Upward spiral

The news that China’s inflation rate hit an 11-year high in August was anything but a surprise. In continuation of a climb that began in June, the inflation announcement was bookended by two government economic tightening measures: an increase in banks’ required reserve ratios before the event and an interest rate hike after it. But what next?

The inflation rate is already well ahead of the 3.87% Chinese people can now expect to get on a standard one-year bank deposit. But bringing an end to negative real interest would involve a string of further interest rate rises.

Pessimists contend that the only way out is through an economic downturn, which could come about in one of three ways: spiraling inflation followed by tough monetary controls; global economic collapse and the demise of Chinese exports; and deflation though overcapacity as supply significantly outstrips demand.

Of course this is always followed by a qualifying tag: A government that knows when to apply the brake or hit the gas at the correct moments can make a hard landing much softer.

But China’s current inflation dilemma doesn’t necessarily require a mainstream solution. Overall consumer prices rose 6.5% in August because food prices rose 18.2%. And food prices rose because meat, eggs and vegetable prices shot up 49.2%, 23.6% and 22.5%, respectively. Take food out of the equation and the overall increase plummets to 0.9%.

So the problem is ultimately a mismatch between supply and consumer demand. Meat prices are going up because people want more meat than there are cattle. For example, the country’s beef herd may have risen by 100 million in 25 years but imports will still have to hit 50,000 metric tons next year if growing demand is to be met. Efforts are also being made to breed more livestock with Beijing pledging to spend US$199 million in the counties that supply up to 800,000 of China’s pigs every year.

These measures may offer medium-term respite from the price pressure. In the long-term, though, the changing dietary patterns thrown up by China’s growing wealth will expose the cracks in its agricultural system.

Conditions are improving for China’s farmers – indeed, it could be argued that they are the real beneficiaries of food price hikes – but they are still restricted by strict rules on rural land tenure. As long as agricultural output remains fragmented, economies of scale will remain elusive.

In some areas farmers have formed collectives or sold out to corporate management but, most of the time, China’s arable land – which is already being eroded by industrialization and general environmental abuse – is farmed inefficiently. Meanwhile, the supply chain that connects the farm gate with the marketplace is so kinked that miscommunication is inevitable. Every year, countless farmers still lose out because they grow or rear the wrong thing or the right thing but in the wrong way.

It is at this very real level that China’s economic, social and environmental challenges come together.

Learning to play the game

Even in its darkest moments, China never quite descended to the crude Khrushchev theatrics of banging a shoe on the UN lectern, but in the past there was still an overly simplistic approach to diplomacy, resulting from isolation, ideological stubbornness and inexperience.

The APEC summit in Sydney, at which Chinese President Hu Jintao was widely viewed as having upstaged the US, was a sort of coming of age for Chinese diplomacy. China is now in less need of PR guidance – no doubt thanks to new faces at the Foreign Ministry and the confidence that comes with being able to negotiate from strength.

The Western line, that China is ignoring abuses and simply making foreign policy on the basis of self-interest, sounds high-minded until you remember that the accusing nations have a history of doing the same themselves.

But the decision to dispatch a Chinese military detachment to the peacekeeping force in Darfur certainly helped to offset perceptions that China was doing little to help the effort to find a solution to the mess in Sudan. Beijing seems to have realized that staying friends with countries viewed as rogue states is not helpful to its overall goals. So no more Beijing trips for Zimbabwe’s Robert Mugabe.

Some smart footwork by both sides has also defused the China-Japan situation which looked ugly two or three years ago, and is now viewed as smooth despite seeing no real changes in the interim. A recent report issued by the Foreign Ministry saying that Sino-US relations had made substantial progress in the past year was also a smart move.

But it could be that the big test still lies ahead – the Taiwan problem. When rallies took place in Taiwan in favor of the island gaining a separate seat in the UN, Beijing responded with an air raid practice in Shanghai. Well, that’s one way of handling it.

The Taiwan issue is complex, and while the risk of armed conflict has more or less disappeared, handling a situation fraught with tricky emotional and economic factors could well one day test Beijing’s sophistication.