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Will high inflation + unemployment cook China’s goose?

 Chinese inflation came in at 5.1% over the weekend. Seriously?  Is anybody in the financial media noticing how the Chinese central bank keeps adding liquidity? Ni How Ma! The People’s Bank of China is incredibly stubborn and has refused to allow a stronger exchange rate, wanting to keep its goods cheap in the West.  Somebody has to tell them to look inward, not outward, because they are undermining the purchasing power of the very people who make all the crap Americans buy.  I guess the leadership is waiting for food riots.

How much liquidity is China pouring in? Well take the US as a comparison – with all the criticism of Bernanke and the Fed printing money and flooding the system with $600 billion, the money supply (M2) has risen 3.2% since October 2009. China’s money supply on the other hand, has risen almost 20% in that same time!! How will they mop that up? Chinese inflation is predicted to be 4.2% in 2011, and it’s quite worrisome. It means the real rate of return for bank deposits is negative. (Inflation rate is greater than interest rates on deposits).

“China is behind the curve. Policy makers have been complacent and failed to anticipate the inflationary consequences of the massive stimulus program.” – Fred Hu, Goldman Sachs chief economist on China.

Lucky for China it exports so much, and the demand for Yuan is high. This means that inflation in China can roar while the Yuan is still appreciating. So while we see China as an economic powerhouse from the outside, Chinese society will be reeling from the morose of a disenchanted youth or worse, a spike in food prices.

But at least all leaders aren't clueless spinners – one Chinese leader even mentioned stagflation (high unemployment and high inflation) when talking about the current state of affairs.  Even the NY Times focused on struggling college grads this weekend, detailing how the inequity of jobs and disappointments is wearing down the young and ambitious. China will be forced to raise rates at some point. But even then, it’s hard to imagine them being able to contain inflation.Bloomberg suggests getting into stocks that will benefit from rate hikes, like banks. But that assumes the Chinese central bank is smart, which is a big assumption. You might want to also keep an eye out for Chinese plays that take advantage of inflation. So the idea is to look for stocks that go higher as the value of the Yuan goes down, like commodities.  Some good examples: Sinopec Shanghai Petrochemical (SHI), Huaneng Power (HNP) and Aluminum China (ACH)

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Coming soon – Chinese economic levers!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.