Inflation in China is not necessarily a bad thing
Yesterday, the release of key economic indicators in China produced headlines like this: China Targets Inflation as Economy Runs Hot. The table below lists the full release, including the consensus expectations (Bloomberg’s survey) for each statistic. (Here is the link for the actual data release.)
As you can see, the survey undershot the actual results across many of the releases, including that for GDP and inflation (CPI). The surge in the CPI, 1.9% y/y in December versus 1.4% y/y expected, attracted a lot of attention. According to the Economist, Helen Qiao and Yu Song at Goldman Sachs points out that prices may be on an (increasingly) upward trajectory:
The recent rise in inflation was caused mainly by higher food prices as a result of severe winter weather in northern China. In many cities, fresh-vegetable prices have more than doubled in the past two months. But Helen Qiao and Yu Song at Goldman Sachs argue that it is not just food prices that risk pushing up inflation: the economy is starting to exceed its speed limit. If, as China bears contend, the economy had massive overcapacity, there would be little to worry about: excess supply would hold down prices. But bottlenecks are already appearing. Some provinces report electricity shortages, and stocks of coal are low. The labour market is also tightening, forcing firms to pay higher wages.
The final sentence is very important – a tight labor market will lead to higher wages (the data on wages is 4 months old, so I will not plot it out). This suggests, completely by inference on my part, that prices pressures will be the wage-price spiral type – this can quickly get out of hand.
To be sure, the inflation surge was driven primarily by food prices, up 5.3% over the year; but with retail sales growing at a rate of 17.5% over the year and broad money growing at a 27.7% pace in 2009, prices hikes are bound to spread. We already saw inflation pressures building in the trade balance. Now I get to my chosen post-point: why is inflation in China necessarily a bad thing?
The inflation pop sparked a lot of market angst yesterday. Of course, this is just a single data point; but if inflation does build, and the government insists on maintaining its tight peg against the $US, then inflation will do what US consumers and Asian savers have not: reverse trade flows.
Specifically, and holding all else equal, sizable inflation in China would drive up the value of its real-exchange rate (REER), where the REER is the nominal exchange rate adjusted for relative prices in China versus its trading partners – faced by the Chinese.
As illustrated in the chart above, the REER has been on a downward trajectory throughout 2008, but remains elevated compared to its 2006 levels. The real exchange rate is the single-most important factor in determining trade flows. An inflation-driven growth in the real value of the Chinese yuan (REER) would effectively, and eventually, drop China’s export share with key trading partners.
Rebecca Wilder
Article ~ “The final sentence is very important – a tight labor market will lead to higher wages (the data on wages is 4 months old, so I will not plot it out). This suggests, completely by inference on my part, that prices pressures will be the wage-price spiral type – this can quickly get out of hand.”
This wage-price spiral analysis confuses me. The Chinese have such a large number of potential workers that exist outside of their participation rate that labor-supply should not be an issue at present. This urbanization is what explains their success in regards to poverty and so why would this trend cease? They still have a much higher percentage of their population living in rural environs than any of the industrialized nations.
The ASEAN-China free-trade zone agreement(Jan. 1) removed tariffs on thousands of items and yet Wall St. seems to be in denial about the affects of what will involve 13% of all global trade. There seems to be some wishful thinking involved here, but then if anyone can make dreams come true, it is the folks at GS. ~ray
What amuses me is to see how many US economic “pundits” keep predicting terrible things that will soon happen to the Chinese economy. You might even suspect they are wishing for that. I note YOY consumer inflation is 1.9% according to your table. That sure is a disasterous number that will make the Chinese economy collapse in the very near future without a doubt. LOL
warprofiteers=warmongers
Good grief….read the chart again please. You will not find China phobics nor cheerleaders here….
Hi Margery,
This is what bothers me, “but with retail sales growing at a rate of 17.5% over the year and broad money growing at a 27.7% pace in 2009, prices hikes are bound to spread.”
Can’t be too short-sighted about inflation – prices are very sticky.
Rebecca
Not to mention, the point of the article was to assuage the inflation-phobes rather than join them. Rebecca
Hi rl love,
You definitely have a point – the labor surplus is much greater than that in industrialized nations. However, the surplus is dropping, and is small compared to that of ten years ago. My point is: is that inflation stemming from input costs has a much higher probability than in previous years.
Rebecca
Rebecca,
I don’t think there is any info any more recent than this, I found it in a WSJ article out of Asia (12-23-09):
“The leadership is betting on the connection between accelerated urbanization and consumption too. In 2008, 43% of China’s population was considered urban, versus an average of 79% for Latin America , 73% in the Euro area and 82% in the United States: China still has a long way to go.”
I would not have said anything so rude as “China still has a long wat to go”, but it was there and I only hope I do not offend, I certainly do not mean too.
I was not referring to the post here but to TV commentator and news stories, etc. Bloomberg is always predicting bad things will happen to China.
I think we’ve been through all this before. Inflation disaster was coming to China in 2008, remember?
http://www.nytimes.com/2008/02/19/business/worldbusiness/19iht-19inflation.10173154.html
Seems to me the Chinese did pretty well in spite of it all.
I think China is the least of our worries. Quite a few Americans wish for it to have troubles. Here evidently the idea is that inflation there will cut exports and this will benefit us. Really? Fact is China for the last five years or more has been the best performing economy, as far as I know, in the world. The Great Recession didn’t do it too much harm and I don’t think it will suffer much in the near future either. If there is inflation there, whatever the consequences for us, good or bad, we’ll have to live with it. China isn’t to be manipulated by us.
Further, if Chinese exports to us decline is this a good thing for us? Lower exports would bring them fewer dollars to invest in our bonds. We want that? Higher prices for its exports would raise the prices of all the stuff we buy from them. Unless we can get those things elsewhere, is this good for us? I recall Nixon’s Secty of the Treasury (Connolly as I recall) saying when we closed the gold window. “it’s our currency but YOUR problem.” Perhaps things have come full circle. The Chinese can say perhaps now “It’s our currency but YOUR problem” Oh, that hurts.
Tangentially, I might mention how interesting I find it that the Chinese leadership seems to handle the nation’s problems with complete calm and serenity. If things need to be done, they do them, period. Here Washington seems in constant confusion and upset. After the Mass. election Congress is on a “populist” tear (although how Brown can be regarded as populist is difficult to say). Bernanke will be dumped perhaps. The bankers are all in a tizzy about their gluttonous salaries being in danger and are set to thwart that as the insurance industry thwarted universal medical insurance, etc., etc. Geithner isn’t happy about Volker’s recommendations, etc., etc. One might say this is “democracy at work” except that the US is really not a democracy for anyone who can see through the facade. The US is in trouble and completely confused about what road to take forward so it lurches in one direction and then another and basically gets nowhere. Obama has been blocked so he has accomplished almost nothing since he came to the White House and it looks as if he won’t be getting anywhere in the near future either.
The Chinese and the Japanese for that matter, do what they want to do and are loathe to let agencies like the IMF or the credit raters bully them into policies that dont fit their national goals. Bully for them I say.
International finance people have been screaming for decades that Japans sovereign debt situation is un sustainable, that inflation was imminent and that their currency would crash. Well for 20 yrs they have ignored them and none of the fears have materialized. I’d say this should have completely discredited the finance/economist fools but nooooo. This is just like the whack job christian zealot who predicted the end of the world on a specific day in the 1980s and has now gone back to the drawing board (bible) to “recalculate” (which now says a day in 2011). There are still people who are behind this “prophet” and are getting ready for the revised apocalypse. The level of credibility the human mind kind give to experts, even thoroughly discredited ones, is astounding.
China and Japan have figured out the first rule of modern money, the currency issuers rule. They say the stock market is a pimple on the ass of the bond market, well the bond market is subserviant to the currency issuers not vice versa. Let the bond traders scream. When a currency issuer like Japan or China “offers” a promise to pay a certain interest rate on their “debt” someone will take it. Safe money like that will NEVER be passed up. The US knows that, they are just too politically subserviant to bond traders.
China can produce everything it needs and Chinese people will always need renmibi to pay taxes so they can issue as many as they wish.
Your darn right they have come full circle Margery. China understands modern currency better than the US, or at least it is willing to use the tool to its full effect. We still want to follow stupid “monetarist” rules.
You are right Margery, China and the Japanese will not be bllied by international forces into doing things against their national interests. Their governments actually have national interests. Our government doesnt believe in national interests, only private ones.
Japan has been badgered for 20 yrs+ about their “debt levels” and have been told they are unsutainable, inflationary and will lead to bond market revolts of their assets. Well none of this has happened and instead of tucking their tails between their legs and skulking away, the discredited economist/finance voices just yell louder. They have no shame and no grasp of new financial realities in this floating exchange rate currency regime we operate under. These guys remind me of the religious zealot that predicted the end of the earth on a specific day in like 1994 and has since recalculated and NOW predicts a certain spring day in 2011 when it will all end. This guy is still being hailed by the very people who went with him to await the end the first time and are “sure” he is right this time. Its amazing the level of reverence we humans give to, discredited experts.
China and Japan have figured out the power of modern currency and are using it, debt markets be damned. Bond traders need currency issuers more than vice versa. The US needs to stop fawning over these market makers and get to the business of repairing its economy.
Hi Margery,
<< Fact is China for the last five years or more has been the best performing economy, as far as I know, in the world.>>
Yes, China enjoys one of the highest growth rates in the world based on a targeted export policy, via the nomional exchange rate. But that’s just the headline number. The PBoC sits on $2.4 trillion of FX reserves – and this number is quite meaningless, since it does not include transfers to the SOEs and local governments, there’s a lot more. So there is an unmeasurable amounc of “resources” that are held back from the domestic economy (i.e, much of the uneducated and unemployed population that drives the average income to something below $3,500 per year) in order to finance export growth. That’s a problem. The only way for this kind of growth to be welfare-enhancing is for this stock of resources to be transfered to the domestic economy.
If inflation drives up the REER, then we will import (if necessary) from another competitive economy. But the fact is that our import capacity has likely dropped for quite some time – at least until demographice bring it up – that’s the whole point of the “rebalancing” effect.
Rebecca
Hi Margery,
<< Fact is China for the last five years or more has been the best performing economy, as far as I know, in the world.>>
Yes, China enjoys one of the highest growth rates in the world based on a targeted export policy, via the nomional exchange rate. But that’s just the headline number. The PBoC sits on $2.4 trillion of FX reserves – and this number is quite meaningless, since it does not include transfers to the SOEs and the banking system, there’s a lot more. So there is an unmeasurable amounc of “resources” that are held back from the domestic economy (i.e, much of the uneducated and unemployed population that drives the average income to something below $3,500 per year) in order to finance export growth. That’s a problem. The only way for this kind of growth to be welfare-enhancing is for this stock of resources to be transfered to the domestic economy.
If inflation drives up the REER, then we will import (if necessary) from another competitive economy. But the fact is that our import capacity has likely dropped for quite some time – at least until demographice bring it up – that’s the whole point of the “rebalancing” effect.
Rebecca
Hi Margery,
<< Fact is China for the last five years or more has been the best performing economy, as far as I know, in the world.>>
Yes, China enjoys one of the highest growth rates in the world based on a targeted export policy, via the nomional exchange rate. But that’s just the headline number. The PBoC sits on $2.4 trillion of FX reserves – and this number is quite meaningless, since it does not include transfers to the SOEs and the banking system, there’s a lot more. So there is an unmeasurable amount of “resources” that are held back from the domestic economy (i.e, much of the uneducated and unemployed population that drives the average income to something below $3,500 per year) in order to finance export growth. That’s a problem. The only way for this kind of growth to be welfare-enhancing is for this stock of resources to be transfered to the domestic economy.
If inflation drives up the REER, then we will import (if necessary) from another competitive economy. But the fact is that our import capacity has likely dropped for quite some time – at least until demographice bring it up – that’s the whole point of the “rebalancing” effect.
Rebecca
China does have a long way to go – it is still early in the development stage!
Hi rl love,
Consumers are definitely saving it; but with the money supply rising at such a pace, they are spending it, too! Retail sales are strong, and investment grew 30.1% over the year. If they weren’t spending it (firms and consumers), then the money supply growth rate would be much, much smaller, i.e., what it is in the US (a mere 3.4% annual M2 growth).
Rebecca
It is my belief that China is a paper tiger who fakes the numbers and eventual will be imploding. The ponzi scheme of government spending will end over there.
http://talkofliberty.com