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China's Reminder to the Fed on Controlling Inflation

U.S. consumer prices flashed mixed signals again in April: from a year ago, the overall headline CPI was down 0.7 percent -- once again the biggest drop in 50 years -- as large declines in energy prices offset rising costs for everything else, including food. However, the core CPI, ex-energy and food, rose 1.9 percent. Two weeks ago the Federal Reserve reiterated its forecast of subdued prices as the economy bottoms out, and even observed that a little more inflation might be a good thing to give the economy a push. But ahead of the CPI report yesterday, the Fed, and all Americans, got another gentle but important reminder about inflation -- the rampant, long-run sort -- from our lenders in Beijing.

Price inflation in the US economy is slow, but picking up speed, says the Bureau of Labor Statistics. When the volatile prices of energy and food are removed from the calculation, and measured at the annual rate for the preceding three months, here is the recent record:


The pattern makes sense: as demand fell last year, so did prices. Now that there are signs the economy is picking up a little, prices are on an uptrend again. In the past three months, at annual rates, food prices are down 1.6 percent, housing is down about one percent, while clothing and medical care are up about 3.5 percent. (Prices of "other goods and services" were up 25 percent, due to a big increase in tobacco taxes.)

For the near term, then, our purchasing power is intact, with neither widespread increases nor cuts in prices.

In a NYT op-ed yesterday, however, Victor Zhikai Gao of the Beijing Private Equity Association warned American citizens and policymakers not to get complacent. People in China used to hold "American gold" -- U.S. currency -- as a store of value, he wrote, but no longer. China's reserve assets of $2 trillion are held 75 percent in dollar assets, and Gao says the government is worried about inflation eroding the country's hard-earned savings.

Gao's homespun editorial is a reiteration of several recent salvos from Beijing: among others, a proposal for a new reserve currency to replace the dollar in the world markets, and China's selling some of its U.S. bonds during January and February, only to resume purchases in March.
In the NYT on the same day, doomsaying economist Nouriel Roubini contributed an op-ed on higher interest rates and other economic costs that would follow if the dollar lost its status as the currency of choice.

China wants to sound an alarm to the United States, Gao says. I imagine we will hear plenty of these friendly cautions in months to come, because the Chinese government, and every other investor, fears the inflation potential embedded in the current $787 billion stimulus package, as well as the impact of having to borrow still more money in the world bond markets. Thirty years ago, the U.S. government's deficit spending to revitalize the economy sent inflation to 15 percent -- and those were much smaller stimulus packages.

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