Inflation key piece to tricky Chinese puzzle
It is often said that admitting you have a problem is the most difficult step for any addict seeking a solution. China's leadership now concedes that an obsession with continued high rates of gross domestic product growth may be unhealthy and even unsustainable.
Yet this recognition has not been accompanied with the traditional remedy of higher interest rates. Without cutting off the supply of cheap and easy money, high growth and renewed inflation look increasingly likely.
Instead, emphasis has focused on playing down growth expectations. Next year, GDP growth is targeted at only 7 per cent, a modest ambition for an economy that has consistently achieved more than 8 per cent, while a new 'green' GDP figure has been muted to measure sustainable growth.
The proposed green GDP deflator will make subtractions for resource depletion and pollution and calls for a balanced development for mankind and the environment.
The semantics may be commendable but they obscure growing disquiet at the costs of China's growth binge. The obvious symptoms are stagnant rivers and Beijing's dust clouds, but there are also wider-felt implications of overinvestment and overcapacity.
Outside its borders, the scale of China's industrial machine is increasingly being felt. China now sets the global price benchmark for a range of commodities such as zinc, iron ore and stainless steel, of which it alone consumes a quarter of the world's supply. Two million new cars bought this year mean that China's craving for oil has ranked it as the world's second-largest oil user.
Understandably, there is a lot vested in ensuring China does not give up its growth habit.
A slowdown does not just hurt domestic employment goals but also world growth and, as United States Federal Reserve chairman Alan Greenspan pointed out last week, it would curtail China's ability to keep purchasing US dollar assets - read, finance the US budget deficit.
Anyone taking the pulse of China's economy today would find that it is running on overdrive. Third-quarter GDP growth registered 9.1 per cent and annualised M2 money supply expansion again exceeded 20 per cent last month. Friday's announcement of a 3 per cent increase in consumer price inflation for November represented the largest year-on-year increase since 1997.
Ten years ago, when China's economy overheated, the central bank responded with a series of interest rate rises. The worry now is that the cure could be worse than the cause of the problem. Higher interest rates not only slow lending but also attract savings. The currency link means that a rate rise in China could also create discomfort for the US Treasury.
Any narrowing of the interest rate premium between US dollar fixed-income products and comparable mainland instruments is likely to accelerate the trend reported by the Bank for International Settlements of mainland banks repatriating US dollars into yuan. Such capital flows boost money supply growth and add to pressure to revalue the currency.
Domestically, the problem is that inflation penalises thrifty savers who are not compensated by higher interest rates.
A rational response among mainland consumers would be to buy inflation-hedging assets or purchase consumer goods before they increase in price. However, predicting rational responses is complicated by the peculiar inflation trends in the mainland. While food, commodity and energy prices are on the rise, almost 90 per cent of manufactured goods are in oversupply.
Amid such conflicting signals, mainland monetary authorities seem to have concluded that a little inflation is not always bad.
In fact, as politicians around the world can attest, a little inflation can be your best friend. The trick is being able to balance growth and runaway expansion.
