Why Debt Won’t Spark Inflation

By John Mauldin


Modern technology was supposed to make travel less necessary. We can meet by phone, video, and now in virtual reality. But we’re still traveling more than ever. I certainly am.

The reason is simple: Technology can’t yet replace face-to-face conversation, and especially group conversations. It is genetically hardwired in our species. We spend more time on the phone and Skype than ever but technology also makes information more complex and nuanced. Conveying it often requires a personal presence, so we fly around and talk in person.

I thought of that last week at the Strategic Investment Conference. I’ve been writing about “Japanification” of the developed world economy, explaining what I mean by that as best I can in these letters. But in talking to conference attendees, I found that I have not effectively communicated some of the nuances.

To be clear, I don’t want Japanification, nor do I think it will deliver the desired results. I believe that in the next recession…

  • Policymakers will respond with massive fiscal and monetary stimulus, and

  • Instead of producing growth, it will depress growth and leave us all in the same morass Japan has endured for almost three decades.

In other words, I believe that both government and central banks will try Japanification (of course under other names) but I don’t expect it to work in the way they would hope.

When faced with the imminent possibility of recession, depression, or even a crash, authorities will try to do something but they will have very few choices. The “default” option of ever larger stimulus will kick in. So, like Japan, the US will see yet more quantitative easing and extraordinarily low interest rates, along with annual federal deficits of $2 trillion and higher. Alternatives like restructuring the tax code and balancing the budget will be nowhere in sight.

At best, this “process” will result in an even slower-growing economy and avoid total meltdown. That’s the optimistic view. Given what I understand today about the political and economic realities as I see them, I also believe that it is the most likely scenario. The others are much darker.

However, I also believe there is an “off-ramp” that could short-circuit the Japanification effect, leading to something closer to “normal.” More on that below.

Today I want to go deeper into the intellectual and academic rationale behind this outlook. Dr. Lacy Hunt has long been an enormous influence on my understanding of economics. In this letter I’ll discuss his latest ideas. I should note that any errors are mine and not his fault.

Lacy briefly presented two theorems at the SIC. After his scholarly lecture (that’s really what it was), I brought up my favorite central banker and former BIS chief economist Bill White. The three of us had possibly the most stimulating discussion of the whole conference (at least for me). You can (and should) view it all on our Virtual Pass but I’ll share some highlights below.

This is important and you need to understand it, because it is the exact opposite of what many people think.

Missing Inflation

Let’s start with some facts that may be inconvenient for some, but are nonetheless facts.

Back in the 1980s and 1990s, many of us in the conservative and “gold bug” movements (me included) thought excessive government spending and the resulting debt would eventually bring inflation or even hyperinflation. We wanted a hawkish Federal Reserve or, better yet, a gold standard to prevent it. (I have many friends, close friends, who still deeply believe in a gold standard. But that’s a discussion for another day…)

Reality turned out differently. Federal debt rose steadily, inflation didn’t. Here’s a chart of the on-budget public debt since 1970, using actual dollars instead of the more usual percentage of GDP, and with a log scale to eliminate the hockey-stick illusion.

Source: St. Louis Fed

Here is the same data in terms of debt to GDP. Note the brief shining moment when the US was growing faster than the debt rose and actually ran surpluses in the late 1990s. These were also times when GDP grew faster than the deficits and debt. But the general trend is from the lower left to the upper right. There was a significant jump during the Great Recession.

You can see the debt growth started to level out in the late 1990s but then took off again. Yet the only serious inflation in this whole period occurred in the first decade. Paul Volcker stamped it out in the early 1980s.

I am not saying we had no inflation at all. Obviously we did, and in many parts of the economy significantly more than the official “average” measures reflect. Some of it manifested in asset prices (stocks, real estate) instead of consumer goods. We like that and typically don’t consider it inflation, but it is. But there was nothing remotely like the kind of major inflation that this level of government debt should, theoretically, have caused based on what we understood in the 1970s and 1980s. Remember Ross Perot and his charts? It hasn’t happened.

One argument is that technology reduced production costs enough to offset the higher debt burden. That’s probably part of it, but I think a minor part. The real answer is twofold.

  • First is the way high government debt interacts with interest rates, over long periods and with a time lag, but almost inexorably.

  • Second, but no less understood, is the demand for certain currencies even as government debt and obligations rise.

A little reminder: Interest rates and inflation are really two sides of the same coin. Interest is the cost of money/liquidity. That cost is heavily influenced by the risk of money being devalued, i.e., inflation expectations. If lenders expect higher inflation then they expect to be repaid in cheaper dollars, and thus demand more of them via higher interest rates. So inflation drives rates higher, while lack of inflation keeps them low, as we’ve seen since 2008.

This brings us to Lacy Hunt’s SIC session in which he presented two important theorems. They are related but I will discuss them separately.

I’ll start by just quoting Lacy, then explain what I believe he means.

Federal debt accelerations ultimately lead to lower, not higher, interest rates. Debt-funded traditional fiscal stimulus is extremely fleeting when debt levels are already inordinately high. Thus, additional and large deficits provide only transitory gains in economic activity, which are quickly followed by weaker business conditions. With slower economic growth and inflation, long-term rates inevitably fall.

That first sentence should come with a little “Boom!” cannon icon. It will shock many people who think rising federal debt raises interest rates through a “crowding out” effect. That means the government, because it is the most creditworthy borrower, sucks up capital and leaves less available to private borrowers who must then pay more for it via higher interest rates or a weakened currency.

That is the case for most countries in the world.

Yet clearly it has not been the case for some countries in recent decades, specifically larger developed economies. That’s not to say it never will be, but actual experience supports Lacy’s point, and not just in the US. Here are four charts he showed at SIC.

In the US, Japan, the eurozone, and the UK, sovereign rates fell as government debt rose. That is not how Keynesian or most other macroeconomic theories say debt-funded fiscal stimulus should work. Additional cash flowing through the economy is supposed to have a multiplier effect, spurring growth and eventually raising inflation and interest rates. This has not happened.

The reason it hasn’t happened is that we have crossed a kind of debt Rubicon in recent history. Past performance really is not an indicator of future results. Today, in much of the developed world, the existing debt load is so heavy that additional dollars have a smaller effect. The new debt’s negative effects outweigh any benefit. The higher taxes that politicians often think will reduce the deficit serve mainly to depress business activity. We see the result in slower economic growth, plus lower interest rates and inflation.

Note we are talking here about fiscal policy, i.e., government spending on jobs programs, infrastructure, etc., when financed by issuing new debt. Central banks aren’t directly involved until they start financing the government debt via QE or some version of MMT (which Lacy and the rest of the speakers at the SIC will hasten to point out are not equivalent).

Velocity Falling

Lacy’s second theorem supports the first.

Monetary decelerations eventually lead to lower, not higher, interest rates as originally theorized by economist Milton Friedman. As debt productivity falls, the velocity of money declines, making monetary policy increasingly asymmetric (one sided) and ineffectual as a policy instrument.

Irving Fisher’s equation of exchange (M2*V=GDP) says GDP is equal to the money supply times its turnover, or velocity. The Federal Reserve heavily influences the former but not the latter. That, it turns out, is a serious problem.

The Fed’s Phillips Curve fixation gives it the illusion that every macroeconomic problem is a nail and monetary policy is the ideal tool/hammer to fix it. Of course, that’s not true. Looser financial conditions don’t help when the economy has no productive uses for the new liquidity. With most industries already having ample capacity, the money had nowhere to go but back into the banks. Hence, velocity fell 33% in the two decades that ended in 2018.

Now, if velocity is falling then any kind of Fed stimulus faces a tough headwind. It can inject liquidity but can’t make people spend it, nor can it force banks to lend. And in a fractional reserve system, money creation doesn’t go far unless the banks cooperate.

Later in the conference, Bill White observed that this is why monetary policy is increasingly ineffective. The banks respond to each crisis the same way, and every time they find that it takes more aggressive action to produce the same effect. Obviously, that can’t go on forever. Bill called it a “fundamental intemporal inconsistency.”

The result is that public and private debt keeps rising but also becomes less productive. Lacy showed how, in a world of falling monetary velocity, the amount of GDP growth produced by each additional dollar of debt fell 24% in the last 20 years. That’s why we have so much more debt now and yet slower growth.

This also explains why (this year’s first quarter notwithstanding) growth has been so sluggish since 2014. That was when money supply peaked. So for five years now, we’ve had both a shrinking money supply and slowing velocity. That’s not a recipe for inflation. And the more recent jump in federal deficit spending is making matters worse, not better.

In our Q&A, Lacy and Bill discussed how linear economic models are just not working and nonlinear  analysis is so critical. A lot of practical people are turned off by this, thinking it shouldn’t be so complex. But, these same people would never tell a physicist to avoid nonlinear concepts.

The economy is complex and getting more so as the world adds new, seemingly critical variables. (I should also note that Lacy only had 30 minutes for his presentation and had to make a complex argument in an abbreviated time. There are scores more corollary points we could explore.)

The Complex Debt and Currency Dance

Astute readers will quickly point out that rising debt in places like Venezuela has brought extraordinary inflation and currency devaluation. Historically, that’s what rapidly rising government debt does. I simply point you to Rogoff and Reinhart’s This Time Is Different where they examine every debt and currency crisis for the last few centuries. The circumstances may have been different, but the result was the same.

Yet today, things do indeed seem different. Japan, the US, the UK, and other countries seem able to expand their government debts beyond historically acceptable levels and “get away with it.” Interest rates have stayed low, often getting lower and going negative, while currency valuations have remained relatively stable (the operative word here is relatively).

What is different is the international demand for currencies and debt denominated in those currencies. A globalized economy yielded a surplus of savings that seeks a home in what is perceived as “safe” assets. Nobody thinks Venezuela is safe. That is why, in a global crisis, money flies to the US and other “reserve” currencies. These “safe haven” currencies have the exorbitant privilege of running large fiscal deficits.

Thought experiment: If Italy were to remove itself from the euro and reissue the lira, does anybody really think that Italy would keep today’s low rates? Ditto for Greece and other countries. Left on their own, these currencies would devalue relative to stronger ones like Germany, and their interest rates would rise.

This is not necessarily a bad thing. The “safety valves” of currency devaluation and bond market vigilantes saved Italy numerous times before it joined the euro. What most people don’t realize is that Italy grew faster than Germany in real terms for the 20–30 years prior to joining the euro, despite its inflation and devaluations.

How long can this go on? The Japanese experience suggests much longer than we would think. Forever? No. There is a point where the zeitgeist, the perceived global narrative about a country and currency changes, and currencies and interest rates become unhinged. It can happen seemingly overnight.

Again, how long can this go on? We simply don’t want to know the answer to that question. We will only know after the fact, and it will be a horrible, painful fact to experience. Better to find a viable exit ramp.

“Too High and Getting Wider”

I’ll wrap up with a direct quote from Lacy Hunt, which you will probably want to read several times. His academic prose takes a little time to sink in. But when it does, you should be concerned… if not terrified.

The parallels to the past are remarkable, but there appears to be one fatal similarity—the Fed appears to have a high sensitivity to coincident or contemporaneous indicators of economic activity, however the economic variables (i.e. money and interest rates) over which they have influence are slow-moving and have enormous [time] lags.

 In the most recent episode, in the last half of 2018, the Federal Reserve raised rates two times, by a total of 50 basis points, in reaction to the strong mid-year GDP numbers. These actions were done despite the fact that the results of their previous rate hikes and monetary deceleration were beginning to show their impact of actually slowing economic growth. The M2 (money) growth rate was half of what it was two years earlier, signs of diminished liquidity were appearing, and there had been a multi-quarter deterioration in the interest rate-sensitive sectors of autos, housing, and capital spending.

Presently, the Treasury market, by establishing its rate inversion, is suggesting that the Fed’s present interest rate policy is nearly 50 basis points too high and getting wider by the day.

A quick reversal could reverse the slide in economic growth, but the lags are long. It appears that history is being repeated—too tight for too long, slower growth, lower rates.

The Fed waited too long to raise rates and then overshot the mark when it finally got around to it. I was calling for rate hikes in 2012 and 2013. The Fed could have hiked 50 to 75 basis points per year, “normalizing” interest rates and letting the economy adjust slowly rather than all at once, late in the cycle. Having realized it, FOMC members then paused, but too late and possibly for the wrong reasons. Now they’re trapped. Lacy thinks an immediate 50 bp cut might help, but he’s not optimistic they will do it, or that it will work if they do.

If that’s right, then we are in for slower growth and probably recession sooner rather than later. In a debt-laden, highly leveraged economy, it probably won’t be a mild one, either.

I mentioned earlier that I believe there is an “off-ramp” exit for the US economy. In the coming weeks, I’m going to respond to Ray Dalio’s recent two-part letter and then his third longer piece seemingly endorsing Modern Monetary Theory (MMT). It will probably be a multipart series and will allow all of us to have a much larger thought experiment, a potentially educational experience, than we have been having.

In the spirit of Dalio’s own “radical transparency” philosophy, maybe it is time to start thinking the unthinkable.

Before we move on, at least in this letter from the Strategic Investment Conference, let me gently suggest that you take advantage of our Virtual Pass. You can see most of the 33 speakers on video, listen to them on audio, and read the transcripts of the sessions. I’m getting many responses raving about the conference from people who weren’t even there. They watched on the Virtual Pass, which is the next best thing.

And maybe think about joining us next year at The Phoenician in Scottsdale, Arizona on May 11–14. As my friend Kent K. wrote,

“One of the best things about attending SIC is not only the information learned from these “rock star” speakers, you get to actually have a drink with them and sometimes dinner and pick their brain. From a financial context, it would be like seeing the Rolling Stones or Paul McCartney perform and then having a casual conversation with them afterwards. I have never attended any other conference that provides this kind of experience.”

They Shall Not Grow Old

On the five-hour flight from Dallas to Puerto Rico this past weekend, I decided to watch a movie. Scrolling through the seemingly endless choices, I came across the documentary by Peter Jackson (of Lord of the Rings fame) called They Shall Not Grow Old. Jackson and his team went through World War I film archives to assemble an extraordinarily moving view of the reality, total brutality, and utter inhumanity of war. The entire documentary consists of actual film from the era, starting out black-and-white and eventually becoming colorized. It is a well-done homage to these soldiers’ bravery and patriotism. Over 10 million died during that single war and the civilian death toll was almost as large.

In the US, it is Memorial Day weekend, where we annually pay tribute to those who lost their lives to keep countries free and democratic. Spending less than two hours watching They Shall Not Grow Old would be a good way to honor their sacrifice. It is a window into times and events simply not imaginable to most of us.

And while you’re watching, remember that European bond markets were very calm almost up to the last moment. No one really thought war was coming. But then the unthinkable happened.

It’s time to hit the send button. And to those of you who served your country, wherever and whenever it was, thank you. I wish you a truly great week!

Your reflecting on the unthinkable analyst,

John Mauldin
Chairman, Mauldin Economics

The Eternally Optimistic IMF

The International Monetary Fund believes that ringing alarm bells on global economic growth is not its job, especially with many observers spotting signs of improvement in the past few weeks. But with economic conditions set to worsen before they improve, complacency is likely to have a high cost.

Ashoka Mody

mody24_MANDEL NGANAFPGetty Images_imf

PRINCETON – In April 2018, the International Monetary Fund projected that the world economy would grow robustly, at just above 3.9% that year and into 2019. The global upswing, the Fund said, had become “broader and stronger.” That view quickly proved too rosy. In 2018, the world economy grew only by 3.6%. And in its just released update, the IMF recognizes that the ongoing slowdown will push global growth down to only 3.3% in 2019.

As always, the Fund blames the lower-than-forecast growth on temporary factors, the latest culprits being US-China trade tensions and Brexit-related uncertainties. So, the message is that growth will rebound to 3.6% next year. As Deutsche Bank points out, IMF forecasts imply that fewer countries will be in recession in 2020 than at any time in recent decades.

But the forces causing deceleration are still in place. Global growth this year will be closer to 3%, with rising financial tensions in Europe.

The IMF keeps getting forecasts wrong because it misses the big picture. The economically advanced countries – which still produce about three-fifths of global output – have been experiencing a long-term slowdown since about 1970. The reason, Northwestern University’s Robert Gordon says, is that despite the promise of modern technologies, ever-slower productivity growth has dragged down the growth potential of these rich economies.

As a result, China has come to play a dominant role in determining the pace of global growth. Besides its large size, the Chinese economy has extensive trade links that transmit its growth to the rest of the world. When China grows, it sucks in imports from other countries, giving the global economy a big boost. Rapid Chinese growth revved up the world economy between 2004 and 2006, in 2009-10, and in 2017.

But China’s once-heady growth rates have necessarily fallen as the country has become richer. By historical standards, an economy as rich as China today should be growing at 3-5% a year, rather than the 6% or more that the Chinese authorities are trying to achieve through fiscal and credit stimulus.

Pushing too hard for extra growth has increased China’s financial vulnerabilities to worrying levels. By standard measures of credit growth and asset-price inflation, the country should have had a financial crisis by now. The Chinese authorities have therefore played yin and yang, stimulating growth to prevent a rapid slowdown, but reining in the stimulus to contain financial risks.

The latest cycle has been no different. In 2017, Chinese policy stimulus spread through the world, leading to the celebration of a “synchronous upsurge.” The most significant beneficiary was Europe, which depends heavily on trade. European Central Bank president Mario Draghi patted himself on his back for deft “monetary policy measures,” which he said had supported “broad-based” momentum.

When China withdrew its stimulus in early 2018, the IMF, the ECB and other forecasters blissfully continued to project high growth rates, even as the global economy slowed rapidly. Soon enough, Europe swooned, sending Italy into a technical recession and Germany to the threshold of one. (Oddly, the United Kingdom’s economy, for all its Brexit-related troubles, is doing marginally better than both.)

In the past few months, China’s leaders, concerned about their economy’s slowdown, began a new round of stimulus. Although data are not yet available, world trade growth appears to have risen slightly since then. European growth rates have ticked up, although only enough to alleviate immediate recessionary risks.

For the world economy, the continuing problem is the short-lived nature of Chinese stimulus. The OECD has already warned that the latest stimulus will drive up the worryingly high volume of corporate debt, and that over-indebted local governments will borrow more to finance wasteful infrastructure. Faced with the choice of financial crisis or slower growth, the Chinese authorities – and the rest of the world – will once again prefer slower growth. Thus, China’s deceleration will resume in the coming months, dampening world growth yet again. For now, no other country is in a position to take China’s place.

Darkening the global outlook further, the US economy is coming off the “sugar high” of fiscal stimulus and corporate cash repatriation from overseas. In addition, Germany’s slowdown in 2018 and early 2019 may not only reflect its sensitivity to slower world trade growth. Its economy may be finally descending from its high pedestal as its vaunted diesel-engine-based car industry struggles to meet pollution standards and growing competition from electric cars.

The real risk, however, lies in Italy. Running down the checklist of crisis indicators, all of Italy’s are flashing red. The economy has zero – possibly negative – productivity growth, which makes it impossible to generate internal momentum to pull out of recession. The ECB has no room to help. Italy’s debt-to-GDP ratio is above 130%, and the European Union’s absurd budget rules, in any event, make fiscal stimulus nearly impossible. Tremors along the Italian fault line will spread quickly to France, which has only slightly better indicators and also little scope for an effective policy response to a serious downturn.

The IMF, always reluctant to ring alarm bells on the global economy, is especially unwilling to counter the recent upbeat sentiment. But with economic conditions set to worsen, complacency is likely to have a high cost.

Ashoka Mody is Visiting Professor of International Economic Policy at the Woodrow Wilson School of Public and International Affairs at Princeton University. He is a former mission chief for Germany and Ireland at the International Monetary Fund. He is the author of EuroTragedy: A Drama in Nine Acts.

Trump, Tariffs and China Spell Trouble for American Steel

The vanishing levies on Canada and Mexico could be just the beginning of the industry’s problems

By Nathaniel Taplin

It was all just a fleeting, pleasant dream.

U.S. steelmakers woke last week to the brutal reality of evaporating tariffs on Canadian and Mexican steel. But an even greater problem is waiting in the wings: China may soon be tempted to ship more of its unwanted steel to foreign shores.

President Trump said Friday that the 25% tariffs he imposed on Canada and Mexico in mid-2018 would be lifted and that both countries would drop retaliatory levies. That removes a major hurdle to congressional approval for Mr. Trump’s revamped Nafta, the U.S.-Mexico-Canada Agreement.

U.S. steel companies will certainly take a hit, given that the tariffs boosted U.S. prices significantly above the global average for most of 2018, at the expense of steel-consuming industries like oil and autos. Even with the 25% tariff, imports of Canadian and Mexican hot-rolled coil steel are roughly 5% cheaper, according to Moody’s.

           Bad news is coming down the pipe for U.S. steelmakers. Photo: staff/Reuters

Meanwhile, Chinese steelmakers are raising output nearly as fast as property investment, the main source of steel demand, is growing. If that trend continues and Chinese mills send their excess production abroad as they did in 2014, it could sink global steel markets.

The big global steel rally that began in 2016 was made in China. The country’s stimulus pushed property investment sharply higher, while Chinese President Xi Jinping’s signature campaign to reduce excess factory capacity and pollution, launched in 2017, gave steel output a hard knock. Close to 10% annual growth in real-estate investment, paired with falling steel output, sent China’s monthly net steel product exports sliding about 60% between late 2015—when they ran to nearly 10 million metric tons—and late 2017.

Unfortunately, nothing lasts forever. Weakening economic growth in 2018 led to weaker controls on production. Property investment is still growing at about a 10% clip, but now steel output is too. Margins have narrowed, and net exports have begun to creep higher.

One cause for optimism is that regulators appear to be aware of the problem. China’s two biggest steel cities will extend seasonal winter production restrictions into June, Reuters has reported.

This is helpful, but it also puts the global steel market once again at the mercy of Chinese officials. April industrial growth was bad. If May doesn’t show a significant bump, or the Chinese job market keeps worsening, pollution restrictions might be watered down again.

Beijing doesn’t want domestic steel prices to collapse. Given the strained state of trade relations with Washington, sending more steel abroad look tempting. The U.S. steel industry needs to prepare for a bad day.

China’s Fake Numbers And The Risk They Pose For The Rest Of The World

Not so long ago, London Telegraph’s Ambrose Evans-Pritchard was one of the handful of must-read financial journalists. He probably still is, but since he disappeared behind the Telegraph’s pay wall his work is invisible to non-subscribers, only emerging when a free outlet runs one of his stories.

That happened this morning when the Sydney Morning Herald carried his analysis of the financial Ponzi scheme that is China.

After taking on more debt in a single decade than any other country ever — in the process helping to pull the US and Europe out of the Great Recession — China recently shifted into an even higher gear, creating a world record amount of credit in the most recent reporting month.

And – more important for headline writers and money managers – it reported exactly the right amount of GDP growth.

This brings to mind a long-ago interview in which economist Nouriel Roubini asserted that China just makes its numbers up, frequently reporting GDP immediately after the end of the period being measured, something that even the US can’t do.

But it’s one thing to for the rest of us to suspect and/or assert that China is just giving the markets what they want to hear, and another thing to understand the implications and explain them coherently. Evans-Pritchard does this in his latest article.

Maximum vulnerability: China (and the world) are still in big trouble
China’s majestic and elegantly-stable GDP figures are best seen as an instrument of political combat. 
Donald Trump says “trade wars are good and easy to win” if your foes depend on your market and you can break them under pressure. 
He proclaimed victory when the Shanghai equity index went into a swoon over the winter. This is Trumpian gamesmanship. 
It is in China’s urgent interest to puncture such claims as trade talks come to a head. Xi Jinping had to beat expectations with a crowd-pleaser in the first quarter. The number was duly produced: 6.4 per cent. Let us all sing the March of the Volunteers.
“Could it really be true?” asked Caixin magazine. This was a brave question in Uncle Xi’s evermore totalitarian regime. 
Of course it is not true. Japan’s manufacturing exports to China fell by 9.4 per cent in March (year on year). Singapore’s shipments dropped by 8.7 per cent to China, 22 per cent to Indonesia, and 27 per cent to Taiwan. Korea’s exports are down 8.2 per cent. 
The greater China sphere of east Asia is in the midst of an industrial recession. Nomura’s forward-looking index still points to a deepening downturn. “Those expecting a strong rebound in Asian export growth in coming months could be in for disappointment,” said the bank. 
China’s rebound is hard to square with its own internal data. Simon Ward from Janus Henderson said nominal GDP growth – trickier to manipulate – is still falling. It dropped to 7.4 per cent from 8.1 per cent in the last quarter on 2018. 
Household demand deposits fell by 1.1 per cent last month. This means that the growth rate of “true” M1 money is still at slump levels. It has ticked up a fraction but this is nothing like previous episodes of Chinese stimulus. It points towards stagnation into late 2019. “Hold the champagne,” he said. A paper last month by Wei Chen and Chang-Tai Tsieh for the Brookings Institution – “A Forensic Examination of China’s National Accounts” – concluded that GDP growth has been overstated by 1.7 per cent a year on average since 2006. They used satellite data to track night lights in manufacturing zones, railway cargo volume, and so forth. 
“Local officials are rewarded for meeting growth and investment targets,” they said.  
“Therefore, it is not surprising that local governments also have an incentive to skew the statistics.” 
Liaoning – a Spain-sized province in the north – recently corrected its figures after an anti-corruption crackdown exposed grotesque abuses. Estimated GDP was cut by 22 per cent. You get the picture. 
Bear in mind that if China’s economy is a fifth or a quarter smaller than claimed it implies that the total debt ratio is not 300 per cent of GDP (IIF data) but closer to 400 per cent. If China’s growth rate is 1.7 per cent lower – and falling every year – the country is less able to rely on nominal GDP expansion whittling away the liabilities. 
Debt dynamics take an ugly turn – just at a time when the working-age population is contracting by two million a year. The International Monetary Fund says China needs (true) growth of 5 per cent to prevent a rising ratio of bad loans in the banking system. 
China bulls in the West do not dispute most of this. But they say that what matters is the “direction” of the data, and this is looking better. Stimulus is flowing through. It gained traction in March with an 8.5 per cent bounce in industrial output – though sceptics suspect that VAT changes led to front-loading. Suddenly the words “green shoots” are on everybody’s lips. 
The thinking is that China will rescue Europe. Optimists are doubling down on another burst of global growth, clinched by the capitulation of the US Federal Reserve. It will be a repeat of the post-2016 recovery cycle. 
Personally, I don’t believe this happy narrative. But what I do respect after observing late-cycle psychology over four decades – and having turned bearish too early during the dotcom boom – is that investors latch onto good news with alacrity during the final phase of a long expansion. A filtering bias creeps in. 
So sticking my neck out, let me hazard that heady optimism will lead to a rally on asset markets until the economic damage below the waterline becomes clear. 
Let us concede that Beijing has opened its fiscal floodgates to some degree over recent weeks. Broad credit grew by $US430 billion ($601 billion) in March alone. Business tax cuts were another $US300 billion. Bond issuance by local governments was pulled forward for extra impact. But once you strip out the offsets, it is far from clear that the picture for 2019 has changed. 
Nor is it clear what can be achieved with more credit. The IMF said in its Fiscal Monitor that the country now needs 4.1 yuan of extra credit to generate one yuan of GDP growth, compared to 3.5 in 2015, and 2.5 in 2009. The “credit intensity ratio” has worsened dramatically. 
I stick to my view that the US will slump to stall speed before China recovers. Europe is on the thinnest of ice. It has a broken banking system. It is chronically incapable of generating its own internal growth or taking meaningful measures in self-defence. 
Momentum has fizzled out in all three blocs of the international system. We are entering the window of maximum vulnerability.

Lots of good data here – something notably lacking in most reporting on China’s “miracle.”

But the best — and scariest — single stat is the dramatic decline in the marginal productivity of debt.

China, like the US, is getting progressively less bang for each newly-borrowed buck. There’s a point at which new borrowing doesn’t just product less wealth but actually destroys it. The US and China are heading that way fast, while Europe might be there already.

As Evans-Pritchard, notes, the result is “maximum vulnerability.”

Britain is once again the sick man of Europe

If treachery becomes part of the debate, there can only be total victory or total defeat

Martin Wolf

David Cameron, the 'essay crisis' prime minister, resigns after losing the EU referendum in 2016 © Getty

When I was young, in the 1960s, the UK was known as the “sick man of Europe”, for its prolonged economic weakness. But after Margaret Thatcher’s time as prime minister, this grim epithet no longer seemed applicable. Yet now, once again, as I go abroad — and especially in continental Europe — people ask me, with a mixture of bewilderment, pity and Schadenfreude, “What is wrong with Britain?” I do not pretend to know the answer (or answers). But I can describe the symptoms: the UK is undergoing six crises at the same time.

The first and most important crisis is economic. The starting point was the shock of the 2008 financial crisis. But, today, the most important aspect of this is the stagnation in productivity. According to the Conference Board, output per hour in the UK rose by just 3.5 per cent between 2008 and 2018. Of all significant high-income countries, only Italy’s grew less. Yet that is not because the UK’s productivity is already high. On the contrary, output per hour in the UK lags behind that of Ireland, Belgium, the US, Denmark, Netherlands, Germany, France, Switzerland, Singapore, Sweden, Austria, Australia, Finland and Canada. High employment and low unemployment are good news. But stagnant productivity means stagnant real incomes per head. This means that one group can only get better off if another does worse. This does not make for happy politics. A long period of fiscal tightening has made it unhappier.

The second crisis is over whether national identity has to be exclusive. That question soon turns into one about loyalty. Many are comfortable with multiple identities. Others insist there must only be one. One way of looking at this division is as one between “people from somewhere” and “people from anywhere”, as David Goodhart defines it in his book, The Road to Somewhere. But, once politicised, this becomes far more bitter and divisive. It has been, in Brexit.

The third crisis, Brexit, has weaponised identity, turning those differences into accusations of treason. Normal democratic politics are subsumed within (and managed by) appeals to a higher shared loyalty. Once the idea of “treachery” becomes part of political debate, only total victory or total defeat are possible. Such perspectives are incompatible with the normal give-and-take of democratic life. And so, in fact, it has proved. The country is so evenly divided, and emotions are so intense, that resolution is at present impossible.

The fourth crisis is political. The existing parties, based historically on class divisions, do not fit the current identity divisions between those who are gladly both British and European and those who insist that being the former excludes the latter (at least if by “European” one means “citizen of the EU”). Both main parties are being destroyed in the process, but a new political configuration is yet to emerge.

The fifth crisis is constitutional (by which I mean that it relates to the rules of the political game). Membership of the EU is a constitutional question. Use of referendums as the device to resolve such constitutional questions is itself a constitutional question. If referendums should decide such things, what must be the role of parliament in interpreting and implementing that decision? What, for that matter, is a sensible decision-rule for a constitutional referendum? Should it be a simple majority or a supermajority? Why did we stumble into this mess, without asking ourselves any of these questions?

The sixth and perhaps most important crisis of all is of leadership. The UK has stumbled from the “essay crises” of David Cameron to the mulish obstinacy of Theresa May. Now it can see before it the prospect of a general election, with a Conservative party led by Boris Johnson confronting a Labour party led by Jeremy Corbyn. These two men do not have much in common. But they seem to me the least qualified potential prime ministers even in a country that is, after all, still a permanent member of the UN Security Council. One is an inveterate buffoon and the pied piper of Brexit. The other is a hardline socialist and a life-long supporter of leftwing despots. With such leaders, the mess can only worsen — and it surely will.

Why so many crises have befallen the country at the same time and how they all relate to one another are really important questions. Poor economic outcomes, in terms of real income growth, are surely related to the rise of national identity as a salient issue, though there are other factors, notably immigration. What matters, however, is not what caused all this, but that it is going to take a long time to sort all this out. The UK will, alas, remain sick for a while.