China: Hot Money Inflows Coming in Fast and Furious

Monday’s China Daily reports a speech made over the weekend by a senior central bank advisor at the Boao Forum for Asia, in Hainan. According to the article, Fan Gang, a member of the central bank's monetary policy committee and someone whose concern about hot money has often been cited in this blog, said China should remain wary of hot money inflows. “China is seeing an even stronger capital inflow now, despite some nations suffering a credit crunch,” he said.

A perhaps franker assessment was then provided by Zhu Baoliang, vice president of State Information Center, a research institution under the National Development and Reform Commission. According to a China Daily article referencing the official Shanghai Securities News:

“More than $80 billion in hot money came into China in the first quarter, compared to the total hot money inflow for the whole of 2007 of around $120 billion and an average monthly amount of $10 billion (last year). So this year's hot money volume is three times last year's,” Zhu was quoted as saying.

The inflows in the first quarter have increased market liquidity, which in turn could put further upward pressure on inflation, he warned. Because of this, the Chinese government must be cautious in allowing faster yuan appreciation, he said. While faster currency appreciation will help ease domestic inflation by dampening the price of imports, it will also cause higher hot money inflows speculating on the currency's rise.

In Saturday’s entry I tried to figure out what is happening to the hot money proxy as far as the most recent reserve numbers go, and although it is not always easy to understand given the opacity of the PBoC’s accounts and the various did-they-or-didn’t-they moves that may have affected the headline numbers, I think that the evidence is pretty strong that hot money inflows are coming in fast and furious.

I don’t know if Mr. Zhu’s $80 billion is correct – no one can really say how much hot money there is because most of it is necessarily hidden – but I am intrigued that whatever proxy he uses suggests that hot money inflows have tripled compared to last year. That certainly fits in with my own intuition.

The existence and size of hot money inflows is not just a debate about monetary growth. I believe it is the key determinant as to whether or not the PBoC will continue the current appreciation path or be forced into a maxi-revaluation. Rapid but gradual appreciation of the currency will actually worsen the country’s financial imbalances if they cause such an upsurge in monetary inflows that the PBoC becomes totally helpless in controlling monetary growth.

Since the only effective way to stop these inflows would be to eliminate the cause of the inflows – the expectation of appreciation – if these inflows are so huge so as to be seriously destabilizing, the PBoC will have to make the one-off jump that brings the currency into at least temporary balance. The problem is that the longer they wait, the more monetary problems they store up and the more difficult the adjustment.

It is interesting that there seem to be a lot of comments circling around this point. According to Mr. Zhu, “Allowing the yuan to appreciate rapidly in a short period of time and then holding it stable would be very useful to restrain hot money.” He also argued, according to China Daily, that the opportunity for using yuan appreciation to fight inflation will exist in China only in the first half of this year.

I am not sure what he means by the opportunity only existing in the first half of the year, but it is interesting that he favors a rapid appreciation followed by a peg, which is also my own favorite policy choice. The difference between us, and it might not be a difference at all, depends on what he means by “appreciate rapidly in a short period of time.” Certainly a maxi-revaluation could be included under that phrase.

On the other hand Zhou Xiaochuan, the PBoC’s governor, said from Washington Sunday that the PBoC still has room to raise interest rates rather than rely exclusively on RMB appreciation. According to Bloomberg,

“China will do things according to our own economic situation,” as the nation isn't “highly dependent” on the exchange rate for reaching the inflation target, Zhou said. “The anti-inflation policy is a combination of both quantitative measures and price measures.”

Don’t expect too much more appreciation, he seems to be saying, since we still have other tools with which to fight inflation. I guess he has to say that, but I wonder if he is as worried as I think he should be.

Meanwhile Liu Shiyu, the deputy governor of the People's Bank of China, said in Shanghai over the weekend something that I guess we already knew: CPI inflation for March, although not to be formally released until Thursday, is going to come in at 8.3%. This means that annualized inflation for the first quarter of the year is 13%.

I think this is just the beginning of a longer inflationary period in which declining food prices will be matched by rising non-food prices, as explained in my April 4 entry, but to be fair there are still a lot of economists, and still a majority, who disagree. For example, according to Shen Minggao, an economist at Citibank: “Consumer inflation probably stayed high in March on costly food while non-food prices picked up pace. We continue to believe that the estimated 8 percent CPI rate in the first quarter will mark the peak of inflation this year.” We’ll see. A lot of bank economists are arguing that March, or perhaps April, will mark the inflationary peak, but I have to say I am very, very skeptical. This is going to continue much longer, especially as hot money inflows have gotten much worse.

By the way I saw an interesting piece about the problem of surging rice prices in Monday’s Financial Times. The article said that according to the Asian Development Bank, food accounts for 40% of the Chinese consumption basket. The National Bureau of Statistics of China reportedly has food comprising just over 33% of the CPI basket. My quick-and-dirty calculation suggests that if we adjust the food component upward, inflation is actually substantially higher than reported. For example in March it wouldn’t be 8.3% – it would be closer to 9.6%.

Comments

[johnthebear]

It is amazing how stupid financial media is. They advise people to invest in China and Emerging markets.... without understanding HOW HUGE THE BUBBLE ALREADY IS!

Please before you send more money down the rat hole...

1. Get a 10 year Chart and Compare the Dow, NASDAQ with the following

EEM emerging markets ETF
FXI China 25 index ETF
IYR Dow Jones Real Estate Index (REIT)

2. From the base line in 1998 EEM topped at +370% in 2007 at $167, stock price now $140

3. FXI top was +325% in 2007 at $218 top stock price before decline to present $141

4. IYR top was +160%, $93 top stock price, now $66.

5. NASDAQ in 2000 was +160% with a high of 5,000 now NASDAQ is $2274!

6. DOW in 2000 topped at 11,700 +50% above base line before dropping to 7,900, now 12,317.

The point is the bubble in Emerging markets reached a high of 370% compared with the NASDAQ 160% which is MORE THAN TWICE AS HIGH AS IN YEAR 2000!

The China, India, Russian markets are all on a down trend, below their 200 day moving averages. The pattern for the global markets is well established which you can see for yourself. So why in the world would any advisor advise investors to move their money into a declining market. There is no reason to believe that the recession we are now in will end soon. Lets compare how long it took from the 2000 high with the likely end of this mess. It has to be longer in time when you consider that banks have already written off $245 billion of their capital which means they no longer have capital to lend as they did in 2000. In 2000 it was simply a stock bubble, now we have banking system failures of enormous proportions added to highly inflated real estate both residential and especially Commercial real estate as reflected by IYR which reached a high comparable to the NASDAQ in 2000 (up 160%). There is no way this can end as easily as in 2000 recession. This is world wide, not primarily the US as in 2000. All of the stock markets are reflecting the same thing.

So in this world wide crisis the media advisors say pour YOUR gasoline on the fire in China, India and Russia! That advise is so foolish and incompetent. Buyer beware. You have been warned. China stocks will continue their sharp fall and they will take you down with them if you listen to the wrong advise! We were told today that our own inflation rate is more than double expectations at 7% and growing higher. China is higher and growing faster than ours and they will have to do something about it or else face revolution!

[Mr. Zhao]

Hi Mr. Pettis, keep up these great analysis. Your posts are extremely well reasoned and informative.

John the Bear, there a a lot of value investments in the Chinese market right now for the long term investor especially H and B shares. Call me a fool but China's fundamental growth story remains intact.

[J.D]

It's a big bubble and it will take years to work it out. Take a close look at China, is there anything really positive to say these days that doesn't rest on a weak foundation? There are holes in the dike, folks, and the tide is rising.

[Turz]

The housing bubble wasn't supported by a real growth. The Internet bubble wasn't supported by real revenues.
China, India and many other emerging countries are experiencing an unprecedented, *real* GDP growth. There may be a bubble, there WILL be a bubble, but there is still room to grow, while 1% of Chinese population is still moving every year from rural areas to cities.

[chinesepetti]

Mr petti; did you work for failed Bear Stern before? So are you advising Chinese to start another Chinese Bear Stern?

[chinesepetti]

I like to advise every readers here; My petti worked in Bear Stern before, the information is on this website seekingalpha.com/autho...
Thank you Mr Petti for your disclosure! You are a great American!

[User 149939]

Great analysis.

Chinesepetti, as a Chinese citizen, I am embarassed by your comments. Bear Sterns was a great financial institution and his tenure does not correlate to the current problems.

[chinesepetti]

user 149939! why being embarassed ? I am simply reminding readers of the information disclosed on seekinalpha site. And I am embarassed by your saying 'Bear Sterns was A GREAT FINANCIAL INSTITION and his tenure does not correlate to the current problems', Are you insulting the intellingence of seekingalpha's readers?

[lanaar2]

a good article on the so called bubble:

www.atimes.com/atimes/...

[M. Pettis]

JD, I think its important to separate short-term and medium term outlooks. In the short term there is clearly a very serious monetary problem here in China. Yesterday I met some friends, including two PBoC officials, and they are clearly very worried and not sure how to address the monetary imbalances in a way that doesn't create an unemployment problem. This has become largely a political argument between the people around the PBoC and some of the MoF guys, on the one hand, and the Commerce and provincial leaders on the other. It is going to be very dififcult to fix the problem to the satisfaction of both sides.

In the medium term, however, a financial crisis can often be a necessary part of the adjustment process, and if handled correctly would help rebalance the economy in a much healthier way -- first, it may diminish the importance of the very sick banking sector and improve the functioning of the capital markets, and second, it may force China to reorient itself away from export-led growth and towards domestic market-led growth (much as the 1798 crisis did to the US). In the medium term these would be great for China.

The real question for me is how they react to the crisis.

[LJ]

The total direct outbound investment from China was $92 billion last year. Together with their QDII investment and the corrupt money invested in dollar-denominated paper assets (including the fraudulent mortgage backed securities), the total capital outflow amounts to more than $200 billion.

Unless you have not been educated to a level to understand what capital outflow means, this $120 billion inflow is nothing.

[chinesepetti]

I like to remind readers here; Mr Petti worked for Bear Stern and also he is working in a State Chinese Communist run school at the moment. Details please visit seekingalpha.com/autho...

China has many problems on its own; but it's very ironic the red communists do not mind Mr Petti (who is paid salary by the Chinese communist run school) being so critical of everything in China even the air he breathes every day.

[J.D]

Thanks for the extra note, greatly appreciated.