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There’s a China-Shaped Hole in the Global Economy

China’s low-consuming, high-investing economy guarantees conflict with other countries

By GREG IP
Sat, Aug 31, 2024 7:00amGrey Clock 4 min

China’s economy is unusual. Whereas consumers contribute 50% to 75% of gross domestic product in other major economies, in China they account for 40%. Investment, such as in property, infrastructure and factories, and exports provide most of the rest.

Lately, that low consumption has become a headwind to China’s growth because property investment, once a major component of demand, has collapsed.

This isn’t just a problem for China; it’s a problem for the whole world. What Chinese companies can’t sell to Chinese consumers, they export. The result: an annual trade surplus in goods now of almost $900 billion, or 0.8% of global gross domestic product. That surplus effectively requires other countries to run trade deficits.

China’s surplus, long a sore spot in the U.S., increasingly is one elsewhere, too. While China’s 12-month trade balance with the U.S. has risen by $49 billion since 2019, it’s up $72 billion with the European Union, $74 billion with Japan and Asia’s newly industrialised economies, and about $240 billion with the rest of the world, according to data compiled by Brad Setser of the Council on Foreign Relations.

Logan Wright , head of China research at Rhodium Group, a U.S. research firm, said China accounts for just 13% of the world’s consumption but 28% of its investment. That investment only makes sense if China takes market share away from other countries, rendering their own manufacturing investment unviable, he said.

“China’s growth model is dependent at this point on a more confrontational approach with the rest of the world,” he said.

While many developing countries relied on investment and exports to fuel early growth, China is an outlier for how low its consumption is, and its sheer size. In a report, Rhodium estimates that if China’s consumption share equaled that of the European Union or Japan, its annual household spending would be $9 trillion instead of $6.7 trillion. That $2.3 trillion difference—roughly the GDP of Italy—is equal to a 2% hole in global demand.

The sources of this underconsumption are deeply embedded in both China’s fiscal systems and its policy choices.

Chinese incomes are highly unequal, and because the rich spend less of their income than the poor, this automatically depresses consumption. Rhodium cites data that says the top 10% of households had 69% of total savings, while a third had negative saving rates.

Other countries address such disparities by taxing the rich more heavily and boosting the spending power of lower and middle classes through cash transfers, and public health and education. China does much less of this. Just 8% of its tax revenue comes from personal income taxes, compared with 38% from value-added taxes, similar to sales taxes, which fall much more heavily on lower-income families, Rhodium estimates.

China also spends less on health and education than major market economies, forcing poor and middle-income families to spend more of their disposable income on both.

Meanwhile, suppressed wages and interest rates depress household income and spending while boosting the profits of state-owned enterprises. The limited taxing authority of local governments forces them to raise revenue by selling property for manufacturing and infrastructure, which further inflates investment.

A decade ago top Chinese policymakers shared Western economists’ perspective that, at the macro level, China needed to rebalance away from investment to consumption. In 2013, the ruling Communist Party said growth would henceforth rely on market forces and consumers.

President Xi Jinping ended up going in the opposite direction; consumption stayed weak while state control over the economy grew. He has replaced reformers with loyalists more preoccupied with sector-specific targets than overall growth.

The bedrock principle behind trade is comparative advantage: countries specialise in what they do best and then export it in exchange for imports. Xi rejects this principle. In pursuit of “independence and self-reliance,” he wants China to make as much and import as little as possible.

Officials in China boast that it is the “only country to produce in every single one of the United Nations’ industrial product categories,” notes Andrew Batson of Gavekal Dragonomics.

Even as China targets advanced products such as electric vehicles and semiconductors, it refuses to surrender market share in lower-value products: “Establish the new before breaking the old,” Xi has instructed his bureaucrats , my colleagues have reported.

As a result, Rhodium argues , “China provides fewer opportunities as an export market for emerging countries while competing head-on with them in the low-tech and mid-tech space.”

Countries that once saw China as a customer now see a competitor. “Many Chinese businesses are manufacturing intermediate goods, which we mainly export,” Rhee Chang-yong , the governor of the Bank of Korea, said last year. “The decadelong support from the Chinese economic boom has disappeared.”

Mexican Finance Minister Rogelio Ramírez de la O complained last month , “China sells to us but doesn’t buy from us and that’s not reciprocal trade.”

Ironically, foreign officials have tended to see the U.S. as the biggest threat to the world trade system, ever since President Donald Trump in 2018 imposed steep tariffs on China and narrower tariffs on other trading partners. He has promised to expand those tariffs if elected this fall.

And yet Trump’s tariffs should be seen as a reaction to China’s beggar-thy-neighbour economic model, one that has proved impervious to existing trade rules.

Still, no single country can fix the problem. Like a dike deflecting floodwaters, U.S. tariffs have diverted Chinese exports to other markets.

Those other countries are now taking action. Mexico, Chile, Indonesia and Turkey have all announced or said they are considering tariffs on China this year. This week Canada announced steep new tariffs on Chinese electric vehicles, steel and aluminum, aligning with those already announced by the U.S.

Yet the world thus far lacks a unified solution to Chinese underconsumption, because China refuses to accept that it’s a problem.

Xi has rejected fiscal support for households as “welfarism” that breeds laziness. In April, Treasury Secretary Janet Yellen complained that China’s “weak household consumption and business overinvestment” were threatening jobs in the U.S. The state news agency Xinhua called it a pretext for protectionism. Earlier this month the International Monetary Fund advised Beijing to spend 5.5% of GDP over four years buying up uncompleted homes. Beijing politely declined.

With China dug in, more friction is sure to follow, and an already fragile world trading system will be stressed to its breaking point.



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Why Berkshire Hathaway Might Stop Selling Bank of America Stock Once It Reaches This Number

When will Berkshire Hathaway stop selling Bank of America stock?

By ANDREW BARY
Sat, Sep 7, 2024 3 min

Berkshire began liquidating its big stake in the banking company in mid-July—and has already unloaded about 15% of its interest. The selling has been fairly aggressive and has totaled about $6 billion. (Berkshire still holds 883 million shares, an 11.3% interest worth $35 billion based on its most recent filing on Aug. 30.)

The selling has prompted speculation about when CEO Warren Buffett, who oversees Berkshire’s $300 billion equity portfolio, will stop. The sales have depressed Bank of America stock, which has underperformed peers since Berkshire began its sell program. The stock closed down 0.9% Thursday at $40.14.

It’s possible that Berkshire will stop selling when the stake drops to 700 million shares. Taxes and history would be the reasons why.

Berkshire accumulated its Bank of America stake in two stages—and at vastly different prices. Berkshire’s initial stake came in 2017 , when it swapped $5 billion of Bank of America preferred stock for 700 million shares of common stock via warrants it received as part of the original preferred investment in 2011.

Berkshire got a sweet deal in that 2011 transaction. At the time, Bank of America was looking for a Buffett imprimatur—and the bank’s stock price was weak and under $10 a share.

Berkshire paid about $7 a share for that initial stake of 700 million common shares. The rest of the Berkshire stake, more than 300 million shares, was mostly purchased in 2018 at around $30 a share.

With Bank of America stock currently trading around $40, Berkshire faces a high tax burden from selling shares from the original stake of 700 million shares, given the low cost basis, and a much lighter tax hit from unloading the rest. Berkshire is subject to corporate taxes—an estimated 25% including local taxes—on gains on any sales of stock. The tax bite is stark.

Berkshire might own $2 to $3 a share in taxes on sales of high-cost stock and $8 a share on low-cost stock purchased for $7 a share.

New York tax expert Robert Willens says corporations, like individuals, can specify the particular lots when they sell stock with multiple cost levels.

“If stock is held in the custody of a broker, an adequate identification is made if the taxpayer specifies to the broker having custody of the stock the particular stock to be sold and, within a reasonable time thereafter, confirmation of such specification is set forth in a written document from the broker,” Willens told Barron’s in an email.

He assumes that Berkshire will identify the high-cost Bank of America stock for the recent sales to minimize its tax liability.

If sellers don’t specify, they generally are subject to “first in, first out,” or FIFO, accounting, meaning that the stock bought first would be subject to any tax on gains.

Buffett tends to be tax-averse—and that may prompt him to keep the original stake of 700 million shares. He could also mull any loyalty he may feel toward Bank of America CEO Brian Moynihan , whom Buffett has praised in the past.

Another reason for Berkshire to hold Bank of America is that it’s the company’s only big equity holding among traditional banks after selling shares of U.S. Bancorp , Bank of New York Mellon , JPMorgan Chase , and Wells Fargo in recent years.

Buffett, however, often eliminates stock holdings after he begins selling them down, as he did with the other bank stocks. Berkshire does retain a smaller stake of about $3 billion in Citigroup.

There could be a new filing on sales of Bank of America stock by Berkshire on Thursday evening. It has been three business days since the last one.

Berkshire must file within two business days of any sales of Bank of America stock since it owns more than 10%. The conglomerate will need to get its stake under about 777 million shares, about 100 million below the current level, before it can avoid the two-day filing rule.

It should be said that taxes haven’t deterred Buffett from selling over half of Berkshire’s stake in Apple this year—an estimated $85 billion or more of stock. Barron’s has estimated that Berkshire may owe $15 billion on the bulk of the sales that occurred in the second quarter.

Berkshire now holds 400 million shares of Apple and Barron’s has argued that Buffett may be finished reducing the Apple stake at that round number, which is the same number of shares that Berkshire has held in Coca-Cola for more than two decades.

Buffett may like round numbers—and 700 million could be just the right figure for Bank of America.

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