Inflation Comes to China

SHANGHAI – Macroeconomic conditions in any country are like running water. How large and fast is the flow? Where does it originate and where does it go?

The “main stream” of China’s economy is the vast flow of inward investment. China’s economy is prone to rapid growth, with buoyant investment demand sustaining powerful short-term inflationary pressures. As a result, credit controls on investment projects and a close watch on the money supply have been used to promote macroeconomic stability since China began its market reforms.

But in 2003, following five years of deflation, China’s economy entered a new phase. Overcapacity vanished, constraints on consumption were lifted, and a dramatic increase in household demand followed.

Since then, heavy industries – steel, automobiles, machinery, building materials, energy, and raw materials – have experienced an unprecedented investment boom, reflecting demand for urban construction, housing, transport, infrastructure, and equipment renewal. Not surprisingly, the economy began to overheat.