Can China save the world?

The short answer is "no", even if China wanted to.

Michael Pettis over at China Financial Markets posts a good article on why China's consumers are simply in no position to compensate for the fall in US and Europe's consumption. Even if China, as a nation of savers, became consumers, it would hardly dent the global decline in comsumption.

Then we have Chinese job losses and uncertainty which is likely to increase savings.

It is good to see Pettis being pessimistic (realistic). I agree with nearly all of the points made but wonder why these points were not made sooner or more strongly. This is a long article worth reading in full. I highlight only a copy of paragraphs.

Can China adjust to the US adjustment? [China Financial Markets]

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If global demand isn’t to collapse, someone else has to increase consumption by that amount. But who? The US government will probably increase its net spending, although it has already significantly increased its gross debt by recapitalizing the banks, and it will almost certainly see tax revenues fall. Corporations are more likely to be cutting spending than increasing it, so the combination of the two is not likely to be significant.

Can the rest of the world step up and replace US consumption? I am not an expert on global economies, but I think it is pretty safe to say that European, Japanese, and Latin American households and businesses are unlikely to be in a hurry to increase spending. In fact they are all likely to reduce consumption, although perhaps not as dramatically as the US. Given high debt levels in all those areas, there are also some constraints on fiscal expansion.

That leaves the net exporters, of which China is the most important. It is the largest saving nation, and the “other” nation along with the US at the center of the global balance-of-payments imbalance, and so much of that adjustment is likely to be forced onto China. As the country that has benefited most from US over-consumption, in other words, it is likely to be the one that will most have to adjust to a drastic cut in consumption.

What are the comparable numbers for China? US GDP ($13.5 trillion) is about 3.4 times the size of China’s ($4.0 trillion). In that case a 5% adjustment in the US is equal to roughly a 17% adjustment in China. That means, all other things being equal, Chinese consumption must go up by 17% of GDP just to compensate globally for the decline in the US, and bear in mind that consumption in China is only around 30-35% of GDP. What is worse, there is reason to believe that Chinese private consumption is likely to slow down in response to rising uncertainties and a slowing economy. Domestic consumption tends to be positively correlated with exports – a very pro-cyclical type of relationship typical for developing countries with large export components.

There are great hopes pinned on fiscal expansion in China, but I have already expressed my doubt about the government’s ability to expand as rapidly as many of us hope (and Stephen Green and Nouriel RoubiniOpen in a new window have anyway argued that there is less here than meets the eye). Even if they are able to expand dramatically without crowding out domestic investment, the sheer magnitude of the numbers make it almost impossible that China can successfully bear the burden of the global adjustment.

Of course it is not China’s job to replace US demand. Chinese policy-makers are only interested, in principle, in protecting growth in the Chinese economy. So why worry about whether China can or cannot replace US demand? Because with the rest of the world unable to step up, and in many cases even reinforcing the decline, if China cannot do so the whole world must see declining growth and a rise in savings, and since China was the main counterbalance to excess US consumption, it will probably bear much of the brunt.

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