Week Ended: August 3, 2007

A Tough Job - And Perhaps No One Needs to Do It

Not all prices in China are what they seem. Based on the Price Law of 1997, the Chinese government has the right to set the price for commodities and services that are integral to daily life, including agricultural products (grains and cooking oil), public utilities (water and electricity), communication services (telephone bills), transportation (highway tolls), and even entertainment (cable TV and admission ticket prices). The government often exercises this power in an attempt to insulate Chinese citizen's pocketbooks from excessive inflation. However, even with this mechanism in place, inflationary pressures are still trickling through the economy: the last reading on consumer price inflation suggested prices were up 4.4% versus the prior year. Staples such as pork and noodles have been hit particularly hard, impacting the everyday life of many Chinese citizens.

A recent example of the government's intervention occurred as the municipal government of Lanzhou, capital of Gansu Province. The government there announced a price ceiling on one local favorite, beef noodle soup. The price of a large bowl of beef noodle soup may not exceed 2.5 RMB (about 33 cents), and the price difference between a large bowl and small bowl must be 0.2 RMB (almost three cents). The intervention occurred shortly after the city's noodle vendors raised the price by 0.5 RMB (or roughly seven cents) to pass along some of the increased cost of their ingredients.

When prices do rise across the economy, despite attempts to administer otherwise, China's tools to tame inflation are somewhat less developed than other major global markets. As with other global central banks, the People’s Bank of China (PBOC) utilizes the conventional tool of interest rate increases as a means to combat inflation. However, as China’s capital markets are not as deep or as well-formed as most other global markets, they respond less well to the relatively subtle but powerful signal of higher rates. Alternatively, the PBOC sometimes utilizes blunter measures, such as raising commercial bank’s reserve ratios (an action it took earlier this week). As banks’ reserve ratios rise, cash is literally pulled out of the economy; the PBOC hopes that doing so will reign in what it perceives as excess demand, which in turn may be feeding inflation. As China continues to modernize and open its economy to competition, the government's attempts to administer too many prices - whether the general price of goods, the price of money, or even the value of the currency itself - may prove increasingly difficult, if not impossible. A tough job indeed, and perhaps no single party need do it.

 

 

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The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information.