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China linkfest

by Brad Setser
August 1, 2009

Qing Wang of Morgan Stanley: “Given China’s high national savings rate, from the perspective of the economy as a whole, there are only three forms in which China can deploy its savings: 1) onshore physical assets; 2) offshore physical assets; and 3) offshore financial assets. …. We therefore think that from the perspective of the economy as a whole, the opportunity cost of domestic fixed asset investment, or formation of physical assets onshore, should be the total returns on US government bonds. Put in simple terms, in the debate about over-investment at the current juncture, it actually boils down to an investment decision on building railways in China versus buying US government bonds, given China’s high national savings.

David Pilling: “Far from a sign of strength, Beijing’s accumulation of vast foreign reserves is the side-effect of an economic model too reliant on exports. The enormous trade surplus is the product of an undervalued renminbi that has allowed others to consume Chinese goods at the expense of Chinese people themselves. Beijing cannot dream of selling down its Treasury holdings without triggering the very dollar collapse it purports to dread. Nor are its shrill calls for the US to close its twin deficits – which would inevitably involve buying fewer Chinese goods – entirely convincing. Rather than exposing the superiority of China’s state-led model, the global financial crisis has laid bare the compromising embrace in which the US and China find themselves. ”

Peter Garnham touches on similar themes for the FT.

Philip Bowring on the obstacles (mostly self-created) to internationalizing the renminbi: “China’s expressions of desire to reduce the role of the dollar are anyway contradicted by its actual policy of maintaining a de facto peg to the U.S. currency, meanwhile continuing to accumulate dollars in reserves now totaling $2 trillion. The modest yuan appreciation after 2005 came to a halt more than a year ago as China has sought to sustain exports in the face of the global slump. There is conflict between macro-economic stabilization goals and pressures from industries and employment creation not to put more pressure on exporters. … Nor has there been any significant move towards full convertibility as the financial crisis has, with good reason, made the authorities nervous of liberalization …. any significant use of yuan requires and significant offshore stock of the currency. That is incompatible with China’s expressed desire to reduce its dollar reserve dependence.”

Robert Pozen on the limits of the SDR.

Michael Pettis on his blog and in the Financial Times: ” If the Chinese economy was the biggest beneficiary of excess US consumption growth, it is likely also to be the biggest victim of a rising US savings rate. … Eventually, and maybe this is already happening, the decline in the US trade deficit must result in a decline in China’s ability to export the difference between its growth in production and consumption. When this happens, China’s economy will grow more slowly than Chinese consumption, just as the opposite is happening in the US. Put another way, rather than act as the lower constraint for GDP growth as it has for the past two decades growth in Chinese consumption will become the upper constraint, as for the next several years Chinese consumption necessarily rises as a share of GDP, just as US consumption must decline as a share of US GDP.

And Paul Cavey on China’s credit boom — which clearly jump-started China’s economy in the second quarter.

The Economist on China’s low level of consumption.

Additional recommendations welcome.

Update, based on the suggestions in the comments:

Lardy and Goldstein on China’s exchange rate regime.

And John Makin’s evaluation of the risks associated with China’s stimulus program. Makin and Pettis don’t seem all that far apart: Both worry about efforts to support production in anticipation of future demand, and worry about the impact of rapid money and credit growth of China’s long-run economic health.

Free exchange claims that many things you know about China are wrong, specifically arguing against the notion “China depresses domestic demand to boost its exports” as Paul Cavey forecasts that “China’s current-account surplus will fall to under 6% of GDP this year and 4% in 2010, down from a peak of 11% in 2007. Exports amounted to 35% of GDP in 2007; this year … that ratio will drop to 24.5%.” There are other forecasts that suggest a smaller fall in China’s surplus (it is down in q2 09 v q2 08, but is still running at roughly the same level as in 2008 in nominal dollar terms), but projecting some fall in China’s surplus isn’t unreasonable in a “rebalancing world.”

Let’s be clear here though. No one is arguing that China is currently limits domestic demand to support its exports; China is currently stimulating domestic demand. The question is whether or not Chinese policy makers took steps to depress domestic demand back when net exports were contributing 2 percentage points or more to growth, bring China’s surplus up to that 2007 peak. And on that point, I don’t think there is much room for debate. Fiscal policy was tight — look at the data on the central government’s fiscal balance from 2004 to 2007, and the large deposits that the government built up over this time. More importantly, after 2003, the government reigned in bank lending with administrative limits on loan growth and high reserve requirements. As a result — according to the IMF data — China entered into this crisis with one of the lowest loan to deposit ratios in the emerging world. That, in turn, gave China greater capacity to stimulate than most, as it could simple take its foot off the brakes it was applying to the banking system.

China is not currently suppressing domestic demand. But back when exports were booming China opted to limit inflationary pressures with a range of policies to limit domestic demand growth rather than allowing currency appreciation (yes, the RMB appreciated v the dollar after 2005, but that appreciation came when the dollar was generally depreciating v many currencies). Look back at China’s policy choices back in 2003/04, when a lending boom threatened to produce a sustained rise in inflation. There is a reason why China’s import growth didn’t keep pace with China’s export growth from the end of 2003 to the end of 2006. See the data in this post; there is a clear dip in import growth in 2004, one that coincides with China’s decision to limit bank lending.

I agree though with other argument that Free exchange (drawing on the Economists’ coverage of China) makes, namely that China’s export boom was capital rather than labor intensive, and didn’t generate all that many jobs. That is one reason why labor income slid relative to GDP during China’s boom.

27 Comments

  • Posted by Twofish

    I need to put this on a sign, since this is the fiftieth time I’ve said this.
    ——————-

    Yd = C + I + G + (X-M)

    CONSUMPTION IS NOT DEMAND.

    China can deal with a drop in exports by increasing investment or government spending.
    ——————–

  • Posted by Twofish

    Pettis: But rapidly rising bank lending, especially if misallocated to nearly the same extent as in previous loan surges, cannot be a long-term solution for slowing Chinese growth.

    First of all, economists seem to be so concerned about “long term solutions” that they ignore the short term. If you are following from the sky into a wilderness, then pulling on the parachute is not a “long term solution” to your problems, but you got to do it because if you don’t get past the short term then the long term does not matter.

    Second, I don’t think that previous loan surges were grossly misallocated. The banks did end up with huge non-performing loans in the early 1990′s, but these were because they were ordered by the government to provide social welfare spending to state owned enterprises, and given that was a crucial part of winding down the SOE’s, I hardly think that it was a misallocation or a mistake.

    Similarly the burst of infrastructure spending around 2001-2002 led to things that for the most part increased economic growth. Again, it’s going to take a lot of convincing to argue that Chinese bank lending in that period was misallocated. The notion of Chinese banks as grossly misallocating capital is a common one, but it’s something that people have just got to defend now, because it doesn’t seem to be to be true at all.

    Also, the infrastructure spending this time for the most part seems to directed at useful things. Railways. A lot of the stimulus was also directed to increase consumer spending. The government fired up the helicopters and dropped appliances purchase certificates that let consumers buy refrigerators.

    Part of the issue here is that personally I think that the Chinese economy basically works. Sure there are a dozen things that can be done to improve it, but it’s basically a functional economy.

  • Posted by Alan Murdock

    The Peterson Institute has posted video, audio and slides of the book release event for The Future of China’s Exchange Rate Policy. The authors, Morris Goldstein and Nicholas Lardy, speak for about 40 minutes and then take questions from the audience for another 40.

  • Posted by AK

    2fish, I read the full article and one of his posts and I think you may be getting too caught up in a static economic model.

    Yd = C + I + G + (X-M) is simply an accounting expression of economic components at a point in time, but changes in any of these things will cause the model to evolve, and the point of I is to generate production which must be consumed in the future.

    In the medium term whether an increase in “I” can cause Yd growth sustainably to exceed consumption growth is very doubtful. If “I” is to have any meaning (for example unwilling increases in “I”, also called inventory build-up, can in theory go on for a long time, as they did in Japan, but this is not a meaningful measure of wealth creation) it must lead to increases in production that are matched by increases in consumption, or else we are right back to rising inventory.

    There is also the problem of sustainability that Pettis keeps referring to. You may be confident that the fiscal and credit boom will not lead to misallocated capital, but this suggests that Chinese banks have radically changed their approach to lending and Chinese authorities have forsworn the types of “investment” to which they were so prone until recently. In China there is almost no one in the banking industry that would agree with you, except maybe in front of a reporter.

    Most estimates of the last lending boom suggested 30-40% of the loans went bad. Not only is the current lending boom far in excess of the last, but as Victor Shih said in the WSJ last week, last time around Zhu Rongji was cracking the whip and slamming bad projects – and there is no equivalent today. Maybe you are right. Perhaps Chinese bankers have found religion, but the circumstantial evidence isn’t there.

    Pettis also claims Chinese debt levels are higher than we think. I have no idea if he is right and often think that Pettis tends to get overly fussy about balance sheets, but I think he is right to argue that to have achieved nominal GDP growth of 3-4% in H1 with an expansion of loans equal to 25% of GDP and central and provincial government deficits of around 4-6% (the data is, as always, fuzzy) does not necessarily indicate money well spent. And last week the NBS said investment accounted for 88% of GDP growth, which is a number that I don’t ever recall having seen in history. This means that the ability of the government to push “I” for much more than a year or two is limited, and then we get right back to the problem of consumption growth limiting GDP growth.

    I think if you accept his argument as a medium-term argument, not a point-in-time argument, it might make more sense.

  • Posted by Qingdao

    Heres another quote from Qing Wang: “Although the rapid expansion of bank credit has caused concern about the risk of inflation, we argue that these concerns are unwarranted, at least in the next 12 months, as the dominant contributing factor to headline CPI inflation is export growth instead of money growth.” So no exports, no inflation. Apparently Zimbabwe exported too much.

  • Posted by Qingdao

    John Makin has an excellent article “China: Bogus boom” at AEI (2 Fish will not like it; which is always a good sign). Ronald Mckinnon has yet another paper: Stanford Center for International Development, Working Paper No. 391; The Global Credit Crisis and China’s Exchange Rate, June 2009. Recommend: Michael Mussa’s critique of McKinnons argument at BIS; he gently calls it “economic nonsense.” Excellent article by Eswar Prasad: Is the Chinese growth miracle built to last? China Economic Review; available at Prasad’s home page web site. I would enjoy a discussion of this last (Prasad); especially the underlying assumptions; that seems to be where most of the confusion lies.

  • Posted by Twofish

    AK: In the medium term whether an increase in “I” can cause Yd growth sustainably to exceed consumption growth is very doubtful.

    I don’t think it is doubtful at all. We have to be careful about the term “increase in consumption.” The fact is that Chinese consumption has increased dramatically over the last few years, and will continue to do so. If you increase investment this makes more capital available for projects with less return, but that’s fine as long as the return on investment is positive.

    You can also increase G, government spending, and over the next decade or so, as the Chinese population ages that’s going to happen one way or another.

    AK: You may be confident that the fiscal and credit boom will not lead to misallocated capital, but this suggests that Chinese banks have radically changed their approach to lending and Chinese authorities have forsworn the types of “investment” to which they were so prone until recently.

    And most of the bank investment in 2001-2003 did actually pay off. There are a huge number of “white elephant” projects in China, but the interesting thing is that if you trace their source of funding, the final source of funding is invariably not a commercial bank. Commercial banks lent primarily to SOE’s and started lending to consumers in 2001-2003. Those loans are doing fine.

    AK: In China there is almost no one in the banking industry that would agree with you, except maybe in front of a reporter.

    Conventional wisdom can be wrong. In this case I think it is. Also, one tendency I’ve seen is that Western newspapers will find someone in China that says “Oh this is totally horrible” and the reaction is “well things much be much worse.” What’s happening here is the Western reporter has a preconceived notion that things are bad, and simply finds someone in China to confirm those notions. (Chinese banks must be in bad shape, I have this employee here that says it’s awful. I have this other guy that says it’s not that bad, but he must be brainwashed.)

    In the case of Chinese banks, people have been very worried about NPL’s and risk management, and people have been looking closely at any situations where you have bad risk management. That’s why Chinese banks are in good shape right now. When people stop worrying, then you should worry.

    AK: Most estimates of the last lending boom suggested 30-40% of the loans went bad.

    That’s not true. 30-40% of the loans issued in the early 1990′s went bad. The last major lending boom happened in 2001-2003, and the number of those loans that have gone bad are in the 2-3% range.

    AK: last time around Zhu Rongji was cracking the whip and slamming bad projects – and there is no equivalent today.

    Yes there is. You don’t want a great leader doing these sorts of things. Wen Jiabao has a thousand other things that he needs to worry about. What Zhu did was to create a set of regulatory institutions to regulate bank lending (namely CBRC). Also the banks were largely restructured so that they were under central control so that they didn’t have pressures from local officials.

    AK: Maybe you are right. Perhaps Chinese bankers have found religion, but the circumstantial evidence isn’t there.

    Yes there is. The world just went through the worst financial crisis since the Great Depression. American banks blew up. Chinese banks didn’t.

    The fact that Chinese banks didn’t blow up and American banks did drastically alters the terms of the debate.

    People have been predicting the imminent collapse of the Chinese economy for twenty years. Maybe the Party will collapse next year, but people have been crying wolf for so long that it’s reasonably to ask them what makes this prediction of doom different from the thirty other predictions they’ve made since 1989.

    My theory is that people say “CHINA HAS THIS BIG HORRIBLE PROBLEM AND IT IS DOOMED.” What actually happens is that the government says “WE HAVE THIS BIG HORRIBLE PROBLEM, LET’S FIX IT.” The Chinese stimulus package will create lots of big horrible problems. The question is why any of those problems are unfixable.

    AK: Pettis also claims Chinese debt levels are higher than we think.

    There is quite a bit of debt that is “off-balance sheet” but if you add up all of the numbers with hidden liabilities, it’s not scary.

    AK: And last week the NBS said investment accounted for 88% of GDP growth, which is a number that I don’t ever recall having seen in history.

    There are lots of things that you see in China today that you’ve never seen in history. That particular number is likely to be unsustainable and to go down, but that doesn’t mean that you end up with a consumption limited economy.

    Let’s do a thought experiment. Suppose a lot of the investment turns out to be white elephant projects. Mounds of concrete doing nothing. Then what effectively happens is that some of the investment turns out to be actually consumption, and all the numbers work out.

    This is what I don’t understand. You have tons of workers producing things for export. If everyone is happy, and the exports disappear, then you get the workers to still produce things for export, you take those exports and then toss them into the Pacific. If everyone was happy before, why doesn’t that work? Now if you have idle hands, you can probably figure out something more productive for them to do.

    The problem with the excess consumption argument is that it’s basically one that Karl Marx came up with. If you read Das Kapital, he comes up with an argument based on excess production that capitalism is doomed. It wasn’t because there are about ten things you can do to fix that problem. It’s not a hard problem, and I don’t see any particular reason why it should constrain economic growth.

  • Posted by Twofish

    It’s very interesting that you have a paper that is self-contradictory. The first half talks about how the GDP numbers are cooked, but then the second half talks about all of the dangers if China if the economy overheats. The other thing that is missing is that the government quietly gave up the 8% GDP target around January. Around January/Februrary the consensus figures that everyone was looking at was 6%.

    The other thing that you have to watch out for is the “we don’t know therefore it’s bad” assumption. “We don’t know, therefore we don’t know, therefore we should find out.”

    Also, yes the stimulus package has substantial risks. So does every other economic decision. If you pull on the parachute ripcord, you might break your finger. The risks of massive stimulus are manageable and nowhere near as bad as the alternative.

  • Posted by Twofish

    Qingdao: Is the Chinese growth miracle built to last?

    As Krugman points out, there is nothing particularly miraculous about Chinese economic growth. It’s been done many, many times before.

    The first thing is that it turned out that the Chinese economy survived an economic shock a lot better than the US economy did, and for me that is because the Chinese did a much better job of government regulation of finance than the United States.

    Right now China is in the developing market phase of economic growth (sort of like South Korea and Singapore in 1950). What’s basically driving Chinese growth is that people are no longer farmers, but are doing something else.

    This will end around 2020, and the challenge is to create a set of institutions that will allow China to continue economic growth once everyone stops being farmers.

    One other big problem is that we really don’t know the best way of structuring an economy and a financial system. We thought we did, but we were wrong.

  • Posted by Twofish

    Also be careful about questions that turn into statements. The title of Makin’s article is “Bogus boom?” not “Bogus boom!!!!”

    He does that sort of thing in his paper. He asks a question, then turns it into a statement. He basically asks “Could it be that retail sales are overstated because statistics count only shipments?” That’s a perfectly valid question. But then Makin throws up his hands and says “we don’t have any data, therefore maybe its bad.” Summarize that and pretty soon it becomes “we don’t have any data, therefore it is bad.”

    It’s actually not hard to get the data he wants. Go to some retailers and get Q1, Q2, earnings reports and it’s clear that consumer spending is up.

    Also, you can get figures on inventories and project progress. Call up a few factories and construction companies, and ask them out things are going.

    The other thing is that if it is the case that stimulus projects are being bottlenecked then how is increasing credit going to change the situation? The increase in money supply in the Q2, can also be interpreted as signs of a recovery. Once people start spending, the velocity of money speeds up and this increases the money supply. The thing about this is that it’s very difficult for a central bank to increase credit quietly so that if you do have an increase in money supply, but no announcements of macroeconomic changes, then you are likely looking at recovery.

    The other thing I dislike is when economists make wishy-washy statements “Maybe China’s boom is bogus!!” That’s a useless statement. I’d prefer if he sticks his neck out and says “China’s boom is bogus and things will blow up in sixmonths!!!”

    Either it blows up or it doesn’t. Whatever happens we can go back in the essay and see what people got right and wrong. One of the cool things to do is to go back to Gordon Chang’s “The Coming Collapse of China” read the book, and then figure out what he got wrong.

  • Posted by Rien Huizer

    MIchael,

    Crude, but effective..

  • Posted by Twofish

    One important fact about the Communist Party of China is that they are motivated by power, and will do pretty much whatever it takes to stay in power. The fact that the Party is intent on developing the Chinese economy is because without that sort of development, they are doomed.

    In the case of banking reform, one reason that it was successful is that the CCP saw that a banking crisis very will could threaten it’s hold on power. The reason the Party was motivated to fix the banking system was that they saw what happened to Suharto in Indonesia, so you had people in the Politburo looking at each other and saying we have to fix the banking system or else when the next crisis comes, we’ll all be out of jobs.

    The next crisis came, and the system held.

  • Posted by Cedric Regula

    Until the Party establishes a meaningful minimum wage, I believe they are rather disingenuous about shifting growth to sustainable domestic consumption.

    The West learned in the labor movement of the early 1900s that this was the only may to make trickle down economics work.

    But there still is room for worthwhile government sponsored projects.

  • Posted by greg

    Pettis: ……

    Pettis’s bearish arguments on China’s economy basically boil down to “net demand vs. total demand” and “short-term vs. long-term.”

    Pettis loves his creation of the concept “net demand” and often castigates people to confuse “net demand” with total demand, which include both consumption and investment. But I think he is too caught up with his own idea when it comes to analyze the direction of China’s economy.

    The line between consumption and investment is often blurred in national economy, at least in short- and medium-term for a developing country like China, which have many areas are either consumption-constrained or investment-constrained. In order to defend and justify his theory about China, Pettis repeatedly mischaracterizes China’s stimulus package, calling it investment into excess capacity. But as many people have argued, as Wang Qing in his articles above, and me in Pettis’s blog, China’s stimulus is mostly about infrastructure spending, earth-quake reconstruction, social programs and consumer subsidiaries. They’re NOT about investing in excess manufacturing capacity, as Pettis repeatedly likes to portrait. Who is investing in export industry today in China?!

    To be sure, some of these stimulus in infrastructure has questionable return in short-term. But long-term, they will not be wasted for a country like China, as Wang Qing argued above.

    The other confusion that Pettis kept having is short-term vs long-term. The concern about NPL, the fuss about the 1H economic growth contributed by investment, can all fall into this category.

    People forget we’re in the midst of severe recession and China’s export has been a negative growth contributor. To make up for the short fall in growth, the quickest and most effective way to increase investment and government spending, which China did, very successfully.

    Pettis’s assertion that China’s economy will grow more slowly than consumption, which I believe he made to justify his bearish view about China’s economy since most people agree that it’s not easy to boost consumption’s share of economy rapidly. He is not correct. China can grow its economy more rapidly than its consumption growth. Why? Because export growth can be negative or slower than economic growth. The short-fall will be made up by investment, as is happening now. None of this is suggesting that consumption grows slowly – Chinese consumption has been very steady and grow rapidly throughout this crisis. And it’s obvious, to the policy-makers and everybody else, that China needs to increase the consumption more in the long-term; I think government is working on that.

    The concern about NPL, while understandable, does not justify a medium- to long-term bearish view on Chinese economy. Pettis cited a lot of Chinese analysts, and former government officials’ concern about credit expansion as evidence to support his bearish view. To me, this is exact evidence that China’s economic prospect is bright, since this shows there are balancing and different voices and views within Chinese economic and policy-making circles, which actually has been the case for over 30 years now.

    Western commentators’ negative view on NPL and banking problems in the past have been proved to be spectacularly wrong. The potential scale of NPL, even if true, is well within the government’s ability to deal and is the risk worth taking. The important thing, as is true last time, is to maintain healthy economic growth, and growth will solve and ease a lot of problems, real or potential. And China still has plenty of room for growth.

    I guess we debate this upcoming Chinese crisis endless, but only time will prove who is right. And it will only take a few years’ time to know.

  • Posted by Twofish

    greg: The concern about NPL, while understandable, does not justify a medium- to long-term bearish view on Chinese economy. Pettis cited a lot of Chinese analysts, and former government officials’ concern about credit expansion as evidence to support his bearish view.

    And the fact that people are (justifiably) worried about NPL’s is a good sign. The think about risk management is that it’s a constant struggle, and if you go to the office and say “nope, we have nothing to worry about, then you have to worry.”

    Having said that, there is no particular reason so think that the bank lending is going to lead to excessive NPL’s. Since 1998, Chinese banks have gone through two rounds of massive credit expansion (2001) and (2005), each of which hadn’t lead to NPL’s. People are using stereotypes of Chinese banks from the 1990′s. Things change.

    The fact that things can change, means that it is possible that the government changes policies in a way that causes NPL’s to balloon. But there is no reason to think that this will happen, and it is awful, awful policy to avoid using a fire extinguisher or pulling a parachute ripcode because it *might* cause problems.

  • Posted by Twofish

    greg: Western commentators’ negative view on NPL and banking problems in the past have been proved to be spectacularly wrong.

    Western commentators views on the seriousness of the NPL and banking problems were completely correct in 1999. What Western commentators vastly underestimated was the ability of the Communist Party to make pretty fundamentally changes in the way that the Chinese banking system worked. If China had the same banking system that it had in 1999 that it had in 2009, the financial system would have completely imploded.

    One issue here was that most of the changes were incremental changes that took a few years to implement. What Western commentators were looking for was some sort of “big bang” change, and when you didn’t seem any big bang, dramatic changes, people assumed nothing was happening.

    The are thing that happened was that often Western commentators have a fixed idea of how an economy should work, and when China decided to solve it’s banking problems by doing something that wasn’t the method that a particular economist thought was useful, then they assumed nothing was happening.

    Finally, there was this *huge* and in hindsight very strange blind spot. Basically everything that people were warning China about was happening in the US financial system. If you read the “Coming Collapse of China”, Gordon Chang basically talks about what happened with the US banking system.

    But all that’s in the past… Lots of people got lots of things wrong, and right now I’m looking closely at Nouriel Roubini, Nassim Taleb, and Paul Krugman. They got things wrong, but they got things much less wrong than everyone else.

    It’s OK to be wrong. I thought that derivatives would allow for much more economic stability than they did. I personally did not imagine Freddie and Fannie going under. Ooopppssssss….

    What does irk me a bit is not learning from your mistakes. A lot of the writers on the Chinese economy are basically making the same points and writing the same things they did pre-crisis, and that simply will not do.

    In 2007, you could tell China that what it should do is to copy the US economy. In 2009, I don’t think that anyone really knows how the US economy should be structured or will be structured. What the Congress and the Obama administration decide to do with Freddie/Fannie, AIG, Citi, credit derivatives are going to have vast impact on the financial system, and that decision has not been made yet.

    Also saying “well China avoided a blowup this time, but in three years, everyone will see how I was right all along” won’t work. The state of the Chinese economy (and American economy) in 2012 is going determined in large by decisions that are being made now and in the next year. “Wait three years and watch the Chinese economy blow up” is simply useless and unacceptable. People want ideas *now* for what to do next.

    It’s good that people do question statistics, but the problem with saying “I’m sure that the boom is fake, just wait six months” is that time is critical. While we are waiting six months for you to be proven right, precious time is being lost in trying to structuring the global financial system.

    There are some very major decisions that have to be made on both sides of the Pacific in the next six months (Beijing has to figure out what it wants to do with its reserves), and if someone’s attitude is “wait six months and I’ll be proven right.” Fine, just stay out of the way of the rest of us who have work to do right now……

  • Posted by Twofish

    One thing that I like amount business is that you don’t have the ability to debate things endlessly. You have to come up with a decision. In the case of what caused this financial crisis, my main concern is that we don’t nearly blow up the world again when the Crash of 2015 happens (and I’m pretty sure there will be a Crash of 2015). If there are any sort of fundamental financial system changes that need to be made, it needs to start before the end of the year.

    It takes about three to five years to draft any new legislation, so by the end of the we need a consensus on what new legislation needs to be drafted (both in China and the United States).

    The other big decision that needs to be made is when to move the foot off the accelerator and onto the brake. In China, it’s very difficult to hit the brakes, since you have so many officials making so much money off having the foot on the accelerator, that it takes a few months of screaming to start slowing the economy. My preference would be to reduce stimulus as early as possible, knowing that once you decide to remove stimulus, it will take a few months of screaming at people to actually have it happen.

    In the US, it’s much less hard to change monetary policy. The big battle next year is going to over fiscal policy (i.e. tax hikes).

  • Posted by Qingdao

    A Tidal Wave of New Credit in China

    Victor Shih | Jul 26, 2009; found at RGE Monitor

  • Posted by Qingdao

    EconoMonitorMichael PettisJuly 21, 2009
    Notes on a Real Estate Trip in China

  • Posted by alan

    2fish’s most powerful argument is “That isn’t true because I don’t believe it.” It’s a powerful argument because it allows for pages of pontification :)

  • Posted by Anders

    Greg:

    But as many people have argued, as Wang Qing in his articles above, and me in Pettis’s blog, China’s stimulus is mostly about infrastructure spending, earth-quake reconstruction, social programs and consumer subsidiaries. They’re NOT about investing in excess manufacturing capacity,

    I still think that a lot of the bank loans (or stimuli) were spent on real estate developers refinancing of their ongoing projects, the starting of new real estate projects, on speculative bets in the Chinese stock market and on inventory build up.

    If you are right that most of the money went into reconstruction after the earth quake, social programs and consumer subsidiaries then all is good.

    The thing is if I guessed right then a pull back of credit from the Chinese banks (because of inflation fears) will cause problems, because no ne can buy real estate at the prices the developers want, and there will be no more speculative bets on stocks and on inventory build up.

    Basically we don’t know where the money goes and we don’t know how it’s spent, so it comes down to if you expect the worst or the best of the system. It could be a little of both.

  • Posted by Twofish

    alan: 2fish’s most powerful argument is “That isn’t true because I don’t believe it.” It’s a powerful argument because it allows for pages of pontification

    It’s actually “I don’t believe it.” Whether or not it is true or not is something that we need to argue about. “It’s not true because I don’t believe it, and I don’t believe it for the following reasons which you can contradict.” is a lot stronger argument than “It is true because everyone else believes it, and I haven’t done any fact checking to explain why.”

    If I agree with the conventional wisdom, then I tend to shut up, because there’s no point in me talking.

    The fact is that American banks blew up. Chinese banks didn’t. This was against the conventional wisdom, so if you want to explain what China and the United States should do next, it’s not unreasonable to ask you to explain why you think that it.

  • Posted by Twofish

    Anders: I still think that a lot of the bank loans (or stimuli) were spent on real estate developers refinancing of their ongoing projects.

    This is something that you can check by looking at bank lending. One thing I think people seriously got wrong pre-crisis was over estimating the degree to which Chinese real estate was financed by the state banks.

    The problem with bank loans funding real estate (or stocks) is that real estate prices (and stocks) crash, and if you are funding risk investments from risk-free demand deposits, you are going to be sunk when the inevitable crash happens.

    As point of fact, Chinese banks *don’t* lend a spectacularly large amount to real estate projects, and real estate projects usually get their loans from places other than banks, which is *really* important. If you get your money from an investment pool of rich investors using their own money, and the project blows up, you don’t put the rest of the world at risk.

    Anders: No ne can buy real estate at the prices the developers want, and there will be no more speculative bets on stocks and on inventory build up.

    The big other problem with using bank loans to fund real estate is that you can’t take a loss when you need to. If you fund a real estate project with borrowed money, then it is *painful* to drop the price, because if you drop the price of real estate, the bank forecloses and you lose everything.

    If you own the project 100%, it’s much, much easier to drop prices. One important point is that China has had both a major stock market crash and a major real estate crash (and it has these once every few years). Because people are doing things with their own money, it doesn’t collapse the banking system when you do have a crash.

    Anders: Basically we don’t know where the money goes and we don’t know how it’s spent, so it comes down to if you expect the worst or the best of the system. It could be a little of both.

    If you don’t know, figure out what you need to know, and then go find out. If you have to find a dozen real estate developers in Shanghai and find out the ultimate source of their money.

    One important thing about Chinese banks is that many of them are listed in HK or NYSE, so they have to issue financial statements that are as good as any that you can see in an American bank.

    Also, if you don’t know the details, then you have no basis for judging the soundness of the system. If your judgment is based on guesses as to whether the system is good or bad, then what do you use to figure out if the system is good or bad?

  • Posted by greg

    Qingdao responds: EconoMonitor Michael Pettis July 21, 2009 Notes on a Real Estate Trip in China

    This is one of Pettis’s better blog post. It reflects the view of a particular foreign investor, on the real estate market of a particular city in China, based on his cursory inspection. It’s one interesting data point.

    Does that lead one to conclude that the crash of Chinese property market is imminent? Not necessarily. Does that portend a significant slowdown or even crash of the overall Chinese economy? Far from it.

    Don’t get me wrong. I also think China’s real estate markets in some major cities are over-valued based on my own experience and assessment. But for a lot of reasons, I suspect it can and will stay that way for quite some time, including cultural and structural. The important questions that are of interest to our discussion here are 1) is it going to impede the growth of overall Chinese economy significantly? and 2) is the potential real estate market downturn, if it occurs, pose some serious systematic risks to the financial system?

    My answer to both question is no, not likely as it current stands.

    China’s housing market is pretty young and will definitely experience ups and downs; there will be quite some changes to the sector (property tax, for instance). To use real estate market to predict China’s trendline growth is not appropriate. And that’s where I disagree with Pettis, not whether a particular sector has problem or not.

  • Posted by Anders

    “To use real estate market to predict China’s trendline growth is not appropriate. And that’s where I disagree with Pettis, not whether a particular sector has problem or not.”

    I think Pettis is using the U.S and E.U consumer to predict China’s trendline growth. He seems to think they are going to consume less and save more, thus slowly down the growth of any export based economy. Seems right to me.

  • Posted by Twofish

    greg: Does that lead one to conclude that the crash of Chinese property market is imminent?

    The Chinese property market has been crashing since the late 2007. Personally, I think it’s a good thing that the Chinese property and stock markets crash from time to time. You need a very sharp drop every now and then to remind people that they are dealing with risky assets, which they should use their Vegas money to gamble with.

    The trick is to have a system that allows the real estate and stock markets to crash without destroying the entire financial world. If you need to ask yourself what happens if property values in Shanghai drop by 60%. If the answer is, some rich people become much less rich, but the world goes on, this is good.

    If you look at Chinese state banks, they aren’t very heavily exposed to real estate. If someone wants to invest their own money in a stupid real estate deal, that’s fine as long as it’s their own money.

    If they start borrowing massive amounts of money that come from checking accounts, then we have a big, big problem, because when the bubble bursts, it will cause everything else to crumble.

    Pettis does make a good point that boom times can hide a lot of bad loans, but we are now in the middle of a bust, and if the banks did have bad loans, then would have exploded by now.

    greg: Not necessarily. Does that portend a significant slowdown or even crash of the overall Chinese economy?

    I don’t think it does. The Chinese real estate and stock markets have crashed before. It hasn’t taken down the banks. Also, I think don’t think that a real estate bubble exploding is going to really cause even slow growth.

    You look at a building that is half rented or half built, and then ask what is the most economically useful thing that you can do with it. If the building is built with equity capital, then the owner puts out a sign “CHEAP APARTMENTS FOR RENT” just takes a loss. If you have the building built with borrowed money, then you are looking at extreme pain and agony as people sort out what happens next.

    Meanwhile you have an ugly mob outside the bank wanting to know where their money went.

    Anders: He seems to think they are going to consume less and save more, thus slowly down the growth of any export based economy. Seems right to me.

    Except that China’s economy is not strongly export based. Where I think Pettis is wrong is:

    1) I think he vastly underestimates the ability of the Chinese government and economy to change, when there is an strong incentive to change.

    2) I also think it vastly underestimates the importance of non-numerical measures. If you want to understand the difference between US and Chinese banking, you simply cannot just look at numbers. There is this idea that the only way you can control an economy is through things like interest rates, currency values, etc., when things like the fraction of security that you require for mortgages makes a huge difference.

    The other thing is that my guess right now is that the ultimate source of financing for real estate projects in China didn’t come from Chinese banks but rather from Western ones.

  • Posted by Analysist

    The pundits who report on the reserves of China need some insight into the culture. The PRC is run from Beijing. The education system, from stories to advance financial mechanics, promotes control, ownership, and cash above all else – there is little care for social values or the planet. The trillion or so in USD will not be sold up. It will be diversified into ownership of other assets that can be controlled – the “going out” policy! This is the era where USA, with its promotion of trade with China, without consideration for the consequences of low employment rates, and no floating rates, no quality control, and no rules, will end up handing itself over to China control. Soon USA will work for China and the people go to work for their Chinese bosses who will cut the standard of living for USA like no one could ever imagine in promotion of China rule and growth.

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