CHEAP imports from China have helped to hold down prices in America and other developed economies. However, a flurry of recent reports suggesting that Chinese wages and prices are surging have triggered fears that China is now exporting inflation, rather than deflation, to the rest of the world.

In May the 12-month change in the average price of American imports from China turned positive for the first time since the index was first published in 2004; it showed a rise of 0.6% in June. The subsequent news that China's rate of consumer-price inflation shot up to 4.4% in June has added to concerns that its red-hot economy is now fuelling rather than dampening global inflation.

Such fears are overblown. The main reason for the upturn in China's export prices is not rampant domestic inflation, but the rise in the yuan. As the dollar has weakened, America's import prices from most countries have accelerated over the past 18 months , especially from Europe. Since July 2005 the yuan has gained 9% against the dollar, so in industries such as clothing, where profit margins are slim, exporters have been forced to raise their prices in dollar terms. According to Mingchun Sun and Rob Subbaraman at Lehman Brothers, the dollar prices of Chinese clothing exports were about 4% higher in the first half of 2007 than a year ago, roughly matching the rise in the yuan. If Beijing gives in to Washington's demands for a much bigger revaluation, Americans must expect further price rises.

 It is the weak dollar, not cantering cost inflation in China, that is to blame for higher American import prices. China's manufacturing costs and export prices in yuan terms are still falling overall. The surge in consumer-price inflation is entirely due to higher food prices, which do not affect export prices.

Nor is China close to running out of cheap labour, as some commentators suggest. There are shortages of managers and skilled workers, but it could take at least another decade before China's surplus rural labour is fully absorbed by industry. It is true that average wages have jumped by 15% over the past year, but productivity in manufacturing has been growing faster still, so unit labour costs have fallen. Moreover, those productivity gains—ie, a higher value of output per worker—partly reflect a shift in the mix of exports towards higher-value goods. This shift, misleadingly, makes it look as if China is charging more for its exports.

In any case, many worries about the effects of rising Chinese export prices are based on a misunderstanding. The impact of a low-cost producer, such as China, on global inflation depends more on differences in price levels between countries than on the rate of change in its export prices. China has helped to hold down global inflation not because its prices have been falling, but because its goods are so cheap and are gaining global market share. This pushes down the prices of all competing goods sold in domestic markets.

Even if China's export prices start to rise, they will curb America's inflation rate as long as they remain lower than the global average and China's share of America's market continues to rise. The real threat to America's inflation is not that Chinese export prices start to rise modestly, but that Congress is short-sighted enough to impose protectionist measures which prevent American consumers from continuing to buy cheap Chinese imports. 
(from www.economist.com)