My Blog

July 9, 2008

This is turning out to be a great week for the Chinese stock markets.  After pausing for breath – it rose a mere 0.8% yesterday – the SSE Composite continued Monday’s 4.6% rally to gain another 3.8%, all of which rise came in the morning.

What drove it?  Aside from lower international oil prices, largely two things, I think.  First, the markets continued to be buoyed by Premier Wen’s comments over the week-end that suggested that the government was more interested in policies to boost growth than in policies to combat inflation and overheating (the “two prevents”).  Second, there are strong rumors that June year-on-year CPI inflation is going to come in at 7.1%, a big decline from its March 8.7% year-on-year increase.

These are both terrible reasons to be bullish.  I’ve already written Monday why I think the government’s reorientation from anti-inflation to pro-growth is a bad thing.  For very similar reasons I think the “moderation” in CPI inflation indicates very little of value.

The CPI numbers have become less and less valuable as an indication of China’s underlying inflation pressures because they have become so tainted by the under-counting of the food component of the basket as well as by the many price controls on goods in the CPI basket, which have had the effect of converting inflation from overtly rising prices into hidden rising prices, shortages and unbearable subsidies.  Increasingly PPI inflation has become the more robust indicator.  That is what we should be watching.

In addition if you believe, as I do, that the underlying cause of inflation is China’s out-of-control money growth, it is hard to be anything but dazed by the latest numbers.  Chinese reserve accumulation continues at its fastest pace ever.  I expect June numbers will be “low” – I expect around $20 billion or so – but that will have been caused almost wholly by the impact of the redenomination of last month’s hike in minimum reserve requirements into dollars.  That should bring headline reserve growth down by $40-45 billion. 

That means that headline reserve growth for the first half of the year should come out a little under $300 billion (versus $462 for all of last year and $247 the year before).  When we adjust the headline numbers for the various transactions that reduced headline reserve growth but had little to no impact on real inflows and, more importantly, the PBoC monetization of those inflows, reserve accumulation this year will be around $500 billion (versus around $500-550 for all of last year).

Under those conditions how confident can we be of any proxy that indicates inflationary pressures are declining?

Comments (5) for "The stock market is feeling ...

Food price kept flat m2m in June. Given the gas price hike, it should be a good sign if CPI is merely 7.1%. And it is really justified to worry about growth. Millions of unemployed in quake zone, slowing economy in EU and US, declining domestic consumption...all these require a pro-growth policy to be put in place. It will be too late if they employ the policy tool when the economy hits the bottom. Regarding the reserve, lending cap in formal banking would somehow keep money supply seperate from reserve accumulation. Yes, there is an informal bank system. But according to your information in the past few posts, the interest rates in informal banking system is quite high and flexible. Such a high interest rate in informal banking system would curb money demand. It does not seem that much hot money had been in the informal banks since the interest rate should be really low and votile if you put such huge amount of hot money in a system. By fatbrick - 7/8/2008 9:01 PM

Sorry, it should be "...since the interest rate should be really low and volatile...." By fatbrick - 7/8/2008 9:02 PM

Michael, A couple of questions, if I may: You often say China's money supply is growing fast because of its currency policy. Surely, if this was the case, base money growth would be strong. In fact, it appears to be very weak (growing about the same rate - 11%ish - as REAL not nominal GDP). It appears that sterilisation is completely successful. What indicator do you look at that makes you worry? Why is inflation considered a social problem in China (beyond the usual efficiency losses such as menu and shoe leather costs). Even if the official inflation figure is understated, is that not less than income growth? Thanks for any light you can shed. By RebelEconomist - 7/9/2008 12:23 AM

RebelEconomist, I can try to answer your 2nd question. Look back at 89, inflation was one of the biggest reasons of the demonstration. Again in 93-94, when inflation was skyrocketing, one example of social unrest: there were plane hijacks almost every week in China. By fatbrick - 7/9/2008 12:39 AM

RebelEconomist, this is an interesting question and I try to respond in today's entry. I apologize if my response is a little quick and sloppy, but I had a crazy day and barely have time to work this out very carefully. Feel free to poke as many holes as you like into my argument. I think it is a case of my trying logically to work out my beliefs from an almost instinctive feel that 1)reserve accumulation of this magnitude must have domestic monetary consequences, and 2)China feels like it has an exploding money supply. By the way Fatbrick is right. Inflation in China has nearly always been followed by social instability. I think this is in part because the rigid labor structure and the very weak (and often fraudulent) social safety net makes it very difficult for losers to accomodate the transfers caused by inflation. it may also have something to do with the fact that the biggest losers (students, SOE workers, retirees, former military) are politically volatile and almost always urban-based. By Michael Pettis - 7/9/2008 5:55 PM