China refuses to adjust its economy

• a surge in supply despite continued weakness in demand; and
• price bubbles in stocks, property, and other assets.

The implications for both the Chinese and the global economy can be summarised as a return to some conditions that existed prior to the financial crisis. On the asset side, bubbles are already reforming in stocks and some urban property markets, mimicking 2006-07. Speculative capital flows to the PRC that seek out these bubbles re-emerged in force in the second quarter, despite a real depreciation of the yuan and no movement against the US dollar at all. This is also reminiscent of 2006-07.

On the output side, demand cannot match supply fueled by a one-third leap in bank loans. Beijing will need to choose between deflationary pressure in consumer and producer goods - the first half saw nearly 2 per cent consumer deflation and 6 per cent producer deflation - and pushing the excess output onto a now unwilling world via massively subsidised exports.

There is also an ecological component: for example, coal production is accelerating to fuel the Chinese industrial machine. That suggests the development of more asset bubbles in global commodities such as copper, just as occurred pre-crisis.

Back to the future

China's participation in the pre-crisis world economy featured gigantic exports, equivalently gigantic capital inflows, and imbalances in both stocks and flows that harmed international economic stability in the short term and harmed China in the long term. Prior to the crisis, calls for restructuring were rejected in Beijing on the grounds of the apparent success of high growth and low inflation.

The PRC's response to the crisis has been to intensify pre-crisis policies. The damage caused by a global demand bubble inflated by overly loose American money is to be healed by Chinese production and asset bubbles inflated by overly loose Chinese money. Restructuring is to be put off to some indefinite future when the external situation is better. Of course, at that time, the economy will appear to be hitting on all cylinders and reform will - again - be dismissed.

Keeping one's eyes pinned to current GDP growth shows an improving Chinese economy. A broader view shows the PRC trying to drag itself and the rest of the world back along the trail that led to the current economic crisis.