Today’s China Daily has yet another article bemoaning China’s export performance.The article is titled “Growth of Exports in Steady Decline” and it starts out:
The growth of exports from China's labor-intensive industries is slowing, and the trend is set to continue, the Ministry of Commerce said Wednesday.In the first quarter of the year, the value of clothing exports rose 14.7 percent, less than the 17.6 percent growth reported for the same period of last year, the ministry said in a report. Similarly, the value of shoe exports rose 11.2 percent (compared with 16.7 percent last year) and toy exports grew 3.3 percent (down from 29.9 percent).
It is only at the bottom of the article that they point out that “the value of China's exports in the first three months grew 21.4 percent to $305.9 billion year on year. In contrast, the value of imports rose 28.6 percent to $264 billion in the first quarter.”This doesn’t strike me as a collapse in exports, but it does strike me that some exporters and their government allies are waging a very spirited campaign against further appreciation of the RMB.
Even if there is a slowdown in exports, it seems, at least for the time being, that domestic consumption may be taking up the slack.The Purchasing Manager’s Index in March rose to its highest level ever (although it was only started 28 months ago, so this might not be as big a deal as it seems).Most of the increase came from domestic customers, with export orders actually declining slightly for the first time in three months.This is exactly what we want to see – exports decline in importance and domestic demand increase in importance – but of course we shouldn’t get too excited about just one or two data points.We need to see this continue over the rest of the year before we can talk with confidence about a real rebalancing of the economy.
Today is a major holiday in China, as is tomorrow, so there is not a whole lot happening.My student Shang Ning tells me that there was an article in the current Caijing (probably China’s leading financial periodical) in which a senior SASAC (State-owned Assets Supervision and Administration Commission) official warned that because of the “uncertain macroeconomic environment”, large SOEs should “get ready for a two-year period of tightening.”The article claimed that this year is the first year since the SARS year of 2003 that we are expecting a decrease in SOE profits, led by the energy companies. His advice was that large Chinese companies should “control their debt levels and manage their budgets carefully.” A major concern he discussed was the weakness in operating cash flows.
I think this is very sound advice and gives an indication of how worried officials are about the next couple of years. I don’t have the numbers yet but my impression is that debt levels among large companies are very high and a large part of that debt is short term.Cashflow for many companies is weak, and of course any forced build-up of inventories caused by declining demand will put even more serious cashflow strains on companies. This, of course, is exactly the kind of balance sheet that seizes up during a contraction and forces companies into the type of self-preserving activities that are systemically bad.
That’s all for now.For any of my readers in Beijing, the only thing to add to this sleepy, slow day (it is very hot outside) is that today is the anniversary of D22, the music club I started two years ago. Since we have been credited with having been at the heart of the Beijing explosion in new and underground music, nearly everyone of the best bands in Beijing (and from elsewhere in China) have trooped to our doors, beginning two days ago and continuing on until Sunday, for celebratory performances. If you’re in Beijing I strongly recommend that you come tonight and Friday night, when we have some really great artists performing, but come early because we will probably be forced to close the doors at 10. These are going to be packed shows.
We are just finishing with the May holidays and next week we will return to the busy schedule of the past few weeks.I think much of the focus for the next few days will be on the stock market.I know that I’ve been invited to speak Thursday on CCTV’s Dialogue, a current events show, on the subject of the stock market and what the government ought to be doing about the recent market volatility.This is clearly an issue that has drawn an awful lot of attention and debate recently.Regular readers of my blog know that although I sympathize with the government’s political concerns about recent stock market volatility, the fact is that each one of their interventions undermines the capital allocation process, and by strengthening the speculative nature of the market, actually increases volatility in the medium term.This is the point I will try to make on Dialogue.
I don’t know if it comes out at the end of this week or the beginning of next, but probably what many of us are most curious to see is the April CPI inflation number.The initial noise in the market is relatively positive. Bloomberg has a short article today, for example, that suggest that at least some analysts believe it will come in above January’s 7.1% but well below February’s 8.7% or March’s 8.3%:
China's consumer prices likely rose 8.1 percent in April, slowing from a month earlier, after prices of some agricultural products fell, the China Business Journal reported, citing unidentified people. Inflation is mainly driven by food prices, and as long as it remains stable, China shouldn't take steps to suppress economic growth, Liu Yuanchun, a professor at Renmin University of China, said in the Chinese-language report.
Likewise today’s China Daily also has a pretty optimistic report.
The slowing growth of China's main inflation indicator is set to continue in the April figures, thanks to falling farm produce prices, market analysts said on Sunday.
The consumer price index (CPI), which hit 8.7 percent for February and 8.3 percent for March, would probably be around 8 percent for April over the same month last year, said Chen Jijun, an analyst with CITIC Securities. Falling farm produce prices were the main factor dragging down the rise in the CPI, said Chen.
CPI inflation of 8.0-8.1% would bring month on month CPI inflation to negative 0.3-0.4%.It would mean that year to date we are running at an annualized inflation rate of 8.3% – well below the 12.9% at the end of March.
This would be great news if it were true and would certainly give the authorities a sense that they had gained some respite, and they certainly would have, but of course we need to be careful about how we interpret the data.The first and most obvious point is that any sustained upward inflation cycle is never in a straight line.For example the US experience in the 1970s did not consist of an unbroken series of rising monthly inflation numbers but rather consisted of an inexorably rising trend with many monthly and even quarterly periods in which CPI inflation actually declined substantially, before rearing again.
More importantly, we would need to look at the breakdown in the numbers.Given the extremely high jump in food prices earlier this year, it could very well be we are experiencing a necessary and temporary sharp drop in food prices within an overall rising trend.We won’t know for sure from looking just at food prices, but the non-food component will tell us a lot.If non-food inflation is stable or declining while food prices decline sharply, April’s CPI report would be an unmitigated blessing (or would be if it continued for at least one or two months more).
If non-food prices keep rising, however, the numbers are far more ambiguous.One explanation would simply be that the very sharp, temporary jump caused by exceptional January and February conditions was partially reversing itself, but underlying inflation continued unabated and was spreading into other goods and services.
I suspect I am falling into the trap of reading way too much into individual data points, but with so little information coming out recently, it is hard to resist the temptation.
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 GuangzhouDaily 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).
The Chinese stock market continued to bounce around today, driven down largely by the poor performance of bank stocks.There were fears among investors that we may see more tightening measures in the form of hikes in interest rates or minimum reserve requirements, or both, and these fears have hurt bank stocks in particular.Shanghai opened the day down about 1% and quickly dropped another 1% or so in the first few minutes, before trading up in the late morning and bouncing in and out of positive territory all day, until by late afternoon it was up 0.6%.In the last 30 minutes, however, it gave up all its gains and then some to close down 0.73%.That doesn’t bode well for tomorrow, but either way I don’t think there was a lot of conviction.
A couple of my Peking University students who trade regularly and who keep track of the market gossip tell me that there is a real sense among investors that the government is in control of the market and won’t allow it to fall much further – 3000 seems to be the magic number below which it can’t fall (the SSE Composite closed at 3681 today).This has buoyed market sentiment and has kept investors in the market.Needless to say, this kind of belief can cause damage to the capital allocation mechanism by distorting the market clearing mechanism.
There is something else here that may be of interest to those curious about the mechanics of the markets – and the rest of this post is not really about the Chinese financial markets.It is just some speculation on ways in which markets can adjust after distortions have been introduced, so probably of very little interest to most of the regular readers of this blog.
It is widely known that the perception of a minimum trading level, enforced by some credible agency, can distort the actual trading level in a predictable way – keeping it above whatever the fundamental level supply and demand would have naturally created.I try to show this in the graph below:
In the graph, assume that the hard horizontal line is the perceived minimum trading level of the SSE Composite permitted by the government (which the market perhaps assumes to be around 3000 or just below). If we assume that normal supply and demand in the market would have caused the index, absent government support, to move up and down the upward sloping straight line labeled “fundamental value”, the implicit belief in the government support level will actually drive the market along the curved “trading value” line, so that its price will lie directly above where it should have traded without the perception of government intervention.
The problem with this kind of distortion is that if and when the government is no longer able or willing to support the market, or more importantly the perception of government support evaporates, probably at some point where the “fundamental value” is well-below the perceived minimum trading level (the horizontal line), there is a risk of a sudden and sharp drop in price from the “trading value” line to the “fundamental value” line as real market supply and demand are forced to clear.
This is what Paul Krugman predicted would happen to the value of the euro many years ago when it traded down shortly after its launch but hovered above $1 – largely on the perception that the European governments would not want it, for political reasons, to trade below $1. He said that when the euro broke $1, it would not do so gradually.Instead it would fall very sharply.
That is in fact what happened.For many weeks the euro stayed above $1 dollar, trading up and down in a narrow range. But the supposedly temporary support extended by intervening governments in the hope that the markets would eventually “get it” (i.e. understand that the euro really was worth a lot more than $1) was not able to turn market sentiment – perhaps because the creation of the euro itself caused a one-time liquidity adjustment, as Robert Mundell predicted it would – that would result in an excess supply.
The attempts to change market dynamics by changing underlying sentiment, in other words, failed. Eventually, after extended intervention was clearly unable to turn sentiment solidly around, European governments were forced to stop intervening.Shortly afterwards the euro broke $1, and just as Krugman predicted, it immediately dropped very sharply by nearly 10 percent, before resuming its gradual drift downwards to below 80 cents.
If the SSE Composite trades within a narrow band above 3000 for several weeks or months, with new administrative measures (or rumors of such) emerging every time it trades too close to 3000, we may find ourselves in the sort of situation Krugman posited for the euro.In that case the model would predict that if and when it broke 3000 (or, more probably, some psychological support level below 3000), it would break sharply. In that case we might see the index lose 5-10% or more within a day or two.
P.S. I know Cui Enze, Liu Bing and Shang Ning, as well perhaps as some of my other students who are fascinated by the dynamics of trading, are going to be all over this blog entry.
The Chinese stock market started the day well, with the SSE Composite starting below yesterday’s close but quickly trading up to 3767 within the first hour of the morning – a hefty 2.3% jump from yesterday’s close.But investors quickly lost heart, and the market subsequently gave up nearly 200 points from its peak today to close down at 3578, for a very ugly 4.11% loss for the day, with banks, real estate-related companies, and Olympics-related companies leading the way down. The steepest declines took place in the last 90 minutes of trading, when a slew of selling orders ran up against a sharp decline in trading volume. For all the talk of government support it does not seem that there is a great deal of confidence in the market.
A lot of investors are still wondering what, if anything, the government can do next to stimulate the market.I don’t doubt that there are still things government agencies can do to signal official intentions, but there doesn’t seem much they can do actually to influence real supply and demand in the market for more than a few days. As expected, their many interventions are losing credibility.Institutional investors seem to be using every rally as an opportunity to get out of their positions, while retail investors are filling internet bulletin boards dedicated to discussing the stock market with anxious and angry comments.
On the inflation front, according to a Credit Suisse report today, Dong Tao, who has had a pretty good call on Chinese inflation, is expecting the April CPI number to come in at 8%. Like many other analysts he expects second-quarter inflation to stay high, but well below the drastic first-quarter numbers.However he, like me I might add, is worried that as food price rises decelerate non-food inflation will soon take center stage and drive the index up higher in the send half of 2008.In that context I should mention a piece from Capital Economics on the subject of inflation in Asia. “Inflation has re-emerged as a unifying theme across many Asian economies in recent weeks. Driven by the continuing high international oil and food prices, persistent upside surprises to inflation have forced a rethinking of monetary policy in the region.”
I think this should not be a surprise.After the 1997 Asian crisis a number of Asian economies, including China, have been so determined to protect themselves from a repeat of those events that they put into place a set of systematically mercantilist polices aimed at limiting exposure to external debt – often by managing their currencies so as to run persistent current account surpluses and burgeoning reserves.The problem with these policies, as I have discussed often on this blog, is that they seem to have misjudged the cause of the earlier sequence of crises.
Financial crises do not occur because countries have currency mismatches. They occur because they have asset-liability mismatches, of which the currency mismatch is only one form. By managing domestic monetary policy so as to minimize the risk of a currency mismatch several Asian countries may have simply transferred the balance sheet risk into a different form. Specifically, interventionist currency regimes have often resulted in significant monetary expansion, which create not just the risk of inflation but can also lead to domestic balance sheet imbalances, most dangerously in the banking system. Remember that in the 1920s the US also experienced massive capital inflows on the trade and capital account, resulting in the accumulation, in John Maynard Keynes’ words, “all the gold in the world.”The result, in the case of the US, was not a national balance sheet impregnable to disruption. On the contrary, the US experienced the stock market crash of 1929 and the banking crisis of 1930-31 that led to the consequences with which everyone is familiar.The lesson is that current account surpluses and massive reserve accumulation are no guarantee against financial disruption.
Headline food prices do seem to be moderating in China, so we will see a deceleration in CPI price rises, but I am not sure this is for all the right reasons, and I wonder if food price increases can continue to be restrained. As a long-time trader and observer of developing countries I always get a little nervous when government officials keep repeating that they don’t have a problem in some specific area, so I guess I am getting a little nervous about yet another announcement, this time from the NDRC, that they have “ample grain to keep food prices stable”, as the prominent headline in today’s China Daily put it.
We are starting to get these assurances nearly every two or three days now.“Our grain supply and demand is basically stable, our reserves are full, and we can ensure supply and stable grain prices,” the NDRC said in its statement. The same article pointed out that customs and commerce authorities are cracking down on illegal grain exports by traders hoping to profit from surging international prices. It points out that whereas price of rice in Thailand has soared from $300 a ton to $1000 a ton in six weeks (wow! can this possibly be true?), the price of rice in China is still frozen at $300 a ton.
Not surprisingly this seems to have led to wide-spread rice smuggling. Another article in the same issue of China Daily also makes this point: “But there are concerns about how long the nation can hold its rice price at about one-fourth of that in overseas markets, given recent reports of illegal rice exports in the past months.”Not only do we have a problem of local “businessmen” smuggling oil out of the country to take advantage of the heavily subsidized prices in China, but the smuggling problem now seems to be spreading to grains too.
I suppose this was only to be expected. With such long and complex borders, and with an endemic corruption problem, it was inevitable that the huge disparities between the subsidized prices of certain commodities in China and their equivalents in neighboring countries would lead to “arbitrage,” as the more polite among us might put it.I have no idea of how extensive this smuggling is, but given the fact that the authorities are publicly admitting the problem (and twice in a single issue of the China Daily), I would guess that it is a big problem. The monetarist in me would also point out that smuggling rice out of China will have a similar monetary impact as bringing foreign currency into China, so this is not just a problem for the Ministry of Finance, who has to raise taxes to pay for the subsidy going to smugglers, but also for the PBoC.
One final note: John Garnaut, of the Sydney Morning Herald, wrote an interesting article three days ago on unemployment in China.As worthless as the official unemployment numbers are (the Economist recentlyargued that they are the least accurate of all the important economic numbers provided by the Chinese government), it may well be that unemployment in China is much lower than many in the government think. If this is true, the social consequences of further monetary tightening may not be as grave as many government officials fear, especially given that the expected economic slowdown caused by China’s slowing export growth is likely to have been counteracted by a recent surge in infrastructure spending.There may still be time to take the steps needed to reduce China’s out-of-control monetary growth.
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.
Subscribe to this Site
reported, citing unidentified people. 
September, 2007