Pacific Money

Is the World Ready for a Great Rebalancing?

Professor Michael Pettis’ new book The Great Rebalancing presents some bold ideas — take a look.

The United States should be relieved, not distraught, if the dollar’s use as the sole global reserve currency were to come to an end — as some believe may soon happen. The 2007/8 Global Financial Crisis (GFC) has not been resolved, and China is yet to face the worst of its effects. German domestic policies post-unification were as much responsible for the Eurozone debt crisis as any domestic factors in the affected countries.   The Eurozone debt crisis will continue to affect Spanish and European politics and will probably lead to Spain and other countries leaving the Euro absent a strong fiscal union or a transformation of Germany’s economic model. China’s rebalancing, when it properly begins, will see GDP growth rates fall to below 5% and will average around 3% for a decade, but this will not be a disaster for China. Trade tensions are set to rise until global imbalances are resolved.

If any of the above predictions seem to contradict what readers have seen in the financial or mainstream press recently, they would be recommended to get a copy of Peking University Professor Michael Pettis’ new book The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy. Professor Pettis is very well known amongst China finance watchers, and his blog is a must read for many who have interests in China’s economy or financial system.  

Pettis bases much of The Great Rebalancing’s content on fairly simple economic accounting identities (necessary truths) concerning the relationship between any country’s domestic savings and investment rates, production and consumption rates, and external current and capital accounts.  Building off these, he creates a book full of easy-to-understand, yet often misunderstood theories, explanations and predictions for what went wrong internationally before the 2008 Financial Crisis, what has been going on since, and where things are likely to head in the future.   A key area of his argument is that any domestic policy which affects the relationship between savings and investment or production and consumption has a trade effect, whether or not it is intended as such. 

For example, he argues that the U.S. dollar’s role as the global reserve currency does not give Washington the “Exorbitant Privilege” argued by many, but rather places on the United States an “Exorbitant Burden.” Foreign nations, as they export capital to the United States, force onto it a trade deficit, which lowers U.S.growth, worsening the fiscal deficit (as opposed to the commonly held view that foreign capital allows the U.S. to borrow cheaply by lowering interest rates), facilitating the disruptive real estate bubble and the decline in U.S. savings through higher unemployment and more debt.

Pettishas also argued for years on his blog, and comprehensively in this book, that China’s unbalanced economy must undergo a disruptive and probably painful rebalancing.  This once contrarian view has become more and more accepted by both commentators and experts watching China’s economy (and its leaders), and the recently announced policy that aims to close the income gap can also be seen in this light.   The argument that Chinese GDP growth rates will probably fall to just 3% on average during China’s rebalancing period is still controversial, yet Pettis believes that as long as household incomes are growing at much faster rates, there is little risk that the social unrest that many fear will accompany a decline in GDP growth will come to pass. After all, people are usually content when they can consume more, better support their families and obtain higher-quality services, not when GDP increases.

Although much less technical than Professor Pettis’ earlier book The Volatility Machine, which focuses on balance sheet stability,The Great Rebalancing still requires quite a bit of concentration, as any book tackling the complex interactions between various nations and their domestic and external economic situations invariably must.  Having said that, The Great Rebalancing is probably one of the clearest, most elegant and logically written explanations of world trade, including both how policies affect trade and how trade affects economies.   As described above, this is not just a China book, but a book encompassing some of the biggest economic and financial questions of our time.  The persuasive, clear and well-reasoned arguments behind many of the seemingly unorthodox ideas in the book will make it both pleasing and nicely unsettling for many readers.  Hopefully its message will be heard amongst policymakers before some of the more disturbing predictions become realities.