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Thursday 6 June 2013

China Exporting Inflation?

Its been widely reported that the US's quantitative easing program or QE as it's affectionately known has flooded the global monetary system with cheap US dollars causing monetary inflation throughout the world.  Could China be doing the same thing?

The US dollar being the world's reserve and trading currency has undoubtedly exported monetary inflation using freshly printed US dollars in exchange for goods and services. Little is known that China is also a prolific money creator.  To maintain its currency peg, foreign currencies that flow into China needs to be neutralized and this neutralization process means that China has to create lots of Chinese Yuan (CNY) too.   

So with all these created reserves, the second part comes into play and it has to do with credit creation, the Chinese version of the fractional reserve banking system.  China during the financial crisis of 2008-09 flooded the financial system with nearly CNY 5 trillion liquidity and loan growth has continued at higher levels than pre-crisis.  

The True Chinese Credit Bubble: 240% Of GDP And Soaring

While it is difficult to pin-point the true level of debt in the system because of the unregulated shadow banking system, we can look at where this money has ended up on the liability side of the banking system. 

Can you spot the odd one out?  China's M2 money supply is twice as large as its GDP.  M2 by the way is a key economic indicator used to forecast inflation.  So whilst in the west QE has gone on to inflate stock markets around the world.  The Chinese are keeping their money in the bank.

China Accounts For Nearly Half Of World's New Money Supply

Regulating China's bulging money supply

The government machine, elites and the wealthy Chinese know that this excessive debt fueled boom and money printing is making the CNY worthless and cannot go on indefinitely.  Hence real estate prices continues to sky rocket despite property cooling measures being imposed and gold demand in China is going crazy.  Real estate prices is merely a symptom of the huge supply of CNY.

Gold Premium Surges in China as ‘Aunties’ Buy

It is widely reported that Chinese people are buying gold because they fear US money printing, the truth is more mundane.  Regular Chinese folks do not really follow financial news channels like Bloomberg or Reuters so they do not know about QE1 to infinity, all they know is that the CNY cannot buy much these days.  Hence they fear that holding CNY will not be a good idea.

These are anecdotal evidence but for example:

In 2003

- a bus ticket cost 0.5 Yuan, the same bus ticket cost 2.0 Yuan. 
- a haircut cost 5 Yuan now cost on average 20 Yuan. 
- a bowl of noodles 1.6-1.8 Yuan now cost 5-10 Yuan.

The even smarter money however are leaving through inflated export figures where money is re-cycled out (China Export Gains Seen Halved With Fake-Data Crackdown) and through the porous channels that border HK and Macau.  Whilst it may seem conspiratorial, consider this, Chinese currency controls means that a person is only allowed to bring out of the country an amount that is equivalent to US$50,000 per annum.  Yet recent changes in immigration in Australia for example requires A$5m upfront from under circa A$200,000 - A$250,000 just a few years ago.  No wonder this invoice inflation is a problem now. 

Indeed because of the ravages of internal inflation, it is now "cheaper" for China that has an average per capita income lower than that of Iraq at US$6,000 to import food than produce it.  China knows it and that is why it is using its fiat currency to go out and buy pork (US), beef (Australia), milk (New Zealand), farm land (Australia, France) and real estate.

China Investor Said in Talks for Stake in NYC GM Building

"北京遇上西雅图” (Beijing Meets Seattle)

As China cannot contain inflation within its boundaries anymore it is now exporting it.  The servant has become the master now. 

While inflation is not the reason for wealth leaving the country indeed wealthy Chinese (2.8m millionaires with more than US$10m in liquid assets) are migrating because of political, health and education issues.  They do so because they can due to this wall of money.  Indeed printing money benefits those first in line at the queue - as they get the money at the cheapest rate. 

Inflation is not contained and will not be contained.  Some inflation might be positive for equities but excessive inflation is not.

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