America Can’t Escape China’s Inflation

Federal Reserve chief Ben Bernanke is not worried about inflation in America, but investors should be concerned about the threat of something far more ominous - stagflation, when inflation soars but economic growth stagnates.

Despite record profits on Wall Street, the danger of a double dip recession hitting America remains real as unemployment hovers above 9 percent. Although inflation has not come to America’s shores yet, it might soon because of raging inflation in its second largest trading partner, China, which is causing companies to increase the prices of goods shipped to America.

Conventional wisdom of many economists over the last quarter has been that administrative measures like increasing bank reserve ratios, which the Chinese government has implemented, were enough to tame inflation in that country and prevent price hikes on goods exported to the US and Europe.  Those analysts must be looking at a different China than I am. 

Last week guards in the compound where I live in Shanghai went on strike demanding higher wages. Severe drought has caused vegetable prices to soar 20 percent in the last month with cabbage prices rising 60 percent.

The situation is set to worsen as brownouts hit 10 provinces in the main manufacturing belts of the Pearl and Yangzte River Deltas as electricity firms lower production in response to price caps

Fearing the wrath of the Chinese government and slack consumer demand, until recently most companies had not raised prices. Unilever got punished with a two million yuan fine for announcing price hikes and the government has pushed companies like Procter & Gamble not to raise prices. Instead, Pepsi and Coca-Cola shrunk drink sizes from 600 ml to 500 ml and Starbucks introduced higher priced items.  

Inflation is squeezing profit margins so much that companies are starting to transfer price increases to consumers. In April, the overall price of exports from China to the US rose 2.6 percent.

Global Sources, an information provider for trading companies, surveyed 232 exporters and found 74 percent expected to increase prices on goods they exported to America and Europe this year. A senior executive with home appliance maker Haier told China Daily it expected a 10 percent increase on goods exported to America because plastic and rubber prices have soared 50 percent annually for the last three years.

Rising prices on the costs of goods sent to America will continue as domestic Chinese inflation reaches a boiling point, and we have yet to reach the high mark. Tightening measures have not solved problems because China is facing a perfect storm: a confluence of the nuclear disaster in Japan that disrupted supply chains, water and energy shortages, an appreciating yuan and finally systemic issues.  

Inflation is systemic and not easily solved as China tries to avoid the middle income trap many developing countries get stuck in where average GDP per capita cannot pass $6,000 a year.  The government is pushing up minimum wages to create a more equal wealth distribution.

Sichuan Province increased its minimum wage 44 percent last year and in its latest five-year growth plan the central government made increasing the country's minimum wage by 11 percent annually a goal. Combined with soaring real estate prices, inflation is the natural result of an evolving economy rather than a short-term blip.

The American and Chinese economies are too interrelated now to say that inflation in China won’t eventually move to the US. Bernanke has been wrong to only look at the short-term with regard to the American domestic economy as his loose monetary policies have caused inflationary bubbles in emerging markets and commodities. After a lag time, eventually inflation will go back to America.

Unless America can restart its economic engine the dangers of stagflation are real. To prevent stagflation, America needs to reduce its debt and bolster the dollar. Until then, more investors will shy away from Treasurys and diversify reserve holdings as China has been doing. America also needs to stop wasting money on wars, which is causing oil prices to spike.

Shaun Rein is the founder and managing director of the China Market Research Group () a strategic market intelligence firm, and is based in Shanghai. Follow him on Twitter at @shaunrein.