Record High Inflation in China

The Chinese government have just announced the consumer price index for January. Inflation in China has reached a 11-year high of 7.1%, after the worst snowstorm in a century affected food supply. The prices of food category products 18.2%, in particular, the price of pork rose 58.8%! High inflation will certainly pose an important social problem. I just watched the TV news in Hong Kong, the old lady said she has no money to buy food, because the food price rose much!

As I have written before, China has been trying hard to prevent overheating of the economy and inflation. China has raised interest rate and bank reserve ratio for many times last year, but it seems that there wasn’t much use. Why was that!?

When we look at the money supply data, we would probably understand more about the reason behind. The M2 supply increased 16.7% in December 2007 compared to a year ago, compared to around 6% increase in US. Even the People’s Bank of China has been raising the bank reserve ratio and interest rates to tighten the credit, the money supply increase was still on record high. It is thus no wonder that the inflation in China is so high. One thing which is lucky for China is that, the inflation seems to be especially high only in food. The price increase in other products looks modest.

I was wondering why the money supply still increase that much after tightening monetary measures. Perhaps it has to do with the exchange rate and capital control. I am not sure if any other has expressed the same opinion, but I speculate that the high current account and financial account surpluses have to do with the increase money supply. First, people in China cannot invest money freely abroad. Second, the high current surplus lead to inflow of money, and investment in China from foreigners also bring much money into China. Because the Chinese government do not want to have remenbi appreciated, and because money cannot be invested freely abroad, the central bank can only increase the supply of remenbi to prevent rapid appreciation. What they can do is to print more money and use the money to buy foreign assets. So we see rapid growth in money supply and foreign reserve.

In the long run, this imbalance cannot be sustained. It is now lucky that the inflation is high only in food. If the money supply growth is to be sustained in this rate, we may see a broader inflation. What can the government do is to allow the currency to float freely. Perhaps they know this will happening sooner or later, but they are still reluctant to do so.

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About Zarathustra

Zarathustra: Founder and Managing Editor of Also sprach Analyst. Once an analyst, now an investor and entrepreneur. Based in Hong Kong, but Londoner at heart.