By: Dr. Mike Campbell
China is widely regarded as the powerhouse of the global economic recovery. By some accounts, it has already eclipsed Japan to become the world’s second largest economy behind that of the USA.
However, strong economic performance is often accompanied by risks of inflation and the creation of asset bubbles. Concerns have been voiced that parts of China are in the midst of an eventually unsustainable property bubble which has been fuelled by “cheap” money provided by the State as a mechanism to stimulate economic recovery after the worst of the global economic crisis. A property bubble can be devastating as many business people in Ireland will attest.
With official inflation figures coming in at 5.1% in November against a target figure of 3% and food inflation in low double figures, tackling inflation has been identified at a top priority for the government. The standard approach for reigning in inflation is to make the cost of borrowing more expensive, reducing liquidity. Of course, the downside of this in a relatively weak global recovery is that the knock-on effects may harm the recovery; particularly if the move is made by an economy as large as China’s.
This explains why markets reacted favourably to the news that China would keep its interest rate hold and seek to tackle the problem by other means. China is requiring that banks hold larger reserves, thereby choking off money supply somewhat, but without actually increasing the cost to business of borrowing.
The banks have been instructed to increase their reserves by 0.5% - this is the third such rise in the past month. It remains to be seen if the move will have the desired effects quickly enough to avoid public unquiet about the rising cost of food which provides a potentially explosive political problem.