Chinese Treasury holdings not necessarily a sign of strength

Michael Pettis on Japan’s response to US import collapse:

“let me note something that an unnamed official confessed about the impact of the US crisis on his country’s economy:

‘We intended first to boost the stock and property markets. Supported by this safety net – rising markets – export-oriented industries were supposed to reshape themselves so they could adapt to a domestic-led economy. This step was supposed to bring about an enormous growth of assets over every economic sector. The wealth effect would in turn touch off personal consumption and residential investment, followed by an increase in investment in plant and equipment. In the end, loosened monetary policy would boost real economic growth.’

It sounds plausible and like it might work. Except that it didn’t. The unnamed official was not an anonymous friend of mine at the PBoC. According to Tomohiko Taniguchi, in Japan’s Banks and the “Bubble economy” of the Late 1980s, the speaker was an official at the Bank of Japan and he made the comments in 1988, during a period when Japan was routinely referred to as a “creditor superpower” (and a country, by the way, with enormous foreign currency reserves, and whose currency would within one or two decades, everyone knew, become the world’s reserve currency).

After the 1987 Crash in the US, many expected the Japanese markets also to crash. But they didn’t. After faltering briefly, the Ministry of Finance ordered the Big Four brokerages to support the market, and support it they did. Within a few months the Nikkei was testing new highs, leading a Ministry of Finance official to boast that manipulating the stock market was easier than controlling foreign exchange. Check Edward Chancellor’s Devil Take the Hindmost for an illuminating take on the Japanese bubble economy of the 1980s.

The comparisons with China are, and of course are meant to be, a little worrying. This is not to say that China must repeat Japan’s spectacular 1990 crash and subsequent lost decade (or two). It is simply to point out that none of what we are seeing in China is particularly new and far from being a source of great strength, the intense manipulation of monetary and fiscal policies and the financial markets can actually make the necessary adjustment for China much more difficult. Just as Japan failed to come to terms with the sudden collapse of the US trade deficit and tried to export and monetize its way out, China may be doing something very similar.”

I think Pettis’ ideas here make a great deal of sense.  I think that China is very dependent on the US, which may be weakness rather than strength.


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