Out of Control Inflation Leaves Chinese Regime With A Few Options

November 22, 2010 Updated: February 16, 2016

Chinese authorities have finally admitted that inflation is out of control. No matter how Beijing plays with the Consumer Price Index (CPI) by using rent instead of the purchase price when calculating housing costs, the rapidly rising prices migrant workers must pay for meals and the daily increasing food prices with which housewives must contend make it hard to cover up any more.

Deutsche Welle’s recent report on the political impact of China’s inflation tells us why the Chinese Communist Party (CCP) admitted the existence of runaway inflation. Although it wasn’t a secret, the warning by officials of the National Development and Reform Committee to prepare for higher inflation is very rare. It is also uncommon that there would be such differing estimates of the inflation rate, ranging from 5 percent to 15 percent, between the National Bureau of Statistics, the National Development and Reform Committee and the banking industry.

For the past decade, China’s broad money supply (M2) has increased 18 percent annually, nearly twice the official GDP growth rate. Considering the poor quality of the official GDP data, M2’s relative growth rate is even more alarming. From another perspective, inflation is the acid test of GDP, as inflation emerges after the issuance of currency and can be partly diluted by economic growth.

If China’s economic growth was real and high quality, inflationary pressures wouldn’t have come so fast. When Chinese people have to face such rapid inflation, it’s reasonable to distrust the GDP figures provided by the CCP.

What is interesting is that the Secretary of the Department of Commerce actually blamed the issuing of currency in the United States for China’s inflation. Why would an increase in the U.S. money supply cause inflation in China? Have U.S. dollars been circulating in China? Or does the CCP actually admit they lied about the yuan’s decoupling from the U.S. dollar? If it is because of the “imported inflation,” it only shows that the price gap between the international market price and the Chinese market is too large. The CCP tried hard to lower workers’ income, and pressure from the outside world will benefit the Chinese workers.

Options to Control Inflation

How should the CCP deal with the runaway inflation? The options are not many and each one comes with pros and cons.

Option 1: An Active Response. That more currency is in circulation than there are productive assets is the main reason for the inflation, especially when taking into consideration the $2.4 trillion in foreign reserves, which have been converted into RMB and put into circulation, and the over ten trillion yuan issued to stimulate the economy in recent years. To eliminate inflation, the most effective way is to get the money back.

Part of the foreign reserves could be returned to people. How can that be done? One could allow the yuan to trade freely. Give Chinese people a preferential rate to buy US dollars or give them the US dollar directly, which would reverse the years-long practice of hoarding foreign reserves. Or, use foreign reserves to purchase products or strategic resources and sell them at subsidized prices or even give them to people for free. The increased supply would immediately reduce inflation, effectively restoring the RMB’s value. Obviously, the CCP won’t adopt either approach, as they do not want to return wealth to the people and will not give up their vested interests.

Option 2: A Passive Response. This option is not as effective as Option 1, but it would still strengthen the currency and cool down inflation. Appreciation of the RMB is a simple way of easing inflation. One could use monetary measures to either increase interest rates immediately, or appreciate the RMB substantially, or both. Most likely, the CCP would keep depreciating the RMB, because they would sacrifice people’s interests willingly to keep the economy from crashing. But a slight rate increase to ease the external pressure wouldn’t be very useful, since it would continue to attract hot money (that searches for the highest rate) and wouldn’t be able to stop the worsening of inflation. Substantial increases in interest rates and RMB appreciation would be effective, but would increase the cost of exports and cause a chain reaction, such as unemployment.

Option 3: Do Nothing. It is also possible that CCP could choose to do nothing. This is in their interest, but doesn’t guarantee that the people would do nothing under the huge pressure of high inflation. The public’s anger and discontent are bubbling underground and could burst at any time.

Option 4: Transfer the Crisis. CCP could choose to transfer the crisis should inflation go further out of control. They could: launch a war, provoke war between other countries, or issue a new currency, forcing people to exchange the yuan, which is what North Korea did. Of course, there are also risks associated with this option.

No matter which option CCP chooses, it’s likely that the final outcome will be the same. Given the inflation and the real estate bubble, its burst could make an angry public take to the streets. The monetary measures are a passive way of slowing down inflation, whereas the active way, through eliminating the root cause of inflation successfully, would collapse the economic base on which the CCP rules.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.