Art Laffer’s Chinese curve ball
Egged on by misguided advice, the Trump administration is bringing a knife to a gunfight in its competition with China
By
AUGUST 25, 2018 2:25 AM (UTC+8)
God bless Arthur B Laffer, the author of
. If statesmen are hedgehogs (with one big idea) or foxes (with many little ideas), Art is the mayor of Hedgehog City. His big idea is that lower taxes give you more economic growth.
Along with my former business partner Jude Wanniski, Wall Street Journal editor Robert Bartley, and a handful of other economists and publicists, Art sold the idea of dramatic tax cuts to Ronald Reagan and thus stood midwife to the greatest US economic boom of the past century. All of them were the intellectual children of the great Robert Mundell, but that’s another story.
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Art had one magnificent idea; to the extent he had other ideas, they were not only bad, but very bad indeed. I took his economic newsletter when I ran research groups at Credit Suisse and Bank of America, and he stopped by once a year for a talk.
In 2001 he stopped by at Credit Suisse. American manufacturing jobs were disappearing and America’s trade deficit was exploding, but Art wasn’t fazed. Americans shouldn’t manufacture anything, Art averred: We would do the design, like Apple, and foreigners would dirty their hands making the actual goods.
In 2007 he was still bullish on US stocks. I told him that the financial system was about to crash (at the time I was working in the bowels of the hedge fund world, manufacturing some of the toxic waste that would blow up in 2008). He thought I was mad; after all, taxes were low and the Republicans were in office. How could anything go wrong? On July 18, 2007 I appeared on Larry Kudlow’s CNBC show and warned of a “trillion-dollar AAA asset bubble” that would bring down the banking system. Larry didn’t believe me, either.
Neither Art nor Larry will believe me now when I tell them that all the tariffs the US can impose won’t derail China’s economy. Under the title “The Great Fall of China,” Art warned July 30 that “China’s prosperity is now at risk and why China’s economy is highly vulnerable to harm from the tariffs that have either been proposed or already been enacted.”
This report was closely read in the White House, according to press reports. President Trump appears to be of the same mind. This week he declared that China is no longer on a rapid trajectory towards parity with the US economy.
Art vastly overestimates American economic strength and Chinese economic weakness, and his mistakes amplify the Administration’s mistaken view that tariffs will occasion intolerable economic pain for China. This is a strategic error of potentially disastrous magnitude, on the order of the Russians at Port Arthur, the British at Singapore, or the French at Dien Bien Phu.
Western observers speak ignorantly of a “Chinese economy,” when there really is no such entity: There is a past economy and a future economy which are quite different from each other. What we observe at any given time is the destruction of the old and the creation of the new. Averaging the two together is pointless.
Art’s argument has two parts (I will summarize rather than cite at length because the report was written for private clients). The first is that Chinese stock prices have underperformed US stock prices, and the second is that China has a very high level of corporate debt.
Art writes: “Chinese debt as a share of GDP includes corporate debt (160%), household debt (49%), government debt (36%), and bank debt (20%). Analysts point to excessive debt as the reason for China’s crazy GDP growth, claiming that debt-fueled infrastructure spending renders these GDP numbers misleading. And, they continue, this level of indebtedness leaves the Chinese economy highly levered, thereby increasing the risk of collapse in the future for the Chinese economy. The phrase ‘house of cards’ is frequently invoked.”
These observations are correct, but in my view misconstrued. The US and China both have roughly the same level of debt to GDP. US government debt is about 96% of GDP, household debt is 78% of GDP, and corporate debt is 93% of GDP, for a total of about 250% of GDP. In China, government debt is just 46% of GDP and household debt is just 47% of GDP, while corporate debt is 163% of GDP. A great deal of corporate debt is really government debt, that is, money owed to government banks by government-owned companies.
Most of that is debt-funded infrastructure, as I documented in a report for
published last October, 2017. I examined the share of corporate debt held by every major Chinese company and found – not surprisingly – that the big infrastructure companies starting with PetroChina were the main debtors. China, in other words, used corporate balance sheets and state banks to finance infrastructure, rather than municipal bonds or federal trust funds or tax revenues. That’s why we observe so much “corporate debt” and so little “government debt.”
This bears on the relatively poor performance of Chinese stocks. A great deal of the capitalization of the Chinese market is state-owned companies that have been used like quasi-government agencies. Their stock performance has been mediocre. The single biggest nonfinancial name in the Shanghai Composite Index, PetroChina, traded at 9.5 yuan three years ago and trades at just 8.13 now. On the other hand, Alibaba, the Amazon+Google+UPS of China, has roughly tripled in price during the past three years.
China’s stock market capitalization is about 30% of GDP, and represents just 9% of household assets. The US stock market is worth about 140% of GDP and comprises 40% of household assets. In other words, the stock market is roughly five times as important for the US.
If you want to compare the debt position of the United States and China, consider that the United States has run up US$21 trillion in government debt, and has nothing to show for it but future obligations to pay entitlements. China has run up a similar amount of debt but has used it to build infrastructure. It now has dozens of brand new cities designed for self-driving cars, 30,000 kilometers of high-speed trains, excellent roads, and brand new airports. The US has collapsing infrastructure, a rail system that is a national humiliation, and airports look like third-world leftovers.
I suppose it is correct to say that China’s economy is fragile. It is in the midst of a convulsive transformation. Deng Xiaoping began the convulsive transformation in 1979, launching the largest migration in world history, a movement of 550 million from the countryside to cities – two Americas, or the whole of Europe from the Urals to the Orkneys. Xi Jinping is presiding over another convulsive transformation, from a smokestack-and-export economy to a high-value-added, consumption-focused economy.
