Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Will You Make Money in the New Silver Bull Market ? - 13th Aug 20
Hyper-Deflation Capital Destruction And Gold & Silver - 13th Aug 20
Stock Market Correction Approaching - 13th Aug 20
Silver Took the Stairs to $21 in 2008, Took Escalator to $29 2010. Is Silver on Elevator to 120th floor today? - 13th Aug 20
President Trump Signs Additional COVID Relief – What To Expect from the Markets - 13th Aug 20
Has Gold's Upward Drive Come to an End? - 13th Aug 20
YouTuber Ads Revenue & How to Start a Career on YouTube - 13th Aug 20
Silver Notches Best Month Since 1979 - 12th Aug 20
Silver Shorts Get Squeezed Hard… What’s Next? - 12th Aug 20
A Tale of Two Precious Metal Bulls - 12th Aug 20
Stock Market Melt-Up Continues While Precious Metals Warn of Risks - 12th Aug 20
How Does the Gold Fit the Corona World? - 12th Aug 20
3 (free) ways to ride next big wave in EURUSD, USDJPY, gold, silver and more - 12th Aug 20
A Simple Way to Preserve Your Wealth Amid Uncertainty - 11th Aug 20
Precious Metals Complex Impulse Move : Where Is next Resistance? - 11th Aug 20
Gold Miners Junior Stcks Buying Spree - 11th Aug 20
Has the Fed Let the Inflation Genie Out of the Bottle? - 10th Aug 20
The Strange Food Trend That’s Making Investors Rich - 10th Aug 20
Supply & Demand For Money – The End of Inflation? - 10th Aug 20
Revisiting Our Silver and Gold Predictions – Get Ready For Higher Prices - 10th Aug 20
Storm Clouds Are Gathering for a Major Stock and Commodity Markets Downturn - 10th Aug 20
A 90-Year-Old Stock Market Investment Insight That's Relevant in 2020 - 10th Aug 20
Debt and Dollar Collapse Leading to Potential Stock Market Melt-Up, - 10th Aug 20
Coronavirus: UK Parents Demand ALL Schools OPEN September, 7 Million Children Abandoned by Teachers - 9th Aug 20
Computer GPU Fans Not Spinning Quick FIX - Sticky Fans Solution - 9th Aug 20
Find the Best Speech Converter for You - 9th Aug 20
Silver Bull Market Update - 7th Aug 20
This Inflation-Adjusted Silver Chart Tells An Interesting Story - 7th Aug 20
The Great American Housing Boom Has Begun - 7th Aug 20
NATURAL GAS BEGINS UPSIDE BREAKOUT MOVE - 7th Aug 20
Know About Lotteries With The Best Odds Of Winning - 7th Aug 20
Could Gold Price Reach $7,000 by 2030? - 6th Aug 20
Bananas for All! Keep Dancing… FOMC - 6th Aug 20
How to Do Bets During This Time - 6th Aug 20
How to develop your stock trading strategy - 6th Aug 20
Stock Investors What to do if Trump Bans TikTok - 5th Aug 20
Gold Trifecta of Key Signals for Gold Mining Stocks - 5th Aug 20
ARE YOU LOVING YOUR SERVITUDE? - 5th Aug 20
Stock Market Uptrend Continues? - 4th Aug 20
The Dimensions of Covid-19: The Hong Kong Flu Redux - 4th Aug 20
High Yield Junk Bonds Are Hot Again -- Despite Warning Signs - 4th Aug 20
Gold Stocks Autumn Rally - 4th Aug 20
“Government Sachs” Is Worried About the Federal Reserve Note - 4th Aug 20
Gold Miners Still Pushing That Cart of Rocks Up Hill - 4th Aug 20
UK Government to Cancel Christmas - Crazy Covid Eid 2020! - 4th Aug 20
Covid-19 Exposes NHS Institutional Racism Against Black and Asian Staff and Patients - 4th Aug 20
How Sony Is Fueling the Computer Vision Boom - 3rd Aug 20
Computer Gaming System Rig Top Tips For 6 Years Future Proofing Build Spec - 3rd Aug 20
Cornwwall Bude Caravan Park Holidays 2020 - Look Inside Holiday Resort Caravan - 3rd Aug 20
UK Caravan Park Holidays 2020 Review - Hoseasons Cayton Bay North East England - 3rd Aug 20
Best Travel Bags for 2020 Summer Holidays , Back Sling packs, water proof, money belt and tactical - 3rd Aug 20
Precious Metals Warn Of Increased Volatility Ahead - 2nd Aug 20
The Key USDX Sign for Gold and Silver - 2nd Aug 20
Corona Crisis Will Have Lasting Impact on Gold Market - 2nd Aug 20
Gold & Silver: Two Pictures - 1st Aug 20
The Bullish Case for Stocks Isn't Over Yet - 1st Aug 20
Is Gold Price Action Warning Of Imminent Monetary Collapse - Part 2? - 1st Aug 20
Will America Accept the World's Worst Pandemic Response Government - 1st Aug 20
Stock Market Technical Patterns, Future Expectations and More – Part II - 1st Aug 20
Trump White House Accelerating Toward a US Dollar Crisis - 31st Jul 20
Why US Commercial Real Estate is Set to Get Slammed - 31st Jul 20
Gold Price Blows Through Upside Resistance - The Chase Is On - 31st Jul 20
Is Crude Oil Price Setting Up for a Waterfall Decline? - 31st Jul 20
Stock Market Technical Patterns, Future Expectations and More - 30th Jul 20
Why Big Money Is Already Pouring Into Edge Computing Tech Stocks - 30th Jul 20
Economic and Geopolitical Worries Fuel Gold’s Rally - 30th Jul 20
How to Finance an Investment Property - 30th Jul 20
I Hate Banks - Including Goldman Sachs - 29th Jul 20
NASDAQ Stock Market Double Top & Price Channels Suggest Pending Price Correction - 29th Jul 20
Silver Price Surge Leaves Naysayers in the Dust - 29th Jul 20
UK Supermarket Covid-19 Shop - Few Masks, Lack of Social Distancing (Tesco) - 29th Jul 20
Budgie Clipped Wings, How Long Before it Can Fly Again? - 29th Jul 20
How To Take Advantage Of Tesla's 400% Stock Surge - 29th Jul 20
Gold Makes Record High and Targets $6,000 in New Bull Cycle - 28th Jul 20
Gold Strong Signal For A Secular Bull Market - 28th Jul 20
Anatomy of a Gold and Silver Precious Metals Bull Market - 28th Jul 20
Shopify Is Seizing an $80 Billion Pot of Gold - 28th Jul 20
Stock Market Minor Correction Underway - 28th Jul 20
Why College Is Never Coming Back - 27th Jul 20
Stocks Disconnect from Economy, Gold Responds - 27th Jul 20
Silver Begins Big Upside Rally Attempt - 27th Jul 20
The Gold and Silver Markets Have Changed… What About You? - 27th Jul 20
Google, Apple And Amazon Are Leading A $30 Trillion Assault On Wall Street - 27th Jul 20
This Stock Market Indicator Reaches "Lowest Level in Nearly 20 Years" - 26th Jul 20
New Wave of Economic Stimulus Lifts Gold Price - 26th Jul 20
Stock Market Slow Grind Higher Above the Early June Stock Highs - 26th Jul 20
How High Will Silver Go? - 25th Jul 20
If You Own Gold, Look Out Below - 25th Jul 20
Crude Oil and Energy Sets Up Near Major Resistance – Breakdown Pending - 25th Jul 20
FREE Access to Premium Market Forecasts by Elliott Wave International - 25th Jul 20
The Promise of Silver as August Approaches: Accumulation and Conversation - 25th Jul 20
The Silver Bull Gateway is at Hand - 24th Jul 20
The Prospects of S&P 500 Above the Early June Highs - 24th Jul 20
How Silver Could Surpass Its All-Time High - 24th Jul 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Hyperinflation Begining in China and Will Destroy the U.S. Dollar

Economics / HyperInflation Jan 19, 2009 - 03:31 AM GMT

By: Eric_deCarbonnel

Economics Diamond Rated - Best Financial Markets Analysis ArticleThe conventional wisdom on China is dead wrong. Specifically, there is a widespread belief, as expressed by Goldman Sachs, that "China will keep the yuan trading within a narrow range in 2009 due concerns about exporters." Worse still, others are even predicting that China will devalue its currency! The sheer wishful thinking is astounding! The idea that "China will keep the dollar peg to help its exporters" ranks all the way up there with "Housing prices always go up" and "You can spend your way to prosperity".


THERE ARE NO FREE LUNCHES

If you have learned nothing else in the last year and a half, you should have learned that if something sounds too good to be true, that is because it IS too good to be true . The media overwhelmingly presents China's dollar peg as a win-win situation: Americans get cheap imports and low interest rates while China gets a strong manufacturing sector. While commentators do sometimes debates whether China will keep lending us money forever, they never talk about the REAL problem with the dollar peg.

Below is a chart which shows how China's dollar peg works. See if you can spot the downside that the media never seems to mention.





The US's trade deficit requires China to print money!

The little discussed downside of the dollar peg is all the money China has to print to maintain it. China's Central Bank puts the extra dollars it receives from its trade surplus into its growing foreign reserves and then prints yuan to pay Chinese exporters. This results in an increase in China's base money supply by an amount equal to the increase in its foreign exchange reserves. While China's ability to keep accumulating US reserves is endless, its ability to keep its money supply under control is not.

The true threat to the dollar peg

If there is one development which could force China to drop its dollar peg, it is out of control inflation. Rampant inflation would result in millions of citizens starving and would create widespread social unrest. Keeping food prices low is a matter of political survival for Chinese authorities. So, facing the choice between losing their grip on power and losing the dollar peg, they will not hesitate for a second to sacrifice the dollar to save their own skin.

So far China been able to contain inflation, but…

In recent years, China has been able to contain the inflationary effects of its trade surplus by soaking up or "sterilizing" all the extra liquidity (printed yuan). These sterilization efforts mostly involved:

A) Raising the reserve requirements of commercial banks. In essence, the PBOC (People's Bank of China) prints money to fund its trade surplus and then increases the amount of yuan banks have to keep as reserves at the Central bank, preventing the printed cash from reaching the economy. As of May of last year, commercial banks' reserve requirements were at 16.5 percent

B) Selling RMB -denominated sterilization bills. The state owned and controlled banking system has been forced to absorb the majority of these bills. As of May of last year, the value of sterilization bills reached 10 percent of bank deposits.

Taken together, these two steps have immobilized roughly 26.5 percent of Chinese commercial banks' deposits. This shows the magnitude China has had to intervene so far, as the value of sterilization instruments outstanding has been increasing at roughly the same rate as its foreign reserves.

PBC Foreign Reserves and Sterilization Instruments (US$ Billions)



While China has been able to contain inflation to single digits for the last decade, that is about to change. All economic forces are aligning in China for a surge in inflation.

1) China has abandoned its sterilization operations

Currently, the PBOC has abandoned its sterilization efforts all together:

A) The PBOC has lowered reserve requirements by 2 percentage point for China's big banks and by 4 percentage point for all other banks.

B) The PBOC has scaled back sterilization efforts by reducing liquidity-draining three-month and 52-week bill sales from once a week to once every two weeks. As a result of these decreasing sales, the clearing house for China's interbank bond market expects PBOC's 2009 bill issues to be down over 70% , which will increase the Chinese base money supply by 2 trillion yuan.

These actions signify that the PBOC has ceased sterilizing its currency interventions and is focusing on (imaginary) deflation risks. A flood of cash has been unleashed, and a tsunami of pent-up inflation will soon hit China.

2) China is running record trade surpluses

China's imports are crashing much faster than its exports. In December, Chinese imports fell 21.3% while exports fell only 2.8%. As a result, China has been running record trade surpluses these last three months: $35 billion, $40 billion, and 39 billion.

The reason for China's surplus is obvious when you think about it. Consider the following list of goods a country can exports and ask yourself what would hold up best during a severe global economic downturn.

*** Commodities (Oil, gas, steel, etc)
*** Capital goods (Airplanes, Caterpillars, Machinery for new factories, Machinery for new mining/oil exploration projects, etc)
*** Durable goods ( SUVs , CARs , appliances, business equipment, electronic equipment, home furnishings, etc)
*** Luxury goods (brand name products, designer clothing, artwork, etc...)
*** Cheap consumer goods (everything you buy at Wal -Mart)

The answer is that the demand for cheap consumer goods will hold up better than anything else. This can easily be seen in the retail sales this holiday shopping season . Wal -Mart, which imports 70% of its products from China, was the only retail to post a year-on-year increase in sales. So while the world economy might be imploding spectacularly, demand for Wal -Mart's cheap Chinese goods is holding up quite well. The implications of this is that while China's exports will fall, they will fall less than those of any other country.

The current trade surplus is still completely unsustainable. If China's continues running a 40 billion dollar trade surplus all year, its base money supply will double by the end of 2009. Also, since China has halted the appreciation of the yuan, its trade surplus is unlikely to shrink as demand for cheap consumer goods is set to remain strong.

3) The Chinese economy will shrink in 2009

Consistently amazing economic growth is the biggest factor which has helped China contain inflation. Inflation happens when the money supply is growing faster than the economy, and china's economy has been growing fast. This economic growth has helped absorb the enormous quantities of yuan that have been printed to support the dollar. However, this will change in 2009. Due to falling global demand, China's economy is set for zero, if not negative, growth which will remove a significant mitigating force against inflation and amplify the inflationary impact of China's printing press.

Side note: China's economic strength is underestimated

It is important to note that, while economic growth will go probably go negative, China's economy will not crash. The strength of the Chinese economy is widely underestimate in the media today. In addition to the resilient worldwide demand for its cheap consumer goods, China is also benefiting for import substitution at home. This is why imports to China are falling so fast: Chinese are switching to cheap domestic product instead of expensive foreign imports. So while there has been a sharp drop in Chinese demand for big-ticket brands (Dior, Chanel, Hermes, etc…) and others luxury items, knock-offs and other cheap goods are still flying off the shelves. Chinese consumers are downshifting, but they are still spending strong, as reflected by the 21% year-over-year growth in 2008.

However, despite China's strong fundamentals, the current worldwide downturn is too strong for it to escape. The worldwide financial carnage is so severe that even the demand for cheap consumer goods will decrease. As a result, while China may outperform every country on Earth, its economy will still suffer in 2009.

4) Deflation in China would be too good to be true

China has been in a constant war with the inflation caused by the dollar peg. Economic growth and sterilization operations alone have not been enough to absorb the growing liquidity, and China has been forced to turn to ever more drastic steps in its efforts to contain inflation. These stifling policy measures together with its sterilization efforts have enormously suppressed domestic demand and have distracting the government from developing key services enjoyed by other developed nations. This suppressed domestic demand has also distorted China's economy, as reflected by the undersized service sector, and has lowered the quality of life for Chinese citizens.

Chinese financial repression and market socialism

In its losing battle with inflation, China has adopted stifling policy measures to suppress domestic demand and keep prices down:

(these are only a few of the anti-inflation measures China has adopted)

A) Strict price controls. ( ie : Large wholesalers must seek central government approval if they want to raise prices by 6 percent within the space of 10 days or by 10 percent within a month.)
B) Credit ceilings. (limits on how much commercial banks can lend)
C) Floors on lending rates and ceilings on deposit rates
D) Strict rules governing lending decisions
E) Tight land purchase and lending requirements
F) Direct government intervention to limited expansion in certain industries ( ie : aluminum, steel, autos and textiles sectors in 2004)
G) Penalty taxes on anyone buying and selling real estate in a short period of time.
H) Forcing local government to cut back spending by delaying approval of their investment projects
I) High sales taxes.
J) Etc...

Suppressed domestic demand has distorted China's economy

The distortions caused by sterilization operations and stifling policy measures are best seen when comparing China's and the US's economy:

A) US home buyers get tax incentives VS Chinese home buyers get tax penalties
B) US gets artificially low interest rates VS China's artificially high interest rates
C) US's "service economy" VS China's "service-less economy"
D) Etc…

In the US, the overvalued dollar and easy credit environment have caused the service sector to become oversized , artificially raising America's standard of living. In contrast, China's suppressed domestic demand has led its service sector to become undersized, artificially decreasing its standard of living.

Focus on inflation has lead to a lack of key government services

With Chinese authorities sidetracked by their export oriented focus and battle with overheating, the development of key government services enjoyed by other developed nations has been neglected. As a result, Chinese citizens' lack of social security, free education, and available consumer credit, which has forced them to save far more than their Western counterparts, leaving them with less disposable income.

Deflation would be a godsend to China

Chinese authorities must be thrilled about the prospect of fighting deflation instead of inflation. Fighting deflation would allow China to:

A) Scale back its increasingly costly sterilization efforts.
B) Lower interest rates.
C) Get rid of all the controls which are distorting domestic property markets.
D) Promote consumer spending without worrying about the inflationary impact.
E) Develop a comprehensive social security net.
F) Increase funding of public education.
E) Accelerate the development of a system to rate people's credit.
F) Encourage growth in underdeveloped domestic sectors (housing, health care, education, entertainment, etc)
G) Etc…

Most of the steps above are already being taken by Chinese authorities. Unfortunately, there are no free lunches. The possibility that China can maintain a highly inflationary currency peg, reverse years of anti-inflation policies, release a flood of sterilized yuan back into circulation, and go on a Western-style stimulus/bailout binge without experiencing double digit inflation is zero.

5) No deleveraging

There is no chance of real deflation happening in China. None. The Strength of China's Banking System makes it impossible.

A) Apart from Bank of China, Chinese banks have little exposure to overseas debt. So, although toxic US securities were sold to banks around the world, China's capital controls protected its banking system from America's bad debt

B) As a side effect of the country's sterilization operations, 26.5 percent of Chinese commercial banks' deposits were placed with the central bank last year (reserve requirements and forced underwriting of PBOC bills).

C) Unlike Western banks, who have been enjoying a credit bonanza for decades, Chinese banks have only recently gotten into the credit game, after years of being ridiculed for being overly cash-centric. Because of this late entry, Chinese banks completely missed the subprime party.

D) China is also in the enviable position of being one of the few countries which doesn't need to deleverage . While Western banks were going insane with high leverage and off-balance sheet financial vehicles, Chinese banks were doing the opposite, as can be seen on the chart below (from Tao Wang of UBS ).



E) China has been waging a war against NPLs (non-performing loans) in the last few years. For example, with heavy penalties having been imposed on bank managers responsible for new NPLs , Chinese banks have become much more concerned about the loan safety than profitability. This battle again NPLs has paid off. As of September 30, 2008, nonperforming loans totaled only 2 percent for Chinese banks, compared to the 2.3 percent for FDIC-insured banks in the US. Loan loss provisions have also improved substantially, with provisions of Chinese banks amounting to an impressive 123 percent of their NPLs .

F) Finally, China's money supply itself is underleveraged when compared to the rest of the world. For example, the US's M2 to M1 ratio is 65% higher than China's. The Chinese M2 to GDP ratio is also more 160 percent, perhaps, the highest in the world.

When considering the strength of Chinese Banks and underlying strength of China's economy, no debt deflation is possible.

If there is no chance of deflation, then why is China's cpi slowing down?

There are three main reasons for the slowdown in China's cpi :

A) The bursting of the commodity bubble. Because of speculator dominated futures markets in the US , commodity prices were boosted to artificial level going into the summer of 2008. As these inflated commodity prices fell back down to Earth, they caused a temporary worldwide slowdown in inflation.

B) In the second half of the year, deleveraging and hedge fund redemption caused the outflow of a large amount of hot money from China. This outflow temporary depressed asset prices.

C) The unwinding of the commodity bubble spread deflation fears worldwide and caused the velocity of money to drop.

6) Deflation fears are paralyzing China's money supply

"deflation fears" have slowed the Chinese money supply to a crawl. While they are still spending, Chinese consumers are delaying big purchases and downshifting to discount stores. Businesses are strapped for cash, and scared Chinese banks are dumping riskier borrowers, like credit-card holders. China is experiencing one of the brief deflationary periods which typically precede hyperinflation .

Deflation fears in China also provide the perfect example of how a slowdown in the "velocity of money" and makes prices fall. Right now, Chinese banks are hoarding cash and delaying payments on personal credit cards . Only a year ago, most banks paid credit-card transactions in 14 days, but now merchants are having to have to wait 20, 40 or even 90 days to get paid. With lenders making credit-card transactions as unattractive as possible, many merchants are refusing to take credit cards from Chinese consumers. Think about that for a second, all that purchasing power from Chinese credit cards wiped out due to nothing but fear itself.

The important point to note about the price deflation caused by the deflation fears is that it will reverse sharply once inflation picks up. Banks will begin paying credit cards normally, and merchants will start accepting them again. The enormous amount of purchasing power which disappeared will reappear just as suddenly, causing a wild jump in inflation.

7) Sterilization operations have become a loss generating ventures

Until last year, China's sterilization operations had been profitable, since the rate of interest that Beijing earned on foreign exchange reserves (mainly US Treasuries) had been higher than the rates it was paying on its yuan-denominated sterilization bills at home. However, now that the fed has lowered US interest rates to zero for the foreseeable future, China's dollar peg has become a loss-making policy. When inflation hits china and interest rates rise again, China's losses from its currency sterilization will become staggering.

8) China likely to attract a flood of hot money in 2009


China has had a problem with hot money inflows in the past, and those problems are likely to get worse this year. Hot money refers to the money that flows regularly between financial markets in search for the highest short term interest rates possible. This hot money has found ways around China's capital controls and flows freely in and out of China to the authorities great frustration.

When hot money flows into china, it forces the PBOC to print money the same way as the trade surplus does. At the beginning of last year, these hot money inflows were one of China's biggest problems, bringing inflation up to 8.6 despite the authorities best efforts. The country's hot money problem ended temporarily with the bursting of the commodity bubble.

In the second half of last year, deflation fears and hedge fund deleveraging cause much of this hot money to leave China and seek the "safety" of US treasuries. This small exodus is what is responsible for the brief fall in China's foreign reserves. However, the outflow of hot money from China has ended, and it now looks set to reverse.

In the next month or so, rising inflation will start pushing up Chinese interest rates at a time when central banks around the world have set their rates at or near zero. Since the entire world knows that the yuan is undervalued, these higher rates will make China the most attractive destination on Earth for those seeking safe high yielding interest rates, and the hot money problem will return with a vengeance.

9) Chinese authorities are pulling out all the stops


The Chinese authorities are pulling out all the stops to get the country back on track. In order to prop up economic growth, Chinese authorities have:

A) Raised tax rebates for exporters of everything from high-tech and electronic products (motorcycles, sewing machines and robots, etc) to some rubber and wood products.
B) scraped export taxes for some steel products, aluminum, rice, wheat, flour and fertilizers
C) Cut the lock-up period beyond which people can resell their property without paying a business tax from five years to two years.
D) scraped the urban property tax for foreign firms and individuals
E) Allowed people to buy second homes on the same preferential terms normally reserved for first time buyers.
F) Announced plan to spend 900 billion yuan over three years to build affordable housing
G) Cut the deed tax payable by first-time buyers of homes smaller than 90 sq m is to 1 percent.
H) Announced measures such as cash subsidies and tax cuts to encourage home purchases
I) Announced plans for a 4 trillion yuan (586 billion) stimulus package to boost domestic demand through 2010.
J) Announced plans to invest 5 trillion yuan roads, waterways and ports in the next three to five years (over 2 trillion yuan more than originally planned).
K) Approved 2 trillion yuan for railway investment
M) Announced a tax break for public infrastructure projects.
N) Abolished the 5 percent withholding tax on interest income.
O) Scraped the 0.1 percent tax on purchases of equities.
P) Instructed Central Huijin (a government investment arm) to buy shares of listed Chinese firms.
Q) Encouraged state-owned firms to buy back shares.
R) Raised minimum grain purchase prices by 15 percent
S) Approved landmark reforms that give peasants the right to lease or transfer their land-use rights
T) Issued a stimulus package for its auto sector, including a tax cut
U) Set a price floor for air tickets
V) Handed out cash gifts to brighten their mood before the Chinese New Year
W) Etc...

10) Banks are flooding the economy with new loans

Chinese authorities are pushing banks to extend credit and help fight "deflation". To encourage this money supply growth and new lending, the PBOC (the People's Bank Of China) has halted sterilization operations and has cut the benchmark one-year lending rate by 2.16 percent and the deposit rate by 1.89 percent. Also, as part of these efforts, Chinese officials are reversing decades of financial repression and freeing up their banking system.

As China lifts restrictions on lending, banks are flooding the economy with new loans. Credit ceilings under which commercial banks have been operating have now been removed, and credit controls have been relaxed to give banks more leeway in making lending decisions. Chinese lenders will now be able to restructure loans and adjust the types and maturities of debt. Banks are being pressured to use this new financial freedom to "promote and consolidate the expansion of consumer credit".

In addition to stimulating consumption, credit constraints are being relaxed to give loan access to small and medium privately owned businesses, which have until now been mostly shut out of credit by the state-owned financial system. As part of this effort and in order to help banks overcome their deflation fears, China has said it will tolerate more bad debt . This step is particularly significant, as the heavy penalties imposed for the creation of new non-performing loans has been a big restraint on credit expansion.

Finally, the commitment of Chinese authorities to fight deflation is so great that regulators have stated they will support the sale and securitization of loans. I repeat, China is moving towards securitization of loans ! The adoption of securitization holds the potential to enormously accelerate money supply growth.

China's efforts to boost lending are working. In December, China's M2 money and loan growth soared . Just look at the graph of Chinese money supply growth below.



Does it look like China is headed towards deflation to you? (this chart will become much scarier once January's numbers are added in)

Conclusion

I view hyperinflation in China as absolutely guaranteed. Zero doubt. China is dismantling all the measures it has put in place over the years to fight inflation. It is dropping restrictions on purchasing property, eliminating price controls, getting rid of loan quotas, lowering interest rates, ceasing its sterilization efforts, etc… It is also pulling out all the stops to boost government spending and new loan creation.

Meanwhile, China's 40 billion dollar trade surplus means that its base money supply looks set to double in 2009. There is also the fact that China's money supply is frozen due to cash hoarding and will cause inflation to increase when it accelerates. Finally, the commodity bubble has finished bursting, and China's economy looks set to shrink.

Every economic factor in China suggests an enormous wave of hyperinflation will begin early this year. While I have written about the threats facing the dollar , this will be the event that finally ends the US's borrowing binge and destroys our currency.

Hyperinflation in China will be a monumental event

Because China makes most of the world cheap consumer goods, it will export its hyperinflation around the world. This means that no fiat/paper currencies will survive this with its purchasing power intact. Some will lose all value (dollar) while others will only survive but experience a loss of purchasing power (yuan, euro, yen, etc...). The only money that will retain its full value in the face of Chinese hyperinflation is gold.

China will sink the dollar to save the yuan

Once hyperinflation kicks into gear, Chinese authorities will find it impossible to bring it under control without sacrificing the dollar. Since hyperinflation would hurt Chinese exporters as much as losing their US exports, China will face a clear cut decision. By dumping the dollar peg and selling its USD holdings, China will help contain domestic inflation in many ways:

1) China will no longer be printing massive quantities of yuan to support the dollar.
2) By selling dollars in exchange for yuan, China will be able to take those yuan out of circulation, shrinking its monetary base.
3) Since the yuan will strengthen enormously again foreign currencies, Chinese exports will fall and that means there will be a lot more goods available for domestic consumption.
4) Since the yuan will be stronger against foreign currencies like the dollar, Chinese imports will rise. That means cheaper commodity prices across the board.
5) Dropping the dollar peg will make the yuan a major reserve currency. That means lower interests rates in China as foreign central banks build up yuan reserves.

Those expecting deflation are in for a surprise

Western nations who are lowering interest rate very sharply, without fearing inflation, are mainly concentrating on the domestic dynamics of their economies and the value of their currency. My bet is that no one is even considering the possibility that inflation could be imported from China, and, when cheap Chinese imports stop being cheap anymore, it will catch everybody completely by surprise.

By Eric deCarbonnel
http://www.marketskeptics.com

Eric is the Editor of Market Skeptics

© 2009 Copyright Eric deCarbonnel - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Eric deCarbonnel Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Bob G.
19 Jan 09, 22:24
A Flaw in Your Reasoning?

I didn't past the first 10 paragraphs because I couldn't understand your point of view.

You assume you know the outcome to the situation you describe, however, I didn't see any evidence that you had spoken to anyone in the Chinese government and got their thoughts on how they are going to proceed to handle the problem, if they see it that way.


EQ
22 Jan 09, 13:46
This makes no sense

I have to say that is one of the most ridiculous things I have ever read. China destroying the dollar? I think you need to wake up, the only thing China can destroy is its own currency. It doesn't matter if that destruction is by inflation or deflation, the currency will dump. The US exported its deflation not the other way around.


Marc in VA
17 Dec 09, 16:42
What happened?

Eric,

I appreciated reading your post from about this time last year and that you were willing to make a forecast that was not so ambiguous as to be meaningless. My question is...what do you think happened? Why do you think China avoided the hyperinflation that you strongly believed would come?

v/r,

Marc


mario cavolo
28 Dec 09, 06:30
to Marc in VA

Marc,

They DIDN'T avoid it. Eric's analysis has hit the mark quite nicely. I live here in China for 10 years and all my and my other foreign friends living here notice is HIGH INFLATION. I I like to use my "extra virgin olive oil" indicator, seeing a litre bottle of that fabulous elixir go up 60% in price over the past 18 months along with plenty of other consumer product, staples, and the asset bubble in property prices here with properties doubling in the past couple of years. Its an inflation frenzy over here get rich by asset inflation bubblicious champagne party here. Plenty of articles on it at my blog....no sales pitches here.

Cheers and all the best for 2010, Mario

www.mariocavolo.com


madona
20 May 10, 04:49
Hyperinflation Begining in China and Will Destroy the U.S. Dollar

I think that China should take into perspective the risk of inflation, which will face if you continue to curriculum

So I think that China should develop a number of rules to combat this threat and it must in the preparation of the primitive rules and act on it quickly


Nicolas Garay
20 May 10, 09:20
Hyperinflation...

Dear crowd:

One has to live in an inflatioanry economy to grasp how the process evovles!.

I live in one of the mroe stable countries in South America..But, we have had long times of "moderate inflation" which is "hypoerinflation" for Western Parameters...like sustained inflation for years above the 20% and below the 35%.

It is an evil erosion for labor income...For example, in some five years with high salaries you could lost the 25% of purchasing power in your salary!...believe me, it affects in the end the final consumption...

For low income people, it is better not TO SAVE. It is better to buy bricks and iron to finish their shanty houses...Because, cosntruction material price go up and dwon like crazy!

If there is not savbings,..there will be no investment...No investment, such crazy figures of growth will be unsustenaible!...Maybe, it is time to review some articles of growth economics from Von Neumann....And, we can wait for some "wave effect" on the western economies...

SO,..JUST WAIT AN SEE!

After all,..it is time to SEE the first big economic chinese crisis in POST-MAO era!


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules