China’s inflation set to fall further

The People’s Bank of China published the latest set of monetary statistics, which are no longer reliable…

M2 Money supply grew by 13.0% yoy, well below the long-run pre-financial crisis average rate of around 16.8% yoy and slowest in many years, and less than the expected growth of 14% yoy, while M1 rose by 8.9% and currency in circulation increased by 12.7%.

New Chinese yuan loans in September amounted to RMB470 billion, which is below expectation of RMB550 billion, and well below the RMB 548.5 billion of new loans in August.  Total deposits in September amounted to RMB81.03 trillion, increased by 13.9% compared to a year ago.  Chinese Yuan deposits amounted to RMB79.41 trillion, rising 14.2% compared to a year ago.

At the end of September, Foreign Exchange Reserve US$3.20 trillion, which is also below expectation of US$3.33 trillion:

But I began by saying that the figures have become less reliable now.  And this is why: last month after the People’s Bank of China announced its monetary statistics for August, it published a short note on the money supply figures.  This is what it says:

China’s financial innovation has been growing, thus there has been more diversified products available for households.  At the start of this year, there has been a huge growth in banks’ off-balance sheet wealth management products, which is outside of the regular deposits.  The M2 money supply does not include these off-balance sheet products as part of the measurement, thus the M2 being reported has underestimated the money supply growth.  In order to understand the actually financial condition, we are looking at including these off-balance sheet products and developing a new M2+ measures.

Thus it basically says that the M2 measure is no longer reliable, and the credit creation in the shadow banking sector is not fully accounted for in monetary statistics.  So on the surface of it, the growth of money supply is slowing quite significantly in a recent months, a development which I very much welcome.  But the reality is that it has excluded a whole lot of other measures, which should have been included as a broad money supply measures.

So on the surface of the data, the monetary tightening is having some real impact on money growth.  In reality, no one knows.

Meanwhile, on the inflation front, Friday’s number did fall, the latest data from the National Bureau of Statistics shows that the headline consumer price index (CPI) inflation eased to 6.1% yoy in September from 6.2% yoy in August, in-line with expectations.  On a month-on-month basis, the headline number rose 0.5% vs. 0.3% in August, which is not so welcome.

Food prices are still leading the gain, with prices up by 13.4% yoy, unchanged from August, while non-food prices rose by 2.9% yoy vs. 3.0% in August.  Meat products are still the biggest gainer within the food category, which rose by 28.4% vs. 29.3% in August, coming down slightly.  On a month-on-month basis, good prices rose by 1.1% vs. 0.6% in August, while non-food prices increased by 0.2%, unchanged from August.

On another note, the producer price index rose by 6.5% in September vs. 7.3% in August, lower than the expectation of 6.9%.

The year-on-year headline figures have been coming off the high, but the month-on-month trend certainly does not look like inflation is solved.  However food prices are going to come off the high quite significantly, that’s according to the Bloomberg Brief’s Michael McDonough:


Given the high weight of the food basket within the CPI, we may see a more meaningful fall of the headline figure next month, but probably still way above 5%. Even with inflation coming off, however, the full-year overall target of 4.0% is lost. Overall, some progress on inflation.

For now, the probability of further tightening looks extremely low given the global macro picture as well as the local government debts and shadow banking crisis concerns, though it is hard to argue for outright easing as well as inflation will still be above target for quite a while.  I do not expect any real tightening or easing for the moment.

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  1. This article seems to be predicated on a belief that M2 can in some way predict the direction of inflation.

    Can the author point to a country where that is the case? Maybe start with USA M2/inflation and Aussie M3/inflation.

    Even the first two charts show that M2 in China is not a predictor for inflation. For the 3 years from mid 2005 to 2008 M2 money growth is fairly flat. The next chart however shows the CPI rising steadily (in part steeply) over the same period.

    • That was my linkage so have altered it because I don’t want to put words in the author’s mouth. However, the relationship, such as it is, between M2 and inflation is uncontroversial.

      • Uncontroversial? Would that be in schools of economic thought that don’t bother with empirical data??

        I just went over to the FRED website and plotted YOY M2 and CPI. No positive correlation at all. In fact the correlation is inverse — the largest growth in M2 corresponds to declines in the CPI.

        The only period where a weak correlation exists is post 2010!

        If this really is uncontroversial it looks like yet another example of the failure of economic theory.

        I’ll email you the chart.

        • Many mistake as labelling changes in prices as inflation. It is not. Inflation is a pure monetary phenomenon (changes in money supply).

          Changes in prices are just that – changes in prices. They can be caused by a number of factors including demand, supply and inflation.

          Generally, one would expect excessive increases in the money supply (inflation), which has been happening internationally, to eventually lead to an increase in prices due to a larger supply of money. However this is not necessarily the case and even if it were, it could have a long lead time.

          • Using your definition of inflation (which I am not arguing with for the purposes of this reply) there would never be any need to talk about money supply growth and inflation because they have been defined as being the same thing. i.e. there is no relationship, they are two descriptors of the same phenomena.

            Therefore a discussion of a relationship between money supply growth and inflation implies a different definition of inflation (to yours) by those making the discussion. It was in that context that I have been making comments to this article.

        • I’ve said it before and I’ll say it again: Guest posts from you would be a most welcome addition. Having read your profile it would be a bonus to have the benefit of a contributor that has a long-term view re the resources story combined with eye for evidential support on a range of economic issues.

          I enjoy your analysis of Zarathustra’s posts – you challenge his broad statements and often loose conclusions. Zarathustra can be a little patchy (I’ve said that before too).

          • No worries. I added some more stuff on the link. If you want more of my analysis offer me a job. I might be looking for something in 2012 🙂

  2. Hi Carl great links, that FRED database is awesome! Especially for non-financials who may not have access to the same number of well organised databases.

    As an extra, Steve Keen has demonstrated that growth in M1 generally has little bearing on growth in M2. Since 1930 it has been M2 that has led M1 creation, not the other way round. The data suggests money is created endogenously, not by central banks.

    However this relationship has broken down in the last 2 years in the US, with M1 growth finally leading M2 growth.

    As you point out, there doesn’t seem to be any direct correlation between M2 growth (and thus M1 growth) and CPI, except for the last year and a half. However it bears reminding that CPI now is the same as it was in 2007, but with vastly different levels of M1 and M2 growth. So while QE might have boosted stock prices, it appears that direct links to CPI cannot yet be proven.

    If inflation is caused by a combination of supply, demand and money supply is there data series in FRED that can prove/disprove this?

    Also are you aware of any data series that are strongly correlated with inflation?

  3. Zarathustra may enjoy this Micheal Pettis post where Pettis challenges the assumption that China raising interest rates restrains inflation.

    and he also provides a link to a new blog which could prove to be quite interesting:

    On China Economics Seminar, graduate students in economics and finance at China’s Peking University analyze and discuss China’s monetary and macroeconomic issues.

    Both provide a model of the level of analysis Zarathustra may endeavour to adopt in the future.