Wei Shangjin, a Chinese top-level economist: How to avoid the trap of "deflation and debt".

Author: Wei Shangjin, Visiting Professor, Fanhai International School of Finance, Fudan University, and Tenured Chair Professor at Columbia University (Source: Phoenix Finance)

Wei Shangjin: How to regain vitality in a divided and mediocre world economy

This article is a speech by Wei Shangjin, visiting professor of Fanhai International School of Finance, Fudan University and tenured chair professor of Columbia University, at the "2023 Phoenix.com Finance Annual Conference".

Hello everyone, it's a pleasure to have the opportunity to share some of my thoughts with you. My topic for this topic is "How to regain vitality in a divided and mediocre world economy".

There has been a divergence in world economic growth, with growth in developed countries much lower than in developing countries. In fact, there is also a phenomenon of differentiation among the developed countries, the US economy is relatively good, and the hard landing that has been worried about in the past year or so has not yet appeared in a depression, which has greatly increased the probability of a soft landing for the US economy, but the situation in other developed countries, especially the euro zone, the United Kingdom, and other countries is very bad.

This is certainly not surprising, because the United States has benefited from two things, one is that the wars in Europe and the Middle East have pushed up energy prices, and the United States is now a net exporter of energy, so this situation is not a negative shock to the US economy as a whole. In addition, the war in the two regions has also increased the demand for weapons as an export commodity in many countries, the United States is the world's largest arms exporter, while most European countries are net importers of energy, and they are very close to the war zone, so Europe has been hit negatively twice.

Most developing countries, if they are food importers, or energy importers, will also have a negative impact on their economies. Therefore, the economic performance of Latin America, Africa and other countries is not particularly good, and the relatively good performance is the developing country group in Asia, which is the fastest growing place in all regions of the world.

Now there are some institutions that are concerned that China's economy will not be able to fully recover as expected after the epidemic. The International Monetary Fund (IMF) originally revised China's economic growth rate upward in 2023, from 5.2% to 5.4%, but at the same time it lowered China's economic growth rate to 4.6% next year. Despite this, China is still one of the few large economies (both developed and developing) with relatively good growth. The only country that can sustainably grow faster than China is India, with forecasts of around 6.3% this year and next.

Of course, there is still room for China's economy to continue to improve relative to its potential growth rate. In the short term, neither the investment confidence of enterprises nor the consumption confidence of residents have fully recovered to a level consistent with the potential growth rate.

In both the short and medium term, China's economy has some challenges to address. Short-term challenges include how to further enhance residents' consumer confidence and business investment confidence, how to manage the negative impact of geopolitics on economic development, how to block the negative spillover of the adjustment of the real estate industry to other industries, how to effectively stimulate economic growth in the context of high debt leverage between local governments and enterprises, and how to avoid the double trap of inflation and debt. There are many long-term challenges, one of the most important of which is how to hedge the downward pressure on economic growth from negative growth in the working-age population.

Short-term and long-term challenges can be discussed, and given my limited time, I would like to focus on a very brief conversation on how to avoid the "deflation plus debt" trap.

At the outset, I would like to point out that deflation and high debt are a very dangerous combination for economic growth. The Great Depression of the thirties in the United States, which saw deflation, negative CPI growth, and relatively high debt, made it difficult for the economy to develop. In the past, the so-called lost 10 years, lost 20 years, and lost 30 years of the Japanese economy were actually the phenomenon that the economy was always hovering around deflation, and then there was a relatively high level of debt in the economy.

The reason why deflation and high debt are a dangerous combination is very simple. In the case of deflation and higher debt, from the perspective of enterprises, because debt is denominated at nominal value, in the case of deflation, the actual level of corporate debt is getting higher and higher, and then it is difficult to obtain financing, and there is no bank or capital market willing to provide better financing for such enterprises, so it is very easy for the situation that the capital chain of enterprises is broken.

Also, let's say I'm a business, in the case of deflation, my customers will think that my product will be cheaper after 6 months than now, and after 10 months or so it will be cheaper than now, and no one wants to buy my stuff, so it will also artificially create a lack of demand for me, which is manifested in the form of a lack of interest in my investment.

Similarly, assuming that most of the residents think that it is deflation, once the phenomenon of deflation becomes a normal development, residents will also have expectations that the expected price will be cheaper in six months than now, and even cheaper in ten months, so everyone will postpone consumption, and the behavior of postponing consumption will also cause the appearance of insufficient demand, and the background behind it is caused by this deflation. Therefore, deflation and high debt are very dangerous combinations, and once households and businesses have formed such expectations, it will be more difficult to pull them out.

The Chinese economy has not yet fallen into such a trap, but it is teetering on the edge of the trap, and in this sense, it needs to step up policy efforts to pull the economy back from the brink of the deflation and debt trap.

Fiscal policy is useful, but stronger and stronger monetary policy, coupled with structural reforms, is indispensable and is the most important policy to pull the economy back from the brink of a combination of deflation and high debt. Under the state of our domestic economy, it should be said that there is room for a stronger and more powerful monetary policy, and the current monetary policy is not strong enough and not strong enough to achieve this goal.

The reason why the policy is not strong enough and not strong enough may be that there are several worries: one is the fear of a sharp depreciation of the renminbi exchange rate; the second is the fear of high inflation in the American and European style; the third is the concern that the loose monetary policy is ineffective and does not seem to be very effective in the past; and the fourth is that there is limited room for further easing of the monetary policy, and there seems to be little room for further easing.

My personal opinion is that every one of these concerns may not be valid.

First of all, we are worried about the sharp depreciation of the RMB exchange rate, and we must realize that the exchange rate itself is not a policy goal, but only a policy tool. Our choice is not to say whether to let the exchange rate depreciate, if it is simply to choose whether to depreciate, of course, we want to choose the stability of the exchange rate, but if our choice is to let the economy decline sharply, or let the exchange rate have more fluctuations, obviously it is more important to keep the economy. If, in the course of the implementation of the goal of preserving the economy, a temporary depreciation of the exchange rate through a stronger and more forceful monetary policy would not be a big deal, and that the depreciation of the exchange rate could increase external demand by increasing international demand for domestic goods and services, which might be more beneficial to the recovery of the economy. After the economy recovers, the renminbi will naturally appreciate again and return to its original value.

Second, the fear that a monetary policy that is too strong will lead to high inflation like in the United States and Europe in the past year and a half, which should be too much for the current economic fundamentals. Because the problem we are facing now is just the opposite, we don't need to worry about a large inflation, but we are worried that we are already hovering around the deflationary periphery, and once the deflationary expectation becomes the expectation of residents or enterprises, the cost will be very high if it is reversed in the future, so there is no need to worry.

The third is that some people say that we have tried before, and we have lowered the interest rate a little bit, and it seems that we have not seen a great effect. This is actually a very easy answer, because the limited efficiency of small movements in the past does not mean that stronger and more powerful movements will be ineffective.

The final concern is that there is limited room for further easing of monetary policy. Some people say that our interest rates seem to be very low, if they were low compared to a few years ago, but the comparison is not complete. For example, compared with most of the developed countries, Japan and the United States, our bank reserve ratio is still relatively high, there is room for continued easing, even the policy interest rate is still room to continue to relax, and now our policy rate is still far from zero, even if it is close one day in the future, the so-called quantitative easing policy of the major central banks in the past year is also a tool that can be considered. Therefore, the concern that there is no room for further easing of monetary policy is not well founded.

Of course, what I am emphasizing now is that we need to use a stronger and stronger monetary policy to avoid falling into the trap of deflation, and if we can better solve the trap of deflation and debt, we need to make a series of structural changes. I hope that our other speakers will be able to address what kind of better structural reforms can continue to be rolled out to bring China's economy back to its potential growth rate.

Thank you!