Chinese inflation divides the experts

A few years ago reports of Chinese inflation would generate about as much excitement as details of Paraguay’s cotton harvest or Iran’s crop of pistachio nuts. But last week’s news that China’s inflation rate was the highest for 11 years generated discussion and even concern worldwide about the country exporting inflation.

Not only is the Chinese economy far larger than it used to be but the news came against a backdrop of concern about global inflationary pressures. Rising prices in China could, it was argued by some, push up prices worldwide at a time when inflation was already rising. The gradual appreciation of the renminbi could also add more momentum to the rising prices of Chinese exports.

However, there is disagreement on the significance of China’s inflation figures. Some see rising inflation as primarily a domestic question related to local food prices. Other equally well informed commentators argue it is a symptom of a more general overheating of the Chinese economy.

The headline figures are not disputed. China’s consumer price index (CPI) in January rose 7.1% on the same month last year. Foodstuffs rose by 18.2% while non-foodstuffs rose by 1.5%. As the World Bank’s recent Quarterly Update* on China noted, several special factors pushed up food prices. Pork rose sharply because of supply problems, partly caused by the outbreak of disease. The prices of internationally traded products, such as grain, also rose sharply.

Mark Williams, an international economist at Capital Economics, took a generally sanguine view of the inflationary picture (“Chinese consumer prices (Jan)” February 19, 2008). He wrote that “as far as we can tell given the seasonal disruption, non-food inflation still seems to be under control”.

However, he acknowledged that two factors make the data hard to interpret. First, prices often rise in the run-up to the Chinese new year, which itself was relatively early this year. Second, the worst snowstorms in 50 years in January destroyed large areas of crops.

In contrast, Charles Dumas, an economist at Lombard Street Research, predicted that Chinese inflation could easily reach 10% later this year (“Chinese inflation forces further yuan gains” February 19, 2008). He argued that rising food prices reflected inflationary pressures more generally since, as is normal in a poor country, food accounts for a large proportion of consumption. From this premise he concluded that “the acceleration of food prices is chiefly driven by excess demand – overheating.”

For Dumas the solution is for Beijing to revalue the renminbi or, better still, float its currency.

Andy Xie, an independent economist in Shanghai, takes a similar view. Rising inflation is itself a symptom of a rapidly expanding money supply. “Inflation is a lagging indicator,” he says. Xie argues that the authorities need to raise deposit rates aggressively to quell such pressures. Falling interest rates in America complicate matters for the Chinese authorities, but tightening monetary policy within China remains possible.

There is also a debate to be had about the extent to which inflation in China will be exported abroad. Paul Krugman, a professor of economics at Princeton, concedes in his blog that stores such as Wal-Mart sell many Chinese products. However, many of the prices in the stores reflect American costs for such operations as transport and warehousing.

Overall, Krugman points out that America spends just over 2% of its GDP on Chinese goods. So if Chinese prices rose by, say, 10% the effect on America’s cost of living would be a price increase of less than a quarter of a per cent.

A similar conclusion was drawn in a study by Tarhan Feyzioglu and Luke Willard, respected foreign economists, in the January-February 2008 issue of China & World Economy, an English language journal from the Chinese Academy for Social Sciences.* “Quarterly Update” February 2008. Available at www.worldbank.org/china