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»21/06/2008 [Independent reports]
China Fuel Prices in Surprise Rise by Michael Pettis

I was going to write about speculative inflows and their impact on Chinese monetary policy, but a lot has been happening – and just in the middle of my week-long trip out of China – so I will postpone that discussion for Monday. On Thursday, as almost everyone knows by now, just after the market closed Chinese authorities announced that were allowing fuel and energy prices to rise – fuel by nearly 18%. This came as something of a shock to everyone because it was widely believed that although fuel-related pressures were becoming intense, nothing would be done before the Olympics because of the socially disruptive impact a price hike might have – not to mention the worries about allowing inflationary expectations to grow. Aside from showing how little faith we should place on expert consensus, and that the embedded wisdom that nothing bad can possibly be allowed to happen before the Olympics is an exaggeration, there are at least two interpretations we might place on the timing: 1. The authorities were so comfortable with the May inflation report that they were not as frightened as many had assumed of the inflationary impact on CPI of a price rise, and decided that they can now begin allowing price freezes to unwind. 2. The fuel-related losses and shortages had become so severe that it was becoming too dangerous to wait. My suspicion is that the latter was more important a reason. I have been hearing reports from friends and readers around China that shortages were becoming a far more serious problem than most of us realize. I will discuss some of these reports and comments in a later entry, but it may be that it was getting harder and harder for the authorities to postpone some sort of price rise. The relatively benign May CPI numbers may have created enough comfort for the authorities, especially if they were eagerly hoping for good news and willing to interpret any good news in the most positive light, that they were able to arrive at the necessary consensus. If I am wrong, and it was the resurgence in confidence that inflation is being beaten that propelled the hike in fuel and energy prices, we should probably begin to see price freezes on food relaxed quickly. At any rate the impact on the stock market of the hike in fuel and energy prices was quite predictable. Rising oil prices have been especially bad for the Shanghai market because, aside from all the other negative economic consequences they have for most companies, they were especially bad for oil companies who had to sell rising amounts of imported oil at huge losses. When China made the announcement that it would let fuel prices rise, and oil immediately fell on international markets, it was almost a certainty that the market would rise. And they did. Not without a struggle at first, however. The market dropped 104 points in the first 30 minutes of trading, before staging a rally that took it up to 2902 by the end of the morning, after which it lost steam in the afternoon to close at 2832, up 3.01% for the day. I don’t expect this rally to continue, although a number of large banks and funds have moved China to overweight on the argument that the Shanghai market is oversold. Higher oil prices in China may be good for the oil companies, but I expect it is bad for everyone else, and after investors have had the weekend to think things over, I expect pessimism will return, unless international oil prices continue falling.

 

As a complete aside there is a pretty amusing article from last week’s New York Times ("Booming, China Faults U.S. Policy on the Economy"). The article starts out:

Not long ago, Chinese officials sat across conference tables from American officials and got an earful. The Americans scolded the Chinese on mismanaging their economy, from state subsidies to foreign investment regulations to the valuation of their currency. Your economic system, the Americans strongly implied, should look a lot more like ours.

But in recent weeks, the fingers have been wagging in the other direction. Senior Chinese officials are publicly and loudly rebuking the Americans on their handling of the economy and defending their own more assertive style of regulation. Chinese officials seem to be galled by the apparent hypocrisy of Americans telling them what to do while the American economy is at best stagnant. China, on the other hand, has maintained its feverish growth.

For several years as the US benefited from the early pleasures of excessive monetary growth, the Bush administration (and, to be fair, the Clinton administration too, although perhaps not to the same ugly extent), seemed to find it hard not to assume a marked superiority over everyone else when it came to managing domestic economic policy. We lectured our foreign friends fairly aggressively and a tad more arrogantly than was justified by the actual numbers.

But of course all good things must end, and an economic boom generated by monetary excess and greater risk-taking among financial institutions, as pleasant as it can be in its early stages, must end too, and usually in an ugly way. As the US is working itself out of the now-obvious monetary excesses of the last ten or so years, this is a great time for once-lectured-at countries to sneer.

The New York Times article goes on to suggest that the problems besetting the US economy, set against the rude good health of the Chinese economy, has created a "brash new sense of self-confidence on the part of the Chinese." For the first time in several years the Chinese are behaving in a less humble – some might even suggest arrogant – manner and are pushing back. They are arguing that perhaps their model of development is not so obviously inferior to the more markets-oriented models proposed ham-fistedly by the US and the other "Anglo-Saxon" countries.

It must be an especially great pleasure to point out publicly, and in international forums, the problems with US currency management, after hearing for so long that their own currency was mismanaged. Unfortunately just because your critic turned out to be full of hot air doesn’t mean his criticisms were all wrong. China’s currency has been mismanaged, and China is going to be forced into some kind of adjustment – and I am willing to bet it will be more difficult than what the US is likely going to suffer.

I guess it is hard to begrudge Chinese officials their forgivable glee in seeing US self-righteousness brought down, but I wouldn’t take too much comfort if I were them. The fact the US financial model had serious flaws shouldn’t make us too confident of alternative financial systems. They all have the same basic flaws – the real question is how quickly they can adjust.

My worry has intensified because there are rumors that at a recent high-level meeting in Beijing involving the most senior economic policy-makers, the consensus was that an economic slowdown is a much more urgent problem than that of monetary excess. Maybe, but monetary excess is a very big problem – a much bigger problem for the long-term – and it won’t pay to downgrade its policy-making implications. The longer this goes on the more vulnerable China’s financial system becomes, and the harder it will be to adjust.


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