"Macro" Musings

[AtlCDore]

I have a couple of questions to the board:

 

1) Do any of you think that there could be a benefit to a country like Italy leaving the Euro? And if Italy were to leave, is that the domino that breaks apart the Euro?

 

2) Regarding the HK dollar.  Do you think it's a foregone conclusion that they not longer peg it to the US$?  If so, then do they make it a floating currency or peg it to the Yuan?  It would seem to me that China would like to have it pegged to the Yuan. 

 

Thanks,

 

AtlCDore

[ni-co]

I have a couple of questions to the board:

 

1) Do any of you think that there could be a benefit to a country like Italy leaving the Euro? And if Italy were to leave, is that the domino that breaks apart the Euro?

 

2) Regarding the HK dollar.  Do you think it's a foregone conclusion that they not longer peg it to the US$?  If so, then do they make it a floating currency or peg it to the Yuan?  It would seem to me that China would like to have it pegged to the Yuan. 

 

Thanks,

 

AtlCDore

 

1) There'd be great benefits for Italy. They could devalue their currency, inflate away their debt and export more goods to Germany. They'd probably have a domestic investment boom and could thereby get rid of their high unemployment.

 

2) Seems reasonable to me that they'd want to to peg it to the Yuan. Sooner or later China will want to "merge" HK into China – though that might be some years down the road – and pegging the currencies might be one step towards this goal. On another note, China doesn't seem to intervene directly in the currency markets at the moment because the Yuan is relatively weak. – Though the decision to cut rates is essentially another form of intervention to keep their trade surplus where it is.

[rb]

Interesting that deflation after the civil war in 1865 to 1890 was 2.84%!

 

Yet you had highest gdp growth ever at 4.54% for 25 years.

 

I wonder what debt gdp was over that period? That tells you, you don't need inflation to stimulate consumers or investors. If the opportunities are there, people will spend and invest.

 

So what is happening is really politics influenced economics to say that inflation is good, so politicians can borrow more money to get more power? Even though it is complete bullshit. Allthough at some point it becomes necessairy to inflate away the excessive debt. But at the expense of the common man.

 

The period after the civil war was completely different than what you have now. Back then was a period of significant technology advancement. So you had supply side disinflation. Basically supply increases, and GDP increases with inflation going down. On top of that, back then you had the gold standard so a really rigid money supply. It's actually likely that if the money supply was more loose you would have had even greater GDP growth. Maybe 10-12% vs 7.4%.

 

Getting back to inflation, it's not just politicians that say inflation is good. Actually from what I read politicians tend to be against inflation. But some stable inflation truly is good.

 

Firstly, there is nothing really wrong with inflation per se when it's stable. Think of it like a math constant. You multiply an equation with a constant and nothing changes. So say you have c% inflation per year.... then you expenses go up by c%, your income goes up by c%, so your buying power stays the same. And generally you cannot have inflation without incomes going up.

 

Secondly inflation is good because it stimulates consumption. If you have some inflation you're more incentivized to buy stuff vs hoard currency. You also probably want inflation to be higher rather than 2%, maybe 4-5%. This is for your monetary policy to have traction. Let's say that you have 1% inflation, real rates of 1% and full employment. Then ur nominal rates are 2%. You get a recession, interest rates drop and you've hit zero bound and you can't lower rates to stimulate the economy. But if you had 4% inflation, nominal rates were 5%, and when they drop you still have monetary policy traction.

 

Right now this is the problem. Let's say that currently the interest rate required for full employment is -2.5%. But you have 0 rates and 1% inflation. So real rate is -1%, which is too high, so you get deleveraging, low demand, unemployment, and economic slack to the tune of $1Tn per year. If you had 3% inflation, then you could have 0.5% rates and problem solved.

[rb]

I have a couple of questions to the board:

 

1) Do any of you think that there could be a benefit to a country like Italy leaving the Euro? And if Italy were to leave, is that the domino that breaks apart the Euro?

 

2) Regarding the HK dollar.  Do you think it's a foregone conclusion that they not longer peg it to the US$?  If so, then do they make it a floating currency or peg it to the Yuan?  It would seem to me that China would like to have it pegged to the Yuan. 

 

Thanks,

 

AtlCDore

 

1) There'd be great benefits for Italy. They could devalue their currency, inflate away their debt and export more goods to Germany. They'd probably have a domestic investment boom and could thereby get rid of their high unemployment.

 

2) Seems reasonable to me that they'd want to to peg it to the Yuan. Sooner or later China will want to "merge" HK into China – though that might be some years down the road – and pegging the currencies might be one step towards this goal. On another note, China doesn't seem to intervene directly in the currency markets at the moment because the Yuan is relatively weak. – Though the decision to cut rates is essentially another form of intervention to keep their trade surplus where it is.

 

I don't think that HK will break the peg to the USD. It's really engrained in the HK economy and they are prepared to defend it. I know there's a lot of financial data on this somewhere but I'm a bit busy right now to look it up for you guys. Also to Ni-co's point, the HKD is already kinda pegged to the yuan if you think about it. The yuan is loosely pegged to the USD and HKD is pegged to the USD. Thus transitively the HKD is loosely pegged to the yuan.

 

In regards to Italy exiting the euro. I'm sorry, I don't think they will, and the benefits aren't that big for them.

 

Firstly, they don't need to devalue their currency. Italy is running a trade surplus of 2.3% of GDP, so unit labor costs are competitive.

 

As for debt, yes Italy has high gov debt, but they always had high gov debt. And their public finances are not in that bad a shape. They have a deficit of 2.3% of GDP, but also a primary surplus of 2.2% which is very good. And the deficit should decrease as they roll over debt on lower rates. Furthermore Italy is not very levered. Yes gov debt is high, but has little private debt so as a country they're actually doing pretty good.

 

Where Italy would gain by going off the Euro, is getting their own currency, central bank and monetary policy. That way they could stop bank runs and do some of their own monetary stimulus to bring the economy towards full employment as it looks like the unemployment is due to sluggish domestic demand. But I don't think that Italy would like to endure the bank runs and all that nasty stuff that comes with a Euro exit just to shave 3% off the unemployment rate.

 

The countries that would really benefit from Euro exit are Greece, Portugal, and Spain. In those cases I'm pretty sure that the Euro survives Greece and Portugal, Spain--- I don't know.

 

rb

 

[yadayada]

Secondly inflation is good because it stimulates consumption. If you have some inflation you're more incentivized to buy stuff vs hoard currency. You also probably want inflation to be higher rather than 2%, maybe 4-5%. This is for your monetary policy to have traction. Let's say that you have 1% inflation, real rates of 1% and full employment. Then ur nominal rates are 2%. You get a recession, interest rates drop and you've hit zero bound and you can't lower rates to stimulate the economy. But if you had 4% inflation, nominal rates were 5%, and when they drop you still have monetary policy traction.

 

There is not really any evidence for this statement is there? I mean people still buy computers, iphones and cars, even though they could get that same model the next year for much cheaper. Or buy a better model for the same price next year? It seems people are really motivated by wether they need the thing they want to buy.

 

Seems like one of those statements that sound kinda logical, but there is no convicing evidence this is actaully true in reality.

 

It seems the only good argument for inflation is that it stimulates investing activity?

 

As for Italy, it seems to reduce government debt, politicans need to reduce spending, which they won't do. Isn't it likely that they follow Japan here? And a exit of Italy is inevitable? And italy rates really badly with regards to corruption and productivity, which will greatly stunt their future growth.

 

And when they then leave the euro, you will get bank runs, because it takes time to switch to the lira? So banking system will collapse, doing a lot of damage. And capital will flee from the country.

 

Finally household debt is relatively low, but that is because italians are not as wealthy. And corporate debt is still quite high?

[ni-co]

I have a couple of questions to the board:

 

1) Do any of you think that there could be a benefit to a country like Italy leaving the Euro? And if Italy were to leave, is that the domino that breaks apart the Euro?

 

2) Regarding the HK dollar.  Do you think it's a foregone conclusion that they not longer peg it to the US$?  If so, then do they make it a floating currency or peg it to the Yuan?  It would seem to me that China would like to have it pegged to the Yuan. 

 

Thanks,

 

AtlCDore

 

1) There'd be great benefits for Italy. They could devalue their currency, inflate away their debt and export more goods to Germany. They'd probably have a domestic investment boom and could thereby get rid of their high unemployment.

 

2) Seems reasonable to me that they'd want to to peg it to the Yuan. Sooner or later China will want to "merge" HK into China – though that might be some years down the road – and pegging the currencies might be one step towards this goal. On another note, China doesn't seem to intervene directly in the currency markets at the moment because the Yuan is relatively weak. – Though the decision to cut rates is essentially another form of intervention to keep their trade surplus where it is.

 

I don't think that HK will break the peg to the USD. It's really engrained in the HK economy and they are prepared to defend it. I know there's a lot of financial data on this somewhere but I'm a bit busy right now to look it up for you guys. Also to Ni-co's point, the HKD is already kinda pegged to the yuan if you think about it. The yuan is loosely pegged to the USD and HKD is pegged to the USD. Thus transitively the HKD is loosely pegged to the yuan.

 

In regards to Italy exiting the euro. I'm sorry, I don't think they will, and the benefits aren't that big for them.

 

Firstly, they don't need to devalue their currency. Italy is running a trade surplus of 2.3% of GDP, so unit labor costs are competitive.

 

As for debt, yes Italy has high gov debt, but they always had high gov debt. And their public finances are not in that bad a shape. They have a deficit of 2.3% of GDP, but also a primary surplus of 2.2% which is very good. And the deficit should decrease as they roll over debt on lower rates. Furthermore Italy is not very levered. Yes gov debt is high, but has little private debt so as a country they're actually doing pretty good.

 

Where Italy would gain by going off the Euro, is getting their own currency, central bank and monetary policy. That way they could stop bank runs and do some of their own monetary stimulus to bring the economy towards full employment as it looks like the unemployment is due to sluggish domestic demand. But I don't think that Italy would like to endure the bank runs and all that nasty stuff that comes with a Euro exit just to shave 3% off the unemployment rate.

 

The countries that would really benefit from Euro exit are Greece, Portugal, and Spain. In those cases I'm pretty sure that the Euro survives Greece and Portugal, Spain--- I don't know.

 

rb

 

I'm sorry but I completely disagree. In my opinion you are heavily overestimating the power of politics vs. market forces.

 

I think it's quite naive to assume that the USD/HKD or USD/RMB peg is a purely political decision. If there's no other form of rebalancing going on they will be overrun by the markets – as it has always been with such pegs.

 

Don't you think that Italy's banks are perceived to be safer under an implicit ECB guarantee than on a standalone basis? I don't get that argument. Neither do I understand your argument with Italy's surplus. This has been the case since 2013 only. It took ZIRP and massive unemployment in Italy to get to that point. The obvious elephant in the room is that Italy can't devalue in relation to Germany – which is the only really important aspect of breaking the euro apart.

 

Yes, Italy would gain by getting its own monetary policy which was exactly my point. With regard to Italy's private household debt: I think what matters in the end is total debt to GDP ratios – including accounting for retirement claims which no country within the EU does momentarily. From this perspective every country in the EU looks just outright awful.

 

I don't share your optimistic view with regard to the euro staying either. Yes, Spain is a problem but so are Italy and France with their huge debt loads – the absolute numbers matter far more here because what matters in the end is whether markets assume that other countries are even able to somehow counterbalance/shoulder them (and are politically willing to!). In the long term the only way I can see the euro surviving is a United States of Europe scenario – but this doesn't seem to be the most probable case to me.

[rb]

 

There is not really any evidence for this statement is there? I mean people still buy computers, iphones and cars, even though they could get that same model the next year for much cheaper. Or buy a better model for the same price next year? It seems people are really motivated by wether they need the thing they want to buy.

 

Seems like one of those statements that sound kinda logical, but there is no convicing evidence this is actaully true in reality.

 

It seems the only good argument for inflation is that it stimulates investing activity?

 

As for Italy, it seems to reduce government debt, politicans need to reduce spending, which they won't do. Isn't it likely that they follow Japan here? And a exit of Italy is inevitable? And italy rates really badly with regards to corruption and productivity, which will greatly stunt their future growth.

 

And when they then leave the euro, you will get bank runs, because it takes time to switch to the lira? So banking system will collapse, doing a lot of damage. And capital will flee from the country.

 

Finally household debt is relatively low, but that is because italians are not as wealthy. And corporate debt is still quite high?

 

YadaYada,

 

It's hard to get evidence on inter-temporal purchase decision based on inflation since it's not something you can really count. The best evidence to that you can find is that when Japan got deflation, the only thing that was selling really well over there were safes. Besides that there is academic stuff that covers it. But it doesn't really matter too much, cause for you need some inflation for other purposes such as monetary policy traction, avoiding debt and deleveraging spirals, etc. The main thing to not rock the boat is not so much the level of inflation but the volatility of it. You want to keep it steady.

 

My point in regard to Italy is that they won't leave the Euro because I don't think that the benefits are greater then the cost. They don't need to devalue (trade is pretty much balanced). The fiscal situation is not that bad either. Yes, the gov debt is quite high, but the deficit is not that big and will shrink and they have a primary surplus. So here to improve the debt situation they just need nominal GDP to growth to be a bit bigger than the deficit and they'll be ok. They're problems are mostly related to domestic demand. Probably a bit too much austerity. So going off the euro will probably help with that. But is it worth it just to lower unemployment by 3-4%?

 

The question about the banks is yea, there will be bank runs if the exit gets more imminent. But even if you do it over a weekend and impose capital controls, then the banks have assets in Lira and liabilities in Euro, then even a 10% decrease in Lira/Euro would wipe out the banks capital.

 

When it comes to household debt, no it's not just because they are poorer. I'm looking at debt/GDP ratios here. And the corporate debt is also quite low. Total private non-financial debt to gdp for Italy is 120.8%. They just don't have a lot of debt. For comparison, private debt/gdp for Germany is 111.6%.

 

rb

[rb]

I'm sorry but I completely disagree. In my opinion you are heavily overestimating the power of politics vs. market forces.

 

I think it's quite naive to assume that the USD/HKD or USD/RMB peg is a purely political decision. If there's no other form of rebalancing going on they will be overrun by the markets – as it has always been with such pegs.

 

Don't you think that Italy's banks are perceived to be safer under an implicit ECB guarantee than on a standalone basis? I don't get that argument. Neither do I understand your argument with Italy's surplus. This has been the case since 2013 only. It took ZIRP and massive unemployment in Italy to get to that point. The obvious elephant in the room is that Italy can't devalue in relation to Germany – which is the only really important aspect of breaking the euro apart.

 

Yes, Italy would gain by getting its own monetary policy which was exactly my point. With regard to Italy's private household debt: I think what matters in the end is total debt to GDP ratios – including accounting for retirement claims which no country within the EU does momentarily. From this perspective every country in the EU looks just outright awful.

 

I don't share your optimistic view with regard to the euro staying either. Yes, Spain is a problem but so are Italy and France with their huge debt loads – the absolute numbers matter far more here because what matters in the end is whether markets assume that other countries are even able to somehow counterbalance/shoulder them (and are politically willing to!). In the long term the only way I can see the euro surviving is a United States of Europe scenario – but this doesn't seem to be the most probable case to me.

ni-co,

 

In regards to HKD/USD peg, don't think it's the same with other pegs that broke down. Those usually did because the currencies were weaker than the USD. HKD is stronger. Anyway, it's more complicated, and I'll write another post about it when I have more time to look up more info about it.

 

In regards to the Euro stuff, I completely agree with you that the best solution would be the United States of Europe scenario but I don't think that that's likely to happen. In regards to the split up, to be honest, in the beginning I was sure it was going to happen, now I'm not so sure. A lot of people have been willing to take a lot of pain to keep it together. Also it's not going to be good for Germany either to break it. So maybe they'll find a way to make it work.

 

My argument regarding Italy's trade surplus is that it's an indication whether the currency is too high or not, so if you have trade surplus, it's not. And yes, their surplus is recent: 2.3% in 2013, 1.1% in 2012. For 2005-2012 there were deficits but small ones - sub 1% (except for 2010, 2011 at 1.9 and 1.4). I fail to see why they would so desperately need to devalue just because they run a deficit with Germany when they're balanced overall.

 

Regarding the ECB's implicit guarantee... Well there is no guarantee really. The ECB has no mandate to be a lender of last resort. The bank guarantee is more from the goodness of their hearts and can take it back at any time, probably when it's needed the most. So yea your own central bank would be better. This is a bit of a moot point tho because the Italian banks go bankrupt when Italy leaves Euro.

 

Now let's take a look at some debt ratios. I agree with you that you need to look at them in totality. I'll leave aside the pension liabilities cause I didn't feel like digging for those. If you get them, post them because I'm interested.  I got the gov debt to gdp and private non-financial debt to gdp for Germany, Italy, France, and Canada (for non-eu comparison)

                  Gov Debt    Private Debt      Total

Germany          78.4              111.6        190.0

Italy                132.5            120.8        253.3

France              91.8              178.2        270.0

Canada            88.8              206.2        295.0

 

Now, some of the debt is on the higher side, but nothing catastrophic. Italy has higher gov debt, but that has really been accumulated mostly in the 70s and 80. They've been pretty responsible for the past 20 years. I also don't see how France is going bankrupt any time soon. Gov debt is not ideal but nothing catastrophic, not that far from the pillars of fiscal responsibility that are Germany and Canada. I must admit that I am a bit surprised by the Private debt. I thought it would be smaller. If there's a worry to be had it would be there.

 

As a P.S. to this, and I see you're from Germany so I hope you can help. From what I know German home ownership rates are the lowest in the developed world (55-60%) though I cannot find good stats. For our discussion here that would mean that German private debt is understated (less mortgages). But what I really want to know is 1. Is that true? 2. If yes, do you know the reason for that?

[yadayada]

Yes, the gov debt is quite high, but the deficit is not that big and will shrink and they have a primary surplus. So here to improve the debt situation they just need nominal GDP to growth to be a bit bigger than the deficit and they'll be ok.

I think you make some interesting points, but I disagree here. I think you are leaving out the human element in the equation here, and that is: people are idiots. They think for themselves, and don't give a shit (or really know) what is good for the country. Look at spain with podemos. If that party would get to power and do all the things they say they would do, it would do huge damage to spain. I dont think governments are going to be responsible, they are going to push things untill everything spins out of control, because that is what their people want. The people dont know anything about economics, and most believe that a deficit is good, and not having one is bad and not social.

 

Running a surplus is really political suicide, politicians are not incentivized at all to do what you say. And there is no central bank to nicely inflate their debt away at 4% inflation or so. So I think it will be pushed untill the bond markets push back, and then things will get ugly.

 

Also business climate and corruption is just horrible in Italy, and this is not about to be changed, unless shit really hits the fan. They rank worse then various third world countries in this regard.

 

But let's see I guess, I hope Im proven wrong.

 

That is also why I like current greek government so much, these guys know what to say to get power, but secretly they know what is good for the country (I think). Im actually more optimistic about greece  if they would manage to restructure their debt, and current government keeps its power for a few more years.

[yadayada]

stats on Chinese concrete use:

 

And some interesting top comments from some engineers.

 

Apparently, judging by those comments, the Chinese construction industry is a smaller % of GDP then the west.

[rb]

I think it's quite naive to assume that the USD/HKD or USD/RMB peg is a purely political decision. If there's no other form of rebalancing going on they will be overrun by the markets – as it has always been with such pegs.

 

I promised I would come back with a post about HKD/USD peg so here it is.

 

One of the things that govern this situation is the monetary trifecta that all countries want: A fixed exchange rate, open capital markets, and independent monetary policy. The trick is that they can only have 2 of the 3.

Now in the past markets forced pegs to break because countries tried to have all 3.

 

In all of the broken peg situations that I know of, countries with weaker currencies came under attack with basically a carry trade that depleted their reserves and had to break the peg and devalue.

 

So how would you try to break the peg to a currency that is stronger than the one it is pegged to? Well you would go long HKD short USD until Hong Kong gets tired of accumulating reserves.

 

Now you may think well if a big trade gets put on then that will increase money supply and smack the HK economy with inflation until it comes to its senses. Well… no.

 

A little background here. HKD is not issued by the Central Monetary Authority, it is issued by the commercial banks (3 of them). By law, the banks must have in reserve the USD to back all the HKD it issued and stand behind them. The commercial banks also get to set interest rates to balance the whole situation.

 

Now, back to aforementioned inflation. Inflation doesn’t just magically happen. It happens when monetary infusions get transmitted through loans which create too much money chasing not enough goods. If money doesn’t get lent out then no inflation.

 

The problem here is that the new HKD will not get lent out.  This is because when you increase the amount of HKD through the attack on the peg, HK banks will drop rates on HKD. This creates an arbitrage opportunity and other market players take the opposite side and neutralize the attack.

 

Now let’s go even further and assume that the market ignores the opportunity to make risk-free profits because it is utterly convinced that the peg will be broken and day now or something like that. Then all that’s need to do to sterilize the new infusion of HKD is for the banking regulator to raise the reserve requirements of banks. So again no inflation. Peg stands.

 

rb

 

[vinod1]

A really good post by Pettis:

 

http://blog.mpettis.com/2014/12/how-might-a-china-slowdown-affect-the-world/

 

Vinod

[yadayada]

what i miss in that post is the actual discussion of people. Their skills work ethic , their cost of labor, levels of corruption etc. I miss that in a lot of macro discussions. Probably why a lot of macro economists are so terrible at predicting stuff? They are the drivers of an economy, not some abstract savings ratio. That is a sympton. And a lot of macro economists treat people like they are uniform rational spheres that are all the same, and not matter a great deal. ANd ignore them in their analysis. Probably has to do with assumptions that market partcipants are always rational and everything is always fairly valued?

 

It seems to me that growth comes from the fact that Chinese workers are working like crazy, their education level is good, and they charge little for their work. So you have workers that are almost as smart as western equivalents, work like crazy and you can pay them only a fraction of what you pay people in that west. And the system those people are functioning in works relatively well. Without crippling levels of red tape and corruption that can run a good business in the ground. As long as they can keep taking over more jobs in China for less money, and they keep up their productivity, China will grow like crazy over the next decade or so.

 

China, in other words, is not the world’s growth engine. Behind Germany and ahead of some of the oil producers, it runs the largest current account surplus in the world, which means that it is exporting its excess savings in a world that has nowhere to put the money, and so the world must respond either with speculative asset bubbles, unproductive investment, debt-fueled consumption binges or unemployment.

I see nowhere why exactly this is true? Why is there no need for investment? Why is demand lacking? Maybe it has to do with supply? With ballooning debt levels? With the fact that western workers are becoming less competitive for what you have to pay them? Because if demand lacks, it means that those people and institutions that would demand stuff, have nothing to supply in return to get that demand. If you figure that out, you get to the core of the problem.

 

Also is the world worse off if China has a shitload of workers with more work ethic that are slowly catching up with the west in terms of their ability? And are willing to do it for cheaper? It means cheaper stuff goods for the west. It seems China is still good value in this regard. And if you want to predict a medium and longer term slowdown, you are predicting that this value gap between western workers and Chinese workers has closed. Or that Frontier economies are surpassing China in this regard. I dont think that is true. I think we will see a move to China of higher skilled jobs and higher tech industries in the future.

 

I think a ccontinuing increase of labor arbitrage to China is the best predictor of growth. If you want to analyze Chinese growth, you have to analyze that. Because if there is more value the Chinese can provide in the future, it means they can take more value, and it means their GDP will keep growing, even if the rest of the world is slowing down.

 

That is also why a lost decade for China is very unlikely right now. When that happened to Japan it was because that value arbitrage gap was mostly closed, Japanese workers did not produce much more value vs western workers considering what you had to pay them. So that stunted growth. ANd debt had reached crippling levels there.

 

So I guess to summarize, it is kind of strange to discuss chinese growth without discussing both debt and the value of workers comparing to the rest of the world.

 

FWIW, i did not come up with this, im just parroting ray dalio :) . I think his view on this makes the most sense.

[Liberty]

what i miss in that post is the actual discussion of people. Their skills work ethic , their cost of labor, levels of corruption etc. I miss that in a lot of macro discussions. Probably why a lot of macro economists are so terrible at predicting stuff? They are the drivers of an economy, not some abstract savings ratio. That is a sympton. And a lot of macro economists treat people like they are uniform rational spheres that are all the same, and not matter a great deal. ANd ignore them in their analysis. Probably has to do with assumptions that market partcipants are always rational and everything is always fairly valued?

 

It seems to me that growth comes from the fact that Chinese workers are working like crazy, their education level is good, and they charge little for their work. So you have workers that are almost as smart as western equivalents, work like crazy and you can pay them only a fraction of what you pay people in that west. And the system those people are functioning in works relatively well. Without crippling levels of red tape and corruption that can run a good business in the ground. As long as they can keep taking over more jobs in China for less money, and they keep up their productivity, China will grow like crazy over the next decade or so.

 

Not saying I agree or disagree about China, but have you read the book The Halo Effect? (I'm trying to take this one meta-level up)

 

If China keeps doing well, people will say what you're saying above.

 

If they do badly, people will change their tune and say: "Well, of course. They have an uneducated population without real innovation, too much debt, no track record of rule of law, there's corruption, the government is too big and misallocates resources, they lack creativity, how do you expect people one generation removed from illiterate farmers to compete on the world stage, etc." (or whatever, the specifics don't matter too much, and I'm not saying any of those things are true as generalization -- the point is that both the good and the bad things are true simultaneously, and that the set that becomes the dominant narrative is decided based on how well things are going).

 

Just look at what people were saying about Japan in the 80s before the peak and after. Same country. Same workers. Same infrastructure and education and everything.

 

Same with Germans. Now they have a great work ethic and everything. But before the country turned around, different qualities were being highlighted to explain why things were going poorly.

 

There's danger in relying just on numbers, but there's danger in narratives too.

 

Basically, you can't know what will happen. Anymore than 10 years ago you could have predicted the subsequent 10 years. Ironically, this incertitude feels like more solid intellectual ground to stand on than the certitude of a narrative to me.

[petec]

what i miss in that post is the actual discussion of people. Their skills work ethic , their cost of labor, levels of corruption etc. I miss that in a lot of macro discussions. Probably why a lot of macro economists are so terrible at predicting stuff?

 

 

Pettis covers this quite a lot, pointing out that it's usually nonsense made to fit the current facts and that the same country's culture can be blamed for failure one generation and then success the next.  I'm inclined to agree with him. 

 

He also makes the point repeatedly that China's growth has been investment intensive not labour intensive.  As investment slows they're going to have issues, especially since labour rates there have risen dramatically and no longer give them much of an advantage over places like Mexico.

 

Investment will slow, because there's too much of it; that will cause GDP to slow and possibly drop, because investment is a crazy 50% of GDP; that will cause debt to look unsustainable, and he's written repeatedly that there is a lotof debt.  And the debt's all local so Chinese consumers (who don't consume anyway because they're so repressed) will lose their savings.  Might not be much fun.

 

Don't know how much of Pettis' stuff you've read but I find him a pretty thorough thinker.  I'm afraid hard work and cheap labour can't overcome the bursting of bubbles, as the (young and ambitious) US found in the 1930s.

 

Pete

[petec]

 

If China keeps doing well, people will say what you're saying above.

 

If they do badly, people will change their tune and say: "Well, of course. They have an uneducated population without real innovation, too much debt, no track record of rule of law, there's corruption, the government is too big and misallocates resources, they lack creativity, how do you expect people one generation removed from illiterate farmers to compete on the world stage, etc." (or whatever, the specifics don't matter too much, and I'm not saying any of those things are true as generalization -- the point is that both the good and the bad things are true simultaneously, and that the set that becomes the dominant narrative is decided based on how well things are going).

 

 

+ several!

[ni-co]

Yadayada, that's almost exactly 1:1 what the mainstream was saying about Japan in the 1980s. Japanese are still known for their work ethics and look what Japan's economy has been doing!

 

EDIT: Sorry, Liberty, I didn't see your post, at first – take this as an agreement with your Japan argument ;D Completely agree with you in seeing the Halo effect at work and also with regard to Germany. I'm old enough to remember that Germany was called "The Sick Man of Europe" and now we're the "hard working Germans" (with a 39-40h workweek and 30 leave days paid in a lot of industries…).

 

Yadayada, it's not that Pettis is saying structural reforms, work ethics etc. are not important! As Pete pointed out, Pettis is saying that the importance of trade and how your economy is structured is completely underestimated and that people are much too focused on issues like work ethics – they are overrated in their relative importance. It's a bit ironical that you accuse him of not taking this into account because the overemphasis of work ethics is exactly one of his major points – and he makes this clear in his books and quite a few articles (s. this for example).

 

 

He also makes the point repeatedly that China's growth has been investment intensive not labour intensive.

 

+1. Yes, this is a very important point, too, and one that's quite hard to argue with. The same was true for Japan during the 1980s and for Brazil during the 1960s – examples Pettis provides in his China book – both "economic miracles" ending with "lost decades".

[yadayada]

Yeah except that argument doesn't really fly right now. GDP per capita now in China is much lower then in the western world. Median pay is lower etc.

 

If you compare cost of labor in Japan in the 80's and cost of labor in the US and China, You will see that Japanese labor wasn't much cheaper as they had caught up mostly to the rest of the world, yet were loaded up with so much debt because they thought the party would continue.

 

If you read dalio's paper, you will conclude that labor in China is still very cheap to what they have to offer. I think China now is more comparable to Japan in the 60's. I think my point was that you need to look at what value they can provide for what they demand in pay.

 

So ignoring this seems kind of silly.

 

GDP per capita in Japan :

http://knoema.com/mhrzolg/gdp-statistics-from-the-world-bank#Japan

Note how there was a massive catch up from the 1960's to the 1980's

 

GDP per capita in 1970 in Japan: 2k$, and in the US it was 5.2k$. and it kept going well because of enourmous debt built up, except when they passed the US, and their labor was no longer competitive. You basically had western people overseas, who would demand much lower pay, so obviously Japanese exports exploded.

 

http://knoema.com/mhrzolg/gdp-statistics-from-the-world-bank#United%20States

 

Now look at China:

http://knoema.com/mhrzolg/gdp-statistics-from-the-world-bank#China

 

Plenty of catching up to do...

 

Unless you think there are crippling levels of corruption and lack of work ethic. That is why China exploded in the 80's, when it opened up to the west.

 

I think you got to worry when GDP per capita reaches 15-20k$.

 

So really the biggest risk for China is other emerging countries and India:

http://knoema.com/mhrzolg/gdp-statistics-from-the-world-bank#India

 

 

 

If you add a catch up, with crippling levels of debt relative to GDP, you get a lost decade. As you see in Japan there was a huge catch up in the 80's, and then it all overheated, and grinded to a halt. If your workers are paid more, they also need to provide more value.

 

But you would have done really well if you invested in Japan in the early 60 and 70's, because there was still a lot of catching up to do relative to the value they provided to the US:

http://blog.irishlife.ie/wp-content/uploads/2011/03/japanese-equities-20-years1.png

 

 

So really if you want to study Chinese growth, you need to analyze how much companies still want to move jobs to China vs other countries. Which is really ahrd to measure.

 

But you have to agree that China is still many times cheaper then the west with regards to labor.

 

So really this discussion should revolve around, how competitive is labor in China in various levels of industry with regards to the west (don't forget price here!). And not about current account ratio's.

[Liberty]

The point was not that China is Japan in the 80s.

 

The point was that you can't know what will happen in advance, and if you think you do, you are fooling yourself.

[yadayada]

The point was not that China is Japan in the 80s.

 

The point was that you can't know what will happen in advance, and if you think you do, you are fooling yourself.

Yeah but you can look at the huge gap in cost of workers and conclude there is still plenty of catching up to do. They would have to be a lot worse then western workers to justify their cheaper price. I agree with this sentiment if the difference was much smaller. But because the difference is so large, you can safely say that it is likely they will keep growing for another decade.

 

Yadayada, that's almost exactly 1:1 what the mainstream was saying about Japan in the 1980s. Japanese are still known for their work ethics and look what Japan's economy has been doing!

 

 

You are forgetting cost, the cost of workers surpassed the cost of workers in the US in the late 80's. Since they were very comparable, they crashed. When one economy is growing very fast, it is because the gap is closed in relation to the most wealthy countries.

 

That is why Japan exploded in the 60's and 70's. They had a smart population, low levels of corruption, and a lot of work ethic. Yet workers cost only a fraction of workers in the west. And when they caught up in cost, they had too much debt, and it all collapsed really violently.

 

The hard part is predicting. If you look at Russia in the 90's, you will see a huge gap in pay, yet Russia did not catch up untill the last decade, and most of taht is because of the rising oil prices. This is due to corruption, poor justice system, and poor work ethic. That is also why China was lagging so much untill the 70's.

 

[Liberty]

The point was not that China is Japan in the 80s.

 

The point was that you can't know what will happen in advance, and if you think you do, you are fooling yourself.

Yeah but you can look at the huge gap in cost of workers and conclude there is still plenty of catching up to do. They would have to be a lot worse then western workers to justify their cheaper price. I agree with this sentiment if the difference was much smaller. But because the difference is so large, you can safely say that it is likely they will keep growing for another decade.

 

A lot of things that are "likely" and "supposed to happen" don't happen, because there are way too many moving parts and variables and feedback loops and reflexivity in the system, and our information is too imperfect and limited, as is our brainpower. Looking back it's always obvious why something happened, but at the time nobody saw it coming. Were you shorting oil before the crash last summer? How are the other BRIC countries that everybody praised a few years ago doing?

 

You need to learn self-doubt.

 

I'm not even saying that China will do badly. Maybe it'll do better than people expect. That's not my point.

[yadayada]

Liberty I think you are missing the point. My argument was that current ratio's do you no good in predicting the longer term prospects of a country. And that looking at the things that do matter (in  my opinion) is a better idea. And when you look at those things, it looks likely China will keep growing, as they really resemble Japan in the 60's. But you seem to ignore that argument for the most part coming in with something about bias.

 

So far you have not provided a convicing argument why China's workers should be worth 5x less then western workers. And that this gap is justified because of some sort of bias i should have?

 

It could be that China will crash and burn, but I think the odds are good they will not over the next decade.

 

I would suggest reading this paper:

http://bwater.com/Uploads/FileManager/research/how-the-economic-machine-works/ray_dalio__how_the_economic_machine_works__leveragings_and_deleveragings.pdf

 

also you are ignoring my argument, and basically say 'well you dont know'! Because who saw the oil crash coming! A short term fluctuation in a commodity, or the longer term prospects of a country are very different things. One is very difficult to predict, and the other is easier to predict. Predicting when a banking crisis will happen in China : extremely hard. Predicting 10-20 year prospects of a country: much easier. I also never said I was sure of anything. Just that I thought it would be likely China would do well.

[mcliu]

yadayada has a good point.

 

There's significant productivity growth available for China's economy on a per capita basis. The current output per person is significantly lower than most developed countries. Meanwhile, Japan's productivity has largely caught up to Western standards by the late 80s.

 

I mean GDP per capita is China is still 1/5 of Taiwan..

[Liberty]

I never said I was negative on China. I commented on a specific post about the Chinese work ethic and such.

 

Nevermind.

 

[yadayada]

If you assume fair value of Chinese workers is 1/4 that of the west, then that would mean GDP would grow roughly 25% more then in the west. So if you think the west will grow about 2-2.5%, China will still grow 4.5-5% a year over the next decade.

 

Edit: @liberty: yeah and I never said that work ethic alone would matter. The price you pay for that work is just as important. You ignored that in your argument.

 

If you come with this:

You need to learn self-doubt.

You are basically saying 'well i dont have any argument on why you are wrong, but you should still not predict the future and have some doubt, even though I did not provide an argument and gave basically zero new information and mostly ignored what you said, and twisted it out of context'.