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Will the Chinese Keep Saving?

by rziemba
July 13, 2009

This is Rachel Ziemba of RGE Monitor where this post also appears.

In a recent post, Jeffrey Frankel asks will the U.S. Keep Saving? noting that despite the recent increase in the U.S. savings rate, the demographics of the U.S. (as well as those of Japan and Europe) will contribute to a reduction in savings. He argues that despite the fact that wealth losses will boost savings rates, the dis-saving of the retired population will keep the savings rate relatively low, if higher than the pitiful rates of recent years.

The companion question, whether the Chinese will keep saving is equally of importance. Whether the Chinese stimulus is able to boost private consumption ahead will be critical to global and Chinese demand. So far Chinese consumption has held up and even grown slightly from a weak base –as illustrated by retail and auto sales. Yet one reason that the Chinese economic reacceleration is fragile is because it is uncertain where the new production in China’s factories will be consumed. Chinese domestic demand still seems weak and overpowered by some structural incentives to save.

In the near term U.S. savings rates, which reached 6.9% in May, seem destined to keep climbing as U.S. consumers retrench. This could contribute to slower growth in the so-called export-led economies which had grown reliant on exporting demand.

One outcome of the financial crisis has been a narrowing of global economic imbalances, as illustrated by the reduction in the Chinese trade surplus and a reduction in the corresponding deficits of countries like the U.S.. The combination of a sharp fall in consumption across the globe and withdrawal of credit, partly accounted for swift reductions in some countries. I wrote last week about the narrowing of the surplus of oil-exporters. All in all, surpluses and deficits might be smaller given the reduction in credit available even as the increase in government borrowing leads to higher long-term interest rates. This narrowing is likely despite the fact that reserve accumulation seems to have restarted in Q2. Setting aside China which will report reserves data at some point over the next day or so and adjusting for valuation, reserve growth was about $40 billion in the quarter of 2009. While this is much smaller than in the heyday of 2007, it is the first quarter of positive reserve growth since Q3 2008. Yet, there are some signs that we will not return to the earlier pace.

The U.S. current account deficit has been narrowing for some time and has fallen from 6.6% of GDP at the end of 2005 to 3.7% at the end of 2008 and the IMF estimates that it will fall further to 2.8% of GDP over the course of 2009. With U.S. consumers buying less (the savings rate rose to 6.9% in May 2009), Chinese producers need to find new markets.

The Chinese current account surplus was $420 billion in 2008 and is likely to be smaller this year. The Chinese trade surplus (the largest component of the current account) was about $100 billion in H1, but one month (January) accounted for almost half. The absolute level of China’s trade surplus has shrunk, to about $13 billion in April and May and just over $8 billion in June. While the greater cost of China’s commodity imports (watch for more on this tomorrow) accounts for part of this narrowing surplus, it may reflect a sign of things to come should Chinese exports stabilize at a weak level in the absence of external demand.

Should export-oriented “surplus” countries like China keep saving and keep trying to export demand, the reduction in imbalances could actually exacerbate the global economic contraction or contribute to a more sluggish recovery. The high savings rate or rather artificially low cost of capital in China has contributed to misallocations of capital that will be difficult to reverse and will take some time.

However expansionary fiscal policies in these countries and a reallocation of capital within these countries, could in the long-term contribute to reducing internal and global imbalances. Chinese officials seem cognizant of the need to rebalance the domestic economy even as some of their policies seem to operate at cross-purposes.

While government incentives are contributing to an increase in some purchases, Chinese consumption (and that of other emerging economies) may find it very difficult to pick up the slack from a U.S. consumer that is spending less. However, Chinese fiscal stimulus does seem to be doing more to potentially boost domestic demand. Yet the effect of some of these incentives could diminish over time and there is of course a risk that Chinese production could add to global overcapacities in the absence of an increase in domestic demand.

In the Wilson Quarterly, Michael Pettis argues that whether or not the Chinese start consuming more, their savings rate will drop from the 50% marked in 2007. Either Chinese policies will contribute to more private consumption or the reduction in global demand will lead to reduced growth, limiting savings.

So what would be the package of consumption-led growth?

Eswar Prasad details how China and other Asian savers might rebalance their domestic economy through removal of the policies that suppressed domestic demand. These are largely long-term in nature including the development of China’s capital market to increase the return on domestic assets and patching holes in the social safety net.

The massive credit extension in China, which rebounded in June 2009 after slowing slightly in April and May suggests that the cost of capital in China remains well below global costs. This distortion raises the risk that non-economic projects are being financed to meet bank quotas. Thus there is a risk that even as Chinese officials try to take some steps to support domestic demand, other policies might add to the misallocation of capital, contribute to asset bubbles (especially property). Meanwhile, some Chinese investors are worried about future inflation. The blunt policy tools continue to be hard to manage.

The raft of Chinese data to be released over the next few days may give us some more clues as to the trajectory and possible risks ahead

31 Comments

  • Posted by don

    “The massive credit extension in China, which rebounded in June 2009 after slowing slightly in April and May suggests that the cost of capital in China remains well below global costs. This distortion raises the risk that non-economic projects are being financed to meet bank quotas.”
    Very interesting. I wonder if the misallocation is worse than the U.S. model for stimulus, which is to have the government devise ways to spend the money directly. Maybe their way is better.

  • Posted by q

    “The massive credit extension in China, which rebounded in June 2009 after slowing slightly in April and May suggests that the cost of capital in China remains well below global costs. This distortion raises the risk that non-economic projects are being financed to meet bank quotas.”

    i’ll echo don — this is interesting.

    but wouldn’t this cause inflation, somewhat mitigating the problem?

  • Posted by Kung.Fu.Panda

    Blowing out monstrous amounts of money supply might keep the masses content in the short term, but could eat through China’s dollar reserves in a hurry down the road. It looks like “extend and pretend” on a massive scale to me. To me what the Chinese govt is doing is far more reckless than any actions taken to date by US or European governments and financial institutions. In my mind, the Chinese leadership know that when the economic boom collapses, the jig will be up for them. They are just stalling the inevitable.

  • Posted by DOR

    “Bank quotas” ? How 1980s.
    .
    Of course the Chinese will continue to save, with a tiny blip from the pending consumer stimulation package.

    The real question is this: Will that savings continue to be invested in US paper?

    Stay tuned . . .

  • Posted by ReformerRay

    I do not understand the reluctance to look at the bright side of increased U.S. savings. What is happening today (solely in terms of decreased use of credit and increased savings)is the remedy I have been advocating for years.

    If we are going to have all the misery associated with high unemployment, we may as well get some benefit from it (a rebalanced economy).

    The global slowdown was apparently the only way the U.S. would cease purchasing more imports than they can sell as exports. I see no reason why the previous reliance upon credit and an unbalanced trading system will not return when the economy recovers. The U.S. has not reversed its allegiance to free trade as an ideal.

  • Posted by menomnon

    I’m not sure we can return to the status quo ante.

    Wherever we ‘return’ to will be new. And it’ll be a while before it arrives.

  • Posted by RodgerRafter

    The average Chinese citizen saves for security. They always must have a cushion in case they need medical care. When they are raising a child, they save for a college education. They also save for retirement.

    The government is working on reducing the need for these types security saving and encouraging people to spend more on themselves, especially in the rural areas.

    But the government has been an even bigger saver when it comes to funding the US trade gap. In my view this has been a direct function of China’s desire to maintain full employment by keeping the value of the currency low. To do this, they print RMB and buy dollars (and Euros in a higher proportion from 2005 to 2008), then save the foreign securities that they purchase.

    If China can grow its local economy fast enough through domestic demand, it will need to save less.

  • Posted by Too Much Fed

    “In the near term U.S. savings rates, which reached 6.9% in May, seem destined to keep climbing as U.S. consumers retrench. This could contribute to slower growth in the so-called export-led economies which had grown reliant on exporting demand.”

    I would like to see that savings rate broken into those making $75,000 per year or more and those making less?

    I think using nearly real time income tax data from the treasury, Trimtabs is claiming the savings rate is lower.

  • Posted by Too Much Fed

    “Chinese domestic demand still seems weak and overpowered by some structural incentives to save.”

    Is this why? From:

    http://www.theatlantic.com/doc/200801/fallows-chinese-dollars/3

    “… But the Chinese manufacturer can’t use the dollars directly. It needs RMB—to pay the workers their 1,200-RMB ($160) monthly salary …”

    “At no point did an ordinary Chinese person decide to send so much money to America. In fact, at no point was most of this money at his or her disposal at all. These are in effect enforced savings, which are the result of the two huge and fundamental choices made by the central government.”

    Enforced savings or wealth/income inequality?

  • Posted by Too Much Fed

    In the USA, are reverse mortgages considered a reduction in savings?

  • Posted by Rien Huizer

    Rachel,

    How can “the Chinese” (I assume you mean chinese private households, i.e. people also knowm as “consumers” and “employees” save less than they do now (or consume more) they just do not earn enough. China’s savings are heavily concentrated in SOEs, and many of those SOEs are local market oriented and oligopolistic. As far as I can see, the Chinese government allows SOEs to be too profitable, and often in unfair ways. If any country would like to criticize the Chinese government earnestly, that zould be the topic. Not macro terms, like FX, savings rates etc, but microeconomic policy that allows firms to prey on Chinese consumers and private sector businesses (and then hoard the proceeds -for what?) in ways that no Western government would allow.

  • Posted by rziemba

    Hey, great comments… we will have some (backward looking) indicators of the willingness to invest these assets in US treasuries later this week when the TIC data is released

    ReformerRay- good point. increased savings is I think a good thing. the US consumer has been living beyond its means. I was just posing again the argument that the adjustment will have costs if other countries do not also shift some of their economic models.

    Rien- good point. one of the most significant reforms would be a change in tax and dividend structures to change the incentives for SOEs.

  • Posted by Glen M

    Rien,

    The biggest victim in the conspiracy of ‘trade’, has been the lowly Chinese worker. Made into a slave by large national and foreign companies, with help from the state. On top of that,the actions of the government has prevented them from enjoying the increased purchasing power of their savings.

    http://www.bloomberg.com/apps/news?pid=20601109&sid=avXC8Im_FK5I

  • Posted by Noah

    “Should export-oriented “surplus” countries like China keep saving and keep trying to export demand”

    Don’t you mean “export supply”?

  • Posted by bill j

    Agree with Rien, China’s savings are predominantly the excess profits of its SOEs, the real question is will these SOEs maintain their profitability?
    Probably yes at least in the short term, as falling raw materials prices restore profit margins, and increased demand allows them to raise prices notwithstanding lower costs.
    Will China’s balance of payments remain in surplus? That’s a different question and maybe not if it carries on lending like it has done in the first half and export markets remain in the doldrums.

  • Posted by Ying

    See lots of bashing on salve wages of Chinese immigrant workers. Realistically, wages has little to do with government. On individual level, producers always try to lower cost and attract workers from less developed regions. Even in developed world, hard labor work are dominated by legal or illegal immigrants from poor countries. Average wages in developed world has been slowly declining since 70s and consumers resort to credit provided by producers and financial institutions to keep the purchasing power.

    As to the credit expansion in China, most of them are used in boosting collective consumption such as social security and investment. In contrast to US, credit expansion has been used to maintain the status quo of financial sector in the whole economy. Financial sector produces financial securities which is the claim to future streams of cash flow from business and wages. They don’t create real wealth for the economy. You can see the macro differences here for the two countries.

  • Posted by Ying

    Credit expansion in China will have an inflationary effect while US is still going through debt deflation. The outcome is that cost of goods imported from China will be more expensive for US consumers. This combines with the internationalization of Chinese Yuan will have a negative impact on US recovery in the long run.

  • Posted by Too Much Fed

    Rien Huizer said: “China’s savings are heavily concentrated in SOEs, and many of those SOEs are local market oriented and oligopolistic. As far as I can see, the Chinese government allows SOEs to be too profitable, and often in unfair ways.”

    If that’s true and considering the few probably own the SOE’s, do excess corporate profits lead to wealth/income inequality?

    Same thing in the USA? Since the few own most of the stock market, do excess corporate profits lead to wealth/income inequality?

    Is that what the fed, the chinese central bank, and the oil exporters are up to, using excess corporate profits to maximize wealth/income inequality for their own benefit?

  • Posted by Rien Huizer

    Too Much Fed,

    SOEs are (majority owned by the PRC state) most have listed shares but there is not a lot of shareholder discipline and I do not believe that Beijing has much control over some of them either (provinces often do). The current witch hunt for corrupt SOE steel managers (iron ore supplier Rio Tinto’s local manager Sern Hu is (dual nationality Australian) is apparently accused of bribing local steel firms (all SOEs) has the fingerprints of an old fashioned CCP approach (taking away corruption benefits and public treatment of a few expendable stray comrades) used when the centre is losing control or in the process of showering money. Keep in mind that the Centre is not as powerful as people often believe. Its three main tools are the army (dos not work anymore), partydiscupline/police and the state banking/budget system. It is extremely hard to consolidate an industry for instance and I had expected the CIC to become the agency for that but so far not much.

  • Posted by Larry

    Is there a model that tells us what the equilibrium US private savings rate is? It seems like that tells us a lot…

  • Posted by Rien Huizer

    Too Much Fed:

    Here is an excellent working paper that may answer many questions regarding SOEs, SOE policy background (the paper is from 2003, but the policy background is still relevant)

    http://www.soas.ac.uk/economics/research/workingpapers/file28847.pdf

  • Posted by Rien Huizer

    Bill J

    1. see my above reference to Dic Lo’s working paper
    2. until fairly recently the SOE problem was that they were not profitable enough (possibly because the profits went to the state for posible redeployment elsewhere in the economy. That gave the managers (part boss, part local offocial, part union leader, part provider of housing etc to SOE’s employees, very little incentive. The SOE reform of the mid 1990s had two important features: “contract management” and “tax for profit”. The aim was to retain the ownership structure but motivate managers to make money for themselves and the firm. Meanwhile banks were reformed as well (originally bank loans were basically grants (in return for performance) booked as loans and the banks essentially the finance function of the state. The banks were modernized and centralized (thanks to western ICT ), and became normal lenders (the latest incarnation of China’s model under Messrs Hu & Wen appears to misuse the banking system again. Later the managerial incentive system was extended by having many SOEs (and the state banks) list a minority of their capital. All of this does not make a normal market for corporate control or managers of course. But one of the ideas was to curb waste (corruption, paternalism, entrenchment etc).
    I would not be surprised if the high rate of saving in the SOEs is a symptom of a stand-off between managements who may want to formalize their managerial benefits (these people see their Russian peers get seriously wealthy by taking care of state shares), local governments and hangers on in the private sector, and the centre that does not get a lot, except tax. Sooner or later things will change in SOE land. But there appears to be no plan for further expansion of finance and markets in a Western sense. The problem that Beijing has with some of the SOEs is similar to what the Koreans once had (the government lost) with the Chaebol. I guess that we are going to have a bit of a clampdown on managers (especially the naughty ones that can easily be replaced and have many friends that will be have like the proverbial monkeys when the chiken gets killed) which would then be followed by another wave of liberalization that would reward both central and local people. But meanwhile the money stays where it is..

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  • Posted by Twofish

    Demand is not consumption. You can have high demand with high savings, if that savings gets converted into investment.

    One thing about corporate governance is that every country in the world does things differently, and in some cases *very* differently, and I don’t see that the way that China structures its industries to be particularly unworkable.

    Also because so much of the economy is owned by the state, you get to see market like interactions. For example, the Communist Party has no particular reason to favor banks over oil companies, or one oil company over another oil company, or one province over another. Because the political pull for these sorts of things are even, the Party lets the market sort things out.

    The thing about SOE’s is that when the SOE’s makes a lot of money, managers benefit, this is a good thing. The larger the amount of money that the SOE has in the bank, the nicer office you get and the more you can pay yourself. What the government has said to the SOE’s is that the government takes X% in tax, and everything else you get to keep.

    The reason the government really doesn’t want to take too much money is what is the point of making a profit, if the government comes in and takes all of it? Conversely, if you are an SOE and you start losing money, then your office isn’t going to be as big.

  • Posted by Twofish

    Huizer: SOEs are (majority owned by the PRC state) most have listed shares but there is not a lot of shareholder discipline and I do not believe that Beijing has much control over some of them either (provinces often do).

    Under Chinese law, an “SOE” is 100% owned by the state. People use SOE loosely because the division between what is an SOE and what isn’t is (intentionally) fuzzy.

    Beijing has quite a bit of control through SASAC and the Party Organization Committee, but in most situations it has decided not to use it. The problem is that the job of a manager is to manage. If you second guess the managers, then you need another set of managers and then another set of managers and then another set of managers. Either let the managers do their jobs, or fire them, and the Party-state is a good position to fire managers when they don’t make money.

    Also there is a huge interest in expanding markets but not with the large SOE’s which is considered to be a “solved” problem. The big thing that the government is trying to push markets to do is to have a private equity system that helps develop small/medium enterprises.

  • Posted by Twofish

    Stern Hu is not a dual national since the PRC doesn’t recognized dual nationality. I have a strong suspicion that Hu was arrested in order to prove that it *wasn’t* a witch hunt and he really did do something nasty. As the PRC has arrested an Australian citizen, this whole process is going to be monitored by the Australian government, and if the Australian government concludes that yes Hu really did do something nasty, then it has the credibility that Chinese officials do not have.

    This is very common in Chinese business. The big SOE’s tend to list in Hong Kong and NYSE because no one trusts the PRC officials, and the recent mess on Wall Street is going to seriously hurt business there.

  • Posted by Twofish

    Too Much Fed: If that’s true and considering the few probably own the SOE’s, do excess corporate profits lead to wealth/income inequality?

    Probably not since much of the savings is intended to shore up the pension system.

    To Much Fed: Same thing in the USA? Since the few own most of the stock market, do excess corporate profits lead to wealth/income inequality?

    Probably not. You have to distinguish between shareholders and management. The more money shareholders make, the less management makes. Shareholding in the US is very highly distributed which means that in most cases, shareholders have essentially zero control over a company.

    The structure of most US corporations resembles the Communist Party with the Board being the Politburo. This resemblance is not accidental as the Soviets looked toward the US in the 1920′s on how to organize the CPSU.

  • Posted by DOR

    Ray, my friend, I’m with you all the way. I’ve been saying for years that the fastest way to rebalance American foreign trade was to drive the economy into a deep recession.

    I just didn’t think the GOPers were listening!

    (But, you’re off base with the printing Rmb and the Chinese government savings bits. Government isn’t the one making money on trade; that would be 60% foreign-invested companies, 30% Chinese SMEs and 10% Chinese SOEs. The excess savings is mainly in the corporate sector.)

    = = = = =

    Rien Huizer,

    Chinese households are doing just fine. They are earning many multiples of what they earned 20 or 30 years ago. Prices are low and they haven’t developed bad habits such as having an inefficient car for every driver or living off of credit cards.

    I accept your point (as noted above) about corporate savings, but don’t dismiss households.

    = = = = =

    Twofish,

    Ethnic Chinese with foreign and PRC passports who enter China on the foreign passport are granted the status of foreigner in matters such as consular services when arrested. Those who enter on PRC passports or other travel documents do not.

    De facto recognition of dual nationality.

  • Posted by Twofish

    DOR: Ethnic Chinese with foreign and PRC passports who enter China on the foreign passport are granted the status of foreigner in matters such as consular services when arrested. Those who enter on PRC passports or other travel documents do not.

    But ethnic Chinese are not dual nationals under PRC law because by acquiring foreign citizenship they are considered to have renounced their PRC citizenship. If the PRC finds that you have entered the PRC with a PRC passport and you are a citizen of another nation, they can seize your PRC passport, remove your citizenship, and deport you.

    This doesn’t cause issues because in situations where there is a problem you usually *want* the PRC to seize your passport, remove your citizenship, and deport you.

    There is an interesting story about a Dutch citizen of Chinese ancestry that was arrested. The Dutch ambassador was going to angrily *demand* that the PRC treat that person exactly like a local before the person’s defense attorney told him that that would not be a good idea.

  • Posted by Rien Huizer

    Twofish,

    Just a coincidence I looked at this post again and saw quite a few new entries.

    Re SOEs: from your point of view you are entirely right (and I agree my “SOE”is not strictly so. If you believe that it is OK for a government to let individuals who happen to run state-controlled firms treat those as real “capitalist” firms, but without either capitalist (market) discipline or bureacratic (party, whatever) discipline my decidedly non-marxist new-institutionalist economics tells me you are going to get pretty wird incentives, even if they are different from bureaucratic ones.

    And I see that you agree that de facto, the Centre does not get too involved in what SOEs do. And of course, theoretically they can. But I do not think that it is plausible that there are delicate enough mechanisms (rather that the various sledgehammers) readily available (of course they can be developed) to make/keep SOEs efficient and “market respecting” (which is very different from being profitable due to market power, however much that type of profitability is cherished by shareholders and managers alike in capitalist democracies, which is then , or should be, countered by gvt regulation to prevent the expensive externalities of market failure.

    That is basically my main criticism of many Asian rapid development cases (hesitate to call them models, too sui generis): mobilizing production on the basis of preexisting human capital was a brilliant strategy at the time (Korea, Taiwan) following the success in militaristic precedents like Imperial Germany and Japan, as well as the spectacular success of Manchukuo (alas politically incorrect). It did a lot of things better than bureaucratic socialism (aka marxism leninism) but it had one weak spot. Sooner or later the state would lose control over the Frankenstein businesses it had created. And businesses (state- or privately owned does not matter in this context), without the presence of developed. properly institutionalized and fair markets to prevent true (not marxist jargon) would focus on exploitation of the bulk of the population. I guess China’s domestic economy can easily develop the same pathologies as Japan’s. And pse do not refer to the US as a place that has pathologies of its own, those are well known, understood and so entrenched that it will take generations to change without very dramatic events intervening. I just meant to say that China does not have to make the same mistakes as others.

    Re Stern Hu: I guess you are right. The term dual national was used loosely, like “SOE”. Although he has hardly lived in Australia (less than 2 yrs I believe) he is an Aussie citizen and gets the commensurate attention. And it is unlikely that he resides in the PRC on the basis of an invalid (and probably long expired) Chinese passport. But it will be interesting to see what comes out. One of the things that has changed (and will change more) is that iron ore used to be traded on fixed price term contracts that were renegiotated annually. Those did not offer much scope for decentralized corruption and were easy to monitor. During especially the last year more and more iron ore is traded on a spot basis, with pricing that is much more difficult to monitor, especially given the presence of China-based trading firms (absent in the term market). It would be odd that such an increase of opportunity would not foster increased central scrutiny into the prevalence of irregular activities. The interesting thing is that Rio was a relative latecomer to spot iron ore. BHP has been doing this for years. No investigations going on there, apparently. There are rumours that a big part of the excess iron ore imports (over current production use) were for account of two (local) trading firms.

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