Wednesday, January 11, 2012

Pettis on Europe and China

by Calculated Risk on 1/11/2012 06:24:00 PM

Yesterday, in answering a question on China, I mentioned that Professor Michael Pettis is an excellent source about China. He also comments on Europe.

An excerpt from Michael Pettis: If no trade reversal now, then when?

Europe’s underlying problem is not budget deficits or even unsustainable debt. These are mainly symptoms. The real problem with Europe is the huge divergence in costs between the core and the periphery – in the past decade costs between Germany and some of the peripheral countries have diverged by anywhere from 20% to 40%. This divergence has made the latter uncompetitive and has resulted in the massive trade imbalances within Europe.

Trade imbalances, of course, are the obverse of capital imbalances, and the surge in debt in peripheral Europe in the past decade – debt owed ultimately to Germany and the other core countries – was the inevitable consequence of those capital flow imbalances. While European policymakers alternatively sweat and shiver over fiscal deficits, surging government debt, and collapsing banks, there is almost no prospect of their resolving the European crisis until they address the divergence in costs. Of course if they don’t resolve this problem, the problem will be resolved for them in the form of a break-up of the euro.
It doesn't appear European policymakers are addressing the imbalances at all.

And on China:
There isn’t nearly as much (at least visible) antagonism and undermining behavior among Chinese policymakers, but I worry that there is nonetheless the same lack of logical thinking among them in regards to their “right” to a trade surplus – although at least they are not facing massive defaults in the countries to whom they have lent. As China’s trade surplus declines dramatically, more and more people within the country are calling for interventionist steps to halt the decline, including depreciating the RMB, or at least halting its appreciation.
But we would have to ask the same question of China as we would of Germany: if now is not the right time for China to run a trade deficit, when its reserves are sky high, when rebalancing the Chinese economy away from investment to consumption is more urgent than ever, when global imbalances have thrown the world into crisis, when will it ever be the right time?

Not [this] year, apparently. There is developing in Beijing, I think, almost a panic about global economic prospects and the impact of the European crisis on China. This panic is going make the rebalancing process harder than ever ...