Inflation in China Poses Big Threat to Global Trade

As the United States and Europe struggle to get their economies rolling again, China is having the opposite problem: figuring out how to keep its revved-up growth engine from generating runaway inflation.

The latest sign that things were moving too fast came on Sunday, when China’s central bank ordered the biggest banks to set aside more cash reserves.

The move essentially reduces the amount of money available for loans, and is an attempt to cool down the economy. It follows the government announcement on Friday that China’s economy was growing at an annual rate of 9.7 percent, by far the strongest performance by any of the world’s biggest economies.

Because China is now the world’s second largest economy, after the United States, and because the country has been a leading source of global growth during the last two years, money problems here can reverberate from Wal-Mart to Wall Street and the world beyond.

High inflation endangers China’s status as the low-cost workshop for the world. And if the government’s efforts to fight inflation cause the economy to stumble, that will cloud the outlook for international businesses — whether multinationals like General Electric or copper miners in Chile — that have been counting on China for growth.

Inside China, inflation also poses a threat to social stability, a particular worry for Beijing, especially since authoritarian governments in North Africa and the Middle East have become the focus of popular uprisings.

“China’s inflation is a big concern, and actual numbers are worse than officially reported,” said Carmen M. Reinhart, an economist at the Peterson Institute for International Economics in Washington.

She says Beijing is engaged in an economic tug of war, trying to encourage sustainable growth while struggling to control inflation.

Food prices are soaring, and the government said on Friday that the consumer price index in March had risen 5.4 percent, its sharpest increase in nearly three years. Hoping to tame inflation, in the last six months Beijing has tightened restrictions on bank lending and raised interest rates on loans (to discourage borrowing) and deposits (to encourage savings).

The decision on Sunday to raise the capital reserve ratio for banks, to 20.5 percent of their cash, was the fourth such increase this year.

The government has also increased agricultural subsidies to curb food prices, and tried to forbid some Chinese companies from raising consumer prices. These efforts stand in contrast to those in the United States, where inflation is low (the underlying annual inflation rate was 1.2 percent last month) and where the debate centers on how much to stimulate the economy given the size of the deficit. Inflation is also running low in Europe, where some countries are imposing harsh austerity measures to pare their budget gaps.

But analysts say the results of this economic management have been mixed. Growth has begun to moderate from its torrid pace of about 10 percent annual growth but inflation has become worse.

For example, housing prices continue to climb even though Beijing has long promised to curb the property market and to spend billions of dollars over the next few years on affordable housing.

The average apartment in central Shanghai now costs more than $500,000. Even in second-tier cities like Chengdu, in central China, the price of a typical home costs about 25 times the average annual income of residents.

Analysts say too much of the country’s growth continues to be tied to inflationary spending on real estate development and government investment in roads, railways and other multibillion-dollar infrastructure projects.

In the first quarter of 2011, fixed asset investment — a broad measure of building activity — jumped 25 percent from the period a year earlier, and real estate investment soared 37 percent, the government said on Friday.

Some of the inflationary factors, like global commodity and food prices, may be beyond Beijing’s ability to influence. Gasoline prices have also jumped sharply, in line with global oil prices. As the world’s largest car market, China’s demand for fuel is soaring, and gasoline prices are close to $4.50 a gallon, up from $3.82 a gallon in late 2009.

Rising food prices, meanwhile, are showing up in various ways — including higher prices at fast-food chains, like Master Kong, which in January raised the price of its popular instant noodles by about 10 percent.

China’s current supercharged boom began in early 2009, during the global financial crisis, when Beijing moved aggressively to increase growth with a $586 billion stimulus package and record lending by state-run banks.

The loose monetary policy, and big investments in local government projects, did revive economic growth. But even at the time there were already concerns about soaring property prices, undisciplined bank lending and the huge debts being amassed by local governments.