Why China’s inflation is running out of control

China’s growth has also spurred a new trend: runaway inflation, along with soaring food and fuel prices. As China’s stock markets roared, the amount of money flowing into China grew at extreme rates. Coupled with the high central bank rates and an ever increasing trade surplus, credit and money has been flowing into China. The amount of goods and services has stayed about equal, while the amount of money circulating in China is making highs. Inflation is up 8% year over year.

Government is stepping in

The growth in China might spark a government controlled recession, where bank reserve requirements and treasuries are issued to take money out of circulation. The bank reserve rate currently resides at 16%, thus one sixth of deposits must be slated for reserve before the banks can make any loans. That rate is 60% higher than the 10% reserve requirement in effect in the US.

China’s inflation topped 8.3% in March alone with a $13 Billion trade surplus. All the money pouring into the PRC is having an inflationary effect because the Chinese central bank has long tried to maintain a peg between the yuan and the value of the US Dollar. If the supply of dollars increases, the Chinese central bank must act to keep inflation at the same rate. Now that the Yuan freefloats against a basket of currencies, inflation must be kept equal on both sides of the Pacific.

Interest rates bring foreign money

The interest rate increase has also spurred activity from foreign investors. While the Fed interest rate dropped to its lowest in years at 2%, China has stepped up its interest rates 6 times this year to a rate of 7.47%. The corresponding carry trade generates a lot of income as US investors exchange their dollars for yuan, which has been accelerating in value and reaping a huge interest rate differential. The prospect of investing in thriving Chinese markets is taking capital out of the declining developed markets of the world.

Oil prices

Oil and food prices do have some affect, but are due more to a shrinking supply. Oil reserves are shrinking as the summer driving season enters full swing and prices have risen with a weakening supply. Food prices are also due to a smaller supply, as high prices have left many countries out of the food market. While oil and food prices do not affect inflation, high inflation does affect food prices.

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