46 Months Of Accelerating Deflation Mean Beijing Is Now Trapped
It may be Saturday, but there is no rest for the onslaught of negative data from China, which overnight reported the latest, December, consumer and producer price inflation numbers, with the former printing at 1.6% Y/Y, matching consensus estimates, and a tiny increase from the 1.5% in November: the modest pick up was due to one-time items, primarily vegetable prices. For all of 2015, CPI rose 1.4%, down from 2.0% in 2014, and the slowest annual increase since 2009 and well below Beijing's goal of keeping last year's inflation below 3%.
It was wholesale inflation which again was the more troubling of the two prints, with PPI declining at 5.9% for the 5th consecutive month, below the -5.8% consensus, and printing negative for almost 4 years, or 46 months, in a row, highlighting the deeply entrenched pressures facing China's manufacturers as the economy cools. The biggest contributors to the PPI drop were extraction and raw materials, which plunged by 19.7% and 10.3% over the past year, respectively. For all of 2015, the PPI fell 5.2% compared with a decline of 1.9% in 2014.
The modest CPI rebound was due to food prices, which rose 2.7% in December, up slightly from November, while nonfood items rose 1.1%, matching November's increase. Vegetables seem to be a bit more expensive recently, the WSJ cited a 45-year old Beijing homemaker wearing a cream-colored down jacket who gave her surname as Li, adding that she hasn't noticed much change in the price of meat or fruit.
Ms. Li said her family isn't planning on buying any new appliances but might purchase a car if it can win a license plate, which are allocated in Beijing by lottery to reduce congestion and pollution. "Most of the time, if I need something, I'll just buy it," she said.
Goldman's quick take on the Chinese data:
CPI inflation was in line with market and our expectations. Higher food prices (especially the price of fresh vegetables and fruits) contributed to the increase in overall CPI. Non-food inflation decelerated from November on a sequential basis. Core CPI (excluding food and energy) was up 1.5% yoy (vs. November: 1.5% yoy), which implies sequential inflation of 1.5% mom ann (vs. 1.2% mom ann in November).
PPI inflation came in at -5.9% yoy in December, below market and our expectations. On a sequential basis, producer prices fell 5.8% on month-over-month annualized seasonally adjusted basis, compared with -5.7% in November.
While December CPI inflation edged up from November, it was mainly driven by food price increase during winter and will likely fall in the next several months. PPI inflation was below expectations. We continue to expect further easing on the monetary policy front (our baseline expectation is 75 bps cut in RRR to largely offset liquidity drain from FX outflows each quarter of this year, and two 25 bps benchmark interest rate cuts this year). We believe policy makers are also likely to rely on fiscal and quasi-fiscal (via policy banks) policies to support growth.
Other analysts agree and are confident that another wholesale burst of stimulus is imminent, most likely in the form of an RRR cut:
"The inflation profile remains soft," said Commerzbank AG economist Zhou Hao. "China will maintain a relaxed monetary policy to reduce the local borrowing cost for corporates." Mr. Zhou added that yuan exchange rates are expected to weaken further as China attempts to reduce its external debt. China's consumer inflation remains soft while deeper than expected factory deflation last month suggests that Chinese companies need to reduce their debt as overcapacity continues to fuel losses in many industries, said Commerzbank AG economist Zhou Hao.
Just like in the west, Beijing is hoping that China's depreciating currency could add to inflationary pressure by pushing up the cost of imported goods in yuan terms, said Oliver Barron, China research director with investment bank North Square Blue Oak. He added that Beijing will likely have to ease monetary policy to cushion the impact of industrial restructuring and rising debt levels.
"So a potential benefit if inflation is below target is the reform aspect," Mr. Barron said. "It's easier when inflation is low."
China's producer-price index declined 5.9% in December from a year earlier, unchanged from the decline in November. It was the PPI's 46th consecutive monthly decline as Chinese manufacturers continue to battle fierce price pressure and fight overcapacity.
Less downward pressure on prices at the factory gate in the coming months would signal that the government is serious about reducing excess capacity, although progress is likely to be incremental, Mr. Barron said. "There's still huge overcapacity in the industrial sector that's not being addressed," he said. "I think the government's push to address overcapacity this year will go slowly."
Which brings us to Keynesian problem #1: while lower prices help an economy if consumers and companies use the savings to buy and invest, protracted price declines may encourage them to delay spending in the belief that waiting will result in still lower costs in the near future, dragging down already slowing growth. While this is great news for consumers, it is terrible for levered corporations who provide goods and services. And in a country in which total debt is 3.5x more than GDP deflation, any accelerating deflation means a debt crisis, with trillions in bad debt finally floating to the surface, is inevitable.
Finally, even if China does engage in more stimulus, which it will perhaps as soon as this week when it cuts either RRR or its interest rate (or both) again, there are two major problems:
- With its economy rapidly slowing down and millions of (very angry) people in the process of being laid off, leading to record strikes and a groundswell of social unrest, the last thing the government can afford to do now is to force companies to cut costs even more when, as a result of a plunging currency, soaring import prices (see Japan) will slam profit margins and lead to even more layoffs.
- As China depreciates even more (recall that a month ago we predicted at least another 15% in CNY devaluation, something Bloomberg agrees with today), it will face even more capital outflows: at least $670 billion according to BBG, which in turn will drastically cut the country's pile of FX reserves (and put pressure on US Treasurys). That would come at the worst possible time: just as China's banks are forced to begin recognizing the huge pile of non-performing loans as a result of a tsunami of pent up corporate defaults mostly in the commodity sector, which as we reported back in October, is as much as $3 trillion, and which as we followed up yesterday, is the basis for Kyle Bass's top trade of the year, shorting the Yuan.
Of course, the longer China does nothing, the greater its problems will become as the status quo is the status quo is also fundamentally destructive. As such Beijing needs to choose: either collapse the economy in a deflationary wave, leading to a debt crisis and widespread social unrest, or devalue massively overnight in hopes of stimulating inflation, leading to collapsing profit margins, and even more widespread social unrest.
In short, our condolences China: having decided to adopt Western neo-Keynesian economics, with the typical monetarist bent, you too are now trapped with no way out. But don't worry: so is everyone else. Good luck.
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