How Financial Repression in China Helped Cause the Trade War

Tracy Alloway (0:11)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:16)

And I'm Joe Weisenthal.

Tracy Alloway (0:18)

So Joe, you know there's a very, very important date coming up.

Joe Weisenthal (0:23)

Hmm, what is it?

Tracy Alloway (0:27)

I'll give you a hint. It's in October.

Joe Weisenthal (0:29)

Oh, right, of course.

Major deadline for the trade tariffs. It took me a second, I'm sorry.

Tracy Alloway (0:37)

Yes, those are always happening, but there's a date that's even more important. And it's actually really important for the US-China trade war. But it's October 1st, and that is the National Day of the People's Republic of China. And this year, it's even more important than usual because it's the 70th anniversary of the founding of the PRC.

Joe Weisenthal (1:01)

Ah, okay, that I didn't realize.

Tracy Alloway (1:04)

Okay, and this tends to be a sort of politically sensitive date for the Chinese authorities. It usually comes with a big military parade and they seed the clouds to a couple of days before to make sure that the skies are blue. And it's a big, huge holiday.

But it's also a chance for the authorities to sort of evaluate or more likely sort of crow about everything they've done to improve China, including the economy.

Joe Weisenthal (1:32)

I like how you just sort of casually throw in there that they affect the weather for the day.

Tracy Alloway (1:36)

Yeah, it's really interesting. Everyone knows it's going to be good weather on October 1st.

Joe Weisenthal (1:41)

That's amazing.

Tracy Alloway (1:43)

So I thought in connection with the October 1st date, we could talk about how far China has or hasn't come when it comes to the goal of rebalancing their economy.

Joe Weisenthal (1:55)

Right.

And this is something that people have been talking about for a long time because people look at the Chinese economy and they see, at least on the service, all kinds of crazy things going on. There's very, historically, there's been extreme fluctuations in asset prices, real estate prices, claims of real estate bubbles, an economy extremely geared towards investment and so forth. And so people look at an economy that's grown extraordinarily well, that's brought all kinds of wealth to people over the last several decades, going from one of the poorest countries in the world to building up this significant middle class. But they still see extraordinary imbalances and skewed forces domestically.

Tracy Alloway (2:41)

That's right. And the big one is, of course, the imbalance between an investment-driven economy on the way to becoming more of a consumption-driven economy. That's the big one.

And to talk about this, we really have the perfect person. Our guest for today is Michael Pettis. He's finance professor over at Peking University and also senior fellow at the Carnegie Endowment. He's also a former banker and a trader and has been watching exactly this and writing about it for a very, very long time. So we're very happy to have Michael on the show today.

Joe Weisenthal (3:16)

I can't wait. I've been wanting us to have a podcast with an episode with Michael for a long time. So really looking forward to jumping into this one.

Tracy Alloway (3:23)

Well, yeah, no pressure, Michael, thank you so much for coming on.

Michael Pettis (3:28)

My pleasure.

Tracy Alloway (3:30)

So maybe just to begin with, we could talk a little bit about what we mean when we talk about an investment driven economy versus a consumption driven economy. What does that actually mean and how does it pertain to the case of China?

Michael Pettis (3:44)

An investment driven economy can also be thought of as a savings driven economy. And China is not the only country that's followed this growth model. At least two dozen countries have since the Second World War. And you could argue that this model was more or less invented in the 1930s in the Soviet Union. But basically, in a consumption driven economy, and the classic case is probably the United States in the 19th century, you had very high wage levels. So, it was high wages that drove high levels of consumption, which then drove high levels of investment to serve those consumption needs. And it also drove productivity growth and a bunch of other things.

In the savings economy, what you do is you force up the savings rate, which is usually a good thing to do in a developing country, because developing countries tend to have insufficient investment and they tend to have insufficient investment because they have insufficient domestic savings. So, you force up the savings rate in order to increase the amount of savings that are available for domestic investment.