Speaker 1: Hello, and welcome to another episode of the All Thoughts podcast.
Speaker 1: I'm Tracy Allaway and I'm Joe. Wisn't thal so, Joe.
Speaker 1: You know, there's a very very important date coming up.
Speaker 1: Mm hmm what is it. I'll give you a hint.
Speaker 1: It's in October. Oh, right, of course. Uh, major major
Speaker 1: deadline for the trade tariff. It took me a second,
Speaker 1: I'm sorry. Yes, those are always happening. But there's a
Speaker 1: date that's even more important, and it's actually really important
Speaker 1: for the US China trade war. But it's October one,
Speaker 1: and that is the National Day of the People's Republic
Speaker 1: of China. And this year it's even more important than
Speaker 1: usual because it's the seventieth anniversary of the founding of
Speaker 1: the PRC ah Okay that that I didn't realize, Okay,
Speaker 1: And this tends to be a sort of politically sensitive
Speaker 1: date for the Chinese authorities. It usually comes with a
Speaker 1: big military parade and they seed the clouds to a
Speaker 1: couple of days before to make sure that the skies
Speaker 1: are blue. And it's a big, huge holiday, but it's
Speaker 1: also a chance for the authorities to sort of evaluate
Speaker 1: or more likely, um sort of crow about everything. They've
Speaker 1: done to improve China, including the economy. I like how
Speaker 1: you just sort of casually throw in there that they
Speaker 1: affect the weather for the day. Yeah, it's really interesting.
Speaker 1: Everyone knows it's going to be good weather on October one.
Speaker 1: That's amazing. So I thought, in connection with the October
Speaker 1: first state, we could talk about how far China has
Speaker 1: or hasn't come when it when it comes to the
Speaker 1: goal of rebalancing their economy. Right, And this is something
Speaker 1: that people have been talking about for a long time
Speaker 1: because people look at the Chinese economy and they see,
Speaker 1: at least on the service all kinds of crazy things
Speaker 1: going on. There's very historically, there's been extreme fluctuations and
Speaker 1: asset prices, real estate prices, claims of real estate bubbles,
Speaker 1: an economy extremely geared towards investment, and so forth. And
Speaker 1: so people look at an economy that's grown extraordinarily, well,
Speaker 1: that's brought all kinds of wealth to people over the
Speaker 1: last several decades, going from one of the poorest countries
Speaker 1: in the world to uh, you know, building up this
Speaker 1: significant middle class. But they still see extraordinary imbalances and
Speaker 1: skewed forces domestically. That's right, and The big one is,
Speaker 1: of course, the the imbalance between an investment driven economy
Speaker 1: on the way to becoming more of a consumption driven economy.
Speaker 1: That's the big one. And to talk about this, we
Speaker 1: we really have the perfect person are. Our guest for
Speaker 1: today is Michael Pettis. He's finance professor over at Packing
Speaker 1: University and also senior Fellow at the Carnegie Endowment. He's
Speaker 1: also a former banker and a trader and has been
Speaker 1: watching exactly this and writing about it for a very,
Speaker 1: very long time. So we're very happy to have Michael
Speaker 1: on the show today. I can't wait. I've been I've
Speaker 1: been wanting us to have a podcast with an episode
Speaker 1: with Michael for a long time, So really looking forward
Speaker 1: to jumping into this one. Yeah, no pressure, Michael, Thank
Speaker 1: you so much for coming on. My pleasure. So maybe
Speaker 1: just to begin with, we we could talk a little
Speaker 1: bit about what we mean when we talk about an
Speaker 1: investment driven economy versus a consumption driven economy. What does
Speaker 1: that actually mean and how does it pertain to the
Speaker 1: case of China. An investment driven economy can also be
Speaker 1: thought of as a savings driven e company, and China
Speaker 1: is not the only country that's followed this growth model
Speaker 1: at least two dozen countries that since the Second World War,
Speaker 1: and you could argue that this model was more less
Speaker 1: invented in the nineteen thirties in the Soviet Union, but
Speaker 1: basically in a consumption driven economy, and the classic case
Speaker 1: that is probably the United States in the nineteenth century.
Speaker 1: Um you had very high wage levels. It was high
Speaker 1: wages that drove high levels of comment, which then drove
Speaker 1: high levels of investment to those consumption needs. And it
Speaker 1: also grow productivity growth and a bunch of other things.
Speaker 1: In in the savings economy, what you do is you
Speaker 1: force up the savings rate, which is usually a good
Speaker 1: thing to do in a developing country because developing countries
Speaker 1: tend to have insufficient investment, and they tend to have
Speaker 1: insufficient investment because they have insufficient domestic savings. So you
Speaker 1: force up the savings rate in order to increase the
Speaker 1: amount of savings that are available for domestic investment, and
Speaker 1: you can get very, very rapid growth as long as
Speaker 1: you continue to be under invested in that's really the
Speaker 1: problem in China in the nineties, China had gone through
Speaker 1: five decades of Maoism, the Civil War and anti Japanese war,
Speaker 1: and it was hugely under investment for its level of development,
Speaker 1: for its for its the its ability to absorb investment productively.
Speaker 1: And so a model found that really focused on pushing
Speaker 1: up investment as rapidly as possible was the right model.
Speaker 1: And for that you have to push up the savings rate.
Speaker 1: And here's what I think. There's a huge amount of
Speaker 1: misconception about China. China, as everyone knows, that's the highest
Speaker 1: savings rate in the world. But that's not a cultural
Speaker 1: propensity to save. It's got nothing to do with what
Speaker 1: households want to do. China has the highest savings rate
Speaker 1: in the world because it has the lowest household share
Speaker 1: of GDP. In other words, they produced a hundred dollars
Speaker 1: of GDP and their total compensation is roughly fifty dollars,
Speaker 1: and so of course their consumption is less than that.
Speaker 1: That's why China has such a low consumptions and such
Speaker 1: a high saving ship. Now, this is a great model
Speaker 1: when you have significant amount of investment that you need
Speaker 1: to do when you're severely under invested economy, which China
Speaker 1: was in the eighties and nine nineties. But at some point,
Speaker 1: perhaps at the end of the nineties or beginning of
Speaker 1: the two thousand's trying to reach the level of investment
Speaker 1: that it could productively absorb. And and in that case,
Speaker 1: what it should have done is that could have switched
Speaker 1: this growth model towards more of a consumption driven growth model,
Speaker 1: and that's what has been trying to do. But the
Speaker 1: the the important point to remember is that if you
Speaker 1: want the consumption share of GDP to grow, then you've
Speaker 1: got to get the household income fare to grow. And
Speaker 1: if you want the household incomes share to grow, you've
Speaker 1: got to reduce someone else's share. And that's why it's
Speaker 1: such a politically difficult problem for China. So, Michael, you've
Speaker 1: been writing about this problem or this challenge for China
Speaker 1: for several years, and I went back, I was over
Speaker 1: the weekend doing so propriating your book from You're like,
Speaker 1: it's pretty clear that in the coming years they're reaching
Speaker 1: the absolute limits to the existing investment driven model. They
Speaker 1: have to make the change now, because if they don't
Speaker 1: make it gradually, it's going to be a painful adjustment. Eventually,
Speaker 1: explain to us the sort of specific mechanism by which
Speaker 1: the investment driven growth model has to come to an end.
Speaker 1: Why it can't last forever, why it uh, why it
Speaker 1: must run into a wall? And then since then, like
Speaker 1: in recent years and before the trade war. So before
Speaker 1: we get to like the sort of immediate stuff, how
Speaker 1: has China done with its domestic rebalancing in your view models,
Speaker 1: But lean have significant amounts of productive investment that you
Speaker 1: need to do. And the way it works, since you
Speaker 1: borrow dollars, you invested in building a factory, of building
Speaker 1: a road, building bridge, that increases the value of the
Speaker 1: economy by a hundred and ten dollars. So you're fine,
Speaker 1: your debt's going up, but your your debt burden is
Speaker 1: actually going down. That's healthy growth. But when you reach
Speaker 1: the point at which you can no longer absorb all
Speaker 1: of this investment productively, So again, you borrow a hundred dollars,
Speaker 1: you build something, but there's something only creates twenty dollars
Speaker 1: worth of value for the economy. Now you have a
Speaker 1: hundred dollars of additional debt, but only twenty dollars of
Speaker 1: additional debt service and capacity. So now your debt burden
Speaker 1: is growing, and that's you know, you can argue it's
Speaker 1: been this has been the case of the last ten years,
Speaker 1: of the last twenty years or whatever. It's certainly been
Speaker 1: the case. And that's why China. China's debt burden has
Speaker 1: exploded to becoming among the highest developing countries. What do
Speaker 1: we think about China's debt burden at the moment, because
Speaker 1: we've had China bears warning about it for I mean,
Speaker 1: over a decade at this point. And yet even though
Speaker 1: we we see these concerns and we see the authorities
Speaker 1: you know, occasionally try to reduce credit in the wider economy, um,
Speaker 1: they tend to give up after a couple of years,
Speaker 1: and if the economy starts to slow, they just ramp
Speaker 1: up lending again. So is this something that can keep
Speaker 1: going for for a while longer? It probably can for
Speaker 1: another two or three years. Now. There are types of
Speaker 1: China Bear warnings about the debt I would say a
Speaker 1: lot of them have looked at the debt problem said
Speaker 1: if that continues going, China will have a debt crisis.
Speaker 1: I don't think that's what the history tells us. Debt
Speaker 1: crisis one of the ways you resolve the debt problems,
Speaker 1: but another way you resolve it have failed to resolve
Speaker 1: it is through a really long, slow adjustment. So for example,
Speaker 1: Japan after never had a debt crisis, I think that's
Speaker 1: the moon likely outcome in China because that crisis it
Speaker 1: was really a balance sheet problem, it's not a debt problem.
Speaker 1: And in China, as long as the system was closed
Speaker 1: and the regulators to be powerful, um, they can always
Speaker 1: restructure liabilities, in which case you will never have a
Speaker 1: debt crisis. But that doesn't mean you won't have a
Speaker 1: debt problem. As the debt level grows, the debt itself
Speaker 1: becomes a constraint on on the future growth. And the
Speaker 1: problem is can only continue growing as long as debt
Speaker 1: continues growing even more quickly. Now we don't know where
Speaker 1: the limit to debt capacity is, but we certainly don't
Speaker 1: want to find out, and I think in Beijing there's
Speaker 1: a growing sense that wherever that limit is, we're getting
Speaker 1: awfully close to it. So we started to see in
Speaker 1: the last two years a much more serious attitude towards
Speaker 1: trying to reign in debt. They haven't done, so that
Speaker 1: continues to grow much more faster than any measure of
Speaker 1: debt servicing capacity, but at least it's improve it. The
Speaker 1: Chinese investment led growth model has been built on several
Speaker 1: foundations which keep household household spending, household consumption, household income unnaturally.
Speaker 1: Low interest rates are said artificially low, punishing or hurting savers.
Speaker 1: Savers don't have very good investment opportunities. Worker rights aren't
Speaker 1: particularly strong. There are other things built into the system
Speaker 1: that is essentially create a lot of household procarity and
Speaker 1: drive the savings rate up. Has China done anything structural
Speaker 1: in the last few years to make a meaningful change
Speaker 1: towards this domestic rebalancing in your view? You know, not, really,
Speaker 1: there has been some improvement. If you look at the
Speaker 1: consumption share of GDP, it's risen pretty significantly in the
Speaker 1: last four or five years. But there are two things
Speaker 1: that account for almost all of that growth. The first
Speaker 1: thing is just that GDP has dropped to grow than
Speaker 1: GDP has dropped significantly, so the consumption share, just as
Speaker 1: a matter of arithmetic, gets larger and larger. The second
Speaker 1: thing is, you know, there's two ways you can increase
Speaker 1: the consumption share of GDP for any country, not just
Speaker 1: for China. One way is to increase household debt. The
Speaker 1: other way is to increase the house that income share
Speaker 1: of GDP. Now four or five, China had very little
Speaker 1: household debt and since then it's really exploded. But that's
Speaker 1: not sustainable because if you're trying to solve for a
Speaker 1: debt problem, obviously additional debt isn't the way you're going
Speaker 1: to fix the problem. So we're probably reaching a limit there.
Speaker 1: What they really have to do is do the transfers.
Speaker 1: But when you go through all of the mechanics, ultimately
Speaker 1: they have to transfer well from local governments and local
Speaker 1: elites to the household sector. And there's you know, a
Speaker 1: dozen different ways you can do it, and now I
Speaker 1: have to do them all. But the problem is a
Speaker 1: political problem, and that is the local government's the local
Speaker 1: elites very very strongly resist these wealth transfers. Well, I
Speaker 1: wanted to press you on this issue, and you mentioned
Speaker 1: this already, but one thing you often hear is that
Speaker 1: the Chinese are culturally prone to excess savings, possibly because
Speaker 1: of recent history where there was a lot of turmoil
Speaker 1: in the country, possibly because of a lack of social
Speaker 1: safety net in China. So are there political solutions to
Speaker 1: this problem and what could those realistically actually be well.
Speaker 1: The key is increasing the household share of GDP. One
Speaker 1: of the ways of doing so, of course, is strengthening
Speaker 1: the social safety net, although it depends on how you
Speaker 1: pay for it. So if you strengthen the social safety
Speaker 1: net and pay for it by borrowing at negative real
Speaker 1: rates from household sector, then what you're doing is you
Speaker 1: are uh you know, with one hand you're giving them
Speaker 1: additional income in the form of the stone safety net,
Speaker 1: and with the other hand you're taking it away from
Speaker 1: them in the form of a negative return on their savings.
Speaker 1: The key is that it has to be funded by
Speaker 1: transfers from the household sector. Let me let me give
Speaker 1: a classic case of how this could happen. Very unlikely
Speaker 1: because it's politically quite difficult. But as you know, in
Speaker 1: China you have what's called the Huko system, which means
Speaker 1: that as a Chinese you're only allowed to live and
Speaker 1: work in the area for which you have a permit
Speaker 1: called the hukoh So when you think about all these
Speaker 1: migrant workers and saying Beijing, most of them here are
Speaker 1: technically illegal. Now they're allowed to work here, but the
Speaker 1: problem is they have a limited ability to access city services, schooling, medical, treatment.
Speaker 1: They have limited standing and law if they ever get
Speaker 1: into a conflict with their employers c So imagine that
Speaker 1: you eliminate the Hukoh overnight. Immediately, migrant workers would be
Speaker 1: richer because they would now have full access city services. Also, immediately,
Speaker 1: the city would be poorer because it now has to
Speaker 1: cover all of these services. This would be a classic
Speaker 1: transfer mechanism, and it's something the Chinese have been talking
Speaker 1: about for many years. It's just too politically difficult to
Speaker 1: pull it off. So let's fast forward to the present day.
Speaker 1: Because obviously, and this is something you've talked about in
Speaker 1: your writing, is that you know, the the growth model
Speaker 1: can continue even with all the dead even with all
Speaker 1: the domestic imbalances, so long as there's a significant amount
Speaker 1: of foreign demand for Chinese goods and as long as
Speaker 1: someone is out there buying in. For a long time,
Speaker 1: really for the whole world, but for China in particular,
Speaker 1: the US has been a major contributor of demand for
Speaker 1: goods of all of all sorts, and we see that
Speaker 1: now running into an obvious problem, which is President Trump
Speaker 1: and the trade war and this sort of general feeling
Speaker 1: maybe in the US that the current system is going
Speaker 1: on too far, and we don't want to be the
Speaker 1: the demand creator of last resort for the Chinese economy.
Speaker 1: How is that contributing to what we're seeing domestically? I mean,
Speaker 1: we know the data for China has not been particularly good.
Speaker 1: Some talk recently about giving up on the six percent
Speaker 1: GDP growth goal. Talk to us about how you know
Speaker 1: there's all these all these challenges, and how the additional
Speaker 1: challenge of the US no no longer wanting to play
Speaker 1: its UH the role it has been for the last
Speaker 1: few decades. How that is affecting things. Everything that China produces,
Speaker 1: everything that any countries has to be evolved in one
Speaker 1: of three ways. It's either consumed domestically, or it's invested domestically,
Speaker 1: or it's consumed or invested abroad, which is through the
Speaker 1: through the trades, or plus. So the total UH, total
Speaker 1: GDP that's produced in China goes into one of those
Speaker 1: three things. Now, the consumption shares we discuss is very
Speaker 1: very low, so much of it goes into investment and
Speaker 1: the trades built plus investment we want to bring down
Speaker 1: as quickly as possible because China is investing primarily and
Speaker 1: stuff that's not productive. So that's just represents a growth
Speaker 1: in the debt um But here's the problem. If the
Speaker 1: US were to put in constraints that forced the Chinese
Speaker 1: trade surplus to contract, then China either has to accept
Speaker 1: lower growth because now it can't sell everything that it's producing,
Speaker 1: so it has to close down factories and fireworkers, or
Speaker 1: it has to make up for that growth in some
Speaker 1: other way. And the only other way it can make
Speaker 1: up for that growth is by increasing investment even further,
Speaker 1: which means increasing the debt burden even more quickly. That's
Speaker 1: why the trade conflict is so important for China. It's
Speaker 1: sort of it sort of mediates the pace at which
Speaker 1: they can bring down investment, and the smaller the trade surplus,
Speaker 1: then the more slowly they're able to bring down investments.
Speaker 1: And that's the big problem now, the the overall trade problem.
Speaker 1: You know, China is not even the worst defender of
Speaker 1: this case. The Germany and Japan have bigger current accounts
Speaker 1: surfaces than China does, and the problem there is really
Speaker 1: on the capital side. No, this gets a little bit technical,
Speaker 1: but what ends up happening if you have a very
Speaker 1: very high savings rate, uh and and and all countries
Speaker 1: really high stavings rates. Contrary to popular opinion, they don't
Speaker 1: have high savings rates because there are countries that value drift.
Speaker 1: The Germans aren't particularly more thrifty than other Europeans. They
Speaker 1: have high savings grades because the household share of DDP
Speaker 1: is low and the share the controlled by businesses or
Speaker 1: by the government or by the wealthiest quite high. So
Speaker 1: those are high saving entities. You take money away from
Speaker 1: a low saving, high confirming part of the economy and
Speaker 1: give it to a high saving, low consuming part of
Speaker 1: the economy, your savings right to automatically goes up. Now,
Speaker 1: if your savings exceeds your investments, then you have to
Speaker 1: export the excess savings, which is just the flip side
Speaker 1: of running a current account or trade surplus. So countries
Speaker 1: with excess savings have to export those savings somewhere. Trade
Speaker 1: theory tells us that they export them to developing countries
Speaker 1: that need the savings, but of course we know that's nonsense.
Speaker 1: Most of it goes to wealthy countries that don't need
Speaker 1: the savings, for example, the US, and as a result,
Speaker 1: because the US is forced to absorb foreign capital that's
Speaker 1: that's exported to the US. Then it must also run
Speaker 1: the corresponding um current account or trade deficit. Now it's
Speaker 1: a little pedantic, but the point of all of that
Speaker 1: is to suggest that the reason the US runs a
Speaker 1: trade deficit is because it runs a capital account surplus
Speaker 1: over which it has no control. If that's the case,
Speaker 1: then putting tariffs on Chinese goods is worse than useless.
Speaker 1: It has no impact at all. It will reduce the
Speaker 1: US deficit with China, but if Chinese savings continue to
Speaker 1: pour into the US, China will continue to run a
Speaker 1: surplus and the US will continue to run a deficit,
Speaker 1: just not with each other. The only impact the tariffs
Speaker 1: have is to shift trade around. They don't really affect
Speaker 1: the overall sir plus of China or the overall deficit
Speaker 1: of the United States. And you can see that in
Speaker 1: the data. The US deficit with China has gone down,
Speaker 1: the US deficit with the rest of the world has
Speaker 1: gone up by even more, exactly as you would expect. So,
Speaker 1: just to be clear, is the suggestion here that the
Speaker 1: trade war between the U S and China is basically
Speaker 1: sort of an excess money problem, and the US is
Speaker 1: maybe indirectly trying to shrink these capital inflows by targeting
Speaker 1: Chinese goods, because that's one way that it could possibly
Speaker 1: alter those inflows. Yes, it's just the wrong way of
Speaker 1: doing it, but but that's exactly right. So the country
Speaker 1: like China has such a high savings and it's not
Speaker 1: an accident. It's because when you have policies that force
Speaker 1: the household sector to subsidize manufacturing, then of course that
Speaker 1: means that ultimately the part of product she retained by
Speaker 1: the household sector goes lower and lower. So you can
Speaker 1: take the case of Germany in two thousands three, two
Speaker 1: thousand four the Hearts reforms. Basically the Hearts reforms represented
Speaker 1: a transfer of income from German workers two German businesses.
Speaker 1: The households share went down profits sword that's why Germany
Speaker 1: was so competitive in the international markets because basically workers
Speaker 1: subsidize their exports. It's the same thing in China. And
Speaker 1: that's really what the US has to address, not the
Speaker 1: not the not through tariffs. So if you're President Trump,
Speaker 1: or sorry, if you're advising President Trump, you'd say, don't uh,
Speaker 1: you know, forget about all the terroraffs and soybeans or
Speaker 1: and all these things. Pressure j and pink to get
Speaker 1: rid of the JUCO system, transfer the domestic wealth of
Speaker 1: the country to the workers, eliminate this excess savings that
Speaker 1: causes all the excess money to come to the US
Speaker 1: and actually put money in the hands of people who
Speaker 1: might over time by stuff from the US. Absolutely, of course,
Speaker 1: the US can't really go insane right right now, I know,
Speaker 1: just exaggerating, But that's sort of like the contours here,
Speaker 1: which is that And I have to admit just I know,
Speaker 1: like you have a book coming out next year with
Speaker 1: Matt Klein who's at Barrens, and I remember reading this,
Speaker 1: I think a year ago. He had a really good
Speaker 1: column sort of making this point, which is that the
Speaker 1: real way for the US to make progress on the
Speaker 1: trade war would be for essentially the US to pressure
Speaker 1: a that domestic realignment that you've been talking about, so
Speaker 1: that more of the money in China is in the
Speaker 1: hands of consumers as opposed to people with a lot
Speaker 1: of extra cash to put somewhere exact exactly right, you know,
Speaker 1: when when the Chinese sell us something from a hundred dollars,
Speaker 1: that's a hundred dollar flow from from that the US
Speaker 1: to China. Ideally we want that money to flow back
Speaker 1: in the form of imports of goods, it will flow back,
Speaker 1: but it typically flows back in the form of imports
Speaker 1: of capital. So the Chinese will buy US treasury bones
Speaker 1: rather than US manufacturing equipment, and that's surely caused because
Speaker 1: of the way income is distributed in China. Um. Now,
Speaker 1: they're the only way the US can really pressure China
Speaker 1: and Germany and Japan and the rest of them to
Speaker 1: fix their domestic problems is by somehow refusing to allow
Speaker 1: that capital to flow into the US, perhaps by taxing
Speaker 1: and perhaps by quotas. I don't know, but that's really
Speaker 1: the kind of pressure that the U s should be
Speaker 1: able to resort, right, So this is something that keeps
Speaker 1: coming up. And just to play Devil's advocate for a second,
Speaker 1: can you walk us through both the positives and the
Speaker 1: negatives of having a lot of foreign money basically poor
Speaker 1: into the US, Because on the one hand, clearly it
Speaker 1: affects employment through manufacturing, but on the other hand, it
Speaker 1: does lower the US is funding costs and you know,
Speaker 1: helps people maybe spend more than they would otherwise. So
Speaker 1: there seem to be pros and cons. So could you
Speaker 1: just walk us through them and how you see it?
Speaker 1: Net net as a positive or negative. Yeah, So suppose
Speaker 1: the rest of the world exports one hundred dollars to
Speaker 1: the US. You know, we start from from balanced payments,
Speaker 1: and then for whatever reason, their savings go up and
Speaker 1: they export a hundred dollars to the US. That means
Speaker 1: in the US we will have a hundred dollar capital
Speaker 1: account of surplus and we must have a hundred dollar
Speaker 1: current account deficits. So how do we get the deficit. Well,
Speaker 1: if the US are developing country, then, for example, the
Speaker 1: way it was in the nineteenth century, then investment in
Speaker 1: the US there would be huge investment needs that would
Speaker 1: be strained by the lack of domestic savings. In that case,
Speaker 1: foreign money coming into the US would be a good thing.
Speaker 1: It would cause American investment to go up. That's exactly
Speaker 1: what happened in the nineteenth century when the US depended
Speaker 1: very heavily on British capital for its domestic investment. But
Speaker 1: the US isn't a developing country anymore. Uh. Now we
Speaker 1: have a different problem. We have too much capital interest rate. Sorry,
Speaker 1: historically historically low levels. American businesses have huge hordes of
Speaker 1: cash on their balance sheet which they are unable to
Speaker 1: invest so then they do stock buybacks and things like that.
Speaker 1: Um So, if you increase the amount of um of
Speaker 1: foreign savings, the increasing amount of capital and the US
Speaker 1: by hundred doors, will US investment go up? Well, clearly
Speaker 1: it doesn't, and we have evidence from other countries. So
Speaker 1: for example, again Germany after two thousand three, two thousand four,
Speaker 1: when they're savings went up and the cost of capital declimbed,
Speaker 1: their investment didn't go up. It actually went down. And
Speaker 1: I think that reflects the fact that we're no longer
Speaker 1: living in a capital constrained world. We have even negative
Speaker 1: interest rates to drive down the American savings rate, either
Speaker 1: you increase unemployment, or you increase household debt, or you
Speaker 1: increase the fiscal deficit. None of those are good things obviously.
Speaker 1: So that's why for the US running a current account
Speaker 1: deficit in a capital account surplus is a real problem.
Speaker 1: And so that's why I think it does make sense
Speaker 1: for the Trump administration. And Bernie Sanders said the same thing,
Speaker 1: and and Liz with Orans said the same thing for
Speaker 1: them to address the current account deficit. It's just that
Speaker 1: they're addressing it the wrong way. Yeah, I thought it
Speaker 1: was pretty striking that during one of the recent Democratic debates,
Speaker 1: the moderator asked the candidate, who would uh immediately reverse
Speaker 1: Trump's terror on China? And none of them raise their hands.
Speaker 1: And so even to your point, maybe that's not the
Speaker 1: right that's not the right approach. There is this political
Speaker 1: alignment in the US between Trump and the Democrats where
Speaker 1: none of them want to go back to the old
Speaker 1: relationship with China right away. It's no one thinks it's
Speaker 1: as simple as just reversing trumps um and that everything's fine.
Speaker 1: And I know again, I know you have an upcoming
Speaker 1: book sort of exploring this dimension or the sort of
Speaker 1: the connection between class warfare and trade warfare, domestic inequality
Speaker 1: and trade wars. Regardless of whether Trump is pursuing the
Speaker 1: right approach, everything that you've laid out on what all
Speaker 1: of our political leaders seemed to intuit is that there
Speaker 1: really was something truly broken about the existing or the
Speaker 1: the old relationship. Absolutely, it's the imbalances were much higher
Speaker 1: than than than trade theory will submits. They last much
Speaker 1: more more than trade theory would permit. They were created
Speaker 1: by significant distortions. And you mentioned the book that Matt
Speaker 1: Klein and I are are publishing. Sometimes I think it
Speaker 1: may and and in in the book, what we try
Speaker 1: to argue is that what looks like a conflict between
Speaker 1: nations is really a conflict between economic sectors. The same
Speaker 1: groups in China and in the US, or in Germany
Speaker 1: and in Spain benefited from the imbalances, and the same
Speaker 1: groups paid the cost of the imbalances. Who's the biggest
Speaker 1: culprit when it comes to economic sectors? You mentioned both
Speaker 1: in the case of the US and China, this idea
Speaker 1: of corporates having a large size of national wealth. So
Speaker 1: I'm just wondering, is there one particular entity that you
Speaker 1: would say is worse than others? Well, you know, I've
Speaker 1: spent most of my career on one street, so I
Speaker 1: hate to say this, but the fact is, the global
Speaker 1: banks benefit tremendous and this system from these international capital flows. Large,
Speaker 1: large businesses that are easily able to move their operations
Speaker 1: around benefit from it. Small producers and workers are there,
Speaker 1: and household savers are ultimately the ones that pay for
Speaker 1: this system. Before we go, we have to wrap it up. Surely,
Speaker 1: I want to just turn to one other thing. It's
Speaker 1: not directly related to this, but it touches on all
Speaker 1: this stuff, of course, but these days there's a tremendous
Speaker 1: amount of discussion and political pressure on Germany specifically to
Speaker 1: expand engage in fiscal expansion. That when people look at
Speaker 1: the imbalances in the world right now, obviously the U. S.
Speaker 1: China trade relationship is all its issues, but that there's
Speaker 1: this sort of obvious issue in Europe where the richest
Speaker 1: country really should be spending a lot more and they
Speaker 1: have this, uh, you know, obsession with balanced budgets doesn't
Speaker 1: make any sense, and um, well, how big of a deal,
Speaker 1: like how big of a problem is German fiscal rectitude
Speaker 1: right now? And how what could happen if if they
Speaker 1: don't do something to address their own imbalances. It's it's
Speaker 1: a huge problem because you know, the problem that we
Speaker 1: have globally is a demand side problem. We have insufficient demand.
Speaker 1: And one of the reasons we have such weak demand
Speaker 1: is because, thanks to income inequality and also thanks to
Speaker 1: our cantilsm, the consuming part of the world is too small,
Speaker 1: so there is insufficient consumption unless it's boosted by debt,
Speaker 1: which of course is unsustainable and risky. And with that
Speaker 1: insufficient consumption there's insufficient business investment to serve that consumption.
Speaker 1: When Germany says that the solution for the world is
Speaker 1: for everyone to be like us, that's a huge problem
Speaker 1: because what that means is that everyone should continue lower
Speaker 1: ages in order to become more competitive. But if we
Speaker 1: all lower wages to become more competitive, we just get poor.
Speaker 1: We run into the problem of the nineteen thirties, which
Speaker 1: the then governor of the FED, a brilliant man by
Speaker 1: the name of Mariner Echoes, explained it. He said that
Speaker 1: as you keep pushing down workers wages in order to
Speaker 1: benefit the wealthy, you're not even benefiting the wealthy because
Speaker 1: if workers are unable to consume the things that the
Speaker 1: wealthy produced, then everyone gets caught him this downward spiral,
Speaker 1: and that's sort of what Germany forced onto the rest
Speaker 1: of Europe. So I think that they're going to have
Speaker 1: to change your fiscal rectitude, because I don't think they
Speaker 1: really have a choice. Once the world is unable to
Speaker 1: absorb all of Germany's excess production, and it's huge, it's
Speaker 1: about nineotone percent a g d P, then what can
Speaker 1: Germany do if it is unable to consume it domestically?
Speaker 1: Then it must stop producing it, and stopping producing it
Speaker 1: means closing down factories and firing workers, etcetera, etcetera. So ultimately,
Speaker 1: I don't think they'll do that. I don't think. I
Speaker 1: think they're smart enough to recognize that they have to
Speaker 1: engage in domestic spending, and they will, but they'll only
Speaker 1: do it when they're forced to. I think. So before
Speaker 1: we go, one of our listeners said that we absolutely
Speaker 1: have to ask you the following question. So I'm going
Speaker 1: to try to tie it into some of the topics
Speaker 1: that we've been discussing. But when you view China's economy,
Speaker 1: are you confident that the rebalancing is going to happen?
Speaker 1: And in what time frame do you think it might happen?
Speaker 1: And also are you sort of positive about the direction
Speaker 1: over of the overall China economy? And when you do
Speaker 1: some of the other stuff that you do in Beijing,
Speaker 1: which is you know a music label, you're involved in
Speaker 1: the music scene over there, and I think at one
Speaker 1: point you ran a club. I'm not sure if it's
Speaker 1: still open or not. But what does that tell you
Speaker 1: about the direction of the Chinese economy? Well, the question
Speaker 1: is will rebalancing happen. Is is very obvious. Yes, it
Speaker 1: has to happen, and it will happen. One thing historically
Speaker 1: is we know that all great imbalances eventually reverse. The
Speaker 1: question is how does it reverse. It could reverse in
Speaker 1: the form of a crisis. So, for example, if you
Speaker 1: look at the US in the early nine thirties, in
Speaker 1: the US had many of the same problems that China did,
Speaker 1: and the way it rebalanced was in the first three
Speaker 1: years of the decade, GDP contracted by something like thirty
Speaker 1: five the household income contracted by roughly half. That incredibly painful,
Speaker 1: but it rebalanced. Another way of rebalancing is the way
Speaker 1: the Japanese did after They also have the same imbalances
Speaker 1: that China does. Nowhere needs the same imbalances, so they
Speaker 1: rebalanced two, but they rebalanced in the form of two
Speaker 1: lost decades of stagnant GDP growth. Those are basically the
Speaker 1: models that the world gives us. Those are the two
Speaker 1: ways you rebalance. And my guess is that China will
Speaker 1: rebalance the Japanese way in a very long drawn out rebalancing.
Speaker 1: Now for China, the sooner they start that process, the better,
Speaker 1: which basically means the more rapidly GDP growth drops, the
Speaker 1: better for China, and I have to say in the
Speaker 1: last few months, I've been pretty impressed that they haven't
Speaker 1: done what they always do when growth slows, and that
Speaker 1: is the panic and stuff on the accelerator. They haven't
Speaker 1: done that, and growth is slowing pretty sharply. I just
Speaker 1: met with one of my former students, is very well
Speaker 1: plugged in, and he thinks it's possible we may even
Speaker 1: see months of five eight percent growth this year. That
Speaker 1: I think would be a really good sign because that
Speaker 1: means that China is really serious about getting its debt
Speaker 1: under control. The problem is that I think they think
Speaker 1: that is an are controlled somewhere around four and a
Speaker 1: half the five, whereas I think it's it's got to
Speaker 1: go below three before it gets under control. But we'll see,
Speaker 1: We'll see what happens. And what about the music scene.
Speaker 1: What does that tell you about the future of China.
Speaker 1: There's been good and bad things, but one of the
Speaker 1: one of the most exciting things about being in China,
Speaker 1: and it's something that I think a lot of people
Speaker 1: miss because they're looking for the wrong signals, and that
Speaker 1: is there's this incredibly buoyant cultural explosion taking place among
Speaker 1: the urban young China, and music is at the center
Speaker 1: of it, but it's not the only part of it.
Speaker 1: You see it in fashion, you see it in art,
Speaker 1: you see it in comics, you see the movies, lots
Speaker 1: of different things. It's really quite impressive what's happening here.
Speaker 1: But I don't think that should be a surprise. Chinese
Speaker 1: incomes have have have soared in the last twenty to
Speaker 1: thirty years, and China has gone from a country that
Speaker 1: is primarily rural to one that is primarily urban, and
Speaker 1: and we've never seen anything take place at this speed before,
Speaker 1: so we don't really know what the result is going
Speaker 1: to be, but it's probably a safe bet that it's
Speaker 1: going to be culturally extremely interesting, in something very vibrant. Alright,
Speaker 1: Michael Pettis, we're going to have to have you come
Speaker 1: back on just to talk about music for an episode.
Speaker 1: I think I'd love to. That was great. Thank you
Speaker 1: so much, Michael. That was I learned so much. I
Speaker 1: really appreciate it. Thanks very much. I hope that was useful.
Speaker 1: So I love that conversation and I love that we're
Speaker 1: having at a sort of key political date in the
Speaker 1: Chinese calendar, because I think the policy is so important
Speaker 1: to all of this, right, absolutely, I really really liked
Speaker 1: that conversation, and the way Michael explains things is so
Speaker 1: clear because a lot of this type of analysis, a
Speaker 1: lot of which is sort of based on seemingly accounting identities,
Speaker 1: the sort of axiomatic relationship between savings investment and the
Speaker 1: current account. It could seem like it can be. I
Speaker 1: always have a slightly hard time keeping these relationships in
Speaker 1: my head exactly like what moves up and so what
Speaker 1: therefore then has to go down? And I just think
Speaker 1: Michael did such a clear job explaining it and then
Speaker 1: explaining how these things have real world out ramifications. Yeah,
Speaker 1: And the other thing that seems to be coming through
Speaker 1: on our episodes recently is the notion that there is
Speaker 1: some sort of problem of imbalances with too much money
Speaker 1: flowing into the US. We talked about it with David
Speaker 1: Beckworth most recently, and Michael brought it up yet again,
Speaker 1: and people seem to be moving towards a consensus that
Speaker 1: there is an issue here. They just disagree how exactly
Speaker 1: to fix it. And it's one of those things that
Speaker 1: to the average person, they would have a really hard
Speaker 1: time wrapping their head around why that's a problem. So
Speaker 1: it's like, Okay, China is investing all this money, all
Speaker 1: this exporting all this capital to the US. I think
Speaker 1: intuitively to a lot of people like that's a good thing.
Speaker 1: Why not have people bring their money here? But then
Speaker 1: the way Michael explains it in terms of driving up
Speaker 1: asset prices, driving up the dollar, etcetera, or closing ing
Speaker 1: loosening of lending standards, and that hurts us savings. Uh,
Speaker 1: you start to actually crystallize what it really means to
Speaker 1: have capital flow to you as as opposed to demand
Speaker 1: for our goods. So I just feel like that was
Speaker 1: so instructive and just seems to explain so much of
Speaker 1: what's happened in the economy over the last several decades. Yep,
Speaker 1: for sure. And we'll have to hap him back on
Speaker 1: to talk about his music label and his club as well.
Speaker 1: All right, well, let's leave it there for now. This
Speaker 1: has been another episode of the All Thoughts podcast on
Speaker 1: Tracy Alloway. You can follow me on Twitter at Tracy
Speaker 1: Alloway and I'm Joe. Why isn't thal? You could follow
Speaker 1: me on Twitter at the Stalwart and you should definitely
Speaker 1: follow our guest on Twitter. He's way underfollowed for how
Speaker 1: much he knows, criminally underfollowed, criminally underfollowed. Michael Pettis, He's
Speaker 1: at Michael X Patris. Check him out and be sure
Speaker 1: to follow our producer on Twitter, Laura Carlson. She's at
Speaker 1: Laura M. Carlson, as well as the Bloomberg community of podcasts,
Speaker 1: which is under the handle at podcasts. Thanks for listening.