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Monday, March 17, 2008

Too Little Pork, Too Much Money, Or Both of These Plus Too Few People To Work The Land, To Grow The Pork, To Move The Money.......?

The yuan today climbed yet one more time to its highest level (against the dollar, but not of course against the yen or the euro) since China its peg in the summer of 2005 as the central bank stepped up efforts to curb inflation which is currently running at an 11-year high. China has so far permitted a 3.4 percent gain in the currency so far this year, almost half the advance for the whole of 2007, as it seeks to cut the cost of imported goods and slow export growth. The precipitating factor in today's rise was yesterdays decision by the People's Bank of China that banks should set aside more reserves. According to the new ruling banks must now place a record 15.5 percent of deposits with the central bank, up from the previous 15 percent. This is the second time this year it has done this foolwing ten similar hikes last year (all but one of which were by 50 bp) , and, although the increase is not especially large, it does give us some indication of the difficulty the central bank is encountering in its ongoing effort to slow down expansion in China's money supply.

One indication that such measures may well fall far short of what is needed is provided by today's movement in government bonds, which gained after the finance ministry sold 10- year notes at a yield which was sloghtly lower than the market generally anticipated. The finance ministry auctioned 27.9 billion yuan ($3.95 billion) of the securities at 4.07 percent, compared with the 4.1 percent general estimate among analysts. The yield on the 4.16 percent note due in February 2023 also fell 3 basis points to 4.17 percent, according to the China Interbank Bond Market. The price of the bonds was up 0.34 per 100 yuan face value to 99.9. All of this suggests there is still very ample liquidity left in the system, and considerable "draining" yet to do.

The yuan was up by 0.26 percent on the back of the news - to 7.0630 to the dollar - as of 5:30 p.m. in Shanghai, the biggest gain so far this month, according to the China Foreign Exchange Trade System. The currency has so far climbed around 0.6 percent in March alone. However gains in the yuan have trailed behind some other Asian currencies over the past month, suggesting the central bank may have been intervening to slow its appreciation. The yuan has risen 1.2 percent against the dollar in the period, while the yen has gained 8.3 percent and the Taiwan dollar 3.3 percent. Obviously the yen is a somewhat special case, since the unwinding of the carry trade is an important part of the picture here, but still a rather greater increase in the yuan could really have been expected.

China's stocks rose, giving the CSI 300 benchmark index its biggest increase in six weeks. Yuan-denominated A shares listed on China's two exchanges, gained 124.91, or 3.3 percent, to 3,888.86 at the close today. This is the biggest rise since Feb. 4, and follows hard on the heels of a five-day, 15 percent loss. Only yesterday the index tumbled 5.1 percent yesterday - to its lowest since July 16 - after Premier Wen Jiabao said the government will take "forceful" measures to battle inflation. In more general terms the index is now down by about 40% from its November peak.

Obviously, as I keep signally, inflation is definitely the biggest worry, with consumer prices rising at an 8.7 percent annual rate in February, the fastest pace in 11 years, as wahes continued to increase at a 20% plus annual rate, and food and energy prices held steady to their long upward march.

Michael Pettis over at China financial markets blog had a relevant posting on the inflation front yesterday. Alongside a detailed analysis of the breakdown of the inflation data, he reports on the February wholesale price index reading which was released yesterday. February wholesale prices were up 9.2% year on year and 1.1% month on month (which amounts to an annualized 14%). Thus inflation is at this point well engrained inside the system.

As Michael notes we do have some quite stunning differences in the components of price inflation. Foodstuffs - which constitute some 33% of the basket - increased by 23.3 percent year-on-year. Of the foodstuffs total, the price of meat, poultry and associated products surged 45.3 percent (of which, that pork component which has attracted so much of ken Rogoffs attention increased 63.4 percent).At the same time price deflation persisted in other areas. The price of clothing declined 1.4 percent year-on-year, while the price of garments alone dropped by 1.6 percent. The price of durable consumer goods was up a mere 0.8%, while household services, maintenance and renovation (which is of course very labour intensive) were up 8.5. Not surprisingly communication services were down by 19.9%.

Housing costs were up by 6.6 percent year-on-year, and included in this category are the price of water, electricity and fuels, building and decoration materials, and renting, which were up 6.5, 5.9, and 4.5 percent respectively. What this indicates - when we consider these price rises along with the rise in wages - is that second round effects are now well into the system, following a pattern which is all too familiar already from Russia and Eastern Europe.

But given the great variance in prices we seem to have structural constraints in some areas and not in others. Agriculture seems to be the bigggest issue, given the percentage of additional income that Chinese families are liable to spend on food. So what is happening?

Well perhaps one clue is provided in another piece of information which Michael has dug out for us from the pages of the People's Daily;

Tian Chengping, Minister of Labor and Social Security, said on March 9 that there are 24 million job-seekers in cities and towns every year, including the new additional urban workforce and the people carried over from the previous year who did not find work. But there are only a little more than 12 million jobs available in cities and towns every year. Approximately 8 million additional rural laborers move into cities and towns every year; and this phenomenon will continue for quite some time. The current employment situation remains grim.

Tian Chengping said that in the future, we should promote employment in six ways that include regulating and controlling unemployment; establishing an early warning system for unemployment; and making efforts to maintain stable employment conditions.

So what we may well have here are some rather important structural mismatches between jobs on offer and the people who are applying to do them. I do find it hard to see how there can be year on year wage increases in the 20 percent plus range if there are serious surplus labour pressures.

What we have are 8 million people flooding into the cities and towns from the countryside every year, and 12 million jobs being created there. What this means is that you can have a backlog of people already in the cities who are finding it difficult to obtain work, some of them being unemployed of over one years duration. But just how many of the over one year unemployed people are actually employable? This is a question which we have been having to ask in country after country across Eastern Europe, and I doubt the situation is that different in China.

What there may be are a lot of people over 40 (for example) underemployed, or something like that, there may also be too many people arriving in some urban areas looking for work for those areas to absorb, while in other areas - and especially some rural ones - severe shortages develop. Some of this then gets knocked on to the food prices issue.

But this "buffer overflow" in the urban labour market is not at all inconsistent with labour shortages in other areas of the economy, particularly in the rural ones, where in fact food prices may be rising due to the unavailability of sufficient labour to work the land intensively enough, and the very low productivity of labour which can't simply be changed overnight. If this is the case then the "pork barrel inflation" (my apologies to Ken Rogoff) may well be about more than money and only money. As he admits why we didn't get inflation before in China, given that the monetary conditions were already present, is rather surprising:

Inflation of more than 6 per cent is the immediate problem. Those who think inflation is caused by too little pork rather than too much money are wrong. China’s relatively pegged exchange rate system has led the authorities to flood the economy with renminbi. ... The real surprise is that inflation did not sprout earlier. The authorities must stuff the inflation genie back in the bottle. It is not going to be easy...

Could it be that before living standards hadn't risen far enough or fast enough, and that there was still sufficient surplus labour out there in the heartlands, surplus labour which - like that legendary liquidity over at Paribas on the 9th August last - has suddenly and astonishingly evaporated as the Olympic driven boom finally takes the system near to breaking point. Remember that the Economist reported that 7 million people failed to return to work in the "growth hothouse" Guandong region after this year's New Year holiday. So could it be that despite all that excess liquidity there are now be deep seated structural questions lying behind China's recent inflation surge. Some additional evidence for this is provided by a paper that Claus Vistesen dug out and reported on in this post.

Basically in the February 2008 issue of the journal "China and the World Economy" Fang Cai (Director of the Institute of Population and Labor Economics, Beijing) and Meiyan Wang publish a paper entitled "A Counterfactual Analysis on Unlimited Surplus Labor in Rural China". Here is the abstract.

Using a counterfactual analysis approach, the present paper examines a host of conventional wisdoms relating to issues of farmer, the countryside and agriculture, which are believed to be all originated from the existence of mass surplus laborers in China. When analyzing various sources of statistics, evidence shows that there is no longer a large pool of surplus laborers in rural China as most people believe. Based on this counterfactual result, all related events, such as the direction of agricultural technological changes, the level of comparative productivity of agricultural labor, and the degree of rural-urban income gap must be reconsidered.

So what this suggests is that China may indeed be finding it difficult to increase food production due to rural labour shortages which are a direct consequence of the one child per family policy. What I feel is that if this view is right we shouldn't be treating increasing food prices as a temporary blip in inflation, since the shortage of rural population (and the low productivity of Chinese agriculture given the labour quality of what is left) and the increasing living standards of the urban population is going to put an upward pressure on prices for some time to come. Add to this labour shortage generated pressures on wages and you are into all sorts of problems.

Evidently, given they will continue to need to increase the volume of food imports, letting the yuan rise can ease the internal inflationary pressure, but this will only result in exporting Chinese inflation out into global food prices for the rest of us. So really, you could say you are going to see the direct impact of thirty years of one child per family policy sitting right on your dinner plate.


Those interested in a more growth-theoretically oriented explanation of the argument in this post may find my "Has China's Economic Growth Passed It's Peak? post well worth reading.

And for a fuller explanation of the inflation dynamics problem in another context see my "Inflation in Russia: Too Much Money Chasing Too Few People?".

Also of general interest are my "China's Inflation and Labour Shortage Problem, It's The Fertility Stupid!" and Claus Vistesen's "China's Economic Development - People ... I see no People"

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