The subtitle is Trade, Conflict, and the Perilous Road Ahead for the World Economy and the author is Michael Pettis (2013). He writes a blog about China that I enjoy (see sidebar).
The book focuses on trade imbalances as the key input in today’s economic problems. Pettis concludes that many of the prevalent assumptions, about why we are where we are, are simply misguided. Rather than some moralistic tale about virtuous savers and slavish, consuming pigs, the drivers are far more nuanced and caused by policies both foreign and domestic. If you can remember that the current account and capital account must balance to zero, that the difference between total domestic savings and total domestic investment is equal to the net amount of capital imported or exported (i.e., the current account surplus or deficit), and everything that a country produces must be consumed or saved, then you’re ahead of the game in getting it. These tautologies govern internally for a single country and across all countries in a global economy.
Some other interesting takeaways:
-The explanation that the financial crisis came as a result of financial deregulation and abuse of derivatives is to ignore how history provides many examples where those issues were not prevalent and there was still a crisis. A better lens to view it through is one that focuses on imbalances between production and consumption.
-There are several common ways that countries try to raise investment and exports: tariffs, devaluation and consumption taxes. All reduce purchasing power and consumption at the household level, and therefore cause savings to rise in the form of deposits in the banking system, which can then be lent to producers at extremely low interest rates to subsidize exporters.
-The impact of a revaluation of the Chinese currency is net beneficial to the household sector and a problem for the state and manufacturers. Put differently, the state is long dollar assets given its huge reserves, so it stands to suffer if the currency strengthens. By contrast, the average citizen will have more purchasing power. So, to think about it yet another way, the state stands to lose even more the longer that it waits to effect this revaluation as it continues to accumulate dollar assets. (Maybe that’s why they are buying so much gold :) )
-When wages grow more slowly than productivity, there is a wealth transfer from households to producers that causes consumption to decline and savings to rise, and invariably more exports than imports. Unfortunately for the United States, concurrently with that dynamic, there has been a booming stock and real estate market that created a wealth effect, so there was a growth in private debt without the savings.
-China is an investment-driven economy, not export-driven. Consumption has grown, but at a pace slower than GDP, implying that the real driver has been investments. And the state has taken steps towards financial repression in order to subsidize preferred parties and industries. Since consumption is not as high, they have imported demand, but now face a period where global demand is down. The answer should be to transition to internal consumption, but there are many vested interests that want to maintain the status quo. But, the longer the state is in control of how investments are made, the higher the likelihood of misallocations and the more wealth that will be destroyed.
-Pettis tries to answer an important question: “When do countries have too much debt? The short answer is they have too much debt when the market believes they have too much debt.” Not sure Fleckenstein would agree. And if you are an investor, it might be too late at that point to salvage your money. Otherwise, everyone could tippy-top a market.
-Pettis does not believe that it would be a bad thing for the United States if China decided to sell its Treasury holdings, nor that it would necessarily lead to higher rates. As he notes, when China is stockpiling these treasuries, it is in essence exporting capital in order to import demand, thereby allowing it keep unemployment low at the expense of its trading partners. If it gave up that surplus, the U.S.’ trade deficit would stand to go down.
-In his section of forecasts at the end, I think Pettis totally misreads the U.S. situation, arguing that corporate balance sheets have gotten healthy and asset markets have cooled, neither of which is true. As to the former, while cash levels are up, so are corporate liabilities. Moreover, when one looks at market caps (not book values) right now, operating leverage is at even higher levels than in 2000 or 2007. As to the question of whether financial asset markets are in a bubble, I have to assume that this book came out at least 500 points ago on the S&P 500.
Anyway, the rub in all of this analysis, as Pettis points out, is high levels of debt. With all of the talk about trade imbalances, and all the discussion (which I didn’t even really touch on) about what changes need to occur globally, debt inhibits growth. Which basically means there is still more pain to come in the global economy.
In conclusion, this book is full of information and an explanation of important concepts. Definitely worth picking up if these topics interest you even remotely.
