Chinese Inflation
Research for Online Investors

by John Dalt

1/11/11

The Federal Reserve is pumping money into the U.S. economy.  We all know the efforts of the Fed through the term “QE2,” quantitative easing (second round).  The intention is to push money into banks at low interest rates, then into the economy as they lend it to businesses and individuals.  It is an inexact science.  They buy short term treasuries to keep interest rates low, and flood money into the banks.  What else can banks do with it?

Understanding the ramifications of QE2 on the U.S. economy is tantamount to making educated decisions in your investments.  Will there be inflation?  Will the Fed be successful in withdrawing the “punchbowl” if the U.S. economy begins to overheat?  The answers to these questions tells you whether you want to be in commodities, precious metals, retail store chains, or other sectors you think will benefit from the steps (or missteps) that will be taken.

I had about decided to pull away from the precious metals trade.  Everything just seemed very quite.  The economy seems to be growing, the Fed is fighting de-flation and investors are looking to equities for returns rather than cold metal.  That seems to have changed in just a few days.

Portugal looks like they are headed for a rescue package from the European Central Bank and IMF.  This morning the New York Times detailed the inflationary pressures in China.  I was surprised at the money growth in China.  The article helped me understand why I should stay invested in precious metals and commodities or commodity companies.  Let me explain.

Every time you buy a do-dad at Walmart or Target, dollars are sent to a manufacturer in China.  The Chinese manufacturer cannot spend dollars; they have to convert the dollars to Renminbi.  The Chinese government converts the dollars and Euros at the ‘official’ exchange rate.  Where does the government get the Renminbi to buy the dollars and euros?  From the government printing office.

China’s foreign exchange reserves grew by a record amount in the fourth quarter.  Renminbi circulating in the Chinese economy grew at an alarming rate also.  Unlike in the U.S. (where excess dollars sit in banks) the Renminbi the government exchanges into the economy are circulating.  When more money circulates, inflation occurs.

Printing money is not itself inflationary.  Additional money becomes inflationary as it is spent.  More money chasing the supply of goods causes prices to rise.  In China, the additional Renminbi are being spent on food and real estate. Chinese consumer prices increased 5.1% in November

The Chinese government has intervened in banking at least seven times in the last few months.  They have either raised interest rates that borrowers must pay or raised bank reserve requirements.  Raising reserve requirements forced the banks to keep more money on their balance sheets rather than making loans.

The broad based measurement of money in circulation known as M2 increased by 19.7% in December over one year ago.  China is experiencing the inflation that we fear in the West.  The difference is they are in the present predicament because of their strong exports and the government trying to control the value of the Renminbi.  If they let their currency appreciate in value relative to the U.S. dollar and the Euro, pressure would be reduced as they would pump less “money” into their economy. Economists estimate the Chinese government spent close to two billion dollars PER DAY intervening in currency markets in the fourth quarter.  Chinese foreign reserves are currently at $2.85 trillion dollars.

There are still reasons to stay long commodities, commodity companies, precious metals and miners for now.  As long as China keeps the Renminbi cheap against the dollar they will continue paying out piles of Renminbi to soak up the dollars their exporters take in.  In effect, the U.S. is exporting inflation into their currency market until they let the Renminbi rise in value.

Today’s quote:
A people can vote themselves into slavery, though they cannot vote themselves out of it. ---Frank Chodorov

Editor’s note:Thanks to subscriber D.E. for sending in this great quote from an American Patriot.  Mr. Chodorov was a Russian immigrant that championed libertarian principals and a non-interventionist foreign policy in the first half of the 20th Century.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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