The Great Rebalancing

Michael Pettis, who teaches finance at Peking University, argues that global trade imbalances are produced by domestic policies that suppress household consumption, and that currency values and trade policy are secondary. The argument follows from an accounting identity: a country's current account surplus equals the excess of its savings over its investment, so any explanation of the surplus must explain that gap.

His mechanism concerns the transfer of income away from households. In China, financial repression through low deposit rates, an undervalued currency, and wage growth below productivity growth transferred income from households to firms and to the state, which raised the savings rate mechanically. Germany achieved a similar result through wage restraint after 2000. The surplus countries then require deficit countries to absorb the difference, and the deficit countries must respond either with higher unemployment or with higher debt.

Pettis draws several conclusions that unsettle both sides of the usual argument. Trade surpluses reflect weak domestic demand rather than competitive strength. Deficit countries do not choose their deficits; capital inflows force the adjustment onto them. China's investment-driven growth model produced capital misallocation that must eventually be recognised, either through slower growth or through explicit losses. And rebalancing requires raising the household share of income in surplus countries, which is politically difficult because it means reducing the share going to the interests that benefit. The framework is powerful and Pettis states it more confidently than the evidence always supports. It has become one of the standard lenses for analysing Chinese growth.