Yu Yongding/Member of the Faculty of the Chinese Academy of Social Sciences
Source: The Paper, 2024-07-22, Zhang Yunpo/Collation
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Yu Yongding: China's economy can still grow, but it needs really active policies
The series of seminars on "In Beijing, Shanghai in Beijing" and "Surging Afternoon Tea/Between Beijing and Shanghai" will be officially launched on May 17, 2024. "Between Beijing and Shanghai" aims to analyze the central government's policies and discuss Shanghai's ideas. The second seminar focused on the construction of an international financial center, and invited Yu Yongding, a member of the Faculty of the Chinese Academy of Social Sciences, to give a summary of Yu Yongding's speech. Yu Yongding made several views on the United States economy and China's economy, providing background materials for discussing the construction of Shanghai as an international financial center.
Part I
Whether a city can become an international financial center generally meets the following conditions:
• Brings together a large number of financial talents and other professionals
• Competitive regulations and highly qualified enforcers
• Preferential tax arrangements
• A government that can respond to industry concerns
• A just and equitable business environment
• Good living environment (quality of life, culture and language)
• Easy access to international financial markets
• Reasonable operating costs, excellent business infrastructure
• High-quality commercial real estate
According to some questionnaires, one of the most important conditions seems to be a good business environment. Whether a city can become an international financial center, or whether the timing is appropriate to build a city into an international financial center, not only depends on the city's own conditions, but is also inseparable from the economic and financial development and economic and financial situation at home and abroad. Shanghai is undoubtedly the city in China with the best conditions to become an international financial center. However, many of the necessary conditions for building Shanghai into an international financial center are not up to Shanghai itself. For example, the liberalization of the capital account, the free floating of the exchange rate (Hong Kong as a city may be pegged to the US dollar for a certain period of time), the internationalization of the renminbi, and so on, all of which have to be decided by the central government and implemented nationwide.
Building Shanghai into an international financial center is a very significant, but very difficult undertaking. I will not study this issue specifically and have no right to speak, but I would like to make a few comments on the United States economy and the Chinese economy, so as to provide some background material for discussing the construction of Shanghai as an international financial center.
Part II
The evolution of the United States economy after the 2008 global financial crisis can be divided into many phases (Figure 1). These include several policy adjustments by the United States government and the Federal Reserve from 2008 to March 2020. What I'm going to talk about today is how the United States economy has changed since March 2020.
Figure 1: Market yields on United States Treasuries Image source: Federal Reserve
In March 2020, against the backdrop of the pandemic and supply chain disruptions, the United States stock market suddenly plummeted for various reasons. From February 12, 2020 to March 20, 2020, the Dow Jones stock index plummeted by 35.1%, and the dollar liquidity dried up. In order to save the market, on March 23, the Federal Reserve announced an unprecedented "no bottom line" rescue plan, starting an unlimited quantitative easing mode. At the same time, the Fed also reinstated its zero-interest rate policy. Since then, the Fed's balance sheet has soared from around $4 trillion to more than $8 trillion in just three months, peaking at $8.9 trillion.
In March 2021, inflation broke through the 2% target and began to rise. There are basically two reasons for inflation in United States: first, external shocks. In particular, the supply chain disruption caused by the new crown epidemic, trade frictions with China, and other things, the aggregate supply curve has shifted to the left. Second, in order to support the stock market, the Fed has adopted an extremely expansionary monetary policy, and the United States government has implemented an extremely expansionary fiscal policy in response to the coronavirus shock.
The Fed's mistake was to focus only on the role of supply shocks after inflation broke through 2% (2.6%) in March 2021 and ignore the role of consumption and investment, especially household demand, in raising prices due to increased consumption and investment, especially consumer demand, after March 2020. Since the subprime mortgage crisis in 2008, inflation has remained around 2% except in 2013, although the Fed has been implementing expansionary monetary policy. After March 2020, the situation finally changed. Extremely expansionary fiscal money has finally led to a sharp rise in inflation. At the same time, the United States fiscal deficit reached a staggering 14.9% of GDP in 2020 and 10% in 2021.
The experience of the United States shows that ultra-loose monetary policy does not necessarily lead to inflation, although for a long time. But in any case, there should be a threshold, and once it is crossed, the inflation situation can suddenly worsen. China's quasi-deflationary state provides us with a window for expansionary fiscal and monetary policy. If we do not actively seize the time to stimulate economic growth through expansionary fiscal and monetary policies, and reverse the trend of declining GDP growth year by quarter since 2010, the window of opportunity may close at any time.
Figure 2: The Fed raised interest rates 7 times in 2022 and 4 times in 2023, for a total of 11 rate hikes. The target range for the Fed funds rate rose from 0-0.25% at the beginning of '22 to 5.25%-5.5% in July '23. No further rate hikes have been raised so far, but no rate cuts have been made. Unless otherwise specified, the charts in this article are all from Yu Yongding's speech PPT
Since the Fed believes that inflation is mainly caused by supply shocks, monetary policy is basically powerless against inflation caused by supply shocks. At the same time, because the employment problem is still relatively serious, it is naturally reluctant to raise interest rates to curb inflation. The Fed's attitude did not begin to change until November 2021. In fact, inflation in the United States has reached 7% in 2021. In March 2022, the Fed began raising interest rates. Seven times in 2022 and four times in 2023. As the Fed raised interest rates, United States inflation also began to gradually decline. From 9.01% in June 2022 (a 40-year high) to 3.2% in July 2023. Since then, however, the Fed has not raised interest rates again, and inflation has remained largely at around 3%. The Fed's war to curb inflation is now at a stalemate.
Part III
Figure 3: United States 10-year Treasury returns in 2022 were dismal
The Fed's interest rate hike has led to an increase in the yield curve of financial products in United States. The yield on United States 10-year Treasuries was close to 5% in October 2023 (4.98% on October 19). A rise in Treasury yields means a fall in the price of Treasury bonds, just as lower house prices and lower stock prices cost property and equity holders, and holders of Treasury and other fixed income assets lose a lot. Market participants exclaimed: "Something impossible" happened in 2022! United States Treasuries, the "world's largest, deepest, most liquid, and most risk-free" asset, have achieved double-digit negative returns (Figure 3). It was only after October 2023 that the yield on the 10-year Treasury note in United States began to turn down. The phenomenon that the market will pay the most attention to in 2023 is the continued rise in United States Treasury yields. On October 19, 2023, the 10-year United States Treasury almost exceeded 5%.
Have United States fixed income bond yields peaked or fixed income bond prices bottomed? The influx of giants such as Berkeley into the bond market indicates that they have reached a turning point in their judgment that the United States economy, Treasury bonds and Fed policy have arrived. But most investors, out of caution, are still on the sidelines. In December 2023, as the Fed decided not to raise interest rates again, more and more United States investors made optimistic judgments about the United States economic situation (inflation situation improved), and the yield on United States 10-year Treasury bonds began to fall. At the beginning of 2023, it was 3.88% and at the end of the year it was 3.88%. However, it rebounded to around 4.45% in July 2024.
The pattern of capital inflows in the United States has changed, from foreign central banks buying Treasury bonds to private investors buying stocks around 2023. Global equity markets have skyrocketed in '23 (excluding the MSCI China Index and the Hang Seng Index). Semiconductors (SOX) added 64.90%, the Nasdaq 100 (NDX) added 53.81%, and the Nasdaq Composite added 43.42% to its value. Global equities outperformed in 2023: Semiconductor: +64.90%, NASDAQ 100: +53.81%, NASDAQ Composite: +43.42%, Nikkei 225: +28.24%
The Fed's continued interest rate hikes and rising United States Treasury yields have led to an influx of overseas funds into the United States. For the United States, the influx of overseas funds has helped maintain the United States' balance of payments and contributed to the strengthening of the dollar. The United States has maintained a current account deficit for decades. Net overseas debt as a percentage of GDP is very high. For a long time United States it has relied on foreign investors, especially foreign central banks and the Organization of the Petroleum Exporting Countries (OPEC), to purchase United States government bonds to maintain its balance of payments. Rising Treasury yields mean that the United States will have to pay a higher price to bring in foreign capital. The Fed's high interest rate means a steady flow of foreign funds, and it also means that the United States' net international investment position (NIIP) will accelerate its deterioration.
Four
Figure 4: The Dow Jones Equity Index Trajectory: After a poor performance in 2022, it improved after October
United States stocks underperformed in 2022 for a time, but improved after October. The performance in the middle of the two straight lines (Fig. 4) was not very good, and then it went up again. Now it's almost 40,000. Equities are doing well, United States' own funds are retreating, and private investors in other countries are buying in large numbers. The Dow Jones has been rising. There are no particularly noticeable signs of change. While the United States will benefit from foreign capital inflows, equity market inflows, rather than Treasury funds, into the United States and a stronger dollar will lead to an increase in United States' net overseas debt.
In 2023, United States' net overseas debt is $19.58 trillion, reaching 80% of GDP. In a developing country, such as Mexico, a 40% ratio of net debt to GDP means the outbreak of the "tequila crisis". Thailand and other Southeast Asian countries, when their overseas net debt to GDP is much lower than that of United States debt, have experienced a balance of payments crisis, the currency has depreciated sharply, and a large number of domestic enterprises have gone bankrupt due to excessive foreign debt. But the United States did not have such a crisis, because the dollar has long enjoyed high creditworthiness, and the dollar is almost the only international reserve currency. Foreign residents are still willing to hold U.S. dollar assets. However, everything has a degree, and overseas investors cannot always ignore the continued increase in United States' overseas debt-to-GDP ratio.
At some point in the future, we may be faced with the crisis we had before 2008 again. The three major international credit rating agencies have successively downgraded the sovereign credit rating of United States. If the United States overseas net debt-to-GDP ratio continues to rise, a so-called "sudden stop" is not out of the question.
Since July 2023, the market has been expecting the Fed to cut interest rates. The Fed has been on hold. Inflation has not changed much either. I have always believed that the Fed's main problem is that it still sticks to the 2% inflation target that was set more than 20 years ago. Due to factors such as de-globalization, the Russia-Ukraine war, and the US-China trade war, global supply chains have been severely disrupted. In other words, the aggregate supply curve has shifted to the left permanently. In this case, if the Fed insists on reducing inflation to 2%, the probability of stagflation in the United States will be greatly increased. If the Fed abandons its 2% inflation target and starts cutting interest rates, the credibility of the Fed's policy will be greatly reduced, and inflation expectations will no longer be anchored at a given level, which will make it extremely difficult for the Fed to implement monetary policy in the future. Not only that, but whether the United States public can accept higher inflation is also a question. A convenient "solution" for the Fed is to pay lip service to its 2% inflation target, but not know when it will be achieved, delay it indefinitely, and then act on it. At the moment, the Fed does seem to be doing just that.
Part V
Figure 5: The U.S. Dollar Index fluctuates at its highs
Everyone is concerned about the exchange rate of the renminbi and the changes in the US dollar. Figure 5 plots the trajectory of the dollar. The reasons are very complex. You can't simply explain it with a Fed rate hike. In retrospect, China intervened in the external market on a large scale in 2015-2016 to stabilize the RMB exchange rate. In fact, whether the renminbi appreciates or depreciates is largely related to the external environment and a series of United States policies. From the end of 2016 to the beginning of 2017, the renminbi stopped depreciating and stabilized. I don't think it was the result of the intervention, it was the dollar index that stopped rising. When Trump came to power, he believed that the dollar was too strong and not good for exports, so the dollar had to depreciate. At that time, the exchange rates of all developing countries were stable.
So far, the RMB exchange rate against the US dollar is 7.3, and I still tend to wait and see what happens, and not to intervene too much, especially not to change the stance of implementing expansionary monetary policy and expansionary fiscal policy because of the stability of the exchange rate.
We do face the possibility of a further depreciation of the renminbi. This is where a trade-off is needed. We should not put too much emphasis on exchange rate stability right now. Exchange rate depreciation is a "double-edged sword", with benefits and disadvantages. We are concerned that depreciation expectations will accelerate capital flight. Judging from the figures provided by the Bank of United States of New York Mellon, the climax of China's capital outflow has passed, and everything that should have run has run away. In fact, quite a few foreign investment banks are now preparing to re-enter China.
Part VI
First of all, we need to be clear that at the macroeconomic level, China's current problem is that aggregate demand or effective demand is insufficient. Second, we know that aggregate demand can be divided into three main blocks: final consumption, capital formation, and net exports. Third, based on the available data, it can be assumed that by the end of 2023, these three blocks will account for 54.7%, 42.8% and 2.5% of GDP, respectively. Thus, in terms of economic growth in 2024, the normative question is: what will be the contribution of final consumption, capital formation, and net exports to the 5% GDP growth target? In fact, in 2023, of the 5.2% GDP growth, consumption, investment, and net exports contributed 4.3 percentage points, 1.5 percentage points, and -0.6 percentage points, and contributed 82.5%, 28.9%, and -11.4% to economic growth, respectively. Clearly, consumption will contribute the most to GDP growth in 2023.
From January to May 2024, the year-on-year growth rates of consumption (social zero), investment (fixed investment) and net exports were 4.1%, 4.0% and 3.2%, respectively, and their contribution to GDP growth was 2.24 percentage points, 1.7 percentage points and 0.13 percentage points, respectively. Clearly, consumption remains the main driver of GDP growth in 2024 so far. As the base effect has largely disappeared, the contribution of consumption to GDP growth has declined significantly compared to 2023. The contribution of the investment and trade surplus to GDP growth will increase in 2024, but it will not be enough to offset the negative impact of lower consumption growth on GDP growth to achieve the 5% target. Manufacturing investment increased by 9.6% year-on-year from January to May, becoming the biggest bright spot for China's economy in 2024. However, the growth rate of real estate development investment will drop from minus 9.6% in 2023 to 10.1%, which has seriously dragged down the growth of investment, which in turn has dragged down the growth of GDP. It could have been hoped that the significant increase in the growth rate of infrastructure investment would hedge the adverse impact of negative growth in real estate investment and the decline in consumption growth on GDP, but from January to June 2024, the national fixed asset investment increased by 3.9% year-on-year, and infrastructure investment (excluding electricity, heat, gas and water production and supply) increased by 5.4% year-on-year. Therefore, in the second half of 2024, the Chinese government must adopt a more aggressive expansionary fiscal and monetary policy, otherwise it will have to accept lower GDP growth as a last resort.
Due to the emergence of the "new three" and some other factors, manufacturing investment increased by 9.6% year-on-year from January to May 2024. The significant increase in the growth rate of manufacturing investment partially offset the drag on the growth of fixed asset investment due to the 10.1% year-on-year decline in real estate investment. But even so, the growth rate of fixed asset investment is far from enough to offset the adverse impact of lower consumption growth on GDP growth. Statistics show that China is likely to achieve its GDP growth target of 5% in 2024 only if the growth rate of infrastructure investment is greatly increased.
Personally, I believe that in order to achieve the 5% GDP growth target by 2024, China must step up the expansion of fiscal policy. In 2024, the government will issue 4.06 trillion yuan of general treasury bonds, 3.9 trillion yuan of special bonds, and 1 trillion yuan of ultra-long-term special treasury bonds, totaling 8.96 trillion yuan. The broad fiscal deficit is as high as 11.1 trillion yuan. Although the expansion of China's fiscal policy in 2024 will be significantly stronger than in 2023, the central government should increase fiscal spending and support infrastructure investment further and significantly more.
Since 2024, China's medium- and long-term bond yields have been declining. The yield on the 10-year Treasury note remained roughly low at 2.21%, the yield on the 30-year Treasury note fell below 2.5%, and the yield curve shifted downward overall. Market participants believe that a large number of bank deposits have entered the bond market, and the yield of long-term treasury bonds is too low, and there are certain risks. I think that the issuance of treasury bonds of various durations is smooth, and the low level of treasury bond yields, especially long-term and ultra-long-term treasury bond yields, is certainly a reflection of the "asset shortage" of banks, but it is more a reflection of investors' confidence in China's economic prospects. Low yields suggest that there is room for the Chinese government to further expand its fiscal policy. There is absolutely no need for the Chinese government to abide by the so-called Maastricht Treaty fiscal rules of "fiscal deficit ratio of 3% and national debt-to-GDP ratio of 60%". There is no need to shy away from saying that the central bank will buy new government bonds in the secondary market if necessary. China's top macroeconomic policy goal for 2024 is to achieve a GDP growth target of around 5%. "There is no time to lose." China's current low inflation level allows us to confidently pursue a bold expansionary fiscal policy, complemented by an accommodative monetary policy. If, as a result of some kind of shock, inflation suddenly rises, we may be put in an awkward dilemma. We should have greater courage and determination, implement the central authorities' economic work guidelines in the spirit of seizing the day, and resolutely implement an expansionary fiscal and monetary policy; only in this way can China get out of the "L-shaped growth" predicament that has been in place for more than 10 years. ■