My Blog

February 19, 2008

After all the market-related anxiety I felt during the last few days in New York, I returned to Beijing yesterday expecting a little less gloom, but nonetheless I suspect that anxiety levels in the corridors of power in Beijing are probably higher than ever.  Yesterday the National Bureau of Statistics released PPI numbers for January and today it released the CPI numbers.  Regular readers of my blog will not be surprised when I say the numbers weren’t good.  According to the NBS release:

In January, Producers’ Price Index (PPI) for manufactured goods up by 6.1 percent from the same month last year; purchasing prices for raw material, fuels and power rose by 8.9 percent.  PPI for means of production increased 6.5 percent over last January. Of the total, PPIs for mining and quarrying industry increased 20.5 percent; that for raw materials industry and manufacturing industry correspondingly up by 8.5 and 3.8 percent; that for means of consumer goods grew 4.6 percent. Of which, price for foodstuff increased 10.4 percent; that of clothing and commodities rose 2.2 and 3.0 percent respectively, while that for durable consumer goods dropped 0.6 percent.

PPI numbers rose from October to December by 3.2%, 4.6%, and 5.3%, respectively.  January’s 6.1% indicates that upward price pressures continue stronger than ever.  Food prices were a big part of that, but notice that mining and the raw materials industry were also up substantially.

CPI was even more alarming.  A lot of debate during the last few weeks was whether we would see CPI hit 7% for January.  According to the NBS release today:

In January, consumer price index (CPI) was up by 7.1 percent over the same month last year, of which, urban area and rural area rose 6.8 and 7.7 percent respectively. The price of foodstuff, non-foodstuff, consumable and services expanded 18.2, 1.5, 8.5 and 2.6 percent respectively. CPI made 1.2 percent growth over that in December 2007.

7.1% CPI inflation for January is up from 6.9% in November and 6.5% in December (although remember that for statistical reasons the price jump in December is rally equivalent to the November rise – I discussed why in an entry last month).  The bulk of the increase was still caused by food inflation, but what worries me is that non-food inflation, while low (1.5%) is still rising, which it shouldn’t be if inflation were really caused primarily by a one-time food supply constraint – indeed it should be declining or even negative.  It is also pretty clear that inflation is starting to spread to other areas of the economy.  For those of us who have always been convinced that inflation in China is a monetary problem, and not a one-off food supply problem, the recent numbers, while not conclusive, only make us worry even more.

A lot of January inflation has been blamed on the effect of the recent weather crisis, but I believe that much of the weather-related price increases didn’t show up in January and are more likely to show up in February.  I should also point out that some Chinese analysts are warning that certain industries whose prices have been frozen (or for whom price increases are subject to approval) may have concealed the true extent of price increases, so the CPI number may actually understate inflation.  At any rate, according to the press, Deutsche Bank and Goldman are warning that inflation may go as high as 8-10% in February and March.  I am not sure how they get to those numbers, but regular readers of my blog know that I have always been much more easily convinced by the inflation pessimists than by the optimists.

So what can the government do?  Precious little, it seems to me.  There is still a fast and furious debate about tightening versus non-tightening.  On the one hand January’s numbers – rising inflation, the surge in bank lending, and the surprisingly high trade surplus – should argue for more tightening.  The government seems to have shifted policy from pro-growth until late last year, to slow-growth after October, and now back to pro-growth.  These rapid policy shifts are very damaging – they undermine credibility and, perhaps worse, they add unnecessary volatility since we never seem to wait around long enough to see what the impacts of the policy decisions have been – but there is a strong case that can be made that we need to shift once again to a slow-growth policy.

Still, it is easy to argue against a policy shift and it seems that many in China seem to be doing exactly that.  The weather crisis and the possibility of a sharp US slowdown add enough uncertainty to the picture that an equally strong case can be made for taking a wait-and-see attitude before acting further.  Given the government’s ideological and institutional commitment to gradualism, a good reason to do nothing would be warmly welcomed.  Add to this the fact that new leadership will be announced in March, and one can imagine a lot of future newly-promoted provincial and municipal leaders eager to give their bailiwicks a big fiscal boost at the beginning of their watch.

Not surprisingly the analyst community is split on will-they-or-won’t-they.  Some are expecting a rapid return to interest rate hikes, reserve hikes, and tougher lending constraints, while others think that the authorities are unlikely to move before March or April, until we can get the first set of economic numbers uncontaminated by the effects of the weather crisis and the Spring Festival, and after we have a better sense of whether or not the US economy is likely to slow enough to affect the Chinese economy in a significant way.

Either way I don’t think it will matter.  I continue to believe that China’s problem is a monetary problem, and that the root cause of the problem is the massive amount of the trade and capital account surpluses that need to be monetized by the PBoC.  Until these inflows are eliminated, tightening policies will be as ineffective in the future as they have been in the past.

In principle the more rapid appreciation of the RMB should be one way to affect inflows, but in practice, of course, it is not.  Rapid appreciation stimulates speculative inflows, and as long as this money creation continues to feed China’s investment boom, industrial production will keep surging and the gap between production and consumption will continue to keep the trade surplus abnormally high.  None of the tightening measures being discussed – even if they are implemented – will do anything to get China out of its monetary trap.

Comments (12) for "Bad numbers, but China might...

I couldn't agree with you more. Monetary policy is rendered completely ineffective under a "fixed" exchange rate system. Under such a system, however, the fiscal policy is made stronger. Therefore the only way to cool China's economy is by decreasing government spending. To my knowledge, Chinese officials still lack a concrete strategy to cut back on spending. (http://www.eeo.com.cn/ens/feature/2008/02/13/92300.html) As global growth starts to slow this year, China's growth will undoubtedly slow as well. However, if officials sees this as a chance to shift their policy back to pro-growth, then China will have some nasty long-run inflation consequences. By Henry Bee - 2/18/2008 6:29 PM

China does have a "third lever" of administrative measures. The state can just order state-owned enterprises to cut production. It's a very crude measure, but it might turn out to be necessary. By Twofish - 2/18/2008 9:43 PM

It is amost 9 months since the food prices spiked last year. The pattern is pretty clear to me: food,raw material-->wage-->non-food. The problem is that food and raw materials are so closely connected to the world markets. Food is also the basic necessity good. The monetary policy of one country cannot do anything about it. The only thing it can do is to boost supply, panelizing food export and subsidizing import and production. By fatbrick - 2/18/2008 10:22 PM

Fatbrick, yes, China's inflation problems are connected with a global problem of rising prices, especially rising food prices, which makes it all the more worrying that many in China still see the domestic inflationary problem as being caused by a food-supply constraint in China. Twofish it would be interesting to see if the authorities can actually force SOE's to cut down production. The trick, of course, is to do it without causing a disruptive increase in unemployment. By Michael Pettis - 2/19/2008 2:15 PM

China inflation pressure is intensifying, besides short term snow disaster impact on food prices-energy-transport, there is more sticky long term inflationary drivers: 1. Key factor prices are kept at distortional level due to poor policies; oil-gas, coal, power, pollution charges, land are mostly way below global market prices and/or economical-ecological sustainable level. Therefore, rational phasing out of direct-indirect subsidies will be inflationary in longer terms 2. Key barometers of monetary policy: real interest rate( deposit, lending, bond), real exchange rates still low despite some rise since 2H2007. Credit-money are still rising at close to 20% annual pace, monetarist back of envelop formulae: M=Price* Output, until liquidity-monetary conditions are tightened, inflation will probably continue to heading to 10% rather dropping to 5%. 3. Inflation expectation, government propaganda policy of first dismissing inflation as non-core structural, then covering up is losing credibility. Inflation expectation is a dangerous thing, it already get on its own life and can drive inflation until government re-establish credible anti-inflation stance. 4. As food-energy prices surge, labor costs is also rising, core inflation is no longer stable. 5. Globally, post bubble FED is pumping liquidity by printing money and energy-food( even industrial metals) are surging, believe it or not, US-global recession and FED/very soon G7 remedies are very inflationary The inflation pressure is surging while growth outlook is faltering, this makes government policies very tricky and difficult, if we are in 2004/2005 with significant growth overheating, no doubt we will see draconian monetary-credit squeeze, rate hike by 100bp per dose, however the global growth outlook in 2008 makes it all very tough. I guess one thing is clear, government have to be credible in terms of anti-inflation, despite the snow disaster, short term room for flexibility-ambivalence is quite tight consider how high inflation can go heading into 2008 Olympics. 10% CPI in Beijing Olympics is too de-stabilizing economically, politically and strategically. Growth oriented camp can certainly wish inflation moderate in next two quarters, my crystal ball is very murky on this, I guess politicians have no gut to take that immediate risk, however growth risk is still abit far out in horizon. By credible anti-inflation, I mean "painful and costly", there is no freelunch to curb inflation, Economic Growth and Profit have to be sacrificed whether government want it, this is probably more by necessity than by choice. However, government could choose which parts of economies to sacrifice through rational policies choice. 1. Rmb appreciation is disinflationary and less painful. Not only rising Rmb could counter imported inflationary pressure and lower commodities cost, lower export and shrinking trade surplus/ reduced capital inflow will address the fundamental excessive monetary liquidity issue. Current 15% annualized Rmb/USD rise probably will sustain till inflation stable. 2. Emergencies price control to stay in ST but dangerous in LT. For short term, they are necessary evil and probably sustain well into summer, but long term very distortional. Without proper fiscal subsidy to suppliers, Price control will discourage investment in key bottleneck sector such as agriculture, food processing, coal, oil-gas, power , alternative energy and railway, price control will also prolong /cement inflation expectation, in extreme cases supply disruption -chaos will occur as producers boycotted by closing down. ( happened before in refined oil supply, certain services provider such as taxi) 3.More positive supply side policies: massive tax cut, fiscal subsidy to producers( energy, power, farmers, food processor ) and households. Government have room to cut income tax, VAT by up to 1-2 ppt of GDP, Rmb300-600b to promote production and ease pain of price control for these sectors. This will also help " Harmonious Society" 4. State Monopoly's fat margin/ROE have to go: The high ROIC of state monopoly in telecom, expressway, power grid are economically tax on overall economy, while benefiting small interest groups( shareholders, employees, management). During inflationary environment, their monoploy pricing power will result free-riding tariff-toll hike. To counter these, proactive competitive deregulation or administrative price cut are necessary and coming. Mobile roaming fee cut are first shot across bow, I see expressway very vulnerable as expressway toll key cost component for food. 5. Interest rate hike-credit control is the least useful tools for anti-inflation or even counter productive, but government will be difficult to ease simply to maintain credible anti-inflation public image. By isaac - 2/19/2008 2:21 PM

Jonathan Anderson of UBS says: No need for emergency inflation fighting. One of the most common arguments in favor of a large up-front revaluation is that China now needs emergency measures to fight inflation. But this argument makes no sense to us, for the following two reasons. First, as we've stressed continually over the past months, there's no indication whatsoever from the data that current headline inflationary pressures are structural in nature. We apologize for showing Chart 3 yet again, but as of end-December "core" non-food CPI is perfectly stable; all of the increase in headline CPI in 2007 has come from food, and nearly all of the pressures within food have come from meat and eggs prices alone. This is hardly a picture of widespread, spiralling inflation (the picture may change temporarily in January and February as weather-related shortages lead to price spikes, but this effect should soon fade as well). By TR - 2/19/2008 2:22 PM

At UBS we say that Anderson is almost always extremely smart and almost always wrong. Most of his predictions on trade, reserves, and inflation have not worked out. I hope he is right this time. By Banker - 2/19/2008 2:36 PM

It has been stated that "all of the increase in CPI in 2007 has come from food and nearly all of the pressures within food have come from meat and eggs prices alone." Before hastily jumping to this conclusion and, for the purposes of illumination, I think it is important to dissect the extent and breadth of China's inflationary numbers by looking at the raw data at hand. First: China's food prices have spiked to an +18.2% yr-yr rate of inflation led higher by pork (up +58.8% yr-yr), poultry (up +41.2% yr-yr), edible oils (up +37.1% yr-yr), vegetables (up +13.7% yr-yr), and fruits (up +10.3% yr-yr). The Price of Articles Related to Residences rose to a +6.1% yr-yr rate of inflation led by water (up +5.5% yr-yr), electricity (up +5.7% yr-yr), building materials (up +4.7% yr-yr) Further, the Urban CPI rose to +6.8% yr-yr, and was outpaced by the Rural CPI, which spiked to a 7.7% rate of yr-yr inflation. Worse yet, the monthly rate accelerated to a +1.2% or +14.4% annualized, TWICE the pace of the yr-yr rate, strongly suggesting that the CPI will continue to rise into the next couple of months, particularly given that the full impact of the winter storms that have exacerbated the inflation in food prices, will not be "felt" until the February figure is released on March 11. Worst of all, the spike in inflation comes on the back of a surge in money supply and bank lending data....indirectly causing "real" official short-term interest rates in China to fall significantly, with the key on-year lending rate plunging from an already low 0.93% last month to 0.37%......or less than fifty basis points! Remember that China's M-2 growth accelerated in January, with the yr-yr expansion soaring to +18.9% from December's +16.7% yr-yr rate. China's Currency-in-Circulation, the M-O aggregate, EXPLODED during January with the yr-yr rate of expansion reaching +31.2%, spiking higher from December's +12.1% rate of growth. In other words, the growth in "cash" more than DOUBLED in January. Moreover, Chinese banks extended a WHOPPING 803.6 billion Yuan, or $111.8 billion NEW loans during the month of January, while Household Savings Deposits expanded by 168.4 billion Yuan, or $23.4 billion. With that in mind, if you examine the recently released Producer Price data you see the PPI Raw Materials Prices spked to a +8.9% yr-yr rate led by the following components: Crude Oil.....up +29.9% yr-yr Lead...........up +27.9% yr-yr Steel Rod.....up +25.0% Latex..........up +20.7% Mining.........up +20.5% Smelting.......up +17.3% Crude Coal.....up +14.9% Power...........up +14.8% Kerosene.......up +10.9% Diesel............up +10.0% Industrial Prices up +8.5% Anyway you choose to look at this data, China's economy is clearly overheating. If you are paying attention to equities you can see that Chinese copper stocks such as Yunnan Copper (China's third largest copper producer), along with Western Mining Corp (China's second largest producer of Lead concentrate), and Huludao Zinc (the nation's second largest producer of Zinc) have been leading the upside in Shanghai shares. Looking at the London Metal Exchange Warehouse supply of Copper you can see that there is a deepening decline in copper inventories...copper stocks have plunged more than THIRTY PERCENT this year alone, down from historically low levels i.e. -86% below their 2002 peak, and remain under 200,000 tons. In conclusion, I do not agree that "there's no indication whatsoever from the data that current headline inflationary pressures are structural in nature." By kevinfischer2002 - 2/20/2008 12:56 AM

By Banker - Tue, 19 Feb 2008 22:36:18 GMT The market can stay irrational longer than you can ... finally, it started being rational, long after your insolvency. I think Anderson just fits in here. kevinfischer2002, The raw materials prices are spiking because the speculation in world markets. Not only China, every country faces the same price for Crude Oil, Lead, Steel...So your list does not really prove anything about China. Regarding to stock price, have you ever paid any attention to Chinese stock markets recently? Although stocks in raw material sectors are strong, the overall markets just keep sliding. By fatbrick - 2/20/2008 8:31 AM

Banker, I don't agree with your comments on Anderson. I find myself disagreeing with him on several points but the quality of his analysis is among the highest in the market. Fatbrick, I have seen a lot of arguments back and forth about whose "fault" inflation is, especially here in China. It seems to me that this is a pretty fruitless argument. Both China and the rest of world have experienced a lot of monetary growth in trecent years (I would say excessive monetary growth), and it would not be surprising if the consequence in both China and the rest of the world is upward pressure on prices. The fact that there is inflation outside China in no way mitigates rising prices within China. Commodity prices seem to be rising outside China. They also seem to be rising inside China. In both cases the result may be a hard-to-control surge in inflation. Isaac and Kevin, thanks for your posts. This is a very complicated picture. I admit to a bias in my approach to the numbers perhaps similar to the biases I think you might have. I am enough of a monetarist to think China's excess money growth must result in inflationary pressure, so when I look at the data I tend to look for confirmation. In the end we won't really know for a few more months whether we are witnessing the beginning of a Chinese (and global) bout of inflation. By Michael Pettis - 2/20/2008 11:29 AM

Michael, I don't think there is any doubt that we are in the beginning stages of massive global inflation. One need only point to the fact that the 12-month pace of headline CPI inflation in the U.S. has more than doubled since August (during which time the economy has slowed dramatically and the Fed has eased monetary policy aggressively). With the Scylla of commodity inflation on one side and the Charybdis of debt deflation on the other, clearly the Fed's over-riding goal is to circumvent an AFL scenario. Accordingly, Bernanke has no choice but to acquiesce to a broad based rise in peripheral inflation. Meanwhile the yield curve continues to steepen dramatically on the back of Fed stimulus, rising gold-commodity prices, and accelerating inflation. Most noteworthy is the upside reversal in the forward implied yield within the deferred Dec-09 Eurodollar Deposit Rate futures. From below 3%, this contract has pushed toward 3.75% to imply the prospect of Fed tightening next year. In fact, the short-end Eurodollar Deposit Rate strip is implying that the Fed will cut rates one more time, before stopping, and then eventually reversing, to remove the "insurance" it has taken out against a possible AFL scenario. Mishkin's comments on Friday as much as confirmed this strategy. The Fed is walking the high wire without a safety net. Next consider the UK PPI which soared for the month of January, rising by a full one percent on a month-month basis, the largest rise since 1995. The yr-yr pace of inflation has more than doubled in the last five months, spiking by +5.7% on a yr-yr basis, for the most rapid rise of PPI inflation since 1991, and far above the cycle low set at +1.6% yr-yr in September 2006. Moreover, the PPI Index for Raw Materials Input Prices shot up at a +19.1% yr-yr rate, the fastest rate of commodity price inflation posted since the UK began keeping records for this index in 1986 and a COMPLETE REVERSAL since posting its secular low at MINUS -2.1% yr-yr in January 2007. In other words, in the UK, commodity price inflation has gone from deep deflation just one year ago, to rampant inflation. Note the parabolic rise posted since August alone: July 07..........up +0.7% Aug 07..........up +0.9% Sep...............up +6.9% Oct...............up +8.9% Nov...............up +10.9% Dec...............up +12.2% Jan 08...........up +19.1% Albert Edwards of Société Générale argues that typically from top to bottom, an economic cycle would render the UK current account deficit up to the dangerous level of near 10% of GDP. (In 3Q2007, the UK current account deficit rose to 5.7% of GDP). Edwards said, “This is approaching Banana Republic status. The UK household sector is borrowing at a cyclically unprecedented 4% of GDP. Allowing economic growth to be based on unsustainable asset price bubbles was always going to be a recipe for disaster because the snapback can be vicious. This is a mess of the policy makers own making.” In Australia, we have Aussie banking leaders citing the need to reduce domestic spending and demand in order to contain price inflation, without any mention of soaring money supply growth, running well over 10%. Inflation is at 16-year highs in Saudi Arabia, a 14-year high in Europe and Switzerland, a 25-year high in Singapore. "In previous booms, we've had inflation causing central banks to tighten and that brought growth to a halt......this time, we have weakness from another source that in some places stops central banks from tightening, so there is a risk of embedding inflation expectations." (Gabriel Stein, an economist with Lombard Street Research in London) Greenspan's December 12, 2007 article in the Wall Street Journal explained the current global situation quite well when he stated, in effect, that short of moving toward hyperinflation, central banks have no cure for a collapsed debt bubble. By kevinfischer2002 - 2/21/2008 2:01 AM

Kevin, if you are suggesting that we may fact the prospect of stagflation, I hate to say this but I think I agree with you. In Latin America, a region I follow actively, there is also strong evidence of a new inflationary cycle. Given the comnbiantion of inflationary pressures and very weak balance sheets, the immediate policy implications are not obvious. By Michael Pettis - 2/21/2008 2:03 PM