With yesterday’s bad April CPI number, the subsequent increase in minimum reserve requirements to 16.5%, and the slowing will-they-won’t-they appreciation of the RMB, it is tempting to stick to monetary topics in this and the next few blog entries, but regular readers know what I am going to say anyway.First, inflation may get a little better in the next month or two (although I wouldn’t bet on it), but by now it is pretty clear, at least to me, that this is a monetary phenomenon and, given the continued recent expansion in the domestic money supply as reserves pile on, we are going to see non-food inflation surge in the coming months.
Second, as far as the slowing of RMB appreciation is concerned, I bet this is going to be a very temporary phenomenon, and is probably largely a response to the dollar’s appreciation against the euro.But this new strategy (or revival of a failed old one) is not going to improve the worsening monetary dynamics.Reserves are going to continue to surge, driven increasingly by hot money rather than the trade surplus, and with inflation rising and still no sign of an economic slowdown it is just a question of time before the monetary authorities throw in the towel and go for the one-off appreciation.Nothing else will work.By the way last night I had dinner with a group of Chinese academics, including a very famous and influential finance scholar (who for obvious reasons shall remain nameless), and he said there was little doubt in his mind that a one-off revaluation was the only solution left to the country’s monetary problems.Our only disagreement was that he said it should be a 10% jump, whereas I think that is too little and is only likely to encourage speculative inflows.
Interesting as all this is, however, in this blog entry I want to change the subject to something very different and with much longer-term implications. I spent the last week going thorough historical and projected population data for China by age group, and the most interesting summary of the data I have put in the table below. It shows the growth rate of Chinese population by decade (of course these are average annual growth rates for each decade), as well as the growth rate of subcomponents of China’s population. Given the way the data is presented I am defining “Young dependents” as anyone 19 or younger, and “Old dependents” as anyone above the age of 65. “Working population”, of course, is everyone else.
1990-00
2000-10
2010-20
2020-30
2030-40
2040-50
Total population
1.00%
0.60%
0.60%
0.21%
-0.05%
-0.21%
Working population
1.72%
1.42%
0.40%
-0.26%
-0.60%
-0.49%
Young dependents
-0.51%
-1.50%
-0.30%
-0.44%
-1.36%
-0.41%
Old dependents
3.34%
2.43%
4.30%
3.51%
3.20%
0.62%
To summarize the raw numbers, China’s population is expected to grow from 1.32 billion today to 1.46 billion in 2030, after which it will decline slowly, to around 1.42 billion in 2050. Its working population is currently around 840 million.This component of the population will rise in the next ten years to around 910 million and then will decline quite rapidly to around 790 million by 2050.
The graph below shows the composition of China’s population by age group.Needless to say the most dramatic change is the explosive growth of the over-65 population, followed by the decline in the share of the young.Another way of understanding this is to note that China’s median age basically climbs over this period from 24 to 45 (which, by the way, may have favorable consequence for long-term political stability).
The graph shows the consequence of these differential growth rates on the age composition of China’s population. Notice that the Y-axis begins at 50%, so the working population is much bigger than its share of the graph might indicate. As is nonetheless evident, the real interesting story here is in the age composition, especially in the growth of the over-65 population.In 1990 China had about 63 million people over the age of 65. Today that number has grown to around 109 million.The rate of growth really starts to pick up in the middle of the next decade so that by the year 2050 China is expected to have about 350 million people over the age of 65 – this, for comparison sake, is more than 15% bigger than the total current population of the United States. The ratio of the elderly rises from 5% of the population in 1990, to 8% today, to an expected 25% in 2050.
The graph also indicates that, thanks to the baby boom in the 1950s and the implementation of the one-child policy beginning in the mid-1970s, China has enjoyed a huge demographic dividend beginning around 1970 or so, when people of working age comprised around 51% of the working population (one worker for every non-worker), to 2015, when they will comprise around 65% of the total population (one and one-half workers for every non-worker). Their share is then expected to decline to around 56% of the population by the middle of the century.During and after the 1970s, the working population exploded as the baby boomers joined the work force, but with very few children being born, even the very rapid growth among the elderly (thanks, I assume, to significant improvements in health care) meant that China’s working population grew much faster than its total population.Even if worker productivity were constant (and it wasn’t – it rose dramatically), the consequence would be a sharp improvement in per capita income and living standards.
I don’t have the figures yet from before 1990, but looking at other sources I would guess that China’s working population grew by about 2% or more annually during the 1970s and 1980s.In the 1990s, as the table indicates, the growth rate of the working population slowed to 1.72%, declining further in the current decade to around 1.42% on average. The number of working Chinese keeps growing until around the middle of the next decade, and then begins to decline by about half a percent a year.
Actually these numbers might understate the change, since as China transitions from a largely rural society to a largely urban one I suspect that the definition of the working population becomes more rigid. In a peasant and rural societies, in other words, the definition of working population is probably a lot more flexible, and many too-young people and too-old people do the same work that the working population does. As the society becomes increasingly urban, however, young people are expected to go to school and old people to retire, so their contribution to the work force probably declines.This suggests that the real working population may have grown a little more slowly in the past decade or so and may decline a little more rapidly in the coming decades than the age numbers indicate.
All this has important implications both for nominal growth rates and per capita growth rates in the next few decades.For one thing, a country’s GDP growth rate can be expressed as a factor of the growth rate of its working population and the growth rate of average productivity per worker.As the growth rate of the working population swings from positive to negative – by a little more than 2%, depending on what periods you compare – this will have a commensurate impact on Chinese GDP growth rates, i.e. all other things being equal (which of course they are not). China’s equilibrium growth rate should be about 2% lower than the equilibrium growth rate of the past two or three decades.
The other thing worth noting is that beginning some time in the next decade, China’s working population will begin to grow more slowly (or shrink more quickly) than its total population, suggesting that the demographic dividend it has enjoyed during the past three decades will become a demographic tax. Per capita income, in other words, will grow more slowly than the growth in worker productivity.
Since total consumption is a function of the size of the total population and its income per capita, and total production is a function of the size of the working population and its productivity, the demographic relationship between total production and total consumption also will change. Remember that a country has a trade surplus if it produces more than it consumes, and a trade deficit if it consumes more than it produces. This implies that over the last three decades China has had a demographic bias towards trade surpluses (working population, a proxy for production, grew faster than total population, a proxy for consumption), but over the next three decades it is likely to have a demographic bias towards trade deficits.
This doesn’t mean, of course, that China necessarily ran trade surpluses during the last three decades (in some years it ran deficits) and will necessarily run trade deficits over the next three decades.Other factors, including most obviously changes in worker productivity and savings rates, matter too. But it does mean that since demographic conditions contribute towards the relationship between consumption and production, in China we are going to see a switch in those conditions from a bias towards trade surpluses to a bias towards trade deficits.
Three years ago I argued in a Wall Street Journal OpEd piece that because of the aging and declining populations of Europe and Japan (and to a lesser extent China and Russia), compared to the growing population and relatively stable age distribution in the US, it was not unreasonable for the former countries to run large current account surpluses with the US since they would need the accumulated claims against the US to pay for the current account deficits they would need to run to manage their demographic adjustments. This is why I have never been terribly worried about the sustainability of the US trade deficit. In the next decade it is likely that demographic changes will create pressures to reverse those US trade deficits.
It also suggests at least one extenuating circumstance explaining the very mercantilist trade policies followed by the Chinese government.As they are probably very aware of the dramatic demographic adjustments China will need to make in the coming decades, it is reasonable for them to want to accumulate claims against the US to pay for these adjustments. Of course now, I think, their policies have caught them in a monetary trap from which it is very difficult to escape and which is causing balance sheet havoc.Still, after their upcoming monetary adjustment, however painful, I expect them to continue favoring export oriented policies.The only certainty about their demographic future is that there will be a difficult adjustment from a rapidly growing working population to a rapidly shrinking working population.
April’s CPI numbers were released earlier today and, as the pessimists among us expected, inflation came in at 8.5% year on year, quite a bit higher than most analysts’ predictions.March’s year-on-year inflation was 8.3%.Probably in response to the higher-than-expected numbers, late in the day the PBoC announced that minimum reserve requirements were going to be raised by 0.5%, to 16.5%.
Throughout the past two weeks we had been getting a lot of soothing noises about inflation and confident predictions from analysts and even from Governor Zhou of the PBoC that it would come in at 8% or just above – Bloomberg’s poll of 22 analysts predicted on average that year on year CPI inflation for April would be 8.2%. Even Credit Suisse’s Dong Tao, who has normally been very pessimistic – and very right – about inflation, predicted that April’s CPI number would come in at 8% year on year. It took a bitter, twisted guy like Stone & McCarthy’s Logan Wright, who refused to bask in the good feelings and insisted on counting the numbers up for himself, to throw in an 8.5% prediction. He was right, thereby reinforcing my claim a few days ago that for the past six months you would have always done best by betting on the most pessimistic prediction.
Month-on-month inflation rose by 0.1%. This means that inflation for the first four months of the year is running at an annualized 9.9%. At this rate we would need inflation for the next eight months of the year to be 2.4% on an annualized basis to bring us to the government’s 4.8% target for 2008.Clearly this is very unlikely, and even government officials have acknowledged that the official target is intended more for signaling purposes than as a real statement of government intentions.
I assume that most of the investment bank researchers, who are still predicting annual inflation for all of 2008 as coming in between 6% and 7%, will want to reconsider their predictions. With CPI inflation running at an annualized 9.9% for the first four months of 2008, we would need price increases to run at less than an annualized 5.6% for the next eight months if we hope to bring CPI inflation under 7% for 2008. This is not impossible, of course, but it is very unlikely to occur without a significant economic slowdown, so if investment banks are still predicting CPI inflation for 2008 below 7% they should probably revise their GDP growth expectations sharply downwards.For the record, I think year-on-year inflation will exceed 8% in 2008 and could easily approach double digits.
Year on year non-food inflation at 1.8% was the same this month as last month. Commodity, energy, labor, household items and residential property are the main culprits, which unfortunately suggests that inflation is, as expected, spreading away from food.Remember that it is rising food prices that have absorbed inflationary pressures, according to my model of inflation in China, and because food prices have increased so quickly – 22.1% year on year – they have actually forced downward pricing pressure on non-food items. The fact that non-food prices continue nonetheless to rise is, in my opinion, ominous.
Today’s numbers won’t do much to resolve the debate between the pork and money camps.This of us in the money camp will point out that non-food inflation may still be relatively low, but instead of decelerating, it has been accelerating all year. This is wholly inconsistent with the idea that Chinese inflation is just a food problem, since annual price increases of over 21% for food, with food officially 33% of the CPI basket, should have put tremendous downward pressure on non-food prices.By the way I think the ADB claims (more realistically, in my opinion) that food is 40% of the consumption basket, not 33%, which if true would take CPI inflation up closer to 9.9%.
The money camp will also argue that recent foreign currency reserve growth has been way too high and is clearly causing excess monetary expansion, which must show up in overheating and inflation. Finally, they will argue, even with the moderation in export growth, there has been no sign of a slowdown in the economy.
The pork camp will argue that non-food inflation is still low, and we are still seeing the delayed impact of the food supply constraints from last year and during this year’s storm. As long as the government can resist pressures for inflationary expectations to spread, inflation for the rest of the year will continue to drop as the food supply problem eases. They will also point to a slowdown in export growth and continued concerns about weakness in the US economy to insist that the financial authorities have very little room to get it wrong on the side of excess tightening.
We still need to wait and see a few more months of CPI inflation before this debate is fully resolved. I am of two minds as to what the CPI numbers for May and June are likely to be. On the one hand food prices have held up stubbornly but price increases are starting to moderate somewhat and in some cases may even be declining, so we may see some relief there.Thanks to price controls and spending rigidities there may be a lag between a slowdown in food inflation and a pick-up in non-food inflation. From that point of view we may see the CPI index rise only very slowly from its current level, and overall year-on-year CPI inflation hover around 8% to 8.5% for the next month or two, before picking up substantially in the third and fourth quarters as non-food inflation kicks in more aggressively.
Alternatively, with the beginning of the great Olympic party, we may start to see pressure for price increases much earlier. There are already reports of a significant increase in domestic airline tickets, and of course in and around Beijing we are all braced for a big increase in prices – if we haven’t seen them already.There is also pressure for a relaxation of price controls on certain goods because of hoarding, smuggling, and their distorting impacts on consumption.All of this might result in sharper increases in CPI inflation fairly quickly.My worry is that even if we do see a pick-up in inflation in the next two or three months, those who continue to want to postpone the monetary adjustment will argue that the most recent bout of inflation will have been caused by yet another one-off event: the Olympics, which once it is behind us everything will be fine.
The stock markets have behaved a little erratically today. According to my student Shang Ning, who follows the markets closely, the SSE Composite opened around 1.8% below Friday’s close of 3613, and traded further down to 3522 (down 2.5%) a few minutes before the release of the CPI numbers, on expectations that CPI inflation was going to be higher than expected and might result in further tightening action by the PBoC.After the CPI release, however, the market rebounded for the rest of the morning and continued up in the afternoon to close the day up 0.37%, driven by airline manufacturers and steel companies.It seems that bad CPI numbers haven’t really fazed anyone.
Since there hasn’t been a whole lot of news so far this weekend, let me turn now to something totally different.Some of my friends know that on the side I am very heavily involved in the Beijing underground and experimental music scene.For those who don’t know, the music scene here has exploded in the past two or three years, and as someone who was very actively involved in the heady music atmosphere of New York in the early-1980s I can say with some confidence (and a number of well-known foreign critics and musician have told me the same thing) that Beijing right now may be one of the five or six most exciting cities in the world for new and experimental music.
For any of my blog readers in the UK or Europe, you have a chance to see one of the astonishing young figures of the Beijing underground music scene – 22-year-old Shouwang.His underground rock band Carsick Cars just played England’s prestigious All Tomorrow’s Parties festival in Cambers Sands last night, and to great success I hear.The band will subsequently play dates in Manchester and Glasgow before opening for Dinosaur Jr. at London’s Koko on May 15.His experimental duo, White, will then tour Europe with Germany’s legendary Einsturzende Neubaten, with dates, among others in Amsterdam (May 20), Brussels (May 21) London (May 22) and Berlin (May 24).I know my blog is meant to be about Chinese financial markets, but one of the most exciting things going on now in Beijing is the music scene, and I am a close friend and huge fan of Shouwang, who may be the first young genius to emerge from this scene.His performances are riveting.Go see him if you can.
Monday is CPI day, and I promise I will return to financial topics.
China’s PPI numbers for April were released today and, to no surprise to those of my readers who agree with my argument that inflation in China is primarily a monetary problem, they weren’t good.Year on year the index was up 8.1%, a little below market expectations but above last month’s 8.0%.This was fastest pace of increase in four or five years. Just six months ago year on year PPI inflation was well under 3%.
Although the food component was up, by 11.9% year on year, much of the increase in PPI prices was driven by even sharper increases in the prices for crude oil, steel, raw materials, fuel and power.In my opinion it has become very hard to hope that inflation has not spread to other goods.We are seeing exactly what we would have expected if the monetary model of inflation in China is correct – for a while rapidly rising food prices absorbed much of the inflationary pressures caused by excess money, but as food inflation abates the inflationary pressure will spread more evenly among other goods and services.The debate still isn’t fully resolved, of course, but another month or two of these kinds of price increases should really damage the argument that this is “just” a temporary problem of too little food.
According to yesterday’s Bloomberg the median estimate from 22 economists for April CPI inflation is 8.2%, a moderate improvement from March’s 8.3%, with most predictions bunching around the 8.0-8.3% level.I suspect, however, that we are going to be disappointed, and that the actual number is going to come in substantially higher. With most economists continuing to believe that Chinese inflation is a food-supply constraint problem, the recent moderation in food inflation has led them think that CPI inflation is also moderating but, as I have been insisting for several months, we are going to continue to be surprised by accelerating inflation in the non-food component of the CPI basket.
Earlier today I had coffee with a group of people that included the chief economist for one of the larger Beijing-based securities companies in China (since I didn’t ask her opinion to quote her I won’t mention her name). She struck me as an extremely smart lady, very knowledgeable, and probably very well-connected as far as her information sources.She told us that she expected April CPI inflation, which is due to be released Monday, will actually come in at 8.5%.As I mentioned in a posting on May 5, Stone & McCarthy’s Logan Wright, whose inflation pessimism in recent months has largely been justified, did his own counting and also came up with 8.5% as his prediction.Finally an article in today’s South China Morning Post cites two unnamed sources who are supposedly “familiar with the data” as making the same claim.Sounds worrying, although not at all surprising if true.
On that and other topics Vice Premier Wang Qishan gave a much-anticipated speech in Shanghai today and had some very sound things to say about China’s financial system.He stressed the importance of financial risk prevention.“Safeguarding financial stability and preventing risks will be one of our policy priorities,” Wang said according to Bloomberg. “The subprime crisis, globalization of financial markets, and financial product innovation have magnified financial risks to the world as well as China.”Given the huge monetary imbalances of the past few years and the enormous growth in bank lending I think one of the biggest dangers facing China must be the increasing risk of a sharp financial adjustment leading to a crisis in the banking sector, and so I think it is very important that the financial authorities recognize and worry about these risks (actually worry is not strong enough a word, in my opinion – they should obsess about it).
Wang, who is widely described as the chief financial policy-maker, also insisted that China will maintain a tight monetary policy to cool price increases and prevent economic overheating, and he made some strong references to the need to “step up” its management of cross-border capital flows, i.e. hot money. As if on cue Xinhua published an article today on hot money, which, according to the piece,
…is becoming an increasingly important concern for Chinese regulators as anticipation of an inflow surge strengthens along with a widening gap between interest rates in the United State and that in China. The exact amount of “hot money” into the country would be difficult to discern, however, there is indeed an acceleration of capital influx into the Chinese market as investors bet on a stronger yuan and rising domestic interest rates.
Later on in the piece they quote a widely-cited recent estimate of hot money inflows:
Zhu Baoliang, the chief economic analyst of the prediction department of the State Information Center (SIC), told an industry seminar last month the first-quarter speculative inflow exceeded $80 billion, compared with $120 billion for all of 2007.
The State Information Center has been arguing pretty consistently, it seems to me, against continued increases in the value of the RMB, and they have especially pointed to the acceleration of hot money inflows as one of the major reasons against rapid appreciation. Of course I would argue that the acceleration of hot money actually suggests something very different: that the only option left for the PBoC is a one-off revaluation.
The same Xinhua article then referred to another piece of research, this time one with which I was not familiar:
Speculative capital inflows into China may climb to $650 billion by the end of this year, or $800 billion by the end of 2009, Zhong Wei, director of the financial research department under the Beijing Normal University, said in a recent report without elaborating on his calculation method.He put the amount of hot money at $320 billion at the end of 2005, 400 billion at the end of 2006, and $500 billion at the end of last year.
It doesn’t matter that these different estimates for hot money inflow don’t agree among themselves, because it is very difficult to measure what are after all often illegal transactions, and often buried in trade and other transactions, especially since there isn’t even an accepted definition of what kinds of capital inflows can be regarded as “hot money”.The important thing, I would submit, is that everyone who has attempted to construct proxies for hot money has reported a significant increase in his measure.With Wang Qishan bringing up the subject in his Shanghai speech, it is clear that this is a major consideration one way or the other.
I can’t finish the week with out noting that we had another bumpy day on the stock market.I will once again turn to my student Shang Ning for color:
It seems today the PPI number shocked some players, but not too much. The SSE index opened up by roughly 0.8%, and then bounced up and down within a range of + or – 0.8% from yesterday’s close. Around 10:00 a.m., the PPI number was released, and the market dropped sharply to 3556, for a 2.85% loss for the day. That was the day’s low, but in the last hour, it moved back with some volume and finally closed down for the day by -1.19%. Coal companies and consumers gained. Financial companies, banks, and real estate were the big losers, with the financial sector losing 3.16% on average.
Banks have been hit pretty hard the past few days, mainly on concerns about slowing growth and interest rate hikes.There still is very little conviction in the market.Today I was interviewed for CCTV’s current events program, Dialogue, and the topic of discussion was whether government interventions are likely to work to keep the market strong, at least until the Olympics.The other guest, Bi Jiyao, Deputy Director of the NDRC’s Institute for International Economic Research, was much more sanguine than I was about the ability of the government to support the market and turn around negative sentiment, but we both agreed that over the long term these interventions are not positive for the development of a healthy investor base.
Ultimately, he argued, the question is one of social stability, and although market interventions are not healthy in principle, it was very important for the government to keep the current market from turning into a rout and causing huge damage among the urban middle classes just before the beginning of the Olympics. I guess I agree, although I think I am also less optimistic than he is about how successful these interventions are likely to be.
There is an article in today’s Financial Times, whose title, “Battle-scarred bankers lapse into a hoarding habit,” immediately triggered my interest.The article argues that one of the recent “paradoxes” of the international markets, that recovering stock prices for the leading international banks seem to indicate that the worst of the credit crisis may be over, while very high LIBOR rates seem to indicate the opposite, may be resolved by considering that high LIBOR rates are not a response to credit concerns but rather to old-fashioned hoarding:
Until now, bank analysts have assumed that the high cost of interbank borrowing stemmed from a sense of mutual distrust. This would suggest that, on two occasions in the past eight months, banks have been so nervous of counterparty risk – the danger of one’s trading partners failing to honour their financial commitments – that they did not wish to extend funds to each other.
However, some observers are now thinking that the interbank, or money, market has entered a new, third, phase, one that has less to do with counterparty risk and everything to do with the risk that any institution could face a run on its deposits or other short-term funding.Thus, the problem is not that banks are paranoid about each other, or so the argument goes; instead, banks are paranoid about their own funding state – not least because they have seen what a lack of liquidity did to Bear Stearns.
Large international banks, in other words, are responding to the current financial crisis by hoarding liquidity, as they have always done, at least since the invention of joint-stock banking, I think in the very early 18th century, and even before. We have been reminded very dramatically that banks are clearly vulnerable to liquidity runs.The collapse of my old employer Bear Stearns occurred largely, as far as I can see, because of a very old-fashioned bank run on an institution that was far from bankrupt, or would have been had it not experienced the bank run (i.e. until the forced fire-sale, its assets were worth significantly more than its liabilities).That, plus the experience of Northern Rock and a number of other close calls has made it imperative for banks that they have sufficient liquidity to meet any potential liquidity run, and for this reason they may simply be unwilling to lend to each other.
The article goes on to point to the policy dilemma.
If this argument is correct, it leaves policymakers such as Mr Trichet facing a huge challenge. In recent weeks, central banks such as the ECB have taken steps designed to reassure the banks that they will be able to get access to liquidity, via special lending facilities, if this is needed. But this may not be enough to break the hoarding habit, some analysts fear, given the stigma that continues to surround these operations.
Instead, many observers now think that the real key to resolving the current tension lies in a corner of the financial system that tends to be ignored and which is outside the hands of policymakers – namely the money market funds, which have amassed some $4,000bn of assets and only make low-risk investments.Until last summer, these money market funds played a crucial role in the interbank market; however, in recent months these funds have effectively gone on strike. That has not merely created a funding shortfall for banks but has also added to the sense of paranoia and thus hoarding.
The possibility and consequences of banks’ hoarding on a massive scale is not something that we normally think about until it happens, but a very strong argument can be made for the case that the root cause of the great stagnation that Japan experienced after the bursting of the bubble in 1990 was caused by the reluctance of Japanese banks to lend.They were selling assets to raise capital and hoarding their resources.
Since the banking system was pretty much the only functioning part of the Japanese financial system (and still is, as far as I can see), the consequences of the financial crisis for the real economy were pretty severe. The refusal to lend and the need to sell assets were, in my opinion, the mechanism by which the financial crisis was transmitted into the real economy.
The US has also had similar, bank-dominated financial crises, but their economic impacts were much more limited.This is because, I would argue, the US has a very diverse and sophisticated financial and capital market that doesn’t leave the financing of the real economy hostage to any one sector.
For example, in the 1970s the US S&L industry was almost wholly bankrupt. That should have put a real constraint on mortgage lending and, via mortgage lending, on the whole housing sector. By “coincidence”, however, that period saw the rapid development of the mortgage-backed securities business, which eventually replaced the role of S&L’s altogether as the source of new mortgages.Similarly the LDC crisis of the 1980s, which left all the major international banks in the US either functionally bankrupt or with seriously depleted capital levels, should have left medium-sized companies and low-rated large companies gasping for capital as these banks struggled to rebuild capital and replenish liquidity (at the time only large, highly-rated companies had access to the bond markets). Given the importance of these companies to the US economy, US GDP growth should have slowed significantly, but the impact of the banking squeeze left barely a blip.Why?Perhaps, again by “coincidence” the junk bond market exploded, fulfilling the role of large banks in providing capital to this sector.
When there are no financing alternatives what happens to the banking sector in a bank-dominated economy is a very important question, and the causes and consequence of any event that leads to liquidity hoarding should be pretty well monitored and understood. This whole discussion is nominally about foreign banks and the impact of bank hoarding, and not about China, but its relevance to China should be pretty obvious.In China the stock and bond markets are practically non-existent, and financial regulations are so murky and the system so rigid that it is extremely unlikely that any serious alternative to the banks will emerge in the near term (except, intriguingly enough, the informal banking sector, which may turn out to be a real boon in the case of a crisis). Anything that forces the banks – already barely solvent, and almost certain to see NPLs shoot up in a contraction – to confront liquidity issues will directly have a large, and of course self-reinforcing, impact on the real economy.
Meanwhile the stock markets have had another interesting day.I will let my student Shang Ning explain (with some editing on my part):
The SSE Composite opened roughly 1.4% below yesterday’s close, and then declined further during much of the morning to 3523, for a total loss of 1.57%. During the last 30 minutes of the morning session the market started trading up on limited volume and then bounced around to close strongly up at 2.17%, the day’s high.
It seems the rebound was driven at least in part by yesterday’s worst performers.In addition volume continued to shrink.This is not a market with much conviction.
The Chinese stock market started the day well, with the SSE Composite starting below yesterday’s close but quickly trading up to 3767 within the first hour of the morning – a hefty 2.3% jump from yesterday’s close.But investors quickly lost heart, and the market subsequently gave up nearly 200 points from its peak today to close down at 3578, for a very ugly 4.11% loss for the day, with banks, real estate-related companies, and Olympics-related companies leading the way down. The steepest declines took place in the last 90 minutes of trading, when a slew of selling orders ran up against a sharp decline in trading volume. For all the talk of government support it does not seem that there is a great deal of confidence in the market.
A lot of investors are still wondering what, if anything, the government can do next to stimulate the market.I don’t doubt that there are still things government agencies can do to signal official intentions, but there doesn’t seem much they can do actually to influence real supply and demand in the market for more than a few days. As expected, their many interventions are losing credibility.Institutional investors seem to be using every rally as an opportunity to get out of their positions, while retail investors are filling internet bulletin boards dedicated to discussing the stock market with anxious and angry comments.
On the inflation front, according to a Credit Suisse report today, Dong Tao, who has had a pretty good call on Chinese inflation, is expecting the April CPI number to come in at 8%. Like many other analysts he expects second-quarter inflation to stay high, but well below the drastic first-quarter numbers.However he, like me I might add, is worried that as food price rises decelerate non-food inflation will soon take center stage and drive the index up higher in the send half of 2008.In that context I should mention a piece from Capital Economics on the subject of inflation in Asia. “Inflation has re-emerged as a unifying theme across many Asian economies in recent weeks. Driven by the continuing high international oil and food prices, persistent upside surprises to inflation have forced a rethinking of monetary policy in the region.”
I think this should not be a surprise.After the 1997 Asian crisis a number of Asian economies, including China, have been so determined to protect themselves from a repeat of those events that they put into place a set of systematically mercantilist polices aimed at limiting exposure to external debt – often by managing their currencies so as to run persistent current account surpluses and burgeoning reserves.The problem with these policies, as I have discussed often on this blog, is that they seem to have misjudged the cause of the earlier sequence of crises.
Financial crises do not occur because countries have currency mismatches. They occur because they have asset-liability mismatches, of which the currency mismatch is only one form. By managing domestic monetary policy so as to minimize the risk of a currency mismatch several Asian countries may have simply transferred the balance sheet risk into a different form. Specifically, interventionist currency regimes have often resulted in significant monetary expansion, which create not just the risk of inflation but can also lead to domestic balance sheet imbalances, most dangerously in the banking system. Remember that in the 1920s the US also experienced massive capital inflows on the trade and capital account, resulting in the accumulation, in John Maynard Keynes’ words, “all the gold in the world.”The result, in the case of the US, was not a national balance sheet impregnable to disruption. On the contrary, the US experienced the stock market crash of 1929 and the banking crisis of 1930-31 that led to the consequences with which everyone is familiar.The lesson is that current account surpluses and massive reserve accumulation are no guarantee against financial disruption.
Headline food prices do seem to be moderating in China, so we will see a deceleration in CPI price rises, but I am not sure this is for all the right reasons, and I wonder if food price increases can continue to be restrained. As a long-time trader and observer of developing countries I always get a little nervous when government officials keep repeating that they don’t have a problem in some specific area, so I guess I am getting a little nervous about yet another announcement, this time from the NDRC, that they have “ample grain to keep food prices stable”, as the prominent headline in today’s China Daily put it.
We are starting to get these assurances nearly every two or three days now.“Our grain supply and demand is basically stable, our reserves are full, and we can ensure supply and stable grain prices,” the NDRC said in its statement. The same article pointed out that customs and commerce authorities are cracking down on illegal grain exports by traders hoping to profit from surging international prices. It points out that whereas price of rice in Thailand has soared from $300 a ton to $1000 a ton in six weeks (wow! can this possibly be true?), the price of rice in China is still frozen at $300 a ton.
Not surprisingly this seems to have led to wide-spread rice smuggling. Another article in the same issue of China Daily also makes this point: “But there are concerns about how long the nation can hold its rice price at about one-fourth of that in overseas markets, given recent reports of illegal rice exports in the past months.”Not only do we have a problem of local “businessmen” smuggling oil out of the country to take advantage of the heavily subsidized prices in China, but the smuggling problem now seems to be spreading to grains too.
I suppose this was only to be expected. With such long and complex borders, and with an endemic corruption problem, it was inevitable that the huge disparities between the subsidized prices of certain commodities in China and their equivalents in neighboring countries would lead to “arbitrage,” as the more polite among us might put it.I have no idea of how extensive this smuggling is, but given the fact that the authorities are publicly admitting the problem (and twice in a single issue of the China Daily), I would guess that it is a big problem. The monetarist in me would also point out that smuggling rice out of China will have a similar monetary impact as bringing foreign currency into China, so this is not just a problem for the Ministry of Finance, who has to raise taxes to pay for the subsidy going to smugglers, but also for the PBoC.
One final note: John Garnaut, of the Sydney Morning Herald, wrote an interesting article three days ago on unemployment in China.As worthless as the official unemployment numbers are (the Economist recentlyargued that they are the least accurate of all the important economic numbers provided by the Chinese government), it may well be that unemployment in China is much lower than many in the government think. If this is true, the social consequences of further monetary tightening may not be as grave as many government officials fear, especially given that the expected economic slowdown caused by China’s slowing export growth is likely to have been counteracted by a recent surge in infrastructure spending.There may still be time to take the steps needed to reduce China’s out-of-control monetary growth.
The Chinese stock market continued to bounce around today, driven down largely by the poor performance of bank stocks.There were fears among investors that we may see more tightening measures in the form of hikes in interest rates or minimum reserve requirements, or both, and these fears have hurt bank stocks in particular.Shanghai opened the day down about 1% and quickly dropped another 1% or so in the first few minutes, before trading up in the late morning and bouncing in and out of positive territory all day, until by late afternoon it was up 0.6%.In the last 30 minutes, however, it gave up all its gains and then some to close down 0.73%.That doesn’t bode well for tomorrow, but either way I don’t think there was a lot of conviction.
A couple of my Peking University students who trade regularly and who keep track of the market gossip tell me that there is a real sense among investors that the government is in control of the market and won’t allow it to fall much further – 3000 seems to be the magic number below which it can’t fall (the SSE Composite closed at 3681 today).This has buoyed market sentiment and has kept investors in the market.Needless to say, this kind of belief can cause damage to the capital allocation mechanism by distorting the market clearing mechanism.
There is something else here that may be of interest to those curious about the mechanics of the markets – and the rest of this post is not really about the Chinese financial markets.It is just some speculation on ways in which markets can adjust after distortions have been introduced, so probably of very little interest to most of the regular readers of this blog.
It is widely known that the perception of a minimum trading level, enforced by some credible agency, can distort the actual trading level in a predictable way – keeping it above whatever the fundamental level supply and demand would have naturally created.I try to show this in the graph below:
In the graph, assume that the hard horizontal line is the perceived minimum trading level of the SSE Composite permitted by the government (which the market perhaps assumes to be around 3000 or just below). If we assume that normal supply and demand in the market would have caused the index, absent government support, to move up and down the upward sloping straight line labeled “fundamental value”, the implicit belief in the government support level will actually drive the market along the curved “trading value” line, so that its price will lie directly above where it should have traded without the perception of government intervention.
The problem with this kind of distortion is that if and when the government is no longer able or willing to support the market, or more importantly the perception of government support evaporates, probably at some point where the “fundamental value” is well-below the perceived minimum trading level (the horizontal line), there is a risk of a sudden and sharp drop in price from the “trading value” line to the “fundamental value” line as real market supply and demand are forced to clear.
This is what Paul Krugman predicted would happen to the value of the euro many years ago when it traded down shortly after its launch but hovered above $1 – largely on the perception that the European governments would not want it, for political reasons, to trade below $1. He said that when the euro broke $1, it would not do so gradually.Instead it would fall very sharply.
That is in fact what happened.For many weeks the euro stayed above $1 dollar, trading up and down in a narrow range. But the supposedly temporary support extended by intervening governments in the hope that the markets would eventually “get it” (i.e. understand that the euro really was worth a lot more than $1) was not able to turn market sentiment – perhaps because the creation of the euro itself caused a one-time liquidity adjustment, as Robert Mundell predicted it would – that would result in an excess supply.
The attempts to change market dynamics by changing underlying sentiment, in other words, failed. Eventually, after extended intervention was clearly unable to turn sentiment solidly around, European governments were forced to stop intervening.Shortly afterwards the euro broke $1, and just as Krugman predicted, it immediately dropped very sharply by nearly 10 percent, before resuming its gradual drift downwards to below 80 cents.
If the SSE Composite trades within a narrow band above 3000 for several weeks or months, with new administrative measures (or rumors of such) emerging every time it trades too close to 3000, we may find ourselves in the sort of situation Krugman posited for the euro.In that case the model would predict that if and when it broke 3000 (or, more probably, some psychological support level below 3000), it would break sharply. In that case we might see the index lose 5-10% or more within a day or two.
P.S. I know Cui Enze, Liu Bing and Shang Ning, as well perhaps as some of my other students who are fascinated by the dynamics of trading, are going to be all over this blog entry.
The stock market had another good day today.My teaching assistant Shang Ning tells me that it started the day strong, faltered in the late morning, and then finished with a burst of energy to close up 1.84%.There seems to be continued confidence in the government’s determination to prevent a further collapse in prices before the Olympics.
On the overheating and inflation front, however, there is a lot more confusion about what is likely to happen.Today’s Bloomberg reports Zhou Xiaochuan, the PBoC governor, as saying yesterday at the Group of Ten meeting in Basel that export growth is slowing and inflation will be moderate this quarter.As I noted before, RMB appreciation has slowed markedly over the past few weeks and this is usually attributed to the failure of its recent rapid appreciation to put a dent in inflation.However another article in today’s Bloomberg has Vice Finance Minister Li Yong telling delegates at the Asian Development Bank’s annual meeting in Madrid today that China's economy is at risk of overheating and policy makers may raise interest rates and do more to soak up the cash flooding the financial system.“We will combat demand and prevent rapid economic growth from turning into overheating,” he apparently told the conference.
Meanwhile the GuangzhouDaily reported on Sunday that the State Information Center, the powerful NDRC’s think tank (the adjective “powerful” is always placed before “NDRC”) said in a recent report that the risk of overheating has waned as China's economic growth in the first quarter slowed, with both the trade surplus and credit growth brought under control. The conclusion?The government does not need to introduce new tightening measures although, the think tank warned, perhaps a bit perfunctorily, that inflationary pressure still must not be ignored.I don’t think this is a surprise conclusion because it seems to me that State Information Center has pretty consistently been more worried about unemployment than about controlling China’s monetary growth.
In the battle between the monetary camp and the growth camp it seems to me (based purely on reading tea leaves – I have no real information here) that the growth camp now has the upper hand, largely because the authorities are increasingly anxious about a more-rapid-than-expected decline in export growth. In the May 2 edition of Macquarie Bank’s China Diviner Paul Cavey points out that although China’s exports in dollar terms expanded 21% year-on-year in the first quarter of 2008, part of that can be explained by the declining dollar, and in volume terms the growth was actually much lower – I think he says 15%. There is real concern about the possibility of an unexpectedly sharp downturn, and as a result the authorities are far more willing to err on the side of monetary excess than contractionary excess.
In fact Observatory Group’s Li Xinxin said in an April 30 report that “One week ago, the State Council convened a meeting among eight government agencies to discuss hot money inflows, but no consensus was achieved. Note that PBoC governor Zhou said there was neither a clear definition of hot money nor any convincing measurement for it.” Xinxin also has Zhou saying that the rise in consumer prices was “mainly caused by food prices this time” rather than a “very classic case in which inflation is caused by too much aggregate demand.”Xinxin goes on to point out that “These recent remarks are quite different from the PBoC’s previous view that China’s inflation is largely a monetary phenomenon and needs to be addressed through tighter liquidity control.”
It is a little surprising to me that Zhou would suddenly desert the monetary camp, but I understand that he is worried about being criticized again for overreacting on the monetary side and may be wary of taking the blame for any possible slowdown.On the other hand I think the authorities may be overestimating the impact of a slowdown in export growth. Many months ago I wrote about the five-year promotion cycle and about how at the beginning of each of these cycles (the latest one began in March) China typically experienced a burst of new infrastructure investment as new leaders, eager to start off with a bang, engaged in an orgy of investment.
In a research report produced today Dong Tao of Credit Suisse argues that the risk of an economic slowdown in China has dropped significantly, and that economic growth may even have “reaccelerated.”At least part of the reason may be “anecdotal evidence regarding infrastructure projects,” and that this is being accommodated at least in part because of relaxed credit conditions stemming from the government’s worries about growth risks.
I am not sure how to read all of this, but I wonder if fear of an export-led slowdown caused by slowing demand in the US and (perhaps) by a rising RMB may end up causing an excessive relaxation of credit and monetary conditions, especially as we are less than 100 days away from the start of the Olympics.Given all the fuss and noise already, the government is particularly worried about any further disruption of the celebrations.Most of my friends here in China assure me that there is little the government will do now to threaten the success of the Olympics, so I suspect there is a strong relaxation bias rather than a tightening bias.
And what are we hearing about April inflation?Li Xinxin of the Observatory Group believes year-on-year inflation for April will come in under 8.3%, and I have already posted other reports about analysts who argue that it will be around 8.0-8.1%, but today Stone & McCarthy’s Logan Wright came in with a very different set of numbers.He tells me that he believes food prices, based on data from the Ministry of Agriculture and the Ministry of Commerce, will turn out to be fairly stable to slightly up in April, and that non-food prices will continue to rise, so that year-on-year inflation will be 8.5%. His prediction is a bit of an outlier here, but he has been an outlier on the pessimistic side many times before and, so far, the most pessimistic predictions have generally been the most accurate.We will know next Monday.
Meanwhile I thought I would attach a graph I made from my own CPI series (starting at 100 in January 2006).
The little fork at the end shows the range between 8.0% and 8.5% year-on-year inflation for April. As the graph shows, the CPI has trended upwards pretty steadily since late 2006, before taking a very sharp jump above trend in January and February.Also notice that around every February there is a spike. It is not unreasonable for the CPI to decline from the spike before reverting to its upward trend, so there is no way to judge whether March represented the peak, or simply a temporary spike.Whatever the April CPI number turns out to be, I don’t think it will resolve the debate unless CPI inflation comes in even above Logan’s prediction and is driven mainly by a jump in non-food inflation (although if that were the case we would probably already have heard rumors to that effect).
three days ago on unemployment in China.