on a daily basis, and a junkie getting caught by police while trying to inject himself and then “threatening” the police with the syringe. Of the 106 reported cases (actually more than 500 reported but most of them rejected as groundless), no one has demonstrated that they attacks were caused by syringes rather than pins, knitting needles or (yes, several Urumqi doctors said this) insect bites. There has also been not a single case of a recipient testing positive for poison, AIDS, or anything else. Of course I am sympathetic to any real attacks, but I am also concerned about mass hysteria leading to beatings and deaths, which have already happened, according to police reports. The 19-year-old boy, Yilipan Yilihamuwho, pricked the girl with a pin may be an idiot, and may deserve some punishment, but the hysteria has landed him 15 years in jail – a pretty tough punishment
CautiousInv, I am not sure China should be looking for new export markets to replace the US. Europe for structural and political reasons cannot absorb anywhere close to the deficit levels of the US and no other market is big enough. At any rate, a continental sized economy, and soon to be the second biggest in the world, should not rely so heavily on foreign consumptionj for its growth.
Alphameister, I wonder if you are old enough to remember the same nonsense that was said during the credit-fueled bubble in Japan in 1988 and 1989. And if you really do look closely at Chinese data you may be one of the few who do who nonetheless accepts retail sales as a measure of consumption growth. For the past five years retail sales have always been higher than GDP growth, and yet consumption as a share of GDP has declined, which at the very least is mathematically curious.
Alan, I am not giving stock advice because that involves timing. I expected that after the 1987 crash Japan’s economy would get into serious trouble, but it enjoyed another 2 years and more of bubble conditions and high growth before the final adjustment took place. I think the same may happen in China. And as one of my Columbia professors assured me before I became a trader, “never short a bubble.”
Roma, you would probably have been wiser to say “I disagree” rather than “wrong”. First, you have obviously assumed that once you put money in a bank it disappears from the economy forever. Strangely enough banks actually use deposits to fund investment, which directly or indirectly ends up in USG bonds. As a rule you should assume money invested continues to exist, and figure out the subsequent cashflows. Second, even a very brief familiarity with balance of payments economics would have made you realize that if Americans do not buy Chinese goods, and so China does not run a trade surplus with the US, the whole question of whether China should buy US bonds becomes moot. They cannot. Third, I am a little surprised that you think China has so much lower debt level than the US. Since total government debt in China is considered a state secret I am curious how you got your numbers – what are your sources? Perhaps you think that the official debt numbers in the US are as representative of total US debt as the official debt numbers in the China represent total Chinese government debt? And third, as to why they can’t go on borrowing for 5-10-15 years more, in 1997 Argentine government debt was lower than the US, but strangely enough they only were able to continue borrowing for three more years before defaulting. The amount of debt, the structure of the debt, and the volume of new borrowing would, I suggest, have something to do with all of that. I would suggest that when new banks loans are growing at 25% of GDP every six months, even ignoring the rise in central, provincial and municipal debt, the answer as to why they can’t continue for 3 years, let alone 15 years, should be pretty clear.
Johngh, although confidence is of course important, I think the world requires a lot more than that. There has been a significant and unsustainable leveraging of household balance sheets in the US and until that process has been sufficiently unwound I think we will continue to see a slowdown in US consumption growth. And it is precisely this slowdown in US consumption growth that will make it so hard for China, whose stimulus involves a big bet on a rapid recovery of the US ability to run large and growing trade deficits, to sustain the growth.
Sober realist, the savings rate is probably declining if fiscal debt were correctly counted. More importantly, the Chinese savings rate has no choice but to decline. As long as the US had very low savings rates that fed into consumption that exceeded production, China could run the opposite position, but with the rise in US savings, unless we see a real surge global investment we are going to see non-US savings decline, either via a decline in the savings rate or a decline in GDP. With Japan and China accounting for most of the increase in savings when US savings declined, I expect they will see most of the decline as US savings rise.
Sober Realist, in that light I do agree with your comments. For exmaple one of the problems we are seeing here of is that without a better system of enforcing concerns of ordinary households onto the government some of the necessary reforms, including for example liberalizing the banking system so that households aren't so heavily taxed via low deposit rates, are unlikely to happen as long as there are powerful consituencies that benefit from the existing sysytem.
As for your question, much of John Lee's information is (or was) publicly available. The data on the number of incidents of "mass unrest" for example, although probably understated, used to be released by one of the ministries annually until 2005, when the release was discontinued for reasons never explained.
Sober realist, of course I agree that China is not a democracy, and not even close, but when you argue that this is why China favors domestic producers over foreign, then I have to disagree. The US did the same thing in the early 1930s. I think there is much to criticize, but for the criticism to be effective it should also be fair.
Sober realist, although there are certainly grounds for criticism, I think your last statement is unfair. What China is doing today is not so different from what the US did in 1930-31. Like in most countries, domestic politcal considerations in China trump international obligations until the foreign response forces otherwise.
What drives the value of a currency is the balance of payments flows, so that China, with its massive trade surplus and very large capital account surplus should see its currency revalue, and would if the PBoC didn't counteract those flows by massive purchases of foreign assets. The only reason "strong" economies tend to see appreciating currencies (and they often don't) is that perceptions of strength often encourage investment inflows. In this case, China still has a massive balance of payments surplus, even if the economy is slowing (and by the way a slowing economy would still give it above average growth).
Cesar, of course people save for insurance purposes, and especially the poor, but that does not explain why some poor people save more than other equally poor people. If it were just insurance there would be a lot of countries that save more than China, whereas no large country, and perhaps no small country either, saves as much of its income as does China. There must be also be other reasons.
Tern, it is not clear that inflation necessarily discourages savings. During the last great period of US inflation, in the 1970s, US household savings exceeded their normal range of 6-10% of GDP to rise as high as 13% (I am quoting the numbers from memory, so please check before you use them elsewhere, but the magnitudes are more or less correct).
Unexpected inflation benefits borrowers, but expected inflation actually discourages borrowing in part because of high real rates and in part because high nominal interest rates have the impact of accelerating real payments on the debt, making cashflow more difficult to manage.
Thanks Ma-lin, but I am not sure I agree with your historical observation – a fairly widespread one, it seems – that China has always run trade surpluses. I haven’t looked at Roman era trade and don’t have any feel for it, but the Ming and Qing trade, in which China largely exported silk, tea and porcelain and imported silver, at least until the early 19th century when opium replaced silver, has often been mistakenly compared to modern trade surpluses which are balanced by reserve accumulation, with silver taking the place of reserve accumulation. But besides being anachronistic – China of course did not have a central bank and did not try to accumulate reserves – this version of history may misrepresent Chinese needs at the time.
In the mid-Ming period China experienced a collapse of its money system. This resulted in and was exacerbated by silver hoarding, which became worse after Japan, China’s major source, cut off silver exports in response to declining silver stocks in Japan. Fortunately for China the Spanish colonization of the Americas resulted in massive silver discoveries in the 16th Century and was the main cause of burgeoning trade between China and Europe. China desperately needed silver to re-monetize its monetary system, for which it exported silk, tea, porcelain, and other goods, and European wanted those goods and were willing to exchange it for the suddenly plentiful silver.
In fact historians estimate that one-third of all American silver ended up in China. If China was simply passively accumulating silver as the clearing of its trade surplus, this would have been almost impossible – why would China give up so much real production for passively accumulating silver, and why did the monetary system strengthen rather than collapse? By the way the Qianglong’s “famous reply” probably had to do more with domestic court politics and factional infighting (between “openers” versus “closers”, a long Chinese tradition) than with any real description of trade needs.
By the end of the 18th century, with the drying up of silver from the Americas, the silver drain started to become a serious problem for Europeans, which is when the British hit on the idea of “balancing” trade by exporting Indian opium to China. In fact, contrary to what one would have expected if China merely passively accumulated silver, there is quite a lot of evidence that the Chinese emperor turned against opium imports not because of the deleterious effect on the Chinese people but rather because China’s growing economy and monetary system needed silver, and with the importation of opium the Chinese monetary system began experiencing the consequences of a too-tight monetary conditions.
I think we have to be careful about these kinds of arguments because we assume things are immutable that are not. Until the early 1990s everyone talked about how Asian trade surpluses were the consequence of culture and not monetary and trade policy, but in then until 1997 Asian trae accounts went wildly into deficit until the 1997 crisis scared policymakers into engineering trade-surplus policies. I think policies and economic conditions do matter to the trade account, at least as much as culture does.
As for your import duty proposals, this might have had the effect you say, but it probably would have violated the WTO and would have set a terrible precedent for a country that is eager to encourage free trade.
JWG, ha ha actually I meant late 1970s
HaavBline, while everyone rails about the weakness of the dollar it has actually strengthened over the past six months. In fact we have seen the weird spectacle of Chinese worrying about future weakness in the dollar (which hurts their reserves) while complaining about current strength (which hurts exports). I don’t know what the dollar will do in the next ten years, but it isn’t obvious to me that it will decline against any other major currency.
TERN, a more important question is whether other countries would want to hold a significant portion of their reserves in RMB. Twenty years ago anyone with “brains” knew that Japan would be the world’s largest economy, and the yen the dominant reserve currency, by the end of the century. As a famous wag once said, predictions are difficult, especially about the future.
Aalan, China has been in a demographic sweet spot since the mid-1970s, when the one child policy caused a collapse in the number of young and, as a consequence, the dependency ratio improved dramatically (i.e. working population grew at more than twice the rate of overall population). So while China’s population has recently peaked out (and may even be shrinking) the working population nonetheless continues to grow.
This process reverses itself, however, over the next five years, during which time we should see a sharp deterioration in the working population as the baby boom pre-1975 and the baby “bust” thereafter brings China the most rapidly aging population in history. They are sort of stuck because over the next 30-40 years a relaxation of the one-child policy will cause a much sharper deterioration in the dependency ratio for about 20-25 years before the positive impact finally kicks in. As for immigration, China is a net exporter of immigrants.
Aalan, China has been in a demographic sweet spot since the mid-1970s, when the one child policy caused a collapse in the number of young and, as a consequence, the dependency ratio improved dramatically (i.e. working population grew at more than twice the rate of overall population). So while China’s population has recently peaked out (and may even be shrinking) the working population nonetheless continues to grow.
This process reverses itself, however, over the next five years, during which time we should see a sharp deterioration in the working population as the baby boom pre-1975 and the baby “bust” thereafter brings China the most rapidly aging population in history. They are sort of stuck because over the next 30-40 years a relaxation of the one-child policy will cause a much sharper deterioration in the dependency ratio for about 20-25 years before the positive impact finally kicks in. As for immigration, China is a net exporter of immigrants.
HaavBline, the problem with that argument is that it assumes that manipulating the currency is the only form of trade policy. In fact although other countries have devalued (sometimes, as in the case of Vietnam, because of inflation, so that there has been no real depreciation), there are many ways to boost net exports artificially, including by national purchase requirments for state sector or state controlled buyers, low interest rates, suppressed wage increases, forced credit expansion, etc.
If you want to see whether or not China has been more agressive in its trade policy, you would probably want to check to see if China's exports have fallen less than those of other Asian countries (it has declined by much less) or whether its trade surplus has declined as quickly as other Asian countries (in fact its trade surplus has surged while others' have declined).
Other Asian countries are claiming that China has been very aggressive about forcing increasing amounts of overcapacity onto the world, thus causing them to bear more than 100% of the adjustment, and so they would not be sympathetic to the argument that China needs to devalue in order to protect it from predatory currency behavior among its competitors. That is why trade relations between China on one side and India, Indonesia and Malaysia on the other have gotten so bad. I suspect those bad feelings will spread.
A lot of these comments and questions are discussed, including by Jack, on my original site.
Thanks for the comments. Yes, Dalmasian, it is often difficult to figure out the real numbers behind official numbers, but the National Bureau of Statistics seems really to be trying to get the numbers right and has made heroic efforts to do so, even though for lots of different reasons (including the speed of China's transformation) it is not always easy. Most of us who watch China closely try to combine official numbers with alternative statistics, gossip and anecdotal evidence. We don't always get it right.
lbsterling, no. I mean that with total external liabilities of under $450 billion and reserve of over $2 trillion (if counted correctly) there is little chance that a run on the RMB can become self-fulfilling.
The hand, I think China has less monetary independnce than may of us suppose given its current currency regime. I don't want to suggest that there is nothing it can do, but my instinct is that their lack of control on the way up will be mirrored on the way down.
Amouna, for reasons I have discussed in other pieces the fear of whether or not China would support US fiscal expansion are groundless. It is hard to know if China can or should float the currency. After having waited too long they now face significant risks either way.
Thanks Jegan. No need to defend me from Dissenter. If someone thinks the way the global balance of payments adjusts is obvious, he probably isn't sure what it means. The important issue, I think, is to figure out how demand contraction in the US and deficit Europe works its way through the system. I think an increasingly number of economists and policymakers are now beginning to see the implications, even in China, where criticism from both the left and the right seems to be stepping up.
Although I agree with some of your conclusions, I think you make two very common mistakes. The first is the assumption that China can use its foreign reserves to shore up domestic investment. It cannot. Reserves can only be used for spending abroad, and if China tried to convert reserves into RMB it would cause a massive surge in the value of the RMB that would destroy its export sector. Given the importance of the export sector to China, this will almost certainly not happen. The PBoC, by the way, has tried to point this out many times but most people continue to confuse foreign reserves with domestic wealth.
Second you say "Thus, while we stand on the verge of a huge increase in US Treasury offerings, the largest buyer has left the trading room." I am not sure how you came to that conclusion. As long as China runs, or wants to run, a trade surplus with the US (and August and September were the two highest surplus months in history), it has no choice but to buy US dollars directly or indirectly. If it stops, its trade surplus with the US disappears. Again, given the importance of its exports to the US, it is pretty unlikely that it will want to do so – on the contrary they are now doing everything they can to shore up exports. In fact while China's reserves continue to surge, there is some circumstantial evidence that they have increased the dollar share of total reserves.
I am also hearing that pension funds and endowment funds have suffered big losses and are likely to be taking more money away from hedge funds, even those that have performed well. That may force additional selling, although I suspect a lot of people are already in cash.
PA, looks like they're putting short selling and margin trading on hold. good thing too. The assumption was that 1800 was so obviously a floor that everyone would rush to buy at that level, so the downsdie risk was not worth worrying about.
CCCC, unfortunately the answer to your question might be that not nearly as many people put the required minimum deposit as we think. In some cases the deposit was borrowed and in others it may have been concealed. We won't know until the contraction.
James, sorry for taking so long to respond, but I am on a tiny island in Thailand at a friend's wedding, and reading about economics is not at the top of my list right now. I agree with Feng and NG. In the past, inflationary periods were followed by serious tightening, and given the importance of financing to the Chinese property market, I suspect that property prices will be weak.
Meanwhile at a recent high-level meeting it seems that there is increasing concern about an economic slowdown. I think they are right to be concenred, but if this means that they are putting the monetary problems on the back burner, I worry that we might have a real shot at stagflation,Chinese style.
RUFC, anyone who presents a World Bank projection as proof isn't likely to be taken very seriously.