China Inflation A Serious Risk for the Regime

China's inflation leapt to its highest level in more than 11 years in January after the worst snowstorms in 50 years disrupted supply and distribution.

Ensuing shortages drove the country’s consumer price index (CPI) up 7.1 percent. Food prices — which comprise about one-third of the country’s CPI — skyrocketed 18.2 percent, causing concerns about future social unrest.

Some 300 million Chinese live in poverty. Inflation has traditionally preceded social instability there.

Non-food sector costs rose by 1.5 percent. Consumer prices in cities and towns rose 6.8 percent in January from a year earlier while those in rural areas jumped 7.7 percent.

Story Continues Below

Analysts warned sharper that increases may be on the way, especially during the next two months, triggering tighter controls.

Food categories reporting major January price increases include pork, which soared 59 percent, edible oil, which went up 37 percent and vegetables, which increased 14 percent.

The Chinese government already has imposed food and energy price controls and could curb bank lending. It also might let the yuan — which has risen 2 percent since its 7 percent rise in 2007 — to appreciate in order to contain price increases as well.

A stronger yuan would make Chinese export products pricier, diminishing their cost advantage, and make foreign imports cheaper.

Such a move could also begin right the trade imbalance China has with much of the developed world, including the United States.

In short, sharp inflation might tip China’s hand on the yuan and force it to do what months of international pressure has not — let the currency rise.

Economists have already predicted an inflation rate of more than seven percent in January and said the peak is yet to come.

Deutsche Bank's Ma Jun forecast a CPI of 7.3 percent for January and 7.8 for February and observed that inflation may reach hit 8.1 percent in March.

"The greatest macro risk is that inflation can turn into a 'spiral' when expectation becomes a more important cause of inflation,” Ma told the Shanghai News.

Citi economist Shen Minggao believes the CPI could serve to tighten Chinese policymakers economic attitudes. He sees inflation growing by five percent this year and expects one more interest rate increase in the first quarter plus another increase in reserve requirements.

Tighter economic moves are expected following the central bank’s promise to "increase innovation in monetary-policy tools.”

China raised rates six times in 2007 and moved up the reserve requirement ratio 11 times since 2007 to cool the economy; the current key one-year lending rate is at 7.47 percent.

"The economy faces a serious short-term inflationary threat," notes Standard Chartered Bank economist Stephen Green. "The central bank will have to move on rates before too long.”

Standard Chartered forecasts a whole-year inflation rate of 6.5 percent, up 1.5 percent from its earlier estimate, and four more interest rate increases this year to fight inflation.

If the central bank raises interest rates as Bernanke’s Fed continues to cut them, even more unwelcome cash is likely to flow into China’s already overheated economy — and the higher cost of borrowing money would adversely impact Chinese companies, where production is already suffering.

In a five-year plan for the finance industry posted on its website, the central bank noted that China's economy faces "prominent" problems of imbalanced international payments and excess liquidity.

Editor's note:
The ETF Set to Soar the Most on a Bottoming Dollar. Find Out More.
Aussie Dollar Calls up 2,850% Since August! Sign Up Now For Just $99!
Our Options Plays Are Up 60%-1593%. Don`t Miss Out. Go here now.
Turn $10,000 into $161,000 in less than six weeks!
Fortunes Will be Made From 2008 Dollar Collapse. Take Action Now.
Bernanke Punishing the Dollar. More Profits Ahead.
Dollar Slammed Again. What To Do Now.
Why the Fed Interest Rate Cuts Won`t Work