Is Beijing Tightening Going To Make The Inflation Problem Worse Than Ever?

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Inflation in China is obviously too hot for the taste of authorities, and the country is clearly in a tightening cycle, with regulators having raised bank reserve ratios another 50 basis points on Friday.This Thursday we’ll get fresh CPI data, giving another clue to where things are at in the cycle.

But is tightening just going to make the problem worse? That’s counteruintuitive, but as Michael Pettis notes in his latest newsletter, a cutback in lending will necessarily cutback production and investment, and, well, there’s no good reason to think that less production would reduce costs, especially if end demand doesn’t go down.

Here’s Pettis:

I would argue that declining real interest rates reduce the real return on household deposits, and so they also put downward pressure on both the household income and household consumption share of GDP.  Meanwhile low interest rates encourage borrowers, and in China borrowing is done mostly to increase manufacturing capacity, to increase infrastructure investment, and to increase real estate development.  It is not done to increase consumption because there is very little consumer financing.

Stay tuned.

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