Chinese inflation to boost gold prices?

Posted on 20 August 2010 with 1 comment from readers

A recent report from Credit Suisse has warned that wage inflation in China is going to put pressure on the profit margins of major Western brands dependent on Chinese manufacturing over the next 12 months.

Over the past decade Chinese manufacturing salaries have risen from $1,000 to $3,900, according to The Daily Telegraph yesterday. But a series of strikes at key factories have sent wage inflation soaring to 25-30 per cent this year.

Inflation returns

The low cost of manufacturing in China has been the secret of low inflation in the West in the 2000s. That deflationary force is gone.

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This is inflation at a very basic level. Eventually manufacturers will have to pass this higher cost on with higher prices or inflation.

Now we hear the selling of gold by Chinese banks is being liberalized. The Chinese are not immune to inflation either and will want to buy protection in the form of gold, the one currency that cannot be printed.

At the same time investors in the West are waking up to the likely return of retail price inflation and what are they buying? Well, also gold for the same reason as the Chinese.

You do have to ask, where did that Chinese inflation come from? The answer is clearly the huge stimulus of historic proportions – actually half of GDP in six months – that ’saved’ China from the global financial crisis.

It is an economic axiom that too much money chasing too few goods will cause inflation, and this is what happened in China, causing workers to strike for higher pay. This is the classic wage-price spiral of inflation.

Gold prices

Of course, it will not only be gold prices that rise with inflation. Interest rates will have to go up to keep bond holders earning a reasonable return. Cash will buy less and therefore be worth less though not worthless.

House prices can fall in real terms in this environment, with interest rates rising, even if nominal prices remain static or fall only slightly.

It is really a matter of going back to the 1970s. Then it was oil price inflation sparking retail price inflation. Now it is the Chinese money supply expansion of last year.

Gold did well in the late 1970s while inflation undermined most other investment classes. We have been here before. It is no different this time.