Learning Economics From Chinese Students
As shameful as it is, a Chinese student gets what we’re struggling to understand – government policies are stifling consumption, exports and therefor the economy.
A Bloomberg.com post mentioned that when a professor was discussing the nation’s move to keep interest rates low, a student chimed in with true wisdom:
Peking University professor Michael Pettis was discussing declining bank-deposit returns when a student interrupted with a story about her aunt that may stymie China’s plan to boost consumer spending.
“To send her son to university in six years it means she must replace each yuan in lost income with one from her wages,” the student said, according to Pettis.
Read it again, this example demonstrates one of the pressures that government-control of the economy (or in our case, Fed control) exerts. By keeping interest rates artificially low, investment income is hard to come by through anything but the most-volatile markets: Bond yields stink, CDs are worthless, and savings accounts generate no appreciable income. That means that savers now have less income to pay for normal expenses and that limits their ability to buy goods and services within the economy. Without investment income, your paycheck is all there is and that’s not enough.
China’s problem is very much similar to ours:
“Consumption is already at a dangerously low level,” said Pettis, author of the “The Volatility Machine,” a 2001 book that examines financial crises in emerging markets. “If it doesn’t begin to rise very quickly, China has a problem because household consumption will continue to drop as a share of GDP.”
Consumption represents as much as 70% of U.S. GDP. This lack of non-wage income, a large portion of income of retirees and near-retirees, means there is simply less to spend. This represents another downward push on the supply of money. If deposits in banks decline due to CDs and savings accounts being poor investments or not growing effectively, the banks have fewer assets to loan against. We are a fractional reserve system and only money loaned creates more money. As I discuss in this post on serious deflationary concerns, that’s the last thing we need.
As the post continues, it raises an interesting point that is of concern with Obama’s current direction. It’s been well-publicized that the President would like us to rely more on exports and less on consumer spending to power the U.S. economy.
The Group of 20 nations has urged China to boost domestic consumer spending to help offset reduced consumption from debt- strapped consumers in the U.S. and Europe. If Chinese shoppers fail to take over that mantle as the government’s 4 trillion yuan in stimulus wanes, then the nation may have to fall back on exports for growth. That would revive trade disputes with the U.S., which is battling 9.5 percent unemployment, said Huang.
Great, protectionist trade battles to return: Chicken tariffs anyone?
Low interest rates are intended to create investment through credit and therefor grow the economy, but left too long and in a disinflationary economy, they create a just the environment required to foster deflation. As this article at AARP.com states:
On Thursday, James Bullard, the president of the Federal Reserve Bank of St. Louis, warned that the Fed’s current policies were putting the American economy at risk of becoming “enmeshed in a Japanese-style deflationary outcome within the next several years.”
So we’re keeping loose monetary policy because even the Fed has figured out that deflation is a real concern. What’s startling is that the Fed’s next action will pull even more investment income out of the market.
Mr. Bullard, in an conference call with reporters on Thursday, said he was not calling right away for the Fed to drop its position that interest rates would remain exceptionally low for “an extended period,” or to resume buying long-term Treasury securities to stimulate the economy.
When the Fed buys Treasury bonds, it means they are infusing cash into the economy by buying U.S. Treasury debt: monitizing the debt. This action will lower the rate on bonds (yields) which should make it less-expensive to borrow money. In economics, there are two sides to every position. If borrowing costs are low, lending incentive is minimized. The risk-reward ratio gets out-of-kilter. Why risk money for measly 3% return? If investor/saver mind-set is to stuff cash into a mattress, lowering interest rates won’t fix that and in-fact may make it worse.
A Chinese student uses a simple story to relate that the world may be heading into an unavoidable deflationary spiral. Throwing money at it (stimulus), artificially lowering borrowing costs (fed actions) and just pretending that the recovery is happening (Obama and Biden on T.V.) are not the solutions. It is quite possible that deflation is the solution to the bubbles that governments have caused over the last decade. If we don’t let them occur, they will anyway.. just worse. If that’s the case, are you prepared?