by Tyler Cowen
on June 9, 2014 at 3:10 pm
in Current Affairs, Data Source, Economics |
Average capacity utilization is now below 60 percent.
The article is scary throughout.
“Scary” for whom? About 89% of the world’s product is not made in China. China goes through a disagreeable recession. Disagreeable recessions happen often.
Scary for the US, having the largest buyer of its Treasuries unable to keep up the pace.
The Fed was by far the biggest buyer of treasuries. In fact with the shrinking deficit and the continuation of QE near maximum levels, the Fed’s demand made up nearly the entire new issuance for 2013. Chinese demand is now largely irrelevant to the treasury market. Even Japan is now a larger buyer than China.
and the fed can just to buy more…don’t really need taxes or China…fund it all with QE. Lets test this new magical source of growth.
You’re committing a fallacy of false equivocation. I didn’t argue any of the points that you seem to be implying. The facts are quite clear though in recent years China’s demand for treasuries has been shrinking quite precipitously. Despite this treasury prices are at record highs and the US dollar index is at the same strength it was at the height of Chinese demand.
A few years ago it was quite reasonable to subscribe to the hypothesis that the United States’s economic position was precipitously dependent on cheap Chinese funding. That if China ever woke up from its almost irrational appetite for US treasuries that we’d be screwed. Treasury rates would go through the roof and we’d face some combination of a sovereign debt crisis, deep fiscal tightening or serious currency devaluation.
Well, we’ve now had half a decade of China cutting their treasury holdings. And in the ensuing time thousands have lost their shirts waiting for their treasury shorts to pay off any day now. The explanation is quite simple. There’s massive and increasing global appetite for perceived risk-free assets that extends far beyond China. And US treasuries hold a near monopoly status on the supply side of these assets.
Doug,your committing the fallacy of assuming what I am implying.
I agree with everything you have said.
QE seems to be a more fair way to tax us.
I really would like to see the US government say they will now end payroll taxes…or income taxes and then say they will replace the hole in their budgets with more QE.
It may or may not cause inflation. Who is to say QE has caused lots of inflation so far?….in any case the inflation QE causes can be hedged against even by upper middle income people like myself. I can only get around the taxation problems if I am super rich like a gates or buffet and am able to employ my family in my tax-free foundations or own a tax shelter insurance racket of some sort.
Gabe, your understanding of Gameboy economics is deep, but your suggestion that the fed give up its independence is treasonous. This leads me to conclude you are Eugene Goostman.
The underlying demand for any government currency is that it’s the medium by which taxes are paid. Without taxes there’s no difference between official currency and any arbitrary paper. The currency may retain value simply due to a relatively inelastic supply and the fact that other people hold it (e.g. bitcoin). But without the stabilizing demand pressure of taxes the equilibrium is ultimately unstable.
In short some level of taxation as a significant proportion of overall economic activity is necessary for a QE financed budget. But that level of taxation may continuously fall short of overall government spending as long as sufficient demand exists for assets denominated in the domestic currency. That is to say budget deficits are proximately irrelevant, only asset price and currency stability matter.
and so far the necessary demand has been created with QE and the Fed and you now are saying we have zero negative consequences. I hope they decide to push it further. It seems like a free lunch to me and I never turn down a free lunch.
The Fed is independent-ISH.
The underlying demand for any government currency is that it’s the medium by which taxes are paid. –
The underlying demand for any government currency is that it remains a store of value, i.e., you can turn around and exchange a dollar for roughly what it took to acquire it. It didn’t help Zimbabwe banknotes at all that the government had declared them legal tender. This is actually a very old lesson.
I think if it were as simple a matter as printing money and buying your own debt with it, a lot of past regimes would have figured it out by now. That’s the bizarre part to me: it’s like the entire US economy is a Bubble, and is hoovering up labor and capital from all over the world.
I feel better already!
But aren’t the trade deficit and Chinese purchases of treasuries two sides of the same coin? If China stops buying treasuries, the dollar declines, and manufacturing shifts back to the US. The federal government gains tax revenue and has to pay less in unemployment benefits. It seems to me that we really need China not to keep buying treasuries forever (and perpetually buying US treasuries is a losing strategy for China as well).
Similarly, American leaders complain about China’s suppressed currency valuations. China attains these by buying treasuries, to my knowledge.
They say US debt is the best place to put Chinese reserves because the US dollar (and especially US government bonds) offers liquidity which cannot be matched by other competing places to put their money.
Clearly this will have impacts on the exchange rate. Clearly these impacts benefit the competitiveness of many Chinese firms. Clearly the Chinese are not naive to this situation. Assuredly, changes will be marginal, and one-off major changes in currency will not occur if/until full convertibility is achieved (which presumably will occur some time after it is more obviously in their interests to have a fully convertible currency, which could be not that long from now …)
But their rationale for holding so much US debt (which as a ‘side effect’ effectively holds down their currency) is solid enough, imo. I wouldn’t doubt they would be very happy to diversify and lock in the gains, but where else can China put a trillion or two dollars a) without creating significant additional liquidity risk and b) without raising suspicion that the government of China plans to buy the entire world post haste.
OK, but if China is only going to marginally change their policies, then they are going to continue to buy almost as many treasuries!
That is the conclusion (marginal changes means buying almost as many US treasuries) that I would be most sympathetic to under that reasoning.
I do think they aspire to a more highly valued currency eventually in order for the masses to access greater purchasing power.
I feel like the whole world is living in this fantasy where Kotlikoff’s $222 trillion fiscal gap doesn’t exist. Let’s just enjoy the dream and pretend we never have to wake up.
I’m not clear on what you’re saying.
sorry…not the whole world, mostly the US.
It is very much like how most of the world knows that the US government sponsors terrorism, but most Americans pretend to be shocked to even contemplate that their government would do such things.
Shifting the discussion back to whether we need China and others to buy treasuries or we’re doomed, I do not agree. Again, those purchases just enable us to buy imports. Were they unavailable, there would be more manufacturing in the US. Even though manufacturing is becoming less labor intensive, it would increase revenues while shifting employment slightly in the right direction.
Were they unavailable, there would be more manufacturing in the US. Even though manufacturing is becoming less labor intensive, it would increase revenues while shifting employment slightly in the right direction.
Assuming the Great Reset is allowed to happen (it wasn’t allowed to happen in 2008), then that’s $X trillion in capital we’ve now got to raise on our own to build those factories to keep goods the same price. That’s where (the thinking goes) Tyler’s bean-fed immigrant army steps in to save the day. This will be fun to watch.
Looks like Treasuries may be the best thing China invested in.
If China has a major crisis, they will have to sell U.S. Treasuries to defend the yuan, unless they just let the yuan collapse, which seems likely considering they would not want to suffer deflation for years on end. As far as financial markets are concerned, a drop to 6.5 might as well be a collapse since everyone was bet on one-way appreciation, but a move well below 7 yuan to $1 is more likely if the economy experiences a recession and financial crisis. U.S. Treasuries would probably rise in price and the U.S. dollar would rise relative to emerging market currencies.
If you need evidence, the yuan declined versus the dollar in 2008, 2011 and 2012, and each time there was a dip in forex reserves or flat growth. Global markets are not smooth: as soon as China is clearly in crisis, the selling of yuan will begin and the PBOC will be forced to sell Treasuries (into a seller’s market) and buy yuan overseas in order to keep the yuan from collapsing in HK. They set the peg on the Mainland, but the price in HK is market determined. Chinese have shown there are many ways around capital controls and China is opening up its capital account as we speak. If offshore yuan is persistently below the yuan price onshore, there will be a persistent force pulling dollars out of China.
+1 This mighty economic weapon that China allegedly wields is useless. Selling Treasuries would tank the dollar and Americans would move manufacturing back home. The yuan would skyrocket. Exactly what China has tried desperately to avoid for decades.
Forget it, Tyler, it’s China.
If you had to bet 10K USD, what would you choose? Another 30 years of 9% growth per year or “normal” 3% average growth for the next decade?
Can we do the bet in yuan?
Since no money has to be paid until the bet is resolved, what difference does it make?
Tyler quoting John Maudlin is terrifying, yes.
(I mean, do a Straussian reading of Maudlin and my god, it is Eco all over the place)
Visiting China is even scarier than reading about it. One wonders what William Blake would have written about smog-crippled Harbin’s satanic mills in 2014.
Out of curiosity, when were you in Harbin? I was there for a few weeks in March and was surprised by how clear the skies were (compared to other parts of China).
I suspect capacity would often be overstated, since managers will hesitate to report that, for example, 25% of capacity cannot be used until some repairs are made. Probably real money would need to be spent to put capacity into action.
Even then, 60% is very high. Even gargantuan overestimates of capacity would have a hard time explaining numbers that high.
More importantly, probably, is that a lot of Chinese operations sort of “on call”, with a shell of a facility ready to tool up if/when a deal is negotiated. It’s not like a Ford plant running at 60% capacity. As far as I understand, in many cases it would be more like Ford sitting on 3.5 empty and untooled factories while the other 6 run at or near capacity.
I can make 100,000 units, and if I like it, I order 5 million more. How to choose the supplier? The one who can make the 5 million units I actually want if the first order goes well. This (flexibility and untooled production floors) alone probably explains a few percent. An empty untooled factory which produced 10 million units last year could count as 0% capacity, even though the tooling was removed, sold … (who knows what).
I read recently that many operators are using a “China plus one/two” strategy with a factory in, say, Vietnam as a second base, in part to mitigate effects of rising wages in the relatively highly skilled Chinese labour market. Perhaps this excess capacity could pose certain challenges for China, but I would not consider it as such a strong indicator of global demand, for example, since many manufacturers who use Chinese manufacturing services may have just taken their tools somewhere else.
Once you count for all the untooled factories, and combined with the desirability of the ability to rapidly ramp up production, on the part of many B2B transactions between Chinese and international firms, well … there’s an argument for maybe it’s not such a big deal if capacity fell so much, specifically, over this timeframe and in such production and trade conditions.
Generally speaking, I would argue that In a more flexible economy we should expect excess capacity to be higher, because ability to rapidly adjust output is itself part of the B2B sales package.
Hebei province alone was producing almost twice as much steel as the United States last year.
Beijing is famous both for long-term marginalist approaches and for taking a strong and committed position on something with not all that much notice (but when will this happen for hukou?).
For economic issues, I think the CCP is sufficiently modest in their self-evaluated ability to manage every detail of an economy, and thus strongly tend towards marginalist approaches (large SOEs excepted, but I doubt that their objectives often differ from those responsible for overseeing the development of the economy).
This makes #3 the only option of the 6 provided which is consistent with the stated understanding of how visions are pursued with respect to major policy issues in China.
Anyways, I don’t get how Chinese growth of 5% or 4% will cause slower growth for us. They will still be pulling global growth upward relative to anemic growth in rich countries, and in the meantime, many of the lower wage and lower skilled production processes will be increasingly moving to poorer countries with similarly endowed labour forces.
An outright recession would surely be a problem, but how does slower Chinese growth affect us, except in that their demand will increase more slowly. This may force some/many companies to rejig effective market size or sales forecasts in China (e.g., which percentage of Chinese can afford a Big Mac today, or in ten years?), but it’s not the same as actively dragging us down.
I don’t think your conclusion, that a slowdown in growth in one market can’t cause negative growth in another. For a direct comparison the recession of 2001 started because of a slowdown in the tech sector. The technology sector continued to grow through period, despite the overall economy shrinking, but it did so at a slower rate than in the late 1990s.
It goes beyond just rejigging sales forecasts. When a market delivers below expectations that causes a lot of marginal investment that was dependent on that demand to fall below their profitability requirements. That in turn leads to bankruptcies, layoffs, overcapacity, forced liquidation, and loss of liquidity. All of that drags down aggregate demand and can precipitate a recession.
Marginal investments in response to slowdowns. That would be consistent with that way of saying it. For a larger slowdown, yeah, that could have some pretty big knock-on effects that would make my questions/confusion basically moot.
So if the US slows down, the world isn’t affected? The Chinese economy is close to the size of the US.
Isn’t it interesting that the US showed a contraction in the first quarter and Europe is planning some central bank maneuvers to goose the economy coincidentally at the same time that China is slowing down?
The Chinese economy is far more important for global growth because the EU, US and Japan aren’t contributing much. China is the guy holding the final straw off the camel’s back. If China slows for real, commodity prices tumble and emerging market growth goes away. Housing markets in Australia, Canada, California, New York, London etc are all affected. Multinational profit growth shrinks. China exports deflation to the world.
I agree about 4% not being a problem with the caveat that the Chinese economy is currently growing at 4% based on “natural” statistics (not man-made ones). If not, then no, China cannot slow to 4% growth because China cannot even slow to 5.7% growth (the annualized rate of qoq growth in Q1) without experiencing a credit crisis. It’s full speed ahead or full stop.
In part, what I mean is that the difference is relative to the baseline assumption that growth would be 10%, not 5%, for example.
It’s like comparing the statement “If growth in USA or China is slower than expected, then growth here will be slower than expected”, as compared to “their high growth is still pulling us up, but not by as much as it would have if they had grown twice as fast.”
China could have negative investment growth but very strong consumption growth, and the rest of the world (or the average Chinese) might not feel much of an impact. There’s no magic GDP number.
I’m skeptical of the source on that under 60% average capacity utilization. Is it IMF, or SG? How did they calculate it?
Out of curiosity, is the current negotiation between the ILWU and Pacific Maritime Association on anyone else’s radar? A two week work stoppage could cause enough of a cash crisis to do serious damage to the Chinese economy, especially if it takes six months to get back to normal operations as in 2002.
Tyler a couple of weeks ago was telling us how bullish he is on Pakistan of all places. Periodically he makes similar claims about other third rate countries.
Meanwhile he continues to foresee doom and gloom for China.
I’m going to go with Alex here for once and say if Tyler’s honestly predicting a dire future for China he should put his money where his mouth is.
I don’t see that Tyler is “predicting a dire future for China”.
Isn’t it scary that a few months ago most people were still pretty sure the VA was doing great healthcare?
You can only do so much misallocation before people start to notice.
And remember much of China’s political elite now personally control billion-dollar concerns. How will they respond to the incentives?
This is why it’s a freaking miracle every time any country manages to break out of the middle income trap: in almost every middle income country the incentives aren’t aligned with growth. At all. If you can’t threaten established interests, you can’t innovate and you don’t improve.
So far all East Asian countries have emerged from the middle income trap aside from, so far, the DPRK.
China will graduate as well. It may stall out at lower developed nation status, but that’s something else entirely. And being a nation of 1.3 billion, it will dominate the global economy even at that level.
Southeast Asia, meanwhile, is the archetypal home for the middle income trap. And Thailand, the smiling nation of military coups, might be its poster child.
South Korea, Taiwan, and Japan all have a much, much smaller SOE sector than China does. TallDave is right, there is no incentive for politicians to grow the economy at the expense of the SOE sector where they make all their cash.
The middle-income trap is directly related to a government’s willingness to let go of the economic stranglehold. In a democracy it’s a lot easier to hold political control without also holding economic control.
Is capacity utilization even a economic concept? Does one want one’s toilet to operate at 100% capacity?
It strikes me how Keynesians aren’t too far removed from the old stereotype of stolid, heavy-handed Soviet socialists. (“Is good concrete block, tovarish. We make MUCH concrete block!”)
It gives an indication of whether we may expect investment growth, to increase capacity. For example, at 95% capacity most businesses would be screaming to expand capacity in case they start to miss out on orders (assuming they can’t just jack up prices when they reach 100%).
Could someone help separate the demand-side from supply-side issues in China? With respect to aggregate demand in the US, how is a slowdown in China any different from tax hikes or budget cuts a la 2013? Doesn’t monetary policy offset export demand for the same reason that it offsets fiscal policy? If the Fed does its job in setting M*V, why would China impact aggregate demand P*Y = M*V?
On the supply-side, I could see how “malinvestment” could indeed impact long-run growth prospects in the US (and worldwide). If corruption in state-owned enterprises, for example, has led to the “wrong” kind of factories being built, then that will impact global production capacity. If, as a result, US long-term growth rates decreased from 3% to 2%, then that would indeed be tragic, equivalent to cutting our childrens’ wages 25 years from now by 22%. Monetary policy would not help with that. However, the article seems to be concerned primarily with short-term shocks caused by “rebalancing” in China, unless I am missing something.
Ironically, people seem fixated on short-term demand-side factors, which are offset by monetary policy anyways, and unmotivated by supply-side factors, which impact economic growth slowly and in hidden ways but, ultimately, seem far more significant to living standards.
I think if you set up the problem right, you could find cases where the aggregate effects on monetary and real economy variables are the same, but where there are major distributional differences. The aggregate variables could have the same outcomes, but the effects will be felt differently by different sectors.
For example, a slowdown in China would affects sectors which export to China (coal, industrial equipment, engineering, marketing and management services, etc.), whereas raising taxes would affect the decision of people targeted by those tax cuts and cutting budgets would primarily affect those.
But I think you can pick this apart once you get into the details of common ways to modell the transmission mechanisms of impacts across sectors and time for the three aggregate demand shocks you refer to.
From the supply side, you could be interested in improving human capacity by supporting improved employee retention (say, vacation pay required to go from 2% to 3% or 4% after periods of time) so that employees are more likely to develop high skill levels in their most specialized areas.
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