Michael Pettis: The World Bank Proposes Tough Medicine For China

Lambert here: The “tough medicine” is proposed in China 2030, from the World Bank and a Chinese government think tank, scheduled to be released Monday, March 12. Excerpts appear in the text.

By Michael Pettis, a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management. Cross posted from China Financial Markets

Contrary to some recent research reports cited in the press I do not think we have seen any substantial rebalancing of the economy towards consumption in 2011.  This is largely an argument being made by economists who did not see why Chinese consumption repression was all along at the heart of the growth model.  These economists are now too quick, I think, to hail evidence of a surge in consumption, but I find the evidence very weak and more importantly I am convinced that there cannot be a sustainable surge in consumption as long as the investment-driven growth model is maintained and as long as debt continues to rise unsustainably.

And as for debt, it is still rising quickly. As regular readers know I have always argued that the rise in Chinese debt, as bad as it is, was not going to lead to a banking collapse or any other sort of financial collapse because of the way local and specific debt problems would be “resolved”.  Debt would simply be rolled onto the government balance sheet.

Last Monday I was in Hong Kong visiting few clients, and during my visit to Hong Kong the Financial Times gave me a nice gift – an opportunity to center my discussions – with this article:

China has instructed its banks to embark on a mammoth roll-over of loans to local governments, delaying the country’s reckoning with debts that have clouded its economic prospects. China’s stimulus response to the global financial crisis saddled its provinces and cities with Rmb10.7tn ($1.7tn) in debts – about a quarter of the country’s output – and more than half those loans are scheduled to come due over the next three years.

Since the principal on many of the loans is not repayable, banks have started extending maturities for local governments to avoid a wave of defaults, bankers and analysts familiar with the matter told the Financial Times. One person briefed on the plan said in some cases the maturities would be extended by as much as four years.

We are going to see a lot of stories like this.  There is a growing amount of unrepayable debt in China and ultimately most if not all of it will end up on the government’s balance sheet.  On that note I disagree with something Simon Rabinovich, in another article published in the FT on the same day, said on the topic:

China’s debt woes are very different from those of Europe or, for that matter, the US. In developed countries, the concern is the sheer amount of debt they have accumulated. The Chinese problem is less one of quantity and more one of structure: rather than issuing bonds, local governments have used opaque bank loans for funding.

“The problem is rooted in the national fiscal system,” said Huang Haizhou, chief strategist at China International Capital Corp, the country’s leading investment bank. “If a successful fiscal reform is implemented over the next three to five years by the new government, the problem will only be a temporary shock.”

Borrowing your way out of debt

This is almost certainly incorrect.  The problem in China is as much the amount of debt as the structure – and by structure I don’t mean the distinction between bonds and loans (bonds end up mainly on the banks’ balance sheets anyway) but rather the unstable and self-reinforcing relationship between underlying conditions and debt servicing costs.  The fact that much of the debt is being accumulated in an opaque fashion only explains why so many people did not see this coming, but it is not the fundamental problem.

As for the claim that successful fiscal reform can keep the impact limited, I am not sure what this means. Fiscal reform in China can only be successful, in this context, if it eliminates loss-making investment activities, and unfortunately I see it doing nothing of the sort.  If the problem is that China is keeping growth high only or mainly by borrowing and misallocating the proceeds, then hidden losses are rising and one way or another the bad debt must be resolved.  The only two ways to resolve the bad debt are by defaulting or by forcing someone else to make up the loss, and the former almost certainly won’t happen to any great extent.

That leaves the latter.  The structure of the debt as this article defines it – transparent bonds versus opaque loan – is I think almost irrelevant.  For example the article goes on to propose one solution:

“Five or ten years from now, local governments will borrow very, very little from banks. Their debt structure will be almost entirely bonds,” said Fan Jianping, chief economist of the State Information Centre.

There seems to be an almost touching faith in cosmetics here.  If banks make foolish loans, stop calling them loans and start calling them bonds and the problem is immediately resolved – we’ll have no more bad loans. 

True, we won’t, but we’ll have bad bonds, probably still on the bank balance sheets, and we’ll still be left with the problem of how to pay for them.  Since household income is probably much too low to support another massive transfer to subsidize debt forgiveness, as happened after the last banking crisis of a decade of ago, the next debt crisis will have to be subsidized by government transfers.

But if households don’t clean up the next banking mess, how will it be resolved?  My guess is that it will be resolved in the same way local government debt is being resolved – it will simply be directly or indirectly passed on to the government.  And given the constraints that limit Beijing’s ability to push the household share of GDP down much further, Beijing, as I have argued before, basically has two ways to resolve another surge in bad debt. 

Both involve transfers of assets from the government, but each has very, very different long-term implications.  One way to resolve the bad debt is to privatize assets and use the proceeds to clean up the banks.  The other way is to have the government absorb the debt.  If debt rises faster than debt servicing capacity, there will have been a real transfer of assets from the government to the borrowers.

Japan’s debt 

Which will Beijing choose?  An article in Reuters this week reminds us of the consequence of the second way, which unfortunately way has the great advantage of being politically easier than the alternative.  The article is about Japan and here is what it says:

Capital flight, soaring borrowing costs, tanking currency and stocks and a central bank forced to pump vast amounts of cash into local banks — that is what Japan may have to contend with if it fails to tackle its snowballing debt.  Not long ago such doomsday scenarios would be dismissed in Tokyo as fantasies of ill-informed foreigners sitting on loss-making bets “shorting Japan.”

Today this is what is on bureaucrats’ minds in Japan’s centre of political and economic power.  “It’s scary when you think what could happen if there’s triple-selling of bonds, stocks and the yen. The chance of this happening is bigger than markets think,” says a senior official. Leaning back in a leather sofa in his office, the official appears relaxed, but the way he wastes no time answering questions about a debt meltdown, suggests it is an all too familiar topic.

The official, like many others interviewed by Reuters, declined to be named because of the sensitivity of the subject and his alarm over Japan’s $10 trillion-plus debt overhang has yet to be reflected in public debate or action. But these officials would be the ones pulling the levers in the command center if Japan were to be hit by a debt crisis. The government borrows more than it raises in taxes, and its debt pile amounts to two years’ worth of Japan’s economic output, the highest debt-to-GDP ratio in the world.

This what I worry about most for China as it decides its adjustment process.  Beijing could easily choose to absorb debt rather than pay it down through asset sales, and as debt rises it will be all the harder to raise interest rates. It will ultimately also create what is potentially a destabilizing debt overhang, although as Japan showed, it can take many years before the debt itself becomes unsustainable.

That is why although I don’t think it is a certainty, I am expecting that the most likely economic outcome for China for the rest of this decade is a combination of much slower growth and rapidly rising government debt.  Privatizing assets and using the proceeds to shore up household wealth, directly or indirectly, is politically tough to do. 

But that doesn’t mean it can’t happen.  On Thursday the Wall Street Journal published a very interesting article on what is supposed to be an upcoming World Bank report – to be published this Monday.  According to the article the report is already controversial but may gain traction within Beijing:

How much the report will help reshape the Chinese economy is unclear. Even ahead of its release, it has generated fierce resistance from bureaucrats who manage state enterprises, according to several individuals involved in the discussions.  China’s political heir apparent, Xi Jinping, now vice president, has given few clues about his economic policies. Analysts expect the high-profile report will encourage Mr. Xi and his allies to discuss making changes to a state-led economic model that has alarmed Chinese private entrepreneurs while creating tension between China and its main trading partners, including the U.S.

The report’s authors argue that having the imprimatur of the World Bank and the Development Research Center, or DRC—a think tank that reports to China’s top executive body, the State Council—will add political heft to the proposals. The World Bank is widely admired in Chinese government circles, particularly for its advice in helping China design early market reforms.

They are also counting on the clout of the No. 2 official at the DRC, Liu He, who is also a senior adviser to the all-powerful Politburo Standing Committee, to help ensure that its findings are considered seriously by top leaders. Mr. Liu declined to comment.

Restructuring state involvement

The World Bank report will apparently warn that China is facing a very difficult economic transition:

An exclusive preview of an economic report on China, prepared by the World Bank and government insiders considered to have the ear of the nation’s leaders, offers a surprising prescription: China could face an economic crisis unless it implements deep reforms, including scaling back its vast state-owned enterprises and making them operate more like commercial firms.

“China 2030,” a report set to be released Monday by the bank and a Chinese government think tank, addresses some of China’s most politically sensitive economic issues, according to a half-dozen individuals involved in preparing and reviewing it.

It is unquestionably a good thing, in my opinion, that Beijing is made aware of how difficult, and urgent, the transition is likely to be, but it is also a little disheartening that it has taken so long to warn about what should have been deeply worrying us five or six years ago.  China’s growth model was clearly unsustainable even back then, and was just as clearly heading to a debt crisis, and the longer it took to address the problems the more severe they were likely to get.

According to the WSJ:

The report warns that China’s growth is in danger of decelerating rapidly and without much warning. That is what has occurred with other highflying developing countries, such as Brazil and Mexico, once they reached a certain income level, a phenomenon that economists call the “middle-income trap.” A sharp slowdown could deepen problems in the Chinese banking sector and elsewhere, the report warns, and could prompt a crisis, according to those involved with the project.

It recommends that state-owned firms be overseen by asset-management firms, say those involved in the report. It also urges China to overhaul local government finances and promote competition and entrepreneurship.

…The World Bank and DRC argue that asset-management firms should oversee the state-owned companies, say those involved in the report. The asset managers would try to ensure that the firms are run along commercial lines, not for political purposes. They would sell off businesses that are judged extraneous, making it easier for privately owned firms to compete in areas that are spun off.

“China needs to restrict the roles of the state-owned enterprises, break up monopolies, diversify ownership and lower entry barriers to private firms,” said Mr. Zoellick in a talk to economists in Chicago last month.

Currently, many state-owned firms have real-estate subsidiaries, which tend to bid up prices for land, and have helped to create a housing bubble that the Chinese government is trying to deflate.  The report also recommends a sharp increase in the dividends that state companies pay to their owner—the government. That would boost government revenue and pay for new social programs, said those involved with the report.

Growth slowdown

This is good as far as it goes, but it doesn’t go far enough.  Of course increasing SOE dividends to the government for use in social programs will transfer wealth from the state sector to the household sector, but if the total profitability of the SOE sector is less than one-fifth to one-eighth of the direct and indirect subsidies transferred from the household sector, as I have argued many times, then even 100% dividends is not enough to slow the transfer significantly, and remember the transfers have to be reversed, not merely slowed.  This proposal falls in the better-than-nothing category, but just.

What we really need are much more dramatic transfers, for example wholesale selling of assets, with the money used either to clean up bad loans or delivered directly to households.  According to the article, however, “neither the World Bank nor the DRC proposed privatizing the state-owned firms, figuring that was politically unacceptable.”

This is the problem.  The best solution for China, economically, seems to be off limits because it will be politically difficult.  In that case the second best solution, a gradual build-up of government debt as growth slows for many years, is the most likely outcome.

And how much will growth slow?  The World Bank report apparently doesn’t say, but the consensus has been slowly moving down towards 5-6% annual growth over the next few years.  That’s better than the crazy numbers of 8-9% most analysts were predicting even two years ago (and some still are), but it is still too high.  GDP growth rates will slow a lot more than that.  I still maintain that average growth in this decade will barely break 3%.  It will take, however, at least another two or three years before a number this low falls within the consensus range.

And by the way when it does, metal prices should fall sharply. Copper prices have done reasonably well in the past few months as Chinese buyers have restocked, as we suggested might happen to our clients last fall.  With the recent easing we may see more strength in copper over the next month or so, but I have little doubt that within two or three years copper prices are going to be a whole lot lower than they are today.  Chinese investment demand simply cannot hold up much longer.

Before ending I wanted to make one last, and totally unrelated, comment.  There was a Financial Timespodcast last Thursday in which David Bloom, global head of FX strategy at HSBC, worried that if the euro keeps strengthening, it will end up “harming the region’s competitiveness.”  He is right of course that if the euro strengthens, this can hurt the region’s competitiveness and so slow growth, but if this is a problem, why are European government’s still asking China and the other BRICs to contribute to their bailout?  Don’t they realize yet that importing foreign capital means strengthening the euro and exporting domestic growth?  The more money they take from abroad, the harder it will be to pay back any of the debt.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. kris

    Thx for posting the excerpts. A good portion of the financial knowledge I have comes from Mr. Pettis. When he speaks, I listen.

  2. Heretic

    Thus far, China has conducted itself in a manner consistent with governement that understands MMT and a sense of purpose…when they need money, they will print, and put it to some use. Of course, this being China, they like to do it in an opaque way, such as to not openly offend the money-and-debt-are-sacred beleifs frien-nemies at the IMF and the US, and they have to allow cronies to become rich…hence massive real-estate speculation. My suspician that China will simply roll-over their internally held debt in some unique Chinese structure, while maintaining ‘Face’ , just as Japan does via the Japan Central Bank.

    In the short to medium term, as long as China can maintain a positive net balance of trade, and foster an economy that allocates resources toward projects that actually increase well being of the nation(an issue of government foresight and clarity of purpose), they can import technology and resources, and they can grow their economy in a sustainable manner.

    In the longterm, China needs to be careful that it does not suffer the fate of Brazil in the 1980’s. Although I suspect prudent and conservative consummer and commercial credit polices, taxes on speculation and rentier activity, will control the financial aspect of inflation, and a focus on real productivity, real resource cultivation and conservation, and active effort to reduce resource intensity per unit of GDP will control the real demand push behind price growth.

    1. kris

      Communism in eastern europe was pure MMT. We did MMT until everybody ended up with food stampts. It didn’t work.
      Chinese may not run out of chinese money but in order to import commodities they will have to export cheap, very cheap, with US dollars.

      1. Hugh

        Do you have any evidence for your contention that socialism in Eastern Europe was “pure MMT” because I rather get the impression you have no idea what MMT is?

        1. kris

          I am the evidence. I lived it.
          Everything was guaranteed including pensions and social welfare until we had nothing REAL to give in return of imports. MMT works for currency issuers like US as long as:
          – The rest of the world accepts US dollars in return for real goods
          – The rest of the world pays US as a world policeman with real goods in return for protection by accepting US dollar as world currency.

          1. j.grmwd

            You do realize that even the most far-left socialist MMT program imaginable, basically Sweden plus a job guarantee, leaves the entirety of the consumption economy and the majority of capital assets in private hands. So basically NOTHING at all in common with a centralized command economy where everything from potato farms to toy factories are owned by the state.

          2. kris

            If a country does not have a world currency, they can do MMT as long as they can export, world accepts their good in exchange for other good.
            – Japan
            – Sweden
            – Netherlands etc
            If theoretically, South Korea replaces Japan as a major car manufacturer, hence South Korea can do MMT and Japan is screwed.

        2. kris

          Correct, as long as Germany and the rest of the world buy their products. I don’t know about Sweden, but Norway has a huge sovereign fund. That sounds like centralized economy to me.

          1. kris

            As far as I remember, Volvo is an indian product. Saab is gone. They became too expensive. I have no intention of studying swedish economy, but they were a “slower version” of the eastern european style. Unless they have high end products to sell to the rest of the world, the fate of Volvo and Saab is not a good sign.

          2. j.grmwd

            You’re missing the point. MMT, even the MMT of its most far-left proponents, doesn’t propose wholesale nationalization of anything so raising the command economies of Soviet Eastern Euope as examples of the failure of MMT is ludicrous.

            P.S. Sweden isn’t important. Just an example of the kind of economy a “hard-left MMTer” might institute. Nontheless, Sweden has run a substantial current account surplus for the last twenty years so it would appear that they have plenty to sell the rest of the world, even if Volvo was sold to the Americans.

          3. kris

            I’m ok with 2nd paragraph about Sweden
            As to the 1st one, I’m saying that in a longer term, it may end up being like that. History never repeats but very often rhymes.

          4. kris

            USA gov practically owns or funds:
            – Military business
            – Medical care
            – Major banks
            – Mortgages
            – Car industry
            Not much left for private sector. If US$ were not world currency, USA wouldn’t be able to do MMT and would have theoretically ended up like Russia. This again theoretically assumes that nothing is produced in USA but most of goods were to be produced let’s say in China.

          5. j.grmwd

            In actual fact, the US collects the lowest proportion of GDP in the developed world in taxes (with the exception of Singapore). So proportionally, the USA has just about the biggest private sector in the world. In the singular case of the US, influential industries in the private sector have taken over the government not vice-versa.

          6. kris

            Ok, banks and military industry have taken over the gov. Hence they are the gov, hence not private. Do you include in your calculation GDP from these industries as private?

          7. j.grmwd

            I must admit I’m flabbergasted. Redefining Goldman-Sachs and the like as no longer part of the private sector simply because they have hired a bunch of lobbyists to buy off congressmen seems pretty weird to me.

            I don’t include or exclude any industries. The tax take is the tax take, and that’s the proportion of resources that are potentially transferred from the private to the public sector. However, if those funds are transferred straight back to the private sector (e.g. social security payments), the actual spending and resources remain with the private sector. I think it’s fair to say that the US government at all levels engages in less direct spending and hence controls less the disposition of real resources than any other country in the developed world.

          8. kris

            Neither Goldman Sachs nor Boeing can exist without government funding, same as US car industry, military, medical care.
            Taxpayers are putting way more money into Goldman Sachs than they are consuming from Goldman Sachs. It sounds like Social Security to me.

      2. Historicaecon

        This sounds right to me. What struck me during a long working stay in China after many discussions with local officials is that they don’t believe in money the way, say, the U.S. does. They’re sensible enough to see it as a system of signs that must be maintained but can ultimately be subordinated to the rule of the state. That’s why the Chinese are “Communist” in a nutshell: they simply don’t allow the logical extensions of capital to decide policy. And unlike Eastern Europe they’ve developed the export might to make whatever arbitrary work-arounds they make stick.

        1. j.grmwd

          This is absolutely right. Money can be used to mobilize resources or to store value, but only imperfectly both at the same time. If you want to maximize the rate of development of your economy, as the Chinese do, you create money out of thin air and loan it out. When a lot of those loans go bad, you write them off, and set the scoreboard back to zero. The Communist party would appear to have the authority to make that stick. The money and debt is gone. But the country’s left with the real assets.

          1. kris

            No wonder Communism sprang from Utopians. When I came to Canada people with “good intentions” told me that communism was not applied properly in eastern europe and had to be applied again.
            You are one typical one, a utopian and a theoretician.
            Please do not take this as a personal attack.

            I lived it man….I lived it. Please do not theorize.

          2. j.grmwd

            There’s no theorizing going on here. This is how capitalist investment works. A lot of credit is created out of thin air. Picking winners is never easy. In a boom lending standards almost inevitably relax. And a fair proportion of the credit can go into sectors, like real estate, which are not strictly productive. The result – a lot of loans which can never be paid back in real terms. But they do mobilize the workforce and they do mobilize entrepreneurial spirits and they do result in a lot of real production. The question remains what to do with the bad debt that you’re left with. The traditional solution has been to keep it on the books but inflate it away. But of course that goes against the Western capitalist instinct that money should be an absolute store of value. Nevertheless, that’s what the western powers did with their massive WWII debts. They went for growth and let that and inflation shrink the real burden of the debt. I agree with the OP that the bureaucrats of the Chinese Communist party do not see money in Western capitalist terms as the source of absolute value. As a result, they’ll inflate, write off, do what it takes to keep the real economy moving. And in an authoritarian state like China it will probably work because the creditor interests that would fight tooth and nail in a Western country to ensure that debts are honored don’t have the same degree of power there.
            To be clear I’m talking about the monetary aspect of economic development here and the way in which time and time again in booming rapidly developing economy countries we see credit creation and speculative lending get out of control. I didn’t comment on the allocation of capital, centralized planning, nationalization, or anything else for which your talk about the naivety of wannabe Canadian communists before the fall of the Soviet Union might be relevant. For the record, in the modern age, it’s the faith that the market can infallibly solve all problems in all sectors of the economy that seems touchingly naive.

  3. different clue

    “Privatising assets” ? What “assets” does Mr. Pettis have in mind? Does he mean a Russian-style Yeltsinization of every public thing of value?

    1. kris

      It didn’t happen only in Russia, it happened all over eastern europe. But since Russia supplied Europe with gas, nobody cares about anything else.

    2. mtnplover

      That’s what I wnat to know too. Which Chinese assets sales are being proposed? Commercaai real esate? State-owned banks? Farmland? State-owned Enterprises that are typically owned and managed by the private sectors in most other industrialized countries?

      1. kris

        God knows. As Jim Chanos says, anything stats from China should be taken with a grain of salt.
        I would say, any news or stats from China should be taken with a sack of salt.

      2. different clue

        I suspect it means to steal and privatise absolutely anything and everything which the Kleptons feel they can monetize at their leisure. And give the empty-bagholders ( in this case the 1.3 billion people of China) a brass farthing for their troubles.

        1. different clue

          For example, decide which parts of the Great Wall of China yield steady reliable tourist revenue, and slowly dismantle all the rest of it and sell it by-the-brick to souvenier-seekers who wish to own a piece of the Great Wall.
          At $3.00/brick and a billion bricks, that makes the Great Wall worth 3 billion dollars right there.

          Don’t tell me a clever Klepton hasn’t already thought of it first.

          1. different clue

            (Actually a reply to Kris),

            One could make the “hopeful” case that this is mere callous vandalism . . . destroying the Wall to get to the minerals underneath it. But it is only a step away from saying: since we are going to destroy the Wall to get the minerals anyway, why not dismantle the Wall into a billion little pieces and sell the pieces, and then go get the minerals. Lets hope they at least don’t take that very last step.

          1. different clue

            Thank you for the kind encouragement. If you feel that word can somehow be meme-launched and viralized into the mass-mind; feel free to try doing just that.

            I hereby Copyleft the word “Klepton”.

  4. Hugh

    The debt rollover is just can kicking. All the major economic players are doing it: the US, Europe, and Japan. So why not China?

    What is missing from this analysis is how this debt rollover is related to the big three issues of kleptocracy, wealth inequality, and class war. Essentially, can kicking keeps the show going and the casino open so elites can continue their looting and gambling.

    I would agree too with Heretic that Pettis comes across as clueless with regard to the MMT basics of a fiat currency, which China certainly has, and how this changes the equation of debt accumulation.

    Pettis also seems kind of naïve about the politics. China is going to change course because of some World Bank report? What has he been smoking? As for China transitioning to greater internal consumption, just not going to happen within a kleptocratic framework. If it’s real, the benefits go to the people and reduce looting opportunities. If it’s not and the push was to load up the people with debt, something to which there is also a lot of cultural resistance, the consequences would be politically, as in regime ending, explosive.

    1. kris

      As it is explained in the link, China sells UST and buys crude oil. As long as they have UST they can buy and do MMT. However if they run out of UST (theoretical no more exports to US or Europe), hence MMT will pull an eastern europe.
      Eventually it comes down to exchanges of goods, unless Yuan becomes a world currency. If that happens, different story.

    2. kris

      Pettis could be incorrect about the currency, but what matters is his analysis and not his predictions. I can draw different conclusions from his analysis.

    3. Anonymous Jones

      Ah, the ignorance and arrogance on display again!

      MP certainly does not believe this World Bank proposal changes the future course of the Chinese economy.

      He is, for the most part, all about the politics, and if you had read him at all, you would know that. Well, maybe not, because how you got it from this one post is still mind-boggling to me.

      Please see following post. He understands the political transmission mechanisms take place over *long* periods of time, but they do occur, they have always occurred.


  5. RepubAnon

    What if the Chinese use their US Bond holdings to solve the problem by some kind of a swap, or by asking the US Government to buy the Chinese bonds to avoid having the Chinese dump their US bond holdings?

  6. American Slave

    Consummerism for China would be dumb. they need to become a society of savers and investors it works for Buffet.

    1. j.grmwd

      Saving and investment is undertaken now to increase consumption in the future. Saving for savings sake makes little sense. Eventually someone has to consume the extra goodies that all the previous saving and investment has allowed you to produce. Otherwise, what’s the point?

      1. American Slave

        Exactly and the west will keep on consuming just like they do now. consumerism is a horrible way of re-shuffiling money is all im saying.

      2. j.grmwd

        I agree. In a finite world “consumerism” is a recipe for disaster. But private investment is inextricably linked to profit potential and hence to increasing future consumption. In the end if we want to end consumerism, it can’t be a matter of just saving and investing more, but of working less. Staying home and playing with the dog.

    2. alex

      “[China] need[s] to become a society of savers and investors”

      They already are. And as virtuous as that seems, beware the paradox of thrift. If the US (and various other countries) ever wake up and decide to do something about the trade imbalance, a lack of Chinese consumption could be disastrous for them. Historically creditor countries have fared much worse than debtor countries in such cases (e.g. the US in the Great Depression, when it was a creditor).

      Investing in the ability to produce much more than you can sell (e.g. the US in the 1920’s) is a bad strategy.

      “it works for Buffet”

      Berkshire-Hathaway is a holding company, not a country. The price for Berskhire-Hathaway would fall through the floor if Americans saved at the same rate as Chinese, and I’m sure Warren knows it. No point in making things you can’t sell.

  7. American Slave

    I dont understand it, why do corperations own things like steel mills and car factorys yet they want China to sell them. It didnt work for Russia vs China.

    1. j.grmwd

      Perhaps, the confusion results from thinking that the World Bank’s recommendations are genuinely intended to help developing countries. When a survey of the actual results suggests the opposite.

  8. mtnplover

    I’m sure the SOE and local government are loaded with over-valued assets and missing liabilities that don’t show up on anyone’s books. Cleaning up their finances will take some real effort. I’ll bet – giving 10:1 odds – that many assets will be written down and liablities discovered that will greately increase whatever financial exposure the authorities think already exists.

    The Chinese command economy has advantages most western coutries don’t. They can change the tax system fairly easily without the usual blowback from affected parties. A 10% tax on commercial rents and a modest land value tax on 2nd – 10th homes would raise a lot of revenue to pay down some of the state and SOE debts. A reduction in any VAT or other regressive sales or payroll taxes will also help the economy by boosting household consumption, which will boost business activity, boost employment and boost tax revenues.

    It’s the same policy prescription that applies in most countries – reduce regressive taxes on labor and increase taxes by a similar amount on land rents.

    1. kris

      Actually to be more specific, they can just absorb all municipal debts. Baaamm. All gone.
      Hence the central gov will be responsible to pay those debts to foreign creditors in US dollars, unless they accept RMB which I think has the same probability of an asteroid hitting earth.

      1. ebear

        >>Actually to be more specific, they can just absorb all municipal debts. Baaamm. All gone.
        Hence the central gov will be responsible to pay those debts to foreign creditors in US dollars, unless they accept RMB which I think has the same probability of an asteroid hitting earth.<<

        How much external debt does China have compared to their external credit (US treasuries being the most glaring example)?

        China has an option which I don't see being discussed much. Devalue the RMB. Right now the RMB is pegged to USD. Devalue RMB by half, and your external assets double in RMB terms which you can then use to pay down domestic debt. Perhaps this is why the CCP is encouraging gold ownership – so that domestic savings are somewhat protected against the rise in prices a devaluation would bring?

        Sure this has consequences, but so does every other path available to them, and if push comes to shove in a world of faltering growth and rising protectionism, it may be the best option in a world of bad choices.

        1. kris

          I do not disagree. I never said there are no other options. I was just making the point that in a communist country the leaders can do whatever they want, the citizens are brain dead until …..Tien An Men style.

          My take is that there is no solution that will be painless and China is in the worst place of pain.

        2. Common Sense

          High inflation is already hitting the rising middle class there, with stagnant wages and rising RE prices and a lot of debt and no safety nets it would be difficult for the state to pull it out.

  9. Awake

    “China needs to restrict the roles of the state-owned enterprises, break up monopolies, diversify ownership and lower entry barriers to private firms,” said Mr. Zoellick in a talk to economists in Chicago last month.”

    The state owned enterprises were “corporatized” in the early 90’s, they were made more independant from the central government. Many were privatized. If you look at the amount of assets that the SOE’s own, it is something between a quarter and about forty percent of overal firm assets in China. The SOE’s are, however, something like 3% of the firms in China. There were many more SOE’s in decades past, there were things like Township Village Enterprises which barely exist today, and they owned much more of the economy then. While SOE’s were privatized and turned into more Western style corporations, they grew individeually and have huge economics of scale advantages over most private firms there.


    “The Second National Economic Census conducted in 2008 reveals that of all the 208 trillion RMB total assets of the secondary and tertiary sectors (industrial and service sectors), 63 trillion – or 30 percent of total – was held by SOEs. (SOEs here correspond to state sole funded corporations and enterprises with the state as the biggest share holder.) Meanwhile, in terms of enterprise number, there were 154,000 SOEs at the end of 2008, only accounting for 3.1 percent of the total enterprise number. Hence, the big picture is clear: SOEs control a substantial part of total enterprise assets in China despite the fact that their total number is marginal.”

    If you look at the 2010 Forbes 500 list, there are 69 Chinese firms listed. All but two are SOE’s. So will these large firms, that took decades to build by the Chinese people, be privatized and sold? If so, who will they be sold to? Will they be sold for pennies on the dollar to these people or groups?

    Most of the commanding heights of China’s economy (telecommunications, finance, heavy industry, energy) is in state hands. When people talk aboug selling this off, what they are saying is not handing it over to a “free market”, it is handing over large, globally successful companies to what will amount to a new class of rentier interests. China’s state owned financial firms and other SOE’s have been heavily involved in land speculation and are weighted down with debt. Will China privatize its financial system? Its capital controls did save it during the late 90’s East Asian Financial Crisis and I would imagine that if China were to privatize its banks and remove its capital controls the investors would try their best to rob them blind.

    What will happen to China’s price controls on things like energy? There have been conflicts recently on its price controls with private and state owned or supported energy companies. Do they privatize these giant companies, remove price controls and allow them to jack up prices, causing the cost structure of its economy to go way up? China charging bellow market rates for its energy has benefited domestic producers and consumers. What if that is taken away and the costs of energy massively increase?

    The government admitted there were well over 100,000 “mass incidents”, protests and riots related to government policy, last year. The three biggest reasons for this unrest are environmental degradation, corruption and inequality. Will they reform their economy in ways that allows the new private monopolies or oligopolies to raise prices on needed goods and resources, given this?

    By the way, anyone who does an economic analysis on China and doesn’t include the environmental factor is in for a surprise in the coming decades. Look at China’s water and air pollution, the lack of water availability, (especially in the north and especially given that a large percentage of that water can’t be used as a result of pollution), desertification, soil erosion, eutrophication, its massive consumption of coal and nitrogen, China’s cancer explosion, amongst other things.

    My guess, given all of this and the rise of social movements and the new left in China, is increased social unrest and a possible move to the left that will slow down or even reverse the late 70’s market reforms. Whether that is good, bad or something in between, we will see. I could very well be wrong.

    I did live there though for over a year. I hope it is as peaceful as possible and my friends there don’t see their lives get worse thanks to a Pinochet type of asset grab.

  10. Leverage

    A comment on comments,

    There is a limit to printing money yes, but with balanced trade (don’t even need a surplus), strong political power 6 stability and growth this limit is ample.

    In the end is all about inflation and wealth/income, if growth can keep with inflation then you can keep printing money. If inflation rises above growth and income then you have a buffer of time to shift policies, but you need to stop printing or you could eventually suffer a currency crisis and political instability.

    Inflation AND real growth is what reflexes all the underlying complex dynamics. The great theme of the upcoming decades is how rising cost-push inflation and diminishing growth can be fought for systemic stability to remain. China as a growing economy will face a lot of trouble, but given they understand they can’t run out of money, and helped by diminishing population probably will be able to do it.

    In developed nations pretty much the same if they understand that running out of money is stupid: diminishing population can help with inflationary pressures as long as productive capacity (of a diminishing workforce) is sufficient to service an increasing retired population. This along better technology, decreasing consumption, and financial stability (hard to do, but we can if we want) not needing so much debt, hopefully, will ease problems and avoid collapse and chaos.

    Nations which do not understand increasing populations with diminishing resources are bad will suffer a lot (ie. Middle East nowadays), if they don’t work policy about this issue and let nature fix it, well, nature will fix it like it does in some countries already.

  11. Calgacus

    The World Bank always prescribes “tough medicine”. Poison in other words. The only idea, the only message the World Bank ever has is: Take our medicine (poison) and die. The we steal your stuff.

    China is big enough & smart enough that they will do the right thing: always the opposite of what the World Bank says to do.

    1. financial matters

      The difference with Pettis is that he says the income from these asset sales should go directly to households rather than to service western bank debt or other private corporations. Actually the same thing a competent and non corrupt government should be doing in the first place…

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