Red Hot China!

Last week, China’s trade balance figures were accidentally leaked out. While this caused a ruckus in the markets, what was more surprising was that the report revealed that China’s trade surplus for the month of May stood at 19.5 billion yuan, more than twice the initial projections of an 8.2 billion yuan surplus!

On an annualized basis, exports rose by 48.5%, marking the largest increase in six years. Talk about beating expectations! However, some believe that the increase in exports could smoothen out in the next couple of months as the euro zone’s debt problems plague global demand.

Moving on, the consumer price index report indicated that demand is picking up, as consumer prices are up 3.1% from levels a year ago. This was slightly higher than May’s inflation figure of 2.8%. It appears that the growth of money supply in the past year has led to rising food and housing prices.

Some analysts are projecting that China’s CPI could top out at 3.2% this year, a couple of notches higher than the central bank’s 3% annual inflation target. Of course this puts central bank officials on their toes, careful not to let the Chinese economy overheat. Does this mean that a rate hike is in the cards?

With the possibility of a debt contagion still on the back of everyone’s mind, Chinese central bank officials might put off on any tightening moves until global fiscal conditions become a bit more stable. Besides, risk aversion from all that debt drama has already caused commodity prices to fall, which would probably keep China’s inflation in check in the coming months.

Should the Chinese economy still require tightening in the near term, the People’s Bank of China does have other monetary policy moves up its sleeve. Recall that the central bank recently increased its reserve ratio instead of hiking rates in order to drain excess liquidity from the markets. Perhaps they could do same again in order to reduce money supply and eventually tame inflation.

Ok, all that information about inflation is good and all, but what does China have to do with the rest of the world, particularly with us forex fellas?

Well, since interest rates have a direct effect on money supply, a reversal of China’s loose monetary policy could put a serious dent in the overall global economic activity. Remember, whenever interest rise, the cost for businesses to secure loans increases, which could eventually discourage investment.

Doesn’t sound too good for economic growth, right?

Ever since the beginning of the financial crisis, when export demand from the world’s most industrialized regions like the US, EU, and Japan fell, it was China that picked up the slack. If China were to reduce absorbing all the unused production capacity, who will be left to mop up all the excess supply? Any takers? Heck, in the past few months, any news that dealt with tighter monetary policy in China led to a sharp sell-off in commodities!

For now, I am holding my breath as to how China will handle this dilemma. A loose policy could lead to hyperinflation in China, while too much tightening might stunt global recovery. I guess we’ll all just have wait and see what China’s has to say about the whole issue!

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