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Every country in the world understands the need for
global trade rebalancing. Yet, politicians have done nothing but take stances
that mathematically cannot work.
Mathematical
Impossibilities
1.
Germany
wants the rest of Europe to raise exports and become more competitive while
simultaneously protecting its export machine and imposing numerous austerity
measures on the rest of Europe. Mathematically,
it cannot happen.
2.
China
wants to wean itself off an export model but does not want the pain
associated with measures that would actually increase domestic demand. Mathematically, it cannot happen.
3.
Japan
wants to raise taxes, increase consumer spending, and protect its export
model, all at the same time. Mathematically,
it cannot happen.
4.
The US
needs to reduce its budget deficit, rein in pension promises, and fix various
structural problems (many associated with public unions - the same as in
Greece and Spain), but lacks the political will to do so. Mathematically, U.S. deficit
spending is not sustainable.
In all four situations above, I have described situations that are
mathematically impossible, not just unlikely.
Bug in Search of Windshield
With the world's worst demographics, Japan has no politically acceptable
solution to its trade imbalance problem. Japan is a "bug in search of a
windshield" as writer John Mauldin puts it.
Global Trade Imbalances Poised to Worsen
With the above principles in mind, please consider a
few snips from an email from Michael Pettis at China Financial Markets
regarding "Japan's Debt Disaster and China’s Non-Rebalancing
Act".
China’s current account surplus has declined
sharply from its peak of roughly 10% of GDP in the 2007-2008 period to probably just under 4% of GDP last year. Over
the next two years the forecast is, depending on who
you talk to, either that it will rise significantly, or that it will decline
to zero and perhaps even run into deficit. The Ministry of Commerce has
argued the latter and the World Bank the former.
I am not sure which way the surplus will go, but I would argue that either
way it is going to be a very strained and difficult process for both China
and the world. On the one hand if the Ministry of Commerce is arguing, as
many do, that the rapid contraction in the surplus indicates that China is
indeed rebalancing and will continue to do so, I think they are almost
certainly wrong. China is not rebalancing and the decline in the surplus was
driven wholly by external conditions. In fact until 2010, and probably also
in 2011, the imbalances have gotten worse, not better.
For proof take a look at the graph below sent to me by Calla Weimer, a
Visiting Scholar at the US-China Institute, University of Southern
California. It shows China’s total savings rate as a share of GDP as
well as China’s total investment rate. As you can see, both numbers are
extraordinarily high.
The current account surplus, of course, is equal to the excess of savings
over investment – any excess savings must be exported, and by
definition the current account surplus is exactly equal to the capital
account deficit. This is the standard accounting identity to which I have
referred many times in my newsletters.
As the graph shows, the last time investment exceeded savings was in 1993-94,
and during that time China of course ran a current account deficit.
So is China rebalancing? Of course not. Rebalancing would require that
domestic consumption rise. Is the consumption share of GDP rising? From the
graph it is pretty clear that consumption has not increased its share of GDP
since the onset of the crisis. If it had, the savings share of GDP would be
declining.
And yet savings continue to rise. This is the opposite of rebalancing, and it
should not come as a surprise. Beijing is trying to increase the consumption
share of GDP by subsidizing certain types of household consumption (white
goods, cars), but since the subsidies are paid for indirectly by the
household sector, the net effect is to take away with one hand what it offers
with the other. This is no way to increase consumption.
What then explains the decline in China’s current account surplus over
the past three years? The graph makes it pretty obvious. The sharp
contraction in China’s current account surplus after 2007-08 had was
driven by the external sector, and in order to counteract the adverse growth
impact Beijing responded with a surge in investment in 2009.
Meanwhile investment continues to grow and, with it, debt continues to grow,
and since the only way to manage all this debt is to continue repressing
interest rates at the expense of household depositors, households have to
increase their savings rates to make up the difference.
Can China’s surplus rise further?
Declining trade deficits around the world require declining trade surpluses.
Part of the adjustment in Europe I suspect will be absorbed by a contraction
in Germany’s surplus, but the Germans of course are resisting as much
as possible since they, too, are dependent for growth on absorbing foreign
demand. I don’t know how this will pan out, but certainly Europe as a
whole expects its trade surplus to rise, and if instead it begins to run a
large deficit, German growth will go negative and the debt burden of
peripheral Europe will be harder than ever to bear.
Don’t expect Europe, in other words, easily to accommodate
China’s need for a growing trade surplus. If foreign capital flows to
Europe increase – perhaps as China and other BRICs lend money to Europe
– Europe’s exports will certainly decline relative to imports,
but because this means much slower growth for Europe, I don’t think it
is sustainable.
The problem of Japan
Tokyo is clearly worried that it is running out of time to manage the debt,
and the indications are that it has finally become serious about reducing its
debt burden. What’s more, Japan’s current account surplus has
already contracted substantially in the past two years, and in January it ran
the biggest monthly trade deficit it has ever run – $5.4 billion,
although the early Spring Festival this year may have distorted the number.
[Mish comment: For further discussion, please see Japan Faces Moment of Truth:
First Annual Trade Deficit Since 1980; New Trend or Simply the Tsunami
Effect?]
How can Japan reduce its debt? I am no expert on Japanese policies but
according to much of what I am hearing Tokyo is planning to raise taxes
further, especially consumption taxes, and to use the proceeds to pay down
the debt.
[Mish comment: Japanese government officials without a doubt want to hike
taxes. Please consider Japan's Prime Minister Seeks
Doubling National Sales Tax; No Winning Play for Japan.
Also consider World’s Biggest
Economies Face $7.6T Debt Led by Japan $3 trillion, U.S. $2.8 trillion;
Rollover Problems in Japan and Europe]
In addition Tokyo and the business community are putting downward pressure on
wages in order to increase the competitiveness of the tradable goods sector.
The Financial Times article Low wages
compound Japan’s grim prospects highlights the problem.
Bonuses have been coming under heavy pressure in Japan for years as part
of a wider effort to restrain incomes. And while workers around the developed
world have been complaining of a squeeze on incomes over the past two
decades, in Japan thinner pay packets fuel wider deflation. That makes it
even harder for the government to rein in its runaway debt and for the
central bank to use monetary policy to boost growth.
Japan Reverses Course
Yikes! This could turn out to be a huge problem for China and the world. Why?
Because raising consumption taxes and reducing wages will push up the
Japanese savings rate substantially. Either action pushes
the growth rate of disposable income down relative to GDP growth, and
lower disposable income usually means lower consumption – which is the
same as higher savings.
These policies will probably also reduce the investment rate. Lower Japanese
consumption, after all, should reduce business profits and so reduce the
incentive for expanding domestic production, while pressure for austerity
should restrain or even reduce government investment.
By definition more savings and less investment mean that Japan’s trade
surplus must rise. Japan, in other words, is planning to move backwards in
terms of rebalancing.
This Isn't
Going to Work
Pettis concludes with "Needless to say this isn’t going to
work. The 'good news' is that if this conflict leads to much slower global growth,
as it certainly will, the resulting reduction in commodity prices, including
oil, will help absorb some of the changes in the trade imbalances as
commodity exporting countries see their exports fall sharply. But I
don’t see much other relief."
That bit of "good news" is certainly not good news for the
commodity exporting countries like Australia, Canada, and Brazil all of which
have their own problems, especially Australia and Canada with enormous
property bubbles.
Moreover, Europe is an absolute basket case. Greece, Portugal, and Spain are
in economic "depressions". Expect European balance of trade
problems to worsen until those countries exit the eurozone.
Unfortunately career politicians like German Chancellor Angela Merkel have
bet their reputations on preserving the impossible.
Eventually, Germany is going to pay an enormous price for European imbalances
and ECB president Mario Draghi's LTRO program, now
hailed as an enormous success, is likely to be viewed as anything but success
when countries exit the eurozone piecemeal down the
road.
Economic Toxic Brew Portends Currency Crisis
As I said upfront, every country in the world understands the need for global
trade rebalancing. Yet, politicians have done nothing but take stances that
mathematically cannot work, some of which are likely to further exacerbate
the problems.
This economic toxic brew will simmer until the pot explodes in a massive
currency crisis at some unknown point down the road.
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