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China vs. Inflation: A Love-30 Match So Far
By Dian L. Chu, EconForecast
China released a slew of important economic data on the evening of Wednesday, Jan. 19, and markets were paying particular attention to China’s inflation. In order to put out the wild fire of inflation, China's central bank raised interest rates twice, and increased the reserve ratio for lenders four times in the span of just last two months.
Those tightening measures have prompted great concerns about the major growth engine of the world. Partly on speculation (based on leaked information) that China’s inflation eased last month, emerging market stocks and the MSCI EM index climbed to its highest level in two and a half years just before the official data release.
CPI Eased in Dec…You Say?
The actual December Consumer Price Index (CPI) came in exactly as leaked—easing to 4.6% month-on-month from the 28-month high of 5.1% pace in November. For the whole year, CPI grew 3.3% in 2010.
China’s National Development and Reform Commission was quick to declare the government's effort to contain inflation has achieved initial, incremental success. However, instead of a rally, commodities sold off the morning after, and it is fairly easy to understand the market reaction since the official figures seem to defy economic common sense.
An Overheated GDP
First, let’s take a look at GDP, which is closely linked to inflation.
China's economy surged 10.3% in 2010, and expanded 9.8% in the fourth quarter from a year earlier, faster than the third quarter's 9.6% growth. Inflation and growth typically comes hand in hand. With an accelerated growth in Q4, it is hard to digest that inflation actually went the opposite direction last month.
Food Price Bites
Some attributed the easing in December CPI to lower food prices. The prices of food was up 7.2% year-on-year in 2010, just based on the official number. Meanwhile, various news reports indicate that the food price inflation in China is actually running in double digits, and the government had to release strategic grain reserves just to keep a lid on prices.
CPI Out of Sync
Now, let's just take the 7.2% as the inflation number for food prices, which accounts for a third of the basket of goods in China's CPI calculation, and we know the price of housing, also a CPI component, rose 4.5% in 2010.
So, in order to arrive at the final number of 3.3% overall inflation in 2010, the other two thirds of the CPI basket needs to yield a below 1.4% year-over-year increase.
It is a challenge, to say the least, finding things that consumers typically buy with such moderate price increase--particularly in China--within this environment of QE excess liquidity, where every commodity seems to be hitting new highs every day.
So, again, the 3.3% or the 4.6% CPI seems totally inconsistent with the undercurrents, which makes me suspect the real consumer inflation could be running as high as 6-7%... or more.
PPI = More Inflation Pain
Furthermore, the second measure of inflation--the Producer Price Index (PPI)--grew 5.5% year-on-year in 2010. Some numbers from the PPI-- raw materials, fuel and power rose 9.6% year-on-year in 2010, 9.5% year-on-year in December—suggest even more pain to surface in the CPI as early as Jan. 2011.
Lavish Lending Continues in 2011
China’s already battling a liquidity problem mostly from a surging money supply (M2 was up 53% over the past two years), record lending by state-owned banks and private lending, as well as foreign speculative hot money inflow.
And contrary to the claim that the government anti-inflation measures are having its intended effect, the fact that China's four biggest State-owned commercial banks issued $240 billion Yuan new loan in just the first ten days of January has proven Beijing is fighting a losing battle.
A Looming Banking Crisis?
Now, in a bid to tighten the strong loan growth and risk controls, the China Banking Regulatory Commission said on its website that Chinese banks have been given until the end of this year to bring onto their books CNY1.66 trillion in off-balance sheet lending.
This move will soak up some liquidity--up to CYN 324 billion--due to new higher reserve requirement, which is 19.5% for some of the biggest banks. But it could also bring about some kind of a banking crisis.
Bigger banks most likely are sufficiently funded as some of them already went to the market last year, partly in anticipation of such a move by the central government. Smaller banks, on the other hand, may have funding difficulties. As such, the Chinese banking sector could become the unwilling victim in the fight against inflation.
We Mean [Inflation] Business
The Chinese government so far seems reluctant to use measures other than reserve requirement to cool inflation, as most of them tend to have even more undesirable consequences. For instance, raising interest rate could put more burden on some of the already highly indebted local governments, and further attracts hot money, while a Yuan revaluation would hurt China’s highly export-dependent economy.
However, Beijing most likely will come to grip very soon that eventually somebody got to pay somewhere, and there’s just no way around it, and that the time has come for some decisive actions with a combination of more aggressive monetary, fiscal and regulatory measures to show it really means business.
Monetary & Fiscal
For example, instead of the symbolic two 25-bps interest rate hikes in Oct. and Dec., Beijing probably will do an immediate 50-bps rate hike by early February and another 50 bps in early March to blunt the start of the typical yearly run-up of crude oil, and other commodities. Then, depending on the market reaction and new economic data, more hikes could be implemented later on in the year.
Fiscal policies such as taxes, and financial regulations and restrictions on speculative activities could be necessary.
A Currency Devaluation...Perhaps?
Meanwhile, the expectation of a Yuan appreciation is keeping liquidity swimming. So, perhaps China would do just the opposite, as suggested by Andy Xie, a currency depreciation, which would lead to a capital outflow forcing interest rates up.
There many more things that China has to do to get the inflation situation under control, which most likely will send shock waves throughout global markets.
Social Unrest Could Make or Break A Party
Numbers may be rigged or "smoothed out", but can't fool the regular Chinese Joe's and the smart money.
Chinese Premier Wen Jiabao was confronted with questions about inflation from callers during a visit to China National Radio in late December. Although he reassured the public about the government's ability to control inflation, it is nonetheless an early sign of social unrest and instability.
I believe if China stays on its current "prudent course", the real consumer inflation could hit double digit by early next year. Inflation and widening wealth gap helped the Communist Party seize power from the KMT back in 1949. The same force could also break the ruling party some 60 years after.
A slowdown now or a crash later....for global financial markets, neither offers a real happy ending.
Dian L. Chu, Jan. 21, 2011 | Read Me on Kindle | Facebook Page | New Article Alert | Google Profile
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China is the problem. Watching oil bid and dry shipping indexes sink.
Something very serious is brewing.
you may try to ride tiger. You may try to stay on. Tiger hungry. Tiger eat you when he throw you off. Tiger don't care about ancient chinese proverb about tiger.
JPM own china now because China net exporter of silver at 16 and now import silver at 27. China still buy copper at highs. JPM eat China if tiger don't. China not very good investah. Inflation and rice riot kill china soon, if China overleveraged banks don't kill china first. China hold record for overleverage. Make easy for tiger to devour.
This is awfully confusing to me, but JPM is poised to make a mess of china in the copper and silver markets. If the enemy of my enemy is my friend should I root for JPM?
Mr. Hu said that inflation in China "is on the whole moderate and controllable....We have the confidence, conditions and ability to stabilize the overall price level," he added.
No problemo, Hu's on first. Ben's on second?
http://online.wsj.com/article/SB10001424052748704511404576085330819413022.html?mod=googlenews_wsj
LMFAO! China soon to be shown for the rubes that they are. But watch out. Angry rubes are dangerous!
I thought you went and grabbed a banking job...
Great Work Product as always!
Thank You, JW
Does China use the same stupid, intentionally deceptive methodology to calculate their CPI as the US? If so, their figure is certainly garbage that grossly understates the true inflation.
no their system is much worse and their numbers are pure fiction. USA numbers are quite realistic for the "average" consumer, but the USA needs to develop inflation numbers based on each group of peoples' purchase baskets. For example older people and lower income people feel food and health care inflation first, but for the average person with a job and health care benefits the effects of inflation or limited benefits are not so large. If the average person spends 17 percent of income on health care then ten percent inflation is not as noticeable as it is for a fixed income social security beneficiary. A lot of people who post here must be dirt poor, otherwise why worry about a little food inflation? Food costs about 14 percent of the average american budget, so even ten percent inflation raises your bill only 1.4 percent per year in food costs. We will beat the chinese at this game. We can always hedonic down and eat beans and rice every day. We can switch to robusta coffee from arabica. Lots of things we can do to adjust. It is hard for a chinese person who is already spending 40 percent of his income on beans and rice to hedonic down much further, but the chinese have learned to like snakes and insects and tree bark, so they might last longer than expected in this inflation war, but I seriously doubt it. Even the North Koreans have their limit and they are three to four inches shorter than south koreans, the few left alive. (stupid north koreans don't know how to fight a 50 year war of attrition, but we do!) The Chinese are getting fucked by the fed's huge strapon affectionately labeled qe2. Fuck them harder Ben. Make it hurt!
China (CCP) will take hold on inflation sooner or later by reduction the share of productive capitalist enterprise in its output and hold on power by forcible reduction of income gap, eradicating part of the new middle class. That is what communists normally do when the West is in crises ( see New Economic Policy in the USSR, 1921-1929). Normally that includes an internal fight within the Party. I think it will be won, by 2012 , by true hardliners who has been set to sidelines fore the last 20 years.
Chinese communists does not see the economic growth translated to the wellbeing of richest and general population as the ultimate good.
Economic development of last 30 years is a temporary phenomena that can be reduced in order to pursue other more important ideological priorities- export of Chinese model and militarization. That may include such means as nationalization, including foreign owned companies, elimination of the wealthiest and middle class, confrontation over territories that possess resources Central Asia, Russian Far East) , technology (Taiwan, South Korea) , export of capital to buy economic influence and technology ( in detriment to local needs of capital) to the West that in crisis needs this capital to create employment .
Chinese are well known for their ability to give away food needed for their own population to pursue higher goals of their MODEL superiority, and expand worldwide influence. They are not done yet, they took a break for the last 30 years, which for them is a fleeting moment in their history, necessary revisionism to build up economic force to attack capitalism once again.
All their market institutions are still run by CCP and can be turned in planned economy with one decision of CCP Politbureau, consisting of 9 engineers who may think they are able to engineer economy without the invisible hand.
West just can not truly imagine what Chinese might do. Russians can, and Merkel ( since she grew up in GDR) can. Vietnamise can. Perhaps even South Koreans still can. Japanese-they know they are a target Nr.1. due to 1930ties war atrocities- they are in very vulnerable position and must be allowed (allow themselves) to militarize, although, with aging population, who is going to serve?
We should all remember that for the Chinese economy, 8% growth is essentially standing still. That is the minimum growth rate needed to keep employment stable as new workers enter the pool. As a fraction of GDP, their version of TARP was 3-4 times larger than the bailouts/stimulus engineered over here and that should tell us something about what they are facing if Hu falls off the tiger.
The inflation als counts as "growth" so if you subtract that, their growth looks pretty poor.
And a second indicator that this growth is almost all inflation and investment related engineered growth is simply the BDI that is start to look more like a submarine index then a shipping index.
The chinese have been priming the pump for a couple of decades now. If you think we got debt problems it's much worse for china. Hiding the debt, hiding inflation, price caps, increased reserve requirements. those are the signs of a ham fisted economic planning board. Say what you will about Bennie and Timmah, but they have played well the hand they were dealt. China does not have the sophistication to avoid the crack up boom or the deflationary depression. Does Timmah and Bennie? We are going to find out soon aren't we?
Nice article