In an article in Thursday’s Financial Times, Jim O’Neill, who heads global economic research at Goldman Sachs, asks if the US trade deficit is about to disappear.According to him the latest monthly data show that the US trade deficit, at $59 billion, has declined from 7% of GDP to 5%.Exports have been growing nearly 15% year-on-year whereas imports have been growing at just over 5%.If a subprime-crisis-related economic slowdown keeps import growth at this level, and a weak dollar also keeps export growth at this level, the trade deficit would drop to 3% of GDP within one or two years.
I am not smart enough to say whether O’Neill’s speculations are loony or sound, and I am not sure what is driving this shift, but O’Neill points out that retail sales are growing in all the BRIC countries at double-digit levels (China recorded over 17% growth in July).They only account for half the global share of GDP that the US does, but their spending growth is double the US rate.This satisfies the savings-glut model by suggesting that a slowing down of the growth rate of developing-country savings is having the expected effect on the US balance of payments.The weaker dollar and the consumer fears arising from the sub-prime crisis, I guess, satisfy the excess-US-consumption model.Either way, if things continue at this rate and the US trade deficit declines sharply – a big if, I know, I know – we could see a major shift in the world economy, and it might not necessarily be a very pleasant one.
I say this not because I am one of those apparent crazies who are not terribly worried about the US trade deficit, and even believe it is a necessary pre-condition for the very difficult demographic adjustment needed by Europe, Japan, Russia and especially China in the coming decades.I am, but my concern is different.As I said in an earlier post I believe that the recycling of the US trade deficit has been the main factor underpinning the recent globalization cycle.If so, and when the current cycle ends, if history is any indication the adjustment from the insanely happy days of too much liquidity (with its attendant surge in risk appetite) to a more “normal” level of liquidity will be a very difficult one and can result in significantly reduced global growth lasting many years – especially for those countries that begin the slowdown with the weakest and most rigid financial systems.
In previous cycles, financial systems, which during the good times had evolved into greater risk-taking activity and more-tightly-stretched asset-liability structures, were suddenly caught short by the secular change in risk appetite.In many cases their ability to intermediate the flow of capital slowed considerably, and what followed often involved considerable economic slowdown.My evidence is largely anecdotal, but it seems to me that those countries with the highest levels of financial risk-taking and the least flexible financial systems were the ones that did most poorly – the United States in the 1930s, with its reliance on thousands of small banks with rigid deposit bases, a weak and inexperienced central bank, and an investment banking industry in shock, of course did among the worst, although there were plenty of other non-financial factors that exacerbated the problem (by the way, it is worth remembering that in 1929 the US had, after several years of very high trade and capital account surpluses, very high levels of reserves, which in the end didn’t help).
I am curious to know what readers of this blog think are the major economies with the most susceptible financial systems.IF the US trade deficit really is declining sharply, and IF the recycling of the US trade deficit really was the industrial-strength punch that kept this party going for so long, who is most likely to be hurt when the punchbowl is taken away?
It is hard to overestimate the importance of the meeting to China’s near-term and longer-term prospects of the 17th CPC Plenum in two weeks.These meetings, held every five years, are the main events of China’s political cycles and it is during these meetings that the big promotions to senior positions within the Party and, juiciest of all, membership in the Standing Committee of the Politburo are made. The Standing Committee consists of the nine men (previously seven, and there are not completely credible rumors that it may be reduced to seven again – the decision has everything to do with factional fighting) who are the ultimate source of power in China today, and is headed by President Hu Jintao and Prime Minister Wen Jiabao.
Although the deliberations are secret, the months leading to the congress are rife with factional infighting, sweetheart deals, attacks on frontrunners, corruption scandals, and the all-important maneuvering for promotion. Unfortunately, on the assumption that that any serious contender must at all costs avoid doing anything that may give rise to criticism before the promotions are decided, the period before the meetings tends to be a time in which very little, no matter how urgent, gets done. For this reason, although the government is watching with terror China’s rising inflation, after the last interest rate move little has been done except to freeze a number of prices, and this latter is rumored to have been done almost solely to prevent rising prices from ruining the feel-good ambience that is always required to permeate the national congress meetings.
Once the Congress is over – we expect that to occur around October 22 or shortly thereafter. – the financial authorities have some very serious problems to deal with. Logan Wright, a Beijing-based analyst who regularly writes excellent reports on China’s financial system for Stone & McCarthy, puts it this way in a September 27 report called “China's Perfect Storm? Food Price Inflation and a Possible PBOC Policy Shock:”
First, at the same time that pork prices have driven August CPI growth to 6.5%, China has also been ravaged by unusually harsh floods in the south and droughts in the north. As a result, the autumn harvest, which comprises around 70% of total annual grain output, could produce a significant negative surprise, accelerating the rapid rise in food prices. At the same time, global food prices and futures continue to trend higher based on a series of bad harvests around the world, just as China may need to increase imports to supplement its own supplies. Secondly, signs of weakness in the housing sector spilling over into U.S. consumption are developing, and this could have consequences for China's exports, which have been a critical engine of China's growth and a safety valve for domestic overcapacity in several industries. Third, and perhaps most significantly, inflation is more salient politically in China than in other nations, because of its tendency to produce social unrest that challenges the legitimacy of the Chinese Communist Party's rule. Support for the CCP depends heavily upon improving standards of living for Chinese citizens. This means that the Chinese government is very likely to react quickly and strongly in response to a potential threat of escalating inflation.
I think that one very important change that has happened this year is the very belated recognition, beginning all the way from the top with Wen Jiabao (about whom, unfortunately in my opinion, there are lots of rumors about his wanting to retire), that the arguments about excess monetary expansion and overheating are no longer widely resisted. It has taken far too long, but I think that the leadership has finally recognized how out-of-control China’s monetary and trade policies have been and how dangerous the next few years will be. In spite of this recognition, there has been precious little done to address the root causes of the imbalance, and I would guess that an important part of the reason has been the reluctance politicians have always had to taking tough measures during promotion time. Whatever the risks, it is still safer to do nothing now, and pray, then to take the kind of actions that will be needed to address the overheating problem.
After the National Congress meeting, my guess is that we are going to see an acceleration of programs and proposals to slow the economy down, although the fear of creating problems before the Olympics may continue to slow down the process of reform. What will they do?I have always believed that the currency regime is at the heart of China’s trouble, and as long as the leadership fails to see this and change the currency regime directly, I am afraid the measures they impose will be more of the same ineffective measures – interest rate changes, administrative measures, etc. – the have failed to slow things down during the past three years.
I am not enough of a political insider to say what is likely to happen and who will drive policy over the next few years, but there are two individuals who are rumored to be among the candidates being considered for the Standing Committee whose promotion may give some indication of where things are likely to go.Bo Xilai, the current Trade Minister, has a great reputation for his grasp of economics, his openness to the rest of the world, and his understanding of monetary policy.Zhou Xiaochuan, the Governor of the People’s Bank of China, is another extremely strong and very smart candidate who is rumored to have been among the most vocal supporters of a faster RMB appreciation. Generally speaking I don’t think many of the current leaders – whose backgrounds are predominantly in engineering and who are not particularly well-known for their imaginative approaches to new problems – have been able to understand how imbalances are being built up within the economy and banking system, and it is good that so many of the rumored “promotees” are supposed to have stronger backgrounds in economics.
If either of Bo or Zhou are promoted onto the Standing Committee, I think we may end up seeing smarter and more preemptive activity in dealing with China’s monetary imbalance. If inflation figures for September and October stay above 5% or even accelerate I think we may see an acceleration of RMB appreciation even earlier than expected.This is all speculation, but like a lot of people in China I will be following the NPC rumor mill very closely.
Yesterday’s South China Morning Post discusses more measures taken by he financial authorities to address the overheating problem. Readers of my blog probably know that I don’t expect these latest measures to have much impact.
All the problems of overheating, speculation, inflation, etc. are, in my opinion, caused by the currency regime, and until that is addressed, there isn’t much the authorities can do to address the problem. All they can do is temporarily move the underlying problem from someplace we can see it to some place we haven’t yet seen it.
Here is what the South China Morning Post has to say:
Financial authorities on Friday unveiled a series of measures to tighten property lending in its latest attempt to cool the country’s overheating real estate market and curb mortgage lending risks.
The central bank and China Banking Regulatory Commission said in a joint statement that authorities would ban banks from lending to developers found to have been hoarding land. The changes were expected to take immediate effect. Down-payment requirements for second homes were raised to 40 per cent from 30 per cent, and requirements for commercial properties such as offices and shopping malls were increased to 50 per cent from 40 per cent, the statement said.
Mortgage rates for such purchases had to be no less than 1.1 times benchmark rates, it said. “Recently, property prices had gone up quite fast, which is obviously irrational,” the statement said. “Once prices tumble, bad loans at commercial banks would surge.” The statement said it would still encourage people to buy their first homes. Down-payments for buying homes smaller than 90 square metres (1,000 square feet) would remain unchanged at 20 per cent, while for larger homes, the rate would be kept at 30 per cent.
It is the second time since last year that the government has guided commercial banks to raise the down-payment requirements for home purchases.
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.
Subscribe to this Site
January, 2008
.