Pettis on yuan

From Michael Pettis this week:

On Friday last week the National Bureau of Statistics released the eagerly anticipated first quarter data.  As has been widely reported, first quarter GDP was up 9.7% year on year. CPI inflation 5.4% in March, a 32-month high, and up from 4.9% for the first two months of this year.  For the first quarter as a whole CPI inflation was 5.0%.  PPI inflation for March was 7.1%.

Here is what the NBS said:

According to the preliminary estimation, the gross domestic product (GDP) of China in the first quarter of this year was 9,631.1 billion yuan, a year-on-year increase of 9.7 percent.

The value added of the primary industry was 598.0 billion yuan, up by 3.5 percent; that of the secondary industry was 4,678.8 billion yuan, up by 11.1 percent; and that of the tertiary industry was 4,354.3 billion yuan, up by 9.1 percent. In the first quarter of 2011, the gross domestic product went up by 2.1 percent on quarterly bases.

Both CPI inflation and GDP growth were higher than most analysts expected, although, needless to say, by the Wednesday before the release my colleagues at Shenyin Wanguo were hearing gossip that turned out – yet again – to be remarkably accurate.

So what do these numbers mean?  Frankly not too much.  We are continuing to see the pattern of the past two or three years in which growth slows sharply in response to overheating fears and then accelerates as Beijing worries about the pace of the slowdown.

… In response to the high growth rates over the weekend the PBoC raised the minimum reserve requirement for the fourth time in 2011.  They also announced that they will employ administrative measures to address worries about overheating.

According to an article in last Friday’s Financial Times:

China has imposed strict price controls on basic consumer items and is expected to allow faster appreciation of its currency in the coming months after annual inflation in the country reached its highest level in nearly three years in March.  In a speech this week to the governing State Council, Chinese Premier Wen Jiabao said Beijing would, along with other policy measures, “further improve the yuan exchange rate mechanism and increase yuan exchange rate flexibility to eliminate inflationary monetary conditions”.

Analysts said this was the first time Mr Wen had publicly and explicitly mentioned the renminbi exchange rate as a tool for fighting inflation, and this reference meant Beijing was likely to allow faster appreciation to counter rising global prices of oil and other commodities.

Perhaps we will indeed see faster appreciation of the RMB in the next few months.  The market certainly seems to be expecting it – in my central bank seminar on Sunday a trader at Citibank told the class that the demand for RMB-denominated assets is so strong that dim sum bonds are actually trading at negative yields.  If I remember correctly she mentioned yields of -1.5%.

It is some good news, if proven correct, that the yuan is set to rise. I’ve felt for months that raising interest rates to address a problem emanating from the currency was self-defeating. But that is not the end of it. Pettis also argues that credit remains very loose, with a novel twist

As for Sunday’s reserve hike, my colleague and former student Chen Long at Shenyin Wanguo points out that even with all the recent hikes, overall liquidity in the market is still high:

Liquidity in the inter-bank system is sufficient as foreign exchange purchases by the PBoC have exceeded expectations despite the trade deficit.  Lending quota restrictions, however, have made it harder for borrowers in the real economy to get bank loans.

In the first quarter of 2011, new bank loans amounted to RMB 2.24 trillion, but new bank deposits reached RMB 3.98 trillion. A possible reason for this is that off balance sheet trust-linked wealth management products have been moved back onto balance sheets. The incremental loan-to-deposit ratio is just 56%, much lower than the normal ratio of around 68%. This suggests that banks have set aside a lot of cash as excess reserves. We have heard that the excess reserve ratio for the big banks has reached 3%, so the recent RRR hike will have a limited impact.

I will get to foreign exchange purchases a little later, but as far as credit conditions in the market go, it seems there is a bit of a paradox.  By some measures credit is very tight and borrowers are desperate to gain access to the limited loan quotas, and by other measures the market is drowning in liquidity.  To return to Chen Long´s comments:

Another highlight last week was the release of total social financing (TSF) data. TSF amounted to RMB 4.19 trillion in the first quarter of 2011, very high, but down RMB 322.5 billion compared to last year. The drop is mainly due to the decline in bank loans and trust loans. This came as a result of the restrictions on bank lending and the fact that banks could no longer issue off-balance-sheet trust loans and had to move outstanding trust loans back onto their balance sheets.

Companies continued to look for other channels of financing given what seems like the tight lending quota – that is what increases in the other components of total social financing usually mean.  Bank loans accounted for 53.5% of total social financing, down from 57.6% in 2010, and the proportion of entrusted loans and corporate bonds increased. Credit, in other words, is expanding much faster than the already rapidly growing loan and deposit numbers would suggest.

So is credit growth tight?  A lot of analysts are saying that it is, but I have a different view.  It seems to me that credit expansion is so great that it isn´t really useful to think of credit conditions as being tight, even though so many borrowers in the economy are desperate to access credit.

Instead I would argue that investment – especially infrastructure, SOE and other official investment – is so great that it is managing to overwhelm what would otherwise be considered very loose credit conditions. If credit were in fact tight, growth would slow dramatically but at least we would be rebalancing the economy and limiting future demand on household wealth transfers.  As it is, I don´t think we are rebalancing at all.

What is most interesting to me about Pettis latest musings is what is missing. For months he has confidently predicted that the PBOC will get get prices under control. That contention is gone.  At this point, the Chinese blowoff scenario that culminates in a hard landing still looks a risk.

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.


  1. Gotta question the growth figures release by the Chinese centralist government. If real GDP growth drops below 8% then unemployment starts rising with no social security structure in place. Will China have a revolution? When people loose everything and have nothing left to loose – that’s when they’ll loose it.

    China’s economy is 2/3rds export based. As America and Europe keep declining and China’s local economic stimulus program comes to an end, it ain’t gonna be pretty for Australia’s mining sector.

    Will China revalue it’s Yuan and dilute the value of its holdings in foreign debt? Depends what happens to the US dollar with QE3 and maybe a QE4. Like any investment, after weighing all options, there comes a point where you would seriuosly look at jumping ship and cutting your losses.

    The following are extracts from the latest issue of The International Forecaster – Bob Chapman.

    “After eight years of increasing money and credit, and the creation of a real estate bubble, the US Federal Reserve has been fighting off asset destruction with ever more money and credit accompanied by debt deflation. Part of the Fed’s policy has been zero interest rates, which has helped Wall Street and banking and to a limited extent real estate, but has destroyed the purchasing power of retirees and has driven funds into speculation, which in many cases has ended in ever more losses and less buying power.”

    “The bailout of financial institutions by American taxpayers, both in the US, UK and Europe, won’t be allowed to happen again. In the next go-around they will go bankrupt. Those in the US and other stock markets with the exception of gold and silver shares, those in bonds, derivatives and hedge funds, will be wiped out as well. Few will be spared.”

    Makes you want to run for the hills!

  2. This Pettis quote sums up why China is an accident waiting to happen:

    “Instead I would argue that investment – especially infrastructure, SOE and other official investment – is so great that it is managing to overwhelm what would otherwise be considered very loose credit conditions”

    The regional governments instruct the SOE’s to continue investing in plant so they can report a high regional GDP number to the central government. Meanwhile the banks are instructed to continue lending in what amounts to massive regulatory forbearance.

  3. “Instead I would argue that investment – especially infrastructure, SOE and other official investment – is so great that it is managing to overwhelm what would otherwise be considered very loose credit conditions”

    and China is NOT different!