Muddling along

The CPI numbers released Thursday have created a wide variety of responses among analysts and economists, both inside and outside China.  Some are hailing the reduction in CPI as an indication that China may have turned the corner on inflation, whereas others see this as a temporary reduction that will soon reverse as inflation spreads into non-food goods and services, and may even return quickly to the food component of CPI as more bad weather in China puts pressure once again on food supplies.  I would add that there is some evidence that the authorities have been aggressively selling food from their reserve stockpiles, in part to keep prices down, and, aside from the fact that at some point these reserves have to be replenished and so will once again put upward pressure on food prices, this means that the impact of any more supply interruptions will be more severe than they have been in the past.

Fortunately the authorities don’t seem convinced yet that the problem is over.  President Hu had a meeting yesterday, according to Raymond Li of the South China Morning Post, in which the top leaders were summoned to discuss China’s economic problems.  A statement released by the group cited increasing risks and uncertainties that made macro-economic management more complex, and pledged to use “a thousand ways and a hundred plans” to control prices.  As the Li points out, this is the first time this particular phrase has been included in the macroeconomic management toolkit.

What does this mean?  Unfortunately it sounds to me that it means an increase in administrative measures, probably including more price freezes, to manage prices.  As it is I think these kinds of measures used previously probably have more to do with the decline in May’s CPI than any real release of inflationary pressures.  I say this because, as I pointed out in yesterday’s entry, all the other indicators seem to indicate that inflationary pressures all still there

One such indicator is what otherwise should be very good news – retail sales are up strongly.  Paul Pankhurst at Bloomberg had this to say in an article today:

China's retail sales rose 21.6 percent in May, close to the fastest pace in nine years, as the strongest earthquake in half a century, a stock-market slump and the scrapping of a week-long holiday failed to cool demand.  Sales soared to 870.4 billion yuan ($126 billion) after gaining 22 percent in April, the statistics bureau said today. Last month's 7.7 percent inflation rate swelled the numbers.

Given all the problems Pankhurst correctly cites – the earthquake, the collapsing stock market, the scrapping of May’s “golden week” holiday – plus a few more, such as the rising economic uncertainty, nervousness about real estate, the general sense among many in China that something is not going right, it is interesting that retail sales expanded so quickly.  This is good news of course because it does mean that if there is a slowdown in exports China has another part of its economy taking up the slack.  The thing is that exports don’t seem to be slowing.  Says Bloomberg in the same article:

The retail sales data came two days after statistics showing exports surged 28 percent in May after a 22 percent gain in April. In a June 3 statement, the central bank played down the threat that overseas shipments will collapse, causing an economic hard landing. A “drastic” export slowdown won't come soon, it said.

It seems to me that all the circumstantial evidence is showing the same thing.  China’s money growth is still pounding though the financial system and showing up as increased industrial production – which results in more strong export performance – and it is also causing surging consumer demand.  The CPI statistics are becoming less and less useful as a gauge of future inflationary pressure because of the combination of price controls and the selling of food reserves (and perhaps even, I have heard, because of the reluctance of some institutions to record price increases that go beyond the officially sanctioned ones).  Meanwhile we hear increasing talk of power and fuel shortages.  As I tried to explain Friday night on Dialogue (the current events program on CCTV), if you spend an extra half hour every week waiting at the gas station to fuel your car, the price at the pump might not have changed, but your living standard has nonetheless declined, and that is as much a form of inflation as paying more at the pump but not waiting half an hour in line.

Pankhurst’s point about the stock market is worth stressing.  Yesterday the SSE composite dropped another 3.0% to close at 2869, only three points above its low for the day, and this weekend Chinese newspapers are filled with articles about the unhappiness of investors who have seen a 13.8% drop this week – the biggest weekly decline in 12 years.  The nominal cause of this week’s awful results was the PBoC decision to raise minimum reserve requirements last Saturday by 100 bps, and this decision has generated some uncharacteristic anger.  There were reports of a small demonstration in Shanghai by investors angry that the government wasn’t protecting them, and more importantly, according to the Observatory Group’s Xinxin Li, economists with ties to the government have also protested.

The surprising 100 bps reserve ratio hike over the weekend immediately caused strong complaints from other government agencies, banks and industrial firms.  A reserve ratio of 17.5% seems close to a tipping point that may seriously damage the profitability of some small‐and‐middle‐sized commercial banks.  Note that Wang Jian, a well‐known economist with close ties to the influential National Development and Reform Commission, publicly criticized this latest reserve ratio hike as “a wrong move”.  Such strong talk by such an economist has rarely happened in the past. Both banking and securities regulators are also increasingly unhappy with a tougher and tighter market environment.

Of course it goes without saying that rumors are swirling about new government actions aimed at propping up the market since it is clearly below the 3000 level below which it was not supposed to fall.  The biggest hopes are placed on the supposedly imminent launch by the CSRC of stock-index futures and margin trading rules, although as I have already noted in an earlier entry it isn’t clear to me why these should push the market up in any serious way.

I think the government is very determined to address the myriad problems and uncertainties China’s financial system is facing, but they are growing increasingly frustrated that nothing is really working.  That is not surprising.  The basic problem is monetary policy, which is driven by the currency regime and which, right now, is mainly an expression of massive speculative inflows.  Until this is addressed, and policy-makers are still very reluctant to do so, I don’t see that things will improve much.