Friday, June 25, 2010

Michael Pettis on Europe and China

There are a couple of very smart thoughtful posts by Michael Pettis that are worth reading on the European sovereign debt crisis and global trade flows.  The first from yesterday is here.  A sample:
3. The European crisis will be accompanied by a trade shock.

In the early 1980s Latin America countries were suddenly cut off from funding during what was subsequently called the LDC Debt Crisis, or the Lost Decade. These countries had been running large current account deficits, and of course current account deficits require capital account surpluses. These surpluses were financed by the the huge petrodollar recycling of the 1970s, when commercial banks around the world made staggeringly large loans to many developing countries.

Of course after 1981-82 it became clear that the loans exceeded the repayment capacity of the borrowing countries, and suddenly financing dried up – almost overnight. What’s worse, the debt crisis had already been preceded by flight capital, so that when financing dried up, a capital account surplus quickly became a capital account deficit. Of course once Latin America began to experience capital outflows, its trade deficit necessarily had to become a trade surplus. This is exactly what happened.

The deficit countries of Europe, whose combined trade deficits are nearly two-thirds the size of the US trade deficit, will also be forced into a rapid contraction in their trade deficits for the very same reasons – they are going to find it hard enough simply to refinance themselves, let alone receive net capital inflows. Without a capital account surplus, however, they simply cannot run current account deficits. This contraction must, one way or another, be absorbed by the very unwilling rest of the world.
The second is here (from May 19th, for background).  An excerpt
Will southern European countries have trouble attracting capital inflows? Probably. In fact, almost certainly. In that case, they are all going to see sharp contractions in their current account deficits, exactly equal to the contraction in net capital inflows – and of course if any if these countries experience flight capital, this contraction can be very sharp. Again, the reasoning behind this is explained in an earlier post

To get a sense of magnitude, those four countries are the equivalent in trade deficit terms of more than half the US. If we assume that other European countries with large trade-deficits are also going to have to pay down debt, and may even find difficulty in attracting net capital inflows, then roughly 26% of all trade deficits in the world, an amount equal to more than two-thirds of the US trade deficit, are under pressure to contract rapidly.

Why does this matter to China? Because, of course, the global balance of trade must balance. Every dollar reduction in the trade balance of a European trade-deficit country must be matched, either by a dollar reduction in the trade surplus of Germany or some other European country, or by a dollar increase in Europe’s trade surplus.

Which will it be? Probably a combination of both, but the sharp decline in the value of the euro against the dollar makes it likely that we will see much more of the latter than of the former. In fact for many Europeans, the “silver lining” of the Greek crisis is that by pushing down the euro, it is making all of Europe, even countries like Germany that already have locked-in structural trade surpluses, more competitive in the international markets. Europe’s trade surplus is likely to surge.

So where is the countervailing trade impact? Beijing argues that the depreciation of the euro has automatically forced an appreciation of the RMB, and with deteriorating international markets, there is no need for China to accelerate the process. I would argue that with real interest rates declining in China, it is as if the RMB has been depreciating in real terms in order to protect China from the cost of the trade adjustment. China (along with Japan) does not want to bear the brunt of the global adjustment.

So that leaves the US. Most policymakers around the world – while publicly excoriating the US for its spendthrift habits – are intentionally or unintentionally putting into place polices that require even greater US trade deficits.

This cannot be expected to happen without a great deal of anger and resistance in the US. The idea that suffering countries should regain growth by exporting more to the world, and that rapidly growing surplus countries should not absorb much of this burden, will only force the US into even greater deficits as US unemployment rises to reduce unemployment pressure in Europe, China, Japan and elsewhere.


Burk said...

Yes, this is sadly a replay of the 30's with beggar-thy-neighbor trade policies in an attempt to avoid what they should be doing, which is domestic Keynesian policies.

Europe needs Brussels to print up some Euros to promote growth instead of retrenchment, and a federalized fiscal policy where they regulate state debt while supporting anti-cyclical fiscal policy.

Likewise China shouldn't be hanging its stability on external demand. Just how many trillions of $ can they pile up?

Anonymous said...

The focus on the PIIGS to the exclusion of the rest of Europe seems awfully strange to me; while Italy and Greece have real, severe debt problems, Spain's debt to GDP is less than France, Germany or (needless to say) the UK.

This article focuses on trade balance; on that score, you could say Germany is safe, and they can carry their debt. But France is worse than Greece by that score, and the UK is not much better!

The focus on the so-called PIIGS seems very odd to me in light of the data on France. Am I missing something really important or is everyone else?

The writer also mentions Japan - that country is an example that sits on the extremes of both issues he's working with; it has extreme debt-to-GDP but also is a very high net exporter. The end result of that is what, exactly? He seems to imply that they have issues but can somehow hoist them off on the US, but something is not quite washing there.

Something isn't right here.

Stuart Staniford said...


I think the point is that the market considers the PIIGS as default risks to varying degrees (eg as evidenced by bond spreads). In some cases it's high debt, in other cases it's perception of no way to recover the economy while staying in the Euro (Spain).

What I thought was interesting (at least I hadn't seen it before) was Pettis's working through of the trade shock implications of those countries being unable to attract further capital.

Anonymous said...


Anonymous said...

What has been absurd in this global economy is that countries like Mexico ("a developing country"=="developing what?") could (1) export = import at around 300 billion (billions of 9 zeroes) USD, per year with a net deficit of 10 billion in the current account. A huge industrial operation leading to a net loss, while still (2) not having a well developed domestic market = 30 million families not being able to purchase the basic basket of goods and services. If every family in Mexico was given the chance to purchase the 2,000 usd monthly basic basket of goods and services, Mexico's GDP would 4 fold with an enormous wealth increase of the shortsighted vampires at the source of the capital account surplus not caring about or not seeing the importance of Mexico's domestic market. Not only a wealth increase for those "vampires" but a wealth increase for any factic power, with an overall reduction in crime due to poverty.