Beijing-based economist Michael Pettis has carved out through his "China Financial Markets" blog a distinct position with his commentaries on the Chinese economy, notably with his consideration of the difficulties it faces with its necessary rebalancing towards a more consumption-based model. Asia Times Online here draws the attention of Pettis' latest insightful analysis to a wider public.
Five or six years ago, a few skeptics first started pointing out that the credit dynamics underlying Chinese growth was creating an
unsustainable increase in debt. This, they warned, would ultimately undermine the banking system and cause growth to collapse if it were not addressed in time.
There were three standard rejoinders to the warnings. First, analysts argued that investment was not being misallocated, and because credit growth poured mostly into investment, it did not therefore follow, as the skeptics argued, that debt was rising faster than debt servicing capacity. This is a losing battle and, like the capital stock argument, distressingly ahistorical. I think that the evidence of investment misallocation has continued to rise.
The second rejoinder, which has also largely faded away as an argument over the past few years, is that debt in China doesn’t matter. But debt always matters: Either it must be repaid out of the proceeds of the investment that was funded by the debt, or - if the debt funded consumption or was misallocated into insufficiently productive investments - it must be repaid by transfers from some other sector of the economy, and these transfers reduce growth by reducing real demand.
The third rejoinder should have been, in principle, the easiest to refute, and for a while it looked like it had been refuted to everyone’s satisfaction, but in the past year I have seen a revival. China doesn’t have to worry about rising bad debts in its banking sector, according to this argument, because the People’s Bank of China's extensive reserves will make it easy to recapitalize the banks. ... more
Michael Pettis is a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has taught, from 2002 to 2004, at Tsinghua University's School of Economics and Management and, from 1992 to 2001, at Columbia University's Graduate School of Business. He is also Chief Strategist at Guosen Securities (HK), a Shenzhen-based investment bank.
(Reprinted with permission. For Michael Pettis' blog, see here.