The view I have been forming of near-term inflationary pressures is that we’re seeing two very different dynamics in play, with the dollar prices of things the Chinese can stockpile and import going up and the dollar prices of everything else (like U.S. wages and rents) under significant downward pressure. The last week seemed to bring some reprieve on the first front.
I wondered what to make of this story from the Wall Street Journal on January 27:
Several state-run Chinese banks have ordered some branches to suspend new lending for the rest of this month, suggesting a coordinated effort by Beijing to manage state banks’ torrid lending in the year’s first few weeks.
A person with direct knowledge of the matter said Tuesday that Industrial & Commercial Bank of China Ltd., the country’s biggest lender by assets, last Friday ordered its branches in Beijing not to issue any new loans for the rest of January.
China Citic Bank Corp. also suspended new lending in Shanghai last week because its local operations have already used up their monthly quota for new loans in the city, a Shanghai-based official at the medium-sized bank said Tuesday. The Citic Bank official added that both the bank’s own headquarters and the People’s Bank of China, the country’s central bank, “have told us to control the pace of lending this year.”
The moves by the two state-owned banks follow similar steps taken last week by state-run Bank of China Ltd.
I’m not sure how significant that is, but thought it made interesting reading side-by-side with earlier anecdotal accounts of Chinese speculative buying and a graph of what happened to commodity prices following the Chinese tightening.
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After your quote of the WSJ’s story, you say “I’m not sure how significant that is”. None really knows how significant the government’s decision to limit lending for a few days (at most the last week of January) could have been. The reason is very simple: none knows how today the state banks work.
I spent more than three years (1994-1997) there trying to understand how the reforms implemented after the 1993 inflation were going to change the state banking system. Indeed in the past 12 years state banks have continued to change their organization and behavior, but I don’t know anyone that really can say how government policies are being implemented by the state banks. And when I say none I include the brilliant PBC governor Mr. Zhou X., PBC deputy governor Mr. Yi G. (he used to teach in Indiana U.), other PBC’s high level staff, and PBC Graduate School’s professors. If you want to do our own research on this issue I suggest that you contact Ms. Wu Xiaoling and Mr. Tang Xu at PBC’s Graduate School. Both have been involved in the many reforms and policies of the past 16 years. Good luck and be patient.
Now let me comment on inflation. First, although you link to your previous post on inflation in China, I’m glad that at least you don’t mention your wrong idea of a monetary-induced boom in China.
Second, regardless of how the state banks work, there are a few things that the Chinese government can accomplish through the state banks: (a) Between 15-20% of state bank deposits are invested as reserves in PBC and the government controls these reserves, and (b) The government may have some control on the investment of Beijing’s deposits with the HQ state banks (one critical issue in understanding the state banks is the degree of decentralization of their decisions). Since the FLOW of deposits into the state banks appears to be as large as in the past 10 years, the government can control a large amount of people’s flow of savings. They may have changed the investment of this flow into commodities (particularly copper, BTW I’m writing from Chile so don’t be surprised if I know the copper market) and their dollar prices may have been reflecting the changes in policy. But regardless of these fluctuations, the dollar prices of copper and some commodities will remain two or three times higher than their 1950-2000 average with important implications for the world economy, especially if the supply of these commodities is restricted by government intervention (as to a large extent has been happening in the past 6 years). In sum, despite the fluctuations of the dollar prices of copper and some other commodities, they will continue to be much higher than in 1950-2000 but not as high as in 2007 and most of 2008.
Third, that conclusion about the dollar prices of commodities points to your other source of concern: significant downward pressures on the dollar prices of everything else. Two or three years ago I suggested to pay attention to Latin America’s structuralist position on inflation as developed by Julio Olivera who claimed in the 1960s that under some conditions changes in relative prices led to inflation. In the past 6 years there should have been a much larger change in relative prices than we have observed so far. The question is whether the change in relative prices will be through inflation (additional increases in the dollar prices of commodities) or through lower prices of everything else. I bet on inflation, especially if the supply response of commodities is weak. (BTW: you may have heard that yesterday the IMF recommended some EU countries to lower salaries as part of their domestic adjustment to their terrible fiscal imbalances–and since you’re in Cal you should not be surprised of a much greater downward pressure on salaries).
James, sorry. I also posted the first comment.
It seems Chinese bank regulation is ham-fisted at best. Unfortunately the reporting is beyond sketchy.
This is from an article at Caixin, “Lending Takes a Dip After PBOCs Moves,” that contained this gem:
“However, some local governments appear to be ignoring the mandate. In a city in southwestern China, local bank branches with aggressive lending were rewarded with generous bonuses. The branches of the central bank and the CBRC (China Banking Regulatory Commission) in the city were also given bonuses comparable to bank officials.”
The regulators received bonuses based on the aggressive lending by banks.
http://english.caing.com/2010-02-01/100112740.html
[Hu Shuli, the former founding editor of Caijing Magazine, brought most of her well-regarded staff with her to Caixin.]
And a Bloomberg article contained this:
“Almost 40 percent of buyers of luxury residential properties worth more than 10 million yuan last year in Shanghai were from overseas, the person said. The CBRC found one case where 38 foreign citizens who never entered China managed to take out mortgages from a bank in Shanghai through their agents and lawyers, without providing necessary documentation, according to the person.”
That is something that, officially, the regulators would insist can’t happen.
http://www.bloomberg.com/apps/news?pid=20601087&sid=a8436CVMALBY&pos=4
U.S. equity markets also lost around 2% the last 3 trading days of January. If speculators come to ‘believe’ a correlation between Chinese lending and asset prices exists (whether real or not), then any contraction or expansion of Chinese lending will eventually lead to momentum swings initiated by Chinese lending announcements. If China thinks the dollar price of a commodity (or risky asset) is ‘too high’, they simply announce a lending restriction and speculators instantaneously drive prices down. This is a frightening scenario, assuming that China’s influence on world markets will only get larger in the years to come.
Everyone’s wondering how significant China’s recent tightening will prove to be. The clue that I would point to is that there was a pretty radical burst of lending in early January, apparently because banks had wind that a tightening was coming. So while the methods of the tightening were severe and alarming, the absolute extent of tightening seems less so. I think that explains why commodities initially sold off severely, and have recently been recovering as people have had time to assess what was really going on behind the scenes in China, and as the Fed reiterated its commitment to current rates for an “extended period”.
But this is a space that we should all keep watching. The inflationary effects of monetary stimulus occur where the money flows. The most obvious place where new money is flowing is US housing, where it cushions the ongoing bubble implosion. Some also is reaching US consumer goods markets, where it cushions the ongoing deflationary forces of the recession. Much is heading into securities markets, driving up valuations and driving down yield spreads, and thus fomenting new misallocations. And much is heading to emerging markets, particuarly China, where it is converted into commodity price inflation due to the Chinese governments policy of suppressing general imports while directing current account surpluses into subsidies of commodity-importing industries.
US commodity traders have been trading based on what they think China is going to do, ever since they caught wind that China started stockpiling, and then stimulating.
I don’t think there is any strong direct US equity-China link however. In that case, I think there is growing concern that stock prices have gotten far ahead of where the economy is going.
In a Reuters’ breaking news (http://www.reuters.com/article/idUSWEN960720100203?type=usDollarRpt)
I read
On China, Obama says US must address currency rates
Wed Feb 3, 2010 10:43am EST
WASHINGTON, Feb 3 (Reuters) – President Barack Obama said on Wednesday China and Asia would be a huge market for U.S. exports going forward but it would be important to address currency rates to ensure American goods were not facing a disadvantage.
Neither hope nor change.
I am fascinated by China’s approach to the control of the money supply. Please let me know if my understanding is correct.
In the US, the Fed control the money supply by indirectly influencing credit demand with setting of interest rate. Notice the Fed’s control doesn’t directly control the supply of credit. This means, during boom time when rationality goes out the window, investor may continue to demand credit even when interest rate is high. The supply of credit will still be there for these irrational borrowers that are willing to pay.
In China, the central bank directly control money supply by setting bank lending quota. Notice the control is very direct. Even if a borrower is willing to pay the high interest rate, the borrower cannot borrow once the bank lending quota is used up. During a boom when investors become irrational, this could be an affective the safe guard.
At any rate, I love to hear what others think of these two approaches to managing money supply.
Heresy!
Turning money supply on and off like a common public water utility! It could never work.
Sir Cedric,
When the east wind blew (or was it the other way ’round), England’s central bank of yore, knew it had to turn on the spigot. And they did it how?
silly things?
As an example of states interventionism in the credit growth, France under the presidency of Valery G d Estaing and R Barre governance of the ministry of finance imposed a limit on banks credit growth.
Both money supply and credit were administered stringently,through minister of finance and reports to Banque de France.
In essence Banks assets were granted a growth limit as a percentage of their reporting loans assets at a given period.The gray market of non utilized credit growth (very scarce and expensive) was available at high cost,when needs to supplement the credit growth allowance would arise.
These measures and a balanced budget brought France macro accounts to an economic equilibrium never reached after.The therapy was socially demanding and required a large confidence in the financial system,its actors,its ethic, and its credit allocation.
May be worth exploring this thread content.
http://www.jstor.org/pss/421665
Rob,
Depends when in Her Majesty’s England and Scotland history.
Join The Royal Navy was always a popular way, but surpassed in recent history by join The Royal Army.
Then there were all the normal ways, like mortgages, and a few not so normal ways, like allowing broker-dealers to pledge 100% of their client’s portfolios as collateral for overnight repos to fund leverage. (Lehman – Britain was one, hedge funds clients are now suing to get their portfolios back)
But here is a story about how it works in the USofA in present times.
http://www.nakedcapitalism.com/2010/02/rosner-has-the-new-york-fed-been-serving-the-public-trust-has-geithner.html
Thanks Cedric,
That is a doosy of an article… and what follows is a different vein, or at least seemingly when CBs were on the up and up;
“…The problem is that over short periods the link between the money supply and inflation is fickle, because the demand for money moves unpredictably. The Bank of England’s early days provide a good example. Uncertainty over exactly when ships laden with valuable commodities would arrive in London could cause unexpected shifts in the demand for money and credit. The uncertainty was caused by many factors, notably changes in the direction and the speed of the wind as ships came up the river Thames. The bank’s Court Room therefore had a weather vane (still there today) to provide a surprisingly accurate prediction of shifts in the demand for money. Sadly, no such gauge exists today. Financial liberalisation and innovation have also distorted measures of money, making monetary targetingall the rage in the early 1980sunworkable…”
http://www.economist.com/businessfinance/displaystory.cfm?story_id=E1_VGGNGQS
Rob,
haha. I wasn’t aware of that one and didn’t even know you could do it with a weather vane.
But, when The Economist is right, they are right.
It did get more complicated….
“The imminent round 2 of the foreign bank dollar funding crisis, or the eurodollar squeeze redux”
http://www.zerohedge.com/article/imminent-round-2-foreign-bank-dollar-funding-crisis-or-eurodollar-squeeze-redux
Despite all the centralized decision-making shenanigans in China, copper is still trading at over US$3/lb after the nastiest recession in the post-war period. Stunning.
Oil stockpiling had decreased significantly since early 2009. Forward capacity is up, well above 5-year averages. But benchmark prices remain stuck above US$70/barrel.
I suppose monetary policy is attempting to drive down the value of the US dollar to help boost US exports. This policy will come at the sacrifice of considerable American wealth. But in the best sleazy tradition of the Neo-classical-Keynesian synthesis policy approach, most Americans are not supposed to notice in drop in wealth.
Inflation-targeting is supposed to incorporate a policy of full central bank transparency. It is not at all clear to me that the Bernanke fed is being fully forthcoming with the American people.
Sir Cedric,
What an interesting link the latest zerohedge article proved to be; I gambled that the $ would surge back in Nov, contrarian like. What interests me is that my premise was somewhat wrong? (another flight to safety not a “we aint got no $ to lend”?). Better to be lucky than smart?
Royalty Rob,
I went to cash in November, on the combination of the first sign of reversal of the dollar index, combined with COT data indicating everyone short dollars, along with all the talk on CNBC of the “short dollar and go long _____(insert anything)” trade. I was all in foreign bonds.
One thing I got surprised by in the last crisis driven credit crunch is that a lot of short term lending is done in dollars world wide, and when lenders don’t want to continue doing it(this is called de-leveraging), borrowers have to scramble for dollars to pay off revolving loans that stopped revolving. This is why Bernanke did the big currency swaps so other CBs could provide exchange for their local dollar demand.
I didn’t understand that fully, and couldn’t figure out why the epicenter of the financial crisis had a rising currency. After leaving a few bucks on table, I finally figured it out (or read someone who understood it) and bailed.
So really you weren’t far off,”we aint got no $ to lend” is really a subset of “flight to safety”.