from Follow the Money

Inflationary real adjustment in China?

June 13, 2007

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Chinese inflation seems to be picking up.   

That is a good thing.  If China insists on holding the value of the RMB down -- and if the RMB's pace of appreciation against the dollar is slow, so the RMB in practice is depreciating against a host of currencies that are appreciating faster than the RMB is against the dollar -- the only way China's real exchange rate can adjust is through a rise in inflation. 

Indeed, the biggest surprise coming out of China -- and there have been many -- is that rapid money growth hasn't, at least until now, generated much inflation.    A DBS report (See Chart 1 on p. 2)shows that China has had Philippine style money growth over the past ten years without experiencing Philippine-style inflation.  Indeed, the average inflation rate in China over the past ten years looks substantially lower than the average inflation rate in the US. 

Even with inflation above 3%, China isn't appreciating all that rapidly in real terms.  US and European inflation isn't that much lower.  

If China only could experience a bit of Qatari-style inflation.  Or a burst of Russian-style import growth.  (see Danske Bank)

I am kidding.  I generally don't think negative real rates are healthy, especially in rapidly-growing economies. I would rather see more nominal appreciation across the emerging world.   But in countries whose real exchange rate is undervalued, rapid inflation is a logical consequence of resisting nominal appreciation.  

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