China’s rumble with globalisation - part I

At this point, even if policymakers theoretically have the ability to pass more effective methods to control inflation while fostering growth, the political imperative of keeping the population quiet has placed China in a catch-22 situation. The government delicately balances the need to listen to investors and the need to protect the poor. Investors would benefit from looser monetary policy and eased control of prices because many listed companies are hurt by margin squeeze.

But looser money will exacerbate inflation and hurt China’s poorest, who lack bargaining power. Passing an economically feasible plan that would satisfy both parties and create conditions for the stated party goal of a harmonious society is difficult politically. It’s also difficult for the government to start an all-out war with inflation. For example, China could relax capital controls to lower their reserves, an economically sound move that would eventually lower inflation. However, China’s stock market has been performing weakly, and the risk of capital outflows would make the move extremely unpopular.

Also, given the turmoil that developing countries like Vietnam and Indonesia have experienced with capital outflows, China is perhaps too cautious when it comes to liberalising its capital account. Most likely, the government will continue its strategy of distorting the market to keep inflation low. Any sudden reversal of government sentiment towards inflation, such as relaxing price controls, would send alarming signals to the market. In this case, policymaking is likely to remain indecisive before the Beijing Games.

The bottom line is that China’s unique economic profile allows for remarkable policy leeway to support strong economic growth in the face of the spread of global stagflation. However, Chinese policymakers should realise that an economic model to sustain growth for the longer term can only be achieved by removing severe distortions stemming from artificially low prices of land and pollution, as well as energy. For China’s own good, artificially low inflation must end.