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Chinese Inflation Does Not Mean Global Inflation

Posted by Larry Doyle on March 11, 2010 8:10 AM |

News this morning that China’s inflation rate has hit a 16-month high is garnering significant attention.

China’s economy is only one-fifth the size of the U.S. economy while China’s population is more than four times that of the United States. In fact, China’s population is approximately one-fifth of the entire world’s population. Clearly, the People’s Republic of China represents a huge growth opportunity in this century.

Bloomberg highlights this inflation news this morning in writing, China Inflation Quickens as Industrial Output Climbs:

China’s inflation reached a 16- month high, industrial output climbed and new loans exceeded forecasts, adding to the case for the government to pare back stimulus measures.

Consumer prices rose 2.7 percent in February from a year earlier, the National Bureau of Statistics said in Beijing today, compared with the 2.5 percent median estimate of 29 economists surveyed by Bloomberg News. Seasonal factors stemming from a weeklong holiday may have boosted prices. Production rose 20.7 percent in the first two months of 2010, the most in more than five years.

Premier Wen Jiabao aims to hold full-year inflation around 3 percent after banks flooded the financial system with money to drive a rebound from the global recession. Gross domestic product grew 10.7 percent last quarter and central bank Governor Zhou Xiaochuan said March 6 that anti-crisis policies, including the yuan’s peg to the dollar, must end “sooner or later.”

What does this increase in Chinese inflation mean for the global economy? Is it accurate to project that the boom in China’s economy is a precursor to a global boom? Is it accurate to project that inflation in China will lead to inflation elsewhere?

As with most everything in economics, in my opinion, these questions have no clear cut and simple answers but we would be remiss not to assess the developments in China in the context of the global economy.

First and foremost, be aware that within the inflation in China, food inflation is in runaway mode running at an 18% annual clip according to Bloomberg. How will Chinese officials react to this inflation news? In order to ease what are clear signs of asset bubbles, especially within the property sector, China will have to raise interest rates and allow its currency (Chinese yuan) to appreciate while loosening its tie to our U.S. greenback.

Bloomberg’s report adds fuel to this fire in reporting:

“Inflation may top the 3 percent policy target by April, which is bound to trigger further monetary tightening,” said Dariusz Kowalczyk, chief investment strategist at SJS Markets Ltd. in Hong Kong. He sees benchmark interest rates increasing as early as this month.


“More decisive policy tightening measures than those implemented so far are needed to prevent the economy from overheating,” said Song Yu and Helen Qiao, Hong Kong-based economists with Goldman Sachs Group Inc. The government may increase interest rates and bank reserve requirements and control investment approvals and funding, they said.

While China will have to raise rates to stave off inflation, what is happening to its closest global economic engine, that being Japan? Deflation is gaining a stronger foothold as Bloomberg highlights in writing, Japan Yield May Reach December Low on Deflation:

Japan’s bonds may gain, pushing 10-year yields to the lowest level since December, as the economic recovery slows, deflation lingers and interest rates stay near zero, Citigroup Global Markets Japan Inc. said.

Deflationary pressures are most widely highlighted in Japan, but are also building in the Euro-zone as well.

Meanwhile here in the U.S., we have a mixed bag of inflationary pressures within selected segments of our economy (food, fuel) while little pricing pressure, if not outright deflation, within other segments (wages, housing, commercial real estate).

Add it all up and what does it mean?

China’s raising rates will not only slow the strongest economic engine in the world today, but it will also attract more capital to that nation.  I do not see how Japan or the EU can raise rates given their economic weakness and deflationary pressures. I see the U.S. as stuck in the middle currently, but with the likelihood that the U.S. will have to indicate a moderate tightening sooner rather than later.


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