Can China's Central Bank Wait Until August 25, 2008 to Rein In Inflation?

By: Paul_L_Kasriel

The Chinese government reported today that Chinese consumer inflation in July reached 5.6% on a year-over-year basis - its highest rate since February 1997. As the chart below shows, Chinese consumer inflation has been trending higher throughout 2007. The People's Bank of China (PBOC) and the Chinese central government has implemented a series of measures this year in an attempt to rein in consumer price as well as asset price inflation.

As I argued in the July 20th commentary (How Do You Say "Rube Goldberg" in Chinese?), these acts will prove to be futile until the Chinese decide to stop supporting a fundamentally weak currency - the U.S. dollar. The PBOC supports the U.S. dollar by purchasing dollars in the foreign exchange market. It pays for these dollars with Chinese yuan, which it creates, figuratively, out of thin air - the way all central banks create their respective currencies under this global anchorless fiat money system that we have had since 1971. The yuan the PBOC creates as a consequence of its U.S. dollar support operations is causing Chinese consumer and asset prices to rise at faster rates.

The Chinese central government may be loathe to stop supporting the U.S. dollar until after the upcoming summer Olympics, which are to be held in Beijing on August 8 through August 24, 2008, for fear of creating an economically-destabilizing financial market reaction. But if the U.S. dollar remains under downward pressure and the PBOC continues to support it through August 24, 2008, Chinese consumer and asset prices are likely to continue rising at undesirable rates, which, themselves, may be economically destabilizing. The volatility the global financial markets have experienced in the past week is nothing compared to what they will experience when the PBOC stops supporting the U.S. dollar.

By Paul L. Kasriel
The Northern Trust Company
Economic Research Department - Daily Global Commentary

Copyright © 2007 Paul Kasriel
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

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