KEY POINTS:
Chinese inflation is at a 10-year high and what do economists expect officials in Beijing to do? Raise interest rates a little.
Granted, economists are right. The People's Bank of China tends to move in baby steps - 0.18 or 0.27 percentage point at a time. Its preference for such increments rather than, say, 25 basis points has to do with the Chinese calendar, superstition and that ancient counting device known as the abacus.
Yet the next time China raises its benchmark lending rate, one wonders if it shouldn't add a zero to whatever basis-point increment it decides on.
That won't happen, of course. There's no way the Communist Party would allow a 270 basis-point increase in short-term rates - even if that's what China needs. That, and an assortment of other bold policy changes, is necessary to get control over the fourth-biggest economy, one on which the world is increasingly depending.
The biggest mistake China's central bank is making is thinking it's like the Federal Reserve or European Central Bank. In developed economies with liquid debt markets, transparency and an independent central bank, 25-basis-point moves matter.
In a developing, immature economy like China's, small moves do little. Chinese central bank Governor Zhou Xiaochuan on Tuesday told China Business News that "fighting inflation is our objective". If so, he's failing in his job.
Consumer prices rose 6.5 per cent in August from a year earlier after gaining 5.6 per cent in July. Food costs drove the increase, jumping 18.2 per cent after a shortage of pigs pushed up meat and poultry prices.
As Communist Party leaders prepare for a five-yearly congress next month, they are right to be concerned that food inflation will lead to broader-based price gains and will fan unrest in the most populous nation. After all, inflation was one of the catalysts behind the Tiananmen Square uprisings in 1989.
This is no longer about calming markets; it's about keeping China from going off the rails. China really needs to get serious about slowing growth and cooling asset markets.
China will claim it's doing just that. Aside from rate increases, the required-reserve ratio for banks has been increased seven times this year. The Government is looking at additional measures to cool speculation in the stock and property markets. It is also opening up outbound capital channels to relieve pressure on the monetary system.
Yet China could be underestimating the risks associated with overheating. To keep citizens from amassing at Tiananmen Square once again to demand change, China must create millions of jobs. For all the lip service about cooling the economy, slower growth may be the last thing China's leaders really want.
Inflation pressures are partly a side effect of growing affluence. The proportion of meat in the diet and shortages in arable land and water could mean even higher food prices down the road, says Jing Ulrich, chairman of China equities at JPMorgan Chase in Hong Kong. That's hardly a small issue considering hundreds of millions of Chinese live on less than $3 a day.
The bigger problems involve too much money-supply growth. China has great difficulty keeping its US$1.3 trillion ($1.85 trillion) of currency reserves from boosting credit expansion. M2, the broadest measure of money supply, grew 18.5 per cent in July. It was 10.3 per cent in the euro area and 6.1 per cent in the US.
China also isn't doing enough to dissuade companies from overinvesting. It is fiddling with incremental increases in the costs at which banks borrow. What it really should be doing is decreasing the profit potential of companies borrowing from the banks. It should consider higher taxes, especially on capital gains.
Rising prices also hurt China's efforts to get consumers to spend more and create an economy led by domestic demand. The trend is becoming a global problem. Price spirals that originate in China may only spread around the globe at a time when central banks are cutting rates to add liquidity to credit markets. That would be a huge change from recent years, when China was exporting deflation.
It's time for China to stop fine-tuning its economy and start doing a bit of major surgery.
- Bloomberg
