A U.S. 2.0% Inflation Rate Leads to a Discussion about China’s Flaws

03/19/2013 by Alex Carrick

The U.S. all-items inflation rate in February, spurred on by an uplift in gasoline prices, recorded an out-sized seasonally-adjusted month-to-month gain of 0.7%, according to the Bureau of Labor Statistics.

On a year-over-year basis, the all-items consumer price index (CPI) (not seasonally adjusted) was +2.0%.

In a rare show of unanimity, the “core” rate of inflation in the U.S. was also +2.0% year over year in the latest month. The “core” rate omits price changes in two volatile sub-categories, food and energy. The former was +1.6% year over year and the latter, +2.3%.

This January, the year-over-year change in the all-items index had been +1.6%; and for the “core”, it was +1.9%. Therefore, February featured acceleration in the rate of advance, more-so for the all-items index than for the more-focused core.  

Canada’s latest comparable CPI changes were +0.5% for the all-items index and +1.0% for “core”, although these were for January as opposed to February. Our inflation numbers are usually published a week or so later than in the U.S.

There are aspects of the economy in the U.S. (e.g., auto sales, retail sales and housing starts) that are moving forward at a quicker pace than in Canada, giving rise to more upward price movement.

The increase in U.S. gasoline prices in February was 9.1% month over month. In February of last year, gasoline prices were also elevated. Therefore, on a year-over-year basis, the price increase was a more restrained +3.3%.

There were some wild year-over-year price swings in individual sub-categories. On the upside were: lettuce (+24.5%); apples (+11.1%); newspapers and magazines (+8.1%); college textbooks (+7.8%); car and truck rentals (+7.1%); men’s footwear (+5.7%); eggs (+5.8%); poultry (+5.0%); and motor vehicle insurance (+5.2%).

Offering price bargains on a year-over-year basis were: televisions (-17.2%); personal computers (-8.9%); photographic equipment (-5.7%); lamb and mutton (-16.6%); and coffee (-4.1%);

Speaking of prices in general, a key explanation for their movement can be found in commodity markets. Raw materials such as oil and gas, base metals and grains, are the building blocks of many of the items we consume or install in our homes.  

In turn, much of the driving force behind commodity prices over the past decade has come from China. For example, that nation is now running neck and neck with the U.S. in a contest to determine the world’s largest importer of oil.

In many other commodity categories, China accounts for as much as 40% of world demand. 

Since the recession, most commodity prices have been sitting on a ledge below their previous peaks. The Chinese economy has slowed from a mad dash to a smaller-stride run. Between 2001 and 2011, the nation’s average annual “real” (i.e., inflation-adjusted) rate of growth was +10.4%. In 2012, year-over-year gross domestic product (GDP) moderated to +7.8%, the slowest since 1999.

The Communist Party Congress held in November of last year followed by the National People’s Congress this March established a new leadership in China for the next ten years.  The extended time frame confirms how much the authorities like stability.

The new men at the top are Xi Jinping – who, as President and General Secretary of the Communist Party, is in charge – and Li Kiqiang, who is now the nation’s Premier and second in command. It seems likely they will forever be poetically referred to as President Xi and Premier Li.

They’re facing some difficult challenges. Beijing has established an aggressive goal. It wants to achieve a doubling of GDP per capita by 2020. It’s been estimated that an annual average growth rate of 7.5% will be required from now until the end of this decade to achieve that objective.

There are concerns about the growing gap between the extremely wealthy elite at the top of China’s economic pyramid and the vast hordes below. To keep social unrest to a minimum, there must be even more progress in raising the poor to middle class status.

Bloomberg News regularly compiles a list of the world’s wealthiest individuals. In what can only be termed an astonishing revelation, there are apparently more super-rich individuals on a proportional basis in China’s legislature than in the U.S. House of Representatives.

This hardly seems right in a nation supposedly grounded in a socialist ideology.

President Xi and Premier Li want to move their economy from being mainly labor-intensive and export-oriented to one that is more consumer-driven and domestic-dependent. Large infrastructure construction projects will continue regardless.

China’s nascent economic difficulties have come to fruition in several areas. Due to the one-child policy that’s been in place for decades, there are no longer the large gains in youth employment that provide both an infectious vitality and lower wage rates. Productivity gains have been suffering as a consequence.

Inflation is proving difficult to contain, especially in overheating real estate markets. The latest reading on house prices shows a year-over-year gain in 62 of the nation’s 70 major centers. In Beijing, the most recent year-over-year increase was +6.0%; in Shanghai, +3.9.

Officials are striving hard to break the expectation of an ever-rising spiral that will evolve into a speculative bubble. Several draconian measures have been adopted to cool things down. There has been some upward adjustment of interest rates and down payments have been increased.

A capital gains tax of 20% has been imposed on profits from home sales. And it’s now harder to obtain a second mortgage. It’s even more difficult to gain approval to finance a second home purchase.

This has led to an interesting and disturbing side effect. It’s a variation on Newton’s law of physics that says for every action there is an equal and opposite reaction. In economics, for every regulation that’s introduced, a great deal of effort goes into finding a way around it.

The restriction on a second home purchase is waived when one becomes divorced. Spotting the opportunity this loophole provides, there has been a dramatic increase in the number of “sham” divorces in China. “Divorces of convenience” have become fashionable.  

There can be little doubt this isn’t the result officials were aiming for when they instituted their tighter lending policies.

U.S. inflation: all items (CPI-U) vs all items less food and energy
(not seasonally adjusted)
U.S. inflation: all items (CPI-U) vs all items less food and energy
In the U.S., the February 2013 year-over-year change in the energy sub-component index was +2.3% year. Gasoline was +3.3%.

The U.S. figure (CPI-U) is the All Items Consumer Price Index for All Urban Consumers.
Data source: U.S. Bureau of Labor Statistics (Department of Labor).
Chart: Reed Construction Data - CanaData.