Michael Pettis: Global Fracture - Nationalism on the March

Transcript

Rob Johnson:

Welcome to Economics and Beyond, I’m Rob Johnson, President of the Institute for New Economic Thinking. I’m here today with Michael Pettis, he’s a professor of finance at Beacon University and a senior fellow at the Carnegie-Tsinghua Center. He’s an author of several books that I’m quite fond of, The Volatility Machine, Avoiding the Fall, The Great Rebalancing and most recently in 2020, Trade Wars Are Class Wars with Matthew Klein. Michael thanks for joining me today.

Michael Pettis:

Thanks very much.

Rob Johnson:

So you and I are talking here, it’s the middle of June 2020, the pandemic has crossed the planet, there’s a whole lot of turbulence and turmoil in many places on earth. We seem to be how I say amidst a trajectory where social sustainability and particularly environmental sustainability were already in question, increasing inequality and concentration of income and wealth and many people blame globalization and trade for being at the center of this. What do you see right now, what is drawing your attention in light of the shock of this pandemic and in light of the turbulence that we see politically and economically across the planet?

Michael Pettis:

Well, it seems to me that the COVID 19 pandemic has had a pretty important impact not so much in changing the trajectory or the direction in which the global economy was moving but really in accelerating a whole series of problems that were already implicit, that were already embedded within our currently globalized system. Among others its worsened income inequality which was a huge problem, income inequality in itself has had a significant impact on both stagnant growth and demand and a rising debt, and this has all been part of a globalized trading system in which the system is stacked very heavily in a type of pro-cyclical behavior in which rising income inequality worsens the trade imbalances and deeper trade imbalances puts more pressure on rising income inequality. So COVID 19 has really accelerated this whole process.

Rob Johnson:

Well, I know in the United States where even before President Trump was elected, even before he campaigned there was an increasing concern even expressed by the Council on Foreign Relations that the U.S.-China interaction was not going smoothly concerned about China 2020 Intellectual Property Rights Protection. The ability to achieve economies of scale on a foreign direct investment in China. There were other parts of the American we might call power structure, Wall Street was frustrated by not getting as much access to the Chinese market and seeing both internal development and international integration and opening. But one thing I know from, I run a thing at INET called the Commission on Global Economic Transformation that’s chaired by Mike Spence and Joe Stiglitz, is that people do see globalization as something that increase the relative power of finance, of technology, of the things that they say have wings and people being less mobile, particularly labor has lost relative power. Do you see things through a similar lens?

Michael Pettis:

Yeah, very much so and what’s more I find it difficult that not everyone sees it because it’s fairly clear I would argue. First off a word about Trump, a lot of people have focused on the conflict between Donald Trump and Xu Xianping as the heart of this process and that’s a mistake. If you look at global trade as a share of global GDP, it basically peaked around 2011, 2012 and then it began contracting. That contraction has continued under Donald Trump but it wasn’t really started by him or especially sped up by him, it’s been part of an overall process.

Michael Pettis:

I would also argue that it’s not just wrong to see this as a Trump, Xu problem, it’s also wrong to see this as a China-U.S. problem. The problem of globalization is much bigger than that. And while Washington-Beijing gets all of the attention we forget that there are rising geopolitical tensions everywhere today for example, India announced a confrontation on its border with China. We’ve been seeing the U.S. have difficulties with many of its allies including Japan and Germany on trade, we’ve seen Chinese relationships with its neighbors seen uniformly to deteriorate, in Europe there are more real questions about whether COVID 19 is the last nail or not in the coffin of the Euro.

Michael Pettis:

So it’s a real mistake to see this as a U.S.-China problem, it’s much, much bigger than that. And in fact in my 2013 book, The Great Rebalancing, I argued that all of this was inevitable, we were going to see a contraction in global trade and we were going to see as part of that arise in geopolitical tensions and increasing tendency in most countries to blame local problems on foreigners or on immigration, all of this. So I think it’s important to understand that this is not just something that arises because of the personalities of Donald Trump and Xu Xianping, this was inevitable, this was going,] and it’s happening much, much more widely than simply between the two capitals.

Rob Johnson:

In Europe, I know you’re originally from Spain as I recall, we see a very substantial imbalance between Germany and the other members of what you might call the EU or the Eurosystem, are these flaws something that are structural, that are similar in each region what you might call global agreement could begin to address or is it more textured and complicated in region specific in your view?

Michael Pettis:

Well, Europe is very interesting because the process that we’re discussing shows up more clearly there than almost anywhere else. Basically, Europe was reasonably balanced that deterrent of the century at the creation of the Euro but something radical changed between 2003 and 2005 after which you saw an explosion in the German current account surplus it had been running deficits before that. And simultaneously a collapse in the current accounts of a bunch of other countries, so-called peripheral Europe, some of them had been running small surpluses others had been running small deficits but at the same time they all saw their deficits explode to incredibly high levels, with Spanish deficit at one point was something like 9% or 10% of the country’s GDP which is really astonishing.

Michael Pettis:

So what happened it’s pretty straightforward it seems in 2003, 2004 and into a less extent in 2005 Germany implemented a number of labor reforms and that turns out to be a euphemism for putting downward pressure on wage growth. And it’s pretty astonishing because you can look at the growth of household income in Germany relative to the growth of GDP and it had been pretty constant household income grew roughly as quickly as GDP. But after that 2003, 2004 period, GDP growth picked up a little and household income growth dropped substantially so we started to see a big gap between the two. And the flip side of that gap was a surge in business profits in Germany. So basically what the labor reforms did in Germany, was they transferred wealth from households in the form of lower wages to businesses in the form of higher profits, and this was all in the name of making Germany more competitive.

Michael Pettis:

Now, what should happen assume that Germany was a more or less closed economy, of course it isn’t but let’s pretend that it was, if that were to happen there would be a big problem within Germany, there would need to be some way of rebalancing that. So when you reduce the household share of GDP, not surprisingly you reduced the consumption share of GDP. And of course, a smaller consumption share is the same thing as a higher saving share. It’s not that German households went out and saved more money they didn’t, if anything they saved less money. But because part of their income was transferred to business profits which was all saved, total German savings started to rise really, really rapidly.

Michael Pettis:

Now, normally when savings go up investment should go up, but that’s not what happened in Germany investment actually declined as a share of GDP, which shouldn’t be a surprise because businesses invest in order to mostly serve consumption and exports, and with the decline in the consumption share of GDP, perhaps it’s not surprising that there was a decline in investment. Now, in a closed system you can’t have that, savings can’t go up if investment stays the same or goes down because savings is equal to investment. So there would’ve had to have been some adjustment within Germany, one adjustment could have been the government could have engaged on an infrastructure building spree to raise investment which they didn’t do. But if that didn’t happen then something would’ve had to bring the savings rate back down again and typically that would mean a surge in the household debt or a rise in unemployment, both of those would bring the savings back into balance with investment. But in an open economy you have another alternative, and that is you can export the excess savings.

Michael Pettis:

And luckily for Germany at the time, thanks to the structure of the Euro, they were able to export massive amounts of excess savings to other European countries, Spain, Italy, Greece, all of those so-called peripheral European countries. Now it’s not a coincidence that most of those countries entered the Euro with higher inflation than in Germany, so the initial impact was that, as interest rates in Europe converged they became very high in real terms for Germany but very lower or even negative in real terms for peripheral Europe. So you saw an explosion in borrowing in peripheral Europe as a response to this huge amount of excess savings flowing from Germany into countries like Spain.

Michael Pettis:

Now, when tons of money flow into a country it’s almost always terrible for that country, you almost always have bubbles, et cetera and that’s exactly what happened in countries like Spain. But it’s important to think about how this process works because as German savings flow into Spain there are only two ways Spain can react, either Spanish investment must go up or else Spanish savings must go down in order to absorb all of these German savings. And if Spain were a developing country in which investment was constrained by the lack of savings then what would’ve probably happened is Spanish investment would’ve gone up. That’s what happened in the United States in the 19th century, British money coming into the U.S. caused American investment to go up.

Michael Pettis:

But we live in a world today where investment really isn’t constrained by savings, there is an awful lot of savings, interest rates have been at the lowest in history, large companies in Europe and the U.S. sit on massive piles of cash and they have nothing to do with the cash, they can’t invest it. So when you increase the amount of foreign savings entering a country like Spain investment was never likely to go up, there was some increase in investment mostly unnecessary apartment buildings but will leave that aside. But if investment doesn’t go up then savings must go down. And there’s really three ways savings can go down in the short term, one way is with an increase in the fiscal deficit, but Spain was very disciplined it actually ran a fiscal surplus. The other way would be an increase in household debt and there was an explosion in household debt, and then the third way is with an increase in unemployment, Spain responded with an explosion in household debt.

Michael Pettis:

I remember in the 1990s getting a credit card in Spain was a really big deal, it was hard to get a credit card but in the subsequent decade your pets could get credit cards. Banks were falling over each other trying to extend credit to anybody who wanted it and as a result we saw an explosion in household debt. Now, the important thing about this explosion in household debt, is that was only one of unlimited number of ways Spain could absorb all of these inflows from Germany. If Spain did not increase its domestic investment and as an advanced economy it couldn’t any more than Germany increased its investment, then it must either increase its debt or increase its unemployment. And of course, what happened is that debt in Spain soared until 2009 when we had the crisis and debt could no longer go up.

Michael Pettis:

So the other part of the equation occurred which is a surge in unemployment, so the important point and I apologize for this very long answer Rob, but the important point that I want to make is that it was really a policy decision in Germany to make Germany more competitive by reducing the wage share of GDP that caused a whole series of things to occur in the rest of Europe. And I would argue that that’s not just a European issue, Europe was a very clear example because the structure of the Euro meant that there was absolutely nothing Spain could do to protect itself from German inflows.

Michael Pettis:

But we see this more broadly in other countries that try to generate competitiveness, effectively there’s only one way to become more competitive and that’s to reduce workers’ wages directly or indirectly through depreciation or eliminating the social safety net, all stories that we hear a lot about in the U.S. are not a coincidence but when a country tries to become more competitive it does so by reducing wages and that reduces its contribution to global demand but in exchange it gets a bigger share of foreign demand. And that sets us up in this pro-cyclical beggar-thy-neighbor policy, where if I lower my wages you then have no choice but to lower your wages if you want to stay competitive with me. And so we get into this process where income inequality automatically rises, imbalances get worse, and we’re really stuck in this process.

Rob Johnson:

Yeah. I remember Michael in studying the dynamics in Europe and then what someone like Gemo Calboy would call “the sudden stop” related to a Lehman crisis. And I remember learning that the ECB essentially would allow repo discounts for all of the countries than the bonds within the Eurozone, which encouraged particularly financial institutions to essentially extend credit to the higher yielding bonds of places like Greece, Portugal, Spain, and to some degree Italy and it led to a convergence in yields as that capital flowed in and just as you described particularly in the case of Spain household did emerged. And then with the advent of the Lehman crisis the desire to shrink balance sheets through things into reverse and all the while the developments in the real sector, particularly related to China sent essentially an adverse shock to the labor intensive sectors many of which were in Southern Europe, and a positive shock, a stimulus to the higher value added goods like capital goods that could be exported from Germany and that further exacerbated these tendencies that you were talking about.

Michael Pettis:

Yeah, very much that’s the process of what happened, we saw, if you look at it again Spain and Germany become a really good microcosm for looking at the world. What happened is that as Germany lowered its wages it expanded its manufacturing sector at the expense of the Spanish manufacturing sector, but because of the surge in household debt Spanish workers moved from the manufacturing sector to the services sector, which became overvalued and then once you had the inability to continue increasing debt, that was the sector that got so badly hurt, the labor intensive sector as you mentioned. But yeah, it’s a pretty straightforward process and we see it across the board. Now, what’s interesting to me is that we see something very similar in the U.S. in a way very similar and in a way very different.

Michael Pettis:

The rise in income inequality in Germany caused the German savings rate to go up. Obviously, as you take money away from an ordinary or a poor household and you give it to a rich household, the share of that money that’s consumed goes down and the share of that money that’s saved goes up. So rising income inequality should force up the savings rate. Now, if you look at the U.S., the U.S. has suffered from even more rising income inequality than has Germany. And so the question is, well then why does Germany have such a high savings rate and the United States have such a low savings rate. And I would argue that in a funny way the U.S. is in a position like Spain was within the Euro, the U.S. and the other so-called Anglo-Saxon financial markets, England, Canada, Australia, are economies that have very liquid, very deep, very well governed financial markets.

Michael Pettis:

So as a result, excess savings from around the rest of the world, roughly half of it ends up in the U.S. and of the remaining amount nearly half of it ends up in the UK and then in the other so called Anglo-Saxon economies. And this isn’t what economics tells us should happen, what we all learned is that the rich countries would have excess savings which would then pour into the developing countries where A savings is constrained and B investment needs are very high, and that’s how the world should work. But as you know, that’s not how the world works, very little of the excess savings of the world flows to developing countries. Most of it flows to the U.S., the UK, and a few other rich countries. So that’s why the U.S. and Germany are so different, if the German savings rate goes up they can export those excess savings but the U.S. isn’t in that position, the U.S. capital account is not determined at all by the U.S. and for the same reason the U.S. current account is not determined at all by the U.S.

Michael Pettis:

The U.S. capital account surplus is determined by foreigners who decide to invest their excess savings in the deepest most liquid market they can, that’s why the U.S. has been running a permanent capital account surplus since the late 1970s and therefore also a permanent current account deficit in complete contrarians to what economic theory tells us. Now, this is really important because if the U.S. is running a capital account surplus, some economists have this very obsolete understanding of the capital account that of course the U.S. runs a capital account surplus, it needs to borrow money from abroad because of its very low savings rate and that’s exactly backwards, the U.S. doesn’t need money from abroad.

Michael Pettis:

Before COVID 19 our interest rates and they still are, we’re at the lowest in our history and companies were sitting on huge pools of cash and the only thing they could figure out what to do with it is to buy back stocks or just to sit on cash, nobody was investing. There was no constraint in the U.S., no investment constraint, if you wanted to invest you could easily raise the money to do so. So money coming into the U.S. didn’t come in because the U.S. urgently needed capital to meet its investment needs, it came into the U.S. because the U.S. is where you place all of your excess savings. But that has an important balance of payment implication and that is just as I said with Spain, if money comes into the U.S. it must either cause U.S. investment to rise, which it doesn’t because the U.S. isn’t capital constrained or it must cause American savings to go down, and that’s exactly what happened, American savings drops because of foreign savings coming into the U.S.

Michael Pettis:

Now, a lot of people are really shocked by this because it seems like I’m saying the U.S. cannot control its savings rate, and that’s exactly right the U.S. cannot control its savings rate. As long as it has an open capital account, its savings rate is equal to definition by its level of investment minus the amount of foreign capital coming into the U.S., this is just an accounting identity. And so the U.S. savings rate unlike in the case of Germany is forced down precisely because Germany can export its excess savings. The U.S. has no control over its capital account so it is always a net importer of excess savings and that drives down the American savings rate.

Michael Pettis:

The trick is to figure out how does that happen, and there are many ways that can happen. Foreign money can cause the dollar to rise and as the dollar rises that increases that basically transfers wealth from the manufacturing sector to households and so it increases consumption. Foreign money can ignite a stock market bubble or a real estate bubble and then you have a wealth effect which causes American households to reduce their savings out of current income so the savings rate goes down forcing the U.S. to run a current account deficit could cause domestic unemployment to go up. And when workers get fired their savings rate goes from positive to negative money, pouring into the banking system could put pressure on the banks to expand their loans which they do by lowering their lending standards and you have the famous NINJA loans, et cetera, where basically anybody with a pulse can borrow money and spend it.

Michael Pettis:

So there’s a lot of mechanisms for doing so but the point is that the income inequality in the U.S. doesn’t result in high savings because of the open U.S. capital account. Now, I’d like to talk about trade, maybe a little bit about Washington’s trade policies because they are a really misdirected, misguided. Should I jump into that Rob or do you want to-

Rob Johnson:

Yeah, I was just going to mention that I remember a paper by Pierre-Olivier Gourinchas and Helene Rey must have been 10 or 12 years ago about from World Banker to World Venture Capitalist which described much of the dynamic that you have been illuminating here about the capital account driving the current account and the financial services’ industry transforming, which you might call from those deep and liquid treasuries into particularly things like venture capital and private equity investments. And in that transformation additional margins or fees were earned. But let’s focus on… I just wanted to underscore their work because I remember it at the time being quite illuminating but let’s focus on trade as you suggested and errors in U.S. trade policy.

Michael Pettis:

As you mentioned that paper, I would also remind people that this year Atif Mian, Ludwig Straub and Amir Sufi put out a couple of extremely important papers on exactly this topic on the relationship between income inequality, debt and the trade balance. But the point that I wanted to make about the Trump administration’s response to these trade imbalances is that if you believe my story then you would argue, you would probably accept that the U.S. role in the trade imbalance is a role that forces the U.S. either into rising debt or rising unemployment and typically the U.S. chooses rising debt. And so those who criticize the role of trade imbalances and who worry about its impact on the U.S. economy are absolutely correct.

Michael Pettis:

You still get a few of the or a lot of the old dinosaurs who will say that trade imbalances don’t matter at all, it’s very good for countries like China and Germany to run surpluses and it’s really good for the U.S. to run deficits, there’s weird some faulty logic there. But if you agree that these trade imbalances forced down the U.S. savings rate and they do so by causing either American debt to rise or American unemployment to rise, then you would think in that case it makes sense to put constraints on globalization to reduce the U.S. trade imbalances, to reduce the trade deficit. And yes, it does but here is where the Trump administration and Peter Navarro are deeply mistaken and they’re working on a really obsolete idea of trade.

Michael Pettis:

200 years ago if England ran a surplus with France it would be because England could produce exiles much more cheaply than France and so it was able to produce them and sell them to France. It ran a surplus, France ran a deficit, and then the British banks would finance the deficit and that’s how you had your capital account and your current account balancing. In other words, what drove the imbalance was England’s ability to produce textiles cheaply. Now, if you were France and you didn’t want to run a trade imbalance, it would make sense to put tariffs on English textiles, if England can produce it more cheaply than you raise the cost of English production and you will no longer run a trade deficit in fact, that’s the whole Hamiltonian program. The U.S. as you know had extremely high tariffs on trade for most of the 19th century behind which it protected the rise of its manufacturing industry.

Michael Pettis:

But that doesn’t work today anymore because what really matters, what really drives the imbalances is the capital flow side, capital flows are enormous and they move around the world not to finance trade as they did 200 years ago, 150 years ago, they move around the world for other reasons, the flight capital, investment fads, reserve accumulation, et cetera, et cetera, nothing to do with the productive flow of capital but with lots of other things. And the problem is that these savings imbalances are automatically matched by trade imbalances, so if China raises its savings rate by lowering the household share of Chinese GDP, and they have done that households in China retain the lowest share of GDP of any country in history then the savings rate in China by definition must be the highest in the world, investment is the highest in the world in China too but savings is so high it exceeds investment. And that balance is exported abroad, and let’s say it’s exported mostly to the U.S., probably two thirds to three quarters of it are exported to the U.S.

Michael Pettis:

Well, here’s the thing, if China exports a $100 to of savings to the U.S., China must run a current account surplus of $100 and the U.S. must run a current account deficit of $100. Now it could be that they run the surplus and deficit with each other but it doesn’t need to be the case, and that’s why tariffs are irrelevant because if the U.S. puts tariffs on Chinese good, that might reduce the U.S. deficit with China. But as long as China is exporting a $100 of excess savings to the U.S., China will still run a $100 surplus except not with the U.S. and the U.S. will still run a $100 deficit except not with China. And that’s exactly what the data tells us, as all of these tariffs have been put on Chinese goods the American deficit with China has declined substantially, the Chinese surplus with the U.S. has declined substantially and this will allow Washington to announce it’s been very successful.

Michael Pettis:

But if you look at the overall Chinese surplus it’s going up, and if you look at the overall American deficit it too is going up, which is exactly what the theory tells us should happen if what’s driving these imbalances is the flow of excess savings. So that’s why I would argue that the U.S. should try to address these imbalances, the best way for the whole world to address these imbalances is to redistribute income downwards so that we can increase consumption demand which will then increase business investment, but if we can’t do that collectively then the best way to resolve this is to start thinking about putting on controls on the ability of foreigners to import or export massive amounts of excess savings into the U.S. So this way of looking at the world gives us a very, very different set of solutions for resolving the problems caused by income inequality and the trade imbalances.

Rob Johnson:

Yeah, I also think in the United States we’ve had a very awkward policy regime, which is as globalization has affected the distributional balance the winners that narrow constellation of the wealthy have used their power in the realm of money politics to allow the withering of the infrastructure that creates broad based prosperity and participation and opportunity.

Michael Pettis:

Absolutely.

Rob Johnson:

And they’ve allowed the manipulation of politics to do things like make what used to be tax evasion now into legal offshore tax avoidance or allegedly deferment. And so it looks to me, and I’ve spoken in great detail with high level Chinese officials who I visit two or three times a year when I go over about their feeling that yes, say unlike Tonga, China is a very large economy so if you used a metaphor that there’s a tugboat pulling along development you could imagine Toga getting people educated, Tonga bringing things home, moving up the value chain but it wouldn’t really affect the tugboat called the United States or the EU.

Rob Johnson:

But in the case of China, the sheer scale starts to essentially swamp the tugboat or impact the tugboat and then the divisiveness of this class-based money politics seems to exacerbate that which was going on, what you might call through the market and the international capital flow process that you’ve described. And the Chinese officials say to me there’s nothing they can do about that, it’s not an adjustment they can make. There are other things related to intellectual property rights and other things within China and before we finish today I do want you to describe how you see this internal dynamic in China and perhaps India as well. But I just wanted to underscore the U.S. policies that exacerbate inequality are playing a very big role.

Michael Pettis:

Absolutely. Although there is a role that China does play and that is, remember China from the 1980s until roughly 2011, 2012 where it were at peaked or bottomed out, I had put into place a whole series of policies that did the same thing, that transferred massive amounts of wealth away from ordinary households towards the business, local governments and the local elites. It isn’t as obvious in the case of China because China was growing so quickly that if you looked at household income, it too was growing very quickly. What’s important about China is that while the economy was growing at 10% or 11%, household income was growing quite strongly but only at around 6% or 7%. So basically it was the similar process where you had all of these hidden transfers that basically taxed the household sector to subsidize rapid growth and investment in manufacturing, et cetera.

Michael Pettis:

Now, this wasn’t necessarily a bad policy in the 1980s China had gone through five decades of anti-Japanese war, Civil War and Maoism and so it was hugely underinvested, it had four airports in the country, it had no bridges, no subway system, it had terrible manufacturing facilities, terrible transportation, et cetera. So this growth model China followed was very, very successful, it forced up the domestic savings rate by constantly taking money away from ordinary households and it poured all of these savings into domestic investment, it had the highest investment rate by far in history and the highest investment growth rate in history. And that caused so much growth that even with all of these policies that exacerbated income inequality most Chinese didn’t notice because their income was still growing quite quickly.

Michael Pettis:

Now, this is a great policy, this is a great development model when you are hugely underinvested and every country that’s followed it has had a period of very, very rapid healthy growth. But it’s interesting that every country that’s followed this growth model has then ended up in a period of soaring debt and then ultimately an extremely difficult economic adjustment. And I would argue that the reason is because when investment is growing so quickly no matter how underinvested you are at some point, you reach the point where you have as much capital stock, as much investment as you can productively absorb. At that point, what you should be doing, and Albert Hirschman wrote a great deal about this in the 60s, 70s and 80s, is implementing the institutional changes legal, financial, et cetera, political that allow workers and businesses to absorb capital more productively but no country has ever done that. They’ve kept on the same policy, and Hirschman explains that the reason they do so is because that very successful growth model created a very powerful constituency in favor of that model and it’s always been extremely difficult to change the model.

Michael Pettis:

And this is almost a perfect description of China as far back as 2007, then premier when JBA promised that they would change the model, rebalance the demand and increase the household income share of GDP. And that didn’t happen in fact it got worse for the next five years before it finally stabilized around 2011, 2012. And the reason is because it’s been politically very difficult to do so. Now, what’s the problem, the problem is that as you continue taxing the household sector and pouring all of the savings into investment, if that investment is no longer productive then what happens is that debt starts to grow faster than the ability of the economy to service that debt.

Michael Pettis:

And what the basic theory would tell you is that at some point, China should have shifted from rapid growth without a growth in the debt burden to rapid growth with explosive growth in the debt burden, and of course that’s exactly what we’ve seen, debt levels are extremely high. So China knows that it must contribute both to its own rebalancing and to the global rebalancing, in the same way the U.S. and Germany must and a number of other countries, but it’s been politically extremely difficult to do so and it’s because the same groups in all of those countries, basically the bankers and the owners of movable capital have benefited tremendously from this system and are extremely resistant to a significant adjustment of the distribution of demand, the distribution of income, et cetera, et cetera. So it’s really a global problem.

Rob Johnson:

So as we look at, we’ve toured around the different regions of the world and you’ve done a beautiful job of illuminating what’s taking place in each. If there was a world government and you were their chief strategic advisor, and you saw as you described this distress and this unsettling politics in many, many different regions, what would you prescribe as the way out of this, as the way to shift gears, as a way to join what you might call a sustainable trajectory?

Michael Pettis:

Well, the problem the world faces is weak sustainable demand growth that means growth and demand without even more rapid growth in debt in large part because income is so badly distributed and this is an old story, John Hobson explained this 120 years ago and we’ve been periodically reminded, Marriner Eccles the chairman of the Fed in the 1930s explained the same thing. The problem that we have is that ordinary households retain too low a share of what they produce to be able to consume it and therefore businesses don’t bother investing because consumption growth isn’t strong enough to justify it. So what we need to do is we need to rebalance income, we need to redistribute income back down from those who save it rather than consume it to those who consume it, which is just another way of saying from the rich to the poor.

Michael Pettis:

The problem is that in a globalized world you can’t do that. Yesterday I was watching Bill Clinton’s speech in 1993 when he signed NAFTA, and he said the U.S. has to embrace all of these changes because the fact that money can move around the world in the blink of an eye means we have no choice. And technically he’s right except his conclusion was incorrect. His conclusion was because money can move around in the world in the blink of an eye, we have to accept these changes that undermine the social safety net, we have to undermine labor unions, we have to put downward pressure on wages because otherwise we lose out in the global battle of competitiveness. Well, maybe but another way of addressing that was saying, if the problem is capital moving around in the blink of an eye, well, then let’s stop it from moving around in the blink of an eye.

Michael Pettis:

I cannot raise my wages if you don’t raise your wages because if that happens I’ll lose competitiveness, your businesses will benefit and my businesses will go bankrupt. So maybe what we need is a new Bretton Woods but this time rather than following Harry Dexter White’s proposal, we follow Kane’s proposal which was very concerned about the imbalances, which was very unhappy with the idea of any national currency being the global reserve currency.

Michael Pettis:

So I would argue if there were a world government that what we need is a new Bretton Woods conference in which we change the rules of the game in a way that penalize beggar-thy-neighbor policies and once that happens we can start addressing domestic income inequality in all of these various countries. But I’m pretty skeptical Brenton Woods didn’t occur because we were all terribly smart in 1944, Brenton Woods occurred because one country, the United States represented roughly 50% of global GDP and it was the only government that had more or less collapsed in [inaudible 00:49:52] and fighting, et cetera. So it was basically able to bang heads together and force a global agreement, I don’t think anyone could do that today.

Michael Pettis:

So I would argue the next best solution and it is definitely next best, it’s a painful solution, is for individual countries to take steps to either withdraw from this hyper globalized world in which there is nothing you can do about rebalancing domestic income as long as other countries don’t do it into a world in which you regain control of domestic policy of the domestic economy, and that means countries particularly like the United States unilaterally taking steps to reduce of the unfettered flow of global capital. For example, taxing money that comes into the country or taxing interest payments on foreign investment, et cetera. So there’s a lot of ways of doing it. The U.S. basically only really had a free capital flows after 1983, before that there were taxes on foreign ownership of domestic bonds, we need to return to that period where individual countries can regain control of domestic policies and do what is the most important thing we need to do and that is redistribute income in a way that is economically more optimal. And frankly at this point almost anything is more optimal.

Rob Johnson:

Yes. Well, Michael this has been a superb exploration around the world, around and within each major region. And I do want to encourage people to buy your new book written with Matthew Klein, Trade Wars Are Class Wars is put out by Yale University Press. In addition to thanking you for today I do hope that you and I can in a few months time come back and continue to explore and share your expertise with our audience. But for now, thank you and I wish you well stay safe and keep bringing us the insights that for the last 15 years I’ve known you to repeatedly uncover and share with thought leaders around the world. Thank you.

Michael Pettis:

Thanks very much Rob, and I hope we’ll be able to travel some time in our lifetimes and that the next time you come to Beijing we meet up.

Rob Johnson:

Well we’ll go listen to some music together that’s for sure.

Michael Pettis:

There we go.

Rob Johnson:

Thanks bye bye.

Michael Pettis:

Thank you.

Speaker 3:

And check out more from the Institute for New Economic Thinking @ineteconomics.org.