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?
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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January, 2008
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