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Michael Pettis: Plenty Of Signs Of Dangerous Competitive Devaluations

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Michael Pettis: China Gives The Year A Wild Beginning by Global Source Partners

Special points to highlight in this issue:

  • The wild gyrations in the Chinese stock market this week don’t tell us much about the direction of the Chinese economy, but they do tell us just how much uncertainty there is, both in the outlook for the economy and in the way Beijing will manage it.
  • Three years ago I warned that because China’s rebalancing had been so long postponed, the country’s balance sheets had become extremely fragile and the financial system overly dependent on government guarantees. As a result, periodic financial shocks were inevitable. We are going to have, in other words, many more frightening weeks before this year is over.
  • The recent announcements of the new reform programs, being called “supply side” reforms, suggests that Beijing has become very impatient with the thrust of its policies so far and is looking for a new approach. We should take their evaluations at face value: the reforms so far have not fixed anything.
  • The biggest risk of events this week is that they set off a new round of competitive devaluation. It is already going to be very hard for the US to provide as much demand as the rest of the world wants it to provide. Another set of devaluations will almost certainly derail the US recovery.

China Gives The Year A Wild Beginning



Finally, as crazy as were the stock market gyrations, I think the rapid decline in the RMB, accompanied by what seems like another surge in capital outflows, is likely to be a lot more worrying in the medium term. I don’t think Beijing is planning competitive devaluations in order to strengthen the tradable goods sector in the hopes that this will boost growth. The source of China’s slowdown has really been weakness in domestic construction more than weakness in exports, although manufacturing overcapacity is certainly a problem.

I think the problem is that Beijing is trying to boost liquidity in the hopes that this will generate stronger domestic demand, but it is mainly fueling capital outflows, and Beijing is very nervous about letting a lot more money leave the economy. I want to watch to see what happens over the next week or so, especially as regards to outflows, and then plan to write more about the currency. For now, I don’t have anything new to say, and I suspect that officials at the PBoC and among other regulatory bodies are as puzzled as everyone else. I would like to see their reactions before writing much more about the currency.

The big risk, of course, is that the rest of the world sees the recent Chinese currency moves as a signal for a new round of competitive devaluations, and there are already plenty of signs that this is happening. I have already said that I expect 2016 to be a terrible year for trade, and I am worried that it seems as if every major economy in the world has implicitly decided to use US demand to bail out its own faltering economy. This will almost certainly derail the US recovery unless the US, too, decides to step in and intervene in trade. If that happened, of course, the impact on Europe and China would be terrible.

By the way, if all of this uncertainty causes the savings rate to rise significantly, not just in China but everywhere else too, our problems are compounded. The last thing we need is for even weaker demand, but it looks like we are going to get it.

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Sheeraz Raza

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