Fisher Investments Editorial Staff
Currencies, Emerging Markets, Inflation, Trade

Reap What You Sow

By, 01/13/2011
 

Story Highlights:

  • Chinese currency policies appear to be stoking inflation even as regulators are taking steps to slow lending and cool economic growth.
  • The Chinese government must print renminbi to buy the foreign currencies flowing into the economy to maintain the low foreign exchange rate.
  • Rising Chinese inflation likely remains a domestic issue because the effects of higher inflation in one nation can be offset or dampened elsewhere.
  • The US likely won't see materially higher inflation this year, though there are many tools to deal with the issue if it eventually arises—foremost, monetary policy.

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Chinese currency manipulation has been an overall boon to its exporters over the years and, at times, a headache for the rest of the world. But it seems China may be reaping what it sowed, as its policies appear to be increasing inflation there even as regulators are taking steps to slow lending and cool economic growth. 

The latest data showed Chinese consumer prices were 5.1% higher in November than a year ago, and they are forecasted to continue increasing in 2011. However, not only is November's rate higher than China's 3% overall inflation target for 2010, it's surmised this calculation greatly underestimates true inflation—for one, surging owner-occupied housing prices are not included. 

In response to the global financial crisis, the Chinese central bank pumped extra money into the banking system in 2009 through early 2010. Trade surpluses bloat growing foreign exchange reserves and add to the money circulating in the Chinese economy—contributing to inflationary pressures as the Chinese government is forced to print renminbi to buy the foreign currencies flowing in to maintain the low foreign exchange rate.  

Additionally, poor harvests and weather disruptions globally are also creating upward pressure on food prices. Such rapid inflation, especially in areas like food and property markets, could attract speculation and, at its extremes, lead to social dissatisfaction. The Chinese government could let the renminbi rise to alleviate some inflation pressures, but it remains to be seen if it's willing to deviate from its exports-focused currency policy. China recently allowed its banks outside the mainland to trade the yuan—a positive step in freeing its currency, though transactions will not affect the official rate set by the central bank. 

Though China's a huge exporter to other countries, rising Chinese inflation likely remains mostly a domestic issue. Exporters may raise prices, but it's important to remember higher inflation in one nation can and does get offset by disinflation or even deflation elsewhere (and vice versa) and can be dampened along the business supply and delivery chain. 

The US, a huge importer of Chinese goods and materials, has seen tame inflation rates despite increasing Chinese inflation over the past year (and increasing money supply at home).  Of course, the US could face higher inflation down the road as the economy expands and companies raise prices. But elevated unemployment and spare capacity utilization will likely continue to constrain US companies' pricing power for now.  

The US likely won't see materially higher inflation this year, though there are many tools to deal with the issue if it eventually arises—foremost, monetary policy. As for China, its rapid economic expansion appears at odds with the very policy that helped fuel that growth—possibly creating hard decisions that could in some ways change its strategic course down the line. 

 

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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