Citi Chief Economist Names China’s Three Problems
The chief economist of Citigroup is not your average economist. Yes, Willem Buiter studied plenty of economic theory at Yale and Cambridge, but then he says funny things like the New York State Driving Test was his “greatest educational achievement.”
He is also very outspoken for someone who works for one of the biggest banks in the world. He thinks Citigroup “must have decided that it was better to have somebody who tells the truth occasionally than to have somebody who tells what people want to hear.”
Epoch Times spoke to Mr. Buiter about a possible financial crisis in China, a devaluation of the currency, and potential solutions. [Skip to 19:00 in the video]
Epoch Times: What are China’s problems?
Willem Buiter: China has three problems. It has a madly over-leveraged corporate sector, banking sector, and shadow banking sector that really need restructuring and consolidation. It has massive excess capacity in many of the crucial industries, so it has a cyclical problem.
And then it needs to rebalance: From export growth to domestic demand that goes from investment growth to consumption; from physical goods growth to services; from I can’t breathe to green; and a growing role for the private sector. This simply isn’t happening at the moment.
Growth has stopped falling at the moment, though it is significantly lower than what it was, but only by unsustainable stimulus measures.
This is credit growth that adds to the excessive leverage. Investment in sectors where there is already excess capacity, basically building up a bigger and harder landing by postponing the necessary adjustments.
The rebalancing has been put on hold because this requires active and innovative policy making. With the anti-corruption campaign still in full swing, in its fourth year now and if anything intensifying, all senior civil servants in the ministry or the party are unwilling to stick their necks out and do something untried and new. The stuff that is required both in terms of financial stability management, in terms of stabilization policy, the right kind of fiscal stimulus and in terms of rebalancing.
Epoch Times: What can be done?
Mr. Buiter: We need to increase the role of the private sector to cut back on state-owned enterprises. What is happening? We’re growing state-owned enterprises because that is the path of least resistance, because we know how to do that.
So then China is in a holding pattern, and I think it won’t change until there is a long-run rebalancing; until the political issues that are reflected in the anti-corruption campaign are settled, it won’t be supported by the right fiscal policies.
Unless they are willing to go for Chinese helicopter money, fiscal stimulus targeted mainly at consumption not at investment. Yes, some capital expenditure like social housing, affordable housing, yes, even some infrastructure.
But organization supporting infrastructure, not high-speed trains in Tibet. It has to be funded by the central government, the only entity with deep pockets, and it has to be monetized by the People’s Bank of China.
That is what the country needs, and at the moment it is incapable politically—not technically—of reaching that kind of resolution. I think it is unlikely that they will be able to achieve that without at least a cyclical downturn of some severity. How deep depends on how quickly they respond when things start visibly going pear-shaped.
Epoch Times: What’s your estimate of Chinese GDP growth at this moment?
Mr. Buiter: Somewhere below 4 percent. The official figure is still around 7 percent, but those data are made in the statistical kitchen.
Epoch Times: So if growth is 4 percent and interest rates are 8 percent, doesn’t this create problems?
Mr. Buiter: Real interest rates are high in China. Especially for what I call honest, private borrowers. The relationship of the interest rate to the growth rate drives the debt to GDP dynamics. The so-called snowball effect is adverse when the interest rate exceeds the growth rate, and that is probably the case now.
So there’s a problem there. They are solvable. That’s nothing beyond the ken of man. The wheel doesn’t have to be reinvented, but having the tools and being politically able to use them and willing to use them are different things. China has the tools but not yet the willingness and ability to use them in the way that is necessary to avoid a hard landing.
Epoch Times: So we are talking about a somewhat similar problem than in Europe. We would have to write down a lot of bad debt. We recapitalize the banks and then stimulate the consumer to get inflation?
Mr. Buiter: In Europe, of course, we should really fund the capital expenditure. Investment rates are notoriously low in Europe. China has the opposite problem. They need to boost consumption. So there’s an obvious win-win situation that we could have.
Debt restructuring, haircuts if necessary, and then a well-targeted fiscal stimulus funded ultimately through the European Central Bank (ECB), people’s helicopter money. China will be aiming at consumption. The composition is different because China invests too much.
Epoch Times: What if China doesn’t address the problem?
Mr. Buiter: They are going to have a financial crisis. It can be handled because 95 percent of the bad debt is yuan-denominated, but you have to be willing to do it, you have to be proactive.
The United States didn’t have a foreign currency denominated debt problem when it had the great financial crisis. Banks fell over. These were all dollar-denominated liabilities. You can have a good old financial crisis without having the 1997–1998 Asian foreign debt issue, which China does not have.
So a financial crisis is a risk. Then, of course, a sharp depreciation of the yuan, which would be the consequence if the reserves would have to be used to safeguard systematically important entities that do have foreign currency debt. This would be the consequence of a failure to act, a recession and, in the worst case, a financial crisis. Again, something that’s survivable; not the end of the world, but very costly and politically destabilizing.
Epoch Times: But the currency would have to go down.
Mr. Buiter: I cannot see the yuan following the dollar over the next year, let alone two years, no. I do think that at the moment, the market is no longer afraid of an eminent sharp depreciation. So capital outflows driven by expectations of a sharp depreciation have ceased. But they could be back like that, especially if there are more kerfuffles in Europe, another flare up. Maybe the banking crisis, and as a result further upward pressure on the dollar and other safe-haven currencies.
And the Chinese currency is being dragged along? I don’t think so. They will have to decouple. So that is a channel which, for external reasons, the yuan peg might become hard to manage.
Epoch Times: How do you see the rest of the year?
Mr. Buiter: Continued subdued growth. China is flirting with the loss of faith in its ability to manage its currency and flirting with a sharp slowdown in activity. Europe and the rest of the industrial world, assuming that the Brexit negotiations remain orderly, not too hostile and growing more slowly than it did last year but not dramatically more slowly.
If Brexit becomes a dog fight between the 27 and the U.K. If Brexit becomes contagious, through general elections in the Netherlands in March next year, in France, Germany. If the Italian referendum in October or November this year goes against the government and fear of emulation of the British example takes over, then there could be a further, deeper slowdown in activity.
The United States again should putter around roughly the same way as last year. So mediocre growth at best with mainly downside risks. A few emerging markets—Russia, Brazil—will do better this year than they did last year simply because it’s impossible to do worse.
The specific shocks, home-made mainly in Brazil, partly external like oil prices in Russia and sanctions. These things are no longer slowing them to the same extent. So some recovery is possible.
It’s going to be a secular stagnation world, unless we provide the combined monetary fiscal stimulus and the longer term, supply side, enhancing measures to promote growth, higher capital expenditure, better education and training including vocational training, sensible deregulation, less disincentivizing taxation and all that.
All these things are necessary to keep potential output at a level that allows fulfilling our ambitions, but even the miserable level of the growth rate of potential output won’t be achieved unless we have additional stimulus.
Epoch Times: So no way for stocks to go up another ten percent from here?
Mr. Buiter: Everything is possible but I think the fundamentals say no.
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