Hot Money And Cold Reality

Hot money, fickle by nature, may be turning its back on China. Figures showing that banks were net sellers of foreign currency in October for the first time since May last year suggest just that. They sold 24.9 billion yuan ($3.9 billion) worth in October versus buying 247.3 billion yuan worth in September. Reasons could be various: dollar flight in the face of the euro crisis; cooling property prices; expectations of near-term yuan appreciation evaporating. Be cautious, beyond our usual one month’s figures warning, of taking the numbers as a bearish sign for the economy that might turn the current “fine tuning” of monetary policy into something looser. The central bank says that credit is abundant and inflation remains relatively high.

Footnote: The central bank’s comments came after it broadened its M2 definition of the money supply, effectively bringing in the banks’ off-balance sheet lending, implicitly acknowledging that the old measure underestimated the money supply, and made it an unreliable benchmark of whether monetary policy was being effective.

China’s Inflation Peaks On A High Plateau

With our usual caveat about not relying on one month’s data, China’s inflation seems to have peaked with August’s consumer price inflation (CPI) coming in at 6.2% year-on-year, against July’s 6.5%. The number is considerably higher than target so getting it down further remains policymakers’ priority. August’s CPI figure was driven by food prices, up 13.8%, and contributing 4 percentage points to the headline number, officials say. Stripping that out would put inflation below target, which is making some think that there won’t be a further round of interest-rate rises as food prices aren’t overly susceptible to monetary policy. However, food prices are remaining stubbornly high and this Bystander suspects that the CPI underreports other prices rises that affect the politically sensitive cost of living. Thus another gentle twist of the monetary ratchet is likely before year’s end.

China And America In 2030; Which Will Be Ready First?

Compare and contrast. This weekend, in Washington, President Barack Obama and his advisors will have been putting last-minute touches to a speech he is to make later this week about dealing with unemployment in the U.S. Their preoccupation would not have been with the long-term structural changes the U.S. economy needs but with the finer calculations of the politics of what can be got through a recalcitrant and divided U.S. Congress barely a year out from elections. Meanwhile, in Beijing, policy makers have spent the weekend in conclave with outside experts, including those from the World Bank, to consider what China’s economy will need to look like in 2030.

Writing in the Financial Times, Robert Zoellick, president of the World Bank, previewed that meeting and the ‘the big questions” China has to answer:

The drivers of China’s meteoric rise are waning: resources have largely shifted from agriculture to industry; as the labour force shrinks and the population ages, there are fewer workers to support retirees; productivity increases are declining, partly because the economy is exhausting gains from the transfer of basic production methods. Then there are other challenges, including serious environmental degradation; rising inequality; heavy use of energy and production of carbon; an underdeveloped service sector and an over-reliance on foreign markets.

While that is well known, including to the Party’s leaders, “without fundamental structural changes, China is in danger of becoming caught in a “middle income trap”. Zoellick says, adding that “China’s policymakers are well aware of “what” they need to do…Their challenge now is “how” to do it.”

A critical question is how China can complete its transition to a market economy. A broad agenda needs to include redefining the role of the government and the rule of law, expanding the private sector, promoting competition, and deepening reforms in the land, labour, and financial markets.

China has three five-year plans after the current one ends in 2015 to implement the how. Not that it will be easy or painless. Not only will those changes have to be navigated through the current leadership transition, they will also have to go through another one in a decade’s time. But the constant through that is the Party’s need to survive as China’s paramount ruler.  There is no guarantee that China will be able to pull off the transition. While countries like Japan and South Korea have undergone a similar process of transformation from developing to developed economy, the political primacy of their governing institutions has not escaped unscathed. No country that has avoiding the middle income trap has yet done so without making its political institutions more transparent and accountable to it population.

As we noted before in a post on the middle-income trap, if the Party’s legitimacy to monopolistic rule depends on continuing to deliver the economic growth that keeps its citizens getting richer and it is right that China’s economic growth cannot continue beyond a certain point without institutional reform, then managing the role of government in the economy and overcoming state-owned vested interests — in other words reforming itself — becomes China’s policy planners most important concern.

America, too, is, arguably, a generation ahead in this process, trying to deal with what we could call the high income trap, trying to overcome the results of the profligacy that comes with the assumption that good times continue for ever, an assumption that has been brought up short by the current sluggish growth in the U.S. economy.

The lessons of the last two devastating economic downturns in the U.S. that preceded its current  Great Recession — the Long Depression of the 1870s and the Great Depression of the 1930s — is that when prosperity returned it, first took a long time to come back and, second, looked different from what it was before.  Both China and America should be looking at what their economy’s will need to be like in 15-20 years time. On the evidence of this weekend, only China seems to be doing so. Compare and contrast.

China’s Financial Reform On Hold

The report on China’s economy prepared by the IMF as part of its annual bilateral discussions with Beijing highlights the importance of advancing financial reform in the cause of rebalancing the economy.

Financial reform holds significant promise in contributing to the needed transformation of the Chinese economy. Over the horizon of the 12th Five-Year Plan, reforms should seek to secure a more modern framework for monetary management, improve supervision and regulation, deepen the channels for financial intermediation, transition to market-determined deposit and loan rates, and open the capital account. In all of this, a stronger renminbi will be an important complement.

Financial reform alone isn’t sufficient for rebalancing the economy in the IMF’s view. There will also need to be a stronger social safety net, higher household incomes and increases in the costs of various factors of production–i.e. an unwinding of price-distorting subsidies to things like energy. But the need for financial liberalization is pressing.

[The] potential combination—of rising inflationary pressures, already-high prices in the property market, and a weakening of direct monetary control—poses significant risks to financial and macroeconomic stability. In addition, the current system for financial intermediation continues to hold back rebalancing and the development of the service sector, generating industrial overcapacity that could present negative implications for long-run growth prospects.

China’s economy has become complex. Further financial liberalization will have to advance on a wide front: appreciating the currency, absorbing liquidity and strengthening monetary management, improving regulation and supervision, developing financial markets and products, particularly in fixed-income to help develop institutional investors, liberalizing interest rates and, once more market-based macroeconomic policymaking is in place, easing controls on capital flows.

The new five-year plan is broadly aligned with these needs. The question will be how far and how fast the reformers can push. Policymaking on this, and most other fronts, is now in stasis because of the leadership transition. There will always be economically delicate and politically difficult trade-offs between growth, inflation, financial stability and structural liberalization of the economy. Tackling inflation is the short-term political priority for economic policymakers, and absent a property or bank-credit crisis, there won’t be much political appetite for tackling financial reform until the factional jockeying for position within the Party’s new leadership calms down. That won’t happen for at least a couple of years, by which time the five-year plan will be deep into its second half, and the financial sector, we suspect, not look a lot different from what it is today.

China To Raise Inflation, Lower Money Supply Growth Targets For 2011

The recently concluded annual economic policy meeting set a growth goal of 8% for 2011 with the inflation target raised to 4% from 2010’s 3% and new bank lending to be held at 7.5 trillion yuan ($1.1 billion), according to local press reports quoting authoritative sources. The broad money supply (M2) is set for 16% growth, a slowing from the 19.5% rate it is running at this year, as monetary policy continues to be gently tightened to tackle inflation. All in all, a modest application of the liquidity sponge, and one which suggests a growth rate target of 8% looks unrealistically low.

Other headline goals for 2011 include creating more than 9 million new urban jobs, keeping the official unemployment rate below 4% and extending the incentives for new appliance sales in the countryside emphasizing the tilt towards social goals, income equality and more domestic consumption that are priorities in the new five-year plan that starts next year.

 

Manufacturing’s Robustness Allows More Interest-Rate Hikes

Not unsurprisingly, it looks as if the food price controls introduced last month won’t have much impact on November’s inflation figures, due to be released in the middle of this month. The consensus view is that consumer price inflation number will come in at approaching 5%, up from October’s 4.4%, itself the highest level for more than two years and way above the 3% target for the year.

High food prices are the symptom not source of China’s inflation. As we and many others have noted the excess liquidity slopping about the system is the underlying cause. Hence two reserve-ratio increases for lenders last month and increasing constrictions on new loans, particularly for the bubbly property market, as policymakers strive to rein in the money supply.

The central bank raised its benchmark interest rates in October, the first rise since 2007. The increasing pace of manufacturing output’s increase, up in November for the fourth consecutive month as measured by the Purchasing Managers’ Index, suggests the economy is growing robustly enough to take in its stride the further rise in interest rates that we believe is inevitable before the end of the month — and, dare we even think it, a rise in the value of the yuan, the only inflation-fighting tool that the central bank has barely touched.