Preston Pysh  7:20  

I love it. So that’s your background. So now it all makes sense why you were so immersed into this and trying to understand it because of your firsthand experience of seeing all that. 

So here’s the thing that this episode is really titled around China, and understanding the credit growth and everything that’s going on in China right now, because that’s a huge hot item. But before we get there, we really have to start off understanding the dollar and a little bit of a history lesson. So we’ve asked Richard to really kind of go into depth and talk us through this history lesson of the dollar and what has created the circumstances for what we’re seeing that’s happening globally. More importantly, what’s happening over in China right now. 

So we’re getting to that we’re getting to present day China, but we’re not getting there right now. We’re going to start off with a history lesson. We’re gonna sit back, we’re going to put our mics down, Stig and I, and we’re just going to listen with you in the audience on what Richard is about to teach us. So he’s gonna start off back in 1968 when the US came off the gold standard.

Richard Duncan  8:25  

What I realized, watching the Thai economy boom and bubble, and then bust, was that the thing that was driving it was an enormous amount of foreign credit coming into Thailand, and going on deposit in the Thai banks. That led to rapid deposit growth. So the banks had all the deposits and they had to lend out these deposits in order to earn money. So they could pay interest on the deposits that forced very rapid credit growth. 

So I started thinking about where all of this foreign credit was coming from. I studied economics and literature at university both. I enjoy the literature and I did the economics because I wanted to have a job one day. So I’d always enjoyed reading and when I was traveling around the world, I read more and more history books. So once I started doing work in economics, I read a lot of economic history. And what I realized was, well, the global economy now works completely different way than it did under the Bretton Woods System. 

The Bretton Woods International Monetary System was set up after the end of World War Two. Our side one, and they tried to recreate something very similar to the gold standard in the Bretton Woods System. 

Now, this may sound a little dull initially, but it’s very important to understand how the gold standard used to work. Let’s go back, for example, 150 years ago. If anyone had a big trade depths that was France. England’s gold would literally have been put on a ship and sent over to France to pay for the deficit. Since gold was money, the only money basically, England’s money supply would have contracted very sharply. And so they would have had less money, they would have gone into severe recession, unemployment would have gone up, and they would have had deflation. 

The opposite would have happened in France. France would have had more gold, the credit would have expanded, their economy would have boom, and they would have had more inflation. Pretty soon the rich French would start buying more cheap English goods, and the poor unemployed English would start buying so many expensive French goods and trade would come back into balance. The trade imbalances were impossible. That’s the way international trade works.

Preston Pysh  10:56  

And this is… I’m sorry to interrupt, Richard, but this would be completely based on the fact that the conversion rate from that paper currency to the gold would remain fixed, because if they would manipulate that, then that would cause more wrinkles. But we’re assuming that ratio that the banks would hold, call it 30% in gold backing would remain intact between both countries just for simplicity of our example here. Is that correct?

Richard Duncan  11:19  

That’s right. In those days, governments didn’t create paper money. Banks would sometimes issue paper money, but paper money just represented so much gold. When World War I started, all of the European countries went to war with each other and they didn’t have enough gold to fight the war in 1914. So that’s when they went off the classical gold standard and all the European government started printing a lot of paper money that they needed to use to finance all of the government bonds, all of the government deficit spending that they were using to fight the war, to buy war material for the soldiers. 

So all the paper money created during World War I, and all the government debt issued during World War I, that created a worldwide global economic boom called the roaring 20s. And the 20s, by all accounts were fun, but in 1930, all the credit couldn’t be repaid and the International Monetary System collapsed. The international banking system collapsed, global trade collapsed. The policymakers at that time believed in laissez faire and capitalism. They really had no idea what to do. And so everything collapsed, the world went into depression. 

Depression lasted 10 years. During that time, Germany took over Europe, Japan took over most of Asia. World War II started and at that point. The depression is still going on at that point. Then the United States government increased US government spending not by 9% , not by 19%, not by 90%. But by 900%. That extraordinary increase in government spending into the Great Depression. And when the war was over, England and the United States tried to create something quite similar to the gold standard. Problem was at that point, our side had all the gold. You can’t trade in a world where only one side has all the gold. So they created the Bretton Woods System, in which dollars would serve as the new international currency, but the dollars would be backed by gold at $35 an ounce. And other countries, if their central banks accumulated dollars, they have the right to convert those dollars into us gold at $35 an ounce. That was the system from 1945 up until 1971. 

But during the 60s, you started spending too much money on the Vietnam War abroad and on social welfare programs, President Johnson’s Great Society programs and all, and US banks and corporations started investing a lot of dollars, particularly in Europe. So a lot of dollars left the United States, they were accumulated by governments overseas. And those governments abiding along with their right to do so, they converted those dollars into us gold. 

So during the 1960s, the US lost half of its gold reserves. And by 1971, there were four times as many dollars overseas as we had gold available to convert it into. And so in 1971, at that point, we were bleeding gold, and President Nixon, he could have brought about a big recession in the United States, so that the Americans would consume less and import less, but that would, of course, cost him his reelection. 

So instead, Nixon stepped on the economic accelerator and just made things worse. And he said, “Okay, sorry, world, we told you you could convert your dollars into gold, but now you can’t.” And that was the end of the Bretton Woods system. 

Okay, so that happened in August 1971. That was the breakdown of the Bretton Woods International Monetary System. In fact, it had been breaking down before then because up until 1968, there was a law. The US Central Bank, the Federal Reserve, by law, they had to maintain gold backing for every dollar that they issued. At that point, they had to have at least 25% gold backing for every dollar. 

But by that time, the US gold reserves had shrunk so much that they hit the point where they couldn’t issue any more dollars, because they didn’t have enough gold. So President Johnson asked Congress to change the law, so that there will no longer be this legal requirement for the Fed to back dollars with gold. And Congress did change that law in 1968. 

From 1968, there was no longer any gold backing for the dollar domestically. And in 1971, there was also no longer any back in international either. So at that point, the world was in shock, the International Monetary System had collapsed, and no one knew what was going to happen next. And they had hoped to put together a new one or revise it somehow and make it work because under the Bretton Woods System, currencies were all pegged to each other at a fixed exchange rate. Currencies did not move up and down. And also under the Bretton Woods system, trade between countries was in balance. 

People were terrified about what would happen, and no one quite knew what would happen. Well, one thing that happened right away very soon thereafter is we started having very high rates of inflation and we had the oil shock. Oil prices quadrupled and then they quadrupled again. And this wouldn’t have been possible if we’d been on a gold standard, the Bretton Woods System, the US wouldn’t have had enough gold to pay for the oil. Oil wouldn’t have gone higher and stayed higher. 

But under this new system, US didn’t have to pay with gold anymore. It could just pay with paper dollars, or treasury bonds denominated in paper dollars. And those trade started to become unbalanced for the first time in history. 

By the early 1980s, the United States started running truly very large trade deficits for the first time in history. And by the mid 1980s, the US trade deficit was equal to three and a half percent of US GDP, which was unlike anything the world had ever seen before. Most of this stuff was with Japan. 

So Japan had a very large trade surplus with the United States. So Japan is receiving not gold, but it was receiving dollars. But still, the dollars were almost as good as gold. And they started going in Japan’s economy because of Japan’s big trade surplus with the US. Those dollars went into Japan’s banks, because rapid deposit growth just like in France and my earlier example, trade surplus country. So more and more deposits of the Japanese bank started having to lend out more and more credit. And this set off an extraordinary credit boom in Japan. 

And by 1989, there was such an extraordinary economic bubble in Japan. For this reason, because of all of the dollars going into Japan, that the stock market was trading on 100 times multiple property prices had gone through this through the sky. The park around the Imperial Palace in Tokyo was more valuable than California. Then the Japanese bubble pops, as every bubble ultimately does. The reason that the bubble grew so big is because it went on and on. Surplus kept getting larger and larger. And the US unlike England, it didn’t deflect. It didn’t run out of gold. It could keep buying and buying using paper money, or government bonds denominated in paper money. 

So, this trade imbalance caused Japan to turn into an economic bubble. Japan’s bubble popped and economy today is no larger than it was in 1993. If you don’t adjust for deflation, so next, there in the mid 80s there was the Plaza Accord. They tried to bring the US trade deficit back under control. And Germany, G7. Maybe the G5 at the time, reached an agreement to devalue the dollar. The dollar devalued by 50 percent against the yen and the *mark, in the next couple of years after 1985-1987. That devaluation brought the US trade back into balance by 1990. 

But then, in 1990, China’s started really entering the global economy. Asia, entered the global economy with their cheap workforce. So the US trade deficit started growing again. What I saw living in Thailand from 1990 to 1996, I saw extraordinary amounts of dollars coming into this little country, and it blew Thailand into a bubble. In 1997, when the bubble popped in Thailand, it turned out that it wasn’t just Thailand, but it was also Malaysia, Indonesia, and Korea. This was the Asia crisis. All of these economies went into extreme shock and it required the IMF to bail them out very large IMF rescue funds. IMF joint bank, World Bank rescue funds. And again, it was just a lot of foreign dollars coming into these economies, blowing them into a bubble. 

The US trade deficit continued to become larger and larger, and it became larger and larger, particularly with China. China’s trade surplus grew and grew and by 2006, the US trade deficit had grown to be $800 billion. That was 6% of US GDP. And or put differently, that was $2 million a minute. The US was going into debt the rest of the world. 

So of course, as the US trade deficit became larger, the rest of the world’s trade surplus became larger. They were selling $800 billion more to the US. The US was selling to them. So this was extraordinarily fantastic for our trading partners, and for the global economy. The global economy grew hundred billion dollars more than it would have otherwise that year, with a very big multiplier on top of that. 

So the system that came after the Bretton Woods system, there was no new international conference that decided on a new international monetary system. They could never figure out how to make it work. So what came afterwards, it just evolved. You could say naturally, everyone was free to do what they thought was in their best interest. So this post-Bretton Woods International Monetary System, I believe, is best described as the dollar standard because it is the US dollar that is flooding the world as a result of our US trade deficit throwing dollars out into the global economy. 

And so as long as the US trade deficit became larger and larger every year, the global economy boomed and boomed and boom, right up until 2006, when the US went into crisis in 2008. It corrected very sharply from $800 billion, at its peak, to less than $400 billion. So when the US went into crisis, the US stopped importing so much from the rest of the world., and the rest of the world also went into crisis for that reason.

Now, there’s one other very important element to this story. Under the Bretton Woods System or the gold standard, governments could not print money. Gold was money, governments had nothing to do with it. But once the Bretton Woods System broke down, governments were pretty much free to do what they wanted and currency started floating against one another. And it didn’t take our trading partners very long to understand, for instance, the Japanese central bank would print the yen from thin air and use that money, the yen, to buy the dollars coming into Japan and hold down the exchange rate, because if the Japanese exporters are selling a lot of goods in the US, they’re getting paid in dollars. They took the dollars back to Japan. They wanted to convert them into yen so they could spend them at home. But if they’d done that in the free market, again with that appreciated very radically, that would have killed Japanese exports and the economy. 

So the central bank intervene, they printed yen. They use the yen to buy these dollars at a somewhat fixed exchange rate to hold down the value of the yen. And so in this way, the Japanese exporters could convert their dollars into yen and spend them on anything they wanted. But the Japanese central bank ended up buying what turned out to be eventually more than a trillion US dollars that the Bank of Japan obtained by printing money from thin air and buying the dollars. This is where Japan’s foreign exchange reserves.

Once the Bank of Japan, using Japan because they did at first in the 80s, once the Bank of Japan had accumulated a trillion US dollars, well, they had a few choices. They could have buried it under Mount Fuji. They could have burned this trillion dollars, or they could have taken the trillion dollars and then invested in US dollar denominated assets, like US government bonds, corporate bonds and stocks, and the Rockefeller Center, and golf courses all over Hawaii. And as they did, so, this was paper money creation on a previously unimagined scale, starting in the 80s. But growing exponentially ever afterwards, more or less exactly in line with the US trade deficit. But they still to this day, they have a very large trade surplus with the US and the world. But the trade surplus is not owned by the government, that money is not owned by the government. The manufacturers get to keep all the trends surplus money. The Bank of Japan only keeps the dollars that they buy by printing money. So these were Japan’s foreign exchange reserves. They still have them. 

But later on, China surpassed Japan as the largest exporter to the US, and largest trade surplus with the US. When the Berlin Wall fell in 1989, the United States reconsidered its relationship with China. Up until then, China had been a communist Cold War enemy, and we didn’t trade with China. But after communism started collapsing, the idea was, “Okay, let’s let them sell us some stuff and maybe they’ll become capitalists.” 

In 1990, China didn’t have a trade surplus with the US. But it didn’t take long for China’s trade surplus to grow and grow and grow and explode. It became enormously large. Last year, China’s trade surplus with the US was 370 billion dollars, a billion dollars a day. So here we have another story. The same story again. Chinese manufacturers sell their goods in the United States. They received dollars. It took the dollars back to China. More and more and more of them, they wanted to convert them into Chinese renminbi, or Yuan. But if they converted all those renminbi into dollars, Chinese currency would have quadrupled in value. And that would have stopped China’s export machine and stop China from growing. So China’s central bank, the PBOC, the People’s Bank of China, they began printing money from thin air and they bought all these dollars coming into China. So when the Chinese exporters converted their dollars into renminbi, the Bank of China bought them at a fixed exchange rate. So the currency wouldn’t depreciate.

So by any definition of the word manipulation. This was manipulation of their currency, they kept their currency from appreciating. If they have not done this, the Chinese currency would have appreciated extraordinarily, and their trade surplus would have stopped growing. So in this way, China accumulated $4 trillion worth of foreign exchange reserves by printing the equivalent of $4 trillion worth the Chinese yuan. 

And it wasn’t just China in Japan, but many of the other countries around the world that we trade with did the same thing. So total foreign exchange reserves grew to $12 trillion in total. And what that means is that the central banks of our trading partners printed $12 trillion from thin air, just between the year 2000 to 2014. It went from 2 trillion to 12 trillion. So that’s $10 trillion of fiat money creation and in a 14 year period. This was fiat money creation on a scale that Adam Smith would have found completely unimaginable. 

Stig Brodersen  29:15  

And Richard, it seems like all these problems well, partly the stem from the expansion credit, but also stems from the account deficit in the US. So would it be correct to say that if the Americans would spend less money and then transition into having a surplus, instead of a deficit, US could basically just turn the tables and the US start to manipulate their currency the same way as the Japanese and the Chinese? Is that a, I wouldn’t call it a disillusion, because clearly this is a currency war? But do you see where I’m going with this? Would that be the best way of fixing the problems with currency manipulation from the US?

Richard Duncan  29:55  

That’s a very important idea to think about. Let me just say conclude on that last point, though, that once China had accumulated the $4 trillion of foreign exchange reserves… As they accumulated it, they bought more and more US dollar denominated assets like treasury bonds, corporate bonds and stocks. So that pushed up the price of the US government bond. And when the bond prices go up, the yields go down. So the interest rates went lower and lower and lower, and also because the Chinese goods were made with $5 a day labor. They were very inexpensive. So we had disinflation, inflation rates went lower and lower and lower, and interest rates went lower and lower and lower, and total foreign exchange reserves in the world grew to $12 trillion to be our money creation. Not all of these reserves were US dollars, but I would say 75% of them were. The other trade deficit, countries like England would have also so there would have been pound in the foreign exchange. reserves. All the trade deficit countries would have thrown off their currency and they would have been accumulated as foreign exchange reserves. 

So this massive amount of investment of these foreign exchange reserves back into the United States that lose the us into a bubble. It helped finance the bonds that were being issued by Fannie Mae and Freddie Mac. Fannie and Freddie borrowed trillions of dollars, a large part of which came from foreign central banks. And then Fannie and Freddie use that cash to buy mortgages, which pushed up property prices and created the property bubble. And meanwhile, interest rates are so low that is fueling the property bubble. Alan Greenspan tried to increase the US interest rates in 2004 and 2005. to cool down the property bubble, increase the federal funds rate, I think it was 17 times but the 10 year bond yield didn’t follow the short end of the yield. kerb up the 10 year bond yield kept going down. And some pesky senator said, Chairman Greenspan you’ve increased the federal funds rate 17 times. Well, and but the 10 year bond yield isn’t going up. It’s going down. Why is that? Mr. Greenspan, I think lied and said, I don’t know. It’s a conundrum. But he must have known that his counterparts and the other central banks around the world were printing a lot of money and buying US government bonds, pushing up their price and pushing down their yield. So in other words, the trade imbalance not only blew the trade surplus countries into bubbles, because those trade surplus countries printed their own currency and accumulated dollars and reinvest those dollars into US dollar denominated assets. It also blew us into a bubble. The bigger the US bubble became, the more money the Americans had to buy things from China and our other trading partners. And so this is how the dollar standard first created this Great economic boom. And now the duck the dollar standard boom has become $1 standard bust.

Now, to answer your question, you need to think about who benefited from this arrangement. The Chinese Communist Party leaders all became very wealthy, a billionaire class emerged. A very large millionaire classes merged. Hundreds of millions of people went into the middle class, and hundreds of millions of very poor Chinese farmers got to work in factories for $5 a day, maybe as much as $8 a day now, which radically improved their lifestyles. The only downside in China was horrible environmental degradation. 

Now, in the US, certain groups benefited and certain groups lost. For instance, the US industrialist, the reason the US corporate profit margins are so wide now is because US corporations move their factories out of Michigan and into Guangdong. In Michigan, they had to pay some people $200 a day to build an automobile. In China, they can pay them less than $10 a day. So their labor cost collapsed by 90%, and their profit margins expanded. 

So the industrialists were all in favor of this new economic relationship with China, and so were the US bankers. The bankers werealso supportive, and as  we know, they supported it because more debt ruined the United States and the bigger the financial markets became, the more of the banks earn. 

Consequently, the high relatively high paying factory jobs cease to exist. The people who would have worked in factories had to move into the service sector, which typically paid much less and generally put downward pressure. So, US wages have been stagnant now for decades, and the middle class is shrinking, and we have much greater income inequality than we’ve had since at least 1929. And this stems from this economic relationship with China, which some people refer to as Chimerica. But so it wasn’t just a matter of China taking advantage of us, the wealthiest classes in the United States were fully on board with this new arrangement. They’ve benefited from it enormously.

Preston Pysh  35:19  

So Richard, I want to go back to this idea that you were talking about with Alan Greenspan and like 2005ish timeframe where you’re saying that he was raising interest rates, he was raising interest rates as the Fed was trying to raise these rates. But they were remaining stagnant and not really going anywhere. And they were asking, why was this happening? It really gets to the main theme that I really took away from your book and it comes down to this idea of fiat money creation has actually created these account surpluses in China and Japan and other places. 

So you show this in your book, through diving into the Feds’ capital flows that you track then you pull the straight from the feds books, where you look at the flow of money that comes in and comes out of America, and where does it go. When you look at that, and you see what’s driving these outflows from America, it’s almost a one-for-one correlation. And correct me if I’m wrong, but it’s almost like a one for one correlation in China. If they create, a billion dollars of fiat currency, they then turn into a billion dollars of account surplus for them, in the long run after it materializes. It eventually turns into that account surplus. 

So it’s not that they’re better savers and you debunk  Bernacchi’s claim that it’s a saving surplus. It’s not that it’s actually they created this much fiat currency and it immediately turns into account surplus. So as these countries are sitting on this account surplus, call it China’s 3$ or $4 trillion, as they’re sitting on that, they have to do something with that money. So where are they going to take that money and what are they going to invest it in? 

Well, when you look at the US debt market, the treasuries, the 10 year Treasury, 30 year bonds, whatever, you name it. They have to buy something. Well, that market is absolutely huge people. I don’t think people realize how big that debt market is forUS debt. And so you got China, you got Japan, you got all these countries that are buying up this 10 year Treasury at ridiculous levels, and when they do that, they bid up the price, they push the yield down, because those are inversely correlated. 

Look at the 10 year Treasury right now. We literally just hit all time low on the yield. It is the lowest it’s ever been. Okay, which means the price is sky high for 10 year yields, everyone’s buying them. And the reason they’re buying them is because you got all these countries with these surpluses, which were completely created out of fiat currency. That money has to go somewhere. They have to invest it in something that’s better than holding cash. They can get a one point whatever percent return right now by buying the 10 year Treasury. They’re not going to sit on the cash.

Richard Duncan  38:07  

Well, this is very important economically and politically, because as you said, Ben Bernacchi said the reason that they couldn’t make the US interest rates go higher, is because there was a global savings glut. He suggested that Chinese save so much money, and darn it, I just wouldn’t spend it at home or invested at home, even though their economy was growing at 10% a year. They couldn’t find any place to invest in their 10% a year growing economy. Therefore, because there are a billion Chinese people, how can we control them? How can we make them not save. Therefore, there’s nothing we can do about this global savings plot as pushing down US interest rates and creating the US property bubble in the United States. 

But that’s so untrue. He must have understood what really was happening because it wasn’t the millions of 19 year old girls working in Chinese factory, earning $5 a day, who saved all of their $5 a day after expenses and bought US Treasury bonds with it. If it had been, there wouldn’t have been anything we could have done about it. 

But the reality was his counterparts at the Central Bank in China, the PBOC. They were printing literally, trillions of dollars worth of yuan from thin air, just like the Fed did through quantitative easing, around 1, 2, 3, exactly the same story. And with that yuan, they bought the dollars. And that’s where the savings came from. 

The central bank saved this money by printing it from thin air. They are printing money is savings money. And yes, there’s a global savings but there’s not a savings glut. It’s the global money glut. The global paper money glut that was running out of control, that blew US into a bubble. And  Bernacchi must have known that. But we could have stopped the PBOC from printing trillions of dollars worth of yuan, buying dollars, and buying US Treasury bonds with them. They would have only taken a few phone calls and a few threats of trade tariffs, and that would have stopped. 

Stig Brodersen  40:23  

So does that mean, Richard, and you just briefly mentioned that it would just take a few phone calls to stop this currency manipulation. Is that we’re just saying that it would be the solution? And then that the reason why we don’t do it is simply because the most wealthy will have an interest in the Chinese still manipulating? And now I’m just blaming Chinese but basically, a lot of countries in the world will still have an interest in manipulating the currencies because it will put a pressure on the wages in those countries. Is that what you’re saying? 

Richard Duncan  40:52  

Well, so to be more fair, I have been, the story is somewhat more complicated than I’ve painted it to be. Other people in the United States or other groups who benefited, first of all, the US government benefited from this arrangement, because it didn’t… After a few years, the 1980s, they realized that by having a trade deficit, that meant other countries would have a surplus, and they would accumulate this surplus as dollars and have to buy US Treasury bonds with the dollars that accumulated. And so that would make it very easy for the US government to finance a very large budget debts at very low interest rates. 

So this benefited the US government by holding down us interest rates, making it very easy for the US government to run increasingly large budget debts. And on top of that, it also turned out to be very helpful in terms of promoting US foreign policy initiatives. When you have a $200-$300 billion a year trade deficit with China, it’s incredible how much more friendly China becomes, and how much more willing China is to look the other way. You can buy a lot of Chinese cooperation on foreign policy initiatives, particularly the ones outside of Asia, when you have such a massive trade deficit with China. 

So, in many ways, the United States obtained numerous benefits from this arrangement, the government, state department foreign policy initiatives, lower interest rates, and lower cost of consumer goods. So every American consumer benefited from the lower cost of imported consumer goods and potential homebuyers benefited from the lower interest rates. But the factory workers lost their jobs and wages stopped rising. The middle class started shrinking, we deindustrialized and income inequality grew.

Preston Pysh  42:55  

So Richard, I got just kind of a transition into more current conditions in China. So when we look at what we’re talking about, as far as them in China adjusting their fiat currency, which created this surplus and created enormous growth in China for the last 20 years, call it. But in the last credit cycle, you’ve seen China kind of develop a different tactic in order to produce the so-called growth numbers that we’re seeing over there. And this was all in their credit growth, and their shadow banking. This is something that I don’t understand all that well. I think a lot of people in our audience don’t understand that well. So can you describe what has happened in in China over the last eight years with this credit explosion, and kind of put it in proportion so people understand how big this growth has been? 

And then I’m sorry to kind of add the questions here. But then after you’re done describing this credit growth to us, can you tell us why billionaire George Soros at the Davos convention just a few months back about six months ago, said that he’s currently watching a hard landing occur in China. And what does he mean by all that?

Richard Duncan  44:05  

Okay, well, let’s put this in the right perspective. Let me return to the US for just a few more minutes. Once the Bretton Woods system broke down, that removed all the constraints on how much credit can be created in the US, back when we were on the gold standard, and money was backed by gold. That really constrained how much credit could be created. 

So for instance, total credit, which is the same thing as total debt, two sides of the same coin. Total credit first went through $1 trillion in 1964. But by 2007, US credit expanded 50 times the $50 trillion. So from 1 trillion to $50 trillion of credit in just 43 years. And that explosion of credit from the US economy drove the global economy. It created the world we live in. Credit growth drove the economic growth. 

Back in the olden days of the 19th century, capitalism worked, because industrialists would make factories, sell things, and save money, accumulate capital, and reinvest that capital in new businesses. And it was slow and hard, but it accumulated capital, and it was savings and investment that drove the economic process. That’s why they call it capitalism. It was driven by capital accumulation. 

But in our age, this post Bretton Woods world of paper money creation, it doesn’t work like that anymore. Our world is not driven by savings and investment. It is driven by credit creation and consumption. And the more credit we create, the more the economy grows and more people have to spend and that drove the US economy for decades. 

But in 2008, all of that credit couldn’t be repaid. So as long as US credit was expanding very rapidly, the Americans bought more, and so the rest of the world could sell more. And so they grew. This ushered in globalization. And China was the main beneficiary of this finance economy. In 1990, it was the 11th largest in the world. It was only something like 7% the size of the US economy. But by 2014, it did become not only the second largest economy in the world, but it was 60% of the US economy and size. In 2007, US credit grew by just that one year alone, US credit grew by $5 trillion. But at that point, it was such a bubble, the Americans couldn’t repay the credit. All of the investment banks were leveraged 30 times, everything imploded. All the credit was cut off the whole thing came  very close to complete collapse and credit didn’t grow at all next year. So, US imports contracted very sharply. Chinese exports contracted very sharply. 20 million Chinese factory workers had to go home and work in the countryside and agricultural once again. 

And so the Chinese at that point, had to step on the accelerator, and they increased credit in China. They started rapidly expanding credit in China. So between 2009 and last year,mobile bank loans in China triple just in five years. And on top of that, all kinds of new shadow banking lending occurred on a very aggressive scale. They were investing in new bridges and new highways, new airports, plus building new factories of every kind of imaginable. 

So since 2008, every year since then, up until last year, credit growth in absolute dollar terms is greater in China, considerably greater than China than it was in the US. So if you’re planning to surpass… the US credit growth has been driving the global economy, had been driving the US and China, and Chimerica, and the whole world. But in 2008, that blew up and China took over the leadership role in terms of credit growth. Not just credit growth, but also in absolute dollar terms. China’s economy has been growing more than the US economy has since 2008. 

We always have known for a long time that they’ve had very rapid GDP growth, 10% a year in percentage terms, but not in absolute dollar terms. The US economy was always growing much more in dollar terms than China’s economy was, but no more. 

So China had this explosion of growth in the last several years. They built more and more factories of every kind, and resulting in more and more production, and more excess in industrial capacity that’s unnecessary. So one well known example is in three years, 2011, 2012, 2013, over that three year period, China produced more cement than the United States did during the entire 20th century.

Preston Pysh  49:26  

I mean, that’s unfathomable and I know people have seen these videos of the of the ghost cities over in China. We’ll put up a video of this into our show notes so if you’ve never seen this, you need to watch this. Go to our show notes and watch this, where entire cities were cemented, if you will, and put up. There wasn’t a soul living in them. Do those still exist over there? Are these ghost cities still prevalent?

Richard Duncan  49:51  

Well, yes. Let’s think about this. So if they do the same thing for the next three years, and once again, of course, they’ll be producing as much demand again, as the US in the entire 20th century, and the next three years, but if they only produce that much, there’ll be zero percent growth in cement. That will just be no growth. That’s just flat. That’s not creating any economic growth. 

So the problem is they are drowning in cement, steel, and every other imaginable product you can make in a factory. So they have extraordinary excess capacity across every industry just on a mind boggling scale. Consequently, the prices of all the products all of these factories produce, they are crashing. So the companies producing them are not profitable, and they are unable to repay their bank loans. So they’re non-performing loans and the banks, in reality must be exploding, even though it doesn’t appear that way. 

Meanwhile, China’s trying to flood the world with steel and cement and everything else that you make in a factory and the rest of the world. Economically, it is just too weak to be able to continue absorbing all of this Chinese production. So the world is not economically strong enough to keep absorbing more and more Chinese goods every year. And within China, the wages are so low. I would say less 70% of the people in China earn less than $10 a day. The median personal disposable income per person is $8.13 cents a day. You can’t buy a lot of stuff. Your disposable income is $8 a day. So how many half a million dollar condos are you going to buy? How much cement you actually bought? How many tennis shoes and televisions can you buy? So there’s not enough purchasing power within China because factory workers don’t make enough money to buy the things that they’re producing. 

And in the past, that was okay because they just sold everything to the United States. Now, the Americans are in trouble and they can’t keep buying more and more Chinese goods. And no one else can either. And at this point, their strategy, their economic growth model was based on export led investment driven growth. But now their exports didn’t grow as they did in the past. The more they invest, the more money they lose. Their economic growth model is in crisis. 

Last year, China’s exports actually dropped. And when China’s exports drop, then China’s imports drop. So we’re told that last year China’s economy grew by more than 6.5%: 6.7 or 6.9%. And maybe it did or maybe it didn’t. You know, if you build enough ghost cities, you can make the economy grow. There’s certainly no question China’s economy has been completely transformed over the last 25 years. Shanghai now looks like Emerald City in the Wizard of Oz. It is quite amazing. 

But it doesn’t matter how much China’s economy is growing as far as the rest of the world is concerned. What matters to the rest of the world is how much Chinese imports are growing. In other words, how much more China’s going to buy from Brazil every year than the year before? Or America, how much are their imports growing? Well, last year, China’s imports contracted by 17%. So China did not act as a driver of global growth last year, regardless of what their economy may or may not have grown by. Their imports contracted by 17%. Consequently, they were a big drag a big break on the global economy. Global commodity prices crashed. 

Stig Brodersen  53:40  

One of the great things about having you on the podcast is that Preston and I have been studying China for quite some time and we see a lot of warning signs in the Chinese economy, GDP or the contraction, GDP growth might be one thing. We also see some problems with import and export, as you talked about recently, but I’m curious to hear how you see the current economic situation in China. And perhaps more importantly in that relation, how you identify reliable data about China, because it seems every time we bring this up with a guest, and that guest would say, ‘This is the data we have, but we’re really not sure about them.” But I’m thinking someone to your background also in IMF and various banks do have access to another type of data that might be more reliable. 

Richard Duncan  54:26  

Even if you dig into the officially available data that is provided by China, you can learn a great deal. I have a list of things here in front of me. Just for example, steel production increased at an average rate of 14% a year between the year 2000 and 2014. But last year it contracted by 2%. In the same period, cement production increased by 10% every year during those 14 years, last year it was down by 5%. And most important of all, exports were down 9%, imports were down 17%. So those are the official statistics. And it’s showing recession across all of those areas. It’s not clear where the growth is coming from that adds up to 6.5% or 7% GDP growth that was reported. So you can look at even the official statistics, but the most important one, again, for the world is the import growth. And you can check that because the other countries are reporting their export growth. You can verify that with external sources.

Preston Pysh  55:31  

The thing that everyone focuses on is that GDP number and they’re looking at it, “Well, you know, they’re saying that this is what it is.” But you’re just like, “Well, let’s, let’s dig into the numbers beneath that. And more importantly, let’s look at the change that’s occurred.” So if they’ve been doing 10%, every year for the last eight years, now all of a sudden the numbers are negative. And it’s like that across the board as we look at all these different metrics, that’s pretty profound. That’s something that really for me tells a story. So whether you actually know what the exact number is or not, I think the thing that’s more important is looking at that change in the tide. Is the tide going in? Or is it going out? And at this point, it’s really seems based on all those metrics that you just quickly throw it out to us that it’s starting to go out. 

My question would be this, what would be something that could turn this around? Like, how could they revive their economy so that they could start growing and basically turning all those numbers back into the green again? What could the government do at this point, or can’t they do anything?

Richard Duncan  56:33  

It was one thing when China was a relatively small economy, that balance becomes so large. It’s the second largest in the world. US GDP is $18 trillion a year, China’s GDP is getting close to $11 trillion a year now. A country’s economy is made up of really just a few parts: investment, household consumption, government spending, and net trade, or exports minus imports. 

Normally, consumption is by far the largest. US consumption is about 70% of GDP. Well, then China consumption is only 35% of GDP. In China, it is investment that’s so large. Investment in China makes up quite something quite close to 48% of all China’s economic output. Whereas in the US investment is only something like 18% of GDP. 

So in China every year, last year, China invested, I don’t have the numbers in front of me, but something like $4.5 trillion dollars, whereas the US invested something like $3 trillion. So even though the US economy is much larger, China’s investment is much larger: building factories, residential condos and bridges. 

Here’s a funny story. I was just in a debate with someone at a big conference in Korea. We were asked to debate China’s future. They hired me to take the negative side. The other guy didn’t put up much of a fight. He told a story that he was a Chinese professor at one of the prestigious universities. He said he was recently taken to one of China’s many, many, many large cities and somewhere in the interior, and he was shown two new bridges that had just been completed. Very fine looking bridges. The thing was they didn’t cross anything. The river was not there. The river was still planned for the future. 

Preston Pysh  58:34  

Oh my gosh. 

Richard Duncan  58:36  

And so that just gives you some idea of how, what this challenge was, to put it mildly. This country’s  leadership is facing now in terms of how are they going to make the economy grow when it’s so dependent on an investment and they have too much investment of everything. And there are people only earn $10 a day. You can’t somehow shift from being an investment driven economy being a consumption driven economy, because if you start shutting down steel factories and laying off steel workers, laying off coal miners, these people aren’t going to consume more. They’re going to consume less. These people may find jobs in the service sector somewhere. But as we know, from the American experience, service sector jobs pay less than manufacturing jobs. 

And so China is in serious trouble, and the entire global economy. Chimerica is entering recession. Chimerica, if you add the US economy and China’s economy together, it makes up 36% of the world’s economy. If you add their investment together, it makes up 41% of all the investment in the world. America is going into recession. So this is not just a Chinese problem. This is a global problem. This is an American problem. This is a European problem and we have to solve it on a global basis. China’s not going to solve it alone. And if this economic relationship between the United States and China, this Chimerican relationship, if it ends in divorce, involving trade tariffs, then the global economy is going to collapse into a global depression. So the global economy is in great danger now of taking a very serious hard turn for the worst.

Preston Pysh  1:00:25  

So Richard, at this point in the show, our audience clearly can see your your depth of knowledge or understanding of these topics. And so if they want to learn more about you, first of all, where can they find you? I know I’m a personal subscriber to your newsletter. So where can they sign up for your newsletter and then just tell people the names of your books again, in case they’re interested in buying this.

Richard Duncan  1:00:47  

We’ve been talking a lot of very high level macroeconomic stuff, and even with a political slant, but that’s not really what I spend most of my days working on. I think it’s very important. But I also leave that clearly people want to understand how to invest. So my business now is, I produce a video newsletter called Macro Watch that I sell on a subscription basis. And every two weeks, I upload a new video describing developments in the global economy, and how they’re likely to impact asset prices. So your listeners can find Macro Watch, which is RichardDuncanEconomics.com. If they use the coupon code “watch”, like Macro Watch, they get a 50% discount. And there they can find and they can subscribe to Macro Watch, or they can also sign up for my free blog. The recurring themes that run through my videos are built around what I believe the new truth about the way the economy and investing works in this era of fiat money.

Preston Pysh  1:02:02  

Richard, thank you so much. This episode was just phenomenal. This is amazing information. And I know that people are probably going to go back and listen to this over and over again to try to capture all the nuggets that you put out there. So thank you for your time. And we just really appreciate that. So thanks for joining us and that’s all we have for you this week. 

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Extro  1:04:17  

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