Timeo Danaos … A Chinese End Game?

China has started the year with a charm offensive across Europe and the US. In Europe, the Chinese were placing orders with exporters and their central bank was mopping up Euro-bonds in the Portuguese and Spanish bond auctions. This has led to speculation that China will be the engine that draws Europe out of recession whilst it props up the Euro with its bond purchases. Time will tell if this is right.

In the US the story is slightly different. China has placed itself as an engine of growth, China still likes to buy US bonds to help lower US interest rates, but it also seeks to reassure Washington that its rise should not be seen as threatening in the west Pacific. There are parts of this story where the rhetoric is different to the actions that the Chinese government has undertaken. A key issue that is looming is to find a permanent settlement for the Korean peninsula.

Many futurists take the continued rise of China as axiomatic. We are a little bit more sceptical of the conventional wisdom. This week, three pieces of the jig-saw fell into place. It appears that, in 2010, China attracted record levels of inward investment. Much of that investment was originated in funds seeking returns higher than those prevailing in Europe and the US. Of these inflows, one fifth were destined for the Chinese property market.

Cue the next piece of the jig-saw. It appears that Chinese property prices continue to rise. This looks very much like a dangerous property bubble taking form. The Chinese government has reacted by raising interest rates and by raising the reserve requirements of its banks, but with the flow of hot money flooding in, can it really stem the flow without adjusting the exchange rate? The government has ruled out an important policy tool at just the wrong time.

And this leads to the final piece – China is still inflating at too rapid a rate. Although the headline inflation rate is slowing, the core drivers of inflation – mainly food prices, fuel prices, and commodity prices – continue to rise. Once again, the Chinese government has refrained from dealing with this problem through an exchange rate adjustment. And this is where we get excited from a futures perspective – is this the beginning of the end of the Chinese titan?

Will the mighty China be humbled by a runaway inflation exacerbated by a bursting property bubble? It is certainly a scenario worth exploring.

© The European Futures Observatory 2011