Interview of Andy Xie, former Morgan Stanley Chief China economist.

Pay attention to his view that raising interest rate will have limited effect on containing inflation because it may prick the housing bubble. This is especially true when considering local governments’ huge stake in keeping housing and land prices high.

I expect Chinese government will resort more to raising bank reserves and administrative measures to contain inflation.

Three other things are also likely to happen:
1) Chinese government may distort official inflation numbers, i.e., more human smoothing.
2) Accelerate Yuan’s appreciation, which I think is most likely. In fact, Qing Wang of Morgan Stanley expects the RMB to appreciate from currently 6.64 to 6.2 by Dec. 2011. Marty Feldstein, in my earlier post, echoed the similar view.
3) tighter capital control to prevent inflow of hot money.

More broader picture is that the super easy monetary policy by the Fed is propping asset bubbles everywhere in the world, especially in the fast growing emerging economies (carry trade factor). Besides China, Brazil also faces grim inflation outlook, and Brazilian interest rate is already above 10% and expected to rise further.

Commodity prices are already high and fast rising. But given the debasement of paper currency across board, and the grim inflation outlook in emerging markets, it’s reasonable to believe commodities are set to rise further.

Higher volatility is ahead of us; expect to see more booms and busts; and China is facing another real challenge.