April 6, 2016; Michael Pettis: Concerned Capital Flowing out of China

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“The reason that we have been seeing what looks like currency weakening moves within the country is really for domestic purposes. They have to expand the domestic money supply. But it’s not being interpreted that way abroad. So, every time there is weakness in the renminbi we see moves in all of the Asian currencies, and in other currencies, to weaken. So the fear there is that it sets off a real trade war.”

– Michael Pettis

Kevin: David, we have a guest today that you’ve talked to since, actually, I believe 2008-2009. He is a specialist in economic history, but specifically, China. One of the reasons that you wanted to talk to him, going back to 2008, was that China was seen as the ultimate growth model, and as the model for the world, that China was going to bring growth to the world for many years. That really has not played out.

David: The economic miracle is, in this case, no different than any other economic miracle that we have seen in 50 years, 100 years, 150 years. And I think one of the valuable insights that Michael Pettis brings is because he combines not only a theoretical background in economics and finance, but also a very practical background.

Kevin: He was raising the warning flag back in 2008 and 2009, “Hey guys, don’t be fooled by this model. China has a lot of problems and debt is coming to the degree that they are going to have to deal with it.”

David: Right. And practical experience comes from trading sovereign debt with Manufacturer’s Hanover in the 1980s when you began to see some of the significant growth miracles in that period start to come up against natural limits, debt limits and fractures within their system. So the story and the narrative that could be told through that period started to falter, and he was there to see that, in fact, balance sheets actually do matter.

Kevin: Just a reminder for the listeners, Michael Pettis is a Senior Associate in the Carnegie Asian program. He is an expert in the Chinese economy. He is a professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. So, to get your head around what he is saying, he has a great Western background, but he brings us a Western view of the East from the inside.

David: I think the best Chinese beer I’ve ever had was sitting in the XP, which is a music venue in downtown Beijing, talking about global finance and the implications of too much debt on the Chinese balance sheet, several years ago with Michael Pettis. And clearly, it was the conversation that added the flavor and spice to that beer.

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Michael Pettis, the conversation continues. What I’m curious about is, what is market volatility telling us here in 2016, more than the actual price levels?

Michael: It depends on which market volatility you’re talking about. Market volatility within China, that is, in the domestic stock markets, reflects the fact that the Chinese markets are primarily speculative, and they always have been. But what really happened in 2015, really in the summer of 2014 when we saw the rally, is that not only is it primarily a speculative market, but on top of it there has been a real convergence of speculative strategy. There is basically one strategy, and that is, if you would ask most people during the rally why they were buying Chinese stocks, didn’t they know that the economy was slowing and profitability was coming down, they would tell you, “Yes, yes, we know that, but the government has more or less guaranteed that the stock markets are going to go up, and we know that that can’t go on forever, but we’re going to ride this up as long as the guarantee is credible.” What has happened is that as the credibility of that guarantee weakened, as you would expect, you get complete collapses in the market until somehow the government is able to get it going again. But I really don’t think we can expect any sustained rally in the market because it’s far too jittery, and far too focused on any sort of government signaling, intended or unintended.

In the external markets, I think what has really been happening is not so much that foreigners are correctly interpreting the data coming out of China, because a Chinese adjustment is going to be much less painful for the world than many people expect. It depends on who we are speaking about, of course. Metal producers and things like that have been hurt very badly, and will continue to be hurt badly. But in general, countries like the United States are going to be benignly affected by the Chinese adjustment, as long as it is not chaotic and disruptive.

But I think what is happening there is that there is this rapid catch-up to the kinds of things that you and I have been discussing for many years. It has taken a while, I think, for people to recognize just how difficult the Chinese adjustment was going to be, and I would say that in the last year or so pretty much everyone has caught up to where China really is.

David: There is this issue of massive indebtedness in China, and I wonder if it is possible to avoid the negative implications of over-indebtedness, including an increase in nonperforming loans when the financial sector in China is largely guaranteed by the central bank.

Michael: Well, there is no way to get around it. I’ve not been able to find any country in which debt levels have become high enough that they have caused the level of concern that we see here in China, and in which the country was ultimately able to grow its way out of the debt. The historical precedent suggests that China is not going to grow significantly, and it is certainly not going to grow its way out of its debt until it gets some kind of partial forgiveness on the debt, whether explicit or implicit. The explicit way, of course, is you default, the restructure the debt with a haircut. That’s probably not going to happen.

What is much more likely is that the debt servicing costs are going to be allocated, somehow or the other, to the state sector, and that is mostly the provincial state sector, because it is really the only group that is able to absorb the cost of the debt without significantly negative economic implications. Normally, when you have a debt problem, it is allocated to the household sector, because the household sector is politically not strong enough to protect themselves, and I’m not just talking about China. That’s what happened in the U.S. and in Europe and everywhere else.

But in China, that is how they solved the last debt crisis about 10-15 years ago, and during that period, consumption as a share of GDP, which started already quite low, fell very dramatically. And that makes sense. If you force the household sector to clean up the debt, then you can’t really ask for a surge in household consumption to drive growth. So they are not going to be able to allocate it to the household sector, and that pretty much means that they are going to have to allocate it to the state sector, and that’s politically really tough to do.

And when we were promised that Beijing would make rebalancing a priority, which people forget was all the way back in 2007 with Premier Wen Jiabao, the imbalances got worse, and it was during that period that the phrase “vested interests” became widely used in the Chinese press, because it was as they attempted to rebalance that they first realized the tremendous opposition that would emerge from the provincial elite, the group referred to here as the vested interests.

So that is really the issue about the debt. It is going to be allocated to the provincial elites, to the provincial state sector one way or the other, but when that happens is very hard to say because it is politically very difficult to do so. But one thing we do know is that the longer it takes to do so, the more costly the overall adjustment is going to be for China.

David: In a recent article in Project Syndicate, Minxin Pei describes the speed and energy on display in the anti-corruption campaigning of the current administration. Is this President Xi’s consolidating power enough to overcome the opposition of vested interests, and thus be able to move forward toward that assignment of losses that you were describing?

Michael: Well, he has to. Once again, his [unclear] are pretty clear. The only countries that are able to implement these types of reforms successfully tend either to be democracies or very centralized autocracies, very much like China in the 1980s. So, unless Xi Jinping centralizes power to that point, it is simply not going to be possible to implement the necessary reforms. Now, is he there yet? I don’t really know, and people like me are not going to know. There is a really limited number of people who have a really good sense of that, and all we can really do is say after the fact whether or not the reforms have been implemented. I’ve said for a while now, last year in particularly, that this was really the period, 2016 for me was the key year, in which we would see the real credible steps implemented by Beijing to manage this process. If we don’t see it in 2016, I get a lot more nervous.

David: Would you say that assigning those losses is easier in an economy like China’s where there is not the same democratically driven feedback loop as we have in the U.S. or Europe?

Michael: I can only tell you what the historical precedent suggests, and that is that democracies tend to be pretty good at adjusting, and highly centralized autocracies tend to be pretty good at adjusting, and the intuition behind it sort of makes sense. What we do know is that countries that are in the middle have always failed to implement these types of adjustments, or they have done so with tremendous political instability domestically. So we’re still waiting to see how it turns out.

David: A few years ago the Chinese economy was held to be a superior economic model, exhibiting a faster return to growth following the global financial crisis, and it seems the Chinese playbook then was to drive demand via massive government spending. Now the emphasis is shifting to the supply side. I wonder if Reagan would believe they were talking about China experimenting with some version of supply side economics. Is there a Reagan revolution happening in Beijing?

Michael: I think what has happened is that the reforms that they have been working on for the last four to five years have been recognized as not accomplishing anything, really, because the key is to get debt growth under control and that hasn’t happened. So I wonder if supply side reforms represent something real, or whether it represents nothing more than an acknowledgement that the the first set of reforms didn’t work. Now, if supply side has any meaning at all, I don’t see how it can be useful in China because supply side reforms really focus on cutting taxes and taking steps to promote savings on the grounds that productive investment has been constrained by the lack of savings.

In addition, supply side economics tends to look at distortions in corporate production caused by taxes, and could change the tax structure. But it is really hard for me to see that those are the problems that China faces. Certainly, we don’t have a problem with insufficient savings, we have a problem with way too much savings. And the idea that we have to cut corporate tax rates – corporate tax rates in China really have been quite negative for a long time, once you include the various subsidies, especially the interest rate subsidy, until about two to three years ago.

So it is hard for me to imagine why we think we have a supply side problem in China. I don’t think we do, I think we continue to have a demand side, and it’s really not insufficient demand, it is really the structure of demand that has been the problem in China.

David: So the five objectives which you have explored relating to the implementation of the supply side policies, to me it seems that only one of them has an immediate or measurable effect, reducing real estate inventories, essentially filling the empty 60-70 million apartments, thereby improving household net worth by, I think you penciled it out as anywhere from 1.5 to 3 trillion dollars.

Michael: That’s a theoretical exercise because I would imagine that it is going to be extremely hard to do that. But it gives you a sense of the type of challenges that they are facing. The other big set of reforms that they are talking about that also makes sense are the reduction in capacity, and they specifically spoke about steel and coal. China is just producing way too much of both, and they’re piling up an inventory. So it is going to be very interesting to see how seriously they take this reduction of capacity because if you cut back in capacity you are solving one of the big problems that we have here in China. You are resolving the debt issue, because debt is not going to rise in order to fund all of this continued production and rising inventories.

But the problem in China is that as you constrain the growth in debt the consequence is going to be a rise in unemployment, and obviously you can see how that works. If you close down all of these factories you have to fire the workers. And if you don’t want to do that, then you need consumption to rise, and the only way to get consumption to rise when you are closing down factories and firing workers is increasing household income by some other means, and really, the only other means involves transfers from the state sector, or filling up these apartments, but I just think filling up the empty apartments is politically going to be very, very difficult.

David: When we see a drop in foreign currency reserves, and the run rate on a monthly basis is close to 100 billion dollars a month, it is easy to assume a slippery slope that on X time frame, the Chinese are going to be running out of foreign currency reserves, or reach a critical threshold. What prevents that continued diminution of foreign currency reserves from happening?

Michael: One of the things they’re trying to figure out is whether or not there is a currency policy that will reduce the outflows, and I would say the answer to that question really depends on what is driving the outflows. Some people seem to believe that what is driving the outflows is a perception of overvaluation of the renminbi. And if that is the case, then some form of depreciation, whether it is a constant depreciation, 4%, 5%, 6% a year, or a maximum devaluation of 10% followed by a peg, or even if they stop intervening and let the currency find its own value, that would work because as the currency goes down outflows would abate, and at some point you would get some kind of stable currency.

But I don’t think that is why capital is leaving the country. To the extent that capital is leaving the country for other reasons, concerns about financial risks, political risks, etc., then it seems to me that a weakening renminbi may actually exacerbate outflows, in which case there really isn’t a currency policy that will slow the outflow. So my guess is that we are going to continue to see stability in the renminbi and some people may be surprised when I say continue to see stability because they will say, “But the renminbi has been depreciating.” The renminbi really hasn’t been depreciating. The dollar has been appreciating.

So against the dollar the renminbi has depreciated, but against a basket of currencies it really hasn’t; it has been fairly stable. And I think the governor of the central bank, Governor Zhou, made it very clear that he is going to continue that policy. My guess is he is going to continue that policy for a few more months, but if capital outflows remain very high then I think Beijing is going to question how successful that policy is likely to be, and they are going to look at other things.

And where are we starting to see other things? They are not going to implement new capital controls, not for a while, but they are going to implement the existing capital controls much more harshly, and we are seeing that there is a lot of talk about some of the government-related or government-driven outflows of strategic assets abroad. That is probably going to slow down. So we are going to see a variety of measures aimed at slowing down the outflow, and if they don’t work then we really have a problem because, as you know, declining reserves undermine credibility, and as credibility is undermined there is a tendency for the outflows to increase. So we’re caught in one of those positive feedback loops that can be really destabilizing.

So we need to see what they do over the next three to four months, and whether they can stop, or at least reduce, these outflows significantly. And that is going to be quite tough. And to a large extent it also depends on the external environment and what the U.S. does to interest rates and things like that.

David: The bet against the RMB is a trade that, as you said earlier, assumes the RMB is over-valued, and it assumes that the current outflows are driven by the conclusion that the RMB is over-valued. While there are a few elements similar to the exchange rate mechanism bet in 1992, it seems that Soros and Druckenmiller knew where the line of defense was and pushed hard against that line. Maybe you could comment on this. It doesn’t seems as wise to bet against a nondescript line of demarcation.

Michael: Yes, you know, there are different types of bets. If there is country with a tremendous amount of external debt, like Mexico in 1994, then it is a pretty safe bet that once you break the currency the depreciation will be very, very violently pro-cyclical because as the currency weakens the dollar debt increase relative to local currency assets and that puts pressure on everyone to buy dollars. Now, that’s not what happened in England, but in England you also had a pretty clear strategy in the sense that the German Bundesbank was not going to lower interest rates; they made that very, very clear.

And those high interest rates were stifling the British economy, the stock market had come down, unemployment was very, very high. So it was a safe bet in that it was almost impossible that the pound sterling would rise against the deutsche mark. So you had a one-way bet and it made sense to pile on and make or break it. But in China, I know the former condition doesn’t apply – and I don’t think the latter condition applies, so we will see what happens.

David: When you look at the PBOC and the possibility of devaluation, if the PBOC were to allow for some devaluation, what is the biggest risk implicit to that?

Michael: A risk for whom, the PBOC?

David: I think both of the global markets and of the perception of what that implies, or what it means.

Michael: For China, the biggest risk is that some kind of depreciation program actually causes an acceleration of outflows, and then we get caught up in that, we pass that point at which you can pull it back. Some people call it a tipping point, but it is a point at which the depreciation causes further depreciation because of the outflows. For the rest of the world, the risk, I think, is really on the trade front, because I don’t think China has been depreciating in an attempt to strengthen the export sector. In fact, China’s export sector has done pretty well. Exports are down, but exports across the world are down, and the Chinese share of exports has actually expanded.

The reason we have been seeing these outflows, and the reason we have been seeing what looks like currency weakening moves within the country is really for domestic purposes. They have to expand the domestic money supply. But it’s not being interpreted that way abroad. So every time there is weakness in the renminbi we see moves in all of the Asian currencies, and in other currencies, to weaken. And that means that ultimately everyone has the same policy, the same beggar thy neighbor policy, and all of that ends up in the form of a rising U.S. current account deficit. And I’m not sure the U.S. has a huge amount of appetite for that. So the fear there is that it sets off a real trade war.

David: Looking at monetary easing that has been applied over the last several years, is it possible that monetary easing may actually be causing deflation? You look in China at the PPI and it has declined now for its 47^th month in a row. Is it possible that, again, monetary easing could be causing deflation instead of curing the system of it?

Michael: I think that is very, very possible, and I think the reason most of us don’t think that is possible is because we implicitly assume that every country is structured the way the U.S. or great Britain are structured, where monetary easing tends to increase consumption relative to production. But in China it is the opposite, and in Japan it seems to be the opposite, and that is, when you ease monetarily, most of the growth and credit flows into new factories, new infrastructure, not into new consumption. So we haven’t really seen this very, very rapid money expansion.

I was at a meeting yesterday when someone told me that within one or two years, depending on which definition of money you use, 50% of the global money base might be Chinese, which is really extraordinary when you consider it is about 15% of global GDP. By any standard, money growth has been very, very rapid, but we are seeing pretty severe deflation in the manufacturing sector. So I think it is time to dust off some of these beliefs that we have.

David: We’re dealing with debt capacity limits and I’m curious if you can only know what those debt capacity limits are in retrospect.

Michael: I think that is the only way you can tell. There are way too many moving parts, including confidence, and there is really no way to measure confidence, especially in a place like China. So, unfortunately, we will know that we are approaching the limits when it is too late.

David: When you look at the Chinese economy today, do you see more similarities with the U.S. in the 1920s, or are there some similarities with Japan in that period of the 1980s?

Michael: I think it’s closer to Japan, with the difference being, of course, that it is very poor, so that creates a different set of dynamics, particularly on the debt side. Remember that the U.S. adjusted very quickly and very brutally, and Japan didn’t. Japan is still adjusting 25 years later. And I suspect that China, for political reasons, is more likely to at least try to follow the Japanese version. The problem is, I don’t think China can allow debt levels to grow to anywhere near the same extent they have in Japan. So we’ll see what happens, but I think the tendency here is to see a slow, long, drawn-out adjustment rather than a very quick, brutal one.

David: Which speaks to the difference in character between how various debt crises are solved, and you might argue that not all of them are in an absolute or dramatic crisis. It can be extended over a long period of time. Are we essentially witnessing that in China today, where it is a crisis, but not with the fireworks that some anticipate?

Michael: Yes, I think that’s an important point. Too many people think that a debt problem manifests itself in the form of a crisis. And no, it doesn’t have to. In fact, usually it doesn’t. And the problem emerges long before you have the crisis. It emerges in the form of very slow growth. And it is the debt, itself, I think, that prevents the growth. And I think that’s what we are seeing in China.

David: It seems to be an issue that is almost universal, having too much debt in the system, and dealing with lower levels of growth, and this is both in China, in Europe, in the U.S. I wonder if we aren’t fascinated with this idea of perpetual growth as an implicit part of a healthy economy? The growth dynamic is, in fact, at one point enabled, or exaggerated by leverage, by high levels of debt. How do you see policy makers coming to terms with the natural consequences of deleveraging, a slow growth, no growth, or negative growth environment? When the expectation has become that we must have perpetual growth, how do politicians and policy makers deal with the social and political consequences?

Michael: I think that we are able to have perpetual growth, but what has happened in recent years, and it is not the first time this has happened, we saw it before in the 1920s, in the 1870s, a number of times. What has happened is that when you have significant income inequality, that reduces consumption, because of course the rich consume a far smaller share of their additional income than do the poor. And as consumption is reduced, private sector investment tends to be reduced. So you get this reduction in total demand. As this happens, the first way you compensate for it tends to be with a surge in consumption among the middle class fueled by debt, and once you reach the debt limits, then the only way you can adjust to this reduced consumption caused by income inequality, is in the form of rising unemployment. And I don’t it’s a coincidence that that is what we saw in the 1870s, that is what we saw in the 1920s and 1930s, and that’s what we have seen more recently.

So for me, the key issue is, we can’t continue to rely on debt to generate growth, so one way or the other we’re going to have a redistribution of income downward. In the U.S., it has usually occurred for political reasons, in the period of Andrew Jackson, in the period of the progressives in the 1930s, we all saw that happen. If it doesn’t happen that way, it has to happen some other way, in the form of massive bond defaults, and we’re probably going to get that, or in the form of inflation, because bond defaults and inflation both erode the savings of the wealthy, erodes their wealth.

So one way or the other we are going to have to get this redistribution and we always do. The question is, do we do it in a way that is controlled and non-disruptive, or do we do it in the form of a collapse in the market, runaway inflation, or one of these other things. But there is only a limited number of ways history shows us for this redistribution of wealth back down toward the group that needs to spend it. It is like Marriner Eccles says, “The problem is that those who have the money don’t want to spend it, and those who want to spend it don’t have the money.” And we’re right back to that problem again.

David: So the political conflict between progressives at both ends of the spectrum here in the United States is giving some anecdotal support for what you are saying. We have Sanders and Trump, who are surprisingly popular, both of them, and it suggests that this issue of income inequality is alive and well, and that some form of redistribution, whether it is a market leveling or a top-down leveling of the playing field, is in the process of happening. I wonder if you could speculate on a different issue. I wonder if you could speculate or guess, what is the official Chinese view of American foreign policy in Asia?

Michael: That is not something I can discuss, partly because it is politically sensitive, and partly because it is not really my area of expertise. But what I can say is that there is a very mixed reaction. The U.S. has a lot more goodwill in China than it thinks it does, but at the same time there is also a lot of suspicion in China. It is sort of the way Americans think about China. You have a lot of people who are very favorable toward China and a lot of people who are extremely paranoid toward it, and that is replicated here in China. But I think we should expect that, geopolitically, tensions are likely to get worse, not just between China and the United States, but more generally.

I am very worried about Europe where you are seeing a strong anti-foreign and anti-immigrant feeling emerge. And these are things that I think we should have normally expected as part of this process. Whenever you have these great big global crises, you always see an increase in geopolitical tensions, you see a reduction in international trade, and we’re following the pattern pretty closely. So it’s a time that I think we all have to be extra concerned about the possibility of things getting out of hand. But it’s going to be an issue for a few more years.

And you mention this issue of Trump and Sanders. I’m actually working on a paper right now. It seems to me that the followers of Trump and Sanders and the so-called Tea Partyers, this has been a pretty permanent faction in American history. It comes and goes, but I think of them as the Jacksonian faction, but it includes pre-Andrew Jackson. I think the original Tea Partyers were a lot like this. And they are a group that tends to get really incensed and riled by income inequality, and the domination of the banking system, by a number of things that I think they are right to get riled up about.

The problem is they also have a history of selecting real scoundrels as their leaders, and I think we’re seeing that replicated again. But it is interesting because they do tend to emerge when income inequality becomes a big problem in the United States, and so I think it is not surprising that we’re starting to see things that seem so unexpected to us politically.

David: In that period of Jacksonian revolt against central planning you had the first and second central bank, ultimately the second central bank, allowed to just go away. Now, we have the Fed, the third iteration of a central bank in the United States, and there are changes that seem to be occurring at the level of money. “What is money?” is a question that is still difficult for many to answer. And I thought it was very interesting, as we consider changes in the role of central bankers and a certain protest, perhaps, the “Audit the Fed” cry has been getting louder and louder here in the United States.

If we go back to the February 15^th speech there in China, the interview with Zhou, he talks about the implementation of a digital currency, exploring the benefits and the drawbacks, and I wonder if moving toward a digital currency doesn’t radically change the commercial banking space, and in the process of changing the commercial banking space, and to some degree the nature of money, also the role that central banks play. What are your thoughts about digital currencies, the benefits to monetary policy, the drawbacks, negative rates, and the greater likelihood of implementation in the environment of a digital currency. Any thoughts?

Michael: I would go back a little bit further because I think one of the great mistakes that we made, probably beginning in the 1970s, or maybe even in the 1960s, was to start believing that monetary policy and central banking is some sort of technical neutral function, when in fact it is highly political. And Americans have known this for most of our history. You mentioned the fight over the second bank of the United States. That was one of the most vicious political fights we have ever had in American political history. Only, perhaps, the Civil War and one or two other things were worse.

We had, in the 1890s, the silver movement. We had, in the 1920s and 1930s, ferocious debates about banking because back then it seems that we understood that banking policy, central bank policy was not neutral. It, in fact, involved significant redistributions of wealth to one group or to another, and so a lot of our political fighting was about how that distribution of wealth was going to occur. And I wonder if what is not happening is that we are sort of rediscovering what we always used to know, and that is that it really does matter what kind of policies central banks implement.

It is not a question of figuring out what is the right policy for the economy at this point in time, because there really isn’t a right policy. There is a series of policies and all of them involve different types of wealth distribution among different sectors, and we’re returning to the days when that becomes part of the political atmosphere and properly part of the political atmosphere, because it is just as important, in fact, maybe even more important, than the tax structure, in determining who benefits and who pays. So maybe that is what we’re going back to. Maybe we’re relearning that central bank policy matters a great deal, and not just for technical purposes, which is probably a good thing.

David: Has it cast any light, again, back into the shadows of our past, where money and international trade relationships – there was a greater degree of automaticity under the gold standard, and less of a need for central planning and the potential for central bank policies not remaining neutral; gold has less of a personality, and maybe the period of 1860 to 1914 gives an example of that: growth in global trade, a currency that is universal in nature – are to some degree on auto-pilot?

Michael: Yes, I think we have to be very careful about romanticizing that period. It was a very, very difficult period. We had bubbles, and those bubbles broke very, very brutally. In fact, Barry Eichengreen makes a very powerful argument that one of the main reasons we can’t go back to gold is because the adjustment mechanism under the gold standard involved the terrible costs to workers, and as long as workers were disenfranchised and as long as that cost wasn’t fully understood, you could get away with it. It seemed more like an act of nature. I think that is no longer the case.

I think the kinds of gold standard adjustments that we used to experience in the 19^th century, we simply cannot experience any more, certainly not in democracies, because the brutality of the adjustment is no longer going to be accepted politically now that workers have the franchise. So, we don’t want to overestimate, or we certainly don’t want to romanticize the gold period era, but we do have to recognize that one of the great differences between now and back then is that in a period of credible fiat currency there isn’t that automatic adjustment, and it is possible for debt levels to get much, much further than they would have under some tougher regime.

So we certainly need to reconsider the global monetary regime. We probably need a new Bretton Woods, but I don’t think that means returning to something like gold, I think it means understanding the weaknesses of a fiat currency system and adjusting for those weaknesses.

Among other things also, I think we need to dust of Keynes’s proposals during Bretton Woods, because I think having the dollar as the dominant reserve currency was a cost that the United States could bear in the 1950s when it was 43% of the global economy, but it is a cost that I don’t think the United States can bear any longer, and it shouldn’t. We need to find some other way of managing that process.

So one of the things that is definitely going to come out of the global crisis is a significant rethinking of monetary policy and global currencies, etc., and it is actually very interesting to be part of this process, but it is also going to be very difficult as we stumble toward whatever solution we end up with. Maybe digital currency is a kind of solution, but we have to be very aware that we don’t have constraints on the ability of debt to grow, at least we don’t have automatic constraints. And that means debt can grow until it can’t grow any longer, and that is where you have a really, really painful adjustment.

David: These are the adjustments we have been talking about that are possible in China and in other parts of the world, as well. We appreciate you shedding some light on this, and we look forward to the publishing of your next book. Do you have a time frame for when that will be through the edit process, and we can enjoy conversing about it?

Michael: I’ve written bits and pieces of it, but I haven’t really sat down and started the book, which I was supposed to do last year, because it has been so incredibly busy. I’m really going to make a stab at it this year, and the focus is going to be on why national balance sheets matter so much, and what the debt constraints are. I hope that is finished this year, which means it would come out early next year, but that is what I said last year, so we’ll see. I will certainly let you know.

David: Good, good. Well, it sounds like you are building conceptually on the framework that you set out, and the volatility machine, kind of a crossover between corporate finance and macroeconomic policies. Is that fairly accurate?

Michael: Yes, that’s the point. I think in corporate finance we have a pretty good understanding of debt in a balance sheet, and shockingly, we have no such understanding in macroeconomics. What I hope to be able to do in this book is create a bridge between the two.

David: We look forward to it. Thank you for joining us from Beijing. I hope you have a wonderful evening. We appreciate your time.

Michael: Thanks very much.