In your book, you say China’s problem is worse than that of the US. Why?
The first law of macroeconomics is, ‘If you don’t prevent the boom, you can’t prevent the bust.’ The second is, ‘The bigger the boom, the bigger the bust.’ Now that the Dubai bubble has popped, there’s only one exception to that rule over the past 250 years - China - but I don’t believe it will remain the exception much longer.
China responded to the American crisis with a massive, unprecedented stimulus and bank lending. It’s been useful, of course. It’s like China has drunk a quart of Red Bull: it gives you a very big jolt, and it makes you feel alert. But after a while, the effect will wear off, and China will have to drink two quarts of Red Bull - or accept the reality that the economy will slow very sharply and that much of the stimulus money will have been misallocated, given that China already has excessive capacity across industries.
China sceptics have for years now warned of a ‘coming collapse’, but they’ve been proved wrong. Why can’t China similarly keep its economy rolling?
A year from now, Chinese authorities will have to decide whether to force banks to increase their lending again by 30% of GDP. If they do, they’ll succeed in keeping the economy growing by 10% a year or whatever. But the longer they continue with that, the more certain will be the crash, and the harder the crash will be. The longer they carry on with this extraordinary stimulus, the harder their bubble will ultimately implode and potentially more serious the consequences for the Chinese people will be. Chinese leader would be wiser to accept reality, and prepare their people for much slower economic growth - say 2-4% a year - rather than promising 8% growth forever. If China can achieve 2-4% GDP growth a year for the next 10 years, that would be an excellent outcome.
The Chinese government has a low debt liability: only 20% of GDP. Doesn’t that give it headroom to prevent a collapse?
The low level of government debt will allow China to do what Japan did. When the bubble pops, the government will be able to borrow and spend. It will be able to stimulate the economy with large deficit spending programs. Japan took it from 60% of GDP to more than 200% of GDP. That’s the most hopeful thing China has going for it: that the government can take its debt up to 100% or even 200% of GDP. That will allow the government to avert a Great Depression. But if it forces banks to make more and more loans when there are no profitable lending opportunities, their banks will have to be bailed out. Bank bailouts can be expensive, and will cause the government’s debt to jump up quickly. It won’t take long under a banking crisis scenario for government debt to reach 100% of GDP; that would leave them less room for manoeuvre in terms of supporting the economy.
Isn’t China better positioned, financially and politically, than the US to invest in 21st century industries and take the lead?
China is becoming a leader in areas related to clean energy, but China’s problem is that it cannot consume what it produces because its workers don’t make enough money. And China has an unprecedented trade surplus with the rest of the world: this will be met with a protectionist backlash that will put a cap on China’s ability to export anymore anywhere. For China to transform its economy, it has to wean itself off its export-led growth strategy and develop its domestic sources of demand. But that’s very difficult: China’s economy is built for export, where its advantage has been its low-cost labour. But that also makes it impossible to create in a short period of time a consumer-led industrial society.
The US, on the other hand, has a trade deficit with everyone. Other countries couldn’t object to the US balancing its trade if it made something that other countries needed. That would remedy the global imbalances that are destabilising the world.
Also, the US economy is roughly 30% of global GDP. Only the US has the ability to finance the kind of investment programs I have in mind. $1 trillion each in three different industries is an enormous amount of money. It’s like the NASA space program, on a much larger scale and with much more at stake. China is still a small economy compared to the US.
China has pitched for an alternative to the US dollar as a reserve currency, but you say it should be careful what it wishes for. Why?
The last thing China wants is an alternative reserve currency. If there were another reserve currency, it would mean that all international transactions would have to be denominated in that currency. It’s not clear what the new currency would be; let’s say it’s the IMF’s Special Drawing Rights (SDRs). The US cannot print SDRs the way it does dollars. It would have to pay for its imports with its limited supply of SDRs. Given its current trade deficit with China, it would be out of SDRs in three months, and it couldn’t buy anything more from China. China’s trade surplus would plunge about 75% within months, and China would go into an economic crisis on an unimaginable scale. China knows this. But its officials are making some noises to put pressure on the US to prevent it from pressuring China.
The reason the dollar is a reserve currency is that the US for many years had the largest trade deficit, which throws dollars off into the global economy. Until some other country comes along and has a giant trade deficit for a couple of decades, there’s no replacement for the dollar.
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