China Grapples With Stagflation

The latest round of monetary stimulus from Beijing has stoked inflation without much helping industry

By guest author Nathaniel Taplin from Wall Street Journal

Lending binges in China used to produce lots of new houses, factories and growth. These days they mostly produce higher prices for food and housing—and more debt.

Onnext Friday, October 18, 2019, China will report its third-quarter economic growth, which is broadly expected to be slower than the second quarter’s 6.2 % increase. But nominal growth—which includes changes in prices—is likely to be roughly flat, and could even accelerate. This is starting to shape up as a significant problem and has become a major constraint on monetary policy.

Idiosyncratic factors are at play, particularly the African swine fever outbreak that has decimated the hog population in China. But the broad picture is clear: Beijing has been very conservative with its most recent round of stimulus starting in 2018, compared with previous rounds in 2012 and 2015, but even a modest jolt has been enough to push housing and food prices sharply higher.

Debt and equity finance outstanding expanded by 10.8% in September, the same rate as in August and down modestly from 11 % in June, figures released Tuesday showed. Meanwhile, consumer price inflation is running at its hottest in nearly six years, housing prices are up close to 10 % on the year, and food-price inflation is running at 11 %. Industry and employment have yet to find a bottom.

The contours of the dilemma were visible even in June, before pork prices had yet reached dizzying levels. Second-quarter headline growth came in at 6.2 %, down from the first quarter’s 6.4 %. But nominal growth actually accelerated for the first time since late 2017.

Trouble BrewingNominal gross domestic product, changefrom a year earlier Source: CEIC

% Farm sectorService sector. pumping up prices without much helping real activity, it is also pumping up prices in the wrong places. Nominal growth accelerated in agriculture and services—likely thanks to food and real estate—but slowed in manufacturing. Skyrocketing home and food prices are a problem for both social stability and real consumer spending. But falling prices for factory goods make grinding down China’s massive debt burden, which is concentrated in industry, harder to deal with.

This conundrum is a big reason why Beijing has relied so heavily on infrastructure bond issuance as a way to prop up credit growth this time around. In theory, more infrastructure funding should help boost prices for industrial products without further pumping up housing prices.

The problem is that China already has very good infrastructure for its income level. And heavy infrastructure bond issuance—officials are considering pulling forward part of next year’s quota into the fourth quarter, according to Barclays—also risks crowding out already weak private-sector borrowing.

This all amounts to a serious challenge to China’s growth model—and another reason why even a limited stand-down on trade tensions would be very welcome in Beijing right now. China’s monetary policy makers are running out of road.