Thursday, July 1, 2010

One Eye on China: High Inflation or No?

Reading an article published on May 20 in the Caixin, an english language newspaper in China. The article is authored by the chief economist of China Capital Corp., One of the largest investment banks in the country.

Inflation is officially not a problem in China, though unofficially it is. Officially, May inflation is measured at an annual rate of 3.1%, year over year. That is the 'obvious inflation', mostly reflected in consumer prices. But there is 'hidden inflation' to recognize too. He says "in economies where prices are entirely or partially controlled by the government, inflation may not be perceivable by simply looking at consumer prices. Instead, inflation may become evident when there is a shortage of goods, or after enterprises chalk up losses because their product prices are controlled by the government. This so-called hidden inflation leads to imbalances in resource allocations. And when hidden inflation is superimposed on dominant inflation, the result is so-called true inflation."

China responded to the global financial crisis by printing more money, like in the US. In China, more of the new money is in circulation and is influencing prices moderately higher. The rate of inflation is officially modest, but interest rates on bank deposits are low. Here is how the author describes it... "Another reason for inflation is that the nation's bank deposit interest rates are too low. Consumer willingness to accumulate money in banks depends on how deposit rates compare to expected inflation. Thus, inflation climbs when deposit rates are in negative territory compared to inflation; people are more likely to buy goods rather than deposit savings in a bank if they expect those prices to rise in the future." The same scenario exists in the US except that US consumers have personal debt balances instead of savings balances. Paying off the personal debt is a new priority for US consumers and so the negative savings rate here is less influential than in China. The Chinese economy is a cash based system, rather the debt based economic system Americans relate to. A major influence for this distinction is the Chinese have little to no social safety-net system. This creates concern about their long-term financial security and motivation to be self-sufficient savers of a high percentage of their personal incomes. The title of the article is Time to Admit, Then Douse, Our Inflation Fire.