By: Our Correspondent

china-moneyinflatAs China
grapples with the consequences of its devastating earthquake, it has
also begun to finally confront the destabilizing forces bubbling up
beneath its economic landscape. This week, several key Chinese
officials, typically not known for their candor, conspicuously noted
the need to both stimulate domestic consumer spending and bring down
roaring inflation. While at first blush these two goals might appear
mutually exclusive, China's leaders do have a magic bullet that can
hit both targets at once.

A stronger
currency, commensurate with China's increased economic strength,
would both tamp down inflation and allow Chinese consumers to buy
more goods and services. However, for reasons not entirely clear to
me, or few others for that matter, China's leaders are resisting this
simple and beneficial solution.

The
Chinese leadership's stated goal in prodding their citizens to spend
more is to decrease their economy's dependence on exports. If the
Chinese, who currently save 50 percent of their incomes, saved less,
more of their production would be consumed locally. As a result,
China would be less vulnerable to economic downturns abroad. Without
a vibrant domestic market, over-leveraged Americans will apparently
remain China's most important customers.

A
strengthened yuan would lower the real costs of goods for domestic
consumers and allow the Chinese themselves to compete more evenly
with consumers in other nations to whom they currently send the
fruits of their labor. As goods become more affordable in China, the
Chinese would naturally consume more. A rising yuan would therefore
kill two birds with one stone: it would reverse recent consumer price
increases and it would induce Chinese consumers to buy their own
products.

If the
Chinese were to follow such a sensible path, the consequences in
America would be immediate and severe. By allowing their currency to
appreciate, Chinese monetary authorities would no longer need to buy
and remove as many dollars from the open market, producing an
immediate reduction in the demand for US Treasuries, mortgage-backed
securities and other US dollar-denominated debt.

The result
in America would be a simultaneous increase in both consumer prices
and interest rates. Such developments would only compound the
problems already rippling through the US economy. To spur domestic
spending absent such currency rebalancing, Beijing must instead rely
on the nominative, simulative effects of inflation.

By further
expanding their money supply and allowing those increases to be
passed on to workers in the form of higher wages, Chinese consumers
would have more yuan to spend and hence would buy more.

However,
such a policy would only solve one problem by aggravating the other.
Further, by penalizing savers through the erosive effects of
inflation, China would discourage savings and jeopardize one of the
true sources of its rising living standards. Contrary to the
economic hocus-pocus propagated on Wall Street, Washington and at
American universities; economies grow not as a result of consumer
spending, but as a result of savings. Under-consumption is the true
source of prosperity as it engenders capital formation, which lies at
the root of sustainable economic growth.

Here too
the implications for Americans are dire. In effect, with the Chinese
only spending half of their incomes and lending much of the rest to
the US, Americans have merely been enjoying the current consumption
that more frugal Chinese consumers have decided to defer. As the
Chinese consume more, Americans would simply be forced to consume
less. Low prices and rich consumers are a potent concoction that is
sure to soothe China's roaring economy while raising the living
standards of its hard working citizens. It's a simple solution that
only an economist can miss.

Peter D. Schiff
is president of Euro Pacific Capital, Inc of Darien, Connecticut,
USA. He publishes the free, on-line investment newsletter
http://www.europac.net/newsletter/newsletter.asp