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CNN: China’s Inflation Problem

February 18, 2011

On Friday, China’s central bank raised its reserve requirement ratio (RRR) for banks by 50 basis points (0.5%), the second hike this year, in a further move to combat inflation.  Just a few hours earlier, CNN’s Jaime FlorCruz  devoted his weekly column to the challenge inflation is posing to China’s economy.  Jaime and I talked at length (via email) about this topic, and some of the thoughts I shared — which will sound familiar to regular readers of this blog — were reflected in his post:

Still, some economists say the CPI is only one measure of inflation and does not capture the full inflationary pressure in China’s economy today. China’s money supply, they say, has expanded by more than 50% over the past two years — the stimulus fueling China’s red-hot growth rates.

With such monetary expansion, the question isn’t why China is battered by inflation, but why China hasn’t seen more inflation sooner.

One explanation: All the new money printed went mainly into an investment boom, not a consumption boom. State banks lent out new money, which went to bid up the price of land, the price of commodities — into so-called “asset inflation.”

Asset inflation, experts say, does not feel like inflation. “When the price of bread doubles, it feels like it’s getting harder to make ends meet,” says Chovanec of Tsinghua. “When the price of high-end condos doubles, it feels like smart investors are getting rich — it feels like a boom.”

Eventually, the asset inflation spills into the general price level. “In my view, that’s the real worry in China — that what we’re seeing in terms of CPI rates could just be the tip of the inflation iceberg,” Chovanec added.

By incrementally raising interest rates and reserve requirement ratio for banks, China has slowed down its inflation rate but only modestly. Ultimately, experts say, what China needs to do is tighten its money supply, which is still growing at nearly 20% yearly.

Earlier in his article, I noted the political risk that China’s leaders are keenly aware of, should inflation spin out of control:

But inflation is no joking matter for China’s Communist Party rulers, as soaring costs could trigger social instability.  “The Communist Party came into power in 1949 in part due to hyperinflation after World War II that broke the back of the Chinese economy and the Nationalist regime,” says Patrick Chovanec, associate professor at Tsinghua University School of Economics and Management in Beijing. “They know they nearly lost power in 1989 in part due to anger over rising inflation that fueled the Tiananmen protests.”

The PBOC’s consistent tightening measures this year indicate that China’s leaders are indeed taking the risk of rising inflation much more seriously than a few months ago.  What remains to be seen is whether they will have the resolve to stay the course once those measures start to “bite” by reining in China’s credit-fueled growth.

4 Comments leave one →
  1. Rex permalink
    February 19, 2011 3:13 pm

    well,the problem is that most chinese people are living through every single day…the skyrocketing housing price, the deformed education system, etc.. Can you imagine how much it will cost to buy some “decent” clothes? it will be much cheeper to live in a normal or small-sized city in American than in China. The Country is destroying its crystalized national wisdom and spirit.

  2. February 20, 2011 1:44 am

    “The Country is destroying its crystalized national wisdom and spirit.” Read:

    As for the Govt., they know what they’re doing, they increased the reserve rate, and the interest rate. Great. All we have here is some speculation that it won’t be enough. So would 1% increase be enough. We’re splitting hairs here.

    China’s problem is an overly succesful economy.. they increase reserve rates to slow down money supply and increase the interest rate, to make Chinese products relatively more expensive. This should work fine.

    • February 21, 2011 8:28 am

      I’m not so convinced as Michael is that the govt. can quickly reign in inflation. After all they have been battling housing prices for over a year, but a recent study showed that prices still increased in 68 of the 70 cities (People’s Daily Feb. 19).
      I think China has big problem on it’s hands as I outlined in my post about China’s banking problems (


  1. The Gold Standard » Currency devaluation and domestic demand

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