Friday, July 19, 2013

Krugman Warns on China

Paul Krugman nails it:
All economic data are best viewed as a peculiarly boring genre of science fiction, but Chinese data are even more fictional than most. Add a secretive government, a controlled press, and the sheer size of the country, and it’s harder to figure out what’s really happening in China than it is in any other major economy.

Yet the signs are now unmistakable: China is in big trouble. We’re not talking about some minor setback along the way, but something more fundamental. The country’s whole way of doing business, the economic system that has driven three decades of incredible growth, has reached its limits. You could say that the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be.

Start with the data, unreliable as they may be. What immediately jumps out at you when you compare China with almost any other economy, aside from its rapid growth, is the lopsided balance between consumption and investment. All successful economies devote part of their current income to investment rather than consumption, so as to expand their future ability to consume. China, however, seems to invest only to expand its future ability to invest even more. America, admittedly on the high side, devotes 70 percent of its gross domestic product to consumption; for China, the number is only half that high, while almost half of G.D.P. is invested.

This is no surprise to EPJ Daily Alert readers. In the October 10, 2012 ALERT for example, I wrote:
 China is likely at the start of one the greatest stock market and economic crashes in history. In 2010, Chinese money supply growth was over 30%. In order for the Chinese central bank to maintain the manipulated economic structure created by that money printing, the PBOC would have to print at 30% plus, but fears of stoking price inflation and civil unrest will prevent them from printing anything close and thus the collapse of the structure.

The only difference between my warning and Krugman's is that I focus directly on the cause of the spectacular increase in the capital sector (versus consumption) and place the blame for that at the on money printing conducted by China's central bank, The People's Bank of China.

Krugman, on the other hand, ignores the money printing being done by the PBOC and comes up with a convoluted explanation for the booming capital sector. That said, Krugman's warning on distorted capital sector is a view that gets to Austrian perspective that the boom period (caused by central bank money printing) is a period of malinvestment in the capital sector, so he is getting to the correct conclusion almost by accident.

One further note, this capital sector expansion in China includes a lot of government expenditures of extremely questionable quality and value at any price---which could result in the economic crash being of a truly spectacular nature.

6 comments:

  1. Add a secretive government, a controlled press, and the sheer size of the country, and it’s harder to figure out what’s really happening in the USA than it is in any other major economy.

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  2. "Krugman, on the other hand, ignores the money printing being done by the PBOC "

    He doesn't actually.

    "The need for rebalancing has been obvious for years, but China just kept putting off the necessary changes, instead boosting the economy by keeping the currency undervalued and flooding it with cheap credit."

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  3. Using the word "ignore" was probably a bit harsh. But I say that "The only difference between my warning and Krugman's is that I focus directly on the cause of the spectacular increase in the capital sector (versus consumption) and place the blame for that at the on money printing conducted by China's central bank, The People's Bank of China." Emphasis on "directly."

    Krugman doesn't do so. He mentions "cheap credit" as an after thought. His main contention is that the expansion of the capital sector occurred because of the large supply of peasant labor:

    "How is that even possible? What keeps consumption so low, and how have the Chinese been able to invest so much without (until now) running into sharply diminishing returns? The answers are the subject of intense controversy. The story that makes the most sense to me, however, rests on an old insight by the economist W. Arthur Lewis, who argued that countries in the early stages of economic development typically have a small modern sector alongside a large traditional sector containing huge amounts of “surplus labor” — underemployed peasants making at best a marginal contribution to overall economic output.

    "The existence of this surplus labor, in turn, has two effects. First, for a while such countries can invest heavily in new factories, construction, and so on without running into diminishing returns, because they can keep drawing in new labor from the countryside. Second, competition from this reserve army of surplus labor keeps wages low even as the economy grows richer. Indeed, the main thing holding down Chinese consumption seems to be that Chinese families never see much of the income being generated by the country’s economic growth. Some of that income flows to a politically connected elite; but much of it simply stays bottled up in businesses, many of them state-owned enterprises.

    "It’s all very peculiar by our standards, but it worked for several decades. Now, however, China has hit the 'Lewis point' — to put it crudely, it’s running out of surplus peasants."

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  4. Lucky they have 3.44 trillion in foreign reserves to soften the blow.

    http://www.bbc.co.uk/news/business-22567974

    Seriously, though, they are letting a lot of the re-balancing happen, while also engaging in a pretty serious anti-corruption campaign and forging ahead with structural market reforms. So if you were to look ten years out, China may not be your first choice, but it is pretty much the opposite trend of the US.

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  5. Depressions occur after investment bubbles burst. In free-market capitalism, capital generates income for the owners of the capital which in turn is used to create additional capital. This is very good. Sometimes, it can be actually too good. As capital continues to accumulate, its owners find it more and more difficult to deploy it efficiently. The business sector generally must interact with the household sector by selling goods and services or lending to them. When capital accumulates too rapidly, the productive capacity of the business sector can outpace the ability of the household sector to absorb the increasing production.

    The capitalists, or if you prefer, job creators use their increasing wealth and income to reinvest, thus increasing the productive capacity of the business they own. They also lend their accumulated wealth to other businesses as well as other entities after they have exhausted opportunities within the business they own. As they seek to deploy ever more capital, excess factories, housing and shopping centers are built and more and more dubious loans are made. This is overinvestment. As one banker described the events leading up to 2008 - First the banks lent all they could to those who could pay them back and then they started to lend to those could not pay them back. As cash poured into banks in ever increasing amounts, caution was thrown to the wind. For a while consumers can use credit to buy more goods and services than their incomes can sustain. Ultimately, the overinvestment results in a financial crisis that causes unemployment, reductions in factory utilization and bankruptcies all of which reduce the value of investments.

    If the economy was suffering from accumulated chronic underinvestment, shifting income from the non-rich to the rich would make sense. Underinvestment would mean there was a shortage of shopping centers, hotels, housing and factories were operating at 100% of capacity but still not able to produce as many cars and other goods as people needed. It might not seem fair, but the quickest way to build up capital is to take income away from the middle class who have a high propensity to consume and give to the rich who have a propensity to save (and invest). Except for periods in the 1950s and 1960s and possibly the 1990s when tax rates on the rich just happened to be high enough to prevent overinvestment, the economy has generally suffered from periodic overinvestment cycles.

    http://seekingalpha.com/article/1543642-a-depression-with-benefits-the-macro-case-for-mreits

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  6. "They also lend their accumulated wealth to other businesses as well as other entities after they have exhausted opportunities within the business they own. As they seek to deploy ever more capital, excess factories, housing and shopping centers are built and more and more dubious loans are made. This is overinvestment. As one banker described the events leading up to 2008 - First the banks lent all they could to those who could pay them back and then they started to lend to those could not pay them back. As cash poured into banks in ever increasing amounts, caution was thrown to the wind. For a while consumers can use credit to buy more goods and services than their incomes can sustain."

    It's fascinating to me that you can write up the entire diatribe above and not touch on credit creation/money printing one time.

    It seems like you believe all the excess wealth generated by economic activity alone was responsible for this "overinvestment" as you deem it.

    Is that the case?

    ReplyDelete