The Answer to the Exchange Rate Debate: Chinese Inflation

BY Paul Solman  January 18, 2011 at 12:56 PM EDT

The Chinese currency debate has developed a new twist in recent months: Chinese inflation. Making SenseThe argument, made by Columbia University economics professor Geng Xiao in an updated story of ours running on Tuesday’s broadcast, is that the rise in Chinese inflation is the functional equivalent of a rise in the value of its “people’s currency,” the renminbi.

“China has been very much concerned about cost increases and [resulting] inflation — wage increases, property price increases, raw material price increases. All those mean that exporting Chinese companies are losing competitiveness.”

In other words, as the costs go up for Chinese companies, they have to pass them along in price increases.

Interestingly, the very fact that China pegs its currency to the U.S. dollar would seem to be part of the problem. The Fed creates new dollars (“quantitative easing“). Investors, presumably fearing U.S. inflation, flee to gold, oil and other industrially important commodities. China, as the world’s major buyer of commodities for production, suffers a rise in price.

But the overall trend is inevitable, says Professor Deng:

“Basically, Chinese income is rising, the Chinese price level are rising, and U.S. income is stagnating, right? So the two are converging. That’s what we expect and this is what happens no matter what the Chinese government wants.”

Watch the original story here and an infographic on just how China gets so many dollars.

As today’s subject is China, our usual Tuesday Tool$ We Use feature will have to wait a week. It will return next Tuesday with some carbon emission calculators and a global warming video with blue men and some ear-popping percussion.

This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions _Follow Paul on Twitter._