Deflation, not inflation, in the wind

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Last updated at: (Beijing Time) Wednesday, November 12, 2003

Deflation, not inflation, in the wind

An in-depth analysis of the recent price rally reveals that it is far from a prelude of a major inflation, but rather there is a danger of triggering deflation if it is not checked properly.

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An in-depth analysis of the recent price rally reveals that it is far from a prelude of a major inflation, but rather there is a danger of triggering deflation if it is not checked properly.

China has witnessed rapid price rises since mid-October for its farm products, like wheat, corn, rice and cotton. Price increases in flour, cooking oil and beverages soon ensued. These are the first large-scale price hikes in agricultural produce since 1997.

According to figures from the National Bureau of Statistics, the national consumer price index (CPI) in September was 1.1 per cent higher than that of last September, 1.2 per cent higher than that of this August, reaching the peak of this year by far.

The CPI in the first nine months was up by 0.7 per cent over the same time last year, and the GDP was 8.5 per cent higher year-on-year. The prices of crude oil and iron and steel were subject to two-digit growth.

The price growth in consumer goods and production materials seems to suggest that the deflation obsessing the nation for years is fading away while major inflation is on the horizon.

The dramatic changes in the economic situation have generated discussion in the media and among academics.

A Wall Street Journal piece at the end of October announced "inflation hits China."

A research paper from Peking University pointed out that the gross supply of the society is accelerating. A major inflation will occur in a short time if current policies are not altered.

There are still other opinions like "inflation amid deflation" and "deflation as a whole and inflation in certain sectors."

Before taking sides with any of these opinions, we should make a thorough analysis on the reasons for the price hikes and their possible consequences.

The economy is showing several notable traits this year.

First, investment has experienced rocketing growth. The total investment in fixed assets in the first nine months stands at over 3.43 trillion yuan (US$413.9 billion), 30.5 per cent higher than the same time last year. The same growth rates in 2001 and 2002 were 15.1 per cent and 21.5 per cent respectively, far less than the growth rate of this year.

Meanwhile, investment has been focussed on several sectors, like automobile production and real estate development.

The loans given to projects involving real estates increased by 426.4 billion yuan (US$51.4 billion), a 37-per-cent increase in the amount of all long- and mid-term loans. Loans to develop real estate rose by 135 billion yuan (US$16.3 billion) and this sum is 100.6 billion yuan (US$12.1 billion) higher than the growth achieved in the same period of 2002 over 2001. The investment rise in real estate is 7 percentage points higher than the level in other fields.

The investment in iron and steel production rose by 150 per cent, while investment in textiles increased by 626 per cent.

Booming investment in these sectors drives the demand higher than the supply for raw materials, energy and relative commodities. Price goes up as a natural result.

Second, banks also witnessed unusually rapid growth this year. By the end of September, the broad money (M2), the narrow money (M1) and cash in circulation (M0), all of which are economical jargon indicating money supply, experienced two-digit growth year-on-year.

The national foreign exchange reserve was US$383.9 billion by the end of September, US$97.5 billion higher than it was at the end of last year.

The balance of individual bank deposits exceeded 10 trillion yuan (US$1.2 trillion) for the first time, and the balance of loans in financial institutions were 16.7 trillion yuan (US$2.1 trillion), 2.5 trillion yuan (US$ 301.2 billion) higher than it was at the end of last year.

These could all induce an oversupply of money, which is an important inducement to inflation.

Third, the changes in the global economy also contributed to the price hikes in this country. Studies indicate that the 75 per cent price increase in production materials this year can be attributed to the international jump in energy prices. And 50 per cent of the CPI growth was caused by the same factor.

The global price rise is produced by policies tackling deflation in most countries. But more importantly, it is caused by the devaluation of the US dollar in recent years.

Given the widespread use of US currency in international markets and its prominent position in foreign exchange reserves in most countries, its devaluation caused a sustained price hike around the world.

At the same time, US dollar devaluation also generates large sums of idle money on the international market, which, according to economic theories, is also an important factor producing price hikes and inflation.

Based on the three elements causing price increases it is easy to say that an inflation, which means a sustained and extensive price hike caused by the gross demand overwhelming the gross supply, has not happened and is unlikely to happen soon.

The current price hikes are mainly taking place in production materials and agricultural produce. They have mostly influenced the sectors where investment is growing fervently.

In other words, the price hikes are driven by an unusual surge in investment.

This growth, or investment fever, triggered a boost in the sales of housing and automobiles, but other consumer goods are almost free of its influence.

The price rise of food is within a reasonable range, and the prices of clothing, home appliances, transportation and communication have even dropped by more than 2 per cent.

This is an indication that the consumer market is seeing a sluggish demand for finished products and services and the semi-finished products are experiencing inadequate demand as well.

Under these circumstances, if investment fever is not checked, bubbles in some sectors, for example real estate and automobiles, will inevitably occur though these sectors may seem prosperous for the time being.

Also, if bank loans are concentrated in the hands of some large enterprises, these enterprises with overtly abundant capital may abuse the bank loans, investing the money blindly or even embezzling from these funds, which in turn will produce duplicate construction, unbalanced industrial structure or uneven development among regions.

Therefore, the investment fever will not produce inflation. Instead, it will further what is already serious deflation.

Admittedly, the price jump for agricultural produce will certainly benefit the national economy. But with a low price of produce, farmers are unable to see their income rising and their demand will remain sluggish.

Of course, we should still remain vigilant against possible inflation, no matter what the real reasons of price hikes are. After all, inflation, once it has occurred, will hurt the interests of the people. And the authorities should take some precautions before it is too late.

The author is a researcher with the Financial Research Institute under the Chinese Academy of Social Sciences.

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