China’s actions to Stimulate their Economy may have only Stimulated Inflation

Posted by PITHOCRATES - February 12th, 2012

Week in Review

China is state capitalism at its best.  The government really massages the economy over there.  With wise bureaucrats making wise decisions to steer the economy to endless prosperity.  Embracing Keynesian economics.  Manipulating interest rates to sustain economic growth.  And a small but manageable permanent level of inflation.   Spending money the only way government knows best.  Like the Japanese did in the Eighties just before they collapsed into a deflationary spiral that lasted a decade or two (see Chinese New Year pushes up prices in January posted 2/8/2012 on the BBC News Business).

China’s rate of inflation unexpectedly accelerated in January for the first time since it peaked in July, as consumers raised spending around Chinese New Year.

Consumer prices rose 4.5% from a year earlier, the National Bureau of Statistics said. That compares with 4.1% in December…

Chinese authorities, who were once implementing measures to control high inflation, had recently begun easing monetary policy to spur growth as inflation eased and weak demand from Europe affected exports…

The biggest contributor to the rise was pork prices, which gained 25% compared with 21.3% in December. That drove overall food inflation to rise 10.5%.

Hello, what’s this?  Inflation getting a little out of hand?  Blimey, that’s not supposed to happen.  Not with wise bureaucrats carefully applying Keynesian economic tweaks to the economy.  But it has, hasn’t it?  As it always does.  Because when you use monetary policy to stimulate the economy this is what you do.  You increase the money supply long enough (by keeping interest rates low) you devalue your currency.  And raise prices.

In the West it’s usually wage inflation that’s the killer.  Those sticky wages that can reset quick enough to avoid a recession at the end of an economic boom.  But there is no wage inflation in China.  Because the government sets wages.  And they set them low.  Which is why they can out-manufacture the West.  And to prevent any opposition to these low wages that maintain their manufacturing advantage they outlaw unions.  To keep the peace in their state capitalism.  And their workers obedient.

But none of this will work if no one is buying the things they make.  Which is their problem.  And it’s a big one.  They were keeping rates low to stimulate their economy to produce more when people were already buying less.  High inflation and excess capacity?  Only one way to fix that.  Like the Japanese did in the Nineties.  A deflationary spiral to bring prices and capacity back in line with actual demand.  And if it can happen to the Japanese it can happen to the Chinese.  For let’s not forget that the Japanese were quite the capitalists for a very long time before they had their troubles.  Much longer than the Chinese have been playing with their experiments in capitalism.  A little here and a little there.  But never so much where markets were truly in control.  No, in China, the state never lost their control.  Which may make their inevitable deflationary spiral worse.

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