A report in today’s China Daily says:

Second-quarter housing prices in 70 large and medium-sized Chinese cities rose 9.2 percent year-on-year, said the National Development and Reform Commission and the National Bureau of Statistics on Monday.  The rise was 1.8 percentage points less than in the first quarter.

One of the regular debates on this and other sites is over whether there really is a problem of excessive hot money inflows, as I have been arguing for over a year.  If stock market and real estate prices are collapsing, skeptics ask, then how can hot money inflow be excessive?  Where does the money go? 

Aside from the fact that there are many other places where hot money can go (commercial bank deposits, deposits in informal banks, and commodity hoarding are just three of the most obvious), I think we have to distinguish between slowing growth in real estate prices and declining prices.  There are declining prices in certain real estate sectors – for example in some of the major cities – but overall prices still continue to rise, even in spite of what seems to have been massive overbuilding.  It is hard to prove this, but the combination of overbuilding, hot money inflows, and all the gossip about SUVs carrying armed men in sunglasses and bags of cash suggests plausibly that hot money inflows have managed to keep up demand for real estate in what otherwise might have been a sharper supply/demand imbalance,.

Gregor Neumann, in the comments to Friday’s posting, cites a piece that argues that at least some property markets in China are seriously oversupplied, and yet we haven’t seen a real collapse in real estate pri

As expected, the National Bureau of Statistics of China released a new set of economic numbers today.  According to the release, CPI inflation year on year for June was 7.1%, its lowest level since January.  It was 7.7% in May, 8.5% in April and 8.3% in March.  On a month-on-month basis CPI declined by a little under 0.2% (following a 0.4% decline last month).  This is more or less in line with expectations.  The information is presented a little differently than it has been in the past, and I cannot back out the food and non-food components.  I am hoping some cleverer analyst will be able to do so, but so far I haven’t seen anyone else provide a breakdown.

PPI numbers, also as expected, were much worse.  PPI prices rose 8.8% year on year in June, compared to 8.2% in May, 8.1% in April, and 8.0% in March.  I have already pointed out many times before that as the CPI numbers become increasingly tainted by price controls, more and more of us are looking at PPI to get a sense of underlying inflationary pressures.  I think any sense of relief prompted by the continued decline in CPI inflation will be held in check by the frankly very poor PPI numbers.

On a related topic today’s Financial Times has an interesting article by Jamil Anderlini and Geoff Dyer with the rather worrying title “China on the brink of electricity shortfall.”

China faces its worst power shortage in at least four years as soaring coal prices and government-set electricity tariffs force dozens of small power plants to shut down rather than face mounting losses.  Nearly half of China’s provinces have started to ration electricity as the country enters the peak summer season, facing what analysts descri

The stock market had another bad day today, with the SSE Composite trading more or less straight down to 2657, before rallying in the last 30 minutes to close at 2706, down 2.65% for the day.  According to Bloomberg, China has overtaken Vietnam to become the world’s worst performing stock market year to date.

Several things drove the decline.  The market is still very worried about the threats of a slowing economy and rising costs, and their impacts on corporate profits.  On the positive side, this has seemed to suggest in the past that the authorities would loosen up on money and credit conditions.  But the market is also nonetheless very concerned that the financial authorities will maintain a “tight” monetary policy – i.e. raise interest rates, hike minimum reserve requirements, or otherwise constrain lending growth.  According to today’s China Daily, “Chinese shares declined for the second day on Wednesday, led by property developers and banks on concerns they would be further pressured by the continuing tightening monetary policies.”

There continues to be a lot of confusion about government intentions.  Recent statements by several very senior leaders seemed to suggest that they were downgrading inflation as their top concern and turning more worriedly to slowing economic growth.  I still think this to be true, but the RMB has continued to rise and we continue to hear very hawkish statements about inflation and the currency.  We get a bunch of economic data tomorrow, and I hope these new numbers will provide us with a better sense of what is happening in China.

As an aside I had lunch with a group of investment bankers today to discuss monetary

After a decent day Monday (up 0.7%) the market today took a beating today, with the SSE Composite closing at 2779, down 3.4% for the day.  The decline was probably partly caused by mortgage fears in the US (insurance companies and banks, who may be big holders of Freddie Mac and Fanny Mae, led the declines), but worries about a slowing domestic economy were likely to be the biggest concern. 

There has been mixed news on the whether or not inflation is still the top worry.  There have certainly been a lot of statements that suggest that the authorities are very worried about a slowdown, and even some suggestions that they are willing to put the fight against inflation on hold, but a statement released by the NDRC yesterday, in which they said that “upward pressure on prices remains strong” seemed to dampen at least some expectations that the government would loosen up on the monetary side.

I am still a monetary pessimistic.  I think the balance of opinion, or at least the opinion that matters, is tilted towards putting inflation-fighting on the back seat and worrying more about a possible slowdown.  I am worried that our inflation respite is going to be temporary.

On the other hand today’s Sydney Morning Herald has a very interesting article by John Garnaut (“Chinese calls for yuan rise to ease inflation”) that was sent to me by Jonathan Lerner, and I haven’t seen any other reference to the story.  The article starts out:

A GROWING number of top Chinese economists are advising their Government to consider a currency revaluation to fight persistent inflation and destabilising "hot money" capital inflows.  “The Chinese currency shoul

The idea of “dangerous” lending that is likely to be caused by excess control of parts of the system (their forced piling up of PBoC bills and minimum reserves) and by current monetary and credit conditions is something about which I have had a surprisingly hard time arguing, both with Chinese and with foreign analysts.  I am not sure why, since in most markets this is fairly well understood, and given the ongoing crisis in the US, the idea that seemingly smart banks can do some pretty dumb things during optimal times is getting quite a lot of newspaper coverage. 

None of this is new.  Hyman Minsky in particular, has long argued that it is impossible to protect financial systems from periodic crises because the very conditions designed to prevent instability are the ones that create the incentives for bankers to take excessive risk – usually in less well-monitored areas – that end up ensuring that at some point the system will go through a period of “adjustment” and distress.  The empirical evidence that loose monetary conditions and implicit or explicit credit guarantees lead to banking crises is also pretty ample.

I can’t prove it, of course, and no one will be able to prove it until we have our own contraction, but I would be willing to bet that over the last few years the banks and the financial sector in China have been engaging in behavior that will one day seem self-evidently dangerous.  That is both the biggest risk of a sudden revaluation and the strongest argument for doing it as soon as possible.

Speaking of monitoring the banking system, I saw another very interesting piece, this time in ChinaStakes.com (“Government Moves to Legitimize Underground Lending in Zhejiang”).  The title says it all, but here is what the article says:

In Zhejiang Province, with the mo

The Shanghai stock market capped yesterday’s 1.5% decline with a further decline today of 0.7%.  It’s still been a great week, up nearly 8%, but the party, at least for a while, seems to have ended.

At least one government official is, alarmingly enough, wondering if there are ways to manage the process better.  According to an article in today’s China Daily:

It's necessary and urgent to set up buffer funds to confront big speculators and stabilize the mainland market, a senior official said.  Jiang Lianhai, head of Jilin provincial securities regulatory bureau, published an article in Shanghai Securities News yesterday, which pointed to the necessities, functions and capital resources of launching a buffer fund. Later, an official from China Securities Regulatory Commission reiterated the view in an interview with China Daily.

In the article, titled "The capital market with Chinese characteristic calls for a buffer fund", Jiang said that in recent years, international hot money has flooded into China's stock market and real estate sectors. Some international speculators are planning to buy cheap stock when the market is sluggish and close out in a high price. "If the government does not have an effective tool in hand, it will be dangerous."

One of my Peking University students sent me the article, highlighting the last two sentences.  His sardonic comment: “Nothing can be worse for China than to allow foreigners to make money.”  

He was being sarcastic, of course, and I am glad to see that my students are sophisticated enough to laugh at this kind of comment (a very widely held view here, by the way), but it is a little dismaying that a senior government official would say something that even an undergraduate would find so silly.  There is plenty of evidence that hot money inflows are driven mainly by Chin

Even the growth of monetary aggregates, which in yesterday’s entry I explain why I don’t consider too seriously, is high, again especially considering they are also growing from very high bases.  My student undergraduate Liu Bing kindly interrupted his internship at Van Eck in New York to send me the following data.  In May the year-on-year growth in M_O, M₁, and M₂ were, respectively, 13%, 18% and 18%.  For reference purposes, according to Deutsche Bank, M₂ is expected to be 164.0% of GDP this year, up from 156.3% last year.  That is a pretty high base from which to grow.  The growth in PBoC liabilities, by the way (and this is the indicator that most impresses me), was 31% in May, from an already astonishingly high base.

So far none of these numbers seem to indicate anything approaching “tight” monetary conditions.  Perhaps the reason why many people believe, according to Paul, that Chinese monetary policy is tight is conflated with concerns about an economic slowdown. 

These two issues are very different.  I think it is possible for China to have excessively loose monetary policy and for the economy nonetheless to be at risk of a slowdown.  In fact I think both are highly likely.  Next Monday I have been invited to speak on CCTV’s Dialogue, the country’s main current events program, on the topic of stagflation.  I have found that this program often discusses issues that are being widely debated among the country’s leadership and analyst community, and in the five shows I have done this year, stagflation has been one of the main topics of discussion (the others being inflation and the currency regime). 

The stock market rally finally stopped today.  After trading up most of the day, by over 1%, the SSE Composite lost its legs in the last hour of the day to close at 2876, down 1.54% for the day.  I guess the main reason for the fall was the release of trade numbers, which suggest that export growth is slowing sharply.  The trade surplus for the month of June was $21.3 billion, compared with $20.2 billion in May and $26.9 billion in June 2007.  I suspect the real trade surplus would be even lower if there were some way to strip out speculative inflows hidden in the invoicing of trade transactions.  Here is what today’s Bloomberg says:

Overseas shipments grew 17.6 percent from a year earlier, the slowest pace in four months, after gaining 28.1 percent in May, the customs bureau said on its Web site today. That was less than the lowest estimate of 23 economists surveyed by Bloomberg News.

Predictably, this has caused renewed calls for a slowing down of RMB appreciation and a loosening of (what they still call) “tight” monetary conditions.  I won’t do the broken record routine and explain why I think this is a mistaken interpretation of the causes of the export slowdown (which has far more to do with a slowing global economy and rising wages in China, neither of which will be positively affected by looser monetary conditions) and is a potentially costly mistake, but I will say that it is going to be harder than ever for the monetary alarmists to maintain their already-weakening grip on policy.  My favorite source on the politics of Chinese finance is Victor Shih, a professor at Northwestern, and he has this to say on his blog:

What we see

This is turning out to be a great week for the Chinese stock markets.  After pausing for breath – it rose a mere 0.8% yesterday – the SSE Composite continued Monday’s 4.6% rally to gain another 3.8%, all of which rise came in the morning.

What drove it?  Aside from lower international oil prices, largely two things, I think.  First, the markets continued to be buoyed by Premier Wen’s comments over the week-end that suggested that the government was more interested in policies to boost growth than in policies to combat inflation and overheating (the “two prevents”).  Second, there are strong rumors that June year-on-year CPI inflation is going to come in at 7.1%, a big decline from its March 8.7% year-on-year increase.

These are both terrible reasons to be bullish.  I’ve already written Monday why I think the government’s reorientation from anti-inflation to pro-growth is a bad thing.  For very similar reasons I think the “moderation” in CPI inflation indicates very little of value.

The CPI numbers have become less and less valuable as an indication of China’s underlying inflation pressures because they have become so tainted by the under-counting of the food component of the basket as well as by the many price controls on goods in the CPI basket, which have had the effect of converting inflation from overtly rising prices into hidden rising prices, shortages and unbearable subsidies.  Increasingly PPI inflation has become the more robust indicator.  That is what we should be watching.

In addition if you believe, as I do, that the underlying cause of inflation is China’s out-of-control money growth, it is hard to be anything but dazed by the latest numbers.  Chinese reserve accumulation continues at