China's Market Crash — and the Man Who Saw It Coming
WHY YOU SHOULD CARE
China might face a difficult future, but at least it’s got some cool tunes.
By Steven Butler
Michael Pettis isn’t always where you expect him to be. Initially, I missed the Cassandra of China’s economy by just a few minutes when I dialed the Beijing number he provided. But I managed to reroute the call to his “operator,” who turned out to be a musician in a performance space where artists could be heard warming up in the background. Wrong number? Hardly. This is just Pettis’ latest venture — the Beijing-based indie music club XP.
It’s tempting to talk about Pettis, 57, as a dual persona — an indie music impresario cum global financial clairvoyant — but that would make things too simple. His budding worldwide fame comes courtesy of a piquantly dour take on the so-called “Chinese economic miracle.” As expressed in books, his blog, publications like The Financial Times and a newsletter peddled to select clients for thousands of dollars, the “Pettis hypothesis” is that China has greatly over-invested borrowed money — in factories, infrastructure and construction — leading to a painful reckoning. The theory has proven to be uncannily on target during the country’s record-breaking market sell-off over the past few weeks.
Between the market meltdown and music promotion — plus a professorship at Peking University’s Guanghua School of Management and work at the Carnegie Endowment for International Peace — there’s no doubt Pettis keeps busy. When OZY finally catches up to him, he is preparing to jet away on another global speaking and consulting tour — while squeezing in a few days at his erstwhile home, and the beach, in southern Spain. And I first met Pettis at a conference about China, in Washington, D.C., where he’d just arrived from another conference in Europe, jet-lagged (which really only showed when he couldn’t recall the third question in a series piled on him).
China’s growth miracle is not unique.
An animated speaker, he gesticulates so wildly that he keeps knocking the microphone from the lapel of his rumpled gray blazer, which he wears over an open-necked white shirt. His square jaw and squarish glasses give off an air of professorial dignity, which seems to collapse as he speaks with increasing passion, interrupted by the coughing you might expect from someone who lives in Beijing’s polluted air and smokes. Pettis attributes his current success to a combination of “stubbornness and good luck.” In this case, the former Wall Street trader, Latin America debt specialist and Columbia University finance prof visited Beijing in 2001 and loved it so much that he decided to stay — just as the country’s economy revved into high gear.
But, he notes, “China’s growth miracle is not unique.” Instead, he argues, it repeats a pattern found in upwards of 40 other cases, including the U.S. in the 1920s and the Soviet Union in the 1950s, not to mention Japan, Korea and Taiwan, or largely failed cases such as Brazil. The pattern, he says, is that each has squeezed household consumption and offered dismal returns to savers while funneling all available resources to investment. And here’s the headline: It doesn’t usually end well. “Very few developing countries have become advanced nations,” he says.
At times, he sounds insufferable, attributing his clairvoyance to a knowledge of history that other economists ignore. But it’s also true that China finds itself uniquely distended, after slamming its way through the 2008 global financial crisis by ramping up debt and force-feeding investment in new factories, residential complexes and transportation infrastructure. Maintaining China’s nearly 50 percent investment rate — maybe the highest sustained investment boom in history — is impossible, economists agree, but nudging it down is extremely painful, even if household income continues to rise, as all the industrial capacity aimed at supporting that growth is suddenly superfluous. (There’s also the pain felt by commodity exporters around the world.)
So what’s Pettis’ grand prediction today? That during the decade of current President Xi Jinping’s term, China will enjoy only an average growth rate of 3 to 4 percent, down from 10 per cent in the previous 10 years. That suggests a few really bad years ahead, perhaps starting now. The view is gaining traction: Hong Kong fund manager Geoffrey Barker at City Financial Investment Company says that China’s current stock market meltdown is the result of too much borrowing throughout the economy and warns of an “inevitable” recession. “Nobody here really believes that GDP is running at 7 percent — 3 percent maybe.”
Not everyone agrees with Pettis. Nicholas Lardy, China economist at the Peterson Institute for International Economics, a nonprofit think tank, cites evidence that China has already entered a virtuous cycle in which rising household income and consumption is stimulating the growth of labor-intensive service industries, giving a strong counterweight to the slowdown in investment. China’s continued control over the economy also gives the government tools to manage the transition without crisis, he adds, provided it can overcome political opposition from entrenched interests. “I’ve been skeptical of the Pettis hypothesis from the outset,” Lardy says.
Less subject to theorizing, perhaps, is Pettis’ record as a music entrepreneur. Pettis dipped his toe into the New York club scene in the 1980s, and then founded D22 in Beijing with a partner in 2006, only to close it down in 2012 on the grounds that the music club had become unpleasantly popular, with crowds lining up to get in and — horror of horrors — nods in tourist guidebooks. “I’m interested in what young musicians are doing,” says Pettis, preferring on-the-edge Chinese groups such as White or Carsick Cars. Now performances of edgy music have moved to XP — smaller, more obscure, perhaps purer. As for fast growth? Well, maybe it isn’t what it’s cracked up to be.