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Like all of professor Pettis's posts, this one requires pretty deep background or a lot of reading to follow completely... But it's well worth it. If you think

Like all of professor Pettis's posts, this one requires pretty deep background or a lot of reading to follow completely... But it's well worth it. If you think you understand what's going on in China's economy, you should be sure to read Pettis exhaustively (Andy Xie is good reading, too). The general punchline: expect massively lower GDP growth in China. Not "below 7% low," more like below 3% at best, if the economy is managed correctly. Big caveat because the government's actions lately are pretty poor. His analysis of the Chinese economy is similar balance sheet economics. Great stuff.

blazespin 11y ago
is that nominal GDP or real GDP? If nominal, should we also expect massively less real GDP? I should read it, but he used too many ","s .. hurts my brain.
- ryandamm 11y ago
  Real. The isn't a statement about exchange rates or currency, it's a statement about the real state of the Chinese economy (even though parent post is definitely about monetary issues). We should expect Chinese growth to average 3% or less in real terms for the next ~decade if Pettis is correct. How's that for a bold economic prediction?
mistermann 11y ago
> expect massively lower GDP growth in China. Not "below 7% low," more like below 3% at best, if the economy is managed correctly Is it possible to sum up for us why this drop in growth?
- ryandamm 11y ago
  Very briefly, because the bulk of GDP growth (and GDP) has been investment, either in infrastructure out production capacity (in support of exports). Great way to industrialize, but it's not sustainable as China starts to have more capacity than the world can consume, and if continued investment in infrastructure doesn't result in higher long term productivity (cf ghost cities). The'correct' way forward is to rebalance toward domestic consumption: make the Chinese people richer, and sell more to themselves. The balance sheet argument says consumption must therefore grow faster than investment, which should probably contract (we're well past the point of a dollar of investment producing a dollar of future productivity), but since consumption is starting from a relatively small base it has to grow impossibly fast to maintain the current growth levels. Critical to this argument is Pettis's concept of 'financial repression,' that a lot of the uneconomic behavior and investing is a result of below-inflation deposits rates that have made household wealth shrink at the expense of cheap capital for business, particularly large and inefficient state owned enterprises. That implicit subsidy meant a lot of malinvestment was rational, but also implied an unsustainable environment. Current global contraction is maybe the pin pricing the bubble, because what's ultimately unsustainable is the world's capacity to absorb Chinese production. In other words, demand-side softness, which is a global problem. Sorry, that's not brief, nor is it necessarily easy to understand, but it's a complex issue that manner economists and China watchers don't necessarily understand (I'm assuming Pettis if correct, just in the strength of his arguments and other references agreeing; IANA economist)...
  - simonh 11y ago
    So basically Chinese production has been expanding to meet world demand. Eventually world demand will be met and China will stop expanding.
  - mistermann 11y ago
    I don't disagree, but one could have said (speculated on) the same thing 2 years ago. Also, there is still a lot of other market share China can steal from others (which of course causes GDP decline in those countries). It's extremely complex that's for sure.
    - ryandamm 11y ago
      I wouldn't say there's a ton of market share to be grabbed: the global economy is suffering from a savings glut. Chinese manufacturing dominates entire industries, and already other countries in Asia are offering lower-cost alternatives for labor (e.g., textiles in Vietnam). In practice, China has driven down the cost of many finished goods (while driving up the cost of commodities) through its investment in manufacturing capacity and infrastructure. Its latest investments were probably non-economic; in other words, they will never pay back the principal due to overbuilding both capacity and infrastructure. On the infrastructure side, there are entire cities with almost no inhabitants. These 'ghost cities' exist as hedges against principal-robbing inflation -- Chinese households have used property as a stable store of savings since traditional bank deposits and investment vehicles return below-inflation rates of return. This has inflated multiple speculative bubbles in Chinese real estate; the actual reckoning probably has yet to arrive. On the capacity side, it's the same story. To choose a single, specific example: over 50% of Chinese steel capacity is lying idle; there have simply been too many factories built in the past ten years. The price of solar in the past few years has dropped precipitously because of Chinese over-investment in production capacity -- just ask Solyndra. The price of solar plummeted below what anyone predicted because of China's state capitalism, and a mandate to gobble the market share in the solar industry. (In this case, at least, there are positive externalities.) Chinese solar panel manufacturers are not making profits due to the intense competition and oversupply in the market. The list is long. So no, there's isn't much 'market share' left to steal. China needs to build its domestic consumption share of the economy, by building its service sector and stoking domestic demand -- basically by making its citizens richer and selling to themselves. That's the only way forward, at least according to Professor Pettis.

blazespin 11y ago

is that nominal GDP or real GDP? If nominal, should we also expect massively less real GDP? I should read it, but he used too many ","s .. hurts my brain.

ryandamm 11y ago
Real. The isn't a statement about exchange rates or currency, it's a statement about the real state of the Chinese economy (even though parent post is definitely about monetary issues). We should expect Chinese growth to average 3% or less in real terms for the next ~decade if Pettis is correct. How's that for a bold economic prediction?

mistermann 11y ago

> expect massively lower GDP growth in China. Not "below 7% low," more like below 3% at best, if the economy is managed correctly Is it possible to sum up for us why this drop in growth?

ryandamm 11y ago
Very briefly, because the bulk of GDP growth (and GDP) has been investment, either in infrastructure out production capacity (in support of exports). Great way to industrialize, but it's not sustainable as China starts to have more capacity than the world can consume, and if continued investment in infrastructure doesn't result in higher long term productivity (cf ghost cities). The'correct' way forward is to rebalance toward domestic consumption: make the Chinese people richer, and sell more to themselves. The balance sheet argument says consumption must therefore grow faster than investment, which should probably contract (we're well past the point of a dollar of investment producing a dollar of future productivity), but since consumption is starting from a relatively small base it has to grow impossibly fast to maintain the current growth levels. Critical to this argument is Pettis's concept of 'financial repression,' that a lot of the uneconomic behavior and investing is a result of below-inflation deposits rates that have made household wealth shrink at the expense of cheap capital for business, particularly large and inefficient state owned enterprises. That implicit subsidy meant a lot of malinvestment was rational, but also implied an unsustainable environment. Current global contraction is maybe the pin pricing the bubble, because what's ultimately unsustainable is the world's capacity to absorb Chinese production. In other words, demand-side softness, which is a global problem. Sorry, that's not brief, nor is it necessarily easy to understand, but it's a complex issue that manner economists and China watchers don't necessarily understand (I'm assuming Pettis if correct, just in the strength of his arguments and other references agreeing; IANA economist)...
- simonh 11y ago
  So basically Chinese production has been expanding to meet world demand. Eventually world demand will be met and China will stop expanding.
- mistermann 11y ago
  I don't disagree, but one could have said (speculated on) the same thing 2 years ago. Also, there is still a lot of other market share China can steal from others (which of course causes GDP decline in those countries). It's extremely complex that's for sure.
  - ryandamm 11y ago
    I wouldn't say there's a ton of market share to be grabbed: the global economy is suffering from a savings glut. Chinese manufacturing dominates entire industries, and already other countries in Asia are offering lower-cost alternatives for labor (e.g., textiles in Vietnam). In practice, China has driven down the cost of many finished goods (while driving up the cost of commodities) through its investment in manufacturing capacity and infrastructure. Its latest investments were probably non-economic; in other words, they will never pay back the principal due to overbuilding both capacity and infrastructure. On the infrastructure side, there are entire cities with almost no inhabitants. These 'ghost cities' exist as hedges against principal-robbing inflation -- Chinese households have used property as a stable store of savings since traditional bank deposits and investment vehicles return below-inflation rates of return. This has inflated multiple speculative bubbles in Chinese real estate; the actual reckoning probably has yet to arrive. On the capacity side, it's the same story. To choose a single, specific example: over 50% of Chinese steel capacity is lying idle; there have simply been too many factories built in the past ten years. The price of solar in the past few years has dropped precipitously because of Chinese over-investment in production capacity -- just ask Solyndra. The price of solar plummeted below what anyone predicted because of China's state capitalism, and a mandate to gobble the market share in the solar industry. (In this case, at least, there are positive externalities.) Chinese solar panel manufacturers are not making profits due to the intense competition and oversupply in the market. The list is long. So no, there's isn't much 'market share' left to steal. China needs to build its domestic consumption share of the economy, by building its service sector and stoking domestic demand -- basically by making its citizens richer and selling to themselves. That's the only way forward, at least according to Professor Pettis.