West's debt crisis means China must look inwards to maintain rapid growth
By John Ross |
August 9, 2011, Tuesday
|
Print Edition
Print Edition
HEADLINE economic news in the United States and Europe has sharply worsened with weak US growth, the Eurozone crisis, falling share prices and now the Standard & Poor's downgrading of the US debt rating. How will these international developments affect China?
Much recent analysis on the causes of these problems has focused on government finance - the struggle over the US debt ceiling and the Eurozone sovereign debt crisis. But the biggest problems in government finance are a transposition of much bigger build-ups of private sector debt.
The illustration to the right shows total US domestic debt divided between the domestic private non-financial sector - both businesses and households - and the US government.
The private sector has twice as much debt as the government. Taking the latest available data, for the first quarter of 2011, US non-financial sector debt was 243 percent of GDP - 80 percent government and 163 percent private.
Since the financial crisis began in 2008, private debt has fallen and the government's has risen. But this primarily reflects the transfer of private debt to the government, either directly, via bank bail outs and similar measures, or indirectly via the effects of economic slowdown. In their book "Endgame," John Mauldin and Jonathan Tepper describe it correctly: "Debt is moving from consumer and household balance sheets to the government. While the debt supercycle was about the unsustainable rise of debt in the private sector, endgame is the crisis we will see in the public sector debt."
Threatening levels
In Europe the picture is more mixed. Countries such as Greece and Italy have run very large government debts while other Eurozone countries with problems, such as Spain, have not. But taking the US and Europe together the biggest problem lies in private sector debt. Therefore, the key issue determining the dynamics of the situation is total debt and not the narrower situation with governments.
To reduce debt from current threatening levels requires an entire period of "deleveraging," or debt reduction. So far, little progress has been made in this. It will, therefore, be impossible to bring the US or European debt crises to a rapid conclusion.
How is this debt situation driving the international economy and how will it affect China?
The private sector's need to pay down debt is reducing its spending and, therefore, slowing growth. Simultaneously, attempts to restrain rising government debt leave little room for fiscal stimulus to accelerate economic growth.
These two processes interact. Resources released to the private sector by reducing budget deficits will not increase spending and growth as they will simply be used to pay debt. Reducing government spending will, therefore, reduce public sector demand, but not increase that in the private sector, and will, therefore, be contractionary. As a consequence, China faces slow growth in its developed economy export markets.
China will also be affected by means used to reduce debt other than repayment. Greece has partially defaulted, with the latest EU bailout involving a 21 percent bond write off. Partial default may occur in some other European economies - the threat of which is causing the sharply rising interest rates for Spain and Italy. China has significant European bond holdings.
The US will not default, but has other means to reduce the real value of debt. Internationally, falls in the dollar's exchange rate devalue China's holding of US debt in real terms as effectively as a partial default.
Inflation was also a chief means by which the real value of US government debt was reduced after World War II. Inflationary policies, including a new round of quantitative easing (QE3), would be a classical way for the US to reduce its real debt burden.
In the coming period - even more than at present - China's rapid growth will, therefore, primarily have to be driven by its domestic economy, while developing economies will further increase their importance for China's exports.
Much recent analysis on the causes of these problems has focused on government finance - the struggle over the US debt ceiling and the Eurozone sovereign debt crisis. But the biggest problems in government finance are a transposition of much bigger build-ups of private sector debt.
The illustration to the right shows total US domestic debt divided between the domestic private non-financial sector - both businesses and households - and the US government.
The private sector has twice as much debt as the government. Taking the latest available data, for the first quarter of 2011, US non-financial sector debt was 243 percent of GDP - 80 percent government and 163 percent private.
Since the financial crisis began in 2008, private debt has fallen and the government's has risen. But this primarily reflects the transfer of private debt to the government, either directly, via bank bail outs and similar measures, or indirectly via the effects of economic slowdown. In their book "Endgame," John Mauldin and Jonathan Tepper describe it correctly: "Debt is moving from consumer and household balance sheets to the government. While the debt supercycle was about the unsustainable rise of debt in the private sector, endgame is the crisis we will see in the public sector debt."
Threatening levels
In Europe the picture is more mixed. Countries such as Greece and Italy have run very large government debts while other Eurozone countries with problems, such as Spain, have not. But taking the US and Europe together the biggest problem lies in private sector debt. Therefore, the key issue determining the dynamics of the situation is total debt and not the narrower situation with governments.
To reduce debt from current threatening levels requires an entire period of "deleveraging," or debt reduction. So far, little progress has been made in this. It will, therefore, be impossible to bring the US or European debt crises to a rapid conclusion.
How is this debt situation driving the international economy and how will it affect China?
The private sector's need to pay down debt is reducing its spending and, therefore, slowing growth. Simultaneously, attempts to restrain rising government debt leave little room for fiscal stimulus to accelerate economic growth.
These two processes interact. Resources released to the private sector by reducing budget deficits will not increase spending and growth as they will simply be used to pay debt. Reducing government spending will, therefore, reduce public sector demand, but not increase that in the private sector, and will, therefore, be contractionary. As a consequence, China faces slow growth in its developed economy export markets.
China will also be affected by means used to reduce debt other than repayment. Greece has partially defaulted, with the latest EU bailout involving a 21 percent bond write off. Partial default may occur in some other European economies - the threat of which is causing the sharply rising interest rates for Spain and Italy. China has significant European bond holdings.
The US will not default, but has other means to reduce the real value of debt. Internationally, falls in the dollar's exchange rate devalue China's holding of US debt in real terms as effectively as a partial default.
Inflation was also a chief means by which the real value of US government debt was reduced after World War II. Inflationary policies, including a new round of quantitative easing (QE3), would be a classical way for the US to reduce its real debt burden.
In the coming period - even more than at present - China's rapid growth will, therefore, primarily have to be driven by its domestic economy, while developing economies will further increase their importance for China's exports.
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