China Ramps-up the Inflation Fight

by Peter A. Grant

March 09, a.m.
(from USAGOLD.com) --

China's inflation rate has been running above target for some time now, but as the British and Europeans could have probably told them, targeting inflation in a world awash in debt and liquidity is easier said than done. It would seem that even an economy that is still largely centrally planned isn't faring much better in their fight against inflation than the so-called 'free market' economies. I say "so-called" because the developed economies have become increasingly less free as the level of government intervention surged dramatically in the wake of the near-collapse of the global banking/economic system in 2008.

Nonetheless, the Chinese government has been attempting to target CPI at 4%. That's twice what the West has been generally targeting, but the growth rate in China has been running more than twice the anemic growth rates of the developed economies. China's CPI remained well above target in Jan at 4.9%, up from 4.5% in Dec, but down from the recent high set in Nov at 5.1%. Market expectations are currently favoring a modest downtick in Feb. Yet these levels remain disturbingly high despite ongoing efforts by the Chinese government and the PBoC to knock them down via rate hikes, a string of increases in bank reserve requirements and various other capital controls.

In his speech before the 11th National People's Congress, Premier Wen Jiabao said that he would make stabilizing consumer prices in China a top priority this year. He acknowledged that the rising price of food, housing and other essential items "affects social stability". Undoubtedly, recent political unrest in the Middle East and North Africa is weighing heavily on the minds of the Chinese leadership. It is very reminiscent of the deadly 1989 Tiananmen Square protest, which was largely spurred by soaring prices and economic discontent.

Premier Wen lowered the growth target for the next 5-years from 8% to 7%, suggesting that the country would focus on sustainable "good growth". However, I heard a report over the weekend, where leadership in the less developed provinces (essentially all of them not on the coast) seemed to believe that the 7% growth target didn't apply to them. Perhaps that's why actual growth in China during the previous 5-years consistently exceeded target. Last year, the economy grew 10.3%. So, one has to wonder what Wen has in mind -- beyond what has already been attempted -- to get growth closer to 7% and inflation closer to 4%. Arguably, he has his work cut out for him.

China would certainly like to see domestic demand for goods and services grow, lessening the countries dependence on exports. However, the rapid growth of China's middle-class has been largely driven by the export market it is now looking to curtail. There is probably room for further rate hikes, but that will slow the growth of domestic demand, while more attractive yields would increase hot money flows from the West -- where interest rates are being artificially suppressed -- raising price risks. Clearly there is a very fine line to be walked here and risks abound.

China has increasingly been pointing the finger at the US in recent months as the source of rising consumer prices. Commerce Minister Chen Deming complained that rampant dollar printing by the US was saddling China with “imported inflation”. Both President Hu and Premier Wen, in perhaps a slightly more diplomatic manner, have hinted that US monetary policy is indeed a component of Chinese inflation. While Fed chairman Bernanke has dismissed the notion that the Fed is in any way to blame for rapidly rising prices in the emerging world, even the average man in China believes the US is at least somewhat culpable. An Asian news agency recently quoted a 50 year-old shopper in a Beijing vegetable market as saying, "The source of China’s inflation is America, they are printing too much money."

One thing China is doing, both at the government level and the individual level is buying gold. Chinese demand has been described as "voracious" and "unbelievable" in recent months and is expected to continue to rise. Li Yining, a leading economist and adviser to the Chinese government, called for further diversification of China’s massive $3 trillion foreign exchange reserves into gold. Li also said that it was safe to let private individuals in China hold more gold in order to diversify risks. It has been estimated that China will buy nearly 50% of the global supply of gold in 2011. That is astonishing in and of itself, but the World Gold Council thinks that Chinese demand may double in the next 10-years. This, in an environment where global gold production is in decline. Rapidly rising demand, combined with tightening supply? It doesn't take much of an economist to deduce the likely price reaction.

We alerted our clients to the paradigm shift in the gold market nearly two years ago in an article entitled Dragon's Hoard: In one fell swoop, China profoundly alters gold market synergy.

Peter Grant is USAGOLD's resident economist and a well-known analyst globally in the forex and precious metals markets.

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