Effective yesterday, the Chinese Ministry of Finance increased its so-called stamp tax on stock market transactions from 0.1% to 0.3% in an effort to curb speculation in the Chinese stock market. This stamp tax is nothing but a transactions tax imposed on both buyers and sellers of stocks.In reaction to the increased tax rate, the Shanghai Composite stock index fell 6.5%.

Although the increase in this transaction tax may temporarily temper stock market speculation, it is doubtful that it will temper overall asset speculation as it does not get at the root cause -- rapid central bank credit creation. And that rapid central bank credit creation will not be curbed until the People's Bank of China (PBOC) allows the yuan to appreciate vs. the dollar. The PBOC has to rein in bank reserves growth if it wants to moderate inflation - inflation in asset prices as well as goods/services prices. And to rein in bank reserves growth, the PBOC will have to allow the overnight interbank interest rate to rise, something it has been reluctant to do.

But so long as the PBOC continues to support the dollar, neither bank reserves growth can slow nor can interbank interest rates rise. (For additional discussion on the PBOC's predicament, see People's Bank of China Takes With One Hand, Gives With The Other? )

By Paul L. Kasriel
The Northern Trust Company
Economic Research Department - Daily Global Commentary

Copyright © 2007 Paul Kasriel
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

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