My Blog

January 10, 2008

THU 10 JAN

Will Olympic hype lead to Olympian depression? By Michael Pettis

An American environmental consultant has just published a study claiming that the main reason the city has been able to meet environmental targets linked to the coming Olympics is because of “irregularities” in the accounting system.  He identifies two major irregularities.  First, the city dropped a few monitoring stations in high pollution areas and replaced them with monitoring stations in low pollution areas.  This caused an immediate improvement in the average numbers, unrelated to any improvement in air quality.  Second, the consultant found that after officials set targets for every monitoring station in the city, a statistical improbable number of ratings fell just under the cut-off point between good (“blue-sky”, which in Beijing doesn’t really mean the skies are blue) and bad days.  Authorities wanted to see more “blue sky” days, and their underlings duly gave them more, apparently by shaving points.  Chinese government officials are justly famous for their ability to deliver what their bosses want.

 

I have a mild case of asthma, so my lungs are reasonably good at detecting air quality, and during the six years I have lived in Beijing I have been very skeptical about claims about the pace of improvement, but clearly my measuring stick is not very scientific.  I don’t know much about environmental monitoring but nonetheless bring up this issue of Olympic environmental standards for a different reason.

 

I have been thinking a lot about something I read several years ago in a book by Charles Kindleberger and which I discussed in one of my own books (The Volatility Machine).  Kindleberger was discussing the 1873 financial crisis, which was a devastating financial crisis that threw the world into depression and which some claim to have been the first truly global financial crisis.  As he describes it, the booming markets of the 1860s (powered by high tech railroads and chemicals) turned into a global financial bubble by the early 1870s, fueled in part by the recycling of the massive French reparations to Prussia after the 1870 war.  Although the bubble spread to markets around the world – including most of Europe, North and South America, and parts of Asia, its most extreme manifestation among the developed markets may have been in Austria.

 

Austrian markets were clearly unsettled by the end of 1872 and the beginning of 1873, but the World’s Fair was scheduled to take place in Vienna in May of 1873.  This was considered a major (and heavily hyped-up) event that elicited a great deal of excitement and enthusiasm among Austrians.  There was a general feeling in Vienna, according to Kindleberger, that something important was happening, and the world, or at least Austria, would somehow be changed by the upcoming World’s Fair.

 

When the fair opened in May, and not surprisingly the world was no different after its opening than before, within days disappointment and worry set in, and the Austrian markets began to fall, quickly turning into a collapse.  The panic spread to Germany and over the next few weeks and months one market after the other around the world fell, culminating in the closing, for the first time in its history, of the New York Stock Exchange that September.

 

I mention this because here in China I think there is a very unrealistic set of expectations about the importance to China and the world of the upcoming Beijing Olympics.  The Olympics are obviously a major sporting event and a sort of “coming out’ party for China, but here in China the event has achieved significance well out of proportion to its reality.  For example a lot of my students, and hundreds of thousands more around the country, are “volunteering” for the games, and I think they have very unrealistic (and overly glamorous) expectations of what volunteering will entail.  Many of them have planned their futures out until August 8, and haven’t really though about what comes after.  The government itself is certain to increase the noise and hoopla as the event draws closer (not that it hasn’t already done so).

 

I am worried that many Chinese, especially young Chinese, are going to be horribly disappointed when the world doesn’t, somehow, transform itself in a major way the day the Olympics opens.  If the ceremonies are seen as less than successful, and one obvious way is if Beijing is criticized for failing to live up to environmental commitments, I think the disappointment will be very deep.  I read today that the Swiss dressage team has decided not to compete because the weather in Hong Kong, where those events will be held, may be damaging to the horses, and although I don’t think the world is obsessed by dressage, a few more such cancellations (and the worst will be if there are air-quality-related cancellations) will lead to feelings of deep frustration here.

 

Already one of the commonplaces in every day conversation is that nothing bad can happen in China before the Olympics, and an awful lot of stock market speculators talk very confidently about closing their positions just before the Olympics.  I myself plan to close my B-share position in March to give me plenty of time to beat the expected rush (although I suspect the government is going to do all it can to ease market conditions in expectation of a selling rush).  Too much may be riding on these Olympics.

 

THU 10 JAN

China wants to force inflation down. Can it? By Michael Pettis

Just as we start hearing serious rumors about government plans to streamline the government bureaucracy, merge various ministries and departments to create fewer “super-ministries”, and increase economic flexibility by reducing red-tape and government interference, the State Council announced “temporary price intervention measure” which will allow the authorities to prevent large scale producers from raising prices on what are called “daily necessities” (I have seen no definition of what this means, but assume it refers primarily to food and energy).  In a related announcement, following a cabinet meeting yesterday, Premier Wen Jiaobao announced a freeze on prices of natural gas, electricity, water, transportation, education and health care prices.

 

The urge to reduce the complexity of government is not new.  China is awash in red tape, and so many competing ministries and departments regulate different aspects of the economy that it is hard to get any coordination.  According to an article today by Andrew Batson and Rick Carew of the Wall Street Journal, the government has already tried reducing complexity – the number of ministries declined from 45 in 1983, to 41 in 1988, to 29 in 1998 to 28 currently.  The target is to get down to around 20 or fewer.  Although this top-down approach to reform may seem aesthetically pleasing to the bureaucratic mind, I am not sure that reducing the number of ministries and increasing their power will make the economy or the bureaucracy more flexible if there isn’t a significant change in the incentive structure for powerful bureaucrats – which to me means real accountability and a well-functioning mechanism to enforce bureaucratic response to the needs of the sectors being managed.  Increasing the power of these super-ministries may simply increase political infighting and factional struggles.  We’ll see.

 

Meanwhile the announcement that the State Council can “‘temporarily” intervene in price hikes and is freezing certain utilities suggests that inflation is worrying them enough to force them to reverse direction in freeing up the economy.  No one is certain how serious they are about these new measures – this might just be an attempt to show the people that they are truly concerned about inflation, which a recent survey has identified as the number one worry among the population at large, or it may be a very temporary measure to ensure a happy Spring Festival (this year it is on February 8, I think).  By the way in its announcement the cabinet also said some firms were hoarding goods, unreasonably jacking up prices or spreading rumors about price rises.  They assured us that they would crack down on such antisocial acts.  That makes me think these announcements are at least as much about public perception than about real measures.  Everything is so much better if we can identify the hooligans who have caused our troubles.  But even if they are serious about implementing these new measures I am still very pessimistic about the chances of their working.

 

The success of government measures to restrain prices depends very much, as I have argued several times, on which model you use to explain inflation.  If you believe that inflation is a temporary food-price phenomenon, one which will work itself out later this year as food production gets back on track, the greatest danger is the development of inflationary expectations which cause price rises to spread to other parts of the economy.  In that case the various measures the government has taken – steps to cool the economy, to sell food reserves, and now to freeze prices – might actually work, although even that is open to argument.  

 

If the problem is monetary, as I believe it is, then these measures are likely only to make things worse.  Price freezes will translate, as they already did in the energy sector, into reduced production, consumer shortages and long lines – which may be even worse for the population at large because there will almost certainly be unequal treatment, and people find it much harder to bear difficulties if there is a perception that these difficulties are not evenly shared.  Already the government is taking big losses on its fuel price subsidy and there are persistent rumors about fuel hoarding in expectations that prices will be forced up again in the near future.  Needless to say this makes matters worse, not better.

 

Selling off grain reserves to depress prices is not likely to be much of a help either because it means, effectively, backdating inflation – lower prices today will be met by an increase in inflationary pressure as grain stocks are replenished in the future, and if in the meantime lower prices today reduce incentives to increase production, the net effect will be an overall increase in prices.  Finally, restraining consumption simply means increasing the trade surplus and so increasing monetary expansion.

 

However you interpret these measures, the government is clearly very worried about inflation.  December CPI numbers haven’t come out yet, but I expect we will get them in the next week or so.  I would be very surprised if they are not high, but I think even then that December and January CPI numbers will understate the problem because of the immediate impact of measures aimed at keeping prices down for the Spring Festival, such as selling off grain reserves.  Most CPI inflation estimates I hear are in the low 6% range, down from November’s 6.9% but still far outside the government’s comfort range.  By the way the rumors are that producer prices will show in December continued rising from November’s already high 4.6%.