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MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

China Raises Lending, Deposit Rates as Inflation Accelerates

Posted by WARREN MOSLER on October 19th, 2010

A lot more evidence of an inflation problem here.

Market forces may be at work forcing ‘currency adjustment’ from that angle as China undergoes the transformation from employment growth via export led growth to employment growth via domestic demand as world demand for their exports remains soft.

As previously discussed, their currency has probably been fundamentally weakening for a while, supported by capital flows rather than trade flows.

This is a bubble like process that can ‘burst’ when the capital flows decelerate with a bout of currency weakness, double digit inflation, and political unrest.

And their next gen western educated economists seem to be doing the traditional interest rate hiking response to inflation they learned in school, which only makes it worse through the ‘fiscal channel’ of higher interest payments by the govt. on the demand side, and rising costs of real investment on the supply side.
A lot more evidence of an inflation problem here.

Market forces may be at work forcing ‘currency adjustment’ from that angle as China
undergoes the transformation from employment growth from export led growth to employment growth through domestic demand as world demand for their exports remains soft.

As previously discussed, their currency has probably been fundamentally weakening for a while, supported by capital flows rather than trade flows.

This is a bubble like process that can ‘burst’ when the capital flows decelerate with a bout of currency weakness, double digit inflation, and political unrest.

And their next gen western educated economists seem to be doing the traditional interest rate hiking response to inflation they learned in school, which only makes it worse through the ‘fiscal channel’ of higher interest payments by the govt on the demand side, and rising costs of real investment on the supply side.

Headlines:

China Raises Lending, Deposit Rates as Inflation Accelerates
Investors Should Cut China Property Stake, Gave Says
PBOC’s ‘Vicious Cycle’ Worsened by Fed, Yu Says: China Credit
China to Do More to Manage Inflation Expectations, Zhang Writes
World Bank Cuts East Asia Outlook, Warns on ‘Bubbles’
South Korean central bank looks to gold

China Raises Lending, Deposit Rates as Inflation Accelerates

October 19 (Bloomberg) — China raised its benchmark
lending and deposit rates for the first time since 2007 after
inflation accelerated to the fastest pace in 22 months.

The one-year deposit rate will increase to 2.5 percent
from 2.25 percent, effective tomorrow, the People’s Bank of
China said on its website today. The lending rate will
increase to 5.56 percent from 5.31 percent, it said.

China’s inflation quickened to 3.5 percent in August,
highlighting overheating risks that have prompted the
government to curb credit and clamp down on the real-estate
market this year. Higher interest rates may encourage inflows
of speculative capital from abroad, complicating management
of the fastest-growing major economy.

“Policy makers need to better anchor inflation
expectations by boosting real interest rates,” Liu Li-Gang,
a Hong Kong-based economist at Australia and New Zealand
Banking Group Ltd., said before today’s release.

China last raised benchmark rates in December 2007, with
central bank Deputy Governor Zhu Min saying on March 25 that
rates are a “heavy-duty weapon” and alternative measures
were working well.

Today’s move came after two surveys showed manufacturing
accelerated in September and input prices jumped, signaling
stabilizing growth and inflation pressures.

Global Recovery

“China would be wise to raise rates,” Dariusz
Kowalczyk, a Hong Kong-based senior economist at Credit
Agricole, said ahead of today’s announcement. “It has led
the global recovery and yet is one of only a few emerging
Asian nations that have not begun to reverse the steep rate
cuts orchestrated during the crisis.”

Chinese officials are grappling with the risk created by
last year’s record 9.59 trillion yuan ($1.4 trillion) credit
boom that fueled the nation’s comeback from the global
recession. China’s property prices in 70 cities rose 9.1
percent in September from a year earlier, according to the
statistics bureau.

China will speed up the introduction of a trial property
tax in some cities and then expand the levy to the whole
country, the government said Sept. 29, without giving a
timetable. The state also told commercial banks to stop
offering loans to buyers of third homes and extended a 30
percent down payment requirement to all first-home buyers.

16 Responses to “China Raises Lending, Deposit Rates as Inflation Accelerates”

  1. Min Says:

    “This is a bubble like process that can ‘burst’ when the capital flows decelerate with a bout of currency weakness, double digit inflation, and political unrest.”

    Hmmm. If that happens, could it offer ammunition to the anti-MMT crowd, as a counter-example to using a large stimulus to recover from a severe recession, because doing so leads to out of control inflation?

    Reply

    WARREN MOSLER Reply:

    Which means we need current rates of unemployment to prevent inflation? Even the most Fed members wouldn’t agree with that?

    Also, inflation is necessarily a function of prices paid by govt so inflating is always a choice. govt can simply elect to pay less in general which would force deflation.
    however, that’s not usually an optimal decision as it has output and employment consequences that may not be worth the presumed benefits.

    And in the US inflation as we define it has for the last 40 years been a function of crude prices which are set by a foreign monopolist. We need an energy policy to deal with that supply side constraint

    Reply

    markg Reply:

    Warren,
    You say taxes function to control demand. If energy demand needs to be controlled do you advocate a higher gas tax? You call for a 30mph speed limit but do you think people will go for that? How about eliminate the payroll tax and increase the gas tax incrementally over the next few years? An incremental increase will give consumers time to adjust. And knowing a cut in demand is coming should keep speculators and OPEC in check.

    Reply

    WARREN MOSLER Reply:

    I don’t like regressive taxes in general. doesn’t make for happy populations

    30 mph probably a no go politically, at least for now.

  2. beowulf Says:

    I was reading the other day how the United State dealt with German and Japanese property during World War II. For the duration of the war, it was held in trust by the “Alien Property Custodian” (the Attorney General). It was at the President’s discretion, unless Congress passed a law to the contrary, whether the property was kept or returned at the end of the war.
    http://en.wikipedia.org/wiki/Alien_Property_Custodian

    If we had a peacetime equivalent, we could accommodate sovereign wealth funds without sacrificing US sovereignty. China could recycle their dollars by buying up any or all US property or corporations it wanted, but since the property would be held in trust by the Attorney General (ehh, why give Tsy something else to screw up), the US Government would have sole operational control by appointing the board of directors and management.

    The beneficial owners would receive their dividends, royalties and capital gains from the trust fund and the US would be secure from the property being used in ways adverse to the national interest. Fair is fair, US-owned property overseas could likewise be held in trust by host governments.

    Reply

    WARREN MOSLER Reply:

    sounds a lot like non voting stock

    Reply

    beowulf Reply:

    Exactly. It’d allow China (and other nations with sovereign wealth funds) to recycle its dollars into higher yielding US investments without creating a xenophobic backlash against foreign powers taking control of our economy.

    Reply

    WARREN MOSLER Reply:

    i’d keep US rates at 0, limit tsy to 3mo bill issuance, and have a full payroll tax holiday, 500/capita fed revenue distributions for the state govs, and an fed funded $8 job for anyone willing and able to work

    Reply

  3. Unforgiven Says:

    Looks like they’re going to try one of your suggestions. Are interest rate hikes really needed in this case? From the article:

    “China will speed up the introduction of a trial property
    tax in some cities and then expand the levy to the whole
    country, the government said Sept. 29, without giving a
    timetable. The state also told commercial banks to stop
    offering loans to buyers of third homes and extended a 30
    percent down payment requirement to all first-home buyers”

    These steps would seem more powerful than interest rate hikes. Raise the requirements to qualify for a loan AND make it less profitable to invest that money in Real Estate. Should put a considerable damper on R.E. speculation.

    Reply

    WARREN MOSLER Reply:

    and tells you the problem is serious enough for those types of measures

    Reply

  4. Jason Says:

    and rising costs of real investment on the supply side.

    Wouldn’t investments (volume) decrease and make up for any cost increase. I guess this is the traditional economics thought?

    Reply

  5. Tom Hickey Says:

    OT: from Ed Harrison about an aspect of QE that is little known:

    Blanchflower: The Fed should buy munis and monetize state debt

    Reply

    beowulf Reply:

    That actually makes a lot of sense if the Fed buys state and municipal bonds and can unilaterally cut interest to the FFR. I believe the average municipal bond yields 3.7%, cutting interest rate to .25% would cut interest costs by over 90%.

    As for China, if they’re trying to keep inflation in check, they might as well take a stab at a Lerner-Vickrey anti-inflation market.

    Reply

  6. SethM Says:

    I think the MMT prism provides a lot of understanding to the Chinese economy that most analysts miss. GDP and especially GDP growth are now dominated by investment, not exports. This investment boom is the reason for the massive overcapacity found in China today as well as the real estate bubble.

    This boom is being fueled by extremely loose lending and hence money creation by state controlled lenders. As we all know, a huge increase in the money supply should lead to increased spending and later inflation.

    Inflation is being kept in check by price controls on basic commodities and by suppressing consumer incomes through a variety of means: limited means by which to monetize or otherwise “cash in” on property capital gains, low deposit rates at banks, slow wage growth through control of unions, and the currency peg that takes away spending power.

    The real danger to the Chinese economy is not a collapse in exports but an increase in inflation. The recent uptick in the lending rate is a sign that officials are concerned, but such a small move will make little difference. The Chinese can not significantly slow the growth of money because GDP growth heavily depends on it, but the longer this lending boom continues the greater the inflation threat will become. I believe one major supply shock could induce rapid inflation and bring a halt to GDP growth.

    Reply

    Tom Hickey Reply:

    Continued exports are necessary for China because they are the source of demand for its overcapacity. Estimates are that consumer spending is only about 36% of GDP. If exports decrease significantly with a double dip in the US, the Chinese domestic economy cannot provide the necessary demand and there would be a huge output gap without massive stimulus.

    Basically, the Chinese economy is not well integrated and is therefore vulnerable to external shock.

    Reply

    WARREN MOSLER Reply:

    investment in public infrastructure vs consumption is sustainable.

    Reply

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