Is this all they got? The commodities markets sent a strong message to China: In your war on inflation, you are losing terribly. One must wonder if the People's Bank of China is a little bit embarrassed about the way the markets just laughed in their face after global commodity markets shrugged off China's feeble attempt to slow inflation by increasing its one-year yuan lending rate to 6.06% from 5.81%, and the one-year yuan deposit rate to 3.00% from 2.75%. The markets seem to be wondering if this is this some kind of a joke.
In fact instead of commodity bulls fleeing in fear after the Chinese rate increases, they used the tiny rate increase as a rallying point. It seems the lack of courage and foresight by the Chinese government is sending a signal to the market that China does not have what it takes to cool inflation. China is refusing to admit the obvious that their currency manipulation is feeding this inflationary spiral and that it will end badly unless they have the guts to do what is necessary to deflate this bubble. They need to allow their currency to float or at the very least, quit these small incremental rate increases and shock and awe the market with a dramatic increase.
If the Chinese allowed their currency to trade in a free and open market, there would have been no need for a QE2, an act that is accelerating emerging market inflation. While China has been siphoning off growth by their unfair currency advantage, Ben Bernanke said enough is enough. Now it is up to the Chinese to put their inflationary fiscal house in order.
Yet sometimes, when living inside a bubble, it's hard to see what is obvious to the people outside the bubble. The bubble is steadily growing bigger and bigger and therefore the burst will deafen and devastate when it pops.
Gold and silver in particular, seemed to have been emboldened by China's latest lame inflation fighting attempt. Oh sure, gold did get some support on the news that J.P. Morgan will allow gold to be posted as collateral on some transactions, but that of course would not explain why silver took off as well. Industrial metals like copper initially took a hit but came roaring back.
Wheat prices did not care that China raised rates. They did care about what the United Nations said about what a severe drought in China could do to global supply. The UN's Food and Agriculture Organization, or FAO, warned that China's main winter wheat region could pose a serious threat to output saying that 5.16 million acres out of about 14 million could be lost as the lack of rain and snow cover could damage the dormant seeds. When you have shortages of high quality wheat, it is unlikely that a rate increase is going to stop the frenzy.
The truth is that China is losing its battle with inflation because they are being outgunned and refuse to use the weapons at their disposal that could win this war. They are making the mistake that many other growing economies have made in the past and that is to not want to have the discipline to say no to growth and expansion. China is being intoxicated with their enormous growth, but if they don't start to moderate it, they are going to have one heck of a bad hangover.
Oil prices were a bit more complex in its reaction to China's rate increase. Initially oil prices fell on the announcement yet came back in part because of rising gasoline prices. Still the concerns about Egypt and now pirates may play a pivotal role in prices.