So there’s all this talk about inflation these days, though it has been overshadowed by all those Tibetan protests and political stuff. So let’s look at how this inflation began and what the possible impacts are.
Early to mid last year, there were reports of some kind of disease that was killing a large number of pigs in the south, though I haven’t seem too many official reports on this. Combine this problem with the freakishly cold winter during the Spring Festival in central China with the continuous loss of agricultural land to development has created an acute shortage in food supplies. There has also been a huge increase in demand of energy, especially in China and India, which resulted in global rise of energy prices.
The shortage in agricultural products enabled the peasants to sell their goods for a higher price while higher energy prices increase the cost of transportation, as well as higher costs of production in almost all sectors, and in the end translates into higher consumer prices when the goods finally reach the local Carrefour or wet markets.
The higher consumer prices cause people to spend a greater propertion of their income on essentials and thus cuts into the amount that can be saved or spent on other consumer products. The people will then demand higher wages to offset the higher costs, but this does not lead to immediate changes since wages are generally slower in their response to the market.
So the farmers should be able to make more money, have higher incentives to increase production which would cause supply to rise, and prices to decrease. As a result, the current inflation problem should be self correcting. By this line of thought, the China Development Forum is correct in their analysis that the current inflation ins outside the influence of monetary policy.
However, lets assume that wage pressure does increase and actually results in a rise of income. If this is true, the problem of inflation will spread quickly into other sectors. Let’s take a look.
With more money, the people will either spend or save more. Increases in spending will lead to higher demand of a wide variety of products while higher savings can lead to higher rates of risky investments. Prices of goods would increase, which would cause an increase in production as well as opening of new firms to meet the increased demand.
Higher production requires more labor, which further increases wage pressures. If inflation continues to increase, and it should, the people will have lower purchasing power. This should cause the people to save money, but with high inflation expectations, the rational response would be to spend now instead of watching inflation bite into their bank accounts. The higher rates of spending leads to higher production, higher wages, higher inflation, higher inflation expectations, and it keeps on going until the entire economy reaches the breaking point and explodes.
The only way to break the cycle is for the government to actively control the monetary supply by increasing interest rates to make investment costlier and slow down the rate of growth. However, this creates problems in societal and political areanas.
Slowing down growth with high inflation would cause wages to remain the same while prices have already increased. The purchasing power of the people would have decreased and they would see the government’s policy as further hurting them. Unemployment might increase as hastily built firms close due to the credit crunch. The poor become even poorer and the disgruntled become angry. The government is seen as corrupt as local officials continue to collect extra ‘fee’s and ‘fines’ from the people despite their difficulties. Protests break out. Some get violent. A charismatic leader leads them under a red banner and smashes the evils of capitalism and imperialism, creating a communist nation immune to market forces.
Inflation is one of the most troublesome issue economic planners have to deal with. I remember playing Supreme Ruler 2010 as Somalia. I was doing great, building up my agricultural surplus to fund the creation of more profitable factories while selling military supplies to the warring nations around me. My GDP was soaring at 15-18%, my people’s lives were getting better, and I was increasing my investment in new technologies while preparing to take over the entire continent with my light tanks backed by hordes of artillery. Then all of a sudden, I saw my inflation at 20%. I was slow to act and before I knew it, it was 30%. I increased my taxes, but still I was hitting marks of 40%. My economy was going straight to hell so I shot my taxes up to 90%; saw my inflation finally slow, but my economy also died. I was then invaded by Ethiopia and it was all over.
So if the PRC does not want to get invaded by Mongolia again, I would suggest that they start doing something before it all gets out of hand.
