Andreas Kern and Cora Jungbluth write,
Driven by an almost uninterrupted property boom, household debt has exploded. China’s home ownership is now the highest in the world at 89.68 %, rising from almost zero two decades ago.
Did you know that? I sure didn’t. Anyway, the point of the article is that China’s firms, households, and government have taken on very high levels of debt. This would seem to make the Chinese economy fragile.
Fragility in my mind means something that can fail catastrophically, with spillover effects that are impossible to contain. Something that can fail gracefully is not fragile. That is why the retail sector is not as fragile as the banking sector. Closing down Sears does not create huge spillover effects.
In general, what are the sources of fragility that we might worry about? Unsustainable government debt is high on my list. I suspect also that the electric grid is fragile. Bruce Schneier has me concerned with the Internet of Things.
Are the big tech firms fragile? Can Amazon fail gracefully, of would it necessarily fail catastrophically?
I don’t think the Chinese situation is as precarious as usually assumed: The Chinese still expect income growth so they are borrowing against that. Any debt to *current* income metric isn’t that useful here.
Fears about Chinese debt have been reported over and over again in recent years. If anything bad happens it will be blamed on debt no matter what actually occured.
The Chinese still expect income growth so they are borrowing against that.
You could have said the same thing about the US in 2001 or 1925 or Japan in 1985. The issue is income growth will stall at some point so once that happens then we will see the debt overload.
The Really Big debt crisis don’t come poor economies (Valenzuela or Argentina) but strong economy evidently overheating.
As to Amazon, I think the major way that their failure could spill over to many other parts of the economy is AWS disappearing without providing a way for customers to migrate away. However, AWS is now one of Amazon’s core lines of business and a strong profit center, so it’s hard to see an endogenous failure mode for it. That doesn’t mean it can’t happen, but it seems like any failure would be due to a disruptive competitor that convinces customers to switch, which would not cause widespread malaise. Alternatively, it could fail through something like a massive EMP attack that would also severely affect many other businesses.
Like Sears, there isn’t anything that Amazon does where there aren’t competitors. And, like Sears, there’s no prospect of Amazon going under suddenly. Amazon would fail only if, over time, it was out-competed by other firms taking its market share. So, as with Sears, by the time Amazon shipped its last package and turned off its last server, nobody would missing it any more than most of us are going to miss Sears when it switches off the last light in a store. So, no, Amazon is not fragile. I think a similar analysis applies to other large tech companies — there’s no prospect of sudden, catastrophic failure that would leave users/customers hanging. Any failure would come only gradually as people moved on to other options.
Amazon or Apple can fail gracefully. They could go bankrupt, but none of their business models are based on unproven value propositions. With debt restructuring, any of Amazon’s parts could continue operating.
Facebook and Google can collapse because their intrinsic value propositions are so opaque. Facebook and Google don’t understand the consequences of what they are doing, much less do their customers. This accumulates massive risk.
Technology companies could fail because of established professions or agencies attacking their business model with regulations that defeat it. An example is the loan company Wonga that used TV and Internet advertising to provide loans. The interest rates were high because of defaulters, but once they were regulated to reduce them, defaulters won.
https://www.thesun.co.uk/money/7109639/what-happens-wonga-debts-collapse-debt-compensation/
Companies that use technology to disrupt highly regulated health care professions and agencies seem particularly at risk, even if they provide a superior service or product.
In a summary of an NBER paper entitled “The Return to Capital in China” by Chong en Bai et al, at NBER Les Picker writes:
“Why have China’s high investment rates not brought low returns to capital? The authors propose two possible explanations. First, output growth driven by growth in total factor productivity appears to have been quite rapid. Therefore, the capital-output ratio does not appear to have risen by much, despite the high investment rate. Second, the capital share of aggregate income has increased steadily in China since 1998, precisely the period that witnessed a significant increase in the investment rate. One explanation for this might be that a gradual restructuring of China’s industrial sector has moved it toward more capital-intensive industries, requiring higher aggregate investment rates in the steady state. The data the authors use did not allow them to examine the sources of the increase in the aggregate capital share since 1998, but this is clearly a fruitful avenue for future research.
An open question is the efficiency of the allocation of investment in China. While the authors find clear evidence of misallocation of investment across provinces and across the three major sectors of the economy, they also find some evidence that it may have lessened over time. However, it could be that the bulk of the capital misallocation takes place within provinces and within the three broad sectors. Data at the firm and farm level would be needed to address this question. The authors note that other researchers’ estimates, based on firm level manufacturing data, indicate improvement in the allocation of capital across firms within sectors since 1995.”
Viewed in these terms, that is debt as investment, fragility does not seem to be a provlem. China appears to be on a reformist path. Writing at Forbes, Yuwa Hedrick-Wong notes that China;s incremental capital output ratio appears to be improving and declares that “For now, a debt-induced financial crisis in China is sheer fantasy.” Seems persuasive to me.
Technology innovation is Amazon’s potential downfall. If better alternatives to AWS emerge, Amazon could be hosed in rather short order. Such innovation, of course, is difficult if not impossible to predict. I do predict Amazon will lose market share in the online shopping segment as consumers realize they can get better prices elsewhere.
I don’t believe the US debt is unsustainable. US federal and state regulatory hurdles to business formation are probably the single greatest component of US fragility. Interest payments undoubtedly have the highest multiplier of any category of federal spending so that is not necessarily a bad thing, especially if it decreases the rate of increase in other spending categories.
The most likely response to growing interest payments will be tax increases. Even though the Trump tax cuts did not result in a reduction in total revenues collected, the political sentiment seems to be to increase taxes regardless. The Democrats have been highly successful selling the line that business does not pay its fair share and they won’t stop. They are increasingly aware of and proactive in their attempts to prevent capital flight as well. After 2020 look to see an increasingly authoritarian and stagnant US.
In the short term this may improve the balance sheets a smidge but in the mid term growth rates will go back to the slow Obama era new normal. If we are lucky, the pressure may build great enough to get the federal government to fnally divest some of its real estate portfolio. BLM alone controls 1/8 of the US land mass. Who could doubt that land would generate exponentially higher returns and tax receipts in the hands of the private sector? Unfortunately regulatory barriers might be the obstacle cutting that lifeline short.
I’d say the fragility of basic commodities is something to worry about before retail and banking. The commodity price rises circa 2008 were pretty uncomfortable.
California has more people than water; not a long term bet I want to take. Syria has a “drought” as part of its problems; I call this too many people for whats available.
Up to now we’ve been able to find and farm our way out of energy and food problems; someday this may not be the case, and the shocking begins.
Can Amazon fail gracefully, of would it necessarily fail catastrophically?
Why Amazon here? The great about Amazon is extremely competitive and pushing for new and better things. Sure they are over-valued but I think they are more of the future of retail than WalMart which seems so 2005ish. (WalMart ain’t disappearing but they don’t seem to dominate as much.) They are one of the few Dotcom Tech firms that truly did survive and with tech they continue to have falling marginal costs. (They are building their own delivery service!) Also Amazon failing would not be a huge economic loss as other retail stores would pick quite easily.
Anyway, I placing money on Facebook being the spectular failure as it is quite clear teens and early 20s are not using as much.
Well, Illinois is about as collapsed as one gets with small towns cutting services under government edict and populations vanishing. California almost went under in the crash.
What the federal government imposes is high interest rates or high taxes, neither of which the millennials can afford. The current plan has millennials producing 4.5% of their income just to cover federal interest payments, and this cannot be done. Current federal interest costs, nearly 600 billion, or 3.5% of the real economy, generally cause sequesters. But boomers are escaping leaving millennials and that comes to a horrid 4.5% of their income, just federal interest costs. They have little future with productivity growth of less than 2% and mortgage rates above 5%.
The two big holders of Illinois debt are Fidelity and Vanguard, each with over a billion in exposure but held in their junk bond funds, so no real global threat there. The question is whether the federal government will bail out the Illinois state pension funds when Illinois goes bankrupt. Given the horrid Puerto Rico precedent it looks fairly likely the rest of the country will be paying for Illinois’ extravagance for generations to come.
Communist countries where nobody “owns” any private property can quickly increase home ownership — by transferring ownership from the state to the people who live there.
Slovakia, like other ex-commie places, did this and also has about 89-90% home ownership.
https://tradingeconomics.com/slovakia/home-ownership-rate
Nov 17, 1989 was the Velvet Revolution for Czechoslovakia, celebrated as a holiday in both Republics (29th! already).
What we don’t have so much, yet, is home equity borrowing. Tho also not much flipping, short term house investment (=speculation).
The Chinese debt is in Yuan/ renminbi, so, like Japan’s internal Yen debt, is not such a problem. When a country’s gov’t owes a lot to the rich of that country, there won’t be such a crisis. Country debt fragility is much more related to how much of the debt is held in other currencies, not under control of the country’s central bank.
This is exactly why Greek, and now Italian, debt is such a problem. It’s Euro debt, but those countries don’t control the Euro — and Slovakia is also in the Euro zone (tho the Czechs are not).
I might prefer balanced budgets, but the question of whether government debt are sustainable has certainly been raised with the practice of quantitative easing in both the United States and Japan.
Japan has run up government that’s equal to 230% of GDP, but the Bank of Japan has purchased back half of that debt. The Bank of Japan has trouble hitting its 2% inflation target and that’s from the bottom side.
And we saw in the United States that quantitative easing lead to a roaring 1% or 2% inflation rate.
Many economists say the Fed will have to return to quantitative easing in the next recession as inflation and interest rates are already so low. But the Fed still retains the bulk of bonds that are purchased in the last recession. This raises the prospect that the government will own government debt .
It is a horrific concept for conventional macroeconomists is to entertain. But the fact remains central banks appear to be able to buy back national debt without inflationary consequence and with mild economic stimulative effects.
Is more sermonizing on federal debts really appropriate in this context?
Yes, I would say sermonizing is necessary. In the US the spike in cash printed mostly wound up being held by banks as reserves to meet the new tranche of bank solvency laws and regulations and didn’t wind up in the economy. That lucky break won’t happen again. When we start printing money again the results aren’t likely to be the same. The US was also helped a bit by deflationary pressure which Japan had in spades. Yes, you might be able to get away with printing money when you face deflation, but will we be facing deflation the next crisis?
As I understand it, one of the purposes of a stimulative monetary policy is to pull forward future consumption. The Chinese building housing stock in excess of household formation is their way of pulling forward future investment.
A benefit of that investment is keeping people working and by doing so, reducing the level of drug abuse and crime, costs which always rise in recessions. That reduction in those costs should count as a return on that real estate investment (even if those houses sit empty for a time).
Also, it means that in the future, the Chinese can devote more resources to consumption, having made that investment earlier. Basically more guns now means more butter later, rather than having to make that trade-off at least in the near future.
As I understand it, one of the purposes of a stimulative monetary policy is to pull forward future consumption… it means that in the future, the Chinese can devote more resources to consumption…
Seems like a contradiction.
The line I’ve always been fed is that stimulative monetary policy encourages investment in people and things, so future economic activity is more productive, and the People can afford more cool stuff.
If it just encourages consumption, people pile more crap in their houses. Then, when the money runs out, we’re back to the doldrums the initial stimulus tried to overcome.
The line I’ve always been fed is that stimulative monetary policy encourages investment…
In an economy operating below potential, you have excess capacity as evidenced by a low capacity utilization rate (CUR). Investment is not required and would be counter-productive as it would lower the CUR even further.
No, what you want is to increase consumption so as to hit that capacity restraint, at which point businesses begin investment spending, i.e., capex.
As regards the Chinese, they can spend more in the future on consumption because they’ve already got those houses built. That frees up capital and labor for consumption instead of investment.
That’s assuming that the houses are where people want to be, and there was an economy of scale to build the extra housing at the time because it was cheaper than building it later.
So if they built a three story building instead of a two story building so there is extra room that story makes sense, but building sky scrappers that stand virtually empty for years doesn’t seem to be the best way to increase consumption. So then you increase cap ex to build more housing that is not being used.
From an economics viewpoint, the best time to build housing is when you need it.
But the argument I was making was that the financial returns were indirect, namely the reduction in the social costs of having unemployed Chinese.
Suppose the US used the extra slack in the economy after the 2008 recession to repair its infrastructure. How many workers would that have saved from the opioid epidemic? And if you hire workers to dig holes and fill them up again, is there not a social benefit to doing that, considering the alternative to what those workers would be doing?
I’m always more partial to concrete real world goods investment myself. However, if we are just talking ditch digging there are costs.
Who is being paid to supervise and organize the ditch digging (someone who would otherwise have skills the real economy would value)? Who is paying for the equipment they use (which could be used in the real economy)? Is much of the ditch digging taking place in a way that hampers the rest of the economy? Most “road work” in my city seems pretty make work, but it shuts down lanes and increases traffic frequentely. Do the wages from ditch digging allow these workers to bid up zero sum resources from those in the productive economy?
Your underutilized resources may well be packaged with resources people want to utilize. It can also delay the repurposing of an underutilized resource into a resource someone might want. People and institutions change when they have to, not when they are being subsidized not too.
Given their history, I suspect that what many see as housing, the Chinese middle class see as a savings account. They own something real and owe a debt in an unstable currency. What is the downside?