The recent financial crisis in the West was triggered by bad debt. In specifics it was bad debt in the housing market. Lenders took insane risks and borrowers accepted them. Following the burst bubble there’s been a lot of media attention on how the West has become a “credit” society and that no-one saves anything anymore. This has been deemed “a bad thing”.
In fact it’s such a “bad thing” that the perception of debt as a disaster has infected the global economy – and now everyone is worried about how much money countries owe. This may be the clearest indicator of all time, that no-one understands capitalist economies properly.
If you accept that China’s economy has grown dramatically over the last 30 years, and how could you not? Then you know that the money has had to come from somewhere. China’s economy is export driven – which means that the money for their economy comes from outside of China.
So far so good right? To a certain extent, the answer is yes. It’s a sign that globalized capitalism is winning the day – consumers are free to buy the cheapest products, the Chinese make those products and thus they are making money.
So what’s the problem? The problem is that once that money comes to China, the Chinese people save most of it. They don’t spend anything (in real terms) on what’s known as the “internal economy” and thus the money comes into China and is then removed from circulation. And it’s not coming back into circulation until the person retires in around 20-40 years’ time.
Why is that a problem? It’s a problem because we live in a capitalist world – and for a capitalist economy to function perfectly money needs to constantly circulate around the system. Otherwise there will be less money out there to buy things with, than there was yesterday (in economic terms) and thus jobs will be lost, and gradually the economy will run out of steam (rather like a slow puncture in a tyre – you won’t notice it at first, but you’ll certainly know about it in the long run).
In fact ideally that money should go full circle round economies – the perfect model has the European economy buying say; $1 billion worth of clothes and shoes from China and in exchange China buys $1 billion worth of cars and planes. Then the money is always economically active.
It’s at this point that you usually get angry Chinese people shouting; “But it shows we’re responsible not like you wasteful foreigners! You spend what you don’t have!” And this is true – at an individual level the decision to save is an excellent idea, it prepares you for future short falls in income and emergencies, and means you don’t need to borrow money (and pay interest on it). But… at the macroeconomic level this is a very bad idea – because when you combine lots of people together, they take a lot of money from the economy and the tyre begins to deflate.
It’s also saving that makes China appear richer than it is, in a Western style economy the government can access taxation earnings (and those earnings provided through other forms of investment, or assets, etc.) and this is the money it has for infrastructure projects and other investments. In China taxation is still a polite fiction for most, the government is working very hard on fixing that – but today the amount of tax revenue collected in most parts of China doesn’t pay for much more than the collection system.
In fact by and large China’s government (both provincial and the overall government in Beijing) makes most of its money in short-term land sales (which won’t end up all that short-term). And this money is spent on infrastructure etc.
However unlike in the West, the banking system in China is essentially a state asset and that means all those deposits made by ordinary Chinese people are available for investing in anything that might provide some return for those savers. And it’s this pot of money which makes up the vast amount of China’s foreign investments – and traditionally the Chinese are highly risk averse when it comes to investing. So that money goes into traditionally low risk areas of investment– like for example; American Treasury Bills (which don’t pay a lot of interest – but have always been paid).
This is a huge topic – so I’m going to leave it here today and pick it up again tomorrow, for a look at how much debt China’s savings have really bought, and why there’s nothing to fear from this. And why the Chinese consumer may soon be asking some hard questions of their banks instead.