Gaming China

Man oh man. The "Macro Man absent from his office" trick worked once again, as financial markets performed more gyrations than a gold medal-winning gymnast on Monday and Tuesday. Those who chased the price action such as, alas, Macro Man's carry basket model, have no doubt rued their impetuosity, as the volatility has proved sufficient to enable one to lock in a tasty loss by selling weakness and getting squeezed into covering.

And really, we're none the wiser, as the S&P 500's bum-clenching round trip over the past few days has occurred on realtively no news. All the more reason, then, to try and keep one's head and avoid over-trading.

There has, on the other hand, been a raft of key data released in China this week, and the developments are sufficiently curious as to inspire Macro Man to devise a simple game for the pleasure of his readers. Hearkening back to the old Sesame Street song, which of the following developments is not like the others; which of the following just doesn't belong? Answers on a postcard addressed to Macro Man Towers (or at least via the comments section!)

1) China's CPI inflation registers 6.5% in October, the joint highest level in more than a decade. Macro Man's jaw continues to drop at the number of commentators who appear willing to blame the rise in CPI on one-off factors, such as the blue ear disease that has driven up pork prices. Non-food CPI remains well-contained at 1.1%, the argument goes, so there's no real reason to worry about the medium term inflation trend.

Riiiggghhhhtttt. While it's true that food inflation has been extremely high at 17.6%, it would appear to be inaccurate to lay the blame solely at the door of temporary factors such as the porcine malady noted above. True, pork prices are up 54.9% y/y, and Macro Man is happy to put that down to temporary distortions. But how in the world does blue ear disease drive up the price of eggs by 14.3% y/y? The price of fish by 7% y/y? The price of vegetables by 29.9% y/y? Any farm-working readers should feel free to chime in. More to the point, if Chinese food inflation isn't a durable phenomenon, why has the delta of inflation been virtually identical to food inflation in the US over the past several years (see chart below)?
Moreover, the non-food pricing looks decidedly dodgy. The "vehicle fuel" component of CPI is down 1.4% y/y. Now, maybe petrol prices really have fallen in China, unlike anywhere else on planet Earth. Of course, that's difficult to marry with the stories on multi-hour queues and fuel rationing at petrol stations. While there may be distortions to Chinese CPI, it would appear more likely that they are depressing rather than elevating the true level of consumer price inflation- the recent 10% rise in administered energy prices looks like nowhere near enough to replicate a market equilbrium price. In Macro Man's view, inflation remains a very real problem for China.

2) A record trade surplus. Yes, October's trade surplus fell short of market expectations. But it still registered a whopping $27.1 billion. Perhaps the growth in trade is showing signs of deceleration, but if so that only represents the achievement of the policy preferences spelled out by the regime. In any event, it's still a bloody big number....and it's growing.
3) M1 growth of 22.1% y/y in October; M2 growth rose to 18.5%. Chinese money growth remains very robust, exceeding both expectations and the PBOC's target levels. The reason isn't particularly difficult to understand; PBOC is intervening heavily in the FX market but only partially sterilizing the proceeds, thus leading to a net "printing" of RMB in the process. Given growth and inflation in China, it's small wonder that banks are not terribly thrilled about parking their money in sterilization bills yielding peanuts, particularly as their deposit bases are beginning to contract. Perhaps that is how the stock market bubble will finally feed therough into macroeconomic policymaking; if banks' deposit bases continue to shrink, then it will make it very difficult indeed to force banks to participate in exchange rate sterilization via bill purchases or even RRR hikes without finally slowing the economy.
4) USD/RMB has reversed its decline this week. So CPI, the trade surplus, and money growth all accelerated in reports released this week....and the policymaker response is to weaken the currency?

Go figure....






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jdc
admin
November 14, 2007 at 10:56 AM ×

"maybe petrol prices really have fallen in China, unlike anywhere else on planet Earth. Of course, that's difficult to marry with the stories on multi-hour queues and fuel rationing at petrol stations."

I don't think it is.

I mean, I doubt prices are falling too, but falling prices at a time where demand exceeds supply would surely be consonant with queues and rationing.

Rising prices are what gets rid of queues :)

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OldVet
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November 14, 2007 at 11:34 AM ×

Oka, #2 Record Trade Surpluses doesn't fit with inflation in prices, except that it fits with #4 which is the Chinese govt offsetting need for higher prices with lower FX rates to keep exports high. US slowdown looming doesn't bode well for exporter profits in China, unless PBOC goes completely insane.

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tmcgee
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November 14, 2007 at 11:38 AM ×

Can't let them think we allow one-way bets, can we??

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Macro Man
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November 14, 2007 at 12:57 PM ×

1) jdc, I think we're saying the same thing. My point is to criticize the common analytical fallacy that food price inflation is somehow distorted, whereas non-food inflation somehow presents an accurate reading of underlying inflationary pressures in China. I am suggesting the the combination of falling prices and massive queues means that the non-food inflaiton measure is unrepresentative of TRUE underlying inflationary pressures in China.

2) OldVet, I am not sure if domestic inflation and a rising trade surplus cannot co-exist, particuarly given that a weak exchange rate is a partial explanatory variable for both. China has made significant inroads in moving up the value chain in recent years, moving from balance or deficit into surplus in sectors like electronics, metals, and machinery. That represents a winning of market share and is a large reason why the trade surplus and equilirium exchange rate level have both risen sharply in recent years.

3) Mr. Mcgee: what, you mean like EUR/USD in the 4th quarter of every year when these guys do a disproportionate amount of their reserve currency rebalancing?

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Ken
admin
November 14, 2007 at 5:46 PM ×

Gas prices were part of the big price-freeze in mid-September, but they were just increased at the beginning of this month to take the pressure off of refiners. So, to the notion that pump-prices might be decreasing in China, I give you an emphatic no.

FT- http://www.ft.com/cms/s/0/f91f9a70-88c5-11dc-84c9-0000779fd2ac.html

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OldVet
admin
November 14, 2007 at 6:06 PM ×

You're right in terms of Yuan volumes of exports increasing. With new industries competing for skilled workers and complaints about rising wages, older export industry margins should be squeezed and tendency toward higher unit prices. Inflation seems genuine across the board in China, and recent estimates indicate retail sales growing at some 18% as better paid middle classes spend. Now we have both foreign and domestic pressures for inflation.

With the highly geared 48-to-1 P/E of Xinhua index (appx) any pressure on profits makes equities vulnerable, absent allowing hot money speculators from abroad and savers fleeing negative bank deposit rates to bid up "P."

Rises in FX value helps inflation some, but can also lead to exit from stocks. Now there's an opportunity worth considering- a big one off revaluation followed by collapsing equity indexes. No?

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Anonymous
admin
November 14, 2007 at 7:17 PM ×

¿How do you get high inflation?

-Pretending that every increase in prices is "temporary" and is going to reverse soon.

-Being more afraid of the remedies (much higher interest rates) that of inflation itself.

-Dont want to "rock the boat" because the political situation is difficult or you have an Olympics next year.

-Anchoring your currency to a falling standard of value.

As today, China is following the manual to the letter.

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Anonymous
admin
November 14, 2007 at 8:00 PM ×

Those f@#$ing Greeks have got a lot to answer for...


Meanwhile someone put the frighteners on King enough to fiddle with his forecasts.. (and Sterling?)

http://www.ft.com/cms/s/0/1aec57f6-92b7-11dc-b9e6-0000779fd2ac.html

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Macro Man
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November 14, 2007 at 8:59 PM ×

Ken- as with jdc, we're saying the same thing. The official data says those prices are falling, when common sense says no way. Ergo, the reported non-food inflation of 1.1% would appear to be rather fictional.

OldVet, a maxi-reval would make a lot of sense...which is why specs are short USD/RMB...which is why the authorities won't do it. They wanna make money speculating on your currency, but they're damned if they'll let you speculate on their currency.

As for Swervin' Mervyn...one might think that the BOE is simple acknowledging the inevitable and that because the City is going to see bonuses fall, the outlook for housing and conumption is rather dim. Sad as it may seem, the City really is quite important to the UK.

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Anonymous
admin
November 14, 2007 at 9:07 PM ×

So important, as to be absurd!

London is 50% of UK GDP. So they say.

Has it any real economic sense?

Or just a gang of godfathers?

Sad as it may be!

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Macro Man
admin
November 14, 2007 at 9:17 PM ×

What I find interesting is that the UK has been at the forefront of selling off its "crown jewels" for years, from its automakers to its houses to its football clubs. Sterling hits well above its weight in terms of global FX reserve holdings, and one reason is that the authorities have been happy to let the pound be the mercantilists' plaything.

Yet Merv sounded rather alarmed at curreny-land today, and one wonders if he's belatedly realized that the mercantilist chickens have come to roost (and poop) in his back yard.

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Anonymous
admin
November 15, 2007 at 3:58 PM ×

I have a distinct theory on why the Chinese central government pursues the policy it does. It has little to do with macroeconomics and everything to do with power.

Maintaining a fierce peg serves two purposes:

1) concentration of wealth and hence power in the holdings of the PBOC, and hence the Communist party.

2) Strategic long-term deindustrialization of the U.S.

In the end they will have the money and the factories.

What more could they want? Both outcomes have been extremely successful and beneficial to the elite. Why should they change? Pork prices today versus strategic triumph over a generation. That's why they don't have stupid things like elections.

If they unpegged, average Chinese would gain more money and they--central govermnet---would have less money. This is a stealth tax they can use and explain that it's keeping all the Chinese employed in their jobs.

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Macro Man
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November 15, 2007 at 4:21 PM ×

While I'd certainly concur that the currency regime is politically motivated -how could any economically literate person conclude othrwise?- I take what I suppose is a more orthodox view on the matter.

I agree that the paramount goal of the CCP is to stay in power. However, I don;t think that they choose to do so by beggaring the populace: the enormous middle class and huge rise in $ billionaires attests to that. Moreover, Deng Xioaping, who had no real reason to utter empty platitudes for public consumption, famously said "to get rich is glorious."

Now, the hollowing out of the US and European industrial bases is no doubt a welcome development, though of course to date China has primarily taken over low value-added manufacturing, though perhaps that is changing.

But I see the primary motivation of the CCP is wishing to avoid another, more serious, and broader Tiannemen Square type episode, one that is organzied by mass opposition using wireless and/or online technology. Hence the persecution of organzied groups like the Falun Gong.

AT the same time, they don't want a Louis XVI style deposition by angry peasants, either. Allowing inflation, particularly food price inflation, to continue to accelerate is the latter day equivalent of saying "let them eat cake."

The same holds true elsewhere, which is why I think that accelerating inflation amongst the mercantilists and oil producers suggests that we are now witnessing the denouement of Bretton Woods II.

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Anonymous
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November 17, 2007 at 6:57 PM ×

AT the same time, they don't want a Louis XVI style deposition by angry peasants, either. Allowing inflation, particularly food price inflation, to continue to accelerate is the latter day equivalent of saying "let them eat cake."

I believe the control of the CCP is far stronger than Louis XVI, and they have in fact delivered strong real income growth (which is what truly matters) by dint of this policy of strategic deindustrialization of the USA.

They certainly do not have only low value-added manufacturing---the point is that they needed expertise in that before they could do the hard stuff.

Huawei: fully domestic, makes high-end products fully competitive with Siemens, Alcatel, Cisco, NT, etc.

http://en.wikipedia.org/wiki/Huaweiroutesr

Note, Phillipines doesn't, Argentine and Brazil don't, even Poland, Turkey and even Russia don't and can't do anything like this.

There's something fundamentally different with China.

They can and will deliver continued real income growth to their people---who aren't going to riot successfully over the increase they would have gotten with an unpeg---while simultaneously ruining the West, and making them ever more dependent on China.

Who says mercantilism will lose?

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