Even if the trade war threat turns out to be more talk than action, there are other ways in which Beijing might risk a Minsky-style deflation.
China’s debt build-up has provoked increasing concern amongst Beijing’s policy makers. The resultant excess capacity exports deflation to the rest of the world. This creates pressures for China’s competitors which could engender a tougher response in line with that of Trump. How China deals with these constraints is the big question for their economy.
The transformation of China’s economy, both in terms of GDP growth rate and poverty reduction since it started its transition to the market system in the late 1970s, has arguably been the biggest macroeconomic event of the past half-century. The model that has characterized the country’s high output growth rates has followed in the footsteps of the Asian “tigers “: first, its high growth rates of capital accumulation, driven by high investment-output ratios; second, a marked outward orientation through export-led growth policies; and third, the pursuit of industrialization (in particular the production and export of manufacturing goods), a key ingredient for fast growth and development. By almost every metric, China has advanced from economic backwater to the world’s second-largest GDP ( and by some measures, is now the largest economy).
But in spite of signs of renewed economic activity in March, the country’s debt build-up has provoked increasing concern amongst Beijing’s policy makers, as it points to an underlying long-term financial fragility, particularly if trade war pressures intensify. Just last October during the Communist Party Plenary, Zhou Xiaochuan, then head of the country’s central bank, warned of a “Minsky moment “:
“When there are too many pro-cyclical factors in an economy, cyclical fluctuations will be amplified. If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky Moment’. That’s what we should particularly defend against.”
To elaborate on Zhou’s statement, the economist Hyman Minsky described how once the debt “disease” goes metastatic, there will come a “Minsky moment” ( a term originally coined by economist Paul McCulley) when euphoria gives way to concern and then to panic liquidation and credit revulsion. When that dynamic is in full flower, policy makers are powerless to avert it, no matter how much they want to bring the punchbowl back. Governor Zhou’s public warning was no doubt in response to recent rapid increase of debt which, according to Professor L. Randall Wray, “increased from 162 percent to 260 percent of GDP between 2008 and 2016,” and remains “a topic of discussion, if not deep concern.”
It may seem odd to warn of a Chinese slowdown, given the recent renewed surge in exports and the corresponding rise in both the manufacturing and non-manufacturing purchasing managing indices (both the manufacturing and service gauges remain above 50, and therefore indicative of robust economic activity). But these gains ought to be viewed against the backdrop of a more hostile external environment for Chinese manufactured goods. Discussing the recently imposed tariffs on steel and aluminum, the New York Times reported that Trump has already provided brief exemptions to “Canada, Mexico, the European Union, Australia, Argentina, Brazil and South Korea” (countries that “account for more than half of the $29 billion in steel sold to the United States in 2017”), which reinforces the idea that it is largely China that remains the major target of Trump’s economic nationalists.
In that context, China’s ramped-up production in March could well be interpreted as an effort to evade the tariffs by exporting products into the U. S. under the wire, suggested economist Raymond Yeung of the ANZ group. If so, that could provoke further aggressive responses from Trump’s trade hawks, especially if it results in an expansion of the bilateral trade surplus with the U. S. Adding to the pressures, Reuters reports that “Top Trump administration officials are asking China to cut tariffs on imported cars, allow foreign majority ownership of financial services firms and buy more U. S.-made semiconductors in negotiations to avoid plans to slap tariffs on a host of Chinese goods and a potential trade war.”
But how serious are these threats? Are they simply a case of “smoke and mirrors,” as the economist Dani Rodrik has suggested? China itself appears to be taking the risk of a trade war seriously, imposing retaliatory tariffs of up to 25 percent on 128 food imports from the U. S., an understandable negotiating posture given its position as a major creditor nation. But the very fact of its creditor status might presage problems for Beijing. If anything, history has shown that it is trade surplus nations, not debtors, that tend to be the biggest casualties of trade wars, as this account of America’s ill-fated Smoot-Hawley tariff imposition illustrates:
“World War I… made America the world’s creditor.
