Michael Pettis on current accounts and the Chinese economy transcript of a disucussion and may need registration.
The first part is a general discussion from US to Europe. Excerpts:
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Michael Pettis Right. Again, one of the big problems in this discussion is that we tend to think of savings as something that households do and households are one of three groups that save. And we tend to think of changes of saving as reflecting changes in thriftiness or all that stuff, prudence etc.
Cardiff Garcia The other two groups by the way in addition to households are the corporate sector and the government.
Michael Pettis Yes, exactly. So if you look for example at Germany, Germany was running current account deficits in the 1990s, quite large. And then after the labour reforms of 2003-2004, they started running huge current account surpluses, the largest in the world. Many people said that was because German households, seeing an uncertain world, became thriftier, more prudent etc, but if you look at the numbers that’s not the case. Their household savings rate was unchanged.
What happened was that the labour reforms, which is usually a euphemism for reducing wages, caused, and you can see it clearly in the numbers, the household share of German GDP contracted. And because the household share contracted, consumption contracted and savings went up. Who was responsibility for the higher savings? German corporates, because their profitability went up as wages went down, so it was business savings that went up and business savings went up simply because wages went down."
About China:
"Cardiff Garcia Michael, you wrote recently in the Wall Street Journal that a few years ago everybody thought that China was going to have a financial crisis. You said that wasn’t the case. You recently wrote that now everybody is saying that China might even be able to manage 6% or 7% GDP growth into the future for the next ten, 15 years and you said that’s wrong also. Let’s take the first bit: why is it that China will be able to avoid a financial crisis?
Michael Pettis..........Crises are caused by what economists refer to as sudden stops. That is when you have a significant mismatch between assets and liabilities and some event prevents you from rolling over the liabilities. That’s when you have a crisis. Now, if you look at the Chinese balance sheets, they look terrible, particularly the small banks. Not only do they have really awful assets but their funding base is terrible. It’s all purchased money, very little retail deposits. So you would think with these kinds of balance sheets, China should have a crisis. But as long as the banking system is closed and most of the money remains within the banking system and the regulators are credible, then that mismatch disappears because the liabilities can easily be restructured by the regulators. They can force banks to lend among themselves if there’s a run on any one bank......
I think there’s a consensus on this now, they know what the reforms are, and they involve a transfer of wealth from local governments — from governments, but because of political centralisation it will be local governments — to the household sector. That’s the only way to increase consumption and reduce savings.....
Now, again wearing my banker’s hat, that means among other things you want to re-centralise the credit allocation process. So what I’m expecting to see, what I have been speaking to my students about for a couple of years, is that one of the indications that the President is being successful in his attempts to implement the necessary reforms is we should start to see a change in the credit allocation away from the local governments back towards Beijing. There are many ways this can happen.
For example we all know there are too many banks in China so there are going to be a lot of mergers. The big question is, do you have all of these local banks merged into the big Beijing banks, so you create these huge zombies but run by Beijing, or do they merge among themselves and create alternatives to the Beijing banks? If my model is right it’s going to be the former. That’s what the President will have to do. And what I suggested is that this is related to the fact that interbank interest rates have been extremely high recently. You know how the interbank lending works in China: it’s basically the big four lend to the local provincial and local banks because of their huge retail branch system. So what happens if you raise the interbank rate? Well if you raise the interest rates it’s a transfer of wealth from net borrowers to net lenders. Who are the net borrowers? They’re the small local provincial banks. Who are the net lenders? They’re the big Beijing banks.
So I don’t know if this was their plan but to me it’s very consistent with this whole process of the re-centralisation of power. Basically high interbank rates weaken the local banks tremendously at the expense of the big Beijing banks and that’s what I would want to see if Xi Jinping is going to be successful."
