Michael Pettis: China’s Consumption Crisis Is The World’s Crisis
What this covers
Learn more about the VanEck Rare Earth and Strategic Metals ETF: www.vaneck.com/REMXJack
In this episode of Monetary Matters, Jack sits down with Michael Pettis, Senior Fellow at the Carnegie Endowment, to deconstruct the massive economic imbalances between China and the rest of the world.
For decades, the global economy has relied on a specific mechanism: China suppresses domestic consumption to subsidize manufacturing, and the US runs massive deficits to absorb that excess supply. Pettis argues this model has reached its limit. They discuss the concept of "economic involution," why China’s shift from real estate bubbles to manufacturing bubbles is dangerous for Europe and the US, and why the current tariff regimes are merely shifting trade routes rather than solving the problem. If you want to understand why the trade deficit keeps growing despite political intervention, and what a "Great Rebalancing" actually looks like, this is a must-listen. Recorded on November 24, 2025.
Trade Wars Are Class Wars book: https://www.amazon.com/Trade-Wars-Are-Class-International/dp/0300244177
Michael Pettis’ Work At Carnegie Endowment For International Peace: https://carnegieendowment.org/people/michael-pettis?lang=en
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Timestamps 00:00 Intro 00:37 VanEck Rare Earths $REMX Pre-roll 06:50 Why China's Consumption Is So Low 09:24 "Brutally Difficult" To Raise Consumption As A Share of GDP 16:20 China's Manufactured Economy: The Statistic Is The Goal 19:03 Why U.S.' Trade Deficit Keeps Growing 22:38 VanEck Rare Earths $REMX Mid-roll 27:20 Why Bilateral Tariffs Likely Won't Work 37:00 A Warning From The 1930s: Intelligent Globalization vs. Deglobalization 1:00:46 AI 1:02:11 Deflation Is Rampant In China: Is This A Problem? 1:05:58 Chinese Stock Market 1:08:00 Chinese Economic Growth in 2025 and 2026: 4.5% Instead of 5%? 1:14:14 Trillion Dollar Deals To Invest In U.S.? 1:18:12 VanEck Rare Earths $REMX End-roll
#macro #china #chinafactory #involution #chinaeconomy #pettis #michaelpettis #economy #macroeconomics #chinesemarket #tariffs #trade #trading #brettonwoods #eurodollar
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Global trade imbalances are fundamentally unsustainable because deficit countries (US, UK, Canada) are forced to accommodate surplus countries' (China, Germany, Japan) export of their domestic economic problems; the current system will inevitably collapse into either deglobalization or require fundamental restructuring through mechanisms like capital controls or balanced-trade customs unions.
- Internal imbalances must equal external imbalances; surplus countries' policies to subsidize manufacturing and suppress consumption force deficit countries into forced trade deficits and deindustrialization
- China's investment-driven model produces excess capacity it must export; the US absorbs this by running deficits, but this is politically unsustainable and already triggering protectionist responses
- Current bilateral tariffs and foreign investment pledges cannot solve systemic imbalances because they only shift trade flows; only systemic reforms (capital controls, customs unions, or complete trade contraction) can rebalance
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Historical periods of great change (1930s, 1970s, 1980s) are periods when democracies look very bad and lose prestige, ironically because they are doing what they are good at—adjusting—but adjustment is a horrible process.
“This period is a lot like, say, the 1970s or the 1930s. Also periods of great change, great difficulty. Periods during during which democracies looked very bad and lost a lot of their prestige. Ironically, because they were doing exactly what they're good at, which is to adjust. But adjustment is always a horrible process.”
When consumption is very low relative to production, high investment initially drives healthy growth (when there are real infrastructure and investment needs), but once those needs are met and investment continues at high levels, you are no longer getting wealthier—you are investing nonproductively and destroying wealth.
“In the early stages when they had very high investment needs, that very high investment and low consumption led to very rapid healthy growth. But once you close the gap between the investment that you have and the investment that you need, then high investment levels continue to generate economic activity, but you're no longer getting wealthier.”
Chinese employment prospects have become 'very scary,' people are seeing wages decline, and when economic conditions worsen, households rationally reduce consumption, which explains part of the decline in consumption as a share of household income (separate from the decline in household income as a share of GDP).
“Consumption as a share of household income is also also declined, but it probably declined for very rational reasons. Employment prospects have become very, very scary. People are seeing wages decline, et cetera. And so, when things are going badly, you typically reduce your consumption.”
When property investment collapsed in 2022 as a result of the real estate bubble bursting, Beijing faced a constraint: GDP growth equals investment growth plus consumption growth; if investment growth drops sharply and consumption growth cannot be increased, then GDP growth will drop sharply, which Beijing is unwilling to allow, so they must sustain investment growth or accept recession.
“GDP growth is basically equal to investment growth plus consumption growth... investment growth drops sharply and you can't bring consumption growth up, and they couldn't, then the risk is that GDP growth will drop sharply, and they didn't want that. So they said, 'We can't let investment growth drop sharply.'”
Manufacturing is 27-28% of China's GDP, larger than the property sector at its peak; undermining manufacturing competitiveness by reversing subsidies would cause damage to the Chinese economy comparable to or larger than the property crisis—which is why Beijing will not do it.
“in a country like China, uh manufacturing is huge. It's 28% of GDP, 27% depending on how you count it. It's bigger than the property sector at its peak. By the way, globally manufacturing was around 16% of GDP. So, if you undermine the manufacturing sector, you're causing huge damage to the Chinese economy.”
Soft budget constraints in China (where banks are instructed to finance company losses) mean that losses do not reduce production or trade imbalances, because profitability is disconnected from production decisions; this is a defining feature of the Chinese economic system.
“when an economy when businesses in an economy operate under what's called soft budget constraints, the banking sector is instructed to give them as much funding as they need to cover their losses. Then losses don't really matter. That's, you know, that's not going to really affect overall production and the trade imbalances.”
Consumption is determined by resources (physical goods and services), not money; therefore, increasing consumer debt without increasing production of consumable resources, or while production is structurally biased toward business and government spending, cannot increase consumption because you consume resources, not credit.
“You don't consume money, you consume resources. And if you structure an economy in such a way that household income is very low as a share of GDP, as a share of what households produce, then you have two qualities. Quality number one is that consumption is very low. But quality number two is that your manufacturing sector is incredibly competitive.”
Every country's internal imbalance must always be perfectly consistent with its external imbalance, expressed by the equation that current account surplus equals the excess of savings over investment, meaning any changes in the domestic economy must be reflected in changes in the external economy.
“Every country's internal imbalance must always be perfectly consistent with its external imbalance. We typically express that with the equation the current account surplus is equal to the excess of savings over investment. But it's just a pretty obvious point. Any changes in the domestic economy must be reflected in changes in the external economy.”
Imbalances only matter at the systemic level, never at the bilateral level; bilateral imbalances are irrelevant to understanding trade dynamics, as was emphasized by Pettis's mentor Michael Adler at Columbia University who threatened to fail students for even mentioning bilateral imbalances.
“My my mentor at Columbia University, Michael Adler, used to threaten to fail any student who even mentioned bilateral imbalances, because imbalances only matter at the systemic level, never at the bilateral level.”
Every country's internal (domestic) imbalance must always be perfectly consistent with its external (trade) imbalance, expressed as: current account surplus equals excess of savings over investment; and conversely, one country's external surplus must be matched by another's deficit.
“every country's internal imbalance must always be perfectly consistent with its external imbalance. We typically express that with the equation the current account surplus is equal to the excess of savings over investment...The other rule is that my external imbalances must always be consistent with the external imbalances of my trade partners. And that too is pretty obvious. I can't run a surplus unless you run a deficit.”
China's excess savings is the result of a low consumption share of GDP (which means a low household income share of GDP), because consumption is just negative savings and if China saves the most in the world, it consumes the least; the problem is not that Chinese people won't spend, but that they don't have the income to spend.
“To say that China has the highest saving rate in the world is exactly the same as China has the lowest consumption rate in the world. So the problem is that Chinese production exceeds everything that China invests and consumes domestically. That's why it has to run trade surpluses. Because the alternative to a trade surplus is to produce less, which means to fire workers and allow unemployment to rise.”
Consumer debt cannot solve the consumption problem because consumption requires consuming resources, not money; increasing consumer lending without increasing household resources just creates non-performing loans without boosting real consumption.
“No, because it's not about consuming money, it's about consuming resources, right? So, what you need to do is to increase the amount of resources, of of stuff produced by the Chinese, to increase the amount that is actually consumed. And the problem is, if you do that without increasing production just as quickly, then the only way you can do that is by transferring resources away from the business sector.”
People confuse two different debt crises: (a) financial crises from external debt or default risk (not China's problem because China has all domestic debt in its own currency), and (b) crises from misallocated investment, where debt represents investments that earned low returns and create wealth destruction requiring large transfers to service; the US in the 1930s and Japan after 1991 both had domestic currency debt with no external debt but suffered severely from the second type of crisis.
“People think the problem the problem with debt is that you might have a financial crisis. And that's not true. The problem with debt is that it typically represents a huge amount of misallocated investment that is finally recognized and allocated. When you look at the two biggest debt crises, if you like, of the last 100 years, basically the United States in the 1930s and Japan after 1991, neither of them had any external debt. They were all big exporters of capital. All of their debt was domestic domestic debt uh in local currency. And yet, they both suffered tremendously from that debt.”
High-saving, high-surplus countries like China, Germany, Japan, Taiwan, South Korea, and Sweden allow certain countries to control their domestic economies while meaning other countries lose control of their domestic economies.
“Not so long ago Germany was the country running the biggest surpluses. Before that it was Japan. As a share of GDP, Taiwan has among the biggest surpluses of any economy in the world. South Korea, Sweden. A lot of countries do this. But the the main point is that that allows certain countries to control their domestic economies and it means other countries lose control of their domestic economies.”
The Chinese stock market is very small relative to the economy because corporate finance is 90%+ bank loans with very little equity financing, unlike the US where finance is 1/3 each from equity, bonds, and bank loans; this structural difference means the stock market can never matter as much in China as in the US.
“The Chinese stock market is quite small... in the US, corporate finance is roughly 1/3 equity, 1/3 bonds, and 1/3 bank loans, right? In China, bank loans are more than 90% of all corporate finance. Very little comes from equity.”
Tariffs are a policy transfer tool that can be contractionary or expansionary depending on conditions; ideally they work like currency depreciation by taxing imports and subsidizing exports, transferring income from the household sector (net importers) to the manufacturing sector (net exporters), causing manufacturing to grow faster than consumption but potentially leaving households better off if manufacturing grows enough.
“Tariffs are just a policy tool. They're a transfer... Ideally, what you want to do with tariffs is the equivalent of a currency depreciation. So remember in the 1930s, all the countries that could depreciate their currencies depreciated their currencies and all the countries that couldn't implemented tariffs. They're basically equivalents... when you depreciate your currency, you're basically taxing imports and you're subsidizing exports... you're taking income from the household sector to subsidize manufacturing.”
Deflation in China is not caused by productivity increases (good deflation) but by demand being so weak that prices drop because production far exceeds consumption; prices drop because demand is weak, not because of efficiency gains.
“Deflation can be a good thing. If income is growing and prices are dropping, then the real value of income is growing even even more quickly. But prices are not dropping for that reason. They're not dropping because of increases in productivity. Prices are dropping because they're just producing far more stuff than they can possibly buy, right? So, prices are dropping because demand domestic demand is way too weak.”
China has implemented policies in the 1990s and 2000s that led to rapid growth, which subsequently led to very large trade surpluses and huge excess domestic saving that must be invested abroad, with investment going to safe economies like the Anglophone countries (US, UK, Canada, Australia) that have deep, liquid financial markets and good corporate governance.
“For a whole series of reasons, China has implemented policies that in the 1990s and 2000s led to very rapid growth, but subsequently have led to very large trade surpluses and a huge amount of excess domestic saving... The Swiss do it. Colombian drug dealers do it. Anybody with excess saving tends to put it in very safe entities, in very safe economies. And that means economies with deep, liquid financial markets, with very good corporate governance... basically those economies are the so-called Anglophone economies.”
The IMF, originally designed to regulate country imbalances at Bretton Woods, no longer serves that function; even if the IMF tells China it must do XYZ to reduce imbalances, China can ignore the directive and political power within countries is much more powerful than so-called world government institutions, making international cooperation difficult.
“Isn't the IMF, which obviously exists and has existed for a long time, isn't the I wasn't the IMF originally supposed to serve that function, but it no longer does? And what happens if the IMF says, 'Hey China, you're causing these imbalances. You need to do XYZ.' And China waffles and says, 'Oh, okay. Yeah, well, we'll look into it, and we'll have a report that will come out two years later.'”
China invests too much and saves even more, so Chinese production exceeds everything China invests and consumes domestically, forcing China to run trade surpluses because the alternative would be to produce less, fire workers, and allow unemployment to rise.
“Chinese production exceeds everything that China invests and consumes domestically. That's why it has to run trade surpluses. Because the alternative to a trade surplus is to produce less, which means to fire workers and allow unemployment to rise.”
If you borrow $100 and invest it in assets worth $80, you will become poorer; while you can pretend assets are worth $100 and roll debt over, eventually the gap is so large that servicing debt requires huge transfers that undermine the economy.
“If you borrow $100 and invest it in things that are, you know, that are worth $80, you're not going to get richer and richer, you're going to get poorer and poorer. As long as you can pretend it's worth $100 and roll it over, you won't feel poor. But at some point, the gap between the two is so great that the only way you can service the debt is with huge transfers.”
Local governments, seeking to curry favor with Beijing, directed manufacturing investment into hot sectors that Beijing was promoting (electric vehicles, batteries, solar panels), leading to massive overcapacity in these sectors.
“because governments were very eager to curry favor with Beijing, they all directed much of that investment into the the hot manufacturing sectors that that Beijing was promoting, basically electric vehicles, batteries, solar panels, things like that.”
Trump did not start the current trade conflict; he is an expression of an existing problem (political demand to revive manufacturing and reduce deficits); the fact that Trump's policies have not reduced the trade deficit shows they were not the right policies, but eventually the US will figure out correct policies.
“Trump really didn't start this. Trump is an expression of a of an existing problem. And the fact that I don't think they've really implemented the right policies, and that's clear from the direction of the trade deficit, which continues to grow, just shows that they still haven't figured out how to do it, but they will.”
By 2015, China's infrastructure was already oversupplied, but when the economy began slowing again, Beijing shifted investment from infrastructure to real estate by lowering mortgage rates, reducing down payment requirements, and removing apartment purchase restrictions to trigger another property boom.
“by 2015, around that time, the economy seemed to be getting into trouble again...Beijing decided to counter that with another surge in investment, but not in infrastructure. Infrastructure was already too much. What they did is they made it easier, uh they lowered mortgage rates, they reduced the minimum purchase requirement, they removed a lot of the restrictions on apartment purchases in order to set off another wave and turned out to be the last wave of the property boom.”
Increased foreign direct investment in the US would likely strengthen the dollar, making US manufacturing less competitive, creating a paradox where trying to attract manufacturing investment makes US manufacturing less competitive through currency appreciation.
“Ironically, the more foreigners invest in the US, the stronger the dollar and the less competitive US manufacturing becomes. So, the less likely US manufacturers are to invest.”
The problem with raising consumption is not that people won't consume more money if given it, but that you must consume resources; if household income is very low as a share of GDP, then consumption is low AND manufacturing is incredibly competitive because the manufacturing sector benefits from all the transfers away from households.
“The problem is that you don't consume money, you consume resources... If you structure an economy in such a way that household income is very low as a share of GDP... then you have two qualities. Quality number one is that consumption is very low. But quality number two is that your manufacturing sector is incredibly competitive.”
Foreign direct investment into the US (whether announced as trillions or realistically a fraction of that) will not improve manufacturing or trade balance because the constraint is not capital availability but lack of domestic demand; when capital is abundant and interest rates are low, the problem is no profit opportunities, not capital scarcity.
“If Americans if there were good investment opportunities in the US, Americans would have funded them, right?... The problem is that there aren't good investment opportunities because domestic demand is too weak... Maybe they can buy a trillion dollars worth of US government bonds, but so what? If businesses needed capital, they could easily gain access to the capital.”
The US did not decide 40 or 50 years ago to abandon manufacturing; rather, countries that decided to expand their share of global manufacturing and export imbalances primarily to the US made that decision for America, resulting in low manufacturing shares in traditional deficit countries not by choice but because trading partners chose the opposite.
“Nobody in the United States decided 40 or 50 years ago that we don't like manufacturing. Let's abandon manufacturing. That was not a decision made by Americans... That was a decision made by countries that decided to expand their share of global manufacturing and to export the imbalances primarily to the US.”
Chinese companies operating under 'soft budget constraints' (where banks are instructed to provide unlimited funding regardless of losses) continue expanding production even when experiencing negative profit margins; these companies' loss-generating capacity makes them insensitive to tariffs since losses are funded by banks rather than reducing production.
“When an economy when businesses in an economy operate under what's called soft budget constraints, the banking sector is instructed to give them as much funding as they need to cover their losses. Then losses don't really matter... that's not going to really affect overall production and the trade imbalances.”
In China, low household income as a share of GDP benefits the central government, local governments, and businesses, but benefits do not translate to excessive profits in Chinese companies; instead, the problem emerges in local government bankruptcies and unsustainable investment levels, mirroring patterns seen in Japan, the Soviet Union, and Brazil.
“If household income as a percentage of GDP is so low in China, who are the net beneficiaries? There's the central government, the local government, and then businesses... What ends up happening is that when consumption is so low, what really drives growth is high levels of investment... in the early stages when they had very high investment needs, that very high investment and low consumption led to very rapid healthy growth. But once you close the gap... high investment levels continue to generate economic activity, but you're no longer getting wealthier.”
In response to the 2008 global financial crisis, which caused China's current account surplus to collapse from over 10% of GDP to 3% in two to three years, Beijing deliberately engineered a massive surge in investment, primarily infrastructure, not because China discovered it suddenly had massive infrastructure needs, but to prevent GDP slowdown by stepping on the investment accelerator.
“The reason is that in response to the contraction in the current account surplus, Beijing engineered a huge increase in investment primarily into infrastructure, right? Now think about the logic. Nobody in Beijing said, 'My god, turns out we don't have nearly enough infrastructure in this country. Isn't it lucky that I've discovered this at exactly the same time that the global crisis occurred?' That's not what anyone said.”
Property investment eventually became an out-of-control bubble that collapsed by 2022; as property investment dropped sharply and consumption could not be increased, investment from property was replaced almost dollar-for-dollar by an increase in manufacturing investment, again not driven by identified manufacturing capacity needs but by the constraint that GDP growth equals investment growth plus consumption growth.
“Investment in property collapsed... GDP growth is basically equal to investment growth plus consumption growth... if investment growth drops sharply and you can't bring consumption growth up... the risk is that GDP growth will drop sharply, and they didn't want that. So they said, 'We can't let investment growth drop sharply.' So what ended up happening... as investment gets out of the property sector, it is replaced almost dollar for dollar for an increase in manufacturing investment.”
As governments directed investment toward hot manufacturing sectors Beijing was promoting (electric vehicles, batteries, solar panels), massive overcapacity developed leading to 'involution'—massive capacity with too little demand, forcing companies to sell at prices below variable costs (which standard economics says is impossible but is happening), creating havoc in these sectors.
“So much investment poured into these areas that we ended up with a problem that around April or May of this year, we started calling involution, where you had massive capacity, way too little demand... they had to sell them at cut-rate prices and they were actually selling in many cases below variable prices, something which you and I learned in economics can't happen. Well, it was happening, right?”
Europe is panicking because if the US, UK, and Canada reduce their deficits and nobody else can replace the US as the deficit absorber (not the developing world, not Japan, not India), then Europe must become the deficit country of last resort, making Europe the big loser in the global rebalance.
“And that's why in Europe you're getting such a sense of panic. Because there is a real sense that if they don't get their act together and don't start doing what China has been doing and what the US is starting to do, which is unilaterally to control their external accounts, then Europe will be the big loser in the global rebalance.”
Effective tariffs should be simple and uniform (e.g., 30% on all imports with no exceptions), not complicated bilateral and sectoral tariffs which are like depreciating currency bilaterally against different countries at different rates, an approach that simply shifts currency movements without reducing overall currency value and thus fails to address imbalances.
“That implied that tariffs should be pretty simple, say like a 30% tariff on all imports, no ifs, ands, or buts, no exceptions. And that's not what we're doing. What we're doing is all of these really complicated bilateral and sectoral tariffs that make no sense. It's like depreciating your currency bilaterally... You can't do that. All that will do is shift currency movements around without really causing a significant reduction in the value of your currency.”
A trade surplus is a way of externalizing your domestic costs and imbalances onto your trade partners; Keynes, Joan Robinson, and Michael Lind have all pointed out that countries should not have the right to force their domestic imbalances onto trade partners and must resolve them domestically.
“A trade surplus is a way of externalizing your domestic costs, your domestic imbalances... What Keynes said is, 'No, you can do whatever you want, but if you have a domestic problem, you don't have the right to force it onto your trade partners. You have to resolve it domestically.'”
Chinese currency (renminbi) has been weakening in real terms due to lower inflation, which offsets the effect of tariffs; even a 10% nominal tariff is negated by currency adjustment, explaining why tariffs have had minimal impact on trade flows despite being implemented.
“One reason is that you can see adjustment in the currency. So, if you put 10 10% tariffs on all Chinese imports and the Chinese currency goes down, you eliminate them. And in fact, the the renminbi has been weakening substantially, not in nominal terms, but in real terms. Because remember, uh a country with lower inflation has a depreciating real currency, all other things being the same.”
The United States did not choose to abandon manufacturing 40-50 years ago; rather, countries that decided to expand their share of global manufacturing exported those imbalances primarily to the US through trade surpluses, forcing the US into deficit and deindustrialization.
“Nobody in the United States decided 40 or 50 years ago that we don't like manufacturing. Let's abandon manufacturing. That was not a decision made by Americans. So the US has soaring debt to support consumption. China has soaring debt to support production...That was a decision made by countries that decided to expand their share of global manufacturing and to export the imbalances primarily to the US.”
By April-May 2024, China's massive investment in electric vehicles, solar panels, and batteries created so much excess capacity (called 'involution') that companies were forced to sell products at prices below their variable costs, something microeconomic theory says cannot happen in equilibrium, because banks would not finance inventory of unsaleable goods.
“much investment poured into these areas that we ended up with a problem that around April or May of this year, we started calling involution, where you had massive capacity, way too little demand...they couldn't run up inventory because the banks didn't want to finance this inventory. They had to sell them at cut-rate prices and they were actually selling in many cases below variable prices, something which you and I learned in economics can't happen.”
It is extremely difficult for countries with historically low consumption shares to increase consumption because raising the consumption share requires transferring income from businesses to households, but those businesses are globally competitive largely because of subsidies and transfers that favored them; reversing those subsidies causes businesses to collapse and GDP to contract sharply, as happened in the US in the 1930s and Japan in the 1980s-2010s.
“it's really easy. Raise wages or raise interest rates or raise the value of the currency or somehow implement policies that shift income away from businesses to households, and immediately the consumption share of GDP will go up. The problem is that if those businesses are competitive globally mainly because of all of these subsidies and transfers in their direction, when you reverse them, they stop being competitive...a collapse in GDP which is greater than the reduction in consumption.”
China's decision to run massive trade surpluses and invest excess savings abroad (primarily in the US) is not made to accommodate US low savings, but is driven by China's own policies of high savings and rapid production; the Chinese leadership does not wake up and decide to help the US by investing there, but rather follows the pattern of all high-savers placing their capital in deep, liquid Anglophone economies (US, UK, Canada, Australia) with good corporate governance.
“the governor of the Chinese Central Bank doesn't get up in the morning and read the newspaper and say 'Oh damn, the Americans have reduced their savings rate. We had better save more to accommodate them.' That's not what happens. What ends up happening is that for a whole series of reasons...China has implemented policies that...have led to very large trade surpluses and a huge amount of excess domestic saving...The decision to invest in the United States is not made to reflect weak savings in the US. It's made to reflect excessive savings in China.”
Bilateral trade imbalances (e.g., US-China trade deficit) are economically irrelevant; what matters is the systemic level—the global US trade deficit must accommodate the global Chinese trade surplus, and as long as the US deficit grows, it can absorb the growing Chinese surplus regardless of bilateral composition; transshipment (China → Vietnam → US) and income effects explain why bilateral tariffs don't reduce systemic trade deficits.
“what really matters is trade imbalances at the system level. Bilateral trade imbalances are irrelevant...As long as the US trade deficit is growing, it's accommodating the growing Chinese trade surplus...The real story is an income story. As long as the US continues to import without exporting, then what it's doing is it's creating income outside of the US...some of that consumption comes in the form of imports...from anywhere...by the multiplier, the increase in Peruvian exports to the US...must be matched by an increase in Peruvian imports, but not necessarily from the US, from anywhere.”
Chinese manufacturers are not primarily competitive because of superior efficiency or technology, but because of enormous direct and indirect subsidies: unlimited funding at very low interest rates, very low wages relative to productivity, massive infrastructure investment, and large research and development budgets—these subsidies, not efficiency, drive their competitiveness.
“if I told you to start an EV factory in whatever, in Canada, and you said, 'Yeah, but I don't know anything about EVs.' And I said, 'Don't worry, I will give you unlimited funding at incredibly low interest rates. I will give you all the workers you want at very low wages relative to their productivity. I will build whatever infrastructure you need. Tell me you need a road, and I'll build the road the next day. And I will give you a huge budget for research and development.' Well, eventually you're going to figure out how to do EVs.”
Countries that control their external accounts are able to implement industrial and trade policies that effectively become the industrial and trade policies of their trade partners, meaning surplus countries unilaterally impose their manufacturing and trade policies on deficit countries.
“the former are able to implement industrial and trade policies to fit whatever they believe their domestic needs are. And those industrial and trade policies effectively become the industrial and trade policies of their trade partners.”
In historical adjustment periods, most predictions about how the world will look are wrong, so it is better to avoid making many specific predictions and simply state that adjustment is inevitable and will happen one way or another.
“We'll make a lot of predictions about how the world will look. Almost all of them will be wrong. So, I'm going to save myself the heartache by not making too many predictions, just saying that we're going to go through a difficult adjustment. And, you know, it's going to happen one way or another.”
Consumption as a share of household income is exactly the same as consumption as a share of GDP when you account for the relationship between household income and GDP; if households consume less as a share of what they earn, production will exceed domestic consumption and surpluses must rise.
“you don't consume money, you consume resources. And if you structure an economy in such a way that household income is very low as a share of GDP, as a share of what households produce, then you have two qualities. Quality number one is that consumption is very low.”
Chinese manufacturers are increasingly reluctant to sell in the domestic market because it is impossible to make money there due to deflationary pressures and excess supply; they prefer to export, and when they export, they often cannot make money either but are forced to continue producing to keep workers employed and avoid political problems.
“one of my former students who owns a whole bunch of chemical manufacturing factories in China told me recently that he finally accomplished his great goal, and that is he doesn't sell anything in China. Everything he sells is into Europe or the Middle East. And there was recently an article, I forget where, it could have been in in Bloomberg, in which they quoted uh they were talking about steel capacity, and they quoted the head of the steel industry association saying, 'Nobody wants to sell in China. You simply cannot make money. Everybody wants to export.' It's not the only way you can make money, it's the only way you don't lose money.”
When looking at deflationary conditions in China, deflation can be good if income is growing while prices drop; but China's deflation is bad because prices drop due to weak demand and excess supply, not productivity improvements.
“deflation can be a good thing. If income is growing and prices are dropping, then the real value of income is growing even even more quickly. But prices are not dropping for that reason. They're not dropping because of increases in productivity. Prices are dropping because they're just producing far more stuff than they can possibly buy, right?”
China plans to shift investment from involuted sectors to non-involuted manufacturing (petrochemicals, chemicals, steel, automobiles) and infrastructure, as evidenced by recent government announcements that it wants to stabilize 10 different industries.
“What's going to happen is they're going to shift that investment somewhere else...Probably into infrastructure and we're already seeing some indications that there will be an increase in infrastructure spending. But most likely into other non-involuted manufacturing sectors. And that includes petrochemicals, chemicals, steel, automobiles, a whole bunch of things. There was 10 industries that that 2 weeks ago the government announced that it wanted to stabilize, which means expand.”
The current unsustainable system will be broken; we are seeing an inevitable adjustment toward a great imbalance between countries that control their external accounts and countries that do not, which will manifest as trade war and trade contraction as deficit countries attempt to regain control of their accounts.
“The system is unsustainable. It needs to be broken... We're going through sort of an inevitable adjustment towards this great imbalance between countries that control their external accounts and countries that control it much less or don't control it. And we will call that trade war and trade contraction. But it's inevitable.”
Chinese consumption as a share of GDP was normal in the 1980s, declined to among the lowest in the world by 2000, and collapsed to historically unprecedented levels by 2011 when China was cleaning up its banking system; since 2011 it has risen only 2-3 percentage points, and consumption would need to increase by 10-15 percentage points for China to be at a normal consumption level.
“consumption...declined from the 1980s when consumption was more or less normal to 2000 when it was among the lowest in the world. And then from 2000 to 2011, when China was cleaning up its banking system...it collapsed to levels never before seen in history. From 2011 until around 2019, it increased by two or three percentage points...a very prominent Chinese economist...acknowledged that China needs to raise the consumption share of GDP by around 10 to 15 percentage points”
China's enforcement of a law limiting lending above 24% interest (in a gray zone between 24-36% that was previously loosely enforced) discourages productive consumption lending because you cannot borrow at 24% for productive reasons—this is Ponzi-style, non-productive borrowing that the government correctly wants to prevent.
“on October 1st, there was a new enforcement of a law...about lending at interest rates above 24%...now they're increasing enforcement on that...I don't see how you can borrow at 24% for productive reasons. It's...a kind of Ponzi borrowing. You really don't want your economy to go in that direction. That's non-productive borrowing.”
Chinese equity market participation is low because retail investors have been repeatedly burned buying at highs and selling at lows, experiencing massive wealth transfers to more sophisticated investors; banks are achieving better performance through high dividends and attracting retail investors on that basis.
“Part of it is because they've done it in the past and the market shoots up, and then when it shoots down, you know, it's incredible how quickly it can come down. And what typically happens is that the more sophisticated investors have sold earlier in the cycle, and the less sophisticated have bought later in the cycle. So, basically, it's a huge transfer of income.”
Wall Street and owners of movable capital are ferociously opposed to taxing capital inflows because free flow of capital is beneficial to billionaires and banks but harmful to American farmers, workers, manufacturers, and middle-class savers, explaining why proposed capital inflow taxes were extracted from recent legislation.
“Wall Street would be ferociously opposed, as would owners of movable capital, because the free flow of capital is really great, you know, if you're a billionaire or a bank. Uh not so good if you're an American farmer or worker or manufacturer or middle-class saver.”
Bilateral tariffs in theory cannot work because imbalances only matter at the systemic level; they could only work in practice if every country imposed bilateral tariffs on China simultaneously, which is not happening and appears unlikely.
“bilateral tariffs in theory simply don't work...my mentor at Columbia University, Michael Adler, used to threaten to fail any student who even mentioned bilateral imbalances, because imbalances only matter at the systemic level, never at the bilateral level. Now, in practice, they could work to some extent if every country in the world decided to impose bilateral tariffs on one country, say China. In that case, it would work, but clearly that doesn't seem to be happening.”
Joan Robinson warned in the 1930s that persistent trade surpluses are unsustainable; eventually deficit countries will try to regain control of their external accounts, leading to what will be called trade wars and trade contraction, but which are actually inevitable adjustments to correct global imbalances.
“Joan Robinson wrote about this in the 1930s and she said this isn't sustainable. And if it goes on long enough, at some point the deficit countries will try to regain control of their external accounts. And we will call that trade war and trade contraction. But it's inevitable.”
Around 2008-2009, China's investment pattern changed fundamentally: before that, debt grew rapidly but debt-to-GDP ratio was stable because most debt funded productive investment (building infrastructure worth more than borrowed); after 2008, debt accelerated while GDP decelerated, which should be impossible if debt funds productive investment, proving that China had run out of productive investment opportunities and was investing in non-productive 'bridges to nowhere'.
“normally when all of your debt goes to fund investment...it should be impossible for debt to rise faster than GDP if you're investing productively...And if you look at before 2007, 2008, that was the case in China. Debt grew very rapidly, but the debt-to-GDP ratio just sort of bounced around. It never really grew. That all changed around that time when debt started to accelerate and GDP started to decelerate, which shouldn't be able to happen”
Europe is in a panic because if the US and other traditional deficit countries reduce their deficits and surplus countries won't rebalance, Europe must become the new deficit country absorbing all surplus production; Europe should unilaterally control its external accounts like China has done, but the lack of geopolitical will to do this is driving a sense of crisis.
“there is a real sense that if they don't get their act together and don't start doing what China has been doing and what the US is starting to do, which is unilaterally to control their external accounts, then Europe will be the big loser in the global rebalance. And that's why in Europe you're getting such a sense of panic.”
Chinese non-performing loans are rising as the government pressures banks to increase consumer lending to less creditworthy borrowers; this is similar to what happened in Spain in the 2000s when lending standards were lowered to boost consumption, which created credit problems later; it is not a sustainable solution.
“The way you do it in China, the way you do it in the US, the way you did it in Spain in the 2000s, is by lowering lending standards. And that may end up creating problems in the future...we're already seeing that in the Chinese banking system”
Foreign direct investment in the US (such as announced plans for trillion-dollar investments) will not improve manufacturing or reduce trade imbalances because: (a) if investment opportunities were good, American businesses would fund them; (b) American companies hold huge cash piles and can borrow easily, so capital is not the constraint; (c) the constraint is weak domestic demand; (d) foreign investment strengthens the dollar, making US manufacturing less competitive.
“Look, if Americans if there were good investment opportunities in the US, Americans would have funded them, right? It's very America American businesses sit on huge piles of cash. And it's very easy to borrow money...The problem is that there aren't good investment opportunities because domestic demand is too weak...Ironically, the more foreigners invest in the US, the stronger the dollar and the less competitive US manufacturing becomes. So, the less likely US manufacturers are to invest.”
AI investment (over 1% of GDP annually in the US, less as a share of GDP in China focused on efficiency) is good for productivity growth but not large enough to change the structural trade imbalances; most people in both countries don't work in AI but in traditional sectors (mixing cement, delivering food), so even transformational AI may not solve the imbalance problem unless it generates unprecedented productivity gains.
“Generally, those things increase productivity growth, but they're not big enough to make huge differences in the great imbalances. The vast majority of Chinese, uh a little bit, you know, less true for the US, but still the vast majority of Americans don't work in AI. Uh they work in other things, you know, in China they, you know, mix cement or deliver food on bicycles, stuff like that. And maybe AI will be such a transformational change in productivity growth that it will solve all of our problems. But, you know, I'm old enough to remember so many things that were going to solve all of our problems, and and they just don't seem to.”
Local governments are extremely powerful in part because they own and control assets; shifting assets to households would be an institutional revolution, which is not necessarily bad but would be very difficult and politically contentious.
“local governments are extremely powerful in large part because of all of the assets they own and control, what you're talking about is really a complete institutional change in the local government system, which may not be a bad thing, but it will be a very difficult thing.”
China's participation in equity markets is very low compared to the US because: (a) Chinese retail investors were burned by prior stock market bubbles and crashes where sophisticated investors sold before retail investors bought, causing massive wealth transfer losses, making households nervous; (b) corporate finance in China is over 90% bank loans, less than 10% equity, compared to the US where it is 1/3 equity, 1/3 bonds, 1/3 bank loans; and (c) the Chinese stock market is small relative to real estate and will never be as important.
“Part of it is because they've done it in the past and the market shoots up, and then when it shoots down...the more sophisticated investors have sold earlier...the less sophisticated have bought later. So, basically, it's a huge transfer of income. So, a lot of Chinese are very nervous...the Chinese stock market is quite small. So, in the US, corporate finance is roughly 1/3 equity, 1/3 bonds, and 1/3 bank loans, right? In China, bank loans are more than 90% of all corporate finance...it's a very small market...it's never going to matter as much as it does in the US. And it certainly will never matter as much as the real estate market mattered in China.”
A third theoretical path would be to surge consumption without slowing growth by raising consumption so that total production remains high, but this is arithmetically possible and has never been done historically; it requires major transfers that would be disruptive economically or politically.
“In theory, there's a third way. So again, production is too high relative to consumption. What if you could get consumption to surge?... That's arithmetically possible. It's just that no one has ever done it. And it's very hard to imagine how you would do that without major transfers that would in and of would in of themselves become probably disruptive either politically or or economically.”
The US and Japan both had no external debt and were capital exporters, yet suffered severely from debt crises, showing that the problem with debt is not default risk but the misallocation of investment recognized as such, creating a gap between asset values and debt servicing costs.
“The problem with debt is that it typically represents a huge amount of misallocated investment that is finally recognized and allocated. When you look at the two biggest debt crises, if you like, of the last 100 years, basically the United States in the 1930s and Japan after 1991, neither of them had any external debt. They were all big exporters of capital. All of their debt was domestic domestic debt uh in local currency. And yet, they both suffered tremendously from that debt.”
Increasing a country's consumption share of GDP is brutally difficult; historically, countries with excessively low consumption shares (US 1920s, Japan 1980s, Brazil 1970s) had to raise consumption but did so by substantially lowering growth—the US via the Great Depression with 3 years of negative growth, Japan via 20-30 years of stagnation.
“When you look historically at countries that had excessively low consumption shares, like the United States in the 1920s, Japan in the 1980s, Brazil in the 1970s... In every case, it was brutally difficult. The US did it in the form of the Great Depression... Japan did it in the form of 20 to 30 years basically of stagnation.”
Manufacturing as a share of Chinese GDP is 27-28%, larger than the property sector was at its peak and far larger than the global average of 16%, so dismantling manufacturing subsidies would cause massive damage to the Chinese economy through manufacturing contraction.
“Manufacturing is huge. It's 28% of GDP, 27% depending on how you count it. It's bigger than the property sector at its peak. By the way, globally manufacturing was around 16% of GDP. So, if you undermine the manufacturing sector, you're causing huge damage to the Chinese economy.”
China continues 'slugging along' despite deflation and real estate collapse because of surging debt and refusal to lower investment; if the US faced the same situation and the government said 'we're going to invest massively in X, Y, Z even though nobody's buying them,' the US would also not slow down, but sustainability depends on debt capacity which is finite.
“Slugging along. Because of the surge in debt and their refusal to lower investment. So, if the US were to run into a recession and the government were to say, 'Well, we're going to invest massively in producing X, Y, and Z.' And everyone said, 'Yeah, but no one's buying the stuff.' And the government said, 'Doesn't matter. We're going to produce it anyway.' Then the US also wouldn't slow down. The question is, how sustainable is that? Because when you're doing that, debt is growing much faster than your debt servicing capacity.”
China's problem of excess capacity forces it to export excess supply abroad, creating 'reverberations around the world' not just in the US but particularly in automobile-dominant and developing countries like Germany, Thailand, Brazil, Indonesia, where the problems are most acute.
“The problem is that there's excess supply, so you have to export that excess supply and that causes reverberations around the world, not just in the US, but particularly, you know, automobile-dominant countries like like Germany, which are having big big problems. In fact, the the real problem is in developing countries with automobile sectors, so Thailand, Brazil, Indonesia, etc. And in Europe.”
Total social financing in China (a measure of credit growth) has been rising by 8.7% with very little going to consumption stimulus; most goes to investment through central government, local governments, large businesses, and SOEs, continuing the pattern of channeling credit into non-productive investment.
“Very little is the former. I mean, the amount that went to consumption is quite low, and and from what the banks are telling us, a lot of that was bad investment in bad lending to consumption. But most of it goes into the investment side through the central government, local governments, or or large businesses, or SOEs.”
Tariffs are just a transfer policy that can be contractionary or expansionary depending on conditions; ideally they should function like currency depreciation, but actual implementation is complex and involves taxing imports while subsidizing exports.
“Tariffs are just a policy tool. They're a transfer. And like all transfers, they can be contractionary or they can be expansionary depending on the condition. Ideally, what you want to do with tariffs is the equivalent of a currency depreciation.”
China's renminbi has been weakening in real terms (despite nominal strength) because China has lower inflation than trading partners, which provides real currency depreciation that offsets 10% tariffs almost immediately.
“the renminbi has been weakening substantially, not in nominal terms, but in real terms. Because remember, uh a country with lower inflation has a depreciating real currency, all other things being the same. So, the you know, that's quickly wiped out by that.”
All advanced economies (excluding Norway, which is an oil producer) divide into two perfect overlapping groups: surplus countries with high manufacturing share (Taiwan, Germany, Japan, South Korea) and deficit countries with low manufacturing share (US, France, UK, Canada).
“you can divide them into two groups in two different ways. One way you can divide them is all the countries that run persistent surpluses...All the countries that run persistent deficits...And then you divide them another way. All the countries where manufacturing is a higher share of GDP than the global average, and all the countries where it's a lower share. And surprise, surprise, those two groups perfectly overlap.”
The ECB recently found that Europeans are not investing because they don't have the money, but because they lack demand; there are no profitable investment opportunities without demand.
“The ECB did a study in Europe 2 weeks ago that found exactly the same thing. The reason Europeans are not investing is not because they don't have the money, it's because they don't have the demand.”
One way to enforce balanced trade is through a customs union with penalties for persistent surpluses; another is to restrict capital inflows through a tax like the 'market access charge' proposed by John Hanson, which would be more effective than universal tariffs.
“If you run persistent surpluses, you get a penalty. That's one way...another way of doing it if you can organize a custom union, I would argue, is to restrict capital inflows. Because remember, when a country runs a trade surplus, it has to export excess saving...what we should do is tax the the the foreign exports of capital into the United States. An economist by the name of John John Hanson came up with a very good kind of Tobin tax, which he calls the market access charge, which I think is a very good idea.”
Nobody in Beijing believed they lacked infrastructure when they engineered the post-2008 stimulus; they did it specifically to prevent the economy from slowing in response to the external shock, not because infrastructure was genuinely needed.
“Nobody in Beijing said, 'My god, turns out we don't have nearly enough infrastructure in this country. Isn't it lucky that I've discovered this at exactly the same time that the global crisis occurred?' That's not what anyone said. What What they said is that we don't want the global crisis to slow down the economy, so we're going to step massively on the investment accelerator.”
AI investment (US spending over 1% of GDP on data centers vs China's lower spending) will not solve fundamental trade imbalances because most workers in both countries do not work in AI; while AI may increase productivity, betting everything on AI solving these problems is unwise given history of failed technological panaceas.
“Generally, those things increase productivity growth, but they're not big enough to make huge differences in the great imbalances... the vast majority of Americans don't work in AI... in China they, you know, mix cement or deliver food on bicycles... Maybe AI will be such a transformational change in productivity growth that it will solve all of our problems. But, you know, I'm old enough to remember so many things that were going to solve all of our problems, and and they just don't seem to.”
Chinese companies and manufacturers prefer exporting to selling domestically because domestic margins have become so negative that exporting is the only way to avoid losses; this is evidenced by chemical manufacturers selling nothing domestically and steel producers saying 'nobody wants to sell in China.'
“One of my former students who owns a whole bunch of chemical manufacturing factories in China told me recently that he finally accomplished his great goal, and that is he doesn't sell anything in China... there was recently an article... they quoted uh they were talking about steel capacity... the head of the steel industry association saying, 'Nobody wants to sell in China. You simply cannot make money. Everybody wants to export.'”
The question of whether the US is serious about reviving manufacturing depends on whether it will adjust its trade policies; if serious about reindustrialization, it will eventually get it right despite taking time and trying many alternatives, reflecting the nature of democracies that adjust only after exhausting other options.
“The real question is how serious is the US about reviving manufacturing and reindustrializing. If it's serious, and I believe there's a real bipartisan consensus behind that, if it's serious, it will eventually get it right... Remember what what Churchill was supposed to say... he was supposed to have said that the Americans always get it right, but only after choosing all the alternatives.”
China's medium-term growth outlook (next year or two) will be around 4-4.5% rather than 5% (the stated target), but only because China has the debt capacity and willingness to fund non-productive investment to hit whatever target it sets; once debt capacity is exhausted, growth will face a hard constraint; the lower the growth target, the better for China's long-term health, as it slows debt accumulation.
“You know, what I'm really hoping in the summer, I would have told you growth next year is going to be 5% because that'll be the target. Today, I'm starting to think that it may be 4.5%...Basically, as long as they have debt capacity and are willing to make bad investment, non-productive investment, and both is true both are true, they can achieve any target they want. So, the lower the target, the better for China over the long term. The higher the target, the more rapid the growth in debt.”
Most economists misunderstand debt because they focus on default risk; if you guarantee no default, they assume infinite debt capacity, but this is false—infinite debt capacity would allow making everyone a millionaire overnight, which is obviously impossible.
“I think most economists don't really understand this. Uh they think the problem with debt is that you might default. And so, if you can guarantee no default, then hey, no problem. You have infinite debt capacity. Not true. If you had infinite debt capacity, literally, it would be a trivial thing to to figure out how to make everyone in your country a millionaire, a real millionaire, right? And clearly, that can't happen.”
There has been no real adjustment in trade imbalances; China's trade surplus continues to grow and the US trade deficit continues to grow, so the rest of the world is accommodating the Chinese surplus growth by allowing the US deficit to grow further.
“There hasn't been an adjustment. If you look at the Chinese trade surplus, it continues to grow. If you look at the US trade deficit, it also continues to grow... as long as the US trade deficit is growing, it's accommodating the growing Chinese trade surplus.”
China is increasing enforcement of laws against lending at interest rates above 24% and in the 24-36% gray zone, preventing the high-rate consumer borrowing that would be Ponzi-style financing; Minsky would call this non-productive borrowing that makes economies vulnerable.
“On October 1st, there was a new enforcement of a law... about lending at interest rates above 24%... you're increasing enforcement on that 24 that that that gray area zone... you don't have to borrow at 24% for productive reasons. It's, you know, that's that's what Minsky called... a kind of Ponzi borrowing. You really don't want your economy to go in that direction.”
High saving and high investment growth model ends when debt stops the game; this has happened in every single case of a country following this model, and is the inevitable outcome because households, businesses, and governments all get worse off when investment becomes non-productive.
“Everyone gets worse off until ultimately debt stops the game. That's what's happened in every single case I can find of a country that's followed this high saving high investment growth model.”
Japanese manufacturing collapse in the 1980s was world-beating but achieved through huge subsidies (particularly capital subsidies); as subsidies were reversed, manufacturing became less competitive and contracted in a way consistent with very low growth, suggesting this pattern is not coincidental.
“Japanese manufacturing, uh, uh, in the 1980s was world-beating, but it was world-beating for many of the same reasons. Huge subsidies, of which the most important was probably the capital subsidy. And as you started to reverse that, its manufacturing became less and less globally competitive, and it contracted. And it contracted in a way that was consistent with very low growth.”
Trade surpluses are created by policies that subsidize manufacturing at the expense of household income, forcing households to pay for manufacturing competitiveness; as a result, manufacturing grows faster than GDP and consumption grows more slowly.
“trade surpluses are typically created by policies that are aimed at subsidizing manufacturing at the expense of household income. So, you're subsidizing manufacturing, and you're forcing household consumption basically to pay for it. So, not surprisingly, your manufacturing grows faster than your GDP, and your consumption grows more slowly, and so you have to run a trade surplus.”
Intelligent globalization with balanced trade driven by comparative advantage would see rapid growth; deglobalization would see trade collapse, but either way, the global system is forced to choose.
“we'll have a free trading world with balanced trade driven by comparative advantage in which we see rapid growth. Or we will go in the direction that Joan Robinson warned us about, in which trade collapses”
China has faster-growing debt than the US despite starting from similar levels; Chinese debt to GDP is higher than the US and is among the fastest-growing debt burdens ever seen, with last year and this year among the highest growth rates.
“China has much more debt than the US. A lot of people don't know this. Chinese debt to GDP overall is higher than in the US, but more importantly, it's growing much much faster. It's among the fastest-growing debt burdens we've ever seen. And last year and this year are among the highest growth rates we've ever seen.”
China's only viable policy option to increase consumption without economic collapse is a major technological breakthrough in productivity (requiring 'one of those technological breakthroughs that happen once every thousand years'), which Pettis considers unlikely; the other option is institutional reform where local governments transfer their state-owned enterprise assets to households through share distribution, which would undermine local government power.
“one policy is to win the lottery, and that's sort of what they're they're they're trying to do. That is, if you invest enough in technology and you keep your fingers crossed, you might get such a major technological breakthrough that you cause a surge in productivity. And if 100% or or or most of that increase in productivity is directed to workers rather than to profits or to taxes, then presumably, you could get a surge in, uh, in in, uh, in in consumption growth that would get you out of the problem. If you look at the if you look at the the the just the sheer numbers that are required, you will realize that this only works if you, you know, if you come in with one of those technological breakthroughs that happen once every thousand years.”
Restricting capital inflows (through a Tobin tax or 'market access charge') is a better solution than tariffs because trade surpluses exist only if excess savings are exported, so taxing capital inflows directly addresses the cause rather than the symptom.
“When a country runs a trade surplus, it has to export excess saving. And the country to which it exports that excess saving must run the corresponding trade deficit. So what I would argue is that what we should do is tax the foreign exports of capital into the United States. An economist by the name of John John Hanson came up with a very good kind of Tobin tax, which he calls the market access charge, which I think is a very good idea.”
Pettis's medium-term outlook for China is that growth will come in around 4.5% with potential target lowering (down from 5% target); as long as China has debt capacity and is willing to make bad non-productive investment, it can achieve any target, but lower targets are better for China long-term since they reduce debt growth.
“What I'm really hoping in the summer, I would have told you growth next year is going to be 5% because that'll be the target. Today, I'm starting to think that it may be 4.5%. They may lower the target. Basically, as long as they have debt capacity and are willing to make bad investment, non-productive investment, and both is true both are true, they can achieve any target they want. So, the lower the target, the better for China over the long term.”
Beijing will likely shift investment out of involuted sectors into non-involuted manufacturing (petrochemicals, chemicals, steel, automobiles) and infrastructure, pursuing the same pattern of maintaining growth through investment rather than allowing structural adjustment.
“So what's going to happen is they're going to shift that investment somewhere else. Where? Probably into infrastructure and we're already seeing some indications that there will be an increase in infrastructure spending. But most likely into other non-involuted manufacturing sectors. And that includes petrochemicals, chemicals, steel, automobiles, a whole bunch of things.”
Without enough geopolitical will to create a new custom union, trade is expected to go down as a percentage of GDP, with the question being whether GDP grows and trade stays flat (less severe) or whether both decline (severe recessionary consequence).
“Given that, it kind of sounds like you think we are headed to a world where trade goes down as a percentage of GDP. What is the rough timeline? Or do you anticipate that? And do you think trade is going to go down as a percentage of GDP by GDP just going up and trade staying flat? Or really, do you estimate that there to be a substantial drop in trade that could have some severe recessionary economic consequences?”
China has a unique third option if it could get consumption to surge dramatically: rebalance without GDP slowdown, which is theoretically possible but would require major transfers that could be 'disruptive either politically or or economically' and may require redistributing assets from SOEs to households through holding companies that give shares to households.
“it's arithmetically possible...no one has ever done it. And it's very hard to imagine how you would do that without major transfers that would in and of would in of themselves become probably disruptive either politically or or economically. But at least it's arithmetically possible...One Chinese professor proposed every province creates a holding company. They shift all of the assets of their SOEs to the holding company. And then the holding company gives, you know, one share to every man, woman, and child in the province...when you consider that local governments are extremely powerful...because of all of the assets they own and control, what you're talking about is really a complete institutional change”
Wall Street and owners of mobile capital are ferociously opposed to capital inflow taxes because free capital flows benefit billionaires and banks, while being harmful to farmers, workers, manufacturers, and middle-class savers, revealing that capital account liberalization is a policy of wealth concentration rather than general prosperity.
“Wall Street would be ferociously opposed, as would owners of movable capital, because the free flow of capital is really great, you know, if you're a billionaire or a bank. Uh not so good if you're an American farmer or worker or manufacturer or middle-class saver.”
The real question about re-industrialization is how serious the US is; if serious, and there's real bipartisan consensus, the US will eventually get the policies right, though only after trying many alternatives (as Churchill supposedly said about Americans).
“if it's serious, and I believe there's a real bipartisan consensus behind that, if it's serious, it will eventually get it right. Remember what what Churchill was supposed to say...he was supposed to have said that the Americans always get it right, but only after choosing all the alternatives.”
Trump did not start the rebalancing; he is an expression of an existing problem—the recognition by Americans that deindustrialization is unacceptable. However, Trump has not implemented the right policies, as evidenced by the continued growth of the US trade deficit.
“Trump really didn't start this. Trump is an expression of a of an existing problem. And the fact that I don't think they've really implemented the right policies, and that's clear from the direction of the trade deficit, which continues to grow, just shows that they still haven't figured out how to do it, but they will.”
The period of global trade imbalances (1970s-2020s) mirrors the 1930s and 1970s as periods of great systemic change where democracies looked bad while doing exactly what they're good at (adjustment), but the changes that emerged were profound; predictions about how these adjustments will unfold are almost always wrong, so careful historical analysis is better than specific forecasts.
“this period is a lot like, say, the 1970s or the 1930s. Also periods of great change, great difficulty...we'll make a lot of predictions about how the world will look. Almost all of them will be wrong. So, I'm going to save myself the heartache by not making too many predictions, just saying that we're going to go through a difficult adjustment.”
Pettis is old enough to remember many purported solutions to economic problems that didn't work; while AI might be different, betting everything on AI solving imbalances is risky.
“Maybe AI is different, but I let's not I wouldn't bet everything I owned on on AI solving our problems.”