Bloomberg on China’s Property Crisis

A Twitter Thread and an Essay by Michael Pettis

Both of which are a continuation of the theme for this week.

The thread:

This thread answers the question about whether China finds itself in a liquidity trap. In English, it would seem that no matter what levels of interest rates in the economy, Chinese businesses prefer to save rather than invest.

You may agree or disagree with the conclusion (I most certainly agree), but the data is instructive. Please read the article linked in the first tweet.

The essay:

Any economy broadly speaking has only three sources of demand that can drive growth: consumption, investment, and trade surpluses. For that reason, there are basically five paths that China’s economy could take going forward.

China can stay on its current path and keep letting large amounts of nonproductive investment continue driving the country’s debt burden up indefinitely

China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with productive investment in forms like new technology

China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with rising consumption

China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with a growing trade surplus

China can reduce the large amount of nonproductive investment on which it relies to drive growth and replace it with nothing, in which case growth would necessarily slow sharply

The Only Five Paths China’s Economy Can Follow

Quick note: Blogging may be sporadic and light in the coming days.

A Tale of Two Countries

Although I should note that I have given up on trying to figure out if it is the best or worst of times. Who knows?

But rhetoric aside, today’s blogpost continues our attempts at trying to understand just what the hell is going on in China. And we do so by reading an excellent report written by Michael Pettis (here are previous EFE posts where Michael Pettis has been mentioned):

In the United States and China, rising debt is structural, and necessary to the way in which their economies currently operate. While it is indeed likely that part of the debt in both countries is due to profligacy, irresponsible behavior, and even fraud, these do not explain the bulk of the increase in debt. Even with the strictest controls, until more fundamental changes are made to the two economies, either debt must continue to rise or growth must slow to politically unacceptable levels—levels that cause unemployment to rise.

Michael Pettis makes the claim (and in my opinion it is a convincing one) that investment in China is not going to come down anytime soon. Which means, we know by now (see the first two posts of this week), that investment by government will not come down anytime soon. And why will it not come down anytime soon? Because China needs to grow, and growth can’t come from anywhere else but government led investment.

Think of three questions:

  1. Why does China need to grow?
  2. If we accept that China needs to grow, how can China ensure that it continues to grow?
  3. So what happens next? This question I can answer right away, actually. It is, currently, anybody’s guess!

Question 1: why does China need to grow?

Well, because growth is good – is that not a good enough reason?

Sure, it is, but more importantly, a lack of growth is not politically acceptable. How can low growth be possible when it is Xi himself at the helm? And so China Must Grow. Or be seen to be growing. Or don’t see the fact that China is not growing. But preferably, China Must Grow.

Question 2: How can China ensure that it continues to grow?

Well, let’s have China consume more! Except that this is easier said than done:

China suffers from two forms of income distortions that limit demand for Chinese businesses. The one most discussed is income inequality: rich Chinese individuals (like rich Americans) retain a disproportionately high share of household income. But the second, more important form of income distortion is the very low share Chinese households retain of the country’s GDP—roughly 60 percent versus the roughly 80 percent typical in the United States. The low household share of GDP has the same effect on demand as income inequality.

OK, then how about getting China to invest more?

Well, that pretty much describes the twenty year period between 1995 to 2015 (more or less). But that party ended a while back:

In fact, in more recent years, they have actually reduced investment in response to stagnant domestic consumption. In both the United States and China, the biggest constraint to productive investment by private businesses is weak domestic demand.

So OK, China has to continue to grow rapidly, but that can’t happen via consumption. Because inequality, and because Chinese households get a very low share of China’s GDP. It can’t happen via private investment either, because faced with weak domestic demand, private investment prefers to stay out of the game. So what comes next? Government led, non-productive investment.

The problem is that around the mid-2000s, investment in infrastructure, property, and government-owned projects in the aggregate began to create less economic value than it cost. The result was that China responded to the high savings of wealthy individuals and the government with a surge in nonproductive investment, which led to a surge in the country’s debt burden. This is the reason that China is forced to encourage a rapid rise in debt as the only way to prevent a rapid rise in unemployment.

Or, alternatively, if domestic demand is weak, cater to global demand:

China’s trade surplus allows it to externalize a part of the domestic demand deficiencies caused by low consumption, and so reduces the amount of nonproductive investment (and debt) needed to balance Chinese supply and demand. The American trade deficit forces it to absorb foreign demand deficiencies and so increases the amount of debt needed to balance American supply and demand. But while the countries’ different trade positions exacerbate U.S. debt and reduce Chinese debt, it leaves China overly sensitive to changes in external demand and to trade conflicts, while the United States actually benefits from trade conflict.

But now, post the pandemic, and post the world’s reluctance to remain overly dependent on China, “externalizing domestic demand deficiencies” is no longer possible. And China has done more than its fair share of government-led, non-productive investment. And so China is now faced with two choices:

  1. Don’t accumulate debt, and therefore grow more slowly. But hey, Great Helmsman, so China Must Grow.
  2. Accumulate debt, and grow rapidly, but by making stuff nobody wants. But even this has run its course in 2023, it would seem.

There is secret option 3: liberalize markets, let investments be market driven, and let consumption grow organically and therefore eventually more rapidly. This is the theoretically correct answer, if you ask any economist. This is the politically impossible answer, if you ask any political scientist even remotely familiar with China.

Which boils down to the all-important question:

In a fight between good economics and bad politics, who wins?

My answer to this question is another question:

What time horizon do you have in mind?

Scott Sumner on “The Confusing China Debate”

You should read yesterday’s post before tackling this one. Consider yourself warned!

Scott Sumner, whose post on China we’re discussing today, has a nice excerpt from the WSJ, which I’ll reproduce below:

Economists and investors have been calling on Beijing to make bolder efforts to boost output—especially by promoting consumer spending, if necessary, by offering cash handouts, as the U.S. did during the pandemic.
Accelerating China’s transition to a more consumer-led economy—such as that of the U.S.—would make growth more sustainable in the long term, economists say.
But top leader Xi Jinping has deep-rooted philosophical objections to Western-style consumption-driven growth, people familiar with decision-making in Beijing say. Xi sees such growth as wasteful and at odds with his goal of making China a world-leading industrial and technological powerhouse, they say.
Xi believes Beijing should stick to fiscal discipline, especially given China’s deep debt. That makes stimulus or welfare policies akin to those in the U.S. and Europe less likely, the people said.

He goes on to say that Xi is right when he says that welfarism ain’t right for China. But, he goes on to say, the economists are also right when they say that China needs stimulus. So if the government won’t give the meds but China needs the meds, then where do the meds come from? Monetary stimulus should step up to the plate, per Sumner.

GDP, as any first year student of econ will tell you, is C+I+G+NX. Well, any Indian student, at any rate, but that’s a whole other story. Look this up, if this is not familiar to you.

Scott Sumner says that this framing is problematic. Why problematic? Because if we economists see that I (investment) is down, and GDP needs to go up… well then, we’ll say that either C should go up or G should (or both). But Scott says that this is wrong. No policymaker, he says “could realistically have the information required to make that judgment.”

His point is that what we should be saying is that China needs to do less wasteful investment. China has a lot of “white elephants“. Stop building those out, and let the market work out what is needed. The Chinese government should encourage more private investment and discourage public investment.

Well… that’s a bit like saying that an alcoholic should not drink quite as much. Easy to say, difficult to make happen. This is not, to be clear, me making fun of Scott’s argument. I’m simply trying to give you an analogy that might make understanding this easier. In fact, Scott himself later on in his post says that he is describing what ought to happen in an ideal scenario:

Some might argue that my analysis is naïve because China is far from being a laissez-faire economy. Monetary stimulus won’t necessarily go into the most efficient sectors. I agree. I am describing the sort of outcome that China should be aiming for. Determining which policy levers to push requires an in depth knowledge of the current policy distortions that lead to a misallocation of resources. Thus monetary stimulus might be combined with banking reform to reduce moral hazard. The goal would be to reduce lending for nonproductive investments, such as dubious real estate projects. But again, that’s not aiming for “less investment”, that’s aiming for less wasteful investment.

I find myself in agreement and in disagreement with Scott’s post. Agreement because the advice is sound. Disagreement because there isn’t a snowball’s chance in hell of this happening. How does the Chinese government, of all institutions, credibly show that it will be a passive and benevolent spectator to market-driven investment? Remember, this is XI’s government!

So as a theoretical solution, sure. As a practical solution? Not so much. If you want the Chinese economy to get out of the situation it finds itself in, you have to come up with solutions that take into account the ground reality. And the ground reality is that the Chinese economy works at the pleasure of the Chinse government, and the Chinese economy is never quite sure about what the Chinese government will do next. So for the Chinese economy to muster up the courage to gather funds and deploy them on multi-year investment projects, and to trust that the Chinese government will do nothing to get in the way across all of those years is… well, not happening.

Scott Sumner knows China a million times better than I do, so of course he knows this. Don’t read his blog post as being indicative of what he thinks the Chinese government will do. Read it as what he things the Chinese government ought to do.

The real issues are using monetary policy to assure nominal stability, and moving to a more market oriented economy to insure economic growth and higher living standards for the future.

You may or may not agree with the first half of that sentence (I personally think there is room for fiscal policy along with monetary policy). Everybody agrees with the second half.

Everybody, that is, except the Chinese government.

More’s the pity.

China and a Balance-Sheet Recession

This is a topic I’ve been thinking about a fair bit recently, and to the extent that it is possible to do so, I want to spend some time in thinking about this in greater detail throughout this week. What’s up with China, and how should we think about

  1. What got China where it is today?
  2. Where does China go from here?

There are other things to think about in this regard, particularly as an Indian, but that takes me into the realm of geopolitics, and I know very little about it. One day, maybe. But for now, the question of what got China where it is today.

And lots of things have gotten China where it is today. But one of the many strings that we need to pick up on and see where it takes us begins with a country and a person. The country is Japan, and the person is Richard Koo. Koo is most famous, of course, for having coined the phrase “balance-sheet recession”:

After its stockmarket bubble burst in 1989, share prices plunged by 60% in less than three years. Property prices in Tokyo fell for over a decade. Deflation, by some measures, persisted even longer. Even the price of golf memberships—tradeable on organised exchanges in Japan—tumbled by 94%. Many companies, which had borrowed to buy property or shares in other firms, found themselves technically insolvent, with assets worth less than liabilities. But they remained liquid, earning enough revenue to meet ongoing obligations. With survival at stake, they redirected their efforts from maximising profit to minimising debt, as Mr Koo put it.

How should you think about this? Well, here’s a very simplified example. Imagine that every single household in your locality decides to not spend more in the month of September 2023, but instead save more. That may be good news for each household, but can you imagine what the local grocer, the neighborhood restaurants and the local movie-theater might feel about such a move? Exactly the same thing happened in Japan, but at a national level:

In post-bubble Japan, things looked different. Instead of raising funds, the corporate sector began to repay debts and accumulate financial claims of its own. Its traditional financial deficit turned to a chronic financial surplus. Corporate inhibition robbed the economy of much-needed demand and entrepreneurial vigour, condemning it to a deflationary decade or two.

The question that The Economist article asks and answers is whether China is “going the Japan way”. Note that this has been covered on EFE before, by the way.

And the answer they come up with is yes, but only kinda-sorta. And there’s (of course) more to it than just that. Yes, Chinese firms have accumulated insane amounts of debt, yes China’s house prices are undergoing a massive correction, and yes credit growth has slowed sharply.

But most of the debt is held by SOE’s, and they will borrow more, if that is what the Chinese government desires. And Chinese households drawing down their debts has more to do with the peculiarities of the Chinese market for mortgages than with households having stressed balance sheets. In fact, if anything, Chinese household debts are reasonably low. On the whole, the article argues, Chinese businesses don’t seem to be behaving the way Japanese businesses were in the 1990’s.

So yes, debt reduction is a thing in China, but it’s not quite Japan all over again, not yet. There is a problem, in other words, and it kind of looks like the Japan problem, but only in some ways. Still, it is a problem, there is no getting around that fact.

So how should this problem be solved?

Richard Koo says that the government should spend its way out of this problem. If the private sector is running up fiscal surpluses (saving more), than those savings need to be deployed somewhere. Where? The government should borrow and spend that money, according to Richard Koo.

If you accept that this is a good solution, there is only one problem. It would seem the Chinese government is not willing to play ball:

The country’s budget deficit, broadly defined to include various kinds of local-government borrowing, has tightened this year, worsening the downturn. The central government has room to borrow more, but seems reluctant to do so, preferring to keep its powder dry. This is a mistake. If the government spends late, it will probably have to spend more. It is ironic that China risks slipping into a prolonged recession not because the private sector is intent on cleaning up its finances, but because the central government is unwilling to get its own balance-sheet dirty enough.

And if you’ve got a mild headache thinking through all of this, I’ve got worse news for you. There are other economists who would argue that it is a good thing that the Chinese government is not willing to play ball. Fiscal policy, they argue, is not the way to solve this problem.

So what is their solution?

We’ll find out tomorrow.

Brad Setser on Tyler Cowen on China

In which Michael Pettis tells us that institutions and culture remain underrated

William Hurst on China

Gulzar Natarajan on Industrial Policy for Large Investments

…the idea of attracting large manufacturers in ecosystem creating industries might be a promising strategy to adopt. An example is the Indian government’s push for Apple.

Industrial policy – what it is, what its benefits are, and what its limitations are – has been the focus of many an op-ed in the recent past. That, to me, is a signal to avoid reading most of them. But not because the topic itself isn’t important! On the contrary, industrial policy is the topic to learn more about if you are a student of the manufacturing sector in the Indian economy.

Why do I say so? Many reasons, but Gulzar Natarajan offers as good a summary as any I’ve read in the lead-up to the excerpt I’ve pasted above.

But in this post, Gulzar Natarajan points to a specific aspect of industrial policy:

Conventional wisdom would have it governments should not pick winners. India’s courting of Apple and mobile phones success is a good example that questions this wisdom. Mobile phones and Apple/Foxconn (and Samsung) are winners. Just as electric vehicles and Tesla, or semiconductor chips and Samsung/TSMC could be. Solar and wind power generation equipment manufacturers and defense manufacturers are another two examples. The same can be said of contract manufacturers Pou ChenFeng Tay, Hong Fu, Apache, etc in footwear, and Toray, etc in apparel. The facilities of these companies will be large enough to create a manufacturing ecosystem that has transformational impacts in its town or region. In fact, there’s a strong case that instead of spreading resources thin by targeting economy-wide measures like concessions and input subsidies, an outcomes-focused industrial policy for a government would be to identify a few winners (sectors and large brands or contract manufacturers) and court them. Success would be measured by the ability to get one of them to actually make a meaningful enough investment.

By the way, as regards footwear, here are my notes from an earlier Gulzar Natarajan post on the topic.

But to come back to the point being made in this post, he is making the point that one way to do industrial policy is not by targeting an entire sector, but rather by picking “winners”. By the way, for students looking to answer the question “but what should I be working on?”, he has an answer.

But what of the risks with such a strategy? He identifies four of them:

  1. You need to pick the “right” kind of winner, which is easier said than done.
  2. It could well lead to crony capitalism.
  3. This can be countered with effective state capacity, and we don’t have it.
  4. It could crowd out the focus on small and medium enterprises.

I would add a fifth, and it is my biggest worry with such a policy: what if the winner ends up being a dud? Do we have the capacity to be ruthless and play hardball? To me, it is this that was, and remains, the key differentiator between East Asia of the 60’s and India today.

It’s Baaaack, But In China This Time

China’s Japanification, by Robin Wigglesworth in FT

What does Japanification mean? From the same article that came up with my favorite chart from 2023 (shown above):

“It can be described simply as a protracted period of deflation, economic sluggishness, property market declines and financial stress as households/companies/governments unsuccessfully try to deleverage after a debt binge.”

And is that where China finds itself today? Well, it is difficult to say, because data is hard to come by:

The statistics bureau stopped publishing a consumer-confidence index after April numbers fell to levels last seen during the depths of the pandemic. With youth unemployment climbing remorselessly, the same bureau stopped reporting that statistic this week, saying it is reviewing how to count jobless young.

Data has, of course, been hard to come by for a while:

Bu you can suppress bad news for only so long, and to even the most casual of China watchers, it has been clear for a while that China is slowing down. And China slowing down is, in a sense, both inevitable and predictable. If you know anything about China’s demographics, it’s emphasis on capital-led growth and the Great Decoupling, China had to slow down.

But ah, the debt. That is where the problems become truly worrisome:

According to the BIS, China’s total non-financial credit/GDP ratio approached 297% of GDP by end-2022, similar to Japan in the 1990’s. Also similarly, debt is mainly domestic, and the domestic saving rate is high in both countries.

China’s Japanification, by Robin Wigglesworth in FT


  1. China is ageing more rapidly than Japan was in the 1990’s
  2. China’s debt, when properly accounted for, is even more than Japan’s was.
  3. China has less wriggle room when it comes to monetary policy.
  4. China also seems to be less willing to use monetary policy as a tool.

And above all, culture. I wish I knew more about China, and I wish I could travel to China. Lots of reasons for me to say this (food included, and it is one of the top three reasons) – but in this blog post, I say I wish I could travel to China to make sense of this from The Economist.

It is difficult to excerpt from it, but here are the concluding paragraphs:

Does Mr Xi understand this? His thoughts on how to achieve national greatness have evolved, along with his message to young people. A few months after coming to power in 2012 he met a group of young entrepreneurs, volunteers and students, telling them to “dare to dream, to bravely chase their dreams and to strive to fulfil them”. Their ambitions will make China great, he said. One beaming participant, who had recently climbed Mount Everest, said it was a good time to be young.
Now, though, Mr Xi says the “Chinese Dream” of national rejuvenation is to be achieved by focusing on collective goals, rather than by encouraging individual aspirations. He admonishes the young to obey the party and toughen up—to “engrave the blood of their youth on the monuments of history, just as our fathers did.” That is a message that relatively few young people are taking to heart. Told to eat bitterness, they prefer to let it rot.

Keep a close eye on China in the coming months, it is a story that is likely to be interesting and of immense relevance to everybody who lives on this planet.

By the way, did you get why today’s blogpost is titled the way it is? If you are a student of macro, you should have. You might think there’s a typo on my part, but hey, China deserves an extra “a”.

At least.