Burgeoning debt was not an unlucky accident. It is fundamental to the way the growth model works, and we have arrived at the stage, probably described most imaginatively by Hyman Minsky in his work on balance sheets, in which the system requires an acceleration in credit growth simply to maintain existing levels of economic activity. China’s debt problems, in other words, cannot be resolved administratively, by fixing the shadow banking system, by imposing discipline on borrowers, or indeed by eliminating financial repression (much of which, by the way, has already been squeezed out of the system by lower nominal GDP growth). Without a massive transfer of wealth from the state sector to the household sector it will be impossible, I would argue, for GDP growth rates of anything above 3-4% – and perhaps even less – to occur without a further unsustainable increase in debt, whether that increase occurs inside or outside the formal banking system and whether or not discipline has been imposed on borrowers.
Author: Michael Pettis
By Michael Pettis It might seem almost churlish to wonder what would happen if Spain were to leave the euro. The official European position is that the battle of the euro has been pretty much won, and anyone who argues otherwise will be accused of being a euro hater, an Anglo-Saxon or, even worse, a writer for theFinancial Times. But […]
By Michael Pettis Debate about the global savings glut hypothesis is mired in confusion, a fundamental one of which is the seemingly obvious but false claim that a global savings glut must lead to higher global savings. Here, for example, is a recent piece by one of my favorite economists, Barry Eichengreen: There is only one problem: the data show […]
This is a loaded topic. This entry, however, is not intended to be political. Very few things in economics are good or bad in themselves, but rather can be good under certain conditions or bad under others. I want to try to tease out as logically as I can the conditions under which rising income inequality can be good or bad for the economy.
By Michael Pettis I don’t often make reference to these kinds of things in my blog, but Saturday’s terrorist attack in the Kunming train station – in which 29 innocent people were hacked to death (the toll was especially high among the elderly who were unable to run away quickly enough from the killers) – fills me with dread and […]
Owning shares in a bank is the functional equivalent of owning a call option on the bank’s future operational earnings, and if the share price contains little intrinsic value (i.e. the value of its assets does not exceed the value of its liabilities by a large margin, and may even be less than the value of liabilities), by definition most of its value consists of time value, and so is extremely sensitive to changes in expectations.
I got a lot of feedback from my January 5 blog entry because of my argument that the implementation of the reforms proposed in the Third Plenum all but guarantees that growth rates in China will slow down. For that reason I thought it might make sense for me to explain a little more carefully why I think this must happen, and why I think that we can almost judge how successfully the reforms are implemented by how quickly growth slows.
Although still vague on the specifics, China’s Third Plenum November partially clarified the nature of the reforms that Beijing is proposing for China over the coming year. Of course very little was said in any of the related releases about the difficulties, of which the most important are likely to be political, in implementing these reforms, nor did we hear – not unsurprisingly, I think – much about what specific steps Beijing will take to address these difficulties. What has been surprising to me is that many analysts – some of whom, but not all, recognize how difficult implementation is likely to be – expect that the reforms will unleash such a burst of productivity that growth rates in China will be maintained or even raised from the current GDP growth target of 7.5%.
In order to understand much of what is happening in China it is important to understand how financial systems operate under condition of financial repression. Because most of what we know about economics is derived from economists whose operating environment is the classical “anglo-saxon” economies, we underrate important economists that don’t follow this tradition, like the German Freidrich List or the American Albert O. Hirschman. And it leads us into mistaken assumptions, like the belief that higher interest rates lead automatically to higher savings rates.
China is not the first country to have experienced a long period of miraculous growth. But the most difficult part of growth miracles has not been the growth miracle itself but rather the subsequent adjustment.
To me, much of the argument about whether or not markets are efficient misses the point. There are conditions, it seems, under which markets seem to do a great job of managing risk, keeping the cost of capital reasonable, and allocating capital to its most productive use, and there are times when clearly this does not happen. The interesting question, in that case, becomes what are the conditions under which the former seems to occur.
debt matters, even if it is possible to pretend for many years that it doesn’t (and this pretense was made possible by the implicit capitalization of debt-servicing costs). Japan never really wrote down all or even most of its investment misallocation of the 1980s and simply rolled it forward in the form of rising government debt. For a long time it was able to service this growing debt burden by keeping interest rates very low as a response to very slow growth and by effectively capitalizing interest payments, but if Abenomics is “successful”, ironically, it will no longer be able to play this game.