Meanwhile, in China... by David Atkins

Meanwhile, in China...
by David Atkins ("thereisnospoon")

The problem hasn't received as much press attention as the domestic or Eurozone troubles, but China is in its own world of hurt right now, too. The Chinese economy has grown too much, too fast and is currently suffering both from a real estate bubble and from having purchased too many foreign treasuries and having allowed its currency to depreciate too far to aid its manufacturing sector. The result? Massive inflation:

In the first seven months, the CPI gained 5.5 percent from a year earlier, well above the government's target ceiling of 4 percent for this year.

In July, CPI even jumped 6.5 percent year-on-year, reaching its highest level in 37 months, placing the government in a tough position with worsening global liquidity in sight.

The Producer Price Index, which is used to calculate inflation at the wholesale level, jumped 7.5 percent year-on-year in July.

The stubbornly high inflation rate has been driven by rising food costs, which jumped by 14.8 percent in July from a year ago.

The price of pork, a staple food in China, soared by nearly 57 percent in July.

Addressing a Forum on China's Macroeconomic Conditions and Macro Policies in Singapore, Zhang Liqun, an economist from the Development Research Center, said he expected the inflation pressure resulting from surging food prices to start easing as supply increases.

It's not just food. Cab drivers in China are striking nationwide despite fears of retribution from the supposedly Communist government:

Woe is the taxi driver in China.

The roads are clogged with about 40,000 new cars a day, the price of gasoline has doubled in the last five years and passenger fares have barely budged even though everything else in the country is getting more expensive.

Fed up with their shrinking profit margins, 1,500 cabbies in the eastern city of Hangzhou went on strike this month demanding higher fares.

“Ten years ago, taxi drivers belonged to the high income group. Now we have become part of the low income group,” a Hangzhou cab driver told the Oriental Daily, explaining how his pay after expenses had dropped from about $730 a month six years ago to $470 today.

It’s no wonder then that taxi drivers have become the poster children of China’s nagging inflation, which grew 6.5% in July from a year ago to reach a 37-month high.

Their struggle to make ends meet underscores the pressure on China’s broader working class population who are most vulnerable to consumer price increases. And when they strike, they remind the central government how inflation can trigger social unrest...

Guo said there have been 60 taxi strikes since 2004, including a violent demonstration by 9,000 drivers in the western city of Chongqing in 2008.

In an article published Thursday in the official Communist Party mouthpiece the People’s Daily, cab drivers in Beijing said they had to work up to 18 hours a day and give half their earnings to lease their cars.

This sort of thing cannot continue. So China may finally allow appreciation of their currency in order to curb inflation and reduce the risk incurred from owning so many foreign currency bonds. The only problem for China is that this will hurt their domestic manufacturing economy at a time when the economy is already slowing worldwide:

China's government may be about to let the yuan-dollar exchange rate rise more rapidly in the coming months than it did during the past year. The exchange rate was frozen during the financial crisis, but has been allowed to increase since the summer of last year. In the past 12 months, the yuan strengthened by 6 per cent against the dollar, its reference currency.

A more rapid increase of the exchange rate would shrink China's exports and increase its imports. It would also allow other Asian countries to let their currencies rise or expand their exports at the expense of Chinese producers. That might please China's neighbours, but it would not appeal to Chinese producers. Why then might the Chinese authorities deliberately allow the yuan to rise more rapidly?

There are two fundamental reasons: reducing the portfolio risk and containing domestic inflation.

Consider first the authorities' concern about the risks implied by its portfolio of foreign securities. China's existing portfolio of some US$3 trillion (Dh11.01tn) worth of dollar bonds and other foreign securities exposes it to two distinct risks: inflation in the US and Europe, and a rapid devaluation of the dollar relative to the euro and other currencies.

Inflation in the US or Europe would reduce the purchasing value of the dollar bonds or euro bonds. The Chinese would still have as many dollars or euros, but those dollars and euros would buy fewer goods on the world market.

Even if there were no increase in inflation rates, a sharp fall in the dollar's value relative to the euro and other foreign currencies would reduce its purchasing value in buying European and other products. The Chinese can reasonably worry about that after seeing the dollar fall 10 per cent relative to the euro in the past year - and substantially more against other currencies.

With the Eurozone in crisis and the future of the Euro itself in question, there is no telling what may befall treasuries and the U.S. dollar. In any case, China would be wise to strengthen the yuan and acquire a little more financial independence--except for the fact that the Chinese economy still depends mostly on its manufacturing sector, which can only be hurt by a stronger yuan.

The other thing a stronger yuan would mean is higher prices for Chinese goods overseas (that's why it would hurt Chinese manufacturing.) It's a dirty secret that one of the reasons Americans haven't complained too badly about a lack of rising domestic wages is that there has been price deflation in cheap manufactured goods from China at the local Target or WalMart. Increase the prices of those goods, and it will have social and economic ripple effects in the American economy as well.

This is all part of why no single nation can truly control its own financial destiny. The world is now a globally interconnected system: one that is far too dependent on elite financial institutions and the rapacious greedheads who run them, and far too little interested in the general welfare of the real people who toil every day to put food on the table all across the planet.

Sooner or later, the sovereign nations of the world will need to come together in a spirit of mutual cooperation, understanding that a slowly rising tide lifts all boats, that massive income inequality is to be avoided, that bubbles need to be popped through government intervention before they grow too big, and that allowing financial institutions to control our collective destinies is a very bad idea.