April 16, 2013
Most analysts predict China’s growth will slow; they disagree only as to the depth and timing of its eventual recession. A rare exception to that group is Michael Pettis. Pettis, who describes himself as a skeptic, believes China can rebalance its economy.
Pettis is a senior associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. He is author of the recently released and widely acclaimed book, The Great Rebalancing. He spoke at the Wine Country Investment Conference April 5. That event was sponsored by Mish Shedlock and his firm, California-based Sitka Pacific Capital Management, as a benefit for ALS, the disease which claimed Shedlock’s wife last year.
China’s policy decisions will produce stress in various sectors of its economy, and political factors will ultimate dictate the direction its economy takes.
China commands a pivotal position in the global economy. Its exports drive consumer spending in the developed world, and its industrial sector uses a disproportionate share of the world’s commodities. Few things will matter as much in the coming decade as the fate of China.
I’ll look at the options Pettis laid out for a well-managed rebalancing and their implications. First, let’s review the conditions China faces in its economy today.
Why China is a mess
Debt is the key problem for China, according to Pettis, due to China’s investment-driven growth.
No one should be surprised at China’s excessive leverage, which Pettis said substantially exceeds its published number of 80% debt-to-GDP. “We have seen these investment-driven growth models before and they all end up exactly the same way,” he said. The initial spate of economically viable projects is ultimately displaced by less viable ones, and then by unviable projects. When that happens, he said, debt-servicing capacity becomes unsustainable.
“That is why we always run into a debt problem,” he said.
One of the least understood issues, Pettis said, is that urbanization will exaggerate China’s debt problems. Urbanization is highly pro-cyclical, he said. It supports growth in good times: Migration to cities spurs consumption and employment, providing a source for cheap labor. But urbanization can also accelerate recessionary forces during bad times, because it leads to higher unemployment and crime rates.
“Urbanization is now the default bull argument for China,” he said. “But is only a bull argument when things are going really well.”
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