Why is China printing so much money?

December 7th, 2006

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In our previous article, Cause of inflation: Shanghai bubble case study, we explained that the root cause of price inflation is monetary inflation. The Chinese economy is awash with growing liquidity (that is, the economy is soaked with ever-growing supply of money). The next question to ask is: why is money supply growing in China?

One of the culprits for this problem is the inflexible exchange rate of the Chinese currency (RMB). The RMB is not a freely floating currency?its exchange rate is still controlled by the Chinese central bank albeit having some semblance of flexibility. At the current rate of exchange, the RMB is undervalued. Since it is undervalued, foreign capital will want to enter China in the form of foreigners buying up the RMB. If the RMB is a freely floating currency, the demand for it by foreigners will bid up its price, which will reduce its demand as it becomes more expensive. Conversely, as its price rose, domestic sellers of RMB will sell down its price. Finally, a market equilibrium price will be reached where the quantity supplied will meet its quantity demanded. Since the RMB?s undervalued exchange rate is still barred by the Chinese central bank from rising, foreign demand will exceed its domestic supply. So, the question is: where is the RMB going to come from? In the absence of capital controls freedom, the only choice the Chinese central bank has is to print RMB to maintain the undervalued exchange rate. Now, with foreigners armed with freshly printed RMB, they bided up the prices of Chinese assets, including stocks and properties. In the case of Shanghai, real estate prices had reached dangerously bubbled prices. As those newly printed money permeate its way into the rest of the Chinese economy, the result is price inflation. We are hearing reports from the grassroots level that prices of many things (including everyday goods and foodstuffs) in Shanghai are increasing.

Lately (as we mentioned before in Are you being ripped off by fund managers?), we are not keen in handing our hard-earned wealth into the managed fund that is sinking more money into the massive pool of raging liquidity in the Chinese economy. There are better alternatives to take part in the growth of China than to join in the bubble.

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  • dt

    Hi cij,

    Thanks for the reference (from CIJ News).

    Would it be fair to say, as with Zimbabwee, it seems it is the new RMB not distrubuted evenly but absorbed by foriegn buying up of the currency, who do not just invest rationaly but cause the spiraling misplaced (mal)investing in the ecconomy that creates the inflationary distortions and instability?

    Also, wndering, does not the printing of RMB resolve the devaluing of the currency (ie more RMB are worth less) not to mention the recking of ecconomic stability impacting the value of the RMB? Or is it that once mal-investment (I hope that is the term) takes hold it just follows it’s parabolic curve to an inevertable climax?

  • dt

    Hi cij,

    Thanks for the reference (from CIJ News).

    Would it be fair to say, as with Zimbabwee, it seems it is the new RMB not distrubuted evenly but absorbed by foriegn buying up of the currency, who do not just invest rationaly but cause the spiraling misplaced (mal)investing in the ecconomy that creates the inflationary distortions and instability?

    Also, wndering, does not the printing of RMB resolve the devaluing of the currency (ie more RMB are worth less) not to mention the recking of ecconomic stability impacting the value of the RMB? Or is it that once mal-investment (I hope that is the term) takes hold it just follows it’s parabolic curve to an inevertable climax?

  • http://contrarianinvestorsjournal.com Contrarian Investors? Journal

    Hi dt!

    …it seems it is the new RMB not distrubuted evenly but absorbed by foriegn buying up of the currency, who do not just invest rationaly but cause the spiraling misplaced (mal)investing in the ecconomy that creates the inflationary distortions and instability?

    That’s the Austrian School economic theory (see How to secretly rob the people with monetary inflation?). That’s why there is a disparity of wealth in China due to monetary inflation. It was said that foreigners are responsible (to some extent) for the property price inflation in Shanghai. For Chinese stocks, even our home-grown AMP China Growth Fund (ASX code: AGF) pour in Aussie money into the chinese stock market.

    Also, wndering, does not the printing of RMB resolve the devaluing of the currency (ie more RMB are worth less) not to mention the recking of ecconomic stability impacting the value of the RMB? Or is it that once mal-investment (I hope that is the term) takes hold it just follows it’s parabolic curve to an inevertable climax?

    We are not sure whether we understand your question fully. Well, mal-investments (which is more than just over-investment) are investments in the wrong lines of production for which the economy does not have adequate resources and capital to see it through fruition. So, as mal-investments accrues, it will come to a point whereby all these wasteful and wrong investments have to be liquidated i.e. a bust/recession in mainstream language. For the concept of mal-investments, take a read at our guide, “What causes booms and busts?” at the Popular Topics section (at the right).

    All these are Austrian School economic theory.

  • http://contrarianinvestorsjournal.com Contrarian Investors’ Journal Editor

    Hi dt!

    …it seems it is the new RMB not distrubuted evenly but absorbed by foriegn buying up of the currency, who do not just invest rationaly but cause the spiraling misplaced (mal)investing in the ecconomy that creates the inflationary distortions and instability?

    That’s the Austrian School economic theory (see How to secretly rob the people with monetary inflation?). That’s why there is a disparity of wealth in China due to monetary inflation. It was said that foreigners are responsible (to some extent) for the property price inflation in Shanghai. For Chinese stocks, even our home-grown AMP China Growth Fund (ASX code: AGF) pour in Aussie money into the chinese stock market.

    Also, wndering, does not the printing of RMB resolve the devaluing of the currency (ie more RMB are worth less) not to mention the recking of ecconomic stability impacting the value of the RMB? Or is it that once mal-investment (I hope that is the term) takes hold it just follows it’s parabolic curve to an inevertable climax?

    We are not sure whether we understand your question fully. Well, mal-investments (which is more than just over-investment) are investments in the wrong lines of production for which the economy does not have adequate resources and capital to see it through fruition. So, as mal-investments accrues, it will come to a point whereby all these wasteful and wrong investments have to be liquidated i.e. a bust/recession in mainstream language. For the concept of mal-investments, take a read at our guide, “What causes booms and busts?” at the Popular Topics section (at the right).

    All these are Austrian School economic theory.

  • dt

    Hi cij,

    Yes I’m trying to graple with this understanding and Austrian School economic theory is obviousy forming a good part of that – is that okay?

    For mal-investment I was using the term to refer to the foriegn investment spiraling into “wrong lines of production” etc, and by the inevitable climax (sudden end) I mean “come to a point whereby all these wasteful and wrong investments have to be liquidated”, untill then, with the speculative investment gains is it that the URB continues to be sort despite, I would think, the new printing of money devaluing the currency.

  • dt

    Hi cij,

    Yes I’m trying to graple with this understanding and Austrian School economic theory is obviousy forming a good part of that – is that okay?

    For mal-investment I was using the term to refer to the foriegn investment spiraling into “wrong lines of production” etc, and by the inevitable climax (sudden end) I mean “come to a point whereby all these wasteful and wrong investments have to be liquidated”, untill then, with the speculative investment gains is it that the URB continues to be sort despite, I would think, the new printing of money devaluing the currency.

  • http://contrarianinvestorsjournal.com Contrarian Investors? Journal

    Hi dt!

    We are glad to be of help to you. :-)

    Yes, when the central bank ‘prints’ money, it is fundamentally devaluing the currency by increase the supply of it. That is, assuming that everything else being equal.

  • http://contrarianinvestorsjournal.com Contrarian Investors’ Journal Editor

    Hi dt!

    We are glad to be of help to you. :-)

    Yes, when the central bank ‘prints’ money, it is fundamentally devaluing the currency by increase the supply of it. That is, assuming that everything else being equal.

  • dt

    Hi cij,

    I think the trouble I’m having with this is trying to understand the terms ?undervalued?, which I thought would mean on the foreign exchange the RBM is cheap, that is, relatively you can buy a lot for you foreign money, and ?devalued? by printing more RBM which I would have thought would make the RBM at a fixed exchange rate more expensive, that is you can not now buy as much with you exchanged dollars as the price of goods become inflated and so the RBM becomes less attractive to foreigners to buy. I guess however the lag between printing new RBM and the inflation effect is a window while the RBM is still undervalued. I?ll continue to mull on this …

  • dt

    Hi cij,

    I think the trouble I’m having with this is trying to understand the terms ?undervalued?, which I thought would mean on the foreign exchange the RBM is cheap, that is, relatively you can buy a lot for you foreign money, and ?devalued? by printing more RBM which I would have thought would make the RBM at a fixed exchange rate more expensive, that is you can not now buy as much with you exchanged dollars as the price of goods become inflated and so the RBM becomes less attractive to foreigners to buy. I guess however the lag between printing new RBM and the inflation effect is a window while the RBM is still undervalued. I?ll continue to mull on this …

  • http://contrarianinvestorsjournal.com Contrarian Investors? Journal

    Hi dt!

    If a currency is undervalued, it means that it is buying less than what it should be able to. For example, if x amount of RMB can buy a bicycle when it should be able to buy a car, then it is undervalued. Therefore, to ‘solve’ this problem, then the central bank will print more RMB to make it ‘less’ valuable, so that it x amount of RMB can now no longer buy a car.

  • http://contrarianinvestorsjournal.com Contrarian Investors’ Journal Editor

    Hi dt!

    If a currency is undervalued, it means that it is buying less than what it should be able to. For example, if x amount of RMB can buy a bicycle when it should be able to buy a car, then it is undervalued. Therefore, to ‘solve’ this problem, then the central bank will print more RMB to make it ‘less’ valuable, so that it x amount of RMB can now no longer buy a car.

  • dt

    Hi cij

    I not sure you have quite said what you want to here. To try and spell this out;

    State 1: No extra RBM printed.
    X RBM “can buy a bicycle when it should be able to buy a car”
    Stated fact – CAN NOT BUY A CAR

    State 2: Extra X RBM printed.
    RMB “can now no longer buy a car”
    Stated fact – CAN NOT BUY A CAR

    In what you have specified in state 1 and 2 there is no change i.e. CAN’T BUY A CAR stated in both states, however conflicting; in state 2 (after printing new RBM) in saying “can now no longer buy a car” you imply you could buy a car in state 1 but obviously in state 1 (before new printed RBM) you say you can not?

  • dt

    Hi cij

    I not sure you have quite said what you want to here. To try and spell this out;

    State 1: No extra RBM printed.
    X RBM “can buy a bicycle when it should be able to buy a car”
    Stated fact – CAN NOT BUY A CAR

    State 2: Extra X RBM printed.
    RMB “can now no longer buy a car”
    Stated fact – CAN NOT BUY A CAR

    In what you have specified in state 1 and 2 there is no change i.e. CAN’T BUY A CAR stated in both states, however conflicting; in state 2 (after printing new RBM) in saying “can now no longer buy a car” you imply you could buy a car in state 1 but obviously in state 1 (before new printed RBM) you say you can not?

  • http://contrarianinvestorsjournal.com Contrarian Investors? Journal

    Hi dt!

    Sorry, our illustration is unclear and lacks important details. When we said,

    For example, if x amount of RMB can buy a bicycle when it should be able to buy a car, then it is undervalued.

    We mean “if x amount of RMB can buy a bicycle in US$ when it can buy a car in RMB, then it is undervalued”

    When a currency is undervalued, it means x amount of RMB can buy a car while that same x amount converted to US$ cannot buy a car. That means a lot of people in the US are going to convert their US$ to RMB and then use the RMB to buy a car. If the RMB is freely floating, then this will cause the RMB to rise in value. It will rise to the point where the price of a car in US$ or RMB is the same i.e. purchasing power parity.

    Since the RMB cannot rise, the only way is to print more RMB to devalue the currency. But when you print more RMB, price inflation occurs. That is, the price of car in RMB will rise. In theory, it should rise to the point where the price of car in US$ or RMB reaches parity.

  • http://contrarianinvestorsjournal.com Contrarian Investors’ Journal Editor

    Hi dt!

    Sorry, our illustration is unclear and lacks important details. When we said,

    For example, if x amount of RMB can buy a bicycle when it should be able to buy a car, then it is undervalued.

    We mean “if x amount of RMB can buy a bicycle in US$ when it can buy a car in RMB, then it is undervalued”

    When a currency is undervalued, it means x amount of RMB can buy a car while that same x amount converted to US$ cannot buy a car. That means a lot of people in the US are going to convert their US$ to RMB and then use the RMB to buy a car. If the RMB is freely floating, then this will cause the RMB to rise in value. It will rise to the point where the price of a car in US$ or RMB is the same i.e. purchasing power parity.

    Since the RMB cannot rise, the only way is to print more RMB to devalue the currency. But when you print more RMB, price inflation occurs. That is, the price of car in RMB will rise. In theory, it should rise to the point where the price of car in US$ or RMB reaches parity.

  • dt

    Thank you, that is what I assumed I was previously saying. So at parity one would think the RMB is no longer so desirable and the inflation cycle based at least on this factor alone would stop. However, I was also wondering, (Austrian School economic theory) as the new RBM is not evenly distributed but probably bought up on the foreign exchange until parity is reached an imbalance in speculative investment will thrive and build on itself (due apparent appreciative gains) into inflationary bubbles and so continue to attract foreign investment irrespective of the RBM no longer being undervalued, until these bubbles pop. Hence seeing this demand continue, is it that the central bank keeps inputting new dollars causing this cycle to continue

  • dt

    Thank you, that is what I assumed I was previously saying. So at parity one would think the RMB is no longer so desirable and the inflation cycle based at least on this factor alone would stop. However, I was also wondering, (Austrian School economic theory) as the new RBM is not evenly distributed but probably bought up on the foreign exchange until parity is reached an imbalance in speculative investment will thrive and build on itself (due apparent appreciative gains) into inflationary bubbles and so continue to attract foreign investment irrespective of the RBM no longer being undervalued, until these bubbles pop. Hence seeing this demand continue, is it that the central bank keeps inputting new dollars causing this cycle to continue

  • dt

    [RBM? – Revolutions By the Minute :-) ]

    Just to add. Alternatively, is inflation continuing simply because the RMB has been so undervalued that more RMB printing has not yet resolved this, that is has the RMB not yet risen “to the point where the price of car in US$ or RMB reaches parity” -in theory?

    Anyway thems me mullings, no worries, leave me to it. :-)

  • dt

    [RBM? – Revolutions By the Minute :-) ]

    Just to add. Alternatively, is inflation continuing simply because the RMB has been so undervalued that more RMB printing has not yet resolved this, that is has the RMB not yet risen “to the point where the price of car in US$ or RMB reaches parity” -in theory?

    Anyway thems me mullings, no worries, leave me to it. :-)

  • dt

    Hi cij,

    I should have read “Cause of inflation: Shanghai bubble case study” first, as what I’ve been considering seems covered there.

    Regards dt

  • dt

    Hi cij,

    I should have read “Cause of inflation: Shanghai bubble case study” first, as what I’ve been considering seems covered there.

    Regards dt