My Blog

May 5, 2008

MON 5 MAY

Better too loose than too tight? By Michael Pettis

The stock market had another good day today.  My teaching assistant Shang Ning tells me that it started the day strong, faltered in the late morning, and then finished with a burst of energy to close up 1.84%.  There seems to be continued confidence in the government’s determination to prevent a further collapse in prices before the Olympics.

 

On the overheating and inflation front, however, there is a lot more confusion about what is likely to happen.  Today’s Bloomberg reports Zhou Xiaochuan, the PBoC governor, as saying yesterday at the Group of Ten meeting in Basel that export growth is slowing and inflation will be moderate this quarter.  As I noted before, RMB appreciation has slowed markedly over the past few weeks and this is usually attributed to the failure of its recent rapid appreciation to put a dent in inflation.  However another article in today’s Bloomberg has Vice Finance Minister Li Yong telling delegates at the Asian Development Bank’s annual meeting in Madrid today that China's economy is at risk of overheating and policy makers may raise interest rates and do more to soak up the cash flooding the financial system.  “We will combat demand and prevent rapid economic growth from turning into overheating,” he apparently told the conference. 

 

Meanwhile the Guangzhou Daily reported on Sunday that the State Information Center, the powerful NDRC’s think tank (the adjective “powerful” is always placed before “NDRC”) said in a recent report that the risk of overheating has waned as China's economic growth in the first quarter slowed, with both the trade surplus and credit growth brought under control.  The conclusion?  The government does not need to introduce new tightening measures although, the think tank warned, perhaps a bit perfunctorily, that inflationary pressure still must not be ignored.  I don’t think this is a surprise conclusion because it seems to me that State Information Center has pretty consistently been more worried about unemployment than about controlling China’s monetary growth.

 

In the battle between the monetary camp and the growth camp it seems to me (based purely on reading tea leaves – I have no real information here) that the growth camp now has the upper hand, largely because the authorities are increasingly anxious about a more-rapid-than-expected decline in export growth.  In the May 2 edition of Macquarie Bank’s China Diviner Paul Cavey points out that although China’s exports in dollar terms expanded 21% year-on-year in the first quarter of 2008, part of that can be explained by the declining dollar, and in volume terms the growth was actually much lower – I think he says 15%. There is real concern about the possibility of an unexpectedly sharp downturn, and as a result the authorities are far more willing to err on the side of monetary excess than contractionary excess.

 

In fact Observatory Group’s Li Xinxin said in an April 30 report that “One week ago, the State Council convened a meeting among eight government agencies to discuss hot money inflows, but no consensus was achieved. Note that PBoC governor Zhou said there was neither a clear definition of hot money nor any convincing measurement for it.”  Xinxin also has Zhou saying that the rise in consumer prices was “mainly caused by food prices this time” rather than a “very classic case in which inflation is caused by too much aggregate demand.”  Xinxin goes on to point out that “These recent remarks are quite different from the PBoC’s previous view that China’s inflation is largely a monetary phenomenon and needs to be addressed through tighter liquidity control.”

 

It is a little surprising to me that Zhou would suddenly desert the monetary camp, but I understand that he is worried about being criticized again for overreacting on the monetary side and may be wary of taking the blame for any possible slowdown.  On the other hand I think the authorities may be overestimating the impact of a slowdown in export growth.  Many months ago I wrote about the five-year promotion cycle and about how at the beginning of each of these cycles (the latest one began in March) China typically experienced a burst of new infrastructure investment as new leaders, eager to start off with a bang, engaged in an orgy of investment.

 

In a research report produced today Dong Tao of Credit Suisse argues that the risk of an economic slowdown in China has dropped significantly, and that economic growth may even have “reaccelerated.”  At least part of the reason may be “anecdotal evidence regarding infrastructure projects,” and that this is being accommodated at least in part because of relaxed credit conditions stemming from the government’s worries about growth risks.

 

I am not sure how to read all of this, but I wonder if fear of an export-led slowdown caused by slowing demand in the US and (perhaps) by a rising RMB may end up causing an excessive relaxation of credit and monetary conditions, especially as we are less than 100 days away from the start of the Olympics.  Given all the fuss and noise already, the government is particularly worried about any further disruption of the celebrations.  Most of my friends here in China assure me that there is little the government will do now to threaten the success of the Olympics, so I suspect there is a strong relaxation bias rather than a tightening bias.

 

And what are we hearing about April inflation?  Li Xinxin of the Observatory Group believes year-on-year inflation for April will come in under 8.3%, and I have already posted other reports about analysts who argue that it will be around 8.0-8.1%, but today Stone & McCarthy’s Logan Wright came in with a very different set of numbers.  He tells me that he believes food prices, based on data from the Ministry of Agriculture and the Ministry of Commerce, will turn out to be fairly stable to slightly up in April, and that non-food prices will continue to rise, so that year-on-year inflation will be 8.5%.  His prediction is a bit of an outlier here, but he has been an outlier on the pessimistic side many times before and, so far, the most pessimistic predictions have generally been the most accurate.  We will know next Monday.

 

Meanwhile I thought I would attach a graph I made from my own CPI series (starting at 100 in January 2006).

 

 

The little fork at the end shows the range between 8.0% and 8.5% year-on-year inflation for April.  As the graph shows, the CPI has trended upwards pretty steadily since late 2006, before taking a very sharp jump above trend in January and February.  Also notice that around every February there is a spike.  It is not unreasonable for the CPI to decline from the spike before reverting to its upward trend, so there is no way to judge whether March represented the peak, or simply a temporary spike.  Whatever the April CPI number turns out to be, I don’t think it will resolve the debate unless CPI inflation comes in even above Logan’s prediction and is driven mainly by a jump in non-food inflation (although if that were the case we would probably already have heard rumors to that effect).