Review by Stefan Wagstyl ? Financial Times
Examining the global economic crisis, it is easy to focus on specific issues ? the US housing bubble, China’s trade surplus, Greece’s rotten public finances. It is even easier to single out specific villains ? greedy Wall Street bankers, Beijing officials manipulating the renminbi and lazy Mediterraneans living off thrifty Germans.
It is much harder to put the whole puzzle together, as Michael Pettis does in The Great Rebalancing (*). The former Wall Street banker, now living and teaching in Beijing, argues that in a globalised economy everything connects with everything else.
One country’s trade deficit must be matched by other countries’ surpluses, and cannot be blamed only on a deficit country’s supposed failings. A surplus country’s policies also matter. So Greek deficits are born not of the population’s imagined laziness. Rather, they result from Berlin’s policies to boost competitiveness to cut the job losses created by unification. Wages were held down, limiting domestic consumption. Extra production had to be exported ? notably to the eurozone, where a favourable exchange rate benefited Germany.
The same argument applies to the key US-China relationship. The US trade deficit is not generated mainly by Americans gorging on consumer products made by hardworking Chinese. It is also created by Beijing’s sustained promotion of production and suppression of consumption, creating surpluses for export. Chinese goods flow to the US because it is the world’s biggest open economy.
These arguments are familiar. But Pettis’s book stands out in its emphasis on the surplus countries’ responsibility for producing these imbalances ? and the role they should play in correcting them.
In China, the authorities not only suppressed consumption by restraining wages; they also limited returns on household savings to create huge flows of cheap finance for investment. This “financial repression”, writes Pettis, created a savings glut even bigger than the huge domestic investment need. In economics, since everything must balance, the excess is exported in the form of China’s huge accumulation of US dollars.
Pettis underlines that China is not “choosing” to buy US bonds. Its purchases are the automatic result of its domestic policies. This leads Pettis to debunk popular fears of a possible Beijing boycott of US bonds plunging America into a public debt crisis.
Chinese bond-buying, he writes, is matched by increases in the supply of US bonds because Washington has boosted the fiscal deficit to counter the effect of jobs going abroad. If Chinese bond-buying falls, it will be because there are fewer savings to export, and that will happen only when China boosts consumption, creating demand for, among other things, US goods. US unemployment will fall and so will the fiscal deficit.
The problem is that orderly rebalancing takes time and a disorderly rebalancing through future crises could be catastrophic. In his emphasis on the mechanics of the global economy, Pettis pays too little attention to the role of history in shaping events. The reasons why the Chinese Communist party opted for investment-led growth can help explain why it now finds it so hard to change tack. Ditto Germany and exports.
Something on the critical role of investor expectations would also have been useful. For instance, even if theory dictates a Chinese bond-buying boycott is not possible, a boycott scare is ? as is the mayhem it might bring.
Pettis’s followers will not be surprised that his conclusions are bearish, not least for China: Beijing has taken “too long” to address its imbalances and “is running out of time”. He predicts growth to fall from about 8 per cent last year to 3 per cent over “the decade of adjustment”.
For Germany, the outlook is worse, with slow growth “for many years” and “significant losses” for banks. He warns that trade-surplus nations have historically suffered most in global recessions, drawing ominous parallels with 1930s’ France. Meanwhile, Spain, Italy, Greece and others will be forced to leave the euro and restructure debt. Perhaps, says Pettis, only a German Marshall plan for the Mediterranean (unlikely) could save the eurozone.
The US outlook is brighter because it is already “slowly and painfully rebalancing”. But global prospects are gloomy with demand “weak for many years”. Trade tensions are rising and policy makers are doing too little. So imbalances “will reverse, but in possibly disorderly and even more painful ways than necessary.”
Investor hopes have risen markedly since last year, when Pettis completed his book. Perhaps he underestimates the growing willingness of EU leaders to reform the eurozone. But he is right to say that radical change is essential. His book is a call to action.
*The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy, by Michael Pettis, (Princeton, RRP?19.95, $29.95)