Surprise! China Has Inflation Problems…

China's Central Bank

 News of the Chinese central bank's move to increase interest rates yesterday has sparked frenzied debate over where Chinese monetary policy is headed.  In turn, economists and traders have started taking up positions on what a tight monetary policy means for the valuation of the Yuan.  Opinions are split on how soon the Dollar peg will be readjusted, but one thing is for sure, China is formally addressing their inflation problems through quantitative tightening.  The central bank increased the benchmark one-year lending rate and the overnight deposit rate.  This comes after the bank's moves to increase reserve requirements and cut back on money supply.  Hyper growth and the inflation that has ensued has sent real estate prices sky rocketing in China.  The rate cut will give a short-term hit to the real estate industry as evidnced by stock price declines in China Resources Enterprises Ltd. (0291.HK) and China Overseas Land and Investment (0688.HK).  But is raising rates and limiting money supply enough to get a hold on over-inflated real estate prices in China?

In order to avoid the global recession that took hold in 2008, China implemented an aggressive stimulus policy.  Credit was made plentiful and the inflation machine kept on chugging.  The amount of foreign capital attracted to China's continued growth helped to push prices of real property higher and higher.  By raising interest rates, China is trying to limit domestic spending, including the amount that is spent on real estate.  Economic theory suggests that raising rates does indeed curb spending domestically.  At the same time, however, higher rates attract foreign currencies as well.  While China's rate move might limit domestic spending, further capital inflows will make it difficult to get a handle on real estate prices. 

Limiting money supply domestically and slowly increasing rates will not be enough to curb China's real estate inflation.  Until China revalues the Yuan, overinflated real estate prices will remain a problem.  At a time when the Fed is easing policies to help stimulate the economy, China has got to be more aggressive in taming unchecked growth.   I say this selfishly because restrained growth in China will help improve the U.S.-China trade imbalance.  This will result in GDP growth in the U.S. and in turn bring strength back to our commercial real estate markets.