China’s fear right now is that their economy could overheat. Are these fears justified?
Sure! Inflation soared to the fastest pace since 1996 as food prices jumped 22 percent, and consumer prices overall rose at an 8.5 percent pace from a year ago.
So there’s a lot to be concerned about. Growth is good, but growth that’s out of hand means spiraling inflation and, potentially, social unrest.
What can they do? Their central banker gave some clues in a recent speech.
He stated that China needs to cut its trade surplus in order to prevent excess cash from stoking inflation.
One of the best ways to slow that surplus down is to raise the value of your currency. So you can bet that more yuan gains are on their way.
After all, the government made a stupid decision a month or two ago to slow down those gains in order to discourage speculation on the currency. Once it got the focus on speculators profiting from the strengthening yuan — and off inflation for a moment — that ended up stoking inflation even more.
Surely they’ve learned that such a mistake will allow the yuan to now gain at a faster pace.
That strategy is one of the best ways to cut a trade surplus. It’s also a way to slow down the economy just a bit without more interest rates hikes, which they appear reluctant to do in any case.
However, that reluctance makes it more likely that the bank will use the yuan as the tool of choice to reduce the surplus.
They’re already using other tools — but it hasn’t been enough. For instance, the central bank ordered the banks to set aside more money in reserves. This is the fourth time they’ve done that this year. Now banks have to set aside 16.5 percent of their funds as reserves.
The more the banks have to hold, the less they can lend. The less they can lend, the less businesses can borrow and expand. This is one way to slow down inflation. But it’s not enough.
If China were growing at some meager pace, maybe this would do it. However, when you have monster inflation like they do, you’ve got to pull out all of your weapons and not play around.
This is why I feel that the yuan will continue to head higher. It has strengthened 4.5 percent against the buck so far this year and strengthened 7 percent in 2007. Yet there’s much more to go.
Consumer prices were expected to grow at 8.2 percent, less than the last reading of 8.3 percent.
Instead, the number came out at 8.5 percent, way over expectations. They have to do something, and do it fast.
While China is raising reserve requirements and may have to raise rates again, they’re definitely going to raise the value of the yuan, in my opinion.
The yuan has been trading around 6.98 to the U.S. dollar. Expect it now to head toward 6.80 as it continues to slaughter the greenback.
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