Continued Inflation Pressure In China

To underwrite its economic recovery in late 2008, China undertook a massive economic stimulus
program and allowed the growth of credit and money to proceed at extraordinarily rapid rates.
From mid 2008 through early 2011, China's benchmark M-2 money supply increased by an
astounding 64%. Even factoring in 10% growth per year in real output, China allowed creation
of a liquidity pool consistent with inflation of 15% per year. Now, much of this excess liquidity
was mopped up by residential and commercial real estate, but plenty was still left on hand to
support an inflation surge in basic goods and services. Officially CPI rose 5.4% yr/yr in Mar.,
but seasoned observers would argue that inflation was more likely about 8%. Wages have been
rising rapidly in a policy move to boost consumer spending, but the surge in food prices, a highly
sensitive issue with the populace, is up around at least 11% yr/yr, an intolerable development.

China is opting for broad and strict price controls to compliment ever tightening credit standards
in an effort to curtail the growth of money, and it may also further loosen the yuan / USD peg
to further curtail the growth of money and credit via allowing the yuan to rise in value.

The growth of M-2 has has fallen from over 30% yr/yr as of late 2009 down to 17% presently.
and given the underlying inflation pressures now extant, the gov. may need to push M-2 down
closer to 10% and keep it there for a while even if the growth of the real economy tails down
further as a result.  Imposition of price controls and a loosening of the currency peg indicate
clearly that China's gradualist approach has not worked.

The gov. through its far reaching purchasing agencies will have to absorb the differential
between market prices and controlled prices and those agencies will be under pressure to
buy wisely if they wish to avoid working at a cabbage farm in central China.

To me the crowning irony is that observers widely expect the yuan to appreciate if and
when the currency peg is loosened. I regard the yuan as play money -- growing twice as fast
as the real economy with a large negative real interest rate. But, since so little of the stuff
is convertible, it has a bizarre "scarcity value" internationally.

My thinking regarding the stock market remains that it will have some good appeal when
the Boyz nail down the growth of the money stock and remove the sizable inflation potential
from the system. Some players are jumping the gun, reasoning that a stronger yuan will
invite speculative capital flow into the market.

Shanghai stock market $SSEC.