Michael Pettis on Global Fracture: Capital Flows, Inequality, and the Ineffectiveness of Trade Policy

Michael Pettis argues that the COVID-19 pandemic has not fundamentally altered the global economic trajectory but has significantly accelerated pre-existing problems, particularly rising income inequality, stagnant growth, and increasing debt. He contends that the globalized trading system is pro-cyclical, where worsening income inequality exacerbates trade imbalances, which in turn puts more pressure on income inequality. This dynamic, he emphasizes, is a structural issue far broader than the US-China relationship or the personalities of leaders like Trump and Xi Jinping, with global trade as a share of GDP having peaked and begun contracting around 2011-2012, making current geopolitical tensions and protectionist tendencies an inevitable outcome.

Pettis illustrates these structural flaws using the European experience, particularly the relationship between Germany and peripheral European countries like Spain. He explains that German labor reforms in the early 2000s, which suppressed wage growth, led to a massive transfer of wealth from households to businesses, causing a surge in German savings. Due to the structure of the Eurozone, Germany was able to export these excess savings to other European countries, leading to an explosion of household debt and asset bubbles in places like Spain. He draws a parallel to the US, which, despite high income inequality, has a low savings rate because it acts as a net importer of global excess savings, driving down its domestic savings through mechanisms like dollar appreciation, asset bubbles, or increased household debt, rather than stimulating productive investment.

Pettis critically assesses current US trade policy, particularly the use of tariffs. He argues that tariffs are largely ineffective in addressing trade imbalances driven by capital flows rather than comparative advantage. If a country like China exports excess savings to the US, it must run a current account surplus, and the US a deficit. Tariffs might shift the bilateral deficit away from China, but the overall US deficit and China's overall surplus will persist because the underlying capital flow imbalance remains. This highlights a fundamental misunderstanding of modern trade dynamics, where capital flows, driven by factors like flight capital, investment fads, and reserve accumulation, dictate trade balances, not vice versa.

For practical insights, Pettis suggests that the most effective way to address these global imbalances is through policies that redistribute income downwards, thereby increasing consumption demand and stimulating business investment. If collective global action on income redistribution is not feasible, he proposes that countries like the US should consider capital controls to manage the inflow of foreign excess savings. He also acknowledges the role of domestic US policies that exacerbate inequality, allowing the wealthy to influence politics and enable tax avoidance, further contributing to the structural issues that globalization has amplified. The discussion concludes by touching on China's internal dynamics, where policies have historically transferred wealth from households to businesses and local governments, creating a high savings rate that must be exported globally.

"the coven 19 pandemic... has had a pretty important impact not so much in changing the trajectory or the direction in which the global economy was moving but really in accelerating a whole series of problems that were already implicit that were already embedded within our currently globalized system"

"it's not just wrong to see this as a trump sheep problem it's also wrong to see this as a china-us problem the problem of globalization is much bigger than that"

"in my 2013 book... the great rebalancing i argued that all of this was inevitable we were going to see a contraction in global trade and we were going to see as part of that a rise in geopolitical tensions"

"basically what the labor reforms did in germany was they transferred wealth from households in the form of lower wages to businesses in the form of of higher profits"

"when tons of money flow into a country it's almost always terrible for that country you almost always have bubbles etc"

"investment really isn't constrained by savings there is an awful lot of savings interest rates have been at the lowest in history large companies in europe and the us sit on massive piles of cash and they have nothing to do"

"the u.s doesn't need money from abroad before covid 19 our interest rates and they still are were at the lowest in our history and companies were sitting on huge pools of cash and the only thing they could figure out what to do with it is to buy back stocks or just to sit on cash nobody was investing"

"the u.s cannot control its savings rate as long as it has an open capital account its savings rate is equal to definition by its level of investment minus the amount of foreign capital coming into the u.s it's just an accounting identity"

"tariffs are irrelevant because if the u.s puts tariffs on chinese goods that might reduce the u.s deficit with china but as long as china is exporting a hundred dollars of excess savings to the u.s china will still run a hundred dollars surplus except not with the us and the us will still run a hundred dollar deficit except not with china"

"the best way to address but for the whole world to address these imbalances is to redistribute income downwards so that we can increase consumption demand which will then increase business investment"