China's Economy Re-Accelerating

China again raises interest rates today. Yet despite several interest rate increases and increases in banks' reserve requirements and a slow appreciation of the yuan against the dollar, the Chinese economy actually appears to be re-accelerating after slowing down to "just" 10% growth in late 2006. The trade surplus for the first two months of the year rose a full $27 billion compared to a year earlier, which if sustained in March, will add 6 to 7% to growth. Yet domestic demand seem very strong too, with retail sales rising 14,7%. Not surprisingly, industrial production growth therefore rose 18,5% in January-February compared to the previous year. Even if the trade surplus rises somewhat less in March and even if ( note how I wrote if, I haven't seen any evidence that it actually has done so) investment growth have slowed somewhat, GDP growth probably rose back to 12% or so during the first quarter.

While this is mostly the result of the structural strength of the Chinese economy, with its extremely high savings rate and vast supply of workers, it seems clear that it is also to some extent a result of the failure of the People's Bank of China to contain monetary excesses. Money supply growth re-accelerated to 18% in February.The reason why it has failed is of course its unwillingness to allow the yuan to rise in value faster than its current slow rate. While the yuan reached a new high against the dollar in Friday at 7,728, it is still rising too slowly to prevent foreign exchange reserves from accumulating at an unsustainable rate. This means both that there will be excess investments despite its increases in interest rates and reserve requirements and administrative lending restrictions, and it will also mean that to the extent these investment restrictions are successfull, an increasing amount of Chinese savings will be squandered in foreign exchange reserves.