Chinese Inflation

China's inflation rate is soaring. While that's unlikely to derail China's economy in the near term or infect the global economy with higher prices, the problem underscores a still fragile and developing nation fraught with peril for investors.

Story Notes:

  • Inflation in China is on the rise—highlighting China's still developing status
  • China's battle with rising food prices underscores potential financial problems and societal rifts the country must face after Olympic-mania settles
  • Economic and market turbulence is common in emerging markets, and even seemingly "out-of-control" problems like high inflation won't necessarily derail a bull market

China's inflation rate hit 6.5% in August, driven by a sharp rise in pork and other food prices. Food prices jumped 18.2% from a year ago, while non-food goods crept up only 0.9%. Couple that with GDP growth of 11.9% in the most recent quarter, and China's stellar stock market returns so far this year, and you've got a recipe for a classic (and turbulent) emerging market economic boom.

China Inflation Surges to Near 11-Year High
The Associated Press,

China's government will likely try taming inflation with a few interest rate hikes—possibly slowing its economy as a result. We at MarketMinder thinks it's unlikely China's inflation will affect global markets much—rising food prices (specifically pork prices) are country-specific and don't have much impact beyond China's borders. But China's food-inflation woes underscore the turbulence many developing nations face.

Emerging markets are chaotic, developing, bipolar things. They have big ups and downs, huge disruptive innovations, dislocations, and relocations of capital—all happening at breakneck pace. Some areas thrive, others implode. Crimes are committed as mavericks operate in unregulated markets. Corruption abounds. The government mettles. All this amid a populace eager to build wealth and improve their lives.

China is a great burgeoning story of economic growth for the 21st century. Still tip-toeing out of decades of isolationism and complete communism, free trade and even property rights (oh my!) are nascent but growing. Olympic-mania has caught hold, spurring the government to open its mondo-coffers to build infrastructure.

But there's the rub. The government. There's an illusory feature to China's gangbusters economy in that its growth is still mostly government-catalyzed. Are property rights growing? Yes, but the People's Republic still owns almost all property. Is there greater financial freedom and foreign investment in China? Yes, but the vast majority of activity is still tightly government-controlled.

It's important not to think about China the way we think about the US or other developed countries. Of 1.3 billion Chinese citizens, most live on subsistence farms—many still without running water and electricity. There's a massive gulf between the "haves" and "have-nots" in China surpassing anything we know here. What's more, most China city-dwellers are the elite and employed near-ubiquitously by the government.

China's stock markets, for all their gains, are treacherous territory. For one thing, stock supply is rapidly increasing—a bane for stock prices. (See our past commentary, "When Destruction is Good," 10/20/2006, for more.) Also, financial reporting in China is still very opaque. It's difficult to glean true financial standing of even the largest companies. An easy (and relatively less volatile) way to get exposure to China's expansion is through multinational companies. Many major multinational corporations are establishing beachheads in China—bolstering revenue and profits in the process.

Maintain caution with China, but don't let scary inflation numbers put you off the emerging markets. Turbulence in an emerging market economy is natural—if you're going to invest there, you must be willing to take your lumps to get the big gains. But, as Eric Hoffer said, "Capitalism is at its liberating best in a noncapitalist environment. The crypto-businessman is the true revolutionary in a Communist country." There's a lot of crypto-business going on in China today, but don't forget the country has a very long way to go before resembling anything like a developed, free market economy.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.