China vs. inflation: a love-30 match so far
This post is a guest contribution by Dian Chu, market analyst, trader and author of the Economic Forecasts and Opinions blog.
China released a slew of important economic data on the evening of Wednesday, Jan. 19, and markets were paying particular attention to China’s inflation. In order to put out the wild fire of inflation, China’s central bank raised interest rates twice, and increased the reserve ratio for lenders four times in the span of just last two months.
Those tightening measures have prompted great concerns about the major growth engine of the world. Partly on speculation (based on leaked information) that China’s inflation eased last month, emerging market stocks and the MSCI EM index climbed to its highest level in two and a half years just before the official data release.
CPI Eased in Dec … You Say?
China’s National Development and Reform Commission was quick to declare the government’s effort to contain inflation has achieved initial, incremental success. However, instead of a rally, commodities sold off the morning after, and it is fairly easy to understand the market reaction since the official figures seem to defy economic common sense.
An Overheated GDP
First, let’s take a look at GDP, which is closely linked to inflation.
China’s economy surged 10.3% in 2010, and expanded 9.8% in the fourth quarter from a year earlier, faster than the third quarter’s 9.6% growth. Inflation and growth typically comes hand in hand. With an accelerated growth in Q4, it is hard to digest that inflation actually went the opposite direction last month.
Food Price Bites
CPI Out of Sync
So, in order to arrive at the final number of 3.3% overall inflation in 2010, the other two thirds of the CPI basket needs to yield a below 1.4% year-over-year increase.
It is a challenge, to say the least, finding things that consumers typically buy with such moderate price increase–particularly in China–within this environment of QE excess liquidity, where every commodity seems to be hitting new highs every day.
So, again, the 3.3% or the 4.6% CPI seems totally inconsistent with the undercurrents, which makes me suspect the real consumer inflaiton could be running as high as 6-7%… or more.
PPI = More Inflation Pain
Lavish Lending Continues in 2011
And contrary to the claim that the government anti-inflation measures are having its intended effect, the fact that China’s four biggest State-owned commercial banks issued $240 billion Yuan new loan in just the first ten days of January has proven Beijing is fighting a losing battle.
A Looming Banking Criss?
This move will soak up some liquidity–up to CYN 324 billion–due to new higher reserve requirement, which is 19.5% for some of the biggest banks. But it could also bring about some kind of a banking crisis.
Bigger banks most likely are sufficiently funded as some of them already went to the market last year, partly in anticipation of such a move by the central government. Smaller banks, on the other hand, may have funding difficulties. As such, the Chinese banking sector could become the unwilling victim in the fight against inflation.
We Mean [Inflation] Business
However, Beijing most likely will come to grip very soon that eventually somebody got to pay somewhere, and there’s just no way around it, and that the time has come for some decisive actions with a combination of more aggressive monetary, fiscal and regulatory measures to show it really means business.
Moneary & Fiscal
Fiscal policies such as taxes, and financial regulations and restrictions on speculative activities could be necessary.
A Currency Devaluation … Perhaps?
There many more things that China has to do to get the inflaiton situation under control, which most likely will send shock waves throughout global markets.
Social Unrest Could Make or Break A Party
Chinese Premier Wen Jiabao was confronted with questions about inflation from callers during a visit to China National Radio in late December. Although he reassured the public about the government’s ability to control inflation, it is nonetheless an early sign of social unrest and instability.
I believe if China stays on its current “prudent course”, the real consumer inflation could hit double digit by early next year. Inflation and widening wealth gap helped the Communist Party seize power from the KMT back in 1949. The same force could also break the ruling party some 60 years after.
A slowdown now or a crash later … for global financial markets, neither offers a real happy ending.
Source: Dian Chu, Economic Forecasts and Opinions, January 23, 2011.
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