China Continues to Overheat, Inflation at 5.3%, More Tightening to Come; Will it Work?

Consumer prices in China rose a reported 5.3% as China's feeble measure to rein in inflation have not produced results. Bloomberg reports China Inflation Signals More Tightening May Come

China?s inflation held above 5 percent in April and lending exceeded analysts? estimates, signaling that further monetary tightening may be needed to cool the fastest-growing major economy.

Consumer prices rose 5.3 percent from a year earlier and banks extended 740 billion yuan ($114 billion) of local-currency loans, according to reports from the statistics bureau and central bank. Weaker industrial-output growth, also reported today, may diminish price pressures in coming months.

Today?s data showed that inflation has exceeded Premier Wen Jiabao?s 4 percent target each month this year. The figures may buttress the case made by U.S. Treasury Secretary Timothy F. Geithner in annual bilateral talks in Washington this week that China needs a stronger yuan to contain prices and spur domestic demand.

Today?s report showed a 25.4 percent increase in fixed- asset investment in the first four months of the year. That figure, combined with a report yesterday showing record export shipments in April, indicates the world?s second-biggest economy has made limited progress in shifting to a growth model more driven by domestic demand.

?The data looks bad,? said Dariusz Kowalczyk, senior economist at Credit Agricole CIB in Hong Kong. ?The economy is slowing more sharply than expected but inflation is not.?

Learning to Live with Inflation

MarketWatch reports China learning to live with inflation

The Chinese authorities appear to have accepted that a higher inflation rate is an inevitable outcome of their broader economic strategy. The days when the People?s Republic could count on consumer prices increasing in the 2% to 3% range are past. Instead, the target is 4%, but this spring has seen year-on-year increases of more than 5%.

Higher inflation is now part of the Chinese landscape ? and the consumer price index captures only part of the boom in real estate prices.

Three main factors lie behind this shift: credit, food and wages. The 2009 credit splurge, in which banks advanced $1.3 trillion in new loans, has led to high liquidity, pushing up asset prices across the board, from property to fine French wines. The government is now trying to bring this under control, but ? as Premier Wen Jiabao said recently ? it?s tough getting the tiger back in the cage.

The supply side is deficient. Arable land is shrinking under the impact of urbanization, infrastructure development and desertification. Pollution is affecting farms. Water is short in northern China, especially around Beijing. Food distribution logistics are inefficient. Lack of ownership rights for farmers who hold their fields on a leasehold basis, while all farmland belongs to the state as represented by local authorities, creates distortions. Too many farmers work small leasehold plots that cannot provide efficient larger-scale farming or support mechanization.

Alongside the food problem, the government?s policy of raising blue-collar workers? wages from last summer is starting to feed through into price rises.

The official line is that this will be absorbed by increased productivity and the move of manufacturing from high-wage southern provinces to cheaper regions in central and western China. However, though population growth is slowing, the country still must create at least 10 million jobs a year to maintain employment required for social stability. The move to central China brings lower wage rates but, if the substantial increases in minimum pay continue, the effect will be diminishing.

China's Threefold Problem

China's Growth mandate is way too high
China has few remaining infrastructure that make any sense
Credit expansion is excessive to the point of recklessness

In regards to point number 3 above, please see Ponzi Financing Involving Copper Trade Gone Wild In China for details.

China has tried to cool things off by hiking reserve requirements. That hasn't worked yet, and cannot work in practice because it does not address the core issue: China can no longer grow as fast as it wants to and high inflation is the result.

Building airports that no one uses, cities that no one lives in, and malls that no one shops in cannot go on forever. However, for as long as it does go on, China is going to have excessive inflation.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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