Chinese Inflation May Be Just What Doctor Ordered

Chinese Economy Inflation…Is It All Bad?

You could almost hear the sound of the sky falling as journalists around the world hit their keyboards pronouncing judgment on the latest inflation figures from China. Consumer prices rose by 2.7 percent in February, the most in 16 months. That exceeded the expectations of professional prognosticators by about 0.2 percent.

Bloomberg quickly declared that,

China’s accelerating inflation has started to erode household savings, threatening to spur purchases of property and stocks and fuel asset-price pressures.

Other news sources and analysts jumped in with predictions that China will be forced to raise interest rates to prevent a property price bubble and runaway inflation.

But Beijing rarely takes guidance from reporters and Wall Street talking heads. What’s really likely to happen?

In fact, Beijing’s least favored choice would be raising interest rates. That move would put the brakes on a broad spectrum of economic activity. Instead, an array of micromanagement controls have been the pattern in the past, and will likely continue to be Beijing’s preferred economic option for as long as possible.

Remember January, when the government ordered banks to rein in their lending and raised reserve ratios to control asset bubbles and inflation?

February figures showed results. Banks extended just 700 billion yuan ($103 billion) of loans, down from 1.39 trillion yuan in the month before. In other words, runaway bank lending was cut almost in half by an edict from Beijing. There was no need to raise rates.

What about inflationary cycles? Bean counters argue that the inflation rate now exceeds the one-year bank deposit rate of 2.25 percent. That should mean depositors will be likely to abandon their money-losing bank accounts and go out to spend aggressively on hard assets before their money depreciates even further.

Guess what? That’s exactly what Washington and Beijing have been fervently hoping for. Increased domestic consumption is widely seen by Chinese authorities as the key to a more stable economy, less reliant on fluctuating, low-margin exports. Of course, Washington also wants Chinese consumers to spend more in the hope that U.S. exports to China will be boosted and trade imbalances will be evened out.

What about those feared property bubbles driven by inflation? Once again, it is not Mom and Pop with a few thousand yuan in a bank account who are driving prices to dangerous highs in China’s major cities. It is largely the work of speculators.

Again, Chinese micromanagement is quietly at work. Beijing has just increased the deposit requirement to 20 percent of the minimum price of land on auction in order to curb worrisome increases in the price of land. Some land auctions in the past had required deposits of as low as 3 percent. Share prices of developers fell on the news.

And finally, there is the usual fear that depositors who are losing money in the bank will flood the stock market in search of higher returns. The market says differently.

The Shanghai Composite Index fell on the day the news was released by 37.87, or 1.2 percent, to close the second week of March at 3,013, the biggest decline since March 4th. The Shanghai Index has lost 8.1 percent this year.

Obviously there is no great rush of money from the banks into the stock market.

History shows us that China’s notoriously thrifty depositors are hard to dislodge from the savings habits. But record-breaking auto sales during the past twelve months indicate a trend toward greater internal consumption.

That’s exactly what governments on both sides of the Pacific hoped to see.

Disclosure: No positions