CHINA AND THE WORLD ECONOMY

CHINA'S INFLATION COULD THREATEN THE GLOBAL RECOVERY

Scott Boyd

Seeking Alpha, February 27, 2011

On February 8th, the People’s Bank of China raised the one-year lending rate twenty-five basis points to 6.06%. This marked the third rate increase in four months and most observers believe more interest rates hikes will be necessary for China to keep a lid on inflation.

The latest figures from China’s Statistics Bureau indicate that consumer prices jumped 4.9% in January compared to the same month one year ago. The actual result was less than the expected 5.3% but January’s outcome keeps intact a long string of monthly price increases, underscoring the risk of inflation in the Chinese economy.

In addition to raising rates further in the coming months, China’s monetary authority will likely continue the trend of forcing lending institutions to increase the percentage of funds to be held in reserve. This effectively removes liquidity from the money supply, leaving financial institutions with a smaller pool from which to lend to businesses and consumers. Rampant property speculation for instance has helped fuel a property bubble. In light of the Japanese and more recent American experience with property bubbles, authorities in China have good reason for concern.

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