Wednesday, 26 March 2008

On China's Monetary Trap and Inflation

A link to the always excellent "China Financial Markets" posts on China's Monetary Trap and the increasing problem of inflation.

The first article summarises Pettis' arguments as to why he believed China's monetary policy is out of control. He lists eight main arguments which are well made. The only issue is whether his envisaged "revaluation" will ever take place due to the political implications.

China's monetary trap [China Financial Markets]

This whole argument in favor of a maxi-revaluation depends crucially on the assumption that foreign exchange inflows will continue to accumulate at extraordinary levels until the adjustment is made. This is the bet I made four years ago – I argued that reserves would surge. Of course like everyone else I seriously underestimated just how much it would surge. The key argument against continued rapid appreciation is of course the incentive this creates for speculative inflows.

In a second post Pettis deconstructs Chinese inflation to reveal in simple terms just how bad things have got and how quickly.

Deconstructing Chinese inflation [China Financial Markets]

This gives a better idea than do the headline annual figures of how variable inflation has been and how it has accelerated. The first thing to note is that inflation really began to pick up at the end of 2006, but only began showing up in the annual numbers in the summer of 2007. A quick calculation (which is not included in the graph) indicates that from May 2007 to now China has suffered from double-digit inflation (11.1% annualized). The same calculation also suggests that if the next three months show price increases that on average equal the price increases of the past eight months (around 1% month-on-month) we will have double digit year-on-year inflation in China by May.

The second thing is that the February rate of increase in the CPI was very high (35% on an annualized basis), more than twice as high as the already-high January rate of increase. Because of the big jump in February prices, the numbers for March are likely to be distorted. In fact prices could decline significantly in March (by 1.8% on average) while still maintaining a continuation of January’s 7.1% year-on year CPI inflation. If prices do not decline this month, March 2007 year-on-year CPI inflation will reach 9.1% or more.


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