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Is Inflation a Chinese Export?
Will Inflation Burst the China Bubble?
by Jim Trippon
As the world watched the Olympic drama play out this August
in Beijing, the financial community will also be watching
another unfolding economic drama, one with much wider global
implications. The world's fastest growing major economy is
starting to feel some serious growing pains, and we are beginning
to feel China's pain as well.
Alarm
bells went off last February when inflation in China hit a
twelve-year high of 8.7 percent. Premier Wen Jiabao promptly
declared fighting inflation to be the nation's top priority
for the year. The Chinese government slapped a freeze on fuel
and utility prices as it struggled to meet its goal of keeping
inflation below 4.8 percent for 2008.
Always
uneasy about the specter of popular unrest, Beijing is taking
the prospect of runaway inflation very seriously. Major macroeconomic
changes are underway, and as we all now know, what happens
in China no longer stays in China. The effects of economic
changes in China will be felt worldwide.
The
effects of China's economic growth are already
apparent to every American. High prices at the fuel pump and
the grocery have become a staple of the U.S. news media, and
commentators waste no time in pointing the finger at China
and other emerging economies for causing America's troubles.
Certainly the shrinking dollar is an important factor in skyrocketing
fuel prices, but prices at the pump have risen far more than
the dollar has fallen.
HOW
CHINA EXPORTS OIL INFLATION
China's insatiable thirst for oil has tipped
the global petroleum supply balance, contributing to inflation
at the consumer level in the United States and the rest of
the world. Because Beijing slapped a ceiling on refined fuel
prices in China, that aspect of China's inflationary problem
is effectively being exported globally.
Oil
consumption in China soared to a record high during the first
quarter of 2008 as demand soared in an artificially created
low-price environment. The China Petroleum and Chemical Industry
Association (CPCIA) reports that China's consumption of oil
products composed of gasoline, diesel and kerosene rose by
16.5 percent year over year to 52 million tonnes during the
first three months of 2008. That's a whopping jump in consumption
at a time of record-setting world prices for crude oil.
Part
of the blame for China's thirst for energy goes to China's
consumers who are buying cars and driving over China's expanding
highway network with a degree of enthusiasm rarely seen outside
of the United States. With auto production setting new records
every month, it is small wonder that commodities like copper
and steel and, of course, oil are jumping in price relentlessly.
The
surge in auto production and consumption is also happening
in a number of other emerging economies, like that of India.
But China is truly the proverbial thousand pound gorilla in
the global commodity inflation situation.
China
ordered national oil companies to stock up on fuel supplies
in advance of the Olympics in order to prevent embarrassing
supply shortages during the Beijing games. For the first time
in history, China became a net importer of gasoline. As giant
Chinese oil companies like Sinopec and PetroChina complained
of heavy losses in their refining operations, the government
handed out massive subsidies to keep the oil flowing at a
price that is technically below cost.
The
Chinese government has also given oil refiners huge rebates
on imported crude and fuel supplies rather than risk social
unrest by raising domestic pump prices before the all-important
Olympic spectacle. China has also added to the pressure on
international supplies by starting to fill the tanks of a
national oil reserve similar to America's Strategic Petroleum
Reserve. This is a project that will continue for years to
come, putting continuing pressure on global petroleum supplies.
PAYING
THE FOOD BILL
The
cost of food is currently at the heart of China's inflationary
concerns. Analyzing the 8.3 percent spike in the Consumer
Price Index during March, the National Bureau of Statistics
determined that most of the price increases came from a 21
percent jump in food costs, most importantly pork, vegetables
and grains.
Since
last year, Chinese authorities have been doing everything
they can do boost food production with only mixed results.
In an effort to boost grain production, China has raised minimum
purchase prices for rice and wheat several times. Command
economy measures may alleviate supply shortages eventually,
but the immediate effect is even more inflation. During my
most recent visit to China the most common inflation-related
complaint I encountered was concern over the soaring cost
of food.
China's
growing economy
and demand for foods with higher protein content
and the government's earnest attempts to control the problem
have certainly contributed to a global food price bulge. Just
as China sent inflationary ripples abroad by discontinuing
shipments of gasoline to East Asia, China's grain exports
are being sharply restricted while internal consumption is
increasing.
The
rising value of the Chinese yuan has coincidentally increased
China's competitiveness in the global market for agricultural
goods. Until 2005 the yuan was firmly pegged to the U.S. dollar,
but that year Beijing started to loosen its policies on exchange
rates and the yuan began a slow and controlled increase in
value. As the dollar began to fall precipitously during 2008,
the yuan was allowed to appreciate much more quickly in order
to maintain China's purchasing power for essential commodities
on the world market.
In
many ways China's macroeconomic expansion is transforming
worldwide commodity markets permanently.
TOO
MUCH MONEY
One
of the biggest unseen drivers of inflation is China's growing
mountain of foreign currency. As dollars and euros pour in,
China must issue large volumes of yuan to soak up foreign
currencies. In the process of buying up foreign currencies,
the Bank of China unleashes a flood of yuan, creating a demand-driven
inflationary push. In short there are too many yuan chasing
too few goods.
The
one thing that Chinese authorities will admit freely is that
managing the inflation problem is an extremely complex challenge.
China
raised interest rates six times during 2007 as part of a massive
effort to curb excess liquidity using monetary tools. But,
while China was raising rates, the United States Federal Reserve
lowered American interest rates an equal number of times.
Of course, U.S. authorities had little choice but to cut interest
rates as they struggled to alleviate a liquidity crisis and
stimulate the growing China economy despite the risk of generating
inflation in America.
The
immediate result has been a major interest rate gap between
the United States and China and that's bad news for Beijing's
anti-inflation fight. Although increased interest rates and
bank reserve ratios were intended to dry up excess liquidity,
one side-effect has been an inflow of hot money due to arbitrage
on the rising yuan and the gap in interest rates. The broadest
measure of money supply, M2, rose more than 15 percent every
month during the first quarter in a year over year comparison.
As the money supply ballooned, assets of Chinese banks topped
$7.5 trillion.
There
are few signs that China's surging inflow of foreign reserves
will be staunched easily. Foreign direct investment (FDI)
in China continues to accelerate. The Ministry of Commerce
reports that FDI jumped by more than 75% during the opening
months of 2008 with monthly inflows in the range of $7 billion.
An astonishing 4,327 new foreign-funded enterprises were established
during the first two months of the year.
CHINA
DRIVES ITS OWN GROWTH CURVE
Many
China watchers remember the gloomy predictions that a U.S.
recession or downturn would crush the long-running Chinese
growth curve. To be sure, some easing off was to be expected
after last year's blazing 11.9 percent growth rate. But there
has been no sign at all of the U.S.-driven collapse that seemed
inevitable to some pundits just a few months ago. Instead,
China came roaring into the New Year with an enviable 10.8
percent growth rate during the first quarter.
What's
driving China's economic growth in the face of a slump among
western economies? The U.S.-led recession has indeed caused
a slight easing in the rate of growth of exports. But China's
own consumers appear to be filling the gap. Retail sales growth
in the first quarter accelerated to 20.6 percent, suggesting
that domestic demand may be more than strong enough to offset
a decline in exports.
But
the boom in domestic consumption is also an important driver
of inflation. Beijing has no intention of clamping down on
consumption. Quite the opposite. The Chinese government's
primary interest is in continuing the nation's rapid economic
expansion. Well aware of the danger of being too dependent
on exports for its economic health, Beijing is increasingly
eager to encourage domestic consumption of Chinese-made products.
Although
booming consumption may be another driver of inflation, there's
no sign that the retail boom will end anytime soon. Total
retail sales of consumer goods have now topped the 10 trillion
yuan mark…almost 1.5 trillion U.S. dollars. Income growth
in both urban and rural areas is expected to outpace inflation
and that means more consumer demand. The Chinese Academy of
Social Sciences predicts that per capita disposable income
will rise by 11.1 percent in urban areas this year and 7.3
percent in rural districts.
China
hopes to ratchet the inflation rate down to 4.4 percent by
the end of the year but that would be quite an achievement
considering the many economic pressures that Beijing is grappling
with. Even the most optimistic analysts predict that China's
inflation rate will not drop below 6.5 percent by the end
of the year.
After
the Olympics, Chinese authorities will wrestle with the problem
of lifting the ceiling on retail fuel and electricity prices.
Ending the price freeze would create new inflationary pressures
at the very moment the government hoped to force down the
consumer price index. But allowing the freeze to stand will
exacerbate the distortions that are rippling through the economy.
In addition to the multi-billion dollar losses being absorbed
by oil refiners, periodic fuel shortages are developing, and
gasoline smuggling is rapidly increasing because of the artificially
low price of fuel on China's mainland.
The
World Bank does not share China's optimism about managing
inflation. The development bank predicts that the economic
growth of East Asia will continue to be affected by high inflation,
driven by increasing prices for grains and energy. The growth
of East Asian economies is expected to slow to an average
of 8.6 percent due to inflationary strains according to the
World Bank.
If
China's massive and sustained economic expansion is a driver
of regional and global growth and inflation, don't expect
that trend to ease in the near future. According to the powerful
bureaucracy known as the National Development and Reform Commission
(NDRC), China's boom won't end in this decade or the next.
The
NDRC confidently predicts that China's boom cycle will last
at least until 2020. If Beijing is correct about the nation's
economic future, internal inflationary trends will be an ongoing
concern for the mainland economy.
For
the rest of the world, China's expansion, and the growth of
its consumer class, means increasing global competition for
shrinking food and energy resources.
Unless
those demands are met with room to spare, an ongoing commodity
price squeeze is inevitable. That means consumers in the West
will be feeling the effects of Chinese inflationary pressures
for many years to come.
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