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Liquid Lament

Liquid Lament
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Currency concerns help to maintain inflationary pressures

The main preoccupation of China’s economic authorities in recent months has been trying to curb consumer price inflation. Inflation has eased slightly, moving to 4.6 per cent in December 2010 from 5.1 per cent the previous month. Inflation for 2010 as a whole was 3.3 per cent, which was above the government’s 3 per cent target. Also, the recent decline in inflation largely reflects ‘base effects’ and it is too soon to be sure that inflation has been fully brought under control. The most politically sensitive component of inflation ― food prices ― has eased but remains in risky territory, rising by 9.6 per cent. Non-food price inflation was 2.1 per cent in December, up from 1.9 per cent the previous month.

Excess liquidity to blame
Rapid economic growth, higher international commodity prices and rising wages have all contributed to the rise in inflation. But the main culprit is excess liquidity. The amount of money flowing around China’s economy is growing at a rate of around 20 per cent – slower than in early 2010 but still significantly faster than the rate of economic growth. The authorities prefer to blame ‘hot money’ inflows, triggered by ultra-loose monetary policy in the West. But at the heart of the jump in
liquidity lies the authorities’ overstimulation of the economy via a huge fiscal stimulus package and surging state bank lending, combined with relatively low interest rates.

Undervalued currency exacerbates the problem
Many analysts also argue that China’s heavily managed currency policy is making liquidity matters worse as it leads to large trade surpluses and swelling foreign exchange reserves. Exports grew at a rate of 17.9 per cent in December, whilst imports grew by 25.6 per cent. The monthly trade surplus fell in December, to US$13 billion from US$23 billion the month before. But it is difficult to argue that the trade surplus is on a downward trend. The expected further policy tightening and likely strengthening of the global economy suggest the trade surplus could increase this year.
However, the Renminbi has only risen by a cumulative 3.5 per cent against the dollar since it was de-pegged in June 2010. Despite lingering high inflation, the
authorities are reluctant to allow significant appreciation. They are concerned about the impact on employment in the export sector, especially as exporters are facing higher input costs, including rising wages.

Liquidity also affects property
Although property prices have slowed somewhat, excess liquidity and negative real deposit rates continue to fuel local property bubbles in some areas. Premier Wen has complained that local governments are not fully implementing central government edicts. However, it is at the local level that the latest weapon in the fight against property price inflation is being developed. Shanghai and Chongqing will soon trial a new property holding tax aimed at reducing the incentive for speculation.

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