China's economy overheats

March 2010

The story
The People’s Bank of China increased the reserve requirement ratio of its banks by 0.5% to reign in inflation, raising fears that a tightening in lending for the second time this year would also slow economic growth in China. At the same time, China slashed its US bond holdings by $34.2bn after Beijing expressed concern over the ballooning US fiscal deficit. Barack Obama hit back, calling for China to let the yuan rise in value and put and end to its unfair trading advantage.

The reaction
Newswire AFP interpreted the drop in bond holdings as muscle flexing, quoting Cornell University professor Eswar Prasad saying: “Chinese leaders are deploying their reserves to pressure the US to stop haranguing China about its currency and trade issues, and to back off from interference in its domestic political and human rights issues.” Others warned against concluding China had a long-term strategy to sell US debt, with The Guardian questioning what else China would do with its money.

The Financial Times accused markets of overreacting: “here we go again. Markets have been spooked by China taking another twist on the monetary garrotte”, concluding it was taking a sensible approach. The BBC pointed out that on its currency trajectory, the Chinese economy would overtake Japan’s as the world’s second largest. Writing in The Daily Telegraph, Jeremy Warner warned that a slowdown in the Chinese economy would have dire consequences for the rest of the world.

What next?
Philip Lowe, a top Australian central bank official, predicted that China would continue to grow “for some decades” a view held by many, including the famous Fidelity fund manger Anthony Bolton who has just relocated to Shanghai. But that doesn’t mean a temporary blip is out of the question.