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Is over-urbanization causing China's inflation?

By Yu Xianzhong (Jiefang Daily)

16:54, August 25, 2011

Edited and translated by People's Daily Online

China's Consumer Price Index (CPI) rose nearly 7 percent in July from a year earlier, hitting a new high. Certain people believe that over-urbanization is at the root of China's inflation, arguing that urbanization leads to the loss of agricultural land, a massive influx of rural labor to urban areas and increased consumption of resources. These factors have jointly pushed up the prices of resources, food and services, thereby raising inflation expectations. Is the country's inflation really caused by over-urbanization?

China's modernization, driven by marketization and urbanization, has long been plagued by inflation, but it is far-fetched to say that over-urbanization is the root of China's inflation.

First, urbanization has become an irreversible trend, and the proportion of urban residents in a country’s total population is bound to increase gradually. In other words, there will be fewer rural residents and more urban residents.

For China, urbanization is not only the core content of transitional development but also the primary way to achieve modernization. During this course, the market-driven price mechanism plays a dominant role in distributing resources, and investment and consumption demands need to be satisfied by marketization transactions. As the demand for marketization continues to grow, the phenomenon of inflation expectations will inevitably appear.

Second, although urbanization is accompanied by inflation, it is not the root-cause of inflation. Related price increases signify lack of resources. The high-speed economic growth is inevitably accompanied by huge consumption of resources, and the lack of resources will inevitably lead to rise of prices of related resources. This kind of price increase is inevitable and proper, and it is conducive to resource conservation and technical innovation. Therefore, it is not right to regard this kind of price rise as inflation.

Therefore, the accelerating course of urbanization and the related increase of prices are a simultaneous phenomenon, which is important for development. But urbanization is not the root cause of inflation.

Finally, inflation is caused by complicated factors, the key of which is the "fast pace of money creation by money-making machines." Currently, mainstream economists generally believe that the basic causes behind inflation are excessive issuance of currency, market demand and supply costs. People have been made further aware that the rise in supply costs caused by investment demand will result in a universal, considerable and continual increase in the market prices of raw materials, equipment and labor.

The rise in money supply will increase the market demand, which will in turn push up inflation. The rise in money supply is essentially due to excessive currency issuance, which will lead to currency depreciation and an increase in the prices of goods and services. Milton Friedman, an American economist and a Nobel laureate, regarded inflation as a market phenomenon of "too much money chasing too few goods."

Inflation is a type of monetary phenomenon. If the inflation resulting from lower grain output because of large-scale natural disasters or wars and conflicts is excluded, almost all inflation is the result of excessive currency issuance. Therefore, the seemingly complicated cause behind inflation simply lies in that the rise in money supply has far outpaced the actual economic growth.

Therefore, managing the inflationary phenomenon should make the issuance of currency subject to a single rule: additional money should be issued in proportion to the GDP growth. In terms of microeconomics, developing a scientific outlook on development is the fundamental strategy to emerge from the shadow of inflation.

Because China's society is continuing its traditional reliance on the "planned economy," people lack the sensitivity and adaptability to the market economy and price changes. Thus, China's inflation can only be curbed through knowledge innovations, the advancement in the public market view, the formation of core competence as well as the modernization of the population and institutions.

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Chris at 2011-08-2671.83.116.*
If the PBoC allowed the Yuan to float freely in the open market, China would solve its inflation problem over night.
  

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