Stated numbers don’t tell China’s inflation story

September 8, 2011

By John Foley
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

When China reports this week that the consumer price index rose around 6 percent in a year in August, economists may say inflation has peaked. They said the same last year, when CPI was running half as fast. The problem isn’t bad forecasting, but that China’s headline inflation measure is flawed.

Headline inflation is easily bent out of shape by lumpy prices. Take pork, which rose 57 percent year on year in July. Vegetable prices are increasing over 5 percent a week and the effect is magnified because food is around a third of the CPI basket. Conversely, some prices are artificially low, like energy and transport. A ticket on Beijing’s subway has cost a flat 2 yuan for three years.

China’s size creates another problem. While Shanghai urbanites lament the price of their latte, farmers in the hinterland have different concerns. Perhaps it would be better to have one CPI for the city and one for the country. New tailored bank rules for low-income Xinjiang province make that not so far fetched.

Finding the genuine inflation number is not easy. One insight comes with the difference between nominal and real reported GDP, the so-called GDP deflator. By that measure, 2010’s inflation was around twice the CPI’s reported 3.3 percent rise. If that is a guide, today’s inflation could be in double digits.

Savers, who are robbed by rising prices, are giving a strong signal. They have flocked to real estate and high-yielding wealth products to beat the measly 3.5 percent mandated one-year deposit rate. That makes inflation harder to fight, since money pushed into informal lending channels isn’t affected by monetary policy tools like bank credit quotas. Allowing deposit to be set by the market would draw more back into the banks. But the fear of eroding banks’ margins seems to stand in the way of what would be a potent anti-inflation tool.

And then there are the dog whistles from politicians. Premier Wen Jiabao wrote in a state magazine on Sept. 1 that price stability is his priority, and warned of “unstable” conditions. Whatever the numbers say, when savers and politicians worry, investors should too.

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