No, Chinese inflation isn't a good sign
Well, well, well, the Chinese economy is experiencing inflation.聽Overall consumer prices rose by 3.6 percent in March 2012, year-over-year, including an聽upsurge in food prices聽of 7.5 percent.聽Even the prices of venerable Chinese herbal medicines took an upward leap of 8.3 percent.聽According to a CNNMoney ,聽inflation is 鈥渢he price of prosperity.鈥澛燭he report goes on to fatuously instruct us, 鈥淲hile inflation poses challenges for consumers, it is the byproduct of one of the most robust economies in the world.鈥澛燗 comparison of聽China鈥檚 9.2 percent real GDP growth in 2011 with the paltry 1.2 percent growth rate for聽U.S. real GDP in the same year is聽thrown in as supposed proof of this statement.
But this is utter nonsense and one of the most deeply entrenched myths in both academic economics and聽media commentary.聽Basic economic theory demonstrates that 鈥渆conomic growth,鈥澛爓hich is nothing but聽聽an increase in the supplies of various goods and services, is in and of itself deflationary. An increase in the supply of any good (or service),聽with the聽supply of money and all other factors fixed, results in a听蹿补濒濒 in its price and a growth in its sales, as the excess supply of the good drives the equilibrium price down and expands the quantity demanded.聽This聽irrefutable economic truth聽has been illustrated time and again since the late 1970s by聽sharp declines聽in the prices of聽items聽like personal computers, video game systems, HDTVs, digital cameras, and cell phones and聽of聽(uninsured) medical procedures like Lasik eye surgery and cosmetic surgery.聽Furthermore, this fall in prices has聽not caused stagnation in these industries but has instead coincided聽with聽their rapid expansion.聽I have explained this phenomenon of聽 鈥済rowth deflation鈥澛爄n more depth elsewhere.
What then is the cause of the accelerating Chinese inflation?聽We need look no further than the money supply. The broad measure of the Chinese money supply, M2, which includes currency in circulation and all bank deposits, increased by 13.6 percent in 2011, although the People鈥檚 Bank of China had targeted a 16 percent increase. The PBOC has that it will set the money supply growth rate at 14 percent for 2012.聽This inflation targeting policy, so beloved by聽contemporary macroeconomists,聽augurs more rapid price inflation for Chinese consumers for years to come.聽More important,聽聽China鈥檚 long-standing聽super-loose monetary policy means that inflationary credit expansion has fueled聽a great part of the聽rapid growth of the Chinese economy, which聽is therefore unsustainable and聽doomed to collapse. Indeed, the pace of Chinese economic growth has already begun to falter in the last two quarters.聽In response, the PBOC has already reserve requirements twice in the last three months.
Having allowed the inflation tiger out of its cage, the Chinese government聽is now desperately hanging on to its tail.聽It must either cage聽the tiger forthwith 聽and confront the damage it has already wreaked in the form of a collapse in聽its聽economic growth rate; or it must聽inevitably lose its grip and permit its burgeoning market聽economy to be devoured by the beast in an聽inflationary breakdown聽and聽reimposition of direct controls.
