Posted on Friday, November 16th, 2007
By bsetser
Michael Pettis
Two related stories in today’s Financial Times point out one of the most worrying economic risks facing the world today. The first is a report by China’s National Bureau of Statistics that fixed asset investment (FAI) in urban areas was up 26.9% (to RMB 8.9 trillion) during the first 10 months of the year compared with the same period last year. This is the highest it has been in over a year. Market expectations were for an already high 26.3%, in line with last month’s figure of 26.4%.
In an entry on my own blog yesterday I pointed out that the slowing down of the growth of industrial production (it was up 17.9%, versus 18.9% in October) was one of the few good numbers that had come out in recent months because rising industrial production is what powers growth in the trade surplus, and China desperately needed to bring the trade surplus down. Although most economists were expecting continued moderation in the industrial production growth rate, I was (surprise!) less optimistic because September’s number had been so high and October’s trade surplus was at a record level, so it seemed to me that the dynamics driving this money-creating machine were stronger than ever.
The very high FAI numbers deepens my concern. All of this investment is likely to increase production, and if Chinese consumption does not keep pace (and it seems that it cannot), the excess must increase the country’s trade surplus and so its money growth.
The second article in the Financial Times has the headline “US slowdown threatens Chinese export growth”. It reports that China’s commerce ministry has warned that a slowdown in the US economy could create a sharp enough drop in China’s exports to create what they called a “turning point” for economic growth.
According to the article the PBoC estimates that every 1% drop in US GDP growth would be accompanied by a 6% drop in Chinese export growth – scary indeed, given that exports account for one-third of Chinese growth, and are probably the healthiest part of that growth. Of course this might just be the typical Chinese posturing before a series of important meetings (with Secretary Paulson and with President Sarkozy) later this month in which the currency is sure to come up, but perhaps it is also true.
I think I am less pessimistic than most about a sharp slowdown in the US economy, but I confess to being well out of my depths and I recognize that my expectations come with a very wide standard deviation. The question is what happens if we have both furious Chinese investment and a stalling US economy. High levels of Chinese investment will lead to high levels of industrial production.
Read the rest of this entry »
Posted in China | 50 Comments »
Posted on Thursday, November 15th, 2007
By bsetser
Note: This is Brad Setser, not Michael Pettis.
The UAE is clearly considering changing from a dollar peg to a basket peg. Qatar may be as well. The economic case for change is quite clear. Both countries are in the midst of an enormous boom and face large inflationary pressures. Yet their currencies are depreciating and their central banks are under pressure to cut their nominal interest rates to match the Fed. Neither benefits from importing US monetary policy right now.
Indeed, now that the UAE's governor has indicated that change is possible, I suspect the market will force his hand. The UAE's capital account is pretty open. Its capacity to sterilize large scale inflows is limited. Large inflows have already forced interest rates in the UAE down — the last thing a country facing large-scale inflationary pressures needs. The dhirham is even more of a one-way bet than it used to be.
Just shifting away from a basket peg, though, hardly solves the UAE's problem. The Gulf currencies have already depreciated substantially in nominal terms against many of their major trading partners. The GCC currencies, for example, have depreciated by over 40% against most European currencies over the last five years. Shifting to a dollar peg now doesn't correct for the dollar's past fall. It just insulates the GCC currencies against further falls in the dollar.
And if Stephen Jen is right and the dollar is poised for a rebound against the euro next, a basket peg would keep the GCC currencies from rising along with the dollar.
That is why Standard Chartered — among others — is calling for a large revaluation of the GCC currencies, and a much broader reassessment of their currency regimes. I agree — see my new Peterson institute paper on this topic (more on it later)
Macro man argues, with characteristic force, that dollar pegs are inappropriate for countries with large current account surpluses and high inflation.
Read the rest of this entry »
Posted in Exchange Rate | 20 Comments »
Posted on Tuesday, November 13th, 2007
By bsetser
Michael Pettis
Finally the November CPI numbers for China are in. I said I would try to write about other things besides China, but here I am, my third post on Brad's blog, and still nothing but China. I apologize, but there are so many interesting things happening here that it is hard to get excited by the rest of the world.
China’s CPI was up 6.5% in October, up from 6.2% in September. 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. 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 own blog to see why I think October inflation may actually be over 7 %.) 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.
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. For 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%.
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. 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). Food 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’t fully take into account the 8-10% increase in gasoline and diesel prices that was passed late last month.
There is a lot of disagreement on where this will go. 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. In explaining their forecast, Goldman said to its clients in a note today that “We 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.”
Read the rest of this entry »
Posted in China | 95 Comments »
Posted on Monday, November 12th, 2007
By bsetser
Note: This is Brad Setser, not Michael Pettis. Mr. Pettis will be doing most of the heavy lifting for the remainder of this week as well.
Last week was rather interesting.
Gisele Bundchen was all over the financial pages and not entirely — as the FT's Chrystia Freeland notes — because of her currency trading powers. Gisele doesn't just work for euros either; her manager notes that she is also happy to be paid in Brazilian reais.
"It's false that she only takes euros,'' Patricia Bundchen said in a phone interview on Nov. 7 from Porto Alegre, Brazil. “It's a Brazilian contract, in reais,'' she said … That's turned out to be the better choice. The real has risen 21 percent against the dollar this year, while the euro gained 10.4 percent."
Maybe she accepts RMB too.
The People's Bank of China has no choice but to take dollars in the market. The RMB/ dollar only clears because of the PBoC buys a lot of a dollars every single trading day. But it doesn't necessarily have to hold on to the dollars it buys.
The Vice-Chair of the Standing Committee of the People's Congress, Cheng Siwei, clearly doesn’t manage China’s reserves. It still isn’t entirely clear whether he was just speaking out (as a number of analysts note he has done the past), or whether he was speaking out with the tacit approval of China’s leadership. However, wasn't the only official (or former official) in China calling for China to buy strengthening not weakening currencies. Tang Shuangning seems to be thinking along similar lines.
While Cheng Siwei no longer believes in the strong dollar, French President Nicholas Sarkozy certainly does. Indeed, he may want a strong dollar rather more than Hank Paulson or Ben Bernanke.
The French President seems to want the US to take steps (keep interest rates on hold?) to support the dollar. Or perhaps he really wants the ECB to avoid taking steps (keep interest rates on hold?) that might produce an-even-stronger Euro. Read the rest of this entry »
Posted in Exchange Rate | 25 Comments »
Posted on Sunday, November 11th, 2007
By bsetser
michael pettis
As was widely anticipated, on Saturday the PBoC raised the minimum reserve requirement for Chinese banks by 50 basis points to 13.5%. This is the ninth increase this year and I think at current levels the minimum reserve requirement is the highest it has even been in PRC history. This increase is expected to take RMB 190 billion (or $26 billion) out of the banking system – equivalent to about half a percent of total deposits (RMB 38.3 trillion), and substantially less than one month’s increase in foreign reserves (running at about $35 billion per month).
Many analysts expect that if inflation numbers remain high the PBoC will be forced to raise interest rates again. I think this will probably happen, but I also think there are many constraints on the PBoC’s ability to keep raising them, and these are going to get worse, not better. Apparently a number of state-owned enterprises (SOEs) have started complaining that with rates having jumped 117 basis points this year, financing costs are up roughly 20%, and these SOEs may be putting pressure on the NDRC to ease up on interest rate hikes (the PBoC cannot set interest rates independently but must get approval from the State Council).
Although it is true that rising inflation undermines the real cost of the rate increase over the full life of the loans, increasing interest rates will nonetheless have the same cashflow effect as accelerating principle payments, and rising rates are straining cashflow for some of the less healthy SOEs.
I also heard this weekend from traders that concerns are rising that increasing interest rates are putting a lot of pressure on mortgage borrowers. I haven’t seen figures, and anyway the accounting is notoriously unreliable – it is widely believed that information provided on loan documents is “exaggerated” —but apparently one of the consequences of rising real estate prices may have been that in the past Chinese home-buyers have taken out mortgages whose servicing costs are as much as twice as high as a share of household income than is normally deemed prudent (roughly 25%). This may not be as a bad thing as it sounds because Chinese do save at very high levels, but most, if not all, of the mortgages in China are adjustable-rate mortgages, and so increasing interest rates by 20% this year must have been painful, and may be squeezing a lot of homeowners. This is not a new story, by the way, but perhaps the sub-prime crisis in the US has made people more sensitive to problems in the Chinese mortgage market.
As an aside, two weeks ago one of my Peking University students told me that in another finance class a student had asked the professor if China has sub-prime mortgages, and the professor replied the in China all mortgages are sub-prime. He got a big laugh. He is exaggerating, of course, but it is not hard to hear some pretty hair-raising stories.
Read the rest of this entry »
Posted in China | 28 Comments »
Posted on Wednesday, November 7th, 2007
By bsetser
michael pettis
Wednesday’s South China Morning Post reports that Cheng Siwei, vice-chairman of the Chinese People’s Political Consultative Conference, parliament’s top advisory body, said that Beijing needed to dampen international expectations that the RMB would keep rising. As many of you will remember, in the same speech he caused a global stir when he said that China should “balance” its reserves between the euro and the dollar. Cheng does not really have any control over financial policy and it is obvious that he doesn't understand what are the economic implications for China if they were to "balance" dollars and euros (for one thing, exports to the US would collpase), but I am more interested in his comments on RMB appreciaition because they indicate what at least some people in the leadership may be thinking.
According to Cheng, this “mindset” – international expectations that the RMB would keep rising – was more dangerous than a stronger RMB itself. I think I understand why he is saying it, but I also think he underestimates how serious the RMB problem really is (and he can’t seem to resist the Chinese temptation to explain a domestic problem as somehow being caused by the “international” community).
To the extent that his is a common perception within the government, I think the outlook for policy isn’t good. If they believe that the “problem” of the RMB is not the impact of the currency regime on monetary policy but rather that China will be subject to damaging speculative inflows because of “international” perceptions that the RMB must rise, this may lead authorities to focus more on changing those perceptions by introducing volatility to the RMB’s appreciation, rather than adjusting the currency regime.
By the way his comments make me skeptical of claims by some analysts that speculative inflows caused by faster appreciation are not a serious problem.
According to another article in Wednesday’s South China Morning Post:
Read the rest of this entry »
Posted in China | 93 Comments »
Posted on Monday, November 5th, 2007
By bsetser
michael pettis
It’s always a pleasure to be asked to guest-blog for such a much-admired and widely-read blog. In about an hour I will be meeting up with Brad here in lovely smog-free Beijing (sick joke). As usual I have to warn Brad’s regular readers that I am so enthralled by China that sometimes it is hard for me to notice what is going on in the rest of the world unless there is some China angle (although it is getting harder and harder to discuss anything nowadays without there being a China angle), and so my posts are likely to be highly China-centric.
Apologies in advance to those of you who like to read more about the rest of the world. Regular readers of my own blog know that in the past few months concerns about inflation have taken center stage in China. I thought for my first entry I would summarize a little what we know and what we think we know about inflation. In another week or so we are going to get the October CPI numbers for China and that will allow us to calculate inflation for the most recent month. After three months of inflation numbers (6% on average) that significantly exceed the PBoC’s comfort level, everyone is going to be looking very closely to see what the new number may imply about the various issues bedeviling China.
To summarize CPI inflation behavior over the recent past, China’s CPI prices have been fairly stable until recently, rising by 2.8% in 2006. Prices started to trend up in 2007, but not enough to create any alarm. During the first five months of 2007 CPI inflation year-on-year (which tends to smooth out changes) hovered around the PBoC target of 3%, remaining on average under 3%. In June, the year-on-year increase in CPI prices jumped to 4.4%, and then accelerated to 5.6% in July and 6.5% in August, before “moderating” to 6.2% in September. For the first nine months of the year average CPI inflation has been 4.1%, well above the PBoC’s 3% target.
Much of the recent inflation has been blamed on the sharp increase in the price of food, which comprises about one-third of the total CPI basket, especially of pork, of which China is easily the world’s largest consumer. Excluding cyclical components of the basket, price increases have stayed around 2% or less. According to the authorities, food prices rose largely because of certain one-time events that created significant shortages – primarily flooding in the south and blue-ear disease among pigs. They insist that these food price increases will reverse themselves over the next few months. In that case what looks like inflation is really a one-off price shock that will soon work its way thought the economy unless it ignites inflationary expectations.
I am not sure I agree with this explanation. My understanding of price increases caused by one-off supply shocks is that the increase in the price of a particular product is not inflationary. As consumers are forced to spend more on that particular good, they divert spending from other goods and so exert downward pressure on the price of those other goods. In a frictionless world, a price increase caused by a sudden or unexpected supply constraint should have zero net impact on inflation because it would be perfectly matched by deflation in other goods. This seems to be what happened in Hong Kong. The big rise in food prices in Hong Kong over the past few months was met by a drop in the price of most other goods, so that overall inflation has been very low (well under 2%). Hong Kong may not be a great comparison because food comprises a much smaller share of the CPI basket, but the point is that one-off supply shocks are not automatically inflationary.
Of course we do not live in a frictionless world, and so it may be possible for a significant price rise in an important good to cause a temporary net increase in average prices, but I would imagine that the main source of friction might be downward price-stickiness cause by some kind of money illusion. If that is the case, we might not expect a big rise in Chinese food prices to cause a sufficient decline in non-food prices to counterbalance it, but at the very least if the prices of non-food items were anyway rising too, the rate of increase would decline.
Read the rest of this entry »
Posted in China | 102 Comments »
Posted on Sunday, November 4th, 2007
By bsetser
I'll be on the road for most of the next two weeks, making stops in Beijing and Tokyo. I hope to chime in occasionally. I will be working, not vacationing. But I also will have trouble posting as frequently as I normally do.
Fortunately, I was able to convince emerging markets/ China guru Michael Pettis (of Peking Universitry and the blog China financial markets) to post here on a semi-regular basis here over the next couple of weeks.
In his most recent post, Mr. Pettis notes that the RMB's pace of appreciation picked up last week. That's true, but the rapid appreciation last week came after an extended period when the RMB was stuck at 7.5 even as the dollar was falling.
China basically sat out the dollar's fall in September and October — or rather, it opted to follow the dollar down v. host of currencies. A bit of appreciation against the dollar just undoes some of the RMB's recent depreciation against the euro.
More importantly, as Mr. Pettis notes, expectations of RMB appreciation have picked up. If the market is right and the RMB appreciates by 7% over the next year, simple Chinese bank deposits look mighty attractive. Pettis:
If market assumptions are correct and the RMB does begin to appreciate at 7.3%, with bank deposits yielding 3.8% you can earn 11.4% in US dollars if you can smuggle money into China and deposit it in a bank. Even the most intrepid of my hedge fund friends in New York wouldn’t sniff at those kinds of returns, especially since the biggest risk is upside risk – a sudden maxi-revaluation. There’s the problem – an obvious danger of speeding up the appreciation rate is that it might set off another wave of speculative inflows, thus pushing monetary conditions even more out of whack.
Read the rest of this entry »
Posted in China | 46 Comments »
Posted on Saturday, November 3rd, 2007
By bsetser
Bloomberg’s Matthew Lynn argues that those countries now fretting about the impact of sovereign wealth funds didn’t complain when sovereign governments bought huge quantities of bonds:
Nobody minded when emerging economies recycled all those dollars, pounds and euros by putting cash on deposit in our banks, or buying bonds issued by our governments. So why should we mind when they start buying companies?
Lynn continues:
"If we don't like them purchasing our equities, shouldn't we tell them to stop buying our bonds and currencies as well? "
But isn't that pretty much the US position? The US, and notably the US Congress, is calling for more exchange rate flexibility in China even though that should mean that China buys fewer dollars and fewer dollar-denominated bonds. Remember, it also should mean that China should buy more dollar-denominated goods.
Critics of the “Bretton Woods 2” international financial system have long complained that sovereign demand for bonds masked the impact of large fiscal deficits and low household savings rates, inhibiting a necessary adjustment. They have argued, quite explicitly, that emerging markets should be buying far fewer financial assets.
It consequently, it shouldn't be a surprise that many who thought emerging market central bank demand for US bonds financed too large a US currnent account deficit are less than thrilled by a world where emerging market sovereign wealth fund demand for equities finances equally large deficits.
Read the rest of this entry »
Posted in central bank reserves | 36 Comments »
Posted on Thursday, November 1st, 2007
By bsetser
Some very rough ballpark math:
If the the major oil exporters export around 40 million barrels of oil a day, then every $10 per barrel gap between what the oil exporters spend on imports and what they get on their oil is worth around $150b over the course of the year.
A tiny bit less actually. Call it $145b.
If the oil price stays at $95 a barrel or so over the next year, the oil exporters could spend about $50 a barrel, and still have about $45 a barrel left over to invest in a broad range of assets globally.
If oil exporters are getting $95 a barrel, spending $50 a barrel and saving $45 a barrel, they will have about $650b to invest globally.
That is more than China has to play with. And the fact that China's current account surplus could rise from its 2006 level even with $95 a barrel oil is in some deep sense stunning. The oil exporting economies also have far fewer people than China. Even counting Nigeria.
If the oil exporters attract additional (net) private capital inflows, official asset accumulation in the major oil exporting economies could be even bigger.
And remember, this all assumes that the oil exporters will ramp up spending on imports so that they need $50 a barrel oil to cover their import bill. Not so long ago, any oil exporter that needed $20 a barrel oil to cover its import bill was taking a big risk …
This analysis draws on my oil and global adjustment paper from this March. Back then I assumed that the oil price would stabilize at say $60 or $70 a barrel, allowing the (rapidly increasingly) imports of the oil exporting economies to cut into the oil exporters' current account surplus.
Read the rest of this entry »
Posted in oil | 41 Comments »
