Inflation, the new civil war in China

By George Chen
December 28, 2010
Mao Zedong led his Communist comrades to defeat the Chinese Nationalists in a civil war, founding a “new” China in 1949. Today, the Hu Jintao administration is fighting a new civil war and the enemy is inflation.
Beijing announced the latest interest rate rise — the second of 2010 – on Christmas Day, effective on Dec. 26, also the birthday of Chairman Mao. I suspect, central bankers in Beijing didn’t really want to celebrate the holiday, they just wanted to give the market a surprise Christmas gift.
I asked some friends in the financial industry if the rate increase was a surprise. The responses were very mixed. The 0.25 basis point increase for the benchmark deposit and lending rates was a sort of uniform move. If the central bank had gone for a 50 basis point rise, that would have been a very big surprise. The timing of the increase was a surprise, especially after Beijing raised bank required reserve ratios about a week earlier. We thought Chinese officials also needed a break after a very busy month but they have proved themselves to be unpredictable one again, not to mention tireless.
Just one day after Beijing raised the interest rate, Hu Xiaolian, deputy governor of the People’s Bank of China, published an article on the PBOC’s website, saying the central bank would make good use of a combination of monetary policy tools next year, including interest rates, bank reserve ratios and open market operations, to make interest rates more market-oriented. How often will these tools be implemented? She didn’t say in the article, but now many analysts are predicting the next rate increase could take place in two or three months – within the first quarter. Clearly, China has entered a new cycle of rate increases.
Many economists believe the newest rate rise shows Beijing’s determination to curb inflation, giving that task greater priority than maintaining economic growth. Some analysts also said the cabinet and some ministries were finally on the same page for tackling inflation after earlier disputes over how to balance the interplay between GDP and CPI.
To be honest with you, I am not a big fan of interest rates. If you really rely on interest rates to improve living standards, it’s almost like living in a daydream. Hong Kong broadcaster TVB interviewed some residents of nearby Guangzhou city after the announcement of rate rise. Most of them the move and even the prospect of more increases in 2011 would not do much to help them feel better about inflation, which is rising much faster than the pace of rate rises.
Can Beijing raise interest rates once a month? I don’t think so. Will inflation continue to rise above 5 percent in coming months? That’s my guess.
The core cause of China’s high inflation is food but people are also very interested to see how much property prices can fall. Premier Wen Jiabao does realise that curbing property prices is much harder than controlling food prices. In a rare state radio interview yesterday, Wen acknowledged that the measures Beijing took this year to cool the property market were “not very well implemented” and changed his tone on getting housing prices to return to “a reasonable level”. Previously, he was usually more straightforward in his statements about wanting to see prices under control during his final term, which ends in 2012.
Besides inflation, it will also be interesting to see how Beijing deals with yuan appreciation. With higher deposit rates for yuan, a hopefully more bullish stock market in 2011 and prices of houses and villas rising across the vast nation regardless of policy curbs in 2010, do the factors sound perfect for seeing the yuan increase in value too? In fact, as many economists have already pointed out, a stronger yuan can also allow China to import commodities and other items more cheaply, helping  the government get to grips with inflation.
My grandmother, more than 80 years of age, once told me there were still many old people in China who miss the days when Chairman Mao was the leader and the distribution and balance of wealth were considered by some to be better shape than they are nowadays. Deng Xiaoping wanted to “let some people get rich first”, and today we see more and more people complain of feeling increasingly poor.
It was not easy for Chairman Mao to win the civil war for control of mainland China, and the new civil war on the economic front is going to be a real test of the intelligence and strength of the younger generation of Chinese Communists.

Mao

By George Chen
The opinions expressed are the author’s own.

Mao Zedong led his Communist comrades to defeat the Chinese Nationalists in a civil war, founding a “new” China in 1949. Today, the Hu Jintao administration is fighting a new civil war and the enemy is inflation.

Beijing announced the latest interest rate rise — the second of 2010 — on Christmas Day, effective on Dec. 26, also the birthday of Chairman Mao. I suspect, central bankers in Beijing didn’t really want to celebrate the Western holiday, they just wanted to give the market a surprise Christmas gift.

I asked some friends in the financial industry if the rate increase was a surprise. The responses were very mixed. The 0.25 basis point increase for the benchmark deposit and lending rates was a sort of uniform move. If the central bank had gone for a 50 basis point rise, that would have been a very big surprise. The timing of the increase was a surprise, especially after Beijing raised bank required reserve ratios about a week earlier.

We thought Chinese officials also needed a break after a very busy month but they have proved themselves to be unpredictable once again, not to mention tireless.

Just one day after Beijing raised the interest rate, Hu Xiaolian, deputy governor of the People’s Bank of China, published an article on the PBOC’s website, saying the central bank would make good use of a combination of monetary policy tools next year, including interest rates, bank reserve ratios and open market operations, to make interest rates more market-oriented. How often will these tools be implemented? She didn’t say in the article, but now many analysts are predicting the next rate increase could take place in two or three months — within the first quarter.

Clearly, China has entered a new cycle of rate increases.

Many economists believe the newest rate rise shows Beijing’s determination to curb inflation, giving that task greater priority than maintaining economic growth. Some analysts also said the cabinet and some ministries were finally on the same page for tackling inflation after earlier disputes over how to balance the interplay between GDP and CPI.

To be honest with you, I am not a big fan of interest rates. If you really rely on interest rates to improve living standards, it’s almost like living in a daydream. Hong Kong broadcaster TVB interviewed some residents of nearby Guangzhou city after the announcement of rate rise. Most of them said the move and even the prospect of more interest rate increases in 2011 would not do much to help them feel better about inflation, which is rising much faster than the pace of rate rises.

Can Beijing raise interest rates once a month? I don’t think so. Will inflation continue to rise above 5 percent in coming months? That’s my guess. To feel the real inflation, not just read the official numbers, you may want to go to a local supermarket in China to do your own research.

The core cause of China’s high inflation is food but people are also very interested to see how much property prices can fall and how property prices can be better reflected in China’s CPI statistics. Premier Wen Jiabao does realise that curbing property prices is much harder than controlling food prices.

In a rare state radio interview yesterday, Wen acknowledged that the measures Beijing took this year to cool the property market were “not very well implemented” and changed his tone on getting housing prices to return to “a reasonable level”. Previously, he was usually more straightforward in his statements about wanting to see prices under control during his final term, which ends in 2012.

Besides inflation, it will also be interesting to see how Beijing deals with yuan appreciation. With higher bank deposit rates for yuan, a hopefully more bullish stock market in 2011 and prices of houses and villas rising across the vast nation regardless of policy curbs in 2010, do the factors sound perfect for seeing the yuan increase in value too? In fact, as many economists have already pointed out, a stronger yuan can also allow China to import commodities and other items more cheaply, helping  the government get to grips with inflation.

My grandmother, more than 80 years of age, once told me there were still many old people in China who miss the days when Chairman Mao was the leader and the distribution and balance of wealth were considered by some to be better shape than they are nowadays. China’s late paramount leader Deng Xiaoping wanted to “let some people get rich first”. Deng’s wish did came true, however, today we also see more and more ordinary Chinese people complain of feeling increasingly poor. What’s the answer for them?

It was not easy for Chairman Mao to win the civil war for control of mainland China, and the new civil war on the economic front is going to be a real test of the intelligence and strength of the younger generation of Chinese Communists.

George Chen is a Reuters editor and columnist based in Hong Kong.

Photo: A 100 yuan banknote is placed next to a U.S. 100 dollar banknote in this picture illustration taken in Beijing September 24, 2010. REUTERS/Petar Kujundzic

2 comments

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Perhaps China is trying to avoid the situation which exists in America today. A banking system keeping rates artificially low creating a situation in which investors flock to stock and related markets such real estate creating an artificial demand overvaluing those markets.

Posted by riddelup | Report as abusive

I would argue that corruption is the major civil war taking place in China now. Inflation is a trivial, petty incidental in comparison, and far more easily stopped. Improving living standards is not the first purpose of interest rates, or monetary controls. Raising interest rates is far more powerful than inflation, and thus a small increase in rates has a multiplying, compounding effect in reducing the inflation rate. This is amateur economics, known to every high school graduate.

The best method of controlling real estate bubbles, of course, is the imposition or increase of a property tax. Buying real estate as an investment is self-defeating when every increase in the value of the property simply increases the tax owing on it, that must be paid, each and every year. We can see how effective a property tax would be in China by how loudly and shrilly the upper class screech in protest whenever someone suggests one. Increasing a property tax, or imposing one where none exists, can slow a rise in property values faster than almost any other government measure possible, sometimes stopping a property value increase dead in its tracks. However, the Chinese government is still very young, and they are still learning how to govern efficiently and invisibly, without ever being noticed.

Posted by FirstAdvisor | Report as abusive