Michael Pettis is the best China-centric theoretical-finance commentator I have come across in the no-fees blogosphere. He has posted another good article, which focuses on the PBOC’s latest interest-rate adjustment.
For the sixth time this year the People’s Bank of China raised interest rates, which was not a surprise. The PBoC raised its 1-year benchmark lending rates by 18 bps to 7.47%. Changes in deposit rates were a little more complex. The 1-year benchmark deposit rate went up by 27 bps to 4.14%, the 6-month deposit rate rose 36 bps to 3.78%, and the 3-month deposit rates rose 45 bps to 3.33%.
The PBOC actually cut the deposit rates on current deposits by 9 bps to 0.72%, from 0.81%. The PBoC statement accompanying the hike claimed that the move “will guide more money into short-term time deposits to help consumers better handle rising prices while maintaining enough liquidity.” I think here the concern is that a lot of money has been held in current deposits in order to take advantage of IPOs, and as huge amounts of money flow from current deposits to brokerage accounts, they cause spikes in sort-term rates that really hurt the smaller banks. By encouraging depositors to tie up their money, the PBoC may hope that it reduces the amount of IPO oversubscriptions.
Overall it is pretty clear that the PBoC is trying to encourage savers from withdrawing deposits – with CPI inflation over the past four months averaging over 6%, depositors have to be very unhappy with the return they are getting on their savings. I am not sure about the exact mix of deposits, so I don’t know what the interest spread is, but the spread between one-year deposits and one-year loans has narrowed by 9 basis points (I think altogether it has narrowed by 27 basis points this year, but I have to check). Banks rely on the interest spread for 85-90% of their profits, so the continued squeezing of the spread, along with the ten minimum reserve hikes this year, should have two impacts: it will put serious pressure on bank profitability next year, and it will create strong incentives for bankers to lengthen loan maturities.
There may be problems with China’s strategy. On their website the PBoC argued that “This adjustment will be beneficial in preventing the rapidly growing economy from turning to overheating, and prevent the structural rise in prices from becoming clear inflation.” If raising the deposit rates is intended to fight inflation and prevent overheating, I imagine that it would do so by constraining consumption. However constraining consumption will also mean constraining import growth, which of course means adding further upward pressure on the trade surplus, and so further upward pressure on money creation as the PBoC monetizes these inflows.
In addition it is pretty clear that these increases in interest rates cannot help but make speculative inflows even more profitable – even if the dollar-RMB “arbitrage”, as some argue, is not the main reason for speculative inflows.
A lot rides on which model for explaining inflation and overheating is the correct one. If it is excessive lending and temporary food price increase that have caused the two, and if rising inflationary expectations are the main concern, then the current strategy may be the right one to combat the problem. Restraining spending and calming inflation expectations should do the trick.
If, however, the fundamental problem is the lack of monetary policy caused by the currency regime, then these solutions will only make things worse. Anything that encourages inflows through the current or capital account will simply make the PBoC’s job of managing the domestic money supply even more difficult and will exacerbate the overheating and inflation problems. We may find ourselves in a vicious cycle.
As goes China, so goes commodities. As gold and oil climb to dizzying new highs, never forget that. It’s a lot safer, imho, to bet on base or precious metals, than it is to bet on China.
I would even buy Japan before I’d buy China–although I believe the China bubble has some months to run yet. Japan is the inverse of commodities, so it would make a decent hedge for a major gold bet. However, Japan will continue to stagnate until it drastically increases market transparency and cracks down on rogue bureaucracies. In the fall, Japan’s building authority basically froze the real estate and construction market by imposing unbelievably onerous requirements upon builders. Japanese housing starts plunged to a 40-year low, and the directive probably cost Japan over half a percentage point of GDP this year. There is no reason to make your investment hostage to that kind of behavior.
Anyway, the toothlessness of these PBOC moves show how completely they have lost control of monetary policy, in my opinion. Nobody’s behavior is going to be influenced because they are getting .72% instead of .81% on a short term RMB deposit.
Pettis also notes that a severe drought is gripping China. The peasants are not going to have a very happy 2008 Olympics.
By Michael Pettis
A few weeks ago I saw a report that China had suffered its worst drought in recent times. The dates and details were a little vague, so I tabled the article and decided at some point I wanted to find out a little more about it. Today both Bloomberg and the South China Morning Post have articles about the drought.
Bloomberg stares its piece by saying: “China’s most severe drought in a decade is expanding throughout the country, threatening the normally humid areas along the southern coast.” I searched for more news on China Daily and found a whole slew of articles. Parts of China are suffering their worst drought since the early 1950s, about 400,000 hectares of crops have already been damaged this year, and the State Flood Control and Drought Relief Headquarters reports that 37.4 million tons of grain will be lost. China Daily adds: “In recent times, drought has been striking more areas of the country with greater frequency. It had extended from the north and western regions to the south and eastern areas, worsening water supply conditions for both agriculture and industry.”
On the other hand, the country seems to be making good preparations for the spring festival. Zeng Liying, the deputy director of the State Grain Administration, said on the agency’s website that “China has stored enough grain to fully meet market demand.” She also said, somewhat surprisingly to me given the other news, that “The country’s grain harvest is expected to exceed 500 million tons this year, rising for the fourth consecutive year.”
Not surprisingly food and grain consumption shoots up during the annual spring festival, and I would guess that the government will do what it can to restrain price increases because it will want a happy festival. If that means using up grain stocks to depress prices temporarily, it will help in the short term, which is fine if Chinese inflation really is just a temporary food problem. In that case fighting inflationary expectations will be the government’s main task, and using up food stocks to depress prices will be a successful strategy.
If inflation is really a monetary problem, however, or if continued drought drives food prices up over a longer period, trying to restrain price increases in the short term may cause more trouble later in 2008 after the festival. With food prices around the world rising too, I continue to believe that inflation next year is going to shock on the up side. As an aside, the government this week promised to double its fertile-sow subsidy to farmers. It will also spend additional money to support large-scale pig production. I assume that this means that they are concerned that pig-rearing is growing as fast as they had hoped. I think the government and most other forecasts for CPI inflation in 2008 are in 3.8-4.5% range (I need to check, so please don’t accept these numbers uncritically). I think it will be much higher.
Coincidentally, I notice this article from the Financial Times:
Double challenge to Beijing orthodoxy
By Mure Dickie and Jamil Anderlini in Beijing
Published: December 26 2007 19:22 | Last updated: December 26 2007 19:22
In two highly unusual public challenges to core tenets of Communist rule in China, an academic has announced the launch of a democratic opposition party and farmers in four provinces have claimed ownership of land seized by local authorities.
Former Nanjing university professor Guo Quan on Wednesday claimed his “New Democracy party” enjoyed widespread backing for its goal of ending Communist “one-party dictatorship” and introducing multi-party elections. “We must join the global trend,” Mr Guo said. “China must move toward a democratic system.”
Separately, farmers in the provinces of Heilongjiang, Shaanxi, Jiangsu and the city of Tianjin have announced on the internet that they have reclaimed collective land from the government and redistributed it.
Collective land ownership is one of the foundations of the Communist state. But one of the main sources of unrest in China in recent years has been the seizure of land that is then sold to developers who often work with officials to make huge profits.
Authorities have already detained at least eight of the activists behind the internet statements, people familiar with the situation said on Wednesday.
China routinely detains or jails people whom officials judge to pose a threat to Communist party rule and has dealt harshly with past attempts to set up opposition groups.
In 1998 authorities detained dozens of people involved in setting up the “China Democracy party”. Some of its main organisers were sentenced to more than 10 years in jail.
This month’s land claims break new ground by appearing to be co-ordinated across widely separated regions of the country and by being based on presumed individual property rights.
On December 16, police in the northern province of Shaanxi detained Zhang Sanmin, Cheng Sizhong and Xi Xinji on suspicion of incitement to overthrow the state. The detentions came four days after they posted an open letter on the internet claiming to have asserted rights over 10,000 hectares of land in the name of 70,000 farmers.
That action came less than a week after the detention of Yu Changwu, leader of a group in the north-eastern province of Heilongjiang that claimed to represent 40,000 peasants in the reclamation of 100,000 ha of land.
In the eastern province of Jiangsu, two young couples were under effective house arrest after joining a group that asserted ownership of land confiscated by local officials to build hotels, discos and restaurants.
A fourth group in the northern port of Tianjin staked a claim on behalf of more than 8,000 people for 60 ha taken by officials for development.
The announcement of the new party and the land claims follows the release last month by a provincial government adviser, Wang Zhaojun, of a sweeping open letter indicting the nation’s entire political system.
Is King Kong waking up?
(Supposedly King Kong was symbolic of the commie-sympathizing underclass… yes, I’m a tool)
As a final end note, a former professor of mine (who is very well connected with the Chinese elite) said that he believed Beijing was behind the 2005 Shandong “mass incident.” Beijing has shown a pattern of using the combination of rural riots and very attentive media to make a move on a “rebellious” province and centralize power at the expense of the provincial governments, which collectively hold much more de facto power than Beijing does.
With media reports, especially apparently coordinated roll-outs such as this, you can never apply too many grains of salt …