China's Next Big Export: Inflation

Thursday, Oct. 11, 2007
By AUSTIN RAMZY
TIME MAGAZINE

Wal-Mart shoppers, meet Xu Yaqing. She's a 62-year-old retiree who lives on a fixed income in Beijing. Xu and her husband get by on $263 a month, and lately, the couple's monthly pensions haven't been enough. The price of the peanut oil that Xu cooks with has doubled in the past few months, and soaring costs for other staples have forced them to cut back on milk and to substitute bean curd for meat. They're not starving. But they're scared. "Prices are going up so much and so quickly," Xu complains.
Xu's lamentations, and those of her fellow Chinese, may soon be reverberating around the world, and particularly loudly at big-box retailers like Wal-Mart in the West. That's because all those inexpensive exports gushing out of Chinese factories — the $15 sweaters, the $25 sneakers, the sub-$100 DVD players — may start getting pricier as the mainland struggles to bring its runaway economy under control. Not all economists agree it's inevitable, but some are warning that an era during which low-cost Chinese production helped to maintain unusually stable prices for manufactured goods around the world is coming to an end. This view isn't held just by a few lonely bears in the wilderness. In his new book and in recent newspaper interviews, former U.S. central-bank chairman Alan Greenspan has been emphasizing that prices for Chinese exports have started to rise, which will contribute to a revival of global inflation. Ben Simpfendorfer, China strategist for the Royal Bank of Scotland, puts it succinctly: "Where China was a deflationary influence over the last 10 years, it will be an inflationary influence over the next 10 years."
Although it may not be evident at the local Wal-Mart yet, these forces may already be in play. Demand from China, along with other fast-growing emerging economies, has driven up the price of oil and a wide range of other commodities for the past several years. But what's really worrying many economists is the sudden appearance of relatively high inflation within China and the ripples that might cause abroad. Despite five interest-rate increases this year by China's central bank, the country's consumer price index has been stubbornly on the rise. In August, inflation climbed to a 6.5% annual rate, the fastest clip in more than 10 years.
The government and some economists blamed the jump almost entirely on sharply higher prices for meat and poultry, which surged 49% since mid-2006. Beijing maintains that the rise in food costs, which make up more than one-third of China's consumer price index, was largely the result of more expensive livestock feed and a one-off event: an outbreak of a porcine disease that killed 70,000 pigs and prompted the mid-September release of 30,000 tons of pork (about a quarter of the amount of pork China consumes in a day) from a national reserve to help stabilize prices.
But other costs are rising as well — property prices are going up countrywide at an annual rate of about 10%, according to UBS economist Jonathan Anderson — and Beijing's actions speak louder than its soothing words. After the August inflation figures were released, the government took the unusual step of freezing all state-controlled prices, including those for gasoline, water and electricity. Aware of the potential that high rates of inflation have for fomenting social unrest, officials also warned businesses against gouging consumers; in August, authorities accused instant-noodle makers of illegally conspiring to raise prices. Meanwhile, to allay public anxiety about eroding paychecks, Beijing has been encouraging local governments to raise minimum wages, which cities including Beijing, Shanghai, Shenzhen, Guangzhou and Nanjing have done.
Moves like the latter one could wind up stoking the fires of global inflation. After all, it was China's cheap laborers who turned the country into the world's factory. By one estimate, China's manufacturing unit labor cost was just 4% of that of the U.S. in 2005. Now, as the mainland economy powers ahead — GDP growth jumped by 11.9% in the second quarter — real wages of urban workers have been soaring at double-digit rates, rising 18% in the first half of this year alone, according to the government. Add in higher raw-materials prices, and manufacturers are facing increases in production costs they may no longer be able to absorb. The costs will be passed along to consumers worldwide, a situation that will be made worse by a strengthening Chinese currency. "Internationally, the price of imports from China will come up," says Chen Xingdong, chief China economist for BNP Paribas Securities. "The increase will be inevitable." There's evidence it's already happening. In May, the price of Chinese products imported by the U.S. registered a 0.1% year-on-year increase, the first such gain since the U.S. Department of Labor began tracking Chinese import prices in 2005. Prices have climbed by at least 0.3% each month since then.
If the pattern continues, things could get complicated for central bankers around the world, and for U.S. central-bank chairman Ben Bernanke in particular. Beset by a slowing economy amid the subprime loan meltdown, Bernanke is trying to ease interest rates without triggering higher inflation. Additional inflationary pressure from one of America's largest trading partners will undermine his ability to reduce rates further to prevent the U.S. economy from stalling. He's not likely to get much help from Beijing, which has its own priorities and a limited set of tools to rein in consumer prices. Efforts to cool economic growth by reducing liquidity — China has raised the amount Chinese banks must set aside in reserves seven times this year to curtail the amount of money in circulation — have had little effect so far.
Part of the difficulty for China's central-bank chief, Zhou Xiaochuan, is that the country lacks reliable statistics on which to base economic projections and policies. "They're driving at night without good headlights," says Stephen Green, Shanghai-based economist with Standard Chartered. Another problem is that monetary and fiscal policies are intimately tied up with politics. For example, Chinese President Hu Jintao's centerpiece program of building a "harmonious society" by raising wages and improving state services such as health care for poorer workers plays well with the masses, but may undermine efforts to contain inflation. "As low-income earners enjoy higher incomes they tend to spend money," says Simpfendorfer, the Royal Bank of Scotland economist. "Ultimately that's an inflationary story." Political considerations can also prevent officials from taking aggressive, timely action, says Albert Keidel, a senior associate with the Carnegie Endowment for International Peace and a former Beijing-based senior economist for the World Bank. "It's better to nip inflation in the bud," Keidel says, "but [politicians'] concern is that if they take it seriously, it shows they haven't managed the economy well. It might open them to criticism from political opposition within the party."
For now, Chinese officials seem to recognize that high economic growth almost always leads to higher inflation rates — and that they can live with that as long as people don't revolt. At the end of September, China's central bank predicted consumer price rises would accelerate from an average 4.6% rate this year to 5% in 2008. Higher food costs continue to be a worry. As Chinese grow richer, they are eating more meat, which pushes up demand for grains such as soy and corn, says Jing Ulrich, head of China equities at JP Morgan in Hong Kong. Although Ulrich expects food prices to stabilize by year's end as the pork supply recovers, she says inflationary pressures resulting from rising meat consumption, the country's shrinking farmland and water shortages will persist.
But does this mean it's inevitable that inflation will join the long list of Chinese global exports? Economists disagree. Yiping Huang, chief Asia Pacific economist for Citibank, notes in a recent research report that, while wages are rising fast in China, labor productivity is increasing even faster, which tends to limit manufacturers' need to raise prices. Standard Chartered economist Gerard Lyons says that China's move into more valuable manufactured goods such as automobiles will in years to come have the same deflationary effects on world markets as the country's push into low-end manufacturing.
That's little consolation to ordinary Chinese. Xu and her husband still have concerns about how to put food on the table. "If clothes are more expensive, we could wear old clothes," Xu says, "but we have to eat no matter how expensive it is." She badly wants to see inflation abate. The rest of the world might soon share that sentiment.
— with reporting by Jodi Xu/Beijing