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Tuesday, February 19, 2008

China Inflation January 2008

China recorded an inflation rate above 7 per cent in January – the highest in more than 11 years and providing evidence of entrenched inflationary pressures.
Consumer prices rose 7.1 percent in January from a year earlier, the statistics bureau said today, after gaining 6.5 percent in December. January's consumer prices climbed 1.2 percent from December.

Widespread expectations of a significant jump in retail inflation had been reinforced yesterday when manufacturing producer prices hit a three-year monthly year-on-year high of 6.1 per cent, mainly as a result of winter transport bottlenecks and higher commodity prices.

There are signs that global inflationary pressures have been fuelling higher ­Chinese food prices. Global prices for top-quality spring wheat - for example - have jumped by 90 per cent in the past six weeks, as corporate consumers have scrambled to secure supplies and speculators have bought stocks. The rising cost of pig feed is another example, and pork prices climbed 59 percent, edible oil 37 percent and vegetables 14 percent. Even more preoccupying is the fact that this process might now endure well into the year – creating a further headache for Chinese policymakers.

The breakdown of the CPI is also interesting, food, with a weighting of about 25%, is obviously important, and the price of foodstuffs increased 18.2 percent. Of this total, the price of grain was up by 5.7 percent.

On the other hand clothing was down by 1.9 percent year-on-year. The price of household facilities, articles, and maintenance services rose by 2.1 percent year-on-year. Of which, the price of durables rose by 0.7 percent, but household services and upkeep surged by 10.7 percent.

The price of health care and personal articles increased 3.2 percent year-on-year. The price of western medicines increased by only 0.5 percent, while that of traditional Chinese medicinal materials and medicines was up by 11.4 percent.

The price of transportation and communication dropped 1.1 percent, with transport alone dropping 2.9 percent. Communication prices fell by 19.6 percent. The price of recreational, educational and cultural articles decreased 0.3 percent. Of which, price of tuition and child care increased 0.5 percent; that of teaching materials and reference books dropped 1.3 percent; that of expenditure of culture and recreation increased 2.1 percent; that of tourism and outgoing was up by 5.1 percent; and that of cultural and recreational articles dropped 0.7 percent.The price of articles related to residence expanded 6.1 percent over the same period of the previous year. Of which, price of water (5.5%), electricity (5.7%) and fuels (4.7%) all up strongly.

Inflation has soared since last year on food and fuel costs, but it is important to note that wages were rising by a very rapid 22% on a national basis in Q3 2007, and a surging money supply increasingly poses the risk that these price gains may become self-propelling.

The threat of enduring inflation will add significantly to the pressures on Beijing to allow an even faster appreciation of its tightly managed currency. Food prices soared 18 percent after blizzards paralyzed transport systems and destroyed crops. The government faces the challenge of curbing inflation without derailing the expansion of the world's fastest-growing major economy

The renminbi, which has risen by about 13 per cent against the US dollar since mid-2005, has been rising more rapidly recently, in-creasing at an annualised rate of about 19 per cent in January.

As a result, China’s central bank is, technically, ­losing billions of dollars a month on the foreign exchange reserves it invests in US dollar instruments because it is paying higher rates at home on renminbi bank bills than it is getting in the US. The key one-year lending rate is 7.47 percent.

With interest rates on the back burner, a higher renminbi has become an important weapon for the government to fight inflation, by lowering import costs of oil and other commodities as well as soyabeans. Eighty per cent of soyabean imports are used for pig feed.

Although higher Chinese costs and currency appreciation will inflate its export prices, China is still importing inflation rather than exporting it at the moment, say economists.

“If anything, what is happening in the US is affecting China rather than the other way around,” said one ­Beijing-based economist is quoted as saying.

Monday, February 18, 2008

Foreign Investment in China January 2008

Foreign direct investment in China more than doubled in January from a year earlier, adding to the flood of cash that threatens to overheat the world's fastest- growing major economy. Spending by overseas companies and individuals climbed 110 percent to $11.2 billion, according to data released by the Ministry of Commerce today. In whole year 2007, investment increased 13.6 percent to $74.8 billion the Ministry said.

Meantime in separate news we learn today that China's producer prices rose at the fastest pace in more than three years as energy costs surged, adding pressure for more government measures to tame inflation. Factory-gate prices increased 6.1 percent in January from January 2006, according to data from the statistics bureau.In December the PPI rose a y-o-y 5.4 percent.

The producer price of crude oil surged 29.9 percent in January from a year earlier and that of ferrous metals soared 17.3 percent. Food prices jumped 10.4 percent.

China's trade surplus jumped 23 percent in January from a year earlier to $19.5 billion. Money supply rose 18.9 percent, the biggest gain in 20 months. The People's Bank of China raised interest rates six times in 2007 and has ordered lenders to set aside more deposits as reserves on 11 occasions since the start of last year, pushing the ratio to 15 percent, the highest ever. The central bank has also sold bills to drain cash from the financial system and capped banks' loan growth.

Government restrictions and higher taxes aren't deterring investors from ventures in the world's fourth-biggest economy. The government is also steering investment away from the eastern coastal cities and into less-developed regions in the west and the center. The country's five-year plan, running through 2010, also aims for a shift from assembly work to designing and producing high-technology brands.

China's economy, the world's fourth largest, expanded 11.4 percent in 2007 from a year earlier, the fastest pace in 13 years.

Friday, February 15, 2008

China Trade Surplus January 2008

China's trade surplus jumped 23 percent in January (as compared with January 2007) to $19.5 billion, the state-run Xinhua News Agency reported today. This is bound to stoke up the continuing controversy about the ongoing surplus, and doesn't indicate that the Chinese economy has been slowing significantly at this point. China is trying to slow growth in its surplus to prevent inflows of cash from export sales from stoking inflation that's close to an 11-year high.

Exports rose 26.7 percent from a year earlier, the biggest increase in six months, to $109.7 billion, while imports increased 27.6 percent, the largest gain in almost two years, to $90.2 billion.

But compared to previous months, the surplus shrank. It was the first time since April 2007 that China reported a monthly trade gap below $20 billion. In December, it totaled $22.7 billion, and in October it reached an monthly record of $27 billion.

Thursday, February 14, 2008

China Number One Exporter To US in 2007

China passed Canada to become the largest source of products shipped into the U.S. last year, capping a six-year period during which its exports to the U.S. more than tripled. Led by items such as flat-panel televisions and computers, household appliances, toys and clothing, imports from China surged to $321.5 billion in 2007, according to a US Commerce Department statement today. Chinese trade is accelerating faster than imports from did Mexico after the North American Free Trade Agreement took effect in 1994.

China's rapid rise may well produce an even stronger backlash in the US Congress where lawmakers have systematically complained that China subsidizes its producers at the expense of U.S. companies and workers.

China also passed Mexico last year to become the second- largest trading partner with the U.S. after Canada. As recently as 2002 Mexico sent more goods to the U.S. than China. Now, Chinese totals are 50 percent more than Mexican exports to the U.S. And the rise of China doesn't mean trade with Canada is falling: imports from Canada increased 3 percent last year, despite the rise in the Canadian dollar. Imports from China jumped 12 percent compared with 2006.

Chinese exports to the U.S. were rising steadily through the 1990s. They spiked after China entered the World Trade Organization in December 2001 and after global caps on apparel trade expired at the end of 2004.

Sunday, February 10, 2008

Has China's Economic Growth Now Passed It's Peak?

Is the annual rate of Chinese growth now about to slow, not just temporarily, but may it actually be that the long march of Chinese "catch-up" growth is now finally slowing? This is the question that was asked by the Financial Times earlier this week, and, as they point out, it may well be that behind those headline forecasts for decelerating Chinese output in 2008 there lies a deeper and more significant trend that may mark the arrival of the long-awaited turning point in the trajectory of the Chinese economy.

Certainly both local Chinese and World Bank economists have significantly downgraded their forecasts for China’s 2008 growth in recent weeks – down from 11.4 per cent rate achieved in 2007 to around 9 to 9.5% this year. But more importantly, could the 11.4 per cent expansion in 2007 – the fifth consecutive year of double-digit increase – represent the peak point in headline growth for China's economic development process. That is, after falling back this year, will Chinese growth ever climb back to its previous heights, and even if it doesn't , should this fact be producing concern among us?

On the face of it, it is obvious that noone - not even China - can continue growing at double digit rates forever, and at some stage the cycle of growth will fall steadily back towards the much lower rates traditionally associated with a developed economy. The big question is really, has that point now been reached?

To get an idea of what we are talking about, and of what all this might this mean, perhaps it is interesting to take a quick look at the longer term growth patterns of some other economies who have been through the "accelerated greenhouse" catch-up growth that China is currently enjoying. Perhaps a good place to start would be with South Korea, since South Korea is arguably the South East Asian "tiger" which is most similar to what Chinese economic evolution might look like, since Singapore, Taiwan and Hink Kong are, each in their own way, very special cases.

Now as we can see from the above chart, South Korean was at one point very strong indeed, until growth "peaked" around 1987 (at 11.1%) and since that time growth has followed a more normal cyclical pattern, with the important detail that with each successive cycle Korean growth has slowly and inexorably slowed ("stripping out" the very exceptional sharp decline and rebound produced by the Asian crisis in 1998).

Economic growth for an emerging economy tends to show this kind of profile since in general terms there are both technological and demographic components in "catch up" economic growth - although there may actually be no such thing in reality as a constant steady state rate to catch up with as I try to argue here - and once most of the technological gap has been closed and the benefical momentum of arriving at maximum proportions of the population in the highly productive 25 to 50 age group begins to pass, economies then seem to eshibit a steady loss of momentum rather like air escaping from a pinprick in a gas balloon, as we can see in the cases of the two oldest societies on the planet, Japan and Italy, in the charts below.

Now I have singled out Italy and Japan (the profile for France, or the UK, or the US is really quite different) since they are both late economic developers, and also since their subsequent demographic transition to ultra low fertility has been very rapid, as it is about to be South Korea and China. Hence Japan and Italy have experienced very rapid ageing, and we already know China is about to follow them down this road, at what may well be an even more rapid pace. In fact China may well, thanks to the presence of a forced restriction of fertility, a reasonably high level of life expectancy and a virtually negligible impact from inward migration as we move forward, become the most rapidly ageing society the world has so far seen.

The comparative median age charts for China and South Korea give the general picture. When we get to 2020 China will still be significantly younger than South Korea, but is following the same trajectory. By 2020 Korea will be nearly as old as the three oldest societies - Germany, Japan and Italy - currently are, and will in all probability be older than slower ageing societies like the UK and France. The is a very dramatic change for a newly developed country.

Chinese Growth

So what do we know about growth to date in China? Well, lets look at the longer term chart.

Now when we come to look at this chart, we immediately face a number of important problems. The first and most obvious one is that the further back in time you go prior to 2000 the more unreliable the data is. So the fact that the maximum growth period seems to be in the mid 1980s, followed closely by the mid-1990s burst might, at first sight, seem strange, since it is the growth spurt which China has enjoyed post-1998 which has really been the most convincing. But it should be noted that China's demographic trajectory is virtually unique, and it is the case that it was getting some sort of potential demographic dividend or other well before 2000, so while the earlier data most probably does not give a complete picture, perhaps it would be a mistake to disregard it altogether. Of course, the more credence we give to the 1980s growth, the more we have to reach the conclusion that some significant slowing down or other may well be at hand, since following the trajectory of the line would suggest it. But as I say, maybe we shouldn't give too much credence to earlier data, so we need to be carfeul with this kind of argument.

What we do know is that from the late 1990s onwards China systematically introduced a very extensive labour and financial market reform process, and this certainly has served to unlease a huge amount of pent-up potential, and it is this which has given us the sustained growth since the early 1990s which has only been accompanied by one small dip between 1998 and 1999 (again the Asian crisis).

Now if we think about the currently rather fashionable coupling-decoupling arguments in this context, it is clear that China was effectively "decoupled" during the 2001 internet bust global slowdown, since it kept growing regardless. That is to say there is evidence that China was much more affected by events in surrounding Asia in 1998 than it was by the recession in the G7 in 2001/2002.

There are of course plenty of reasons for taking the view that things may not be the same this time round. China is evidently much more "locked-in" to global dynamics due to its systematically increased share in world trade. Also China was much more able during to trade increasing its market share for slowing overall world growth during the last recession, by using its price leverage - due to all that pent-up unused labour - but again there are reasons (and especially the domestic inflation ones) for thinking that things may not be quite the same this time. This would be doubly the case if China has been able to extend the post 1998 wave beyond its natural duration by taking advantages of the global imbalances situation, and its own currency and price leverage, to extend its export growth beyond what might be considered the normal sustainable extent. Basically I am very suspicious when I see such extended growth with virtually no humps, like we get in the Chinese case. As we can see for the other charts, growth should be more wave like, so we should at least ask ourselves what it is that has been going on?

The Intractable Inflation Problem

So the big question is when will the current wave come to an end, and when could we expect China to follow in the footsteps of South Korea and show us that steady but constant reduction in annual growth rates. Well... looking at the chart, and sticking my neck out, and also making some sort of back of the envelope estimation about how intractable the inflation problem may turn out to be (and of course recent Eastern European and Russian experience is relevant in this context), my feeling is we may well find China starting to slow this year, and the process continuing next year, and the one after etc - with the normal and anticipated ups and downs. So the Financial Times may well be right when it suggested that Chinese growth may slow and never quite be the same again, but there are grounds for thinking that they may perhaps have only captured part of the picture, and the grounds for thinking this are that they do not appear to have factored in population, labour market and inflation dynamics, and the ineveitable interaction of the three of them.

Certainly Chinese growth from now on is going to be constantly pushing up against limits which are increasingly set by the level of inflation. The inflation problem China has is a very real one, and at this point in time it is hard to see how they can adequately address it. Certainly the popular remedy - unchaining the yuan - could just as easily lead to an acceleration of capital inflows and a further increase in the overheating problem as to any more benign outcome, and I here I would suggest we treat New Zealand (and India for that matter) as the "Canaries in the Coalmine" (or if you prefer "smoking guns"). Conventional monetary policy is up against very clear limits at the present juncture.

And the recent resort to administrative measures seems almost destined to fail - as it is failing in the Russian case - since the problem is not a temporary one produced by high oil and food prices (which are anyway in part a by-product of Chinese growth), but is now becoming more endemic and structural. In the face of the present inflation surge the Chinese government has been gradually widening price controls, and finally took the plunge and froze all food prices last month while at the same time clamping limits on fertilizer prices and raising price supports for rice and wheat. These controls are meant to shield China's poor and working classes, who spend up to half their incomes on food. But the inflation spike is blamed on shortages of pork and grain, and it is obvious that putting a lid on prices simply shifts the hardship over to the farmers, discouraging them from raising output, and thus in the medium term reducing output and putting even more upward pressure on prices.

The recent extreme weather has only exacerbated the problem. In order to ease electricity shortages, thousands of trainloads of coal were rushed to power stations and hundreds of mines were kept running through the Lunar New Year holiday. But with the price of coal now forecast to climb by anything up to 100 percent this year, Beijing has yet to say how power companies will cope.

So I am really not that clear that China has any easy way out of the present inflation dynamic - and remember this is a huge change from the moment when China was reportedly "exporting deflation to the rest of the world", a process which at best has lasted from 1998 to 2007, but is unlikely to continue in the same way. In addition there is now significant evidence of labour market tightening in some parts of the Chinese economy. Wages and salaries of employees went up in the 3rd quarter of 2007 - the latest quarter for which we have data - by 22% (and by 27.2% if we take the private sector alone). And there are significant regional differences, with wages in the private sector in Beijing rising by 36.4% year on year. Even subtracting inflation these are sill very high rates of increase in real wages, and are surely not compensated for in their entirety by productivity increases. So China is steadily losing its competitive edge.

Clearly given the very low level from which Chinese wages started, and the restrained growth in the value of the yuan, it is possible to absorb to some extent such increases. The problem is that they may go on and on, and even accelerate.

And The Growing Difficulties In Finding Young Labour

The reason I say that we should expect worse to come in this regard is due to the underlying strong structural break in the Chinese population pyramid, a break which has been produced by many years of one child per family policy. Looking at those other canaries we have sent down the collective coalmine - Latvia and Estonia (and then, of course, Russia), then it does seem that push-comes-to-shove much sooner than any of us had been anticipating in the question of labour market tightening in the key 15 to 24 age group. In a way these could be thought of as the labour market equivalent of "first time buyers" in the housing market, since they tend to set the rates for others higher up the ladder. And just in case you have difficulty imagining how a country with a 750 million odd labour force could possibly have labour shortages, just remember that this labour force has been growing at an annual rate of 6 or 7 million to sustain the double digit growth rate, and even China can't find the additional people to keep explanding its labour force at this rate forever. And in particular it can't with generational cohorts which will soon be much smaller than those exiting the labour force at the upper age end, and with participation rates in the 15 to 24 age group bound to fall as people go for more and higher levels of education. Maybe it is worth bearing in mind here, that size doesn't mean you have less labour supply problems, au contraire you have more as time passes, and it is no accident in this regard that Russia and the US are the two countries with the largest annual migration needs. In theory we might expect the Chinese economy when it finally becomes the largest in the planet to also be the world's largest consumer of economic migrants, but this scenario hardly seems plausible.

As I say, 2008 could well be the year that inflation really gets a hold on China. Certainly the strong uptick in the latter months of 2007 is evident, as can be seen in the chart below.

Curiously this uptick coincides exactly with the peaking of the 15 to 19 age group, as you can see in the chart, and the decline in this age group from here moving forward is really quite dramatic, as you would expect from the drastic policy measure which was applied.

I have selected the 2022 horizon looking forward based on the fact that this is now known data. We can predict with a reasonable degree of accuracy just how many 15 year olds there will be in China in 2022, since they have now already been born. So we have a pretty good idea of China's new labour supply going forward. Obviously China can still get considerable growth by relocating the existing workforce across sectors to more productive ones. But the end of the labour intensive low economic value growth must now surely be in sight, and the big question is can China sustain inflation-free growth of the order of magnitude we have been seeing in recent years, bearing in mind that much of the recent growth in many of the higher growth developed economies - the US, the UK, Ireland, Spain - has been very labour intensive. My feeling is that it can't, this is why all those exhausted canaries swooning in Latvia have been so useful, and that we will see a slowdown in China which will not simply be cyclical, but rather structural. Possibly the moment of inflection (or tipping point) here will come around the time of the Olympic Games.

So, as I say the 15 to 19 age group has now peaked in China, and from here on in it is essentially downhill all the way, as far ahead as anyone can see. The truth is that no-one at this point in time knows what the consequences of this are going to be. But don't worry, since at least one thing is for sure: we are all just about to find out.