Is the Party Over in China?

The last time Chinese policymakers faced such a daunting challenge in charting the domestic economy through such treacherous waters was during the Asian financial crisis of 1997-1998 when capital flight was of paramount concern. his time the stakes are much higher and the risks of a crisis are much greater. During the crisis, policymakers could count on capital flight reversing if temporary measures would just provide a bridge through turbulent external conditions. Asia recovered, China hung on and the world exhaled.

This time around, however, China is, ironically facing the opposite problem where so called hot money inflows are the problem. Unlike with the capital flight problem during the Asian crisis, just hanging on won't solve the current hot money crisis as nothing short of a domestic economic crisis seems likely to slow or reverse hot money inflows into China. The growth rate of foreign exchange accumulation has gone parabolic, with reserve growth doubling in 2006, 2007 and set to double again in 2008 judged by inflows in the first half of 2008 already matching total inflows for 2007. Parabolic growth is a classic symptom of an unsustainable trend in markets.