beyondbrics

The Chinese economy has been described (by James Kynge, for one) as an elephant riding a bicycle – fine so long as it keeps going, but if it slows, it’ll cause an awfully big mess. Now, with the combination of a rapidly ageing population and rising wages,  inflation in China is going to go up, and growth is going to slow.

As one government economist put it on Thursday, for China, ‘a major turning point is at hand.’ 

As Reuters reported on Thursday:

“The current data show China has already crossed the Lewis turning point, and at the same time the window of the demographic dividend will soon close,” Ba Shusong wrote in the Economic Information Daily.

“The shortages of rural migrant workers since 2004 have been no passing blip, but the signal that a major turning point is at hand — a transformational trend,” Ba wrote.

Perhaps even more important – both for China and for the rest of the world – is this:

“Workers’ rising wages will push up the cost core so that the low inflation possible when labor supply was abundant will be unsustainable,” he wrote. “Second, after crossing the turning point, economic growth will experience systemic slowing.”

Over the short-term, most China economists say that inflation will peak in the next month or so (it hit 5.4 per cent last month), and that prices will get back into comfortable territory for the rest of the year. The government is taking steps to make sure that happens – it has prevented some commodity price rises from being passed on to consumers, and there are certainly noises that suggest a stronger renminbi could be coming. But it’ll be hard to keep a lid on prices forever, despite Beijing’s huge cash pile.

If recent years were a period of ‘low inflation’ fuelled by low labour costs, what would ‘normal’ inflation rates look like? Recent history offers some worrying precendents.

In the mid-1990s, for example, Chinese CPI regularly topped 10 per cent. In fact, in late 1994 it peaked at nearly 30 per cent.

As George Magnus wrote in Wednesday’s FT, China could soon be facing a ‘Minsky moment’.

Decisive, sustained measures to put China’s inflation and credit genies back in the bottle, including a significant rise in interest rates, would hit cyclical growth. But they would make growth more sustainable by taming investment and allowing time for other measures to boost household incomes and consumption.

A different scenario is all too plausible. In this, the leadership changeover in 2012, a reluctance to compromise growth or alienate workers, and political interests in rising property prices could lead to a premature call of victory over inflation. This might boost asset price and growth in the short term, but increase the likelihood the new leadership will have to deal with a credit-fuelled Minsky moment.

A Chinese Minsky moment would hit global growth and resource markets, and shock the consensus about steady appreciation of the renminbi. It would also undermine China’s aim of rebalancing its economy towards consumers; and raise the risk of political unrest.

Developed countries (and emerging markets too) have benefited from years of cheap Chinese manufactured products, which have helped usher in a decade of low inflation around the world. Is there any other country capable of picking up the slack?

China, faced with a demographic tipping point, may well win the Inflation Battle of 2011. But the war goes on, and if anything, it is set for a much more difficult next phase.

Related reading:
China’s twilight economy boosts inflation, FT
China looks forward to age of the ‘silvertown’, FT
Boom vs Doom: is Nouriel Roubini right on China?, beyondbrics
China: the end of cheap?, beyondbrics
China: the end of cheap, Foxconn edition, beyondbrics