The New Risk From China: Deflation

About 250 million people in the country still earn less than $1 a day -- the official definition of poverty in China -- and 700 million live on less than $2 a day. Incomes among rural Chinese have actually declined in the last four years, the World Bank reports.

This rural 70% of China's population has an average income of just $318 a year. If benefits like superior schools and medical care are included in the calculation, the average urban income is a huge seven times greater than the average rural income, the Chinese Academy of Social Sciences has calculated.

Rising income inequality has led to a rising tide of protest. There were, officially, 87,000 public disturbances in 2005, up 6% from 74,000 disturbances in 2004, according to the Ministry of Public Security. (And you know that if that's the official number, the actual level of protest is much higher.)

That's brought the typical response from security forces: beatings of protesters and mass arrests. China will strike "hard" against rising unrest, a senior official of the ministry told the Xinhua News Agency this week. "For a considerable time to come, our country will be in a period of pronounced contradictions within the people, high crime rates and complex struggle against enemies," the official said.

No. 4, With a Bullet

All this, mind you, while the economy is booming and deflation is just a story told to scare naughty economists at bedtime. How did China get into this mess?

Start with an economy built around export growth and feed it with lots and lots of cheap money. And then ignore any signals that the rudimentary, somewhat free market might be sending you about overinvestment or overcapacity.

On the one hand, this works really, really well. China's GDP grew 9.9% last year, according to Chinese government figures. That's after 10.1% growth in 2004 and 10% in 2003. When the final data are in, China's economy is expected to jump over France and Britain to rank as No. 4 in the world behind the U.S., Japan and Germany.