My Blog

February 3, 2008

SUN 3 FEB

Inflation predictions By Michael Pettis

I’ve just seen one piece of good news and one favorable prediction about January inflation.  The good news is that the State Administration of Grain said in a statement posted on Xinhua News Agency's Web Site today that in spite of the recent disastrous weather, China still expects to meet its grain harvest target this year.  I did not realize that China is the world’s biggest wheat grower, but last year it harvested 501.5 million metric tons and this year it is on target to harvest around 500 million metric tons.

 

I hope this is true.  The favorable prediction comes from Chen Xiwen, director of the Office of the Central Leading Group on Rural Work, according to today’s China Daily.  “Given that prices of grain, pork and edible oil have seen no apparent rises, January CPI will remain stable,” Chen told the briefing held by the State Council Information Office.  He predicted that January CPI inflation would be 6.5%.

 

This is not stable, by any means, but a lot of other analysts, including me, are predicting that CPI’s rise will be closer to 7%.  Is 6.5% achievable?  Perhaps, but not without some fudging.  The government has been aggressively selling and/or delivering food reserves.  Given the weather-related chaos in the food markets, this is not at all an unreasonable policy, but it does tend to put temporary downward pressure on prices, and that pressure will be reversed when the government replenishes its stocks.  According to other reports farmers are complaining that food price freezes – another way of containing headline CPI inflation – are hurting them because they are being squeezed by higher fertilizer and energy prices.  Finally according to the China Daily article, “To help keep prices down, the government has ordered all highway and expressway operators to exempt trucks carrying vegetables from toll fees.”  Both price freezes and toll-road-fee exemptions reduce nominal food-related inflation, but they do so simply by a sort of accounting trick – what should have been called “higher food prices” will now be called something like “extraordinary loss” on the farmers’ and toll road companies’ income statements (I don’t mean that literally – the inflationary cost will simply show up as lower revenues or higher taxes).

 

I would have thought that it would have been smarter to let the full rise in food costs pass through into CPI numbers in January, because then inflation could be blamed on extraordinary circumstances.  They can continue to subsidize the food costs to the worst-affected consumers, since this is politically and humanitarianly necessary, but the subsidies should be segregated and made explicit, although perhaps this would be administratively too complicated.  Still, as it is, the net effect is to reduce upward pressure on prices in January and postpone that pressure into the next few months.  This is surely more likely to cause inflationary expectations to rise than are price increases concentrated in January.

 

SUN 3 FEB

In China even Warren Buffet would be a speculator By Michael Pettis

The government has spoken, I guess.  At any rate the stock market certainly thinks it has.  As a side project I run a small investment club, with money supplied by me and some friends, that is invested in a diversified portfolio of Shanghai-Stock-Exchange-listed B-shares (which foreigners are permitted to own, unlike shares in the much larger A-share market), so I can’t say I was disappointed when I clicked onto the SSE website and found that the B-share index was up 7.94% today (A-shares are up 8.13%).  Although I am a little surprised at the extent of my gains, I am not at all surprised that my shares, and the market more generally, is up significantly today.

 

In fact I knew all weekend that my shares would be up today.  How did I know?  Easy.  Everybody knew the market would be up today because the government very cleared signaled over the weekend that it wanted the market to go up.  It was as simple as that.  An article in today’s China Daily explains:  “Monday's rally came after the China Securities Regulatory Commission (CSRC) gave the green light to CCB Principal Asset Management Co. and China Southern Fund Management Co to launch two funds expected to raise 14 billion yuan for equity investment.”

 

About four months ago, as a sign that it was very unhappy with the excess rise in the stock market and wanted it to come down, the government embarked on a series of measures to bring prices down.  One of these measures was to prevent the launch of new mutual funds – always an important sign here of the government’s intentions.  The market duly collapsed.  At its peak in mid-October the Shanghai CSI hit 5885, before dropping to 4318 on Friday (a decline of nearly 27%).  But now, by approving the application of two of these funds, the government made it clear that it believed the decline in the markets of the last three months has been excessive and may begin to have adverse effects on public sentiment.  It was time for the market to go up.

 

While I yield to no one in the gratitude I feel towards anyone who can increase my wealth by several tens of thousands of dollars in a single day, I have to say that this is not as good for the development of stock markets in China.  This kind of behavior will only delay by several more years the time when Chinese markets begin to fulfill their role as an efficient allocator of capital, taking money away from the least efficient and passing it on to those with the best growth prospects.  I wrote about why in a January 2 posting (“The government condemns Chinese financial markets to speculation”).

 

A purely speculative market does not allocate capital efficiently based on reasonable estimates of future earnings prospects. Speculative investors simply try to exploit short-term price changes, usually based on changes in short-term demand or supply factors.  In China the only important piece of information is about short-term changes in government and regulatory actions caused by changes in the government’s current intentions (and these change dramatically month-by-month and even day-by-day sometimes).  Bloomberg quotes a grateful fund manager today as saying: “It is encouraging to investors that the government has done something to intervene in the market decline.  We are probably already at a level where the regulators don't want to see a further decline.”  Recent activity simply reinforces the message that in the Chinese markets the only thing that matters is the government’s intention, and the only people allowed to play are the speculators.