Michael Pettis evaluates himself

Exclusively from Michael Pettis’ newsletter comes the following self-evaluation of his once controversial views on a slowing China.

Evaluating the predictions

It is still too early for all of these predictions either to have materialized or to have failed, but I thought it might be useful to review them to see whether or not they have been reasonably accurate in describing unfolding events and, if not, how my model for thinking about global imbalances should be revised:

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1. BRICs and other developing countries have not decoupled in any meaningful sense

…Given the huge change in sentiment in the last year that has already taken place about prospects for the emerging economies, and the sharp slowdown in growth in China and other developing countries, I am tempted to declare victory and say this prediction was correct, but of course it is much too early to say anything of the sort. If I am right, it must get worse. We have only just started to recognize the impact of slower investment growth.

2. Over the next two years Chinese household consumption will continue declining as a share of GDP.

…the unsustainability of the surge in debt became apparent much earlier than I expected, and it seems that the consumption imbalances may have stabilized. I say “may have” because debt has continued to surge in the past two years and with it, problem loans almost certainly have too. There is a relationship between bad loans and the consumption share of GDP, of course, and this is because in the past bad loans were resolved in the form of repressed interest rates that effectively passed their costs onto the household sector, which was the single most important reason, in my mind, for the astonishing drop in the consumption share of GDP during this century.

3. Chinese debt levels will continue to rise quickly over the rest of this year and next.

I don’t think I need to say too much about this prediction – no one doubts anymore that debt is growing much too quickly. Over the past three days the Financial Times has published a series of very interesting if alarming articles about debt in China and it is hard to pick up a business periodical nowadays that doesn’t discuss the topic.

4. Chinese growth will begin to slow sharply by 2013-14 and will hit an average of 3% well before the end of the decade.

 

Again I don’t need to say too much about this prediction. The first part obviously turned out to be dramatically right – in fact growth began to slow sharply in 2012 for reasons I discuss in the next “prediction”. Whether the second part will also be right is exactly where the debate is now, and I stick to my prediction for the reasons I discussed in my August 8 newsletter. The key, as I note above, is whether China can engineer GDP growth rates much above 3-4% without even more rapid growth in credit.

5. If the PBoC resists interest rate cuts as inflation declines, China may even begin slowing in 2012.

This was a pretty good prediction in spite of the fact that only the most ferocious of bears didn’t agree, and to its credit (or, as rumors have it, to the credit of Li Keqiang even before he became premier), the PBoC did not cut interest rates. Growth indeed began slowing sharply in 2012. The same story stands. If the PBoC begins to cut interest rates sharply, growth will pick up but debt will explode.

6. Any decline in GDP growth will disproportionately affect investment and so the demand for non-food commodities.

I argued at the time that as a result of the disproportionate impact of a GDP slowdown on Chinese demand for hard commodities, the price of hard commodities would drop by over 50% in the next five years. So far this seems to be happening, perhaps even faster than I predicted…The only additional comment I would make is that I think the decline in the prices of hard commodities from their peaks will turn out to be much greater than 50%. I wouldn’t be surprised at all if iron traded well below $50, for example, within the next three years.

7. Much slower growth in China will not lead to social unrest if China meaningfully rebalances.

 

Consumption growth rates of 10-11% for the next decade are simply the arithmetical implications of a rebalancing China growing at 6-7%, …In principle China could have this by paying workers much higher wages, sharply revaluing the currency, and sharply raising the deposit rates paid by banks, but since low wages, an undervalued currency and cheap capital are at the heart of China’s growth model, raising wages, the currency and deposit rates enough to rebalance the economy could spread financial distress and cause growth to collapse too quickly. Only a continued, and ultimately self-defeating, surge in debt can get household income to grow quickly enough to accommodate both high GDP growth rates and a rebalancing economy.

8. Within three years Beijing will be seriously examining large-scale privatization as part of its adjustment policy.

The only relatively quick to rebalance the Chinese economy (and they probably don’t have time to do it gradually), which by definition means that households must retain a higher share of GDP and the government a lower share, is to transfer assets from the state sector to the household sector. This will not be easy.

Privatization is the most efficient way to do it… there is no question that it is being increasingly discussed.