Quotable

“The cardinal responsibility of leadership is to identify the dominant contradiction at each point of the historical process and to work out a central line to resolve it.”--Mao Zedong

Commentary & Analysis

China’s Three Choices, the Reserve Currency Fable, and the Far-East Parallel

As 2017 approaches, China faces the same three trade-offs it has faced since the country began to focus on the need for rebalancing its economy thanks to the impact of the 2007-2008 Credit Crunch; it changed the symbiotic relationship between China and the United States (see page 20) and made clear the need for China to rebalance its economy away from investment cum exports to more local consumerism.

Professor Michael Pettis, who has been singing the song of China’s reckoning for several years, well before it became clear to other analysts, bases his three trade-offs about china on two key assumptions, both I believe are spot on.

These two assumptions are:

• China has overinvested in infrastructure and manufacturing capacity to such an extent that in the aggregate the cost of additional public sector investment exceeds the present value of future increases in productivity generated by the investment. China's public-sector investment, in other words, is value destroying, and because it is funded bydebt, additional investment causes China's real debt servicing costs to rise faster than its real debt servicing capacity.
• China's long-term sustainable growth rate is substantially below the economy's current GDP growth target, and so the economy is only able to meet the growth target by increasing its debt burden.

These two assumptions don’t spell Happy New Year for China. At best, we will see a continued muddling through economically with real signs of rebalancing beneath the surface. At worst, another attempt to keep all the balls of growth in the air could only make things a lot worse in the years to come—the Far East Parallel, as I have coined it, looms large if rebalancing is either not successful or delayed.

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