Is China Getting Religion on Restructuring Its Economy?

A story up on Bloomberg may be far more significant than its bland headline, “China to Spur Domestic Demand to Stabilize Economy, Wen Says,” suggests.

In recent posts, we’ve inveighed about the dangers of the path China is now on. Its economy is unbalanced to an unprecedented degree. Exports plus investment account for a full 50% of GDP, an unheard of level. And the investment share, which is now larger than the export contribution, is increasingly unproductive. It now takes $7 of borrowing to create every $1 of GDP growth in China. That’s a terrible ratio for a supposedly emerging economy. Even the US is only $4 or $5 of borrowing for every $1 in GDP growth.

Creditor nations (the ones in China’s position) suffer the most in financial crises. That has not happened yet because the world (including China) has engaged in massive monetary stimulus and China has kept its currency artificially low via currency manipulation. That means it has maintained its trade surplus at the expense of others (most notably Japan, but other developing economies have suffered too).

The rest of the world tolerated China’s mercantilism when everyone was in growth mode. But China has made a monstrous mistake, and it is a fundamental, strategic error. At least until now, it gave no sign of planning to change from a mercantilist model. All the signs from China have been that its leaders think that if it can avoid what happened to Japan , ie being forced to revalue its currency (per the 1985 Plaza accord), all will be well. It actually has been moving to a LOWER consumption share of GDP post crisis, the reverse of what you’d see if it were trying to rebalance the economy.

This movie has ended badly for everyone who has tried China’s game plan. As Michael Pettis has pointed out, China has the largest foreign exchange reserves relative to GDP of any country in modern history. Next two are the US on the eve of the Great Depression and Japan at the end of its bubble era.

So Wen’s remarks, if they are sincere, may signal a fundamental shift in posture, which would be very welcome indeed. As much as the US also badly needs to rebalance its economy too, we cannot get very far if the Chinese do not cooperate.

But Wen’s remarks may simply be another gambit. Recall that China announced its intention to move to a more market based currency on the eve of a G-20 meeting at which it was set to encounter a firestorm of criticism over its sharp rise in exports in the previous month. The move was widely hailed as a major shift; we were virtually alone in dismissing it as a headfake. Events have proven our assessment to be correct. Thus there is good reason to suspect that Wen’s remarks are mere posturing.

First, Wen’s comments are very conveniently timed; they come on the eve of another semi-annual Treasury deadline and in the runup to the Congressional mid-terms, when political scrutiny is at a high level. Even though the House voted to give the President more latitude to impose tariffs on countries that keep their currencies artificially low, Geithner made remarks to try to defuse the situation. Wen’s comments may simply be an empty concession.

Second, everyone understands that switching to more consumption is a very long term project. China could get away with a ton of foot dragging if it were making legitimate moves in that direction, as it needs to. Failure to change means it is effectively exporting goods and related unemployment to other countries. In a period where everyone expects protracted low growth, when there is already a large overhang of unemployed workers, that will not wash. If China does not get with the program, other countries will start retaliating on the trade front.

So as much as this story sound like good news, we need to see action before we can take it seriously. This may simply be a bit of theatrics to placate China’s unhappy trade partners. From Bloomberg:

The global financial crisis has shown the need for China to focus on “structural problems” in its economy including taking steps to encourage more domestic demand, Premier Wen Jiabao said.

“We can rely on stimulating domestic demand to stabilize and further grow the Chinese economy,” Wen said in an interview with CNN’s “Fareed Zakaria GPS” program taped Sept. 23 in New York and scheduled for broadcast today. In the interview, Wen, 68, also said he’s concerned China’s stability may be threatened by inflation and corruption and that he remains committed to pressing for changes in China’s political system.

Wen said he argued even before the recession that China’s economic development “lacks balance, coordination and sustainability. This financial crisis has reinforced my view on this point.”

While these statements are encouraging, enough of the rest of his remarks were disingenuous to raise concerns. In particular:Wen said China’s goal is to “have balance and sustainable trade with other countries.”

“China does not pursue a trade surplus,” he said.

Tell that to Japan. China’s purchases of yen bonds have been a major culprit in driving the yen to unprecedented levels and pushing that weak economy back into the ditch. And what about the rare earths ban? Oh, China denied that it has one despite ample evidence to the contrary.

I hope Wen is sincere but China’s track record says there isn’t much reason to trust mere statements from its officialdom.

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  1. MP

    They have been talking about stimulating consumption since 2004 but, as you note, it has only declined further as a share of GDP, and I am pretty sure the latest measures will be no more effective. The problem as I see it is that they are attempting to stimulate consumption by subsidizing it, but the subsidies are themselves paid for indirectly by households, so what they give with one hand they take away with the other.

    The only way to get consumption to rise as a share of GDP is to get household income to rise as a share of GDP, and that means making very difficult choices that no one can or wants to make. Raising the RMB hurts exporters, raising interest rates hurts the capital intensive SOEs, and raising wages hurts employers. Right now they are all dependent on the long-suffering households for their profitability, and helping households means reversing the main source of their profitability. Not so easy to do, and certainly not quickly.

    1. Stelios Theoharidis

      I find it quite interesting that we try to discuss this game as if it has some rules. Or that we have or are likely to play by these imagined rules for the forseable future.

      Unlike our own short memories I doubt that China has forgotten that Dutch and British merchants flooded their country with opium to destabilize it. They probably know their history quite well, considering the tens of millions that died in the resulting civil war, famine, and chaos. They have probably learned their lessons on what happens to developing nations when they let unbridled capitalism and rapacious greed loose.

      Not that their elite have behaved significantly better or that their brand of nepotism is superior to our own. But at least they have generated productive power on their own terms and secured positions in essential industries, which we have given up without a fight. They have invested in developing the human capital of their citizens while our’s has waned. Our elite have allowed this to occur so that they could secure higher profit margins from foreign operations and avoid taxes through transfer pricing. They have consequently hollowed out their own countries middle classes, regulatory authority, political legitimacy.

      As if the west doesn’t have a history of destabilizing weak nations in order to secure access to resources or maintain special relationships that our corporations have with otherwise docile and corrupt leaders. These people would sell their own mother for a good piece of insider information, decimate currencies despite the moral consequences. As long as there is some sort of tropical island to run off to they have no qualms in turning their own countries into predator states. This isn’t rock paper scissors, multinationals never cared about the consequences of their economic activities until the bad PR affected their bottom line. When it did they just turned the PR machine spinning out the same old greenwash and whitewash.

      I mean come on we orchestrated a false war to secure Iraqi oil, the Russians have been slaughtering Chechnians to maintain that natural gas play, everyone is playing ball with Turkmen to get a piece of that energy play, and the Chinese are in Sudan and Equitorial Guinea. What rules, these people certainly don’t care about life nor do they care too much about a functioning international banking system. They are still playing this realist foreign policy game to secure increase materials resources and productive capacity.

  2. Glen

    Lucky for Chine, they’re dealing with Geithner (and Obama). China could fake a sneeze and Geithener would get pneumonia if that’s what Wall St wanted. The rest of the DC elites are getting pretty anxious to use China as a handy scapegoat for America’s unemployment woes especially as they stare at the 2010 midterms.

    As for China developing it’s own consumption, it’s the inevitable next step. They’ve (like Wall St) have milked the American consumer for all they’re worth (and more). China will concentrate more on taking American manufacturing jobs, and trying to sell more products internally.

  3. attempter

    As much as the US also badly needs to rebalance its economy too, we cannot get very far if the Chinese do not cooperate.

    That’s true given the globalist premise. But it would be much better to restore America’s economy by breaking free of that premise.

    Until then we continue with the “two” elites of Chimerica playing this game against the respective peoples, in a manner similar to the “two” Washington parties in the US.

    It’s always how we can do nothing on our own, but need “our” leaders to do a better job of getting “them” to behave better. It would be better to abolish and overcome that structure completely.

  4. purple

    China is building ports in Piraeus and also taking over operations of the ones in existence. From Greece they will import into Europe on a scale far greater than what currently exists. It actually seems that in practice, China is going the opposite direction and looking to increase export dominance. Whatever gains their general population receive will be as a derivative.

    There are very few reasons to believe that either Anglo financiers or Asian mercantalist elites will reform the system. They have strangleholds on their respective political systems and have grown quite wealthy. We are back to global imbalances and they will probably swell even greater than before, with unknown consequences.

  5. psychohistorian

    I continue to believe that China is working with other countries to bring about a re-balancing of international finance and the clock is ticking on the watershed event to precipitate the crisis leading to that change….less than 10 years, IMO.

  6. Maju

    “It actually has been moving to a LOWER consumption share of GDP post crisis, the reverse of what you’d see if it were trying to rebalance the economy”.

    Can you document this? If this were true, that would mean that their export share is still growing, because their GDP is also growing and still very fast. I doubt their exports are still growing in the context of the great crisis, simply because people everywhere is buying less and less in general, as their (our) purchasing power goes down with all these attempts to put the burden of the crisis on the shoulders of the working and middle classes.

    I find difficult to understand this but I have not explored the data in any depth.

    Also I do not wholly understand why China artificially supported trade surplus is untenable. More exactly: I understand the macroeconomic concepts but, unless the rest expels them from WTO and establish a boycott on Chinese products, they can get away with it until the former First World completely collapses. Then they would proceed with whatever restructuring is needed but by then they will have already won the trade wars.

    The only problematic scenario would be that boycott, which possibly the US and its allies can get together to enforce, but the Chinese do not feel truly threatened at this stage for two reasons:

    1. They hold such a huge share of US and other developed countries’ debt that they could throw it as an economic bomb. And they consciously use this as leverage by purchasing “toxic” debt from these countries, not just the USA.

    2. The capitalist oligarchs who effectively rule NATOplus, from Seoul to Athens, have already invested heavily in China and like it the way it is. The “Chinese” enemy of the West is westerner and rules the West. That’s why some of what we see politicians and central banks doing looks so inconsistent: it’s what a drug addict does, regardless it is the path of doom.

    Instead, it seems to me that the Chinese (who after all invented “virtual” paper money and have a long history of resisting becoming the market for the West’s products, since very early in Modern history) know rather well what they are doing: they are ‘sucking the blood’ of the Western alliance, exploiting carefully the design errors of globalized Capitalism in their benefit.

    Their goal is not so much to have a healthy market economy, that is a Western prejudice. Their goal, logically, is to become the first global superpower, replacing the USA, by careful controlled and slow, and profitable, demolition of their rivals and by co-opting their elites to some extent.

    This is, I understand, a “legitimate” goal from the viewpoint of China, which would like to recover its past glory. The main risk they have its possibly to be drawn to a Cold War style military confrontation, where they cannot win (not yet at least) but that is why, partly, they emphasize “soft power” by trickling rather than openly confronting their rivals.

    On the other side, we can already see how much of a failure is the militarist policy of the USA. The US invaded Iraq, spending huge amounts of money and credibility, China has largely reaped the benefits without raising a single gun. Similarly the intervention in Afghanistan and Central Asia is not really producing the results the USA would like from it (to be able to blackmail China and Russia from their weak spot). Instead they softly organize their pipelines and make trade agreements with whatever “US puppet” there is around. The USA reacts investing in a government change and China bribes them to their side.

    And so on.

    While I agree that the Chinese regime is not mid-term stable because the growing bourgeois class will eventually want to reform the system, they have so far managed to satisfied most of their demands and even co-opt them into the ex-Communist Party. For the Chinese bourgeoisie anyhow allowing the USA to set the rules is not desirable in any case, so they are so far happy with the deal, more or less. But unless the USA and allies are willing to assume the huge costs of “besieging” China (costs in economic readjustment, in greater military expenditure and costs in dissatisfaction from their ruling elite of global capitalists, who would lose much of their own profits as they’d get excluded from China too) this is not going to happen.

    We can see the tension between these Western internal contradictions: the “nationalist” and the “globalist” poles but these tensions precisely cause only half-hearted reactions from the West, as it drifts without a clear plan in relation to China and its own future.

    The West, specially the USA, is caught in its own globalist/imperialist trap, in its own capitalist system trap and China, whose leaders probably have read Marxist economists (often more realist than Liberal ones), know that and toy with it, like a cat with the mouse they have just captures.

    I do not blame China, sincerely. I blame the Western ruling elite and I think that the only option in the mid-term is Socialism, including a good deal of Chinese-style protectionism (but also other things done much better too). However this will not happen yet, so the West is trapped in its own imperialist project that someone finally has managed to manipulate in their own favor.

    1. kievite

      That’s a very good post.

      I agree that Chinese regime is not stable in a long term, but the current crisis serve as huge stabiliser as it discredits the alternative model. Also the plunder of Russia is a reminder of the danger of dismantling the current political system while swimming with sharks.

      I also agree that the West and the USA “is caught in its own globalist/imperialist trap”. The room for maneuvering is almost absent in the current political system with democrats being equally jingoistic as republicans. Regardless of whether Republicans or Democrats are in power, the US has demonstrated consistent pattern of over-reliance on military power probably since Truman if not since Wilson. Now this might be time to face consequences, especially the way Afghanistan war shapes and the amount of resources (and lifes) it consumes. President’s Eisenhower’s warning about the military industrial complex being a threat to the nation well-being is now coming true.

      Bacevich addressed this issue really well in his recent book: Washington Rules: America’s Path to Permanent War.

      I doubt that holding debt gives China the leverage that you assume. It actually more makes them a prisoner of the current economic arrangement. Also in case of really nasty confrontation this debt cannot play a role of the bomb — assets will simply be frozen.

      I think the critical factor here is access to energy which is necessary for sustaining (or gradually declining) standard of living in both China and the USA. Rising energy prices in my view would unleash the de-globalization.

      Energy prices also puts taps on military industrial complex: really jingoistic policies are possible only with cheap oil.

      1. colin

        But keep in mind that China can also seize all american assets in china. In fact, China would be seizing factories and tools of production, while the US would just be seizing paper. This is all unrealistic speculation of course, but I think the former would be the better deal.

    2. Jessica

      Both consumption and exports could fall if the money was flowing into investment in future export capacity that has not come online yet. At one point, I think is what was happening.
      And when that new capacity does come on-line?

    3. Yves Smith Post author

      Unfortunately I am very much under the gun, but you need to read Michael Pettis. He has documented all of this, including the declining consumption share and the alarming investment share.

      And I have discussed here at length, it would be suicidal for China to dump dollar assets. It would send the RMB through the roof, the last thing it wants. And the Fed could simply buy the bonds, it would lead to a large expansion of the Fed’ balance sheet, but we’d see no interest rate impact (once the Fed wised up to what was happening, it might be flat footed at the outset).

  7. fjf

    “China is the most competitive market in the world,” said Larry Yuen, president of Kohler Asia, which has 11 factories in China.

    A decent toilet in China costs $8,000. Kohler is an American company. And like a lot of American companies it invested capital in China, built factories there to service the nascent Chinese market and to use China as an export platform to the west.

    Why are Americans unwilling / unable to spend $8,000 on a toilet? Don’t they like comfort?

  8. fjf

    Those nasty, nasty, evil, mercantilist Chinese. Loo what they have done to GM:

    Today, GM China sells five brands — Buick, Cadillac, Chevrolet, Opel, Saab and Wuling — more than 30 models with sales forecasted at nearly 864,000 vehicles this year. In China GM has eight vehicle assembly plants, three powertrain facilities, an engineering and design center, an automotive financing arm and some of its supplier operations, like AC Delco and Allison transmission. GM employs more than 20,000 people in China.

    Wonder who moved US jobs to China? Wonder who profits from China’s growth?

  9. fjf

    Another great American success story:

    Of course, U.S. companies have been moving jobs offshore for decades, long before Wal-Mart was a retailing power. But there is no question that the chain is helping accelerate the loss of American jobs to low-wage countries such as China. Wal-Mart, which in the late 1980s and early 1990s trumpeted its claim to “Buy American,” has doubled its imports from China in the past five years alone, buying some $12 billion in merchandise in 2002. That’s nearly 10% of all Chinese exports to the United States.

    Sure. You go clamp down on those evil Chinese mercantilists with their vastly overvalued currency resulting from the endless exports of US companies acting to destroy US jobs.

    Americans are worse than children. They believe whatever they read in the MSM and they always find a bogeyman to blame for their faults.

    1. AmericaninChina

      Bingo! US trade policy towards China has been dictated by two powerful corporate oligarchs – the US multinationals and the banking cartel. The multinationals made billions by moving US-based manufacturing jobs to cheap labor in China and “exporting” products back to the US. Now they’re poised to make lots more by selling their products to China’s booming middle class. The banking/financial industry unleashed a deluge of consumer credit/debt that was made possible by the Chinese recycling their giant trade surplus dough into US bonds; enabling many years of cheap credit in the US, and credit cards, equity loans, etc. replaced high-paying jobs. American are now dealing with the terrible consequences resulting when powerful corporate oligarchs pillage the economy, a practice that continues to this day.

      1. fjf

        Americans are now dealing with the terrible consequences

        But the core of the issue is that Americans are not dealing with the consequences. Americans are not even willing to perfrorm an analysis of the issue.

        Instead they run some political theatre, blame the Chinese for actions taken by US MNCs and seek to hurt US industries and US middle and lower classes by a misdirected attack on Chinese mercantilists.

        Once the elections are over the theatre will close and the world will proceed as before. The world is going to fill up with cheap US dollars as the US gets to print whatever amount it wants and Bernanke is free to destroy the entire global economy if he has the whim to do so.

  10. fjf

    Recognize a firm called Intel? Another evil Chinese mercantilist:

    According to Barrett, supplying the global market with products made in China is Intel’s strategy for long-term development.

    So why are US congress critters proposing to attack US capitalists? Are Americans against capitalism? Or are they incapable of comprehending the reality of who is doing what to whom?

  11. Tahoe58

    Stimulating demand, domestic or otherwise is only another form of modifying the energy flow within the entire system. The run up in capacity building for consumers of everything has been built on created wealth. The ‘need’ to shift and stimulate demand at home is founded in the overcapacity. That overcapacity lives in our current system, everywhere. Energy cannot be created or destroyed. The created energy within any demand for anything is not perpetual, nor self-sustaining. We are trying to keep running at full capacity – where full capacity was an illusion. Walking On.

  12. Dave of Maryland

    China has to wonder if or when the rest of the world will wake up & put up walls of tariffs & put an end to their party. I’d lay awake at night if I were them.

    Smoot-Hawley was said to have wrecked trade in the 1930’s, but then WWII came along & absolute de facto trade walls went up, between the US & Europe & most of Asia. Strictly enforced by competing submarines. Competition in trade barriers. Who would have thought?!

    Behind the absolute walls of No Thank-You, America reindustrialized, took the resulting goods to nearby fields, and blew them up. After three years of that lunacy, we realized we’d have a much better time not blowing things up & the result, which I remember very well, was my childhood.

    Gee, I’d like to go back to that childhood . . .

  13. Jessica

    “Did he really mean it” is one question.
    “Can he actually make it happen” is another.
    I think the East Asian mercantile economies build up very powerful structural interests in staying on the same course. In China’s case, the central government has difficulty controlling the individual exporting regions, which also compete with each other.
    As far as I know, none of the relevant comparable nations have made the transition that China needs to make. Certainly the Japanese have failed completely for over a quarter century now.
    And, I would guess that the extremes to which the imbalance has grown in China are a sign of the overall immaturity of China as a modern economy/society.

  14. colin

    Yves, I an a long time reader and enjoyer of your blog, but I feel you come into any discussion of china already prejudiced and myopic.

    1) You label china mercantilist. But so is Japan. So is Korea. So is Germany. So is the US – except that the multinationals find it in their own interest to curb the US politicians on any action. Generally, every sane nation wants to be able to produce things at home, sell them for a profit, and not be dependent on imports. Want to correct the trade balance? Sell them what they want. But then congress says china can’t have our oil or missiles. You wrongly single out china as the one and only merchantilist devil.

    2) You label china as a currency manipulator. Yet every country manipulates their currency to their own advantage. Again, why single out china when Japan, Korea, etc., has been doing this for the last several decades. And the US doesn’t manipulate the USD?Besides, to paraphrase, it’s their currency and our problem.

    3) You talk about all kinds of imbalances that will turn china into a flaming hell, yet don’t mention the massive structural problems in the US. Like how there is so much debt out there that it’s impossible for americans to pay off with actual goods and services. How does the US pay off the trillions held by other nations, in addition to all the debt and obligations in the US itself? Economists really seem to live in another universe. Any rebalancing of China’s problems necessarily involves rebalances of other nations and the world. And I don’t see any such talk about seriously fixing imbalances in the US, other than it’s all china’s fault and they should be made to pay. It’s a joke.

    4) You link in rare earths as a massive mistake by the chinese in the recent spate of incidents and china blindly flexing its brawn, yet the issue of rare earths started appearing in Sept 2009, before the island spat. And with the chinese themselves publicizing it. I think the chinese have some other agenda for rare earths, and is not foolishly throwing in its monopolistic cards in a fit of muscle flexing. Seems more likely some other thought out strategy is at play. Perhaps they realize it’s not in their interest to be producing so much RE so cheaply and dirty, and if they can use the issue to extract some international political value now while prodding others to start producing their own, all the better. Just my speculation, and probably not what they are really up to, but to think they are showing their hand so obviously and mistakingly in a blind fit of national rage seems even sillier to me.

    And to the china bashers, no, I’m not a member of the CCP nor do I have any serious stake in china.

    1. Yves Smith Post author

      You are really off base. What you write is divorced from fact.

      When trade collapses in the crisis, pretty much every exporting country’s trade surplus did too (Japan actually went into a deficit) except China. China’s trade surplus actually rose. It took share form other exporters.

      In addition, Japan has only occasionally intervened in FX markets, now when the yen is sky high, last for a while in 2003, IIRC. China intervenes on a continuous basis and as result has the largest FX reserves to GDP of any country in the last 100 years.

      Yes, Japan and Germany and South Korea are mercantilist too, but none even remotely approaching the scale of China (and we have berated German mercantilism too, due to its impact within the eurozone, you conveniently forget that part. Japan is a has been mercantilist ever since the yen went over 95 to the dollar).

      Differences in degree are differences in kind.

  15. lark

    Great commentary, Yves.

    I would only note that Wen is constrained by a domestic balance of powers in which the exporters are very powerful. Even if (if!) he is sincere, he may not be able to effect this change, which would be wrenching indeed for those elites.

  16. ab initio

    “Creditor nations (the ones in China’s position) suffer the most in financial crises.” – Yves

    How does this mechanism work?

  17. Tempest

    “Second, everyone understands that switching to more consumption is a very long term project.”

    Why consumerism? Why not, instead, the building of infrastructre (green) and of the commons?

    Consumerism as a way of life is dead. The body continues to twitch. But the current way of life in the west has no chance of being spread across China..

  18. ed


  19. Sundog

    Wen and Roach have been flapping their lips for some time now about the need for change which will be coming real soon now. YS is correct in saying we should pay more attention to action and results than to pronouncements.

    Michael Pettis has made us aware that the problem is much more than the exchange rate (though that is not trivial), pointing to subsidized costs of capital, land, energy, obscure tax breaks and on and on.

    Not to mention that pretty much everyone agrees any appreciation of the yuan will not necessarily correct trade imbalances. China’s policy is denying the benefits of free trade not only to its own population but to those of other potential low-cost producers not least of which from the US perspective is Mexico.

    One aspect of the problem is the lack of capacity for strategic thinking among US elites. Read this commentary by Paul Kennedy and ask yourself, if the current situation is untenable what are we to do? You’ll find no real answers.

    Paul Kennedy, “Don’t Surrender U.S. Influence to Beijing”

    My own preference would be for the US to lead a coordinated pull-back from globalization, combining capital controls, exchange rate policies, non-targeted hikes in tariffs, and a realistic evaluation of whether commodities will trade on markets or be exchanged by state actors.

    I believe humans are trading animals, and the ideal of free trade is not to be lightly tossed aside. I believe very strongly in the Enlightenment concept of free speech, too, but just as it is irresponsible to shout “Fire!” in a crowded theater, I believe it’s possible for free trade to encounter boundary conditions and indeed this is the situation in which we find ourselves whether looking at inter-EU problems, US de-industrialization or the radical dependency baked into the East Asian Development Model.

    Keynes advocated public-sector intervention to preserve capitalism. Shrub said the federal government had to bail out the big financial players to preserve capitalism. In the same spirit, all the big players need a bit of a time out, a “trade peace,” a frankly acknowledged and agreed time of introspection and restructuring. The alternative seems mighty ugly.

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