China’s leaders are not doing enough to control the country’s overheating economy, according to our web poll last week.
This is perhaps not a surprising result. Growth of 10.3% in 2010 was frighteningly high and inflation is already above 5%, just as labour shortages are driving wages higher and threatening to kick-start a much broader bout of inflation.
That is the last thing China wants, but the goal of keeping its currency competitive against the dollar means there is no magic bullet in its arsenal. Pushing up interest rates would take it out of step with the US economy and bring an end to the renminbi’s stable relationship with the dollar. Indeed, investors around the world are already betting on the currency’s eventual rise and, despite China’s tight controls, hot money is surging over its borders.
Sooner or later, something has to give.
If all this sounds strangely familiar, Commerzbank reckons it might know why. In a report released last week, chief economist Joerg Kraemer drew lessons from Germany’s experience during the end of the Bretton Woods exchange-rate system in the early 1970s.
Like China’s today, many people considered Germany’s currency undervalued, but under the fixed currency system it had to defend the deutschmark’s value, which promoted a long and powerful upswing that economists at the time described as a “marathon boom”.
“The example of Germany in the Bretton Woods system teaches us that China faces a serious inflation problem because the hands of its central bank are tied — particularly since the inflow of hot money is also fuelling economic growth,” he wrote in a report titled Floating the yuan: What China can learn from Germany.
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33%The conventional view is that the oil crisis kicked off the hyperinflation of the 1970s, but Kraemer argues that the data tells a different story.
“The number of unemployed fell to just 150,000, labour became scarce and wildcat strikes occurred,” he wrote. “From 1969 to 1973, per capita wage growth virtually remained in double digits. High cost pressure stoked inflation, which rose from under 2% in 1968 to 7% just before the oil crisis erupted in autumn 1973. In other words, it was the relaxed monetary policy imposed by the Bretton Woods system and not the oil crisis which created the inflation problem of the 1970s.”
Faced with a similar situation, China might be forced to let go of the renminbi much sooner than anyone expects, according to Kraemer. “The Chinese government seems to have recognised the problems,” he wrote. The central bank has a five-year timeline for liberalisation of the renminbi, but Kraemer doubts that. “Presumably the end of Bretton Woods II will come faster.”
Kraemer signs off his note with a pragmatic assessment: “Releasing the yuan will free the Chinese from the obligation to invest massive sums in the USA and will remove from the Americans the temptation to become massively indebted to the Chinese. The result would be a more stable global economy with less debt and inflation.”
Problem solved.
