My Blog

March 3, 2008

MON 3 MAR

Monetary alarmists back in control? By Michael Pettis

After the October Economic Conference it was pretty clear that the monetary alarmists, who worry that Chinese monetary policy has forced excessive investment and the threat of rising inflation, had gained the upper hand over the pro-growth members of the government, who were determined to maintain employment growth and more willing to accept the risk of overheating.  Premier Wen Jiabao, who is responsible for China’s economic and monetary policy, finally seemed convinced that China needed to address the rising imbalances caused by excessively loose monetary conditions.

 

Last month, however, things seemed a little less clear.  The gloomy outlook for the US economy and the freak snow storms in China last January re-opened the debate on China’s economic outlook and we heard a lot of warnings about the dangers of pressing too firmly on the brakes.  A PBoC-engineered slowdown timed with a US-led slowdown and a domestic weather crisis might push China too far.  It was unclear how these warnings were affecting the policy debate, but I was worried that concerns about slowing growth might cause the government to delay even further their need to address China’s serious monetary imbalances.

 

Now I am increasingly getting the impression that the monetary alarmists are back in control, if they ever were out.  January CPI inflation came in at 7.1% and I have been hearing rumors that February’s numbers are not going to look good, and perhaps that is the reason for anxiety levels to have risen again.

 

In the special red-tinged “2008 NPC & CPPCC Session” pages of the major newspapers announcing the beginning of National People’s Congress on Wednesday, the lead story is “Inflation major concern of lawmakers, advisors”.  It is part of a whole series of recent articles and announcements I have seen recently discussing the dangers of inflation, the limited impact on China of the US sub-prime crisis, and rising inflationary expectations.  As the official news agency Xinhua pointed out today,

 

The central bank had taken a series of measures such as raising the reserve requirement ratio 11 times and the benchmark interest rates six times since last year to absorb excess liquidity and the measures had played an active role in slowing down the inflation growth.  Political advisors and lawmakers, however, have voiced their calls urging the government to take measures to protect the interests of low-income earners, who are affected most by the growing inflation.

 

They quote one of my Peking University colleagues, Song Guoqing, as saying “Even worse than the inflation itself is the anticipation of further price hikes by the public.”

 

In Friday’s China Daily there was a similar warning.  Despite the perfunctory “Domestically, there is a long way to go before the effects of inflation undermine the overall rise in the standard of living”, followed with the not-very-helpful observation by an 84-year-old resident of Pingyao that for all the problems caused by inflation he nonetheless eats better today than he did thirty years ago, the article’s title proclaims that “Inflation threatens economic miracle.”  They cite Ding Jianchen, professor at Beijing's University of International Business and Economics, who says "[Inflation’s] impact on low-income families will be beyond government's imagination."

 

It seems that those who worry about inflation and excess money growth are making very clear the political implications of allowing things to continue as they are.  So what will the government do now?  Obviously a lot of the focus is on the traditional methods for monetary tightening – raising reserve requirements, raising interest rates, putting caps on loan growth, etc – and the fact that they have had so little impact in the past does not seem to have diminished their appeal. 

 

But I don’t think this will have much impact in the future either and clearly I am not the only one who thinks this way.  I am convinced, as I have said many times before, that the fundamental economic problem in China is the country’s currency regime and I am not terribly hopeful that anything substantial can be done about overheating without addressing the furious inflows through the country’s trade and investment accounts.  That is why I was interested to see the following in another story in the China Daily:

 

The central bank has admitted in a monetary policy report that there is an increasing risk of rising inflation. It said it will "further" use the exchange rate policy to balance the economy, which, analysts said, indicated that policymakers may consider allowing accelerated yuan revaluation to reduce prices of imported products.
 
But no definite correlation has been found between faster yuan appreciation and lower inflation, said Dong Yuping, an economist with the Chinese Academy of Social Sciences.  Faster yuan appreciation could reduce prices of imported products, but it may also attract more foreign capital, which may intensify liquidity-induced inflation. "It is hard to conclude that there is a positive correlation between the two."

I am not sure exactly what Mr. Dong was implying for policy-making, but I agree with the facts in his statement, and for me the most plausible conclusion is that China needs to find a way to get the benefits of appreciation without risking the increase in hot money inflows, which only exacerbate the problem.  Regular readers know where I believe that leaves us – only a one-off maxi-revaluation can get us there.  I don’t want to read too much into this little quote and the various informal conversations I have had, of course, but more and more people I talk to seem to agree with this conclusion (which of course may only say more about what kinds of people I talk to then how the consensus is developing).  At any rate I think it is noteworthy if people in CASS, one of China’s most important think tanks, are arriving at a similar conclusion.