By Greg Peel
China released a raft of monthly economic data today which confirmed hopes (or might that be fears?) that China's economy is continuing to accelerate.
Industrial production rose 16.1% year-on-year in October – the fastest growth rate since March 2008 – and retail sales leapt 16.2%. Urban investment has surged 33.1% in the ten months to October.
If it were any other economy, inflation alarm bells would be ringing from every belfry. But while China's consumer price index (CPI) has turned around in recent months from earlier disinflation, October's change remained slightly negative at minus 0.5%. The producer price index fell 5.8% (both numbers year-on-year).
Inflation, it seems, is not yet a worry. But economists now expect China to enjoy 10.5% GDP growth in the fourth quarter (up from 8.9% in the third) and expect Beijing must soon be forced to tighten monetary policy and appreciate the renminbi – measures which dampen economic growth.
Australia does not want China to dampen economic growth.
Inflation may be negative for now, but China's M2 money supply rose 29.4% year-on-year in October, up from a 29.3% rate in September and roughly in line with expectation.
A country's money supply can be loosely defined as the amount of actual cash or immediately obtainable cash floating around in that country's economy. However there are various grades, from M0 (coins and banknotes) to M1 (M0 plus cheque account balances and travellers cheques), M2 (M1 plus savings deposits, money market accounts and overnight repos), and all the way up to M6. For the purposes of forecasting price inflation, economists like to know the amount of M2.
Last year the Chinese government introduced a four trillion renminbi stimulus package which was implemented largely by flooding national and regional banks with cash, drawn from China's vast foreign reserve surplus, and then figuratively beating bank managers with a stick if they didn't on-lend. Infrastructure projects were high priority. The effect of this package was to greatly increase the amount of China's M2 money supply.
DBS Group Research notes China's M2 to GDP ratio hit an abnormally high 1.9 this year, compared to the ten-year average of 1.5. While price stability seems to exist, DBS economist Chris Leung suggests, within a ratio of 1.5 to 1.6, China's average consumer price index (CPI) growth of 1.6% in the period belies what otherwise might be expected as an inflationary fall-out from all that forced lending.
The excess liquidity should eventually lead to price pressure, the analysts believe, but at present inflation has been channelled mostly into asset prices – particularly stocks and property.
Prior to the 1980s, central banks across the globe were expected to control the amount of cash in the local system flowing between official borrowers and lenders, and to keep a lid on any significant currency scares, but not to concern themselves with inflation. Thus when the oil shocks were experienced in the 1970s, central banks allowed CPI inflation rates to bulge well into double digits. The result was a decade of economic recession.
And a lesson learnt.
Since the 1908s, central banks have been given the mandate to manage the balancing act between economic growth and consumer price inflation pressures, and set interest rates accordingly. What central banks still have no mandate to control, however, is asset price inflation which results when funds are too freely available. That is why then Fed chairman Alan Greenspan was happy to keep interest rates low in the mid-noughties while watching the US stock and particularly property markets bubble out of control. Cheap imports of Chinese goods were keeping a lid on consumer price inflation, so a more restrictive monetary policy, in Greenspan's opinion, was unnecessary.
And so we had a GFC.
One of the reasons the pre-GFC bubble was allowed to inflate is because the Chinese renminbi is pegged in a range to the US dollar unlike, for example, the yen. As the flow of goods from China to the US accelerated in the noughties, sending China into a large trade surplus and the US a large trade deficit, a floating renminbi would have appreciated in value, made Chinese imports more expensive, sparked consumer price inflation, forced the Fed to raise interest rates more swiftly, and perhaps a GFC would have been avoided. But as the US dollar fell in value over the decade, the renminbi went with it and the Chinese authorities enacted only a slight official appreciation of the currency. To allow more rapid appreciation would be to derail the Chinese economic miracle.
In a sense, we're now back in 2004. Chinese GDP growth is expected to exceed 10% in 2010, Chinese demand is pushing up commodity prices again, and China's stock and property markets are also bubbling again. For China, the GFC was just an annoying blip. But this time things are different, because China's economic growth is not being fuelled by fresh export receipts – exports are still way down from 2007 levels – but by existing export receipts. China is now living off capital, and not off America.
In the meantime, Alan Greenspan was last night endorsing his successor's similar low interest rate policy and pointing to improving US stock prices and stabilising housing prices as a measure of success. It's hard not to think the words "here we go again" are not applicable. But across the Pacific, RBA governor Glenn Stevens has become increasingly public about his asset price inflation fears, particularly with regard to the Australian housing market, and hinted that the two interest rate rises we've had to date are as much about preventing a runaway housing bubble as they are about getting in ahead of consumer price inflation fuelled by economic recovery.
Indeed, while Leung notes "central banks do not have the mandate to target asset bubbles given a worldwide lack of consensus towards defining what an asset bubble is," Stevens has admitted that RBA boards have been keeping a wary eye on asset (house) price inflation for years.
The People's Bank of China is new to this game however, and while it has learned all about the potential for runaway consumer price inflation, there is little developed world guidance on what to do about stock and property bubbles. Leung thus suggests the PBoC response to the current situation will be "reactive and timid".
The best the PBoC can do is enact measures that ensure stimulus funding is going into the right places, and not just towards stock and property "gambling".
China is not going to turn off the liquidity spigot anytime soon, because it looks like the policy is working, asset price bubbles aside. Many of the infrastructure projects generated by indirect government funding have multi-year completion dates, and many are being driven by both national and local government support. Funding will need to be maintained until completion, Leung notes, and increasing property values provide the funding to local governments to pass on in such cases. In other words, Chinese liquidity is here to stay for the time being.
Leung expects loan growth in China will reach 30% in 2009, dropping to 20-25% in 2010 before normalising to the 15% ten-year average some time in 2010 and beyond.
China also has to worry about a falling US dollar, which will take a pegged renminbi with it and push up import prices locally, thus also fuelling consumer price inflation. There is little the PBoC can do about the dollar. But Leung notes excess capacity in certain industries such as steel and cement is helping to keep a lid on inflation despite a building boom, and DBS suggests the Chinese CPI will probably rise no further than 3% in 2010. (The RBA would kill for 3%). The manufacturing sector should also help choke inflation given the fall in export demand.
China's other big problem is, however, the potential for runaway food price inflation which has proven problematic in recent years. One cannot control the weather, and one cannot control the US dollar value of grain imports, for example, and food is still the biggest household budget item for China's still mostly poor population. Fortunately, China enjoyed a bumper harvest this (northern) Autumn, meaning food prices should be stable enough for the next 6-9 months.
It is thus Leung's opinion that despite strong economic growth in China (and he was writing ahead of today's data but in anticipation of it) Beijing will not be moving swiftly to tighten policy – at least not until the Fed makes a move, and that seems a long way off at present. Even once the PBoC does begin raising rates it will be in the usual baby steps of 27 basis points per quarter. China's current cash rate is already 5.3%, so it hardly compares to the Fed's zero to 0.25% range or even the RBA's 3.5% at present.
This means that unless Beijing adopts some other form of administrative measures, China's stock and property bubbles have further to expand in the near term. China's growth development model will continue to be investment-led, says Leung, and will have to rely on bank funding unless financial market reforms can be rapidly increased.
"In the foreseeable future," says Leung, "it seems like there is no simple exit strategy for China". China will likely face the constant challenge to rein in inflation in 2010 before the real threat in 2011 and beyond, he suggests.
While Australia will watch with glee as China's economy once again bubbles, it does not want to see a bust. Particularly not in 2011, by which time the GFC hangover is expected to have worn off.
