January 21, 2011

China`s Inflation Problem

It was recently announced that in November China's consumer price index rose 5.1% from the same time a year earlier, with food prices rising more than 10%. As unrest builds, the Chinese government has unleashed a series of policies to address the symptoms of the disease while ignoring its root cause.

The feeblest of these attempts is the imposition of price controls in many Chinese cities. But as President Nixon found out in the early 1970s, the laws of supply and demand cannot be suspended at will. The Chinese leaders realize this and have more recently implemented a raft of seemingly more sophisticated responses.

Informed by the mistaken Keynesian economic principle that inflation is created by a strong economy rather than by an expanding money supply, China is hoping to solve its problems by restraining growth. To do this it has just raised interest rates and has moved to restrict bank lending.

On Friday, the central bank said it will raise the share of deposits banks must keep on reserve by half a percentage point. This comes after six such increases last year (the fourth hike in just two months). On the interest rate front, the People's Bank of China is mulling further rate increases, which many analysts expect to come in the first quarter. However, if these moves are not accompanied by a cessation of dollar purchases, they will do nothing to control inflation.

Related: PowerShares DB US Dollar Index Bearish (NYSE:UDN), SPDR Gold Trust (ETF) (NYSE:GLD)

Peter Schiff`s comments on the economy, stock markets, politics and gold. Schiff is the renowned writer of the bestseller Crash Proof: How to Profit from the Coming Economic Collapse.
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