Investment is the New Consumption
We generally think of consumption as indulgent and investment as serious and sober but perhaps in our demand starved world, this is an outdated prejudice. China is proving that investment can be just as flighty. It seems that these days the primary function of both investment and consumption is to stimulate demand.
The financial crisis didn’t just slam the bubble economies. China, which sells manufactured goods to the bubble economies, also took a massive hit. Unlike the EU or Britain, China did something about it. In response to declining export sales, in 2009, the Chinese government enacted a gigantic stimulus package. Chinese state owned banks lent over $500 billion (almost 5% of GDP) to build factories, railways, and roads and indeed Chinese growth quickly recovered. Unfortunately many of these projects have proved to be white elephants. Peter Thal Larsen notes “industries from steel to shipping to solar panels are being kept alive because state-backed lenders are reluctant to call in loans.”
Even though we think of low labour costs as China’s comparative advantage in the world economy, its cost of capital is also spectacularly low. Michael Pettis’ eye-opening The Great Rebalancing reminds us that China, like Germany and Japan and other exemplars of export led growth, depends on financial repression. Households in China receive miniscule returns for their savings, allowing state owned banks to finance projects that anywhere else would be unprofitable. Thus the empty convention centres, the steel factories with no customers.
Even in the west, making bad loans can be good business. Citibank’s profits from 1976 to 1982 came mostly from Argentina, Brazil and Mexico, from the loans that a few years later would spark the Latin America debt crisis. Whenever a payment came due, Citibank would just roll it over, making paper profits for itself, and handing seemingly free money to the Latin American juntas. Even interest payments were usually skipped, the bank happily adding any money owed onto the principal. Any banker that noticed that the borrowers were profligate and their investments would never generate sufficient cash flow to repay the debt would be ignored, fired, or reassigned. Too much money was being made in the short term for the head office to worry about the long term. It took Volcker’s interest rate hikes and a global recession to finally convince Citibank to call in their loans. The result was a lost decade for Latin America.
Chinese state owned banks will probably wait even longer. Since state owned companies owe money to state owned banks, borrowing can be seen as disguised fiscal policy. Although Prime Minister Li Kequiang recently called for a liberalization of the banking system, reform could be dangerous. On the one hand, ridiculously cheap interest rates and a banking system controlled by the government stimulate useless investment. On the other, writing off bad loans could spook markets, shrink growth, and raise unemployment.
Today, the only thing the world lacks is demand. In the west, for the past 30 years we
maintained demand with asset price bubbles and debt fuelled consumption. China imported it through the world’s largest current
account surplus and manufactured it
through heroic levels of investment.
Our economies became addicted to borrowing and spending, theirs to spurious
investment. In a world awash with manufacturing overcapacity, building another
steel mill is just another kind of consumption.