I spent most of the past week in Washington for the IMF’s annual meetings, trying to sell a few books. The focus of the meetings though, was not on emerging markets, but rather on oil, China and the United States. The most interesting presentation I saw came from Nick Lardy, who laid out the case that China’s rapid economic growth was the product of an unsustainable boom in domestic credit.
One thought occurred to me — it is rather unusual for a country to run a 2.4% of GDP current account surplus (the IMF WEO estimate for 2004) in the midst of an investment boom. The US current account deficit widened in the late 90s during the IT driven investment boom (and internet stock bubble). Countries like Thailand had massive current accounts in the mid-90s during their investment boom (and property market bubble). A surge in investment usually leads a country to import capital from abroad to finance that investment.Lardy argued that massive domestic credit expansion is fueling China’s investment boom, and that investment has risen to levels that are unsustainable even in a high savings/ fast-growing Asian economy. Moreover, Lardy argued that investment will fall as a share of China’s GDP, and, if past patterns hold, that consumption will fall as well. This is what happened from 93-97 — after another investment mini bubble burst in the early 90s. Falling investment/ rising savings (relative to GDP) is a recipe for a growing current account surplus. Remember, when Thailand’s bubble burst in 97, it went from a current account deficit to a current account surplus. Lardy expects China to cool, not crash — but his prediction that Chinese current account surplus will rise as China’s investment-driven economy cools is still sobering to those of us who are worried about the US external deficit. Lardy’s forecast implies that China is unlikely to facilitate smooth global adjustment through strong domestic demand growth, as it needs to retrench to address its own domestic imbalances.
Two further points:
1) Lardy’s argument suggests that a growing China’s current account surplus may provide additional financing for the US current account deficit. I doubt that this will provide enough additional financing to significantly delay the need for adjustment in the US, given that the US is so much bigger than China. An increase in China’s current account surplus from say 2.5% of GDP (assuming GDP is around $1.5 trillion) to 5% of GDP provides an additional $35-40 billion in financing — not really enough for the US (it is only 0.3-0.4% of US GDP). But the prospect of a growing Chinese current account surplus is a slight qualification to the argument Nouriel and I made that the US is likely to exhaust available Asian financing for its current account deficit relatively quickly — though it also raises concerns that the US might be forced to adjust at a time when China is no longer booming, and thus not helping to soften the blow to the world economy.
2) Those who emphasize that China’s overall trade is relatively balanced despite its large bilateral surplus with China probably should qualify their argument by noting that China is running a significant (2.5% of GDP counts as significant in my book) global current account surplus despite surging commodity prices (an unfavorable change in China’s terms of trade) and an unsustainable investment boom — both of which would be expected to typically generate a current account deficit. China’s exports to the US look set to grow so strongly this year that they will prevent China’s current account surplus from falling much, even with China’s rapidly growing bill for oil, iron ore and soybean imports! (China’s bilateral trade surplus with the US could be close to $150 billion in 2004, around 10% of China’s dollar GDP — enough to offset bilateral deficits elsewhere). Lardy’s argument implies that China’s cyclically adjusted current account surplus would be larger than 2.5% of GDP — more evidence that the renminbi is undervalued!