My Blog

April 3, 2008

There seem to be conflicting stories in the recent press about inflation and inflationary expectations in China, but I think they may say more about confusion over the causes of inflation than they say about the real trend in prices.  According to today’s Bloomberg, “China's top economic planning agency has started to allow dairy and cooking oil price increases, a move that indicates the government may expect inflation to cool from an 11-year high.”  The article goes on to quote JP Morgan’s Wang Qian, who said “The authorities consider inflation may trend down from the peak in February, so allowing companies to raise prices would give food makers more incentives to increase supply.”  Later in the article Bloomberg says: 

Price gains may be cooling. An index of agricultural products compiled by the Ministry of Commerce shows wholesale prices have fallen consecutively on a weekly basis since mid- February.

I think we may be getting ourselves caught up in a statistical illusion.  Given the very high price rises in February, caused mostly by food price increases – February’s CPI was up 2.5% over January’s CPI, versus monthly price increases of just under 1% on average for the previous three months – it would be pretty reasonable for food prices to decline in March.  This, however, would not necessarily imply any reduction in underlying inflationary pressures.  On the contrary, if CPI in fact declined by up to 1.8% in March, year on year inflation would still exceed January’s 7.1%.  More specifically, if we assume that non-food prices rose at 1.8% year on year in March, like they did in February, a 1.8% decline in CPI would require a 6.1% decline in food prices, which I don’t think anyone is expecting – and recent PPI numbers suggest that non-food inflation is likely to be accelerating, not holding steady.

This is just a very roundabout way of saying that although March year on year inflation is likely to be lower than February’s sharp jump to 8.7%, we should be careful about how we read the numbers.  It will not be easy for March year on year inflation to come in below January’s 7.1%.  It is in fact likely to be much higher – perhaps as high as 8%.  The fact that February numbers were exceptionally high because of special circumstance – the freak storm and the Spring Festival holiday – does not mean that lower food prices in March represent an easing of inflationary pressures.  They may just represent a return to the earlier trend or steadily rising inflation.

The government’s decision to allow dairy and cooking oil prices to increase may nonetheless be good for Chinese inflation because price controls can actually worsen food inflation in the medium term by limiting the salutary impact higher prices might have on supply.  Still, declining prices for agricultural goods are much more likely to be caused by a reversal of the freak February numbers than by a decline in inflationary pressures. 

On the other hand there is a very different story about inflation expectations in today’s China Daily. In discussing plans to increase water prices in some cities, they have this to say:

The central government emphasized the importance of combating inflation Wednesday as some cities plan to raise water fees.  Tang Tiejun, director of the Pricing Department of the National Development and Reform Commission (NDRC), told the 2008 Strategic Forum on the Urban Water Sector that the government hoped some cities would delay raising water fees amid surging inflation.

Tang said that cities wishing to hike water charges should consider the consumer price index (CPI), per capita income and general price levels

Inflationary pressures seem to be spreading to water and other non-food components of the CPI basket, just as we would expect if the underlying cause of inflation were excess money growth.  This is, by the way, consistent with the recent PPI data.

Meanwhile Xinhua reported today on the results of a just-released AC Nielsen survey on the impact of inflation among Chinese consumers.  According to the survey, “the recent increase in food and oil prices is likely to keep more Chinese shoppers at home and change their way of spending.”  The survey also found that most consumers said they would not cut their food spending, with only 18% saying they would reduce their grocery food bills.

If most Chinese continue to consume as much food as they did before, and if food prices have risen by 20%, it seems pretty clear that they must necessarily either save less or spend less on other goods (or both).  If, as the survey seems to imply, one consequence of rising prices is to keep shoppers at home, the reduced spending on non-food items should have been fairly significant.  This is the mechanism by which we should have expected deflationary pressures on non-food items – assuming Chinese monetary policy is consistent with the 2-3% inflation targeted by the PBoC.

Since there is clearly inflation – albeit low – in the non-food component of the CPI, and since this inflation seems to be rising, my interpretation of the inflation data, as I have pointed out many times before, is that inflation is caused by monetary conditions that are far from consistent with the PBoC’s inflation target.  This is why I believe inflation is caused by too much money, and not too little food, and why I think the current crop of inflation-containing measures simply will not work.  Although most of the analyst reports I read continue to argue that Chinese inflation is a limited phenomenon caused by special factors that are reversible, I think more and more of them are switching to the monetary argument, or at least hedging their bets.  I think this makes sense.

One other thing.  If it is true, as the AC Nielsen survey claims, that 82% of Chinese households have not reduced their food consumption, even with the higher food prices, I cannot believe that the food component of the CPI basket can have remained constant over the past year.  As I understand it, food comprised just over 33% of the CPI basket in the beginning of 2007.  It continues to comprise that level in today’s calculations. 

But how can this be true?  If 82% of Chinese households eat as much as they used to, in spite of the 20% or so price increase in food, even if the remaining 18% of Chinese households reduced their food consumption by enough to keep their total food expenditures exactly level (which is pretty unlikely), I would have thought that the food component of the basket would have risen to at least 35-36%.  This may not seem like a big difference, but in that case the inflation in the adjusted CPI basket should have been higher than the headline number, by about 0.4-0.5 percentage points.  The headline CPI inflation, in other words, may understate real CPI inflation.

Inflation is not just a Chinese concern, of course.  It seems to be a rising problem around the world, especially in countries that intervened regularly in the currency markets to promote mercantilist export policies.  This is more evidence, I think, that my theory that the recent policies among several developing countries, aimed at protecting them from the threat of another Asian-Crisis-style meltdown, may have simply transformed one kind of balance sheet mismanagement into another kind.  In their determination to protect themselves from one kind of unstable balance sheet, they seem to have constructed a different, but equally unstable, kind of balance sheet.

Several of China’s neighbors are suffering from domestic monetary problems that resemble in some ways (though not all) the problems China is facing.  I have spoken several times recently to one of my favorite former Columbia-University students, a young Vietnamese.  Besides his stellar subsequent career in the Vietnamese government, he is distinguished by also being the father of my very bright and very cute godson.  During the past week we have had several conversations on monetary and financial conditions in Vietnam, and it seems, at least from first glance, that Vietnam is suffering from an even more acute monetary problem than is China.  Given what seems like a heavier and less stable debt burden, their policy options may be even more constrained.  Several countries in the region seem to have similar problems, and I suspect that the next round of developing country financial crises is going to affect East Asian pretty severely.

Vietnam and China were two of the main topics of a release by the Asian Development Bank, who have recently weighed in on the subject of inflation.  They released a report yesterday that listed their projections for GDP growth and inflation for all the major Asian countries.  The ADB revised their Asia ex-Japan forecast for 2008 GDP growth down from 8.2%, in September, to 7.6%, and they expect inflation in most Asian countries to rise. 

They forecast 10% GDP growth for China – which I think is on the high side of most growth forecasts.  They also forecast CPI inflation in China of 5.5% for all of 2008.  This strikes me as so low that I wonder if it is their real opinion or whether they are merely being polite to one of their shareholders.  Given that in the first two months of the year CPI inflation in China was already 3.8% on a nominal basis (25.1% annualized), they are effectively implying that they believe monthly inflation for the rest of the year will average less than 0.2%, or just 2.0% on an annualized basis. 

So they think China can go from 25% annualized inflation to 2% annualized inflation over the rest of the year?  I’m not sure I’d want to take their side of that bet.

Comments (2) for "Waiting for the CPI inflatio...

Thanks again for an interesting post. Playing with the numbers, if total private consumption rose 20% during the last 12 months, and food conumption rose 40% - then a previous food-share of the consumer basket of 30% would rise to 35%. I guess we are somewhere in that range. Notably, the normal pattern of increasing income in an emerging economy is an ever smaller share of income spent on food, but for China it seems to have gone the other way lately. It seems to me that wage increases have started to accelerate, being close to 20% during the last year. Overinvestment will probably speed this up even further, after all the absolute level of wages is low. By Stefan, Tallinn - 4/4/2008 7:04 PM

Vietnam reminds me of China in early 90s, typical overheating fuelled by loose monetary policies/lending, a hard landing already started due to high inflation, busted investment bubble and surging current account deficit. But one thing positive for Vietnam, they are a commodity producer, net exporter of rice, coal, oil. Also, their labor costs, adjusted for productivity become competitive vs. China/ASEAN So their painful adjustment might be short and shallow By isaac - 4/6/2008 4:08 PM