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Why China is not an inflation threat

February 15, 2011

There is another whiff of panic – panic! – at a 5% China inflation print. I went through the math before in some detail. In my analysis, I assumed that China was lying and China had 10% inflation across the board – more than double the level given by the government.  Then, I also sized the Chinese economy at the maximum size.  Even if China does have 10% inflation, the inflation threat to the U.S. is very, very small.

The idea I used is that there is some amount of “total inflation” out there, and this inflation can be spread among countries.  It’s like an inflation pie – changing the cut of the pie doesn’t change the overall size of the pie.

To figure out how much total inflation we have in the inflation pie, just multiply the inflation rate by the size of the economy.  Then, you can take this “total inflation” and give it to anyplace you like.   This is similar to the idea of adjusting inflation rates through currency appreciation and depreciation – where the inflation does not go away, it just gets shifted to other places through the movement of currency prices.

Again, in the math I used the most aggressive inflation and size assumptions. I assumed an inflation rate in China that is literally double the inflation print from today.

Any reasonable assumptions about Chinese behavior, it is clear that the overall inflation threat from China is comically low.   Under the worst case for the U.S., China might be “hording” 1% of inflation from the United States.

I only included the U.S. in this analysis as a possible inflation sink.  If we include Europe and Japan as other possible sinks of inflation, the threat of China and emerging market inflation is almost nil.  Japan is changing their behavior and seem to be embracing inflation for the first time in memory, and Europe forced out the uber-hawk Axel Weber.

These huge economies are much more open to importing inflation from offshore then they may have been just a few months ago.  And they have very, very low inflation.

There just isn’t a real threat to G-7 countries from emerging market inflation.  The economies are too small to be of concern to the larger world economy.

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