Australia | Dec 20 2010
By Greg Peel
While the most dominant theme of 2010 has been the European debt crisis, jointly and severably concerns over Chinese monetary policy have also kept investors awake at night. The great fear is that having been fundamental in dragging the world rather quickly out of what may have been the Great Depression II, Beijing's inexperience might yet derail the whole process.
It has been to my great amusement in 2010 that every time there is a positive data read out of China – be it a GDP result, a manufacturing PMI or a round a round of monthly production and sales data – global stock markets have reacted swiftly and reapplied the risk trade with haste. Then as soon as Beijing has made some policy adjustment five minutes later, markets have sold off again in sheer panic as if such a move came right out of left field. All year.
In late 2008, Beijing implemented the biggest fiscal stimulus package in the history of the world. And it worked. Commodity prices rapidly began to rise once more and, with the help of the Fed's QE1 in March 2009, stock markets began to rally out of their GFC depths. But it's likely even Beijing was surprised with the success of the program, and suddenly by late 2009 realised that China was once again in runaway growth mode. GDP growth had pushed back up to 12% where it was before the credit crisis began.
Back then, Beijing had belated begun to implement monetary policy tightening measures, albeit very quietly so as not to kill the economic miracle. A couple of years down the track, and with a bit more experience under the belt, Beijing again decided it was time to rein things in. A target was set, being that of sustainable GDP growth of 8%. The tightening began.
At first, global markets were relatively nonplussed – even if there is quite a difference between 12% growth and 8% growth. They were still in rally mode and as such in a bit of a blind state of euphoria. There were plenty of commentators appearing on US business television predicting that Wall Street would sail back up through its pre-crisis highs in no time at all.
Then came Greece. And then the penny dropped that Beijing was in tightening mode. Oh no.
China's rate of economic growth did indeed begin to slow, but as at the end of the September quarter was still only just under 10%. Given it is well understood that China's GDP numbers more closely reflect policy rather than reality it would have come as no surprise if – whaddya know – the December quarter result was to come in bang on 8%. But in 2010 we've had Greece, and then we've had Ireland, and I believe it is safe to assume Beijing is happy to cop 9-10% growth until such time as Europe has safely settled down.
In other words, Beijing has become better at this monetary policy thing. For the last six months economists around the globe have been expecting a currency revaluation which hasn't happened, and in the last couple of months they've expected a second rate rise which hasn't happened either. Instead, Beijing has adopted other measures – both monetary and fiscal – which have managed to keep China's economy on a relatively steady path.
China's rate of consumer inflation has suddenly jumped substantially and that has markets worried because it should follow that a rate rise is the obvious means of defence. But while the world panics, Beijing has been looking at seasonal impacts on food prices and more generally, as the Commonwealth Bank economists put it, has “adopted a multitude of measures to address supply disruption and stem a spill over to broader inflation expectations”. There has been no hit to borrowers from a rate rise and no currency revaluation of any note. From the monetary perspective, Beijing has simply continued to raise bank reserve requirements, which is a means of stemming the flow of bank lending to speculators in the commodity, stock and property markets – in other words asset inflation control.
One might even suggest Beijing is showing up a jumpy financial world, now that it holds all the cards.
There was a genuine fear earlier in 2010, nevertheless, when Europe was at the depths of its contagion crisis, that a sharp decline in the OECD's China Composite Leading Indicator (CLI) had markets in panic that a hard landing was on its way. But CommBank notes that the sudden deterioration in the CLI was all about a “precipitous” fall in steel production, which in turn represented destocking of inventories built up in the production peak of late 2007/early 2008 rather than a complete collapse in demand.
Indeed, in recent months the Chinese manufacturing PMI has stopped easing off and rebounded and November data showed the slowdown in industrial production growth had also stabilised. Leading indicators are now pointing to recovery in Chinese growth momentum, CommBank suggests.
Which means Beijing will soon be lining up with some policy tightening measures once more, although the authorities have made it quite clear that they – like everyone else, including the RBA – have a weather eye out for developments in Europe. The growth rate in Chinese retail sales has also slowed which takes some pressure off inflation fears.
CommBank expects further increases in bank reserve requirements ahead and a “slow” rise in interest rates. Currency appreciation, which the world would like to see, will be accelerated from here as monetary policy continues its shift from overly accommodative to more neutral.
The IMF calculates that, over time, a full percentage point change in China's GDP growth flows to a 0.5 percentage point change in global GDP growth, so important has China become. The IMF is never right and will no doubt change these numbers within six months, but the point is China's is now the most important economy in the world while still being far from the biggest. The US economy could, of course, yet have much bigger impact but it's now on a very slow and delicate road to recovery.
Perhaps CommBank sums it up best by suggesting the People's Bank of China “doesn't want to rock the boat”.
