24/7 Wall St.

The Chinese economic machine has begun to sputter. An ongoing rapid improvement in its PMI, inflation at the wholesale level, and worker demands for higher pay have contributed to increased inflation. Add to those “bubbles” that have formed in part of the real estate market, and concern that inflation may move above 6% or 7% are realistic.

China tighten rates for the second time in a two months. The benchmark lending rate rose 25 basis points to 5.81%. The bank deposit rate moved up 25 basis point to 2.75% according to Reuters. China’s premier used this action to insist that the nation’s inflation was under control and could stay that way

The manufacturing sector in the People’s Republic did not slow as much as many economists expected during the recession and it has coming roaring out of the downturn. Factories may have been dept online by the $585 billion stimulus that the central government put in place nearly two years ago. Consumer spending in China also rose and took some of the factory output, but not enough to be a core driver of the economy.

China’s appetite for oil and other commodities has helped raise prices for these around the world. The nation’s growth would be partially crippled if crude rose about $100 for any prolonged period. China is the world’s largest net importer of oil.

The central government’s attempt to get factory owners to raise wages, in some case above 25% this year, may backfire. Workers will have more money to become consumers, but these new consumption patterns could also raise demand enough to lend itself  to a larger increase of the cost of goods sold in the local consumer economy.

China will not be able to pass the costs of all its finished goods onto its trade partners. Consumer demand in Japan, the UK, US, and Europe is too weak. That will leave China’s manufacturing sector with no way to pass along wholesale prices.

The Chinese economy is about to slow and the slowdown could be sharp.

Douglas A. McIntyre