Commentary on Political Economy

Tuesday 22 January 2019


Just as we were about to address the meaning and significance of Hyman Minsky’s financial instability hypothesis, Professor Rogoff has resuscitated the phrase “Minsky moment” for us at Davos. Hyman Minsky was a Keynesian economist (cf. his homonymous book on Keynes) whom I championed at Cambridge University in the late 1990s to highlight the elephantine stupidity of the members of the Faculty of Economics there who were entirely oblivious of the impending doom of capitalist society. That doom or demise, of course, were only delayed by the providential intervention of the Chinese Dictatorship, which allowed Western capitalists to double the global working class over the next 30 years in what Ben Bernanke styled as “the Great Moderation”. But all good things come to an end - and the great moderation is growing more immoderate by the hour! We shall explain why in the next intervention. Meanwhile, enjoy reading this report from Davos by Mr. Evans-Pritchard at The Daily Telegraph. Cheers.

Davos, Switzerland | China is in the grip of a dangerous downturn and may be forced to rescue large parts of its financial and economic system, the world's leading expert on debt crises has warned.
Harvard professor Kenneth Rogoff said the key policy instruments of the Communist Party are losing traction and the country has exhausted its credit-driven growth model. This is rapidly becoming the greatest single threat to the global financial system.
"People have this stupefying belief that China is different from everywhere else and can grow to the moon," said Prof Rogoff, a former chief economist at the International Monetary Fund.
"China can't just keep creating credit," Professor Rogoff said, speaking before the World Economic Forum in Davos. Bloomberg
"China can't just keep creating credit. They are in a serious growth recession and the trade war is kicking them on the way down," he said, speaking before the World Economic Forum in Davos.
"There will have to be a de facto nationalisation of large parts of the economy. I fear this really could be 'it' at last and they are going to have their own kind of Minsky moment," he said.

This refers to the financial instability hypothesis of Hyman Minsky. It is when a seemingly unstoppable debt bubble collapses under its own weight in a cascade of falling asset and property prices. The authorities can cushion the crash, but they cannot escape the brutal mechanics of reversion.
Prof Rogoff is co-author of a magisterial history of debt delusions, This Time is Different: Eight Centuries of Financial Folly, written with former IMF firefighter Carmen Reinhart.
He said it is an error to think that China's current slowdown is entirely deliberate and calibrated. While the People's Bank undoubtedly wishes to curb the credit boom, it is also riding a tiger that it cannot fully control.

Europe already feeling the pain

"I fear this will be the third leg of the global debt supercycle, after subprime in the US and the eurozone debt crisis. Nobody knows how this is going to play out but it could be on the scale of 2008 and will be very bad for Asia, and there will be spillovers in Europe," he said.
The eurozone is already suffering the fallout from the Asian downturn. Most of the region is in industrial recession. Germany and Italy buckled in the second half of 2018, and confidence has slumped to crisis-level lows in France.
"I am very sceptical that the eurozone system can handle another big shock. It is a house half-built, and if there is something like 2008, it is all going to blow up. Some countries will have to be ring-fenced with capital controls," he said.
The eurozone has little policy powder left to fight deflation. Interest rates are already minus 0.4 per cent and the ECB's €2.6 trillion ($4.13 trillion) blitz of bond purchases has pushed the institution's balance sheet to 43 per cent of GDP. The political bar to renewing quantitative easing is very high.
Europe's leaders have yet to build a crisis machinery fit for purpose. There is still no proper banking union with shared deposit insurance, let alone a fiscal union. The rigid rules of the stability pact inhibit use of budget stimulus a l'outrance in a recession.
Prof Rogoff said there is a danger that China and Asian tigers could be forced to pull in some of their trillions of offshore global funds to cover urgent needs at home, drying up or even reversing the Asian "savings glut".
This would have the unpleasant effect of driving up "real" interest rates across the world, which would be awkward for the US at a time when President Donald Trump's trillion-dollar deficits risk crowding out bond markets. Higher real rates would be trial by fire for parts of Europe.
"This is the Achilles' heel for Italy. Real borrowing costs could rise by 2-3 percentage points," he said. Italy's debt dynamics could not withstand a regime shift of this sort. Markets would see the trouble coming and precipitate events.

Managing losses

Prof Rogoff says China still has room for manoeuvre but it cannot escape the forces of economic gravity. Debt ratios have doubled to 270 per cent of GDP in barely more than a decade. Surges of this kind in a developing economy invariably lead to imbalances that prove malign when the cycle turns.
The one thing the Chinese have in their favour is state control over the banking system. Mark Schiefelbein
The one thing the Chinese have in their favour is state control over the banking system. "They will be able to socialise the losses in a much fairer way than we did in the US and Europe, where it was just intractable," he said.
The country has begun to pay a price for abandoning market reform and reverting to the iron control of the Maoist state under Xi Jinping. The tariff will rise with time.
Official GDP figures Monday clocked in at 6.6 per cent last year, the slowest since 1990. While in line with analyst expectations, it was slower than the 6.8 per cent posted the year prior.
The economy faltered most at the end of the year, recording 6.4 per cent growth for the fourth quarter. But true growth has already slipped to near 4 per cent in this downturn based on proxy measures. Capital Economics thinks the rate will slow ineluctably to nearer 2 per cent by the early 2020s. There lies the middle-income trap.
China's corporate debt levels would be manageable if the torrid catch-up rates of growth of the past were still plausible. It is a harsher story in a future of structural stagnation.

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