Maurits Elen Authors

Willem Buiter on China and the Global Recession

June 07, 2016

Willem Buiter, Chief Economist at Citigroup, on preventing China from leading the world into recession.

China’s boom times are over. With global investor sentiment continuing to slip, concerns are rising about spillover effects of a faltering Chinese economy on global markets and institutions. But although the facts of the problem are well known, fixing it is another issue—the reach and pace of fundamental economic policy choices have been subject to bustling debate. At the forefront of commentary has been Willem Buiter, Chief Economist at Citigroup.

After obtaining his Ph.D. from Yale University in 1975, Buiter lectured at universities such as Cambridge, Princeton, Columbia and the London School of Economics. He has been an advisor to the International Monetary Fund, the World Bank, and the European Commission. He coined the portmanteau ‘Grexit,’ is a former member of the Bank of England Monetary Policy Committee, and has been Citigroup’s chief economist since 2010.

In September 2015, Buiter and his team published a research note stating that it was likely that the global economy would soon slip into recession, caused by sluggish growth in emerging markets, especially China. In this interview with CKGSB Knowledge, Buiter assesses Chinese economic growth and the potential for global recession.

Q. In 2015, you stated that the probability of some kind of global recession, moderate or severe, in 2016 and/or 2017, to be at 55%. Have the odds declined or increased?

A. We predict global growth at market exchange rates to be 2.4% for 2016, somewhat lower than the 2.6% realized in 2015. Correcting for the likely overstatement of China’s growth in the official data, our prediction for 2016 would be around 2.1%. This is very close to our definition of a global recession, which is global growth at market exchange rates below 2%. The credit explosion engineered by the Chinese authorities in the first quarter of 2016 and the model fiscal stimulus that was implemented may well be enough to prevent global growth from falling below 2% this year. Because I consider the credit stimulus to be unsustainable, and because I view the fiscal stimulus as too small and poorly targeted, I expect that the decline in China’s growth rate will resume later this year and in 2017.

Q. To prevent a Chinese recession from happening, you have stated fiscal stimulus—targeted mainly at private and public consumption—had to be undertaken immediately. How do you assess the fiscal stimulus rolled out by China?

A. One, it is too small—about 2% of GDP additional stimulus for the rest of this year is required, in my view. Two, it is targeted poorly. Three, it should be funded by central government borrowing, not through additional bond issuance by local governments or SOEs (state-owned enterprises) or through borrowing from the banks. Four, the additional central government debt issued to fund the stimulus should be purchased by the People’s Bank of China and monetized. Such ‘helicopter money’ makes sense for China as inflation is below target.

Q. You have stated that monetary and credit policy have limited power to boost aggregate demand in China, and neither can the construction sector, funding of small and medium enterprises (SMEs) and high-tech ventures, and even China’s Silk Road initiatives. Why?

A. The construction sector certainly can boost aggregate demand. If the Chinese authorities were to fund or subsidize the construction of social housing and affordable housing generally, if there were additional investment in urbanization-supporting infrastructure, and if full urban hukou (China’s household registration system) were given to the rural migrants now living on the margins of the tier 1 and tier 2 cities, this would help both short-run aggregate demand and the process of urbanization in China. Monetary and credit policies will remain largely powerless until serious corporate deleveraging has taken place and the balance sheets of the banks have been restored. Funding of SMEs and high-tech ventures represents supply-side policies that may have beneficial effects on potential output in the medium and long-term (if properly directed—not an easy task because the state is generally poor at picking winners in the emerging sectors) but do little to support aggregate demand this year and next. The One Belt One Road (OBOR) initiatives have not yet been translated to any significant extent into concrete investment projects in China or abroad. Even when OBOR leads to material capital expenditure, much of this will be spent outside China. The Chinese export content of OBOR projects outside China is an open question. If successful, OBOR could add to potential output both in China and in the other participating nations. If OBOR turns out to be driven more by geopolitics than by economic considerations, the benefits will be correspondingly smaller.

Q. When the Chinese economy opened up, it wanted its currency to be used in the international market to settle trade and financial transactions, however without fully liberalizing its capital account. As a result, there is an onshore renminbi market (CNY) and an offshore renminbi market (CNH). Which is a better reflection of China’s economic condition?

A. Even fully efficient foreign exchange markets reflect a host of factors other than China’s economic conditions. After all, an exchange rate is the relative price of two currencies, so the RMB-USD market (onshore or offshore) reflects directly both Chinese and US economic developments. Indirectly, events and developments outside both China and the US will influence these currency markets. With the CNY market affected by rather tight controls on capital outflows and rather weaker controls on capital inflows, both exchange rate movements and reserve flows are distorting mirrors of domestic and foreign developments. The CNH market is not really an offshore, parallel market, because it is subject to heavy intervention by the Chinese authorities. Price and quantity movements in neither market are particularly informative.

Q. What is the main challenge for the Chinese banking sector?

A. Clean up the banks’ balance sheets after years of being used as a conduit for quasi-fiscal lending activities. Unrecognized non-performing loans and hidden bad assets in general mean that the central government will have to act to restore the banks to financial health. Once that has been achieved, the banks must be put in a position to raise funds, lend and invest using commercial criteria only. Government influence on the composition of lending and investment activities and on the terms and conditions that the banks set in their funding, lending and investment markets has to be eliminated.

Q. Growth in China has been slowing, but China’s total debt has been accumulating in recent years. What is the possibility of a credit crisis occurring in China?

A. China’s corporate debt burden is dangerously high and still rising fast. Even households are being tempted to take on excessive mortgage debt or to borrow in costly peer-to-peer markets. The banks have large unrecognized holes in their balance sheets. Local governments are now issuing bonds instead of borrowing through special purpose vehicles from the banks, but still don’t have adequate recurrent revenue sources, for instance, a property tax or real estate tax. So unless the government intervenes through some combination of bailouts of the banks’ debtors (local governments and SOEs) or recapitalization of the banks, a financial crisis is highly likely within the next year or two. I expect the government to intervene on a sufficient scale and fast enough to prevent a full-blown financial crisis. The authorities have the tools to handle the problem. The main risk is that they will not want to mount a large financial rescue/debt restructuring operation before the 19th Congress of the Politburo Standing Committee in November 2017. I doubt whether the forces of financial turmoil will wait that long.

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