Why is China Facing Inflation?
Here are 5 reasons why China is facing inflation. High inflation is a nightmare scenario for the Chinese government. It could result in social unrest.
The Chinese government will probably do everything possible to keep a balance between limited inflation and sufficient economic growth to avoid social unrest. Currently they are cautious not to increase the interest rate further.
But what is causing the inflation in the first place? There is no simple answer. There is a multitude of reasons and it is not clear how much each reason contributes. What is clear is that each of the following 5 aspects drives up the inflation.
- China has a large current account surplus (mainly due to more exports than imports) and it needs to print money to sell its currency to foreigners to buy the Chinese products.
Keeping its currency artificial low just means that it has to print more money than otherwise. This printed money is flowing into the Chinese economy and supports inflation when it is spent.
- Higher demand and poor harvests are causing global food prices to increase with sometimes more than 50%. This also causes food prices in China to increase.
When the majority of the population spend a major part of their income on food, vastly increasing food prices force people to charge higher prices for their products and services. Consequently minimum wages and other product prices go up.
- Besides food, also other commodities are increasing in price in the global market due to higher demand.
When raw material is a large part of the production costs (and food a large part of the spending of people) and margins are already low, increases in the prices of raw material and food have a big impact on all product prices and are thus driving up inflation.
The 3 reasons above together cause that more and more money is spent in the Chinese economy and that prices are inflating.
- With the growing economy and the prospect of a rising RMB, there is also an influx of foreign direct investment. This just increases the amount of money in the economy and pushes inflation further. But I see reasons 1, 2 and 3 as more essential.
- A high savings rate and extensive lending by the banks leverages the money supply even more.
What other major reasons do you see for Chinese inflation?
One of the measures they can take is to speed up the appreciation of the RMB. That will put some pressure on inflation and increases the attractiveness of imports (reducing the current account surplus) but giving Chinese exporters some extra hurdles to overcome.
It will be interesting to see what measures the Chinese government is going to take to tame inflation and to see their effects.
Note that at this moment I am long on China. Our Trend Signals for the Shanghai Composite Index point up. Here is as an example for this a graph with the general 200-day and 50-day moving averages.
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