In all the worry about the trade numbers I haven’t discussed another data release last week which, until recently, would have been the most important piece of economic news for me. It was only a few months ago that we were intensely debating the cause of rising inflation in China. Now, inflation is clearly receding. PPI and CPI figures for November were released Wednesday and Thursday, and they showed an unexpectedly high decrease in inflation, with month on month numbers implying actual deflation. Year on year PPI prices rose by 2.0%, compared to 6.6% in October and around 4.5% expectations. CPI inflation declined from 4.0% in October to 2.4% in November, also well below the 3.0%expectations.
What does this say about monetary conditions? First of all let me take a radically contrarian position. I think the latest numbers, far from confirming the view that Chinese inflation in the period until this summer was caused by food supply constraints, actually indicate that the money explanation was right. Inflation in China earlier this year, in other words, was caused by too much money, not too little pork, in Ken Rogoff’s famous formulation.
For those of us in the money camp, inflation was the all-too-expected reaction to explosive money creation caused by China’s currency regime, in which the country’s central bank purchased a torrent of inflowing dollars in order to maintain the value of the currency. In order to fund the purchase of all these dollars, it created RMB, which was intermediated by the formal and informal banking systems into rapid credit growth.
For the pork camp, however, this monetary explanation of inflation was wrong. The cause of Chinese inflation, they argued, was temporary food supply constraints, including harsh winter storms and blue ear disease, which seriously affected pork and grain production. These caused food prices to surge. Inflation, in their view, was nothing more than the temporary consequence of rising food prices, and would end as soon as the supply constraints ended.
While we in the money camp of course acknowledged the sharp rise in Chinese food prices because of harvest problems and pig diseases, we felt that this was as much a coincidence as anything else (especially since food prices were rising around the world). I believed that if monetary policy in China were consistent with low inflation, the brutal surge in food prices would have caused Chinese households to divert so much spending away from non-food items that there would be significant downward pressure on non-food prices. I calculated that non-food prices should have declined by 5-7% if Chinese monetary conditions really were consistent with the 1-3% inflation targeted by the PBoC.
But non-food inflation was not negative. It was low, but we were actually seeing rising non-food inflation for most of the year while food prices were soaring. There was not even disinflation in non-food items, which is the least I would have expected if Chinese inflation was not money-based. That is why I rejected the food-supply constraint argument.
Of course based on our very different analyses, each camp had different predictions for the inflation trajectory. The money camp claimed the still-rapidly growing central bank reserves would ensure that inflation continued through the end of 2008 and into 2009. The pork camp argued that as food supply came back onto line by the end of the year, the food supply constraint would ease and inflation would quickly come down to manageable levels.
As we all know, inflation stayed high through the summer but subsided very rapidly thereafter as food prices declined sharply. In fact they declined far more rapidly than anyone predicted. Year-on-year CPI fell to 2.4% in November and year on year PPI fell even more to 2.0%. So the pork camp’s analysis must have been correct, right?
Not quite. The first clue should be the speed at which inflation fell. Last summer even the most hard-core members of the pork camp didn’t believe that the official target of 4.9% inflation for 2009 would be met. I, frankly, wrote it off as silly even to pretend it was possible (note to self: nothing is impossible). The pork camp made their food price projections based on the removal of supply constraints, and the optimists among them were arguing that we might see inflation between 5% and 6% for this year and a little lower next year.
In fact although food prices declined in line with their predictions, CPI and PPI inflation fell way below what anyone expected, and what is more, now everyone is worried about deflation in China. This to me isn’t necessarily consistent with the idea that Chinese inflation was all about food.
But there is a more technical problem with the idea that the drop in inflation was simply a consequence of declining food prices. In the standard inflation model the rapid decline in food prices should have automatically caused Chinese households to spend less on food and more on non-food consumption. If monetary policy was not deflationary, this would cause the price of non-food goods to increase as the price of food decreased.
But that didn’t happen. From September to November, CPI inflation has declined from 4.6% to 4.0% to 2.4%. As expected, food inflation declined from 9.7% to 8.5% to 5.9%.
But non-food inflation also declined. It dropped from 2.0% in September year on year to 1.6% in October to 0.6% last month. If monetary conditions were stable, just as non-food prices refused to behave the way they should have when food prices were rising, they still refuse to behave correctly when food prices are declining. This suggests to me that the pork camp still has to do a lot of explaining, or else the conclusion must be that Chinese inflation has not been caused by changes in food supply, but rather by changes in the money base.
If this is the case, it has very worrying implications. China’s reserves continue to rise, so the central bank has been continuing to create yuan at a rapid pace, but somehow money supply is contracting rapidly, as indicated by the decline in inflation. What could be happening?
Before answering, let me digress. About two months ago I had dinner with an old friend of mine, Arminio Fraga, the former head of the Brazilian central bank and one of the smartest finance guys I know. During our dinner we talked about conditions in China and I wanted his advice on monetary conditions. I had always felt that monetary aggregates in China did not seem to be explaining what was really happening in underlying money. My instinct was reinforced by a piece I had read by Ronald McKinnon and Gunther Schnabl titled “China’s Financial Conundrum and Global Imbalances” in which they say:
Why didn’t China rely more heavily on domestic financial indicators? With rapid financial transformation and very high saving, the velocity of money – whether based on M0, M1, or M2 – was (is) too unpredictable for any monetary aggregate to be useful as an intermediate target. And the velocity of money, defined as GDP/M, becomes even more difficult to predict when nominal GDP itself is subject to large revisions. Indeed nominal GDP was revised sharply upward in 2006.
Since 1990, Figure 5 shows that these monetary aggregates grew faster than nominal GDP—with M2 growing twice as fast so as to approach 200 percent of nominal GDP in 2008. The high growth in M2 was largely a natural result of China’s very high saving rate when bank deposits are the principal financial asset open to Chinese savers. Thus, the authorities had, and still have, no firm idea of what the noninflationary rate of growth in M2 should be.
I asked Arminio based on his tenure at the Brazilian central bank what he thought about the monetary aggregates (M0, M1, M2 and so on) to judge money growth. He responded that from his experience McKinnon was right and the traditional monetary aggregates were not terribly useful in evaluating money conditions. It was far more useful, he claimed, to look at credit growth.
But in China there is a big problem with the credit data. We don’t have good numbers on credit growth. We know what is happening in most parts of the formal banking system because the PBoC has fairly good numbers there, but we have only a vague idea about off-balance sheet transactions, about financing involving municipalities and provinces, and about inter-company lending. Most importantly we have very little idea about the informal banking sector.
But let’s get back to inflation. During the inflation period, officially credit growth was not too high, but there is strong evidence that during the period of explosive credit growth, when the central bank limited the amount of credit creation permitted to the banking system, the market responded by accommodating explosive growth in off-balance-sheet items and within the informal banking system. Anecdotal evidence suggests that much of China’s huge mot money inflow before this summer may have ended up in the informal banking sector. This (and the explosion in reserve accumulation) is consistent with the idea that inflation in China was money based.
It is the opposite now. Banks don’t want to lend and this implies that credit is contracting. Now that banks are not willing to lend, and companies not willing to borrow to invest (they mainly borrow if they are desperate for liquidity), credit growth is mainly being caused by government pressure to maintain credit growth. But of course credit growth in China is not just a function of the size of commercial bank portfolios. These may be growing, even if very slowly, but transactions that were once off-balance sheet may be coming back on balance sheet to give the illusion of credit growth. More worryingly, the informal banking sector, which may consist of as much as one-third of total loan assets, may be contracting rapidly. That is what the anecdotal evidence suggests. As an aside, in today’s weekly meeting of the Guanghua Students Monetary Policy Committee, one of the members, Gao Ming, reported that he had been getting a huge number of phone text messages from informal lenders offering him money. The other students agreed that they had seen a big rise in these kinds of text messages. Perhaps informal lenders are having trouble finding borrowers?
Certainly if inflation is a monetary phenomenon, this would be the implication of the near-collapse of inflation, which occurred more rapidly than even the most optimistic members of the pork camp expected. So what does this mean if true? It means that money is contracting, and perhaps at an alarming rate. Just as too-rapid money expansion until this summer was showing up as inflation, too-slow expansion (or perhaps even contraction) is showing up as disinflation and even deflation.
I can’t prove it, of course, but I think Chinese inflation is a money-based phenomenon and I am guessing that if China is experiencing deflation it is also experiencing rapid contraction in outstanding credit – much more rapid than we think. In China like in most developing countries, as I have written many times before, the structure of balance sheets tends to reinforce trends, which increases underlying volatility. We may have suddenly swung from ferocious credit expansion to ferocious credit contraction. The fear of deflation next year, in that case, is well founded.
Will this result in money outflows from China in 2009? Will this lead to RMB depreciation against other Asian currencies?
Are you assuming if people spend less on pork (due to the price drop) then they’ll have to spend what they saved on pork to non-food stuff, Professor? Sounds to me macro level analysis is not sufficient in this case.
Thanks for the excellent blog.
Loans made in the informal banking sector are linked to the export sector and that´s not good place to do business right now.
If companies (or individuals) are returning the borrowed amount at high interest rates (>20% per month?), then the crash in novembers export numbers will have hurt the borrowers operating within the informal banking sector a lot.
As the more risky business exports adventures crumble I fear we will see some of the darker sides of informal banking soon.
Text messages in China have periodically since 2003 been offering anything from guns to girls – not sure it´s valid evidence to base the supply/demand curve of these particular items (or even money borrowing) on.
Since I’m in the pork camp….
The main contributing factor to inflation in China wasn’t blue ear disease, but rather blue ear disease in an environment in which commodity prices were rising throughout the world. The problem with trying to explain the rise in prices in China terms of the actions of the People’s Bank of China’s actions is that it doesn’t explain the rise in prices in Haiti or Argentina, and it’s really hard to come up with a workable model in which PBC actions influences Mexican corn prices, and any such model I think would give the PBC more influence on the world economy than I think is realistic.
Michael: In the standard inflation model the rapid decline in food prices should have automatically caused Chinese households to spend less on food and more on non-food consumption.
Well then, I’d argue that this means that the standard inflationary model is completely wrong. In any case you can check this empirically, and see if rises in commodities prices *did* cause people to change spending patterns, and my “look at people that I know are doing” seems to indicate that it didn’t.
Pettis: If monetary conditions were stable, just as non-food prices refused to behave the way they should have when food prices were rising, they still refuse to behave correctly when food prices are declining.
No. The problem here is that what ever caused the run up in prices in the summer didn’t cause spending to contract, but the credit crunch *is* causing people to spend less. Again, this is why looking at things empirically is important. You can argue that people are behaving inconsistently, but people do behave inconsistently.
The easy answer is that people’s spending patterns at least in the United States and China are insensitive to the prices of food and energy but are extremely sensitive to the amount of perceived wealth and perception of future risk. The rise in prices in June didn’t change people’s perceived wealth and perceptions of future risk, but the events in October did.
Michael: This suggests to me that the pork camp still has to do a lot of explaining, or else the conclusion must be that Chinese inflation has not been caused by changes in food supply, but rather by changes in the money base.
The explanation seems simple enough to me, Milton Friedman is wrong.
Pettis: Now that banks are not willing to lend, and companies not willing to borrow to invest (they mainly borrow if they are desperate for liquidity), credit growth is mainly being caused by government pressure to maintain credit growth.
And if you have an economy that is dependent on credit like the United States, then things fall apart. If you economy isn’t highly dependent on credit, then things don’t sense when people get their credit lines reduced they can continue to operate using retained earnings, until government stimulus starts to kick in.
The problem that the United States economy (which also was a problem in a lot of emerging economies) is a timing mismatch. Financial crises take place on time scale of hours, whereas stimulus programs take place on a time scale of months, and structural reforms take place on a time scale or years or decades. It’s like calling the fire department and having someone tell you that they will arrive in three months.
Michael,
Off topic but trying to understand retail sales vs. import figure.
Jul: Retail Sales +23.3%, Export +26.9%, Import +33.7%
Aug: Retail Sales +23.2%, Export +21.1%, Import +23.1%
Sep: Retail Sales +23.2%, Export +21.5%? Import +21.3%
Oct: Retail Sales +22.0%, Export +19.2%? Import +12.4%
Nov: Retail Sales +20.8%, Export – 2.2%, Import -17.9%
You mentioned in earlier blog that Import fall cannot be all explained by commodity price fall and it implies big demand fall. Export fall (larger in RMB terms as you point) shows the slow down in production. Also, there is money contraction as you explain in this article, and wealth declined significantly with stock+property market decline.
So, what could be a possible explanation for the robust Retail Sales growth?
Could it be that
- retail sales growth captures only organized retail and the shift from traditional to organized retail is what it is?
- import is mostly for export and domestic retail consumption has nothing much to do with imported materials/goods?
- not enough people have lost jobs? or they have enough savings that they can get by without jobs? or the kids are spending more even if their parents lost jobs?
Would appreciate your thoughts.
jgu, if i may interfere, many chinese households fix their savings and then consume the rest of their income. not just chinese do this — it is mostly rich people who fix their consumption and then save the rest. since their consumer spending are fixed, if they have to spend more for one item they can spend less on others. i think this is the point professor is trying to say.
it seems to me that twofish is asserting the pork case other than making any argument. i have seen studies of previous inflations in china, and in every case the inflation followed money and credit expansion and was stopped by a decline in credit and money expansion. remember the mid 1990s, when zhou killed inflation by destroying money growth.
it has obviously happened again, and if you listen to chinese authorities, they way they have been cajoling the banks to stop lending last year and now to increase lending makes me convinced that you are right, professor.
because of the nature of chinese society, the first place inflation appears is always food prices. i don’t really think the money camp needs to prove the case since the real empirical evidence, not “asking one’s friends”, is pretty supportive of your view. of course the pork camp has never satisfactorily explained how non-food prices moved in the same direction as food prices.
TR,
How does the nature of Chinese society make inflation first appear in food prices? Could you please give some more explanation?
If the “standard inflation model” says that “the rapid decline in food prices should have automatically caused Chinese households to spend less on food and more on non-food consumption”, it cannot be right. Asset prices must also matter, especially in a country that saves as much as China. I note that the stock market seems to have bottomed out.
PS, I like the new website.
TR: it seems to me that twofish is asserting the pork case other than making any argument.
The basic argument is that unless you want to assert that Chinese monetary policy is powerful enough to have an effect on global commodity prices, it’s very hard to explain the link between Chinese inflation and inflation in Mexico. At least one should try. The basic question is that I can see how monetary policy in China should lead to inflation in China, but why should it lead to food inflation in Mexico or for that matter the United States.
It’s not money versus pork. It’s money versus oil. Once oil prices increase, you see corn get diverted to producing ethanol. Once that happens corn prices impact meat prices.
TR: i have seen studies of previous inflations in china, and in every case the inflation followed money and credit expansion and was stopped by a decline in credit and money expansion. remember the mid 1990s, when zhou killed inflation by destroying money growth.
And in each of those cases, the boom and bust cycle was not obviously correlated with global boom and bust cycles. In this case, it obviously (at least to me) is.
TR: it has obviously happened again, and if you listen to chinese authorities, they way they have been cajoling the banks to stop lending last year and now to increase lending makes me convinced that you are right, professor
The banks stopped lending last year. So why did you have a suddenly drop in prices this year?
TR: i don’t really think the money camp needs to prove the case since the real empirical evidence, not “asking one’s friends”, is pretty supportive of your view.
“Asking one’s friends” is quite empirical. The problem with statistical data is that you can miss a lot of things. Asking one’s friends is data. It’s limited data, but it is data. It can be unrepresentative and misleading data, but so can statistics.
All you have to do is to see if people you know spend less when food and fuel prices increase, and my experience is that they don’t.
Twofish,if the the peoples in china have to pay more for the pork,they will consume less,or they will consume less from something else,the only one exception is if somebody put additional paper money into the system.
This can be the only one explanation of the high inflation-everything else is just smoke and mirror from the autohrities.
Two things to note:
Anders: As the more risky business exports adventures crumble I fear we will see some of the darker sides of informal banking soon.
Maybe not. One of the things that you need to remember is that informal and even unregulated banking may not be safer banking. The thing about a lot of informal banking is that people are lending out their own money, and they are often much more careful about risk than formal bankers, which is why their interest rates are high.
The other thing about informal banking is that because they are small (and cannot expand without attracting the attention of the authorities), they often are much more knowledgable about who to loan out to. They it also changes risk benefits/rewards. If you have $10,000 of capital and you get wiped out, it makes a difference if you are $1000 in the red or $50,000. By contrast if you are a banker in an investment bank with $10M of capital, it really doesn’t make that much difference to you whether you are $1M insolvent or $50M insolvent. Either way you get fired.
A pawnbroker in Ningbo is going to know who in Ningbo can be trusted and who can’t more so than a banker in London, and they also will care more because they are lending their own money which is not the case with the London banker. China’s future Goldman-Sachs is probably some pawnbroker or money lender in some back alley somewhere (which is how Marcus Goldman got started).
If an exporter goes out of business but does it in a way that their debts are settled, then it doesn’t hurt the bank. It also doesn’t hurt the banking system if the bank has enough reserve to pull the loans.
This is one problem with bad banks, because if you have a very well capitalized bank (either formal or informal), the bank will not hesitate to pull the loans and write off the losses if they think that the situation is hopeless. If the bank isn’t well capitalized, then the bank will tend to want to throw good money after bad in order and renew bad loans since they know they cannot survive a collapse. (What happened in Japan)
The fact that you have people offering money is a very good sign. It means that 1) you don’t have a credit crunch and 2) you have lenders that are willing and able to lend money for things to make up for the loss of export industries.
Also the other thing that I’ve been hearing is that exporters are making tons of money right now. Demand has fallen off, but the drop in oil and transport prices means that they are making more profit. This makes sense since what is likely happening is that the subcontractors are getting killed as demand falls, but people still in the business are making more money. The big question is how this is affecting employment and demand.
I’m less worried about the economy now, then what will happen in six to nine months. Fiscal stimulus is very easy to turn on. But it’s hard to turn off.
The other thing about trade frictions is that I think that they will increase once you start having recovery. There is a lag between the start of a recovery and an increase in employment, and that’s the time when you have people that are more angry than depressed.
I’m broadly in the money (esp. velocity) camp, but I do have a question.
Your expectation of deflating non-food prices offsetting inflating food prices in a stable money environment seems to have an implicit assumption that we’d see both food and non-food prices move at the same time.
Indirectly adding a factor to RGB’s list, wouldn’t inventories play a role in how price changes show up? If food (a generally fast turnover product anyway) is in short supply, it follows inventories would be unusually low and price changes would show up quickly. Conversely, if non-food products aren’t selling, I’d expect the first effects to be a build of inventory up the supply chain, and only later deflation of prices. Depending on the product and the flow of information in the supply chain, would a few months lag be entirely out of the question?
I’m not sure I understand all the implications of the information presented in this entry.
If there is a decrease in inflation (deflation or disinflation) and the hot money inflows (which were supposed to be a source of base capital for the informal banking system) have decreased lately, does that means that:
a) the Chinese government has overshot in its campaign to restrict credit
or
b) a decrease in the profit margins of the Chinese companies (due to decrease foreign demand for Chinese goods) has left many small companies in limbo between the high rates of informal banking system and the difficult tot get low rates loans of the formal banking system.
Is there another explanation?
Prof Pettis, is option b) is correct, doesn’t it mean the government will have to resort to some form of printing or forced credit expansion and that will lead in turn to further devaluation of the yuan? Wouldn’t that indirectly increase the proportion of bad loans on the balance sheets of Chinese banks?
by 90% chance the chinese M2 data show abnormal movement.
If we can see a drop in the inflation,we have to say that the abnormal slow growth of the M2 connected to the low inflation.
If the M2 growt will be smaller than 0.22%, then the chinese M2 will behaving abnormaly by 95%,based on the previous 32 month.
Raw data,and std dev calc and so on:
http://bomlat.blogspot.com/2008/12/chinese-m2-movement.html
Sorry,the 0.22% mean that it have to be smaller than this in the next month.
My sense is that the Chinese are very worried. Compare China today to an old west mining boom town, where their lifeblood has been manufacturing for the world. If you follow this analogy, theyr vein has played out, with the sudden drop in EU and US demand.
A large negative reaction (ie, a swing from expansion to contraction) is not out of the question, macro analysis aside. The individual Chinese I know are very worried about it.
@RBG, food is always the number one problem and concern in populous China. Unfortunately, I learned from Chinese friends that the governments plans to adjust involve placing more of the food supply in the hands of newly created entrepreneurs (ie, farmland emigres now returning from the factory boom towns). Not necessary a wise idea to me.
Dear Professor,
My readers gave me your link because I talk about China a lot. I happen to be the daughter of one of the very first Americans to go into China to do business and teach DURING MADAME MAO’s YEARS.
She was one scary woman, by the way!
The Chinese government sent some of their high officials to live with me in America where I taught them all about capitalism and money. They then took to all of this like ducks to water, but ONLY after Dear Madame Mao was put behind bars.
About your blog: like Brad Setser, you have a gargantuan blind spot. Where is Japan in your commentaries? Did you know that Japan and China not only have very intense economic relationships but also very bizarre POLITICAL relations?
Do you read any of the diplomatic news from Xinhua? You should! It is a pretty good resource. Why, just this week, China, Japan and South Korea had a little meeting where they decided to form a very tight Asian economic forum that will EXCLUDE the US?
Ah! There are many things involved in all of this! I wish to alert you to a particular mess I witnessed in my house. I had the group read—I told them, they should memorize—Professor Kennedy’s great opus, ‘The Rise and Fall of Great Powers.’ I hammered into their heads that the country that had the physical factories could wage wars, the ones without this resource lost wars.
I hammered into their heads that CREDITOR nations win wars, DEBTOR nations lose wars. We talked quite a bit about WWIII and what would happen if the US unleashed its nuclear arms yet again, on civilian populations.
This was in 1986, we had this chat. Suddenly, Zheng said, ‘Ah, but if we be CREDITOR bank to US, and if we be FACTORY for US business, we win WWIII.’ I said, ‘Yes.’
So they cooked up this 50 year plan. It is now nearly half way done and way, way ahead of schedule. China now holds the most US debts. They also have a lot of our factories that are now located there, not here. They have many things they planned to get and are quite happy with their little plan.
They even told me, they didn’t want lots of billionaires gumming up the works and if the economy took off too much, they would crush these people to keep things firmly in control in Beijing. Indeed, reading news stories this last 12 months, I am convinced that they WANTED to see things go down a bit to keep control at the center of the Party business and to keep their 50 year plan going. Of course, you don’t have to believe a word I say!
But then, this whole business sounds utterly mad. Back in the 1980′s, I thought they were joking. But trust me, they were NOT joking.
By the way, they also said, they would pry Japan away from the US via the lure of cheap labor and China joining Japan when the US tries to stop Japanese imports into the US. Only when Japan joined the other G7 last year in a continuous attack on China’s currency, did China attack Japan’s currency.
And made the yen stronger starting July, 2007. Do note the G7 banking meltdown begin exactly one month later when the Japanese carry trade began to unwind.
You should read my own blog and focus on the Japanese carry trade. I have many cartoons explaining how it works, how it is being manipulated by China and how the US is totally stupid in all this.
Not an expert on this in any sense, but looks to be food prices/supply + inflationary expectations (we’re talking about a time period that saw gold and oil hitting ?!? levels) + PBC action (probably in reaction to what they saw coming enroute from NY and Europe but unfortunately preventive action with the wrong timing!)
Thw swing however looks to be quite disastrous, not going to be pretty especially with the new year round the corner. Hope you’re not disturbed by more worker “gatherings” around the parks/spaces round Beijing.
BTW, someone on your former site seems to want you to change the direction of your blog focus to something on every ill of the modern world, particularly China, wow, a student of yours perhaps?
Tyaresun, I think outflows will be partly a factor of RMB expectations and mainly a factor of concerns about riskiness in the financial system.
RBG, I am really not sure why retail sales were up so much. Note that many of the other demand-related measures are down – car sales, imports, air travel, electricity usage, etc. It may be that we are seeing high year-on-year numbers because of strong growth earlier this year. Month-on-month sales may be down, which is certainly plausible given the drop from October y-o-y to November y-o-y. Perhaps it is because the slowdown has first affected capital spending and big ticket times, and will only move into retail sales later. I am hoping an economist better than me at taking apart statistical data figures this out. As for TR’s point, I think it is just because food is such a large component of the Chinese consumer basket (between 30% and 40%).
RebEcon, you may be right, but that exacerbates the problem. Food prices are down, asset prices are down, and non-food is also down. That doesn’t sound to me like inflation/deflation was caused by food supply constraints.
Twofish, I don’t think you need to assert that Chinese monetary policy is powerful enough to have an effect on global commodity prices for there to be a relationship between Chinese inflation and global inflation. All you have to do it assume that there is excess liquidity growth in dollars globally, and that China pegs its currency to the dollar and so imports (and exacerbates) external liquidity conditions. Both of those statements seem true to me. By the way, informal banking is not necessarily small. Loans can be as high as $50-100 million.
CLN, all very complex questions, but I think increasing NPLs are almost a foregone conclusion. Depreciation is more complicated. The decision to change the currency is largely political, not market determined, and if they depreciate (a huge mistake, in my opinion) it will be because of domestic pressure.
Elaine, thanks for your comments and experience. I do know about the complex relationship between Japan and China, and I do try to keep it in my mind in trying to understand the Chinese economy, but in this case they are both on the same side of the balance of payments. I think cooperation between China, Japan and Korea is a good thing, but I am not optimistic that it will be very strong. There are deep economic and geopolitical differences between the three and a lot of mutual distrust.
Judy, there will almost certainly be more social disturbance. The government has been very clear that they are expecting it. As for the weird comments on my old site, I guess every blogger runs the risk of attracting some pretty weird and often not terribly smart comments. Some are more determined than others.
Michael: Twofish, I don’t think you need to assert that Chinese monetary policy is powerful enough to have an effect on global commodity prices for there to be a relationship between Chinese inflation and global inflation.
I’m arguing that there is a relationship and that relationship is that global inflation was causing Chinese inflation, and that the main driver for Chinese inflation was external commodity prices and dollar liquidity.
One could argue that China could have withstood those pressures with a tighter money policy, but there is a limit to how hard you can slam on the brakes without causing severe damage, and there is also a nasty time lag.
If China had tightening monetary policy more, then it would have started kicking in right when external commodity prices evaporated. The price of oil is one third of what it was this summer.
Michael: All you have to do it assume that there is excess liquidity growth in dollars globally, and that China pegs its currency to the dollar and so imports (and exacerbates) external liquidity conditions.
But in that case the “prime mover” of inflation was neither pork or money, but rather oil.
exVRWC: My sense is that the Chinese are very worried.
You should be always very worried. The more you sweat, the less you bleed, and the fact that people are worried about the future is often a good sign. I don’t know of any moment in the last 30 years, when there wasn’t something for people to worry about in the Chinese economy.
The time you end up with disasters is whenever in power no one is worried.