China's $30b Monthly Surplus

Sydney Morning Herald

Wednesday September 12, 2007

John Garnaut Asia Economics Correspondent In Beijing

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

The $US25 billion ($30.2 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 all of 2006.

While China, which has just become Australia's biggest trading partner, has shown it will withstand the international pressure, it is more likely to respond to new dangers rapidly building at home.

China's major trading partners, particularly the United States, have complained for years that the renmimbi is undervalued, making its exports artificially cheap on international markets and boosting its trade surplus. But the undervalued currency may now be having an effect at home.

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

The surge in inflation 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 crisis in financial liquidity, China's pegged currency regime has helped to 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. This is despite the international product safety uproar that has affected everything from toys to foodstuffs.

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 to support an investment boom, a commodities price boom, a stock market 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.

The price of cooking oil has jumped 34.6 per cent, the price of eggs 23.5 per cent.

The price of meat remains painfully high, up 49 per cent, driven largely by the price of pork. Pork accounts for 70 per cent of Chinese meat consumption - at the cost of 550 million pigs a year.

The National Development and Reform Commission said recently that pork prices had risen 70 per cent rise in the year to August and appeared to have peaked. And recent summer floods pushed fresh 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 a series of one-off supply problems, such as the mysterious blue-ear virus that has felled millions of pigs, analysts are growing concerned that food prices could not have risen as they have without excessive cash washing through the economy.

"The entire blame for the inflationary breakout 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.

Officials at the People's Bank of China are concerned that 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 Chartered 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 interest rates on one-year bank deposits remain at only 3.6 per cent - which means investors are receiving an after-inflation, before-tax return of minus 2.9 per cent.

© 2007 Sydney Morning Herald

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