China's New Inflation Bodes Ill for US

Monday, 13 Dec 2010 11:12 AM

By Christopher Ruddy

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A well-known American businessman called me recently. He wanted to talk politics, but he started the conversation by saying, "Short China. If you want to make a lot of money, short China."

He alluded to having information about the precarious state of China's economy, but he couldn't share all of the details. This was just two weeks ago, but some data is starting to emerge that my friend may be right.

Just this past weekend, China announced that inflation had hit a 28-month record of 5.1 percent for November.

The announcement seemed to stun many as a complete surprise. The Chinese government was quick to blame surging food prices. But food prices had nothing to do with it. Rising food prices are an effect — not a cause — of inflation. Indeed, Chinese fiscal and monetary policies had everything to do with it.

And there are some real lessons for the U.S. because we could face a similar dilemma.

ALERT: Milton Friedman Predicted Obama Inflation Nightmare


When the U.S. economy hit the skids back in 2008, leading to a global recession, China didn't flinch. In 2008, Beijing and the Chinese central bank went to work opening the spigots of easy consumer and business debt at the same time the Chinese government unleashed a 4 trillion yuan stimulus program. This amounted to just shy of $600 billion and was tantamount to a massive intervention in the economy. Since the Chinese economy is about one-third the size of the U.S economy, it was as if Washington had put through a $1.8 trillion stimulus. The Obama stimulus of 2009 has amounted to over $800 billion.

For a while, the Chinese stimulus program worked. Exports from China declined as the recession hit China's manufacturers. But these same manufacturers didn't see any slowdown, as China's pump-priming stimulus led to high demand from China's internal markets.

Meanwhile, China's GDP continued to grow at record levels — The Economist expected GDP at around 10 percent this year — and economists gushed that a new home market had emerged in China, making exports less necessary.

Now such talk is disappearing as easy monetary and fiscal policies are coming home to roost. China is now admitting to 5-percent-plus inflation. This is the official rate. The real rate is probably higher.

Let's say, for argument’s sake, China's inflation is now at 7 percent. If that rate is true, and with 10 percent GDP growth, China has an actual growth rate, adjusted for inflation, of just 3 percent. This is a quantum collapse of the real 10 percent-plus rates of growth China has witnessed for more than a decade.

China's economy is in deep trouble. This inflationary trend should not have come as a surprise.

As we have discussed many times on Moneynews and in our Financial Intelligence Report, inflation is caused by an expansion of money that is circulated in the overall economy.

Milton Friedman's classic book on monetary inflation, "Money Mischief," spells out the exact scenario that we are seeing played out in China. As Friedman posits, politicians want to avoid recession, so they loosen credit and pump cash into the economy. The economy grows as an almost euphoric period of recovery takes place. A lag effect means that neither economists nor the public feel inflation immediately.

When they do realize an inflation wave is hitting, the "hangover" starts as inflation leads to price increases on basic goods. When the public realizes inflation is a problem, it's already too late to fix. Friedman says it is not cured quickly or easily.

And, as Friedman prophetically noted, the politicians never admit they caused inflation, they blame it on rising food prices or wages!

In the U.S., policymakers have dismissed any worry of inflation, just as they did in China. So far, inflation has not become apparent. One reason is that the Obama stimulus was not as massive as China's and was spread out over a longer period.

Another reason is that money has not gained velocity, that is, consumers and banks remain afraid to borrow and lend. The economy is simply not taking off.

Still, the Federal Reserve has dramatically increased the monetary base. And Fed policies, like quantitative easing, are pure inflation.

Commodity prices are stubbornly high — think oil and foods — and growing. Such price increases, as they are for China, are a barometer of inflation. Eventually, inflation will rear its head in the U.S., as it has now in China, and it will be extremely difficult to tame.

China's central bank, for example, is in a difficult position. It should be raising rates to cool monetary expansion. But it's afraid if it does so, it will cause the economy to stall and go back into a recession. And even if it did raise rates, it would not dampen inflation overnight.

Federal Reserve Chairman Ben Bernanke told “60 Minutes” recently inflation is nowhere in sight. He indicated if there was even a whiff of inflation, the Fed could quickly raise rates.

It's clear he was simply pandering. Inflation grows in stealth and when it becomes apparent, it is difficult to turn it off.

Just ask the Chinese.

About the Author: Christopher Ruddy
Christopher Ruddy is the CEO and editor in chief of Newsmax and Moneynews and heads up the Financial Brain Trust. Click Here to read more of his articles. He also is the publisher of The Financial Intelligence Report. Discover more by Clicking Here Now.

SPECIAL: Get Milton Friedman's Books "Money Mischief" for FREE. Click Here.

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