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Busch: China's Inflation and Currency Problem

In an exclusive interview with Xinhua News, Chinese Premier Wen Jibao discussed two key issues that are the economic equivalent of the immovable object meeting the irresistible force.

First, Wen said that the government would maintain order in China's property market. "As the property market is recovering rapidly this year, housing prices in some cities are rising too fast, which deserves the 'great attention' of the central government." Wen said the government would stabilize real estate prices with economic tools of taxes, interest rates and land policies according to Xinhua.

Next, he address the international pressure to allow the Chinese yuan to appreciate. "A stable Chinese currency is good for the international community." Some countries demanded the Yuan's appreciation while practicing trade protectionism against China, said Wen, adding that this in essence was aimed at checking China's development according to the article. "China will work together with other countries to curb trade protectionism and push forward with the Doha Round trade negotiations," Wen said.

The world is not happy with the Chinese currency policy due to the currency weakening alongside the US dollar. This means that the economic adjustment process from a US recession has fallen on countries that have free floating currencies. What makes this particularly onerous is that the Far East and in particular China have weathered the downturn extremely well, but have not had their currency appreciate.

With China's currency not appreciating, there is another way that trade partners have addressed the issue. 19 countries and regions have launched 103 trade related investigations against Chinese products and both the number of the cases and the money involved was at record high.

The ironic twist to this story is that a strong currency with a loose fiscal policy (tax cuts) would mean consistent growth for the country. It would also increase the purchasing power of Chinese consumers and increase foreign direct investment. It would also help cool inflation for consumers which is likely a critical concern for Chinese leaders. A stronger currency would also allow tighter monetary policy as FDI brings in flows to offset the increased cost of capital.

So far, the Chinese have not had to make a choice between the benefits of a weak currency and the disadvantages of inflation. With soaring home prices and trade related investigations, they will soon have this Faustian choice foisted upon them.

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Andrew B. Busch is Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.