Chinese Inflation Revisited

Via Brad DeLong, Noel Maurer looks at the People’s Bank of China’s balance sheet and concludes that maybe we can’t find much consumer price inflation in China because there really isn’t much inflation happening:

PBOC liabilities, 2002-09

He points out that complaints about currency manipulation aside, the renminbi really did appreciate in 2007 and 2008. And when that process stopped the mysterious “other liabilities” category began to grow:

Well, look at the orange indicator. High-powered money isn’t growing. What is growing is the white block at the top, what the PBOC calls “other liabilities.” I have no idea what those are, but they represent currency mopped up by the central bank. In other words, the PBOC is keeping a lid on inflation by taking in liquid renminbi from somebody in exchange for an IOU of some sort.

At some point, the PBOC will no longer be able to keep up this balancing act. They might sink the economy by sucking up too much liquidity and depriving the private economy of credit. They might lose their ability to control inflation. Or they might let the renminbi rise. But there are reasons to believe — and I should mention that I have changed my opinion on this issue in the last year or so — that the Chinese government and PBOC may be able to keep up the balancing act for some time. In theory, I think, it should be sustainable as long as Chinese firms remain profitable enough to finance themselves via retained earnings despite the fact that a big chunk of those earnings wind up metaphorically sitting in the PBOC coffers.

I think that probably the most important part of this is the reminder about the renminbi appreciation that happened in the recent past. People sometimes discuss China’s stance on exchange rates as if it’s driven by an absolutely dogmatic refusal to allow appreciation. But the evidence from this chart suggests to me that when the only way to control consumer price inflation is to have China’s currency appreciate, then that’s what they do.

So to repeat myself, when talking about the currency issue I think it’s important to keep a distinction in mind. If the renminbi appreciates as a result of much tighter money in China, it’s not clear who that helps under circumstances where the global economy remains depressed. But if US undertakes additional monetary easing, that will likely press the Chinese to appreciate the renminbi to prevent major inflation. That would accomplish the narrow goals of US exporters and import-competers, in a way that accords with broader interests.