Cashed Up China Bears Safety Storm

The Age

Wednesday September 12, 2007

John Garnaut, Asia economics correspondent, Beijing

THE "Made in China" brand has survived months of bad publicity to drive the second-largest trade surplus the world has seen.

The $US25 billion ($A30.2 billion) surplus for August has placed China's leaders under renewed international pressure to liberalise the renminbi currency.

Within a week, China's trade surplus for this year is likely to surpass the $US177 billion surplus recorded for 2006.

But China, which has just become Australia's most important trading partner, has shown it will withstand international pressure.

Any currency changes are more likely to be in response to new dangers that are rapidly building at home.

China's National Bureau of Statistics yesterday said the inflation rate shot to 6.5 per cent in the year to August - the highest in nearly 11 years.

The inflation surge has seemingly come from nowhere, as consumer prices rose just 1.5 per cent last year and continued to rise at negligible rates until May.

But prices have jumped 2.5 per cent in the past three months - equivalent to an annualised rate of 10 per cent.

While the rest of the world suffers from a financial liquidity crisis, China's pegged currency regime has helped flood the economy with cash through speculative "hot-money" inflows, abnormally low real interest rates and surplus export dollars.

The August trade figures show the trade surplus is again approaching the record $US26.9 billion set in June.

Since then, Chinese manufacturing exporters have weathered an international product safety uproar.

But China's exports grew 22.7 per cent in the year to August and imports grew 20.1 per cent.

Excessive export dollars have helped support an investment boom, a commodities price boom, a sharemarket bubble and now, it seems, consumer price inflation.

Food prices, which account for one-third of the consumer price index (and a much larger share in poor, rural areas), rose 18.2 per cent in the year.

Cooking oil prices have jumped 34.6 per cent, the price of eggs 23.5 per cent.

Meat remains painfully expensive, up 49 per cent, driven largely by the price of pork. Pork accounts for 70 per cent of Chinese meat consumption or 550 million pigs a year.

The National Development and Reform Commission said pork prices rose 70 per cent in the year to August and appear to have peaked. Recent summer floods helped push vegetable prices up 22.5 per cent compared with a year ago.

The soaring price of meat, eggs and even instant noodles has become a front-line political issue in China. While politicians have talked about several one-off supply problems, such as the mysterious blue-ear virus that killed millions of pigs, analysts are concerned that food prices could not have risen as they have without excessive cash washing through the economy.

"The entire blame for the inflationary break-out cannot be pinned on blue ear disease," said Daniel Meng, an analyst with Louis Dreyfus Commodities in Beijing. "The Chinese economy is running red-hot and this has facilitated the escalation in consumer prices."

A supply shock will tend to change the relative prices of different goods but not the overall inflation rate - unless there is excessive money in the economy. While non-food prices rose only 0.9 per cent, Mr Meng said inflation would have appeared somewhere even without any food supply problems.

People's Bank of China officials are concerned they are not winning their fight to mop up excess liquidity.

"They're worried. They seem to have turned more hawkish in recent months," said Stephen Green, senior economist at Standard Charter Bank in Shanghai.

But the central bank is just one of many players in China's monetary policy settling process and it is frequently overruled. Further, the pegged currency has prevented it from effectively using interest rates to cool the economy, lest higher interest rates attract even greater speculative investment inflows.

It has raised rates four times since March and will no doubt do so again soon. But deposit interest rates on one-year bank deposits remain at only 3.6 per cent - meaning investors are receiving an after-inflation, before-tax return of -2.9 per cent.

© 2007 The Age

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