My Blog

SUN 16 MAR

Fuel shortages, inflation, unemployment, and sundry matters

Hong Kong’s The Standard has an article today entitled “Fuel price worries as rationing spreads.”  According to the article:

 

Fuel rationing begun in Hainan over the weekend has spread quickly across huge swaths of southern and eastern China, leading to speculation the mainland government will raise retail fuel prices within two weeks to put an end to the mounting chaos.  Guangzhou, Shenzhen and Haikou in the south, as well as Fujian province and the city of Ningbo in Zhejiang province have been affected by severe rationing of diesel and gasoline, according to mainland media.  

 

I wasn’t aware of this and have not seen it confirmed elsewhere, so I don’t know how seriously to take it, but of course it wouldn’t be surprising if the heavy subsidy on fuel prices led to shortages (I think fuel is effectively sold within China at around $45 a barrel).  If the reports are true, and if fuel prices are raised, needless to say the higher prices will show up as CPI inflation in March’s or April’s numbers. 

 

For those of us on the monetary side of the debate, by the way, raising fuel prices does not create inflation so much as recognize inflation that has already taken place but not been recorded.  Basically the subsidies convert higher current fuel expenditures into higher current tax payments or higher current government borrowing (which represents higher future tax payments).  The price impact is felt by consumers, only it doesn’t show up in the CPI numbers.

 

How might the PBoC deal with all this?  Yesterday Zhou Xiaochuan, governor of the PBoC, told reporters at a press conference marking the end of the NPC that “There is room for all monetary policy tools, including rates and reserve ratios.”  A lot of commentators are taking this to mean that in fact the PBoC will continue raising interest rates in order to cool down the economy. 

 

I have no idea whether or not this interpretation is correct (the price of government bonds haven’t seemed to change much), but as I have often said I don’t think raising rates will have much effect on inflation which, in my opinion, is a consequence of the currency regime, not low domestic interest rates.   According to the China Daily Zhou did admit that “It is too early to say monetary policy has succeeded in cooling credit and money-supply growth,” and I suspect that even after several more months we will still see that “monetary policy” (but how can we speak of “monetary policy” in China?) has had little real effect on inflation, although raising interest rates may have an effect on slowing overheating by creating bankruptcies.

 

At the same press conference Wu Xiaoling, a former vice governor of the PBoC, acknowledged that loan growth may top a government target for the first quarter of this year.  That is not much of a surprise – I discussed the January and February loan numbers in my posting on Thursday.  By the end of February we were already at 83% of the quarterly target – and this after a very slow February.

 

During the past week RMB appreciation has speeded up (up 0.4% so far this month), and the amount of noise coming from both within and outside China on the need to speed up appreciation has increased. It is almost an article of faith to me that all of this will have sped up hot money inflows.  In fact I expect that in the next few weeks the government will announce new steps to prevent hot money inflows – this is not based on any inside tips but just on what I see as the logic of the situation. 

 

If they happen these new steps will probably have an immediate short-term impact, but I doubt they will much matter beyond a few months.  The incentive to bring money into China is getting better all the time.  By the way over the weekend I met an old friend of mine who is relatively senior in the PBoC/SAFE/MoF world (I don’t want to be too specific), who said over drinks that the option of a one-off revaluation was, in his opinion, a very likely one.  He was not part of the foreign currency department of the PBoC, nor was he speaking in an official capacity, so his opinions don’t matter for policy, but nonetheless I do think it is interesting that someone in his position believed that China would have to consider a one-off revaluation.  Clearly the policy is not seen by everyone as totally unlikely.

 

I also note that China's trade surplus is expected to rebound beginning in March after a sharp year-on-year decline in February, the China Securities News reported, citing Commerce Minister Chen Deming.  According to China Daily Chen was quoted as saying that the sharp decline in exports in February was a one-off because many companies front-loaded their exports to ship before the lunar New Year.  Reserve growth already seems to have been very high so far this year.  A pick up in hot money and in the trade surplus will do nothing to bring this down.

 

On a separate note last week I posted an entry about the number of people joining the job market in China.  A few days ago People’s Daily had the following article:

 

Grim employment prospects: 24 million people competing for 12 million positions

 

Tian Chengping, Minister of Labor and Social Security, said on March 9 that there are 24 million job-seekers in cities and towns every year, including the new additional urban workforce and the people carried over from the previous year who did not find work. But there are only a little more than 12 million jobs available in cities and towns every year. Approximately 8 million additional rural laborers move into cities and towns every year; and this phenomenon will continue for quite some time. The current employment situation remains grim.

Tian Chengping said that in the future, we should promote employment in six ways that include regulating and controlling unemployment; establishing an early warning system for unemployment; and making efforts to maintain stable employment conditions.

 

 

TUE 18 MAR

We'll do anything to kill inflation except threaten employment By Michael Pettis

In his press conference today for the conclusion of the annual session of the NPC, the country's top legislative body, Premier Wen smiled bravely at the attendees and television cameras and said that the government is fully confident that they can control inflation this year, although he admitted that it would not be an easy job.  According to the Xinhua report:

 

Wen acknowledged that it will be hard for China to attain its goal of holding the rise in consumer price index (CPI) at about 4.8 percent and controlling price hikes this year, which was made even more difficult by the worst sleet and snow disaster in decades in the first two months of this year.  “But we have no plan to change this goal,” he told reporters.

 

The premier explained that it shows the resolve of the government to control price rises and curb inflation by setting the goal, and it will help stabilize the people's expectations for price rises by doing so.

 

During that same speech Wen said “We are under mounting inflationary pressure. We also face the potential risk of drastic economic fluctuations.”  He announced no initiatives but said: “If we take the right measures, we are confident we can control inflation”.  He added: “We are sticking to the 4.8 percent target because it helps stabilize consumer expectations.  When prices soar, expectations can be more horrifying than the increases.”  

 

I am not sure what it means to say that inflationary expectations are more horrifying than inflation itself, but I suspect he means that rising expectations have a bigger impact on future inflation than current inflation does.  The trick, in that case, is to control expectations, and that means talking it down.

 

Of course I don’t agree.  In China’s case I think inflation is a consequence of monetary expansion, not “expectations”, but by saying this he more or less admits that the 4.8% inflation they have targeted for 2008 is not likely to be achieved.  He only made the announcement because he is trying to talk inflationary expectations down.  This strategy is not exactly costless, although I guess he didn’t have many options.  It undermines government credibility to insist on something that most people know is likely to be untrue and which will be almost impossible to achieve.  It reminds me a little of President Ford’s strategy for fighting inflation in the 1970s, which as far as I could tell consisted mainly of wearing a “Whip Inflation Now” button during all his television press conferences.

 

Premier Wen also said he was “deeply worried’ about the US and global economy and the fallout from the continuing weakness of the dollar.  He talked about using the full range of monetary policy options to address the inflation and overheating problems, which the market took as a signal that we would see a more aggressive stance on interest rates (the stock market was down nearly 4% today).  “No matter what monetary policies are adopted, we shall weigh their advantages and disadvantages and take both aspects into consideration,” he added. 

 

It sounds to me like he is saying that the financial authorities are willing to consider any policy option, and they acknowledge that at this point the option is not between good policies versus bad ones but between bad ones versus worse.  Actually I should amend this to mean almost any policy option.  According to the Financial Times he was asked a question abut employment versus inflation:

 

Asked whether he would sacrifice economic output to bring down inflation at the possible risk of increasing the jobless rate, Mr Wen indicated that growth and employment remained the overarching priorities. “We must ensure that our economy will grow at a proper rate in order to ensure employment,” he said.  “China is a developing country with 1.3bn people. We have to maintain a certain degree of fast economic growth to provide enough jobs.”

 

That is the nub of the policy dilemma.  One of the consequences of China’s expansionary monetary regime has been fairly rapid employment growth, but not enough growth to eliminate altogether the threat of rising unemployment.  The problem the government faces is in figuring out how to engineer a sharp slowdown in monetary growth without triggering job losses.  It is not going to be easy, but it probably mean that they will take serious steps to address monetary expansion only when the consequences (e.g. inflation) are so severe that they cannot be ignored.

 

Meanwhile the February wholesale price index was released today.  February wholesale prices were up 9.2% year on year and 1.1% month on month (which amounts to an annualized 14%).

 

WED 19 MAR

Minimum reserves up. Stamp duty down? By Michael Pettis

Yesterday I had to join some friends from New York for dinner, so I left my office earlier than usual.  While I was away and after the market had closed the PBoC sneaked in another 0.5% hike in minimum reserve requirements – their second hike this year, after ten hikes last year (all except one were 50 bp hikes).  Chinese banks now have to hold 15.5% of their deposits as required reserves at the central bank. 

 

As I see it, the most interesting question is whether the banks will be asked (as they have in the past) to redenominate these reserves into US dollars.  If they do, the headline PBoC reserve number will drop, I think by about $20-25 billion (compared to $40-50 billion of monthly inflows on average last year), but there will be no real impact on domestic monetary conditions.  That is because the redenomination of commercial bank reserves is simply an accounting event.  The PBoC will still have had to buy the foreign currency inflows in the market and they will have had to inflate the domestic money supply in order to do so.  Only now, they can remove the accumulated dollars from their balance sheet and transfer it to the balance sheets of commercial banks.

 

The only thing real that will change may be future commercial bank exposure to the dollar, unless the banks came to some kind of hedging agreement with the PBoC.  And of course guys like my friend Logan Wright at Stone & McCarthy will have to work harder than ever to figure out exactly what is going on with reserves at the PBoC.  It is worth noting that the Shanghai stock market was up today by 2.5%, after dropping nearly 4% yesterday, suggesting that the local market did not see this latest minimum reserve requirement hike as a big deal.  I suspect the hike was mostly symbolic, especially as it came right after the close of the National People’s Congress, and it was designed to show that the government is really serious about fighting inflation.

 

Talking about the stock market, after having declined by about 40% from its peak in November every investor here in China is looking for relief.  There are a lot of rumors that the Ministry of Finance is going to cut the stamp duty on stock transactions.  Last year, I think at the end of May, the MoF announced that it would triple stamp duties on purchases and sales of stock to 0.3%.  The move was widely seen as a move to cool the frenzied market and, sure enough, in the next week the market lost 13%.

 

Now that the market is down substantially, a number of people are calling for a rescinding of the increase.  He Qiang, a member of the National Committee of the Chinese People's Political Consultative Conference, said he would submit a proposal calling on the government to change its bi-directional stamp tax to one way.  A lot of people supported his call.  For example government economic adviser and professor at People’s University, Wu Xiaoqiu, recently said that stamp duty on stock trades should be completely scrapped.  He also pointed out that the earlier tripling of the tax to curb investor demand was not a correct way to calm the market.

 

Earlier last week Minister of Finance Xie Xuren said public discussions about cutting the stamp duty had been noted and the ministry would “seriously consider” readjustment of the tax.  As a shareholder in the Shanghai B-share market of course I personally support any move to increase the value of my shares, but the finance guy in me is not as eager to see this happen.  Every time government authorities change policies in order to push the market up or down they are simply reinforcing the idea that the Chinese stock markets are not a machine for allocating capital so much as a machine to achieve the immediate political objectives of the government.  I don’t think there is anyone left in China who believes that an investment strategy should be anything other than a strategy to figure out the government’s next move, but if there is, this’ll show him.

 

THU 20 MAR

Tax repeal rumor caused a rebound in Shanghai By Michael Pettis

Yesterday I noted that there were lots of rumors in the market of a cut in the stamp duty as a way for the government to prop up share prices.  In my posting I wrote:

 

Earlier last week Minister of Finance Xie Xuren said public discussions about cutting the stamp duty had been noted and the ministry would “seriously consider” readjustment of the tax.  As a shareholder in the Shanghai B-share market of course I personally support any move to increase the value of my shares, but the finance guy in me is not as eager to see this happen.  Every time government authorities change policies in order to push the market up or down they are simply reinforcing the idea that the Chinese stock markets are not a machine for allocating capital so much as a machine to achieve the immediate political objectives of the government.  I don’t think there is anyone left in China who believes that an investment strategy should be anything other than a strategy to figure out the government’s next move, but if there is, this’ll show him.

 

Today the rumors about a repeal or reduction in the stamp duty were so strong that the markets reversed morning losses of nearly 6% to finish up 3% for the day.  That’s a pretty big swing, and it shows how vital government actions are to the stock market here in China.  Not a good thing.  

 

In general there are pretty widely felt expectations that the government wants to see the market behave well during the next few moths as it grapples with a series of domestic and external problems, including of course rising inflation in China and a slowing US economy.  I suppose we don’t need to see more carnage in the local stock market while all these other problems have to be resolved.

 

In addition to the rumors of a repeal of the stamp duty, a release jointly issued today by the Ministry of Finance and the State Administration of Taxation said that mutual fund companies will get a temporary tax exemption in their stock investment income in China.  The notice said that tax-exempt items include fund companies' profits from stock and bond trading, dividends, and bond interest.  All of this is good news for the fund companies and a pretty clear signal that the government is indeed concerned that the market correction has gone too far.

 

I had originally planned to close out my stock positions in March to avoid the pre-Olympic sell-off, but given that we’ve corrected by nearly 40% from the November peak, I guess I am not too worried that there will be a further big sell-off.  In fact given government worries about the market and the large and perhaps rising amount of foreign currency inflows, which will add to domestic liquidity, I think there is a reasonable chance that we may see a pretty strong market for the next month or two.

 

Speaking about foreign currency inflows, the PBoC released a report today worrying about capital inflows.  I have not yet seen the translated version of the report, but China Daily (headline: “Huge capital influx poses hazards”) describes the report like this:

 

According to the report, the flood of international capital coming into emerging economies undermines the stability of their currency values. Mounting foreign exchange reserves complicate their monetary measures, while irregular and speculative moves in short-term capital make macroeconomic control tougher.

 

…The global liquidity problem may stay for a while, said the report, as major developed nations may continue to relax monetary regulation. Furthermore, the Fed could possibly cut interest rates again and some developing economies are expected to pursue looser monetary policies as well

 

All of this is true enough, and I wonder if the PBoC and others are gearing up in public their explanations of why China is suffering from a monetary problem.  Is this for the benefit of the newly installed leadership?  If capital inflows are really the problem, then they must be addressed, right?  Unfortunately I think the instinct of Chinese political authorities is to address problems with heavy-handed administrative measures – making capital controls, for example, more binding.

 

On a very different note, my student Liu Bing found the following article in a local business newspaper and translated it for me.  I thought it was interesting because it shows the complexity and difficulty of this whole pork business:

 

The Distortion of Pork Price --The Rich's Business

 

In the past, farmer raised pigs because there were not too many people with good jobs, but now most of the young workforce went to in the urban cities, instead of raising pigs, they become consumer of pork in the city (I heard an estimation that this number can be as large as 250 million people )

 

Although the pork price almost doubled compared two years ago, the farmers still can't make a profit by raising pigs. A baby pig's price is 1000 yuan on average, considering the fodder price and other fees, and the selling price of pork is 7.8 yuan per 500g, which is almost the half of the pork price in the city's supermarket (as there are several layers of pork dealers in the middle and the transportation and other fees), the profit of raising a pig can be as much as 400 yuan per head.

 

The blue ear disease killed about 10 thousand pigs in 2007 according to the official release statistics, but according to an officer in the Chongqing Pig Feeding Research Institution, the circumstance he saw is 30% of the pigs died of this disease. Of course, the snow storms worsen this situation.

 

Although there is subsidy from the government, for farmers, the risk of raising pigs is still too high.  About 70% of the supply of pigs comes form household's raising. The pig raising industry is far from institutionalized (only about 10 thousands entities who are feeding more than 100 pigs around the country).

 

This is a distorted business.  Only the farmers who raise pigs take on both the market risks such as the fluctuation of price and the raising risk like the death of pig. The other people who deal in pork assume almost no risk. This pig raising business can only be profitable if it is institutionalized and has economies of scale.

 

FRI 21 MAR

How do you turn this thing off? By Michael Pettis

According to Market News International Chinese foreign exchange reserves hit $1.6471
trillion at the end of February.  This means that foreign exchange reserves rose by a surprising $57.3 billion over the month of February (actually I am lying – none of these numbers surprise me anymore).

 

In January reserves were up officially by nearly $62 billion, although there are strong reasons to believe that the headline number was understated by $22 billion – the amount of the hike in the minimum reserve requirement, which the banks were probably asked to redenominate in US dollars.  For the first two months of the year, then, reserves are up by $119 billion (and in terms of monetary impact they were probably up $141 billion), which far outpaces the already outlandish $40-50 billion monthly increase on average during the 2007.  

 

The trade surplus contributed $25 billion and FDI contributed $11 billion to reserve growth in January.  In February they contributed only $8.6 billion and $6.9 billion, respectively.  So even with sharply lower contributions from trade and FDI ($16 billion versus January’s $36 billion), reserve growth in February has been extremely high.  Let’s assume that valuation mark-ups and interest income added around $10 billion.  That still leaves us with over $30 billion to explain.  It can’t all be hot money, of course, but all the circumstantial evidence seems to suggest that hot money is accelerating.  No big surprise, perhaps, given the pace of RMB acceleration.

 

I am not sure what exactly is going on to account for all this inflow, but it seems that with reserve growth accelerating, and with it the monetary expansion that occurs as the PBoC is forced to buy the reserves, it is going to be almost impossible to rein in the overheating and inflation that plague the economy.  I am afraid that for all the talk and action, things are getting worse, not better.

 

If this level of reserve growth adversely impacts the fight against inflation, which I expect it will, a recent PBoC survey bodes ill.  A 50-city quarterly survey conducted by the PBOC found that in the first quarter, 49.2% of the 20,000 respondents said prices had become “intolerable”.  According to the results, released yesterday, the proportion was a record high, up from 25.9% in the first quarter of 2007.  

 

In an article on the PBoC survey, the China Daily reported:

 

There is some positive news on inflation, however. The survey found that just 49 percent of people expect inflation to rise in the second quarter of the year, down from 65 percent who thought so in the previous survey.  The results show the public has confidence in the country's efforts to stabilize prices, the central bank said.

 

I am not sure this is necessarily all good news.  This public confidence is a good thing if it restrains inflationary expectations, but I am afraid that if the public is confident that the authorities can indeed control inflation, they are likely to be all the less prepared and more disappointed if the authorities fail, and in my opinion this level of reserve growth makes me more skeptical than ever that inflation can be controlled.

 

Meanwhile the administrative fight against inflation is still raging.  According to today’s Xinhua:

 

Supervision departments were urged on Thursday to crack down on market speculation and illegal price hikes to ensure smooth market order. A circular from the Ministry of Supervision asked its local bureaus nationwide to step up inspections to ensure that the central government's price policy was fully implemented. It called for severe punishment of illegal activities including price-fixing, hoarding, cornering markets and spreading price-rise rumors to make profits.

 

The ministry also urged local offices to strengthen monitoring of the implementation of energy conservation and emission reduction regulations and punish violators.  Implementation of the central government's policies on fixed-asset investment and real-estate market development would also be checked and violators would be penalized, according to the document.

 

And as long as we are on the subject of capital inflows, the World Bank released an interesting study on global workers’ remittances yesterday.  According to the study:

 

The top five recipients of migrant remittances in 2007 were India ($27 billion), China ($25.7 billion), Mexico ($25 billion), the Philippines ($17 billion), and France ($12.5 billion).

 

At least now we can explain another $2 billion or so per month in capital inflows.