China Faces Interest Rate Dilemma With No Winning Options


Michael Pettis at China Financial Markets has an interesting chain of Tweets on China's unsolvable interest rate mess.

Preemptive Steps Needed to Contain CPI

China Daily reports Preemptive Steps Needed to Contain CPI

China's consumer price index (CPI), the main gauge of inflation, grew 5.2 percent year-on-year in February, the National Bureau of Statistics said on Tuesday. The growth, in line with market expectations, was slightly lower than 5.4 percent in January. On a monthly basis, consumer prices edged up 0.8 percent.

Food prices, which account for nearly one-third of weighting in China's CPI, went up 21.9 percent year-on-year in February, contributing 4.45 percentage points to the rise in the index as the novel coronavirus outbreak disrupted market supplies and demands.

That the CPI has been above 5 percent for two consecutive months has raised fears that China could face high inflation in the long run, which could have a negative impact on people's livelihoods that have already been affected by the novel coronavirus epidemic.

Bank of China Faces a Real Dilemma with Interest Rates

Hiking rates in the midst of shocks like this are out of the question. There are no preemptive steps to take.

CPI Inflation is at 5% but bank interest rates are only 1.5%.

Food production has collapsed, but lower interest rates to stimulate will stimulate the wrong things while hurting consumer savings.

Lower spreads will hurt bank profits and the Chinese banking system is a basket of nonperforming SOE loans.

Pettis Tweet Thread on China's Dilemma

  1. It seems to me that the PBoC faces a real dilemma with interest rates. Thanks to still-soaring food costs CPI inflation in February remained above 5%, well above the deposit rate, with 1-year deposits at 1.50% and average deposits much lower. This means...
  2. ...that the value of household savings is being eroded by rising food costs, and this effectively represents a wealth transfer away from households, with poorer households being hit harder (both because of limited savings opportunities and because food is a larger share of...
  3. ...their consumption basket). This is exactly the opposite of what Beijing needs if it is to reduce its over-reliance on spurious investment to generate growth. If households have to increase their savings rate in order to make up for the inflation tax, they must spend less...
  4. ...on consumption, in which case China needs more investment to generate the same amount of growth. This is why the PBoC doesn’t want to lower the deposit rate. But it cannot raise rates either. Unlike in 2000-11, when banks and corporate/government borrowers were the huge...
  5. ...beneficiaries from extremely negative real interest rates, they aren’t this time around. With negative PPI inflation, and a 1-year loan prime rate of 4.05%, manufacturers may in fact be borrowing at very high real rates, especially given that all the inflation is showing...
  6. ...up in food prices, whereas the prices of the manufactured goods they produce are stable or even trending down. This probably just means that last year’s collapse in meat production – which is the main source of CPI inflation – is being paid for in part by households, in...
  7. ...the form of an erosion in the value of their savings, in part by businesses, in the form of high real borrowing costs, and of course in part by farmers. This makes it very difficult for the PBoC either to raise lending rates or lower deposit rates, and of course it can’t...
  8. ...narrow the spread because that would effectively force already-undercapitalized banks to absorb the cost. Once food prices drop we might see a very sharp reversal of wealth transfers from the household sector, but until then the PBoC doesn’t have much space for maneuver.

Here is the Lead Tweet if you want to see it all on Twitter.

Inflation or Deflation?

This was the subject of a debate on Twitter. Many see a round of inflation but I generally see it differently.

The collapse in demand will take care of shortages except for critical things like food.

China has a unique problem. Low food production and a soaring CPI in response.

Unless there is a food production problem in the US, the Fed will not face the same dilemma.

Exporters Hit Hardest

The global export powerhouses will get hit the hardest by this.

China and Germany are at the top of the list.

Deflationary US Outcome

I believe a Very Deflationary Outcome Has Begun.

Prepare for another round of debt deflation, possibly accompanied by a lower CPI especially if one accurately includes home prices instead of rents in the CPI calculation.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse

I am not blaming the Fed for the coronavirus and these shocks.

However, I am blaming the Fed for its erroneous inflationary tactics that blew three of the biggest economic bubble in succession: 2000, 2007, 2020.

Bubbles are inherently deflationary. It’s asset asset bubble deflation that is damaging, not routine price deflation

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated a BIS study.

For a discussion of the BIS deflation study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Supply Shock and a Demand Shock Coming Up

A Supply Shock and a Demand Shock are Coming Up.

Worth Repeating

Deflation is not really about prices. It's about the value of debt on the books of banks that cannot be paid back by zombie corporations and individuals.

75% of Companies Suffer From Coronavirus Supply Chain Disruptions

The ISM says 75% of Companies Suffer From Coronavirus Supply Chain Disruptions

Don't expect inflation out of this except in medical supplies and related items.

Q. Why?

A: The demand shock over stock market decline and lost wages has not been felt yet. It soon will.

Peter Schiff on the Deflation Bandwagon

Perhaps that will have some rethinking their position.

Mike "Mish" Shedlock

Comments (22)
No. 1-7
Tony Bennett
Tony Bennett

"A: The demand shock over stock market decline and lost wages has not been felt yet. It soon will."

Yes, and throw in lower domestic demand over virus fear and drop in exports.

Yields will soon resume their downward trend. Only a matter of time before 10 yr yield sporting a negative sign.


A friend of mine works for one of the largest suppliers of electrical transmission equipment.

Their assembly lines have been dark since 3rd week in Jan. Obviously most parts come from China.

One vendor there still has not answered the phone & there's no alternative part without a complete re-engineer of the product. That's 1800 people hanging on a thread

Information v. Noise
Information v. Noise

Someone please explain: Is Chinese supply (manufacturing, mining, and other production) coming back online? If so, what is the evidence of this? And, if Chinese supply does come back online, how do they avoid re-triggering new and serious outbreaks of the virus? Yes, I get that improved personal hygiene and reduced social interactions will help reduce the spread, but can they do so significantly if people are back working in crowded factories and service industries? Is it that the Chinese propaganda machine is back in control and we really have no idea what is happening over there, even through indirect measures and anecdotal reports?


Inflation readings are often high, if not slightly exaggerated at the end of economic cycles. That's why policy makers are often overly tight on policy, creating the spectacular crashes that may have been attenuated had there been less emphasis on fighting end-of-cycle inflation, and more on stimulus early on.
Yes, food is surging in China, but other components of the CPI basket are collapsing. So its probably less of a problem than implied.



I do not believe the Fed will cut rates below zero.
It got negative results in the EU and Japan.


China has an interest rate dilemma, and it counts food prices in the CPI? Oh my, what dark age the country is in?

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