I am having a Dean Baker moment, although I suspect Baker will have even more fun with the front page New York Times article bearing the headline above.
This is how the story starts:
China’s latest export is inflation. After falling for years, prices of Chinese goods sold in the United States have risen for the last eight months.
Soaring energy and raw material costs, a falling dollar and new business rules here are forcing Chinese factories to increase the prices of their exports, according to analysts and Western companies doing business here.
The rise was a modest 2.4 percent over the last year. But even that small amount, combined with higher energy and food costs that also reflect China’s growing demands on global resources, contributed to a rise in inflation in the United States. Inflation in the United States was 4.1 percent in 2007, up from 2.5 percent in 2006.
The article also notes, “Some of the current cost pressures are actually by design — Beijing’s design,” and cites measures like elimination of export subsidies and tax rebates, measures sought by the US.
The article fails to mention the single biggest cause of China’s roaring inflation: massive monetary stimulus caused by large, continuing purchases of dollars to fund our current account deficit. In effect, the US has been exporting inflation, and it is finally coming around to haunt us as the dollar depreciates and domestic inflation in our trading partners rises to the point that it shows up in export price increases. But not a word of the role that the funding of our consumption habit plays, at least in the New York Times.
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Yves, I think you’re exactly wrong on this one. The purchases of dollars aren’t a monetary stimulus — how can buying Treasury bonds increase the Chinese money supply? Quite the opposite: they’re an attempt to sterilize all those dollar inflows, and *prevent* inflation. If China allowed its exporters to simply spend all the dollars they’re earning, *that* would be inflationary.
The Chinese peg their currency to the US$. Therefore, they must buy (support) the $’s fall by buying Treasuries.
Those Treasuries then become the reserves undergirding China’s monetary base.
anonymous is half right. The Chinese buy US Treasurys. But then, in order to control their own money supply, they turn around and sell renminbi-denominated bonds, to suck back the renminbi cash they just put out. So the net trade is buy US Treasurys, sell renminbi bonds.
This is called sterilization. The Japanese also do it. It is leaky, though. It does not always work to control the money supply.
Note that it also makes the reserves in the Chinese central bank worse and worse. I wouldn’t be surprised if the Chinese central bank is the only institution in China that owns no renminbi-denominated bonds.
I didn’t get into sterilization versus non-sterilization issue, incorrectly deeming it to be too technical, although I should have at least alluded to it.
The social unrest resulting from dollar-induced inflation is one of the reasons China is letting the yuan rise. I have not yet tracked it down, but I recall reading Brad Setser saying that it wasn’t clear whether China was sterilizing its Treasury purchases before 2005 (he may actually have said something stronger, as in they likely weren’t). Any past unsterlized Treasury purchases would have led to domestic money supply growth.
He also said in post this week that even permitting the currency appreciation, China was currently having trouble sterilizing its Treasury buys.
Actually, some relevant commentary comes from Nouriel Roubini, in a summary of his paper “The Instability of the Bretton Woods 2 Regime“:
…membership of BW2 leads to significant financial, monetary and real distortions for its members, most of which have to do with the loss of monetary and credit policy independence that a fixed exchange rate peg entails. These distortions are increasingly taking the form of economic overheating, rising inflation and dangerous asset bubbles.
China is a paradigmatic BW2 member.