Several readers pointed to a recent post by Michael Pettis, which mainly discussed how expected wage increases in China are a hopeful sign that China is taking steps to become more consumption-oriented. But as much as this is a move forward, changing the mix of China’s composition of demand is at least a decade-long project unless the powers that be move aggressively to hasten it. As much as I have seen some commentators argue that China understands the need to move away from an export/investment driven model, there does not seem yet to be much in the way of official action along these lines.
But I found Pettis’ discussion of Eurowoes to be useful, and start with his punch line first:
You can’t run large trade surpluses if your trade partners are no longer able or willing to run the corresponding trade deficits.
This is a non-trivial observation. It is common to blame the debtor (after all, they are the ones that welches on its obligations), but like many things in life, parsing out responsibility is often more complex than it appears on the surface.
Let us consider the sad example of Lucent. During the dot-com era, a myriad of obviously-never-gonna-make-a-dime-in-profit companies were accorded all kinds of bizarre adulation, including sycophantic coverage in the business press and IPOs at delusional valuations. So the whole business model was greater-fool theory. And it wasn’t just the poor dumb stock buyers who were duped, but vendors. I am not familiar with the details of the arrangements, but when Carly Fiorina was head of marketing at Lucent, she ramped up sales (and her compensation along with it) by selling equipment by the boatload to these ultimate dot-bomb enterprises in return for paper of various sorts that proved to be worthless. One of my buddies had the misfortune to ride the stock down from $100 a share to $1.
And it wasn’t just Lucent. McKinsey, like many other consulting firms, was desperate to have a robust dot-com business, and similarly sold took equity in lieu of fees. I am told by ex-partners that it took $200 million in writedowns.
So if you think of the surplus country as having put itself in the position of being a vendor (not exactly correct, but a useful way to reframe the problem), it is not in a vendor’s interest to keep selling to a deadbeat, or someone who for other reasons is no longer a suitable outlet for your product. So Pettis’ point is that Germany really does need to do something, which is consume more:
Unfortunately the euro today imposes a kind of gold standard on European countries – it forces them to adjust to excessively high domestic prices, large trade deficits, and/or large fiscal deficits in the same way they would have had to adjust under the gold standard, and I don’t think that is politically likely to be acceptable. The countries that need depreciation to regain competitiveness or monetization of the debt to regain control of the deficit will have to choose between adjusting via deflation and high unemployment or exiting the euro. Politics makes the latter more likely.
There is one other way out, perhaps. Martin Wolf discussed it last week in an important Financial Times article called “Europe needs German consumers”. Wolf argued that trade imbalance within Europe helped to create the subsequent and damning financial imbalances, and that without resolving the trade imbalance it is pretty pointless to talk about fiscal belt-tightening and lower wages as the means by which the problems of outer Europe will be resolved….
This, of course, is the intra-European version of the global imbalance debate. It is simply another way of saying that policies in major trading nations that constrain consumption and subsidize production – in effect trading off lower household income for higher domestic employment – must have the reverse impact on trading partners who implicitly made the opposite trade-off, giving up employment in exchange for higher consumption. As long as those trading partners were able to use the recycling of surpluses to leverage up domestic demand, and so boost domestic employment through debt-fueled growth, the adverse employment effect was hidden.
Once the leverage process started to unwind, however, the deficit countries would inevitably see a surge in domestic unemployment. The best way to deal with the problem is to have both sides unwind the mechanisms that created the mirror trade-offs. Germany must put into place policies that trade higher consumption for lower employment, and use debt to force employment up, so that deficit Europe can gain employment, albeit at the expense of a lower share of consumption.
Germany might not like reversing this trade-off, which was the source of much of its recent growth (almost 70% of its growth since 1997), but in the longer term it will be much cheaper than bailing out the European countries, or allowing them to exit the euro messily and anyway force the reversal of the trade-off on Germany.
Pettis argues that boosting consumption is a cheaper course of action (and will ultimately be forced on Germany regardless) he does not acknowledge a wee timing problem. The budgetary and bond market pressures on Greece are near-term, while (even assuming there was a political consensus for dramatic change) shifting gears in an economy is a protracted exercise. So while this type of change is the ultimate way out this conundrum, I am skeptical that it can happen quickly enough.
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This analysis is pathetic.
1. The population size of post war “free market” (few main western europe, US plus Japan) doesn’t even amount to 2/3 of current china population. Ya really think China couldn’t just emulate that tiny portion of post war trade while ignoring the rest of the world? Western economy hummed along just fine without Africa, China or India in the early part of 20th century.
2. During the cold war, the world run on 2 separate non interacting economic system. This is not counting the third world minimal trade. each side couldn’t care less if the other blown off the planet and die.
3. China is huge. It’s a world onto itself. In fact it lapses into isolation several times. They could exist without the rest of the world for all it cares.
4. US dollar as global fiat currency sooner or later will run its course. US economy is too small and politically too unstable to sustain global economic interest. (observe china dumping asset, war in the middle east affecting dollar based energy price, etc.)
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There is no global imbalance as far as china is concern. It’s pure mismanagement, over consumption and plenty of whining.
All china has to say about global imbalance, well time to live within one’s mean. We need that oil and natural resource, too bad if ya’ll can’t afford it.
adding crude data to support my argument
China cement and oil consumption
http://politicalcalculations.blogspot.com/2008/07/why-does-everything-cost-so-much-more.html
china steel production
http://www.worldwatch.org/node/114
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So yes, china consume gigantic amount of raw material already. They build 4 ultra high skyscrappers that in other country will destroy steel and cement price balance for years. (not to mention real estate. observe dubai)
China consumes already, except they don’t buy consumer market junk, even flat panel TV. Because they make them inside china. (see the booming flat panel TV manufacturing)
It’s all taiwan, korea and Japan IP license. that’s it. that’s their so called “booming middle class” consume from outside world. IP license.
Gah,
With all due respect, you are omitting some rather basic considerations:
1. The issue is not raw population, it is GDP. The EU has a GDP of roughly $15 trillion, the US, $14 trillion, and China $8 trillion.
2. China is now deeply integrated into the US economically, like it or not. Unwinding that is not an overnight project.
A sudden return to isolation would result in a sharp fall in incomes. The government’s entire basis for legitimacy is that it has promised continued growth. So isolation would also lead to political turmoil.
The evidence is also strong that China’s investment is increasingly unproductive. It is taking far more leverage to produce GDP growth. I need to check an earlier post, but I believe the ratio is now 7:1, even worse than the US before the bubble burst.
And China also has a looming demographic problem.
“The issue is not raw population, it is GDP. The EU has a GDP of roughly $15 trillion, the US, $14 trillion, and China $8 trillion.”
That’s just artifact of accounting method. It is not the entire wealth of a nation.
Suppose I am a poor chinese peasant. I wore $15 chinese made Gap outfit last week. For some reason, I become rich and today I wore $300 Ralph Lauren chinese made shirt. Inside china, garment industry just increase 2000% in revenue. From US point of view, I probably only increase few percent from licensing. To me personally I just change another shirt. (this hold true for all consumer products in china, since they make everything themselves. $45 Nike shoes vs. $200 nikes shoes only represent small increase in net profit to nike corporation. It does not represent 400% leap in trade. It won’t take them long to start making high end goods. passenger airplane, high tech weapons, financial service, etc.)
China maintains undervalued currency because they can obtain actual technology and prosperity at small cost of foreign exchange trick. They only need the initial know how, after that import has no value to them. This hold true for all type of technology goods and it happens in very short period of time. (observe aluminium, steel, machineries, initially they import a lot, after few years they flood the planet with theirs.) Dollar really has no value for raw material and maintaining geopolitical goal. Everything else comes from their deep human resource.
On top of that, their economy is closing the GDP gap by $1T each year, taking 2006 growth. (parity before 2020)
“China is now deeply integrated into the US economically, like it or not. Unwinding that is not an overnight project.
A sudden return to isolation would result in a sharp fall in incomes. The government’s entire basis for legitimacy is that it has promised continued growth. So isolation would also lead to political turmoil.”
18% of dollar denominated economy does not the world make. Of course they won’t return to isolation, but US consumer market/export import and dollar are easier to dispose of to china than one wants to admit. Super large country has different gravity after reaching ceertain sophistication. eg. China GDP will be larger than US before 2020 in dollar value hold constant, faster if they change the peg. Russia turns from peasant agriculture to military superpower within 45 years. China was the largest world economy 18 out of last 20 centuries. In modern time they were isolated, go to major wars, huge famine, opening up, etc. and the communist government is still there. give them a little credit. They’ve been around the block a few times longer than anybody.
here is a sign. China’s reaction to Hillary recent attempt to cajole and destabilize them certainly being retaliated in some interesting way. (by threatening US companies with boycott/isolation.)
US threatening China with economic collapse is a little like Belgium threatening US. US is not china’s largest trading partner nor owning any vital natural resource. They are aware of the two wars North Korea and Taiwan, that will eventually turn to hot war.
Gah: “US threatening China with economic collapse is a little like Belgium threatening US. US is not china’s largest trading partner nor owning any vital natural resource.”
Great, then presumably they’ll have no objection to undoing the yuan peg to the dollar.
They want taiwan back. And they need the peg as geopolitical weapon next to price competition.
Um, China had the largest GDP historically by having a large population. China’ per capita income has been far less than the West’s since at least the 1400’s.
“China $8 trillion”
Nope. China GDP is a bit north of $3 trillion. Of course, both $ denominated and ppp GDP figures are distortions, though in opposite directions.
Gah, first you say
“China is huge. It’s a world onto itself. In fact it lapses into isolation several times. They could exist without the rest of the world for all it cares.”
then contradict yourself by saying
“We need that oil and natural resource, too bad if ya’ll can’t afford it.”
If they can so happily exist without the rest of the world, then why do they care about importing oil and all those other natural resources?
Gah: “It’s pure mismanagement, over consumption and plenty of whining. All china has to say about global imbalance, well time to live within one’s mean.”
They’re quite right about that. So why do they maintain the yuan peg? And defend it by accumulating a few trillion in forex reserves (mostly denominated in something you say is doomed as a global currency)?
By your reasoning they’re providing charity to the US by accumulating trillions in our currency and suppressing their currency, which in turn limits their foreign purchasing power. Do you think this “charity” is a goal of Chinese policy? Why don’t they want to maximize their foreign purchasing power?
They are maximizing their purchasing power. Through controlling currency price they obtain manufacturing cost advantage followed by know how. with that trade monopoly.
Oil.
Car culture is recent phenomena, and until very recently they have surplus oil. But you are right, they need raw material (iron, oil, soy, wheat.)
Agree with your dissertation. China can and will do things no other country can or is able to do full stop.
It sends the rest into a tail spin because it’s out side their understanding of global mechanics.
Are we talking about Chinese Exceptionalism here?
Indeed.
I can however not see what could make the Germans change tack. See for instance Otmar Issing’s op-ed in the FT today which essentially says that “yes we have a common currencyh but only an idiot would not see that the euro states’ economies should operate in silo-like isolation inside that currency”. In fairness he refers to the Regional Aid etc. that Greece, and other Club Meds, have received for decades to help push up their economies and flatten imbalances.
I’m enjoying Ellen Brown’s Web of Debt right now, and a major theme in that book, albeit an implicit one, is the purchasing power of the consumer, and how important ever increasing consumption is. To link slightly to the prior post promoting Econned, growth at virtually all costs is another of economics’ core assumptions that needs to be addressed openly and intelligently. Not only is global population predicted to peak in 2050 (if memory serves), we have an ageing population in the West, which may become a worldwide phenomenon in due course. Add to this the finite and delicate nature — at least from the human point of view — of the ecosystem, which has some kind of carrying capacity, and you have two pressing reasons to unpick the mantra of eternal growth. It is peppered through the above post, and simply assumed to be healthy in economics.
Just what is growth exactly, and at what costs to its supporting systems does human economic growth occur? Is there such a thing as sustainable growth?
Is there such a thing as sustainable growth?
Not unless aliens are going to keep transporting us to new planets with new ecosystems to destroy and new fossil fuel trust funds whose principal we can rapidly draw down for a few centuries before returning to steady-state penury.
(The post-oil steady state, though, will be more materially impoverished than the pre-oil state, since we squandered and trashed all other resources in the process. Some think we won’t even be able to hold at, say, the Bronze Age, since the metal inputs which used to exist are no longer there, but have been irrecoverably eroded through repeated transformation into various alloys. I’ve read conflicting reports on how many times you can recycle various metals before they disintegrate completely.
But all you have to compare is how even not much more than a century ago there existed e.g. copper mines where you could literally walk in and pick up hunks of copper the size of footballs, and often much bigger.
Today miners have to move and sift hundreds of tons of earth to extract some dust.
That’s the way it is across the board.
But have no fear! Julian Simon declared as religious dogma that copper is literally infinite, and that even if we ever did run out, the market would force alchemy to be successful.
People try to say Simon was a buffoon, but as crazy as he was he still sounds pretty mainstream to me.)
“I’ve read conflicting reports on how many times you can recycle various metals before they disintegrate completely.”
Hmm, you do not sound like a professional metallurgist. :-)
There are such things as the law of conservation of mass and stoichiometry.
Given a big enough entropy sink (energy source) the entropy added by making alloys can be removed – no matter how dilute. Of course, the amount of energy required rises as a function of the dilution factor.
Yes, that’s exactly what Simon type cornucopians (and pretty much all economists) argue.
Given a “big enough” anything…..
Or another way of putting the same thing: First, assume a can opener….
On paper zero point energy works once you write down big enough numbers.
Should’ve said “mainstream” economists.
Yup, double down, dig in, when you’re in a hole keep digging, hunker in the bunker, when you’re headed towrd a cliff floor the accelerator…
The answer to the bottleneck of unsustainable debt and unsustainable consumerism (and that’s just the economic bottleneck, forget the spiritual, political, and social devastation) is……more consumerism! Go shopping!
Yep, Bush after 9/11 couldn’t have said it better.
At least it does point out the obvious fact which is always self-servingly ignored, that by definition the system can’t have anyone running up debt that’s “too big”, since every cent of debt has to have a creditor, and as I said the other day, the whole point of the system is to ratchet up debt as far as it can go. That’s the only way the elites can maintain their power, impose their taxes, extract their tolls.
Yves,
In case you did not see this – :)
http://thereformedbroker.com/match-the-headline-with-the-blog/
Growth can be sustainable especially if non-market externalities such as environmental considerations are given costs (taxes). At the turn of the millenium, I read somewhere that compared to 1900, the weight of the US GDP had not increased at all despite increasing massively in real terms.
I would suggest however that since overfinancialization is a huge part of global economic problems, the solution is not for export-oriented countries to consume more, it is rather for there to be more production relative to consumption. This is how debt gets paid down.
I also favor concerted government and private action to net out debts to simplify–fairly–the whole debt structure. And ban CDS etc. unless they are treated as regulated insurance products, with reserves etc.
Seems to me that too much is made of the current accounts surplus/deficit matter ignoring what is going on beneath the scenes. What we consistently sees is producers engaged in profitless production and trade. Government deficit spending and bank lending allows this profitless enterprise to continue when real market conditions would prompt entrepreneurs to seek profit opportunities elsewhere.
‘At least it does point out the obvious fact which is always self-servingly ignored, that by definition the system can’t have anyone running up debt that’s “too big”, since every cent of debt has to have a creditor, and as I said the other day, the whole point of the system is to ratchet up debt as far as it can go. That’s the only way the elites can maintain their power, impose their taxes, extract their tolls.’
Let us not overlook what happened in the U.S. since ~1970. Purchasing power of the U.S. consumer remained the same or dipped while productivity increased and jobs were off-shored…meanwhile private sector debt increased. The increased productivity did not go to increased consumer income but instead went to a large increases in the U.S. and world wide financial sectors. Now the financial sector has grown so large that it can control the destiny/ decisions of the largest soverign states, not simply effect the futures of corporations.
Was this power shift to the financial sector by serendipity or design?
Yesterday I read a link that gave evidence that in some European countries cash transactions will be relic of history within 5 years…If this comes to pass the financial sector will receive a slice of every purchase, no matter how large or small. Of course governments will not fight this shift for they will also benefit from the extra taxation that will be flowing their way via the more efficient financial sector tracking of trade. Just sayin…
Ah, Lucent. Vendor financing gone wild. However, Lucent had many more problems than irrational vendor financing, as the company also failed at cash flow, operations and product development.
And doesn’t the vendor financing metaphor apply even more to China?
Yves, just to be clear, Pettis may not have addressed a wee timing issue, but has repeatedly warned that China’s relatively small economy will be unable to shoulder the adjustment necessary to correct the trade imbalance alone.
A commenter to the Pettis post makes the point that if Germany boosts demand, there is no reason to assume that that would boost exports from EU periphery countries. That demand would be satisfied by the China, in large part (for example). It would not fix the EU internal imbalances.
What say yee?
There’s lot’s of interconnection in EU trade, which was the whole point to begin with.
Just as a though exercise – If every sovereign nation closed its borders today in a Global isolationist bonanza, what would be their respective vulnerabilities?
We cannot live without OIL. Thats our achilles.
China needs both. OIL & FOOD. ouch.
So they make stuff and trade for it. We borrow.
Whoever hits the finish line of energy independence first can decouple. We could live without the flat screens, but not food and oil.
Everything we need is on our shores, but we’ve been discount shopping overseas on the Platinum card. Kinda leaves you a touch exposed. But all the pieces are right here.
“Pettis argues that boosting consumption is a cheaper course of action (and will ultimately be forced on Germany regardless)…”
How does one boost consumption by force? Unless literally by force, one cannot make people spend nor borrow.
I remember some old sci-fi movie where the citizens of this dystopia were required to buy “consumption cubes”, worthless plastic doodads which when delivered were immediately incinerated. Failure to “consume” meant penalties. Can’t remember the name of it. But if this is the kind of force Pettis has in mind, yeesh.