Worthwhile Reading

Why should you be freaked out about Greece? Remember the Great Depression had two parts. Megan McArdle.

The most terrifying words I've seen written so far about the growing crisis in Greece were penned by Yves Smith yesterday: "So the whole idea that the financial crisis was over is being called into doubt. Recall that the Great Depression nadir was the sovereign debt default phase. And the EU's erratic responses (obvious hesitancy followed by finesses rather than decisive responses) is going to prove even more detrimental as the Club Med crisis grinds on."

The Great Depression was composed of two separate panics. As you can see from contemporary accounts--and I highly recommend that anyone who is interested in the Great Depression read the archives of that blog along with Benjamin Roth's diary of the Great Depression--in 1930 people thought they'd seen the worst of things.

Unfortunately, the economic conditions created by the first panic were now eating away at the foundations of financial institutions and governments

OK, so neither she, nor I, are saying GDII is around the corner --- but a double-dip is quite likely. Problems that caused the crisis originally haven't been solved --- they've just been shuffled around --- predominantly from private balance sheets to public ones (or just hidden on/off of those private balance sheets).

Who will pay for China's bad loans. Michael Pettis.

I just love this part:

This is why I have argued (predicted?) for the past five years that “within a few months” the market was going to become obsessed with China’s debt structure. Unless you define a “few” months as forty to sixty months, clearly I have been wrong for many years – calling things way too early is perhaps an occupational hazard for those who read too much financial history

but this is the meatier part:

This doesn’t mean however that we don’t need to worry about the debt, and it certainly does not mean that if China runs up more bad loans as a consequence of the recent lending spree it will simply “grow” its way out. In the past China could certainly grow its wayout, even with household consumption declining as a share of GDP, because one effect of declining relative consumption – a rising savings rate along with a rising trade surplus – was easily absorbedby a rapidly growing world economy. As long as debt levels in the US and other deficit countries could easily rise to counteract the adverse employment effect, the world, and especially the US, had no trouble with absorbing China’s rising trade surpluses.

Things may be very different now. Unemployment is high in trade-deficit countries and debt levels are being forced down. If the world can no longer absorb rising trade deficits, and especially if over the next few years trade tensions increase, China must reduce its excessive reliance on exports and investment to fuel its continued growth. The only healthy way it can do so is if household consumption rises as a share of GDP because of surging consumption.

And household consumption will indeed rise as a share of GDP – with such a low current level of household consumption, and rising global concern over the employment effects of China’s trade surplus, China has no choice. But since growth in household consumption has always been constrained by the growth in household income, it may be unreasonable to expect a surge in consumption when households are also required to clean up another sharp increase in non-performing loans.

So as a consequence of the global crisis, China’s growth will rely more than ever on the growth of household consumption. The good way this can happen is by a surge in household consumption that will allow economic growth to remain high. The bad way is by lower growth in household consumption matched by a very sharp decline in
economic growth. If the worriers are right, and non-performing loans surge, China can nonetheless easily avoid a banking collapse, but that does not mean the cost of cleaning up the banks will be negligible. On the contrary, it will put even more downward pressure on low-consuming Chinese households and will make the inevitable rebalancing of China’s economy much more difficult than many expect....

....Unless the rest of the world is willing to absorb rising trade deficits and supply it with rising trade surpluses, rebalancing for China means that instead of being the lower limit of economic growth, consumption growth will now be the upper limit. If future Chinese consumption growth also slows, as it did in Japan, because households are forced to foot the new bad-debt bill, we may see the real cost of the current explosion in bad loans – several years of sub-par growth.

Thankfully, Andy Xie will tell us when the Chinese bubble will burst.