Chief Economist of BoC International Xu Gao argues China Should Increase Debt and Government Spending, Not Deleverage, to Boost Insufficient Domestic Demand
I’d suggest that both Dalio and Xu have a misplaced conception. Dalio fundamentally misreads the historical record because the issue of debt and empires isn’t a general one; it’s embedded in the issue of who owns what to whom. Dalio also does not understand the difference between the notional “debt” of a currency sovereign state and those of currency users. A currency issuing state simply cannot run out of the currency it issues. Solvency is therefore not the issue, contrary to Dalio.
As for Xu, he goes some way to recognising Dalio’s category error via the positioning of Dalio’s confusion as one of micro- versus macro economic views of debt. But Xu also commits a category error by conflating all forms of national debt at a macro level. Private sector debts are fundamentally different to public debt from the currency issuer. Public debt is actually a net addition to system liquidity; the issue is whether it enables the mobilisation of available material resources to achieve higher levels of energy return on energy invested, at a systemic level. Conversely public debt surpluses are a net withdrawal of system liquidity. Understanding liquidity within a system of production and circulation networks is the only meaningful way of appreciating the role of credit in capital accumulation.
> Conversely public debt surpluses are a net withdrawal of system liquidity.
Liquidity IMHO is a function of secondary markets because of changing time-preferences. Govt debt (aka treasuries) in highly regarded OECD countries with transparent governance is (rightly or wrongly) perceived as the lowest risk of default and thus the target of savings surpluses (push expenditure out to future).
If a govt persistently borrows and transfers to household consumption, then it is pre-spending any gains in productivity (think the PIGS during euro crisis) and little prospect of repayment ... ditto with things that go boom. Hence the convention wisdom (AFAIK I'm not an economist) is to achieve a net neutral fiscal position over a business cycle, borrowing more in recessions (COVID) and pay down in boom-times, thus being counter-cyclic and evening out the labor market and inflation expectations.
China used to be able to export surplus labor ... in the old old days, you would describe a famine depending on how many youngsters left to find work overseas (see the origins of ASEAN disapora). Their migration policies (and capital controls) makes it harder to adjust the economy (no guest-workers to expel). But getting back to point of liquidity, IMHO it arises as a function of price-discovery for the market to finely calibrate the risks, thus exists semi-independently of the need (or not) of issuing/cancelling govt debt. Liquidity also implies volatility which can be bad if the holding patterns creates over-leveraged high-frequency loops (see https://themoneyprinter.substack.com/p/is-americas-end-game-in-this-chart). CCP policy is consistent (despite differences in opinion) ... discourage speculation, housing is for living not wealth hoarding, and crack down on uncontrolled consumer credit
China can make the distinction between macro & monetary systems because its currency is not freely convertible. So internal debt crisis such as Evergrand property collapse can be managed via state directed credit allocation (cf Savings & Loans crisis in US). However, an overly centralised credit allocation runs into the problem of finding sufficiently productive investments ... you can see this in Japan with bridges that go nowhere. This is reflected in the faux competition between state champions leading to low profitability and arguably capital misallocation due to govt distortions. One example is the cram-school sector due to under-provision of tertiary education (and prior overseas migration). The lack of profits means inability to repay loans leading to bad debt (the extend and pretend) amongst SOEs starving the private sector (the most dynamic) of expansion capital. So retaining the existing policies will likely lead to deaccelerating growth
a) if they stop isolating the monetary system, the capital flight (fear of confiscation) and without inward FDI will break any soft peg
b) if they stop lending to unprofitable or wasteful SOEs, letting them go bust and liquidate bad loans, mass unemployment will be a social diaster
c) if private sector is starved of credit, then growth will slow
So arguably without structural reforms, China could find itself in a middle-income trap.
I think it would be helpful to simply point out that maintaining a constant debt-to-GDP ratio implies that debt must expand at the same rate as economic growth, and so the key issue is whether debt leads to higher long term growth. If it raises the growth rate, then there is almost no limit to how much public debt can be added. If growth is stagnant, then there is a limit to issuing new debt (unless one is willing to accept a higher debt-to-GDP ratio). If growth continues growing at a steady rate, then debt must also grow at that same rate.
It’s almost mechanical, but the key issue is whether the additional debt leads to higher long term growth. This requires judgement.
Usually simply stimulating consumption does not lead to higher long term growth unless the economy is in a “liquidity trap”
(per Keynes). So usually we want to raise debt for investment purposes. That said, the boundary between “investment”and “consumption” can be unclear. (This also requires judgement.)
I’d suggest that both Dalio and Xu have a misplaced conception. Dalio fundamentally misreads the historical record because the issue of debt and empires isn’t a general one; it’s embedded in the issue of who owns what to whom. Dalio also does not understand the difference between the notional “debt” of a currency sovereign state and those of currency users. A currency issuing state simply cannot run out of the currency it issues. Solvency is therefore not the issue, contrary to Dalio.
As for Xu, he goes some way to recognising Dalio’s category error via the positioning of Dalio’s confusion as one of micro- versus macro economic views of debt. But Xu also commits a category error by conflating all forms of national debt at a macro level. Private sector debts are fundamentally different to public debt from the currency issuer. Public debt is actually a net addition to system liquidity; the issue is whether it enables the mobilisation of available material resources to achieve higher levels of energy return on energy invested, at a systemic level. Conversely public debt surpluses are a net withdrawal of system liquidity. Understanding liquidity within a system of production and circulation networks is the only meaningful way of appreciating the role of credit in capital accumulation.
many thanks for the insights professor
> Conversely public debt surpluses are a net withdrawal of system liquidity.
Liquidity IMHO is a function of secondary markets because of changing time-preferences. Govt debt (aka treasuries) in highly regarded OECD countries with transparent governance is (rightly or wrongly) perceived as the lowest risk of default and thus the target of savings surpluses (push expenditure out to future).
If a govt persistently borrows and transfers to household consumption, then it is pre-spending any gains in productivity (think the PIGS during euro crisis) and little prospect of repayment ... ditto with things that go boom. Hence the convention wisdom (AFAIK I'm not an economist) is to achieve a net neutral fiscal position over a business cycle, borrowing more in recessions (COVID) and pay down in boom-times, thus being counter-cyclic and evening out the labor market and inflation expectations.
China used to be able to export surplus labor ... in the old old days, you would describe a famine depending on how many youngsters left to find work overseas (see the origins of ASEAN disapora). Their migration policies (and capital controls) makes it harder to adjust the economy (no guest-workers to expel). But getting back to point of liquidity, IMHO it arises as a function of price-discovery for the market to finely calibrate the risks, thus exists semi-independently of the need (or not) of issuing/cancelling govt debt. Liquidity also implies volatility which can be bad if the holding patterns creates over-leveraged high-frequency loops (see https://themoneyprinter.substack.com/p/is-americas-end-game-in-this-chart). CCP policy is consistent (despite differences in opinion) ... discourage speculation, housing is for living not wealth hoarding, and crack down on uncontrolled consumer credit
I guess eventually we'll find out who is right.
China can make the distinction between macro & monetary systems because its currency is not freely convertible. So internal debt crisis such as Evergrand property collapse can be managed via state directed credit allocation (cf Savings & Loans crisis in US). However, an overly centralised credit allocation runs into the problem of finding sufficiently productive investments ... you can see this in Japan with bridges that go nowhere. This is reflected in the faux competition between state champions leading to low profitability and arguably capital misallocation due to govt distortions. One example is the cram-school sector due to under-provision of tertiary education (and prior overseas migration). The lack of profits means inability to repay loans leading to bad debt (the extend and pretend) amongst SOEs starving the private sector (the most dynamic) of expansion capital. So retaining the existing policies will likely lead to deaccelerating growth
a) if they stop isolating the monetary system, the capital flight (fear of confiscation) and without inward FDI will break any soft peg
b) if they stop lending to unprofitable or wasteful SOEs, letting them go bust and liquidate bad loans, mass unemployment will be a social diaster
c) if private sector is starved of credit, then growth will slow
So arguably without structural reforms, China could find itself in a middle-income trap.
I think it would be helpful to simply point out that maintaining a constant debt-to-GDP ratio implies that debt must expand at the same rate as economic growth, and so the key issue is whether debt leads to higher long term growth. If it raises the growth rate, then there is almost no limit to how much public debt can be added. If growth is stagnant, then there is a limit to issuing new debt (unless one is willing to accept a higher debt-to-GDP ratio). If growth continues growing at a steady rate, then debt must also grow at that same rate.
It’s almost mechanical, but the key issue is whether the additional debt leads to higher long term growth. This requires judgement.
Usually simply stimulating consumption does not lead to higher long term growth unless the economy is in a “liquidity trap”
(per Keynes). So usually we want to raise debt for investment purposes. That said, the boundary between “investment”and “consumption” can be unclear. (This also requires judgement.)