The column is here and one excerpt is this:
China uses American spending power to enlarge its private sector, while America uses Chinese lending power to expand its public sector.
A longer excerpt is this:
China has been building factories and production capacity in virtually every sector of its economy, but it’s not clear that the latest round of investments will be profitable anytime soon. Automobiles, steel, semiconductors, cement, aluminum and real estate all show signs of too much capacity. In Shanghai, the central business district appears to have high vacancy rates, yet building continues.
Chinese planners now talk of the need to restrict investment in sectors that are overflowing with unsold products. The global market is no longer strong, and domestic demand was never enough in the first place.
Regional officials have an incentive to prop up local enterprises and production statistics, even if that means supporting projects or accounting practices that are not sustainable. For an individual business, the standard way to get more capital resources is to put forward a plan for growth. Because few sectors are mature, and growth has been so widespread, everyone can promise to be profitable in the future.
Over all, there is a lack of transparency. China’s statistics on its gross domestic product are based more on recorded production activity than on what is actually sold. Chinese fiscal and credit policies are geared toward jobs and political stability, and thus the authorities shy away from revealing which projects are most troubled or should be canceled.
Put all of this together and there is a very real possibility of trouble.
I then outline how the negative scenario might run and that involves deflation on the goods side, for both China and the U.S., and higher U.S. borrowing costs on the capital side. A few related points:
1. The word "malinvestment" does not appear in The New York Times style guide but it survived to the final published draft of the piece.
2. Scott Sumner offers a skeptical take on my claims.
3. The piece cites Malthus in the same breath as Hayek. Malthus is a much-underappreciated economist and in macroeconomics he was much better than the naive overproduction theorists. His cyclical story is ultimately about proportionality and it is based on a "tragedy of the commons" effect — for the production of capital goods — which is not so different than his population mechanism. Malthus, by the way, had quite a modern understanding of supply and demand, well before the marginalist revolution.
4. I still am not convinced that we have avoided a new version of "the vertigo years," based on a fundamental discombobulation of economic expectations. This is probably just historical coincidence, but the Great Depression did come last to China.
China uses American spending power to enlarge its private sector, while America uses Chinese lending power to expand its public sector.
State owned enterprises still make up a sizeable portion of Chinese industry right? So China isnt necessarily expanding its private sector.
Re the previous comment, the boom-bust cycle can occur even with a high savings rate, as long as credit-fueled malinvestments have been propped up. Japan would be the obvious example.
To try to grasp the impact of a Chinese crisis on US public finance : what share of the new US bonds does the PBoC currently gobble up?
With or without Hayek, I think you are right with your assessment. (You could also call this a bubble ala Shiller.) One thing you might add to the scenario: along with Chinese overcapacity and deflation, the US dollar will continue to drop, raising commodity prices; US firms, unable to pass on commodity price increases, face Chinese competitors who absorb price increases. It may look like Chinese manufacturers are not raising prices, but, since they absorb commodity increases, US firms cede market share.
I also agree with your assessment of the opacity of the Chinese economy. As opaque as the Soviet economy in some sense, so what might be both good for us and for the Chinese would be an “out of China” center on Chinese statistics (could be a public website) which aggregates non-public Chinese economic statistics.
Great article. I hope that if bad things happen people from these countries don’t view it as having been done to eachother.
E. Barandiarian,
I appreciate your views. I think the purpose of the theory is to explain why it could affect an entire economy in contradiction to Say’s law in the way Sumner says. And when you state the rhetorical question as:
“The relevant question is what the government should do with those savings.”
I think to myself “how could it not?”
So, there needs to be a competing theory against Keynesianism which says that the problem is not enough government control of the money.
Isn’t it a bit hard to try to apply the same economic principles to the Chinese economy as the United States’?
If the Chinese don’t respond to incentives and disincentives, what do the Chinese respond to?
Andrew,
I have just read that earlier today some EU officials pressed the Chinese to appreciate the renminbi. This is wrong because it is aimed at investing at home a larger share of China’s flow of household savings. Investment in China has also been high but because of foreign companies investing in China–in other words, the outflow of Chinese savings has partly been offset by the inflow of foreign direct investment. To maintain a high ratio of investment in good projects, the Chinese need the foreign companies, and to diversify the portfolios of the state-owned banks, the Chinese need to invest a large part of the flow abroad.
Tyler and the Obama administration both try to look at the issues from the point of view of the Chinese authorities. That is probably the only way to negotiate with them a way out of the grand economic imbalances.
Try taking that a step further. The priority Chinese objective since Mao died have been to create a China – that primarily means an economy – too strong for anyone to push China around; and at the same time to avoid serious popular unrest (“Chinese fiscal and credit policies are geared toward jobs and political stability”) . The GDP growth (interpreted by anyone with Marxist training as productive capacity growth)target policy served both ends. So to keep up the pace of growth, it was worth accepting US dollars that would depreciate even though that meant little eventual return on much investment. When US demand shrank, it was worth shoving even more money into investment which probably would not make a proper return rather than risk greater unemployment and popular unrest. Better still if Chinese consumers would save less and buy more. However,while Chinese consumers don’t spend, export and invest are the names of the game; and the Chinese state will absorb the massive accounting losses that this policy causes.
If this is the basic Chines stance, shouldn’t we be very willing to help them maintain it? Carping looks to me like downright ingratitude.
When was the last time “Rev. Thomas Malthus” was used in popular print? I’m not sure I’ve ever seen Malthus referred to this way (despite the fact that, yes, he was a minister).
Your recent link to the story on the Chinese empty city seems relevant:
http://www.marginalrevolution.com/marginalrevolution/2009/11/assorted-links-10.html
“China’s statistics on its gross domestic product are based more on recorded production activity than on what is actually sold.”
This reminds me that, the last time I checked, there does not seem to be any standard way used by all nations to calculate any of the macroeconomic statistics. Even in just one country, the way they are calculated is changed every now and then, so you can’t really compare the numbers from ten years ago with this year’s.
It was kind of weird, since my own background is in engineering with a hint of physics, to find that there wasn’t any broad agreement on these measures. I still don’t really see how macroeconomics can even be done under these conditions – it would be like trying to do Newtonian physics without a way to measure distance and mass.
I second the implied recommendation of Blom’s The Vertigo Years, as an alternative to The Proud Tower and other simplistic analyses of Pre-WWI Europe.
TVY spend much-welcomed time on Eastern Europe.
I suppose, from a global viewpoint, that my earlier suggestion wouldn’t quite work either. In order to protect local industry, it would just spark a perpetual inflationary cycle as everyone devalued deliberately to make their nation the preferred manufacturer. Eventually this sort of shenanigan will happen anyway, to devalue the debt to the price of a can of baked beans – before we all end up in the third world working to pay the previous government’s debt burden.
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