The National Bureau of Statistics released today CPI and PPI data for December 2014. People’s Daily summarizes the CPI data, which came in pretty close to market expectations:
China’s consumer prices grew 2 percent in 2014 from one year earlier, well below the government’s 3.5 percent target set for the year, official data showed on Friday. The increase was also below the 2.6-percent growth registered in 2013. Growth in the consumer price index (CPI), the main gauge of inflation, rebounded to 1.5 percent in December from November’s 1.4-percent rise, its slowest increase since November 2009. On a monthly basis, December’s CPI edged up 0.3 percent against the previous month, reversing a downward trend reported since September.
The People’s Daily also summarizes the PPI data, in which November’s 3.3% decline in prices was quite a bit worse than the 3.1% decline the market expected: PPI
China’s producer price index (PPI), which measures inflation at wholesale level, dropped 3.3 percent year on year in December, the National Bureau of Statistics said on Friday. In 2014, the country’s PPI fell 1.9 percent year on year.
Several journalists contacted me asking me to comment on the implications of the latest data, and I thought I would compile for my blog interview questions and responses from two of them. Before doing so I wanted to quote from one more People’s Daily article, in which the writer proposes very automatically a widely-held view about the monetary implications of disinflationary pressures:
China’s consumer inflation remained weak in December, while price declines at the factory gate level continued to deepen, suggesting weakness in the world’s second-largest economy but giving policy makers more room to take easing measures.
Here are the questions and my responses:
- The current data suggests that China is facing deflationary pressures, much like Japan has since the early 1990s. How will this affect the world compared to Japan’s deflation?
It will be very different. Japanese deflation occurred in an environment of fairly robust global growth. The US was just beginning the surge in productivity associated with the spread of information technology. International trade was expanding rapidly. Many developing world economies, and all of Latin America, had emerged from the terrible Lost Decade of the 1980s determined to reform and liberalize their economies. A lot of developing country debt had been written down or was in the process of being written down, and relatively speaking debt levels around the world were low and rising. Commodity prices were low, but stable, and less than a decade earlier, the Fed and other central banks around the world had been fighting off very high levels of inflation. In that environment disinflationary pressures were welcome.
Today, conditions are very different. Non-food commodity prices have declined significantly and will continue to drop a lot more. Because debt levels are extremely high everywhere many countries will be forced into deleveraging, and I suspect it will be another five years or so before the world seriously engages in the process of restructuring sovereign debt with partial or substantial debt forgiveness. Most importantly, the two main sources of income inequality have not been resolved. First, within the household sector in the US, Europe, China, Japan and a number of other countries, the level of income inequality is nearly as bad as it has even been. Second, at the household level in countries like China and Germany the household share of income is far too low.
This combination has left us with weak consumption, excess savings and excess capacity. Without a major infrastructure investment program in the US, India, or possibly Europe, there simply isn’t enough global demand to absorb the global capacity that has been built up over the last couple of decades. So there is no appetite for disinflationary pressure in today’s global environment, whereas two decades ago the deflationary pressures that Japan might have unleashed were welcome.
I am not sure however that Chinese deflationary pressure is going to matter much to the rest of the world because China is as much a victim as it is a cause of global disinflation. The Chinese economy is simply participating in a greater global environment in which consumption is too low and the resulting excess capacity leaves the private sector unwilling to invest. But Chinese deflation is certainly not going to help.
Where China faces a problem, like many other countries, is in the relationship between debt and deflation. In a deflationary environment unless productivity growth rates are high, it is very difficult to keep the value of assets rising in line with the value of debt. There is a natural tendency for asset values to decline in line with deflation, whereas the nominal value of debt is constant (and, when interest costs are added, the nominal value of monetary obligations actually increases). Of course if the value of debt rises faster than the value of assets, by definition wealth (equal to equity, or net assets, in a corporate entity) must decline. This is why highly indebted countries and businesses struggle especially hard with deflation.
This is a problem for many Chinese borrowers. For nearly two decades, when nominal GDP growth was as high as 20-21% and the GDP deflator at 8-10%, even if they were horribly mismanaged the nominal value of assets soared relative to debt. Very low interest rate – around 7% for preferred borrowers – made servicing the debt almost an afterthought. Under those conditions it was pretty easy to ignore debt costs, and even easier to pick up very bad investment habits. Now that nominal GDP growth has dropped to around 8-10%, and could be substantially lower in a deflationary environment even if growth did not continue to decline, as I expect it will, those bad habits have become brutally expensive.
This is why borrowers are crying out for relief in the form of lower interest rates. But while lower interest rates do provide short term relief, they do not address the fundamental problem, and even allow some borrowers the lassitude to make the underlying problem worse. This puts the authorities in a tough spot.
- We are seeing reforms in many countries, especially Europe, China and Japan to open up their economies and to liberalize the labor and financial markets. When will these reforms begin to affect growth?
Unfortunately they probably won’t. Japan during the past two decades, and European countries like Spain during the past six years, should remind us very clearly of a very old story. When debt levels are low, reforms aimed at improving productivity, if they are correctly designed and implemented, can result in the higher productivity and GDP growth that could, in principle, allow a country to “grow” its way out of debt. When debt levels are high, however, reforms almost never result in faster growth. When growth is most needed, when a country is suffering from excessively high levels of debt, it is hard to find many cases in which the aggressive implementation of reforms led to growth rates fast enough for the debtor to grow its way out of debt.
This seems very counterintuitive at first, even if the history behind it is quite abundant, and very few economists seem aware of the problem (which is why most economic forecasts mistakenly focus on the pace with which reforms are likely to be implemented, and are always disappointed), but in fact the reasons are not so hard to understand. The combination of very high levels of debt and excess manufacturing capacity can lock an economy into a self-reinforcing deflationary process in which growth stagnates and debt rises faster than debt servicing capacity. When debt levels are perceived as excessive, there is downward pressure on growth for at least two reasons.
First, spending on both consumption and investment declines as households and businesses cut back on disbursements in order to repay debt (I think this is what Richard Koo refers to as “balance sheet recession”). Second, high debt levels and weak credit perceptions distort the distribution of operating earnings (at the corporate level) or the distribution of the benefits of GDP growth (at a macroeconomic level) in ways that reduce growth and increase balance sheet fragility. In finance this second reason is referred to as financial distress. By lowering growth to well below growth capacity, the combination of reduced spending and financial distress causes the real debt burden to increase. Of course an increasing debt burden reinforces the poor performance of the economy in a way familiar to anyone who has read Irving Fisher on debt-deflation.
- Comparing the causes in China and Japan, how long do you expect China will take to overcome deflation – several years, or more? What are the biggest challenges to tackle and what policies should Beijing implement?
How long it takes for China to overcome deflationary pressures depends, I think, really on two very different sets of policies. First, Beijing must aggressively tackle the country’s debt burden. For example if local governments are forced to sell off assets and use the proceeds to write down or repay debt, they can reduce the debt burden without reducing total spending. I think most policymakers and understand this, but there is another stronger reason to liquidate assets to pay down debt. Strengthening the liability side of the balance sheet changes the way assets are managed (the process is far better understood in finance theory than in economics), and the result is nearly always more productive use of the assets.
The second set of policies that Beijing should implement to protect the country from a lost decade of much slower growth is to create alternative sources of demand as quickly as possible that do not require credit expansion. I can think mainly of two ways, and both of these are implicit in the reforms proposed during the Third Plenum, in October 2013. First, substantial direct or indirect wealth transfers from the state sector to Chinese households will unleash a surge in household consumption as household income rises (and because the interest on bank deposits is an important source of income for most middle and lower middle class households, if the authorities reduce interest rates, as struggling borrowers are demanding, China actually moves in the wrong direction). The constraint here of course is political, because the elites who benefit from the state control of these assets are likely to be highly resistant to any such transfer.
Second, substantial reform in corporate governance within the banking system should be aimed at causing a substantial shift, as rapidly as possible, in the credit allocation process, so that state-related entities that systematically malinvest, like local governments and state-owned enterprises, receive a smaller share of credit while small and medium enterprises, who tend in China to be far more efficient users of capital, receive a much greater share. Of course there will also be a significant political constraint here too, and for the same reasons.
It will be hard to do either very quickly. The sets of policies that lead to either outcome are politically difficult to implement because they force a disproportionate share of the adjustment costs onto the very powerful sectors that received a disproportionately large share of China’s growth in the past two decades. What’s more, the consumption impact of wealth transfers to the household sector will lag, depending on how credible they are, while reforming the financial sector is always a slow and disruptive process.
It may take many years before China can make the necessary changes. During this time government debt will have to rise as the government absorbs the employment consequences of these disruptions, and unfortunately higher debt will itself put downward pressure on growth. It isn’t easy, but of course the history of reforms in highly indebted economies has never suggested that this would be easy, and so far it seems like Beijing is pretty determined to do whatever it has to do.
- To what extent will an acceleration in price reform help China combat disinflation?
Price reform will help much less than everyone thinks. China’s very weak consumption share of total demand has very little to do with inefficient pricing. It is almost wholly a function of the very low household share of GDP, and the only reforms that matter are reforms either that reduce the implicit transfer of wealth from households to large businesses and the state – for example allowing banks to pay higher real deposit rates, or eliminating subsidies for businesses, including land subsidies – or reforms that directly increase household wealth, including houkou reforms and improvements in the social safety net.
- As deflation also hurts Japan and Europe, what might that affect the global economy and monetary policy?
Excess capacity is a global problem, and not just a Chinese one, but the implications for monetary policy are very different in countries like China and Japan than they are in countries like Europe and the US. The monetary and financial structures of some countries create a very different set of institutions than in others, and one result is that policy responses that might seem to make sense in the US are actually harmful in China. For example lower interest rates and weaker currencies in the US and Europe might create inflationary pressure, so that the proper response to harmful deflation might very well be to reduce interest rates and to encourage currency depreciation.
It turns out, however, that under certain conditions lower interest rates and depreciating currencies may actually exacerbate deflationary pressure. Unfortunately these conditions probably apply to China and Japan. For some reason people are often shocked when I say this, even though you would have thought they would have wanted some way to explain why the roughly 35% depreciation of the yen during the last three years has not unleashed inflation, and has instead been accompanied by weaker, not stronger, consumption. Or again it should have been at the very least intriguing that during the last decade in China we have seen extraordinarily rapid monetary expansion but we have never suffered runaway CPI inflation, and in fact the inflation we have seen has been caused mainly by food shortages, not by loose money.
- How can tighter monetary policies combat deflationary pressures in Japan or China?
You get inflationary pressures when demand rises faster than supply, and deflationary pressures when the opposite happens. This is pretty easy to understand. So what matters is how monetary policies or monetary conditions affect the relationship between supply and demand. In Japan and China, especially the latter, weak consumption and high savings are not driven by very high personal savings preferences. They are driven by the low household income share of GDP. When the BoJ takes steps aimed at changing inflation expectations, for example, they are always surprised because these policies do not seem to affect Japanese psychology at all.
But in fact they probably do, it’s just that the psychology doesn’t matter. With so much being said in the press about the collapsing yen and about policies aimed at forcing up Japanese inflation, it is hard to believe that the Japanese aren’t aware of policies that are supposed to create inflation. But if there is a psychological impact, why doesn’t inflation rise?
Probably because low inflation has very little to do with Japanese household psychology. As I see it, because a weakening yen raises the cost of imports, it reduces the real value of Japanese household income while, at the same time, subsidizing the tradable goods sector. The tradable goods sector in Japan is much larger relative to the household sector than it is in the US, so perhaps it is not surprising if, unlike in the US, a weaker yen increases the growth in household income by the same amount or by less than it increases the growth in the tradable goods sector (adjusted for any change in “psychology”, of course). In that case there shouldn’t be any inflationary pressure. If consumption does not rise faster than production, after all, why should prices rise? In the end it might well take a stronger yen to force up demand relative to supply, although I suspect credibility is so low that it would take many months before the impact were felt.
Something similar happens in China, where the household income share of GDP is a much greater constraint on consumption that household psychology. In the US and Europe, deflationary pressures increase the ability of central banks to loosen monetary conditions, and because too many economists assume too easily that what is likely to be true in the US must be true everywhere, deflationary pressures in China are unleashing calls for lower interest rates and greater credit expansion in China. This is why I copied the People’s Daily article at the beginning of this blog entry.
In the US lower interest rates tend to be inflationary because a substantial portion of credit is consumer credit. What is more, lower interest rates have a positive wealth effect for American households because they tend to be associated with higher real estate prices, a stronger stock market, and of course stronger bond markets. When interest rates are lowered, the positive impact on American consumption is greater than the positive impact on American production, so prices usually rise.
In China, however, most credit is delivered to businesses, not households, and is aimed at increasing production, not consumption. What is more, for Chinese households, bank deposits form a far greater share of total financial savings than they do for American households. Lower interest rates, in other words, generally have a negative wealth effect in China largely because reducing the interest rate on bank deposits makes most Chinese feel poorer, not wealthier. An IMF study in 2011 confirmed the relationship.
This is why deflationary pressures in China indicate that we probably need monetary tightening, not loosening. I know this sounds extremely counterintuitive, and so violates what we have learned about the world by assuming that the world looks a lot like the US, but there is both a logical argument behind it and what I think is overwhelming historical evidence. The convention that any economic variable that works one way in the US must work the same way in China is one of those assumptions that is implicit in so much that is written about the Chinese economy, and yet is made by foreign and Chinese economists who would indignantly reject the assumption were it ever made explicitly.
Post script: will easing price controls cause prices to rise?
The day after I posted this entry I saw in the South China Morning Post that the weak CPI and PPI data were likely to strengthen calls for deregulating price controls. According to the article:
Fresh confirmation of persistent deflationary pressures on the mainland, with a consumer price gauge stuck near a five-year low, has prompted calls for further action to ease government price controls on energy and other key industrial inputs. Perhaps even more telling than stubbornly low consumer prices, a slide in producer prices has extended to 34 months. The entrenched factory-gate deflation might warrant a policy response of similar resolve to the leadership’s battle against corruption.
…In a sign that the delayed price reform may accelerate this year, the commission released a document on Monday for the liberalisation of tobacco leaf prices, fees charged at ports and some prices related to rail transport and civil aviation.
Price reforms in China mean, for the most part, removing price subsidies or controls that keep prices down. It may therefore seem intuitively obvious that eliminating these policies will cause average prices to rise, but this isn’t the case. China’s very weak consumption share of total demand has very little to do with inefficient pricing. It is almost wholly a function of the very low household share of GDP. Raising the prices of individual goods will not cause overall demand to rise relative to supply, and so will have no net impact on inflation.
Let’s assume, for example, that Beijing were to increase tobacco taxes so that Chinese smokers pay more for cigarettes.
- If smokers decide in response to higher cigarette prices to reduce their savings by exactly the same amount as the higher spending on cigarettes, the result would be a one-off increase in cigarette prices and nothing else would change. This would cause a temporary jump in CPI inflation.
- If they spend all of their income on consumption (which is likely to be the case for poor people), or if they saved a fixed amount of their paycheck (which is likely to be the case for migrant workers and for many other types of savers), the increase in cigarette spending would be matched, kuai for kuai, with a reduction in other consumer spending. Cigarette prices would rise, but the price of other consumer goods would decline by the same amount, so that the net impact on CPI inflation would be zero.
There are perfectly good reasons to reform prices. Price reform can lead to a more efficient use of resources. If subsidies to businesses are paid indirectly or directly by households, price reforms also help rebalance the economy, which indirectly creates inflationary pressures. But it is a mistake to think that price reforms are directly inflationary. The only way to cause prices to rise is to increase demand relative to supply, and in China, where low household income is the main constraint on consumer demand, the only substantial way in which to spur CPI inflation is to increase the household income share of GDP.
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Spot on analysis. Japanese political circles are deeply divided because while the PM and big exporters are sold on Kuroda’s cheap yen approach, ordinary Japanese are watching their purchasing power shrink and feel significantly worse off. Recent results and recession have not yet forced the question on the PM, who is still betting on TPP in April or so.
Thanks, Doug. Are Japanese policymakers aware of how a weaker yen might actually be disinflationary, or do they simply see weak consumption as evidence that they haven’t pushed inflation psychology far enough?
Inflation can come about via rising consumption, but inflation can also come about via falling production. If you input most of your food and energy with a rapidly declining demographic and a massive debt burden, isn’t there a risk of falling production? If I’m correct, isn’t this how many countries in the 70’s experienced high inflation.
I don’t think there was a decline in population in the 1970s. My understanding is that US inflation in the late 1960s and 1970s largely came about as a consequence of the increase in government spending on on both the Great Society and the Vietnam War. This increased spending was paid for by borrowing, and not by taxes, and so total demand soared relative to total production. Rising prices were reinforced in the early 1970s by the two great oil price hikes which saw oil prices rise from $2 to, I think, $20 within a decade and with other commodity price hikes. By the middle of the decade an inflationary psychology had set in, with wages and prices around the world implicitly or explicitly indexed to inflation.
A lot of countries experienced high inflation in the 70’s (not just the US), didn’t they? The US actually had relatively low inflation compared to other
The oil shocks definitely played a role, but that’s my main worry with Japan. Japan imports almost all of its food and energy. The most recent drop in the Yen came with a drop in commodity prices, but once commodity prices bottom, I see Japan having a lot of difficulty (see CPI figures linked below). They do seem to have caused inflation to rise, but it’s been entirely on the supply-side with fuel, energy, and food costs leading the way.
http://www.stat.go.jp/english/data/cpi/1581.htm
Pre-World War II, Japan imported >80% of its energy, which is why they (IMO) went imperialistic. Japan is in a similar situation now and doesn’t really have the same military and lacks those same options.
“between 1969 and 1975 federal government purchases of goods and services rose 26 percent, with national defense spending increasing 10 percent and the other civilian functions rising 85 percent-…..” Minsky, Stabilizing an Unstable Economy, pg 28
“In the absence of Big Government and the huge deficit that automatic and discretionary policy combined to generate in 1975, a plunge of the economy, as it occurred in 1974-75, would have been associated with a plunge in corporate cash flows. Business debt-carrying capacity and the margins of safety in the system of borrowing and lending would have
decreased. Even in the absence of actual bankruptcies, such decreases in business cash flows would have forced efforts by business to contract commitments. In fact, business gross profitability increased in 1975, so that a forced or induced curtailment of commitments did not take place..” Minsky, Stabilizing an Unstable Economy, pg 33
So Debt in the world grows to quickly in the current experience of the system.
It seems we are toward limits in this direction, insofar as not laying ground for alteration of the model, why i believe China went in the wrong direction far before 2009 stimulus, and why it gets very difficult at their levels of consumption, and a more mutli-point, in terms of consumer, driven economy.
But also the developed world, and the use of US demand as a driver of global development; this lessens as others grow in the global economy. As Peter Temin of MIT notes, others have let LatAm levels of inequality, and elite structures to continue, if demand of US, and others, is not to move more economies to develop more balanced consumer driven economies, viewing the global economic, development system, through increasing returns to capital, and profiting on the margin, will undermine the very structures that enable growth, and rationalize increases in asset valuations. While some can argue that Fed responses have terrible costs, Minsky notes a similar function in 75 as beneficial, were such to be able to be employed in the future, Pickety with his emphasis on growing internal inequality need grow in primacy of dialogues as we move forward. We either come to terms of greater collaboration based on more than darwinian zero sum thinking (between government, labor, capital and across countries that collaborate) or we will see an orderly or disorderly exit from the system over time, leaving large swathes of the world undeveloped and decreasing our collective security, and domestic potentials for flourishing more broadly.
Csteven,
I think we’re likely to see the latter of the two scenarios you laid out. I suspect it’ll be a disorderly exit from the system.
That being said, what’s your take on Japan? Do you tend to side with Prof. Pettis, who seems to think Japan gets stuck in deflation? Or do you take the other side that supply-side problems will lead them to input price inflation/stagflation? And why…
Suvy
Japan….do we have delfation or asset inflation stagnation with rising prices.
If one were to look at the Japanese economy their Yen size of the economy is roughly what it was 20 years ago (a fate that China, in one scenario, at some point might want among the options it could face) while its housing is at 70% of what housing cost 20 years ago, with slow transition of this grave asset and debt bloat on to the Japanese government coffers through, in the ways Minsky, (who I believe I may be in love with) describes as necessary.
So, Japan has been in a deflation stagnation with slow rises in household incomes and a rapidly aging demographic increasingly stuffed into small apartments in urban metropolis. It sees the price of many goods, as we all do, fall (especially in relation to trajectory when comparing to other elements in society), of great global over-capacity in production.
It will, has, and will continue to see a great off-shoring of its considerable industrial prowess, to SEA as it shores up relations, but also to other markets globally. Hell, the Japanese are even players in the Turkish economic picture, so.
So, I guess I would have side with Michael, but it is not hard to do this, as essentially this is but continuation of the same trend. I guess the issue is to try and kick-start some inflation, and actually get trends that would make prices, growth, wages and similar to cycle government debt as a lower percentage of GDP, while increasing government revenues.
There might be a problem inherent to the Asian Development Model, or the model that is employed of take-off as to the notion of Savings and the systemic psychological impact that this has over time on populations who experience miracles. Minsky shows how things function systemically, and beautifully so, perhaps, the policy-maker, pundit, consumer and industrialist psychologically can’t move on from the storing of nuts, which rationalized so much of their societies advancement, and often becomes a psycho-spiritual rallying point for the resurgence of their cultures, which of course were historically grand, and such limits necessary alterations to the model. Altogether, further, a reason we will inevitably see an exit from the system where people are so beholden to children’s fairy tales, and feel good group dynamics.
I guess I disagree because it seems to be working (or maybe I’m just paying attention to noise). Inflation and wages in Japan are up. Their GDP numbers keep falling though. The problem with Japan is, I think, its biggest problem historically: they import most of their food and energy. A falling demographic actually may be able to help in some regard because old people consume less than the young.
If they keep trying to resolve all of their problems by devaluing their currency, their output will fall from rising input costs. That being said, commodity prices have fallen more than the Yen, but that trend won’t hold forever. If inflation does take off, I don’t think they can stop it. You stop an inflation by inverting the yield curve. Raising short term rates would, I think, probably force a default. So a yield curve inversion is out of the question.
In five years, I think USD/JPY is trading at 200-350. That’s a 100-125% increase in input costs. That will show up in inflation.
So….
ME: [Economy roughly (same as) 20 years ago. Housing 70% of 20 years ago. Slow rationalization of previous access by moderate rises in wages and switching toward consumption on the back of gov’t debt taking. Small apartments, prices of goods fall, global over-capacity, continuation of trend
Kick-start inflation, get rises in prices, growth, wages and similar. Cycle growth in consumption higher and government debt lower (% GDP). With increasing government revenues through increased taxes.
Still preference to save.]
SUVY: [Seems to be working, Inflation and wages…up….GDP…falling. Import…food and energy.
Falling demographic help…old people consume less.
If resolve by devaluing currency, output will fall from rising input costs. Commodity prices fallen more than Yen. If inflation takes off, …can(‘t) stop it. Stop inflation by inverting yield curve. Raising short term rates would force default. Yield curve inversion out of question. Five years, USD/JPY trading at 200-350. 100-125% increase in input costs. Shows up in inflation.]
Minsky to simplify, consumer, business and government…..fall in the current structure of GDP of business and consumer spending leads to government deficit spending, increase in savings, fall in spending, similar, fall in government spending, fiscal cuts, increased savings, increased consumer debt, lower consumer savings, etc and so forth.
So look at Japan before it’s
{debt, asset boom bloat, over-use of industrialization model, weak currency, high savings, high investment, reliance on external demand, creation of grave domestic excess productive capacity} crisis.
So, new QE, after being the carry trade currency of the 2000’s (yet, 2008 was merely Wall Street banksters, CDO’s, and strangely the US providing OTHERS demand while increasing debt).
So, new QE, and increase in value added tax, where there has been price deflation, where Japanese believe they are virtuous savers, where the population ages, an increasing percentage of Japanese corporate income is derived offshore, and new QE, with Increase VAT, will lead to faster growth, some inflation, rising costs, an eventual lowering of Debt to GDP, and increases in government revenue.
I don’t see that happening.
I think they were slowly able to move the structure of the economy, moderately successfully, while keeping up GDP, as assets slowly rationalized from previous excess, as wages increased, and consumption as a component of GDP increased, and this during a period when the US, EU, and EM grew at healthy rates. I think they are facing the same thing much of the rest of the world is facing and that is a deflationary, low rate, environment where asset valuations are troubled, global demand is deficient, global growth will be lower than previous decades, so, I really can not imagine much in the way of inflation anywhere. It seems as asset inflation could be the one area that this is occurring (global stock markets), but not inflation in the real economy. We have a constrained environment, with falling input and final good prices, far too much productive capacity, as to Yen, I do not really see what people are talking about. You see I have a long term view of these matters. The Yen went up significantly, not because of health at end of 2008, or because Japan was doing better in 2008 than US or EU, it went up because of the unwinding of the carry trade, we were talking about this happening in 2006. Same with USD, why all the people who thought that QE in US would tank the dollar didn’t know what they were talking about! Frankly, this is Minsky down to the exclamation point. So I think you should chalk more up to Yen weakness seen in the present, with their QE, likely a reversal, if all the structures and relations can hold, and tick back up later, especially if they can get some inflation, some growth, at least nominally, and that we have seen weakening because they asked to do this, a few years ago, at the G20, when their exporters were screaming. Make 2,000 USD on an automobile in US, where a large percentage of Japanese Automobiles are made, especially those for the American market, so 2000 at 75 yen, is 150,000 yen profit, 2,000USD on 117 yen/usd is 234,000 yen….so, not really sure what you are concerned about insofar as input prices. As per food being imported, consumer goods and food are relatively recent openings for the Japanese economy, if rises due to weakness of Yen, which had long traded in this region, can’t see why that much of a problem, where they suffer the very same global deflationary conditions that we all do of over-capacity in production. If commodities fall more than Yen has fallen, again, do not see this as issue, commodities are entering a subdued era, as is the globe, of growth lower than recent long term trend.
Use trading economics, and not Bloomberg when you are interested in charts. I will never forgive Yahoo finance for moving to 5 year charts, I only use Max, or 10 year, but am not even happy
At some point, Japan must reduce its fiscal deficits. If they don’t relieve their debt burden, they won’t grow. If you don’t know, Japan is now running trade deficits and has a current account deficit.
BTW, I think Japan’s QE is causing asset market destabilization in the US. The BOJ is literally buying EVERYTHING. It’s buying ETFs and stocks.
BTW, government spending can be consumption. Governments can consume and/or invest. For example, transfer payments like Social Security are not investments; they’re clearly for consumption. This is why I define the equation differently at the start of my models.
Y=C+I+NX=C+S
C=C_g+C_p
I=I_g+I_p
Japan’s NX is now negative and its falling. The thing is, as Japan’s currency/commodity ratio falls, it worsens their current account. In other words, if commodity prices stop falling and Japan devalues its currency, all of the beneficiary saving that may come from government spending will be offset in the current account balance.
Japan has a lot of economic issues, but its biggest problem is geopolitical: Japan must import most of its food and energy. If you’re a heavy importer of food/energy, a currency devaluation doesn’t help the current account; it worsens it thereby having a negative effect on saving. I don’t think saving goes up. I think it stays flat or goes negative while the current account keeps falling.
In relation to charts, I use this website for personal charts on ETFs and stocks. Unfortunately, I don’t think it does currencies.
http://stockcharts.com/
Are you saying that US government is spending now less than in the late 1960s and 1970s? I do not have any concrete data to compare between now and than, but it does not seem to me that US government cut on overall spending now.
It looks like with US government spending in full force, but the deflationary pressure is still there.
Could it be that the other reasons are at play, like there is not that many worthy borrowers and not as much desire to borrow and invest for businesses?
Look at http://www.tradingeconomics.com/united-states/government-spending (1960 -2015)
Look at http://www.tradingeconomics.com/united-states/gdp (1960-2015)
If the rise of GDP during the period is rising more slowly than the rise of Government spending during the period then your answer Yes, Government is spending more. If GDP is rising more quickly than Government Spending, then less over period (1960-2015). Of course the mere nominal figure would be more, but likely the proportion is less. Of course the proportion is the number that people consider because the cost of virtually everything is more today, from Milk to Gold to Bread, so why would one even consider the nominal figure of any category of spending to be less. Maybe less on buggy whips.
A while back one of the MP posts had an excellent informative primer on “social capital.” I did a little searching and cannot seem to find it. Can anyone point me to it?
I am not sure which one you mean, GS, but try this:
http://web.archive.org/web/20130623021024/http://www.mpettis.com/2013/06/10/how-much-investment-is-optimal/
That site archives a lot of old posts.
Great post once again. What makes your insights so great is that you focus on the process or “model” of thinking about economic problems and then bring in the current facts, as opposed to most who focus on the facts and then implicitly assume the model.
Given that, i wanted to explore the notion of deflation/inflation a bit more in detail. From my view point there are three main types of deflation in the world currently
1) Goods/Commodity Deflation. As discussed many times by Jim Grant, the mantra of Wal Mart and “every day low prices” the capitalistic process of providing lower prices isnt a bad thing. The computer industry for many years has dealt with high rates of deflation (of course hedonically adjusted by the CPI index makers) but there doesnt seem to be a big problem with this type of deflation. Similarly, the current drop in most commodity prices is due to an increase in supply, not a lack of demand, so I am not really too worried about the current pace of goods deflation
2) Asset Deflation, which is more similar to Irving Fishers, Debt deflation, poses very serious risks, as does, IMO, inflated assets values from low global interest rates. but that is a story for another day, and doesnt seem to pose major risks yet.
3) Wage Inflation. Maybe because I am US based and my education about the Federal Reserve is that they really only care about this type of inflation, but I think wage inflation is the most important type to focus on today. From my understanding this is what is really holding back Japan and Europe a the moment, and even in the US, the lower end of the work force, can’t seem to get any traction in wages. But in China, I was under the impression that wages were rising faster than GDP and thus should help consumption grow as a percentage of the pie.
PS, The last part made me think about how the IMF rules for what a reforming country should do (austerity) doest always work as well.
I don’t think we’ve had to worry about wage inflation in the past two decades. On the contrary, I think wages have grown too slowly, and the result has been falling demand. In fact more generally I think we should be cautious about assuming that high wage growth “holds us back”. High wage growth is the mark of a successful economy, and low wage growth is only a good thing in a mercantile world in which the main goal of economic policy is to run large trade surpluses. England before and during the Industrial Revolution had the highest wages in the world, and the US in the 19th Century when it replaced the UK as the great center for technological productivity growth also had replaced the UK as the place with the world’s highest wages.
As for China, yes, since roughly 2010-11 wage growth has picked up sharply, and this is definitely part of the Chinese rebalancing process. I expect that one way or the other wage growth will outpace GDP growth in China for the next decade.
Agreed Michel, wage growth for the past 2 decades is stagnant and this type of “deflation” is the one policy makers should be focused on, not so much worrying about falling commodity prices. But it seems that as the world moves towards more uniform capitalistic structures, wage growth will be held down. Socialism is good for wages and thus inflation, capitalism is good for firms and profits. Perhaps we are due for a shift and maybe Europe will be the first place to implement it
To the extent that Europe is “anti-globalization”, you may be right. In a globalized world it is hard to protect domestic wages from dropping if a major trade partner decides to use wages to gain competitiveness, as Germany did. There are both benefits and costs to globalization, and unfortunately if the world cannot agree on the kind of behavior that minimizes the costs, then it is a safe bet that countries that are forced to bear those costs will want increasingly to opt out.
Isn’t this how it should proceed? The only time when most people can make money in a globalization cycle is when liquidity is expanding. Once liquidity starts to contract, why would any politician be pro-globalization? That’s just a way to lose elections.
The rest of this comment may seem off-topic and it kinda is, but not really. The problems we’re seeing in Europe aren’t really just economic, they’re geopolitical, economic, social, political, and cultural. If we really want to resolve these problems, we need to change the fundamental structure of Europe.
Another (much more serious) problem with Europe is the way the countries are structured. Geographically, the structure of Northern Europe is designed for war, not for economic well-being and trade. The reason World War I and WWII came about (along with the disgusting nationalism and other European wars) was because Germany and France are effectively fighting for the same economic union.
In mainland Europe, the most natural structure seems to be an economic trade base located around the Mediterranean Sea consisting primarily of Italy, Greece, Southeastern Spain, the northern part of the North African countries, maybe Western Turkey and the geographical area of Greater Syria.
The part above the Alps that’s modern day France, Germany, and maybe some parts of Poland. In that region, there’s a lot of navigable waterway and the entire region composes the Northern European Plain. Then, it makes sense to have some sort of a Scandinavian unification in what’s modern day Norway, Sweden, and Finland with Norway providing the natural resources. Some modern-day unification of the Balkans’ states with some empire (think region held by the old Austro-Hungarian empire) holding that trading network which is separated by mountain ranges. It may make sense for the part split off by the Carpathians to just be a part of the trading network around the Mediterranean rather than its own network (the Danube does run through this area). Basically, we need the recreation of the old Roman Republic with an economic/geopolitical alliance unifying most of the North European Plain to counter it.
One possible way the Euro could split apart is if all of the Southern periphery split off the Euro leaving only the Northern part. If that same economic alliance holds, it could become a geopolitical alliance down the line. It makes sense to have a trading network based around the North European Plain because it’s very easy to trade across.
Basically, if we really want this kind of nationalism and warlike mentality of Europe to change, we need to change the geopolitical economic structure the world has had over the past few hundred years.
In context of your 2 policies (debt reduction and alternative sources of demand) can equity market play a role? Perhaps raising equity market (aided by invisible gov’t hand) can incentivise consumption (it’s not uniform or permanent) and also alleviate debt burden (largely optical). Gov’t divesting would also leave interest groups hanging on their own to survive.
Yes it can. I plan to write a lot more about this, but one mistake orthodox economists often make is not understanding how debt constrains growth directly by creating financial distress costs. These can be alleviated either by writing down debt or by increasing equity. It doesn’t work directly for governments of course, but to the extent that the government backstops corporate debt, a much stronger equity base will certainly help both at the corporate levels and at the macro level.
thank you for this insightful comment.
Fascinating twist on economic conventional wisdom. Doves-Hawk axis of central bankers is even more twisted. thank you.
MP, does the chinese consumer reap the benefits of lower commodity prices? I am not sure how liberalized commodity prices are internally compared to western nations. I know electricity prices are not liberalized, but what about gasoline and bread?
“On the flip side, cheaper commodity imports should be good for Chinese companies, relaxing margin pressure. But that’s not usually what happens in China. Profits of its major industrial sectors rise and fall with commodity prices, says GaveKal.”
http://qz.com/323907/chinas-deepening-deflation-is-making-its-slowdown-much-uglier/
Michael
I assume you see this as true, and if so, because in China profits are derived more from access to finance than company sales revenue (again if that can be accepted as true, which if so, helps to explain growing debt to GDP), such that lower commodity prices will negatively impact companies by lowering need for financing, if not profit, then lower commodity prices might see slower growth in debt. Thoughts.
“decline in prices was quite a bit worse than the 3.1% decline the market expected”.
Michael, you might want to define what exactly WORSE mean to you when it comes to decline in prices. For a lot of people lower prices are actually welcome.
I should iamgine because:
the structure of the economy is started to be illustrated more clearly as vast increase in numbers can no longer paper over the deficiencies
that over-capacity is becoming more of a problem
That producers who need to pay loans are being even more challenged on the revenue side then they had been previously while loan growth has been slowing, even as debt rises, meaning difficulty in servicing loans, and potential for increasing NPL’s
Better yet, ask yourself, how, with rising wages, with rising asset valuations, with increasing M2, with increasing growth in GDP, could drops in PPI, continuously, and consecutively, be viewed as anything but less than desired.
Avoid the gold sites, stay here and read.
Do I actually need someone to tell me that when I go to the store and pay less, somehow on the global scale of things it is bad for me?
Dropping consumer prices is natural phenomena due to productivity improvements. If it was not for government induced inflation ( stealing) consumer would enjoy paying less.
So dropping PPI is more than desired for those who do not have investments.
What” increasing wages” have to do with it? And where exactly are they are increasing? In your head, Csteven? Wages have been stagnating both in Europe and the USA for a very long time.
Suvy,
you might need to define inflation first, before diving in its cause.
In the USA and Europe inflation has mostly to do with expansion of credit through banking sector, not the price level for products and services. Meaning the prices will follow expansion or contraction in credit. But inflation can be defined either way.
Prof. Pettis,
I think your prediction on copper is beginning to come true!!!
Understand what you’re saying about different structures in China vs. US and Europe and therefore different effectiveness of monetary easing to prevent deflation and spur inflation in the face of debt constraints.
However, the notion that monetary expansion is inflationary in the US is outdated by 40 years already, even though we are still being brainwashed with it on a daily basis.
First, the evidence. From January 1959 to November 2014, US CPI Index has grown 8x from 29 to 237 (source: Bureau of Labor Statistics). In the same period (the M2 series starts in January 1959), US M2 has grown 40x from 287 to 11562 (source: Federal Reserve). If you super-impose the two charts, you see clearly that the divergence between the money stock and the CPI level started in 1974, steadily widened until 1990, paused temporarily, then accelerated widely from 1995 with M2 on a +6.2% annual run rate since then vs. +2.3% for CPI. So, by the time Bernanke delivered its famous “Deflation, making sure it doesn’t happen here” speech in November 2002 in which he explained that thanks to the printing press, the US Government can always raise the price level, the disconnect between M2 and CPI was already obvious to everybody (excluding Bernanke apparently) who could look at and interpret a chart. Of course, it is no coincidence that the US economy became a “balloon” economy from 1995. By “balloon economy”, we mean that asset values have ballooned out of proportion with the real economic flows underpinning them: from end 1994 to end 2014, total capital was 497% of nominal GDP on average (and 546% in 2014), compared to a long term average of 390% over 1916-2014). The “ballon economy” of the past 20 years has relative asset values similar to the late 1920’s, though it is lacking the “roaring” aspect of full employment. In fact, the “balloon economy” is only able to temporarily grow and create jobs under condition of asset bubbles.
Now, the interpretation. There are at least two reasons why monetary easing is not inflationary but rather deflationary in the US.
The first reason is that, as the name suggests, credit easing tends to encourage credit expansion. By keeping short term rates lower for longer at each successive cycles, the central bank has helped lowered the entire interest rate curve of intermediate and long maturities. The lower the interest rates, the higher the maximum leverage the system can cope with. At each successive cycle, leverage has thus grown to converge towards the higher maximum debt / income ratio allowed by lower interest rates. In fact, Total Credit Outstanding has far outpaced M2 and has grown 92x from 1959 to 2014 (central bank included). The divergence with M2 started in 1984 and has been accelerating since. Relative to nominal GDP, Total Credit Outstanding went from 180% end 1984 to 355% currently. To the point that, in 2014, the Fed had to resort to a “change of accounting method” to effectively erase $2.4 Tr of debt from the statistics (the 355% above is with the benefit of that $2.4 Tr debt removal), with the revisions going back to 1995 precisely when M2 started to diverge from CPI, thereby removing the most embarrassing debt build-up traces of their increasingly accommodative stance from 1995. (Together with GDP being boosted by ~ $500bn by the BEA by a change in accounting methodology consisting of including intangibles, this is how the much proclaimed US “deleveraging” has been achieved, by Enron style accounting gimmicks. As an aside, one would have thought that, when the evidence has shown that the promoted ideas are not working as expected, one would seek to understand how and why and to adequately change course. One would not expect that, instead, promoters of the ideas would resort to cheating to make failed ideas look better. Just elementary honesty). Of course, the higher debt is relative to income, the stronger the debt deflation pressures are comes the next economic recession and asset correction. In other words, far from preventing deflation, prolonged monetary easing actually increases the risk of deflation, as we have seen in 2008-2009.
The second reason why monetary easing ends up being deflationary in the US is the fundamental contradiction between free movement of capital globally and the autonomy of national monetary policy, in particular for the US given that the $ is the main international reserve currency. Say the Fed ease monetary policy in response to economic slowdown. The lower yield on US assets and the lower exchange rate prompts capital to seek higher returns elsewhere, perhaps going to Emerging Markets where it might enter the credit system and end up funding investments. This is adding to productive capacity in low cost country, typically partly to serve to the domestic market and partly to be exported back to developed markets. When the Fed wants to tighten monetary policy again (now, it’s even when it simply stops easing), the $ tends to appreciate, even more so as foreign central banks intervene in the currency and buy $-denominated bonds in order to keep their own currency competitive, thereby pushing US interest rates lower even when the Fed would like them higher, leading a confused Greenspan to speak about a “conundrum”. And thus the newly installed productive capacity in Emerging Markets financed at least partly by easy US monetary policy finds an outlet in the US market for its production, putting pressure on domestic prices. US trade deficit widens and total US debt rise. In the current uncooperative floating exchange rate system, when the US ease monetary conditions, it ends up subsidizing investments in low cost countries whose production is then exported back to the US with a deflationary influence on the domestic price level. The “exorbitant privilege” comes back as the “exorbitant burden”. It is not by coincidence that US M2 and CPI starts diverging from 1974. That’s when the current world monetary system was born post Nixon departure from Bretton Woods. It is not by coincidence that the divergence accelerate from 1995. That’s when the dysfunctional world trade and monetary system is reloaded with the arrival of the mercantilist Asian Tigers and China.
The evidence gathered from the current cycle is clear: while Central Banks of the G5 (US + Eurozone + China + Japan + UK, together representing ~ $50 Tr of nominal GDP or ~ 2/3 of world GDP) have injected $10 Tr of base money in the past 7 years and G5 M2 has expanded by $20 Tr, G5 CPI (weighted by GDP size) has … decelerated from a +2.3% run-rate in the 2003-2007 cycle to +1.5% in the past 12 months. In other words, the more they print, the more inflation decelerates.
For the US specifically, Bernanke’s November 2002 speech (http://www.federalreserve.gov/boarddocs/Speeches/2002/20021121/default.htm) has become an historically important document in which the future Fed Chairman lists all the arsenal of unconventional measures the Fed could activate if confronted by deflation, the likelihood of which being deemed “extremely small”. As it turns out, the chance of deflation happening in the US was not small and all these measures have actually been implemented in response to the “unforeseen” 2008-2009 deflation. So, we can now compare the results from the real life experience with the results predicted by the theory. In the 2003-2007 cycle, US CPI was averaging +2.9%. From 2008 to 2014, the Fed has injected $3.6 Tr of base money and M2 has expanded by +$4.1 Tr (+6.5% p.a.), far in excess of what was required by the real economy (+2.4% p.a since the trough of mid-2009 in real terms). How has CPI reacted? Initially, it looked like everything worked as expected: the first $2 Tr of monetary expansion till mid-2011 turned the 2009 deflation into a +2.4% inflation in 2010-2011. But, in the first contradiction to the theory, it didn’t help the economy which looked like going into a double dip mid-2011, prompting another round of QE for +$1.7 Tr between October 2012 and October 2014. How did inflation reacted to this renewed monetary stimulation? Well, in the second contradiction to the theory, inflation actually decelerated to a run rate of +1.6% in 2013-2014. The latest print is +1.3% for November and is set to go lower as the sharp drop in energy prices and the lower imported inflation from the stronger $ work their way through to CPI. In the US as well, the more they print, the more inflation decelerates. So, the result of the real life experiment is the exact opposite of what was predicted by the theory. The theory is thus invalid and the speech needs to be re-titled: “Deflation, how to make sure it happens here”. After having confused the symptoms of the Great Depression with its causes in his academic life, Bernanke has managed to repeat that exact same mistake in real life.
Q.E.D.
So are you saying that monetary tightening would be inflationary? Contracting reserves sharply would invert the yield curve and many financial firms may start to experience financial pressure.
I think QE has worked pretty well BTW. The reason you’re not getting inflation is from supply-side factors. The world has excess capacity and it seems to be collapsing right now (see link below). You’ve got China and a few parts of the world overproducing like mad while the developed world is in a demographic collapse. In other words, no one has the capacity to consume the excess production in the world. However, commodities are used as economic inputs, which means that we’ve seen strong commodities as long as the developing world is able to maintain its excess capacity. Once commodity prices bottom, inflation for the entire world, will only go higher.
This excess production was taking headline inflation through the floor while sustaining high commodity prices. Once this excess capacity collapses, everything will change.
No, i’m not saying that monetary tightening would be inflationary. I’m saying that, in the global trade and financial system as currently set up, US monetary easing ends up being deflationary because it raises debt level relative to income and helps funding extra capacity investment in low cost countries where labor arbitrage makes returns more attractive, thus helping “China and a few parts of the world to overproduce like mad” as you say while putting pressure on US wage and price levels. I’m not only saying it, i’m also providing the data suggesting that this is indeed how things seem to be working. In fact, this is the very explicit promise on which globalization was sold to developed countries public opinion a few decades ago: consumers will pay less for their goods, the very definition of deflation.
The issue is not to ease or to tighten within the current unbalanced system. The issue is to have a new global trade and monetary system where exchange rates are fixed but adjustable by reference to a standard which is not also the domestic currency of a participating country so as to prevent labor and FX arbitrage and keep cross current account balances at equilibrium. This is the only way to raise global labor share of production, hence reducing the persistent supply-demand gap in a non deflationary way. Otherwise, the gap will close by shutting down excess capacity and firing people, excess capacity will collapse as you say. That would be another great depression. Same causes. Same policy mistakes. Same consequences. I’m concerned that time is running short now. Yes, once commodities price bottom, inflation will go higher for the entire world but, between now and this hopefully better future, there is a delicate passage in which we are entering just now: input costs deflation is putting downward pressure throughout the entire economic machine, from producer to consumer price, from one country / monetary zone to the other, causing pain to the most leveraged agents along each global value chain, with the very real risk of triggering that self-reinforcing negative feedback loop, causing governments to resort to competitive devaluations to try and stay on top of that shrinking global debt edifice, like in the 1930’s. Small intriguing question if i may: how do we make sure this doesn’t happen right on the back of all the easing measures aimed precisely at making sure this would not happen?
As long as we don’t reform the current global trade and monetary framework, we can only resort to expedients bringing temporary relief to the symptoms while leaving the primary causes unaddressed. Like budget stimulus, the benefit of monetary stimulation are leaking away. Yes, QE has worked well … as an expedient ; it can’t be anything more than that. And expedient is precisely what we don’t need anymore. Several decades of expedients have allowed the problem to grow much bigger.
What do you expect from politicians? For them to make the exact right decisions at the right time?
Have you ever thought that maybe the kind of thinking you’re laying out is the problem? These guys force constraints like most of us. Many of the decisions they make aren’t choices, or if they are choices, they’re much more constrained than we think they are.
I agree that the international financial system needs to be reset. However, maybe the current set-up with the politicians is the problem. We always think about politicians and talk about them like they’ve got all of these abundant options, but do they really? They’re forced into doing what they have to do.
The problem is, as I talk about in my attached post (see comment below or link attached), there’re feedback loops whereby countries get locked into certain policies because the policymakers are forced to do so. Policymakers are always interested in suppressing volatility because they’re human beings and most human beings (particularly suckers) are horrible at thinking about risk. Alas, you have human stupidity combined with forced constraints and you get horrible outcomes. This shouldn’t be a surprise to anyone.
http://suvysthoughts.blogspot.com/2014/10/worldwide-supply-demand-imbalances.html
You’re wondering what’s the likely outcome? It seems pretty clear to me: war. War happens and we can’t control this stuff. What we can do is to make sure that all the scenarios possible have a localized impact on the downside.
I’d also like to add one more thing to the globalization topic. The current globalization cycle stemmed from the US basically protecting everyone else’s trade. Due to there really only being one global navy that protects everyone’s trade, transport costs are very cheap. This means that countries in the world who import >50% of their populations with high fertility rates and exploding populations that rely on natural resource exports for cash have done great because they don’t have to protect their exports or imports. If you switch the financial system, the trade network won’t be there and you’d definitely see war and famine in many of these places.
The current monetary system exists because of Bretton Woods and was a way for the Americans to contain the Soviets with what’s essentially a bribe (protect your shipments, provide security, and provide a market to export into without asking for reciprocity). After the USSR went down, the US still needed this network to protect its key energy imports–primarily from the Middle East. Now, the US is the world’s largest energy producer and could be exporting energy (LNG) to other places. The Americans really don’t have a reason to provide worldwide security anymore, and they simply won’t. This means trouble for countries who rely on massive amounts of imports of critical economic inputs that don’t have a decent navy and trouble for countries that export lots of natural resources/commodities that don’t have a way to protect their network.
Note: I’m not saying that the US becoming an energy exporter is a good thing. It could end up being a terrible thing (particularly as an economic gambit, but maybe not as a strategic gambit).
Suvy,
– I am well aware that politicians are under many powerful constraints which largely dictate their choices, with an understandable tendency to lean towards the interests most generous in their funding of politicians. That’s why i believe the time for a new, more balanced hence more mutually beneficial, trade and monetary system might be more opportune now: many parties representing together close to 3/4 of the world GDP now face the same inescapable debt constraints. Their interest are much more aligned now.
– Yes, it has occurred to me that may be the kind of thinking i lay out is part of the problem. It is my good faith opinion that this would be a significant improvement to the present situation, more realistic than a “laissez faire” approach to global trade and more desirable than an closed autarkic system.
– Since this issue regards how humanity trade and exchange among itself, it is out of the question to suppress “human stupidity”, we have to converge by adaptation to the most balanced system possible taking human beings as they are. Ideologies that have tried to change human beings have led to atrocious carnage.
– Yes, we can’t rule out that the current situation with rising unemployment, rising inequality, rising debt loads, rising skepticism towards governing institutions, rising currency devaluations, rising geopolitical tensions ultimately lead to war. I think we are not there yet. It should be obvious that any practical peaceful solution to these pressing issues should be actively pursued before war becomes inevitable.
– What i’m suggesting involves changing the exchange rate regime and the international monetary standard so as to bring current account balance closer to equilibrium over time. Under this condition, the current trade system can remain largely the same.
DvD
I tend to agree on many areas with you.
I tend to believe that things are altering.
I believe this is because the system has been very successful, insofar as in advancing standards of living globally. While this is true, that standards of living have advanced globally during the reign of the current system, it is not sure whether these would have (1) advanced, (2) advanced as far, or (3) retreated considerably under a different set of institutions and systems relations.
Now you speak, as if some great abomination has already occurred; as if the bubonic plague was long released on a population being ravaged of its effect. To whit, I would say that we are only beginning to feel its problems in gestation, and that we haven’t seen anything yet. This as I have been a multi-decades long critic of the system. Perhaps my ability to hyperventilate was super-ceded by the growing of gills, even able to breathe under water. While, we may fancy ourselves to criticize what is, let us be sure to focus on what is coming of it. What I mean is, that this has been a system that has advanced the lot of a very complex world, made more complex during its evolution; both by number of people, humans, technologies in employ, spread of education, spread of industry, growth of trade, and growth of expectations (one of the gravest problems might be the that the system has merely reached its constraints (insofar as willingness to continue, ability to continue, and the understanding required to continue). One of your points of debt growing over decades, some places far faster, but generally over the expanse of decades has parallels in 19th century Europe (even higher then Japans 800% before collapse) which might imply pace of acceleration and not final destination of a figure.
I suspect that far more than the exchange rate mechanism is to be adjusted. Look at how this fell apart in the last several decades, and look at how some have advanced of it, look at how some want too. It seems to me those advocating a league of Democracies are likely to be moved forward. What are illiberal forces to continue to do, as human capital, and the contradictions are lain bare, continue to pretend in the future, that their cultures, a 19th century creation, are under assault.
We need both more collaboration and to jettison the thought that there is a single solution. The present is built of the success of the past, and the many more forces that are contained within, the excuses of developed and developing alike fall (ideologies, beliefs, values, Hegelian dialectical tactics), as Minsky notes:
“institutional changes affect the policy actions needed to sustain coherence. Policy cannot be a once-and-for-all proposition: as institutions and relations change so does the policy that is needed to sustain coherence.” Minsky, H. (2007). Stabilizing an Unstable Economy, pp 117
Csteven,
Yes, GDP / capita has increased under the current system, especially in developing countries and for the top 5% in developed countries. I have acknowledged that happy fact several times (see for instance one of my comments in “Economic Consequences of Income Inequality”). Note, though, that GDP / capita materially over-estimates the rise in living standards as it has been accompanied by a much steeper rise in debt / capita. It would be a mistake to just look at income and ignore the balance sheet. A successful system would have advanced GDP / capita at least as fast as debt / capita and it is worthwhile to understand why this has not been the case. Your counter-factual argument is a generality that doesn’t add much to the debate, frankly.
Not the slightest allusion to “great abomination having occurred” or bubonic plague having long been released” in any of my comments. There is no need to caricature what i’m saying as it is quite straightforward: the current global trade and monetary system is eroding aggregate demand by allowing widespread labor and FX arbitrage, resulting in falling labor share of production globally, hence forcing up debt-to-income ratios to allow demand to keep up with supply, as well as pushing up profit share of production, leading to fast increase in income and wealth inequalities, leading to increasingly speculative investment activities and a choice between unsustainable debt-funded consumption or unemployment. Efforts to sustain the current system by ever more aggressive monetary easing can only lead to dangerous impossibilities once the system has converged towards the maximum debt / income limit (and maximum asset value / income) allowed by prolonged 0% interest rates while the underlying demand leakage persists. As former Bank of England Governor Mervyn King said at a conference at the London School of Economics two days ago: “There are quite serious disiquilibria both between and within economies that, for good economic reasons, are depressing demand […] Simply lowering rates even further or adding more monetary stimulus is unlikely to solve that problem”. (Amazing how guys who have done £375bn QE up to their last day in office suddenly embrace upon retiring the exact same arguments they have dismissed for decades while in office…). You are welcome to disagree (in which case, please articulate where and why) but please don’t grotesquely misrepresent.
Agree with your Minsky quote. That’s what i meant by “we have to converge by adaptation to the most balanced system possible”. I see the root causes of the current demand weakness in the global labor and FX arbitrage opportunities allowed by the system as currently set up since the early 1970’s, hence it seems to me a natural adaptation to close these arbitrage opportunities so that the advantages of the system are preserved while its weaknesses are corrected. Again, you are welcome to disagree, in which case please explain. Your complexity argument is also a generality that doesn’t add much to the debate.
Thank you.
DvD
Actually we agree and was glad to see you explicitly state the case.
Of course the difficulty is the notion of converging on limits (whether at 0% or otherwise).
As to your quick dismissal of my arguments, I tend to differ as to utility, but then I would, and you might. So, issues of standard of living, progress, sustainable levels of proportional relations between factors (gdp, debt, wealth, income, etc) are very able to be disagreed with.
Seeing these, and experiencing change on streets (Bratislava 1990’s looking like New York Dock districts, 1970’s, and global metropolis looking much better today). Number of universities in more countries, increasing caloric intake, lengthening lives, diffusion of material capabilities…..these undeniable progress, how much to have occurred, under different scenarios, whose to say, but not dismissed of the system that has advanced, and even less able to be quantified, and certainly not merely on a debt to gdp, outpacing income, or the growing use of FX arbitrage to interfere with global trade and production systems in a system that has not been free. So, I am afraid, I do welcome your perspective, and it is a clear and concise explication of what we all recognize, but am none to quick to merely assume that alteration of the practices as existent, upon the principles you state will meet the ends required in the world as it is evolving. IE a whole new global grand bargain, because, the issues you raise, under the conditions I note, with the expectations of so many, and the ideological chatter of even more, highlight that while the changes you describe might be necessary, the are likely to fall far short of what is required in the face of progress, expectations, needs, interests, and oh, so many other forces that coalesce in the space.
My arguments, if they are called so, i would say observations, insofar as complexity or toerhwise, are often framed, to draw out others arguments, and to limit the ideological chatter of others.
DvD
Profound and prescient as usual, on point, but your preference implies far too ambitious a set of collaborations and cooperations than is likely to eventuate. So, you need to think of more than either or, poles and extremes, but alternative passages, and satisficing measures, because that is about as much as we get. While what you say is better to be heard, the transition and the journey, the gap in understanding, the distance in obfuscated understanding and values, ensures that this will occur, only in the graver of crisis, and then likely not as well as can be imagined, due to some grave misunderstanding of the issues at play, and the uncool heads of those lost in mythologies and ideologies. Certainly, most are boundedly irrational, perhaps, by the light of a candle in the past, rather than caught between the choice of very more diversions in the present era, these matters could have been considered more completely, with similar conclusions, by many in more domiciles. But this seems to not be the case, and resultant of the abundance we have in the present world, and the massification of education that leads us to common destinations, half the distance to where we need travel.
Of course there may be an influence of Monetary policy, likely some factor, however, correlation rather than causality, and preponderance of force in this matter, might be more in question. You would have to be able to show, if the preponderance of us monetary policy was in question, that this occurs, either in real time or lag, likely in lag. For example, it would likely be the case that sometime after QE occurred that foreign plant expansions, new greenfield, were being sited. Then you would need explain how, what occurred in US during 2000’s compares with the great expansion of global productive capacity in 2000’s and then to compare previous, and era’s post to GFC to see if holds. I tend to think there is an influence, but perhaps you do to much. What are you considering monetary easing to be?
M2 expansion
Interest rates being lowered
etc…
Further I think the labor arbitrage is being overplayed, it is deflationary psychologically for all on the matter, and obfuscating. It both rationalizes that wages stay low elsewhere, outside the OECD, and why they need go further inside the OECD, which lends to a horrid continuance of the very functions that imbalance economies globally. It is well known that access to cheap finance, free land, export rebates, tax abatement, tax holidays, and other functions have had as great or greater an influence or the siting of production, than merely labor.
Now while what you say is likely and I believe that inequality within countries, and movements to consumption driven economies is necessary, and this might require those elements you desire, I am not sure that such is even possible.
It would be interesting to see, rather than opposite poles, a middle path through, as we already know the potential for excess to continue, and that it leads to depression, just averted in 2008 with such a recent occurrence still unable to drive the minds of global leadership into realms of greater cooperation, compromise and foresight.
Tip O’Neil said that all politics is local, perhaps one of the graver problems that will revert the situation in Rodrikian ways.
While war and reset maybe the most likey scenario, a middle and more peaceful path would be the IMF becoming the backstop to all central banks engaged in QE. The old-SDRs of a few decades ago could be dusted off and they are arcane enough to fool folks into it become a global unit of account. The Fed,BoJ, ECB etc would effectively get a bailout of SDRs and peg their currencies to SDRs set by policymakers. Not a Smithian world, but it would be another messy bailout (money creation) to protect governments and world economic system from massive disruption and war. SDRs would effectively replace the USD as the global reserve currency and provide some price stability. Foreign-exchange volatility is acceptable in small currencies like the Ruble and Swiss Franc, but when the massive swings hit Euro and Yen, there will be another crisis- demanding actions the rockstar central bankers Draghi and Yellen will take the role of Hank Paulson- and save the world one more time before the finale act.
This was the link I didn’t attach.
http://suvysthoughts.blogspot.com/2014/10/worldwide-supply-demand-imbalances.html
If there is deflation in Japan in the context of a falling Yen, I think this implies that the fall of japanese goods & services’ prices must be more pronounced than the headline CPI indicates. Just because imported goods & services prices increase relatively as the Yen falls. Is this correct? What are the implications?
JON,
Just because FED expands credit to banks, it does not mean inflation. Say banks A, B, and C etc. borrow the money from FED and invest in stocks. Stocks inflate, bank A makes a money and other banks loose. They all still owe the FED original amount plus interest. This like a wave in a reservoir ,it does not increase the total amount of water. The inflation usually occurs when households with their increasing savings create a large demand that exceeds production of goods or if FED prints money that is distributed to the households.
HI, prof hi everybody happy new year. I just read some interesting point made by Richard Werner. He b say that we need QE(Japan and EU). He distinguish three kind of QE. The consuption oriented, supply oriented and market oriented. He staed that only one is good, the supply oriented QE. Because it doesn’t create market bubble or inflation. When i read your new piece i think you do not agree with his conclusion. He also say that money creation is at the heart of lots of crisis. Because of asymetric informations, a centralised money creation around few banks are bad for small players. And like you, he think at some point an advance economy, finance is all about bringing small player to big position. I would like your opinion on that.
Professor Pettis,
I find your argument that lowering bank deposit rates would hamper consumer demand interesting, as it seems to delve into behavioral economics. From my understanding, any rate cut by the Chinese government should lead to two countervailing trends among Chinese households: one is a negative wealth effect (as described in your article) where diminished expectations of future wealth lowers present consumption. Yet, counteracting this trend is the lowered opportunity cost to saving, which should encourage present consumption as the reward to saving is lowered. The net outcome on demand depends on the elasticity of each effect.
Given the lack of a strong social safety net and the absence of well-defined pension/retirement plans in China, I would think that the negative wealth effect would be greater than “opportunity cost” effect, for it’s difficult to spend money today if you’re unsure whether the government or family members will help you meet your retirement liabilities. So in effect, with a rate cut, you have a situation where the government lowers the benefit of savings, and to offset this households increase their savings rate to match their future liabilities to the present, lower rate, out of fear that they won’t have enough for retirement otherwise. I think according to most economic models this would seem “irrational”, for it implies that people supply more savings at a lower price than they do at a higher price, but it reflects the economic and social realities that ordinary people face when making decisions about their money. An interesting thought is whether the government could lower bank yields low enough to alter the psychological effect of saving enough to make consumption attractive (perhaps through a tax on deposits or other drastic measures).
Anyway, that’s my rudimentary (undergraduate) level understanding of how to conceptualize your argument. Any feedback would be welcomed.
Interesting article!
How would your theories explain the Japanese deflation/disinflation during the 90′-00’s?