Tuesday, July 10, 2012

592 Trading Away Our Future. Asian mercantilists team up with Corporate 1% behind outsourcing

Trading Away Our Future. Asian mercantilists team up with Corporate 1%
behind outsourcing

Newsletter published on 21-3-2013

(1) Asian Buyers Snap Up Half of New London Homes
(2) Asia model countries, particularly China, constitute a threat to
global integration
(3) China's mercantilism a threat to Globalization
(4) To restore Manufacturing, we have to take on the Corporate 1% who
benefit by outsourcing - Ralph Gomory
(5) Mercantilism's success may be moving the world toward State
Capitalism (Fascism) - Howard Richman
(6) Trading Away Our Future - Howard Richman
(7) Asian Mercantilist trade & currency policies pushing West into
deficit & debt - Michael Pettis
(8) China's exports are understated, and its imports overstated -
Michael Pettis
(9) China is restraining, not leading, global trade rebalancing -
Michael Pettis

(1) Asian Buyers Snap Up Half of New London Homes


January 22, 2013, 5:48 PM

If you've just moved into a newly built apartment in central London,
don't be perplexed if your neighbors speak mostly Chinese.

Market-cooling measures in Asia have helped fuel interest in London's
real estate market—long a popular destination for property buyers on the
prowl, says property consultancy Knight Frank. Last year, overseas
buyers spent $3.5 billion on apartments undergoing construction in
central London, up 22% from the year earlier.

Together, buyers from Singapore and Hong Kong snapped up nearly 40% of
all such apartments in central London. Adding in buyers from Malaysia
and mainland China, Asian buyers accounted for roughly half of all
purchases. By comparison, U.K. buyers made up just 27% of all purchases
of apartments under construction, according to Knight Frank's latest
figures. Such figures were generally consistent with those seen in 2011.

Among overseas buyers, more than two-thirds bought for investment
purposes, says Knight Frank, while another third said they were
motivated to buy for a child enrolled at a local university.

The implementation of cooling measures across parts of Asia in recent
years may have encouraged buyers to spend more in London, as cities from
Beijing to Hong Kong have slapped extra taxes and restrictions on
short-term speculators and those seeking to buy additional properties.
Such measures have "acted as a spur for many potential investors to look
at overseas markets," says Nicholas Holt, Asia-Pacific research director.

The developer of London's Battersea Power Station residential complex
says it is making a deliberate attempt to ensure that buyers of the
first wave of its apartments—which went on sale this month—will be a
balanced mix of locals and expatriates. "We want as many as we can,"
says Battersea Power Station Development Company CEO Rob Tincknell of
U.K. buyers, saying that the company is adjusting its sale strategy to
try and obtain the right combination of residents. Out of the 800
apartments for sale, 600 have already been sold, he says—about half
those to U.K. buyers—with construction to begin in the second half of 2013.

Recently Mr. Tincknell has been touring various cities in Asia to
promote sales of the development. Over the course of a three-day
exhibition in Singapore this month, some 1,000 people showed up, he
says. The company is organizing a similar exhibition in Hong Kong this
weekend, and expects the remaining apartments will be sold off soon.

When it comes to Hong Kong buyers in particular, Mr. Tincknell says, it
isn't surprising that they gravitate so strongly toward London. "The
fact that our legal system is the same makes a huge difference," he says
of the former British colony. "The connection between London and Hong
Kong is very close."

– Te-Ping Chen. Follow her on Twitter @tepingchen.

(2) Asia model countries, particularly China, constitute a threat to
global integration

From: "John Craig" <john.cpds@gmail.com> Date: Tue, 5 Mar 2013 21:18:02

Interesting - there is no doubt that the debt issue is a consequence of
international financial imbalances - and that this is associated with
(though not solely the result of) the distorted financial systems and
demand deficits that have been the basis of East Asian economic
'miracles' (eg in Japan / China). But if major economic set-backs in
Asia result from the currency wars (ie from QE), this will be a
consequence of the distorted systems in East Asia (just as the USSR's
problems arose from communism). Japan and China have been working on the
assumption that bureaucratically-orchestrated market-oriented consensus
within an autocratic social hierarchy can beat independent profit
motivated economic initiative. I doubt that this will prove any more
successful than the USSR's central planning.

Comment (Peter M): Well, John, I disagree; I think that East Asia is
beating us.

(3) China's mercantilism a threat to Globalization


Enough is Enough: Confronting Chinese Innovation Mercantilism

by Robert D. Atkinson



In the last decade, China accumulated $3.2 trillion worth of foreign
exchange reserves and now enjoys the world's largest current account
balance. In 2011, it ran a $276.5 billion trade surplus with the United
States. This "accomplishment" stems largely from the fact that China is
practicing economic mercantilism on an unprecedented scale. China seeks
not merely competitive advantage, but absolute advantage. In other
words, China's strategy is to win in virtually all industries,
especially advanced technology products and services. One may argue that
all countries do this and assert it is the essence of competition. But
China's policies represent a departure from traditional competition and
international trade norms. Autarky, not trade, defines China's goal. As
such China's economic strategy consists of two main objectives: 1)
develop and support all industries that can expand exports, especially
higher value-added ones, and reduce imports; 2) and do this in a way
that ensures that Chinese-owned firms win. It is time for policymakers
in the United States and other countries to begin responding to today's
reality for Chinese mercantilism represents a fundamental threat to not
only the U.S. economy, but to the entire system of market and
rules-based globalization.

{p. 7} As such, China's autarkic goals and mercantilist policies are
fundamentally at odds with the principles of the open and rules-based
international trading system that China committed to when it elected to
join the World Trade Organization (WTO) in 2001. Countries that join the
WTO make a commitment to a trading system, not an exporting system.
Rolling back Chinese innovation mercantilism, while continuing to
integrate China into the rules-based system of market-led global trade
and investment, should be a key priority of U.S. (and European) trade

The stakes could not be higher, for this conflict is not just about
China, but about the future of the entire global trading system,
especially as developing nations become more active participants in it.
China's autarkic and mercantilist approach reflects a fundamental
ideological difference between how China sees its role in bringing about
state capitalism and the traditional western model of capitalism
supported by global organizations such as the WTO. As China increasingly
touts the superiority of the "Beijing consensus" over the "Washington
consensus" (the latter rests on the premise that market forces work and
governments should play only a minimal role in promoting the interests
of their countries' companies and workers), there is a real risk that
the former, not the latter, will become the guiding star of other
nations around the globe seeking to boost their living standards. We
already see this in nations like Brazil and India that are looking to
emulate China by ramping up mercantilism. If this happens, it will be
extremely difficult to maintain a global trading system that operates
along the lines economists originally envisioned. In 1990 Francis
Fukuyama wrote his well-regarded book The End of History and the Last
Man which postulated that "a true global culture has emerged, centering
around technological driven growth and the capitalist social relations
necessary to produce it and sustain it."2

{p. 8} The Nature of Chinese Mercantilist Policies

In contrast to American economic policy, Chinese economic policy is not
about maximizing short-term consumer welfare through free markets.
Rather it is about maximizing long-term producer welfare and achieving
autarky. And it's a particular kind of producer welfare where the owner
of the factors of production is the Chinese Communist Party. As such,
the focus on producer welfare is tied not just to a particular theory of
economic growth but to direct self-interest of the Chinese government
and officials in it. To maximize producer welfare, China has put in
place an array of mercantilist policies whose principal focus is on
helping the home economy in an unfair manner at the expense of the
global economy. For Chinese mercantilists, it is not enough to compete
to make a better product. Instead, they seek destroy the competition and
make the only product.

There are two distinguishing features of these mercantilist policies.
The first is their scope and size. While virtually all governments have
crafted economic development policies to boost competitive advantage,
China has developed the most comprehensive set of policies, with most of
them violating the spirit, if not the letter of the law of the WTO. The
second is their focus on Chinese firms, rather than Chinese
establishments (e.g., Chinese factories and offices owned by Chinese or
foreign firms). Most governments provide incentives to any establishment
within their borders, regardless of its nationality. For Chinese
leaders, at least since after 2006, Chinese firms are the key. Chinese
mercantilist policies champion Chinese firms in two ways: the first is
through policies designed to unfairly spur exports and reduce imports
that help Chinese firms but also foreign firms in China. These policies
include currency manipulation, relative high tariffs (three times higher
than U.S. tariffs); and tax incentives for exports. The second is
through policies designed to help Chinese firms while discriminating
against foreign establishments in China.

These policies take numerous forms including discriminatory government
procurement; controls on foreign purchases designed to force technology
transfer to China; land grants and rent subsidies to Chinese-owned
firms; preferential loans from banks; tax incentives for Chinese-owned
firms; cash subsidies; benefits to state-owned enterprises; generous
export financing; government-sanctioned monopolies; a weak and
discriminatory patent system; jointventure requirements; forced
technology transfer; intellectual property theft; cyberespionage to
steal intellectual property (IP); domestic technology standards; direct
discrimination against foreign firms; limits on imports and sales by
foreign firms; onerous regulatory certification requirements; and
limiting exports of critical materials in order to deny foreign firms
key inputs.

In essence, China has long worked to attract foreign companies to
operate there, often using unfair or illegal practices. And it is now
targeting help to Chinese-owned firms.

{p. 9} The Shift to "China Inc." Through Indigenous Innovation

Until the mid-2000s China actively encouraged foreign direct investment
in the country through a vast array of incentives, many of them
mercantilist and unfair in nature. While the consequences of the
mercantilist policies might not have always been good for the U.S.
economy, and especially for many production workers in traded sectors,
U.S. multinational corporations benefited from access to a low-cost
production platform. And Americans in their role as consumers benefited
from lower cost goods. And while China occasionally engaged in policies
that brought complaints from U.S. industry, by and large U.S. industry
was satisfied with the relationship.

In 2006, that began to change. For that was when China made the
strategic decision to shift to a "China Inc." development model focused
on helping Chinese firms, often at the expense of foreign firms. Chinese
leaders decided that attracting commodity-based production facilities
from multinational corporations (MNCs) was no longer the goal, as it had
been since the early 1980s when Deng Xiaoping made the decision to open
China up to international investment. The path to prosperity and
autonomy was now to be "indigenous innovation" (or in Chinese, zizhu
chuagnxin) with Chinese firms the focus.3

{p. 15} WTO officials need to realize that many of its members,
particularly China, do not accept the principles the WTO stands for and
as such constitute a threat to global integration. The WTO must develop
an enforceable regime that addresses the many non-tariff mercantilist
actions nations take. One place to start would be to institute
enforceable actions with regard to rules for jointventure and
technology-transfer requirements and to allow the interpretation of
requirements to be based on real conditions on the ground not some
provisions in a government legal code. A second area of opportunity is
in how to address state-owned enterprises (SOEs). The idea that opaque,
heavily subsidized, and favored SOEs are competing with firms that must
raise their own capital in the marketplace makes a mockery of the idea
of fair and welfare-enhancing competition. A third area is standards.
Standards manipulation for competitive advantage should be more easily
WTO-actionable. It's not too late for the United States and allies to
contain and roll back Chinese innovation mercantilism. But action will
be resisted not only by Beijing but also by Washington.

Many in the U.S. foreign policy establishment refuse to recognize the
real nature of the threat, preferring to see themselves first as members
of a global community of elites, rather than as American patriots. As
such, they will offer a number of rationalizations for the status quo.

Perhaps the most pernicious concept limiting tougher action against
Chinese innovation mercantilism is that as long as the United States is
not mercantilist it still benefits from trade with China. But this is
not the right way to frame the issue. The right way is to ask whether
reduced Chinese mercantilism would have non-trivial beneficial impacts
on the U.S. economy. Only the most zealous neoclassical ideologues and
"Friends of China" would assert that it would not.

Even if some will admit that Chinese economic mercantilism hurts the
U.S. economy, many in the trade establishment ascribe America's economic
problems to America. According to this view, rather than focus on
China's unfair practices, we should instead get our own house in order.
Of course, as ITIF has long argued, the United States needs to do more
to be more globally competitive.6 But unless China reduces its
innovation mercantilism, these actions will fall far short of producing
the kind of high-growth economy America needs.

Finally, many in the Washington trade and foreign policy establishment
will assert that any efforts to roll Chinese mercantilism will lead to a
destructive trade war. But the trade war is already more than a decade
old, and China has fired virtually all of the shots and done almost all
of the damage. Working to roll back Chinese mercantilism is not
protectionism; it is a defense of the global, free market economy.

{p. 18} This report argues that there are two predominant views in
America of China-U.S. trade and that both miss this point to generate
fundamentally mistaken policy conclusions. The "free trade" view holds
that we should support the current system with China, as problematic as
it might be, and that vigorous efforts to press China to end its
mercantilism will only backfire, leading to a destructive "trade war"
that would dramatically limit what is largely a mutually beneficial
trading relationship with China.12 For this camp virtually all trade is
win-win, even when it is lopsided (mercantilist on one side, free trade
on the other).

{p. 19} In contrast, the "protectionist" view holds that trade with
China is fundamentally bad for the United States, and would be even if
China were to reform and abide by the spirit of comparative advantage.
There is no way, the view goes, that American workers can compete with
815 million Chinese workers who are paid less than 10 percent of
American wages.13 Better we impose protective tariffs, "Buy American"
provisions, and other protectionist measures to build our own autarkic

{p. 30} Tariffs

Most nations place tariffs on at least some imported products but China
places tariffs on a wider range of products and at a higher rate,
despite the country's membership in the WTO. Among twenty-one
Asia-Pacific Economic Cooperation (APEC) economies the average
most-favored-nation (MFN)-applied tariff in 2009 was 6.17 percent, but
China's was 9.6 percent. In contrast, the U.S. rate was just 3.5
percent.56 In terms of the percent of imports entering duty free, just
46 percent of Chinese imports did in 2009, compared to 76.3 percent of
American imports.57 Moreover, despite the fact that China signed on to
the World Trade Organization's Information Technology Agreement (ITA),
it places 30

{p. 31} percent tariffs on magnetic-tape-type video recording or
reproducing apparatus; 24.5 percent on computer monitors; 20 percent on
printers, copying machines, facsimile machines; and video recording and
reproducing apparatus.58 In addition, China restricts imports through a
lack of transparency for customs regulations, burdensome documentation
requirements, and inconsistently applied product certification

(4) To restore Manufacturing, we have to take on the Corporate 1% who
benefit by outsourcing - Ralph Gomory

Mercantilism, Manufacturing, and a Political Problem

Ralph Gomory

Huffington Post

22 May 2012


People talk a great deal about free trade. But for better or for worse
the real world that we live in is more a mercantilist world than it is a
free markets and free trade world. And in this mercantilist world there
is a fundamental divergence between the goal of our corporations, which
is to maximize profit, and the goal of rebuilding manufacturing here in
the United States.

The modern Chinese government wisely exploits the fact that our great
American companies take as their main mission in life to make as much
money as possible for their shareholders. Companies can maximize profits
by taking their technology and know how to China where they receive
subsidies, in the form of tax breaks, shared investment, and undervalued
currency. These are the factors that in high-tech manufacturing are far
more important than lower wages. So our companies manufacture overseas
and import the goods they once made in America back into the United
States. Our companies do not regard it as part of their mission to take
care of the American economy.

In this real world a determined and effective government, like that of
China, can make that shift of our production to their country happen on
a large scale. That is what has been happening and it continues to
happen. And none of this is effectively countered by our standard
discussions of the need for better education, more basic research, etc.
The inducements offered to our companies are working and our domestic
manufacturing is disappearing.

What can we do to change that result? We do not have a government
experienced in giving out these subsidies or well organized to support
chosen companies as national champions. That is not our tradition;
rather In the Unites States our traditional government actions have been
tax incentives and tariffs.

Tax incentives: We are used to the idea of R&D tax credits for
corporations; so why not corporate tax credits for companies that have
high value added in the United States? Make the corporate income tax
lower, but make it lower in proportion to the productive activity that
these companies actually have in the United States, not somewhere else.
Use the corporate income tax rate as an incentive to produce here rather
than somewhere else.

Tariffs: With our present grossly unbalanced trade we are importing the
manufactured goods we once made here and exporting far less value than
we import. We are living beyond our means, consuming more value than we
create while our manufacturing is withering away in the process. This is
not necessary; we can and should balance trade, and U.S. tariffs have a
long history of contributing to that goal in the past.

Almost ten years ago Warren Buffet proposed in Fortune magazine a very
good and straightforward way to balance trade he called import
certificates. Basically if you export you get certificates for the value
of goods you export and these you can sell on an open market. And no-one
can import into the U.S. without buying certificates whose face value
equals that of the planned import. This automatically balances trade.

So even in a mercantilist world, and even within the limited framework
of what we have traditionally done, we could act to incent production
here and to balance trade. And there are many other incentives to
produce and many other tariff-like actions beyond those just mentioned
that could produce those results. Why is it that these actions are not
even a significant part of the discussions about how we could end the
destruction of our industries and how we could revive manufacturing?

We are not taking the actions we could to revive and strengthen
manufacturing because there is no one "we". We, meaning most of the
country, would benefit from taking such actions, but there is another
"we" that would lose from such a change; the global corporations. But
the political power in Washington of the two "we"s is measured more by
money and influence than by the number of people who would benefit, and
the edge in money and influence is overwhelmingly with the global

Given the real world we live in, and the current motivation of our great
global corporations, it is time to apply to our own situation the
immortal words of Pogo: "we have met the enemy and he is us". To solve
our manufacturing problem we will first have to face up to our political

(5) Mercantilism's success may be moving the world toward State
Capitalism (Fascism) - Howard Richman

{State Capitalism or State Socialism? These two terms mean the same;
they are used according to the prejudices of the commentator. Australia
had that system from the 1950s to the 1980s; it was much better than
what we have now. - Peter M.}


Mercantilism's Success may be Moving World Toward Fascism

Howard Richman, 1/18/2013

In a January 10 commentary, Harvard political economy professor Dani
Rodrik (In truth, mercantilism never went away) argues that
mercantilism's success may be moving the world toward state capitalism
(fascism). Indeed, if state-capitalist mercantilism competes with
liberal-capitalist free trade, then fascism is the more prosperous system.

Rodrik correctly summarizes the success of modern mercantilism, writing:

[During] the last six decades: a succession of Asian countries
managed to grow by leaps and bounds by applying different variants of
mercantilism. Governments in rich countries for the most part looked the
other way while Japan, South Korea, Taiwan, and China protected their
home markets, appropriated "intellectual property", subsidised their
producers, and managed their currencies.

He incorrectly argues that the West was right to ignore Asian
mercantilism during these decades:

Liberalism and mercantilism can coexist happily in the world economy.
Liberals should be happy to have their consumption subsidised by

Although the victims of mercantilism do get increased consumption in the
short run, they pay for that increased consumption with their industries
and financial assets. In the long-run they get stagnant economies and
financial crises.

Although Rodrik recognizes that the liberal capitalist economies are now
in decline, he appears to be unaware that the decline is predicted by
the modern mercantilist theory of Jacob Viner, Heng-Fu Zou, and myself
with my father and son. In a nutshell, the mercantilist country
sacrifices short-run consumption in order to get even more consumption
and more power in the long run. In contrast, its victims get more
consumption in the short run, followed by less consumption and power in
the long-run.

This scenario has already played out in at least three different trade
deficit countries:

Spain. Spain's fellow European countries, especially Britain and
France, stole Spain's industries and power through mercantilism in the
fifteenth and sixteenth centuries.
Great Britain. Britain eschewed mercantilism in the nineteenth
century only to have its industries stolen by American and French
mercantilism in the 1920s.
United States. After World War II, the United States eschewed
mercantilism, only to have its industries and power stolen by Asian
mercantilism from 1996 to the present.

So what is Harvard Professor Rodrik's solution? He doesn't have one. He
plans to watch the debate between liberal capitalism and state
capitalism from his ivory tower:

As a result, the new economic environment is likely to produce more
tension than accommodation between countries pursuing liberal and
mercantilist paths. It may also reignite long-dormant debates about the
type of capitalism that produces the greatest prosperity.

Rodrik is missing the fact that there are four trade policy choices, not
just two:

Protectionism - the strategy of protecting selected
politically-powerful industries.
Free Trade - the strategy of not putting up any barriers to imports.
Mercantilism - the strategy of maximizing exports and minimizing
imports in order to beggar one's neighbors.
Balanced Trade - the strategy of insisting upon balanced trade in
order to oppose mercantilism.

Protectionists simply keep out imports. Mercantilists not only keep out
imports, but they also promote exports. Then they prevent trade from
balancing by buying foreign financial assets, including gold.

In a world that is free of mercantilism, countries that practice free
trade are better off than those that practice protectionism, because
countries that practice protectionism hurt their consumers and sacrifice
their other industries in order to favor the politically connected ones.

But when mercantilism is rampant, liberal capitalist countries can
defeat it simply by adopting a tariff system that just taxes
mercantilists, not those who engage in free trade. Great Britain's
"imperial preference" system, got Great Britain right out of the Great
Depression in 1933. The countries of the British Commonwealth put
tariffs on the mercantilists, including the United States and France,
but not upon each other.

Today, the liberal capitalist countries could implement a WTO-legal
Scaled Tariff which places trade-balancing tariffs only upon those
countries with which each trade deficit country has a trade deficit. The
tariffs would be scaled individually to the size of the trade deficit
with each trade surplus country, and would diminish as trade approaches
balance, giving the mercantilists an incentive to let in imports.

Liberal capitalism does not have to lose out to state capitalism. It can
win if it requires balanced trade.

(6) Trading Away Our Future - Howard Richman

by Raymond, Howard, and Jesse Richman

Published by Ideal Taxes Association Copyright 2008


{p. 2} The decline of US manufacturing also had profound effects upon
the US military, lengthening supply lines as more parts were sourced
from abroad and reducing US capability to rapidly develop and deploy new
weapons systems. The United States-China Economic and Security Review
Commission 2007 report sums up the problem as follows:

"U.S. defense contractors have merged and moved some manufacturing
outside the United States. Sources of defense components are becoming
scarcer in the United States, and the supply of American workers skilled
in manufacturing these components is diminishing."3 While this was
happening, most US elected leaders were ignoring the negative effects
that our tax system was having upon the trade deficit and upon American
savings. They were ignoring the fact that our tax system was subsidizing
the foreign savings that were causing the trade deficits. They were
ignoring the fact that our tax system was encouraging the consumption of
capital. America needed to generate more of its own savings instead of
borrowing them from abroad. But the US government is not the only
government that has contributed to the trade deficits. Recently some
economists have begun to realize that the trade deficits are largely the
result of a new form of

{p. 3} mercantilism, dubbed "monetary mercantilism" by Joshua Aizenman &
Jaewoo Lee in 2005, who defined it as "hoarding international reserves
in order to improve competitiveness."4 Under the old form of
mercantilism, countries encouraged their exports and discouraged their
imports in order to build up their gold hoards. Under the new form,
which we call "dollar mercantilism," countries build up their dollar
hoards as part of currency manipulations designed to encourage their
exports and discourage their imports.

Here's how they do it. The dollar mercantilist governments borrow their
own currency and then use it to buy dollars so that they can drive up
the price of the dollar compared to their own currency in currency
markets. As a result of the higher price of the dollar and the lower
price of their own currency, their own products can then outcompete US
products in world markets.

Because the dollars purchased by the mercantilist governments are not
used to purchase US goods and services, demand for US produced tradables
is kept artificially low. This new form of mercantilism intentionally
produces trade deficits for the United States while allowing the
practicing country to build up its manufacturing capacity at the expense
of US industry.

Instead of keeping the purchased dollars in their bank vaults, the
mercantilist governments loan them back to us so that they can earn
interest on them. In effect, the mercantilist countries are lending us
money to buy their goods, and just like a teenager with a new credit
card, we are running up our balance with no thought to the future. Japan
gradually invented dollar mercantilism in the years following World War
II. Beginning in the late 1990s, China copied the policy that had
converted Japan from a weak and backward economy to a world powerhouse.
In recent years, more and more countries have been joining the
bandwagon, with the United States as their primary target. They have
been accumulating dollar assets in order to manipulate currency values
and preserve the conditions that produce trade surpluses for them and
trade deficits for us.

Although the evidence of manipulation was mounting, as recently as 2007
most economists were still in denial. Free-trade ideology

{p. 4} was still blinding them to the severity of the problem and the
fact that the market forces that they expected to correct trade
imbalances were being blocked by government policies. They were
explaining away the causes of the trade deficits. They were minimizing
the costs of the trade deficits. They were minimizing the role of the
mercantilist policies, pursued by Japan for a half century and by China
for over a decade, that had undermined the productive capacity of the
United States and converted the United States from the world's leading
creditor to the world's leading debtor. These economists were still
equating globalization, the signing of the General Agreements on Tariffs
and Trade and the creation of the World Trade Organization, with free
trade. These and other agreements had reduced barriers to trade but had
not prevented countries from pursuing mercantilist policies to our
detriment. [...]

As advocates of free markets, we generally approve of relying on the
free play of market forces to provide the highest level of welfare for
Americans. But we discovered that free trade, normally benefi- cial, had
become an ideology blinding the United States establishment from seeing
key causes of the trade deficits and their disastrous consequences.

The trade deficits are sustained by government policies, both US
government tax policies and foreign government mercantilist policies,
not by the free play of market forces. We have to face it. While trade
often benefits all, when it comes to government-driven trade deficits,
there ain't no free trade!

We must act now! If the correct actions are taken, we may still avoid
the worst consequences of our failed economic policies. That task will
involve direct action to balance trade, ending our tax subsidies for
foreign savings, and changing our tax system to encourage American
savings and investment. If we address the trade deficits now, then the
United States, together with other advocates of democracy, will continue
to dominate the world's economy. If not, then resolutely nondemocratic
China will dominate. The world's future is in the balance.

{p. 9} Trade deficits cannot occur unless foreign governments or private
investors are willing to finance them. There must always be a balance of
payments. Deficits on trade and services have to be made up through a
countervailing flow of funds. Indeed, the flow comes first because
importers have to be sure of funds to purchase goods abroad. That flow
of funds can sometimes include gifts, but it is usually made up of
loans. When there is a trade deficit there is an equivalent flow of
foreign savings in the opposite direction. In this book we will use
"foreign savings" and "foreign financial capital" to refer to the flow
of funds into the United States that finances the US trade deficits.
These inflows caused the dollar to rise to an artificially high level in

{p. 10} 2002 as compared to a broad index of other currencies (an index
calculated by the Federal Reserve). The high value of the dollar kept
foreign goods cheap and stimulated US imports. It kept American goods
expensive and discouraged US exports.

Normally, trade deficits are self-correcting. When a country begins to
run a trade deficit, its currency declines in price in world currency
markets. This makes its goods less expensive and foreign goods more
expensive. But several of our trading partners, including Japan and
China, manipulate currency values, keeping the American dollar
overvalued relative to their own currencies in order to perpetuate and
grow our trade deficits with them. They do this by sending the excess of
dollars they earn back to us, by buying US government bonds and other US
assets, in effect lending us the money to buy their goods. The Japanese
and Chinese governments account for about two-thirds of the
foreign-government-caused component of the trade deficits.


Are trade deficits a problem? Some economists are flippant. Why would a
country want to exchange goods of greater value than it receives? And if
a country willingly sends you goods of greater value than you send it,
what is your complaint? Because most economists believe that trade
deficits are a short-term phenomenon, their analysis of the costs and
benefits of trade deficits has been restricted. In the short term, the
country running a deficit benefits from higher consumption than would
otherwise be possible, and the country exporting more than it imports
consumes less than it otherwise would. But there are long term costs to
accepting long-term trade deficits. There are economic models which show
that in the long run the situation reverses, with the country that "gave
away" goods in exchange for IOUs better off, and the country which
accepted the "free" goods worse off.

{p. 14} Mercantilism was an economic philosophy that dominated
government policies from the sixteenth to the eighteenth centuries. It
equated a country's welfare with an increase in its stock of gold and
treasure. To a large extent, this was the result of the discovery of
Aztec gold in the new world. Spain prospered by the shipment of

{p. 15} treasure from the new world and became the dominant world power.
The evidence thus appeared to justify the mercantilist view that equated
gold and treasure with national power.

The mercantilist countries of the 16th through 19th centuries sought to
export more than they imported in order to build up their gold hoards.
During the sixteenth century, the Spanish gold taken from its American
colonies was used to pay for goods made in England, France, and other
countries. England and France grew economically while Spanish industry
foundered, leaving Spain a second rate power.

{p. 17} There are other important long-term advantages that accrue to
countries with chronic trade surpluses. What they lose in short-term
consumption, they may, under some circumstances, regain in long term
technological advantage. By strengthening their industry and undermining
US industry, they enhance their economic power in the world. These
countries sacrifice some domestic consumption in the shortterm, but gain
tremendously in terms of long-term growth. In contrast, the United
States gains domestic consumption in the short term, but suffers
deindustrialization and, eventually, a severe cut in living standards

{p. 22} When manufacturing moves overseas to China, India, East Asia, or
Europe, it takes engineering know-how because engineers will ply their
trade where the action is – outside the United States. While venerable
U.S. engineering institutions still maintain their foothold, more than
half of their doctoral degrees are awarded to foreign students.17


Whenever the Federal Reserve responds in kind with reciprocal actions to
the monetary mercantilist policies of foreign central banks, the effects
would be exactly the same as if each central bank were minding its own
economy. We'll explain the economics involved with three examples. In
these examples we'll assume that there are only two countries in the
world with trade between them. We will call these countries US and Japan
and we will call their currencies the dollar and the yen. We'll also
assume that, in each country, the central bank is expanding the monetary
base to meet the needs of its growing economy. For simplicity of
discussion, we'll also assume that at the beginning the exchange rate is
such that 1 dollar trades for 1 yen.

Example #1 – Japan and US each buy own bonds.

This is the normal situation. In this example the central bank of Japan
buys 1 million yen of Japanese bonds and the central bank of the US
(i.e. the Fed) buys 1 million dollars of US bonds. There would be no
reason to suppose that these actions would affect either the exchange
rate or the balance of trade. The effects would be expansion of
aggregate demand in both countries just as described in any
macroeconomics textbook:

1. Monetary Base. Both monetary bases would expand.

2. Interest Rates. There would be a reduction in both the Japanese and
US interest rates because the Japanese central bank bid up the price of
the Japanese bonds and the US central bank bid up the price of the US bonds.

3. Credit Expansion. Banks in both Japan and US would have new excess
reserves that they would want to lend out.

4. Aggregate Demand. Consumers and investors in both countries would
have more money that they could borrow and spend. They would spend some
on products of their own country and some on products of the other
country. The consumption and investment components of aggregate demand
would rise in both countries with little expected change in net exports.

{p. 105} Example #2 – Japan and US both buy US bonds.

In this example, the Japanese central bank uses its 1 million yen to buy
1 million dollars and then uses the 1 million dollars to buy US bonds;
the US central bank also uses its 1 million dollars to buy US bonds.
These actions would give the US a lower interest rate, a higher dollar,
and a negative trade balance:

1. Monetary Base. Both monetary bases would expand. The Japanese
monetary base would expand by 1 million yen because the Japanese Central
Bank created 1 million of new yen which it used to buy the 1 million

2. Exchange Rate. The US dollar would appreciate vis-à-vis the yen
because the purchase of 1 million dollars by the Japanese central bank
would increase demand for the dollar. This would increase the relative
price of US products and decrease the relative price of Japanese products.

3. Interest Rates. There would be a double reduction in the US interest
rate because both the US central bank and the Japanese Central bank were
bidding up the price of the US bonds. There would be no expected change
in the Japanese interest rate.

4. Credit Expansion. US banks would have new excess reserves that they
would want to lend out.

5. Aggregate Demand. The consumption component of US aggregate demand
would rise while the trade surplus component would fall. US consumers
and investors would have more money that they could borrow and spend.
Investment in the US could go either way. Falling interest rates would
make fixed investment less expensive but the rising dollar would make
investment opportunities less attractive. The trade surplus component of
aggregate demand in Japan would increase.

6. Balance of Trade. US exports to Japan would decrease and Japanese
exports to the US would increase. The only counterforce that could
prevent this from happening would be a possible flow of private savings
from the US to Japan. The reduced interest rate in the US would
encourage a flow of private savings to Japan, but the appreciating
dollar versus the yen would encourage a flow of

{p. 106} private savings from Japan to the US.

Example #3 – Japan and US each buy other country's bonds . This is what
the Fed could do whenever a foreign country buys dollars to increase its
dollar reserves and trade surplus. In this example the Japanese central
bank uses its 1 million yen to buy 1 million dollars and uses those
dollars to buy US bonds; the Fed reciprocates and uses its 1 million
dollars to buy 1 million yen and then uses those yen to buy Japanese
bonds. The effects would be the same as in the normal situation of
Example #1 where each country buys its own bonds:

1. Monetary Base. Both monetary bases would expand.

2. Interest Rates. There would be a reduction in both the US and
Japanese interest rates because the Japanese central bank bid up the
price of the US bonds that it bought and the US central bank bid up the
price of the Japanese bonds that it bought.

3. Everything Else. Aggregate demand, exchange rate, and trade balance
would be exactly the same as in Example #1.

It is clear from Example #3 that there are absolutely no negative
economic effects if the Fed matches a foreign build-up of US dollar
reserves with a reciprocal build-up of US reserves in the foreign currency.

The effects would be exactly the same as when each bank buys its own
country's bonds: No increased trade deficit. Mutual increases in
consumption and investment in both countries. Mutual increases in the
purchases of each other's exports. Whenever the Fed responds in kind
with reciprocal actions to the trade-war attacks of foreign central
banks, the effects would be exactly the same as if each central bank
were minding its own economy.

(7) Asian Mercantilist trade & currency policies pushing West into
deficit & debt - Michael Pettis


Blame game will not make crisis easier to resolve

Monday, 12 January, 2009, 12:00am

Michael Pettis

A headline in the People's Daily last week blasted outgoing United
States Secretary of the Treasury Henry Paulson for playing the blame
game. According to the article, Mr Paulson had claimed that a failure to
address the rise of emerging markets and the resulting trade-related
imbalances was partly to blame for the global financial crisis. This
follows Federal Reserve chairman Ben Bernanke's long-standing argument
about the Asian savings glut, which was also lambasted in the article.

As the financial crisis deepens, threatening to become a trade crisis,
the eagerness of policymakers around the world to blame foreigners is
escalating. Europe is engaged in a shouting match between Germany on the
one hand and Britain, France and Italy on the other over the same
trade-related issue. Given the nastiness of the European debate, it
would be surprising if the global debate were a polite one.

Many mainland analysts and policymakers are livid at the claim mainland
policies played a role in the massive global financial distortions. The
fact is that several countries, dominated by China, engineered policies
whose result was the decade-long accumulation of foreign currency
reserves at a rate never before seen in history. This could not help but
affect the global financial system.

It is often forgotten that the world is tied together in a series of
relationships that include all trade- and investment-related money
flows, and these relationships are intertwined. When several Asian
countries, after the trauma of the 1997 crisis, put into place policies
aimed at generating massive trade surpluses and in the process
accumulated historically unprecedented hoards of foreign currency
reserves, two things necessarily followed.

First, other countries would have to run correspondingly large trade
deficits. Second, the trade surpluses would have to be recycled to the
trade deficit countries, and the way they were recycled would determine
the size of the deficit.

If this recycling had occurred in the form of private capital flows, it
might have been widely spread into a variety of assets around the world,
and the distribution of trade deficits would have been equally widely
spread. But the recycling was more than 100 per cent accounted for by
reserve accumulation (which sharply exceeded trade surpluses), and so
the distribution of the imbalances was determined almost exclusively by
Asian central banks.

US and European central banks should have been much more vociferous
about the payments imbalances and should have enacted monetary measures
to counteract Asian currency policies, but they so enjoyed the benefits
of low interest rates and cheap goods, that they permitted, and perhaps
even encouraged, domestic financial imbalances to get out of hand.
Nonetheless, however one chooses to assign primary blame, the fiscal
decisions of Asian countries combined with the investment decisions of
their central banks were key determinants in the structure of the
resulting global imbalances. This cannot possibly be a controversial
proposition to anyone who understands the basics of the global balance
of payments.

There is no question that US and European monetary policies were at
least as deeply flawed as Asian monetary policies in creating the
conditions for the massive global credit bubble. There is plenty of
blame to share regardless of how one wants to apportion it.

Normally this blame game would be deplorable, but not worth much more
than a shrug of the shoulders. The world hardly needs further lessons on
our tendency to blame others for our problems. But this time things are
different. The global balance of payments is undergoing a sharp
adjustment in which countries that exported demand - the trade-deficit
countries - are being forced to increase savings and cut consumption.
Every time this has happened in previous cases in history, the cost of
the adjustment turned out to be much worse for the trade-surplus
countries than for the trade-deficit countries. Think of the US in the
1930s, for example, or Japan in the 1990s.

If acrimony leads to a sharp reduction in international trade - and it
is in the short-term interest of trade-deficit countries that it does -
once again the worst impact will be on those countries that have
exported overcapacity and relied on the import of global demand, that
is, the trade-surplus countries. This means that for many of these
countries the effect of the global crisis could be far worse than anyone
has imagined.

It is best for the world, and especially for Asian countries with large
trade surpluses, that the global adjustment be smooth and gradual -
possibly spread out over four to five years rather than the one year in
which it seems to be happening. This will require a clear understanding
of the causes of the global imbalances and real statesmanship on the
part of US, European, Japanese and Chinese policymakers, who must
co-ordinate policies to minimise the disruptive cost to China.

So far, evidence of statesmanship is lacking. This, again, is consistent
with historical precedent, but if things don't change, the crisis will
get much worse before it gets better.

Michael Pettis is professor of finance at Peking University

(8) China's exports are understated, and its imports overstated -
Michael Pettis


10 Things to Watch for 2013



I'll be watching a number of things in 2013 in order to get a better
sense of what the future will bring. On January 22 Princeton University
Press will be publishing my book, The Great Rebalancing: Trade,
Conflict, and the Perilous Road Ahead, and in the last chapter of the
book I argue that the great trade, capital flow and debt imbalances the
were built up over the preceding two decades must reverse themselves.
Imbalances can continue for many years, I argue, but at some point they
become unsustainable and the world must adjust by reversing those

One way or the other, in other words, the world will rebalance. But
there are worse ways and better ways it can do so. Large trade surpluses
can decline, for example, because exports fall, or they can decline
because imports rise. Large trade deficits can contract under conditions
of high unemployment, but they can also contract under conditions of low
unemployment. Low savings rates can rise with declining household income
or with rising household income. Repressed consumption rates can reverse
through collapsing growth or through surging consumption. Excessive debt
can be resolved by default or by growth.

Any policy that does not clearly result in a reversal of the deep debt,
trade and capital imbalances of the past decade is a policy that cannot
be sustained. The goal of policymakers must be to work out what
rebalancing requires and then to design and implement the least painful
way of getting there. International cooperation, of course, will reduce
the pain.

For this reason I have no doubt that over the next few years we will see
the imbalances I have identified over the years in this newsletter
reverse themselves, but whether they reverse in more orderly or less
orderly ways will depend on policy decisions. It is likely to be
political considerations that determine how quickly the rebalancing
processes take place and whether they do so in ways that set the stages
for future growth or future stagnation.

My guess is that we have ended the first stage of the global crisis, and
most of the deepest problems have been identified. In 2013 we will begin
to see how policymakers respond and what the future outlook is likely to
be. Here is what I will be watching this year in order to figure out
where we are likely to end up (and I have a related article, for those
who might care, in last week's Financial Times).

1. Watch how quickly growth adjusts. The speed with which China's GDP
growth slows in 2013 will tell us a lot about how determined Beijing is
to rebalance the economy in such a way that growth is driven more by
higher household income and consumption and less by investment funded by
rising government and government-related debt. It will also tell us how
successful Beijing's new leadership will be in consolidating power and
forcing the kinds of economic and financial reforms on which most
economists now agree, but which are likely to be politically difficult.

China is ending the year on what many are interpreting as a strong note.
Manufacturing seems to be growing at its fastest pace in a while. Here
is the relevant article in an article from the People's Daily:

December's HSBC China final manufacturing PMI rose to a 19-month high of
51.5, thanks to stronger new business in-take and expansion of
production, according to figures released by HSBC Monday. The statistics
suggest that China's economy remains on track for recovery as it enters
2013, said the HSBC report. Despite persistent external headwinds, as
indicated by still contracting new export orders, the financial
organization expects China's GDP to rebound to 8.6 percent in 2013,
underpinned by China's continued policy support.

An article in Monday's Financial Times puts a little more meat on the bones:

China's economy has ended the year on a strong note after a gauge of its
manufacturing sector rose to a 19-month high. The HSBC purchasing
managers' index for December climbed to 51.5 from 50.5 a month earlier,
according to figures published on Monday. In rising further above the
midpoint of 50, the reading signalled an accelerated pace of expansion.

Although China is still set for sub-8 per cent growth in 2012, its
weakest in more than a decade, momentum picked up noticeably in the
fourth quarter after the government increased its spending on
infrastructure. "Such momentum is likely to be sustained in the coming
months when infrastructure construction runs [at] full speed and
property market conditions stabilise," said Qu Hongbin, HSBC chief
economist for China.

As most of us expected, the end of the year saw a reversal of the
attempts earlier in 2012 to slow investment growth, and as a result GDP
growth and manufacturing activity have picked up, but so has debt.
Beijing probably needed to do this for good political reasons – I
suspect that there are many who would have strongly opposed a very weak
ending for the Hu-Wen period of government – but the longer they keep
this up, the worse the overall adjustment will be, and it will be
politics that determines how quickly they can return to a real
rebalancing of the economy.

I expect GDP growth in the first half to be fairly high, probably close
to 8%, continuing the investment boom that was recently unleashed. I am
not fully confident of this number because there seem to be significant
strains in the banking system, and without easy credit growth there
cannot be much investment growth. Of course part of any credit tightness
will be "resolved" by the tried-and-true method of vendor financing,
which is already becoming a problem for SOE balance sheets (see for
example this article on Zoomlion, the construction equipment
manufacturer, which has seen its sales rise in 2012 largely in line with
their increased financing of customer purchases), but the idea that
Chinese SOEs are rushing in where Chinese bankers fear to tread is not
much of a comfort for me.

As an aside, one of my former students, now an investment banker working
on the domestic IPO market, came to visit me today and warned me that
there is a huge backlog of companies trying to get approval to sell
shares. One of the requirements is that they must have two consecutive
years of rising net earnings. Many of these firms expected to come to
market in 2012 and were able to manage the needed two years of rising
net earnings to 2011, but now that they have been pushed back, at least
to 2013, they are struggling to show that net earnings in 2012 also went
up. For that reason his firm is especially wary of sneaky attempts to
boost reported earnings. There are hundreds of companies waiting for

At any rate it is second half GDP growth that interests me more. If
Beijing has really gotten its arms around the rebalancing problem and is
serious about adjusting quickly, I expect reported growth to drop
sharply, perhaps to close to 6%. If not, I expect reported growth to
remain well above 7% in the second half of 2013. This would worry me.

2. Watch how quickly new debt emerges. Debt problems are going to
continue to emerge in 2013, but as long as each new manifestation of
excessively rising debt is treated as a specific and localized problem
that can be resolved with specific polices, overall balance sheets will
continue to get worse. We need to watch what Beijing does to rein in the
growth in debt, and of course this is closely related to overall GDP
growth. As long as GDP is growing at levels above 6% or 7%, it is almost
a certainty that debt is rising too fast. If GDP growth levels come in
much below 6 or 7%, there is a chance that debt growth is not excessive.

How do we keep track of debt levels? Obviously this is no easy task in
China, where both the banks and the informal banking system have done a
great job in recent years of hiding loan growth and keeping formal debt
levels from looking to risky.

But follow the cash. Large increases in infrastructure investment and in
real estate development are almost always funded, directly or
indirectly, by increases in debt. Many of the banks seem to be facing
tight liquidity conditions, so we should also be watching payables and
receivables on the SOE balance sheets. We should also be watching
off-balance-sheet activity by the banks.

3. Watch for financial scandals. We should also be keeping track of
stories about defaults and bank runs. Remember that the Chinese
financial system does not really "do" defaults. When borrowers are
unable to repay debt out of operating cashflow, the problem is usually
"managed" away by forcing losses onto some other entity.

South China Morning Post columnist Shirley Yam, who, I am glad to say,
recently returned from a one-year leave of absence, wrote one of her
typically intelligent articles earlier this month explaining how a RMB
3.5 billion default by Metallurgical Corporation of China was resolved.
It is worth reading to get a sense of how low non-performing loan
numbers in the Chinese banking system are nonetheless compatible with a
surge in bad investments funded by debt.

This is why those economists who understand the structure of Chinese
growth and who worry about the consequences of rising debt notice even
relatively small defaults. When a default actually takes place, it
usually means that the relevant principals have exhausted all other
means of hiding the debt and were forced into recognizing the losses.
For example, on Saturday the South China Morning Post published this

A former employee of Shanghai Pudong Development Bank is alleged to have
acted as a loan shark and run illegal businesses to the tune of 6.4
billion yuan (HK$7.9 billion). It is the latest scandal to reflect the
severity of the mainland's shadow banking problem and banks' lax
management of their branches. Ma Yijiang, formerly deputy head of a
branch in Zhengzhou, Henan province, allegedly used the money from
cash-rich depositors for loan sharking schemes. The bank said in a
statement it was assisting the authorities in their investigations.

Last month, the failure of a wealth management product (WMP) issued by
Huaxia Bank's Jiading branch in Shanghai, which resulted in depositors
losing several hundred million yuan, set off alarms in the country's
banking sector, and analysts warned similar scandals would surface in
the coming months.

A Zhengzhou court heard Ma's case earlier this week. The Shanghai bank
said he resigned in October 2011. The 21st Century Business Herald, an
influential business newspaper, said Ma enticed depositors to hand their
money to him by offering lofty interest rates between 2009 and 2011.

He lent the money, reported to to amount to 6.4 billion yuan, to other
businesses, such as property developers, charging super-high interest,
the newspaper said. "It again proved a lack of proper supervision of
banking outlets around the country," said an official with the Shanghai
branch of the China Banking Regulatory Commission. "There are increasing
risks that the defaults in the shadow banking system would lead to a
credit crisis."

Old news, you might say, and no big deal, but remember that these kinds
of problems when they arise tend immediately to be suppressed, and only
become public when there is no way to prevent information from leaking
out. The fact that we are being regaled almost weekly with stories of
banking fraud and scandals suggests just how unsteady credit in China
has been. Remember what Irving Fisher told us in The Debt-Deflation
Theory of Great Depressions:

The public psychology of going into debt for gain passes through several
more or less distinct phases: (a) the lure of big prospective dividends
or gains in income in the remote future; (b) the hope of selling at a
profit, and realizing a capital gain in the immediate future; (c) the
vogue of reckless promotions, taking advantage of the habituation of the
public to great expectations; (d) the development of downright fraud,
imposing on a public which had grown credulous and gullible.

When it is too late the dupes discover scandals like the Hatry, Krueger,
and Insull scandals. At least one book has been written to prove that
crises are due to frauds of clever promoters. But probably these frauds
could never have become so great without the original starters of real
opportunities to invest lucratively. There is probably always a very
real basis for the "new era" psychology before it runs away with its
victims. This was certainly the case before 1929.

The late stages of a debt bubble are almost always characterized by the
sudden emergence of financial fraud, and the huge extent of the frauds
lead many to assume that fraud was the source of the credit problems,
when in fact widespread financial fraud is more typically a symptom of a
financial system that has already gone to excess. This is why I am going
to be following financial scandals closely, no matter how arcane or
small. The occurrence and pattern of financial scandal will tell us a
lot about the likely problem areas in the financial system.

4. Watch bank activities. More generally I am going to watch the
relationship between total credit growth and the growth in RMB loans.
Much of the off-balance sheet financing in China is designed
specifically to skirt regulations, and the relative size of these
transactions will tell us about transparency (or lack thereof). A
typical example of this might be this Bloomberg article from last Wednesday:

China's bank loans as a share of funding in the economy may have fallen
to a record low, highlighting the growth of alternative financing
channels that have prompted warnings of rising credit risks. New yuan
loans probably dropped 14 percent last month from a year earlier,
according to the median projection in a Bloomberg News survey of 37
analysts ahead of data due by Jan. 15. That would give bank lending a 55
percent share of aggregate financing for 2012, based on UBS AG
estimates, the least in figures dating to 2002.

The decline underscores the waning ability of official loan data to
capture the scale of debt in the world's second-largest economy as
borrowers and investors turn to less-regulated, higher-return
shadow-banking products. The People's Bank of China is putting greater
emphasis on aggregate financing and the International Monetary Fund says
the growth of nonbank credit poses "new challenges to financial stability."

In 2002, if I remember correctly, bank lending represented 93% of
aggregate financing as defined by the PBoC as total social financing.

5. Watch inflation. Inflation is actually a positive indicator for
China's rebalancing, and also worth watching because I expect (hope) it
to rise in 2013, although not by too much. This may sound like a strange
thing to say – everyone else thinks of rising inflation as a bad thing –
but remember that the more you repress household income growth, the more
you divert resources, especially through cheap financing, from
consumption into production, and so this tends to be disinflationary.

If China is truly rebalancing, at least part of this is going to show up
in upward inflationary pressure, although it is likely to be the "right"
kind of inflation – i.e. it will hurt the rich more than the poor
because it will be based on non-food rather than food items. Perhaps
this inflation is already starting to happen, although not in the way I
would like it to happen. There has been an uptick in inflation but it
seems to have been caused by the impact of cold weather on food prices,
rather than because consumption of manufactured goods is rising faster
than production. According to an article in Friday's South China Morning

China's inflation spiked to a six-month high in December after a
freezing winter pushed up vegetable prices, possibly complicating
efforts to sustain a shaky economic recovery. Consumer prices rose 2.5
per cent over a year earlier, up from November's 2 per cent and the
fastest rise since June, the National Bureau of Statistics reported.

That was driven by a 14.8 per cent jump in vegetable prices after the
coldest winter in seven years led to smaller harvests. The statistics
bureau said vegetable prices in some areas rose as much as 40.8 per
cent. Higher inflation could hamper the government's ability to support
China's recovery with interest rate cuts or other moves for fear of
igniting a politically dangerous price spiral. Consumer prices are
especially sensitive in a society where the poorest families spend up to
half their monthly incomes on food.

6. Watch the prices of hard commodities. Of course I will be watching
copper prices and prices of other hard commodities. I expect that hard
commodity prices will fall sharply over the next two to three years, but
to the extent that prices rise in the short term, as they have in the
past three months, it is likely to reflect additional investment growth
in China.

As a quick measure this means that declining copper prices can be seen
as a measure of the extent of Chinese rebalancing. The longer it takes
for copper prices to drop, the slower is the Chinese adjustment likely
to be.

There has, I should add, been a lot of talk recently about the price
impact of copper ETFs. Here is a relevant article from the Financial Times:

A group of copper users has rounded on the Securities and Exchange
Commission for its "arbitrary and capricious" decision to approve the
first US investment product that would hold physical copper. The move is
likely to pave the way for a formal appeal, potentially further delaying
the launch of the product by JPMorgan, which was first publicly proposed
in October 2010.

The users, including fabricators who account for about half of US copper
demand as well as London-based trading house Red Kite, said the SEC had
insufficient evidence for its conclusion that the launch of the product
would not affect supply of the metal.

In a letter sent to the SEC by their lawyer, the copper users reiterated
their view that the launch of the exchange-traded fund would "obviously
drive up the price of copper available for immediate delivery and create
shortages of such supply". The SEC's conclusion to the contrary was "not
based on substantial evidence and is therefore arbitrary and
capricious", they alleged.

I think I would agree with the SEC here. If there is significant
stockpiling of copper to back these ETFs, clearly it can have a short
term price impact, but I don't see how the price impact can be sustained
much beyond the purchasing period, and even this is likely to be muted
if buyers of the ETF substitute it for other long positions in copper.
Still, even if it only has a short-term impact on prices it might muddy
the water and make it a little hard to interpret the impact of copper
price changes, but the price of other hard commodities, including iron
ore, can help clarify the role of Chinese demand.

7. Watch the trade numbers. China's trade surplus for November came in
much higher than expected, although there are so many discrepancies in
the numbers that not all of us are confident about how to interpret the
numbers. It seems like growth in both imports and exports may have been
exaggerated, as local authorities may be round-tripping both exports and
imports in order to make their numbers look good.

In addition, as I have argued many times, China's exports are likely to
be misleadingly low and its imports misleadingly high (and so its real
trade surplus higher than the official trade surplus) to the extent that
there is significant commodity stockpiling and hidden capital flight. Of
course destocking and capital inflows will have the opposite effect.

But in spite of all this confusion the direction of the trade numbers,
especially the trade surplus, tells us something important about the
rebalancing process. Remember that the current account surplus is simply
equal to the excess of savings over investment. China must bring both
its savings rate and its investment rate down sharply. If it can bring
savings down faster than investment, China is probably rebalancing in
the right way, and this should show up as strong growth and a declining
trade surplus.

If, however, the trade surplus rises, then clearly savings are
contracting more slowly than investment. This means that consumption
isn't growing fast enough to compensate for the reduction in investment
growth. It is easy to bring investment rates down (ignoring the
political opposition to doing so). It has proven very difficult to bring
the savings rate down because this can only happen by diverting
resources away from wealthy and powerful groups and families in favor of
ordinary households. The evolution of the trade surplus will tell us
something about how successful China has been in bringing down the
savings rate. ...

10. Watch Japan. Remember that Japanese attempts to get their arms
around their huge debt burden will almost certainly affect China and the
rest of the global economy. If Japan tries to increase domestic savings
to fund the debt, for example by limiting wage increases, or by taxing
consumption, both of which they have proposed, these measures may well
cause domestic investment to fall. Whether or not they do, if domestic
savings rise faster than domestic investment, which is the only way to
increase the domestic savings pool available to fund Japanese debt, then
by definition the current account surplus must rise.

I am not smart enough to tell you what Japan will do, but I do know that
almost anything it does must affect the relationship between its savings
and its investment, and hence Japan's current account surplus, which I
suspect everyone hopes will rise. Of course everyone else wants the same
thing too – rising exports relative to imports – which is clearly
impossible, but Japan needs it more urgently than most of the rest of
us. This is going to increase strains on the global trading system.

This is an abbreviated version of the newsletter that went out four
weeks ago. Academics, journalists, and government and NGO officials who
want to subscribe to the newsletter should write to me at chinfinpettis
@ yahoo.com, stating your affiliation, please. Investors who want to buy
a subscription should write to me, also at that address.

Source: China Financial Markets

(9) China is restraining, not leading, global trade rebalancing -
Michael Pettis


Tricks of China's trade surplus

Michael Pettis

Published 9:52 AM, 21 Mar 2012 Last update 9:52 AM, 21 Mar 2012

In this article I want to sketch out a scenario in which, rather than
analyse policy announcements or make predictions, I try to lay out what
are the various possible paths open to China. The scenario concerns
trade. China's current account surplus has declined sharply from its
peak of roughly 10 per cent of GDP in the 2007-2008 period to probably
just under 4 per cent of GDP last year. Over the next two years the
forecast is, depending on who you talk to, either that it will rise
significantly, or that it will decline to zero and perhaps even run into
deficit. The Ministry of Commerce has argued the latter and the World
Bank the former.

I am not sure which way the surplus will go, but I would argue that
either way it is going to be a very strained and difficult process for
both China and the world. On the one hand if the Ministry of Commerce is
arguing, as many do, that the rapid contraction in the surplus indicates
that China is indeed rebalancing and will continue to do so, I think
they are almost certainly wrong. China is not rebalancing and the
decline in the surplus was driven wholly by external conditions. In fact
until 2010, and probably also in 2011, the imbalances have gotten worse,
not better.

For proof, consider China's total savings rate as a share of GDP
relative to China's total investment rate. The current account surplus,
of course, is equal to the excess of savings over investment – any
excess savings must be exported, and by definition the current account
surplus is exactly equal to the capital account deficit. This is the
standard accounting identity to which I have referred many times.

The savings and investment numbers show that the last time investment
exceeded savings was in 1993-94, and during that time China of course
ran a current account deficit. This was just before Beijing sharply
devalued the renminbi, after which it immediately began running a
surplus, which has persisted for 17 years. Since 2007 savings have
climbed from 50 per cent of GDP to nearly 53 per cent in 2010. During
this time investment has climbed from just over 40 per cent of GDP to
nearly 49 per cent. The difference between the two has declined from
just over 10 per cent of GDP to just under 4 per cent, and this of
course is just another way to say that China's current account surplus
has dropped from just over 10 per cent of GDP to just under 4 per cent.

Savings are rising

From the accounting identity it is clear that if the current account
surplus declines, there are logically only two ways it can happen. One
way is for the savings rate to decline. In that case the investment rate
must either rise, or it must decline more slowly than the savings rate.
The other way is for the savings rate to rise. In that case the
investment rate must rise even faster.

In the first case a declining savings rate indicates that Chinese
consumption is indeed rising and Chinese investment is declining (or at
least rising more slowly than consumption). This is the 'right' way for
the trade surplus to decline because it represents a rebalancing of the
Chinese economy away from its dependence on investment and the trade
surplus and towards consumption. In the second case – the 'wrong' way –
consumption is actually declining further as a share of GDP, and the
reduction in China's dependence on the trade surplus is more than
matched by an increase in its dependence on trade.

So is China rebalancing? Of course not. Rebalancing would require that
the domestic consumption share of GDP rise. Is the consumption share of
GDP rising? Clearly not. If consumption had increased its share of GDP
since the onset of the crisis, the savings share of GDP would be declining.

And yet savings continue to rise. This is the opposite of rebalancing,
and it should not come as a surprise. Beijing is trying to increase the
consumption share of GDP by subsidising certain types of household
consumption (white goods, cars), but since the subsidies are paid for
indirectly by the household sector, the net effect is to take away with
one hand what it offers with the other. This is no way to increase

Meanwhile investment continues to grow and, with it, debt continues to
grow, and since the only way to manage all this debt is to continue
repressing interest rates at the expense of household depositors,
households have to increase their savings rates to make up the
difference. So national savings continue to rise.

What then explains the decline in China's current account surplus over
the past three years? The numbers make it pretty obvious. The sharp
contraction in China's current account surplus after 2007-08 was driven
by the external sector, and in order to counteract the adverse growth
impact Beijing responded with a surge in investment in 2009. You can
argue whether or not this was an appropriate policy response (yes
because otherwise growth would have collapsed, or no because it
seriously worsened the imbalances), but certainly since then as
consumption has failed to lead GDP growth, investment has continued
rising too quickly.

Can China's surplus rise further?

It is, in other words, rising investment, not rebalancing towards higher
consumption, that explains the contraction in the current account
surplus. The savings share of GDP is still actually rising. By
coincidence I recently received a piece from Louis Kuijs, formerly of
the World Bank and now of the Fung Global Institute, that supports this
interpretation. In it he says:

Many a headline has highlighted how rising costs in China are putting
pressure on profit margins and reducing the competitiveness of the
country's huge labour-intensive, export-oriented manufacturing industry
– prompting multinational companies to start shifting production to
other countries in Asia.

However, a closer look at trade data shows that China's overall exports
are still gaining market share. In 2011, Chinese exports grew by around
20 per cent in US dollar terms and 10 per cent in real terms, compared
to an increase in real global imports of around 7 per cent.

Kujis goes on the argue that China's export growth will remain strong in
the future, and he may be right, but for me what is important here is
that while the world is struggling with weak growth in demand, and
surplus countries are being forced to rein in their surpluses, China's
share of total surpluses are probably actually expanding. This suggests
that China is restraining, not leading, global trade rebalancing, and
given China's difficulty in raising the consumption share of GDP this
shouldn't be a surprise.

So which way will China's current account surplus move over the next few
years? If we could ignore external conditions, I would argue that the
current account surplus should grow in the next few years. Why? Because
Beijing is finding it impossibly hard to raise the consumption rate, and
yet it is extremely important that it reduce the investment rate before
debt levels become unsustainable. Under these conditions I would argue
that we should expect the savings rate to hold steady as a share of GDP
or – if we are lucky – for it to decline slowly over the next few years.

Investment, on the other hand, should decline quickly unless it proves
difficult for the post-transition leadership to arrive at a consensus
about the need to slow investment growth. I would expect investment to
begin dropping erratically sometime in 2013, but I confess that I have
no sense of whether or not those who understand how dire the economic
situation is can convince the others within the leadership during this

If investment rates drop more quickly than the savings rate, by
definition this would result in an increase in China's current account
surplus. This is why I would argue that if we ignore external conditions
I would predict a rise in China's trade surplus over the next few years.
But of course there is a huge constraint here. Can the world accommodate
China's need to absorb more foreign demand in order to help it through
its own transition?

Here I am pretty pessimistic. The first problem is that the big deficit
countries have little appetite for rising imbalances. Clearly the US
wants to reduce its trade deficit and at the very least it will resist a
rapid increase in the trade deficit. The deficit countries of peripheral
Europe, who with the US represent the bulk of global trade deficits, are
going to have to adjust quite quickly as the financial crisis continues
and as their growth slows, and their deficits will contract sharply as
their abilities to finance them contract.

Declining trade deficits around the world require declining trade
surpluses. Part of the adjustment in Europe I suspect will be absorbed
by a contraction in Germany's surplus, but the Germans of course are
resisting as much as possible since they, too, are dependent for growth
on absorbing foreign demand. I don't know how this will pan out, but
certainly Europe as a whole expects its trade surplus to rise, and if
instead it begins to run a large deficit, German growth will go negative
and the debt burden of peripheral Europe will be harder than ever to bear.

Don't expect Europe, in other words, easily to accommodate China's need
for a growing trade surplus. If foreign capital flows to Europe increase
– perhaps as China and other BRICs lend money to Europe – Europe's
exports will certainly decline relative to imports, but because this
means much slower growth for Europe, I don't think it is sustainable.

No comments:

Post a Comment