MacroScope

China bear Pettis says world coming around to his view

May 3, 2012

Few mainstream economists have been quite as downbeat on China as Peking University professor and noted China watcher Michael Pettis. Pettis has long held that the world’s No. 2 economy will grow at a maximum of 3.5 percent a year for the rest of the decade, well below a consensus call that appears to have settled into the 5-7 percent range. “And honestly, I think if I’m wrong, it will be to the downside rather than the upside,” he told Reuters.

Lately, though, Pettis says that many people inside China and in some of the countries whose fortunes are tightly tied to its economy are starting to come around to his point of view. At a recent lunch with visiting European Union officials, Pettis said the mood among the attending Chinese economists, academics, think-tankers and policy advisors was universally gloomy. “I’m used to being the most pessimistic guy in the room, but in this case, they were much worse than I.”

Pettis says that’s because the Chinese understand, far better than the average Western investor or economist, just how tough it’s going to be to rebalance from investment to consumption and shift wealth from the state to Chinese households.

There are many ways China can rebalance, but none is without difficulty. A steady, gradual rise in the exchange rate, interest rates and wages would help enrich households and wean exporters off their generous state subsidies but could also stoke inflation. Moving more swiftly could sink the economy as exporters go out of business and people lose their jobs.

Mass privatization, Pettis said, would help revitalize the economy but would likely face stiff political resistance.

How about having the state take over private sector debt, keeping companies humming along and people employed? Pettis points to Japan, which followed that route in the 1990s and today faces a crushing public debt burden at 200 percent of GDP.

When people ask me if China will have a hard landing or a soft landing, I find that whole discussion useless. What I think we’ll have is a long, bumpy landing. If growth rates slow too much, they will step on the credit accelerator. But then they’ll get the wrong kind of growth and they’ll apply constraints to slow it down again. So my guess is we’ll get this very jagged growth, with the peaks lower each time and the troughs lower each time. I don’t expect it to be a straight line.

That more and more policy advisors and officials are aware of these risks is encouraging, Pettis says, and bodes well for Beijing’s ability to steer the ship of state through the rapids ahead without taking on too much water.

Now if only overseas investors would take note. As Societe Generale’s Dylan Grice noted last week, readers in Australia, known locally as “the quarry in China’s backyard,” can rush to their nearest bookstore and pick up a copy of “The Australian Moment,” which details the “miracle economy” down under and why Australia “is made for these times.”

Sure, Australia’s done very well supplying things like iron ore and coal to a Chinese economy that had been growing at double-digit rates, but as Grice says, “to the extent it’s been driven by the commodity bull market, shouldn’t it be in the ‘lucky windfall’ category rather than the ‘sustainable wealth creation’ one?”

He adds:

As far as I’ve been able to tell, miracle economies don’t live up to their billing. Japan didn’t. Thailand didn’t. Ireland didn’t… Australia has five of the world’s 15 most expensive cities (on a median price to median income ratio), has seen household debt levels explode in recent decades and even has a current account deficit despite the windfall terms of trade improvement caused by the commodity bull market. This is not a robust base from which to weather a Chinese hard landing, if and when it comes.

But if the Reserve Bank of Australia’s aggressive 50-basis-point interest rate cut this week is any indication, policymakers are taking a longer view.

Karl Schamotta, who helps corporations hedge their foreign currency risk in his role as senior strategist at Western Union Business Solutions, is recommending his clients do the same. “We recommend they up their hedge ratios in places with close links to China – Australia, Canada, Brazil. We’re trying to inject some caution there.”

 

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