China’s boom—and Wen’s own political fortune—hangs in the balance. Food prices are a critical indicator of whether China’s economy can maintain its five-year bull run without overheating. Historically, inflation is also the harbinger of political unrest (the most recent example was the Tianan-men Square protests, which came to a head 18 years ago this week). Ever since, those who believe China can sustain double-digit growth have pointed to the relative absence of inflation. Now that pillar of the Chinese miracle is under severe pressure. Goldman Sachs and HSBC recently predicted that inflation in China would soon rise to 4 percent, well over the government’s official figure and double what it was a year ago.
Last week officials pledged to help fight food-price inflation by releasing meat from the country’s strategic pork reserve (stockpiled in cold storage and animals kept on the hoof). But as the mass-circulation China Daily pointed out, “The more pressing task is to prevent spiraling [food] prices from ripping through the economy.”
Part of the problem is that in recent years, senior leaders (especially Wen, who holds the overall economic brief) have talked about restraint but permitted much faster growth than their predecessors. Beijing has favored a low-key incrementalism, responding to soaring foreign reserves, a yawning trade surplus and the emergence of asset bubbles in stocks and urban real estate with baby steps: a slim interest-rate adjustment here, a slight uptick in the reserve ratio there. These are modest countermeasures given the forces at play in the world’s fastest-growing major economy.
Some experts laud Beijing’s go-slow strategy, but others criticize the leadership for leaving economic policy on cruise control ahead of two watershed political events: a key Communist Party Congress set for October and next year’s Summer Olympics in Beijing. Leaders “have an understandable desire for stability, social harmony and continued economic growth,” argued Hong Kong’s flagship daily, the South China Morning Post, in a blunt April 30 commentary. “But the government is approaching the economy gingerly, tweaking rather than taking forceful action that is needed.”
Soaring food costs are merely the latest threat to the China boom. In recent months, GDP has hit an annual growth rate of 11.1 percent, higher than most economists expected and about 2 points over the average in previous years. That prompted the IMF to call on Beijing to hike interest rates and adopt a more flexible exchange-rate mechanism to stem the tide of money now coursing into the economy. Rocketing share prices on China’s two main bourses have prompted financial luminaries—including former U.S. Federal Reserve chairman Alan Greenspan and Asia’s richest tycoon, Hong Kong property magnate Li Ka-shing—to warn of a Chinese stock crisis in the making. “Liquidity is running from one place to another and the government is chasing it,” says Nicholas Kwan, regional head of economic research at Standard Chartered Bank in Hong Kong. “They need to get the economy under control in the next one or two quarters. Economies build momentum, and if they let everybody run investments up and push stock prices up, then everyone raises prices, and we’ll see a race to capture rents.”
In some respects, food presents a uniquely delicate challenge; many specific pressures are pushing prices up, including the loss of agricultural land to urbanization, a national shift from grain— to meat-based diets and soaring disposable incomes in cities. Yet food inflation is also a manifestation of what many experts describe as Beijing’s biggest macroeconomic failing: its reluctance to mop up the excess liquidity that’s flooding the economy. “Inflation is starting to move up; this is a turning point,” says Dong Tao, chief regional economist for Credit Suisse First Boston in Hong Kong.
Until now, Beijing’s hands-off approach has helped the economy post some truly impressive numbers. China’s current-account surplus is expected to hit $400 billion this year—pushing foreign reserves to a staggering $1.6 trillion. Fixed-asset investments (e.g., the construction of new factories, offices and homes) in urban areas rose 25.5 percent between January and April, continuing a five-year building boom. This impacts food prices both directly, through increased consumer demand, and indirectly, as when the prices of inputs like feed corn spike. As pork grows scarcer and more expensive, consumers shift their menus to favor chicken, fish or beef—driving those prices higher as well. “[Beijing] has made no effort [to address these problems],” says Jay Newman, senior portfolio manager for AT Asset Management in Hong Kong. “For more than two years, they’ve aggressively avoided being aggressive.”
It’s hard to say exactly how fast overall prices are rising. Officially, the consumer price index is up just 3 percent this year—precisely the target set by China’s central bank. But economists question the quality of price data (because local officials tend to report what the center wants to hear) and worry about price instability. The prices of food, utilities and services have surged, while prices for items like consumer electronics and clothing have plummeted due to technological advances and manufacturing overcapacity. On average, deflation for TVs and tennis shoes may cancel out inflation for meat and fruit, but not the impact of food prices on political stability.
The pork shortage will surely feed the debate now raging among prominent economists over whether the world’s fourth largest economy has reached the melting point. To bearish observers, including economist Andy Xie, higher inflation strengthens the case that strong tightening measures are needed to deflate the stock and real-estate bubbles, curb overinvestment and moderate GDP growth. “There is this backlash in the Chinese political system against tightening,” he says. “Leaders are scared that if they slam the brakes too hard, the economy will just go back into deflation.” But to see where China is truly heading, just watch the price tag.
