My Blog

SAT 8 MAR

Political advisor: Hot money rush may worsen inflation By Michael Pettis

Regular readers may think I am spending too much time looking for evidence of hot money inflows into China, but this has the potential to be a very seriously destabilizing problem and, given the opacity of Chinese accounts, it is not always easy to get conclusive evidence one way or the other.  In fact some very smart commentators still do not seem to believe it is a serious problem.  For example I received today a report from Mark Williams, of London-based Capital Economics, who has consistently seemed less concerned than I am about the risk, and who argues that worries over hot money inflows within the PBoC may have actually eased recently.  

 

What’s more, he seems much more on the side of “pork” as an explanation of China’s CPI inflation, to put it in Ken Rogoff’s now-well-known “pork or money” terms.  (In a February 4 Op-Ed piece in the Financial Times Rogoff says: “Those who think inflation is caused by too little pork rather than too much money are wrong.”)  I suppose this exemplifies the split between the “monetary” and the “real economy” sides of the China debate.

 

In that light today’s China Daily had an interesting article about comments made by a senior political advisor Saturday morning at a plenary meeting of the First Session of the 11th National Committee of the Chinese People's Political Consultative Conference, part of the NPC meetings being held here in Beijing.  The comments were by Li Deshui, former director of the National Bureau of Statistics.  

 

According to Li, “The yuan's rising exchange rate against the greenback has attracted international surplus capital to flood the Chinese market via various legal or illegal channels.”  He went on to say that effective monitoring of capital flows should be at the core of the government's macro-control work.  

 

“More international speculative funds will pour in through various channels,” Li said.  China has now an accumulation of about US$500 billion of hot money, according the analysis of relevant research institutes, he said.  Hot money, if not blocked effectively further, will aggravate the imbalance between China's internal revenues and expenditure, worsen the already excessive liquidity, add more uncertain factors to Chinese capital market, overheat the economy, intensify the inflation pressure and may even trigger a financial crisis, he warned.

 

This is a fairly blunt description of what I believe to be among the biggest problems facing China.  I am not sure how he got to the figure of $500 billion of accumulated speculative inflows, but if even marginally credible it suggests that a significant fraction of the reserve accumulation in recent years was hot money.  It also gives some idea of the magnitude of possible hot money outflows in case of a domestic crisis.

 

Against this backdrop I noted a story in today’s Financial Times about moves by the Fed to expand domestic liquidity:  “A deepening sense of financial crisis yesterday spurred the US Federal Reserve into new emergency action to try to ease strains in the credit markets – and convinced investors that another major interest rate cut is on its way.  The Fed said it would increase to $200bn the amount it lends to banks in one-month funds through two different channels. The action will make it much easier for banks to raise cash against illiquid securities.”

 

China is trying to slow capital inflows even while it is offering a low-risk, with very high and increasing returns, investment opportunity, at the same time that money is fleeing risk assets abroad and the Fed (and others) is pumping liquidity into the system.  Granted, it is not terribly easy to make the low-risk, high-return Chinese investment – capital controls complicate the process – but the former head of the National Bureau of statistics doesn’t seem terribly impressed by the usefulness of those capital controls. 

 

As a good bureaucrat he asks for stricter controls, but while these may add some disruptions, it is unlikely that they will be a lot more efficient.  Countries as big as China with such long histories of capital controls (and so equally long histories of ways of evading them) tend to have a hard time restricting capital flows while at the same time trying to encourage open trade and investment relations with the rest of the world.  I haven’t really thought about the impact of the Olympics, but I would guess that we should see a surge of tourism-related inflows beginning in a few months, and along with it a surge in new ways of smuggling money into the country.

 

MON 10 MAR

High PPI inflation, low trade surplus, but it doesn't much matter By Michael Pettis

The title on the National Bureau of Statistics of China website was perhaps a little blunter than what one would expect from a government website: “Producers' Price Index (PPI) for Manufactured Goods Kept Surging in February.”  PPI was indeed up, by 6.6% from February of last year, substantially higher than January’s 6.1%.

 

Although this is a little lower than what Bloomberg claims was the consensus among economists (6.9%), it nonetheless sent a frisson of worry into the market.  Most people I spoke to now expect CPI inflation for February – to be reported tomorrow – to come in at over 8%.  Because of the breadth of price increases in the PPI report – oil- and steel-related products and coal rose more sharply than food – it is getting harder to argue that inflation will be contained to food prices, especially since the government has tried to squeeze inflationary expectations out of certain sectors by heavy-handed measures.  

 

For example prices of gasoline, electric power, fertilizer prices and certain other consumer necessities have been frozen, while food producers were ordered in January to get official approval for any price increases.  One possible consequence, reported by some in the Chinese media, is that prices reported to government officials may be lower than what companies are actually charging in order for them to respond to price pressures and shortages without angering local officials, so distorting CPI numbers.

 

At any rate we’ll know tomorrow what the official February CPI inflation is, but in fairness we should remember that February numbers are likely anyway to be very distorted by both the horrific weather crisis earlier this year and by the roving Spring Festival holidays, which always affect February numbers.

 

Speaking of distortions caused by the weather and the holidays, February’s trade surplus was way down.  At $8.56 billion this seemed to me to be one of the lowest trade surpluses China has had in the six years I have been here.  In fact I checked, and had to go all the way back to April 2002, three months after I arrived, to find a lower number.

 

Before we read too much into this number we need to remember that it was much lower than most forecasts, and less than half the average economist forecast, and this is almost certainly due to the difficulty of estimating the impact of the storm – which affected some of Beijing’s most export-aggressive regions – on railway, truck and shipping delivery.  A lot of analysts are hailing this as evidence of the end of the period of record-breaking monthly trade surpluses.  I am not sure I agree.  One month, especially one so singularly atypical, means little in establishing a trend, and anyway we would need to see levels drop pretty substantially before we were out of the danger zone for monetary policy.  

 

I saw some local and banking reports that argued that the reduction in the surplus is also evidence that China’s currency appreciation of recent months is really starting to bite into exports and is playing havoc with exporting firms.  Today’s China Daily, for example, carries an article by Xing Zhiming which carries the headline “RMB appreciation poses a challenge to Chinese exports.”  In the article he says:

 

The Chinese Year of the Rat is believed to bring luck and fortune, but for many Chinese enterprises, especially exporters in the coastal regions, it has brought along uncertainty.  Many exporters may be facing closure as their operational costs rise while competition intensifies. “The yuan's appreciation, along with rising labor and materials costs, is squeezing us dry,” says Wang Fu, general manager of Shenzhen Jiayinking Electronics, a 200-staff exporter of hi-fi systems to Europe, Japan and Africa.

 

In the Pearl River Delta, tens of thousands of export-oriented manufacturers may have to close their businesses or move them to places with lower operational costs, such as Vietnam.  The woes of these enterprises reflect the general problems in the wider economy, which is facing challenges on several fronts this year: yuan appreciation, uncertain foreign demand, rising inflation risks and unflagging oil prices.

 

I am not sure we can place too much blame on currency appreciation since the dollar’s decline against the euro and other currencies has softened the brunt of RMB appreciation against the dollar to enough of an extent that by most measures the RMB has actually depreciated, not appreciated, in recent months.  At any rate within China there are at least some influential voices arguing that the pressure on the export sector is actually positive for China.  For example Wu Xiaoling, formerly deputy governor of the People's Bank of China made exactly this point in a speech today.  According to another article in China Daily:

 

Wu went on to say that there is no need to worry so much about the impacts on China's exportation of the yuan's appreciation and the US subprime crisis.  “It is inevitable that some enterprises will be forced out of the market when the yuan rises”, she said, adding that “Currency appreciation, rising labor cost and possible energy pricing mechanism reform will urge enterprises to upgrade their technology and improve their competitiveness.”

 

“We do not need to worry whether appreciation of the Chinese currency will lead to enterprise bankruptcy. What we need to consider is if we have an improved social security system to facilitate the migration of labor force that properly helps employees of a bankrupt enterprise to settle down.”

 

In her speech she also warned that hot money inflows will keep pouring into the country because of the China’s “rosy economic outlook and its appreciating currency.”

 

Very honestly amid all this to-and-fro-ing about whether there is or isn’t a slowdown in the Chinese economy, and whether administrative measures are or aren’t working, I have to say that I still think very little has changed.  China is still on a path that last year Premier Wen called unsustainable.  Tomorrow’s CPI inflation will probably scare everyone a little and maybe even accelerate the pace of action, but I still don’t think the problem is getting any better because I see no evidence that money inflows are likely to subside in the near future.  Most of the action is of the wrong kind.

 

TUE 11 MAR

Why low non-food inflation doesn't mean inflation isn't a problem in China By Michael Pettis

All the bad news and rumors of recent weeks had most analysts inching up their estimates for February CPI inflation to almost 8%.  Of course there were some who were a lot more pessimistic.  Logan Wright of Stone & McCarthy expected the number to come in at 8.5%, and MacQuarie’s Paul Cavey told me a few days ago that he believed that if the numbers were truly accurate CPI inflation would probably reach or break 9%.

 

As it is, the pessimists were once again the more accurate predictors.  Today’s eagerly-anticipated February CPI release by the National Bureau of Statistics had this to say:

 

In February, consumer price index (CPI) was up by 8.7 percent over the same month last year. Of the total, urban and rural areas rose 8.5 and 9.2 percent respectively. The price of foodstuff, non-foodstuff, consumable and services expanded 23.3, 1.6, 10.9, and 2.0 percent respectively. CPI made 2.6 percent growth over that in January of 2008.

 

I am not sure if I can do this, but if I read this correctly the nominal 2.6% increase month-on-month amounts to an annualized rate of 36%.  That is high.

 

Anyway 8.7% year on year is a pretty ugly number by itself, but of course there were a lot of special one-off factors that made things worse than they otherwise should have been.  The most important was the impact of January’s freak storms, which disrupted delivery across the south and central parts of China.  When you combine delivery constraints with the consumption binge that normally accompanies the Lunar New Year festivals in China, it isn’t surprising that CPI inflation was very high. 

 

How much might these special factors have affected inflation?  The hard-working staff at the National Bureau of Statistics was kind enough to tell us:

 

The continued increasing of CPI from this year came of the cryogenic freezing rain and snow disasters, and the Spring Festival factors. According to the preliminary estimates, Spring Festival factor affecting CPI increased 0.53 percentage points, month-on-month, while that of cryogenic freezing rain and snow disasters stood at 1.03 percentage pints, deducted these two factors, CPI in February surging by 1.0 percent approximately, month-on-month.

 

With a precision that would have been impressive even for the inflation counters in places like Switzerland and Sweden, the January storms and the Spring Festival are reported to have added 1.56% to February’s inflation number.  These numbers seem a tad precise for me, and I have no idea of how they were calculated, but let’s accept them as broadly accurate.  I am not smart enough to figure out how the numbers work, but my quick-and-dirty calculation suggests that without these factors, and assuming the impact was correctly measured, normalized February inflation would have still come in at 7.1%, equal to January’s already ugly number.  However you look at it the February CPI numbers were not very good.

 

Of course the latest CPI release still has not resolved the debate about the cause of Chinese inflation and whether or not we need to be worried.  The always-intelligent Jonathan Anderson of UBS does not seem to be overly concerned.  According to today’s Financial Times, he said that “it was crucial to acknowledge that the ‘pattern’ of inflation, which was concentrated in food, had not changed.”  The newspaper quoted him as saying “Core goods and services prices did not accelerate. Most food items did not accelerate: nearly all of the February increase came from a surge in fresh vegetable prices and a further surge in fresh meat prices.”

 

My friend mark Williams of Capital Economics is also less worried than I am about generalized inflation.  In a research report that came out today, he wrote:

 

The data on non-food inflation remain benign. Non-food prices rose by 1.6% y/y last month, little changed from the rate since fuel prices were hiked in November. Core prices, excluding energy as well as food, rose by just 1.0%, which is level with the increase in the second half of 2007.

 

This is strong evidence that underlying inflation is still driven by tightness in local food markets, with rising global commodity prices a lesser factor. Tighter monetary policy can clearly do little about supply side shocks. Previous rate hikes were mainly aimed at preventing real deposit rates from falling too far (which would otherwise encourage even more inflows into the overheated stock market), rather than designed to slow the economy.  (What’s more, even if hiked again shortly, rates would still be far too low relative to the growth rate of the economy to be a significant constraint on activity.) But with the stock market now cooling, there is less pressure for further rate hikes. Indeed, even if food prices drop back only slightly, headline inflation could be back below 2% by the end of the year as a result of favourable base effects.

 

I am not sure I agree that it is pork, and not money, in Kenneth Rogoff’s now-immortal formulation.  It is true that non-food inflation only rose to 1.6%, from 1.5% in January, but I don’t read this as benign at all.  Aside from the fact that the prices of a number of non-food components are frozen, so that their inflationary impact shows up as lower profits or tax revenues rather than CPI inflation, but the upward pressure nonetheless exists, there is a much more serious argument as to why non-food inflation is actually too high and possibly indicative of a more generalized inflationary pressure.

 

The way I see it, a price increase caused by a one-off supply constraint is not inflationary.  Its only effect is to cause a shift in relative prices, not average prices.  If the price of one product or group of products rises, in other words, it should cause a diversion of spending away from other goods and services, so putting downward pressure on the prices of those other goods and services.  In theory, in a perfect world, the downward pressure on other prices would net out perfectly against the rising price of the product affected by the supply constraint, and although there would be a change in relative prices there would be no inflation, which is a change in average prices

 

Of course we don’t live in a perfect world, and price changes would not necessarily net out.  If they did, we would need deflation of around 5-6% in the non-food component of the CPI basket to bring overall inflation back to the 3% target that had been set by the economic policy-makers in China in happier days.  By the way I base this needed-deflation calculation on January numbers – if I had used February numbers they would have been much uglier (and for the geeks out there, I acknowledge I am mixing apples and oranges because I am treating year-on-year numbers as if they were annualized monthly numbers, but this shouldn’t change the results too much, and anyway I hate false precision). 

 

Even in an imperfect world the impact of a 20% increase in food prices over the last year, with food comprising over 33% of the basket of goods and service consumed by the average Chinese household, should have put some serious downward price pressure on the non-food component.  It might be unreasonable to expect the 5-6% deflation in the non-food component of the CPI basket needed, but there should nonetheless have been quite a lot of downward price pressure, and it should have had at least some impact. 

 

Under these circumstances the fact that non-food inflation accelerated to 1.6% cannot be wholly irrelevant in deciding whether or not there is an underlying monetary cause to inflation.  I think there is, but the food-supply constraint has helped mask it by diverting increased spending towards food and away from other goods and services.  Thanks to high food prices, in other words, inflation has not yet showed up in the non-food component.  Once food prices stop rising, it will.

 

I think most of those on the “monetary” side of the fence agree with me that inflation is a persisting problem caused by excess money creation and is unlikely to go away soon.  The majority, who still seem to be what I call “real economy” types, disagree.  We all agree however (I think) that whether or not the cause of inflation is monetary or a temporary food-supply shock, for the average Chinese household these nominal price increases are real and are starting to hurt.  At some point, if they have not already done so, they are likely to cause upward wage pressure and may even cause an acceleration of planned spending on consumer goods, either of which would cause inflationary pressures to spread away from food.

 

None of the debates have yet been resolved.  We probably need to wait at least until March CPI inflation comes out, some time in early mid-April, and perhaps not even that will be enough.  The way I see it, if March inflation is above 6%, the inflation rate for the first quarter will be higher than January inflation and so we would have reason to believe that inflation is continuing to accelerate.  I am assuming of course that the reversal of those factors which unfairly drove up inflation in February should “unfairly” drive inflation down in March.  That is why the “danger” level should be much lower than the January or February CPI inflation numbers.  We can only wait and see what happens.

 

On another topic, a related debate that has attracted a lot of interest is whether or not food inflation is, in an admittedly clumsy way, helping policy-makers achieve one of their very important goals, that of income redistribution from the relative rich cities to the very poor rural areas.  The argument is that China needs a more equitable income distribution, and high food prices are one way to divert income from the cities to the farms. 

 

Not everyone agrees that this is happening.  Some of my Chinese friends tell me that there are several constraints on the ability of farmers to benefit fully from the price increases (price controls and rapacious government-related middle-men are among the reasons often cited).  They are also suffering from consumer inflation as well as the high cost of inputs.  According to the CPI release by the National Bureau of Statistics, rural inflation was worse than urban inflation – 9.2% versus 8.5%. 

 

An interesting piece by Xinhua today explains why this may cause problems in redistributing wealth:

 

For Chen Baoquan, the recent price rise in agricultural products, although welcome, did not make him any happier as production and living costs were also up.  The 46-year-old farmer once thought, by taking advantage of rising crops prices, he could earn extra money to improve his family's living standard.

 

…His dream, however, did not come true as the surging prices of agricultural production materials and the high overall price level erased the gains from crops sales.  Chen…said the 500 kilogram of wheat produced by one mu (0.067 hectares) of land, on average, could be sold for 800 yuan (112 US dollars) as the current market price was 1.6 yuan per kg.

 

After deducting the production materials costs, including those for fertilizer and irrigation, the gross earnings, including labor, were only 500 yuan, he said.  “This (earnings) is almost flat from a couple of years ago. Though the wheat price rises by 0.2 yuan per kilogram, our production costs also surge.”  He cited a 50-kg bag of compound fertilizer as an example. It had jumped to 200 yuan from 130 yuan a year ago.

 

The prices that started to rise since the beginning of last year had greatly eroded the purchasing power of hundreds of millions of low-income farmers like Chen.  “My family earns 5,000 yuan per year by growing crops. That could meet our living costs a year ago, but now that can no longer make ends meet,” he said.

 

The point is that not only have input costs risen, sometimes faster than the price of food, but as the farmers are increasingly integrated into the market economy they become increasingly affected by rising market prices.  Chen Xiwen, director of the office of the central leading group on rural work, is quoted in the article as explaining why:  “People often see the benefits brought to farmers by the surging prices of agricultural products, but that is only one side of the coin,” director Chen said. “Increasingly, more farmers are no longer self-sufficient. They also buy many consumer products, including food, at the markets

 

It is interesting that this article was published.  Of course it contains the obligatory recital of how successful the government has been in alleviating the problems (the article concludes with: “All the pledges have helped to allay farmer Chen's concerns of higher inflation.  “They have demonstrated the government's determination to rein in inflation,” he said.  “I believe the government can finally manage to ease inflation after taking timely and effective measures.”), but it nonetheless paints a pretty depressing picture of the plight of the farmers.

 

WED 12 MAR

More attention on the RMB By Michael Pettis

Retail sales in China for January and February shot up by 20.2% over the same period last year, above most forecasts.  I think along with December’s equally rapid growth rate this is the highest growth rate yet recorded (although they have only been recording this for about ten years or so).  I understand that these are nominal numbers, so part of the increase in spending simply reflects the fact that everything costs more, thanks to a year of 8-9% inflation.  Still, even adjusting for inflation consumer spending is moving along healthily.

 

There is both good news and bad news here.  The good news is that with domestic consumption growing so quickly, China is gradually rebalancing its economy away from its over-reliance on domestic investment and the export sector.  This has to be healthy.  The bad news is that a lot of this consumption growth may have been fueled by concerns over rising prices.  If that is the case, we may already be caught up in the self-reinforcing loop I mentioned in yesterday’s blog entry, in which inflation concerns cause an acceleration of spending, which itself pushes up inflation.

 

Meanwhile we also got FDI figures for February, and they show a very sharp increase over February of last year.  At $6.9 billion February’s FDI investments are up 38% over last February.  Combined with the sizzling FDI numbers for January – $11.2 billion, or more than double the amount for January 2007 – this means that in the first two months of the year China has attracted $18.1 billion, or 75% more than the same period last year.  Does this sharp increase – coming when the RMB is less cheap and tax benefits less copious – have anything to do with speculative desires to take advantage of the rising RMB?  Perhaps.  According to today’s Bloomberg, “The central bank is paying close attention to ‘excessive’ growth in foreign direct investment, the China Securities Journal reported this month, citing Hu Xiaolian, director of the State Administration of Foreign Exchange.”

 

At any rate there is a lot of speculation in the market about a further speeding up of the appreciation, which has been moving along at a rapid clip in recent days.  Some people are even wondering out loud about a surprise move.  Thomas Stolper, a London-based economist at Goldman Sachs said in a report March 10 that we might see a pick up in the rate of appreciation.  According to him “One increasingly likely explanation could be that China's policymakers may be in the process of preparing the next leg of much faster appreciation, and maybe even another one-off revaluation.”

 

Money supply growth has slowed down a tad, although it is still too high, in my opinion.  The PBoC said today on its website that M2 was up 17.5% from February 2007 to February 2008.  Last month it grew by 18.9% and Bloomberg says the median estimate of surveyed economists was 17.8%.  Loans were also up in February, by a relatively low 15.7% compared to the huge jump in January.  We are getting so much volatility in the data that it is hard to get any clear sense of trends.

 

THU 13 MAR

Some numbers on Chinese demographics By Michael Pettis

A friend of mine sent me the following table.  It comes from a paper presented at the September 2007 International Conference on the CCP's 17th Congress by Daniel Xu and Ning Ding ("Distortion of Population Growth and Pressure on Employment") and shows the number of people, in millions, entering the job market in China every year from 2006 to 2020.  I assume this means the number of people turning 18.

 

2006	20.2
2007	21.7
2008	23.2
2009	24.5
2010	24.4
2011	23.0
2012	21.9
2013	20.2
2014	17.0
2015	16.0
2016	15.1
2017	14.4
2018	13.5
2019	13.8
2020	13.4

 

This numbers at first were very surprising to me, but they are at least visually consistent with a graph derived from UN data of population by age cohort, which shows a significant bulge in children born in 1985-1990 and then a rather sharp falling off until 2005.  Thereafter, give or take a few surges and retreats, births are expected to decline by just under one-half percent annually until 2050. 

 

Before anyone blasts these projections as meaningless because it cannot be possible to project that far out into the future, let me say that my understanding is that immigration rates are tough to project (which is why it is hard to make projections about US population growth), but birth rates are much less difficult.  In 1954, for example, the UN predicted that world population in 2000 would be 6.3 billion.  In fact it was 6.1 billion – so they were able to project 46 years into the future with only a 3% error (and in fact much of their “error” came from their failure to predict that China would implement a one-child policy in the 1970s – a fairly unique factor that would have been hard to predict).

 

As I read these numbers, from 2006 to 2010 the number of young people joining the job market has grown or is projected to grow by 6.6% a year on average. From 2010 to 2020 the number of new job seekers is expected to decline on average by 5.8% a year.  Remember that this is the growth rate of one part of the marginal change in the working population (the other part is the number of retirees), not the growth rate of the total working population, which will necessarily be lower in absolute terms. 

 

These numbers seem plausible.  I vaguely remember that last year a government report said that there would be 24 million people entering the job market and, I think, 4 million retiring.  If we net out people of retirement age (I am using 65 as a proxy for retirement), the change in the positive growth of new entrants into the job market is less dramatic until 2009-2010, and then the negative growth rate is more dramatic thereafter.  China still has a young population and so the number of retirees is currently small but is growing very dramatically every year, until roughly 2050, after which the number of people entering retirement is very high.  Today about 7% of the population is 65 or older, but in 2050 about 23% will be over 65 (332 million people – by the way much more than the combined retired population of Europe, North America and Japan). 

 

Until the 1960s China was among the youngest countries in the world, with a median age of 20.  Today the median age is 33, and the UN projects it to be 45 by the middle of the century.  By comparison the median age in the US is around 34, and is projected to be 41 by the year 2050, or a couple of years lower if we assume current immigration rates.

 

It is incredibly complicated to think about the economic implications of such dramatic demographic changes, but I think there are a couple of points that can be made:

 

¨          China currently needs extremely high growth rates – I think I agree with Xinxin Li’s suggestion of 10% annually – in order to keep the urban unemployment rate from rising, but this pressure will abate soon.  After 2010 the number of young people joining the job market will begin to drop quickly, while the number of retirees will continue growing rapidly.  The combination will reduce the need for job creation on the order of 1 million jobs or more a year for several years.

 

¨          In the short term this will be a good thing because it will allow China a little more room to maneuver on the jobs front and will create less pressure for breakneck growth.  In the longer term of course it means that there will be a sharp drop in the number of people working – much sharper than the drop in overall population.  That means workers will need higher levels of productivity to generate the same amount of per capita income.

 

¨          The rapid reduction in the number of young people and the rise in the number of older people are probably good for political stability.

 

Before ending this entry I wanted to throw in a few more numbers – not related to demographics, however.  Yesterday I said that new loans had grown by a relatively low 15.7% in February year on year.  Total new loans in February were RMB 243 billion.  This compares with the huge RMB 804 billion net growth in new loans in January.  It seems to me that there must have been some anticipation of February loans in the January numbers, although remember that every January we get a big number (though not this big) because of some left-over demand from the previous year.

 

Total new loans for the first two months of the year, then, amounted to RMB 1,047 billion.  This is 83% of the first quarter quota of RMB 1.26 trillion and 29% of the total 2008 quota of RMB 3.60 trillion.  I don’t think these quotas are going to last very long.

 

One last thing: I saw that according to the New York Times the CEO of Blackstone received $350 million in compensation in 2007.  I hope that doesn’t become too widely known in China.

FRI 14 MAR

5% revaluation of the RMB? Are you crazy? By Michael Pettis

China’s National Bureau of Statistics released a new batch of interesting information today:  “From January to February, urban investment in fixed assets achieved 812.1 billion yuan, with a year-on-year increase of 24.3 percent.”  Last year’s increase in investment spending was 25.8%, leading some commentators to talk about evidence of a “modest slowdown”, but the numbers suggest no such thing, especially since the January storms may well have depressed spending temporarily, and more especially since investment in real estate accelerated to 32.9%.

 

Speculative investment in real estate is a good proxy in China for speculative behavior in general, and perhaps also a proxy for speculative inflows, so the high growth in real estate investment seems to indicate that China’s easy money conditions are doing all the unhealthy things one would expect them to do.  The rapid growth in real estate “investment” is particularly worrisome because most insiders worry about the impact of real estate on the banks – banking exposure to real estate is extremely high (and, from the anecdotal evidence, not always recorded as such).  In case of a sharp economic contraction that led to a steep fall in real estate prices, banks could be badly hurt, thus exacerbating the slowdown.

 

The good news is that growth industrial investment slowed (but let’s not get too excited, it is still very high), and that should show itself as reduced growth in industrial production.  I am particularly concerned about that number because high levels of industrial production force a rising trade surplus.  As long as China produces more than it consumes it must export the difference, and a rising trade surplus increases China’s monetary expansion since the PBoC is forced to buy the accumulating foreign currency.

 

To make matters worse, the fall of the dollar ($1.5580 to the euro, $2.0310 to the pound, and Y 99.77 to the dollar) is putting unbearable pressure on countries who peg their exchange rate to the dollar.  Not only does this reduce the value of their currencies in international trade (and so put increasing upward pressure on their trade surpluses), but because the Fed is dropping interest rates and pumping liquidity into the system it can only increase hot money inflows into countries like China.  Referring to Chinese Commerce Minister Chen Deming, the China Daily today said:

  

Chen's ministry, which oversees foreign trade and domestic consumption, said that during the first two months, investments from the European Union countries rose a whopping 109 percent, while investments from the United States increased 44 percent.  Wild expectations abroad that the yuan will continue to rise in value against major world currencies has led to money coming to China. 

 

"When you bring US dollars to invest in China, you need to change it into the yuan. Naturally you would like your funds to enter China at an earlier date. Because, if you are late, the same amount of dollars will turn out to be less yuan bills," Chen told reporters.

 

Sure enough.  So what to do?  The China Daily is suggesting that some economists think China should consider a one-off revaluation, “possibly 5%”, to block hot money from flooding into the country.

 

Yes and no.  As I have been arguing for over a year, a one-off revaluation is pretty much the only option available to China to regain control of its monetary policy, and they are eventually going to be forced into doing it.  The fact that China Daily is reporting it suggests to me that this “crazy” idea is becoming less and less crazy every week.

 

But 5%?  That would truly be crazy.  Not only would a 5% revaluation accomplish very little in satisfying hot money expectations of RMB revaluation – we already expect the RMB to revalue by a lot more than that just this year – but even worse it would be a huge public announcement to the world that the PBoC was forced to do what they said they would never do, and anyone with a calculator and common sense will know that a lot more revaluation would be needed to adjust the monetary imbalances.

 

You don’t have to be a shadowy, evil speculator to see that 5% revaluation as a very loud signal to bring every penny you can get your hands on into China as quickly as you can.

 

Meanwhile there is a big debate going on among economists and bank researchers about how many more interest rate hikes, how many more reserve hikes, and so on the PBoC will engineer in order to tighten monetary policy.  The debate is interesting because it does give us an idea of what is likely to happen to the stock market and of course what will happen to the cost of financing additional real estate speculation, but I do not think it is terribly useful for understanding what is likely to happen to domestic monetary conditions.  China’s problem is not which set of tools can best be used to control the domestic money supply.  It has no control over the domestic money supply.  It is the currency regime which needs to be adjusted.