China Hikes Rates, Ponders Capital Controls to Halt Currency Inflows; Eight Reasons China Faces Hard Landing

Inflation is running at a reported 5.1% in China, a figure most believe is on the low side. Nonetheless, China has been loath to hike rates out of fear of more "hot money" flowing in. Something had to give, and it did. The markets forced China's hand.

Please consider China Increases Rates to Counter Highest Inflation in Two Years

China raised interest rates for the second time since mid-October to counter the fastest inflation in more than two years and more moves may follow.

The benchmark one-year lending rate will rise by 25 basis points to 5.81 percent and the one-year deposit rate will climb by the same amount to 2.75 percent, effective today, the People’s Bank of China said in a one-sentence statement on its website late yesterday.

Premier Wen Jiabao is seeking to slow gains in property values and consumer prices that are making it harder for families to buy homes and pay for food. Bank lending and a wider-than-forecast November trade surplus have pumped more cash into an economy already awash with money.

China is tightening after a record expansion of credit to counter the effects of the world financial crisis. The broadest measure of money supply, M2, has surged by 55 percent over the past two years and outstanding yuan-denominated loans have climbed 60 percent to 47.4 trillion.

Residence-related costs, including charges for water, electricity and rent, jumped 5.8 percent last month from a year earlier, the most in more than two years, and consumer goods prices rose 5.9 percent, the biggest gain since August 2008, according to statistics bureau data.

Policy makers are concerned that raising interest rates could “encourage hot money inflows,” Paul Cavey, a Hong Kong- based economist at Macquarie Securities Ltd. said. “Raising interest rates has far more implications” than ordering lenders to set aside more of their deposits as reserves, as it may affect the ability of local governments and companies to pay their debts.

State Council researcher Ba Shusong told state television yesterday that the government will step up regulation of capital inflows, without specifying measures that will be taken.

The Ministry of Commerce is stepping up supervision of foreign investment in real estate to crack down on speculation after a 48 percent jump in overseas fund inflows to the industry in the first 11 months of the year, spokesman Yao Jian said on Dec. 15. Policy makers may also allow faster gains in the yuan to help curb inflation from higher prices of imported commodities, according to analysts’ forecasts.

China Overheating

China was number 5 on my list of Ten Economic and Investment Themes for 2011

5. China Overheats, Multiple Rate Hikes Coming

China, everyone's favorite promised land, has a hard landing. China will grow at perhaps 5-6% but that is nowhere near as much as China wants, or the world expects. Tightening in China will crack its property bubble and more importantly pressure commodities. The longer China holds off in tightening, the harder the landing.

Capital Controls Coming

Initially, rate hikes will encourage more "hot money" inflows into China. In hopes of preventing those inflows, China has announced more capital controls. It will be interesting to see precisely what those controls will look like.

Currency Sterilization Needed

One thing China should do is sterilize speculative hot money and balance of trade inflows via domestic government bond issuance, hoping to curb money supply growth.

However, it is not as simple as that, because in a fractional-reserve credit system, a net increase in lending itself increases money supply.

Clearly the Chinese central bank is behind the curve. Will China simply restrict lending? Would it even work?

I do not know about the former, but the latter would eventually force a hard landing if China gets serious enough. Actually, there are so many problems that I think a hard landing is coming regardless, and the longer China dallies, the harder it will be.

In the meantime, these paltry rate hikes by China of .25 points each pale in comparison to increases in reported consumer price increases.

Enormous Property Bubbles Including Vacant Cities

It is not "consumer price inflation" that is the big problem. Asset inflation, especially property speculation is rampant.

In case you missed it please consider The ghost towns of China: Amazing satellite images show cities meant to be home to millions lying deserted

Speculation will continue until China gets serious or until the pool of greater fools buying property at absurd prices dries up.

China’s Army of Graduates Struggles for Jobs

Exacerbating China's myriad of problems, an Army of Graduates Struggles for Jobs

In 1998, when Jiang Zemin, then the president, announced plans to bolster higher education, Chinese universities and colleges produced 830,000 graduates a year. Last May, that number was more than six million and rising.

It is a remarkable achievement, yet for a government fixated on stability such figures are also a cause for concern. The economy, despite its robust growth, does not generate enough good professional jobs to absorb the influx of highly educated young adults. And many of them bear the inflated expectations of their parents, who emptied their bank accounts to buy them the good life that a higher education is presumed to guarantee.

“College essentially provided them with nothing,” said Zhang Ming, a political scientist and vocal critic of China’s education system. “For many young graduates, it’s all about survival. If there was ever an economic crisis, they could be a source of instability.”

In a kind of cruel reversal, China’s old migrant class — uneducated villagers who flocked to factory towns to make goods for export — are now in high demand, with spot labor shortages and tighter government oversight driving up blue-collar wages.

But the supply of those trained in accounting, finance and computer programming now seems limitless, and their value has plunged. Between 2003 and 2009, the average starting salary for migrant laborers grew by nearly 80 percent; during the same period, starting pay for college graduates stayed the same, although their wages actually decreased if inflation is taken into account.

Chinese sociologists have come up with a new term for educated young people who move in search of work like Ms. Liu: the ant tribe. It is a reference to their immense numbers — at least 100,000 in Beijing alone — and to the fact that they often settle into crowded neighborhoods, toiling for wages that would give even low-paid factory workers pause.

“Like ants, they gather in colonies, sometimes underground in basements, and work long and hard,” said Zhou Xiaozheng, a sociology professor at Renmin University in Beijing.

Odds for social unrest will mount if China's growth slows. Yet, because of short-term overheating concerns on top of long-term peak oil issues there is no way China can keep growing at the current pace.

Eight Problems Facing China

• Hot money inflows
• Huge property bubble
• Massive increases in money supply, much of it property speculation and building of unneeded capacity
  
• Currency manipulation charges from the US and potential trade wars
  
• Unsterilized trade imbalances fuel inflation
  
• Slowing Europe
• Dearth of Jobs for new graduates
• Potential social unrest

Case For Hard Landing

Risks are enormously skewed to the downside, so much so that the odds China avoids a hard landing are not good. China is far more exposed to a slowdown in Europe than the US and the popping of China's property bubble will extract a huge toll.

Those plowing into commodities, foreign currencies, and equities (especially foreign equities), fail to consider those risks.

Moreover, given that much of China's growth is overheating and malinvestment, it is not even clear the Renminbi is undervalued.

For a look at India, please consider Food, Fuel Inflation Hits India; Primary Price Index Up 15%, Credit Expansion Up 23%

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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