My Blog

August 11, 2008

Yesterday I suggested that July’s PPI inflation might be a little higher than June’s already-high 8.8%.  Most other analysts seemed to agree with me, with the median estimate according to Bloomberg at 9.0%.

The actual number, which was released today by the National Bureau of Statistics, was a bit of a shocker.  PPI inflation in July rose to 10.0%.  Raw material, fuel and power were the biggest reasons for the jump in prices which, according to an article in the South China Morning Post, is the highest year-on-year PPI number since 1995’s 14.9%.  Much of the increase can be blamed on rising global commodity prices, which seem to have turned around a little recently, but with continued high prices internationally and shortages domestically, there is a risk that producers will eventually be forced to pass higher prices onto consumers.  

CPI inflation numbers are expected to come out tomorrow and I think most of us still think they will be substantially lower than last month’s 7.1%.  My expectation has been that we would see moderate CPI inflation for the next couple of months before it picked up again towards the end of the year.  The moderation would give further ammunition to those policy-makers more worried about slowing economic growth then about the consequences of unabated money expansion, and I assumed that their current dominance in the policy-making debate would only be strengthened, until inflation reared again late in the year, causing the balance of power to shift once again to the monetary alarmists.

But this PPI number may make up for a declining CPI in its effect on the policy debate.  It is very clearly a warning signal that inflation has not disappeared, although falling commodity prices world-wide may relieve some of the PPI pressure in the coming months.  As an aside, I have heard several times recently that a very senior policy-maker who has lost a lot o credibility in the last year, a leader of the monetary camp, was going to lose his post in a post-Olympics shuffle (I don’t want to mention who he is because it could get me into trouble, but I suspect a lot of readers know who I mean).

China’s trade surplus for July, also released today, came in a lot higher than expected.  Here is Xinhua’s report:

China's trade surplus fell to 123.72 billion U.S. dollars in the first seven months, down 13.1 billion U.S. dollars, or 9.6 percent year on year, the General Administration of Customs said on Monday.  Analysts said the fall was partly a result of China's policies to tame surplus, but was also in part due to the rising prices in energy and resources China imported.

The Jan.-July exports had increased 22.6 percent year-on-year to 802.91 billion U.S. dollars, however, imports rose 31.1 percent to 679.2 billion U.S. dollars.  The total trade volume in the first seven months stood at 1.4821 trillion U.S. dollars, a year-on-year rise of 26.4 percent.  

July's trade volume rose 29.8 percent to 248.07 billion U.S. dollars with exports totaling 136.68 U.S. dollars, up 26.9 percent. Imports were up 33.7 percent to 111.4 billion U.S. dollars. The July trade surplus stood at 25.28 billion U.S. dollars.

The trade surplus for July of $25.3 billion, versus $24.4 billion last July, was much higher than the $20.3 billion median estimate (also much higher than June’s $21.3 billion).  On Friday a Bloomberg article titled “China Trade Surplus Likely to Narrow for Fourth Month” had the 17 economists it surveyed predict that exports in July would climb “only” 16.8% year on year.  In fact the National Bureau of Statistics release recorded a 26.9% year-on-year increase in exports, a big increase over June’s 17.6% gain.  

These kinds of numbers would seem to strengthen the skepticism that analysts like CFE’s Brad Setser have expressed over the story of China’s collapsing export sector.  Given the slowdown in the world economy I would have thought that a 16.8% jump in exports, if the pessimistic expectations of most analysts had turned out to be true, would have nonetheless been pretty impressive,  In fact I think the woes of a small but powerful segment of the export industry – low-value-added processors in the south of China, who have been hit primarily by rising wages and a welcome shift in the southern economies towards higher-value-added goods and services – have created a false impression about dire conditions for China’s exporters.  For such a large exporter to see its exports grow so rapidly, and during a global slump, does not suggest to me an export industry in its death throes.

The good trade numbers and the bad PPI numbers (which will hurt corporate profitability), combined with more worries about political instability in Xinjiang province, had a terrible effect on the country’s stock markets.  Declining international fuel prices and a strong market in Hong Kong were not able to alter the gloomy mood on the mainland.  After dropping 4.5% Friday – mostly at the end of the day on panic selling – the market opened down today, bounced around during the morning session, and then all but collapsed during the afternoon.  The SSE Composite lost 136 points to close at 2469, 5.2% down for the day.  That’s nearly 10% in two days, and it would have been worse if some companies today had not hit their 10% limit and stopped trading.

When almost exactly one month ago the SSE Composite finally broke 3000, the level below which it was believed the government wouldn’t allow the market to fall, it lost ground pretty swiftly (down 17.7% in the next month).  Rumors quickly emerged that the new minimum level at which the government would support the market was 2300.  I have already written several times about how damaging these perceptions of a minimum government-intervention level can be, but I would guess that Friday’s and Monday’s drops have already set alarm bells ringing in the offices of financial policy-makers.  If investors don’t see anything being done to stop the slide, after a short rebound tomorrow we could easily see the market test 2300 before the end of the Olympics.

Comments (7) for "PPI inflation and the trade ...

It seems that the Chinese economy is reaching its bottle-necks, producing ever more nominal growth, and ever less real growth. A downturn will be needed to reallocate resources in the economy. I guess that the trade-balance will deteriorate significantly and that Chinese currency reserves are falling (at least measured in USD). By Stefan, Tallinn - 8/10/2008 5:38 PM

It seems in such a speculative market in China, rumors are very easy to become widespread and infectious among investors, and most of these rumors has nothing or little to do with fundermentals. What's more, chinese individual investors always relies more on these rumors rather than fundermental analysis, which makes these rumors much pore powerful. However, it's not difficult to find out that, in most of the time, these rumors turned out to be not true, and the market never moved like what the rumors said before. This phenomenon really makes me to doubt where these rumors are coming from, and it may be reasonable for people to suspect that some of these rumors are pruduced by someone purposely. It is also ironic that the investors in China seems to have a poor memory that, given a lot of fake rumors in the past, they always go to embrace new rumors without even thinking of the past experience... In addition, fundermental investors may be hard to introduced into this market, since a market full of speculators may be very volatile and inefficient. However, a certain number of fundermentalists are absolutely necessary for this market. Given the current investors base and circumtances of chinese market, it may really take a long time to get rid of the speculation atmosphere in this market. By Bing - 8/11/2008 12:02 AM

Just more of the same: Americans hammered by falling wages, outsourcing, and high debt, which China stays on its tear to become the world's manufacturer, aided and abetted by American MNC's. How foul is American democracy, that it does a worse job of defending America's jobs than China's dictatorship does of defending Chinese jobs. Bush & Co. tiptoe around the currency peg, lest they ruffle the feathers of the Chinese, Americans be d*mned. By dissent - 8/11/2008 4:18 AM

Professor, I just have a hard time believing the trade numbers. At this point the G3 economies are all reporting year-on-year declines in real retail sales. How is it possible that an economy so dependent on exports of consumer products experiences barely a hint of a slowdown in export growth? The reported month-on-month increase in exports was US$15.5 billion. Given the scale of suspected hot money flows, isn't it conceivable that a good portion of the increase was a result of speculative inflows disguised as trade? The recently announced measures targeting this type of false invoicing makes me suspect that the Chinese authorities know something we don't about the scale of these inflows. By Richard Warfield - 8/11/2008 8:59 AM

Richard, that question is one I have been wondering about too. One possibility, as you suggest, is that export growth is overstated because there is a lot of hot money buried in the export numers, although hot money should have also entered via the underinvoicing of imports, and yet they surged even more. Another possibility is that other exporting countries are bearing more than 100% of the decline in global demand as they get squeezed out by China. Unfortunately given the opacity of Chinese numbers and the difficulties in getting good figures, we can only guess at what is going on. One thing, however, is certain. However the money comes in, it must be monetized by the PBoC. Large inflows are a problem for the domestic financial system whether they are trade-related or speculative, although obviously hot money inflows are more pro-cyclical and hence more destabilizing. By Michael Pettis - 8/11/2008 11:41 AM

Bing, I agree with your pessimism. For six years I have argued that none of the measures introduced to improve the functioning of the markets were likely to work, and for six years, in spite of all the positive spin, there is no evidence that the market has become any less speculative or inefficient. The authorities are not addressing the fundamental problem, which is, I think, that the lack of the necessary tools and institutional structures -- including consistent and reliable data, a stable regulatory framework, and a clear corporate governance structure -- to allow the development of a fundamental investor base. On the other hand the market has an over-abundance of factors that encourage speculative behavior, not the least of which is the constant intervention by government authorities to force markets to reflect political objectives. By Michael Pettis - 8/11/2008 11:48 AM

Professor, Certainly all the inflows need to be monetized, whether hot or not. My concern is that the hot money flows are muddying the data at a critical juncture for the economy, when policy is highly data-dependent. I am curious, if you expected a sharp deterioration in the foreign trade sector of the Chinese economy, would you then agree that the authorities should put monetary policy on hold (or even loosen up) rather than tightening? To me the right answer hinges on three questions: 1) Would a deterioration in the external sector cause a substantial growth slowdown in the Chinese economy as a whole? 2) Would such a slowdown relieve inflation pressure? 3) Would the combination of (1) and (2), combined with a clear intention from China to stop the appreciation of the RMB, halt the hot money inflows? I suspect the Chinese government attaches a high probability of truth to all three of these statements. Thus, the right path for monetary policy hinges critically on the question of what effect the external slowdown is having on China, but hot money flows are making it difficult to get a read on both the domestic and external economy. So monetary policy is on hold. (on the other hand I think it's just possible that RMB appreciation has stopped and 6.86 is the new 8.28, if only because both are lucky numbers in Chinese) By Richard Warfield - 8/12/2008 7:08 AM