Most of you know I loathe “It’s Different Here” type of arguments.
However, in a recent newsletter, Michael Pettis of China Financial Markets makes precisely that case regarding interest rate hikes and the effect on the savings’ rate in China.
Pettis writes …
Not surprisingly, many analysts and journalists reported the interest-rate hike as a way of combating inflation by encouraging Chinese households to increase their savings and so reduce their consumption. As the New York Times puts it, “Raising interest rates should encourage depositors to hold more money in their accounts.” As I have written before, however, I suspect that this view reflects a very US-centric view of how financial systems translate changes in interest rates into changes in savings rates (via changes in household wealth).
In China this may be getting the reality backwards. After all, if high interest rates encourage savings, and low interest rates encourage consumption, it is hard to understand why China, with its incredibly low real deposit rates (in fact they are seriously negative, and have been for much of the past decade), has such a high household savings rate, not to mention, more generally, why other Asian countries with very low real interest rates have also had high savings.
I would suggest that the reason is pretty straightforward. Negative real deposit rates actually reduce household wealth in China by lowering the value of savings. Few households in China borrow, and most savings is in the form of deposits, not, as in the US, in the form of assets whose values typically decline with rising interest rates. Since nearly everyone in the world responds to lower income or wealth by cutting back on consumption, Chinese households actually increase their savings when the deposit rates decline in real terms.
So does that mean that the PBoC’s raising interest rates will cause an increase in inflationary pressures? No, because interest rates have only been rising nominally.
China’s “One Child Policy” and the Savings’ Rate
I asked my friend “HB” on the Acting Man Austrian economics discussion blog what he thought of Pettis’ idea. “HB” writes …
I think Pettis may well be right. Think about it this way: China doesn’t have a very well developed welfare state. Moreover, China’s “one child policy” means that parents cannot rely on children supporting them in their old age. Therefore, a high savings rate is the natural outcome, primarily to provide for an extremely uncertain future. Thus, lowering interest rates on savings is a recipe to reduce consumption further.
Compounding the problem, China’s negative interest rate (in real terms) has fueled a malinvestment boom that is truly of historic proportions.
Most of the Western world looks on China’s growth with a sense of wonder, awe, and even envy. However, Austrian-minded economists and writers see China’s growth differently. We see the boom in China as malinvestment, much like the US housing bubble.
Growth for growth’s sake (or to keep the population employed and prevent uprisings), eventually hits a brick wall. Sooner or later there comes a point where building houses, airports, malls, and cities results in a rapid expansion of credit at a cost that vastly exceeds any conceivable benefit.
In China, that point has long been reached. Shopping centers, commercial real estate, apartments, and even entire cities sit empty. Yet the building continues as credit expands. The cost is spiraling inflation and debts that cannot and will not be paid back.
There is early evidence China’s growth is rapidly slowing already. Please see Hidden Losses and Little Reform; China May Be Slowing More Than You Think
Is the Yuan Undervalued?
Eventually China’s property bubble will crash and China’s entire infrastructure boom along with it. When that happens, it will take a monumental effort to recapitalize China’s banks.
In light of that last statement, the widespread belief that the Yuan is massively undervalued is at best questionable.
Mike “Mish” Shedlock
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