The NPC Meets, Krugman Refers to the Savings Glut

With the tense start of China’s parliamentary season this afternoon – and with the National People’s Congress meeting Thursday – there isn’t much incentive to try to figure anything new out in China since we are likely to be given a lot more information and proposals over the next few days. What are the major topics likely to be covered in the meetings? I suspect that this article from yesterday’s South China Morning Post, on the topic of unemployment, gives a pretty strong hint:

If this is not addressed, it will be even more difficult for the government to maintain social stability down the road if unemployment remains high. China’s official urban unemployment rate is expected to be 4.6 per cent this year, which would make it the highest since 1980 when figures first began to be collected.

But, economists, including Zhou Tianyong from the Communist Party’s Central Party School, forecast that the real unemployment rate could reach 14 per cent, counting migrant labourers.

Senior officials estimate that up to 20 million migrant labourers have already lost their jobs because of the global economic crisis. They were mostly laid off by private firms and foreign-funded enterprises, the hardest-hit sectors.

I was told privately by a friend of mine two days ago that the number of migrant laborers who have already lost their jobs is actually closer to 30 million, but nonetheless Mr. Zhou’s comments reinforce some other claims to which I refer in a piece by me in the current Newsweek:

Although official estimates put urban unemployment in China at just over 4 percent of the workforce, most unofficial estimates are much higher—closer to 8 percent—and nearly everyone agrees that the figure is set to rise significantly in the next few months. Some credible estimates suggest that even if China were able to achieve the 7.5 percent growth projected in 2009 by the World Bank, unemployment would nonetheless double before the end of the year.

Clearly unemployment is going to weigh heavily on the minds of policymakers in China, like in the rest of the world, and we will have to wait and see what specific new measures are proposed over the next few days. Meanwhile I did nonetheless want to make a few comments about interesting stuff I’ve seen recently.

The first is a reference to an article in yesterday’s Financial Times, “Asean split on protectionism,” which highlighted the difficulties of getting leaders to agree on free trade even during a conference whose primary goal was to defend free trade:

As south-east Asian leaders gathered on Friday for their annual summit, the region’s united front against protectionism was starting to crack under the pressure of the global economic crisis. The fight against protectionism is top of the agenda at this weekend’s meeting of the 10-country Association of South East Asian Nations, which on Friday signed an agreement cutting tariffs and other barriers with Australia and New Zealand.

However, the leaders appeared far apart in pre-conference comments on the balance to be struck between sustaining open markets and promoting economic activity at home. In the most forthright remarks, Abdullah Badawi, Malaysia’s prime minister, said every country had the right to encourage its citizens to buy local products.

“I think it is a normal reaction under this kind of situation. First of all we have to protect our people; we are doing the same thing. If we do not create projects by Malaysia, for Malaysians, then who will buy our products?” Mr Badawi told the Bangkok Post newspaper.

For some of my readers I may be beating a dead horse, but as usual I will put up my warning that we need to be very aware of the deterioration in global trade relations that is likely to be a consequence of the rising unemployment everywhere in the world. The fact that even in a region heavily dependent on exports it is so easy (and so natural) to make the case for protectionism doesn’t bode well for trade discussions in North and South America, Europe and Australia. The article goes on to say:

Lee Hsien Loong, Singapore’s prime minister, said Asean might miss its target of establishing a regional economic community along the lines of the European Union by 2015 if member states failed to maintain open markets. “In this global environment, if we give the impression that Asean is not fully open for business I think we will be the losers when the new landscape emerges,” Mr Lee told CNBC.

Most of the regional economies have built their prosperity on the back of export growth, and the slowdown in the US, Europe and Japan has hit them hard. “I think we all worry about protectionism, and not just from traditional channels,” said Mari Pangestu, trade minister for Indonesia. In spite of Mrs Pangestu’s reservations, Indonesia is encouraging civil servants to buy Indonesian products, an echo of Barack Obama’s Buy American campaign that angered so many both within and outside Asia.

It may seem like a non sequiter to follow up with a second Financial Times article from yesterday, this one called “Emerging market finance: a gap to fill,” but bear with me:

Two years ago, nearly a trillion dollars flowed into emerging markets as investors in rich countries toured the globe in the hunt for yield. Now there is a melancholy long, withdrawing roar as private capital flees to safer havens.

…Net capital flows to emerging markets will drop to just $165bn (£115bn, €130bn) this year, down from $929bn as recently as 2007, according to estimates by the Institute of International Finance, which represents the world’s leading financial companies. Net lending from commercial banks, the IIF says, is likely to go into reverse. The reasons for this are not altogether straightforward. Some accuse rich governments, particularly the US, of “crowding out” emerging markets, sucking up all the available capital to finance their stimulus packages. But Brad Setser, a former International Monetary Fund and US Treasury official, notes that as the private sector retrenches, the US current account deficit – and hence its need for outside financing – has actually been declining.

More likely, he says, is that emerging markets are being hit by a general decline in demand for riskier assets, as banks and investors haul money back home to shore up balance sheets and reduce borrowings. Similarly, the global shortage of the trade credit that finances cross-border commerce reflects a general desire of banks to reduce leverage, not the rich countries hogging all the available loans.

Why is this relevant to a blog on Chinese financial markets? Because if annual net capital flows to emerging markets drop by the projected $700-800 billion, an inevitable consequence is that foreign currency reserves plus net imports for those emerging market countries will also have to decline by exactly the same amount. In other words while some of this decline will be accommodated by a running down of central bank reserves, we should expect a very large decline in net imports among those developing countries, to add to the decline in net imports from North America, non-German-Europe and other trade-deficit-countries. Needless to say this decline in net imports must have as a necessary corollary an equal decline in net exports in the trade surplus countries.

My final comment – hinted at in the title – is on Paul Krugman’s Op-Ed piece in today’s New York Times. he starts off by discussing the viciousness of the global crisis and then goes on to ask (and answer):

How did this global debt crisis happen? Why is it so widespread? The answer, I’d suggest, can be found in a speech Ben Bernanke, the Federal Reserve chairman, gave four years ago. At the time, Mr. Bernanke was trying to be reassuring. But what he said then nonetheless foreshadowed the bust to come. The speech, titled “The Global Saving Glut and the U.S. Current Account Deficit,” offered a novel explanation for the rapid rise of the U.S. trade deficit in the early 21st century. The causes, argued Mr. Bernanke, lay not in America but in Asia.

In the mid-1990s, he pointed out, the emerging economies of Asia had been major importers of capital, borrowing abroad to finance their development. But after the Asian financial crisis of 1997-98 (which seemed like a big deal at the time but looks trivial compared with what’s happening now), these countries began protecting themselves by amassing huge war chests of foreign assets, in effect exporting capital to the rest of the world. The result was a world awash in cheap money, looking for somewhere to go.

Most of that money went to the United States — hence our giant trade deficit, because a trade deficit is the flip side of capital inflows. But as Mr. Bernanke correctly pointed out, money surged into other nations as well. In particular, a number of smaller European economies experienced capital inflows that, while much smaller in dollar terms than the flows into the United States, were much larger compared with the size of their economies.

I have written often about the savings glut hypothesis and my very strong belief that it lies at the heart of the fundamental global imbalance of the past decade, and I think it has extremely important consequences both for our understanding how the crisis will evolve and what are the likely consequences to the major players involved in the imbalance. I am a big admirer of Krugman’s and have been for fifteen years – in the 1990s I used to read everything he wrote, and often within days of his publishing it – so I am delighted that he seems to agree with Bernanke’s thesis, but I should add that I believe the evidence in support is so overwhelming that even if Krugman decided to deride the whole notion, I would remain convinced that the sudden and massive rise in Asian net savings following the 1997 Asian crisis was a prime cause of the corresponding and necessary decline in US savings.

I know I know, this is going to be considered a very controversial statement – and inevitably someone will very stupidly demand to know why I am blaming China when obviously the full blame for the crisis should fall on the US – but there it is. I just don’t see how recent events can be explained without the Asian Crisis of 1997 having played a major role. At least Krugman seems to agree. At any rate he finishes worryingly with:

And the saving glut is still out there. In fact, it’s bigger than ever, now that suddenly impoverished consumers have rediscovered the virtues of thrift and the worldwide property boom, which provided an outlet for all those excess savings, has turned into a worldwide bust. One way to look at the international situation right now is that we’re suffering from a global paradox of thrift: around the world, desired saving exceeds the amount businesses are willing to invest. And the result is a global slump that leaves everyone worse off.

About Michael Pettis 166 Articles

Affiliation: Peking University

Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups.

Visit: China Financial Markets

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