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


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.