Inflation and Mercantilism
China's Money is Undervalued
By blackhedd Posted in Economy — Comments (22) / Email this page » / Leave a comment »
From the Understating-the-Case Department: This story tells of rising prices in China for staple foodstuffs. Long experience with official statements by China's leadership suggests that they're only letting the tip of the iceberg show.
Why are we concerned about inflation in China? Because it touches on a very sore subject in Congress and on this board, which often goes by the code name mercantilism.
China's economy is continuing its double-digit growth this year, as it has for several years now and is expected to continue for quite a few years more. This is an extraordinary rate of growth, and if you do some simple math, you end up with a vastly larger economy in China after another decade or so. But is it what it seems to be?
China is fessing up to 3.4% inflation inside of 11% growth:
The government has been worried that China's sizzling economy, growing at an 11 percent pace this year, could accelerate politically dangerous inflation. The official inflation target is 3 percent.
Consumer prices rose by 3.4 percent in May, the National Bureau of Statistics said. That was the highest rate since prices rose 3.9 percent in February 2005.
Food prices jumped 8.3 percent from a year ago, up from April's 7.1 percent, the bureau reported.
Now in the first place, I don't completely believe anything the China regime says for public consumption. Remember what I said about icebergs. But if they do end up increasing rates and reserve requirements, that would be a clearly visible sign that they're trying to cool things down.
But that food-price number is crazy. 8.3%? In the US, food prices are quite volatile too, but if they move one percent (annual rate) in a month, that's a big move. Look a little farther:
Meat prices jumped 26.5 percent, while the cost of eggs was up 37.1 percent, the statistics bureau said on its Web site.
Communist leaders are especially concerned about soaring prices for pork, China's staple meat. They have risen by more than 40 percent over the past year, partly by a pork shortage caused by the spread of blue-ear disease, an ailment that the government said Monday has killed at least 18,000 pigs.
These are amazing numbers. I can't tell you whether the spin being given to the pork disease is coming from the AP reporter, or whether it's China's official explanation. But 18,000 dead pigs in a countryside with 800 million peasants ain't going to put pork prices up by 40%.
Remember the SARS epidemic several years back. China only admits to bad things when they figure they can't keep the lid on much longer. The inflation situation is probably a lot worse than it looks.
I'm not inclined to accept a story about a few thousand sick pigs to explain a 40% increase in staple-food prices. I think the phenomenon is monetary.
Much ink has been spilled (including by me) on China's currency peg. As you know, the value of the renminbi (called the "yuan" inside China) is pegged to a basket of currencies and securities that closely matches the US dollar, and is only allowed to fluctuate by a tiny amount per day. What's the problem? Well, renminbi is arguably undervalued by at least several tens of percent.
If you've been listening to the Wall Street Journal, Democratic Senators like Schumer and Clinton, or a standard-issue economics professor, your immediate reaction is: Ah ha! China is trying to make their manufactured cr*p cheaper for American consumers! With the predictable effect of wiping out manufacturing jobs in America and making Walmart richer. Many people call this "mercantilism."
The true picture is substantially more complex.
I believe that China has pegged their currency to the dollar for a handful of deliberate reasons, only one of which is to make their exports more attractive to US consumers. I always have to tread lightly around this here on RedState, because whenever I describe and analyze their behavior, someone pops up to accuse me of excusing or even advocating it.
But in lieu of the entire book I could write on the subject, I'll mention just a couple of key things the Chinese may be thinking. First, memories of 1997, the summer of the "Asian flu," which did not affect China but did affect several of her neighbors. Keeping renminbi undervalued is a way of ensuring that hot money and other sources of direct investment stay in China. China is taking in over $70 billion in direct investment per year. (For comparison, India, with more than half of China's population, takes in perhaps between 10 and 20 percent of that figure.)
Another issue is that China's financial system is primitive at best. As a command economy, China has nothing like the deeply-knowledgeable network of private institutions that make the US far and away the most efficient user of capital in the world. China's leaders know what they don't know, and they're content to import monetary policy from the US, in the form of a currency peg.
Lastly, memories of 1985-87. I'm speculating on this point, but I believe the Chinese are never going to let us jawbone their currency up relative to the dollar, as we did to the Japanese after the Plaza Accord. The result was an incontrollable asset bubble in Japan, and the economic distress they've suffered ever since.
Plenty of us free-market types like to warn the anti-mercantilists that taking protectionist action against Chinese imports would be self-defeating. Why? Well, I'll spare you the comparative-advantage theory that you've heard a thousand times before.
The real reason is because markets reflect reality. Free markets (even the putatively free ones we have in the US) tend to reflect reality without too much distortion or displacement. Command economies can do well enough, as long as they don't try to get in reality's way.
The undervaluation of China's currency relative to the dollar is a distortion of reality. China's leadership think they can get away with this, but you can only go so far before it starts biting you. Markets are vastly bigger and more powerful than governments.
We don't need to protect against China's "mercantilism," because the bad effects of denying reality will show up on their own. That's the real import of the food-price inflation you're seeing in China.
By artificially undervaluing their currency and importing and holding an enormous amount of dollar reserves (more than $1 trillion, including about $350 billion in long-dated Treasury debt), the Chinese have effectively created a monetary base that is far too large for the size of their economy. Inflation is the inevitable result. China has been trying to control inflation they same way they try to control everything else: by denying it exists.
It's impossible to say for sure, but a more natural rate of growth for the Chinese economy might be quite a lot closer to our nominal 4% than to their "offical" 11%. Why? Obviously because their economic activity is driven by our export markets.
But the China regime's political legitimacy (such as it is) depends completely on their ability to deliver what is at least an illusion of prosperity-growth for the country's urban populations. Hence the inflationary effects of China's foreign-exchange policy serve an important, perhaps a fundamental political purpose.
It's possible that China's inflation is far more severe than they are letting on. It's also possible that their growth is more hollow than we think.