Bussola cineseInflation: the main problem in actual Chinese economy

Chinese economy is often hit by inflation: during the Mao Zedong period was caused by the lack of goods inside the economic planning, called economic decline inflation; also after 80’s with the pub...

Chinese economy is often hit by inflation: during the Mao Zedong period was caused by the lack of goods inside the economic planning, called economic decline inflation; also after 80’s with the public reforms, inflation has shown itself as problem.

Without exception, all inflation is due to the fact that there is more currency in the market than they’re worth the goods. The market, therefore, automatically scales in the relationship between the two to create the aggregate value of money, which thus equals the total value of goods. This means that the price of goods increases. If we want to expose this theory with less technical words we can say: “When there’s so little money and goods, the goods become more expensive”. It’s the typical Keynesian mechanism.

Thanks to policies of openness in place since 1979, multinational corporations have invested heavily in China in the nineties, at-tracted by the rapid industrial growth and cost-competitive workforce. China is now the first country in the world as recipient of foreign direct investments: more than half of the 500 largest companies in the world are present in the Pearl River Delta.

Chinese participation in international trade increases every year: in 2003 the volume of commercial transactions was about U.S. $ 851.2 billion.

Producer prices has increased by 7,2 % in 2010. It was the strongest increase since September 2008. The Chinese government has tried to increase the interest rate and raise the minimum reserve to face this problem: Bank of China has in fact the intention to bring lending rates and deposit on a year to to 5.81 and 2.75 per cent.

Over the same period the previous year’s foreign investments have risen to the equivalent of 6.9 billion dollars, making totalizing in the first two months of 2008, an increase of 75% to 18.1 billion dollars.
Foreign direct investments in China in February showed an increase of 38%, fuelling concerns about the growth of liquidity and inflation. This move, unfortunately, has not had desired ef-fects, in fact Zhōngguó Rénmín Yínháng (The central Bank of China) has been forced to grant loans for over than 7950 billion Yuan, more the expected sum of 7500 that the Chinese Gov-ernment has planned. In 2010 in stem to face Real estate speculation and counter the inflation, The People’s Bank of China raised 3 times its base rate using a monetary tightening by raising in arc of 2010, six times the ratio of reserve requirements. Obviously that impact was not the expected, in fact the biggest problem remained intact, which is too high a flow of investment, especially in real estate, where speculation is now skyrocketing.

Monetary reserves continue to raise reaching the amount of 2850 billion USD and this worries US government, since most part of this reserves are held in $, representing a big slice of the entire American public debt. Also the part of European public debt is raising. According to current estimations China detains about 7,3 % of the European public debt, about 600 billion €, including Spanish public debt bought with the intention of help distressed Countries.

To avoid raising in real estate market Chinese Government tried to introduce a luxury real estate duty but all without effects.
Nowadays the main problem is not that Chinese economy is not able to produce goods, the main problem is that most of the goods producers are exporting to Europe or USA, so there is a mismatching between the internal demand and the increase in in-vestments (money), attracted by the low costs and the policy of Chinese Government.

Everyone says that China is the world’s factory, but its capacity is not addressed to the internal market. On the contrary, pointing to the richer Western markets. If we measure it for its do-mestic market, we can say that China simply has too much surplus production. This allow a small minority of population to gain ever greater prosperity using low-cost labour in China and approach high-income markets of the West to secure huge profits.

A really big part of Yuan on the domestic market is used to buy foreign currency, and this makes the Chinese reserves of foreign currency the largest in the world. Surplus money is also used to buy assets such as real estate to preserve the value of purchase, and this brings back money to the domestic money market. So while the real purchasing power of money is lost, the money stays within the country. This accounts for the potential, and growing inflation.

First of all China must stimulate the internal demand trying to reduce the mismatching between different social classes and increase the power of purchase of the biggest part of population with the intent of reduce difference between goods and money. In fact as is showed in the following table China’s GDP is about 10% of Italian’s one and half of Malaysian’s one.

Luxemburg 105918
Italy 35435
USA 45934
France 42413
Malaysia 6950
China 3735

Source: International Monetary Fund, World Economic Outlook Database, October 2010

In a situation like this, the government should use the foreign currency that has to absorb the excess Yuan, as it should try to soften the restrictions imposed on foreign goods seeking to enter China.

The only right way to solve the problem of inflation is to reduce the movement of the Yuan and to support the flow of external goods. Instead, the Chinese government is doing exactly the opposite. It does not allow a free exchange of foreign currency and softens the restrictions imposed on foreign goods that want to enter China. In this way, most of the products of foreign companies in the country will have no market, or are faced with an already glutted market.

Only departing from this China will be able to solve the problem.

by Jesa Investment & Management Co. Ltd – Shanghai – Jesa Chinese Industrial and Economic Studies Center- all Rights are reserved.

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