Volume 64, Number 2
All eyes turn to China this week as they reported their second quarter real GDP growth slowed to 7.6% from a year ago – down from 8.1% last quarter and 9.5% one year ago. Quarter on quarter, growth rose to 1.8% in the second quarter (7.4% at an annual rate) up from 1.6% (6.5% annualized) in the first quarter. The 7.6% reading was slightly below the 7.7% consensus estimate.
It is widely accepted that Chinese GDP numbers are managed, so one has to assume the message being delivered – to both the domestic and international audience – is that the growth slowdown is more serious than thought, but coming under control. Immediately following the release of the numbers, President Wen gave another in a series of speeches indicating that the economy had not yet stabilized, but that the government will continue fine tuning in the second half. There have been a number of easing moves already this year, including the recent interest rate reductions, cuts in the reserve requirement and a loosening of lending policies to targeted industries. There has not been a grand stimulus as in 2009, and there is unlikely to be one given the negative inflationary repercussions of that massive increase in debt. Bottom line, China is managing itself toward a slower more sustainable growth rate and dampening expectations of a rebirth of explosive growth. This is good news for China, but bad news for a global economy that needs a locomotive. If China is happy with its current 7.5% growth target even if the real number is as low as 5% (as the most pessimistic think) there is unlikely to be much pull toward stronger international growth from the only engine that can in the coming year.
We believe that the most important price in the world is the price of pork in China. It is now far more important to the potential for global stimulus than even the price of crude oil or of central bank lending rates. Indeed, the relatively coordinated moves by the Federal Reserve, European ministers, ECB, Bank of England and even China have had a relatively modest effect on financial markets, which are already clamoring for more. It is unclear to the markets that quantitative easing as promised by the Federal Reserve and Bank of England is really effective at all in stimulating growth (as opposed to higher asset prices) based on recent past experiences. The moves outlined by the EU ministers still will take many months to implement, and the ECB’s modest reaction reflects their need to save some powder to support and encourage future – and far more effective – fiscal moves on the continent. A bevy of other nations from India to Brazil are also loosening monetary policy – but the real onus is on China, where policy ease can jumpstart their own $8 trillion economy and the $15 trillion commodity bloc (one quarter of global real GDP) that they drive directly. With the US and European economies – also about $15 trillion – dead in the water, the question is can the global economy gain traction hitting on only one of four cylinders.
The question now is whether Chinese inflation will stay low enough to allow them to continue fine tuning their stimulus – or will the recent rise in global grain prices feed back into another spike in Chinese pork prices leading them to delay. Heat and drought in the US have slashed the once extremely promising US corn crop from a projected yield of 166 bushels per acre to just 146 bushels based on a July estimate by the USDA. Along with some adjustment on estimated harvested acres this reduces the projected corn crop by 12.3%. Unfortunately, these are only estimates, as the USDA does not do its first actual field survey until August – and private numbers have the yield as low as 140 bushels per acre and express further concern about the number of acres that will be actually harvested due to drought. Based on the current estimates, the carryout, or inventory before harvest, is already expected to barely exceed last year’s tightUSnumbers. Moreover, there is trouble in other key markets as production in the Black Sea area (Russia,Ukraine and Kazakhstan) of wheat and corn is disappointing and the Indian Monsoon has been poor. Given the downside risk, markets are already pricing corn at levels that a year ago led to political instability in the third world via the Arab Spring – and helped spike pork prices inChina.
Most estimates indicate that pork accounts for roughly 10% of the Chinese CPI, and food in general roughly one third. The Chinese don’t actually publish weights for their price indexes (consumer or otherwise) so like with many statistics from the Middle Kingdom interpretation is even more than science. Housing costs – primarily fuel for heat – make up another sixth of the index. Unlike the US, there is no home rent estimate in the Chinese CPI (a 24% weight in the US index) as over 95% of residences are owned. The remaining 50%, representing primarily services, is relatively stable over time as many of the prices are managed by the government. Bottom line, fluctuations in food and energy account for nearly all of the volatility in Chinese CPI – with the drop in both over the past year contributing heavily to the decline in inflation from 6.5% in the year ending July 2011 to just 2.2% in the twelve month to this June. With an annual inflation target of 4%, there is some room for ongoing stimulus, but will the government reduce its already tempered actions if food prices spike higher? The outlook for real economic growth in 2013 may depend more on a weather market in grains than on Keynesian or monetarist policies combined.
One factor working in favor of more stimulus is that inflation in China tends to follow growth with a lag. Based on reported real and nominal GDP data we can calculate a year on year change in the GDP deflator, slowing to 2.2% in the second quarter compared to the same quarter a year earlier –down sharply from 7.8% one year earlier. This decline is faster than in CPI indicating that even stronger progress is occurring in investments areas – as suggested by the swoon in commodity prices. Whether moderation in other commodities is enough to offset the surge in grains and allow China to ease waits to be seen – but we find ourselves in a uniquely globally interconnected environment where the pain in Spain may depend mainly on price of grain.