Asset Price Inflation

Greatly exaggerated fears of inflation

PUBLISHED : Monday, 17 July, 2006, 12:00am
UPDATED : Monday, 17 July, 2006, 12:00am

Are prices in China rising much faster than the headline inflation figures suggest? Based on the consumer price index (CPI), inflation has been extremely well behaved, at 1.2 per cent in April and 1.4 per cent in May. Yet consumers are increasingly fretful about costly services, ranging from school fees to hospital expenses and taxi fares. Asset prices, too, are looking lofty; the domestic A-share market's bull run shows no signs of slowing; and prices of flats, paintings and even stamps are rising sharply.

All this suggests there is a lot of money sloshing around. Quite often, asset-price inflation is a classic leading indicator of broad-based inflation. In mainland China today, the conventional wisdom is that the grossly undervalued yuan has released a torrent of liquidity into the domestic economy, causing too much money to chase too few goods. However, concerns over potential runaway inflation are misplaced - and some possible policy responses under discussion to pre-empt it could have unintended negative consequences. True, plentiful liquidity is partly responsible for driving up the prices of properties and artwork. But rising asset prices have less to do with cheap money from the yuan's undervaluation or low interest rates than with the lack of investment choices facing mainland savers.

The combination of high savings and excess supply of many goods provides a strong incentive for capital to seek returns where competition is relatively weak. Property, for example, is attractive because collusion between local governments, developers and state banks is limiting supply.

While housing prices are rising quickly, rents have hardly budged in the past few years in most cities. This situation is due to a strong bias towards home ownership. In terms of the impact on inflation, though, the central bank is supposed to monitor only rents, not housing prices. So, stable rents are helping to moderate headline inflation.

Neither is there much upward pressure on mainland wages. Indeed, the government has recently initiated a debate on whether university graduates should be deemed 'normal workers' - in order to tame their expectations of high starting salaries. This is an implicit acknowledgement of the increasing difficulties faced by fresh graduates in finding jobs, because of their elitist expectations.

How does this square with the growing complaint among many multinational companies in mainland China that retaining staff is one of their biggest headaches? In my opinion, this anomaly stems from an acute skills mismatch rather than from a general shortage of highly educated workers.

Nevertheless, an explanation is needed for the benign headline inflation figures that contrast with consumers' heightened concerns about rising prices. The answer lies in the lack of competition in key livelihood sectors like education, medical care and public transport. The consensus among ordinary mainlanders is that high costs associated with schools, hospitals and housing stand in the way of more consumption.

The shortages of such services will not be alleviated by higher interest rates, a stronger yuan or any other conventional macroeconomic tightening measures. The faster deregulation of monopolistic sectors is the only way to increase supply and bring down prices.

There's no question that the prices of some goods and services are rising, but an outbreak of high inflation will likely be prevented by the excess supply of many industrial goods and the immense slack in the labour market.

Steven Xu is the Economist Intelligence Unit Corporate Network's director of advisory services in China