Yesterday I saw an article on Bloomberg about the possible impact of a US slowdown on China, and I think that once again we may need to revive the excess-consumption vs. excess-savings debate to figure this one out. Among other things the article said:
Weaker demand for exports because of a U.S. slowdown may be "exactly the tonic China needs" to reduce the problem of too much money in the financial system, Ben Simpfendorfer, a strategist at Royal Bank of Scotland Plc in Hong Kong, wrote in a report this month. The World Bank has a similar view. "A moderate global slowdown would mitigate concerns of policy makers on overall growth, inflation and the trade surplus, while China's strong macroeconomic position provides room to adjust the domestic policy stance if necessary," it said in a quarterly report.
This may be missing the point. If the cause of global imbalances is largely, or exclusively, excess US consumption, then a slowdown in the US would indeed be a good way to slow down Chinese export growth and monetary expansion. Lower US consumption would drive down the US trade deficit and the required adjustment needed to make the balance of payments balance would be a rise in Chinese savings relative to consumption.The Chinese trade surplus would then decline, with all the positive things that means for monetary policy in China.
But I am not convinced. If, as I believe, the cause of the monetary imbalance is that high Chinese savings have locked the country into a self-reinforcing trap – in which high money inflow leads to high industrial production which leads to a high trade surplus – then a US slowdown will probably not have much of an impact on China’s trade balance.
In that case the only significant way to interrupt the process would be to slow down or reverse the process of FX accumulation in China, and there is no obvious reason for assuming that a US slowdown will do that. In fact, over the last year or so global growth outside China has been slowing, but you couldn't tell by looking at the Chinese trade surplus, which has ballooned. On the face of it there doesn't seem to be much correlation between global growth and the Chinese trade surplus (which I think is more consistent with the monetary-trap argument).
Ah, you might say, in fact Chinese export growth is indeed slowing, so maybe there is a correlation. Not really. A slowdown in global demand may slow Chinese export growth, but only a slowdown in Chinese export growth relative to Chinese import growth can reverse the growth in the trade surplus.
This is not happening, and is unlikely to happen even if the US economy slows. As long as industrial production in China grows faster than consumption, China must run large and growing trade surpluses, and as long as it runs large surpluses, the banking system will ensure that industrial production will continue to soar. This is why I always refer to it as a trap: it is not clear how China can get out of it short of a major currency adjustment that reverses capital flows.
If a US slowdown results in lower combined US and European net imports, how can the world nonetheless accommodate high and rising Chinese trade surpluses? I guess other developing countries will see their own exports begin to dissipate. In fact isn't that already happening?
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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October, 2007
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