Switching Engines While the Train is Moving:
Mind the Gap!
By Shlomo Maital
Two difficult, complex and crucial transitions are underway today, in the world. One is in China. The second is in the U.S. And possibly a third, in Japan. There is a big difference between the theory that guides those transitions, and reality. Mind the gap!
For the world to endure and prevail, all three must succeed.
First the Chinese. China is shifting from an export-driven capital-driven economy to a consumption-driven economy. China’s phenomenal growth has been export led, which in turn created an investment boom (the capital formation has gone to building enormous factories, and then doubling their size). With world export markets slowing, China must shift to internal demand as its growth engine. China will not likely achieve its 7.5 % GDP growth this year, and even that is much below the 10% rate achieved in recent years. This will impact the whole world. But if China fails in the transition – which is like changing locomotive engines while the train is speeding along the track at 200 km/hr. — first Asia and then the world will suffer. No country has yet made such a transition. Japan tried and failed.
Second, the U.S. America is shifting to weaning Wall St. away from cheap infinite amounts of money, as the Fed gradually reduces its monthly bond purchases amounting today to $85 b. each month. If Larry Summers becomes Fed head, he will make this shift more abruptly; he doesn’t believe QE (quantitative easing, the euphemism for pumping money endlessly) works. If it’s Janet Yellen, she’ll move more slowly. Banks are making record profits; anyone would, if you borrow at zero and lend at high interest. What happens when interest rates rise? And will the massive mountain of money the Fed created induce runaway inflation, as the mountain unfreezes and starts to move?
Two crucial transitions. Both extremely difficult. Both have to work. And in the wings, Japan, with its national debt of 212 % of GDP (only 168% in 2008); when Japanese interest rates rise, how in the world will the government pay the interest on this massive debt? Another complex transition. For contrast, Greece’s debt is only around 120% of GDP, and its government bonds have been downgraded to near-junk.
Watch these three countries, the three biggest economies in the world, each of which is undergoing a complex tricky transition—US, Japan, China. Will all three transitions work smoothly and successfully?