Overheating China Threatens Global Inflation

China’s overheating may soon be the world’s problem. Data released on April 14 showed GDP rising at 9.7% in the first quarter, and consumer prices running at a too-fast 5.4%. The concern isn’t just that Chinese policy may tighten and growth slow. It is that spiraling Chinese wages, rising inflation and a yuan that needs to rise faster could create a source of global inflation.

China previously helped keep inflation low in the West because its abundant cheap labor and controlled currency made the export prices of Chinese goods very low--excessively so, in the view of China’s competitors. While the average price of U.S. imports from industrialized countries has risen by 31% since 2000, the price of imports from China has risen by just 2.7%.

That enabled Western countries to keep rates low, for although consumers binged, inflation stayed under control. And China’s surging foreign exchange reserves and purchases of Western debt provided another, ultimately poisonous gift: abundant cheap credit.

Now that China is inflating, the picture is changing. At least 12 municipalities and provinces have raised their minimum wages this year, according to state news agency Xinhua, half of them by over 20%. Inflation is becoming endemic. A trivial example: in export-rich Guangzhou, residents complain haircuts are up to 50 percent dearer, according to local press.

Rising prices and wages will be reflected in export prices, adding to inflationary pressures for China’s trade partners. And China’s likely response to its own inflation-- to let the currency strengthen--will make things worse. The yuan has been allowed to climb by 4.5% against the dollar since June. But it’s clear that more is needed to reduce the impact of soaring oil and commodities costs and to curb the monetary emission associated with swelling foreign exchange reserves.

A faster rising yuan would please China’s competitors but also have an inflationary downside for the West: exported Chinese goods would become more expensive. Western governments will lose the inflation free ride China once provided. Inflation and rates may tend to be higher. That may mean slower growth and pain for borrowers--among them already stretched Western governments.