Who Picks Up the Slack if Inflation-Fighting China Downshifts?

The latest signal that domestic issues matter far more to the Chinese than global considerations comes as the Bank of China elected to hike interest rates to 6.56%—the fifth time that rates have been raised in eight months in an effort to curb growing inflationary pressures.

There is a perfectly rational decision given the domestic concerns in China, but this action isn’t helping the global economy much. China is highly worried about inflation, and that trumps any concerns about pulling Chinese demand away from the struggling economies of the world. The reduction in Chinese manufacturing has been cited as a prime reason for the decline in export volume for a number of nations.

Overall inflation has risen to 6%, and that is almost 4% higher than the Chinese government would prefer to see. This inflation surge is already causing reactions in China, notably from the critical middle class. They anticipate higher prices, especially on food, and that causes them to buy now when possible. The fact is that this activity triggers a cascading set of reactions that only accelerate the problem. The fear is that the Chinese will start to hoard as they have in the past, and that is a very serious threat as far as much higher pricing is concerned. The nation has significantly less control over pricing than it has had in the past, and it is not clear that the state could impose price controls even if it wanted to.

Analysis: The rational for the Chinese action is understandable and not all that different from the decisions that have been made by the European Central Bank as it worries about inflation, but the Chinese focus has shifted in the last few years. That has implications for the rest of the world. If China is not the engine for global expansion at some point, then what nation is going to pick up the baton? The United States is mired in its own slow recovery and there is nothing to suggest that its consumers are ready to resume their role. Europe is waist-deep in the Greek financial mess and isn’t about to expand suddenly. Japan struggles with its 12th year of deflation and a never-ending set of prime ministers who seem to last in office for less than six months. India is not ready to play that role and so on. The Chinese are the dominant player in this game and, when they start to pull back, the rest of the world worries. It isn’t suggested that they will withdraw altogether. They can’t do that as long as they need the world to buy their output. They still have to find jobs for 3 million people per month -- that can’t happen if they shrink too much and too fast.

Source: Armada Corporate Intelligence

(Editor's Note: Armada's managing director Chris Kuehl is NACM's economic advisor).

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