China's interest rate balancing act

(CNN) – There’s an old joke about economics: “If I have a foot in a bucket of hot water and a foot in a bucket of cold water, on average I’m warm!” Well that same economic principal could be applied to China right now.

The government is proud of its continuing rapid growth; it needs a strong economy to continue modernizing, providing employment and evening out social inequality. But it has to be the right kind of growth, growth that distributes the wealth across the society.

The problem right now is that money has been too cheap and too readily available. That’s led to speculation and investment in the property market that has seen rapidly escalating prices; in other words a good old unsustainable bubble.

This may be good for the cashed-up speculators but it also leads to a spike in inflation. That hurts the vast majority of people who have to pay more for essential goods: clothes, food, power and water.

The government has now decided to hike interest rates with the hope of pricking the bubble and reigning in prices.

By boosting both the lending and savings rates it hopes to encourage people to put their money in the bank for a better return rather than chasing the quick riches of real estate. It needs that bucket to cool.

The hot water bucket is GDP. The government doesn’t want growth to cool too rapidly. It wants to calibrate the economy to get the money flowing into the “real economy” where more people get a share.

There’s a leadership change looming in 2012 and the incoming president hardly wants to be the one left standing when the music stops!

Then there’s the ongoing pressure for China to let its currency, the yuan, increase in value. This, say China’s critics, will level the playing field, making China’s exports more expensive.

It would also help China by making imports cheaper, thus reducing that pesky high inflation. Ordinarily, a rise in interest rates would put more upward pressure on the value of the yuan, but China closely regulates its currency rate and doesn’t want any rapid moves.

There are still so many unanswered questions: Will there be more rate rises? Will the currency value increase? If so: then by how much? Will speculators be lured even further by a greater interest rate return on their investment?

Hot and cold; it’s a delicate balancing act. Right now China needs it feet in two warm buckets.