A very interesting perspective - Thanks. It seems to me that we have crossed a sort of macro rubicon in 2008 (hence the title of your Substack?) Both China and the West appear to be stuck in a doom loop as the debt driven post Bretton Woods period appears to have ended with a bang at the GFC. Both China, the US and Europe are now transitioning to an economic mode of competition that relies on fiscal deficit spending combined with various protectionist measures. I wonder therefore if the commodity/dollar doom loop that you describe might now be somewhat different - As you indicate deflation in commodity prices begets falls in currencies of the producers etc which causes flight to safety of …. The USD?? But post GFC - Is the USD really safe given the increasingly apparent fiscal dominance and financial repression policies now being enacted to address the debt to GDP burden. Would the flight to safety not perhaps be increasingly likely to benefit currencies outside of the global fiat $ (fiscal domination / financial repression) doom loop? Ie.Gold and Bitcoin? Things that governments find difficult to debase and default on that are commodities/currency that are not dependent on economic demand but on financial demand for actual safe financial assets. Sorry to drop the Bitcoin bomb here :-). Thoughts?
Yep exactly, macro is dead because the natural business cycle is dominated by independent decisions to accumulate debt.
The flight to the USD is because the debt of EM countries is dominated in USD, this is not really related to the USD itself. The doom loop created by commodities/USD debt/falling local currency and the flight to the USD it creates is purely due to the fact that the debt of those countries is in USD, no other reason. As long as the US isn't in crisis itself, it will happen.
As for gold, BTC and anything else more debt = more money = higher asset prices in general. This affects all asset classes.
My two cents. Your reasoning of fiat devaluation does not contradict to USD strength. Even during fiat devaluation process, USD is still the cleanest shirt in the laundry, compared to all the other fiats.
thank you! very insightful article. is there any possibility the gold to have its own course and not to follow the commodity index? because in a scenario of low world growth and low rates the gold price could increase
Interesting thoughts. Would quibble with even bothering to cite the official 5% figure given the limited data we have almost conclusively disproves it in favor of something in the ballpark of 1%.
Two unfortunate realities dominate the lives of my Chinese friends and family:
1. The inescapable reality of Y=C+I+G+(X-M) is that in market economies GDP consists of present standard of living (C, M, some of G) plus every sacrifice required to sustain present standard of living (I, X, the rest of G). The latter are a dependent variable; the level of spending needed to sustain the former. In non-market economies, the accounting is thus easily gamed for even quite long periods of time. Governments simply choose to treat the non-consumption components as an input and use fiscal repression and control over the flow of credit to inflate the hell out of them.
2. China's government is not actually capable of the reforms necessary to spin up a virtuous cycle of domestic consumption. It is too afraid of any disruption to employment in major secondary sector industries, the non-market means of disbursing credit are too deeply embedded in the economy, its senior figures are too opposed to "Latin American welfarism"... the structural reasons are many. Long story short, it would sooner exchange the fruits of Chinese labor for pieces of paper far, far more worthless than US Treasuries (in the form of various infrastructure bonds in SE and S Asia) than to buy up empty speculative housing to sell or rent cheaply to young families, institute a universal healthcare system that exists on more than paper outside first tier cities, offer credit for educated young people to start services businesses, or care for its elderly poor.
Between the two of these insights, it is entirely possible to envision a China whose neo-mercantilism has denuded much of the rest of the globe of industrial capacity and *still not fucking made China rich*. In the absence of foreign pushback or domestic resistance (even if only in the form of an imploding birthrate) to having immense tax burdens placed on families to fund export industries, that would seem the most likely outcome, to be frank.
I'm not sure if it's 5%, but I don't think it's 1%. The LKQ index is printing at decent levels, and I can't think of a better proxy out there given the reliance on supply side investment. The number is a bit irrelevant anyway, which is sort of the point of the article....keep analysis to things that are real.
1. Excellent way to put it!
2. Yes, and I think what ties into that is their obvious competitive streak with the US - if you "own" them and they are dependent on you then its proof that you are rising as a superpower. It's a sign of insecurity.
I'm not sure it will get to the point of taxation, that counters with the implied promise between the CCP and the people to maintain absolute power. The USSR will be a better template. China is nowhere near that point though....the fall in the USSR was preceded by years of investment far less than the depreciation of its assets, so it spent many years crumbling before things came to an end.
“Yet, China's saving behavior distinctly deviates from this doctrine. Income flowing to China's corporate sector during primary distribution, due to the lack of a mechanism for redistributing dividends to residents, is rigidly converted into savings and investments. In this scenario, the purpose of savings extends beyond merely facilitating future consumption. Instead, savings serve the dual purpose of strengthening enterprises on a microeconomic level and bolstering the national economy on a macroeconomic scale. It is possible to go so far as to say that China is saving for the "great rejuvenation of the Chinese nation." The rigidity of savings behavior contradicts contemporary Western mainstream economics that regards savings as a mere "means," yet it is one of China's unique national conditions.”
And, on a related topic, a couple defense analysts I pay some attention to basically said that the current downturn and focus on alternative investment engines aside from property is almost certainly going to produce a daunting gap in military industrial capacity because China’s sensitivity to ROIC is near-zero.
I have an issue with this definition of "savings". For them to be true savings, the debt (i.e. investment) that matches it must be "money good", otherwise it's all an illusion.
Any country can create savings by creating collateral in the form of investment and maintaining the interest payments through other means, which in this case is subsidies from the household sector.
I suspect that set of vise’s jaws are exactly the endgame for China; as Xi sows the mistakes of Brezhnev, the Party will reap the decrepit, fully-depreciated USSR of Gorbachov in 20 years’ time.
The entire article smacks of an academic who knows better trying desperately to dress his core argument up in the language the Leninist system requires of him in the hopes it will be heard.
True, the debate over a figure that point 1 renders mostly meaningless is purely academic. Growth in consumption post-2014 has been abysmal and I've seen it up close and personal.
As regards 2, there's definitely something there. I don't think it quite rises to the level of "if we deliberately denude the developed world of industrial capacity we'll have a period of unchecked military supremacy" but it's definitely a bit more than mere point-counting.
As for taxation, the national VAT is 17% or so and income taxes at every level of the distribution are substantially higher than most European nations, let alone North American. They are, in a very real sense, taking money from Chinese families (directly in the form of taxes, notionally in the form of wage suppression and faux collective bargaining, and counterfactually in the form of infrastructure investments geared towards exporters instead of the needs of the citizenry) and using it to suppress cost structures for "strategic" export industrial sectors.
Which is great in the short term for me as a professional-class American, but also suppresses the incentives towards productivity growth and automation that America's high-wage industries have historically led for the last two centuries.
Couple that with their continued inability to actually provide productive outlets for savings and thus suppress property speculation, and it's no bloody wonder my friends and family there will never contemplate having more than one child per couple. It's a pressure cooker society to an even greater extent than Japan, South Korea, or Taiwan.
Current suppression of the household is a very real tax, agree. My point was that the extra level of direct tax or suppression would be far too large to deal with the problem at hand to avoid a debt sustainability problem.
For the American the adage "you get what you pay for" is always true. The cheap TV has other not-so-visible costs associated with it.
High debt societies are always pressure cooker type environments. High asset prices relative to the value of labour and high inequality take a toll on humans.
“For the American the adage ‘you get what you pay for’ is always true. The cheap TV has other not-so-visible costs associated with it.”
Agreed. Quoting myself from elsewhere a few weeks ago:
“I could tell any one of several stories:
A story of how China's entry into the global manufacturing supply chain has systemically halted progress on the automation of whole swathes of tough tasks which can currently only be done profitably with cheap labor.
A story of how an authoritarian regime was better at fiscal repression, targeted credit issuance, and labor cost control, and thus was able to transfer vast sums of money from its people to export industries, driving down their costs and all but halting economic development in countries in Latin America and Southeast Asia which were forced by more democratic political institutions to transfer most of the proceeds of industrialization to the actual citizenry at large, and likely setting back the developing world outside China by decades.
A story of how the initial goal of American firms transferring manufacturing know-how to China was to break union demands for compensation at home and governments pushing back against abuse of workers abroad, not seeking greater productivity, which didn't exist at all at the time.
All of them add up to the same thing: a world in which China doesn't rob its own people blind and beggar the hell out of its developing world peers to make an iPhone cheaper is still a world with several viable paths to a mass market iPhone, all of which produce a healthier status quo in 2024.”
Fantastic analysis! Two follow-up questions. (1) What are possible solutions to China's debt problem? Though households and local government have maxed out their leverage, the central government still has room. Then, a possible way out is for the central government taking in the bad debts and leveraging up, relieving other sectors' debt burden, just like what happened in the late 90s, cleaning up the banking system. (2) A natural conclusion I draw from your analysis would be long USDCNY, as the currency will be the relief valve sooner or later, and we are paid while waiting (positive carry). Yet, you did not mention about this. So I'm really curious. Thanks again!
1) The solution for any country in a situation of serious imbalance can only be one thing - a contraction in activity until the economy finds a level that can be maintained without having to accumulate debt. In the west, this situation was helped by having the govt accumulate debt on behalf of the private sector to soften the blow. See here: https://www.macroisdead.com/i/136107545/the-eurozone-as-an-example
Complicating the issue for China is that the banks and the SOE debt is already govt debt in a way, and the volumes are so large that the central govt would struggle to replace it. Foreign capital just isn't an option for China either.
2) Did you post this before the deval? If so, well done! I've posted about this on X a few times - CNHJPY is a concern for China, but this is balanced with a no deval policy for 2 reasons. First is to not upset the US, and second is to contain capital outflows. I can understand the immediate desire to think they want a weaker CNY, but this would have to be matched with stricter rules on getting money out of the country.
The rules on getting money out of the country are already such that it's difficult to fund ordinary needs like travel or foreign schooling for professional class Chinese folks, and I suspect a significant fraction of sellers on platforms like Temu are selling at a loss to wash cash into dollars.
Tightening them a bit more will push into territory where middle-class citizens traveling to Thailand or the Philippines feel the bite.
I think they recently just did tighten for credit card spending overseas. I don't think that really has an effect compared to the old invoicing methods of getting money out through companies.
Great as always. Thanks.
A very interesting perspective - Thanks. It seems to me that we have crossed a sort of macro rubicon in 2008 (hence the title of your Substack?) Both China and the West appear to be stuck in a doom loop as the debt driven post Bretton Woods period appears to have ended with a bang at the GFC. Both China, the US and Europe are now transitioning to an economic mode of competition that relies on fiscal deficit spending combined with various protectionist measures. I wonder therefore if the commodity/dollar doom loop that you describe might now be somewhat different - As you indicate deflation in commodity prices begets falls in currencies of the producers etc which causes flight to safety of …. The USD?? But post GFC - Is the USD really safe given the increasingly apparent fiscal dominance and financial repression policies now being enacted to address the debt to GDP burden. Would the flight to safety not perhaps be increasingly likely to benefit currencies outside of the global fiat $ (fiscal domination / financial repression) doom loop? Ie.Gold and Bitcoin? Things that governments find difficult to debase and default on that are commodities/currency that are not dependent on economic demand but on financial demand for actual safe financial assets. Sorry to drop the Bitcoin bomb here :-). Thoughts?
Yep exactly, macro is dead because the natural business cycle is dominated by independent decisions to accumulate debt.
The flight to the USD is because the debt of EM countries is dominated in USD, this is not really related to the USD itself. The doom loop created by commodities/USD debt/falling local currency and the flight to the USD it creates is purely due to the fact that the debt of those countries is in USD, no other reason. As long as the US isn't in crisis itself, it will happen.
As for gold, BTC and anything else more debt = more money = higher asset prices in general. This affects all asset classes.
My two cents. Your reasoning of fiat devaluation does not contradict to USD strength. Even during fiat devaluation process, USD is still the cleanest shirt in the laundry, compared to all the other fiats.
thank you! very insightful article. is there any possibility the gold to have its own course and not to follow the commodity index? because in a scenario of low world growth and low rates the gold price could increase
Gold as a precious metal definitely does it's own thing...in this case it has some exposure to China but nothing like the commodities I've mentioned.
Interesting thoughts. Would quibble with even bothering to cite the official 5% figure given the limited data we have almost conclusively disproves it in favor of something in the ballpark of 1%.
Two unfortunate realities dominate the lives of my Chinese friends and family:
1. The inescapable reality of Y=C+I+G+(X-M) is that in market economies GDP consists of present standard of living (C, M, some of G) plus every sacrifice required to sustain present standard of living (I, X, the rest of G). The latter are a dependent variable; the level of spending needed to sustain the former. In non-market economies, the accounting is thus easily gamed for even quite long periods of time. Governments simply choose to treat the non-consumption components as an input and use fiscal repression and control over the flow of credit to inflate the hell out of them.
2. China's government is not actually capable of the reforms necessary to spin up a virtuous cycle of domestic consumption. It is too afraid of any disruption to employment in major secondary sector industries, the non-market means of disbursing credit are too deeply embedded in the economy, its senior figures are too opposed to "Latin American welfarism"... the structural reasons are many. Long story short, it would sooner exchange the fruits of Chinese labor for pieces of paper far, far more worthless than US Treasuries (in the form of various infrastructure bonds in SE and S Asia) than to buy up empty speculative housing to sell or rent cheaply to young families, institute a universal healthcare system that exists on more than paper outside first tier cities, offer credit for educated young people to start services businesses, or care for its elderly poor.
Between the two of these insights, it is entirely possible to envision a China whose neo-mercantilism has denuded much of the rest of the globe of industrial capacity and *still not fucking made China rich*. In the absence of foreign pushback or domestic resistance (even if only in the form of an imploding birthrate) to having immense tax burdens placed on families to fund export industries, that would seem the most likely outcome, to be frank.
I'm not sure if it's 5%, but I don't think it's 1%. The LKQ index is printing at decent levels, and I can't think of a better proxy out there given the reliance on supply side investment. The number is a bit irrelevant anyway, which is sort of the point of the article....keep analysis to things that are real.
1. Excellent way to put it!
2. Yes, and I think what ties into that is their obvious competitive streak with the US - if you "own" them and they are dependent on you then its proof that you are rising as a superpower. It's a sign of insecurity.
I'm not sure it will get to the point of taxation, that counters with the implied promise between the CCP and the people to maintain absolute power. The USSR will be a better template. China is nowhere near that point though....the fall in the USSR was preceded by years of investment far less than the depreciation of its assets, so it spent many years crumbling before things came to an end.
Read something interesting on the topic today:
https://www.eastisread.com/p/part-ii-of-xu-gao-chinese-economy
“Yet, China's saving behavior distinctly deviates from this doctrine. Income flowing to China's corporate sector during primary distribution, due to the lack of a mechanism for redistributing dividends to residents, is rigidly converted into savings and investments. In this scenario, the purpose of savings extends beyond merely facilitating future consumption. Instead, savings serve the dual purpose of strengthening enterprises on a microeconomic level and bolstering the national economy on a macroeconomic scale. It is possible to go so far as to say that China is saving for the "great rejuvenation of the Chinese nation." The rigidity of savings behavior contradicts contemporary Western mainstream economics that regards savings as a mere "means," yet it is one of China's unique national conditions.”
And, on a related topic, a couple defense analysts I pay some attention to basically said that the current downturn and focus on alternative investment engines aside from property is almost certainly going to produce a daunting gap in military industrial capacity because China’s sensitivity to ROIC is near-zero.
This is not a pretty picture.
I have an issue with this definition of "savings". For them to be true savings, the debt (i.e. investment) that matches it must be "money good", otherwise it's all an illusion.
Any country can create savings by creating collateral in the form of investment and maintaining the interest payments through other means, which in this case is subsidies from the household sector.
Otherwise agree on the general picture.
I suspect that set of vise’s jaws are exactly the endgame for China; as Xi sows the mistakes of Brezhnev, the Party will reap the decrepit, fully-depreciated USSR of Gorbachov in 20 years’ time.
The entire article smacks of an academic who knows better trying desperately to dress his core argument up in the language the Leninist system requires of him in the hopes it will be heard.
True, the debate over a figure that point 1 renders mostly meaningless is purely academic. Growth in consumption post-2014 has been abysmal and I've seen it up close and personal.
As regards 2, there's definitely something there. I don't think it quite rises to the level of "if we deliberately denude the developed world of industrial capacity we'll have a period of unchecked military supremacy" but it's definitely a bit more than mere point-counting.
As for taxation, the national VAT is 17% or so and income taxes at every level of the distribution are substantially higher than most European nations, let alone North American. They are, in a very real sense, taking money from Chinese families (directly in the form of taxes, notionally in the form of wage suppression and faux collective bargaining, and counterfactually in the form of infrastructure investments geared towards exporters instead of the needs of the citizenry) and using it to suppress cost structures for "strategic" export industrial sectors.
Which is great in the short term for me as a professional-class American, but also suppresses the incentives towards productivity growth and automation that America's high-wage industries have historically led for the last two centuries.
Couple that with their continued inability to actually provide productive outlets for savings and thus suppress property speculation, and it's no bloody wonder my friends and family there will never contemplate having more than one child per couple. It's a pressure cooker society to an even greater extent than Japan, South Korea, or Taiwan.
Current suppression of the household is a very real tax, agree. My point was that the extra level of direct tax or suppression would be far too large to deal with the problem at hand to avoid a debt sustainability problem.
For the American the adage "you get what you pay for" is always true. The cheap TV has other not-so-visible costs associated with it.
High debt societies are always pressure cooker type environments. High asset prices relative to the value of labour and high inequality take a toll on humans.
“For the American the adage ‘you get what you pay for’ is always true. The cheap TV has other not-so-visible costs associated with it.”
Agreed. Quoting myself from elsewhere a few weeks ago:
“I could tell any one of several stories:
A story of how China's entry into the global manufacturing supply chain has systemically halted progress on the automation of whole swathes of tough tasks which can currently only be done profitably with cheap labor.
A story of how an authoritarian regime was better at fiscal repression, targeted credit issuance, and labor cost control, and thus was able to transfer vast sums of money from its people to export industries, driving down their costs and all but halting economic development in countries in Latin America and Southeast Asia which were forced by more democratic political institutions to transfer most of the proceeds of industrialization to the actual citizenry at large, and likely setting back the developing world outside China by decades.
A story of how the initial goal of American firms transferring manufacturing know-how to China was to break union demands for compensation at home and governments pushing back against abuse of workers abroad, not seeking greater productivity, which didn't exist at all at the time.
All of them add up to the same thing: a world in which China doesn't rob its own people blind and beggar the hell out of its developing world peers to make an iPhone cheaper is still a world with several viable paths to a mass market iPhone, all of which produce a healthier status quo in 2024.”
Fantastic analysis! Two follow-up questions. (1) What are possible solutions to China's debt problem? Though households and local government have maxed out their leverage, the central government still has room. Then, a possible way out is for the central government taking in the bad debts and leveraging up, relieving other sectors' debt burden, just like what happened in the late 90s, cleaning up the banking system. (2) A natural conclusion I draw from your analysis would be long USDCNY, as the currency will be the relief valve sooner or later, and we are paid while waiting (positive carry). Yet, you did not mention about this. So I'm really curious. Thanks again!
1) The solution for any country in a situation of serious imbalance can only be one thing - a contraction in activity until the economy finds a level that can be maintained without having to accumulate debt. In the west, this situation was helped by having the govt accumulate debt on behalf of the private sector to soften the blow. See here: https://www.macroisdead.com/i/136107545/the-eurozone-as-an-example
Complicating the issue for China is that the banks and the SOE debt is already govt debt in a way, and the volumes are so large that the central govt would struggle to replace it. Foreign capital just isn't an option for China either.
2) Did you post this before the deval? If so, well done! I've posted about this on X a few times - CNHJPY is a concern for China, but this is balanced with a no deval policy for 2 reasons. First is to not upset the US, and second is to contain capital outflows. I can understand the immediate desire to think they want a weaker CNY, but this would have to be matched with stricter rules on getting money out of the country.
Thanks for your reply 👍
The rules on getting money out of the country are already such that it's difficult to fund ordinary needs like travel or foreign schooling for professional class Chinese folks, and I suspect a significant fraction of sellers on platforms like Temu are selling at a loss to wash cash into dollars.
Tightening them a bit more will push into territory where middle-class citizens traveling to Thailand or the Philippines feel the bite.
I think they recently just did tighten for credit card spending overseas. I don't think that really has an effect compared to the old invoicing methods of getting money out through companies.