Monday, January 31, 2011

Chinese Inflation

Stetson brought up Chinese inflation in class on Monday. He said he’s seen it mentioned a lot, and there it was in Monday’s issue of The New York Times. The piece entitled “Inflation In China May Limit U.S Trade Deficit” cover some of the details, but paints a naïve picture of the the situation.

First, the data:

China’s inflation is running 5 percent at the consumer level, according to official measures. But Chinese and Western economists describe these measures as based on flawed, outdated techniques and say the real figure may be up to twice as high.

In contrast, the annual inflation rate in the United States is low by historical standards — about 1.5 percent currently.

There are two reasons for this. I mentioned this one:

China’s intervention in the currency market has kept its currency artificially low. But that flood of money has also driven inflation, giving Beijing an incentive to let the renminbi move higher.

I was remiss not to mention this one:

… No country offers refuge from high global commodity prices.

We need to keep our eyes focused on the primary result: it’s good when people around the world get richer. But, the secondary result of that is that it tends to bid up the prices of commodities: it isn’t just oil, but almost all commodities have had severe price inflation over the last decade.

Given all this, the legacy media still gets it all wrong by focusing on the U.S. trade deficit. They are hung up on this being a macroeconomic cause, when it is very likely an effect. Unlike reporters, I’ll actually offer you a testable proposition: if the U.S. trade deficit doesn’t drop in response to Chinese inflation, then those two variables aren’t causing much of what you see around you. Instead, capital flows are driving both. 

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