WASHINGTON, Sept 13—The Chinese government must move quickly and dramatically to increase interest rates to reduce the risk of an inflation crisis, says a new policy brief from the Carnegie Endowment.  Albert Keidel, an expert on China’s economy, urges the Chinese government to avoid the danger of  harsh corrective steps which in the past caused severe declines in GDP growth, fueled deadly urban civil unrest throughout the country, and brought long-lasting damage to China’s international reputation.

In China’s Looming Crisis—Inflation Returns, Keidel argues that political disputes between competing interests groups could hold up adjustments to China’s government-administered interest rates.  A delayed response could be dangerous, however, as both public and corporate bank deposits are already losing purchasing power.  Value-losing deposit rates in the late 1980s and mid 1990s sparked heavy bank withdrawals and accelerated consumer spending—pushing inflationary pressures to the crisis point.

Key Recommendations:

• The Chinese government should raise key deposit rates or index them to future inflation to avoid moderate price rises leading to an inflation-driven panic.
  
   
• The Chinese government should enable farm diversification by increasing wheat and rice imports.  This would contain future food price inflation and realize higher potential farmer productivity.
  
   
• The growing risk of an inflationary storm further confirms that China’s growth and inflation are domestically driven.  U.S. government analysts need to take this opportunity to correct the popular misperception that Chinese growth is export-led—it is not. The nature of this inflation and the results of other recent in-depth research show that market demand behind China’s sustained growth is not subject to vagaries of international demand. U.S. commercial, diplomatic, and military thinking regarding China’s commercial behavior and long-term prospects needs to shift to account for this conclusion.

"The next fifteen months will be especially crucial for China. Foreign criticism has already been severe, thanks to imbroglios over food and toy safety, dollar-holding scares, and Olympics-related activism,” writes Keidel.  “U.S. political players are all sharpening their anti-China claws for the 2008 elections.  Brutal suppression of inflation-related domestic dissent would harden already negative U.S. attitudes governing commerce, sanctions, strategic contingencies, and military spending.”

###
 

Notes:

• To read this report, go to www.carnegieendowment.org/programs/china
    Direct link to the PDF: www.carnegieendowment.org/files/pb54_keidel_china_looming_crisis_final.pdf
  
   
• Albert Keidel is a senior associate at the Carnegie Endowment, where he specializes in Chinese economic issues and related U.S. policy.  He formerly served as deputy director and acting director at the U.S. Department of Treasury’s Office of East Asian Nations. Before that, he was senior economist at the World Bank office in Beijing. He gratefully acknowledges generous Ford Foundation support for research underpinning this policy brief; the opinions and conclusions were generated solely by the author.
  
   
• The Carnegie China Program provides policy makers in China and the United States with a better understanding of the dynamics in China and in U.S.-China relations. In late 2005, the Carnegie Endowment finalized an agreement with the China Reform Forum, a leading Chinese think tank, to set up a joint Beijing Program on globalization and international relations in China.  The mission of the joint program is to advance research in the impact of globalization on foreign policy making and promote scholarly exchange between the United States and China.
  
   
• The Carnegie China Program has a number of online resources to communicate its research findings and policy insights to both governmental and non-governmental audiences in China, the United States, and around the globe. ChinaNet, our Chinese-language website, features international affairs content produced in Chinese and translated from Carnegie publications, including Foreign Policy magazine. The material includes articles on economics, Chinese social and political change, Chinese foreign policy, and U.S.-China relations, often not available from any other source in China. The China Program also produces Carnegie China Insight Monthly, a Chinese-language e-newsletter. The Hong Kong Journal, an online quarterly edited by Robert Keatley, former editor of the Asian Wall Street Journal, covers political, economic, and social issues on Hong Kong and its relations with mainland China, the United States, and other governments and international organizations.
  
   
• Reframing China Policy: The Carnegie Debates: The series aims to candidly discuss the most pressing issues in U.S.-China relations and to provide the most authoritative information possible to those on Capitol Hill who are shaping U.S. foreign policy. Since its inception in Fall 2006, the China Program has hosted six debates on the most critical—and controversial—issues involving China’s economic, political-social, and military evolution and their policy implications.