Back in October, I laughed off the latest China GDP data as utterly fabricated.As it turns out, I was not the only one. China expert Gordon G. Chang (author of The Coming Collapse of China) is more than skeptical — he has the data to question much of China’s growth miracle.

Spoiler alert: Its been wildly exaggerated:

“Beijing, in the 1990s, ordered factories to churn out goods in periods of low demand, and there are indications that officials are resorting to this tactic now. While optimistic analysts point to astounding car sales–up 70.5% in July, 94.7% in August and 83.6% in September–there are reports that central government officials have ordered state enterprises to buy fleets of vehicles and that these businesses are storing them in parking lots across the country. These stories are as yet unconfirmed, but they are consistent with statistics showing that gasoline sales have been flat this year–up only 6.4% in August, for instance, and sliding since then from all indications. So here’s another question: At a time when economic activity is supposedly rising at a quick pace, how can large increases in passenger vehicle sales not be accompanied by corresponding surges in fuel usage? (emhasis added)

The answer is that Beijing’s statisticians have gone back to their old tactic of making up figures to support the Politburo’s predictions. The Chinese economy is probably growing due to state-led investment, but it cannot be doing so at the rates claimed. Wen Jiabao’s stimulus plan is, above all, grossly inefficient. For all the money he is pouring into the economy, the country is getting a small return in economic output. That’s why Premier Wen, despite the high growth numbers he’s been reporting, consistently refuses to end his stimulus program. If his numbers were real, he would be worried about overheating. But he’s apparently not.”

Gee, whoever would have guessed that a Totalitarian government would lie in its official data?

Previously: Who Believes China’s ‘Bernie Madoff’ Data? (October 22nd, 2009) http://www.ritholtz.com/blog/2009/10/who-believes-chinas-bernie-madoff-data/

Source: China’s 8.9% Growth? No Way Gordon G. Chang Forbes, 10.23.09 http://www.forbes.com/2009/10/22/china-growth-gdp-economy-opinions-columnists-gordon-g-chang.html

Just as Asian economies started to recover from the global recession, policymakers and markets have started to worry about unwarranted asset price increases. While the worries are global, especially in the case of stock markets, the risks of asset prices bubbles seem particularly high in Asia, where abundant liquidity is driving up prices of all sorts of assets, from Hong Kong and Singapore real estate to Chinese art.

Where is the liquidity coming from? Capital inflows have received a lot of attention lately. Financial capital is flowing into Asia, attracted by the continent’s relatively good economic prospects. More important, for most economies, is a dramatic easing of domestic monetary conditions since late 2008 that has fueled domestic liquidity.

In part, the easing of monetary conditions in Asia was deliberate, a policy response to sharp weaker growth. However, some of the easing of monetary conditions was not deliberate. Economies with an exchange rate somewhat or completely fixed to the US dollar and fairly open capital markets are “importing” the loose US monetary policy. In some economies, those imported monetary conditions sit oddly with domestic economic conditions. In many Asian economies, spare capacity is much smaller than in the US and cyclical unemployment much lower.

Against this backdrop, prominent policymakers in Asia have warned of the threats posed to financial stability by US monetary policy. The head of the China Banking Regulatory Commission, Liu Mingkang, has warned that the FED’s low interest policy is fueling “arbitrage speculation and thus global asset prices, speculation in stock and property markets and created new, real and insurmountable risks to the recovery of the world economy”. This followed earlier similar comments – but focused on Asia – from Hong Kong’s Chief Executive Donald Tsang Yam-Kuen.  

The US monetary policy stance itself does not seem inappropriate, given the depressed state of the US economy, with unemployment at over 10 percent. Moreover, there is no credit growth in the US at the moment. The main problem for Asia is the importation in a globalized world of US monetary conditions via fixed or managed exchange rate regimes to economies in very different economic circumstances. The worries expressed by these policymakers underscore the tensions that this state of affairs generates at the moment. 

What should governments do to mitigate these risks? Governments in several Asian economies have tightened up prudential regulation and used other administrative measures. They haveincreased loan-loss coverage ratios and minimum down payments for mortgages and restricted lending to property developers. China’s government also took steps to try to avoid new lending going to the stock market and increase the supply of stocks by allowing IPOs again. Taiwan banned foreign investors from putting money into Taiwanese fixed-term deposits. But, except for Australia, Asian governments have so far refrained from tightening overall monetary policy.

Looking ahead, more prudential and other administrative measures can be taken, such as more increases in loan-loss and minimum down payment ratios and higher reserve requirements. Administrative measures may not be enough, though. Adjustments to monetary and exchange rate policy may be needed. To decide what to do in this area, in my view policymakers should first determine what the main problem is: capital inflows or (too) rapid domestic liquidity creation. And, if too rapid domestic liquidity creation is the main problem, to what extent is this because of loose monetary conditions imported via the exchange rate regime?

If capital inflows are a big problem, compared to domestic liquidity creation, countries cannot rely too much on higher interest rates to dampen financial risks, because the increase in capital inflows due to the higher interest rates may outweigh the impact on domestic liquidity. This may especially be the case in some of the smaller, financially more open economies in Asia. If the openness of their capital market creates such big constraints, they should consider measures to control or discourage capital inflows. They can also absorb some of the pressure by allowing their currencies to strengthen. East Asian countries tend to be concerned about loosing competitiveness if they let their currency strengthen unilaterally. With so many countries facing the same issue, it would make sense to strive for more cooperation on exchange rate management, formally and informally.

If capital inflows are not a major problem but the cyclical differences vis a vis the US mean that loose monetary policy is very inappropriate for domestic economic conditions, there may be room to tighten monetary policy, including by raising interest rate. In my view, this is the situation in China, where the role of capital inflows compared to domestic liquidity creation is smaller than many think. In my view, policymakers have at times been unnecessarily reluctant to raise interest rates. In the first half of 2009, net financial capital inflows were equivalent to 3.3 % of domestic credit creation. There have been years when this ratio was higher, and it is likely to be higher in the second half. But, net financial capital inflows are likely to remain modest in size compared to domestic liquidity creation. Thus, given China’s capital controls and the relatively small role of capital inflows, the pros of higher interest rates seem to outweigh the cons. This may be the case in other Asian countries as well, particularly if such moves are flanked by tightening capital controls further.

Some are reluctant to tighten monetary policy because of low inflation, the traditional trigger for monetary policy action. However, the recent global financial crisis has shown the dangers of neglecting asset price increases in monetary and financial policy making. With monetary policy in key high income countries traditionally geared only towards inflation, monetary policy was loose for too long, even as asset prices rose to levels deemed worrisome by many.

In all cases, introducing more exchange rate flexibility would also help discouraging inflows. By introducing useful two way risk on the foreign exchange market, a more flexible exchange rate gives monetary policy more independence to be in line with domestic needs.

In addition, opportunistic timing of structural reforms can reduce risks on asset prices and quality. The supply of financial titles can be increased, by financial sector deepening, including in the bond and equity market. Where interest rates on bank deposits are still capped, easing the  caps and stimulating the development of more long term saving instruments would help absorb financial surpluses.

Finally, opportunistically introducing or increasing capital gains taxes on equity and real estate would reduce pressures as well. As Asian growth prospects are likely to continue to differ significantly from those in the US in the coming years, this may well be a good time to take the steps needed to make monetary policy more independent, so that the monetary stance can be more in line with domestic economic conditions, and to opportunistically time structural reforms.

In recent weeks I have read articles in the economist arguing that there is no bubble in Chinese property. I am not in that camp and believe that there is a bubble that is getting to dangerous proportions.

At last the FT is taking this issue seriously. I will not repeat the reasons - some are covered below. Just think Japan in the late 1980's and Japan's subsequent growth rate ever since.

The problem is a lack of alternative investments for the cash rich in China and loose lending by out of control banks.

This article represents a useful introduction.

Fears of China property bubble [FT]

A large bubble is forming in China’s property market as a result of Beijing’s credit-driven stimulus programme, one of the country’s most prominent real estate developers warned.

Zhang Xin, chief executive of Soho China, one of the country’s most successful privately owned property developers, told the Financial Times the asset bubble was leading to rampant wasteful investment in the sector, undermining the country’s long-term growth prospects.

“Real estate prices should only go up because people want to actually use the space, but at the moment we can see more and more empty buildings across the whole country and in every real estate segment,” Ms Zhang said. “The rising prices are a direct result of so much money coming from the banks and the Chinese banks should be very worried.”

Ms Zhang’s assessment was echoed by Fan Gang, a member of the central bank’s monetary policy committee, who warned on Wednesday that real estate in cities such as Beijing, Shanghai and Shenzhen was expensive and there was a growing risk of asset price bubbles.

Urban property prices in 70 big and medium-sized Chinese cities rose 3.9 per cent in October from a year earlier, accelerating from September’s 2.8 per cent rise, according to government figures.

Price rises in top-tier markets such as Beijing and Shanghai have been much faster. Analysts say the rebound has largely been driven by an unprecedented government-led expansion of bank lending. It is also being driven by government policies, including tax breaks, low interest rates and smaller down-payment requirements.

Investment in real estate development, a key driver of economic growth, rose 18.9 per cent in the first 10 months of the year on a year earlier, a marked acceleration from 17.7 per cent growth in January-September.

Ms Zhang said the current speculation should be a serious warning for the industry and the general economy.

“In Manhattan, they have vacancy rates of 10-15 per cent and they feel like the sky is falling, but in Pudong [the central business district in Shanghai] vacancy rates are as high as 50 per cent and they are still building new skyscrapers,” she said.

“If you look at GDP growth, then China looks like a new engine driving the global economy, but if you look at how growth is being created here by so much wasteful investment you wouldn’t be so optimistic.”

Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any opinions expressed by outside contributors. We encourage cross-linking but must insist that no forwarding, reprinting, republication or any other redistribution of RGE content is permissible without expressed consent of RGE.   

The blog post title says it all. These are great pictures that should be seen to be believed.

Some make for very depressing viewing and are very far from the hotel in central Beijing that I recently stayed at. Amazing Pictures, Pollution in China [China Hush]

My meetings in NY and DC were fairly different from the meetings I had in February.  This time around I got the impression that far more people in the US (although still a minority) understand how risky the Chinese recovery has been and how trade tensions are likely to result as a consequence of the stimulus.  In fact I have the sinking feeling that over the next two or three years I am going to find myself spending an awful amount of time thinking or writing about trade disputes between China and the rest of the world.Regular readers know that for me the key source of China’s high savings and trade surplus is the large excess of the growth rate in national income over household income, caused in large part, I believe, by policies that systematically transfer income from the household sector to investment, SOEs and large producers.  Until these policies are reversed I do not think it is meaningful to talk about China’s rebalancing.  Just before President Obama came to China President Hu gave a speech which my friend Dan Rosen in his November 13 Rhodium Group report described as a “stirring speech about a policy big bang to promote consumption-led growth.”  Dan is skeptical, and I am adamant – a surge in consumption will not happen except perhaps briefly as a consequence of government subsidies and anticipated consumption.

In Washington I had the chance to meet someone I admire a great deal, Nick Lardy at the Peterson Institute, and although I shouldn’t put words in his mouth so as not to misrepresent him, I am glad to say that he seems to agree with the analysis of Chinese high savings as a consequence of policy-related constraints on household income growth, although he thinks currency undervaluation may have a greater impact on high savings than low interest rates, whereas I think it is the other way around.  In fact more generally I think this argument has become increasingly influential, and more and more analysts seem to be taking it up, both inside and outside China.

In that light I read earlier this week a fascinating and perhaps important article by Hung Ho-Fung in the current issue of the New Left Review, in which he argues that China’s development model has left it dangerously vulnerable to changes in US demand, and that these polices include repression especially of rural income.  According to Hung:

The PRC’s urban-biased development model, then, is the source of China’s prolonged ‘limitless’ supply of labour, and thus of the wage stagnation that has characterized its economic miracle. This pattern also accounts for China’s rising trade surplus, the source of its growing global financial power. However, the low wages and rural living standards that have resulted from this development strategy have constrained China’s domestic consumer market and deepened its dependence on the global North’s consumption demand, which increasingly relies on massive borrowing from China and other Asian exporters. As those other exporters have been integrated with China’s export engine through the regionalization of industrial production networks, the vulnerabilities of the Chinese economy have turned into weaknesses of the East Asian region as a whole.

Hung goes on to make a point that I wish many more would make.  When people like me warn about continuing domestic imbalances within China and the difficulty that China will face in its transition, we are often attacked for “blaming” and criticizing China.  Monday I was at a conference consisting of many prominent European and Chinese (and a few American) analysts who were discussing global imbalances.  At the end of one panel a member of the audience, who turned out to be from the Ministry of Commerce, demanded the right to make a rebuttal and set off on a fairly strange harangue in which she lambasted, to everyone’s bemusement, any attempt to assign China responsibility for any aspect of the crisis as well as any suggestion that its fiscal stimulus was worsening the underlying imbalances.  China has not, apparently, made even minor policy mistakes at all in the past decade and especially in the past year.

The nationalist argument

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What a difference seven years makes. No one had a problem with Japan having super low interest rates and stoking a global carry trade, nor with the US running overly loose monetary policy that led to a real estate bubble that spread its impact beyond our borders via the creation of toxic mortgage product sold far and wide.

But one difference this time is now the dollar, rather than the yen, looks like the best funding currency, and the dollar is a deeper market, so the scale of potential damage is much greater. Second is that a lot of countries are running loose money policies, but they are at least making some credible noises re tightening (whether they follow through is another matter, of course). The US, by contrast, has made clear that it is keeping things easy-peasey for the foreseeable future. And the US (starting with the Greenspan era) has signaled any hawkish moves well in advance, so the odds that the Fed will have a sudden change of heart are just about zero.

Now, to play devil’s advocate, one could argue that the loose money policy is warranted. There is tons of slack in the economy, unemployment is high and rising, capacity utilization stinks. Surely raising rates now would be the worst move possible, right?

The authorities are completely responsible for the messes on two different fronts that intersect to create monetary policy dilemma. Going below 2% for Fed funds was a huge error (well maybe you could justify 1% as a very short term expedient), but the Fed is now painted in a corner. But second, and the much bigger issue, is that (as everyone can see) all this cheap money is not going into the real economy. A few very high quality borrowers are getting good rates; everyone else finds credit scarce and costly. So spreads are higher than before, and even absolute rates are often higher expect in markets like mortgages where the Fed has intervened.

Now some readers will correctly say that overly loose lending is what created the problem, and we need to undo that, but they are conflating two issues. Tightening up on WHO gets credit and HOW MUCH they get is separate from pricing. If this was mere improved standards, you’d expect to see more discrimination within various types of borrowers. But instead, across entire swathes of borrowers, particularly consumers and small businesses, banks have simply turned off the spigot. This has little to do with a return to prudent practices. In fact, it illustrates a real cancer: that across consumers and many small business owners, old-fashioned multi-variable decision-making (which included some verification of income) has been replaced by heavily or entirely FICO based systems. Those systems failed utterly. But they were cheap to operate, banks have no intention of reverting to earlier, more costly approaches. So we have a credit assessment process that is broken, but no one wants to admit it.

So if all this loose money isn’t getting to the real economy, there should be no reason not to raise rates, right? Wrong. This little procedure is again, entirely about the banks, screw the real economy and everyone in it. First, low rates (and now a steep yield curve) are an ideal setting for banks to make money. Greenspan pulled the same trick in the wake of the S&L crisis, and it enabled banks to rebuild their very wobbly balance sheets comparatively quickly (I’m amazed at the revisionist history about the early 1990s banking woes, which also involved pretty serious damage from dud LBO loans, and left the US banking system seriously undercapitalized). This plus high spreads makes ofr a very attractive environment for any new business.

But the second reason for keeping rates low is explicitly to keep asset prices aloft. The bubble is an explicit goal of policy. Remember, early in the crisis, they was talk of the markets being irrationally depressed. Funny how it is only prices that are seen as inconveniently low, and not ones that are insanely high, that are criticized.

But to cite Richard Nixon parodists: Let us make one thing perfectly clear. These monetary shenanigans are in no small measure the result of the utter failure of nerve late last year and early this year, to take sick institutions and resolve them. In many cases might not have entailed the bogeyman of nationalization (as in protracted government ownership), but throwing out the old top management and board, and forced debt to equity conversions. Cleaning up the banks was never treated seriously as an option, when the track record clearly shows that that is the fastest, least-cost way to deal with a financial crisis.

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I would be especially interested to hear the views of NC’s Asian readers on this post because Japan and China are usually considered antagonists with a long and sordid past.

Andy Xie thinks the Fed is on an inflationary path.  Last month, he wrote an article in Caijing which says that ‘stagflation lite’ is the Federal Reserve’s preferred outcome. What’s interesting is his recent article about the need for China and Japan to join forces under an ASEAN umbrella, rejecting the APEC umbrella shared with the U.S.

In last month’s article, Xie said:

The bottom line is that, regardless what central banks say and do, the world will be awash in a lot more money after the crisis than before — money that will lead to inflation. Even though all central banks talk about being tough on inflation now, they are unlikely to act tough. After a debt bubble bursts, there are two effective options for deleveraging: bankruptcy or inflation. Government actions over the past year show they cannot accept the first option. The second is likely.

Hyperinflation was used in Germany in the 1920s and Russia in late 1990s to wipe slates clean. The technique was essentially mass default by debtors. But robbing savers en masse has serious political consequences. Existing governments, at least, will fall. Most governments would rather find another way out. Mild stagflation is probably the best one can hope for after a debt bubble. A benefit is that stagflation can spread the pain over many years. A downside is that the pain lingers.

If a central bank can keep real interest rates at zero, and real growth rates at 2.5 percent, leverage could be decreased 22 percent in a decade. If real interest rates can be kept at minus 1 percent, leverage could drop 30 percent in a decade. The cost is probably a 5 percent inflation rate. It works, but slowly.

If stagflation is the goal, why might central banks such as the Fed talk tough about inflation now? The purpose is to persuade bondholders to accept low bond yields. The Fed is effectively influencing mortgage interest rates by buying Fannie Mae bonds. This is the most important aspect of the Fed’s stimulus policy. It effectively limits Treasury yields, too. The Fed would be in no position to buy if all Treasury holders decide to sell, and high Treasury yields would push down the property market once again.

I certainly agree with him. You don’t have to be in the hyperinflation camp like Marc Faber to think the Fed takes Ken Rogoff’s suggestions about 6% inflation seriously. In a May post, I said:

Basically, the Fed wants to inflate our way out of this depression – that’s the dirty little secret.  There is really no other policy choice because the mountain of debt in the United States is immense.  And I think Bernanke, Geithner and Summers have proven they are willing to do anything to reflate this economy and avoid debt deflation dynamics.

And when I say anything, I mean create asset bubbles that are being given intellectual cover by the likes of Frederic Mishkin. This is a policy of economic weakness.

So what should the Asians do?  China is desperate to employ its tens of millions of countryside transplants cruising its cities in search of urban employment. That’s a major reason it keeps its exchange rate fixed to a plummeting dollar, making not just Americans but Europeans irate?  Japan has been in a modern day depression for twenty years. Its sovereign debt-to GDP is now over 200%, risking a downgrade.

Xie says the two should join forces – in part as a rejection of the U.S., which he basically calls a fading power (although the paragraph above points to serious weaknesses in China and Japan as well).

Here is an excerpt of Xie’s article:

Yet the fundamental case for Japan to increase integration with the rest of Asia and away from the United States grows stronger every day. Despite high per capita income, Japan remains an export-oriented economy, having missed an opportunity to develop a consumption-led economy in the 1980s and ’90s. In the foolish belief that rising property prices would spread wealth beyond the industrial heartland in the Tokyo-Osaka corridor, the government of former Prime Minister Kakuei Tanaka pursued a high-price land policy, discouraging the middle class from pursuing a consumer lifestyle as they saved for property purchases…

The point is that Japan has a strong and genuine case that favors more integration with East Asia. The United States is unlikely to recover soon and with enough strength to feed Japan’s export machine again. There is no more room for fiscal stimulus. Devaluing the yen to gain market share is not an option as long as Washington pursues a weak dollar policy. Without a new source of trade, Japan’s economy is doomed. Closer integration with East Asia is the only way out…

Five years ago, I wrote an op-ed piece for the Financial Times entitled China and Japan: Natural Partners. At the time, a prevailing sentiment was that China and Japan were antithetical: Both were still manufacturing export-led economies and could only gain at the other’s expense. I saw complementary demographics and capital: Japan had a declining labor force and China needed to employ tens of millions of youths migrating to cities from the countryside. China needed capital and Japan had surplus capital. And their trade relations indeed tightened, as Japan had increased the Chinese share of its overall trade to 17.4 percent in 2008 from 10.4 percent in ‘04.

Today, the situation has changed. China has a capital surplus rather than a shortage. Demographic complementarity is still good and could last another decade. As China shifts its development model from resource intensive to environmentally friendly, a new complementarity is emerging. Japan has already made the transition, and its technologies that supported the transition need a new market such as China’s. So even without a new trade agreement, bilateral trade will continue growing.

An FTA between China and Japan would significantly accelerate their trade, resulting in an efficiency gain of more than US$ 1 trillion. Japan’s aging population lends urgency to increasing the investment returns. On the other hand, as China prepares to make a numerical commitment to limiting greenhouse gas emissions at the upcoming Copenhagen summit on global warming, heavy investment and rapid restructuring are needed for its economy. Japanese technology could come in quite handy.

An FTA involving Japan and China would be a serious threat to American economic power. You can imagine that policy makers in Washington are opposed to this idea.  Let’s watch to see what kind of rhetoric comes out of Barack Obama’s China trip to see if this issue is discussed.

Xie’s article in its entirety is at the link below.

Source

Andy Xie: Why China and Japan Need an East Asia Bloc – Caijing

Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any opinions expressed by outside contributors. We encourage cross-linking but must insist that no forwarding, reprinting, republication or any other redistribution of RGE content is permissible without expressed consent of RGE.   

Recently, on a China specialist bulletin board, the debate on "the China collapse" hypothesis flared up again.  As you can imagine, things got pretty heated between my colleagues.  I have learned that predicting the future is a losing game, but we can certainly look at facts and bring in some skepticism.  Incidentally, I am working on a project to calculate the extent of borrowing from local government investment entities, which are discussed below.  I am about half way through the provinces, but will update interested readers on my findings in the coming months. Below is my contribution to the "collapse" debate.  

Chiming in among the skeptics, I think we tend to focus on the asset side of China's balance sheet, which is quite impressive to be sure.  However, the Chinese government is also good at hiding its various liabilities (in the accounting sense) through various entities and strategies.  Let's ignore human costs like reduced life expectancy from the environment, lack of social services and work safety for the moment and only focus on financial liabilities.  Among the OECD countries, we see that public debt escalated tremendously due to stimulus programs and financial bailouts. However, it would be mistaken to argue that China accomplished 9% growth without getting into massive debt.  In fact, it got into much more de facto public debt as a share of GDP than the US or Europe did. Read more

As Asia starts down the path to recovery, it is going to have to tackle two issues which are constraining its long-term growth potential: firms that save but do not invest and wealthy households that are reluctant to consume.

At first glance, such behavior seems inexplicable and counter-intuitive.  Let’s imagine for a moment you are an investor—you may well be— you put quite a bit of money into a company to back its expansion plans. Initially, these plans prove successful, and the company makes quite a bit of money. But then the firm ran out of investment ideas. What would you expect them to do?

Surely, you would expect them to return the money you provided, for example by paying it out as dividends. But in the past, prosperous decade before the current downturn this hasn’t been happening in emerging Asia. Firms have been sitting on their profits, not investing them, but not paying them out in dividends, either. That is a puzzle, and a problem.

It’s a puzzle because it’s not obvious why firms should sit on money when they don’t have any need for it. When firms initially started doing this after the Asian crisis of the late-1990s, they had a ready rationale. They wanted to pay down their excessive levels of debt, which during the crisis had brought some of Asia’s largest companies low. But as the years went on, and debts fell, first to safe and then to low levels, it was clear that something else must be going on.

There’s a further puzzling aspect. Economic theory states that households can “pierce the corporate veil” and extract value from a company even if it doesn’t actually pay out profits as dividends. That’s because the retained earnings would increase the firm’s net worth, which would be reflected in its share price. Households could then sell the shares, or borrow against them.

Either way, they could spend more. This theory has been tested in empirical research and found to hold in advanced countries, and some emerging markets. But it doesn’t hold true in China or the rest of emerging Asia. Households simply do not consume more, despite holding valuable financial assets.

Why does this matter? It matters because Asia’s corporate savings puzzle lies at the heart of its economic imbalances. It is precisely the substantial and growing excess of savings over investment in the corporate sector, coupled with subdued household consumption, that over the past decade has produced the region’s large external current account surpluses.

We tried to analyze this mystery in Chapter III of the Asia-Pacific Regional Economic Outlook.

We discovered two vital clues:

• Corporate governance. The higher the level governance, the more shareholders are able to exercise their rights and prevent firms from hoarding cash.
• Financial sector development. The more liberalized the financial market, the less firms hoard cash, because they have easier access to funding and are less worried about being shut out of financial markets. Financial liberalization also allows households to consume against their corporate wealth, because they can borrow using their financial assets as collateral.

These finding have profound implications for policy. For example, the econometric estimates imply that if Asia were to reach the average level of corporate governance in advanced economies, it would be able to lessen corporate savings by as much as 2½ percent of GDP. Similar advances in financial sector liberalization could reduce savings by 5 percentage points.

Resolving the conundrum of firms that save but do not invest, and households that hold this wealth but cannot consume may enable Asia to finally catalyze domestic demand.  It could help to  restore rapid growth, even in a “new world” of softer advanced country demand. Improved corporate governance and further financial sector development may be two remedies worth exploring.

Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any opinions expressed by outside contributors. We encourage cross-linking but must insist that no forwarding, reprinting, republication or any other redistribution of RGE content is permissible without expressed consent of RGE.