IN JANUARY 1992 Deng Xiaoping, then China’s paramount leader,
arrived in Shenzhen for the start of his month-long “Southern tour”. He extolled the success of the coastal special economic zones, lambasted his reactionary opponents in Beijing and ushered in a
torrid economic boom that forced inflation above 25%.
China has not suffered from double-digit inflation since. But the episode did lasting harm to the
credibility of its macroeconomic stewardship. According to Jonathan Anderson of UBS, many outsiders see “the monetary authorities as unreconstructed relics of the socialist planning era without
much grasp of market tools.” They fear that the economy is ‘“beyond control”, prone to speculative excesses followed by clumsy crackdowns.
China is once again stirring their fears. In the year to November consumer prices rose by 5.1%, the fastest
increase for 28 months and a striking turnaround from the deflation of the year before (see chart). Higher prices are now percolating through the economy: last month Starbucks bumped up the price
of a whipped-cream Frappuccino by about 6%.
About 75% of China’s inflation is the result of higher
food prices, as in 2008 when costly food pushed inflation past 8%. But in 2010, unlike 2008, disruptions to food supplies have been modest. China experienced harsh weather early in the year and
floods in the summer. But it suffered nothing like the blue-ear disease that took such a toll on the country’s pigs in 2007-08.
Food inflation may, therefore, reflect stronger demand rather than weaker supply. As China’s households
grow richer, meat, poultry and milk are claiming a bigger share of their budgets, according to Wenlang Zhang and Daniel Law of the Hong Kong Monetary Authority. If the share of spending on other
things were to shrink, this need not be inflationary. But the rejuggling will cause what Kaushik Basu of India’s Ministry of Finance has called “skewflation”, a rise in one set of prices relative
If China is suffering from skewflation, or temporary dips in supply, its inflation problem should soon
resolve itself. Food prices will settle at a higher level, or fall back. The central bank’s only job is to make sure higher food costs do not translate into higher pay demands, which might start a
But many economists now worry that the problem runs deeper than food. If the prices of vegetables, fruit
and other crops are more flexible than other prices, food inflation may be an early warning of an overheating economy. Perhaps China’s monetary policymakers have let the economy slip their grasp
again. They have allowed the money supply to grow by half since January 2009, real interest rates to plunge and bank lending to breach government quotas. The central bank’s own survey of households
shows inflationary expectations at their highest for over a decade.
The People’s Bank of China (PBOC) did raise interest rates by a quarter of a percentage point over
Christmas, following a similar move in October. The hikes mean that banks cannot now lend at less than 5.81%. But in an economy growing by 15% a year (in nominal terms), that floor is unlikely to
deter borrowers. Deposit rates were raised to 2.75%, but in real terms savers get back less than they put in.
The PBOC also raised reserve requirements on banks six times in 2010, obliging them to set aside 18.5% of
their deposits, a record ratio. But such requirements may do little more than offset the expansionary effects of the central bank’s purchases of foreign exchange, made necessary by its stubborn
refusal to allow the yuan to strengthen faster. To ease that pressure, the government has announced that it no longer requires exporters to surrender their foreign exchange in return for
Besides interest rates and reserve requirements the PBOC still relies on non-market tools such as loan
quotas and “window guidance” to banks. Window guidance is not a relic of socialism so much as a throwback to Japan’s clubable capitalism of the post-war era. The central bank convenes a meeting of
bank heads and offers some friendly advice on how to do their jobs. In 2010, for example, it prodded banks to back China’s outsourcing, logistics and culture industries, as well as a drive to
encourage university graduates to fill civil-service jobs at “grassroots level”.
If “window guidance” influences the direction of lending, China’s credit quotas regulate the amount. Or
they are supposed to. The government set a limit of 7.5 trillion yuan for new lending for 2010 but banks exhausted a quarter of that quota in the first two months and over 99% of it by the end of
November (see chart). The government may not bother to set a quota for 2011, preferring to police the bigger banks month by month and one by one. Policymakers have decided they can live with
somewhat higher inflation, raising their target from 3% in 2010 to 4% in 2011.
If China cannot tame its headstrong banking system and quell inflationary expectations, its reputation for
macroeconomic management will suffer. But Chinese inflation still need not inflict too much damage on the rest of the world’s economy. China makes a big contribution to world growth: it is, after
all, 9% of global GDP and it is growing at 10% a year. But it does not make such a big contribution to the rest of the world’s growth: whatever its growing imports add to the GDP of its trading
partners, its burgeoning exports tend to subtract. Inflation in China may even help its rivals. As prices rise in China, its goods become less competitive abroad. China’s trade surplus should
shrink, contributing to growth elsewhere. If Chinese inflation is one of the big worries for the world economy in 2011, it should be a decent year.