China Curbs Bank Loans as Asset Bubble Worries Grow

Unemployment is in the double digits in the United States. China, meanwhile, is expected to expand its GDP at near double-digit rates again.

Given the starkly different scenarios, it's easy to be envious of the emerging giant's seemingly comfortable position in the global economy. But China is actually in the midst of a high-stakes balancing act. And Wednesday's announcement that China is planning to further curb bank lending -- the latest in a series of maneuvers to deflate potential asset bubbles -- sheds more light on the tough choices the country is now facing.China expects new yuan bank loans to fall to about 7.5 trillion yaun, or about $1.1 trillion, in the year ahead from 9.59 trillion yuan, or about $1.4 trillion, in 2009, Liu Mingkang, chairman of the Chinese Banking Regulatory Commission said on Wednesday. Outstanding yuan loans will rise between 16% to 18%, down from a 31.7% increase in 2009. The move comes about a week after China raised bank reserve requirements in another bid to reign in inflation.

Reverberations of China's latest move were felt throughout the global economy. Chinese markets sold off sharply on the prospects of dampened demand. Investors scrambled for safer assets, leading to a rise in blue chip currencies like the US dollar and Japanese Yen.

The sudden market swing seems to show that Wednesday's move caught investors flat footed. And with such supposedly rosy GDP expansion, it is easy for investors to overlook the huge dilemma Chinese officials are staring down.

Indeed, a recent Pew-CFR survey found that 44% of Americans believe China is the world's leading economic power, while just 27% say it is the United States. But a closer examination of the Chinese system paints a much starker picture and suggests that continued machinations out of China are a sign of things to come.

With per capita GDP of about $5,000, 40% of its work force in the agricultural sector, and just 30 years of industrialization under its belt, China more closely resembles the United States in 1900 some commentators have pointed out. Far from eclipsing the United States in terms of economic might, China now has to grapple with the arduous process of economic development that lies ahead.

And with a massive, growing population – nearly half of which are currently peasants, but with rapid migration to urban areas – Chinese officials have no choice but to keep growth at a breakneck pace. At the same time, they seem vividly aware of the consequences of funneling enormous amounts of stimulus through the economy in order to pick up the slack from sagging export markets.

That surge of stimulus has found its way into other assets, and the spike in real estate prices has led to mounting speculation that a bubble might be forming. But with the government staking much of its legitimacy on continued rapid economic expansion, Chinese officials don't have the luxury of hitting the breaks outright, either.

Investors should brace for a bumpy road ahead as the country lunges for ways to keep up hyper growth while keeping inflation at bay.

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