My Blog

SAT 2 FEB

China can't decide whether to tighten or loosen By Michael Pettis

So will they or won’t they?  One worry making the rounds is that on the economic front the government will overreact to the weather crisis in the same way it did during and after the SARS crisis, when it expanded monetary and credit growth much too quickly to make up for a supposed slack in employment growth.  Given the level of unhappiness caused by the storms – not altogether the fault of the government although they have been criticized for being unprepared and for sugarcoating accounts of the crisis (no big surprise on the latter charge) – the government may be biased towards over-stimulating rather than under-stimulating employment growth in the near term.  When in doubt, step on the gas.

 

Not everyone agrees.  At a conference in Beijing today former Central Bank Deputy Governor Wu Xiaoling said that China would continue tightening economic conditions in order to moderate economic growth and rein in inflation.  She also suggested that the government would allow more flexibility in the currency regime, especially since “the U.S. rate cuts have limited the room for the central bank to use interest rate as a leverage tool to adjust domestic demand.”  I guess there are some rather tantalizing ways to interpret that comment, but I guess I shouldn’t read too much into it.

 

On the other hand, according to today’s Financial Times, “China has ordered financial institutions to provide emergency loans to businesses and individuals hit by the snow storms and power cuts that have paralyzed swathes of central and southern China.”  They then go on to say that the directive, issued by the PBoC late Thursday night, “could bring a speedier than expected end to the credit squeeze instituted in recent months to fight inflation and cool a number of sectors of the economy, especially the property market.”  Already, as I have mentioned several times before on this blog, there seems to be evidence that the weather crisis has tilted the balance of policy activity away from the monetary alarmists, who only seemed to gain the upper hand just a few months ago, back to the growth camp.  As a card-carrying monetary alarmist I find that worrisome.  How long the growth camp remains in control depends partly, I guess, on the duration of the weather crisis and the evolving evaluation of its economic, social and political impact.

 

Meanwhile weather conditions are not getting a lot better.  Tthe China Daily today gives us the slightly awkward but soothing headline “Power could resume shortly in worst-hit area by snow”, but the story itself is not particularly optimistic.  Conditions are grim.  Other accounts of what China still has in store are even more alarming.  Yesterday apparently Premier Wen speaking at a State council meeting warned the country that things were going to get worse, and today’s South China Morning Post has the headline “Another 10 days of misery forecast for a city living in fear,” which quotes Yu Jianhua, an operator for China Telecom’s information service in the city of Chenzhou, the subject of the headline, as saying "We know external help has been largely cut off. We know we must rely on ourselves and help each other. We cannot depend on the government.”

 

Most commentators see the weather crisis as an unambiguous political negative for the government, with the effect perhaps of increasing discontent and reducing credibility, unless the government succeeds in convincing people living in the affected areas that it has been sympathetic and effective in assisting them.  The may well succeed in doing so since the leadership, perhaps a little belatedly, has nonetheless been firing all pistons to bring relief.  Still, there is another, perhaps more positive, interpretation of the impact of the crisis making the rounds, at least among elite university students.  Two different students (one from Tsinghua and one from Peking University) assured me yesterday that the weather crisis has provided a great excuse for the government to adjust CPI numbers that should have been adjusted earlier (I am trying to be polite here).  I don’t know where they heard this and I have absolutely no idea if these statements have any basis or are completely groundless – and I am not trying to imply anything by repeating them – but I present them as, at the very least, evidence that there is a lot of cynicism out there.

 

In 16 and 17 days we will get PPI and CPI numbers for January.  I think the consensus is moving towards 7% very quickly.

 

SUN 3 FEB

Inflation predictions By Michael Pettis

I’ve just seen one piece of good news and one favorable prediction about January inflation.  The good news is that the State Administration of Grain said in a statement posted on Xinhua News Agency's Web Site today that in spite of the recent disastrous weather, China still expects to meet its grain harvest target this year.  I did not realize that China is the world’s biggest wheat grower, but last year it harvested 501.5 million metric tons and this year it is on target to harvest around 500 million metric tons.

 

I hope this is true.  The favorable prediction comes from Chen Xiwen, director of the Office of the Central Leading Group on Rural Work, according to today’s China Daily.  “Given that prices of grain, pork and edible oil have seen no apparent rises, January CPI will remain stable,” Chen told the briefing held by the State Council Information Office.  He predicted that January CPI inflation would be 6.5%.

 

This is not stable, by any means, but a lot of other analysts, including me, are predicting that CPI’s rise will be closer to 7%.  Is 6.5% achievable?  Perhaps, but not without some fudging.  The government has been aggressively selling and/or delivering food reserves.  Given the weather-related chaos in the food markets, this is not at all an unreasonable policy, but it does tend to put temporary downward pressure on prices, and that pressure will be reversed when the government replenishes its stocks.  According to other reports farmers are complaining that food price freezes – another way of containing headline CPI inflation – are hurting them because they are being squeezed by higher fertilizer and energy prices.  Finally according to the China Daily article, “To help keep prices down, the government has ordered all highway and expressway operators to exempt trucks carrying vegetables from toll fees.”  Both price freezes and toll-road-fee exemptions reduce nominal food-related inflation, but they do so simply by a sort of accounting trick – what should have been called “higher food prices” will now be called something like “extraordinary loss” on the farmers’ and toll road companies’ income statements (I don’t mean that literally – the inflationary cost will simply show up as lower revenues or higher taxes).

 

I would have thought that it would have been smarter to let the full rise in food costs pass through into CPI numbers in January, because then inflation could be blamed on extraordinary circumstances.  They can continue to subsidize the food costs to the worst-affected consumers, since this is politically and humanitarianly necessary, but the subsidies should be segregated and made explicit, although perhaps this would be administratively too complicated.  Still, as it is, the net effect is to reduce upward pressure on prices in January and postpone that pressure into the next few months.  This is surely more likely to cause inflationary expectations to rise than are price increases concentrated in January.

 

SUN 3 FEB

In China even Warren Buffet would be a speculator By Michael Pettis

The government has spoken, I guess.  At any rate the stock market certainly thinks it has.  As a side project I run a small investment club, with money supplied by me and some friends, that is invested in a diversified portfolio of Shanghai-Stock-Exchange-listed B-shares (which foreigners are permitted to own, unlike shares in the much larger A-share market), so I can’t say I was disappointed when I clicked onto the SSE website and found that the B-share index was up 7.94% today (A-shares are up 8.13%).  Although I am a little surprised at the extent of my gains, I am not at all surprised that my shares, and the market more generally, is up significantly today.

 

In fact I knew all weekend that my shares would be up today.  How did I know?  Easy.  Everybody knew the market would be up today because the government very cleared signaled over the weekend that it wanted the market to go up.  It was as simple as that.  An article in today’s China Daily explains:  “Monday's rally came after the China Securities Regulatory Commission (CSRC) gave the green light to CCB Principal Asset Management Co. and China Southern Fund Management Co to launch two funds expected to raise 14 billion yuan for equity investment.”

 

About four months ago, as a sign that it was very unhappy with the excess rise in the stock market and wanted it to come down, the government embarked on a series of measures to bring prices down.  One of these measures was to prevent the launch of new mutual funds – always an important sign here of the government’s intentions.  The market duly collapsed.  At its peak in mid-October the Shanghai CSI hit 5885, before dropping to 4318 on Friday (a decline of nearly 27%).  But now, by approving the application of two of these funds, the government made it clear that it believed the decline in the markets of the last three months has been excessive and may begin to have adverse effects on public sentiment.  It was time for the market to go up.

 

While I yield to no one in the gratitude I feel towards anyone who can increase my wealth by several tens of thousands of dollars in a single day, I have to say that this is not as good for the development of stock markets in China.  This kind of behavior will only delay by several more years the time when Chinese markets begin to fulfill their role as an efficient allocator of capital, taking money away from the least efficient and passing it on to those with the best growth prospects.  I wrote about why in a January 2 posting (“The government condemns Chinese financial markets to speculation”).

 

A purely speculative market does not allocate capital efficiently based on reasonable estimates of future earnings prospects. Speculative investors simply try to exploit short-term price changes, usually based on changes in short-term demand or supply factors.  In China the only important piece of information is about short-term changes in government and regulatory actions caused by changes in the government’s current intentions (and these change dramatically month-by-month and even day-by-day sometimes).  Bloomberg quotes a grateful fund manager today as saying: “It is encouraging to investors that the government has done something to intervene in the market decline.  We are probably already at a level where the regulators don't want to see a further decline.”  Recent activity simply reinforces the message that in the Chinese markets the only thing that matters is the government’s intention, and the only people allowed to play are the speculators.

 

WED 6 FEB

China: more on “will they or won’t they”? By Michael Pettis

I am currently in Spain for a business meeting and will send the next week or so in New York, so some of my entries are going to be posted late.  In China the debate about policy continues to rage, it seems, and although those of us outside the State Council can only guess at what is happening, the back-and-forth in the press gives us some hints of what the issues are likely to be.  For example in China Daily Fu Jing wrote yesterday that economic policy needs a “rethink”. 

 

The country needs to rethink its economic policy with snowstorms hitting regions and an economic slowdown in the United States, economists have said.  “The economic situation has become complicated with the new factors cropping up," Wu Jinglian, one of China's top economists, told China Daily yesterday.  It is imperative that the new developments are considered with measures to combat high inflation and the overheating of the economy, said Wu, from the State Council Development Research Centre, the central government's think tank.

 

Although the article did mention that vigilance against inflation and overheating needed to be maintained, these seemed to be fairly perfunctory acknowledgements in an article warning that China’s economy may slow down much more sharply than expected, especially if tightening measures are enforced.

 

The fears of people who share Mr. Fu’s views were reinforced by the poor showing in the recently-released headline PMI for December, which dropped from 55.3 to 53.0, although this is still in “expansion” territory (anything above 50).  Nonetheless it does suggest that both internal factors (the weather and the credit tightening) and external factors (a slowdown in export growth) are weighing on the economy, especially given the sharp drop in the new export orders index from 54.4 to 49.0.  Today Goldman Sachs made a trade recommendation that investors short the renminbi against the rupee in part, it seems, because they think the weather crisis will slow the renminbi appreciation.

 

On the other hand the South China Morning Post had this to say:

 

Zhu Hongren , deputy head of the National Development and Reform Commission's economic operations department, the nation's top economic planning body, said overall economic fundamentals remained sound.  He listed several positive elements supporting economic growth, such as the Beijing Olympics in August, efforts to restore agricultural and industrial output, and some "good news" yet to be delivered.  "Let's wait and see what happens. I hope we can hear some good news."

 

Analysts believe he was alluding to a relaxation of economic controls by Beijing. They said policymakers were quietly loosening the monetary reins after the bad weather threatened to stunt first-quarter growth.  The analysts pointed out that President Hu Jintao did not mention the government's resolve to prevent overheating - a common topic - when he spoke about the economy last week. Instead, he told policymakers to "fully realize the complicated and changing economic environment and preserve as long as possible China's stable and relatively fast economic growth".

 

In an article I had missed, about two weeks ago the Economic Observer weighed in against using price controls to combat inflation, arguing that as a monetary problem, the only way to address inflation was by adjusting (read: tightening) monetary policy and the currency.  Similarly, a researcher at the very prestigious Chinese Academy of Social Sciences published an op-ed piece in the China Daily late last week warning that it was too early to claim that adverse global conditions meant it was time for China to relax its new-found monetary hawkishness:

 

Many say the Chinese authorities should reconsider the tight monetary policy currently in effect.  Their concern is not baseless for the economic situation in and out of China does not allow for too much optimism. Capital markets around the world are stumbling. China and the US are also seeing a narrowed difference in their interest rates.

However, these facts are far from adequate for the Chinese authorities to change the tight monetary policy.

 

I have seen more articles supporting than opposing continued tightening and no relaxation of monetary policy, but interpreting what this means is not easy.  As I see it, my sources are more likely to be biased to the monetary camp, who are still much more worried about the consequences of rising inflation and economic overheating, then to the pro-growth camp, who do not want to see economic and employment growth drop sharply.  Until recently the monetary camp seemed to be dominating the debate after having been relegated (much too long, in my opinion) to the margins, so the fact that the so many economists are arguing strongly and urgently in favor of a continuation of monetary tightening and renminbi appreciation suggests to me that they are worried that they are being once again pushed away from the center of the policy debate.

 

Neither I nor any other outsider knows what is really happening, and I am probably doing little more than reading tea leaves, but I am worried that we may be seeing another shift in policy.  If worry about a slowdown causes the authorities to back away from their recent acknowledgement about the serious monetary bind in which China has found itself, I can only imagine that things will get worse as we approach the Olympics.

 

Amid all this debate, the government continues to show the people that it cares about the consequences of the weather crisis.  An article in yesterday’s China Daily tells us reassuringly that “Across China, the worst winter storm in five decades has prompted governments to fight profiteering and maintain market order.”  Among other things the government has told affected mobile phone operators that they cannot discontinue service for lack of payment, and they have punished railway station managers for allocating impossibly-scarce train tickets to themselves and then scalping them at many times their stated value – a popular activity this year since, during the Spring Festival, millions of Chinese overcrowd the trains as they go home to see their families for this most-important of Chinese family holidays, and the recent weather disaster has closed down many of the trains and made this year’s homecoming impossible for hundreds of thousands of workers.

 

It is hard to argue with punishing railway managers who withdraw scarce train tickets and re-sell them at a profit, and of course when the main reason many customers cannot pay their phone service is because of weather-related breakdowns, they should not be penalized, but some of the other inflation-busting activities reported by the media are less helpful, even if they are crowd-pleasers.  In their goal to eliminate “profiteering”, hotels inundated with travelers have been prevented from raising room fees, restaurants and grocery shops running out of food and other supplies have been punished for raising prices, and everyone is required to get approval from the appropriate authorities before raising any of their prices.  It seems that passing on part of the cost of the crisis to small businesses (for some reason I suspect larger businesses have more recourse) is likely to make the economy less, not more, productive.

 

FRI 8 FEB

A US slowdown won’t help China By Michael Pettis

I just got to New York yesterday and have been meeting pretty continuously with friends and investors.  Not surprisingly, everyone is very interested in hearing about what is going on in China.  Last time I was here, in July, a lot of people asked me about the “decoupling” thesis, and not everyone was terrible pleased (or in agreement) when I said I thought the idea was mostly nonsense, based partly on mistaken premises and partly on wishful thinking

 

Now, it seems, no one takes the idea of decoupling seriously at all.  Everyone is convinced that a sharp slowdown in the US will be disastrous for the rest of the world.  This is one idea whose death seems to have come quick and hard.  In fact, the most noticeable aspect of my trip here is the sheer gloom and worry about the state of the US and world economy.  It has been a while since I have seen so much pessimism and nervousness. 

 

Actually on this trip I found myself taking the unusual but not disagreeable role of downplaying some of the risks and terrors that lurked out there.  The sub-prime crisis has certainly been tough, but the resilience of the US financial system has really been impressive during the many crises of the past three or four decades, and the transmission mechanism from financial crisis to economic contraction has, in some way, been sharply weakened in the US. 

 

More importantly, in my view, the long, globalization cycle we have been through since the 1990s won’t truly end until we start to see a sharp reduction in the combined US/Europe trade deficits if, as I believe, it has largely been Asian and (more recently) OPEC recycling of their huge current account surpluses that has underpinned the growth in underlying global liquidity.  I am not saying that this can’t happen – it can and some point must – but so far this has not happened at anywhere near enough of a scale to convince me that we’ve reached the end.  The main thing to watch, in my opinion, is inflation.  If there is a slowdown, however mild, that is accompanied by a sharp increase in inflation, this could really spell the beginning of the end.

 

Talk of rising inflation and a slowing economy brings us straight back to the topic of China.  Xinhua yesterday reported that the “U.S. slowdown could be opportunity, not crisis, for China.”  They report that a number of Chinese economists believe that a US slowdown, by reducing the growth rate of exports, could help rebalance Chinese growth, towards a healthier mix of investment, exports and consumption and would help relieve monetary expansion.

 

To their credit few Chinese have taken the decoupling thesis very seriously, but if they expect a US slowdown to help resolve their domestic problems I think they are missing the point.  One economist mentioned in the article, Zheng Jingping, a researcher with the National Statistics Bureau, did get focus on the key issue when he noted that “it was not export growth but the trade surplus that would be the key issue”.  This is exactly right.  If China’s exports decline, and Chinese imports decline also so keeping the trade surplus high, China will get hit by a double whammy.  The reduction in exports will hurt economic growth but the high trade surplus will keep China’s furious money expansion going, so continuing to put upward pressure on investment and industrial production.  The “rebalancing” would consist of an even greater share of investment as part of total GDP growth.  This would be a worst-case outcome.

 

Could exports slow while causing a decline in imports?  Yes, in fact it is highly likely.  Remember that nearly half of Chinese exports are recycled imports, and any slowdown in the very important and lively export sector might indirectly affect Chinese overall consumption by increasing uncertainty.  But even if there is a small decline in the trade surplus, that is not enough.  In order to halt the money-creating monster that China’s currency regime has become, we need the trade surplus (and hot-money inflows) to decline substantially.

 

The problem in China is excessive monetary expansion, caused by the lack of a domestic monetary policy, and until that is resolved it is wishful thinking to talk about a healthy rebalancing.  Rapid money growth will continue to fuel excess investment and industrial production, until it comes to end either after a sharp increase in unsold inventories forces companies to cut investment or after persistent and rising inflation forces the government to clamp down brutally on economic activity.

 

On a slightly different topic, there has been a lot of recent downgrading of expected growth rates for China (so much for decoupling). According to the New York Times in an article about a recent World Bank report:

 

The bank said in a quarterly update that it now expected gross domestic product in China to expand at a 9.6 percent rate in 2008, which would be the slowest growth since 2002.  In its previous report in September, just as the global credit crunch was intensifying, the bank projected 10.8 percent growth for 2008.

 

Revising 2008 growth down from 10.8% in September to 9.6% in January is a big jump, and I expect that number will be sharply revised upward or down again.  One of the things I have tried to point out about China is that there is a lot of pro-cyclicality embedded into its capital structure, which means that external events, whether adverse or positive will have exaggerated impacts on domestic growth.  In spite of a recent report by UBS claiming that the old boom-and-bust of China has given way to smoother change, I continue to think that economic growth is going to be extremely volatile.  

 

This will be reflected in bank stock prices, by the way