Thursday, January 20, 2011

Inflation in China...a feature not a bug?

China has had some high inflation this year, 5.1% annualized rate in November, and now 4.6% in December. Those numbers really don't seem that high, and inflation supposedly doesn't get really nasty until wages have to be indexed, creating an inflationary spiral. (Prices go up. Workers demand more money to pay for stuff. Prices then go up again, as labor costs more. Workers then demand yet more money...repeat until you reach Brazil or Argentina.)


So China is fine, right? They don't index wages and have a vast pool of labor to exploit.

Actually, maybe not. Local governments have started to raise minimum wages multiple times this year, and by large amounts. You do this twice in one year and if I was a worker I'd start expecting it.

Workers also went on strike last year (not something usually seen in Communist China) and got big pay raises at a Japanese engine plant. I would imagine that they think they could do that again if needed.

Chinese New Year provides a great excuse for price increases, too. And not just for goods and services. Workers can sit at home and wait until wages go up enough to stir them to go back to the coastal factories. Or just find work near their ancestral homes instead as factories come to them. They may take less for a while to work near home, but I bet the labor arbitrage between coastal and interior China doesn't last long.

This seems to me to getting close to a quasi-indexation of wages - the sort of expectation that you will get more money (and rightfully so as food prices soar in China the workers need it in many respects.) This is what cause runaway inflation, a perception that everything will keep going up in price, so I'd better jack my price up too.

Now, here is my crackpot theory. I think the Chinese powers that be may actually prefer inflation, especially wage inflation, than to have price stability. I think they are letting it happen, perhaps even unintentionally, for the following reasons.

Obviously, one-party rulers that base their legitimacy on delivering the economic goodies have to keep the boom going as long as possible. Who wants to be the Suharto of China? So best to err on the side of boom not bust. Hell, that's the rule in democracies too.

To stop inflation, they would need to raise their domestic interest rates (which are essentially negative now) but that could bust the investment boom and also personally hurt the party princelings who are furiously throwing up villa apartments and hotels.

Or they could let their currency appreciate. That would hurt their export industry which is huge and employs a lot of workers. Plus, it could look like they are caving in to the Americans.

So how about this? Let inflation fly. Raise the minimum wages. The cost of Chinese products goes up but the currency peg is still technically held, and no one looks like they lost face to the Americans. The workers love all of the new raises they are getting. They might feel richer for a while, until they see the price of vegetables. The government actually put price controls on vegetable prices - we know what happens when you do that...less supply of vegetables and rationing in the form of waiting in lines. But it looks like you are doing something. The peasant farmers will complain but the city-dwelling middle class and workers won't. Buy some time and hope America recovers to keep buying Chinese stuff with borrowed money from China.

I solicit opinions on whether this is crazy - is it even possible? Did I completely blow the economics? I have a bunch of RMB sitting in accounts waiting for revaluation that may not come if this is their game plan. Shudder.


Most of the above came from this article.

2 comments:

Tracy said...

I see what you say, if workers keep demanding better salaries the situation will end up as in Argentina. I was actually there, and in my Buenos Aires travel I was able to notice that goverments are now not allowing people to get money out of the ATM´s so that inflation will go down a little. That is kind of crazy but it worked. The good side is that tourist will have an even better advantage!

Anonymous said...

China would not let the RMB go up by very much, because its exporters are worried about profits, which could be as low as 3%. They are stuck with an exporting nation -- like Taiwan. Economic miracle, Phooey! That is what was said about Japan in the '80s and Russia in the '30s