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November 26, 2008
So BHP has walked away from its takeover bid of Rio Tinto. That sends a very clear signal about the economic downturn, commodity prices (aluminium, copper, nickel, iron ore and coal) going lower, and the unlikeliness of China's economic growth continuing to power a long-term seller's market for all the major commodities. It's contraction all round these days.
Moir
This has implications for the global balance of payments system, which has been dominated in the last decade by the trade and investment relationship between China and the US. This relationship where excess US demand and excess Chinese supply were in a temporarily stable balance and as part of running a trade surplus, China necessarily accumulated dollars, which were exported to (invested in) the US. is now undergoing a major shift. Domestic consumption is falling in the US and that gives rise to overproduction in China.
In Can China Adjust to the US Adjustment? Michael Pettis says:
But since the balance of payments must balance, something else must happen to equilibrate this decline in US household consumption. Either consumption in other sectors of the US economy (i.e. the government) must expand by that amount, or consumption by China (by which we mean all foreign countries, with China bearing the brunt) must expand by that amount, and as it does so its savings must decline. To the extent that neither happens, global overproduction – which consists mainly of Chinese overproduction – must decline by that amount. This is just a way of saying that if net American consumption (the excess of consumption over production) declines, either consumption must rise somewhere else, or production must fall.
Everybody ---including BHP---has been banking on the first scenario--that consumption will rise somewhere else, namely China to prevent a global slowdown. China was the world's insurance policy. But, as Pettis points out, this is unlikely:
In the best possible world Chinese consumption would rise by exactly the same amount as US consumption drops, and a new stable balance would quickly be achieved with one major difference: the US trade deficit would decline, and the amount of capital exported by China to the US would decline by exactly the same amount ..... But if it doesn’t, total global consumption must decline, and the world economy slow – in fact as it slows global income will decline with it, so that both savings and consumption could decline, trapping the world in a downward spiral.
By how much must Chinese consumption rise to prevent a global slowdown? Given that the US economy is about 3.3 times the size of China’s, and consumption accounts for less than 50% of China’s income, Chinese consumption will have to rise by nearly 40% in order to accommodate a 5% increase in US savings. This is clearly unlikely.
Since domestic demand in China is not rising fast enough there is massive overproduction.The option of relying on net exports to protect itself from its overcapacity--- ie., trying to export their way out of a slowdown---is not there. So there is going to be a global slowdown.
All that Australia, like the US a current-account deficit countries, can do is expand moderately so as to slow down the adjustment period. China, as the central current account surplus country, needs to force domestic demand up. Since expecting private consumption to rise quickly enough is unrealistic, it has to be public consumption – and that means large fiscal deficits. The other option is for both current account deficit and surplus countries to work to expand global trade.
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I see that Citigroup has had to be bailed out by the US Government---by investing $20 billion in the group. It is socialism US style to contain the fallout from the housing slump and credit crunch.
And President Bush continues to defend free markets in the light of massive market failure.