祝融说。

On the dashboard of the macroeconomy, if GDP is the "speedometer," then the price index is the "engine temperature gauge." It tells us whether the machinery of the economy, while running at high speed, is within a healthy, efficient temperature range, or whether it is overheating and about to "boil over," or whether it has cooled down to the point of "stalling out."

In my four decades of research, price analysis has always held a central position. Because prices are the key hub connecting the real economy with monetary finance. On one side, it holds the price of vegetables in the fields and the factory-gate cost of production; on the other side, it holds the central bank governor's interest rate decisions and the inflation expectations of financial markets.

"Inflation" and "deflation" are words with enormous power. They not only affect the real purchasing power of the hundred-yuan bill in your hand but also profoundly change the behavior patterns of enterprises, households, and governments, thereby driving the ebb and flow of the economic cycle.

• Inflation: Moderate inflation is considered the "lubricant" of the economy, but runaway inflation is the "corrosive" of wealth. It distorts price signals, exacerbates social inequality, and ultimately destroys economic stability. The "panic buying" at the end of the 1980s and the inflation peak of 1994, when CPI reached 24.1%, left a feeling of uncertainty and fear that remains a shared memory for generations.
• Deflation: A continuous decline in prices might sound like a good thing, but for the entire economy, it is more frightening than inflation. Deflation means deteriorating corporate profit expectations (things are getting cheaper to sell), suppressed consumer willingness to spend (waiting to buy), and a heavier real burden of debt. It can trigger a death spiral of "falling prices - shrinking demand - business closures - rising unemployment - further price falls." After the 1998 Asian Financial Crisis, I deeply experienced the depression and chill brought by several years of negative PPI growth.

Therefore, maintaining basic price stability is one of the primary objectives of macro-control in all countries. And our two core tools for price analysis are CPI (Consumer Price Index) and PPI (Producer Price Index).

However, interpreting these two indicators is full of pitfalls. "Why does the CPI not seem high, yet I feel everything is expensive?" "What exactly does the 'scissors gap' between CPI and PPI mean?"

In this chapter, we will, like an experienced price bureau official and central bank researcher, thoroughly clarify these issues. We will dissect the composition and logic of CPI and PPI separately and learn how to forecast their trends. More crucially, we will build a framework for analyzing the divergence and convergence of CPI and PPI — this is the key to understanding the structural characteristics of Chinese prices. Finally, we will link prices, money supply, and the economic cycle to see the patterns of their "dance."

Understanding prices allows you to truly grasp the truth of inflation, discern the central bank's intentions, and feel the pulse of the economic cycle.

11.1 CPI: Composition, Interpretation, and Forecasting

CPI, or Consumer Price Index, is the most familiar and frequently discussed price indicator. It measures the relative change over time in the price level of a representative basket of goods and services purchased by an average urban household.

What's in the CPI "Basket"? — Composition and Weights

To understand CPI, you first need to understand what is in that "basket" of goods and services and how much each item weighs. This basket, categorized by consumption purpose, can be divided into eight major categories:

1. Food, tobacco, and alcohol (highest weight, about 20-30%): This is the most important part of CPI and the main source of its volatility.
   • Pork: For a long time, pork was the single highest-weight item in CPI, known as the "anchor of CPI." The cyclical fluctuation of pork prices (the "hog cycle") is the core factor driving short-term CPI fluctuations.
   • Fresh vegetables and fresh fruits: Highly influenced by short-term factors such as seasonality and weather, they fluctuate frequently.
2. Clothing (weight about 5-8%): Clothes, shoes, hats, etc.
3. Housing (weight about 20-25%): This is a category that is easily misunderstood!
   • What does it include? Mainly rent, utilities (water, electricity, fuel, gas), and housing maintenance and repair costs (imputed rent for owner-occupied housing).
   • What does it NOT include? It does NOT include the sales price of commercial housing! The rise or fall of housing prices is not directly included in CPI. This is the core reason for the huge difference between CPI increases and residents' perception of "housing costs." Housing prices are an asset price, not a consumption price.
4. Household goods and services (weight about 5-7%): Furniture, home appliances, personal care products, etc.
5. Transportation and communication (weight about 10-15%):
   • Transportation vehicles (cars), fuels for transportation (gasoline, diesel), vehicle use taxes and fees, communication services (mobile phone charges), etc.
   • Changes in refined oil prices are the main source of fluctuation in this sub-item, linked to international crude oil prices.
6. Education, culture, and entertainment (weight about 10-15%): Education services (tuition), tourism, cultural and entertainment goods, etc.
7. Healthcare (weight about 10-12%): Medicines, medical services, etc.
8. Other goods and services (weight about 2-4%):
   • Personal care, hotels and accommodation, etc.

Two Core Concepts: Food vs. Non-Food, Goods vs. Services When analyzing, we typically regroup CPI:

• Food CPI vs. Non-Food CPI: Food prices, especially pork and fresh vegetables, are highly volatile, mainly influenced by supply-side factors (such as swine fever, weather). Non-food prices, on the other hand, better reflect broader economic aggregate demand and cost pressures, excluding the food supply shock.
• Goods Prices vs. Service Prices: Goods prices (such as food, home appliances, cars) are more influenced by industrial production costs (PPI) and the supply and demand of goods. Service prices (such as rent, tourism, healthcare, education) are more influenced by labor costs (wages) and the health of offline consumption scenarios. Service prices are typically "sticky," only rising but not falling, or rising more than falling.

Interpreting CPI: How to See Through the "Fog of the Hog"

Because food, especially pork, has a high weight in CPI and is highly volatile, it often masks the true trend of prices. A professional analyst must learn to strip away these short-term disturbances to see the more core signals.

• Look at structure as well as the aggregate: When you see a high year-on-year CPI growth rate, the first reaction should be: is it pork prices "causing trouble," or is there a comprehensive price increase?

  • Structural inflation: If the CPI rise is mainly driven by soaring pork or fresh vegetable prices, while non-food prices and core CPI (see below) remain stable, this is usually considered "structural inflation." Its overall impact on the macroeconomy is limited, and the central bank typically does not tighten monetary policy just because "pork is expensive."
  • Comprehensive inflation: If non-food prices and service prices also show widespread, sustained increases, this is a highly concerning signal of comprehensive inflation, indicating that aggregate demand may already be overheating.

• Core CPI: The "Inner Core" Stripped of Short-Term Disturbances To better measure the long-term trend of prices and aggregate demand pressure, we introduce a more important indicator — Core CPI. Core CPI = CPI - Food prices - Energy prices (mainly refined oil)

  • Analytical value: Core CPI excludes food and energy, which are the most volatile and most susceptible to supply-side shocks. Therefore, it can more truly reflect the aggregate supply-demand relationship of the macroeconomy.
  • Core CPI is the "touchstone" for judging the nature of inflation:
    • High CPI, Low Core CPI: Indicates "fake inflation" caused by supply shocks (hog, oil).
    • CPI and Core CPI both rising: Indicates "real inflation" driven by demand.
  • Core CPI is more closely related to the economic cycle: The trend of Core CPI has a much higher correlation with macro fundamentals such as GDP growth and consumer demand than the overall CPI. When the economy is slowing and demand is weak, Core CPI typically stays low.

How to Forecast CPI? — The Bottom-Up "Jigsaw Method"

Forecasting CPI is a bottom-up process of aggregating forecasted values of each sub-item according to their weights.

• Forecasting the food item:
  • Pork: The key is to judge the position of the "hog cycle." By tracking high-frequency data such as the number of breeding sows (leading hog prices by about 10-12 months), hog slaughter volume, and the hog-to-corn price ratio, a general judgment on the trend of hog prices over the next six months can be made.
  • Fresh vegetables and fresh fruits: Mainly track the vegetable and fruit wholesale price indices published by the Ministry of Agriculture and Rural Affairs (weekly), considering seasonal patterns and extreme weather impacts.
• Forecasting the non-food item:
  • Refined oil: Keep an eye on international crude oil prices (Brent, WTI). Domestic refined oil prices correspond to them with a clear adjustment mechanism.
  • Service prices: Have strong seasonality (such as Spring Festival and summer vacation tourism prices) and stickiness, typically extrapolated by referring to their historical trends and economic health.
  • Industrial consumer goods: Their price trends lag behind PPI trends. When PPI continues to rise, cost pressures gradually transmit to downstream consumer goods.
• Weighted aggregation: Weight and average the forecasted month-on-month growth rates of each sub-item according to their approximate weights in CPI (the official does not publish these weights, but market institutions have their own estimates), obtaining the total CPI month-on-month forecast value. Combined with the previous year's base, calculate the final year-on-year forecast value.

11.2 PPI: Composition, Interpretation, and Forecasting

PPI, or Producer Price Index for Industrial Products, measures the price change of industrial products at their first sale. If CPI is the "retail price," then PPI is the "factory-gate price" or "wholesale price."

What's in the PPI "Basket"? — Industry's "Costs and Revenue"

PPI surveys cover 40 major industrial categories and nearly 10,000 products. We can break it down from two dimensions:

• By industry breakdown (upstream, midstream, downstream):
  • Upstream extraction: Coal mining, oil and gas extraction, ferrous/non-ferrous metal mining. Prices here are directly linked to international commodity prices.
  • Midstream raw materials: Oil processing, chemicals, ferrous/non-ferrous metal smelting, non-metallic mineral products (cement, glass). They are both pushed by upstream costs and pulled by downstream demand.
  • Downstream processing (consumer goods): Textiles, food, pharmaceuticals, general and special equipment manufacturing, automobile manufacturing, etc. This is the closest link to final consumption.
• By product use breakdown (the most commonly used classification):
  1. Means of production (weight about 75%): Products used as intermediate inputs in the production process. This is the absolute main body of PPI.
     • Extraction industry
     • Raw materials industry
     • Processing industry (providing equipment and components for downstream production)
  2. Means of livelihood (weight about 25%): Final industrial products that directly meet people's living needs.
     • Food
     • Clothing
     • General daily goods
     • Durable consumer goods (cars, home appliances, etc.)

Two important "avatars" of PPI:

• PPIRM (Purchasing Price Index for Industrial Producers): Measures the price change of raw materials, fuel, and power purchased by industrial enterprises as buyers. It can be understood as the "cost side" of enterprises.
• PPI (the one we usually refer to): Measures the price change of industrial products at the factory gate when the enterprise acts as a seller. It can be understood as the "revenue side" of enterprises (from a price perspective).

The difference between PPI and PPIRM can be approximated as a "barometer" of the gross profit margin of industrial enterprises.

• Widening spread (PPI growth > PPIRM growth): Indicates that the increase in factory-gate prices exceeds the increase in raw material costs, and corporate profit margins are expanding.
• Narrowing or negative spread (PPI growth < PPIRM growth): Indicates that enterprises cannot fully pass on rising costs, and profit margins are squeezed. This is a key indicator for judging the profitability of midstream and downstream manufacturing.

Interpreting and Forecasting PPI: The "King of Cycles" from a Global Perspective

Compared to CPI, PPI is more volatile, more cyclical, and better reflects the cyclical fluctuations of the macroeconomy.

• PPI's core drivers: Global commodity prices + Domestic aggregate demand
  1. International imported factors: Since China is the world's largest importer of raw materials, fluctuations in international commodity prices (especially crude oil, copper, iron ore, etc.) are directly and rapidly transmitted to domestic PPI. Therefore, tracking global indicators such as the CRB Commodity Index and Brent crude oil prices is the first step in forecasting PPI trends.
  2. Domestic demand factors: Domestic investment (infrastructure, real estate) and industrial production activities determine the intensity of demand for means of production. When domestic credit expands and investment increases, it pulls up prices of domestically priced industrial products such as ferrous metals (steel) and non-metallic building materials (cement).
• PPI's leading significance:
  • Leads corporate profits: The trend of PPI is highly synchronized with, or slightly leads, the growth rate of industrial enterprise profits. A PPI rise usually presages an improvement in corporate earnings (especially for upstream enterprises).
  • Leads the non-food consumer goods in CPI: PPI is the "upstream" of industrial consumer goods prices in CPI. The rise in PPI transmits with a lag to CPI through the "raw material → factory-gate → retail" chain. This transmission typically has a time lag of 3-6 months, and the transmission is not complete (because intermediate links absorb some of the cost pressure).

Methods for forecasting PPI: Forecasting PPI is mainly a top-down process:

1. Track globally: Closely monitor the month-on-month and year-on-year changes in the monthly average prices of international commodities such as Brent crude oil, LME copper, and iron ore.
2. Track domestically: Monitor domestic high-frequency data such as the Nanhua Industrial Index, rebar prices, cement prices, and coal prices.
3. Construct weights: Weight these major industrial products according to their approximate weights in PPI, fitting the overall month-on-month and year-on-year growth rates of PPI. Since means of production account for as much as 75%, and commodities dominate this category, grasping the key items of "oil, steel, and coal" can basically get you about 80-90% of the way to judging the direction of PPI.

11.3 Analytical Framework: The Divergence and Convergence of CPI and PPI

In macro analysis, putting CPI and PPI on the same chart for comparison is "standard procedure." You will find these two curves sometimes moving in lockstep, sometimes going in opposite directions. Their "divergence" and "convergence" contain rich information about China's economic structure and cycle.

The difference between CPI year-on-year growth and PPI year-on-year growth is what we call the "scissors gap."

Phase One: Divergence Widens (PPI rises, CPI stable, scissors gap negative and widening)

• Scenario: Typically occurs in the early stages of an economic recovery. Driven by investment (infrastructure, real estate) or exports, demand first impacts the production side, driving up commodity and industrial product prices (PPI) rapidly. However, terminal consumer demand has not yet fully recovered, the labor market is still weak, and wage growth is sluggish, so CPI (especially Core CPI) remains stable.
• Macro implications:
  • The economy is recovering, but the foundation is not yet solid. Momentum comes mainly from the production and investment sides, not the consumption side.
  • Industrial chain profits are sharply concentrated upstream. Upstream extraction and raw material industries reap huge profits, while midstream and downstream manufacturing and consumer goods industries face huge cost pressures and squeezed profits. This is typical "cost-push" pressure.
• Case: In 2016-2017 and 2021, we experienced typical periods of "major divergence" where PPI skyrocketed while CPI was moderate.

Phase Two: Convergence (PPI peaks and falls, CPI starts to rise, scissors gap narrows)

• Scenario: After PPI upward pressure persists for a while, two possibilities begin to emerge:
  1. Cost transmission: Midstream and downstream enterprises can no longer bear the cost pressure and start to raise their product prices. Cost pressure gradually transmits to industrial consumer goods in CPI.
  2. Demand warms up: The economy achieves comprehensive recovery, employment and income improve, and terminal consumer demand truly kicks off, pulling CPI (especially service prices and Core CPI) upward. At the same time, excessively high PPI may have already begun to suppress aggregate demand, or have invited policy tightening, causing PPI to peak and fall from a high level.
• Macro implications:
  • The economy moves from "recovery" to "prosperity" or "overheating." Price increase pressure spreads from the production side to the consumption side, and inflationary pressure becomes more comprehensive.
  • Industrial chain profits begin to shift from midstream and upstream to downstream. Cost pressure on midstream and downstream enterprises eases, while their pricing power strengthens, and profit margins are restored.
• Case: In 2010-2011, in the later stages of the "Four Trillion" stimulus, we saw PPI peak and fall, while CPI accelerated upward, a process of "scissors gap" convergence.

Phase Three: Divergence Again (PPI falls, CPI still high or slow to fall, scissors gap turns positive)

• Scenario: The economy begins to shift from prosperity to recession. Aggregate demand shrinks, first impacting the production-side industrial product prices. PPI falls rapidly, potentially turning negative. But CPI, especially service prices, has strong "stickiness" (wage rigidity, rent contracts, etc.), falling much more slowly.
• Macro implications:
  • Downward pressure on the economy is confirmed. The production side has already felt the chill.
  • Downstream industries are relatively "advantaged." For consumer goods and service industries, this is a "golden period" of "falling costs, stable prices" (provided aggregate demand does not collapse).

Phase Four: Convergence Again (CPI and PPI both at low levels or falling together)

• Scenario: The economy enters a recession or deflation phase. Comprehensive shrinking demand causes both PPI and CPI to fall into negative growth or hover at low levels.
• Macro implications:
  • Deflation risk becomes fully apparent. This is the situation decision-makers most want to avoid and requires strong policy stimulus to counter.

Through this "divergence-convergence" framework, we can discern, from the structural changes in prices, the position of the economic cycle, the switching of driving forces, and the flow of profits along the industrial chain. It is a much more powerful analytical tool than any single indicator.

11.4 Data Linkages: The Relationship Between Prices, Money Supply, and the Economic Cycle

Prices are, ultimately, a monetary phenomenon. The famous saying of the great economist Milton Friedman — "Inflation is always and everywhere a monetary phenomenon" — profoundly reveals the fundamental relationship between prices and money supply.

Core Indicators of Money Supply: M2 and Aggregate Social Financing

We will explain financial data in detail in the next chapter. Here, we introduce two core concepts:

• M2 (Broad Money Supply): Can be understood colloquially as "the total amount of all money in the whole society," including cash, demand deposits, time deposits, etc. Its growth rate reflects the looseness or tightness of the monetary environment.
• Aggregate Social Financing (Social Financing): Reflects the total amount of funds the real economy obtains from the financial system. Its growth rate better represents the financial system's support for the real economy.

The Fisher Equation: MV=PQ, A Classic Framework for Thinking

Classical economics provides a concise and profound formula for understanding the relationship between money, prices, and economic output: M * V = P * Q

• M: Money supply (e.g., M2)
• V: Velocity of money (the average number of times a unit of currency is used in a given period)
• P: Price level (prices, e.g., GDP deflator)
• Q: Real output of the economy (Real GDP)

The left side of this equation (MV) represents "total expenditure," and the right side (PQ) represents "nominal total output." It tells us that, if the velocity of money (V) and real output (Q) are relatively stable, an increase in the money supply (M) will necessarily lead to a rise in the price level (P). This is the simple truth behind "printing too much money makes money worthless."

Linkages in Reality: Time Lags and Complexity

Although the theory is clear, in reality, from the rise in M2 growth to the appearance of inflation (CPI/PPI), there are complex transmission mechanisms and long time lags.

• Transmission path: M2/Social Financing increases → (1) Real economy demand expands (investment, consumption) → (2) Output gap turns positive (Q > potential Q) → (3) Inflationary pressure emerges (P rises)

• Time lag: Historical experience in China suggests that the turning point in M2/Social Financing growth typically leads the turning point in CPI/PPI by about 2-4 quarters (i.e., half a year to a year).

  • Why such a long time lag? Because the "printed money" does not immediately become price tags on shelves. It first needs to flow through channels such as bank credit into the hands of enterprises and residents, who then use it for investment and consumption, forming real demand. Only when this demand exceeds the economy's supply capacity do prices begin to rise. Each step in this process takes time.

• Why is there sometimes "liquidity injection" but no inflation? This is a question that has puzzled many people in recent years. For example, in 2014-2015, M2 growth was not low, but PPI fell into a deep deflation. Why?

  1. Negative output gap: When the economy is in a state of severe overcapacity (Q much less than potential Q), the increased money and demand are first absorbed by idle capacity, manifesting as an increase in output, not a rise in prices.
  2. "Financialization" of money flow: If the "printed money" does not effectively flow into the real economy but settles within the financial system or flows into asset markets such as stocks and real estate, then what we see is not CPI/PPI rises but asset price bubbles.
  3. Decline in velocity of money (V): When the economy is pessimistic and precautionary saving is high, people who receive money prefer to save rather than spend, causing the velocity of money V to fall. According to MV=PQ, a decrease in V offsets part of the effect of a rise in M, thereby suppressing inflation.

Analyst Application:

1. M2/Social Financing is a leading indicator of prices: Compare the chart of M2/Social Financing growth with the chart of CPI/PPI (shifting the former's time axis to the right by 2-4 quarters), and you will find a very good fit. This provides the most powerful weapon for forecasting the medium-term trend of prices.
2. Do not apply mechanically: When using this rule, it must be combined with a comprehensive judgment of the output gap (economic health), asset prices, and household savings behavior to assess the efficiency and direction of monetary transmission.

Chapter Summary

In this chapter, we installed two precise "thermometers" on the machinery of the economy — CPI and PPI.

We dissected the CPI "basket" in depth and learned to see through the "fog of the hog" to the actual demand reflected by Core CPI. We also deconstructed the composition of PPI and understood its dual meaning as the "factory-gate price" and the "cost-revenue" endpoints of industry.

We constructed a framework for analyzing the CPI-PPI "scissors gap" and learned to discern the position of the economic cycle and the transfer of industrial chain profits from the structural divergence of prices.

Most importantly, we opened up the main and collateral channels connecting prices, money supply, and the economic cycle. We understood the profound wisdom behind the ancient formula MV=PQ, and also grasped the complex time lags and transmission mechanisms between "liquidity injection" and "inflation" in reality.

At this point, we have mastered the methods for measuring the "temperature" of the economy. In the next chapter, we will explore the "blood" flowing through the economy's body — financial data. We will see how the central bank regulates the "faucet" and how this "blood" flows from the financial system to every corner of the real economy.