Is China about to hit the brakes?

Inflation is higher than expected in China, and the government's anticipated response is hammering Chinese stocks.

By Jim J. Jubak Nov 16, 2010 5:42PM

Jim JubakThe news is that China’s government is drafting policies to fight inflation. Chinese Premier Wen Jiabao said so on Monday from a supermarket in Guangzhou. The comments were broadcast on state TV, so they count as solid news.

The rumor is that China’s central bank is about to raise bank capital requirements (again) and increase its benchmark interest rates. The People’s Bank raised interest rates in October for the first time since 2007.

The news and the rumors have combined to hammer Chinese stocks -- and the shares of global commodity producers. The Shanghai Composite index was down 4% on Monday after falling 5% on Nov. 12.

Shares of copper miners Freeport McMoRan Copper & Gold (FCX) and Southern Copper (SCCO) have been among the hardest-hit commodity stocks today, dropping 4.7% and 3.1%, respectively.

Inflation came in at 4.4% for China in October, way above economists’ forecasts of 4% inflation and even further above the government’s target of 3% for 2010.

The big driver in inflation was food prices, which is one reason that Wen was in a supermarket and why speculation today is that the government is about to introduce price controls for food. Other measures that would be likely to accompany food price controls are a campaign against hoarding and new penalties for speculation.

China last imposed price controls in January 2008, when the country froze prices for petroleum products, natural gas, and electricity.

But although price controls are a likely move -- they would show that the government is doing something about the soaring cost of food -- they don’t constitute the big policy guns against inflation. To really slow inflation, the People’s Bank will have to slow growth in the money supply with a combination of higher interest rates for deposits so more people will keep money in the bank and restrictions on bank lending. 

Right now, interest rates on deposits are so low compared to inflation that savers lose money. And banks are about to blow through lending targets for 2010.

Those big policy guns would hit property developers, commodity producers, and exporters hardest, so it’s not surprising that those stocks are down the most over the last two days. (For more of my thinking about bubbles and busts, see my post “If we may be headed to a bubble and bust, what should we do about it?” )

At the time of this writing, Jim Jubak didn't own shares of any companies mentioned in this post in personal portfolios. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not own positions in any stock mentioned. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund's portfolio here. 

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