from Follow the Money

China always poses data puzzles in February

March 11, 2008

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Chinese inflation soared to 8.7% -- above expectations. An ominous sign, particularly given how fast reserves are growing and the potential difficulties sterilizing all the "hot money" flowing into China? Or by product of a lot of snow-related transportation bottlenecks, a temporary pig shortage and a global rise in commodity prices that won’t continue?

China’s February trade surplus was smaller than expected, with the y/y pace of export growth dropping off sharply). A sign that China’s trade surplus is now heading down on the back of the US slowdown and the RMB’s recent appreciation against the dollar? A sign of the extent of the weather related delays? A base effect, as exports were unusually strong last February for tax reasons? (The usual lunar new year effect doesn’t show up in the 2007 February data)  Payback for unusually strong export growth in January?

Frankly, it is too early to tell.

My own read is that export growth is indeed decelerating, as one would expect given the slowdown in the US. The y/y increase for January and February combined was around 17% -- below the y/y increase of around 22%. If you project out 17% export growth and 30% plus import growth, then China’s surplus will fall quickly.

On the other hand, there isn’t a particularly good reason to project out 30% plus import growth. Oil prices were in the $50-60 a barrel range early last year. They have basically doubled. The y/y increase in China’s oil import bill embedded in the January and February data isn’t likely to be sustained for the entire year.

One other interesting bit of information: China’s bilateral surplus with Europe now tops its bilateral surplus with the US.  $10b v $9.6b.

That shouldn’t be a surprise. The US economy is slowing sharply; Europe is not.  At least not yet. And the RMB is still very, very weak against the euro. The RMB hasn’t joined the euro in its recent move against the dollar. Since the rise of China’s surplus with Europe relative to its surplus to the US is a long-standing trend, I am much more confident to draw strong conclusions from the February data than I am with other data points.

One last point -- I am not sure that hot money inflows into China totaled $200b in 2007. I probably should refine my argument to claim only that "hot money inflows could have been up to $200b in 2007." It all hinges on exactly how much foreign exchange the banks accumulated in late 2007.  No one has great data on that. 

Few things would please me more than the release of detailed data showing how the foreign exchange position of China’s state banks has evolved, including data on whether the banks met their reserve requirement by holding foreign exchange.   That data might well prove that smaller sums are flowing into China than I fear.

The economics (or perhaps financials) here are clear.   Chinese rates are above US rates.  The US is expected to cut rates further.   The pace of RMB appreciation has picked up recently, at least against the dollar.   The market  expects the RMB to continue to appreciate.   In that context, it makes sense to hold RMB rather than dollars if you can ... 

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