STAFF NEWS & ANALYSIS
Chinese Inflation – the Final Unraveling?
By Staff News & Analysis - March 17, 2010

In its latest quarterly survey, the People's Bank of China (PBOC), the country's central bank, said that 51% of respondents were unhappy about inflation, the highest proportion since the survey began in 1999. In February, China's consumer prices rose by 2.7% year-on-year, up from a 1.5% rise in January. The government has set a 3% target for inflation this year, but some analysts have said the true inflation rate is already far higher, after an enormous increase in money supply last year. In February, Chinese broad money rose by 25.5%, well ahead of the government's 17% target for the year. Analysts said that for the government to hit its target, it must now slow M2 money supply to 11.6% for the remaining 10 months of the year, a sudden deceleration and well below the country's average in the past decade. The PBOC's quarterly survey, which was published in the official China Securities Journal, also showed that the public expects inflation to continue rising next quarter. With food prices, in particular, rising rapidly, the government pledged today (tuesday) to start price controls on pork products. Inflation in China is now outstripping the interest rate on bank deposits and property prices, which are not accounted for in the CPI, have risen rapidly in China's cities. – UK Telegraph

Dominant Social Theme: The Chinese will handle it? The technocratic leadership has terrific expertise.

Free-Market Analysis: We've been coming back to this story again and again because it could be one of the biggest stories – financially, anyway – in the world right now. The European Union seems to be gradually collapsing under the weight of sovereign dysfunction and in America the Federal Reserve has screwed rates down to zero and intends to keep them there – as unemployment and underemployment hovers (realistically) between 20-30 percent. Japan has lapsed into its umpteenth recession and Russia and the central European countries that are not in the EU aren't doing much better than they always have, which is to say not well at all.

And what of China? China, today, (this country that was putting its intellectual class in jail only 60 years ago) is a lynchpin economy of the global marketplace, a radiant orb in an otherwise gloomy firmament, China's exceptional growth rate and rapid expansion of domestic wealth and external trade has been a wonderment to behold. But as we have pointed out umpteen times, the Chinese miracle may be, at least to a degree, something of a fiat-money mirage. Economies in the modern era can certainly be fueled by the endless over-printing of paper money and the immediate "wealth effect" that large-scale, central-bank money-printing can, and often does, generate. But woe betide such an economy in the ensuing decades as the distortive effects of fiat money printing take hold. A crash is seemingly inevitable. And the higher the economy has rocketed, the farther it has to fall.

There are at least two ways that a fiat-money backlash takes hold. One way, mostly in the West, people wake up and find out markets have crashed and by the end of the day, literally, affected economies are in disarray. People realize that all the great investments they made and major property purchases they borrowed from the bank to fund are far less valuable than they thought. Their net worth has taken a beating and in the following weeks and months their worst fears will be confirmed. Not only have they overextended themselves, but their jobs are in jeopardy, their banks are less secure than they ever imagined and their governments may have to raise taxes to cover shortfalls (in additional to printing endless amounts of additional fiat money).

Another main way that a fiat money/central banking unraveling occurs is much slower. In this kind of unraveling, the government foresees that its money printing will result in price inflation and begins to make money dearer through a variety of mechanisms (printing less, raising interest rates, etc). The trouble with this is approach is that if enough money has been printed and the economy is overheated enough, it is very difficult to bring the economy in for a so-called "soft landing." And this is where the Chinese are now apparently. The leadership has printed a great deal of money and as a result there is significant price inflation and perhaps (if the government is truly determined) a good deal of tightening ahead. Here's some more from the article:

In Shanghai, prices were up 68% in January from the previous year. Wen Jiabao (pictured above left), the Chinese prime minister, has said that the survival of the Chinese government may depend on its ability to rein in prices. Many Chinese officials believe that sudden inflation was one of the contributing factors to the Tiananmen Square riots in 1989. "If there is inflation plus unfair income distribution and corruption, it will be strong enough to affect our social stability and even affect the stability of state power," said Mr. Wen, in his closing remarks to the annual National People's Congress meetings on Sunday.

We've thought it important to explain to our readers over the past years that the Chinese miracle may be less stable and powerful than it seems on the surface – and China's current situation would seem to support the possibility of this thesis being correct. The miracle in fact is in some sense simply a desperate evolution of the Chinese communist party's resolve to stay in power at any cost. For nearly half a century, throughout much of the 20th century, the communist party had delivered nothing but chaos, bloodshed and starvation. The idea of using the marketplace to stabilize the prospects of the party going forward was doubtless seen as a most risky and daring proposition – and its success must have seemed miraculous to the leadership.

Having delivered a miracle (even if it was with the wrong ideology) the leadership is well aware that keeping the economy on track is the ONLY thing that matters. So long as the party can deliver the economic goods, it stays where it is, especially as the alternative, many Chinese may feel, is a form of social chaos. Today, Wen Jiaboa, the Chinese prime minister agrees – and says so in an astonishing (though under-reported) statement cited by the Telegraph (see above). The stakes could not be higher, he indicates. If the economy collapses, it likely takes the party with it.

It is not our intention to sound overly grim about all this (even if Wen does). In the Internet era, certain ideas have increasingly been discredited while others have advanced. Human beings need solutions. If something doesn't work, something else is tried, sooner or later. The power elite can capitalize on this biological imperative and try to steer it. But such manipulation relies, in part, on denial of information and subsequent ignorance that tends to make people and societies malleable. But we would argue that the Internet has provided people with real information about the way the world works. And as this information becomes more well-known, changes will continue to occur.

The current forms of governance, central banking and even military power, seem entirely entrenched and formidable today (even worldwide). But tomorrow they could be seen as far less persuasive. Once society loses faith in its dominant social themes, society changes, governance evolves and even military power can prove less-than-formidable. That's why we often write about how gold and silver could re-establish themselves as honest money within a free-banking environment. It seems incredible today, but stranger things have happened.

A communications revolution (and we have had one) can be most unpredictable and powerful. Marry the Internet to ongoing failures of Western economic governance and you may well have a recipe for real, social change. China is the proverbial last man standing, and that's why the story about China's surge in price inflation is so important. It is very difficult for governments to control massive price inflation without sending their economies into a ditch – and a ditch is exactly where the Chinese government does not want to be right now. (The alternative of course may be hyperinflation.)

Central banking, as it is currently practiced for the most part, is neither a science nor a discipline of financial planning. It is mostly a dysfunctional mercantilist promotion that benefits a few at the expense of the many. In fact, it is DESIGNED to collapse economies. The trouble is not with the central banking mechanism or even fiat money – from the elite's point of view – but the Internet, which has bollixed up the system. This was something, in our estimation, that was not counted on. The exposure of the wizard behind the curtain is detrimental to the smooth workings of the entire bait-and-switch enterprise.

After Thoughts

Will the Chinese end up in a great recession with the rest of the world – including Japan and the West? What do we do then? Do people cast around for new ideas? Well, there are some suggestions on the Internet. Maybe more will find their way to the Bell's portal … and to other resources supporting free-market thinking.

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