China’s inflation trap

We’ve seen all kinds of warnings over the years about China’s economy. Several years ago it was all the rage to talk about the “hard landing” China was in for after so many years of growth. Never happened. The banks were going to implode and drag the country down. Never happened. The property bubble was going to pop. Hasn’t happened yet (though I think it’s inevitable). Doom and gloomers also made the general prediction that China’s collage of overwhelming problems — the environment, corruption, local unrest, the class divide — would all contribute to “the coming collapse of China.” It was imminent. I thought so too, back in the earlier days of this blog. Yet China keeps on going, the same existential problems dragging on it like shoes stuck in tar. And yet it keeps going.

Since so many “experts” have been so wrong for so long about China’s economic downfall, it’s risky to point to yet another calamity and say it could bring things crashing down. Maybe the effects of inflation won’t go that far, but I’m not so sure.

Just about nothing is as catastrophic as rampant inflation. A deflationary depression is the only thing worse, but they’re pretty close. As prices inflate, your money can be turned into confetti before your eyes. And it forms a vicious vortex as everyone demands more pay which only fuels higher prices and rents, and one thing feeds on another and the catastrophe spirals out of control.

This is the topic I hear most about from my friends in China. I saw it when I was there about five months ago. The hotel where I often stay in Beijing had gone from charging about 550 RMB per night to 1,000. (I stayed at a Home’s Inn that trip. 225 a night, though you do get what you pay for.) All the food prices had soared, and all my friends were concerned about their apartment rentals gulping up much of their salaries.

Calling a top to China’s property bubble has been as fruitful as those calling for the immediate collapse of China’s banks several years ago. What we do know is that property inflation can’t last forever and there has to be a dramatic drop in prices at some point. Nothing only goes up. Witness the US real estate catastrophe.

For a good overview of the crisis I recommend this post from one of my favorite blogs (and one that practically never mentions China). Although I’ve always loved the outrageous bargain of China’s taxis — you can take a cab from one end of Beijing to another for less than $15 — your heart has to go out to the taxi drivers who are being pushed further and further down the economic ladder.

The blogger seems optimistic that the CCP will take the sane approach and allow the yuan to appreciate. I hope he’s right but am not nearly so sanguine. The party seems convinced that inflation is tolerable compared to a drop in exports and the pain that would come with it. Along with exports, infrastructure stimulus — construction — seems to be the only way for the government to create jobs and keep the economy pumping, and slowing it down could lead to massive unrest.

My own amateur opinion mirrors what I recently read in this superb post that is too complex and detailed for me to quote from, but that should be read by all. The bottom-line prediction: things will continue more or less the same, with a sharp, painful drop in property prices at some point and a steady decrease in GDP as domestic consumption fails to live up to expectations and deficit spending clogs China’s economic arteries. As always, we’ll just have to wait and see.

In the meantime, my heart goes out to the Chinese people. Inflation is devastating, and I hate to think of how many decent people are going to see much of what they worked for washed away.

The Discussion: 20 Comments

Thanks for the post Richard, have always enjoyed them over the years. I have been following the inflation topic reasonably closely and despite most pundits saying inflation has peaked I just can not see it. I have gone on record as saying that I believe it will get to 7.5% (6.5% July)and it will mostly be food price driven with of course many other contributing factors, none the less, property and wages.

August 30, 2011 @ 2:17 pm | Comment

I think what we’re seeing is the breakdown of the global economic system that’s been in place for the past two decades. China suffers in part because the US cannot afford to buy their exports at the same rates as before, and as mentioned, domestic consumption can’t make up the gap. There are no easy or quick answers, and as the Hullabaloo post concludes, this is about economic relations between nations and needs to be dealt with by rational negotiation and consensus.

I know, figure the odds of that happening.

August 30, 2011 @ 3:11 pm | Comment

Exactly, Lisa – my one complaint with the Hullabaloo post was its way too idealistic final paragraph. As though the leading powers are going to sit down at table and politely agree to work together to solve the world’s economic ills, and we’ll all live happily ever after.

August 30, 2011 @ 3:14 pm | Comment

[…] always-excellent Peking Duck on the future of the Chinese economy: We’ve seen all kinds of warnings over the years about […]

August 30, 2011 @ 3:19 pm | Pingback

The numbers we are currently getting are probably friendlier than reality. Since January, inflation calculations have been based on a new weighting in the basket of goods of consumption. I’m wondering if every new number we read is simply based on the new basket, without a mention of the change – and I’m wondering how many times the emperor has re-invented his thermometer before. Public debt is an interesting issue, too. I suppose Pettis mentioned it elsewhere, and so did Victor Shih of Northwestern University. The amounts the banks were ordered to lend provincial investment companies to keep the economy going during the global financial crisis (China’s stimulus) may contain a high share of non-performing loans. Indirectly, the state is more in debt than people are usually aware of.

That said, all this, and the decreasing economic growth don’t need to spell doom. But it may be for the first time in decades that the CCP is facing a real test, re its “macro-economic” skills. As Pettis said, a meaningful rebalance – from export-led growth to a fairer share of all in smaller growth – will be needed.

August 30, 2011 @ 3:31 pm | Comment

Speaking as a total amateur, it is refreshing to see people admitting the limits of their knowledge and speaking from what they know. Too much of the punditry in certain quarters over the last 11 years on the Chinese economy has focused on a limited set of facts, without taking into account the durability of the Chinese political system, or the unusually broad powers that the CCP enjoys.

As for inflation, speaking as someone born into a country where inflation was at 18%, I am not worried by even a sustained period of ~7% inflation, nor do I think the Chinese should be. My guess is that, at worst, inflation will bite into growth the same way it did in Japan during the 80’s. There will be no Weimar in the PRC, nor anything close to it.

August 30, 2011 @ 3:58 pm | Comment

I guess there is one thing which should be said – should Pettis’s prediction come true (3% growth by 2013-14) the general public will likely not be told. The GDP growth statistics at the moment are a a bit of a joke, but even people who know this use them for want of anything better. My guess is that even in a recession the government would continue to set a 7% growth figure, and the provinces would continue to report that they had exceeded it.

August 30, 2011 @ 4:08 pm | Comment

FOARP, while I don’t see China as another Weimar, I do see inflation as the No. 1 issue that could flame massive unrest. The striking taxi drivers could be an ominous sign of things to come. At the heart of the problem is the CCP’s unwillingness to take the painful steps necessary to curtail it. Construction means money, and I can’t see local governments slowing it down, even if it means ghost towns. Something has to give or we’ll have a real house of cards. Japan had the fundamentals to ride it out, as did the US in the 70s. I see China as being in a much more precarious position.

I’m a total amateur, too, but will remain less optimistic than you until I see even a hint of government action to rein in the crisis. And when you have the price of pork skyrocketing 50 percent you know you have a crisis.

August 31, 2011 @ 12:04 am | Comment

Macroeconomically, China in 5 years will probably resemble 1991 Japan, unless there is a large privatization of non-performing state assets to shore up the government’s balance sheet.

Chatter amongst some politically connected 20-somethings already suggests many are positioning themselves to profit from the privatization wave as bankers, consultants, lawyers, PE guys, and the like. Ironically enough, the adjustment for China might be faster than the glacial pace it has been for Japan, since the political class can profit from it.

August 31, 2011 @ 10:09 pm | Comment

The pork price phenomenon might not count in any OECD inflation calculation either – it seems to be the result of speculative production. Over the past few years, there has been excess supply of pork, then farmers – or agro-industries – switched away from it for not being profitable, and given the more recent price levels, there may be over-supply again, soon. Those 50-percent-items (some vegetable and fruits for medical use have seen similar rollercoasting) aren’t indicative for actual inflation, but they are indicators for a still rather unbalanced economy.

August 31, 2011 @ 10:57 pm | Comment


I have no idea if China will experience the kind of destructive inflation that the US did in the 1970s-80s. But I remember those days well. My first mortgage was at 16% – and that was a loan from my and my roommate’s parents! It would not surprise me at all to see inflation take off in the US, either, what with the Fed printing money hand over fist. The signs are already there, in the way all the consumer products companies are shrinking package sizes and weights to avoid raising prices. Inflation is a social and economic disaster, and I cannot believe that there are public economists who say that a little inflation is a good thing. Fools.

September 1, 2011 @ 11:07 pm | Comment

Most economists I’ve read believe the US would be well served by a little more inflation in order to avert a full-blown deflationary depression and stimulate the economy. Not sure I agree, but I understand their thinking. The weaker the dollar and the higher the level of inflation the easier it is to pay the debt and keep interest rates low. This is what the Fed’s quantitative easing is mainly about, increasing the money supply and creating a tolerable level of inflation, though they won’t say that. The Fed’s thinking is that they can control the level of inflation, but I’m not so sure. Some inflation can be tolerated, but obviously hyperinflation would be a catastrophe for everyone. Leading the call to inflate is Paul Krugman, who says inflation fears are groundless and we must stimulate by spending and boosting the system with more dollars.

September 1, 2011 @ 11:59 pm | Comment

I agree with FOARP. If growth drops to embarrassing levels the government will simply lie about it, trying to subtly convince people that if they’re suffering hardship it’s bad luck by having the state media pretend nothing’s wrong.

The question is whether low growth levels will affect people such that they start complaining, regardless of how they think things are for others.

September 2, 2011 @ 4:39 am | Comment


Think about what you just wrote: “the higher the level of inflation the easier it is to pay the debt.” That’s just default by another name – paying back debt in depreciated dollars. It’s no wonder that the US’s bond rating has been cut. As for Krugman, I personally know at least a couple of other Nobel Economics winners who think he’s full of it, so I don’t take him very seriously.

September 3, 2011 @ 3:20 pm | Comment

I take Krugman seriously. Not as gospel, but his predictions on the American economy have been astoundingly accurate.

September 3, 2011 @ 7:10 pm | Comment


Count me a skeptic on Krugman’s foresight. Roubini he’s not. (DId Krugman ever point out that government policy was creating a huge housing bubble that was bound to burst some day?)

What bothers me about Krugman is that he trades on his fame as a Nobel prize winner to offer opinions on policy issues far removed from his area of expertise (trade economics). Believe me, all Nobel prize winners have the opportunity to cash in on their reputation – either monetarily or, as with Krugman, by using it to gain political influence. Most of them are able to resist the temptation. To make matters worse, he admits that he does not apply professional standards to his work for the NYT – he doesn’t check facts, or do research, or deal honestly with opposing points of view, all of which he does in spades in his academic work. He just tosses off his opinions on matters on which he is not an expert.

September 3, 2011 @ 10:37 pm | Comment

Krugman’s the best. He’s never flaunted his winning the Nobel prize or cashed in on it. He’s writing the same way now he always has. His research is impeccable. You can read about the accuracy of Krugman’s prognostications here. and many other places. He is probably the best and most consistently correct pundit on the planet.

September 4, 2011 @ 12:02 am | Comment

One of the main problems with inflation is that it is easy to start, but near impossible to control once started. Once confidence in the currency starts to fall it can easily cascade. I don’t see a repeat of the Great Depression, Weimar Republic, etc., but a period of stagflation is certainly a possibility in the US. It is going to depend on what this administration and Congress do in regards to long term econmic policy and more importantly, unemployment.

Accurate predictions on the Chinese economy are not really possible given the lack of transparency. I believe that is the major reason so many experts have been so wrong. China’s investment in US debt becomes highly problematic if inflation devalues the dollar. The other major influence on China’s economy – in my opinion – is spending on it’s military. Expanding it’s blue water Navy and upgrading it’s aircraft is going to be extremely expensive. And while a very large percentage of that money will be spent domestically, I think the overall effect is going to be negative.

I profess no great knowledge of economics. This is just my opinion from what I see happening and based on my own experience.

September 5, 2011 @ 7:24 am | Comment

I actually agree with everything you say. Can the inflation genie be put back in the bottle once the Fed lets it out? Krugman says yes (he is much more afraid of deflation), but I’m not sure. Engineering the economy is no easy trick.

September 5, 2011 @ 11:15 am | Comment

I think Krugman is dead wrong on this one. Controlling inflation depends on people believing in those in charge of it. Right now, any such belief is next to non-existant. People have no confidence in the President, Congress, Wall street, economic experts of any stripe, etc. The way out is through the private sector. Government by its nature is too slow and inefficient. I believe the better answer is for the Govt. to be the referee and let the private sector play (using a sports metaphor – as much as I dislike them).

This will result in alot of reorganizing, downsizing, etc, but that is going to happen anyway. Consumer spending is dropping. If people reduce spending, companies will reduce production. More layoffs ensue.

Sorry to sound gloomy but from where I sit (production) this is the view I am hearing expressed in meetings. The company I work for just “delayed” buying 2 multimillion dollar machines we had planned on buying just last Feb. We produce paper products for the fast food industry – and they are seeing a drop in their sales.

Maybe my perspective is influenced by me having to be the one that has to tell the people who get laid off but what the upper management types are saying runs along the same lines.

September 14, 2011 @ 3:18 am | Comment

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