More from Michael Pettis on “Japanification” of the global economy. How abundant capital and investment in unproductive works may lead to long-term stagnation:
“Panics do not destroy capital,” John Mill proposed in his 1868 paper to the Manchester Statistical Society. “They merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.” Our ability to postpone the recognition of the full extent of these unproductive works depends in part on our ability to expand the supply of credible money. If we are constrained in our ability to expand the money supply, one impact of the crisis is a contraction in money (velocity collapses) that forces lenders to write down debt. If money can expand without constraints, however, debt does not have to be written down nearly as quickly.
With the main central banks of the world having banded together to issue unprecedented amounts of credible currency, in other words, we may have changed the dynamics of great global rebalancing crises. We may no longer have to forcibly write down “hopelessly unproductive works”, during which process the seemingly endless capital of the globalization phase is wiped out, and we enter into a phase in which capital is scarcer and must be allocated much more carefully and productively.
Instead, the historically unprecedented fact of our unlimited ability to issue a credible fiat currency allows us to postpone a quick and painful resolution of the debt burdens we have built up. It is too early to say whether this is a good thing or a bad thing. On the one hand, it may be that postponing a rapid resolution protects us from the most damaging consequences of a crisis, when slower growth and a rising debt burden reinforce each other, while giving us time to rebalance less painfully — the Great depression in the US showed us how damaging the process can be. On the other hand the failure to write down the debt quickly and forcefully may lock the world into decades of excess debt and “Japanification”. We may have traded, in other words, short, brutal adjustments for long periods of economic stagnation.
Investment in infrastructure is essential to rescue an economy from a contraction of aggregate demand following a financial crisis. The unpalatable alternative is a deflationary spiral and significant contraction in GDP. But we need to ensure that investment is made in productive assets — that generate market-related returns — rather than investments in social infrastructure that cannot generate sufficient revenue to service, nor be be sold to repay, debt funding.
Read more at Can monetary policy turn Argentina into Japan? | Michael Pettis' CHINA FINANCIAL MARKETS.
Investing in new infrastructure (as opposed to repairing or updating existing infrastructure) in Europe and Japan in the midst of their demographic declines would be wasteful.
If existing infrastructure can be repaired to do the same job, then new infrastructure would be unproductive. But how do you earn market-related returns on repairs? How will they generate revenue to justify repayment or servicing of debt? IMO repairs should be funded from the regular fiscal budget unless they meet the definition of a productive, saleable asset. Not saying that they aren’t necessary, but like schools and hospitals, funding them with debt leaves a black hole — debt with no saleable assets.
Yes
Colin – no other method apparent to me to convey this, so have to do it here.
I would appreciate your acceptance of my admiration for your market views of late, especially, and also over the recent medium-term period.
There have been so many extremely complicating, confusing and left-of-centre factors impacting on market direction in the periods mentioned above. Yet – having followed several commentators over many many years – I have found your particular economic, market technical and charting approach, reasoning and communication of the highest quality, consistency, appeal and interpretative value.
I think you display outstanding insights into markets.
I completely understand and expect that no-one can consistently get markets right. Even in any future mis-diagnosing of anticipated market direction, the aforementioned sentiments will not be diminished – such has been the impact on me of your calls mentioned in the first sentence above.
I really hope that more investors become aware of the benefits associated with your expertise.
Thank you Graham,
I hope that you were able to profit from them.