Update: Prof. John Ross backs me up with the facts:
Michael Pettis has repeatedly stated that consumption is falling as a proportion of US GDP because US saving has been rising due to the impact of the financial crisis. Factually the exact opposite is the case. Consumption has risen as a proportion of US GDP and saving has been falling. If the fourth quarter of 2007 is taken as the last before the full impact of the crisis then in that quarter US consumption was 85.8% of US GDP. If the second quarter of 2008, i.e. before the collapse of Lehman’s, is taken then consumption was 86.7% of US GDP – it may be seen that US consumption was rising rapidly as a proportion of GDP during the first half of 2008. For the last US GDP data available, that is for the second quarter of 2009, total consumption was 87.6% of GDP – a further sharp increase.
Taking the period from the last quarter of 2007 to the second quarter of 2009 US consumption therefore rose from 85.8% of GDP to 87.6% – a rise of 1.8% of GDP. Even if the narrow period between the first and second quarters of 2009 is taken US
consumption rose from 87.2% of GDP to 87.6%.
—
This is a response to my former prof Michael Pettis’ pieces on the WSJ and in the FT, as well as his related blog posts. I am hoping to continue this as part of a series of conversations with more established opinion leaders to develop my own debating skills and knowledge.
- The Lucasian Argument, or, all is not ceteris paribus
- When the Japanese and German currencies soared in value against the dollar after the Plaza Accords of September 1985, many analysts thought that these countries’ trade surpluses with the U.S. would decline. But even though the value of the yen doubled, Japan’s trade surplus surged. This should not have been surprising. In response to the Plaza Accords, Tokyo directed a flood of low-interest credit into the manufacturing sector while informally guaranteeing corporate borrowers. Manufacturers increased production for export markets even as household consumption declined. The trade surplus with the U.S. rose.
- Capital account explanation: So currency was forced up but in response interest rates were pushed way down. That triggers a dramatic outflow of capital seeking cheap assets and higher interest rates. Massive capital account deficit. Given that the BOJ did not absorb the full amount of this deficit by taking a hit to its reserves, its hardly surprising that, with export prices stable, the Japanese current account surplus rose.
- Supply side explanation doesn’t cut it: the fact that manufacturers increased export production doesn’t mean that there was a market to buy the additional products at the same prices (if the manufacturers had cut prices by the same percentage they had increased production, no trade surplus increase would have registered as it is a nominal measure). The fact that there was a market means that:
- Substitution effect: US buyers were substituting away from German products to Japanese.
- This argument is not wrong, just misguided about cause-and-effect.
- The false analogy
- China is trying to do the same thing, despite a rising yuan.
- China, outwardly at least, is following a policy of promoting internal demand as a driver of growth instead of the prior export-led growth model. Whether its actions match up with its words are another matter, though.
- The “two countries” ludic fallacy
- China’s trade surplus with the U.S. won’t necessarily soar. In the short run, American consumers are hamstrung by wage stagnation and rising unemployment. For the next few years, U.S. consumption will grow more slowly than its production, and the trade deficit will narrow.
- We speak of TOTAL US consumption growing slower than TOTAL production, but nothing in that precludes the possibility that the trade deficit specifically with China won’t widen. In fact, any adverse income effect (including wage stagnation and unemployment) is far more likely to increase purchases of goods of Chinese origin rather than homegrown ones.
- What time period are we talking about?
- China’s fiscal stimulus consists mainly of a massive expansion in bank lending, which is almost certain to lead to a sharp rise in bad loans. Resolving these, which China will have to do in the next few years, will probably require the same policies used to resolve the banking crisis of the late 1990s, which will inevitably constrain consumption growth.
- Yes; very true, but is this actually a negative point? – in the first instance the consumption growth that is “constrained” will be exactly the consumption growth that resulted from the monetary expansion in the first place. Provided that feedback loops don’t make the constraint effect worse (although they work equally in the opposite direction in the expansion phase too), the entire effect of this will simply be to moderate the up- and down- swings in the economy due to foreign disruptions. Entirely desirable.
- Y=C+X-M??
- Over the next five years or more Chinese economic growth will necessarily be lower than growth in Chinese consumption. The massive but unsustainable investment in infrastructure and new production facilities that characterises the Chinese fiscal stimulus package will not be able to change this fact.
- eh? it wont be able to? why not?
- Currency indifference
- I did have a big problem with the often-repeated assertion (and one that often pops up in discussions about China) that because Japanese trade was not denominated in yen the Bank of Japan was forced to accumulate dollars. In fact it doesn’t matter what currency your trade is denominated in – if you run a net current and capital account surplus, your central bank must accumulate foreign currency.
- I approve, with the usual caveat for managed-float regimes.
- Savings rate vs savings level
- If China continues to pump out capacity and tries to export this excess abroad, and if US household savings rise much more quickly than US fiscal dis-saving (borrowing), we will almost certainly see the bad case scenario occur, at least in China, and especially if it leads to trade friction around the world.
- Household savings rates have increased sharply – but this has little bearing on whether total levels of savings have risen or fallen. If total household income has fallen by X%, and household savings rates increase by less than X% (we all have to eat, even if we start eating Chinese takeout), then savings has fallen, not risen. The argument also overlooks public sector debt and spending, which has famously run into unprecedented deficit.
- Don’t be a banker in China
- In that camp I might add measures to force banks to increase consumer lending, because I think the last time they tried that (with car loans), nearly half the loans went NPL, suggesting that at first consumer lending will simply consist of free consumption financed indirectly by the government, when it bails out the NPLs. This is a form of “consumption” I guess, but it is not really what the doctor had ordered.
- Apalling. Did not know that. Not sure I object to it though
