Finally the numbers are in.\’a0 China\’92s CPI was up 6.5% in October, up from 6.2% in September.\’a0 This matches CPI inflation for August and, with that exception, is the highest monthly CPI inflation number since the 7.0% recorded in December 1996.
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On the one hand October inflation slightly exceeded the consensus forecast of 6.3-6.4%, but on the other hand it is below the 6.8-7.0% that some people (including me) were worrying about. (However you can read my previous entry to see why I think October inflation may actually be over 7 %.)\’a0 This is the third month of inflation over 6%, and I think that given the recent cut in fuel subsidies it is hard to see what can drive CPI inflation below 6% for the rest of the year.
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I think by now it is pretty clear that this is no longer just a food thing, although some analysts continue to say that it is. \’a0For example they argue that the non-food component rose just 1.1% last month from a year earlier, the same pace as it did in September, whereas food prices were up 17.6%.\’a0
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That suggests that food is still the primary force driving prices upward, although in a poor country where one-third of the CPI basket is food, I would think that rising food prices must affect wages and, through wages, the rest of the economy.\’a0 More to the point today we were also told that PPI was up 3.2% in October, compared to 2.7% in September (and 2.6% in August, 2.4% in July, and 2.5% in June). \’a0Food prices were a big part of that, but oil and raw materials were up 4.8% and mining was up 5.4%, (4.5% and 1.2% in September), and this doesn\’92t fully take into account the 8-10% increase in gasoline and diesel prices that was passed late last month.
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There is a lot of disagreement on where this will go.\’a0 Goldman Sachs have just changed their 2008 inflation forecast from 4.0% to 4.5%, whereas Credit Suisse keeps saying that it is going to be very hard to bring inflation down next year. \’a0In explaining their forecast, Goldman said to its clients in a note today that \’93We believe the central bank will likely respond with additional tightening measures including strict control on bank lending and two more rate hikes before the end of this year.\’94
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I have a great deal of respect for my Goldman Sachs friends, but I have to go with Credit Suisse\’92s Dong Tao on this one. Goldman, and everybody else for that matter, is right in saying that the high CPI inflation number is likely to lead to additional tightening measures, but given China\’92s monetary policies I cannot see how these tightening measures will work to reduce inflation. \’a0The whole point of tightening will be to reduce consumer demand as a way of putting a lid on inflation. \’a0But if consumer demands moderates, what will that do to the trade surplus?\’a0
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Of course it will rise even faster, and as the PBoC is forced to purchase the additional inflow, China\’92s money supply will expand even more quickly.\’a0 In addition, whether or not you believe that speculative inflows are a serious problem for China (I think they are), it is hard to argue that raising interest rates won\’92t have at least some positive effect on inflows.\’a0 PBoC tightening, in other words, is likely to increase current and capital account inflows. \’a0The only market tools they have to attack inflation will, perversely enough, increase monetary expansion, and if you believe as I do that the root cause of Chinese inflation is excess money growth, that cannot be a viable solution.
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I think China is stuck and can do nothing about domestic inflation without fixing the currency problem.\’a0 This gets to the nub of the reason why I think China will be forced into a maxi-revaluation (or at least a significant speeding up of the daily appreciation).\’a0 The authorities have no control over monetary policy and never will until they address the currency regime.
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This pessimism of mine was confirmed, I think, by other October data.\’a0 M2 was up in October by 18.5%, a very high number, and more or less in line with monthly growth over the past four or five months (and at record levels since 2003).\’a0 Bad as this is, it was exceeded by the 22.2% growth in M1 in October (also at or near record levels since 2003). \’a0With M1 growing faster than M2 every month since November of last year, (before than for several years either the two grew at near-identical rates or M2 grew substantially faster) depositors seem to be shifting money into more liquid facilities so causing money velocity to rise.
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Logan Wright, of Stone & McCarthy, in a recent uncirculated report finds even more to worry about in looking at October numbers for the composition of bank portfolios.\’a0 Not only is loan growth at near-record levels on a seasonally adjusted basis (loan growth in October tends to low or even negative, whereas this year it is up by RMB 136 billion), but banking deposits actually declined in October.
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More alarmingly from the perspective of the central bank is the data on banking system deposits, which reveal that absolute levels of overall deposits in the banking system fell on a month-on-month basis for the first time since July 2001. Renminbi deposits in the banking system fell by 449.8 billion yuan, and total deposits fell by 434.2 billion yuan. Renminbi deposit growth fell sharply to 14.9% year-on-year from 16.8% in September and 16.5% in August\’85
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\’85Household deposits are now rising at only a 3.7% rate year-on-year, and these deposits have traditionally been the primary source of banking system liquidity. Interestingly, enterprise deposits, which have been rising much more rapidly in recent years, declined month-on-month as well, by 194.7 billion yuan. Enterprise deposits are still growing at a 22.7% rate year-on-year, and this constitutes the bulk of the growth in banking system deposits throughout 2007, meaning that the banking system is becoming even more dependent upon the profits of Chinese enterprises and the macroeconomy as a whole. We should caution that this is only one month of data, and a somewhat distorted one at that, being October, but the central bank is unlikely to be pleased with the flows of deposits out of the banking system and into the equity market, given its previous statements about the importance of maintaining positive real deposit rates.
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It is hard not to look at all of this and not conclude that the fears that some of us had as far back as 2003 \’96 that China\’92s currency regime was locking it into a monetary trap \’96 were unjustified. \’a0Monetary conditions have played out almost exactly as expected. \’a0In my opinion, as this thing continues to unfold the logic of a maxi-revaluation will only become clearer, but it is probably too late to undo all the damage.
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On Wednesday Zhou Xiaochuan was interviewed by a newspaper published by the PBoC, of which he is the governor, in which he insisted that the PBoC would stabilize inflationary expectations, curb excess liquidity and pull real interest rates out of negative territory.\’a0 One-year deposits at 3.87% and inflation for the past year has three months has been 6.4%. \’a0He also said, probably in reference to October\’92s seasonally high growth in credit, \’93We must implement appropriately tight monetary policies, continue to take comprehensive measures, improve and innovate in policy tools, and appropriately step up macro controls in order to maintain reasonable credit growth.\’94
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I don\’92t want to read to much into these particular tea leaves, but from what Zhou has said and from what I am hearing elsewhere it seems to me that a number of recent issues have caught Zhou\’92s eye. \’a0First, most obviously, CPI inflation is not moderating, and there is reason to fear that it might be spreading.\’a0 Second, the RMB 449.8 billion drop in RMB banking deposits in October may be indicating an acceleration of capital flows into the stock market \’96 in part because of a few very large (and crazily successful) IPOs but also perhaps because of negative real interest rates. \’a0Third, new loans expanded by RMB 136.1 billion in October, which is an historical high for a normally very weak month. \’a0Clearly commercial banks are still eager and able to expand their loan books in spite of several minimum reserve hikes and lots of moral suasion.
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Zhou has already said last week that the first priority of the central bank was to curb inflation and maintain price stability.\’a0 Maintaining employment would take a back seat in monetary policy.\’a0 Xinxin Li of the G7 group has this to say:
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“- The PBoC is inclined to define the current problem as an overall inflation pickup, and the conclusion is it is a monetary phenomenon caused by accumulated effects of external imbalances and money supply growth\’85\’a0
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“- By comparison, the National Development and Reform Commission (NDRC, the economic planning committee) still sees the CPI jump as a supply shock of food and commodities.\’a0 By denying a full-scale inflation, the NDRC may have more flexibility to increase energy and utility prices, which are still heavily subsidized by the government. On November 1, the widespread shortage of diesel and gasoline finally forced the NDRC to increase the refined petroleum price by 10%.
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“- The position of the National Statistics Bureau (NBS), another government agency capable of macroeconomic projection, is closer to the NDRC’s view. It is quite optimistic on the inflation outlook and believes that the CPI will moderate gradually in H1′07.”
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The outcome of this policy disagreement is not at all clear in the short run.\’a0 My guess is that the PBoC needs higher CPI inflation numbers to strengthen its case for speeding RMB appreciation, although another few months of record trade surpluses and increasing anger from the US and Europe may also do the trick.
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