China Tightens Again, Will Be Overwhelmed By Inflation

China tightened bank reserve standards again to take some of the capital poured into the market by stimulus programs  out of circulation. The action is unlikely to stop inflation. Too many forces are in place for that to happen.

The central government increased required bank reserve rates up another .5%. for deposits. Some large financial firms may have 20% reserve requirements now. The increase is the seventh in the last year.

Inflation in China is currently 5% or slightly higher. That number hides the increases  in prices of food and fuel. Fuel prices are aided by government subsidies. The price of crude is close to $100 now. Some of that will almost certainly be passed through to oil and gasoline costs. Subsidies are part of an economic policy that China may not longer be able to afford. And, they mask inflation which is already underway in energy prices.

Food prices worldwide have reached record highs. As the largest nation in terms of total population, it will be impossible for China to wall off the effects of those increases on the country’s agricultural products.

China must also wrestle with the significant increase in worker wages that is underway. These increase are as high as 20% per annum. The People’s Republic has encouraged much of this activity. The government believes that without a viable middle class it cannot increase consumer spending. That spending is necessary to absorb some of the goods made by China’s massive manufacturing industry.

China wants to cut the rate of inflation against increases in commodities prices around the world. China also wants to counter its own actions to move up what its population earns. Bank tightening cannot undermine economic forces both inside and outside the mainland. These forces have already become overwhelming for both China and much of the developing world. Growth has suddenly become a double-edged sword.

Douglas A. McIntyre