China: The real problem is nominal
Here’s a report on China in the Financial Times:
Before the release of Wednesday’s second-quarter gross domestic product estimate, China’s nominal GDP growth rate had plummeted from almost 20 per cent to 5.8 per cent since 2011, a much sharper decline than the inflation-adjusted figures that have trended downwards from 9.5 per cent to 7 per cent over the same period.
The difference between this year’s first-quarter nominal and real growth figures implied that the so-called GDP deflator — a broad measure of inflation that covers all types of goods and services — was negative, at -1.2 per cent, for only the third time in nearly two decades. That transformed the government’s 5.8 nominal growth figure into 7 per cent real growth — bang on Beijing’s growth target of “about 7 per cent” for the full year. But it also implied that China suffered from nearly unprecedented deflation in the first quarter.
A few comments:
1. China’s GDP numbers are viewed with some suspicion, but the broad trends are considered fairly accurate, in a qualitative sense.
2. The current slowdown in NGDP growth is very similar to the late 1990s and early 2000s. In both cases RGDP growth slowed, and NGDP growth slowed even more sharply. That suggests a negative aggregate demand shock. In both cases the NGDP slowdown created a debt problem, or perhaps intensified a pre-existing debt problem. This is consistent with the market monetarist approach—sharp slowdowns in NGDP growth reduce RGDP growth and put stress on debtors. Of course China has many other problems, some more severe, but if you are trying to explain cyclical changes in China, then the real problem is nominal.
3. There is nothing wrong with 5.8% NGDP growth. If China kept growth at that pace for the next 20 years, their business cycle would become more stable. The problem now, and in the late 1990s, is the sharp deceleration in NGDP growth.
4. China is not at the zero bound, so there is no doubt that monetary policy explains the sharp slowdown in NGDP. “Debt deflation” is a misleading term, as monetary policy is the causal factor, and debt distress in the symptom. The same was true in the US in the 1930s, and in late 2008, in Argentina in 1998-2001, and in Europe over the past 7 years.
5. But why would the PBoC want to reduce growth in NGDP? There are two possibilities. One is that they wanted to pop the debt bubble, by tightening monetary policy. This would be an indirect method of trying to reform the economy, move it away from debt-fueled growth in possibly wasteful investment spending. But there is a simpler explanation, which applies equally to the episode of the late 1990s. Both then and today, the yuan was linked to a strongly appreciating US dollar. As other countries depreciated their currencies against the dollar, China held fast. The simplest explanation for the Chinese business cycle is to simply look at the strength of the dollar. When the dollar is weak, as in 2007, Chinese growth is really strong, and vice versa.
China should now ease monetary policy, which would mean letting the yuan depreciate against the U.S. dollar. The U.S. would loudly complain, but we are a paper tiger, which (fortunately) has no intention of becoming highly protectionist.