China Raises Reserve Requirements to Fight Growth

The NYT reports that China finds itself in the rather enviable position of fighting to keep its already phenomenal growth rate from becoming excessive. So for the second time in just one month, the People's Bank of China has raised the requirement for how much of the deposits kept in major banks must be held in reserve. And changing the reserve requirements is not the only tool that China has been using to slow growth. China raised interest rates three times in the last year.

The problem China faces is that even with these adjustments, growth is unlikely to slow. China has a $46 billion trade surplus that doubled since just last year. And foreign investors have been pouring money in China's currency as they speculate that the government will have to let the currency strengthen. The stock market has been exploding, rising 130% in 2006 and about 40% so far this year.

Many intelligent people the world over have come to the conclusion that China's rise as a major economic power to rival and even surpass the United States is now a given. In this environment, the huge investments in China are justified, but they have bid down the expected rate of return well below the original potential of the market. The world is facing a level of capital liquidity that is completely unparalleled in history. This liquidity is ultimately a force for good, but a panic could turn this capital influx into an exodus.

The real question that most people are probably asking themselves is: "What's wrong with an economy that grows faster than 10% a year?" The straight answer is that there is nothing magical about growing that quickly that ensures the growth is the result of speculation and not underlying macroeconomic change. But growth of this magnitude has never been sustained before in human history. Economies that have been growing significantly more slowly have been gripped by speculative bubbles that sparked worldwide financial collapse. China treats 10% as the growth rate above which it chooses to be concerned, and with good reason. China's political structure is set up in such a way that continued economic growth is critical to social stability. If the economy stopped growing or even worse began to crash, the Communist Party would face troubles from the countryside that could loosen its grip on power.

Too much growth is actually more likely to cause economic woes for China rather than too little. A speculative bubble popping is the most likely bad scenario and China's steps are a reasonable movement to prevent that. Unfortunately for China, only a slowing world economy is likely to hold back China's export driven growth and outside of the United States, the economies of the world are doing better than they have in years. For once, America's housing bust might do something good for the world economy.

The Rise of China - Sooner than You Think

Businessweek reports that tax revenues in China are up 25.5% in the first quarter. The rising revenues are due to a combination of sharply higher profits as the economy continues to grow at about 10% per annum and a crackdown on tax evasion by Chinese officials.

China is using its rapidly growing revenue stream to fund big increases in spending across the board. Western military planners are concerned about big increases in Chinese military spending, but China is also spending big bucks on social spending to ease the yawning gap between urban and rural livelihoods.

By some measures, China is already a larger force in the global economy than the United States. But China's institutions and global standing have yet to make a commiserate rise. China's leadership attempts to hide behind the rhetoric of a "peaceful rise". The real truth remains that the Communist Party apparatus is ill-equipped to maintain its iron hold on a rapidly changing nation.

Most people in China today are just getting their first taste of real material progress. As long as powerful economic growth continues, the government will be able to keep a firm grip on its people. But growth at this pace has consequences beyond rising standards of living. The toll of rapid industrialization and mass consumer culture on China's environment and social stability will be immense.

It's a good thing that China is rising, indeed to suggest otherwise is to justify the continued impoverishment of more than a billion people. Let's just hope that China can manage the figurative minefield that awaits its citizens.