China and the Inflation Threat

Article excerpt

There's smoke ... China's GDP advanced 11.3% on a year-over-year basis in 2006:IIQ, mostly thanks to vigorous exports and very strong investment spending. China's trade surplus reached a record $174 billion (annual rate) in May, and investment spending this year is advancing at a 30% clip. The strong second-quarter showing brought economic growth to 10.9% for the first half of the year. Economists, who earlier projected that the country's real economic growth would advance only modestly more than 9%, are ramping up their forecasts for this year to roughly 10 1/2%. Rapid money growth is accommodating this brisk expansion. The standard broad measure of money, M2, is reportedly exceeding its 2005 growth rate this year and significantly overshooting the 16% target set by the People's Bank of China.

But no fire! Although the economy is heating up, strong growth and rapid money expansion have not yet ignited an inflationary flame. Chinese consumer prices rose just 1.5% on a year-over-year basis in June. Producer prices have shown somewhat more spark, rising 3.5% for the year ending in June, but producer prices do not seem to forecast inflation at the consumer level.

China's central government has been trying to prevent the economy from overheating. They have relied partly on selective credit controls designed to restrict certain types of investment, notably in the steel, aluminum, and cement industries. …