"Inflation is always and
everywhere a monetary phenomenon." Milton
Friedman's eternal quote must be ringing around
the corridors of power in Beijing, after official
statistics showed a surge in inflation to 6.9% in
November, the highest level recorded recently.
Notably, it is not only food but also other items
in the basket that are pushing up prices in China,
which in the context of industrial overcapacity in
most sectors, is saying something. The problem of
inflation is more serious than corruption,
according to a survey of young Chinese
leaders.
While some factors such as a
government-mandated increases in diesel prices
helped to push up CPI in November, the overall trend
of
money supply staying out of control is
unmistakable. Look at the diesel story for
example: the government mandated a price increase
in order to reduce demand, a strategy that seems
to have failed completely, going by anecdotal
evidence from Chinese refiners.
The fault
lines go back to another piece of data from China
for November, namely surging export surpluses,
which hit US$26 billion for the month, another
record. A simple way of understanding the picture
is to follow the dollars, putting yourself in the
shoes of an average manufacturer of widgets in
Shenzhen.
Say this seller of widgets makes
a profit of $1 per widget sold at $100 each (this
is a common manufacturing margin in southern
China), total sales of $1 billion for the month
would equate to a profit of $10 million. The
moment the money comes in, the People's Bank of
China, or central bank, would provide him with
about 7.5 billion yuan (US$1.017,000,000) or so
(assuming some degree of forward selling), of
which around 75 million yuan would represent the
manufacturer's profits for the month. The other
money would be used to repay bank loans, pay for
raw materials, electricity, employees and all the
good stuff.
Of these, say for example that
the money going towards raw materials is around
500 million yuan, and that for wages is 300
million yuan. In any normal economy, the 75
million yuan profit margin (900 million yuan for
the year) would represent the new addition of
money to the economy, which would contribute to
inflation. Not so in China, as we see below.
Typically over a period of a few months,
the manufacturer would have set aside a large pool
of money, say around 1 billion yuan because as the
Chinese currency appreciates against the US
dollar, his local income decreases. This 1 billion
yuan is used to speculate on assets like shares
and property, with the income used to supplement
the 75 million yuan that is earned every month for
selling widgets. Used on shares listed in Shenzhen
this year, the 1 billion yuan would have returned
more than five times as much, which is obviously
an exceedingly large sum that adds to the
country's surging demand for assets. Keep that as
say 5 billion yuan in the bank for the year, over
and above the 900 million yuan from manufacturing
profits for the year.
Remember the 300
million yuan for wages: that money now is also
going towards property and shares, as employees
find their monthly wages are not enough to pay for
the rising costs of groceries, fuel and rents, as
well as all the other good stuff in life, like a
Ferrari or two. That money fully deployed in
stocks this year would have made 1.5 billion yuan,
but lets not get greedy and call it 500 million
yuan in profits for the employee crowd.
Then there is the matter of the 500
million yuan for raw materials, which is where the
government thinks it exerts the greatest price
controls. Well, that may be so for certain
products but in many cases southern Chinese
manufacturers claim that their suppliers squeeze
them on prices by levying additional charges, as
they themselves attempt to combat inflation. In
any event, the suppliers have to use existing
liquidity to invest in shares and property, which
this year would have garnered them good returns of
say 1 billion yuan.
As I wrote in a recent
article (What' s Chinese for
Ponzi? Asia Times Online, November 10,
2007), the sheer weight of money chasing the stock
and property markets, combined with economic
growth engendered by rising export surpluses, has
allowed companies to prosper with new stock
listings. Money made in the stock markets comes
back to the consumption of pork (now every day
rather than for Chinese New Year as some
middle-aged Chinese remember it), cars (try
driving in Shanghai) and other consumables. All
this supports a new economy of goods made in China
for domestic consumption only, albeit at steadily
rising prices.
Most important to all this
is the circular nature of the story - as
consumption of various goods increase, the need to
earn more through risky investments also
increases. This produces an asset bubble that
inflates with every rise in food and other prices
across China.
The role of
banks Salient in all of the above is of
course the small matter of the PBoC not knowing
any of the characters involved above - the
manufacturer, his employees or his suppliers. All
that work gets done by the commercial banks, which
interact with these folks. These banks obviously
need to make more money than what government
yields in China offer, so they are happy to make
available various forms of lending to the public,
including the lucrative area of unsecured lending
such as credit cards. Anecdotal evidence shows
that some investors are paying for their stock
market accounts with credit cards, in an eerie
throwback to what we saw during the dot-com bubble
in the US at the end of the '90s.
Additionally, banks are also happy to
extend lending to both the supplier and the
manufacturer from above, as they build new offices
for their expanding business empires - it is
another matter that building new headquarters is
one of the easiest ways of entering the commercial
property market.
As the central bank
attempts to mop up excess liquidity, it sells
bonds to the banks, but takes the cash so received
and makes it available for overnight liquidity to
the same banks. In the context of the amounts
described above, increased reserve requirements
would only mop up around 50 million to 100 million
yuan of the 7.5 billion yuan (received when the
goods are sold in the United States) that is
circulated, leaving all the rest available for
banks to lend. More importantly, the profits made
on stock markets - which we counted as 6.5 billion
yuan above, would count as excess money in
circulation, which hasn't been drained.
This is why the PBoC circulars on reserves
are greeted with some degree of derision by
investors in China, as the amounts involved pale
in significance to what helps to bump up liquidity
every month.
At the risk of
oversimplification, the heart of the matter is the
original $1 billion in widget exports. If China
were to revalue its currency, it is quite likely
that sales would decline, perhaps to $750 million,
with concurrent declines in wages. It is to avoid
any decline in wages that the Chinese government
attempts to keep the yuan steady. However, in so
doing, it has unleashed a massive asset price
bubble that feeds domestic inflation.
Any
revaluation would increase the purchasing power of
today's rich Chinese. They would follow the
Japanese in becoming the world's most visible
tourists and also increase consumption of goods
produced locally. The twin forces of consumption
and tourism would probably more than offset the
economic decline caused by lower exports.
Failing this recognition of reality,
Chinese authorities can turn to the Buddha, as I
recommended in a recent piece ( Ben, beef and the Buddha
Asia Times Online, October 13, 2007). More time
spent on teaching the people of China to reflect
on a life without conspicuous consumption may help
authorities fight the inflation battle more
equitably. Somehow though I don't quite expect the
strategy to be successful.
(Copyright 2007
Asia Times Online Ltd. All rights reserved. Please
contact us about sales, syndication and republishing.)
Head
Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East,
Central, Hong Kong Thailand Bureau:
11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110
