When China’s economy was booming people wondered whether a slowdown would lead to social unrest, and the consensus was that problems could crop up at around 8 percent GDP growth. Now that growth has fallen below that number, some people are writing off the whole idea, but as Michael Pettis explains in a recent newsletter sent to ValueWalk, GDP growth might be the wrong stat to be looking at. “Ordinary Chinese, like people everywhere, do not care about their per capita share of GDP,” says Pettis. “They care about their income.” Michael Pettis is Professor of Finance, Guanghua School of Management, Peking University, author of The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy, Avoiding the Fall: China’s Economic Restructuring and The Volatility Machine: Emerging Economics and the Threat of Financial Collapse
Michael Pettis on China’s Double digit growth
Pettis argues that part of the way that the Chinese government managed to hit double-digit growth year after year was through mechanisms that effectively transferred household earnings to corporate borrowers.
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“As a rule when nominal lending rates are broadly in line with nominal GDP growth rates, the rewards of growth are efficiently distributed between savers and users of capital,” Pettis explains. By keeping lending rates significantly lower than GDP growth, the Chinese government pushed household consumption down to about a third of total GDP, extremely low by global standards. But with such strong total growth, many Chinese people felt that their lots were improving and were happy with the situation.
It’s possible for GDP growth to drop while household consumption growth remains steady or even increases, but it will require the Chinese government to manage a difficult transition. The country already has a credit bubble, and the total value of bad loans (something no one can know with any certainty) will eventually take a bite out of GDP growth.
Since the household sector won’t be able to shoulder the burden of the credit bubble when it finally crashes, the only other actor who could fund such a thing is the state. Pettis predicts that another round of Chinese privatization is coming in the next few years. He points out that some Chinese bankers have already broached the issue, but right now it is still controversial. The good news is that if the privatizations do occur, they will give China the opportunity to restructure its economy in a way that makes it more competitive in the long-term.
Michael Pettis’ 12 Predictions
On a related note, in the newsletter Michael Pettis notes 12 predictions he made 12 predictions about the global economy, judge for yourself!
- BRICs and other developing countries have not decoupled in any meaningful sense, and once the current liquidity-driven investment boom subsides the developing world will be hit hard by the global crisis.
- Over the next two years Chinese household consumption will continue declining as a share of GDP.
- Chinese debt levels will continue to rise quickly over the rest of this year and next.
- Chinese growth will begin to slow sharply by 2013-14 and will hit an average of 3% well before the end of the decade.
- If the PBoC resists interest rate cuts as inflation declines, China may even begin slowing in 2012.
- Any decline in GDP growth will disproportionately affect investment and so the demand for non-food commodities.
- Much slower growth in China will not lead to social unrest if China meaningfully rebalances.
- Within three years Beijing will be seriously examining large-scale privatization as part of its adjustment policy.
- European politics will continue to deteriorate rapidly and the major political parties will either become increasingly radicalized or marginalized.
- Spain and several countries, perhaps even Italy (but probably not France) will be forced to leave the euro and restructure their debt with significant debt forgiveness.
- Germany will stubbornly refuse to bear its share of the burden of the European adjustment, and the subsequent retaliation by the deficit countries will cause German growth to drop to zero or negative for many years.
- Trade protection sentiment in the US will rise inexorably and unemployment stays high for a few more years.
- Finally one additional “prediction” which was not included in this list but which belongs here, was that the US would be the first major economy to emerge from the crisis of 2007-08 and China probably the last, although Europe might give China a run for its money.