April 23, 2011

China inflation monster

A quick search on China's XinhuaNews reveals four recent stories related to inflation.  If inflation is a problem in China, it is not going to be alone.  With gas and food prices on the rise across the globe, and massive quantitative easing in the U.S. and a number of other countries over the last couple of years, Chinese inflation will only exacerbate the potential for a global inflationary spiral.  So what's going on in China?

Inflation is going on.  There's the question of why and there's the question of what it will mean in China and elsewhere.  Firstly, Chinese news stories provide some evidence of the inflation.

In one story, the Chinese government is being advised to set up resources to support technology and development for Small and Medium Enterprises (SMEs).  The restructuring though, is not the most important part of the story.  The reason the the government is being called upon to help the SMEs is because of rising production costs - labor and raw materials specifically have become increasingly expensive.

China's housing market is truly a bubble of weird dynamics.  Despite the glut of housing, there's also an inflationary spiral.  In a second story, XinhuaNews discusses the implementation of housing price controls across the nation.

And what would price controls be without price controls in consumer goods?  China's command economy is going to unleash a flood of unintended consequences as it seeks to impose a whole bunch of measures designed to cap consumer prices.
To crack down on speculation in agricultural goods under the backdrop of several drought, the Chinese government has taken emergency and effective measures to curb commodity prices.These efforts include measures to ensure market supplies, strengthen market supervision, improve subsidy systems and boost grain production. The decline in December's CPI compared to November shows these measures have achieved some success.
Despite the growth of China's economy, it remains a predominantly poor country and rising prices in consumer goods have widespread impacts and potentially a lot of unrest.  The government cannot afford to ignore the problem, but intervention serves only to distort the problem.

The unintended consequences of price controls? As inflation pushes production costs up, prices in the market place are driven up (the supply curve changes).  But by imposing a price ceiling that is below the new equilibrium, the demand will exceed the supply as suppliers are willing to sell less than consumers want to buy at the lower price.  That means a shortage arises.  The Chinese government is trading one problem for another, which is potentially more volatile.  "I can't afford it." is a very different feeling than "There's nothing in the stores!"  The other potential outcome is the rise of black markets.  Another consequence is that because so much that is consumed elsewhere is produced in China, price controls will push resources into production where the price controls are less likely to be imposed, which means some of the inflation could be 'exported'.  Or if the Chinese government doesn't or can't distinguish the sectors that are export specific, then price controls would be imposed on goods headed to the rest of the world too, potentially, but not necessarily dampening some inflation there.  Likely though, the Chinese government would not be able to sustain the price controls for an extended period and may be just temporarily delaying the problem.  

No matter what, inflation in China, whether a bubble ready to burst or a long term problem will have impacts elsewhere because it's an export economy.  That will compound the inflation related oil prices and the food prices and the impact could be quite significant. How significant? That's a question that requires more investigation.

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