You were wrong on China, Glenn, wrongly wrong

From Adair Turner, UK central banker via Project Syndicate:

To spur economic growth and achieve prosperity, China has sought to follow the path forged by Japan, South Korea, and Taiwan, but with one key difference: size. With populations of 127 million, 50 million, and 23 million, respectively, these model Asian economies could rely on export-led growth to lift them to high-income levels. But the world market is simply not big enough to support high incomes for China’s 1.3 billion citizens.

To be sure, the export-led model did work in China for some time, with the trade surplus rising to 10% of GDP in 2007, and manufacturing jobs absorbing surplus rural labor. But the flip side of China’s surplus was huge credit-fueled deficits elsewhere, particularly in the US. When the credit bubble collapsed in 2008, China’s export markets suffered.

In order to stave off job losses and sustain economic growth, China stimulated domestic demand by unleashing a wave of credit-fueled construction. As commodity imports soared, the current-account surplus fell below 2% of GDP.
China’s own economy, however, became more unbalanced. Investment rose from 42% of GDP in 2007 to 48% in 2010, with property and infrastructure projects attracting the most funding. Likewise, credit swelled from 130% of GDP in 2007 to 220% of GDP in 2014, with 45% of credit extended to real estate or related sectors.

This property boom resembled Japan’s in the late 1980s, which ended in a bust that led to a protracted period of anemic growth and deflation from which the country is still struggling to escape. With China’s per capita income amounting to only a quarter of Japan’s during its boom, the risks the country faces should not be underestimated.

The rejoinder is that China is relatively safe, because its per capita capital stock also remains far below Japan’s in the 1980s, and much more investment will be needed to support its rapidly expanding urban population (set to increase from 53% of the total in 2013 to 60% by 2020). But counting on this investment may be excessively optimistic. Though China will indeed need more investment, its capital-allocation mechanism has produced enormous waste.

…China’s local-government financing model could hardly be more effective at producing overinvestment and excessive leverage. Local governments use land as collateral to take out loans to fund infrastructure investment, then finance repayment by relying on revenues from subsequent land sales. As the property boom wanes, their debts become increasingly unsustainable – a situation that has already reportedly compelled some local governments to borrow money for land purchases to prop up prices. In the economist Hyman Minsky’s terminology, simple “speculative” finance has given way to completely circular “Ponzi” activity.

As a result, though total credit in China continues to grow three times faster than nominal GDP, a major downturn is now underway. Property sales have fallen, particularly outside the largest cities, and slower construction growth has left heavy industry facing severe overcapacity. The latest survey data indicate a major slowdown in industrial activity. Last month, producer prices were down 4.3% year on year. The resulting decline in demand has caused commodity prices to fall considerably, undermining the growth prospects of other major emerging economies.

…China may well be able to meet the challenge ahead. But, as the investment-led phase of its development ends, a significant growth slowdown is certain – and will inevitably intensify deflationary forces in the world economy. Given this, 2015 may well prove to be another year in which hopes of a return to normality are disappointed.

Versus Glenn Stevens, the central banker that bet biggest on China’s building boom by jacking rates and the currency and “making room” for the thirty year “sell ’em dirt” boom:

RESERVE Bank governor Glenn Stevens has delivered a striking vote of confidence in the ability of the Chinese authorities to continue managing a high-growth economy.

In his testimony to the House of Representatives Economics Committee on Friday, Stevens commended the Chinese authorities for hitting their 2014 growth target of 7.5 per cent and said a target for 2015 of 7 per cent would be appropriate.

“They are by now … the largest trading economy in the world. An economy of that size growing at 7 per cent is still quite an impressive performance, if they can do that,” Stevens said.

It was impossible to say whether the target would be achieved, but Stevens said: “They have done a pretty good job of managing things thus far. I would say there are few countries that could better their track record of growth — I cannot think of any.”

Growth anywhere between 6.5 per cent and 7.5 per cent would be a good result for a country China’s size. Stevens said the main challenge for China was not managing its growth but rather handling the financial excesses left by a period of double-digit growth. “So far, so good, but that will inevitably remain an open question.”

Stevens remains confident in the ability of the Chinese authorities to manage the financial system, including the so-called “shadow-banking” or unregulated sector where most of the problems are believed to lie. “As far as I can see, they are across the issues and are managing them fairly well.”

Yes, they are, but they are not issues you ever forecast, nor expected. In fact, the RBA forecast extreme terms of trade levels for Australia forever:


And here’s what’s actually happened so far:


Yet, as you can see, even today the RBA expects a “permanently high plateau” for commodity prices.

You were wrong, Captain Glenn, wrongly wrong, and you’re still wrong with the terms of trade headed inexorably back into high historical ranges sooner rather than later.

Time to own it, Captain, the failure to do so is preventing any sensible policy discussion about how to address the blunder.


  1. Remember Glenn’s comparison of the number of flat panel TVs you could buy for a tonne of ore? Ahhh the good old days….

  2. China still has a lot of growing to do and they will continue to require raw materials to assist with that growth.

    Sure they have a lot of credit and banking reforms to undertake and they will transition to a consumer economy so it will take some effort, but they won’t take any backwards steps in that journey.

    • China still has a lot of growing to do and they will continue to require raw materials to assist with that growth.

      How do you qualify that? Their population growth has peaked long ago. Their population is set to peak in the next 5%. Their demographic dividend is behind them. Arguably, if all “ghost cities” were occupied, they would hit the 60% urbanisation mark.

      The export lead economic model is out-dated especially if they don’t join the currency wars.

      All this and I am not even pointing to the glaringly obvious bull in the China shop that is their credit fueled binge of the past 5 yrs.

    • So what? The supply response to China’s demand for red dirt has been epic.

      Do you think China’s demand for red dirt will ever climb to its previous highs?

      Since there will be a glut of red dirt for the forseeable future, I fully expect protectionism to raise its head. Also, the Chinese will have their ‘preferred’ suppliers, and we’re probably not one of them. The red dirt market is done for quite some time.

      Here’s a fun article on China’s demographic headwinds:

      By 2050, China will most likely have a smaller population than currently, and it WILL have a much older population than currently.

      If fertility stays at the same rate as now, China’s population will drop below 1 billion by 2060.

      China will hit peak population in 2026.

      Conversely, no-one has any idea when the US will hit that, because it still has plenty of headroom, and will increase in size by 30% by 2050.

      Demographically, China ain’t looking so hot.

    • Undoubtedly PF. But it’s all about rate of change and that’s about to turn negative for steel. One billion tonnes of steel is useless to Australia if it is falling 10 million tonnes per year.

      If you’re total pay is falling faster despite working more hours, where does that leave you?

      • I’m not convinced that low prices forever are locked in for iron ore just as I’m not convinced that they are for oil.

        Eventually sanity prevails and low cost producers stop working for nothing or a loss.

      • ResearchtimeMEMBER

        Thats the difference between oil and commodities. Once you understand that you will understand what H&H is banging on about. China uses blast furnaces to create steel, the US uses arc furnaces to recycle steel. The US does a lot of recycling, China is building everything from scratch.

        You cannot recycle oil. Once gone – its gone. And trust me when I say that oil will go back over $100boe inside the next four or five years (even including an equities crash).

        But IO – it could two or three be decades before we see another mining boom, and it won’t be in steel. Steel producers will have to constrain a collapse in demand in the interim, and if demand is sufficient, marginal iron ore supply could easily be bought on line from existing operations given recent infrastructure upgrades globally. Realistically, it could be four to five decades before we see another boom involving iron ore (at least).

    • If there is a slowing of growth, or even a contraction, the Chinese economy will still be very large and there will continue to be lots of demand and lots of activity. No one would have too much issue with that. It is just that with slowing or low growth rates (with likely faster growing amounts of supply) the nature of the market changes from the tide lifting all boats (where anyone can enjoy some success) to a rabid fight over market share (which is really much harder to get through).

      It is not that any of this is anything new. It is just that, unlike people of my vintage who have been through both types of markets, I am not so sure we are ready for it collectively. But I would love to be proved wrong on that score.

    • Sorry Peter but there will be backward steps in some industries and activities and leaps forward in others, the relative size of the steps in each industry are the subject of speculation, the direction of the steps is less so.

      China faces severe demographic headwinds and they will in time have a significant effect on the economy.

      Other nations with lower costs will displace some of Chinese manufacturing over time.

      Increased environmental regulation and internalisation of costs currently externaised will reduce China’s competitiveness to some extent.

      There will be lots of economic backwards steps, but overall there may still be growth, but likely slower than at present.

      There are two areas every commentator on China (and therefore Australia) ought read:

  3. AlbyManglesMEMBER

    Chinese only like to spend on LV bags, RE, luxury cars and food grown in sewage. They wont transition to a western style consumer economy any time soon or ever

  4. Baltic Dry Index is at the lowest point in history 530. It is now lower than the point reached during GFC! When oil prices were low 30s

    Either there are too many ships operators running at lost or less raw commodities moving around. I think less trade is happening and term of trade will come back to historical level.

    Time will tell.

  5. A million bucks a year would surely attract many candidates. He has to go. You can’t earn that sort of dough with complete impunity, end of story. Most occupations on 20% of that are more accountable for their actions.

  6. At some near point in the future developed country’s will ultimately review how they handle their natural resources towards internal utilization.

    Water it self will become an T1 asset class in its own right, exporting it as a portion of a semi refined or finished good will have a competently different perspective from both a market and sovereign view point.

    Why do people think the Ukrainian fracas is all about, Monsanto and Cargill i.e Food can really screw with the balance of payments. In this case, russia may now have to cough up dollars for food it might have been buying with roubles.

  7. I would like to know whether somebody ever sat down and did the mathematics on whether it’s even possible for China and India to approach peak western levels of prosperity without turning the west into beggars.

    I know economics is not supposed to be a zero sum game, but the method of lifting a country out of poverty through exports might have worked while their were much bigger, more prosperous nations (i.e. the USA) acting as a seemingly infinite sponge.

    But it doesn’t seem possible now that China’s economy is the biggest in the world, they are quite simply destroying the export markets they rely on. Not with any malice, just with the scale and speed of their economic expansion and the rapid retreat of ours.

    The end game has to be the reintroduction of currency controls and protectionism. There are simply no alternatives if we wish to continue in the west the way we are.

    • +1.

      Basically the cycle was that US consumers leveraged up and bought cheap Chinese goods and China bought treasuries with the trade surpluses. This became a positive feedback loop.

      Not to mention that monetary loosening and demographics meant that Japan in the 80s and China in the 90s could actually do this because there was external demand.

      The probability of this happening for China, India or Africa in the short term is rather low. Once the boomer’s depart, possibly.

  8. “The rejoinder is that China is relatively safe, because its per capita capital stock also remains far below Japan’s in the 1980s”

    This statement is quite misleading, there is a belief that China is basically 10 x Japan during its boom however the average wage of China is vastly lower than the Japanese average wage during their boom

    The chinese who can actually afford the property at its current prices are a small portion of the actual chinese population therefore the level of oversupply is far more extreme


  9. “The rejoinder is that China is relatively safe, because its per capita capital stock also remains far below Japan’s in the 1980s”

    This statement is quite misleading, there is a belief that China is basically 10 x Japan during its boom however the average wage of China is vastly lower than the Japanese average wage during their boom

    The chinese who can actually afford the property at its current prices are a small portion of the actual chinese population therefore the level of oversupply is far more extreme