Gravity rules

It has been a good year on the lecture circuit for those arguing the superiority of China’s economic model. In the spring, when a debt crisis seemed poised to engulf all of Europe and threaten economies across the Atlantic, discussion in China was of a different tone entirely: Would the economy grow at more or less than 10%?

There were worries on the fringes about what would happen if export markets collapsed, but it almost seemed unfair to let such hypothetical concerns spoil the party. Throughout, Beijing was quietly smug, relishing its chance at the G20 meeting in Toronto to show off its economic prowess.

However, just as Western economies shouldn’t be counted out just yet, it would be unwise to place blind faith in Beijing’s ability to ensure strong, stable growth, rain or shine. Certainly within China, a greater sense of realism appears to be seeping in. While discussion of China’s need to tighten continues, guesses as to when the central bank might raise interest rates have been steadily pushed back.

Beijing has repeatedly said that it hopes to maintain "moderately loose" fiscal and monetary policy and will seek greater flexibility, but not overall tightening. These are not the words of a country confident in the resilience of its economic recovery. Neither is the NDRC’s announcement of steep fines for companies and individuals found to be hoarding commodities or circulating "misleading or false information" about price hikes.

At the same time, officials have been resorting to familiar habits to keep a lid on inflation. In May, the NDRC called on regulators to stabilize food prices and fight price manipulation, and in late June, it froze coal prices. Both measures were repeats of ill-fated attempts in 2008 to control inflation: Food price controls led to industry cost-cutting and have been implicated in the melamine-tainted dairy scandal, while coal price freezes led to widespread shortages as mining firms sold their product overseas for larger profits.

Given this lackluster history, it is unlikely that Beijing would resort to such tactics again if it did not feel they were necessary. That is has, and clearly does, is a worrying indication of what the central government anticipates over the next several months – particularly given that consumer inflation is already moderate (2.9% in June) and is forecast by most economists to fall further. Officials clearly believe that expectations of higher prices could still lead to destabilizing levels of inflation.

What Beijing is newly worried about is not merely high inflation, but high inflation, high unemployment and slowing growth. Such a situation would put Beijing in a bind: Lower fiscal spending and tighter monetary policy to fight inflation would lead to further slowing and higher unemployment, but encouraging growth by maintaining existing policies could ultimately lead to inflation at levels far above the government’s comfort zone.

An early prediction of trouble came in a June warning from China International Capital Corp that unemployment could boom next year as stimulus-related projects wrap up. Many  low-end jobs will evaporate even as more specialized workers demand pay rises, squeezing corporate margins and potentially feeding into higher inflation.

The central government has the option, as always, of keeping existing policies in place, and even of launching a second stimulus program. It is encouraging that officials don’t seem to be seriously considering this temptation.

A new multi-billion dollar fiscal influx and another surge of bank lending would certainly push up short-term growth numbers and make for great headlines. However, it would do so at too great a cost. There is already real concern over the fate of the US$1.4 trillion in new bank loans issued last year, not to mention the anticipated US$1 trillion in new issues for full-year 2010.

Stimulus was always going to have a distorting effect, and it was always meant as a short-term fix. To drag it out would simply be to paper over – and exacerbate – real economic problems. At the end of the day, Beijing is as subject to market forces as everyone else; it should save the triumphalism for when it has truly triumphed.