Chinese Inflation Affects You

Sources: http://www.forbes.com/markets/2008/02/19/china-inflation-food-markets-econ-cx_vk_0219markets04.html
http://www.china-embassy.org/eng/default.htm

Have all good things come to an end with China? Highly doubtful, but Chinese officials reported Tuesday of record high inflation rates. Their Consumer Price Index (CPI) was up 7.1% for January, making rates higher than they have been since 1997. The problem stems from the detrimental winter snowstorms which devastated crops and cattle. This, according to both Forbes and BBC News, was the main force behind rising inflation rates.

Unfortunately things are only expected to get worse. Goldman Sachs expects inflation to worsen in February as the severe winter storms took place only after January 21^st. “In our view, the inflation impact from the snow storm may have not been fully reflected in the January inflation data,” they said. They also made note that the suggested 7% CPI reading for February is likely to be closer to double-digits.

As a result of the inflation levels China’s central bank is expected to increase interest rates at least four times this year. Monetary policy is expected to continue to be very tight with higher reserve requirements, accelerated currency appreciation (yuan), and more “heavy-handed controls on bank lending.” Speculators note that China continues to constrain monetary policy despite the United States’ economic slowdown. The extremely fast growing money supply of China is another potential threat that could play a role in keeping rates higher. To be blunt, China needs to slow down, and they know it.

As China tightens policy we can expect the economy to slow down as it tries to stabilize itself. Record high Chinese interest rates will cause Foreign Direct Invest (FDI) to increase. With the United States at such low interest rates, a spike in investment from China could be just the thing we need to catalyze us back into motion.

On the opposite side, FDI to china should decrease, which could mean higher prices for durable goods. This would in turn decrease consumption for Americans and other countries who buy Chinese produced goods. Because of globalization, the interconnection between countries not only affects the stock markets, it also affects how monetary policy in one country could potentially effect consumption, prices, and growth in another. That’s globalization.

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