China's Inflation Could End the Commodity Boom

Chinese inflation is getting out of hand and the repercussions for the global economy may not be pretty.

As reported May 12 by the Associated Press, Chinese inflation rebounded in April to 8.5% on a year-over-year basis, just shy of the 12-year high of 8.7% established earlier this year. In recognition of the inflation peril, the Chinese central bank this week boosted bank reserve requirements by 50 basis points to a record high of 16.5%, promising more hikes along with interest rate increases.

Sooner or later, China will succeed in bringing its galloping inflation problem under control. But it has built up so much momentum that stopping it will probably require a substantial contraction in the Chinese economy … just like it did in the U.S. and Canada during the 1970s. Developed economies learned the value of a price-stability target from that era; China and the emerging economies appear to still be on the learning curve in that department.

A contraction in China will likely add another squeeze on the global economy on top of the credit crunch and sky-high prices for energy and other commodities. One casualty could be the current commodity boom itself. And as substantial appreciation in the Chinese Yuan would seem to be a virtual certainty, companies benefiting from importing cheap products from China, particularly Wal-Mart, could face more of challenge.

Comments

[Michael B.Smith]

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[Michael B.Smith]

First, core CPI came in at 1.5% where it has been running for the last couple of years. The difference is in food inflation, which can not be changed with monetary policy. Food inflation will not destroy the Chinese economy...supply and demand will find a new balance.

Second, if inflation were to run out of control, and the Yuan were to rise significantly, it would only drive commodity prices higher. Higher Yuan...cheaper oil; Higher Yuan...cheaper copper, etc.

[bluesmoke]

Seems to me we've had it too good for too long. Granted, China's got issues, but the price of oil, and the worldwide lack thereof, is more inflationary than one country's woes. The only way I see commodity prices falling is when the US adopts a clean energy policy, and leads the way for other nations as well.

[eric hart]

Higher Yuan, lower dollar. Commodities priced in dollars. Oops, greater demand from China. The economy can contract and prices can rise at the same time, and commodities can rise as consumption growth declines--if the growth in the dollar supply continues to increase. I am with Michael B. Smith on this one.

[weng ho teng]

I agree that the commodity boom is about to bust.

I have already moved more money into the stock market.

My favorite pick at this time is the China internet and B2B gem MYST.OB.

That is the best China stock for the remainder of 2008.

[pepster]

Higher yuan --> more expensive Chinese-made products in the US.

More expensive Chinese-made products in the US --> less US demand, esp. with high food and gas prices.

Less US demand --> possibly less goods manufactured in China (if Europe and/or other markets can't pick up the export slack) and by extension a drop in commodities.

I think this is the scenario the author might be trying to present, although both Michael Smith and Eric Hart make logical arguments for the opposite case.

[Dim Sum]

I'm more concerned about China's booming investment growth, now nearly 45% of GDP, up from ~16% only a few years ago, and growing at 20% pa! The investment bubble and commodity prices must surely burst, then it will expose how rickity (like a Rick Shaw) and poorly guided China's financial system is.

[omodes123]

Why would the government try to flight food inflation with a fiscal policy that addresses lending? Are we buying groceries with our credit cards?

[sbenard]

Contrary to perception and media coverage, the Yuan has been falling against the dollar for the past few months, especially since the Chinese stock market began its rather dire correction. Inflation there is running rampant (over 8%), and since their economy is based upon exports, as they pass those prices on through higher export prices, we are importing that inflation here. Their inflation becomes our inflation eventually -- but there will be a delay of 3-9 months.