CHINA’S IMPENDING INFLATION BATTLE
Oh that dreaded government intervention! To describe the contrast between the inflation situation in the United States and China as “stark” might be a bit of an understatement. As we’ve previously described (see here), the inflation issues in the United States remain benign for one primary reason: aggregate demand is weak. The U.S. consumer is grappling with a traumatic balance sheet recession (see here). But none of these problems existed in China to the extent that they did in the United States. Remember, China’s economy was growing relatively fast even at the depths of the recession in the U.S. - a whopping 6.1% at the trough. Most importantly, their consumers were not saddled with debt. Nonetheless, Chinese officials felt that it was necessary to inject the economy with a stimulus package that rivaled that of far more embattled nations. The results have been tremendous. M2 is growing at 25.2% while M1 is expanding at 35%. Unlike Americans, the Chinese are borrowing and they’re using those borrowings to fuel their speculation.
The headline CPI is running at 2.7% year over year. Food prices are up 6.2% year over year. Real estate prices rose at a record 10.7% in February. Equity prices in China are up over 45% in the last 12 months.
In early February we ran this superb interview with the largest commercial real estate developer in China. Her thoughts are almost eerily similar to those of Sam Zell’s when he was predicting a real estate debacle in the United States in 2007:
What is your overall approach to the real estate market today?
Basically – other than Qianmen [Street] in Beijing, which is the only project we decided to hold long term, our strategy for today is to sell everything we have. The real estate business should really be looking at rental yield; build a building and then lease it out with the rent giving a decent return. But, because of where China is with asset bubbles, people want to buy the assets regardless of whether they can be leased out or not. People just want to hold [property], even if it is empty.
Prices are too high, rent is too low, so if you hold property in order to get yield you are likely to get very little. For us it makes no sense to hold property, so our strategy is to sell everything. We see ourselves very much as a manufacturer. We buy land, we build, and then we sell. And the asset bubble has compelled us to be even more of a manufacturer.
When do you think the bubble will burst?
I don’t know. We don’t really have a view on when it will end; [but] we do have a view that this is a bubble. Real estate is very much driven by government policy. This year we have RMB 4 trillion through the stimulus package, another RMB 6 trillion from municipality bonds, another RMB 10 trillion from bank loans: We have RMB 20 trillion in the system and it all finds its way to real estate. If the government next year decides to continue the relaxed monetary policy the market will continue like this, regardless of whether this is a wasteful investment or not – people will still buy and we will still be building and selling.
These buildings are not fully occupied and people should be worried about it. I am sure the government is worried about it, but what do you do, they want the stimulus and if you want to create jobs then this is a by-product. There are a lot of dilemmas in this area – it is not a black and white easy decision.
What is your time period for selling properties?
As soon as possible. We came in [for the Exchange] when it was 30% full and now it’s selling out very quickly. I think in the next few months it is all going to be sold out. People want to buy. It has already reached 50% occupancy.
[Beijing's] CBD has 35% vacancy but our buildings are all over 95% occupied because we push all these Chinese companies to come in. [Normally] if you go to Guomao as a small Chinese company there is no chance they will lease it to you, they won’t even talk to you.
The smart money in China is concerned, but for some reason government officials are talking these problems down, describing them as “moderate”. They wouldn’t be the first central bankers to misjudge an exit strategy….
Analysts are now scrambling to alter their outlooks. UBS predicts a rate hike in the “early second quarter” – much sooner than their previous estimate for the third quarter. Barclays is also adjusting their timeline to Q2. Morgan Stanley has been ahead of the curve on the global rate tightening fears and believes China could be facing multiple months of tightening starting in April. Goldman Sachs is growing increasingly concerned with regards to the nonchalant stance by the Chinese government who continues to call the inflation concerns “moderate” (sounds similar to Bernanke circa 2007 & 2008 when prices were skyrocketing in the oil and real estate patch):
“Recent comments by a number of policymakers that there are no signs of inflation yet are worrisome as it indicates a lack of willingness to take more decisive measures until higher inflation actually occurs.”
Let’s not overreact to this news, however. This is a slowly unfolding phenomenon. China’s growth is the envy of the world, but they have quite a battle on their hands in 2010 and 2011. They are confronted with the ever difficult task of threading the monetary policy needle – a task that ultimately led to the demise of Alan Greenspan (and certainly made Bernanke appear foolish in 2009). This is, in many ways, the most difficult timing trade ever made. Can you inject enough money into the system so that it doesn’t boil over and more importantly, can you sap the system of that necessary liquidity when the time is just right? China would be wise to get ahead of these issues as we here in the United States are all too familiar with – pockets of mal-investment are too often a direct result of poor monetary policy.
Government aid might be the global economy’s greatest hurdle in the coming years, but it won’t be our own stimulus that is the great concern – it will be that of the engine of the global economy – China. Luckily, with aggregate demand still very low in the United States and much of Europe there is little to no concern of inflation here, however, if China’s economy were to take a spill as government officials mishandle monetary policy it would almost certainly result in a global double dip. And unfortunately, a global double dip would only strengthen the deflation that is hard at work around much of the globe. Let’s all hope China gets ahead of this sooner rather than later.
The market shrugged this off earlier last month. And while I agree with you that this is not a near-term concern, I am surprised that there is almost no reaction to this data.
It seems pretty obvious that inflation is spiraling in China and will result in substantial rate increases in the coming quarters which will lead to a much weaker economy. Let’s not kid each other – the global economy is only strong because of China. Europe, Japan and the US are still in the crapper. This looks much scarier than the market thinks.
and the Yuan looks even more attractive today than it already did.
Nice job connecting the dots. This would appear to mesh with your theme of potential second half or 2011 weakness, right?
Nice analysis TPC. Do you have a timeline on this? When does China become a real concern?
It already is – China’s markets have been the first to top, just as they were the first to bottom.
China is America in 1930 – was America a real concern in 1930? Although China bursting will take much longer than America in 1929-33, the end result will not be too much different.
China is a young economy and a paradoxical place. If they want to lead the world as its number one power, both political and financial history suggest China first needs a baptism of fire. History and reason are on the side of those who say China is one, huge bubble.
To believe China will seriously fight inflation is a big mistake. Just check out PBoC’s tracking record. Everytime GDP can’t grow 8% they create bigger and bigger bubble. They are the most irresponsible central bank on the world.
Good post. A few thoughts:
While China walks the tight rope of too much “liquidity” vs. too much price inflation, the real factors at play here are the conditions that create this dilemma and the context in which it is played out. I am speaking of the global structural imbalances and those that exist in China itself, such as overcapacity in manufacturing, the need to build to maintain employment regardless of the need.
Changes in China are moving fast. The NYT recently ran a news article that said wages in urban areas are on the rise due to a shortage of skilled workers who returned to the countryside when laid off and then found work on infrastructure projects.
Also, seems all countries wish to re-grow their economies by maintaining or expanding exports, yet who will be the importer in such a global scenario.
Rather than address the global structural contradictions, which I consider to be way beyond the capability of governments and international cooperation of governments, the effort is to sustain that imbalance. So the same problem exists: over production and lack of aggregate global demand.
The effects of this are that little capital will flow into production in the ‘real’ economy and will continue to circulate in the playground of financial speculation.
“Tangjialing has become a centre of Chinese media attention as a reflection of the fast-paced economy’s inability to create enough meaningful jobs for the annual six million-plus Chinese graduates in their own hometowns. When we wandered down the narrow streets, the students refused to chat.”
“Next time I go to Tangjialing, I won’t recognise it. Officials have drawn up blueprints to demolish and rebuild the neighbourhood.”
http://blogs.hindustantimes.com/middle-order/2010/03/07/the-ant-tribe/
“If China is different — and China is — it is because fiscal worries on the diminutive scale of Athens hardly register on Beijing’s blotter. Overbuilding is not a prime concern. Indeed, some might call it an economic strategy.”
http://www.nytimes.com/2010/02/07/weekinreview/07wines.html
the funny thing is: inflation in china is behaving the same way as in the us.
just compare the charts of chinese (2.7%) and us headline CPI (2.6%).
now the hyppocrites in the banks call for china to hike rates at least 3 times this year, starting next quarter, while in the us “inflation is no problem” and rates can stay at zero(!) until 2011.
the odd thing is: growth in the us is accelerating while recent ISM and lending data out of china indicates a slowing.
so who´s the one that issupposed to hike rates first?
it must be great to be a central banker when you can hide behind academic concepts like “core” measures of inflation (of course nobody has to eat, heat or drive) or “output gap” that proved be no indication of inflation at all.
eventually the willimgness and ability of inflation fighting comes down to whether you are a nation of savers (chinese) or debtors (us).