China’s inflation hits decade high

Note to the US: the Chinese capital outflow tap should be winding down a little bit, soon:

China’s inflation rate has soared to 6.5 per cent, the highest level since December 1996, as China’s artificially low currency floods the economy with cash.

Food prices, which account for one-third of the Consumer Price Index, rose 18.2 per cent in the year to August.

Meat prices remained acutely expensive, up 49 per cent in the year.

Summer floods also helped push fresh vegetable prices up 22.5 per cent compared with a year ago.

The escalating price of pork, eggs and even instant noodles has become a frontline political issue in China.

China actually faces one of the key problems for central banks in a modern economy, with ever-more-free capital flows: in a closed economy, one increases interest rates to slow down the economy. In the new economy, if you increase interest rates everybody will try to invest in your country. Bugger.

Mr Meng said the underlying causes of inflation included surging investment, a trade surplus that has “surged beyond all expectations”, expanding money supply and rising consumer spending.

“This would have seen inflation pick up irrespective of any adverse agricultural events,” he said.

Senior officials at the central bank, the People’s Bank of China, are showing increasing concern about China’s building inflationary forces.

But their hands are largely tied by the Government’s policy of holding down the currency.

“They’re worried. They seem to have turned more hawkish in recent months,” said Stephen Green, senior economist at Standard Charter Bank in Shanghai.

The pegged currency has attracted huge speculative capital inflows and helped build the largest trade surplus the world has ever seen.

But it has also prevented the central bank from effectively using interest rates to control the economy lest higher interest rates attract even greater speculative investment inflows.

Along the way, however, your exchange rate should surge – pushing down export sales, and slowing down the economy. These days, I can’t imagine that makes up for the cash, for most economies. For China, if it would just leave it’s bloody Renminbi the hell alone, the demand for the currency and the troubles in the US economy would slow exports down plenty. Probably enough.

Anyone care to guess why the government might rather face inflation than an economic correction? With an estimated population of 1,321,851,888 and a working population of around 711.5 million (official, I guess), and an ageing society, unemployment is something a Chinese government would rather not face.

It is said that China has surplus workforce of 120 million to 150 million. When they lose their jobs, farmer still have means of production but urban workers are left with no means of production.

The very concept of unemployment, let alone welfare, is not spread broadly. A lot of ‘our’ arguments against the way China acts, macroeconomically, imposes the degree to which we take the business cycle, with its ongoing trade-off between inflation and unemployment, for granted, on China and her government.

This we should not do. It’s standard economics. As long as you can work out what is ‘rational’ in a given market, you can figure out why economic agents act as they do. Most things, in all markets, are rational in that market. I think junkies are morons but, as discussed, the decisions they make are rational to them, and that’s all we need.

So. In this era of relatively free capital. It will not work to the benefit of the US to have Chinese capital dry up. Nor, though, does it work to have other capital pour into China, keeping its cheap crap being exported at a low exchange rate to the US.

My view is this: rather than our insistence on calling things ‘fair’ and ‘unfair’, and trying to police how other countries behave, we ought to spend more time normalising the experience of our business cycles. Send Chinese officials all the help we can to prepare for an unemployment problem, and an ongoing one. It doesn’t need to be a system like the US, or a system like Australia, or Sweden. Just a system. A system that allows the Chinese government to act properly to stabilise their economy, allowing inflation some of the time and unemployment some of the time.

Holding back the tide only makes the flood worse, and we’ll all suffer more for any of China’s missteps (I love saying we’re all in this together!).

More objectively, this is also going to be interesting, from an experimental point-of-view. Some countries have faced capital working against central banks already, a little bit. The US Federal Reserve faces it, in the sense that their economy is demanding lower interest rates, but their need for foreign lending demands higher, and the Asian currency crisis was exacerbated by dickhead speculators as well.

I think the Chinese experience, though will be the first of this sort of magnitude, and the first that is occuring organically (i.e. according to the business cycle, or a boom period), rather than upon a crisis.

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