Even before the Covid-19 outbreak, the Chinese economy was slowing, after more than three decades of rapid economic expansion. Thirty years of recorded growth at around ten per cent per annum is unprecedented in human history. This has enabled hundreds of millions of people to be lifted out of poverty, and the material transformation of a poor country to one that is classified by the World Bank as upper-middle-income.
Despite all this, there is a broad consensus, including among Chinese government officials, that the country’s development model needs to change if it is to continue its transformation and become a rich country. Many economists argue that this will involve a rebalancing of the economy, in order to continue to grow and develop in a way that is more sustainable both for China itself, and for the rest of the world, given that as the world’s second largest economy behind the US, internal changes now have a major impact globally. Continue reading →
Robert Armstrong, US finance editor at the Financial Times, penned a helpful opinion piece in Tuesday’s paper, in which he tries to account for the disconnect between financial markets and the real economy in recent years, the Covid-19 correction notwithstanding. As he says:
“Until last Friday, it looked as if stock markets had lost all track of reality. In the world, we saw spiralling unemployment and political disarray. In the markets, especially the huge American market, exuberance.”
“The market, however, is already acting like it is the fourth of July. The S&P 500 has risen to within 5 per cent of its all-time high.”
This is despite the fact that
“Covid-19 has put working- and middle-class people under immense strain, while the asset-owning classes have felt relatively little pain.”
which is a potential source of political unrest and, in the end, political and economic change.
He accounts for this by positing a self-reinforcing cycle between rising inequality and rising financial markets, in the US in particular, drawing on a recent working paper by Atif Mian, Ludwig Straub and Amir Sufi. It is quite a long and technical paper, so rather than go through it, I will quote from Armstrong’s article, in which he summarises the key points: Continue reading →
In this very brief interview, Michael Pettis argues that in order to sustain growth in the wake of the global pandemic, the Chinese government will need to ramp up public spending. The response to Covid-19, both in and out of China, has hit private consumption, investment and exports hard. Increased government spending is the only element of aggregate demand remaining.
He also repeats what he has said for some years, that the ‘underlying’ growth rate of the economy is much lower than the headline rate and the government’s targets due to massive investment in unproductive sectors and projects. This means that eventually even the headline growth rate will have to fall towards the underlying rate, possibly leading to a ‘lost decade’ for China.
A useful short paper by post-Keynesian economist Jan Kregel of the Levy Institute, focusing on the nature and causes of global financial and trade imbalances, and how they might be resolved in a way that supports global growth and employment.
Kregel argues that in today’s global economy, financial flows dominate trade flows, and are the cause of significant capital account imbalances, which drive concomitant current account imbalances.
Trade policy, such as the imposition of tariffs, and escalating trade wars, are unlikely to resolve these imbalances. On the contrary, controls on capital flows would be much more effective. An alternative to this is Keynes’s original proposal for an international clearing union, able to create liquidity not based on a national currency such as the dollar, and promote international cooperation. This seems a long way off in today’s world.
All this is along the lines of arguments made by Michael Pettis, whose ideas I refer to often on this blog. However, Pettis also links global imbalances to national savings behaviour, so that a ‘savings glut’ not invested domestically in one country can be exported abroad, and can create financial bubbles and rising debt, potentially leading to stagnation or crisis in the longer term.
In this short video, some insights from Michael Pettis on Chinese economic growth numbers, the nation’s debt and its sustainability, the extent (or not) of deleveraging, the low share of consumption in national income, the perennial need for a rebalancing of its economy, and how this can be done.
Donald Trump’s signature policy of 2017, the so-called Tax Cuts and Jobs Act, cut taxes sharply for the richest earners and corporations. As so often in recent decades, many Republicans claimed that this would pay for itself via the increased revenue generated by faster economic growth, which would incorporate higher investment and higher wages for ordinary Americans. There would therefore be little need to cut spending to prevent the deficit from rising.
Such supply-side policies are part of the essence of ‘trickle-down’ economics, which boils down to the argument that making the richest members of society richer will make everyone richer, including those at the bottom. As with previous such policies, this remains to be seen, but the signs are not good.
On the other hand the US budget deficit is rising and is set to rise further. The national debt is also now growing faster than previously. While growth has been stimulated for a while, perhaps more from the demand-side than the supply-side, it seems that it is now slowing once more. This is a long way from the vaunted economic miracle from the President’s State of the Union address. Continue reading →
A fascinating piece from Michael Pettis, an economist I regularly reference, on how China is probably growing much more slowly than the official GDP figures make out, alongside a discussion of the nature and measurement of GDP itself.
This would confirm his long-held thesis that China’s ultra-high investment growth model has been unsustainable for some years, and will change of necessity, either through enlightened policy or, more painfully, in the absence of such a policy.
Trade tensions and rising protectionism are combining with the exhaustion of the recent economic upturn to slow growth in many countries.
The slowdown in China could lead to a ‘lost decade’ of relative economic stagnation there, until growth rebalances away from a significant share of unproductive investment and towards a higher share of consumption and a lower but more productive share of investment in overall demand.
Although the country is already economically powerful, its rise to global dominance could be much further away than many ‘China bulls’ have predicted. Even so, given its prominence in global manufacturing value chains, relative stagnation will have a large but uneven impact on global economic activity.
David Pakman’s videos are well worth watching for his incisive and progressive analyses of US current affairs. But on the question of the global role of the US dollar, which he describes below, I think he is wrong. Watch this short video first, before reading my critique below.
Is the US dollar’s dominant role in world trade and reserve policy an exorbitant privilege or an exorbitant burden? I go with the latter. The argument that it is a privilege and benefits the US economically is often made. This argument draws the conclusion that the US is able to borrow and spend beyond its means as a result. The US current account deficit is therefore a good thing, as it reflects the higher consumption and lower savings that can be sustained. It also apparently allows the US to sustain a higher level of debt, whether on the part of the private sector or the government, which boosts aggregate spending or demand.
But as Michael Pettis argues in his book The Great Rebalancing, it is perhaps just as accurate to say that the dominance of the US dollar in global payments and reserves forces the US to consume beyond its means. It results in lower US savings relative to investment, reflected in the current account deficit, and higher savings relative to investment in the rest of the world.
The stronger demand for US dollars in the rest of the world produces a stronger dollar than would otherwise be the case. This makes US exports more expensive abroad, and imports cheaper in the US, and will thus tend to widen the trade deficit (exports minus imports) and the current account deficit, other things being equal. Production and employment will be lower among US exporters, who will find it harder to compete with rivals abroad. US firms producing for the domestic market will similarly find it harder to compete with cheaper imports.
Larger trade and current account deficits act to drain demand from the US economy. A larger capital account surplus is the flipside of a larger current account deficit, and represents the net inflow of funds required to fund the latter, or what the US is borrowing from the rest of the world. These funds will either be used to fund domestic investment, which can be productive or unproductive, or to fund domestic consumption.
The result is that the US savings rate will be lower relative to the US investment rate than it would otherwise have been. The savings rate could fall, while the investment rate stays the same, necessarily leading to a higher rate of consumption. Or the savings rate could remain the same, while investment, whether productive or unproductive, rises.
If the new investment is productive, and generates flows of income in the future greater than its overall cost, then the US economy will end up larger and more productive, while employment should be higher. If the new investment is unproductive, such as takes place in a housing bubble, then this will ultimately raise the debt burden and slow future growth in output and employment.
So a larger current account deficit need not be a negative factor for an economy, if the funds borrowed from abroad are used to fund productive investment. But this only tends to be the case for an economy which is short of domestic sources of finance for investment. For an economy like the US, with sophisticated and liquid financial markets, there is little evidence that domestic investment is constrained by a shortage of domestic saving. So capital inflows will tend not to lead to higher productive investment, but rather to higher unemployment or higher debt.
The capital inflows to the US, resulting in a capital account surplus, and reflected in the gap between domestic investment and savings, described by some commentators as a shortage of savings, are the consequence of excessive savings relative to investment in the rest of the world, or a ‘savings glut’.
Savings and investment must be equal for the world economy as a whole, but can be out of balance for individual countries. If savings rise in one country but investment does not, the surplus must be exported abroad, and lead either to higher investment or lower savings in the rest of the world, so that global savings and investment continue to balance.
The US can only be a net borrower from the rest of the world and therefore continue to run a current account deficit if foreign economies are net savers in aggregate relative to the US. Economies such as China, Japan and Germany have run the largest current account surpluses (meaning that they are net savers) in recent years. It is their policies as much as those in the US which lead to a lower savings rate in the latter.
This is because, for the world as a whole, the balance of payments must balance! Current account deficits in some countries must be offset by current account surpluses in others. The major surplus countries are avoiding significant appreciations of their currencies by accumulating dollar reserves. They do this in part to sustain relatively weak currencies which boosts net exports by making their exporters more competitive.
These surplus countries are relying on their exporting sectors to boost demand, growth and employment because the growth in their domestic demand is relatively weak. So any rapid appreciation of their currencies would hobble their exporters and growth would falter. It would also probably take some time for the necessary adjustment and certain economic reforms in order for domestic demand to take up the slack.
The surplus countries therefore have a strong incentive to sustain the status quo, which helps to maintain the dollar as the dominant world currency, keeping it stronger than it otherwise would be. This is the exorbitant burden which the US, and ultimately the world, must carry.
All this played a significant role in causing the global imbalances which led to the Great Recession of 2008. These imbalances need to be resolved in order for the world to begin a new period of sustained growth. So Trump and his advisers may be on to something when they complain about the US trade deficit. It may therefore be a good thing if the dollar becomes less widely used for global trade and the accumulation of reserves, whether this is intended or not. Everything else being equal, a decline in the dollar would help the US economy rebalance in the longer run, boosting growth and employment and reducing the debt burden.
Is there a solution to all this, which would go beyond Trump’s muddled bluster? There is, and it has been around since the formation of the Bretton Woods institutions in 1944. It was then that Keynes proposed the creation of an international currency, bancor, which would be used to prevent excessive international payments imbalances and the unsustainable buildup of debt, which he strongly believed would tend to stifle growth. His US counterpart Harry Dexter White rejected the idea.
We have been left with Special Drawing Rights (SDR), a basket of international currencies maintained by the IMF, which were created in 1969 as the Bretton Woods system of fixed exchange rates and managed international payments began to unravel.
If, as Keynes had hoped, something like the SDR were used more widely, then global payments imbalances should be less severe and more easily resolved. But this would, in the short to medium run, and contrary to the arguments of many economists, benefit the US economy and harm the major surplus countries which would be less able to run up large current account surpluses by keeping their currencies relatively weak and boosting their exports. Despite this, the argument should be made that it would create a more balanced global economy, and more sustainable growth.
Perhaps the trick is to appeal to the right vested interests, since ultimately consumers in the current surplus countries would benefit. Exporters in the US, and also in other major and long-standing current account deficit nations, such as the UK, would gain too.
As ever, one can’t ignore the politics. For Trump, whose muddled policies are currently encouraging a stronger dollar, a successful reduction in the US current account deficit might reflect a reduced global role for the US, as Pakman argues in the video, but a less dominant dollar would ultimately be good for US growth and stability. There might be some debate over whether the outcome would be making America ‘great’ again or not. But more widely-used SDR would also be a good thing for the prosperity and stability of the global economy, though this is perhaps a long way off, if it happens at all. Politics will get in the way of good economics, and not for the first time.
At first glance, it would seem fanciful that the theories of Karl Marx and Friedrich Hayek could be drawn on together to explain economic crises, or cycles, booms and busts. Certainly, the two men’s politics could not have been more different: Marx predicted (and hoped for) either the collapse or the overthrow of capitalism and its replacement by socialism and communism. Hayek thought that most kinds of state intervention in the market were the thin end of the authoritarian wedge.
The ideas of John Maynard Keynes and Hyman Minsky are more compatible, and both have many disciples in the post-Keynesian school. Minsky developed Keynes’ theory of investment and its role in instability under capitalism. For Keynes and Minsky then, capitalism is inherently unstable, money and finance play a large role in this instability and it is the job of government to save the system from itself.
On economic policy, these four influential thinkers part ways. Marx offered little theory of policy; Hayek, like others in the Austrian school, rejected it as damaging and favoured a laissez-faire approach; Keynes and Minsky were interventionists. Continue reading →
With Donald Trump’s apparently escalating trade war very much in the news, here are some wise words from Peking University’s Michael Pettis, taken from the final pages of his 2013 book The Great Rebalancing – Trade, Conflict, and the Perilous Road Ahead for the WorldEconomy (p.192-194). They seem particularly relevant right now. Continue reading →