For Americans, “Made in China” often means “cheap.”
But for the Chinese, cheap has become a thing of the past. Over the last year, the prices of goods and services in China have risen dramatically, affecting Chinese consumers. And now that effect could drive up the price of Chinese exports to the United States … and create a a shakier global economy.
The reason? Inflation.
What Is Inflation?
Inflation is a widespread price increase for goods and services. It basically erodes the value of the dollar (or the RMB, in the case of China), because it takes more money now to buy the same thing you could before.
A little inflation is good, because it indicates that a country is growing; most countries aim for an inflation rate of about 2 to 4% each year. But if prices inflate too quickly, consumers won’t be able to purchase as many goods and services because their salaries aren't increasing at the same rate. This might mean that consumers spend less than before, weakening the economy.
(Learn more about inflation in the United States; read this.)
Why Is China Experiencing Inflation?
Rising prices of goods around the world, combined with higher wages for Chinese workers, have led to a price hike for Chinese goods. But the main cause of Chinese inflation is due to the policies of China’s central bank.
The bank has been producing more and more RMB over the past decade to ensure that the RMB’s value didn’t approach the dollar’s value. It might seem counterintuitive, but China would rather its currency be weaker than the United States' since a strong dollar makes Chinese-made goods more attractive to American consumers. Printing more money keeps the RMB weaker than the dollar because, in a nutshell, if there are more RMB than dollars, then the dollar will be worth more because of its relative scarcity.
For a while, this approach had positive effects on the Chinese economy. With a low RMB, China's exports were cheaper than products made in other countries. This helped fuel the demand for Chinese goods, which, in turn, helped keep tens of millions of Chinese employed in factories.
After a point, though, this strategy began to fail, and the surplus of RMB—which was being produced at a rapidly increasing rate—led to highly accelerating inflation.
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A Global Balancing Act
Inflating prices in China led to an increase in the price of Chinese goods being exported to the rest of the world. Meanwhile, struggling economies in the United States and Europe have lessened demand for those same Chinese goods—and higher prices would decrease that demand even further.
This has the potential to rattle the Chinese economy, which would be very bad for the global economy, since governments around the world are depending on China to help spur global growth and economic improvement. For instance, European leaders have approached China about the possibility of China lending money to help restabilize European economies.
Basically, in order for the global economy to recover, it’s necessary for the Chinese economy to stabilize inflation, which will help it continue to grow and prosper.
An End to the Trend?
In July, Chinese inflation reached a peak of 6.5%, furthering worry in China and around the world. “Over the past year [the Chinese government] had a single target—control inflation,” said Capital Economics analyst Qinewi Wang.
Luckily, it looks like inflation may finally be slowing down. In October, consumer inflation declined to 5.5% from September’s 6.1%, and double-digit rises in food prices in China slowed. With this as a sign, analysts expect that China will successfully keep inflation in check.
In the wake of these lower inflation numbers, China’s Hang Seng Index was up 1.7% at the market’s close on Wednesday, after gaining as much as 2.5% earlier in the day. The lower inflation numbers, in addition to the gains in the Chinese market, have improved investor confidence in the Chinese economy—and that's a promising sign for the global economy.
As IMF Managing Director Christine Lagarde put it, “Fundamentally, China is on the right path.”
Image credit: Flickr/danielfoster437