Inflation & Money Supply in China

As China’s economy overheats, inflation is the talk of the town these days:

In China, everyone is talking about inflation. Prices for food, raw materials and other commodities are rising, and that’s making people skittish.

Officially, prices grew at a 4.4 percent annual rate in October, the biggest jump in more than two years. But it’s striking how many people you meet in Beijing who say official statistics lowball the true inflation rate.

One economist I spoke with says inflation is probably running at twice the government’s estimate. A business executive I met says the same. He factors significant future inflation into any investment his firm makes these days.

And on the street it seems to be the same story. “I tend to agree with the housewives,” who are skeptical of the official inflation numbers, says economist Yu Yongding.

So why does China’s actual inflation rate matter? If forecasts are correct and China’s inflation rate levels out next year, then it’s full steam ahead for China’s economy. Factories will keep churning out goods. The building and investment boom will probably continue without pause.

But if China’s inflation rate climbs to 6 or 8 percent or higher, then the situation changes significantly. China’s central bank would continue to raise interest rates. The government might step into to control prices for grain or other commodities. It would probably be forced to rein all that money flowing out of the banking system that’s fueling China’s boom. Lenders would pull back.

And if all that happens, then the China miracle goes on hiatus, at least for a while. And the world will notice.

Some more data on Chinese money supply may help put things into context.

The Chinese money supply figure that is closest to my True Money Supply in the US is M1 as reported by the People’s Bank of China:


The money supply in China has easily tripled over the past 6 years.

And here is a comparison between the money supply growth rates in the US and China:


Money supply and credit supply have both been exploding in China, while money supply in the US has rather stagnated or at least grown a lot slower alongside contracting credit.

This is the main reason why I don’t think that the Yuan will remain strong against the US dollar for very long, and it is also why I don’t think the Chinese bubble can continue for much longer, but then … bubble often times last a lot longer than you’d expect.

The only way how the Yuan can maybe remain strong against the US$ for a sustained period of time, in my view, is if the PBC tries to cheapen the Dollar by selling reserves against Yuan, which in turn would exert an upward pressure toward exports from the US into China while having the adverse effect on Chinese exports, and thus hurt China’s politically powerful export lobby.

However, such a policy, too, would find its natural boundaries in the amount of Dollar reserves accumulated by the PBC.

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