Quotes of the Day

Kong Junying, a 50-year-old housewife, stood seething at the entrance of a supermarket in northeastern Beijing with a salted egg in hand. Kong, her husband and 18-year-old son live on just 2,000 renminbi ($260) a month, and over the first half of this year, she has seen the price of groceries take a bigger and bigger chunk of the couple's fixed income. What was a 300 renminbi ($40) monthly bill is now 500 renminbi ($66) and prices are still rising. Hence the salted egg, which Kong is buying instead of meat. "We are still able to afford food," she says. "But if prices keep going up, I think the government should allocate special food allowances."

That's an increasingly common wish in China, where after years of high economic growth and relatively stable consumer prices, inflation is back on the table — and a bitter fruit it is. China's Consumer Price Index showed a 5.6% year-over-year increase in July, the sharpest rise in more than a decade. Food prices soared 15.4%, with meat and poultry alone rising 45% due to shortages caused by outbreaks of livestock disease as well as severe flooding in agricultural areas. But it's not just food prices that are taxing consumers. The costs of rents and mortgages were up 4.4%, making housing the second most inflationary category after food. That kind of blow to the breadbasket means people like Kong are "raising their chopsticks to eat, but laying them down to grumble," as the Chinese saying goes.

A restive population is worrisome to Chinese government officials, because high inflation historically has led to political problems. Rising prices helped to foment massive civil unrest in 1989, and peasants to this day are resentful over harsh measures the central government used in the mid-1990s to rein in inflation, such as a crackdown on bank lending that brought growth to a halt in areas outside major cities. Inflation is not just a domestic concern, either. Because China supplies so much of the world's manufactured goods, higher costs on the mainland tend to show up on store shelves at Wal-Mart and other major retailers around the world. The U.S. Commerce Department says prices for imports from China rose at a 4.1% annual rate during the first half of 2007. That was the fastest pace since the U.S. began tracking Chinese import prices in 2003, and was well above the current U.S. inflation rate of about 2%.

Rising mainland prices should come as no surprise. For years, economists have wrung their hands over the prospect that China's economy might finally overheat. The latest inflation report signals that time may be at hand. China has recorded four straight years of double-digit economic growth, and 2007 will likely be the fifth: first-quarter GDP expanded by 11.1%. At a moment when the rest of the world fears roiling credit markets might reduce growth, China faces a different challenge: how to slow its economic locomotive before it jumps the tracks.

The debate among economists now is whether another move by China's central bank to raise interest rates — which have already been hiked three times in the past year — will ease growth and inflation. Much depends on the next monthly inflation report, which will indicate whether, as Jun Ma, chief economist for greater China at Deutsche Bank in Hong Kong believes, price rises peaked in July and will now recede. Ma notes that certain key produce prices fell by about 1% in early August, and thus the central bank "doesn't need to overreact."

Chinese officials hope he's right, because the country's policy options are limited. A rate hike would likely only increase the flow of speculative "hot money" into the country from abroad, says Jing Ulrich, chairman of China equities at JP Morgan. And excess liquidity (read: too much money chasing too few goods) is at least partly to blame for China's rising-prices problem. Although some say the July spike was due to short-term food shortages, the increases "are a lot less temporary than some people think," argues Michael Pettis, a professor of finance at Peking University. "China is now exhibiting nearly all the expected consequences of excess money — explosive lending growth, asset bubbles, overinvestment and inflation."

One option to cool things off — one that Beijing's major trading partners are privately urging — would be to allow China's currency to rise more swiftly in value. That would reduce the price of imported goods; it would also relieve some pressure Beijing is getting from U.S. Congressmen, who accuse China of manipulating its currency for trade advantage. Allowing the renminbi to rise might slow China's export-driven growth a bit, at least in the near term, but that may be a price worth paying. The question for Beijing is: will the country absorb a little pain now — or a lot later?

• Bill Powell