The Real Cause of China’s Inflation

Overissuing of RMB

According to the First Financial Daily’s report on January 17, Yi Gang, the administrator of the State Administration of Foreign Exchange (SAFE), predicted in the national SAFE meeting on January 7-8 that the inflow of foreign investments in 2012 would drop drastically compared to the past. Such an outcome will bring both good and bad, but the good should outweigh the bad for China. With a decrease of foreign investments, the Chinese economy will further slow down its current sluggish growth. Nevertheless, the release of inflation at present is more urgent than the need to attract foreign investments.

Mr Yi’s comments in fact pointed to the major cause of China’s persistent inflation as being the inflow of foreign monies. His viewpoint represents the Chinese regime’s wrap-up of the present economic situation in the country.

Yi Gang had expressed similar comments in the CMRC’s CEO colloquium in February of last year. He remarked on how the accumulated $US2.85 trillion in foreign exchange reserves, equal to the free flow of more than 20 trillion renminbi in local markets, caused the persistent inflation in 2010.

Many economists, both local and abroad, have disagreed with this conclusion. Some experts point out that the Chinese regime had overissued a huge amount of renminbi to stimulate the market prior and post to the economic crisis in 2008 in order to safeguard the rapid growth of the GDP, which in reality caused the inflation to persist.

To verify the later viewpoint, we can compare the amount of currency issued by both China and the US in 2008, and the accumulated foreign exchange reserves in 2011.

According to the data released by the US Federal Reserve, the amount of currency issued two years prior to the financial crisis in October 2008 was 1.0222 trillion renminbi. That made it an average of 0.5111 trillion renminbi per year. The amount of currency issued two years after the crisis was 0.7562 trillion renminbi, averaging 0.3781 trillion renminbi per year. Instead of increasing, the amount of issue actually dropped.

According to the data released by the Bank of China, the amount of currency issued two years prior to the 2008 financial crisis was 12.1268 trillion renminbi, averaging 6.0634 trillion renminbi per year. The amount of currency issued two years after the crisis was 24.3338 trillion renminbi, averaging 12.1669 trillion renminbi per year. The amount of issue in fact doubled.

A conclusion can be made based on the above two sets of figures.

Converting the amount of issued US dollars in the past two years, the yearly total average was approximately 2.5332 trillion renminbi. Compared to that of China, which averaged 12.1669 trillion renminbi, China’s figure was 4.8 times that of the US! China’s issue was for local consumption, while the US’s issue was globally consumable. The overall inflow of US currency to China was less than 40 per cent of the total. The impact from this amount on China’s inflation was only minimal. 

On the other hand, according to SAFE data, the accumulated foreign exchange reserves were 0.4178 trillion renminbi in 2008, 0.4531 trillion renminbi in 2009 and 0.4481 trillion renminbi in 2010, thus making an average of 0.4397 renminbi per year. The average amount of currency issued in the past two years was 4.1 times of the average of China’s foreign exchange reserves!

Comparison of the above figures clearly show that the major cause of China’s inflation was the Chinese regime’s overissuing of its currency after the 2008 financial crisis.