China Needs Inflation Help

China's inflation is casting a pall over its economy. To cool things down, the government has lifted bank reserve requirements five times this year. Its most recent increase touched off Tuesday's 8% stock-market selloff. But authorities haven't touched domestic interest rates, which have been negative in real terms since December. That's because China fears higher rates will attract hot money. Raising interest rates to an inflation-quelling level of 11% to 12% would exacerbate the flows of hot money that have increased China's foreign-exchange reserves by $250 billion in the first four months of this year. Increasing bank reserve requirements is helpful -- the latest move will drain $60 billion from the financial system -- yet raising them too far could destabilize shaky Chinese banks. Amid all this, Ben Bernanke, the Federal Reserve chairman, blames excess saving by Chinese and other Asians for global inflation. Yet Chinese saving results primarily from the People's Bank of China printing yuan to swap for dollars to hold down the exchange rate. Allowing the yuan to appreciate sharply, as the U.S. would like, would damage China's exporters, already facing 20% to 25% annual cost increases in dollar terms. There appear, therefore, to be few domestic solutions to China's inflation problem. One answer is to mop up the global pool of liquidity, reducing the upward pressure on China's currency and allowing the government to raise domestic interest rates. Mr. Bernanke's interest-rate cuts since September helped the U.S. banking system absorb losses. But they also further increased international liquidity, which is exacerbating China's inflation problem. Rather than Mr. Bernanke blaming China, maybe China should blame Mr. Bernanke.