Europe’s Economy Will Slow China Inflation

Inflation in China rose 3.1% in May, higher than the government had forecast. Consumer prices were up 6.1% and wholesale prices rose 7.1%

The numbers raised the issue of whether China’s predicted 11% to 12% increase in GDP will set off uncontrollable inflation, or whether increases in wholesale prices which are too high to be passed on to Chinese consumers and its trade partners will cause deflation.

China recently announced that May exports were up roughly 50% from last year.The Chinese do not have to worry about an overactive economy. The real trouble with European finances did not begin until late April. The impact of  a sharp economic slowing in the region is still as much as a quarter away. The EU’s GDP is $25 trillion, which may make it China’s largest trading partner. Pressure to revalue the yuan could also hurt trade with the EU and US.

Europe’s new austerity and falling liquidity, which is undermining bank lending, could sharply curtail imports. Government cuts will cause at least 100,000 public employee layoffs. Germany said it will cut 15,000 public workers as its cuts costs to reign in its deficit. The UK has also said it will cut tens of thousands  of people from the government’s payroll.

Higher taxes will affect spending by private sector workers who will have to give more of their incomes to their governments to help pay off large deficits. The taxes may be regressive and could cause an increase in joblessness  as companies facing higher tax bills lay-off workers to support margins hurt by rising corporate taxes.

The specter of a Greek default still exists. Polls show about two-third of institutional investors who trade in the global capital markets believe that Greece will default on its sovereign bond obligations. A Greek failure and contagion, which would probably affect Spain, would cause huge cuts in public workforces as Europe’s smaller nations attempt to control their debt levels.

China’s inflation will slow as demand for its exports drops, perhaps precipitously.

Douglas A. McIntyre