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Chinese credit expansion has no place to put its money

In regards to Ed’s last post on China and trade, the position of Michael Pettis is much closer to mine (and Martin Wolf’s, which he expressed yesterday in the FT).  The quote of Pettis that Ed cites does not invalidate my position at all:

So after years of dragging its feet, postponing a rebalancing, and forcing rising trade surpluses onto the rest of the world, China may have to adjust its currency policies so quickly that it risks a sharp contraction at home. So what will China do?

This, for me, is the most interesting and perhaps important question. Most probably Beijing will do the same thing Tokyo did after the Plaza Accords and Beijing did after the renminbi began appreciating in 2005. It will lower real interest rates and force credit expansion.

The problem is that China’s credit expansion remains directed toward additional EXPORTING, not domestic consumption.  This is the same problem that Japan had post the Louvre accords.  It doesn’t solve the underlying problem. In some high tech industries, the Chinese banks are financing capacity expansions equal to five times annual demand. Imagine that!  What does that tell you?  The Chinese credit expansion has no place to put its money.  All the targets have been saturated, which means that there will be overinvestment in all industries and to an incredible degree. This will kill industry after industry.  How can there be an encore?  To avoid recession you have to keep the investment ratio up. But in high tech, for example, if you build an additional round of capacity so it is equal to ten times annual demand by next year, and fifteen times by the year after…What this says is that when the fixed investment ratio is this high it is very hard to keep it this high.  There is a tendency for it to fall.  Gravity!  Economic gravity.  The problem is that if it falls there will be a recession in China. So China in effects tries to export the recession overseas. It’s happening now in Japan and will happen in the US next.  I believe that this is very dangerous for China as well, and think it is is far more recession prone than anyone thinks.  We are talking about a development that could move very fast because the excesses of investment are so great.

Ed asked:

What do Mosler and Mitchell say on this one? Just curious.

As far as Mosler and Mitchell, they take the classic MMT view that imports are a benefit and exports are a cost, and in purely theoretical terms they are absolutely right.  However, the benefits of imports are only POTENTIAL benefits when we don’t conduct optimal fiscal policy and have high rates of unemployment.

Let me also add, that I would have no issue about China running a perpetual trade surplus with the US if we responded with a fiscal policy that promoted full employment and therefore let us enjoy the benefits of consuming another country’s economic output via imports.  That’s a basic accounting identity.  Given the political impossibility of doing this, China’s trade policies are likely to be extraordinarily destructive for the US economy. We don’t do that, however.  Instead, we are trying to pursue an export model, which is highly destructive because it embraces a low wage policy and precludes workers from consuming their economic output – exactly the opposite philosophy of Henry Ford in the 1920s.

Marshall Auerback

About 

Marshall Auerback, has 29 years experience in the investment management business, serving as a global portfolio strategist for Madison Street Partners, LLC, a Denver based hedge fund. He also has also worked as an economic consultant to PIMCO, the world’s largest bond fund management group. He is a Fellow at the Economists for Peace and Security, a Research Associate at the Levy Institute, and a non-executive director of Pinetree Capital in Toronto, Ontario, Canada.

10 Comments

  1. Tom Hickey says:

    As far as Mosler and Mitchell, they take the classic MMT view that imports are a benefit and exports are a cost, and in purely theoretical terms they are absolutely right.  However, the benefits of imports are only POTENTIAL benefits when we don’t conduct optimal fiscal policy and have high rates of unemployment.

    Exactly. The problem is lagging global demand in the face of global oversupply, and this is the result of neoliberal policies that have resulted in supply side thinking and especially financialization to draw demand forward based on putative future incomes. This has turned out to be unsustainable and now all countries are rushing to net export their way out of the problem, which is a fool’s errand.

    Global problems must be addressed instead through stimulating demand temporarily through fiscal policy (budgetary deficits) until recovery is established. A lasting solution has to include 1) eliminating financialization and disincentivizing economic rent-seeking (including excessive executive compensation), 2) incentivizing productive investment that increases productivity and sustainability, 3) incentivizing more proportional incomes necessary to increase demand for goods produced , 4) investing in public goods that promote future prosperity, especially education, and 5) disincentivizing negative externality.

    It seem to me that the US going after China or trying to net export out of this bind are bad directions to be heading in. A revaluation of the RMB is not going to solve the economic problems of the US, although it would make the political environment less hostile to China. But without solving the problems and having a roadmap to a real solution, there will must be more scapegoats thrown up to explain the failure of policy. We need to be loudly demanding a real solution based on functional finance and other MMT operational principles that will actually work.

    • I agree tjfxh. What we need is for the US to focus on dealing with its domestic problems (financialization), China to focus on theirs (malinvestment and low relative domestic consumption demand) and co-ordinate in attempting to reduce the external imbalances that have resulted.

      In my view, there are few glide path options to a more closed economy i.e. tariffs and capital controls are likely to escalate and precipitate an exogenous shock that brings on crisis. I am most focused here on Europe as opposed to the U.S. because I think the euro zone’s weaknesses make it a flashpoint for the next leg down.

      • Tom Hickey says:

        Agreed, Ed. I think that EZ asymmetry is unsustainable, and the delevering necessary there is even greater than the US. As I’ve written before, another Credit Anstalt may be in the cards that would upset Europe and aggravate the global situation. The good news is that the neoliberal takeover isn’t going so well.

        As far as the US and China, both parties need to be thinking longer term about globalization. The US needs to play its hand wisely with respect to China and also China with respect to the US, taking not only national interests in to account but also global balance and human progress.

        The US and China are going to be major shapers of the 21st century, and the last thing we need is bad blood for short term apparent advantage, which is no real advantage at all, since even short term this just distracts from the real issues and hampers addressing the challenges that the US and China need to be dealing with together on a broad front. Both countries need to address consumer demand, which means incomes that result in sales. Owing to financialization in both countries, the pie is not being sliced equally, and economic rent-seeking reinforced by corruption is cramping demand and generating imbalances domestically and internationally.

        Humanity cannot be successful as a species coping with environmental challenges going forward in this age of globalization without close international cooperation. Every country’s problems are now becoming more and more the world’s problems. When the largest and second largest (GDP) economies involved, as is the case with the US and China, it becomes even more crucial to get it right.

  2. Attitude_Check says:

    Imagine if China decided to invest in Gold. No problem with attempting to finance even more idle capacity. The Chinese government has already been officially encouraging it’s citizens to buy Gold.