November 29, 2008

The Chinese Depression

Maybe 'these dark times' will be known as the Chinese Depression.

Michael Pettis of Peking University has written a superb clear-eyed analysis of the current economic collapse.

China on the Precipice - A Reading List

Pettis' conclusion: some comparisons to the Great Depression hold true, but the actors have changed. This time, China plays the leading role instead of the U.S.

In 2008 an urbanizing and privatizing China has built up massive overcapacity, huge exports, and a growing current account surplus. Their accumulated near-two-trillion-dollar foreign exchange reserves have flooded the West with artificially cheap capital even as U.S. savings rates have dropped to historic lows, fueling the real estate bubble and debt crisis in the U.S. The U.S. market collapse is decimating demand for Chinese exports, and China's instinct to protect its exporters threatens to worsen the problem.

While the debt crisis has had only a minor impact on the Chinese economy so far, the China-U.S. trade imbalance is the key economic threat for both countries. The way to stave off a Chinese depression, according to Pettis, lies in the Chinese consumer. Instead of trying to boost exports to a world that has no more capacity to buy, China needs to boost its domestic consumption.

Pettis estimates that, to offset the U.S. consumer crash and avoid a depression, Chinese consumers need to spend about 40% more than they do. He thinks that is difficult and unlikely. However, we need to keep in mind that today's Chinese consumer spends only about $600 (USD) each year. If China succeeds in getting every citizen to buy a refrigerator and a TV, the world be well on its way to recovery.

My concern is that China may not be willing to let the Chinese currency rise enough to make Chinese consumers feel as wealthy as they should. In 1933 America, FDR also found it politically necessary to maintain a weak dollar, yet he also did not spend enough to let government demand match production capacity. The Great Depression resulted. It took World War II to soak up American production capacity.

We can only hope China will find a way to spend its excess capacity on homes and cars and microwave ovens instead of missiles and tanks and guns.

Posted by David at November 29, 2008 08:20 AM
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