My Blog

February 19, 2008

TUE 19 FEB

Bad numbers, but China might still prefer to hesitate By Michael Pettis

After all the market-related anxiety I felt during the last few days in New York, I returned to Beijing yesterday expecting a little less gloom, but nonetheless I suspect that anxiety levels in the corridors of power in Beijing are probably higher than ever.  Yesterday the National Bureau of Statistics released PPI numbers for January and today it released the CPI numbers.  Regular readers of my blog will not be surprised when I say the numbers weren’t good.  According to the NBS release:

 

In January, Producers’ Price Index (PPI) for manufactured goods up by 6.1 percent from the same month last year; purchasing prices for raw material, fuels and power rose by 8.9 percent.  PPI for means of production increased 6.5 percent over last January. Of the total, PPIs for mining and quarrying industry increased 20.5 percent; that for raw materials industry and manufacturing industry correspondingly up by 8.5 and 3.8 percent; that for means of consumer goods grew 4.6 percent. Of which, price for foodstuff increased 10.4 percent; that of clothing and commodities rose 2.2 and 3.0 percent respectively, while that for durable consumer goods dropped 0.6 percent.

 

PPI numbers rose from October to December by 3.2%, 4.6%, and 5.3%, respectively.  January’s 6.1% indicates that upward price pressures continue stronger than ever.  Food prices were a big part of that, but notice that mining and the raw materials industry were also up substantially.

 

CPI was even more alarming.  A lot of debate during the last few weeks was whether we would see CPI hit 7% for January.  According to the NBS release today:

 

In January, consumer price index (CPI) was up by 7.1 percent over the same month last year, of which, urban area and rural area rose 6.8 and 7.7 percent respectively. The price of foodstuff, non-foodstuff, consumable and services expanded 18.2, 1.5, 8.5 and 2.6 percent respectively. CPI made 1.2 percent growth over that in December 2007.

 

7.1% CPI inflation for January is up from 6.9% in November and 6.5% in December (although remember that for statistical reasons the price jump in December is rally equivalent to the November rise – I discussed why in an entry last month).  The bulk of the increase was still caused by food inflation, but what worries me is that non-food inflation, while low (1.5%) is still rising, which it shouldn’t be if inflation were really caused primarily by a one-time food supply constraint – indeed it should be declining or even negative.  It is also pretty clear that inflation is starting to spread to other areas of the economy.  For those of us who have always been convinced that inflation in China is a monetary problem, and not a one-off food supply problem, the recent numbers, while not conclusive, only make us worry even more.

 

A lot of January inflation has been blamed on the effect of the recent weather crisis, but I believe that much of the weather-related price increases didn’t show up in January and are more likely to show up in February.  I should also point out that some Chinese analysts are warning that certain industries whose prices have been frozen (or for whom price increases are subject to approval) may have concealed the true extent of price increases, so the CPI number may actually understate inflation.  At any rate, according to the press, Deutsche Bank and Goldman are warning that inflation may go as high as 8-10% in February and March.  I am not sure how they get to those numbers, but regular readers of my blog know that I have always been much more easily convinced by the inflation pessimists than by the optimists.

 

So what can the government do?  Precious little, it seems to me.  There is still a fast and furious debate about tightening versus non-tightening.  On the one hand January’s numbers – rising inflation, the surge in bank lending, and the surprisingly high trade surplus – should argue for more tightening.  The government seems to have shifted policy from pro-growth until late last year, to slow-growth after October, and now back to pro-growth.  These rapid policy shifts are very damaging – they undermine credibility and, perhaps worse, they add unnecessary volatility since we never seem to wait around long enough to see what the impacts of the policy decisions have been – but there is a strong case that can be made that we need to shift once again to a slow-growth policy.

 

Still, it is easy to argue against a policy shift and it seems that many in China seem to be doing exactly that.  The weather crisis and the possibility of a sharp US slowdown add enough uncertainty to the picture that an equally strong case can be made for taking a wait-and-see attitude before acting further.  Given the government’s ideological and institutional commitment to gradualism, a good reason to do nothing would be warmly welcomed.  Add to this the fact that new leadership will be announced in March, and one can imagine a lot of future newly-promoted provincial and municipal leaders eager to give their bailiwicks a big fiscal boost at the beginning of their watch.

 

Not surprisingly the analyst community is split on will-they-or-won’t-they.  Some are expecting a rapid return to interest rate hikes, reserve hikes, and tougher lending constraints, while others think that the authorities are unlikely to move before March or April, until we can get the first set of economic numbers uncontaminated by the effects of the weather crisis and the Spring Festival, and after we have a better sense of whether or not the US economy is likely to slow enough to affect the Chinese economy in a significant way.

 

Either way I don’t think it will matter.  I continue to believe that China’s problem is a monetary problem, and that the root cause of the problem is the massive amount of the trade and capital account surpluses that need to be monetized by the PBoC.  Until these inflows are eliminated, tightening policies will be as ineffective in the future as they have been in the past.

 

In principle the more rapid appreciation of the RMB should be one way to affect inflows, but in practice, of course, it is not.  Rapid appreciation stimulates speculative inflows, and as long as this money creation continues to feed China’s investment boom, industrial production will keep surging and the gap between production and consumption will continue to keep the trade surplus abnormally high.  None of the tightening measures being discussed – even if they are implemented – will do anything to get China out of its monetary trap.