Recently, MarketWatch reported that CPI and PPI information were released for the month of March for all of China. According to official data, the consumer price index showed that prices only grew 2.1% year on year, while the producer price index showed deflation, and fell 1.9% year on year.
At first blush, these numbers are quite promising. A low CPI number indicates that inflation is somewhat under control and that the central authorities are living up to their promises that their aggressive money expansion policies wouldn’t lead to excessive price inflation. Further, with producer prices falling, there is a good indication that price stability will continue forward into the consumer arena and that prices will remain in line there as well.
However, when one looks a bit deeper at the root of these numbers, the story is more disconcerting.
Monetary inflation inherently leads to price inflation. All economic models and policies recognise this, even if they all have different mechanisms to deal with it. So the question must be asked as to why there is no appreciable price inflation when there has been pretty expansive monetary expansion? The economic numbers of CPI and PPI should be much worse.
The reason? The method that the monetary injections entered the market and the distorting effects that the injections had on the markets.
China is currently suffering from a bout of tremendous overproduction and excessive commodity stockpiles that have been brought about through the stimulus programs of the central government. Even the Chinese communist party, through their official website, is beginning to acknowledge the problems they have created, as reported by Xinhua.
All the major basic industries, such as coal, iron, steel, cotton, and textiles, and a number of the secondary industries have been featured over the past several months as suffering from excessive stocks, receding product prices, and plummeting profits.
Simply too much product is being produced in China for the world to currently consume. And an ever greater amount of production is being expected from 2013.
Basic laws of supply and demand tell us that the more of a supply that exists for a given demand, the lower the market clearing price must be. And the oversupply that exists in China is putting tremendous downward pressure on the various product markets around the globe.
An unresolved glut in manufacturing, which is only expected to get worse in the coming years, and not the natural deflation of ever more efficient production by the market, is what is causing the fall in producer prices and the corresponding fall in the PPI.
This fall in producer prices then carries forward into the consumer markets through falling input prices, which helps to keep consumer prices in check, and has resulted in a slow growth in the CPI.
Chinese government policies are the reason for the numbers being held in check, but not for the reasons that they instituted the policies in the first place.
For the government policies were the intent of creating a supply which will create its own demand. That by utilizing monetary stimulus to boost industrial production, jobs could be created, wealth could be generated, and a stable continuous production base would be developed which would propel China to the forefront of the world’s industrial production.
In the end, their policies are only temporary, and only will last as long as the Chinese government keeps the monetary stimulants coming.
However, even with stimulus, there are still economic limits to what can be attained.
Already, profits in the affected industries have dramatically shrunk from previous years, and net inflows of speculative capital to China are becoming net outflows. Low profitability and excessive stockpiles will eventually lead to convulsions in the industries through contractions in production and bankruptcies. Market forces will eventually prevail and force a pull back, which will seriously hamper and possibly derail the productive juggernaut that China has become.
Valuation of the yuan is falling appreciably, and that fall is simply being masked by a concurrent fall in producer prices. A fall in prices which is being created by the government-stimulated overproduction. An overproduction which market forces will eventually correct.
The stable pricing, therefore, that is indicated by the current CPI and PPI, is, in the end, tending to mask from the interested citizen the true state of affairs of the economy. Once the production bubble bursts and the downward price pressures from overproduction are relieved, input prices will rise to more natural levels, and the full consequences of monetary stimulus through currency devaluation will be plain for everyone to see.
- Uneven economic growth in China’s regions (chinadailymail.com)
- Moody’s lowers China outlook after Fitch downgrade (chinadailymail.com)
- Economic Report: China inflation eases, but some economists worried (marketwatch.com)
- China Goes Gold Crazy. Why Now? (forbes.com)
- China March CPI eases, factory deflation stubborn (news.yahoo.com)
- China Petroleum & Chemical Corp (ADR) (SNP), PetroChina Company Limited (ADR) (PTR): Chinese Refiners Are Free to Make a Profit (insidermonkey.com)