“China Rebalancing Has Begun”; What are the Global Implications? Michael Pettis on China Rebalancing, Chinese Price Deflation, and Spain Exit from Euro; Target 2 Revisited

Courtesy of Mish.

Michael Pettis at China Financial Markets has some interesting comments via email regarding much needed China rebalancing and a timeframe for a possible Spain exit from euro.

Pettis On Spain Exit

How will Spanish households react to a default on preferred shares and subordinated bonds, or even a very public discussion about the possibility of such a default?  I don’t know, but I assume that it will speed up deposit withdrawals from the banking system even more.  For that reason it continues to be a very good idea to keep an eye on Target 2 balances.  These serve as a pretty good proxy, I think, for the behavior of depositors.

Things are evolving in Spain exactly as we would expect them to evolve according to the sovereign-debt-crisis handbook.  Unless we get real fiscal union in Europe, or Germany leaves the euro, or Germany stimulates its economy into running a very large trade deficit, or the euro depreciates by 15-20% against the dollar in the next year – all very unlikely, I think – I really see no reason to doubt that Spain will leave the euro and restructure its debt within the next few years. 

Mish Comments on Target 2

Target 2 stands for Trans-European Automated Real-time Gross Settlement System. It is a reflection of capital flight from the “Club-Med” countries in Southern Europe (Greece, Spain, and Italy) to banks in Northern Europe.

Please see Target2 and the ELA (Emergency Liquidity Assistance) program; Reader From Europe Asks “Can You Please Explain Target2?” for a more compete description.

There is much misinformation floating around on how Target 2 works, what Germany’s liabilities are, so please click on the above link if you are interested in target 2 balances.

The following chart from PIMCO article ​​TARGET2: A Channel for Europe’s Capital Flight shows the capital flight through March. The problem has accelerated since then, because of fears in Spain and Italy.

Pettis On China Price Deflation

China’s official GDP growth rate has fallen sharply – on Friday Beijing announced that GDP growth for the second quarter of 2012 was a lower-than-expected 7.6% year on year, the lowest level since 2009 and well below the 8.1% generated in the first quarter. This implies of course that quarterly growth is substantially below 7.6%.  Industrial production was also much lower than expected, at 9.5% year on year. 

In fact China’s real GDP growth may have been even lower than the official numbers.  This is certainly what electricity consumption numbers, which have been flat, imply, and there have been rumors all year of businesses being advised by local governments to exaggerate their revenue growth numbers in order to provide a better picture of the economy.  Some economists are arguing that flat electricity consumption is consistent with 7.6% GDP growth because of pressure on Chinese businesses to improve energy efficiency, but this is a little hard to believe.  That “pressure” has been there almost as long as I have been in China (over ten years) and it would be startling if only now did it have an impact, especially with such a huge impact occurring so suddenly.



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