China's February trade deficit of $7.3 billion is further evidence that the economy is overheating and casts doubt on the wisdom and sustainability of RMB appreciation.
Analysts argue that the monthly figures are volatile and attribute the February deficit to the timing of the Lunar New Year holiday, expecting the balance to return to a substantial surplus. A deficit of $7.2 billion in March 2010 proved a one-off, with the surplus soaring to $28.7 billion by July.
Such claims, however, ignore a steady underlying deterioration in recent months. The chart compares the headline monthly balance with a three-month moving average of a seasonally-adjusted estimate. The latter was stable at about $12 billion at the time of the last monthly deficit in March 2010 but has fallen sharply recently, reaching zero in February.
This deterioration reflects a surge in import volumes and prices on the back of strong domestic demand.
China's inflationary boom is the product of loose domestic monetary conditions rather than an undervalued exchange rate. The correct response is to rein in monetary expansion and restore positive real interest rates rather than attempt to suppress inflation through Nixon-style price controls. The exchange rate may rise temporarily as part of this process but the normal pattern is for currencies of overheating economies to weaken as boom turns to bust.
