Last week, I attended a conference organized by Eduardo Fernandez-Arias and Alessandro Rebucci at the Inter-American Development Bank. One of the panels focused on the impact of China on Latin America’s economy.
Originally, I’d thought that the linkages would have been quite limited, but in doing research for this talk, I’ve re-evaluated my views.
First, Alessandro Rebucci presented a paper which evaluated the implications of shocks to the Chinese economy, using a global VAR (GVAR) model (for more on GVARs, see the published article, and slightly different working paper here). The details of the model are contained in this paper (which differs slightly from the version implemented in the presentaiton). He and his coauthors found that the effect of shocks to Chinese GDP had increased over time. More surprisingly, they also found that a Chinese revaluation would slow growth in the US, Europe, Japan, as well as in Latin America.
Figure 1: Response to a one standard deviation shock to the China CPI adjusted exchange rate, from A. Rebucci, “The Importance of China for LA and the World
Economy” (April 23, 2010).
Figure 2: Response to a one standard deviation shock to the China CPI adjusted exchange rate, from A. Rebucci, “The Importance of China for LA and the World
Economy” (April 23, 2010).
The results are for a one standard deviation shock to the Chinese nominal exchange rate deflated by the Chinese CPI. A one standard deviation shock is about 4%. Such a shock would reduce Chinese GDP by 0.2% (log terms), and interestingly, induces a reduction in US GDP (of 0.06% on impact, essentially zero at the long horizon). Latin American output falls by 0.1% on impact, with some countries more affected than others. Chilean GDP falls by about half a percent in the long run.
All the graphs and figures above pertain to a 4% exchange rate appreciation. For the 20% figure often discussed, one would need to multiply by five.
Update, 27 April, 11:30am Pacific: Alessandro Rebucci kindly provided some additional intuition for this result [some minor edits — MDC]:
Why is this a plausible transmission mechanism? China revalues, net exports go down. If domestic absorption does not expand enough to meet existing supply, overall growth decelerates. So not only is the composition of growth, but also is its level, affected. The implication is that a devaluation would have to come with policies supporting absorption in China to be neutral for the level of growth in China and by implications in the rest of the world. For a change in the real exchange rate of a country to have neutral effect on level of growth, the expenditure switching effect has to be accompanied by compensatory level changes that offset exactly the level implications of the change in relative prices. The simulation says that, historically, this has not been the case. There are at least three set reasons why this may happen: certain configurations of trade elasticities (see my WEO chapter on exchange rates and imbalances for the evidence on the fact that exchange rates alone cannot rebalance the world economy without a recession), perverse effects of different propensity to spend across the world (if foreign demand switch to countries with higher saving, overall demand and growth will be lower (but we know this is not the case), and finally, different monetary and fiscal responses to the shock (not enough expansion in China to make up for the fall in net export), too much of a response in depreciating countries because of concerns with the inflationary impact of the depreciation (again, not that relevant today). This leaves us with trade elasticities as the place to look for a better understanding of the likely impact.
Note: I discussed the indicated WEO chapter in this 2007 Econbrowser post.
Rather than focusing on the specific estimated impacts (which will depend upon the model specification), I think the results are of interest because they show that once one incorporates repercussion effects, one can get perhaps surprising results that would not occur in a partial equilibrium setting. (Another example of surprising results from a macroeconometric model is Fay Fair’s recent paper.)
Mauricio Cárdenas, Director of Brookings’ Latin American Initiative highlighted the linkages between Chinese industrial production and commodity prices; for the commodity exporting Latin American countries, this is perhaps the most important linkage.
Figure 3: Rolling correlation of commodity export prices and Chinese industrial production, from M. Cardenas, “China’s Economic Outlook: Implications for Latin America” (April 23, 2010).
Figure 4: Rolling correlation of commodity export prices and Chinese industrial production, from M. Cardenas, “China’s Economic Outlook: Implications for Latin America” (April 23, 2010).
If correlations were to remain high, then a sustained expansion in Chinese industrial production should keep Latin American export prices high as well.
In my presentation, I observed that commodity links were indeed rising.
Figure 5: Latin American and Caribbean non-fuel commodity exports to world (blue) and to East Asia (red), in billions USD. Source: UN, International Trade Statistics Yearbook 2008, as reported in M. Chinn, “China, Latin America and the World Economy” (April 23, 2010).
However, what this graph suggested is that, to the extent that Latin America was increasingly linked to production cycles in China, it was also exposed to increased volatility. That is, given that price elasticities of supply and demand for commodities are probably pretty low, slight shifts in Chinese demand for commodities could induce large swings in commodity prices (and hence Latin American export revenues).
In my mind, the big question is whether the upsurge in commodity demand prove durable if China rebalances its economy, and shifts its production more toward satisfying domestic consumption.
China’s “miracle” growth has been driven primarily by US supranational firms’ investment and trade credits for their subsidiaries’ and contract producers’ production and “exports”.
China’s foreign exchange reserves have soared commensurately with the massive investment and US firms’ (including banks) deposits in Chinese banks, as well as the backdoor hot money flows via Hong Kong and Singapore. China must buy US Treasuries as reserves against the tens of billions of equivalent US$ deposits by US firms. The more US firms invest in China-Asia, the more US$’s are created that are then converted to Asian currencies (and thus reducing the US$’s value) and a portion retained by the PBOC as reserves against US non-convertible deposits in Chinese banks.
As China-Asia grows more rapidly as a result of US and Japanese investment and “exports” and intra-Asian trade flows, the demand for oil and distillaets increases, requiring more US$’s to purchase oil at higher prices on the world market, putting a further downward pressure on the US$.
Except for a recent excellent report by Corriente Advisors (TX), one hears virtually nothing about this “actual” US-China trade situation and its proximate effects on the US$ and renminbi.
The US neo-colonial/neo-imperial and China client export mfg. relationship is virtually a taboo subject. Yet we have politicians threatening China with trade sanctions and China blustering in return, which amounts to hardly more than urinating in the prevailing hot air.
But China’s growth, fossil fuel import demand, water shortages, drought, and increasing loss of arable land means China will become increasingly a “permanent” net importer of energy and food hereafter, eventually reaching parity with the US in terms of China’s oil consumption vs. US oil imports by ’16-’17.
At the trend rate of growth of US and China oil consumption and imports, as well as peak oil extraction of 73-75 million bbl./day, by ’16-’17 the US and China will combine to consume half of the total world’s oil extraction.
Then, by ’21-’22, the US and China will reach parity of oil consumption and together consume nearly two-thirds of the planet’s extraction of petroleum, leaving the rest of the world to consume 40% less oil than they do today.
How likely will the US and Pentagon chiefs allow this trend to continue and put US and EU national security at grave risk from China’s growth of consumption and the increasing likelihood of supply shocks? Bloody unlikely.
And given the emerging global energy supply constraints posed by Peak Oil and intensifying competition between the US and China for global oil supplies, how likely is the global economy to sustain growth under such conditions over the next 6-7 to 10-11 years? Stick a fork in the turkey of global growth; it’s done.
As China loses US foreign investments, export production, and exports, and faces permanent food and energy deficits hereafter, China’s growth will dramatically decelerate, setting in motion hot money outflows, another 70-75% Shanghai stock market crash, and cascading unreal estate and business loan defaults making Japan and the US banking problems look like amateur hour.
I would not put a nickel in China to see it end up in China’s PLA’s general staff’s penthouses, mistresses, offshore accounts, and gambling trips, or to be plundered by G-ddamn Sachs in a hot money vacuum sweep in the coming months.
China has created the largest credit and fixed investment bubble in terms of GDP in world history.
China is a four-letter word: “SELL”.
“LA” Is that Louisiana, Los Angeles, or Lance Armstrong?
Nemesis,
China has had one of the longest periods of growth of any country in the world, since 1976 or so. They have gone from the 8th largest economy in the 1980s to the 3rd largest and are nipping at Japan’s heels. Compare that to the US headed in the opposite direction.
“In my mind, the big question is whether the upsurge in commodity demand prove durable if China rebalances its economy, and shifts its production more toward satisfying domestic consumption.”
Why is that? Would China’s internal demand be less ‘commodity intensive’? Or is this a temporary result from global disruptions from the rebalancing?
Given that misalignment of China’s currency probably resulted in some rather large investment misallocations, I am surprised that a rebalancing would have negative global impacts for any extended period of time. (Are those years on the horizontal axes in the first graphs?)
The economic modeling behind the conclusions presented in these graphs is not very convincing. Seems a hodge-podge of correlations without much of a story to back them up.
Kharris,
LA is Latin America.
LA = Latin America.
Ricardoz, are you aware of the amount of US and Japanese foreign investment in China since, say, the late 1980s as a share of Chinese investment and GDP? Hint: Massive!!!
And how much of Chinese production and exports are associated with US and Japanese firms’ subsidiaries’ in-country investment, production, and so-called “exports” which increasingly go to US and Japanese intra-Asian production, which in turn ends up as components or finished goods for US and Japanese markets? Hint: MUCH larger than economists realize.
I put it this way because an overwhelming majority of economists and policy hacks have absolutely no clue what I am talking about. Krugman dismisses the neo-colonial/neo-imperial structural case because he claims not to be able to quantify the flows, and he cannot admit to it existing after having received, well, “the prize” for his work. So, say you can’t see it, and it is not there, even when the evidence is all around and embedded in the very nature of “trade” and “globalization”.
Moreover, over the very long term, an economy’s growth is limited by population growth, capital deepening (replacement) of labor, net energy return on energy invested to extract and process raw materials.
China’s very long-term potential growth rate is no more than 2%; however, the country is reported to have grown 7-10%/yr. for several decades, including a similar growth track since the 1990s. I don’t buy it. That’s a growth of investment, production, and energy consumption 3.5 to 5 times sustinable potential, which also includes growing into a hard limit bound already appearing from Peak Oil and increasingly acute water shortages which risk a scale of food shortages I don’t even want to think about.
Now China is creating $5-$6 of debt for every $1 of GDP and contemplating another debt-based “stimulus” of 10-11% of GDP!!! Growth? You betcha: unsustainable growth of claims on future returns to investment and production no economy has ever had to bear with global structural resource constraints on an unprecedented scale.
The point is that without the MASSIVE US and Japanese supranational firms’ investment and China’s build-out of export production capacity for foreign markets over the past 20 years, China would not have grown anywhere near 7-10%. A dramatic slowing of US and Japanese investment and export production in China, China’s falling returns to eye-popping growth in fixed investment, and now the late-bubble signs manifesting from the greatest credit bubble to GDP ever in recorded history risks a secular trend “adjustment” to China’s growth trajectory that most economists have no clue is on the horizon (or won’t publicly say so because they don’t get paid to).
It’s a no-brainer that China will crash, and when they do it will be a breathtaking affair, one that is likely to send China once again turning inward from the rest of the world to deal with drought, famine, food, electricity, water, and food shortages, increasing social unrest.
Don’t be surprised if the PLA steps forward and exerts much more influence and control during the coming crisis, encouraging xenophobia and sending decadent, scheming, thieving “western devils” packing without their assets.
And Singapore, Hong Kong, and Taiwan will be no safehaven from an ongoing decline in global trade, financial services, and tourism, as Peak Oil and rising food, energy, and materials import costs severely constrain growth for these city-states.
Again, Shanghai’s Coppock Curve issed a sell signal in Mar., and a yoy monthly close in the coming months will confirm the sell signal, setting up another plunge in Shanghai stock prices as GS and the hot money cowboys and plunderers unload to the latecomer bullies to “emerging” (soon to be “submerging” again) markets.
Don’t wait for the panic and shoe marks on your face and chest. Sell. It’s over.
Typo watch: Ray Fair, not Fay Fair.
The moral of this story so far is a familiar one: Fair, and righteous free lunches are hard to come by.
In addition to slowing the real estate boom/bubble, a higher currency would allow the Chinese to buy more commodity-levered companies and assets from around the world. Productivity growth should offset some of the exchange rate pass-through effects to American Consumers. At some point higher Chinese costs should help continue the virtuous process of outsourcing to lower unit cost countries.
China will slow as their surplus labor dries up, which seems to be happening to a small extent in some industries now. Capitalism received a much needed shot-in-the-arm with the introduction of cheap labor from China. Economists might want to look into a world where Chinese labor is ‘too expensive’. There aren’t any China’s left.
GNP,
If China were to float the renminbi today, which they WILL NOT because of the nature of the fragile, immature Chinese banking system, the currency would “fall”, as (1) hot money repatriation by US firms and GS and their parasitic vermin would occur; and (2) China’s growing energy, materials, and food imports will result in a trade deficit, requiring more currency to purchase more costly US$-denominated goods, especially oil and distillates.
Moreover, if one looks more closely at China’s “novel” price inflation and income accounting methodologies WRT consumer prices, imports, and inventories, China’s economy is more likely growing at 3-4% instead of 8-10%.
Then, China’s debt growth to GDP and quasi-money supply vs. GDP indicates that money velocity is below 1.0 and returns to expansion of debt are plunging, which is characteristic of requisite conditions for a deflationary crash.
Similarly, US money velocity of M2+ (M3 less repos) to “private” GDP indicates that the US is progressing further into a debt-deflationary regime, which is theoretically bullish for the US$ (all else equal), i.e., increasing risk aversion, liquidity preference, and asset drawdown, and bearish for stocks, corporate bonds, and commodities.
Contrary to inflationist and gold bug expectations of a US$ crash and surging Treasury yields, the secular debt-deflationary precedent implies the US$ trending to and around par against major currencies with the 10-yr. Treasury yield well below 2% and the 30-yr. below 3%.
Purple,
Yes, well said. Capitalism throughout its evolution has relied upon some form of slavery or slave-like labor conditions, gunboat diplomacy, and natural resource expropriation for virtually its entire history.
Along the way, central banks, fractional reserve banking, gov’t debt, money and price inflation, large standing armies, and wars emerged and ultimately were required to sustain capitalism’s evolution.
Now here we are with nearly 7 billion of us human animals on the planet extracting and consuming natural resources as if the planet were a limitless open system.
We perceive ourselves as exempt from Nature’s laws (“the gods”), i.e., thermodynamics, etc., the culmination of “Creation” (evolution), having been created flawed (“fallen”) by the incompetent gods and destined to recreate and perfect humankind to rule over the planet.
Rather than see ourselves as Nature, i.e., ongoing Creation, we have created Nature as an enemy to be subdued and utterly defeated. The human being separate from Nature is the false god we worship and around which we have built a bubble of self-deceit and self-delusion.
Such lack of wisdom. Such hubris. The enemy we have created will now become our nemesis.
“First, Alessandro Rebucci presented a paper which evaluated the implications of shocks to the Chinese economy, using a global VAR (GVAR) model (for more on GVARs, see here). The details of the model are contained in this paper (which differs slightly from the version implemented in the presentaiton). He and his coauthors found that the effect of shocks to Chinese GDP had increased over time. More surprisingly, they also found that a Chinese revaluation would slow growth in the US, Europe, Japan, as well as in Latin America.”
Mr. Rebucci’s paper seems to ignore the the new China-ASEAN trade zone. It represents 13% of global trade and alternative markets which have the benefit of reduced shipping costs. This seems like something too important to ignore.
Ray,
Examine more closely what makes up the composition of the China-ASEAN (intra-Asian) trade flows. IOW, how much of the “trade” is associated with US and Japanese firms’ subsidiaries and contract manufacturers’ production of component and intermediate and finished goods and “exports” within the region and to the US and Japan.
Here is an example. AMAT producers equipment in the US (so far) that is “exported” to an INTC facility in Malaysia, which producers components that are then “exported” to Taiwan to install in motherboards which have components “imported” from Korea, China, and Japan.
The motherboard is “exported” to China where it is tested and certified with test assemblies “imported” from a US test equipment producer’s facility in the Philippines.
Then the intermediate product is “exported” from China to the US where DELL installs the “imported” board in a PC or server system to be sold in the US or “exported” to other markets.
Get the “trade” picture . . . ?
When the British, Dutch, Portuguese, French, and Spanish conducted similar “trade” with conquered or co-opted colonies in the Americas, Africa, and Asia it was referred to as “colonialism” or “imperialism”.
But Americans call it “globalization” and “free trade”.
Nemesis,
Your evaluation though, of intra-Asian trade flows, is based on the past and it would seem that the new trade agreement is about the future. I understand that more than half of China’s exports are actually MNC flows but… what about the fact that China now produces more autos than what the US does? What about their steel production being 10 times that of the US and concrete and etc. Why would they not simply shift their production efforts to suit the new trade zone and take advantage of the lower shipping costs and the removal of what were allegedly extensive trade barriers? If Latin America is important… how can the ASEANs not be in regards to Mr. Reducci’s paper–going forward?
Ray,
They will try to (and are) shift production for regional activity, but the structural effects of Peak Oil, i.e., rising costs for materials, energy, food, will prevent the process from developing as they hope.
But China-Asia is 40-50 to 100+ years too late to the cheap-oil, Oil Age development model. The effects of falling net energy and falling rate of profits to fixed investment are already occurring in China, Singapore, and Taiwan, but economists are trained to look at the wrong indicators, i.e., money illusion and prices, or to ignore obvious effects of resource constraints on the sustainability of investment and profits.
That China has surpassed the US in auto and steel production should be seen as a disaster, not something to celebrate!!! It just means that we are heading off the cliff of permanent ecological constraints and collapse sooner rather than later.
Consider that, at 73-75 bbl./day of peak global oil production and 82-84 bbl./day of liquid fuels, the growth of liquid fossil fuel consumption and imports by China and the US are on course for China’s consumption to reach parity with US imports in ’16-’17, at which point the US and China will together consume about half of the world’s oil and liquid fossil fuel production.
Further, by the early to mid-’20s, the US and China combined will consume nearly two-thirds of global liquid fossil fuel production. And these admittedly linear extrapolations do not count a decline in production, which now even the EIA, DOE, and Pentagon now expect.
Were the trend rates to continue at or near peak global liquid fossil fuel production, hypothetically, China would consume the world’s entire fuel production by mid-century.
Visualize, if you can, a world in as few as 6-7 years when the US and China consume half of oil production, whereas 5-10 years after that the two countries will consume two-thirds of production, leaving the rest of the world, including the EU, Latin America, the Middle East producers, and the rest of Asia, with just one-third of total oil production.
In this context, China is very much in a situation of vulnerability to limited access to resources and to resource shocks as were Japan, Germany, and Italy in the 1930s, prompting these countries to militarize their economies in an attempt to grab resources beyond their borders.
GS and the rentier-parasitic Wall St. types have been working 24/7 to propagandize the world to the “BRIC” story and “Decoupling 2.0” (after 1.0 turned out to be wrong). Now we incessantly hear as part of “the story” China’s “rebalancing”, which is just more silliness and GS talking their (gambling) book.
Now, if you can imagine China-Asia continuing to grow at 5-6% to 8-10% in the above context, allowing the US, EU, and the rest of the world to grow at all, your imagination is superior to mine, I concede.
Nemesis,
Before you continue with the presumptuous insults regarding my “imagination” let me clarify that we seem to share the opinion that the global economy is breaking down. But I disagree on how the nations fail in regards to the order of those failures. I see the energy cost issue as being a relative concern that affects the productive economies in a competitive way that makes efficiency, discipline, and dedication… what decides which nations succeed while others fail. And, essentially… I think that you are underestimating the importance of China’s ability to be proactive while the developed nations are busy being reactive. I believe too that economists fail to recognize the importance of a nation’s need for inspiration or patriotic will, which China now has… while we have instead a collective burden of cynicism and apathy. I believe too that part of the reason that China’s growth rate has been so superior to that of any in US history is because China spends far less on militaristic production and the inherent destruction. The long term benefits of making bullets instead of productive items is something that is not well understood… but it matters.
Ray, we agree on military spending, but note that Anglo-American empire spends 10% of private GDP on war making because of the energy situation (importing 60%+ of oil consumption); it’s what empires do, and one of the factors that lead to decline and eventual collapse.
I visit China (and Singapore) 3-4 times per year, and have done so going on 23 years (this summer). China is a command-and-control, top-down, militarist, totalitarian communist state and planned economy, with the vast majority of Chinese being agrarian or pre-industrial peasants; and the permanent structural effects of Peak Oil will ensure they remain there.
Americans know little of what is actually going on in China (or the rest of the world) because most don’t care or it is not profitable for the corporate media to report from the media. Also, Wall St. needs China to continue to grow so the likes of GS can plunder China-Asia via rentier speculation and capturing decades’ worth of surplus value from labor and production via hot money flows, derivatives, etc. The Chinese elites are being duped by GS and the like to allow, wittingly or otherwise, the plunder of China.
But this has happened every 50-60 years (Long-Wave periodicity) since the 17th century (periods preceding the White Lotus Rebellion, Opium Wars, Boxer Rebellion, and Mao’s revolution). The Chinese eventually wake up after westerners have plundered the country and social unrest erupts and the Chinese leadership reacts violently and then turns the country inward. I expect this to occur yet again right on schedule over the next 10-20 years.
Overcapacity and malinvestment (and shoddy construction) are occurring at a scale that is simply unprecedented and surreal. And it cannot be emphasized enough that China is now the largest credit bubble as a share of GDP in all of world history. All bubbles bursts. And the bigger the bubble, the bigger the effects of the bubble’s bursting.
Air, water, and watershed pollution and traffic are a colossal disaster and getting worse in many or most areas. China rushing at a desperate pace to reproduce the US auto-, oil-, and suburban sprawl-based development is 50-100 years too late and is an act of national ecological suicide.
Water, natural gas, gasoline, and electricity shortages are becoming the norm, i.e., typical Third World conditions.
Desertification, loss of arable land to urbanization, and a shift of more grain production to poultry and livestock guarantees China will become increasingly dependent upon food imports, setting up increasing vulnerability to external shocks from climate and global food production.
Protests and riots are occurring all over the country but at relatively small scale so far.
Wealth and income concentration in China is at a debilitating extreme, as in the US, UK, Russia, and Third World dictatorships, as well as before the Japanese invaded in the 1930s and Mao seized power.
The emerging professional middle class and wealthy on the urban, industrial coast of China are becoming hyper-materialist, smug, elitist, speculative, and self-superior, caring nothing about, and directing their contempt toward, the struggling, seething mass of rural 95-99% of the Chinese population.
Thus, China is at least three countries within a large geographical region: (1) Beijing where the corrupt, militarist-communist elites reside and conduct their bribery and extortion of the business elites so far in a mutual situation; (2) the urban coasts of professional middle class and wealthy making up no more than 4-5% of the population; and (3) the remaining rural and rural-urban refugees, which make up the other 90-95% of China.
The “Three Countries of China” cannot function for long symbiotically, as there is growing antagonism, distrust, resentment, and the certainty of a dramatic structural shock from Peak Oil and demographics ahead.
The militarist-communist leadership in Beijing still have the guns, political power, and willingness to use both in a crisis.
The middle-class and wealthy Chinese cannot buy the affection and loyalty, nor stand up against, 1 billion increasingly landless, impoverished, angry, rural Chinese.
The rural peasant Chinese will suffer horribly on an unprecedented scale in human history from the cumulative effects of drought/desertification, declining crop yields, Peak Oil, inequality, lack of affordable housing, shortages and rising prices of vital commodities, etc.
The cleavages between the “Three Countries of China” are about to widen further to the point of disorganization and disintegration. The coming China-Asia crash will reveal the underlying weaknesses and unsustainability of China’s interdependent relationship with the “trade” arrangement with Anglo-American empire.
Again, China is a BIG four-letter word: “SELL!!!”
Nemesis,
Interesting comments. I am/was under the impression that China was a net exporter of staple goods up until the drought of a couple of growing seasons ago. Your forecasts of food shortages therefore seem to be a contention that China is stuck in a perpetual drought… but of course that is not possible to know. China does of course have amounts of highly fertile soil bested only by the USA.
Most of what you said I agree with, and I was aware of, although my use of the term: ‘inspired’ may have been inaccurate. The only other thing that you said that I find difficult to accept is that China is being duped by Wall St. That is difficult to reconcile with the fact that China has benefited too and of course the Chinese have all of those dollar related assets.$$$
I too am a little skeptical about the ‘peak oil’ argument. I live in Texas and I happen to know one the world’s leading experts on oil extraction and drilling and he has assured me that the ‘peak oil’ fears are mostly propaganda that is allowed to spread because that ‘belief’ serves the industries interests. His view not only makes good sense but I have spent some time with him on a drilling rig and I have seen how sophisticated the equipment he uses is and it is too complicated to explain it all here but… lets just say it would be very difficult to convince me that he is wrong. He is flown in a private jet all over the world and when he arrives at a rig there is a mobile command unit waiting (I have seen this) he looks at a bank of monitors that provide very detailed info from thousands of feet below the ground and after a few hours of analysis he recommends the best course of actions to the site superintendent (someone with many years of experience) and then my friend is flown back to Odessa/Midland. And he chuckles when ‘peak oil’ is brought up.