China gets better news as the Eurozone wonders who its lender of last resort is

9th November 2011

In contrast to the fears of an economic slowdown in Europe China has spent 2011 hoping for an economic slowdown as she battles inflationary trends and an economy that has grown so fast that it is in danger of overheating. Accordingly the consumer price figures for October were a signal of how things are progressing and these are the numbers from the Chinese statistics bureau.

"In October, the consumer price index went up by 5.5 percent year-on-year. The prices grew by 5.4 percent in cities and 5.9 percent in rural areas."

So we see signs of some better news on this front as inflation fell back from the 6.1% of September. Although within the numbers we still see signs of an issue that contributed in my opinion to the Arab Spring and has caused unrest in China itself.

'Food Prices went up by 11.9 percent year-on-year, contributing nearly 3.62 percentage points to the overall growth. Of which, the prices of grain rose by 11.6 percent, meaning 0.32 percentage point growth in the overall price level; meat, poultry and related products, surged 26.1 percent, contributing 1.72 percentage points (price of pork was up by 38.9 percent, contributing 1.12 percentage points); fresh eggs, up 12.6 percent, contributing 0.11 percentage point; aquatic products, up 12.4 percent, contributing 0.28 percentage point; fresh vegetables, dropped 6.8 percent, fresh fruits, up 11.1 percent, contributing 0.19 percentage point, grease, increased 15.8 percent, contributing 0.18 percentage point.'

So we see that the price of food is still rising strongly albeit at a slighty reduced pace. This will impact on the poorest the most which is why I referred to the Arab Spring where we saw this effect be so bad that some were unable to afford to feed themselves. In the detail I noticed the rise in the price of pork, 38.9%. I am no authority on Chinese cuisine but my impression is that pork is used a lot…

Producer price inflation dips too

'In October 2011, Producer Price Index (PPI) for manufactured goods declined 0.7 percent month-on-month, and increased 5.0 percent year-on-year. The purchasing price index for manufactured goods dropped 0.7 percent month-on-month, and soared 8.0 percent year-on-year.'

I think whoever put “soared” as a translation into English is probably undergoing “extra training” right now!


Here we see price trends which are optimistic for the Chinese economy and give some hope for what is called a soft landing for it. If we look at consumer price inflation then it has now fallen from a peak of 6.5% and is now back to a the same level as in May. If we look down the price chain for future signs then we see that output producer price inflation has fallen back to an annual level last seen a year ago and we have just seen the first month on month fall (-0.7%) in 2011. It remains true that input producer price inflation is above its output equivalent but it has fallen too.

In addition we received news that China’s industrial output rose 13.2% on an annual basis in October down from 13.8% in September. China is one of the few places in the world that would welcome such news! So we see that here too the overheating problems may be declining a little. This contrasts considerably with the UK’s annual industrial production figures which were -0.7% yesterday which the media mostly ignored for some reason concentrating on a manufacturing improvement.

So in conclusion we seem to be seeing the hoped for slow down in China. Is this the mythical “soft landing”? That is harder to say but for no it seems good news but if we look for a fly in the ointment it may come from her banking sector. Here there are worrying reports that the Chinese government is pumping liquidity into her banks so she may be afraid of her economy slowing too much. Should that happen then in my opinion it is likely to have been caused by the way she has raised the reserve requirements on her biggest banks up to 21.5%. Regular readers will be aware that I have been critical of that part of the Chinese strategy as it has failed elsewhere in the past as it tends to work slowly meaning that the policy ratchet keeps being turned but then operates like a brick being fired from a piece of stretched elastic!

The price of oil

As we see that China’s economy continues to expand we may be seeing a partial reason to why the price of oil has not fallen as many have predicted. In response to today’s further Euro zone problems it has dipped to US $114.25 for a barrel of Brent Crude this morning but this is still up 5.2% in November. So my message is that commodity price inflation’s death is like Mark Twain’s much exaggerated!

Japan and her currency

In contrast to the generally good news from China this morning Japan is yet again facing a strengthening exchange rate for the Yen. It was only a week or so ago she intervened (again) to weaken it but it has rallied to 77.7 versus the US dollar and 106.8 versus the Euro.

Italy stares further into the abyss

When it was announced last night that Silvio Berlusconi would resign after the latest budget proposals were passed I put this message out on twitter.

'Do we all actually believe that Berlusconi will resign or will he try to rally support instead?'

It also appears true that there is no obvious candidate to replace him or at least one has not appeared so far. Italy’s bond market was on this in a flash today and the price of her government bonds has fallen heavily. In fact the yield curve out to the ten year maturity is virtually a straight line at 7%. This is significant for several reasons.

1. This has been a point of no return in the crisis for Portugal,Ireland and Spain.

2. The flattening of the yield curve is another ominous sign. The reason for this is that at the shorter end of her yield curve one can compare it for example with the official interest-rate of the European Central Bank which is now at 1.25%. So Italy’s two-year bond you could argue have a “credit risk” of 5.75% right now. This is a rule of thumb I use rather than a precise measure but I hope that the principle is clear.

Just to make a grim situation more difficult clearing houses have begun to raise the margin required for trading Italian government bonds. So this has also contributed to today’s falls as traders need more cash now to back the same position (roughly double for a ten-year bond at LCH Clearnet SA). As I type this we are getting ever closer to the main LCH Clearnet Ltd. raising its margins too as we are only 0.07% away!

Where is the European Central Bank?

I gather that it is buying today but yet again it is like the Texas cowboys at the Alamo. Having raised its peripheral bond purchases to 9.52 billion Euros last week it is going to have to do much more to have any serious impact. With his name the new head of the ECB was always going to acquire the moniker SuperMario but so far there is little or no sign of him living up to that.

Where is the European Financial Stability Facility?


emember the boasts and hyperbole of a trillion Euros and maybe two trillion Euros? Well it struggled to raise a mere 3 billion Euros this week in spite of paying a lot higher interest-rate relative to the German bund benchmark. As it stand it is a busted flush.

What could help, the US Cavalry?

Remember the central bank foreign exchange liquidity swaps I explained and described not so long ago? Here is a link to the details.

Should matters deteriorate it is by no means impossible that the US Federal Reserve could in effect bypass the European Central Bank and become again the lender of last resort that it was in 2008. It would be very embarassing for both the ECB and Europe’s politicians but if contagion were to spread then the US Federal Reserve could easily become involved particularly if Europe’s response continues to be so ineffective.

A sign of Euro zone incompetence and ineffectiveness is the market in credit default swaps which appears to have survived their plan to destroy it. Will it get its revenge and destroy them instead? Actually for all the hype it appears to be too small to do that but we are in an “expect the unexpected” era.

The Bank of Greece wants to be a lender of last resort too

Currently the job of being lender of last resort in the Euro zone is a bit like the scene in the film Spatacus when loads og hands are thrust in the air to a chorus of “I am Spartacus!” It should be the ECB but as I have explained above there have been times when you might argue it was the US Federal Reserve and such a period could return quickly.

If you look at the sundry other assets section of the Bank of Greece which at the end of September expanded to 41.39 billion Euros then it too appears to think that it is Spartacus! As I have reported before so does the Central Bank of Ireland.

So there is my question for you today, who really is Spartacus?

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