I don’t know too much about how the Chinese central bank operates, so I’m going to presume it runs on more or less the same principles as most other modern central banks, with the caveat that the international exchange rate on the Yuan isn’t allowed to float freely. What I’m wondering is how we might consider the Chinese economy today in terms of the ABCT. Is there any reason to expect, for example, that part of China’s recent boom has been caused by interest rates that have been set below their natural rate by the Chinese central bank? Or perhaps an artificial boom as a result of the Chinese having artificially pegged their currency to the US, thus resulting in an unnatural level of investment in sectors of the Chinese economy concerned with exports (and an influx of US dollars as a result of Chinese exports which are essentially subsidized by the US dollar peg and maintained by the Chinese government’s continued purchase of US government bonds)? Either of these things, I think, could distort the natural level of investment in certain areas of the Chinese economy and could thus eventually lead to a classic Austrian bust…
Certainly I think most commentators (the US government included) would agree that the Chinese Yuan is undervalued and the results of that could only be distortionary. With regards to the interest rates set by their central bank (and reserve ratios for that matter - which the Chinese seem much more inclined to change that their international counterparts), it seems initially that in order to see if the fixed interest rates are lower than “natural”, we’d have to know what natural interest rates would be. However, in the absence of a market price for interest rates this is a little bit difficult to know. As such we can only really make guesses based on circumstantial evidence. What I’m thinking is that typically the “bust” in the ABCT is characterized by deflation or stagnation in the price of higher order goods (as a result of relative historical overinvestment in those goods) accompanied by relatively much higher inflation in the price of lower order goods (due to a historical underinvestment in production of these goods) and either stagnation or inflation overall (lumping both low and high order goods together). So if what we were seeing in China was the price increases of low order goods largely outstripping the price increases of higher order goods, then that would be circumstantial evidence of a comming bust.
Since inflation in China is currently on the rise, I figured that would be the first red flag that might signal a coming bust… The Chinese central bank is getting pretty worried about inflation, has recently increased reserve requirements and is looking at increasing interest rates again - which may or may not help, depending on the degree to which the problem is the result of interest rates and the degree to which it’s caused by the currency peg.
After doing a little bit of scouting around, I came across the following:
http://www.dbs.com.sg/researchasset/mktalert/2007/cn_14feb2007.pdf
It’s a bit hard to see what’s going on there to be honest. The data only goes up until 2007 and, at first glance, it looks like inflation is dropping and the CPI doesn’t appear to be going up (where it’s going up) very much more (it at all) than the the PPI. However they do note that the cost of food is soaring.
I then came across the following more recent data:
http://www.feer.com/essays/2008/march/pricing-in-chinas-inflation
That one looks much more concerning… and I started to ask myself exactly what “consumer goods” would be in China. Probably, by in large, these are food - that being the main thing that Chinese consume.
As such, and in light of all of the above, is there any way we could know if the inflation situation in China is cause for conern in the context of the ABCT? And what might be the effects of the currency peg on the situation?